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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
COMMISSION FILE NO. 1-12109
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DELTA FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 11-3336165
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1000 WOODBURY ROAD, SUITE 200,
WOODBURY, NEW YORK 11797
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:(516) 364-8500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of March 26, 2001, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $0.45, was
approximately $2,513,885.
As of March 31, 2001, the Registrant had 15,883,749 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, Items 10, 11, 12 and 13 are incorporated by reference from Delta
Financial Corporation's definitive proxy statement to stockholders which will be
filed with the Securities and Exchange Commission no later than 120 days after
December 31, 2000.
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PART I
ITEM 1. BUSINESS
BUSINESS OVERVIEW
Delta Financial Corporation (together with its subsidiaries, the "Company" or
"Delta") is a Delaware corporation that was organized in August 1996. On October
31, 1996, in connection with its initial public offering, the Company acquired
all of the outstanding common stock of Delta Funding Corporation ("Delta
Funding"), a New York corporation that had been organized on January 8, 1982 to
originate, sell, service and invest in residential first and second mortgages.
On November 1, 1996, the Company completed an initial public offering of
4,600,000 shares of common stock, par value $.01 per share.
Delta, through its subsidiaries, is a specialty consumer finance company that
has engaged in originating, acquiring, selling and servicing non-conforming home
equity loans since 1982. Throughout its operating history, Delta has focused on
lending to individuals who generally do not qualify for conforming credit.
Management believes that these borrowers have largely been unsatisfied by the
more traditional sources of mortgage credit, which underwrite loans to
conventional guidelines established by the Federal National Mortgage
Associations ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
The Company makes loans to these borrowers for such purposes as debt
consolidation, home improvement, refinancing or education, and these loans are
primarily secured by first mortgages on one- to four-family residential
properties.
The Company originates home equity loans indirectly through licensed mortgage
brokers and other real estate professionals who submit loan applications on
behalf of borrowers ("Brokered Loans") and, prior to July 2000, also purchased
loans from mortgage bankers and smaller financial institutions that satisfy
Delta's underwriting guidelines ("Correspondent Loans"). The Company decided to
discontinue its correspondent operations in July 2000 to focus on its less cash
intensive broker and retail channels. Delta Funding currently originates the
majority of its loans in 20 states, through its network of approximately 1,500
brokers.
The Company develops retail loan leads ("Retail Loans") primarily through its
telemarketing system and its network of 11 retail offices located in Illinois,
Indiana, Missouri, North Carolina, Ohio (4), Pennsylvania (2), Tennessee, and a
call center in New York. During the twelve months ended December 31, 2000, the
Company closed two under-performing retail offices in Georgia and Florida, and
opened a new retail origination call center at its headquarters in Woodbury, New
York. In January 2001, the Company closed two additional under-performing retail
offices in Florida.
The Company's business strategy is to increase its loan originations platform
by focusing its efforts on its broker and retail channels of originations by (1)
continuing to provide top quality service to its network of brokers, and retail
clients, (2) maintaining its underwriting standards, (3) further penetrating its
established and recently-entered markets and expanding into new geographic
markets, (4) expanding its retail origination capabilities, and (5) leveraging
and continuing its investment in information and processing technologies.
For the year ended December 31, 2000, the Company originated or purchased
approximately $933 million of loans, of which approximately $604 million were
Brokered Loans, $260 million were Retail Loans and $69 million were
Correspondent Loans, compared to $891 million, $319 million and $261 million,
respectively, for the year ended December 31, 1999.
Through the first three quarters of 2000, substantially all of the loans
originated and purchased by the Company were sold in securitizations in which
the loans were sold to a trust, which in turn issued certificates evidencing
ownership interests in the trust, in return for capital to fund the purchase of
the loans by the trust. These certificates are issued through the sale of
asset-backed securities primarily to institutional investors. For the year ended
December 31, 2000, Delta sold a total of $840 million of loans through four real
estate mortgage investment conduit ("REMIC") securitizations. Each of these four
securitizations was credit-enhanced, by an insurance policy provided through a
monoline insurance company and/or a senior-subordinated structure, to receive
ratings of Aaa from Moody's Investors Service, Inc. ("Moody's"), Fitch IBCA
("Fitch") and AAA from Standard & Poor's Ratings Group, a division of The
McGraw-Hill Companies, Inc. ("S&P"). The Company sells loans through
securitizations to improve its operating leverage and liquidity, to minimize
financing costs and to reduce its exposure to fluctuations in interest rates.
1
In the fourth quarter of 2000, the Company again securitized the majority of
its loan production in a $115 million securitization. In contrast to the past
several quarters, however, the Company also sold a considerably larger amount -
$47 million of loans - of its loan production for a cash premium through whole
loan sales, without retaining the right to loan servicing. The Company plans to
continue to utilize a combination of securitization and whole loan sales in the
foreseeable future.
The majority of the Company's revenues and cash flows primarily result from
the sale of mortgage loans (through securitization and on a whole loan basis)
and sale of its servicing rights on newly originated or purchased pools of
home-equity loans. In connection with a securitization, the Company sells loans
to a trust for a cash payment while (1) retaining the interest-only and residual
certificates in the trust, and (2) either (a) retaining the right to service the
loans and receive contractual and ancillary servicing fees, or (b) selling the
servicing rights relating to the securitization to a third party for an up-front
cash premium.
The interest-only and residual certificates in the trust entitle the Company
to receive any "Excess Servicing" income, consisting of any remaining cash flows
collected by the trust from principal and interest payments on its loans after
the trust has first paid (a) all principal and interest required to be passed
through to holders of the trust's securities, (b) all contractual servicing
fees, and (c) other recurring fees and costs of administering the trust. Upon
securitizing a pool of loans, the Company recognizes a gain on sale of loans
("net gain on sale of mortgage loans") equal to the difference between cash
received from the trust when it sells asset-backed pass-through certificates and
the investment in the loans remaining after allocating portions of that
investment to record the value of either the retained servicing rights or the
sale of servicing rights, and the interest-only and residual certificates
received by Delta in the securitization. The majority of the net gain on the
sale of mortgage loans results from, and is initially realized in the form of,
interest-only and residual certificates and the retention or sale of the
mortgage servicing rights. The interest-only and residual certificates and
retained servicing rights are recorded based on their fair values, estimated
based on a discount rate which management believes to be reasonable, and the
stated terms of the transferred loans adjusted for estimates of future
prepayment rates and defaults among those loans. If actual prepayments and/or
defaults exceed the Company's estimates, the future cash flows from the
servicing rights and interest-only and residual certificates would be negatively
affected. (See "-Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Accounting Considerations").
Through and including the first quarter of 2000, the Company retained the
right to service the loans in all securitizations it issued. In exchange for
servicing the mortgage loans in a securitization, the Company receives
contractual service fees and other ancillary service fees over the life of the
loans. As servicer in securitizations, the Company incurs the following
expenses, among others, (i) the cost of capital associated with making monthly
delinquency and servicing advances on mortgage loans where the underlying
borrower of such mortgage loan has defaulted, and (ii) prepayment interest
shortfall. Prepayment interest shortfall represents the amount that the servicer
must pay when a mortgage loan in a securitization trust repays in full prior to
the month end and equals the remaining interest that would otherwise have been
due in that month on that mortgage loan had it not repaid early. Beginning in
the second quarter of 2000, the Company sold the servicing rights associated
with each securitization for up-front cash proceeds and recognized a premium on
such sale that was recorded in Net Gain on Sale. As of December 31, 2000, the
Company had a loan servicing portfolio of $3.3 billion.
Although the Company recognizes income from its retention of interest-only
and residual certificates, and retained servicing rights (where applicable), the
Company receives cash flows from these interest-only and residual certificates
and retained servicing rights over the life of the transferred loans. The
Company typically begins to receive cash flows from the interest-only and
residual certificates retained upon securitization approximately twelve to
twenty months after a securitization, with the specific timing depending on the
structure and performance of the securitization. Initially, securitization
trusts utilize the Excess Servicing cash flows to make additional payments of
principal on the pass-through certificates in order to establish a spread
between the principal amount of the trust's outstanding loans and the amount of
outstanding pass-through certificates. Once a spread of between 1.50% and 3% of
the initial securitization principal (the "overcollateralization limit") is
established, the Excess Servicing cash flows are distributed to Delta as the
holder of the interest-only and residual certificates. The Company utilizes the
more conservative "cash-out" method of valuing future cash flows from residual
certificates (See "-Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Accounting Considerations."). With
retained servicing fees, the Company begins to receive cash flows from monthly
2
contractual servicing fees in the month following a securitization. The
Company's retained servicing fees range from 0.50% to 0.65% per annum of the
outstanding balance of the loans being serviced.
In addition to the income and cash flows earned from the Company's
securitizations and whole loan sales, the Company also earns income and
generates cash flows from the net interest spread earned on loans while they are
held for sale and from loan origination fees on Brokered Loans and Retail Loans.
The Company has primarily operated on a negative cash flow basis in the past
(see "-Liquidity and Capital Resources"), having historically utilized various
financing facilities and an equity financing to offset negative operating cash
flows and support its loan originations, securitizations and general operating
expenses. In July 1997, the Company completed an offering of $150 million
aggregate principal amount of 9 1/2% senior notes due 2004 (the "Senior Notes").
A portion of the Senior Notes proceeds were used to pay down various financing
facilities with the remainder used to fund the Company's loan originations and
its ongoing securitization program. Since the issuance of the Senior Notes, the
debt and equity markets (other than the asset-backed securitization market) have
largely been shut off to monoline non-conforming mortgage lenders like Delta. As
a result, the Company's primary sources of liquidity since 1997 have been (a)
warehouse and other financing facilities, (b) securitizations of mortgage loans
and (c) sales of whole loans and mortgage servicing rights. In 2000, the Company
helped finance its operations by completing securitizations of interest
(delinquency) advances and servicing advances and, following the modification of
the Senior Notes in August 2000 (see "-Corporate Restructuring and Debt
Modification"), obtaining financing against certain interest-only and residual
certificates and subsequently selling certain of these certificates in a Net
Interest Margin securitization (the "NIM Transaction").
CORPORATE RESTRUCTURING AND DEBT MODIFICATION
In August 2000, Delta announced a corporate restructuring in its continuing
efforts to improve operating efficiencies and to address its negative cash flow
from operations. As part of this restructuring, the Company recorded charges
primarily relating to employee severance associated with the layoffs, a
reduction to goodwill and office equipment write-offs.
Also in August 2000, the Company announced an agreement to modify its
Senior Notes (the "Debt Modification"). With the consent of greater than fifty
percent of its Senior Note holders, a negative pledge covenant in the Senior
Notes Indenture, which previously prevented the Company from selling or
otherwise obtaining financing against any of its interest-only or residual
certificates (the "Residual Assets"), was modified. In consideration for the
Senior Noteholders' consent, the Company agreed, in an exchange offer (the
"Exchange Offer"), to offer current Senior Noteholders the option of exchanging
their then existing Senior Notes for (a) new senior secured notes (the "Senior
Secured Notes") and (b) ten-year warrants to buy approximately 1.6 million
shares of Common Stock, at an initial exercise price of $9.10 per share, subject
to upward or downward adjustment in certain circumstances. The Senior Secured
Notes have the same coupon face amount and maturity date as the Senior Notes
and, up until the Second Debt Restructuring (see "Subsequent Events below"),
were secured by at least $165 million of the Company's Residual Assets. The
Exchange Offer was consummated in December 2000, with holders of greater than
$148 million of Senior Notes tendering in the exchange.
SUBSEQUENT EVENTS
In 2000, the Company had taken the steps described above to improve operating
efficiencies and to address its negative cash flow from operations. However,
management believed that additional steps were necessary to permit Delta to
continue as a going concern. Management's principal concerns were: (1) the cash
drain created by its ongoing monthly delinquency and servicing advance
requirements as servicer (the "Securitization Advances"), (2) the high cost of
servicing a seasoned loan portfolio, including the capital charges associated
with making Securitization Advances, (3) the Company's ability to make timely
interest payments on the Senior Secured Notes, and (4) its ability to effectuate
a successful business model given the overhang of corporate ratings of "Caa2" by
Moody's and "CC" by Fitch. Therefore in the first quarter of 2001, management
embarked upon a business plan aimed at alleviating some of these concerns and
issues.
First, in January 2001, the Company entered into a subservicing agreement
with Ocwen Financial Corporation ("Ocwen"), under which Ocwen will subservice
Delta's existing loan portfolio. While the Company remains the servicer, Ocwen
will take over servicing responsibilities, including making Securitization
Advances, and in return
3
Ocwen will retain all servicing related fees. Management expects to complete the
transfer on or before June 1, 2001, at or before which point, it is anticipated
that Ocwen will purchase from the Company its outstanding monthly Securitization
Advances, subject to certain conditions. Until the transfer of servicing, Delta
will continue to service the loan portfolio and earn an interim service fee that
will be used to offset some of its servicing related expenses. By transferring
servicing and, along with it, the responsibility for making advances, the
Company expects to save approximately $5.5 million of annual capital charges, in
addition to the significant cash outlays associated with making such advances.
Second, in February 2001, the Company entered into a Letter of Intent with
the beneficial holders of over fifty percent of its Senior Secured Notes to
restructure, and ultimately extinguish, the Senior Secured Notes (the "Second
Debt Restructuring"). In March 2001, the Company obtained the formal consent of
these beneficial holders of the Senior Secured Notes through a Consent
Solicitation that modified certain provisions of the Senior Secured Notes
Indenture to, among other things, allow for the release of two residual
certificates currently securing the Senior Secured Notes. In consideration for
their consent, the Company has agreed to offer the Senior Secured Noteholders
the option to exchange their existing Notes (the "Second Exchange Offer") for
new securities that will evidence a commensurate interest in a Liquidating Trust
(to be formed in connection with the Second Exchange Offer), into which residual
certificates then securing the Company's obligations under the Senior Secured
Notes (totaling approximately $150 million) will be transferred as well as an
interest in preferred stock of Delta. The Second Debt Restructuring will provide
for, among other things, the following:
(a) The Liquidating Trust will receive $15 million of newly issued Delta
preferred stock bearing a 10% dividend payable semi-annually (with the
first three dividends payable in kind). Delta may redeem the preferred
stock at its liquidation preference plus accrued dividends at any time
prior to conversion (which can occur only once five dividends have not
been paid in cash).
(b) Delta will receive all cash flows from the residual certificates
transferred into the Liquidating Trust through, and including, the June
2001 distributions. Thereafter, the Company will earn a management fee
in return for its oversight and its efforts to maximize the value of
the Residual Assets in the Liquidating Trust, and for absorbing certain
costs and fees on behalf of the Liquidating Trust.
(c) The Company is monetizing the two residual certificates together with
other residual certificates owned by the Company but not securing the
Senior Secured Notes, to provide working capital.
Delta believes that, upon successful consummation of the Second Exchange
Offer (which requires at least 90-95% of the holders agreeing to the exchange
offer), Moody's and Fitch will withdraw their corporate ratings on the Company
as the underlying debt will have been largely extinguished. Delta hopes to
complete the Second Debt Restructuring, subject to receipt of noteholder and
regulatory approvals, some time in the second or third quarter of 2001.
In March 2001, in connection with the Second Debt Restructuring, the Company
entered into a forward purchase agreement to sell five of its residual
certificates during the second quarter of 2001 for a cash purchase price. The
purchasers of these five residuals have provided bridge financing, in the form
of residual financing equal to approximately 64% of the cash purchase price. The
remainder of the purchase price will be paid to the Company upon the transfer of
servicing to Ocwen. The proceeds from the residual financing and subsequent sale
will be used by the Company for working capital.
Management believes that its agreement to transfer servicing to Ocwen and the
Second Debt Restructuring are essential steps in its ongoing effort to
restructure its operations and reduce its negative cash flow associated with its
servicing operations and Senior Secured Notes.
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Delta's consumer finance activities consist of originating, acquiring,
selling and (until the transfer to Ocwen) servicing non-conforming mortgage
loans. These loans are primarily secured by first mortgages on one- to
four-family residences. Once loan applications have been received, the
underwriting process completed and the loans funded or purchased, Delta
typically packages the loans in a portfolio and sells the loan portfolio through
a
4
securitization or on a whole loan, servicing released basis. Historically,
Delta retained the right to service the loans that it securitized. However,
beginning in the second quarter 2000, Delta has sold the servicing rights
relating to its new securitizations to third party servicers for an up front
cash premium.
Delta provides its customers with an array of loan products designed to meet
their needs. Delta uses a risk-based pricing strategy and has developed products
for various risk categories. Historically, Delta offered fixed-rate loan
products and, to date, the majority of Delta's loan production is fixed-rate. As
Delta has expanded geographically, it has expanded its product offerings to
include adjustable-rate mortgages and fixed/adjustable-rate mortgages. However,
since the fourth quarter of 1998, Delta has virtually eliminated originations of
its six-month LIBOR (London InterBank Offered Rate) adjustable rate mortgages,
which are less profitable and more prone to early prepayment.
Delta conducts all of its broker and correspondent lending operations out of
its Woodbury, New York headquarters and a regional branch office in the
Southeast. As part of Delta's corporate restructuring (See "-Corporate
Restructuring and Debt Modification"), two other regional branch offices that
Delta operated in the Midwest and Southwest were closed. Final underwriting
approval for Brokered Loans is centralized and required from the Woodbury, New
York headquarters. Delta's Retail Loans are underwritten by one operational
office in Cincinnati, Ohio, which has full underwriting authority. As part of
Delta's corporate restructuring in August 2000, it closed a second Retail Loan
underwriting office that was previously located in Florida.
Delta adheres to a Best Practice Lending Program aimed at ensuring the
origination of quality loans and helping to better protect consumers. This
Program includes (a) fair lending initiatives to ensure all borrowers are
treated fairly and similarly regardless of race, color, creed, religion,
national origin, sex, sexual orientation, marital status, age, disability, and
the applicant's exercise, in good faith, of any right under the Consumer Credit
Protection Act; (b) increased oversight of mortgage brokers and closing agents;
(c) enhanced fraud detection and protection; (d) enhanced plain English
disclosures; and (e) other originations, underwriting and servicing initiatives
which Delta's management believes help protect consumers.
LOAN ORIGINATION AND PURCHASES
Delta's loan originations and purchases decreased by 37% to $933 million in
2000 from $1.47 billion in 1999. The decrease in loan production was primarily
the result of (a) the Company's strategic decision to first decrease, and
ultimately close, its correspondent operations, and to focus more exclusively on
its less cash-intensive broker and retail channels and (b) a higher interest
rate environment, which management believes deterred borrowers from refinancing
industry-wide.
5
The following table shows the channels of Delta's loan originations and
purchases for the years shown:
Year Ended December 31,
1998 1999 2000
---- ---- ----
(Dollars in thousands)
Broker:
Principal balance............................... $ 841,079 $ 890,822 $ 603,616
Average principal balance per loan.............. $ 92 $ 85 $ 74
Combined weighted average initial loan-
to-value ratio(1)............................. 72.8% 72.8% 71.1%
Weighted average interest rate.................. 10.0% 10.4% 11.7%
Retail:
Principal balance............................... $ 234,011 $ 319,227 $ 260,388
Average principal balance per loan.............. $ 75 $ 68 $ 67
Combined weighted average initial loan-
to-value ratio(1)............................. 79.9% 77.6% 76.9%
Weighted average interest rate.................. 9.4% 9.8% 10.6%
Correspondent:
Principal balance............................... $ 652,503 $ 261,289 $ 69,434
Average principal balance per loan.............. $ 82 $ 77 $ 75
Combined weighted average initial loan-
to-value ratio(1)............................. 73.9% 72.0% 70.5%
Weighted average interest rate.................. 10.8% 11.0% 11.5%
Total loan purchases and originations:
Principal balance............................... $1,727,593 $1,471,338 $ 933,438
Average principal balance per loan.............. $ 85 $ 79 $ 72
Combined weighted average initial loan-
to-value ratio(1)............................. 74.2% 73.7% 72.7%
Weighted average interest rate.................. 10.2% 10.4% 11.4%
Percentage of loans secured by:
First mortgage.................................. 95.5% 94.6% 90.9%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the
lesser of the purchase price or the appraised value of the mortgage
property at origination. The weighted average initial loan-to-value ratio
of a loan secured by a second mortgage is determined by taking the sum of
the loan secured by the first and second mortgages and dividing by the
lesser of the purchase price or the appraised value of the mortgage
property at origination.
6
The following table shows the channels of loan originations and purchases
on a quarterly basis for 2000:
Three Months Ended
-----------------------------------------------
March 31, June 30, September 30, December 31,
2000 2000 2000 2000
-------- -------- -------- --------
(Dollars in thousands)
Broker:
Number of Brokered Loans...................... 2,271 2,208 1,944 1,741
Principal balance............................. $ 173,458 $ 167,240 $ 136,619 $ 126,299
Average principal balance per loan............ $ 76 $ 76 $ 70 $ 73
Combined weighted average initial loan-
to-value ratio(1).......................... 72.1% 71.5% 70.6% 69.9%
Weighted average interest rate................ 11.2% 11.4% 12.2% 12.1%
Retail:
Number of retail loans........................ 1,006 1,055 954 880
Principal balance............................. $ 71,488 $ 70,667 $ 59,713 $ 58,520
Average principal balance per loan............ $ 71 $ 67 $ 63 $ 67
Combined weighted average initial loan-
to-value ratio(1)........................... 77.7% 76.4% 76.6% 77.0%
Weighted average interest rate................ 10.2% 10.6% 11.1% 10.9%
Correspondent:
Number of Correspondent Loans................. 561 339 24 0
Principal balance............................. $ 42,241 $ 25,666 $ 1,527 $ 0
Average principal balance per loan............ $ 75 $ 76 $ 64 $ 0
Combined weighted average initial loan-
to-value ratio(1)........................... 69.8% 71.8% 69.1% 0%
Weighted average interest rate................ 11.3% 11.7% 11.9% 0%
Total loan purchases and originations:
Total number of loans......................... 3,838 3,602 2,922 2,621
Principal balance............................. $ 287,187 $ 263,573 $ 197,859 $ 184,819
Average principal balance per loan............ $ 75 $ 73 $ 68 $ 71
Combined weighted average initial loan-
to-value ratio(1)........................... 73.2% 72.8% 72.4% 72.1%
Weighted average interest rate................ 10.9% 11.2% 11.9% 11.7%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the
lesser of the purchase price or the appraised value of the mortgage
property at origination. The weighted average initial loan-to-value ratio
of a loan secured by a second mortgage is determined by taking the sum of
the loan secured by the first and second mortgages and dividing by the
lesser of the purchase price or the appraised value of the mortgage
property at origination.
