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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, 2001
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:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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. [X]
As of March 19, 2002, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $1.12, was
approximately $6,032,830.
As of March 31, 2002, 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, 2001.
PART I
ITEM 1. BUSINESS
BUSINESS OVERVIEW
Delta Financial Corporation (together with its subsidiaries "Delta" or "we")
is a specialty consumer finance company that originates, securitizes and sells
non-conforming mortgage loans, which are primarily secured by first mortgages on
one- to four-family residential properties. Throughout our 20-year operating
history, we have focused on lending to individuals who generally do not satisfy
the credit, documentation or other underwriting standards set by more
traditional sources of mortgage credit, including those entities that make loans
in compliance with conventional mortgage lending guidelines established by
Fannie Mae and Freddie Mac. We make loans to these borrowers for such purposes
as debt consolidation, refinancing, education and home improvement.
Our mortgage business has two principal components. First, we make mortgage
loans, which is a cash expense outlay for us, because our cost to originate a
loan exceeds the fees we collect at the time we originate that loan. At the time
we originate a loan, and prior to the time we sell that loan, we finance that
loan by borrowing under a warehouse line of credit. Second, we sell loans,
either through securitization or on a whole loan basis, to generate cash
revenues. We use the proceeds from these loan sales to repay our warehouse line
of credit and for working capital, recording the premiums received from the loan
sales and securitizations as revenue.
ORIGINATION OF MORTGAGE LOANS. We currently make mortgage loans through two
distribution channels - wholesale (or broker) and retail. We receive loan
applications both directly from borrowers and from licensed independent third
party mortgage brokers who submit applications on a borrower's behalf. We
process and underwrite the submission and, if the loan comports with our
underwriting criteria, approve the loan and lend the money to the borrower.
While we generally collect points and fees from the borrower when a loan closes,
our cost to originate a loan typically far outweighs any fees we may collect
from the borrower.
Through our wholesale distribution channel, we originate mortgage loans
indirectly through licensed mortgage brokers and other real estate professionals
who submit loan applications on behalf of borrowers ("brokered loans"). Prior to
July 2000, we also purchased loans from mortgage bankers and smaller financial
institutions that satisfied our underwriting guidelines ("correspondent loans"),
but discontinued our correspondent operations in July 2000 to focus on our less
cash intensive broker and retail channels. We currently originate the majority
of our brokered loans in 20 states, through our network of approximately 1,500
brokers.
Through our retail distribution channel, we develop retail loan leads
("retail loans") primarily through our telemarketing system and our network of
11 retail offices located in seven states. In 2001, we closed four
under-performing retail offices - two in Florida, one in Ohio and one in Indiana
- - and opened our second retail call center, in Pittsburgh, Pennsylvania.
In 2001, we originated approximately $622 million of loans, of which
approximately $346 million were brokered loans and $276 million were retail
loans, compared to 2000, when we originated or purchased approximately $933
million of loans, of which $604 million were brokered loans, $260 million were
retail loans and $69 million were correspondent loans.
POOLING OF LOANS PRIOR TO SALE. After we close or fund a loan, we typically
pledge the loan as collateral under a warehouse line of credit to obtain
financing against the loan. By doing so, we replenish our capital so we can make
new loans. Typically, loans are financed through a warehouse line of credit for
only a limited time - generally not more than three months - until such time as
we can pool enough loans and sell the pool of loans either through
securitization or on a whole-loan basis. During this time, we earn interest paid
by the borrower as income, but this income is offset in part by the interest we
pay to the warehouse creditor for providing us with financing.
SALE OF LOANS. We derive the majority of our revenues and cash flows
primarily from selling mortgage loans (through securitization or on a whole loan
basis) and selling securitization servicing rights on newly-originated pools of
home-equity loans. We generally sell loans in one of two manners - either
through securitization or on a whole loan basis.
We securitized the majority of our loans in two securitizations (completed in
the second and fourth quarters of 2001) totaling $345 million. We also sold $261
million of loans in 2001 for a cash premium, on a whole loan
servicing-released basis (without retaining the right to service the loans). We
plan to continue to utilize a combination of securitization and whole loan sales
for the foreseeable future.
SECURITIZATION. Securitizations effectively provide us with a source of long-
term financing.
In a securitization, we pool together loans, typically each quarter, and sell
these loans to a securitization trust, which is a qualified special purpose
entity. The securitization trust raises money to purchase the mortgage loans
from us by selling securities to the public -known as asset-backed pass-through
securities that are secured by the pool of mortgage loans held by the
securitization trust. These asset-backed securities or senior certificates,
which are usually purchased by insurance companies, mutual funds and/or other
institutional investors, represent senior interests in the cash flows from the
mortgage loans in the trust. Following the securitization, holders of these
senior certificates receive the principal collected, including prepayments of
principal, on the mortgage loans in the trust. In addition, holders receive a
portion of the interest on the loans in the trust equal to the pass-through
interest rate on the remaining principal balance. These securities are typically
sold for a par purchase price, or a slight discount to par - with par
representing the aggregate principal balance of the mortgage loans backing the
asset-backed securities. For example, if a securitization trust contains
collateral of $100 million of mortgage loans, we typically receive close to $100
million in proceeds from the sales of these securities, depending upon the
structure we utilize for the securitization.