7
The following table shows lien position, weighted average interest rates
and loan-to-value ratios for the years shown:
Year Ended December 31,
--------------------------
1998 1999 2000
--- --- ---
First mortgage:
Percentage of total purchases and originations........... 95.5% 94.6% 90.9%
Weighted average interest rate........................... 10.2% 10.3% 11.4%
Weighted average initial loan-to-value ratio(1).......... 74.3% 74.1% 73.1%
Second mortgage:
Percentage of total purchases and originations........... 4.5% 5.4% 9.1%
Weighted average interest rate........................... 10.5% 10.8% 11.5%
Weighted average initial loan-to-value ratio(1).......... 70.6% 66.6% 71.1%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the
lesser of the purchase price or the appraised value of the mortgage
property at origination. The weighted average initial loan-to-value ratio
of a loan secured by a second mortgage is determined by taking the sum of
the loan secured by the first and second mortgages and dividing by the
lesser of the purchase price or the appraised value of the mortgage
property at origination.
The following table shows the geographic distribution of loan purchases and
originations for the periods indicated:
Year Ended December 31,
- --------------------------------------------------------------------------------------------------------
1998 1999 2000
----------------------- --------------------- ----------------------
Region Percentage Dollar Value Percentage Dollar Value Percentage Dollar Value
- ------ ------- --------- ------- -------- ------- --------
(Dollars in millions)
NY, NJ and PA............. 55.0% $ 949.3 50.8% $ 747.9 43.9% $ 409.7
Midwest.................. 19.7 340.3 24.5 361.1 29.1 272.0
Southeast................. 9.3 161.0 8.4 123.5 9.4 87.5
New England............... 7.3 125.8 5.8 85.1 7.1 66.6
Mid-Atlantic*............. 6.9 119.1 8.6 126.7 10.5 97.6
West...................... 1.5 26.6 1.9 27.1 0 0
Canada.................... 0.3 5.5 n/a n/a n/a n/a
- ------------
* Excluding New York (NY), New Jersey (NJ) and Pennsylvania (PA).
BROKER AND CORRESPONDENT MARKETING. Throughout its history Delta has been
successful in establishing and maintaining relationships with brokers and, prior
to July 2000, correspondents offering non-conforming mortgage products to their
clientele. The Company decided to discontinue its correspondent operations in
July 2000 to focus on its less cash intensive broker and retail channels.
Delta typically initiates contact with a broker through Delta's Business
Development Department, supervised by a senior officer with over ten years of
sales and marketing experience in the industry. Delta usually hires business
development representatives who have contacts with brokers that originate
nonconforming mortgage loans within their geographic territory. The business
development representatives are responsible for developing and maintaining
Delta's broker network within their geographic territory by frequently visiting
the broker, communicating Delta's underwriting guidelines, disseminating new
product information and pricing changes, and by demonstrating a continuing
commitment to understanding the needs of the customer. The business development
representatives attend industry trade shows and inform Delta about the products
and pricing being offered by competitors and new market entrants. This
information assists Delta in refining its programs and product offerings in
order to remain competitive. Business development representatives are
compensated with a base salary and commissions based on the volume of loans
originated or purchased as a result of their efforts.
APPROVAL PROCESS. Before a broker becomes part of Delta's network, it
must go through an approval process. Once approved, brokers may begin
submitting applications and/or loans to Delta.
8
To be approved, a broker must demonstrate that it is properly licensed and
registered in the state in which it seeks to transact business, submit to a
credit check and sign a standard broker agreement with Delta that requires
brokers to, among other things, abide by Delta's fair lending policy, follow the
National Association of Mortgage Brokers Best Practices Policies, comply with
all state and federal laws, and submit only true and accurate documents and
disclosures. Delta also performs searches on all new brokers using a third party
database that contains public and nonpublic information on individuals and
companies that have incidents of potential fraud and misrepresentation. In
addition, Delta regularly reviews the performance of loans originated through
its brokers.
BROKERED LOANS. For the year ended December 31, 2000, Delta's broker network
accounted $603.6 million, or 65%, of Delta's loan purchases and originations,
compared to $890.8 million, or 60%, of Delta's loan purchases and originations
for the year ended December 31, 1999 and $841.1 million, or 49%, of Delta's loan
purchases and originations for the year ended December 31, 1998. No single
broker contributed more than 2.0%, 3.1% or 5.2% of Delta's total loan production
in the years ended December 31, 2000, 1999 and 1998, respectively.
Once approved, a broker may submit loan applications for prospective
borrowers to Delta. To process broker submissions, Delta's broker originations
area is organized by geographic regions and into teams, each consisting of loan
officers and processors, which are generally assigned to specific brokers.
Because Delta operates in a highly competitive environment where brokers may
submit the same loan application to several prospective lenders simultaneously,
Delta strives to provide brokers with a rapid and informed response. Loan
officers analyze the application and provide the broker with a preliminary
approval, subject to final underwriting approval, or a denial, typically within
one business day. If the application is approved by Delta's underwriters, a
"conditional approval" will be issued to the broker with a list of specific
conditions to be met and additional documents to be supplied prior to funding
the loan. The loan officer and processor team will then work directly with the
submitting broker to collect the requested information and meet all underwriting
conditions. In most cases, Delta funds loans within 14 to 21 days after
preliminary approval of the loan application. In the case of a denial, Delta
will make all reasonable attempts to ensure that there is no missing information
concerning the borrower or the application that might change the decision on the
loan.
Delta compensates its loan officers, who on a loan-by-loan basis are the
primary relationship contacts with the brokers, predominantly on a commission
basis. All of Delta's loan officers must complete an extensive 9- to 12-month
training program to attain the level of knowledge and experience integral to
Delta's commitment to providing the highest quality service for brokers.
Management believes that by maintaining an efficient, trained and experienced
staff, it has addressed three central factors which determine where a broker
sends its business: (i) the speed with which a lender closes loans, (ii) the
lender's knowledge concerning the broker and his business and (iii) the support
a lender provides. Included in this support, Delta offers fair lending training
to all brokers with whom it does business.
CORRESPONDENT LOANS. For the year ended December 31, 2000, Delta's
correspondent network accounted for $69.4 million, or 7%, of Delta's loan
purchases and originations, compared to $261.3 million, or 18%, of Delta's loan
purchases and originations for the year ended December 31, 1999 and $652.5
million, or 38%, of Delta's loan purchases and originations for the year ended
December 31, 1998. The decrease in production was primarily the result of
Delta's strategic decision to close its correspondent operations and to focus
more exclusively on its broker and retail channels, which are less cash
intensive. No single correspondent contributed more than 1.5%, 1.9% or 3.8% of
Delta's total loan production in 2000, 1999, or 1998, respectively.
An approved correspondent was a licensed mortgage banker or savings and loan
who sold loans to Delta that conformed with Delta's underwriting standards,
which the correspondent had originated, processed, closed and funded in its own
name. The loans were sold to Delta either on an individual flow basis or in
block sales. When selling on a flow basis, a correspondent typically sought a
pre-approval from Delta prior to closing the loan, and Delta approved the loan
based on a partial or full credit package, stipulating any items needed to
complete the package in adherence to Delta's underwriting guidelines. On a block
sale, a correspondent offered a group of loans, generally loans that have not
been pre-approved, to Delta for sale, and Delta purchased those loans in the
block that meet Delta's underwriting criteria.
RETAIL LOANS. For the year ended December 31, 2000, this channel accounted
for $260.4 million, or 28%, of Delta's loan purchases and originations, compared
to $319.3 million, or 22%, of Delta's loan purchases and originations for the
year ended December 31, 1999 and $234.0 million, or 13%, of Delta's loan
purchases and
9
originations for the year ended December 31, 1998. Through its marketing
efforts, the retail loan channel is able to identify, locate and focus on
individuals who, based on historic customer profiles, are likely customers for
Delta's products. Its telemarketing representatives identify interested
customers and refer these customers to loan officers at the retail branch
offices who then proceed to determine the applicant's qualifications for Delta's
loan products, negotiate loan terms with the borrower and process the loan
through completion.
LOAN UNDERWRITING
All of the brokers and, prior to July 2000, correspondents who submit loans
to Delta are provided with Delta's underwriting guidelines. Loan applications
received from brokers, correspondents and retail customers are classified
according to particular characteristics, including but not limited to: ability
to pay, credit history of the applicant, loan-to-value ratio and general
stability of the applicant in terms of employment history and time in residence
and condition and location of the collateral. Delta has established
classifications with respect to the credit profile of the applicant, and each
loan is placed into one of four letter ratings "A" through "D", with subratings
within those categories. Terms of loans made by Delta, as well as maximum
loan-to-value ratios and debt-to-income ratios, vary depending on the
classification of the applicant. Loan applicants with less favorable credit
ratings are generally offered loans with higher interest rates and lower
loan-to-value ratios than applicants with more favorable credit ratings. The
general criteria used by Delta's underwriting staff in classifying loan
applicants are set forth below.
10
DELTA'S UNDERWRITING CRITERIA
"A" RISK "B" RISK "C" RISK "D" RISK
-------- -------- -------- --------
Credit profile............. Excellent credit history Good overall credit Good to fair credit Fair to poor credit
Existing mortgage
history.................. Current at application Current at application Up to 60 days delinquent 90 days delinquent
time and a maximum of two time and a maximum of at applic-ation time and or more
30-day late payments in four 30-day late one 90-day late payment
the last 12 months payments in the last 12 in the last 12 months
months
Other credit............... Minor 30-day late items Some slow pays allowed Slow pays, some open Not a factor.
allowed with a letter of but majority of credit delinquencies allowed. Derogatory credit
explanation; no open and installment debt Isolated charge-offs, must be paid with
collection accounts, paid as agreed. Small collection accounts or proceeds. Must
charge-offs, judgments isolated charge-offs, judgments case-by-case demonstrate ability
collections, or to pay
judgments allowed
case-by-case
Bankruptcy filings......... Discharged more than Discharged more than Discharged more than one May be open at
three years prior to two years prior to year prior to closing closing, but must be
closing and excellent closing and excellent and good reestablished paid off with
reestablished credit reestablished credit credit proceeds
Debt service to
Income ratio ............ 55% or less 55% or less 55% or less 55% or less
Maximum loan-to-value
ratio:
Owner-occupied........... Generally 80% (up to Generally 80% (up to Generally 75% (up to Generally 65% (up to
90%*) for a one- to 85%*) for a one- to 80%*) for a one- to 70%*) for a one- to
four-family residence four-family residence four-family residence four-family residence
Non-owner occupied....... Generally 75% (up to Generally 70% (up to Generally 65% (up to Generally 55% (up to
85%*) for a one- to 80%*) for a one- to 75%*) for a one- to 60%*) for a one- to
four-family residence four-family residence four-family residence four-family residence
Employment............... Minimum 2 years Minimum 2 years No minimum required No minimum required
employment in the same employment in the same
field field
* On an exception basis
Delta uses the foregoing categories and characteristics as guidelines only. On a
case-by-case basis, Delta may determine that the prospective borrower warrants
an exception, if sufficient compensating factors exist.
Examples of compensating factors are:
o low loan-to-value ratio,
o low debt ratio,
o long-term stability of employment and/or residence, excellent
payment history on past mortgages, or a significant reduction in
monthly expenses.
11
The following table sets forth certain information with respect to Delta's
originations and purchases of first and second mortgage loans by borrower
classification, along with weighted average coupons, for the periods shown and
highlights the improved credit quality of Delta's originations and purchases.
(dollars in thousands)
Percent
Year Credit Total of Total WAC(1) WLTV(2)
- ---- ---- ---- ------ ----- ------
2000 A $596,946 63.9% 10.8% 75.7%
B 164,024 17.6 11.7 70.2
C 127,041 13.6 12.6 67.3
D 45,427 4.9 13.8 56.9
--------- ---- ---- ----
Totals $933,438 100.0% 11.4% 72.7%
========= ==== ==== ====
1999 A $859,935 58.4% 9.8% 76.4%
B 298,253 20.3 10.7 72.9
C 245,862 16.7 11.3 69.5
D 67,288 4.6 13.0 57.3
--------- ---- ---- ----
Totals $1,471,338 100.0% 10.4% 73.7%
========= ==== ==== ====
1998 A $ 990,988 57.3% 9.7% 77.0%
B 425,056 24.6 10.4 73.2
C 248,488 14.4 11.3 69.0
D 63,061 3.7 12.7 57.2
--------- ---- ---- ----
Totals $1,727,593 100.0% 10.2% 74.2%
========= ==== ==== ====
- ------------------
(1) Weighted Average Coupon ("WAC").
(2) Weighted Average Initial Loan-to-Value Ratio ("WLTV").
The mortgage loans originated by Delta have amortization schedules ranging
from 5 years to 30 years, generally bear interest at fixed rates and require
equal monthly payments which are due as of a scheduled day of each month which
is fixed at the time of origination. Substantially all of Delta's mortgage loans
are fully amortizing loans. Delta primarily originates fixed rate loans that
amortize over a period not to exceed 30 years. Loans that are not fully
amortizing generally provide for scheduled amortization over 30 years, with a
due date and a balloon payment at the end of the fifteenth year. The principal
amounts of the loans originated by Delta generally range from a minimum of
$10,000 to a maximum of $350,000. Delta generally does not acquire or originate
any mortgage loans where the combined loan-to-value ratio exceeds 90%. The
collateral securing loans acquired or originated by Delta are generally one- to
four-family residences, including condominiums and townhouses, and these
properties may or may not be occupied by the owner. It is Delta's policy not to
accept commercial properties or unimproved land as collateral. However, Delta
will accept mixed-use properties of 1-4 units where a portion of the property is
used for residential purposes and the balance is used for commercial purposes,
and will accept small residential multifamily properties (5 to 8 units), both at
reduced loan-to-value ratios. Delta does not originate loans where any senior
mortgage contains open-end advance, negative amortization or shared appreciation
provisions.
Delta's mortgage loan program includes:
o a full documentation program for salaried borrowers;
o a limited documentation program;
o a no-income verification program for self-employed borrowers; and
12
a "stated" income program.
The total monthly debt obligations, which include principal and interest on
the new loan and all other mortgages, loans, charge accounts and scheduled
indebtedness, generally is 55% or less of the borrower's monthly gross income.
Loans to borrowers who are salaried employees must be supported by current
employment information in addition to employment history. This information for
salaried borrowers is verified based on written confirmation from employers, one
or more pay-stubs, recent W-2 tax forms, recent tax returns or telephone
confirmation from the employer. For Delta's limited documentation program, Delta
requires a job letter to be submitted which contains the same information one
would find on a standard verification of employment form:
o job position;
o length of time on job;
o current salary; and
o the job letter should appear on the employer's letterhead.
For Delta's no-income verification program, proof of self-employment in the
same business plus proof of current self-employed status is required. Delta's
stated income program, which represents a very small percentage of Delta's
loans, is only offered for better credit quality borrowers where a telephone
verification is done by an underwriter to verify that the borrower is employed.
Delta usually requires lower combined loan-to-value ratios with respect to loans
made under programs other than the full documentation program.
Delta employs experienced non-conforming mortgage loan credit underwriters to
scrutinize the applicant's credit profile and to evaluate whether an impaired
credit history is a result of adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. Personal
circumstances including divorce, family illnesses or deaths, and temporary job
loss due to layoffs and corporate downsizing will often impair an applicant's
credit record. Assessment of an applicant's ability and willingness to pay is
one of the principal elements in distinguishing Delta's lending specialty from
methods employed by traditional lenders, such as savings and loans and
commercial banks. All lenders utilize debt ratios and loan-to-value ratios in
the approval process. Many lenders simply use software packages to score an
applicant for loan approval and fund the loan after auditing the data provided
by the borrower. All loans underwritten by Delta's underwriters are underwritten
with regard for the borrower's ability to repay, and are not underwritten solely
on the value of the collateral property or the amount of equity therein. All
loans are underwritten to ensure that the loan has a solid purpose and provides
tangible benefits to the borrower.
Delta has a staff of approximately 45 underwriters with an average of
approximately 9 years of non-conforming lending experience. With the exception
of Delta's Atlanta, Georgia office, all underwriting functions for broker
originations (and, prior to July 2000, correspondent purchases) and the New York
Retail Loan call center are centralized in its Woodbury, New York office.
Underwriting functions for its retail operations (other than the New York call
center) is centralized in Delta's retail underwriting "hub" located in
Cincinnati, Ohio. In August 2000, as part of its corporate restructuring
efforts, Delta closed its other retail underwriting "hub" located in West Palm
Beach, Florida (See "-Corporate Restructuring and Debt Modification"). Delta
does not delegate underwriting authority to any broker (nor, prior to July 2000,
to any correspondent). Delta's underwriting department functions independently
of its business development and mortgage origination departments and does not
report to any individual directly involved in the origination process. No
underwriter at Delta is compensated on an incentive or commission basis.
Delta has instituted underwriting checks and balances that are designed to
ensure that every loan is reviewed and approved by a minimum of two underwriters
and/or an AVP of Underwriting, with some higher loan amounts requiring a third
approval. Delta believes that by requiring each file be seen by a minimum of two
underwriters, a high degree of accuracy and quality control is ensured
throughout the underwriting process and before funding.
Delta's underwriting of every loan submitted consists not only of a thorough
credit review, but also the following:
o a separate appraisal review conducted by Delta's appraisal review
department and/or underwriter; and
o a full compliance review, to ensure that all documents have been
properly prepared, all applicable disclosures given in a timely
fashion, and proper compliance with all federal and state regulations.
13
Appraisals are performed by third party, fee-based appraisers or by Delta's
approved appraisers and generally conform to current Fannie Mae and Freddie Mac
secondary market requirements for residential property appraisals. Each
appraisal includes, among other things, an inspection of both the exterior and
interior of the subject property and data from sales within the preceding 12
months of similar properties within the same general location as the subject
property.
Delta performs an appraisal review on each loan prior to closing or prior to
purchasing. While Delta recognizes that the general quality control practices of
conventional mortgage lenders is to perform only drive-by appraisals after
closings, Delta believes this practice does not provide sufficient protection.
In addition to reviewing each appraisal for accuracy, Delta accesses other
sources to validate sales used in the appraisal to determine market value. These
sources include:
o Multiple Listing Services in nine states;
o assessment and sales services, such as Comps, Inc., Pace, 1st
American and Transamerica;
o internet services such as Realtor.com; and
o other sources for verification, including broker price opinions and
market analyses by local real estate agents.
Post closing, in addition to its normal due diligence, Delta randomly selects
one out of every ten appraisals, and performs a drive-by appraisal. This
additional step gives Delta an added degree of comfort with respect to
appraisers with which Delta has had limited experience. Delta actively tracks
and grades, on criteria that it has developed over time, all appraisers from
which it accepts appraisals for quality control purposes and does not accept
work from appraisers who have not conformed to its review standards.
Upon completion of a broker loan's underwriting and processing, the closing
of the loan is scheduled with a closing attorney or agent approved by Delta. The
closing attorney or agent is responsible for completing the loan closing
transaction in accordance with applicable law and Delta's operating procedures.
Title insurance that insures Delta's interest as mortgagee and evidence of
adequate homeowner's insurance naming Delta as an additional insured party are
required on all loans.
Delta performs a post-funding quality control review to monitor and evaluate
Delta's loan origination policies and procedures. The quality control department
is separate from the underwriting department, and reports directly to a member
of senior management.
At least 10% of all loan originations and purchases are subjected to a full
quality control re-underwriting and review, the results of which are reported to
senior management on a monthly basis. Discrepancies noted by the audit are
analyzed and corrective actions are instituted. A typical quality control review
currently includes:
o obtaining a new drive-by appraisal for each property;
o running a new credit report from a different credit report agency;
o reviewing loan applications for completeness, signatures, and for
consistency with other processing documents;
o obtaining new written verification of income and employment;
o obtaining new written verification of mortgage to re-verify any
outstanding mortgages; and
o analyzing the underwriting and program selection decisions.
The quality control process is updated from time to time as Delta's policies
and procedures change.
LOAN SALES
Delta sells virtually all the loans it originates or purchases through one of
two methods: (i) securitizations, which involve the private placement or public
offering by a securitization trust of asset-backed pass-through securities; and
(ii) whole loan sales, which include the sale of blocks of individual loans to
institutional or individual investors on a servicing released basis. Over the
past several years, including 1999 and 1998, Delta has sold close to 100% its
loans through securitizations, with the remainder being sold on a whole loan
servicing released basis. In 2000, Delta securitized approximately 90% of its
loan originations and purchases and sold on a whole loan servicing released
basis approximately 6% of its loan originations and purchases. The majority of
the loans sold by Delta on a
14
whole loan basis occurred in the fourth quarter of 2000, when Delta sold
approximately $47 million, or 25%, of its loans production through whole loan
sales, which is far greater than it had in previous quarters. Going forward,
Delta expects to continue to use a combination of securitizations and whole loan
sales, with the amounts of each dependent upon the marketplace and Delta's goal
of maximizing earnings and liquidity.
SECURITIZATIONS. During 2000, Delta completed four securitizations totaling
$840 million. The following table sets forth certain information with respect to
Delta's securitizations (all of which have been rated AAA/Aaa by S&P Fitch, and
Moody's, respectively) by offering size, which includes prefunded amounts,
duration weighted average pass-through rate and type of credit enhancement.
Duration
Offering Size Weighted Average Credit
Securitization Completed (Millions) Pass-Through Rate Enhancement
- --------- -------- ---------- ----------- ----------
2000-1....................... 03/30/00 $250.0 7.40% Hybrid *
2000-2....................... 06/30/00 $275.0 7.84% Hybrid *
2000-3....................... 09/28/00 $200.0 7.59% Hybrid *
2000-4....................... 12/14/00 $115.0 7.22% Hybrid *
- ------------------
* Senior/Sub Structure with Bond Insured AAA Tranche
When Delta securitizes loans, it sells a portfolio of loans to a trust (a
"Home Equity Loan Trust") for a cash payment and the Home Equity Loan Trust
sells various classes of pass-through certificates representing undivided
ownership interests in such Home Equity Loan Trust. As servicer for each
securitization, Delta collects and remits principal and interest payments to the
appropriate Home Equity Loan Trust which, in turn, passes through such payments
to certificateholders. For each of the 2000 securitizations, Delta retained 100%
of the interests in the residual certificates while selling the interest-only
certificates for cash. Management contemplates continuing to retain residual
certificates in the future as long as, in management's opinion, this practice
maximizes earnings while remaining within the Company's liquidity requirements.
Each Home Equity Loan Trust has the benefit of either a financial guaranty
insurance policy from a monoline insurance company or a senior-subordinated
securitization structure, which insures the timely payment of interest and the
ultimate payment of principal of the credit-enhanced investor certificate, or
both (known as a "hybrid"). In "senior-subordinated" structures, the senior
certificate holders are protected from losses by subordinated certificates,
which absorb any such losses first. In addition to such credit enhancement, the
Excess Servicing cash flows that would otherwise be paid to Delta as holder of
the residual certificate is initially applied as additional payments of
principal for the investor certificates, thereby accelerating amortization of
the investor certificates relative to the amortization of the loans and creating
overcollateralization. Once the overcollateralization limit is reached, the use
of Excess Servicing to create overcollateralization stops unless it subsequently
becomes necessary to obtain or maintain required overcollateralization limits.
Overcollateralization is intended to create a source of cash (the "extra"
payments on the loans) to absorb losses prior to making a claim on the financial
guaranty insurance policy or the subordinated certificates.