In each of the two securitizations we issued in 2001, we derived the
following economic interests:
o we received a cash purchase price from the sale of an interest-only
certificate sold in connection with a securitization. This certificate
entitles the holder to a recurring interest payment over a guaranteed
period of 36 months, and reduces the cash flows we would otherwise
receive as owner of the excess cashflow certificates;
o we received a cash premium from selling the right to service the loans
being securitized. This right entitles the contractual servicer to
service the loans on behalf of the securitization trust, and earn a
contractual servicing fee, and ancillary servicing fees in such
capacity;
o we retained an excess cashflow certificate. This certificate entitles
us to receive the difference between the interest payments due on the
mortgage loans sold to the securitization trust and the interest
payments due, at the pass-through rates, to the holders of the
pass-through securities, less the contractual servicing fee and other
costs and expenses of administering the securitization trust. For any
monthly distribution, we, as the holder of an excess cashflow
certificate, receive payments only after payments have been made on all
the other securities issued by the securitization trust. These cash
flows are received over time, but under existing accounting rules, we
must report at the time of the securitization as income the present
value of all projected cash flows we expect to receive in the future
from these excess cashflow certificates based upon an assumed discount
rate. Our valuation of these excess cashflow certificates is primarily
based on (1) our estimate of the amount of expected losses or defaults
that will take place on the underlying mortgage loans over the life of
the mortgage loans because the excess cashflow certificates are
subordinate in right of payment to all other securities issued by the
securitization trust. Consequently, any losses sustained on mortgage
loans comprising a particular securitization trust are first absorbed
by the excess cashflow certificates, and (2) the expected amount of
prepayments on the mortgage loans due to the underlying borrowers of
the mortgage loans paying off their mortgage loan prior to the loan's
stated maturity.
At the time we completed the 2001 securitizations, we recognized as revenue
each of the three economic interests described above, which was recorded as net
gain on sale of mortgage loans on our consolidated statement of operations.
Our net investment in the pool of loans sold at the date of the
securitization represents the amount originally paid to originate the loans,
adjusted for the following:
o 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;
o the principal payments received, and the amortization of the net loan
fees or costs, during the period we held the loans prior to their
securitization; and
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o any gains (a decrease in the investment) or losses (an increase in the
investment) we incur on any hedging instruments that we may have
utilized to hedge against the effects of changes in interest rates
during the period we hold the loans prior to their securitization. (See
"-Hedging," beginning on page 39).
We allocate our basis in the mortgage loans and residual interests between
the portion of the mortgage loans sold through the pass-through certificates and
the portion retained (the excess cashflow certificates) based on the relative
fair values of those portions on the date of sale. We may recognize gains or
losses attributable to the changes in fair value of the excess cashflow
certificates, which are recorded at estimated fair value and accounted for as
"trading" securities. Since there is no active market for such excess cashflow
certificates, we determine the estimated fair value of the excess cashflow
certificates by discounting the future expected cash flows.
Although we recognize income from retaining excess cashflow certificates at
the time in which we complete our securitization, we receive cash flows from
these excess cashflow certificates over the life of the loans underlying such
certificates. In each of our two securitizations in 2001, we expect to begin to
receive cash flows from the excess cashflow certificates approximately twelve to
twenty months after each respective securitization issuance, with the specific
timing depending on the structure and performance of the securitization.
Initially, securitization trusts utilize the cash flows from the excess cashflow
certificate to make additional payments of principal to the holders of 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 1.5% and 3.0% of the initial
securitization principal amount securitized (known as the "overcollateralization
limit") is established, the cash flows generated by the excess cashflow
certificates are distributed to us as the holder of the excess cashflow
certificates.
WHOLE LOAN SALES. We also sell loans, without retaining the right to service
the loans, in exchange for a cash premium. This is recorded as income under net
gain on sale of mortgage loans at the time of sale. The cash premiums ranged
between 3.5% to 6.3% of the principal amount of mortgage loans sold in 2001.
OTHER. In addition to the income and cash flows we earn from securitizations
and whole loan sales, we also earn income and generate cash flows from:
o the net interest spread earned on mortgage loans while we hold the
mortgage loans for sale; (the difference between the interest rate on
the mortgage loan paid by the underlying borrower less the financing
costs we pay to our warehouse lender to fund our loans);
o net loan origination fees on brokered loans and retail loans; and
o retained excess cashflow certificates and distributions from Delta
Funding Residual Exchange Company LLC (described below in "-Debt
Modification and Debt Restructuring").
BUSINESS STRATEGY
Our business strategy is to increase our overall loan production to generate
sufficient cash revenues to become cash flow neutral to positive. We believe we
have the infrastructure in place to expand loan production significantly in both
the wholesale and retail channels, without having to invest significantly in our
infrastructure. We plan to increase loan production by:
o increasing the number of commissioned-based account executives
responsible for generating new business;
o continuing to provide top quality service to our network of brokers and
retail clients;
o maintaining our loan underwriting standards;
o penetrating further our established and recently-entered markets and
expanding into new geographic markets;
o expanding our retail loan origination capabilities through larger call
centers; and
o continuing to leverage off of our proprietary web-based and workflow
technology platform.
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CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING
In 2000, we began a corporate restructuring - by reducing our workforce and
modifying the terms of the indenture governing our senior notes due 2004 (the
"senior notes") - as part of our continuing efforts to improve operating
efficiencies and to address our negative cash flow from operations. Entering
2001, management still had several concerns, which we believed needed to be
addressed for us to remain a viable company. Our principal concerns were:
o the cash drain created by our ongoing monthly delinquency and servicing
advance requirements as servicer for securitization trusts (known as
"securitization advances");
o the high cost of servicing a seasoned loan portfolio, including the
capital charges associated with making securitization advances;
o our ability to make timely interest payments on our senior notes and
senior secured notes due 2004 (the "senior secured notes"); and
o our 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, we embarked upon a business plan
aimed at alleviating some of these concerns and issues.
CORPORATE RESTRUCTURING
In January 2001, we announced that we had entered into an agreement with
Ocwen Financial Corporation ("Ocwen") to transfer our servicing portfolio to
Ocwen. In May 2001, we physically transferred our entire servicing portfolio to
Ocwen, and laid-off the majority of our servicing staff - a total of 128
employees. We recorded a $0.5 million pre-tax charge related to this
restructuring, which is included in the line item called "restructuring and
other special charges" on our consolidated statements of operations. This charge
relates to employee severance associated with closing our servicing operations.
We no longer service loans nor do we have a servicing operation.
DEBT MODIFICATION AND DEBT RESTRUCTURING
In August 2000, we announced an agreement to modify the terms of the
indenture governing our senior notes (the "Debt Modification"). With the consent
of the holders of greater than fifty percent of our senior notes, we modified a
negative pledge covenant in the senior notes indenture, which had previously
prevented us from selling or otherwise obtaining financing by using our excess
cashflow certificates as collateral. In consideration for the senior
noteholders' consent, we agreed, in an exchange offer (the "First Exchange
Offer"), to offer then current holders the opportunity to exchange their then
existing senior notes for (a) new 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 below) were secured by at least $165 million of our excess cashflow
certificates. The First Exchange Offer was consummated in December 2000, with
holders of greater than $148 million (of $150 million) of senior notes tendering
in the exchange.
In February 2001, we entered into a letter of intent with the beneficial
holders of over fifty percent of our senior secured notes to restructure, and
ultimately extinguish, the senior secured notes (the "Second Debt
Restructuring"). In March 2001, we 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 excess cashflow certificates then
securing the senior secured notes. We were able to first finance and ultimately
sell the excess cashflow certificates underlying five securitizations (including
two excess cashflow certificates that were released as part of the Second Debt
Restructuring) for a $15 million cash purchase price to provide working capital.
In consideration for their consent, we agreed to offer the holders of the
senior secured notes (and the senior notes, collectively, the "notes"), an
opportunity to exchange their notes for new securities described immediately
below (the "Second Exchange Offer"). The Second Exchange Offer was consummated
on August 29, 2001, pursuant to which holders of approximately $138.1 million
(of $148.2 million) in principal amount of our senior
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secured notes and $1.1 million (of $1.8 million) in principal amount of our
senior notes, exchanged their notes for commensurate interests in:
o voting membership interests in Delta Funding Residual Exchange Company
LLC (the "LLC"), a newly-formed limited liability company (unaffiliated
with us), to which we transferred all of the mortgage-related
securities previously securing the senior secured notes (primarily
comprised of excess cashflow certificates);
o shares of common stock of a newly-formed management corporation that
will manage the LLC's assets; and
o shares of our newly-issued preferred stock having an aggregate
preference amount of $13.9 million.
The LLC is controlled by the former noteholders that now hold all the voting
membership interests in the LLC. As part of the transaction, we obtained a
non-voting membership interest in the LLC, which entitles us to receive 15% of
the net cash flows from the LLC for the first three years (through June 2004)
and, thereafter, 10% of the net cash flows from the LLC. The net cash flows from
the LLC are equal to the total cash flows generated by the assets held by the
LLC for a particular period, less (a) all expenses of the LLC, (b) certain
related income tax payments, and (c) the New York State Banking Department (the
"NYSBD") subsidy payments (See "Regulations"). We began receiving distributions
from the LLC in the first quarter of 2002 from a fourth quarter 2001
distribution.
As part of the Second Exchange Offer, all tendering noteholders waived their
right to receive any future interest coupon payments on the tendered notes
beginning with the August 2001 interest coupon payment. With the closing of the
Second Exchange Offer, we paid the August 2001 interest coupon payment on the
approximately $10.8 million of notes that did not tender in the Second Exchange
Offer. The notes bear interest at a rate of 9.5% per annum, payable
semi-annually (on February 1st and August 1st) and a maturity date of August 1,
2004 when all outstanding principal is due.
By extinguishing substantially all of our long-term debt, the rating agencies
that previously rated us and our long-term debt have withdrawn their corporate
ratings.
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Our consumer finance activities consist of originating, securitizing, selling
(and, prior to May 2001, 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, we typically package the loans in a portfolio and
sell the loan portfolio through a securitization or on a whole loan, servicing
released basis.
We provide our customers with an array of loan products designed to meet
their needs, using a risk-based pricing strategy to develop products for various
risk categories. Historically, we have offered fixed-rate loan products and, to
date, the majority of our loan production is fixed-rate. As we have expanded
geographically, we have expanded our product offerings to include
adjustable-rate mortgages and fixed/adjustable-rate mortgages.