WHOLE LOAN SALES WITHOUT RECOURSE. From time to time, Delta has found that it
can receive better execution by selling certain mortgage loans on a whole loan,
non-recourse basis, without retaining servicing rights, generally in private
transactions to institutional or individual investors. Delta recognizes a gain
or loss when it sells loans on a whole loan basis equal to the difference
between the cash proceeds received for the loans and Delta's investment in the
loans, including any unamortized loan origination fees and costs.
In 2000 and 1998, Delta sold $58.3 million and $8.7 million of loans,
respectively on a whole loan, non-recourse basis. In 1999, Delta did not have
any whole loan, non- recourse basis sales.
LOAN SERVICING AND COLLECTIONS
Historically, Delta has serviced virtually all loans it originated or
purchased since its inception in 1982. In the second quarter of 2000, however,
management determined that the cash purchase premium third party servicers were
willing to pay to purchase the servicing rights on Delta's newly issued
securitizations was higher than the value
15
Delta would ascribe to retaining such servicing rights. Therefore beginning in
the second quarter 2000, and in each of the following two quarters in 2000,
Delta sold the servicing rights on its newly issued securitizations to a third
party servicer for an up-front cash purchase price.
In the fourth quarter of 2000, management further determined that its
existing portfolio became more costly to service for a variety of reasons,
including: (1) higher servicing personnel costs associated with a portfolio that
became increasingly more seasoned (delinquent) as Delta continued to sell its
newly originated mortgage loans to the third party servicer, (2) increased
monthly delinquency and servicing related advances, and (4) an inability to
recognize economies of scale on a loan portfolio which was declining in size but
had certain fixed costs associated with it. Consequently, Delta entered into the
subservicing agreement with Ocwen (see "- Subsequent Events") in January 2001,
to have Ocwen subservice its entire loan portfolio with the actual transfer date
to be on or before June 1, 2001. Servicing involves, among other things,
collecting payments when due, remitting payments of principal and interest,
furnishing reports to the current owners of the loans, enforcing the current
owners' rights with respect to the loans, including, recovering delinquent
payments, instituting foreclosure and liquidating the underlying collateral, and
making required monthly delinquency and servicing advances. As of December 31,
2000, Delta had a servicing portfolio of $3.3 billion.
Until the transfer of servicing to Ocwen, Delta will continue to service all
loans out of its headquarters in Woodbury, New York, utilizing LSAMS, a leading
in-house loan servicing system, and FORTRACS, a default management sub-servicing
system with separate "modules" for foreclosure, bankruptcy, and REO. These
sub-servicing modules provide detailed tracking of all key events in foreclosure
and bankruptcy on a loan-by-loan and portfolio-wide basis; the ability to track
and account for all pre- and post-petition payments received in bankruptcy from
the borrower and/or trustee; and the ability to monitor, market and account for
all aspects necessary to liquidate an REO property after foreclosure.
Information entered on FORTRACS is automatically uploaded to LSAMS on a daily
basis. Further, information entered on LSAMS is automatically reflected on
FORTRACS. Additionally, Delta's Management Information Systems Department has
created a market value analysis program to run with LSAMS, which provides Delta
with the ability to monitor its equity position on a loan-by-loan and/or
portfolio-wide basis. These features have led to cost savings through greater
automation and system upgrades and have helped mitigate loan losses as the
Servicing Department has been able to identify problem loans earlier, thus
allowing for earlier corrective action.
Centralized controls and standards have been established by Delta for the
servicing and collection of mortgage loans in its portfolio. Delta revises such
policies and procedures from time to time in connection with changing economic
and market conditions and changing legal and regulatory requirements.
Delta's collections policy is designed to identify payment problems
sufficiently early to permit Delta to quickly address delinquency problems and,
when necessary, to act to preserve equity in a preforeclosure property. Delta
believes that these policies, combined with the experience level of independent
appraisers engaged by Delta, help to reduce the incidence of charge-offs of a
first or second mortgage loan.
Borrowers are billed on a monthly basis in advance of the due date.
Collection procedures commence upon identification of a past due account by
Delta's automated servicing system using Delta's proprietary payment profiling
software. If timely payment is not received, LSAMS automatically places the loan
in the assigned collector's auto queue and collection procedures are generally
initiated on the day determined by the proprietary software to be after the
borrower's typical payment date. This payment profiling allows Delta to focus
its collections efforts on those borrowers who are delinquent and outside their
typical payment date as opposed to those borrowers who are delinquent but
typically pay on or about a specific date each month. These loans are
automatically queued into LSAMS auto queue as well as a Davox predictive dialer.
The predictive dialer initiates the telephone calls and transfers the calls to a
collector when a borrower is reached. If the predictive dialer determines a line
is busy or receives a no answer, it automatically cycles those calls through the
same day at pre-determined intervals. If the predictive dialer contacts an
answering machine, an automated message is left. The account remains in the
queue unless and until payment is received, at which point LSAMS automatically
removes the loan from the collector's auto queue until the next payment profile
pattern is broken. In the case of seriously delinquent accounts, collection
calls can begin as soon as two days after the payment due date.
When a loan appears in a collector's auto queue, a collector will telephone
to remind the borrower that a payment is due. Follow-up telephone contacts are
attempted until the account is current or other payment
16
arrangements have been made. Standard form letters are utilized when attempts to
reach the borrower by telephone fail and/or, in some circumstances, to
supplement the phone contacts. During the delinquency period, the collector will
continue to contact the borrower and property inspections are performed on or
about the 45th day of delinquency. Delta's collectors have computer access to
telephone numbers, payment histories, loan information and all past collection
notes. All collection activity, including the date collection letters were sent
and detailed notes on the substance of each collection telephone call, is
entered into a permanent collection history for each account on LSAMS.
Additional guidance with the collection process is derived through frequent
communication with Delta's senior management.
On or about the ninety-first day of delinquency, the loan is referred to the
loss mitigation department. This department is comprised of the collectors with
the ability to negotiate payment plans, deeds in lieu, short sales and other
cures. If their efforts have also been exhausted without success, the loss
mitigation representative responsible for the account recommends the loan be
sent to foreclosure at one of several foreclosure committee meetings held each
month. The foreclosure committee is comprised of the loss mitigation
representative, the foreclosure department manager and two members of the
executive department. This meeting is held to determine whether foreclosure
proceedings are appropriate, based upon the analysis of all relevant factors,
including a market value analysis, reason for default and efforts by the
borrower to cure the default.
Regulations and practices regarding the liquidation of properties and the
rights of a borrower in default vary greatly from state to state. As a result,
all foreclosures are assigned to outside counsel, located in the same state as
the secured property. Bankruptcies filed by borrowers are similarly assigned to
appropriate local counsel. All aspects of foreclosures and bankruptcies are
closely monitored by Delta through its sub-servicing loan system described above
and through monthly status reports from attorneys.
Prior to foreclosure sale, Delta performs an in-depth market value analysis
on all defaulted loans. This analysis includes:
O a current valuation of the property obtained through a drive-by
appraisal or broker's price opinion conducted by an independent
appraiser or a broker from Delta's network of real estate brokers,
complete with a description of the condition of the property, recent
price lists of comparable properties, recent closed comparables,
estimated marketing time and required or suggested repairs, and an
estimate of the sales price;
O an evaluation of the amount owed, if any, for real estate taxes;
O an evaluation of the amount owed, if any, to a senior mortgagee; and
0 estimated carrying costs, brokers' fee, repair costs and other
related costs associated with real estate owned properties. Delta
bases the amount it will bid at foreclosure sales on this analysis.
If Delta acquires title to a property at a foreclosure sale or otherwise, the
REO department immediately begins working the file by obtaining an estimate of
the sale price of the property by sending at least two local real estate brokers
to inspect the premises, and then hiring one to begin marketing the property. If
the property is not vacant when acquired, local eviction attorneys are hired to
commence eviction proceedings or negotiations are held with occupants in an
attempt to get them to vacate without incurring the additional time and cost of
eviction. Repairs are performed if it is determined that they will increase the
net liquidation proceeds, taking into consideration the cost of repairs, the
carrying costs during the repair period and the marketability of the property
both before and after the repairs.
Delta's loan servicing software also tracks and maintains homeowners'
insurance information and tax and insurance escrow information. Expiration
reports are generated bi-weekly listing all policies scheduled to expire within
the next 15 days. When policies lapse, a letter is issued advising the borrower
of that lapse and notifying the borrower that Delta will obtain force-placed
insurance at the borrower's expense. Delta also has an insurance policy in place
that provides coverage automatically for Delta in the event that Delta fails to
obtain force-placed insurance.
Following the transfer to Ocwen, all servicing functions will be performed by
Ocwen and Delta will discontinue its Servicing Operations, laying off the
majority of the Servicing employees, and give back the entire leased premises to
the Landlord.
17
DELINQUENCY AND LOSS EXPERIENCE
The following table sets forth information relating to the delinquency and
loss experience of the mortgage loans serviced by Delta (primarily for the
securitization trusts) for the periods indicated. Delta is not the holder of the
securitization loans, but generally holds residual or interest-only certificates
of the trusts, as well as the servicing rights, each of which may be adversely
affected by defaults. (See "-Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations Certain Accounting
Considerations"). Following the transfer of a majority of Delta's Residual
Assets in connection with the anticipated consummation of the Second Debt
Restructuring in 2001, and anticipated sales of certain other Residual Assets
for a cash purchase price, Delta will no longer be the holder of the vast
majority of the residual and interest-only certificates of the trusts that own
the loans, the performance of which is reflected in the table:
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
` ---- ---- ----
(DOLLARS IN THOUSANDS)
Total Outstanding Principal Balance
(at period end)................................... $ 3,312,582 $ 3,631,830 $ 2,950,435
Average Outstanding(1)................................ $ 3,638,398 $ 3,362,377 $ 2,436,343
DELINQUENCY (at period end) 30-59 Days:
Principal Balance................................. $ 238,047 $ 208,302 $ 153,726
Percent of Delinquency(2)......................... 7.19% 5.73% 5.21%
60-89 Days:
Principal Balance................................. $ 110,730 $ 83,000 $ 50,034
Percent of Delinquency(2)......................... 3.34% 2.28% 1.70%
90 Days or More:
Principal Balance................................. $ 69,802 $ 56,435 $ 47,887
Percent of Delinquency(2)......................... 2.11% 1.55% 1.62%
Total Delinquencies:
Principal Balance................................. $ 418,579 $ 347,737 $ 251,647
Percent of Delinquency(2)......................... 12.64% 9.56% 8.53%
FORECLOSURES
Principal Balance................................. $ 206,281 $ 185,843 $ 145,679
Percent of Foreclosures by Dollar(2).............. 6.23% 5.11% 4.94%
REO
Principal Balance................................ $ 57,981 $ 36,663 $ 18,811
Percent of REO.................................. 1.75% 1.01% 0.64%
Net Gains/(Losses) on liquidated loans................ $ 28,918 $ (14,722) $ (8,704)
Percentage of Net Gains/(Losses) on liquidated
loans (based on Average Outstanding Balance)...... (0.79%) (0.44%) (0.36%)
- ---------------
(1) Calculated by summing the actual outstanding principal balances at the end
of each month and dividing the total by the number of months in the
applicable period.
(2) Percentages are expressed based upon the total outstanding principal
balance at the end of the indicated period.
COMPETITION
As an originator of mortgage loans, Delta faces intense competition,
primarily from diversified consumer financial companies and other diversified
financial institutions, mortgage banking companies, commercial banks, credit
unions, savings and loans, credit card issuers and finance companies. Many of
these competitors in the financial services business are substantially larger
and have more capital and other resources than Delta. Competition can take many
forms, including interest rates and costs of the loan, convenience in obtaining
a loan, service, marketing and distribution channels. Furthermore, the level of
gains realized by Delta and its competitors
18
on the sale of the type of loans originated and purchased has attracted
additional competitors into this market with the effect of lowering the gains
that may be realized by Delta on future loan sales. In addition, efficiencies
in the asset-backed market have generally created a desire for even larger
transactions giving companies with greater volumes of originations a competitive
advantage.
Competition may be affected by fluctuations in interest rates and general
economic conditions. During periods of rising rates, competitors which have
"locked in" low borrowing costs may have a competitive advantage. During periods
of declining rates, competitors may solicit Delta's borrowers to refinance their
loans. During economic slowdowns or recessions, Delta's borrowers may have new
financial difficulties and may be receptive to offers by Delta's competitors.
Over the past few years, many of the independent mortgage banking companies,
which previously were among Delta's most intense competitors, have either gone
out of business or been acquired by larger, more diversified national financial
institutions. At the same time, many larger finance companies, financial
institutions and conforming mortgage originators have adapted their conforming
origination programs and allocated resources to the origination of
non-conforming loans and/or have otherwise begun to offer products similar to
those offered by Delta, targeting customers similar to those of Delta. Fannie
Mae and Freddie Mac have also expressed interest in adapting their programs to
include products similar to those offered by Delta and have begun to expand
their programs and presence into the subprime market. The entrance of these
larger and better-capitalized competitors into Delta's market may have a
material adverse effect on Delta's results of operations and financial
condition.
REGULATION
Delta's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is subject to
various laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Delta's consumer lending
activities are subject to the Federal Truth-in-Lending Act and Regulation Z
(including the Home Ownership and Equity Protection Act of 1994), the Equal
Credit Opportunity Act of 1974, as amended (ECOA), the Fair Credit Reporting Act
of 1970, as amended, the Real Estate Settlement Procedures Act (RESPA), and
Regulation X, the Home Mortgage Disclosure Act and the Federal Debt Collection
Practices Act, as well as other federal and state statutes and regulations
affecting Delta's activities. Delta is also subject to the rules and regulations
of, and examinations by HUD and state regulatory authorities with respect to
originating, processing, underwriting and servicing loans. These rules and
regulations, among other things, impose licensing obligations on Delta,
establish eligibility criteria for mortgage loans, prohibit discrimination,
provide for inspections and appraisals of properties, require credit reports on
loan applicants, regulate assessment, collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to
comply with these requirements can lead to loss of approved status, termination
or suspension of servicing contracts without compensation to the servicer,
demands for indemnifications or mortgage loans repurchases, certain rights of
rescission for mortgage loans, class action lawsuits and administrative
enforcement actions.
In September 1999, Delta settled allegations by the New York State Banking
Department and a lawsuit by the New York State Office of the Attorney General
alleging that Delta had violated various state and federal lending laws. The
global settlement was evidenced by that certain (a) Remediation Agreement by and
between Delta Funding and the NYSBD, dated as of September 17, 1999 and (b)
Stipulated Order on Consent by and among Delta Funding, Delta Financial and the
NYOAG, dated as of September 17, 1999. As part of the Settlement, Delta, among
other things, implemented agreed upon changes to its lending practices; is
providing reduced loan payments aggregating $7.25 million to certain borrowers
identified by the NYSBD; and created a fund financed by the grant of 525,000
shares of Delta Financial's common stock. The proceeds of the fund will be used,
for among other things, to compensate certain borrowers and for a variety of
consumer educational and counseling programs.
In March 2000, Delta finalized an agreement with the U.S. Department of
Justice, the Federal Trade Commission and the Department of Housing and Urban
Development, to complete the global settlement it had reached with the NYSBD and
NYOAG. The Federal agreement mandates some additional compliance efforts for
Delta, but it does not require any additional financial commitment.
Delta believes it is in compliance in all material respects with applicable
federal and state laws and regulations.
19
ENVIRONMENTAL MATTERS
To date, Delta has not been required to perform any investigation or clean up
activities, nor has it been subject to any environmental claims. There can be no
assurance, however, that this will remain the case in the future. In the
ordinary course of its business, Delta from time to time forecloses on
properties securing loans. Although Delta primarily lends to owners of
residential properties, there is a risk that Delta could be required to
investigate and clean-up hazardous or toxic substances or chemical releases at
such properties after acquisition by Delta, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
EMPLOYEES
As of December 31, 2000, Delta had a total of 851 employees (full-time and
part-time). None of Delta's employees are covered by a collective bargaining
agreement. Delta considers its relations with its employees to be good.
ITEM 2. PROPERTIES
Delta's executive and administrative offices are located at 1000 Woodbury
Road, Woodbury, New York 11797, where Delta leases approximately 120,000 square
feet of office space at an aggregate annual rent of approximately $2.4 million.
The lease provides for certain scheduled rent increases and expires in 2008.
Delta's servicing operations are located at 99 Sunnyside Boulevard, Woodbury,
New York 11797, where Delta leases approximately 40,000 square feet of office
space at an aggregate annual rent of approximately $0.9 million.
The lease is scheduled to expire in June 2001.
Delta also maintains a full service office in Atlanta, Georgia and business
development offices in New Jersey, Ohio, Pennsylvania and Virginia. Delta's
retail operation currently maintains eleven retail mortgage origination offices
in Illinois, Indiana, Missouri, North Carolina, Ohio (4), Pennsylvania (2) and
Tennessee; one telemarketing hub in Ohio; and a retail call center at Delta's
headquarters in Woodbury, New York. The terms of theses leases vary as to
duration and escalation provisions, with the latest expiring in 2004.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of Delta's business involves the collection of numerous
accounts, the validity of liens and compliance with various state and federal
lending laws, Delta is subject, in the normal course of business, to numerous
claims and legal proceedings. Delta's lending practices have been the subject of
several lawsuits styled as class actions and of investigations by various
regulatory agencies including the New York State Banking Department (the
"NYSBD"), the Office of the Attorney General of the State of New York (the
"NYOAG") and the United States Department of Justice (the "DOJ"). The current
status of these actions are summarized below.
o In or about November 1998, Delta received notice that it had been named
in a lawsuit filed in the United States District Court for the Eastern
District of New York. In December 1998, plaintiffs filed an amended
complaint alleging that Delta had violated the Home Equity and Ownership
Protection Act ("HOEPA"), the Truth in Lending Act ("TILA") and New York
State General Business Law ss. 349. The complaint seeks (a) certification
of a class of plaintiffs, (b) declaratory judgment permitting rescission,
(c) unspecified actual, statutory, treble and punitive damages (including
attorneys' fees), (d) certain injunctive relief, and (e) declaratory
judgment declaring the loan transactions as void and unconscionable. On
December 7, 1998, plaintiff filed a motion seeking a temporary restraining
order and preliminary injunction, enjoining Delta from conducting
foreclosure sales on 11 properties. The District Court Judge ruled that in
order to consider such a motion, plaintiff must move to intervene on
behalf of these 11 borrowers. Thereafter, plaintiff moved to intervene on
behalf of 3 of these 11 borrowers and sought the injunctive relief on
their behalf. Delta opposed the motions. On December 14, 1998, the
District Court Judge granted the motion to intervene and on December 23,
1998, the District Court Judge issued a preliminary injunction enjoining
20
Delta from proceeding with the foreclosure sales of the three intervenors'
properties. Delta has filed a motion for reconsideration of the December
23, 1998 order. In January 1999, Delta filed an answer to plaintiffs'
first amended complaint. In July 1999, plaintiffs were granted leave, on
consent, to file a second amended complaint. In August 1999, plaintiffs
filed a second amended complaint that, among other things, added
additional parties but contained the same causes of action alleged in
the first amended complaint. In September 1999, Delta filed a motion to
dismiss the complaint, which was opposed by plaintiffs and, in June 2000,
was denied in part and granted in part by the Court. In or about October
1999, plaintiffs filed a motion seeking an order preventing Delta, its
attorneys and/or the NYSBD from issuing notices to certain of Delta's
borrowers, in accordance with a settlement agreement entered into by and
between Delta and the NYSBD. In or about October 1999 and November 1999,
respectively, Delta and the NYSBD submitted opposition to plaintiffs'
motion. In March 2000, the Court issued an order that permits Delta to
issue an approved form of the notice. In September 1999, plaintiffs
filed a motion for class certification, which was opposed by Delta in
February 2000, and ultimately withdrawn without prejudice by plaintiffs
in January 2001. Delta believes that it has meritorious defenses and
intends to defend this suit, but cannot estimate with any certainty
its ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about March 1999, Delta received notice that it had been named in a
lawsuit filed in the Supreme Court of the State of New York, New York
County, alleging that Delta had improperly charged certain borrowers
processing fees. The complaint seeks (a) certification of a class of
plaintiffs, (b) an accounting, and (c) unspecified compensatory and
punitive damages (including attorneys' fees), based upon alleged (i)
unjust enrichment, (ii) fraud, and (iii) deceptive trade practices. In
April 1999, Delta filed an answer to the complaint. In September 1999,
Delta filed a motion to dismiss the complaint, which was opposed by
plaintiffs, and in February 2000, the Court denied the motion to dismiss.
In April 1999, Delta filed a motion to change venue and plaintiffs opposed
the motion. In July 1999, the Court denied the motion to change venue.
Delta appealed and in March 2000, the Appellate Court granted Delta's
appeal to change venue from New York County to Nassau County. In August
1999, plaintiffs filed a motion for class certification, which Delta
opposed in July 2000. In or about September 2000, the Court granted
plaintiffs' motion for class certification, from which Delta filed a
Notice of Appeal. Delta believes that it has meritorious defenses and
intends to defend this suit, but cannot estimate with any certainty its
ultimate legal or financial liability, if any, with respect to the alleged
claims.
o In or about July 1999, Delta received notice that it had been named in a
lawsuit filed in the United States District Court for the Western District
of New York, alleging that amounts collected and maintained by it in
certain borrowers' tax and insurance escrow accounts exceeded certain
statutory (RESPA) and/or contractual (the respective borrowers' mortgage
agreements) ceilings. The complaint seeks (a) certification of a class of
plaintiffs, (b) declaratory relief finding that Delta's practices violate
applicable statutes and/or the mortgage agreements, (c) injunctive relief,
and (d) unspecified compensatory and punitive damages (including
attorneys' fees). In October 1999, Delta filed a motion to dismiss the
complaint. In or about November 1999, the case was transferred to the
United States District Court for the Northern District of Illinois. In
February 2000, the plaintiff opposed Delta's motion to dismiss. In March
2000, the Court granted Delta's motion to dismiss in part, and denied it
in part. Delta believes that it has meritorious defenses and intends to
defend this suit, but cannot estimate with any certainty its ultimate
legal or financial liability, if any, with respect to the alleged claims.
o In or about August 1999, the NYOAG filed a lawsuit against Delta alleging
violations of (a) RESPA (by paying yield spread premiums), (b) HOEPA and
TILA, (c) ECOA, (d) New York Executive Law ss. 296-a, and (e) New York
Executive Law ss. 63(12). In September 1999, Delta and the NYOAG settled
the lawsuit, as part of a global settlement by and among Delta, the NYOAG
and the NYSBD, evidenced by that certain (a) Remediation Agreement by and
between Delta and the NYSBD, dated as of September 17, 1999 and (b)
Stipulated Order on Consent by and among Delta, Delta Financial and the
NYOAG, dated as of September 17, 1999. As part of the Settlement, Delta
will, among other things, implement agreed upon changes to its lending
practices; provide reduced loan payments aggregating $7.25 million to
certain borrowers identified by the NYSBD; and create a fund of
approximately $4.75 million to be financed by the grant of 525,000 shares
of Delta Financial's common stock valued at a constant assumed priced of
$9.10 per share, which approximates book value. The proceeds of the fund
will be used, for among other things, to pay borrowers
21
and for a variety of consumer educational and counseling programs. As a
result, the NYOAG lawsuit has been dismissed as against Delta.