We primarily conduct our broker lending operations out of our Woodbury, New
York headquarters and a regional branch office in the Southeast. Final
underwriting approval for brokered loans is centralized and required from the
Woodbury, New York headquarters. We conduct our retail operations out of 11
retail offices and a telemarketing hub, located in seven states. Final
underwriting approval for retail loans is required from either our retail
underwriting office in Cincinnati, Ohio, which has full underwriting authority
or from our Woodbury, New York headquarters.
We adhere to our Best Practice Lending Program aimed at ensuring the
origination of quality loans and helping to better protect consumers. This Best
Practice Lending Program includes:
o fair lending initiatives aimed at ensuring 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;
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o increased oversight of mortgage brokers and closing agents;
o enhanced fraud detection and protection;
o enhanced plain English disclosures; and
o other originations and underwriting initiatives which we believe help
protect consumers.
LOAN ORIGINATIONS AND PURCHASES
Our loan originations and purchases decreased by 33% to $622 million in 2001
from $933 million in 2000. The decrease in loan production was primarily the
result of management continuing to devote much of its attention to completing
the Second Debt Restructuring/Second Exchange Offer through the end of August
2001, and completing the servicing transfer to Ocwen during the first half of
2001. In addition, our production for the second half of the year was negatively
impacted by the events of September 11th.
The following table shows certain data regarding our loans, presented by
channel of loan originations, for the years shown:
YEAR ENDED DECEMBER 31,
1999 2000 2001
---- ---- ----
(DOLLARS IN THOUSANDS)
Broker:
Principal balance................................ $ 890,822 $ 603,616 $ 345,916
Average principal balance per loan.............. $ 85 $ 74 $ 79
Combined weighted average initial loan-
to-value ratio(1)............................. 72.8% 71.1% 71.7%
Weighted average interest rate.................. 10.4% 11.7% 11.1%
Retail:
Principal balance............................... $ 319,227 $ 260,388 $ 275,799
Average principal balance per loan.............. $ 68 $ 67 $ 82
Combined weighted average initial loan-
to-value ratio(1)............................. 77.6% 76.9% 77.4%
Weighted average interest rate.................. 9.8% 10.6% 9.8%
Correspondent (2):
Principal balance............................... $ 261,289 $ 69,434 --
Average principal balance per loan.............. $ 77 $ 75 --
Combined weighted average initial loan-
to-value ratio(1)............................. 72.0% 70.5% --
Weighted average interest rate.................. 11.0% 11.5% --
Total loan purchases and originations:
Principal balance............................... $1,471,338 $ 933,438 $ 621,715
Average principal balance per loan.............. $ 79 $ 72 $ 81
Combined weighted average initial loan-
to-value ratio(1)............................. 73.7% 72.7% 74.2%
Weighted average interest rate.................. 10.4% 11.4% 10.5%
Percentage of loans secured by:
First mortgage.................................. 94.6% 90.9% 94.1%
- ---------------
(1)We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio of
a loan secured by a second mortgage by taking the sum of the loan secured by
the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
(2)We discontinued our correspondent operations in July 2000 to focus on our
less cash intensive broker and retail channels.
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The following table shows certain data regarding our loans, presented by
channel of loan originations, on a quarterly basis for 2001:
THREE MONTHS ENDED
----------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Broker:
Number of Brokered Loans...................... 1,470 1,077 985 833
Principal balance............................. $ 105,116 $ 82,605 $ 83,406 $ 74,789
Average principal balance per loan............ $ 72 $ 77 $ 85 $ 90
Combined weighted average initial loan-
to-value ratio(1)........................... 70.6% 71.6% 72.0% 73.0%
Weighted average interest rate................ 11.9% 11.2% 10.7% 10.3%
Retail:
Number of retail loans........................ 866 961 770 753
Principal balance............................. $ 65,624 $ 82,541 $ 63,206 $ 64,428
Average principal balance per loan............ $76 $86 $82 $86
Combined weighted average initial loan-
to-value ratio(1)........................... 77.2% 76.9% 77.8% 78.0%
Weighted average interest rate................ 10.2% 9.7% 9.8% 9.5%
Total loan originations:
Total number of loans......................... 2,336 2,038 1,755 1,586
Principal balance............................. $ 170,740 $ 165,146 $ 146,612 $ 139,217
Average principal balance per loan............ $73 $81 $84 $88
Combined weighted average initial loan-
to-value ratio(1)........................... 73.2% 74.2% 74.5% 75.3%
Weighted average interest rate................ 11.2% 10.4% 10.3% 9.9%
- ---------------
(1)We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio of
a loan secured by a second mortgage by taking the sum of the loan secured by
the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
The following table shows lien position, weighted average interest rates and
loan-to-value ratios for the years shown:
YEAR ENDED DECEMBER 31,
1999 2000 2001
---- ---- ----
FIRST MORTGAGE:
Percentage of total purchases and originations........... 94.6% 90.9% 94.1%
Weighted average interest rate........................... 10.3% 11.4% 10.5%
Weighted average initial loan-to-value ratio(1).......... 74.1% 73.1% 74.2%
SECOND MORTGAGE:
Percentage of total purchases and originations........... 5.4% 9.1% 5.9%
Weighted average interest rate........................... 10.8% 11.5% 11.1%
Weighted average initial loan-to-value ratio(1).......... 66.6% 71.1% 75.4%
- ---------------
(1)We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio of
a loan secured by a second mortgage 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.