The Remediation Agreement and Stipulated Order on Consent supersede
Delta's previously announced settlements with the NYSBD and the NYOAG. In
March 2000, Delta finalized a settlement agreement with the United States
Department of Justice, the Federal Trade Commission and the Department of
Housing and Urban Renewal, to complete the global settlement it had
reached with the NYSBD and NYOAG. The Federal agreement mandates some
additional compliance efforts for Delta, but it does not require any
additional financial commitment.
o In November 1999, Delta received notice that it had been named in a
lawsuit filed in the United States District Court for the Eastern District
of New York, seeking certification as a class action and alleging
violations of the federal securities laws in connection with the Company's
initial public offering in 1996 and its reports subsequently filed with
the Securities and Exchange Commission. The complaint alleges that the
scope of the violations alleged recently in the consumer lawsuits and
regulatory actions indicate a pervasive pattern of action and risk that
should have been more thoroughly disclosed to investors in the Company's
common stock. In May 2000, the Court consolidated this case and several
other lawsuits that purportedly contain the same or similar allegations
against Delta and in August 2000 plaintiffs filed their Consolidated
Amended Complaint. In October 2000, Delta filed a motion to dismiss the
Complaint in its entirety, which was opposed by plaintiffs in November
2000, and is now pending. Delta believes that it has meritorious defenses
and intends to defend these suits, but cannot estimate with any certainty
its ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about April 2000, Delta received notice that it had been named in a
lawsuit filed in the Supreme Court of the State of New York, Nassau
County, alleging that Delta has improperly charged and collected from
borrowers certain fees when they paid off their mortgage loans with Delta.
The complaint seeks (a) certification of a class of plaintiffs, (b)
declaratory relief finding that the payoff statements used include
unauthorized charges and are deceptive and unfair, (c) injunctive relief,
and (d) unspecified compensatory, statutory and punitive damages
(including legal fees), based upon alleged violations of Real Property Law
274-a, unfair and deceptive practices, money had and received and unjust
enrichment, and conversion. Delta answered the complaint in June 2000.
Delta believes that it has meritorious defenses and intends to defend this
suit, but cannot estimate with any certainty its ultimate legal or
financial liability, if any, with respect to the alleged claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders was held on May 16, 2000. At the meeting,
Richard Blass and Arnold B. Pollard were elected as a Class I Directors for a
term of three years. Sidney A. Miller, Hugh Miller, Martin D. Payson and
Margaret Williams continue to serve as members of the Board of Directors.
Votes cast in favor of Mr. Blass' selection totaled 14,598,596, while
30,340 votes were withheld.
Votes cast in favor of Mr. Pollard's selection totaled 14,598,596, while
30,340 votes were withheld.
The stockholders also voted to ratify the appointment of KPMG LLP as the
Company's independent auditors for the fiscal year ending December 31, 2000.
Votes cast in favor of this ratification were 14,620,621, while votes cast
against were 7,365 and abstentions totaled 950.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Delta's Common Stock was listed on the New York Stock Exchange (the "NYSE")
under the symbol "DFC" on November 1, 1996. The following table sets forth for
the periods indicated the range of the high and low closing sales prices for
Delta's Common Stock on the NYSE.
2000 High Low
- ---- ---- ----
First Quarter ............................................... $ 4.13 $ 2.00
Second Quarter .............................................. 2.31 1.25
Third Quarter................................................ 1.63 0.50
Fourth Quarter .............................................. 0.69 0.22
1999 High Low
- ---- ---- ----
First Quarter ............................................... $ 8.25 $ 4.75
Second Quarter .............................................. 8.13 4.88
Third Quarter................................................ 7.81 5.00
Fourth Quarter .............................................. 5.06 3.63
In January 2001, the Company announced that it received notification from the
NYSE that it has fallen below the continued listing standards of the NYSE. The
Company currently does not meet the NYSE's continued listing standards requiring
the maintenance of a minimum of $15 million in market capitalization over a
30-day trading period and the maintenance of a minimum share price of $1 over a
30-day trading period. In accordance with the rules of the NYSE, the Company has
supplied the NYSE with its business plan to address promptly the market
capitalization and minimum share price issues. There can be no assurance,
however, that the Company will be successful in meeting those requirements on a
continuing basis. If the Company is delisted from the NYSE, it will apply for
quotation, and would expect its Common Stock to trade, on the OTC Bulletin
Board.
On December 31, 2000, Delta had approximately 79 stockholders of record. This
number does not include beneficial owners holding shares through nominee or
"street" names. Delta believes the number of beneficial stockholders is
approximately 1,900.
DIVIDEND POLICY
Delta did not pay any dividends in 2000 and, in accordance with its present
general policy, has no present intention to pay cash dividends.
23
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
INCOME STATEMENT DATA: (DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
Revenues:
Net gain on sale of mortgage loans..... $ 47,550 78,663 91,380 85,890 46,525
Interest............................... 32,287 31,041 12,458 22,341 16,372
Servicing fees......................... 14,190 16,341 10,464 7,511 5,368
Origination fees ...................... 24,944 28,774 25,273 18,108 5,266
---------- -------- -------- -------- --------
Total revenues.................... 118,971 154,819 139,575 133,850 73,531
---------- -------- -------- -------- --------
Expenses:
Payroll and related costs ............. 56,525 65,116 56,709 41,214 17,633
Interest............................... 30,386 26,656 30,019 19,964 11,298
General & administrative............... 94,685 55,318 34,351 21,522 11,112
---------- -------- -------- -------- --------
Total expenses................... 181,596 147,090 121,079 82,700 40,043
---------- -------- -------- -------- --------
Income (loss) before income tax expense (benefit)
and extraordinary item................. (62,625) 7,729 18,496 51,150 33,488
Provision for income tax expense (benefit) (13,208) 3,053 7,168 20,739 9,466
---------- -------- -------- -------- --------
Income (loss) before extraordinary item.... (49,417) 4,676 11,328 30,411 24,022
Extraordinary item:........................
Gain on extinguishment of debt......... -- -- -- -- 3,168
---------- -------- -------- -------- --------
Net income (loss).......................... $ (49,417) 4,676 11,328 30,411 27,190
---------- -------- -------- -------- --------
Pro forma information (1)(2):
Provision for pro forma income tax expense
before extraordinary item.............. -- -- -- -- 14,400
---------- -------- -------- -------- --------
Pro forma income (loss) before
extraordinary item.......................... (49,417) 4,676 11,328 30,411 19,088
---------- -------- -------- -------- --------
Per share data(1)(3):
Earnings (loss) per common share -
basic and diluted................ $ (3.10) 0.30 0.74 1.98 1.46
Weighted average number of
shares outstanding............... 15,920,869 15,511,214 15,382,161 15,359,280 13,066,485
Selected Balance Sheet Data:
Loans held for sale, net................... $ 82,698 89,036 87,170 79,247 82,411
Capitalized mortgage servicing rights..... -- 45,927 33,490 22,862 11,412
Interest-only and residual certificates.... 216,907 224,659 203,803 167,809 83,073
Total assets............................... 452,697 556,835 481,907 393,232 231,616
Senior notes, warehouse financing and
other borrowings....................... 238,203 258,493 229,660 177,540 95,482
Investor payable........................... 69,489 82,204 63,790 40,852 20,869
Total liabilities.......................... 354,973 409,694 344,219 266,779 138,098
Stockholders' equity....................... 97,724 147,141 137,688 126,453 93,518
- ---------------
(1) Figures for December 31, 2000, 1999, 1998 and 1997 are actual; pro forma
presentation for the year 1996.
(2) Prior to October 31, 1996, Delta Funding (a wholly-owned subsidiary) was
treated as an S corporation for Federal and state income tax purposes.
The pro forma presentation reflects a provision for income taxes as if the
Company had always been a C corporation at an assumed tax rate of 43%.
(3) Pro forma earnings per common share has been computed by dividing pro forma
net income by the sum of (a) 10,653,000 shares of the Company's common
stock received by the former shareholders in exchange for their shares of
Delta Funding, and (b) the effect of the issuance of 1,976,182 shares of
the Company's common stock issued in the Company's initial public offering
to generate sufficient cash for certain S corporation distributions paid to
the former shareholders, which shares are treated as if they had always
been outstanding.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS OF THE COMPANY AND ACCOMPANYING NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS SET FORTH THEREIN.
GENERAL
Delta, through its wholly-owned subsidiaries, engages in the consumer finance
business by originating, acquiring, selling and servicing non-conforming home
equity loans. Throughout its 19 years of operating history, the Company has
focused on lending to individuals who generally have impaired or limited credit
profiles or higher debt-to-income ratios for such purposes as debt
consolidation, home improvement, mortgage refinancing or education.
Delta originates home equity loans indirectly through licensed mortgage
brokers and other real estate professionals who submit loan applications on
behalf of borrowers ("Brokered Loans") and, prior to July 2000, also purchased
loans from mortgage bankers and smaller financial institutions that satisfy
Delta's underwriting guidelines ("Correspondent Loans"). The Company decided to
discontinue its correspondent operations in July 2000 to focus on its less cash
intensive broker and retail channels. Delta Funding currently originates the
majority of its loans in 20 states, through its network of approximately 1,500
brokers.
Delta develops retail loan leads primarily through its telemarketing system
and its network of 11 retail offices located in Illinois, Indiana, Missouri,
North Carolina, Ohio (4), Pennsylvania (2), Tennessee, and a call center in New
York ("Retail Loans"). During the twelve months ended December 31, 2000, the
Company closed two under-performing retail offices in Georgia and Florida, and
opened a new retail origination call center at its headquarters in Woodbury, New
York. In January 2001, the Company closed two additional under-performing retail
offices in Florida.
In March 2000, the Company finalized its settlement with the U.S. Department
of Justice (the "DOJ"), completing its global settlement with the NYSBD and the
NYOAG. The DOJ settlement, which parallels the NYSBD and NYOAG settlement
agreements, was also signed by the FTC and HUD. See "- Legal Proceedings" for a
discussion of the settlement.
In July 2000, the Company received $2 million in connection with the sale of
one of its domain names previously used as an internet address.
In August 2000, the Company announced a corporate restructuring and
modification of its Senior Notes (see " - Corporate Restructuring and Debt
Modification") to improve operating efficiencies and to address its negative
cash flow. The corporate restructuring was aimed at reducing overhead and
operating expenses. The debt modification enabled the Company to monetize a
portion of its Residual Assets, first by obtaining approximately $17 million in
residual financing in August 2000 and subsequently through the sale of a portion
of its Residual Assets through a net interest margin securitization ("NIM
Transaction") in November 2000. (See "-Liquidity and Capital Resources").
CORPORATE RESTRUCTURING AND DEBT MODIFICATION
In August 2000, Delta announced a corporate restructuring (the
"Restructuring") in its continuing efforts to improve operating efficiencies and
to address its negative cash flow from operations. As part of this
restructuring, the Company recorded a $6.7 million charge primarily relating to
employee severance associated with the layoffs, a reduction to goodwill and
office equipment write-offs. After a cash payment for personnel related costs,
the balance of Delta's restructuring liability at December 31, 2000 was $1.3
million.
Also in August 2000, the Company announced an agreement to modify the Senior
Notes (the "Debt Modification"). With the consent of greater than fifty percent
of its Senior Note holders, a negative pledge covenant contained in the Senior
Notes Indenture was modified. The negative pledge had previously prevented the
Company from selling or otherwise obtaining financing against any of its
interest-only or residual certificates (the "Residual Assets"). In consideration
for the Senior Noteholders' consent, the Company agreed, through an exchange
offer (the "Exchange Offer"), to offer current Senior Noteholders the option of
exchanging their then existing Senior Notes for (a) new senior secured notes
(the "Senior Secured Notes") and (b) ten-year warrants to buy approximately 1.6
million shares of common stock, at an initial exercise price of $9.10 per share,
subject to upward or downward
25
adjustment in certain circumstances. The Senior Secured Notes have the same
coupon, face amount and maturity date as the Senior Notes and, up until the
Second Debt Restructuring (see "- Subsequent Events below"), were secured by at
least $165 million of the Company's Residual Assets. The Exchange Offer was
consummated in December 2000, with holders of greater than $148 million of
Senior Notes tendering in the exchange. The Company recorded a $3.1 million
pre-tax charge in the third quarter of 2000 related to professional fees
incurred in connection with the Debt Modification.
SUBSEQUENT EVENTS
Although the Company had taken the steps in 2000 described above to improve
operating efficiencies and to address its negative cash flow from operations,
management believed that additional steps were necessary to permit Delta to
continue as a going concern. Management's principal concerns were: (1) the
burden imposed upon the Company by its ongoing monthly delinquency and servicing
advance requirements as servicer (the "Securitization Advances"), (2) the high
cost of servicing a seasoned loan portfolio, including the capital charges
associated with making Securitization Advances, (3) the Company's ability to
make timely interest payments on the Senior Secured Notes, and (4) its ability
to effectuate a successful business model given the overhang of corporate
ratings of "Caa2" by Moody's and "CC" by Fitch. Therefore in the first quarter
of 2001, management embarked upon a business plan aimed at alleviating these
concerns and issues.
First, in January 2001, the Company entered into a subservicing agreement
with Ocwen Financial Corporation ("Ocwen"), under which Ocwen will subservice
Delta's existing loan portfolio. While the Company remains the servicer, Ocwen
will take over servicing responsibilities, including the requirement to make
Securitization Advances, and will retain all servicing related fees. Management
expects to complete the transfer on or before June 1, 2001, at or before which
point, it is anticipated that Ocwen will purchase from the Company its
outstanding monthly Securitization Advances, subject to certain conditions.
During the Interim Period, Delta will continue to service the loan portfolio and
earn an interim service fee that will be used to offset some of its servicing
related expenses. By transferring servicing and, along with it, the
responsibility for making advances, the Company expects to save approximately
$5.5 million of annual capital charges, in addition to the significant cash
outlays associated with making such advances.
Second, in February 2001, the Company entered into a Letter of Intent with
the beneficial holders of over fifty percent of its Senior Secured Notes to
restructure, and ultimately extinguish, the Senior Secured Notes (the "Second
Debt Restructuring"). In March 2001, the Company obtained the formal consent of
these holders of the Senior Secured Notes through a Consent Solicitation that
modified certain provisions of the Senior Secured Notes Indenture to, among
other things, allow for the release of two residual certificates currently
securing the Senior Secured Notes. In consideration for the Noteholders'
consent, Delta agreed to offer the Senior Secured Noteholders the option to
exchange their existing Notes (the "Second Exchange Offer") for new securities
that will evidence a commensurate interest in a Liquidating Trust (to be formed
in connection with the Second Exchange Offer), into which residual certificates
currently securing the Company's obligations under the Senior Secured Notes
(totaling approximately $150 million) will be transferred. The Second Debt
Restructuring will also provide for, among other things, the following:
(a) The Liquidating Trust will receive $15 million of newly issued
preferred stock bearing a 10% dividend payable semi-annually (with the
first three dividends payable in kind). Delta may redeem the preferred
stock at its liquidation preference plus accrued dividends at any time
prior to its conversion (which can occur only once five dividends have
not been paid in cash).
(b) The Company will receive all cash flows from the residual certificates
transferred into the Liquidating Trust through and including the June
2001 distributions. Thereafter, the Company will earn a management fee
in return for its oversight and its efforts to maximize the value of
the Residual Assets in the Liquidating Trust, and for absorbing certain
costs and fees on behalf of the Liquidating Trust.
(c) The Company monetizing the two residual certificates together with
other residual certificates owned by the Company but not securing the
Senior Secured Notes, to provide additional working capital.
26
The Company believes that, upon consummation of the Second Exchange Offer
(which requires the consent of at least 90-95% of the holders), Moody's and
Fitch will withdraw their corporate ratings on the Company as the underlying
debt will have been largely extinguished.
In March 2001, in connection with the Second Debt Restructuring, the Company
entered into a forward purchase agreement to sell five of its residual
certificates in the second quarter of 2001 for a $15 million cash purchase
price. The purchasers of these five residuals have provided bridge financing, in
the form of residual financing, of approximately $9.6 million. The remainder of
the purchase price will be paid to the Company upon the transfer of servicing to
Ocwen. The proceeds from the residual financing and subsequent sale will be used
by the Company for working capital. These residual certificates are being sold
at a significant discount to the Company's book value for such certificates and,
as such, the Company expects to record an approximately $27 million pre-tax
non-cash charge in the first quarter of 2001.
Management believes that its subservicing arrangement with Ocwen and the
Second Debt Restructuring were essential steps in its ongoing effort to
restructure its operations and reduce its negative cash flow associated with its
servicing operations and Senior Secured Notes. There can be no assurances,
however, that these or other factors described herein will not have a material
adverse effect on the Company's results of operations and financial condition.
(See "-Competition," "Regulation" and "Risk Factors," among other sections).
In January 2001, the Company decided to close two under-performing retail
offices in Florida.
Also in January 2001, the Company announced that it received notification
from the New York Stock Exchange ("NYSE") that it has fallen below the continued
listing standards of the NYSE. The Company currently does not meet the NYSE's
continued listing standards requiring the maintenance of a minimum of $15
million in market capitalization over a 30-day trading period and the
maintenance of a minimum share price of $1 over a 30-day trading period. In
accordance with the rules of the NYSE, the Company has supplied the NYSE with
its business plan to address promptly the market capitalization and minimum
share price issues. There can be no assurance, however, that the Company will be
successful in meeting those requirements on a continuing basis. If the Company
is delisted from the NYSE, it will apply for quotation, and would expect its
Common Stock to trade, on the OTC Bulletin Board.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, Delta sells the
majority of its loans through securitization to a securitization trust and
derives a substantial portion of its income from these sales. In a
securitization, the Company sells a pool of loans it has originated or purchased
to a REMIC trust for a cash purchase price. The trust, in turn, finances the
purchase of the pool of loans it has acquired by selling "pass-through
certificates," or bonds, which represent undivided ownership interests in the
trust. Holders of the pass-through certificates are entitled to receive monthly
distributions of all principal received on the underlying mortgages and a
specified amount of interest, determined at the time of the offering.
When the Company sells a pool of loans to a securitization trust, it receives
the following economic interests in the trust: (a) the difference between the
interest payments due on the loans sold to the trust and the interest rate paid
to the pass-through certificateholders, less the Company's contractual servicing
fee and other costs and expenses of administering the trust, represented by
interest-only and residual certificates, and (b) the right to service the loans
on behalf of the trust and earn a servicing fee, as well as other ancillary
servicing related fees directly from the borrowers on the underlying loans.
The Company's net investment in the pool of loans sold at the date of the
securitization represents the amount originally paid to originate or acquire the
loans adjusted for (i) any direct loan origination costs incurred (an increase)
and loan origination fees received (a decrease) in connection with the loans,
which are treated as a component of the initial investment in loans, and (ii)
the principal payments received, and the amortization of the net loan fees or
costs, during the period the Company held the loans prior to their
securitization. The Company's investment in the loans also reflects adjustments
for any gains (a decrease in the investment) or losses (an increase in the
investment) the Company has incurred on treasury rate lock contracts (or similar
hedging strategies) which the Company has typically used to hedge against the
effects of changes in interest rates during the period it holds the loans prior
to their securitization. (See "- Hedging.")
27
Upon the securitization of a pool of loans, the Company (i) recognizes in
income, as origination fees, the unamortized origination fees included in the
investment in the loans sold, and (ii) recognizes a gain on sale of loans equal
to the difference between cash received from the trust and the investment in the
loans remaining after the allocation of portions of that investment to record
interest-only and residual certificates and mortgage servicing rights received
in the securitization. The majority of the net gain on sale of mortgage loans
results from the fair value of the interest-only and residual certificates
retained by the Company in a securitization for each period and the market value
of the interest-only certificates sold in connection with each securitization.
The Company sold the interest-only certificates created in each of the 2000
securitizations for cash proceeds and intends to continue to sell the
interest-only certificate as long as the sale effectively maximizes cash flow
and profitability.
The interest-only and residual certificates received by the Company upon the
securitization of a pool of loans are accounted for as trading securities. The
amount initially allocated to the interest-only and residual certificates at the
date of a securitization reflects the fair value of those interests. The amount
recorded for the certificates is reduced for distributions thereon which the
Company receives from the trust, and is adjusted for subsequent changes in the
fair value of interest-only and residual certificates held by the Company, which
are reflected in the statement of operations. The Company assesses the fair
value of interest-only and residual certificates based upon updated estimates of
prepayment and default rates relating to loan groups comprised of loans of
similar types, terms, credit quality, interest rates, geographic location and
value of loan collateral, which represent the predominant risk characteristics
that would affect prepayments and default rates.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2000, COMPARED TO THE YEAR ENDED DECEMBER 31, 1999
GENERAL
The Company reported a net loss for the year ended December 31, 2000 of $49.4
million, or $3.10 per share, compared to net income of $4.7 million, or $0.30
per share, for the year ended December 31, 1999. Excluding certain non-recurring
items, the Company would have reported net loss of $0.4 million, or $0.02 per
share, for the year ended December 31, 2000. These non-recurring items related
to (1) the write-down of the Company's capitalized mortgage servicing rights
based upon the Company's realization, in connection with the bidding process
that led to the subservicing agreement with Ocwen, that it could not sell its
existing loan servicing portfolio for a premium, (2) a reduction in the carrying
value of a portion of the Company's residual certificates related to an increase
in the discount rate of such certificates included in the Company's NIM
Transaction, (3) the write-down of the Company's goodwill relating to the 1997
purchase of Fidelity Mortgage, (4) costs associated with the Company's NIM
transaction in November 2000, (5) restructuring and debt modification charges,
and (6) non-recurring income associated with the sale of one of the Company's
domain names. Excluding a one-time charge relating to the Company's settlement
with the NYSBD and the NYOAG, the Company's net income for the year ended
December 31, 1999, would have been $12.0 million, or $0.77 per share. Comments
regarding the components of net income are detailed in the following paragraphs.
REVENUES
Total revenues decreased $35.8 million, or 23%, to $119.0 million for the
year ended December 31, 2000, from $154.8 million for the comparable period in
1999. The decrease in revenue was primarily attributable to a decrease in the
net gain on sale of mortgage loans and, to a lesser extent, servicing fees and
origination fees. This decrease was partially offset by an increase in interest
income.