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The following table shows the geographic distribution of loan purchases and
originations for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1999 2000 2001
REGION PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE
- ------ ------- --------- ------- -------- ------- --------
(DOLLARS IN MILLIONS)
NY, NJ and PA............. 50.8% $ 747.9 43.9% $ 409.7 40.0% $248.4
Midwest................... 26.4 388.2 29.1 272.0 35.1 218.5
Mid-Atlantic*............. 8.6 126.7 10.5 97.6 11.8 73.1
Southeast................. 8.4 123.5 9.4 87.5 7.5 46.8
New England............... 5.8 85.1 7.1 66.6 5.6 34.9
- ------------
* Excluding New York (NY), New Jersey (NJ) and Pennsylvania (PA).
WHOLESALE MARKETING. Throughout our history, we have established and
maintained relationships with brokers (and, prior to July 2000, correspondents)
offering non-conforming mortgage products.
Typically, we initiate contact with a broker through our Business Development
Department, supervised by a senior officer with over ten years of sales and
marketing experience in the industry. We usually hire business development
representatives who have contacts with brokers that originate non-conforming
mortgage loans within their geographic territory. The business development
representatives are responsible for developing and maintaining our broker
network within their geographic territory by frequently visiting the broker,
communicating our 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 us about the products and
pricing being offered by competitors and new market entrants. This information
assists us in refining our 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 as a result of
their efforts.
APPROVAL PROCESS. Before a broker becomes part of our network, it must go
through an approval process. Once approved, brokers may begin submitting
applications and/or loans to us.
To be approved, a broker must:
o demonstrate that it is properly licensed and registered in the state in
which it seeks to transact business;
o submit to and pass a credit check; and
o sign a standard broker agreement with us that requires brokers to,
among other things:
>> abide by our 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.
We also perform 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, we regularly
review the performance of loans originated through our brokers.
BROKERED LOANS. For the year ended December 31, 2001, our broker network
accounted for $345.9 million, or 56%, of our loan originations, compared to
$603.6 million, or 65%, of our loan purchases and originations for the year
ended December 31, 2000 and $890.8 million, or 60%, of our loan purchases and
originations for the year ended December 31, 1999. No single broker contributed
more than 1.3%, 2.0% or 3.1% of our total loan production in the years ended
December 31, 2001, 2000 and 1999, respectively.
Once approved, a broker may submit loan applications for prospective
borrowers. To process broker submissions, our broker originations channel is
organized by geographic regions and into teams, each consisting of
8
account executives, account managers and processors, which are generally
assigned to specific brokers. Because we operate in a highly competitive
environment where brokers may submit the same loan application to several
prospective lenders simultaneously, we strive to provide brokers with a rapid
and informed response. Account executives 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 our 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 account executive, account manager and processor
team will then work directly with the submitting broker to collect the requested
information and meet all underwriting conditions. In most cases, we funds loans
within 14 to 21 days after preliminary approval of the loan application. In the
case of a denial, we 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.
We compensate our account executives, who are the primary relationship
contacts with the brokers, predominantly on a commission basis. All of our
account executives maintain the level of knowledge and experience integral to
our commitment to providing the highest quality service for brokers. We believe
that by maintaining an efficient, trained and experienced staff, we have
addressed four central factors that determine where a broker sends its business:
o the service and support a lender provides;
o product offerings and pricing
o the turn-around time, or speed with which a lender closes loans; and
o the lender's knowledge concerning the broker and his business.
RETAIL LOANS. We develop retail loan leads primarily through our automated
telemarketing system and our network of 11 retail offices located in seven
states. For the year ended December 31, 2001, the retail channel accounted for
$275.8 million, or 44%, of our loan originations, compared to $260.4 million, or
28%, of our loan purchases and originations for the year ended December 31, 2000
and $319.2 million, or 22%, of our loan purchases and originations for the year
ended December 31, 1999. Through our 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 our products. Our telemarketing
representatives identify interested customers and refer these customers to loan
officers at the retail branch offices and call centers who then proceed to
determine the applicant's qualifications for our loan products, negotiate loan
terms with the borrower and process the loan through completion.
CORRESPONDENT LOANS. We decided to discontinue our correspondent operations
in July 2000 to focus on our less cash intensive broker and retail channels. As
such, we had no correspondent purchases in 2001. For the year ended December 31,
2000, our correspondent network accounted for $69.4 million, or 7%, of our loan
purchases and originations, compared to $261.3 million, or 18%, of our loan
purchases and originations for the year ended December 31, 1999. No single
correspondent contributed more than 1.5% and 1.9% of our total loan production
in 2000 and 1999, respectively.
LOAN UNDERWRITING
We provide all of the brokers from whom we accept loan applications with our
underwriting guidelines. Loan applications received from brokers are classified
according to particular characteristics, including but not limited to:
o ability to pay;
o credit history of the applicant (with emphasis on the applicant's
existing mortgage payment history);
o credit score;
o loan-to-value ratio; and
o general stability of the applicant in terms of employment history, time
in residence, occupancy and condition and location of the collateral.
We have 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 that we make, as
well as maximum loan-to-value ratios and debt-to-income ratios, vary depending
on the classification of the applicant and the borrower's credit score. Loan
applicants with less favorable credit ratings and/or lower credit
9
scores are generally offered loans with higher interest rates and lower
loan-to-value ratios than applicants with more favorable credit ratings and/or
higher credit scores. The general criteria our underwriting staff uses in
classifying loan applicants are set forth below.
REST OF PAGE INTENTIONALLY LEFT BLANK
10
LTD DOC/ LTD DOC/
FULL DOC NIV FULL DOC STATED NIV
CREDIT PROGRAM/ MINIMUM OO OO NOO INCOME-OO NOO
MAX LOAN AMOUNT CREDIT SCORE (1) (2) (3) (4) (5)
- ---------------------------------------------------------------------------------------------------------------------
A+ 625 95% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg
TO $500,000++ 550 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg
525 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 80% 1st Mtg 70% 1st Mtg
500 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg 75% 1st Mtg 65% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
A1 625 95% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg
UP TO $500,000++ 550 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg
525 85% 1st Mtg 75% 1st Mtg 75% 1st mtg 75% 1st Mtg 65% 1st Mtg
500 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
A2 575 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg
UP TO $500,000++ 550 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 80% 1st Mtg 70% 1st Mtg
525 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg 75% 1st Mtg 65% 1st Mtg
500 75% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
B1 600 90% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
UP TO $450,000++ 575 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
550 85% 1st Mtg 75% 1st Mtg 75% 1st Mtg 70% 1st Mtg 65% 1st Mtg
525 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 65% 1st Mtg 60% 1st Mtg
500 75% 1st Mtg 65% 1st Mtg 65% 1st Mtg 60% 1st Mtg 55% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
B2 575 85% 1st Mtg 75% 1st Mtg 75% 1st Mtg 70% 1st Mtg
UP TO $450,000++ 550 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg
525 75% 1st Mtg 65% 1st Mtg 65% 1st Mtg 65% 1st Mtg
500 70 % 1st Mtg 60% 1st Mtg 60% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
C1 575 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg
UP TO $300,000++ 550 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg
525 75% 1st Mtg 65% 1st Mtg 65% 1st Mtg
500 70% 1st Mtg 60% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
C2 550 75% 1st Mtg
UP TO $300,000++ 525 70% 1st Mtg
500 65% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
D1 550 70% 1st Mtg
UP TO $250,000++ 500 65% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
D2*** 525 65% 1st Mtg
UP TO $250,000++ 500 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
D3*** 525 60% 1st Mtg
UP TO $250,000++ 500 55% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
(Chart continued on next page
11a
STATED
CREDIT PROGRAM/ INCOME-NOO
MAX LOAN AMOUNT (6) DTI MORTGAGE PAYMENT HISTORY BANKRUPTCY INFORMATION
- ------------------------------------------------------------------------------------------------------------------------------------
A+ 70% 1st Mtg 55%** EXCELLENT MORTGAGE HISTORY **** MIN 3 YEARS OLD:
--------------------------
UP TO $500,000++ 70% 1st Mtg 0x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
70% 1st Mtg *For extended LTV's, 0x60 13 to 24 months Ch 13 disc must be 1 yr old at closing.
65% 1st Mtg No foreclosures last 3 years.
- ------------------------------------------------------------------------------------------------------------------------------------
A1 70% 1st Mtg 55%** EXCELLENT MORTGAGE HISTORY **** MIN 3 YEARS OLD:
--------------------------
UP TO $500,000++ 70% 1st Mtg 1x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
65% 1st Mtg *For extended LTV's, 0x60 13 to 24 mos. Ch 13 disc must be 1 yr old at closing.
60% 1st Mtg No foreclosures last 3 years.
- ------------------------------------------------------------------------------------------------------------------------------------
A2 70% 1st Mtg 55%** EXCELLENT MORTGAGE HISTORY **** MIN 2 YEARS OLD:
--------------------------
UP TO $500,000++ 70% 1st Mtg 2x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
65% 1st Mtg *For extended LTV's, 0x90 13 to 24 months. Ch 13 must be disc before closing.
60% 1st Mtg No foreclosures last 2 years.
- ------------------------------------------------------------------------------------------------------------------------------------
B1 65% 1st Mtg 55%** GOOD MORTGAGE HISTORY **** MIN 2 YEARS OLD:
---------------------
UP TO $450,000++ 65% 1st Mtg 3x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
65% 1st Mtg *For extended LTV's, 0x120 13 to 24 months. Ch 13 must be disc before closing.
60% 1st Mtg No foreclosures last 2 years.
55% 1st Mtg
- ------------------------------------------------------------------------------------------------------------------------------------
B2 55%** GOOD MORTGAGE HISTORY **** MIN 18 MONTHS OLD:
---------------------
UP TO $450,000++ 0x60 or 2x30, 1x60 on mortgages. Ch 7 disc or Ch 13 filing.
within last 12 months. Open Ch 13 considered. Mortgage
*For extended LTVs, 0x120 13 to 18 months. Must be paid as agreed since filing.
No foreclosures last 18 months.
- ------------------------------------------------------------------------------------------------------------------------------------
C1 55%** FAIR MORTGAGE HISTORY **** MIN 1YEAR OLD:
---------------------
UP TO $300,000++ 0x90 within last 12 months. Ch 7 disc or Ch 13 filing. No derogs
No worse than D-30 at closing. since Ch 7 disc or Ch 13 filing.