The Company originated and purchased $933 million of mortgage loans for the
twelve months ended December 31, 2000, representing a 37% decrease from $1.47
billion of mortgage loans originated and purchased for the comparable period in
1999. The Company securitized $880 million in loans (and sold the related
servicing rights on its 2000 second, third and fourth quarter securitizations,
respectively) during the twelve months ended December 31, 2000, representing a
40% decrease from three securitizations and a loan sale through a conduit
facility totaling $1.46 billion during the twelve months ended December 31,
1999. The Company also sold $58.3 million of loans on a whole loan servicing
released basis for the twelve months December 31, 2000. The Company did not sell
whole
28
loans for the comparable period in 1999. Total loans serviced decreased 9% to $
3.31 billion at December 31, 2000 from $3.63 billion at December 31, 1999.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
represents (1) the sum of (a) the fair value of the interest-only and residual
certificates retained by the Company in a securitization for each period and the
market value of the interest-only certificates sold in connection with each
securitization, (b) the fair value of capitalized mortgage servicing rights
associated with loans securitized in each period and the market value of
capitalized mortgage servicing rights sold in connection with each
securitization, and (c) premiums earned on the sale of whole loans on a
servicing-released basis, (2) less the (x) premiums paid to originate or acquire
mortgage loans, (y) costs associated with securitizations, and (z) any hedge
loss (gain) associated with a particular securitization.
Net gain on sale of mortgage loans decreased $31.1 million, or 40%, to $47.6
million for the twelve months ended December 31, 2000, from $78.7 million for
the comparable period in 1999. This decrease was primarily due to (i) a 40%
decrease in the amount of loans securitized or sold, (ii) a revision to the
Company's loan loss reserve assumption in the fourth quarter of 1999 (see "-Fair
Value Adjustment") and (iii) a revision to the Company's annual discount rate in
the fourth quarter of 2000 (see "-Fair Value Adjustment"). The decrease was
partially offset by (i) a higher gross excess spread expected to be earned over
the life of the loans as calculated by the weighted average coupon on the pool
of mortgage loans securitized less the total cost of funds on the
securitization, (ii) the Company not executing a securitization in the third
quarter of 1999 and instead opting to sell its loan production into a conduit
facility, where the net gain on sale was lower than if the Company would have
sold its loans through securitization and (iii) lower aggregate premiums paid to
acquire loans, resulting from both a decrease in amount of loans purchased
through the correspondent channel and lower average premiums paid to
correspondents. The Company also lowered its prepayment speed assumptions in the
third quarter of 2000, while at the same time increased its loss reserve
initially established for both fixed and adjustable-rate loans sold to the
securitizations trusts (see "Fair Value Adjustment"). The changes largely offset
each other and, therefore, did not materially affect net gain on sale of
mortgage loans. The weighted average net gain on sale ratio was 5.9% for the
year ended December 31, 2000 compared to 5.4% for the comparable period in 1999.
INTEREST INCOME. Interest income primarily represents the sum of (1) the
difference between the distributions the Company receives on its interest-only
and residual certificates and the adjustments recorded to reflect changes in the
fair value of the interest-only and residual certificates, (2) the gross
interest earned on loans held for sale (other than for loans sold into the
conduit in which case, it is the net interest spread), (3) with respect to loans
sold into the conduit, the net interest margin earned (excess servicing) between
the weighted average rate on the mortgage loans less the conduit's variable
funding rate plus administrative fees, and (4) interest earned on cash
collection balances.
Interest income increased $1.3 million, or 4%, to $32.3 million for the
twelve months ended December 31, 2000, from $31.0 million for the comparable
period in 1999. The increase was primarily due to the Company utilizing a
mortgage loan conduit (special purpose vehicle) prior to securitization in 1999
- - in which the Company earns and records the net interest margin between the
interest rate earned on the pool of mortgage loans sold to the mortgage loan
conduit and the conduit financing rate, less administrative expenses that it did
not use at all in 2000.
SERVICING FEES. Servicing fees represent all contractual and ancillary
servicing revenue received by the Company less (1) the offsetting amortization
of the capitalized mortgage servicing rights, and any adjustments recorded to
reflect valuation allowances for the impairment in mortgage servicing rights
(see "--Certain Accounting Considerations"), and (2) prepaid interest
shortfalls.
Servicing fees decreased $2.1 million, or 13%, to $14.2 million for the
twelve months ended December 31, 2000, from $16.3 million for the comparable
period in 1999. The decrease in servicing income is primarily due to (i) lower
ancillary fees collected (primarily prepayment penalties as mortgage loan
prepayments were comparably lower in 2000) and (ii) lower servicing fees
collected due to a more seasoned (I.E., more delinquent) portfolio in 2000, due
in part to the Company's sales of servicing rights on $590 million of newly
originated or purchased mortgage loans securitized in 2000.
ORIGINATION FEES AND OTHER INCOME. Origination fees represent fees earned on
broker and retail originated loans and other income. Origination fees decreased
$3.9 million, or 14%, to $24.9 million for the twelve months ended December 31,
2000, from $28.8 million for the comparable period in 1999. The decrease was
primarily the result of
29
a 32% decrease in broker originated loans and an 18% decrease in retail
originated loans. This was partially offset by the sale of one of the Company's
domain names in July 2000.
EXPENSES
Total expenses increased by $34.5 million, or 23%, to $181.6 million for the
twelve months ended December 31, 2000, from $147.1 million for the comparable
period in 1999. This was primarily the result of (i) the complete write down of
the Company's capitalized mortgage servicing rights of $38.2 million, (ii)
non-recurring charges related to the Corporate Restructuring and Debt
Modification in the third quarter of 2000 of $6.7 million and $3.1 million,
respectively, and (iii) a write-down of goodwill in the fourth quarter of 2000
of $1.8 million. This was partially offset by a decrease in general and
administrative costs (primarily relating to the $12 million the Company expensed
in the twelve months ended December 31, 1999, for the settlement entered into by
the Company with the NYSBD, NYOAG and DOJ) and a decrease in personnel costs
attributable to the Company's initiative to lower costs through its corporate
restructuring in the third quarter of 2000 that included a workforce reduction.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees. Payroll and related costs
decreased by $8.6 million, or 13%, to $56.5 million for the twelve months ended
December 31, 2000, from $65.1 million for the comparable period in 1999. The
decrease was primarily the result of (i) a lower number of employees in 2000
compared to 1999 relating to the Company's restructuring in the third quarter of
2000 (see "- Corporate Restructuring and Debt Modification"), and (ii) due to a
lower amount of commissions paid on a lower amount of originations in 2000
compared to 1999. As of December 31, 2000, the Company employed 851 full- and
part-time employees, compared to 1,134 full- and part-time employees as of
December 31, 1999.
INTEREST EXPENSE. Interest expense includes the borrowing costs to finance
loan originations and purchases, equipment financing and the Company's overall
operations under the Senior Notes and the Company's credit facilities.
Interest expense increased by $3.8 million, or 14%, to $30.4 million for the
twelve months ended December 31, 2000 from $26.6 million for the comparable
period in 1999. The increase was primarily attributable to the accounting for
loans sold through a mortgage loan conduit prior to their securitization during
the twelve months ended December 31, 1999, in which the Company earned and
recorded the net interest margin between the interest rate earned on the pool of
mortgage loans sold to the mortgage loan conduit and the conduit financing rate,
less administrative expenses. Typically, interest expense related to the
Company's other warehouse financing and borrowings are recorded directly to
interest expense. The Company did not utilize its mortgage loan conduit during
the twelve months ended December 31, 2000. In addition, there was an increase in
the cost of funds on the Company's credit facilities, which were tied to
one-month LIBOR. The one-month LIBOR index increased to an average interest rate
of 6.4% in the twelve months ended December 31, 2000, compared to an average
interest rate of 5.2% for the comparable period in 1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, goodwill
amortization, legal reserves and fees, license fees, accounting fees, travel and
entertainment expenses, advertising and promotional expenses and the provision
for loan losses on the inventory of loans held for sale and recourse loans.
General and administrative expenses decreased $10.2 million, or 18%, to $45.1
million for the twelve months ended December 31, 2000, from $55.3 million for
the comparable period in 1999. The decrease was primarily the result of the $12
million settlement the Company expensed in the twelve months ended December 31,
1999, in connection with its settlement with the NYSBD, NYOAG and DOJ.
RESTRUCTURING AND OTHER SPECIAL CHARGES. In the fourth quarter of 2000, the
Company recorded a $38.2 million write-down of its capitalized mortgage
servicing rights coupled with a $1.6 million write-down of other servicing
receivable assets. In the third quarter of 2000, the Company recorded $3.1
million of debt modification charges primarily related to legal fees, and senior
note holder's financial advisor fees associated with the Debt Modification and
proposed Exchange Offering. Also, in the third quarter of 2000, the Company
recorded $6.7 million of charges related to the restructuring of its operations.
These charges
30
primarily relate to employee severance associated with the layoffs, a reduction
to goodwill and office equipment write-offs (see "-Corporate Restructuring and
Debt Modification").
INCOME TAXES. Deferred tax assets and liabilities are recognized on the
income reported in the financial statements regardless of when such taxes are
paid. These deferred taxes are measured by applying current enacted tax rates.
The Company recorded a tax benefit of $13.2 million for the period ended
December 31, 2000 and a tax provision of $3.1 million for the period ended
December 31, 1999. Income taxes provided a 21.1% effective tax rate for the year
ended December 31, 2000, compared to a 39.5% effective tax rate for the year
ended December 31, 1999.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEAR ENDED DECEMBER 31, 1998
GENERAL
The Company's net income for the year ended December 31, 1999 was $4.7
million, or $0.30 per share, compared to $11.3 million, or $0.74 per share, for
the year ended December 31, 1998. Excluding a one-time charge relating to the
Company's settlement with the NYSBD and the NYOAG, the Company's net income for
the year ended December 31,1999, would have been $12.0 million, or $0.77 per
share. Comments regarding the components of net income are detailed in the
following paragraphs.
REVENUES
Total revenues increased $15.2 million, or 11%, to $154.8 million for the
twelve months ended December 31, 1999, from $139.6 million for the comparable
period in 1998. The increase in revenue was primarily attributable to fair value
adjustments the Company made to its interest-only and residual certificates and
capitalized mortgage servicing rights in the second quarter of 1998 (See "-Fair
Value Adjustments"), an increase in servicing fees and origination fees, and was
partially offset by a decrease in the net gain recognized on the sale of
mortgage loans.
The Company originated and purchased $1.47 billion of mortgage loans for the
twelve months ended December 31, 1999, representing a 15% decrease from $1.73
billion of mortgage loans originated and purchased for the comparable period in
1998. The Company completed three securitizations and a loan sale through a
conduit facility in 1999 totaling $1.46 billion, compared to four
securitizations and loan sales totaling $1.73 billion in 1998. Total loans
serviced increased 23% to $3.63 billion at December 31, 1999 from $2.95 billion
at December 31, 1998.
Net gain on sale of mortgage loans decreased $12.7 million, or 14%, to $78.7
million for the twelve months ended December 31, 1999, from $91.4 million for
the comparable period in 1998. This decrease was primarily due to a 16% decrease
in the amount of loans securitized or sold through a conduit facility to $1.46
billion in 1999, compared to $1.73 billion of loans securitized or sold in 1998;
a revision to the Company's loan loss reserve assumption in 1999 (See "-Fair
Value Adjustments"); coupled with wider spreads demanded by asset-backed
investors who purchase the pass-through certificates issued by securitization
trusts during 1999 compared to 1998. The decrease was partially offset by lower
aggregate premiums paid to acquire loans, resulting from both a decrease in
amount of loans purchased through the correspondent channel and lower average
premiums paid to correspondents. The weighted average net gain on sale ratio was
5.4% in 1999 compared to 5.3% in 1998.
Interest income increased $18.5 million, or 148%, to $31.0 million for the
twelve months ended December 31, 1999, from $12.5 million for the comparable
period in 1998. The increase in interest income was primarily due to fair value
adjustments made in 1998 to the Company's interest-only and residual
certificates, including a $15.5 million reduction in the second quarter of 1998
related to the change in prepayment assumptions (see "-Fair Value Adjustments").
The increase was also attributable to an increase in income recognized from the
Company's interest-only and residual certificates primarily due to
slower-than-anticipated actual prepayment rates. (see "-Fair Value
Adjustments"). This was offset partially by the accounting for loans sold by the
Company to a mortgage loan conduit prior to securitization in the third and
fourth quarters of 1999. For conduit-related sales, the Company earns and
records the net interest margin between the interest rate earned on the pool of
mortgage loans sold to the mortgage loan conduit and the conduit financing rate,
less administrative expenses. Typically, interest expense related to the
Company's other warehouse financing and borrowings are recorded directly to
interest expense.
31
Servicing fees increased $5.8 million, or 55%, to $16.3 million for the
twelve months ended December 31, 1999, from $10.5 million for the comparable
period in 1998. This increase was primarily due to an increase in the aggregate
size of the Company's servicing portfolio and the recording of a $1.9 million
impairment provision for the Company's mortgage servicing rights during the
second quarter of 1998 (See "-Fair Value Adjustments"). The average balance of
the mortgage loans serviced by the Company increased 38% to $3.36 billion for
the twelve months ended December 31, 1999 from $2.44 billion during the
comparable period in 1998.
ORIGINATION FEES. Origination fees increased $3.5 million, or 14%, to $28.8
million for the twelve months ended December 31, 1999, from $25.3 million for
the comparable period in 1998. The increase was primarily the result of (a) a
36% increase in retail originated loans and (b) a 6% increase in broker
originated loans.
EXPENSES
Total expenses increased by $26.0 million, or 21%, to $147.1 million for the
twelve months ended December 31, 1999, from $121.1 million for the comparable
period in 1998. The increase was primarily the result of an increase in general
and administrative expenses primarily related to the Company's settlement with
the NYSBD and the NYOAG, and legal fees associated with the settlement, as well
as personnel costs associated with the Company's expanded retail, broker and
servicing divisions, partially offset by a decrease in interest expense.
PAYROLL AND RELATED COSTS. Payroll and related costs increased by $8.4
million, or 15%, to $65.1 million for the twelve months ended December 31,1999,
from $56.7 million for the comparable period in 1998. The increase was primarily
due to staff increases related to growth in the Company's servicing portfolio
and commissions paid to employees related to an increase in loans originated
through the Company's broker and retail divisions. As of December 31, 1999, the
Company employed 1,134 full- and part-time employees, compared to 1,104 full-
and part-time employees as of December 31, 1998.
Interest expense decreased by $3.4 million, or 11%, to $26.6 million for the
twelve months ended December 31, 1999 from $30.0 million for the comparable
period in 1998. The decrease was primarily attributable to the accounting for
loans sold through a mortgage loan conduit prior to their securitization in the
third and fourth quarters of 1999, in which the Company earns and records the
net interest margin between the interest rate earned on the pool of mortgage
loans sold to the mortgage loan conduit and the conduit financing rate, less
administrative expenses. Typically, interest expense related to the Company's
other warehouse financing and borrowings are recorded directly to interest
expense. In addition, there was a decrease in the cost of funds on the Company's
credit facilities, which were tied to one-month LIBOR. The one-month LIBOR index
decreased to an average interest rate of 5.2% in the twelve months ended
December 31, 1999, compared to an average interest rate of 5.6% for the
comparable period in 1998.
General and administrative expenses increased $20.9 million, or 61%, to $55.3
million for the twelve months ended December 31, 1999 from $34.4 million for the
comparable period in 1998. This increase was primarily attributable to (1) the
Company's settlement with the NYSBD and the NYOAG, and the associated legal
costs, and (2) an increase in depreciation expense and management and consulting
fees, reflecting the Company's ongoing investment in technology.
The Company recorded tax provisions of $3.1 million and $7.2 million for the
periods ended December 31, 1999 and 1998, respectively. Income taxes provided a
39.5% effective tax rate for the year ended December 31, 1999, compared to a
38.8% effective tax rate for the year ended December 31, 1998.
FINANCIAL CONDITION
DECEMBER 31, 2000 COMPARED TO DECEMBER 31, 1999
Cash and interest-bearing deposits decreased $7.3 million, or 10%, to $62.3
million at December 31, 2000, from $69.6 million at December 31, 1999. The
decrease was primarily the result of lower prepayments which caused a decrease
in monies held in securitization trust accounts by the Company, acting as
servicer for its ongoing securitization program.
Accounts receivable decreased $10.4 million, or 32%, to $22.0 million at
December 31, 2000, from $32.4 million at December 31, 1999. This decrease was
primarily due to the sale of some of the Company's reimbursable
32
servicing advance receivables, issued through a securitization in 2000. This was
partially offset by an increase in reimbursable servicing advances made by the
Company, acting as servicer on its securitizations.
Loans held for sale, net, decreased $6.3 million, or 7%, to $82.7 million at
December 31, 2000, from $89.0 million at December 31, 1999. This decrease was
primarily due to the net difference between loan originations and loans sold or
securitized during 2000.
Accrued interest receivable decreased $52.9 million, or 84%, to $10.4 million
at December 31, 2000, from $63.3 million at December 31, 1999. This decrease was
primarily due to the sale of some of the Company's interest receivables (monthly
delinquency advances), issued through two securitizations in the first two
quarters of 2000. This was partially offset by an increase in reimbursable
interest advances made by the Company, acting as servicer on its
securitizations.
Capitalized mortgage servicing rights decreased $45.9 million, or 100%, to
$0.0 million at December 31, 2000. This decrease was due to the complete write
off of the Company's mortgage servicing rights based upon the Company's
realization, in connection with the bidding process that led to its subservicing
agreement with Ocwen in January 2001, that it could not sell its existing
seasoned loan servicing portfolio for a premium. By transferring servicing and,
along with it, the responsibility for making delinquency and servicing advances,
however, the Company expects to save approximately $5.5 million of annual
capital charges, in addition to the significant cash outlays associated with
making such advances.
Interest-only and residual certificates decreased $7.8 million, or 3%, to
$216.9 million at December 31, 2000, from $224.7 million at December 31, 1999.
This decrease is primarily attributable the Company's valuation adjustment
related to a reduction in the present value of the Company's residual
certificates in the fourth quarter of 2000 due to a discount rate increase (i)
to 13% from 12% (see -"Fair Value Adjustment") on all senior residuals (I.E.,
those not underlying the NIM Transaction) in the fourth quarter of 2000, and
(ii) with respect to the six residuals underlying the NIM Transaction issued in
the fourth quarter 2000, to 18% from 12% in the third quarter of 2000. This was
partially offset by the Company's receipt of residual certificates valued and
recorded at $32.7 million from loans securitized during the twelve months ended
December 31, 2000.
Equipment, net , decreased $6.7 million, or 31%, to $15.0 million at December
31, 2000, from $21.7 million at December 31, 1999. This decrease is primarily
attributable to the Company's write-down of its assets related to the previously
announced restructuring of its operations.
Prepaid and other assets increased $27.5 million, or 267%, to $37.8 million
at December 31, 2000, from $10.3 million at December 31, 1999. This increase was
primarily attributable to the Company's investment in new affiliate companies
(qualified special purpose entities) in connection with the three securitization
advance transactions issued in 2000. (See "-Liquidity and Capital Resources").
During 1999 the Company had goodwill of $4.8 million. The Company has written
down its entire goodwill balance at December 31, 2000. The goodwill, which was
entirely related to its purchase of Fidelity Mortgage Inc. in 1997, was
primarily attributable to (1) the then-current management team (the "Key
Employees"), and to a lesser extent (2) Fidelity Mortgage's near term prospects
for significant loan origination growth. Management has determined that the
write-down of goodwill is warranted as none of the Key Employees are currently
employed at Fidelity Mortgage and the current origination level at Fidelity
Mortgage is well below the expectations upon which the Company based its initial
purchase price.
The Company has a deferred tax asset, net, of $5.6 million at December 31,
2000, which was primarily attributable to the net operating losses incurred by
the Company in 2000. The deferred tax asset was reduced by a valuation allowance
established in 2000. The Company did not have a deferred tax asset at December
31, 1999.
Warehouse financing and other borrowings decreased $20.4 million, or 19%, to
$88.6 million at December 31, 2000, from $109.0 at December 31, 1999. This
decrease was primarily attributable to the repayment in full of the Company's
bank syndicate working capital line in June 2000.
The aggregate principal balance of the Senior Notes, net of unamortized bond
discount, totaled $149.6 million at December 31, 2000 compared to $149.5 million
at December 31, 1999. The Senior Notes accrued interest at a rate of 9.5% per
annum, payable semi-annually on February 1 and August 1. (See -"Corporate
Restructuring and Debt Modification" and Note 2 of the Notes to Consolidated
Financial Statements).
33
Accounts payable and accrued expenses decreased $10.2 million, or 23%, to
$33.4 million at December 31, 2000 from $43.6 million at December 31, 1999. The
decrease was primarily the result of the timing of various operating accruals
and payables.
Investor payable decreased $12.7 million, or 15%, to $69.5 million at
December 31, 2000, from $82.2 million at December 31, 1999. The decrease was
primarily the result of lower prepayments, which caused a decrease in the amount
payable to investors. Investor payable is comprised of all principal collected
on mortgage loans and accrued interest. Variability in this account is primarily
due to the principal payments collected within a given collection period.
The Company does not have a deferred tax liability at December 31, 2000, as
the Company's net operating loss in 2000 offset its deferred tax liability,
creating a deferred tax asset. The Company had a deferred tax liability of $10.4
million at December 31, 1999.
Stockholders' equity decreased $49.4 million, or 34%, to $97.7 million at
December 31, 2000 from $147.1 million at December 31, 1999. This decrease is due
to net loss for the twelve-month period of $49.4 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has primarily operated on a negative cash flow basis in the past
and anticipates that it will continue to have a negative operating cash flow for
the foreseeable future due primarily to (1) the costs of maintaining its
servicing operations until servicing is transferred to Ocwen, (2) the costs of
its loan originations operations, which currently exceed the cash proceeds
generated from (a) up front origination fees earned on closed loans and (b) the
Company's selling loans through securitization or on a whole loan basis, and (3)
lower projected aggregate cash inflows from the Company's retained interest-only
and residual certificates.
Cash inflows from the retained interest-only and residual certificates are
projected to be lower because (i) the Company sold its right to receive a
portion of the cash flows from several residual certificates in connection with
its NIM Transaction, completed in the fourth quarter of 2000, for which it
received an up-front cash purchase price, (ii) the Company pledged its right to
receive a portion of the cash flows from several other residual certificates in
connection with residual financing that the Company received in the first
quarter of 2001, for which it also received up front cash proceeds, (iii)
expected timing differences between the Company's retained interests in (A)
older securitization trusts generating less cash flows per month per deal as the
related mortgage pool pays down and (B) newer securitization trusts not yet cash
flowing until initial reserve requirements are satisfied, and (iv) the Company
agreeing to transfer the vast majority of its retained interest-only and
residual certificates (currently securing the Senior Secured Notes) into a
Liquidating Trust for the benefit of the Senior Secured Noteholders, in
accordance with the exchange offer contemplated by the Second Debt
Restructuring, in which the cash flows from such interest-only and residual
certificates will be paid over to the Liquidating Trust commencing in July 2001.
(See "-Debt and Restructuring Modification").
The Company believes that its negative cash flow may be somewhat offset in
future quarters by (a) the Company's continued concentration on its less
cash-intensive broker and retail originations, (b) the transfer of servicing to
Ocwen, which removes the Company's monthly delinquency and servicing advance
obligations, (c) the proposed extinguishment of the Company's high yield debt if
the Second Exchange Offer is successful and approximately $14 million of annual
coupon interest payments upon consummation of the Second Exchange Offer, (d) its
recent history of utilizing securitization structures that have allowed the
Company to sell senior interest-only certificates and/or mortgage servicing
rights for an up front cash purchase price, and (e) the continued strategy of
selling whole loans for a an up-front cash purchase price. However, market
conditions and various other factors identified below under "Risk Factors" could
impact the Company's cash flows potentially resulting in a more significant
negative cash flow.
For the twelve months ended December 31, 2000, the Company had a cash deficit
of $7.3 million compared to positive cash flow of $10.4 million for the
comparable period in 1999. The decrease in cash flow was primarily attributable
to (1) the monthly delinquency and servicing advances the Company is required to
make as servicer for various securitization trusts, (2) a decrease in cash flows
from the Company's retained interest-only and residual certificates, and (3) a
reduction in cash received on the sale of interest-only certificates at the time
of securitization. These interest and servicing advances are reimbursable to the
Company as the borrowers repay their loan obligations
34
over time. As such, the exact timing of these reimbursements cannot be predicted
with certainty. In 2000, the Company completed three securitizations of interest
(delinquency) and servicing advances (the "Advance Securitizations"), in which
the Company sold its rights to reimbursement of its outstanding delinquency and
servicing advances on specific REMIC securitizations for a cash purchase price.
The Company used the cash proceeds from the Advance Securitizations to (1) repay
a $25 million working capital sub-line of its bank syndicate warehouse facility
that expired in June 2000, which was secured by the Company's monthly
delinquency and servicing advances prior to the Advance Securitizations, and (2)
finance operations, including the funding of new delinquency and servicing
advances. Delta's subservicing agreement with Ocwen provides for Ocwen to
purchase the delinquency and servicing advances that Delta has made in its
capacity as servicer. In that regard, in March 2001, the Company sold its right
to reimbursement for certain servicing advances to Ocwen, and used the proceeds
of which to simultaneously repurchase the corresponding Advance Securitization.
The Company expects to sell its remaining delinquency and servicing advance
receivables to Ocwen, in accordance with the subservicing agreement; in
connection with which the remaining two Advance Securitizations will be
terminated.
In August 2000, the Company announced a corporate restructuring and
modification of its Senior Notes (see "-Corporate Restructuring and Debt
Modification") to improve operating efficiencies and to address its negative
cash flow. The corporate restructuring was aimed at reducing overhead and
operating expenses. The debt modification enabled the company to monetize a
portion of its Residual Assets.
As part of its Debt Modification in August 2000, a negative pledge covenant
in the Senior Notes Indenture that prevented the Company from encumbering or
otherwise obtaining financing against any of its Residual Assets was modified.
This modification enabled the Company to monetize a portion of its Residual
Assets, first by obtaining approximately $17 million in residual financing in
August 2000, secured by certain of the Company's residual certificates. Shortly
thereafter, in November 2000, the Company sold a portion of its retained
interest-only and residual certificates through a private placement NIM
securitization. In the NIM Transaction, the Company sold six of its residual
certificates to an owner trust that issued senior certificates to institutional
investors for a cash purchase price, and a subordinated certificate retained by
the Company (the "NIM Residual"). The net proceeds of the NIM Transaction, after
expenses was used entirely to repay the $17 million of residual financing the
Company borrowed in August 2000 and to create a $7.125 million cash escrow
account to be used to pay the semi-annual interest payment due to the Senior
Secured Noteholders in February 2001.
As part of its Second Debt Restructuring, the Company obtained approximately
$2.5 million of residual financing secured by certain of its residual
certificates at the time of the signing of the Letter of Intent in February
2001. The Company received approximately an additional $7.1 million of residual
financing secured by certain additional residual certificates following the
consummation of the Consent Solicitation and the execution of the Third
Supplemental Indenture in March 2001. Also in March 2001, the Company entered
into a forward purchase agreement to sell five of its residual certificates in
the second quarter of 2001 for a $15 million cash purchase price. The purchasers
of these five residuals provided bridge financing, in the form of the residual
financing described above, which currently represents approximately 64% of the
cash purchase price. The proceeds from this residual financing and subsequent
sale will be used by the Company for working capital. These residual
certificates are being sold at a significant discount to the Company's book
value for such certificates and, as such, the Company expects to record an
approximately $27 million pre-tax non-cash charge in the first quarter of 2001.
The Company's current primary cash requirements will be the funding of (1)
loan originations pending their pooling and sale, (2) ongoing administrative and
other operating expenses, and (3) its servicing operation until servicing is
transferred to Ocwen.
The Company must be able to sell its loans and obtain adequate credit
facilities and other sources of funding in order to continue to originate and
service loans. Historically, the Company has utilized various financing
facilities and an equity financing to offset negative operating cash flows and
support its loan originations, securitizations and general operating expenses.
In July 1997, the Company completed an offering of the Senior Notes. A portion
of the Senior Notes proceeds were used to pay down various financing facilities
with the remainder used to fund the Company's loan originations and its ongoing
securitization program. The Company's primary sources of liquidity continue to
be warehouse, residual and other financing facilities, securitizations of
mortgage loans and Residual Assets and, subject to market conditions, sales of
whole loans, mortgage servicing rights, Residual Assets, and debt and equity
securities.
35
To accumulate loans for securitization, the Company borrows money on a
short-term basis through warehouse lines of credit. The Company has relied upon
a few lenders to provide the primary credit facilities for its loan originations
and purchases. The Company had one warehouse facility as of December 31, 2000
for this purpose. The warehouse facility is a $200 million credit facility that
has a variable rate of interest and expires in May 2001. There can be no
assurance that the Company will be able to renew this warehouse facility at its
maturity at terms satisfactory to the Company or at all. The Company is
currently in the process of seeking additional warehouse lines of credit, but
there can be no assurances that the Company will be successful in its attempt to
secure an additional warehouse line of credit.
The Company is required to comply with various operating and financial
covenants as provided in the agreements described above which are customary for
agreements of their type. The continued availability of funds provided to the
Company under these agreements is subject to, among other conditions, the
Company's continued compliance with these covenants.
INTEREST RATE RISK
The Company's primary market risk exposure is interest rate risk.
Profitability may be directly affected by the level of, and fluctuation in,
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its borrowings, which are tied
to various United States Treasury maturities, commercial paper rates and the
London Inter-Bank Offered Rate ("LIBOR"). The profitability of the Company is
likely to be adversely affected during any period of unexpected or rapid changes
in interest rates. A substantial and sustained increase in interest rates could
adversely affect the Company's ability to purchase and originate loans. A
significant decline in interest rates could increase the level of loan
prepayments thereby decreasing the size of the Company's loan servicing
portfolio. To the extent servicing rights and interest-only and residual classes
of certificates have been capitalized on the books of the Company, higher than
anticipated rates of loan prepayments or losses could require the Company to
write down the value of such servicing rights and interest-only and residual
certificates, adversely impacting earnings. As previously discussed, the fair
value adjustments that the Company recorded in the second quarter of 1998 were
primarily attributable to the Company's change in prepayment assumptions to
reflect higher than originally anticipated rates of prepayments (see "--Fair
Value Adjustments"). In an effort to mitigate the effect of interest rate risk,
the Company periodically reviews its various mortgage products and identifies
and modifies those that have proven historically more susceptible to
prepayments. However, there can be no assurance that such modifications to its
product line will effectively mitigate interest rate risk in the future.
Periods of unexpected or rapid changes in interest rates, and/or other
volatility or uncertainty regarding interest rates, can also adversely affect
the Company by increasing the likelihood that asset-backed investors will demand
higher spreads than normal to offset the volatility and/or uncertainty, which
decreases the value of the residual assets received by the Company through
securitization.
Fluctuating interest rates also may affect the net interest income earned by
the Company resulting from the difference between the yield to the Company on
loans held pending sales and the interest paid by the Company for funds borrowed
under the Company's warehouse facilities, although the Company undertakes to
hedge its exposure to this risk by using treasury rate lock contracts and/or
FNMA mortgage securities. (See "--Hedging"). Fluctuating interest rates may also
affect net interest income as certain of the Company's asset-backed securities
are priced off of one-month LIBOR, but the collateral underlying such securities
are comprised of mortgage loans with either fixed interest rates or "hybrid"
interest rates - fixed for the initial 2 or 3 years, and then adjusts thereafter
every six months - which creates basis risk (See "--Fair Value Adjustments").
HEDGING
The Company originates and purchases mortgage loans and then sells them
through a combination of whole loan sales and securitizations. Between the time
the Company originates the mortgage and sells it in the secondary market, the
Company may hedge the risk of fluctuations in interest. The risk to the Company
begins subsequent to originating or purchasing mortgage loans and prior to
selling or securitizing such mortgage loans. Since the Company has a closed (and
funded) mortgage loan at a specified interest rate with an expected gain at time
of sale, the Company's exposure is to a higher interest rate environment due to
market conditions. A higher interest rate market implies a higher cost of funds
to the Company which decreases the net spread the Company would earn
36
between the mortgage interest rate on each mortgage loan less the cost of funds.
As a result the Company may experience a lower gain on sale.
The cost of funds is generally composed of two components, the Treasury rate
with a similar duration and average life and the spread to Treasuries or profit
margin required by the investors. Delta had previously used a "Treasury Rate
Lock" to hedge its cost of funds exposure. However, in the third quarter of 1998
and again in the second quarter of 1999, asset-backed investors demanded
substantially wider spreads over treasuries than historically experienced for
newly issued asset-backed securities, which resulted in a hedge loss that was
not offset by a higher gain on sale, as the Company had historically seen. In
response, beginning in the fourth quarter 2000, management implemented a new
hedging strategy that involves selling 15-year FNMA mortgage securities ("FNMA
Securities"), in lieu of treasury rate lock contracts. It did so based on its
belief that FNMA Securities are more similarly correlated to its mortgage loans
because both are considered "spread product" - the FNMA Securities incorporate
both an underlying treasury rate with similar duration to the Company's mortgage
loans plus a general spread meant to take into account additional risks such as
early repayment or extension risk, etc. - that management believes make them
more likely to respond similarly to a change in interest rates than AAA United
States Treasury securities ("U.S. Treasuries"), which do not have a "spread"
component. While neither of the above are perfect hedges, FNMA securities have
demonstrated a closer correlation to the Company's cost of funds over the past
few years, especially during periods of high interest rate volatility and market
uncertainty. The nature and quantity of hedging transactions are determined by
the Company based upon various factors including, without limitation, market
conditions and the expected volume of mortgage originations and purchases. The
Company will enter into these hedging strategies through one of its warehouse
lenders and/or one of the investment bankers, which underwrite the Company's
securitizations. These strategies are designated as hedges in the Company's
books and records and are closed out when the associated loans are sold.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, the Company, upon settlement with its hedge counterparty, will pay
the hedge loss in cash and then realize the corresponding increase in the value
of the loans as part of its net gain on sale of mortgage loans through either
its corresponding interest-only and residual certificates or whole loan
premiums. Conversely, if the value of the hedges increase, offsetting a decrease
in the value of the loans, the Company, upon settlement with its hedge
counterparty, will receive the hedge gain in cash and realize the corresponding
decrease in the value of the loans through a reduction in either the value of
the corresponding interest-only and residual certificates or whole loan
premiums.
The Company will continue to review its hedging strategy in order to best
mitigate risk pending securitization or loan sales.
For the twelve months ended December 31, 2000 and 1999, the Company recorded
a hedge loss of $2.1 million and a hedge gain of $3.3 million respectively,
which largely offset a change in the value of mortgage loans being hedged, as
part of its gain on sale of loans.
INFLATION
Inflation affects the Company most significantly in the area of loan
originations and can have a substantial effect on interest rates. Interest rates
normally increase during periods of high inflation and decrease during periods
of low inflation. (See "--Interest Rate Risk.")
IMPACT OF NEW ACCOUNTING STANDARDS
For discussion regarding the impact of new accounting standards, refer to
Note 1 and Note 8 of Notes to the Consolidated Financial Statements.
RISK FACTORS
Except for historical information contained herein, certain matters discussed
in this Form 10-K are "forward-looking statements" as defined in the Private
Securities Litigation Reform Act ("PSLRA") of 1995, which involve risk and
uncertainties that exist in the Company's operations and business environment,
and are subject to change on various important factors. The Company wishes to
take advantage of the "safe harbor" provisions of the PSLRA by cautioning
readers that numerous important factors discussed below, among others, in some
cases have caused, and
37
in the future could cause the Company's actual results to differ materially from
those expressed in any forward-looking statements made by, or on behalf of, the
Company. The following include some, but not all, of the factors or
uncertainties that could cause actual results to differ from projections:
o The Company's ability or inability to consummate all facets of the Second
Debt Restructuring, including without limitation, the Second Exchange Offer.
o The Company's ability or inability to continue to access lines of credit at
favorable terms and conditions, including without limitation, warehouse and
other credit facilities used to finance newly originated mortgage loans held
for sale.
o The Company's ability or inability to continue its practice of
securitization of mortgage loans held for sale, as well as its ability to
utilize optimal securitization structures at favorable terms to the Company.
o The Company's ability or inability to continue monetizing its Residual
Assets, including without limitation, selling, financing or securitizing
(through NIM transactions) such assets.
o Costs associated with litigation, compliance with the NYSBD Remediation
Agreement and NYOAG Stipulated Order on Consent, and rapid or unforeseen
escalation of the cost of regulatory compliance, generally including but not
limited to, adoption of new, or changes in state or federal lending laws and
regulations and the application of such laws and regulations, licenses,
environmental compliance, adoption of new, or changes in accounting policies
and practices and the application of such polices and practices. Failure to
comply with various federal, state and local regulations, accounting
policies, environmental compliance, and compliance with the Remediation
Agreement and Stipulated Order on Consent can lead to loss of approved
status, certain rights of rescission for mortgage loans, class action
lawsuits and administrative enforcement action against the Company.
o The Company's ability or inability to complete the all facets of the
transfer of servicing to Ocwen within the necessary time frames and as cost
efficient as possible.
o A general economic slowdown. Periods of economic slowdown or recession may
be accompanied by decreased demand for consumer credit and declining real
estate values. Because of the Company's focus on credit-impaired borrowers,
the actual rate of delinquencies, foreclosures and losses on loans affected
by the borrowers reduced ability to use home equity to support borrowings
could be higher than those generally experienced in the mortgage lending
industry. Any sustained period of increased delinquencies, foreclosure,
losses or increased costs could adversely affect the Company's ability to
securitize or sell loans in the secondary market.
o The effects of interest rate fluctuations and the Company's ability or
inability to hedge effectively against such fluctuations in interest rates;
the effect of changes in monetary and fiscal policies, laws and regulations,
other activities of governments, agencies, and similar organizations, social
and economic conditions, unforeseen inflationary pressures and monetary
fluctuation.
o Increased competition within the Company's markets has taken on many forms,
such as convenience in obtaining a loan, customer service, marketing and
distribution channels, loan origination fees and interest rates. The Company
is currently competing with large finance companies and conforming mortgage
originators many of whom have greater financial, technological and marketing
resources.
o Unpredictable delays or difficulties in development of new product programs.
o The unanticipated expenses of assimilating newly-acquired businesses into
the Company's structure; as well as the impact of unusual expenses from
ongoing evaluations of business strategies, asset valuations, acquisitions,
divestitures and organizational structures.
38
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The primary market risk to which the Company is exposed is interest rate
risk, which is highly sensitive to many factors, including governmental monetary
and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Changes in
the general level of interest rates between the time when the Company originates
or purchases mortgage loans and the time when the Company sells such mortgage
loans at securitization can affect the value of the Company's mortgage loans
held for sale and, consequently, the Company's net gain on sale revenue by
affecting the "excess spread" between the interest rate on the mortgage loans
and the interest rate paid to asset-backed investors who purchase pass-through
certificates issued by the securitization trusts. If interest rates rise between
the time the Company originates or purchases the loans and the time the loans
are sold at securitization, the excess spread generally narrows, resulting in a
loss in value of the loans and a lower net gain on sale reported by the Company.
A hypothetical 10 basis point increase in interest rates, which historically
has resulted in approximately a 10 basis point decrease in the excess spread,
would be expected to reduce the Company's net gain on sale by approximately 25
basis points. Many factors, however, can affect the sensitivity analysis
described above including, without limitation, the structure and credit
enhancement used in a particular securitization, the Company's prepayment, loss
and discount rate assumptions, and the spread over treasuries demanded by
asset-backed investors who purchase the Companies asset-backed securities.
To reduce its financial exposure to changes in interest rates, the Company
generally hedges its mortgage loans held for sale by entering into treasury rate
lock contracts (see "Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Hedging"). The Company's hedging strategy
has largely been an effective tool to manage the Company's interest rate risk on
loans prior to securitization, by providing the Company with a cash gain (or
loss) to largely offset the reduced (increase) excess spread (and resultant
lower (or higher) net gain on sale) from an increase (decrease) in interest
rates. A hedge may not, however, perform its intended purpose of offsetting
changes in net gain on sale. This was the case in the third quarter of 1998,
when asset-backed investors, responding to lower treasury yields and global
financial market volatility, demanded substantially wider spreads over
treasuries than historically experienced for newly issued asset-backed
securities. As a result, Delta's $8.8 million hedge loss resulting from lower
interest rates was not offset by a higher gain on sale as the Company has
historically seen.
Changes in interest rates could also adversely affect the Company's ability
to purchase and originate loans and/or could affect the level of loan
prepayments thereby impacting the size of the Company's loan servicing portfolio
and the value of the Company's interest only and residual certificates and
capitalized mortgage servicing rights. (See "Item 7 Management's Discussion and
Analysis of Financial Condition and Results of Operations - Interest Rate
Risk").
39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders of
Delta Financial Corporation:
We have audited the accompanying consolidated balance sheets of Delta Financial
Corporation and subsidiaries as of December 31, 2000 and 1999, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2000.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Delta Financial
Corporation and subsidiaries as of December 31, 2000 and 1999, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Melville, New York
March 29, 2001
40
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
December 31, 2000 and 1999
(Dollars in thousands) 2000 1999
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and interest-bearing deposits..................................... $ 62,270 69,557
Accounts receivable.................................................... 21,954 32,367
Loans held for sale, net............................................... 82,698 89,036
Accrued interest receivable............................................ 10,388 63,309
Capitalized mortgage servicing rights.................................. - 45,927
Interest-only and residual certificates................................ 216,907 224,659
Equipment, net......................................................... 15,034 21,721
Prepaid and other assets............................................... 37,846 10,259
Deferred tax asset, net................................................ 5,600 -
- -------------------------------------------------------------------------------------------------------------------
Total assets.................................................... $ 452,697 556,835
- -------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank payable........................................................... $ 927 1,195
Warehouse financing and other borrowings............................... 88,632 109,019
Senior Notes........................................................... 149,571 149,474
Accounts payable and accrued expenses.................................. 33,414 43,607
Investor payable....................................................... 69,489 82,204
Advance payment by borrowers for taxes and insurance................... 12,940 13,784
Deferred tax liability................................................. - 10,411
- -------------------------------------------------------------------------------------------------------------------
Total liabilities............................................... 354,973 409,694
- -------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Capital stock, $.01 par value. Authorized 49,000,000 shares;
16,000,549 shares issued and 15,883,749 shares outstanding
at December 31, 2000 and December 31, 1999.......................... 160 160
Additional paid-in capital............................................. 99,472 99,472
Retained earnings (deficit)............................................ (590) 48,827
Treasury stock, at cost (116,800 shares)............................... (1,318) (1,318)
- -------------------------------------------------------------------------------------------------------------------
Total stockholders' equity...................................... 97,724 147,141
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity...................... $ 452,697 556,835
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
41
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2000, 1999 and 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
REVENUES:
Net gain on sale of mortgage loans................ $ 47,550 78,663 91,380
Interest.......................................... 32,287 31,041 12,458
Servicing fees.................................... 14,190 16,341 10,464
Origination fees and other income................. 24,944 28,774 25,273
- -------------------------------------------------------------------------------------------------------------------
Total revenues................................. 118,971 154,819 139,575
- -------------------------------------------------------------------------------------------------------------------
EXPENSES:
Payroll and related costs......................... 56,525 65,116 56,709
Interest expense.................................. 30,386 26,656 30,019
General and administrative........................ 45,066 55,318 34,351
Restructuring and other special charges........... 49,619 - -
- -------------------------------------------------------------------------------------------------------------------
Total expenses................................. 181,596 147,090 121,079
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income tax expense (benefit)..... (62,625) 7,729 18,496
Provision for income tax expense (benefit)............ (13,208) 3,053 7,168
- -------------------------------------------------------------------------------------------------------------------
Net income (loss).............................. $ (49,417) 4,676 11,328
- -------------------------------------------------------------------------------------------------------------------
PER SHARE DATA:
Earnings (loss) per common share - basic and diluted $ (3.10) 0.30 0.74
Weighted average number of shares outstanding..... 15,920,869 15,511,214 15,382,161
---------- ---------- ----------
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
42
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 2000, 1999 and 1998
Additional
Paid-in Retained Treasury
(DOLLARS IN THOUSANDS) Capital Stock Capital Earnings Stock Total
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997................ 154 93,476 32,823 -- 126,453
Issuance of common stock related to
Fidelity Mortgage.................. 1 1,199 -- -- 1,200
Purchase of Treasury Stock (116,800 shares). -- -- -- (1,318) (1,318)
Proceeds from exercise of stock options..... -- 25 -- -- 25
Net income.................................. -- -- 11,328 -- 11,328
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998................ 155 94,700 44,151 (1,318) 137,688
Issuance of common stock related to
Legal Settlement........................... 5 4,772 -- -- 4,777
Net income.................................. -- -- 4,676 -- 4,676
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999................ $ 160 99,472 48,827 (1,318) 147,141
Net loss.................................... -- -- (49,417) -- (49,417)
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000................ $ 160 99,472 (590) (1,318) 97,724
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
43
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2000, 1999 and 1998
(DOLLARS IN THOUSANDS) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss)...................................... $ (49,417) 4,676 11,328
Adjustments to reconcile net income (loss) to net cash used in
Operating activities:
Provision for loan and recourse losses............... 670 100 750
Depreciation and amortization........................ 12,912 5,841 4,386
Issuance of common stock related to legal settlement. -- 4,777 --
Deferred tax benefit................................. (16,011) (8,437) (6,064)
Capitalized mortgage servicing rights, net
of amortization.................................... 45,927 (12,437) (10,628)
Deferred origination costs .......................... 174 114 1,840
Interest-only and residual certificates received in
securitization transactions, net................... 7,752 (20,856) (35,994)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable, net...... 10,413 (9,818) 5,755
Decrease (increase) in loans held for sale, net...... 6,159 (2,010) (9,793)
Decrease (increase) in accrued interest receivable... 52,921 (16,412) (17,299)
(Increase) decrease in prepaid and other assets...... (33,071) 411 385
(Decrease) increase in accounts payable
and accrued expenses................................ (10,205) 22,571 7,648
(Decrease) increase in investor payable.............. (12,715) 18,414 22,938
(Decrease) increase in advance payment by borrowers
for taxes and insurance............................ (844) 4,225 3,809
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities..... 14,665 (8,841) (20,939)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of equipment................................ (1,297) (9,330) (8,982)
- -------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities................... (1,297) (9,330) (8,982)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
(Repayment of) proceeds from warehouse
financing and other borrowings, net.................. (20,387) 28,746 52,040
Decrease in bank payable, net........................ (268) (201) (826)
Proceeds from exercise of stock options................. -- -- 25
Purchase of treasury stock.............................. -- -- (1,318)
- -------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities..... (20,655) 28,545 49,921
- -------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and interest-bearing deposits (7,287) 10,374 20,000
Cash and interest-bearing deposits at beginning of year.... 69,557 59,183 39,183
- -------------------------------------------------------------------------------------------------------------------
Cash and interest-bearing deposits at end of year......... $ 62,270 69,557 59,183
- -------------------------------------------------------------------------------------------------------------------
Supplemental Information:
Cash paid during the year for:
Interest ............................................... $ 29,974 24,085 29,576
Income taxes ........................................... 2,010 11,489 7,241
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
44
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, AND 1998
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) ORGANIZATION
Delta Financial Corporation (the "Company" or "Delta") is a Delaware
corporation, which was organized in August 1996. On October 31, 1996, the
Company acquired all of the outstanding common stock of Delta Funding
Corporation ("Delta Funding"), a New York corporation which had been organized
on January 8, 1982 for the purpose of originating, selling, servicing and
investing in residential first and second mortgages. On November 1, 1996, the
Company completed an initial public offering of 4,600,000 shares of common
stock, $.01 par value.