No foreclosures last 12 months.
- ------------------------------------------------------------------------------------------------------------------------------------
C2 55%** FAIR MORTGAGE HISTORY Ch 7 must be discharged by close.
---------------------
UP TO $300,000++ 1x90 on mortgages within last 12 months. Open Ch 13 considered with good
No worse than D-60 at closing. re-established credit.
- ------------------------------------------------------------------------------------------------------------------------------------
D1 55%** POOR MORTGAGE HISTORY
---------------------
UP TO $250,000++ 1x120 on mortgages within last 12 months.
No worse than D-90 at closing.
- ------------------------------------------------------------------------------------------------------------------------------------
D2*** 55%** POOR MORTGAGE HISTORY
---------------------
UP TO $250,000++ No worse than D-119 at closing.
Mortgage NOT in foreclosure.
- ------------------------------------------------------------------------------------------------------------------------------------
D3*** 55%** POOR MORTGAGE HISTORY
---------------------
UP TO $250,000++ Open foreclosures case-by-case.
- ------------------------------------------------------------------------------------------------------------------------------------
+ Minimum credit score requirement for all loans is 500. Minimum credit score
for all 2nd mortgages is 550. Minimum credit score for 90% LTV A+ & A1 of 625.
Consult guidelines for maximum LTV's.
++ Maximum loan amounts available are subject to LTV, income classification and
occupancy requirements.
Note: Minimum 2 years employment history for programs A+ through B2.
11b
* Extended LTV's are defined as: FIC, 00> 80%, NIC/LIC > 75% & NOO > 75%.
** For LTV's above 80% and/or income under 25K/yr, maximum DTI = 50% for
programs A+ through D3.
*** Lower LTV by 5% for programs D2 & D3 in: CT, ID, IL, IA, ME, MA, NJ, NY,
OK VT & WI.
**** Chapter 13 dismissal date follows same guidelines as Chapter 7 discharge.
- --------------------------------------------------------------------------------
(1) Full documentation/owner occupied
(2) Limited documentation/no income verification/owner occupied
(3) Fulldocumentation/non-owner occupied
(4) Stated income/owner occupied
(5) Limited documentation/no income verification/non-owner occupied
(6) Stated income/non-owner occupied
- --------------------------------------------------------------------------------
We use these categories and characteristics as guidelines only. On a
case-by-case basis, we may determine that the prospective borrower warrants an
exception from the guidelines, if sufficient compensating factors exist.
Examples of compensating factors we consider are:
o low debt ratio;
o long-term stability of employment and/or residence;
o excellent payment history on past mortgages;
o a significant reduction in monthly expenses; or
o low loan-to-value ratio.
The following table sets forth certain information with respect to our
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 our originations and purchases.
(DOLLARS IN THOUSANDS)
PERCENT
YEAR CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
- ---- ---- ---- ------ ----- ------
2001 A $ 478,485 77.0% 10.0% 76.7%
B 59,729 9.6 11.5 68.6
C 61,498 9.9 12.2 66.7
D 22,003 3.5 13.2 57.4
--------- ---- ---- ----
Totals $ 621,715 100.0% 10.5% 74.2%
========= ==== ==== ====
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%
========= ==== ==== ====
- ------------------
(1) Weighted Average Coupon ("WAC").
(2) Weighted Average Initial Loan-to-Value Ratio ("WLTV").
12
The mortgage loans we originate 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 origination. Substantially all of our mortgage loans are fully
amortizing loans. We primarily originate fixed rate loans, which amortize over a
period not to exceed 30 years. The principal amounts of the loans we originate
generally range from a minimum of $25,000 to a maximum of $500,000. We generally
do not originate any mortgage loans where the combined loan-to-value ratio on
the loan exceeds 90%. Our loans are generally secured by one- to four-family
residences, including condominiums and town-houses, and these properties may or
may not be occupied by the owner. It is our policy not to accept commercial
properties or unimproved land as collateral. However, we will accept mixed-use
properties, such as a property where a portion of the property is used for
residential purposes and the balance is used for commercial purposes, and will
accept small multifamily properties of 5 to 8 units, both at reduced
loan-to-value ratios. We do not originate loans where any senior mortgage
contains open-end advance, negative amortization or shared appreciation
provisions - all of which could have the effect of increasing the amount of the
senior mortgage, thereby increasing the combined LTV, and making the loan more
risky for us.
Our 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
o a stated income program.
We generally limit total monthly debt obligations - which include principal
and interest on the new loan and all other mortgages, loans, charge accounts and
scheduled indebtedness - to 50% or less of the borrower's monthly gross income.
For loans to borrowers who are salaried employees, we require current employment
information in addition to employment history. We verify this information for
salaried borrowers based on written confirmation from employers, one or more
recent pay-stubs, recent W-2 tax forms, recent tax returns or telephone
confirmation from the employer. For our limited documentation program, we
require a job letter to be submitted which contains substantially the same
information one would find on a standard verification of employment form,
including:
o job position;
o length of time on job;
o current salary; and
o the job letter should appear on the employer's letterhead and include
the telephone number and signature of the individual completing the
letter on behalf of the employer.