(B) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements are prepared on the
accrual basis of accounting and include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Certain prior period amounts in the financial statements and notes have been
reclassified to conform with the current year presentation.
(C) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management of the Company to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
(D) LOAN ORIGINATION FEES AND COSTS
Loan origination fees received net of direct costs of originating or
acquiring mortgage loans, are recorded as adjustments to the initial investment
in the loan. Such fees are deferred until the loans are securitized or sold.
(E) LOANS HELD FOR SALE, NET
Loans held for sale are accounted for at the lower of cost or estimated
market value, determined on a net aggregate basis. Cost includes unamortized
loan origination fees and costs. Net unrealized losses are provided for in a
valuation allowance created through a charge to operations. Losses are
recognized when the market value is less than cost.
(F) SECURITIZATION AND SALE OF MORTGAGE LOANS
The Company sells loans to a loan securitization trust and receives the
excess value of the loans' economic interests in exchange for (i) the difference
between the interest payments due on the loans sold to the trust and the
interest payments due, at the pass-through rates, to the holders of the
pass-through certificates, less the Company's contractual servicing fee and
other costs and expenses of administering the trust, represented by
interest-only and residual certificates, and (ii) the right to service the loans
on behalf of the trust and earn a contractual servicing fee, as well as other
ancillary servicing related fees directly from the borrowers on the underlying
loans.
Upon the securitization of a pool of loans, the Company recognizes as
origination fees any then unamortized origination fees which had initially been
recorded as adjustments to the Company's investment in the loans, and
additionally allocates portions of the remaining investment in the loans sold to
each of (i) the servicing rights retained by the Company and (ii) the
interest-only and residual certificates received from the trust. The retained
servicing rights and interest-only and residual certificates are initially
recorded based upon their fair value, which is estimated based on the stated
terms of the transferred loans adjusted for estimates of future prepayments or
defaults among those loans. The Company recognizes a gain equal to the
difference between the investment in the loans remaining after this allocation
and the cash payment received from the trust.
45
(G) CAPITALIZED MORTGAGE SERVICING RIGHTS
The Company recognizes as separate assets the rights to service mortgage
loans for others, however those servicing rights are acquired. The Company
assesses the capitalized mortgage servicing rights for impairment. Mortgage
servicing rights are amortized in proportion to and over the period of the
estimated net servicing income.
(H) INTEREST-ONLY AND RESIDUAL CERTIFICATES
The interest-only and residual certificates, received by the Company upon the
securitization of a pool of loans to the securitization trust, are accounted for
as trading securities. The amount initially allocated to the interest-only and
residual certificates at the date of a securitization reflects the fair value of
those interests. The amount recorded for the certificates is reduced for
distributions thereon which the Company receives from the related trust, and is
adjusted for the subsequent changes in the fair value of these certificates
which are reflected on the statement of income. The fair value of interest-only
and residual certificates is determined using the same prepayment and default
estimates utilized in valuing servicing rights, together with the consideration
of the geographic location and value of loan collateral, the value of which
would affect the credit loss sustained by a trust upon the default of a loan.
The Company has consistently applied the more conservative cash-out method in
valuing the future cash flows of residual certificates.
(I) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments,"
requires the Company to disclose the fair value of financial instruments for
which it is practicable to estimate fair value. Fair value is defined as the
amount at which a financial instrument could be exchanged in a current
transaction between willing parties, other than in a forced sale or liquidation,
and is best evidenced by a quoted market price. Other than interest-only and
residual certificates which are reported at fair value, and capitalized mortgage
servicing rights, substantially all the Company's assets and liabilities deemed
to be financial instruments are carried at cost, which approximates their fair
value. The fair value of capitalized mortgage servicing rights represents the
Company's estimate of the expected future net servicing revenue based on common
industry assumptions, as well as on the Company's historical experience.
(J) GOODWILL
Goodwill, which represents the excess of the purchase price over the fair
value of the net assets acquired, is being amortized on a straight-line basis
over seven years. The Company evaluates goodwill periodically for impairment in
response to changes in circumstances or events.
(K) REAL ESTATE OWNED
Properties acquired through foreclosure or a deed in lieu of foreclosure are
recorded at the lower of the unpaid loan balance, or fair value, at the date of
acquisition. The carrying value of the individual properties is subsequently
adjusted to the extent it exceeds estimated fair value less costs to sell, at
which time a provision for losses on such real estate is charged to operations.
(L) EQUIPMENT, NET
Equipment, including leasehold improvements, is stated at cost, less
accumulated depreciation and amortization. Depreciation of equipment is computed
using the straight-line or accelerated method over the estimated useful lives of
three to seven years. Leasehold improvements are amortized over the lesser of
the terms of the lease or the estimated useful lives of the improvements.
Expenditures for betterments and major renewals are capitalized and ordinary
maintenance and repairs are charged to operations as incurred.
(M) SERVICING FEES
Servicing fees includes servicing income and prepayment penalties for
servicing mortgage loans owned by investors. All fees and charges are recognized
into income when earned.
(N) INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax effects
of differences between the financial reporting and tax bases of assets and
liabilities. These deferred taxes are measured by applying current enacted tax
rates.
(O) EARNINGS PER SHARE
Basic Earnings Per Share ("EPS") excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects
46
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.
(P) STOCK OPTION PLAN
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation,"
the company continues to apply the provisions of the Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and provide
pro forma net income and pro forma earnings per share disclosures for employee
stock option grants as if the fair-value based method defined in SFAS No. 123
had been applied.
(Q) SEGMENT REPORTING
The Company operates as one reporting segment, as such, the segment
disclosure requirements, are not applicable to the Company.
(R) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No.
140, which replaces SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," provides accounting and
reporting standards for securitizations and other transfers of assets. The
Standard is based on the application of a financial components approach that
focuses on control, and provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. The Standard requires disclosure of information about securitized
assets, including principal outstanding of securitized and other managed assets,
accounting policies, key assumptions related to the determination of the fair
value of retained interests, delinquencies and credit losses. The accounting
requirements of the Standard are effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March 31,
2001, and must be applied prospectively. The disclosures related to
securitization transactions are required for fiscal years ending after December
15, 2000, and comparative disclosures for prior periods are not required. The
Company has provided the required disclosures as of December 31, 2000 in Note 7
of the "Notes to Consolidated Financial Statements" and does not expect the
impact of the accounting requirements of the Standard to be material to its
financial position or results of operations in future periods.
(2) SUMMARY OF REGULATORY SETTLEMENTS
In September 1999, the Company settled allegations by the New York State
Banking Department ("NYSBD") and a lawsuit by the New York State Office of the
Attorney General ("NYOAG") alleging that Delta had violated various state and
federal lending laws. The global settlement was evidenced by that certain (a)
Remediation Agreement by and between Delta Funding and the NYSBD, dated as of
September 17, 1999 and (b) Stipulated Order on Consent by and among Delta
Funding, Delta Financial and the NYOAG, dated as of September 17, 1999. As part
of the Settlement, Delta, among other things, implemented agreed upon changes to
its lending practices; is providing reduced loan payments aggregating $7.25
million to certain borrowers identified by the NYSBD; and created a fund
financed by the grant of 525,000 shares of Delta Financial's common stock, the
proceeds of which will be used, for among other things, to pay borrowers and for
a variety of consumer educational and counseling programs.
In March 2000, the Company finalized an agreement with the U.S. Department of
Justice, the Federal Trade Commission and the Department of Housing and Urban
Development, to complete the global settlement it had reached with the NYSBD and
NYOAG. The Federal agreement mandates some additional compliance efforts for
Delta, but it does not require any additional financial commitment by Delta.
(3) RESTRUCTURING CHARGE
In August 2000, Delta announced a corporate restructuring in its continuing
efforts to improve operating efficiencies and to address its negative cash flow
from operations. During the third quarter of 2000, the Company recorded a $6.7
million pre-tax charge related to this restructuring, which is included in
restructuring and other special charges in the consolidated statements of
operations. This charge primarily relates to employee severance associated with
layoffs, a reduction to goodwill and office equipment write-offs.
47
The following table sets forth the components of the Company's restructuring
charge (in thousands):
Write down of fixed assets $2,394
Goodwill impairment 2,106
Write down of lease obligations 1,521
Employment termination payments 656
--------
Total provision charged to income $6,677
--------
The Company has a remaining unpaid accrued restructuring charge balance at
December 31, 2000 of $1.3 million that is comprise primarily of unpaid lease
obligations and other miscellaneous fees.
(4) LOANS HELD FOR SALE, NET
The Company's inventory consists of first and second mortgages which had a
weighted average interest rate of 11.4% at December 31, 2000. These mortgages
are being held, at the lower of cost or estimated market value, for future sale.
Certain of these mortgages are pledged as collateral for a portion of the
warehouse financing and other borrowings.
Included in loans held for sale are deferred origination fees and purchase
premiums in the amount of $1.4 million and $1.5 million at December 31, 2000 and
1999, respectively. The Company did not have a market valuation allowance at
December 31, 2000. The Company had a market valuation allowance of $0.6 million
at December 31, 1999. Mortgages are payable in monthly installments of principal
and interest and have terms varying from five to thirty years.
(5) ACCOUNTS RECEIVABLE
Accounts receivable as of December 31, consist of the following:
(DOLLARS IN THOUSANDS) 2000 1999
- ------------------------------------------------------------------------------
Securitization servicing advances $ 14,329 25,994
Prepaid insurance premiums 2,047 1,868
Current tax assets 572 846
Other 5,006 3,659
- ------------------------------------------------------------------------------
Total accounts receivable $ 21,954 32,367
- ------------------------------------------------------------------------------
(6) CAPITALIZED MORTGAGE SERVICING RIGHTS
The Company recognizes rights to service mortgage loans as separate assets.
The total cost of mortgage loans sold or securitized is allocated between the
loans and the servicing rights based upon the relative fair values of each.
Purchased Mortgage Servicing Rights ("MSRs") are initially recorded at cost. All
MSRs are subsequently carried at the lower of the initial carrying value,
adjusted for amortization and deferred hedge gains/losses, or fair value. Fair
values are estimated based on market prices for similar MSRs and on the
discounted anticipated future net cash flows considering market loan prepayment
predictions, interest rates, servicing costs and other economic factors. For
purposes of impairment evaluation and measurement, the Company stratifies MSRs
based on predominant risk characteristics of the underlying loans, including
loan type, amortization type (fixed or adjustable) and note rate. To the extent
that the carrying value of MSRs exceeds fair value by individual stratum, a
valuation reserve is established, which is adjusted in the future as the value
of MSRs increases or decreases. The cost of MSRs is amortized in proportion to,
and over the period of, estimated net servicing income.
The Company recognized a $38.2 million write-down, which represents the
entire carrying value of its MSR at December 31, 2000. In December 2000, the
Company entered into discussions with three third-party sub-prime servicers to
either purchase or sub-service the Company's entire $3.31 billion servicing
portfolio. Based upon the seasoning of the Company's loan portfolio, the high
costs associated with monthly and servicing advances necessary to maintain a
seasoned loan portfolio, and the nominal amount of ancillary service fee income,
the three servicers' bids for the portfolio all approximated par, meaning that
none of the bidders believed a purchase premium was justified. Following three
consecutive quarters of selling its mortgage servicing rights on newly issued
securitizations (beginning in the second quarter of 2000) for a cash premium,
the Company was left with a more seasoned, and therefore more costly, servicing
portfolio requiring significant cash outlays for monthly delinquency and
servicing advances, which adversely impacted the overall value of the remaining
loan portfolio. Therefore,
48
management felt this write-down was necessary to reflect the current market
price it would have received at December 31, 2000 for its servicing portfolio.
Prior to soliciting bids in December 2000, management believed that the carrying
value of its MSR was validated as the cash purchase price (premium) the Company
received from selling the servicing rights associated with its securitizations
in June 2000 and September 2000 exceeded the carrying value of the MSR stated as
a percentage of the Company's entire loan servicing portfolio. However, these
specific pools were less seasoned, with lower amounts of monthly and servicing
advance obligations, and generated higher ancillary service fee income.
The activity related to the Company's capitalized mortgage servicing rights
for the years ended December 31, is as follows:
(DOLLARS IN THOUSANDS) 2000 1999 1998
- ------------------------------------------------------------------------------
Balance, beginning of year $45,927 33,490 22,862
Additions 11,611 20,542 19,833
Amortization and FV adjustments (8,916) (8,105) (9,205)
Sales (10,385) - -
Writedown (38,237) - -
- ------------------------------------------------------------------------------
Balance, end of year $ 0 45,927 33,490
- ------------------------------------------------------------------------------
The writedown of $38.2 million is included in restructuring and other
special charges, in the consolidated statements of operations.
(7) INTEREST-ONLY AND RESIDUAL CERTIFICATES
The interest that the Company receives upon sales through securitizations is
in the form of interest-only and residual mortgage securities which are
classified as interest-only and residual certificates.
Upon the sale or securitization of a loan, a gain on sale and a corresponding
asset is recognized for any interest-only and residual certificates. These
assets are classified as "trading securities" and, as such, they are recorded at
their fair value. Fair value of these certificates has been determined by the
Company based on various economic factors, including loan type, sizes, interest
rates, dates of origination, terms and geographic locations, using the more
conservative cash-out method. The Company also uses other available information
such as reports on prepayment rates, interest rates, collateral value, economic
forecasts and historical default and prepayment rates of the portfolio under
review. Any fair value adjustment of the interest-only and residual certificates
is recognized in the statement of income and is reflected as a component of
interest income.
Although the Company believes it has made reasonable estimates of the fair
value of the interest-only and residual certificates likely to be realized, the
rate of prepayments and the amount of defaults utilized by the Company are
estimates and actual experience may vary. The gain on securitization recognized
by the Company upon the sale of loans through securitizations will be overstated
if prepayments or losses are greater than anticipated. Higher than anticipated
rates of loan prepayments or losses would require the Company to write down the
fair value of the interest-only and residual certificates, adversely impacting
earnings. Similarly, if delinquencies, liquidations or interest rates were to be
greater than was initially assumed, the fair value of the interest-only and
residual certificates would be negatively impacted, which would have an adverse
effect on income for the period in which such events occurred. Should the
estimated loan life assumed for this purpose be shorter than the actual life,
the amount of cash actually received over the lives of the loans would exceed
the gain previously recognized at the time the loans were sold through
securitizations and would result in additional income. The Company assumes
prepayment rates and defaults based upon the seasoning of its existing
securitization loan portfolio.
The Company's underlying assumptions used in determining the fair value of
its interest-only and residual certificates are as follows:
(a)Prepayment rate assumptions are based upon the Company's on-going
analysis of industry and Company pool trends, the most recent adjustments
to these assumptions were made in the third quarter of 2000 and the fourth
quarter of 1999. The following table shows the changes to the prepayment
assumptions at each of these dates and the assumptions used prior to the
1999 fourth quarter change:
49
- -------------------------------- -------------------------------------- --------------------------------------
Month One Speed Peak Speed *
- -------------------------------- ----------- ------------- ------------ ------------ ------------- -----------
Loan Type 9/30/00 12/31/99 Prior 9/30/00 12/31/99 Prior
- -------------------------------- ----------- ------------- ------------ ------------ ------------- -----------
Fixed Rate Loans 4.0% 4.0% 4.8% 23% 31% 31%
- -------------------------------- ----------- ------------- ------------ ------------ ------------- -----------
Six-Mo. LIBOR ARMS 10.0% 10.0% 10.0% 50% 50% 50%
- -------------------------------- ----------- ------------- ------------ ------------ ------------- -----------
Hybrid ARMS 4.0% 4.0% 6.0% 50% 50% 50%
- -------------------------------- ----------- ------------- ------------ ------------ ------------- -----------
* Since the second quarter of 1998, the Company has utilized a "vector" curve,
instead of a "ramp" curve, which the Company believes will be more
representative of future loan prepayment experience.
(b)A default reserve for both fixed- and adjustable-rate loans sold to the
securitization trusts of 3.50% of the amount initially securitized at
December 31, 2000 compared to 3.10% at December 31, 1999 and 2.00% at
December 31, 1998; and
(c)Under the "cash-out" method, an annual discount rate of 13.0% was used in
determining the present value of cash flows from residual certificates,
which represent the predominant form of retained interest, at December 31,
2000, up from 12% prior thereto. An annual discount rate of 18% is used
during the duration of the Net Interest Margin ("NIM") transaction on a
portion of the Company's residual certificates.
In the third quarter of 2000, the Company lowered its prepayment speed
assumptions mainly by reducing the peak speed on its fixed rate product, which
comprises the majority of the Company's servicing portfolio. In the fourth
quarter of 1999, the Company lowered its prepayment speed assumption along parts
of the prepayment rate vector curve while leaving the peak speeds intact.
The prepayment rate assumption was revised primarily to reflect the Company's
actual loan performance experience over the past several quarters. The loan loss
reserve assumption was revised to reflect management's belief that (i) slower
prepayment speeds, (ii) anticipated flat to slightly moderate rise in home
values as compared to the past few years and (iii) the inability of borrowers to
refinance their mortgages to avoid default because of industry consolidation and
higher interest rates may have an adverse effect on the Company's non-performing
loans.
In the third and fourth quarters of 2000, the Company changed the discount
rate it uses in determining the present value of cash flows from residual
certificates, as follows:
a. In the third quarter of 2000, the Company increased the discount rate
its uses on those residual certificates included in the NIM Transaction to 18%
(from 12%) and recorded an $8.8 million valuation adjustment. This adjustment
reflects a reduction in the present value of those residual certificates sold in
connection with the Company's NIM transaction completed in the fourth quarter of
2000. The Company increased the discount rate on these residual certificates,
during the period that the senior NIM securities will be outstanding, to account
for the potentially higher risk associated with the residual cash flows the
Company will retain from a certificated interest in the NIM trust, which is
subordinated to the senior security sold in the NIM transaction.
b. In the fourth quarter of 2000, the Company raised the annual discount
rate it uses in determining the present value of cash flows from "senior"
residual certificates (I.E., those residuals that are not subject to a NIM
Transaction) to 13% from 12%, and recorded a $7.1 million valuation adjustment.
This adjustment reflects what management believes is an increase in volatility
concerning the other underlying assumptions used in estimating expected future
cash flows due to greater uncertainty surrounding current and future market
conditions, including without limitation, inflation, recession, home prices,
interest rates and equity markets.
For 2000, the Company recorded a non-cash increase of $9.6 million to its
interest income for its interest only and residual certificates, due to the
decrease in one-month LIBOR. Some of the Company's interest-only and residual
certificates are backed by floating rate securities, which are susceptible to
interest rate risk (positive or negative) associated with a movement in
short-term interest rates.
50
The activity related to the Company's interest-only and residual certificates
for the years ended December 31, is as follows:
(DOLLARS IN THOUSANDS) 2000 1999 1998
- ------------------------------------------------------------------------------
Balance, beginning of year $224,659 203,803 167,809
Additions 32,716 48,356 85,092
Cash remittances, accretion
of discount and FV
adjustments, net (40,468) (27,500) (49,098)
- ------------------------------------------------------------------------------
Balance, end of year $ 216,907 224,659 203,803
- ------------------------------------------------------------------------------
At December 31, 2000, key economic assumptions and the sensitivity of the
current estimated fair value of retained interests caused by immediate 10% and
20% adverse changes in those assumptions are as follows:
(DOLLARS IN MILLIONS)
Carrying amount of retained interests $216,907
PREPAYMENT SPEED (ANNUAL RATE)
Impact of 10% change $ 22,588
Impact of 20% change 40,668
EXPECTED CREDIT LOSSES (ANNUAL RATE)
Impact of 10% change $ 12,557
Impact of 20% change 24,272
DISCOUNT RATE (ANNUAL)
Impact of 10% change $ 21,505
Impact of 20% change 26,060
These sensitivities are hypothetical and are presented for illustrative
purposes only. Changes in carrying amount based on a change in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in carrying amount may not be linear. The changes in
assumptions presented in the above table were calculated without changing any
other assumption; in reality, changes in one assumption may result in changes in
another, which may magnify or counteract the sensitivities. For example, changes
in market interest rates may simultaneously impact repayment speed, credit
losses and the discount rate.
(8) HEDGING TRANSACTIONS
The Company regularly securitizes and sells fixed-rate mortgage loans. To
offset the effects of interest rate fluctuations on the value of its fixed-rate
loans held for sale, the Company in certain cases will hedge its interest rate
risk related to loans held for sale through the use of treasury lock contracts
which function similar to a short-sale of US Treasury securities and/or FNMA
mortgage securities. The Company accounts for these contracts as hedges of
specific loans held for sale. The gain or loss derived from these contracts is
deferred and recognized as an adjustment to the carrying amounts of the loans
for which the contracts were interest rate hedges.
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as of January 1, 2001. The Standard requires that all
derivative instruments be recorded in the balance sheet at fair value. However,
the accounting for changes in fair value of the derivative instrument depends on
whether the derivative instrument qualifies as a hedge. If the derivative
instrument does not qualify as a hedge, changes in fair value are reported in
earnings when they occur. If the derivative instrument qualifies as a hedge, the
accounting treatment varies based on the type of risk being hedged.
As of December 31, 2000, 1999 and 1998, the Company did not have open hedge
positions. The Company included a loss of $2.1 million, a gain of $3.3 million
and a loss of $10.2 million on its hedges as part of gains on sale of loans in
2000, 1999 and 1998, respectively.
51
(9) WAREHOUSE FINANCING AND OTHER BORROWINGS
The Company has one warehouse credit facility for an amount of $200.0 million
as of December 31, 2000. This line is collateralized by specific mortgage
receivables, which are equal to or greater than the outstanding balances under
the line at any point in time.
The following table summarizes certain information regarding warehouse
financing and other borrowings at December 31:
(DOLLARS IN MILLIONS)
Facility Balance Expiration
Facility Description Amount Rate 2000 1999 Date
- -------------------------------------------------------------------------------------------------------------------
Warehouse line of credit $200.0 Libor + 1.00% $ 74.9 $ -- May 2001
Warehouse line of credit n/a Libor + 1.00% -- 42.9 April 2000
Warehouse line of credit n/a Fed Funds + 1.075% -- 51.8 June 2000
Term loan n/a 8.15% 0.3 0.2 June 2001
Capital leases n/a 6.63% - 10.25% 11.4 14.1 Oct 2000 - Nov 2004
Other Borrowings n/a 7.00% - 8.00% 2.0 -- --
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, $200.0 $88.6 $109.0
- -------------------------------------------------------------------------------------------------------------------
(10) SENIOR NOTES
The Company's outstanding 9.5% Senior Notes due 2004 (the "Senior Notes")
totaled $149.6 million at December 31, 2000, and $149.5 million at December 31,
1999, net of unamortized bond discount. The Senior Notes bear interest at a rate
of 9.5% per annum, payable semi-annually commencing on February 1, 1998. The
Senior Notes were issued on July 23, 1997, and mature on August 1, 2004 when all
outstanding principal is due.
Costs incurred with the issuance of the notes, in the amount of $4.8 million,
have been deferred and are being amortized over a seven-year term using a method
that approximates level-yield. The unamortized debt issuance cost was $2.9
million at December 31, 2000 and $3.5 million at December 31, 1999.
In August 2000, the Company announced an agreement to modify the Senior Notes
(the "Debt Modification"). With the consent of greater than fifty percent of its
Senior Noteholders, a negative pledge covenant in the Senior Notes Indenture was
modified. The covenant had previously prevented the Company from selling or
otherwise obtaining financing against any of its interest-only or residual
certificates. In consideration for the Senior Noteholders' consent, the Company
agreed, through an exchange offer (the "Exchange Offer"), to offer current
Senior Noteholders the option to exchange their then existing Senior Notes for
(a) new senior secured notes (the "Senior Secured Notes") and (b) ten-year
warrants to buy approximately 1.6 million shares of common stock, at an initial
exercise price of $9.10 per share, subject to upward or downward adjustment in
certain circumstances. The Senior Secured Notes have the same coupon, face
amount and maturity date as the Senior Notes and are secured by at least $165
million of the Company's Residual Assets. The Exchange Offer was consummated in
December 2000, with holders of more than $148 million of Senior Notes tendering
their notes in the exchange.
In February 2001, the Company entered into a letter of intent with the
beneficial holders of over fifty percent of its Senior Secured Notes to
restructure, and ultimately extinguish, the Senior Secured Notes (the "Second
Debt Restructuring"). In March 2001, the Company obtained the formal consent of
these holders of the Senior Secured Notes through a Consent Solicitation that
modified certain provisions of the Senior Secured Notes Indenture to, among
other things, allow for the release of two residual certificates currently
securing the Senior Secured Notes. In consideration for the Noteholders'
consent, the Company has agreed to offer the Senior Secured Noteholders the
option to exchange their existing Notes (the "Second Exchange Offer") for new
securities that will evidence a commensurate interest in a Liquidating Trust (to
be formed in connection with the Second Exchange Offer), into which residual
certificates currently securing the Company's obligations under the Senior
Secured Notes (totaling approximately $150 million) will be transferred. The
Second Debt Restructuring will also provide for, among other things, the
following:
52
(a)The Liquidating Trust will receive $15 million of newly issued
preferred stock bearing a 10% dividend payable semi-annually (with the
first three dividends payable in kind). Delta may redeem the preferred
stock at its liquidation preference plus accrued dividends at any time
prior to its conversion (which can occur only once five dividends have
not been paid in cash).
(b)The Company will receive all cash flows from the residual certificates
transferred into the Liquidating Trust through and including the June
2001 distributions. Thereafter, the Company will earn a management fee
in return for its oversight and its efforts to maximize the value of
the Residual Assets in the Liquidating Trust, and for absorbing certain
costs and fees on behalf of the Liquidating Trust.
(c)The Company monetizing the two residual certificates together with
other residual certificates owned by the Company but not securing the
Senior Secured Notes, to provide additional working capital.
In March 2001, in connection with the Second Debt Restructuring, the Company
entered into a forward purchase agreement to sell five of its residual
certificates in the second quarter of 2001 for a $15 million cash purchase
price. The purchasers of these five residuals have provided bridge financing, in
the form of residual financing, of approximately $9.6 million. The remainder of
the purchase price will be paid to the Company upon the transfer of servicing to
Ocwen. The proceeds from the residual financing and subsequent sale will be used
by the Company for working capital. These residual certificates are being sold
at a significant discount to the Company's book value for such certificates and,
as such, the Company expects to record an approximately $27 million pre-tax
non-cash charge in the first quarter of 2001.
(11) BANK PAYABLE
In order to maximize its cash management practices, the Company has
instituted a procedure whereby checks written against its operating account are
covered as they are presented to the bank for payment, either by drawing down
its lines of credit or from subsequent deposits of operating cash. Bank payable
represents the checks outstanding at December 31, 2000 and 1999, to be paid in
this manner.
(12) INVESTOR PAYABLE
Investor payable represents the collection of mortgage payments by the
Company as servicer, from mortgagors, which are due to the investors,
representing primarily securitization trusts. These funds, when collected, are
placed in segregated bank accounts as provided by the related servicing
agreements and are reflected on the Company's balance sheet as a component of
cash and interest-bearing deposits.
(13) EMPLOYEE BENEFIT PLANS
The Company had an employee profit sharing plan covering all eligible
employees, as defined, with at least 30 months of service. Effective January 1,
1997, the employee profit sharing plan was merged with the Company's 401(k)
Retirement Savings Plan.
The Company sponsors a 401(k) Retirement Savings Plan. Substantially all
employees of the Company who are at least 21 years old are eligible to
participate in the plan after completing one year of service. Contributions are
made from employees' elected salary deferrals. The Company elected to make
discretionary contributions to the Plan of $0.7 million, $0.8 million and $0.5
million for 2000, 1999 and 1998, respectively.
(14) COMMITMENTS AND CONTINGENCIES
The Company has repurchase agreements with certain of the institutions that
have purchased mortgages. Currently, some of the agreements provide for the
repurchase by the Company of any of the mortgage loans that go to foreclosure
sale. At the foreclosure sale, the Company will repurchase the mortgage, if
necessary, and make the institution whole. The dollar amount of loans, which
were sold with recourse, is $6.2 million at December 31, 2000 and $8.1 million
at December 31, 1999.
Included in accounts payable and accrued expenses is an allowance for
recourse losses of $1.5 million and 1.4 million at December 31, 2000 and
December 31, 1999, respectively. The Company recognized, as a charge to
operations, a provision for recourse losses of $11,600, $70,000 and $720,000 for
the years 2000, 1999 and 1998,
53
respectively. Additions to the allowance for loan losses are provided by charges
to income based upon various factors, which, in management's judgment, deserve
current recognition in estimating probable losses. The loss factors are
determined by management based upon an evaluation of historical loss experience,
delinquency trends, loan volume and the impact of economic conditions in our
market area.
The Company's rental expense, net of sublease income, for the years ended
December 31, 2000, 1999 and 1998 amounted to $7.0 million, $6.4 million and $5.4
million, respectively.
Minimum future rentals under non-cancelable operating leases as of December
31, 2000 are as follows:
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------
Year Amount
- ------------------------------------------------------------------------------
2001 $ 4,713
2002 3,556
2003 2,663
2004 2,330
2005 2,137
Thereafter 5,080
- ------------------------------------------------------------------------------
Total $ 20,479
- ------------------------------------------------------------------------------
Because the nature of the Company's business involves the collection of
numerous accounts, the validity of liens and compliance with various state and
federal lending laws, the Company is subject, in the normal course of business,
to numerous legal proceedings and claims, including several class action
lawsuits. The resolution of these lawsuits, in management's opinion, will not
have a material adverse effect on the financial position or results of
operations of the Company.
(15) STOCK OPTION PLAN
In October 4, 1996, the Board of Directors ratified the 1996 Stock Option
Plan (the "Plan") and authorized the reserve of 2,200,000 shares of authorized
but unissued common stock for issuance pursuant to the Plan. Substantially all
of the options issued vest over a five-year period at 20% per year and expire
seven years from the grant date.
The following table summarizes certain information regarding the Plan at
December 31:
2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Number Wtd-Avg Number Wtd-Avg Number Wtd-Avg
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
- -------------------------------------------------------------------------------------------------------------------
Balance, beginning of year 1,148,050 $12.44 795,060 $16.96 848,760 $17.01
Options granted 20,000 2.00 495,350 5.84 77,000 17.35
Options exercised - - - - 1,500 16.50
Options canceled 175,350 11.57 142,360 14.75 129,200 17.54
- -------------------------------------------------------------------------------------------------------------------
Balance at end of year 992,700 $12.38 1,148,050 $12.44 795,060 $16.96
- -------------------------------------------------------------------------------------------------------------------
Options exercisable 514,120 $15.18 335,400 $16.76 242,862 $16.77
- -------------------------------------------------------------------------------------------------------------------
The Company applies APB Opinion No. 25, and related Interpretations in
accounting for the Plan. There was no intrinsic value of the options granted, as
the exercise price was equal to the quoted market price at the grant date.
Accordingly, no compensation cost has been recognized for the years ended
December 31, 2000, 1999 and 1998.
Had compensation cost for the Plan been determined based on the fair value at
the grant dates for awards under the Plan consistent with the method of SFAS No.
123, the Company's net income (loss) would have been $(49.4) million, $4.5
million and $10.8 for 2000, 1999 and 1998, respectively. Earnings (loss) per
share for 2000, 1999 and 1998 would have been ($3.10), $0.29 and $0.71,
respectively.
54
The weighted-average fair value of options granted during 2000, 1999 and 1998
was $0.34, $3.86 and $9.14, respectively. For purposes of the pro forma
calculation under SFAS No. 123, the fair value of the options granted is
estimated using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for the 2000, 1999 and 1998 grants:
2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Dividend yield 0% 0% 0%
Expected volatility 145% 78% 55%
Risk-free interest rate 6.14% 4.54% 4.54%
Expected life 5 years 5 years 5 years
(16) INCOME TAXES
The (benefit) provision for income taxes for the years ended December 31,
2000, 1999 and 1998 is as follows:
(DOLLARS IN THOUSANDS) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Current: Federal $ 2,203 9,777 11,291
State 600 1,713 1,941
- -------------------------------------------------------------------------------------------------------------------
Total current income taxes $ 2,803 11,490 13,232
- -------------------------------------------------------------------------------------------------------------------
Deferred: Federal $ (19,860) (7,172) (4,586)
State (4,448) (1,265) (1,478)
Valuation allowance 8,297 -- --
- -------------------------------------------------------------------------------------------------------------------
Total deferred income taxes $ (16,011) (8,437) (6,064)
- -------------------------------------------------------------------------------------------------------------------
Total tax (benefit) provision $ (13,208) 3,053 7,168
- -------------------------------------------------------------------------------------------------------------------
Significant components (temporary differences and carryforwards) that give
rise to the Company's net deferred tax asset (liability) as of December 31, 2000
and 1999 were as follows:
DOLLARS IN THOUSANDS)
2000 1999
---- ----
DEFERRED TAX ASSETS:
- -------------------------------------------------------------------------------------------------------------------
Book over tax basis in mortgage servicing asset $ -- 125
Loss reserves 5,306 4,992
Federal and State net operating loss carryforwards 25,318 21,873
- -------------------------------------------------------------------------------------------------------------------
Gross deferred tax assets $ 30,624 26,990
Less: Valuation allowance 8,297 --
- -------------------------------------------------------------------------------------------------------------------
Deferred tax assets net of valuation allowance $ 22,327 26,990
- -------------------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
- -------------------------------------------------------------------------------------------------------------------
Capitalized cost of future servicing income $ -- 17,911
Book/tax difference in interest-only and residual certificate
carrying amount 14,123 17,275
Tax over book depreciation 2,055 1,612
Capitalized origination fees and related cost 549 603
- -------------------------------------------------------------------------------------------------------------------
Gross deferred tax liabilities $ 16,727 37,401
- -------------------------------------------------------------------------------------------------------------------
Net deferred tax assets (liabilities) $ 5,600 (10,411)
- -------------------------------------------------------------------------------------------------------------------
The Company is required to recognize all or a portion of its gross deferred
tax assets if it believes that it is more likely than not, given the weight of
all available evidence, that all or a portion of the benefits of the
carryforward losses and other deferred tax assets will be realized. Management
believes that, based on the available evidence, it
55
is more likely than not that the Company will realize the benefit from its gross
deferred tax assets, net of the valuation allowance.
A valuation allowance of $8.3 million was established in 2000 because the
Company believes that it will have insufficient earnings in the immediate future
to ensure realization of its entire gross deferred tax assets.
As of December 31, 2000 Federal and State net operating loss carryforwards
("NOLs") totaled $63.2 million, with $1.9 million expiring in 2012 and $61.3
million expiring in various years from 2018 through 2020.
A reconciliation of the statutory income tax rate to the effective income tax
rate, as applied to income (loss) for the years ended December 31, 2000, 1999
and 1998 is as follows:
2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Tax at statutory rate 35.0% 35.0% 35.0%
State & local taxes, net of Federal benefit 4.0 1.1 1.7
Change in valuation allowance for deferred tax assets (13.2) -- --
Non-deductible expenses and other (4.7) 3.4 2.1
- -------------------------------------------------------------------------------------------------------------------
Total tax rate 21.1% 39.5% 38.8%
- -------------------------------------------------------------------------------------------------------------------
(17) EARNINGS PER SHARE
The following is a reconciliation of the denominators used in the
computations of basic and diluted EPS. The numerator for calculating both basic
and diluted EPS is net income.
For the years ended December 31:
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (49,417) 4,676 11,328
Weighted-average shares 15,921 15,511 15,382
Basic EPS $ (3.10) 0.30 0.74
Weighted-average shares 15,921 15,511 15,382
Incremental shares-options - 1 23
- -------------------------------------------------------------------------------------------------------------------
15,921 15,512 15,405
Diluted EPS $ (3.10) 0.30 0.74
- -------------------------------------------------------------------------------------------------------------------
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table is a summary of financial data by quarter for the years
ended December 31, 2000 and 1999:
For the quarters ended
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) March 31, June 30, Sept. 30, Dec. 31,
- -------------------------------------------------------------------------------------------------------------------
2000
Revenues (a)((b) $35,945 28,944 27,625 26,457
Expenses (a)(b) 32,820 34,977 43,010 70,789
Net income (loss) (a)(b) 1,826 (3,527) (11,206) (36,510)
Earnings (loss) per common share-basic and diluted (a)(b) 0.11 (0.22) (0.70) (2.29)
1999
Revenues $42,513 44,449 29,686 38,171
Expenses (c)(d) 33,071 40,758 39,844 33,417
Net income (loss) (c)(d) 5,744 2,215 (6,095) 2,812
Earnings (loss) per common share-basic and diluted (c)(d) 0.37 0.14 (0.39) 0.18
56
(a) The quarter ended September 30, 2000 includes $16.4 million non-recurring
items, in connection with its corporate restructuring and a debt
modification, NIM transaction and sale of a domain name.
(b) The quarter ended December 31, 2000 includes $45.7 million non-recurring
items, in connection with the Company's write-down of MSRs, NIM transaction
costs, write-down of goodwill and other servicing related receivables.
(c) The quarter ended June 30, 1999 includes a $6.0 million pre-tax charge, in
connection with Delta's original agreement in principle with the NYOAG.
(d) The quarter ended September 30, 1999 includes the remaining $6.0 million of
the $12.0 million pre-tax charge for the global settlement with NYSBD and
the NYOAG.
57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEMS 10-13
The Registrant incorporates by reference herein information in its proxy
statement that complies with the information called for by Items 10-13 of Form
10-K. The proxy will be filed at a later date with the Commission.
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) FINANCIAL STATEMENTS
Page(s)
----
The following Consolidated Financial Statements of Delta Financial
Corporation and Subsidiaries are included in Part II, Item 8 of
this report
Independent Auditors' Report............................................................... 40
Consolidated Balance Sheets--December 31, 2000 and 1999.................................... 41
Consolidated Statements of Operations--Years ended December 31, 2000, 1999 and 1998........ 42
Consolidated Statement of Changes in Stockholders' Equity--Years ended
December 31, 2000, 1999 and 1998....................................................... 43
Consolidated Statements of Cash Flows--Years ended December 31, 2000, 1999 and
1998................................................................................... 44
Notes to Consolidated Financial Statements................................................. 45
(a)(2) FINANCIAL STATEMENT SCHEDULES
Exhibits 11.1 and 27 (See - Exhibit List)
(a)(3) Exhibits:
Exh.
No. Filed Description
--- ---- --------
3.1 (a) -- Certificate of Incorporation of Delta Financial Corporation
3.2 (f) -- Second Amended Bylaws of Delta Financial Corporation
4.1 (b) -- Indenture dated July 23, 1997, between Delta Financial
Corporation, its subsidiary guarantors and The Bank of New
York, as Trustee
4.2 (h) -- First Supplemental Indenture dated August 1, 2000, between
Delta Financial Corporation, its subsidiary guarantors and
The Bank of New York, as Trustee
4.3 (k) -- Second Supplemental Indenture dated October 16, 2000,
between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.4 (k) -- Third Supplemental Indenture dated November 20, 2000
between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.5 (k) -- Fourth Supplemental Indenture dated December 21, 2000
between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.6 (i) -- Indenture, dated December 21, 2000, relating to the 9 1/2%
Senior Secured Notes due 2004 by and between Delta Financial
Corporation, its subsidiary guarantors and U.S. Bank Trust
National Association, as Trustee.
4.7 (k) -- First Supplemental Indenture dated January 11, 2001, between
Delta Financial Corporation, its subsidiary guarantors and
U.S. Bank Trust National Association, as Trustee
4.8 (k) -- Second Supplemental Indenture dated February 12, 2001,
between Delta Financial Corporation, its subsidiary
guarantors and U.S. Bank Trust National Association, as
Trustee
4.9 (j) -- Third Supplemental Indenture dated March 16, 2001, between
Delta Financial Corporation, its subsidiary guarantors and
U.S. Bank Trust National Association, as Trustee
10.1 (a) -- Employment Agreement dated October 1, 1996 between the
Registrant and Sidney A. Miller
10.2 (a) -- Employment Agreement dated October 1, 1996 between the
Registrant and Hugh Miller
10.3 (g) -- Employment Agreement dated July 9, 1999 between the
Registrant and Christopher Donnelly
58
10.4 (g) -- Employment Agreement dated July 15, 1999 between the
Registrant and Randall F. Michaels
10.5 (g) -- Employment Agreement dated July 1, 1999 between the
Registrant and Richard Blass
10.6 (g) -- Employment Agreement dated July 23, 1999 between the
Registrant and Franklin E. Pellegrin, Jr.
10.7 (a) -- Lease Agreement between Delta Funding Corporation and the
Tilles Investment Company
10.8 (d) -- Fifth, Sixth and Seventh Amendments to Lease Agreement
between Delta Funding Corporation and the Tilles Investment
Company
10.9 (e) -- Eighth Amendment to Lease Agreement between Delta Funding
Corporation and the Tilles Investment Company
10.10 (a) -- 1996 Stock Option Plan of Delta Financial Corporation
21.1 (k) -- Subsidiaries of Registrant
27 (k) -- Financial Data Schedule
- ---------------
(a) Incorporated by reference from the Company's Registration Statement on Form
S-1 (No. 333-11289) filed with the Commission on October 9, 1996.
(b) Incorporated by reference from the Company's Current Report on Form 8-K
(No. 001-12109) filed with the Commission on July 30, 1997.
(c) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 (File No. 1-12109) filed with the
Commission on May 15, 1997.
(d) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 1-12109) filed with the
Commission on March 31, 1998.
(e) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1998 (File No. 1-12109) filed with the
Commission on May 12, 1998.
(f) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1998 (File No. 1-12109) filed with the
Commission on March 31, 1999.
(g) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1998 (File No. 1-12109) filed with the
Commission on March 31, 2000.
(h) Incorporated by reference from the Company's Current Report on Form 8-K
(File No. 1-12109) filed with the Commission on August 4, 2000.
(i) Incorporated by reference from the Company's Current Report on Form 8-K
(File No. 1-12109) filed with the Commission on January 10, 2001.
(j) Incorporated by reference from the Company's Current Report on Form 8-K
(File No. 1-12109) filed with the Commission on March 22, 2001.
(k) Filed herewith
(B) REPORTS ON FORM 8-K.
On August 4, 2000, the Company filed a Current Report on Form 8-K, in which
it reported (a) that it had reached an agreement to restructure its Senior Notes
with the consent of more than 50% of its Senior Notes holders, (b) that it would
launch an exchange offer pursuant to which the Senior Notes holders would be
provided the option to exchange their existing securities for new senior secured
notes and warrants in the Company, and (c) the execution of the First
Supplemental Indenture by and among the Company, its subsidiary guarantors and
the Bank of New York, as Indenture Trustee, dated as of August 1, 2000.
On November 22, 2000, the Company filed a Current Report on Form 8-K, in
which it reported the commencement of an offering to acquire all of its then
currently outstanding Senior Notes in exchange for newly issued Senior Secured
Notes and warrants to purchase shares of the Company's common stock.
On December 20, 2000, the Company filed a Current Report on Form 8-K, in
which it reported that it was extending the expiration date for its exchange
offer and consent solicitation until December 21, 2000.
On December 22, 2000, the Company filed a Current Report on Form 8-K, in
which it reported that it had consummated the exchange offer of its Senior Notes
for newly issued Senior Secured Notes with holders of approximately $148 million
of Senior Notes agreeing to the exchange.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized.
DELTA FINANCIAL CORPORATION
(Registrant)
Dated: March 29, 2001 By: /s/ HUGH MILLER
-------------------------------------
Hugh Miller
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Capacity in Which Signed Date
-------------------------- -------------------------------------- ----------------
/s/ SIDNEY A. MILLER Chairman of the Board of Directors March 29, 2001
- ---------------------
Sidney A. Miller
/s/ HUGH MILLER Chief Executive Officer, President and Director March 29, 2001
- --------------------- (Principal Executive Officer)
Hugh Miller
/s/ RICHARD BLASS Executive Vice President, Chief Financial Officer March 29, 2001
- --------------------- and Director (Principal Financial Officer)
Richard Blass
/s/ MARTIN D. PAYSON Director March 29, 2001
- ---------------------
Martin D. Payson
/s/ ARNOLD B. POLLARD Director March 29, 2001
- ---------------------
Arnold B. Pollard
/s/ MARGARET WILLIAMS Director March 29, 2001
- ---------------------
Margaret Williams