For our no income verification program, we require proof of self-employment
in the same business plus proof of current self-employed status. We only offer
our stated income program, which represents a very small percentage of our
loans, for better credit quality borrowers where a telephone verification is
done by an underwriter to verify that the borrower is employed. We usually
require lower combined loan-to-value ratios with respect to loans made under
programs other than the full documentation program.
We assess an applicant's ability and willingness to pay, which is one of the
principal elements in distinguishing our 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. In
contrast, we employ 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. An applicant's
credit record will often be impaired by personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing.
We have a staff of 45 underwriters with an average of 10 years of
non-conforming lending experience. With the exception of our Atlanta, Georgia
office, all underwriting functions for broker originations are centralized in
our Woodbury, New York headquarters. All underwriting functions for retail
originations are centralized in our retail
13
underwriting "hub", located in Cincinnati, Ohio, and our Woodbury, New York
headquarters. We do not delegate underwriting authority to any broker. Our
underwriting department functions independently of our business development and
sales departments and does not report to any individual directly involved in the
sales origination process. None of our underwriters are compensated on an
incentive or commission basis.
We have instituted underwriting checks and balances that are designed to
ensure that every loan is reviewed and approved by a minimum of two
underwriters, with some higher loan amounts requiring a third approval. We
believe that by requiring each loan to 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.
We underwrite every loan submitted by not only thoroughly reviewing credit,
but also by performing the following:
o a separate appraisal review conducted by our appraisal review
department; 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.
We require appraisals to be performed by third party, fee-based appraisers or
by our approved appraisers and to conform generally 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. We perform an appraisal review on each loan prior to closing. We do
not believe that the general quality control practices of many conventional
mortgage lenders, which is to perform only drive-by appraisals after closings,
provides sufficient protection. As such, in addition to reviewing each appraisal
for accuracy, we access alternate sources to validate sales used in the
appraisal to determine market value. These sources include:
o Multiple Listing Services in eight states;
o assessment and sales services, such as Comps, Inc., Pace, 1st American
and Transamerica;
o on-line internet services such as Realtor.com; and
o other sources for verification, including broker price opinions and
market analyses by local real estate agents.
We actively track and grade (based upon criteria that we have developed over
time) all appraisers from which we accept appraisals for quality control
purposes and do not accept work from appraisers who have not conformed to our
review standards.
After completing the underwriting and processing of a brokered loan, we
schedule the closing of the loan with an approved closing attorney or settlement
agent. We hold the closing attorney or settlement agent responsible for
completing the loan closing transaction in accordance with applicable law and
our operating procedures. We also require title insurance that insures our
interest as mortgagee and evidence of adequate homeowner's insurance naming us
as an additional insured party on all loans.
We perform a post-funding quality control review to monitor and evaluate our
loan origination policies and procedures. The quality control department is
separate from the underwriting department, and reports directly to a member of
senior management.
We subject at least 10% of all loan originations to a full quality control
re-underwriting and review, the results of which are reported to senior
management on a monthly basis. We analyze discrepancies noted by the audit and
institute corrective actions. 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
14
o analyzing the underwriting and program selection decisions.
We update the quality control process from time to time as our policies and
procedures change.
LOAN SALES
We sell virtually all the loans we originate through one of two methods: (i)
securitizations, which involve the public offering by a securitization trust of
asset-backed pass-through securities; and (ii) whole loan sales, which include
the sale of pools of individual loans to institutional investors, banks, and
consumer finance-related companies on a servicing released basis. In 2001, we
securitized approximately 56% of our loan originations and sold whole loans of
approximately 42% of our loan originations. Going forward, we expect to continue
to use a combination of securitizations and whole loan sales, with the amounts
of each dependent upon the marketplace and our goal of maximizing earnings and
liquidity.
SECURITIZATIONS. During 2001, we completed two securitizations totaling $345
million. The following table sets forth certain information with respect to our
securitizations (both of which were rated AAA/Aaa by S&P Fitch, and/or Moody's,
respectively) by offering size, which includes pre-funded amounts, duration
weighted average pass-through rate and type of credit enhancement.
INITIAL DURATION
OFFERING SIZE WEIGHTED AVERAGE CREDIT
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE ENHANCEMENT
- --------- -------- ---------- ----------- ----------
2001-1................... 05/31/01 $165.0 6.15% Hybrid *
2001-2................... 10/16/01 $180.0 4.66% Hybrid*
* SENIOR/SUB STRUCTURE WITH A "AAA" RATED MONOLINE INSURER INSURING THE SENIOR
OR "AAA" RATED PASS-THROUGH CERTIFICATES
When we securitize loans, we sell a portfolio of loans to a trust (a "Home
Equity Loan Trust"), which is a qualified special purpose entity, 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. The servicer of each securitization will collect and remit principal and
interest payments to the appropriate Home Equity Loan Trust which, in turn,
passes through such payments to certificateholders. For each of the 2001
securitizations, we retained 100% of the interests in the excess cashflow
certificates while selling interest-only certificates for an up-front cash
premium. We contemplate continuing to retain excess cashflow certificates in the
future as long as, in management's opinion, this practice maximizes earnings
while satisfying our liquidity objectives.
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 cash flows that would otherwise be paid to us as holder of the excess
cashflow 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 cash flows 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. We have found that, at times, we can
receive better economic results by selling certain mortgage loans on a whole
loan, non-recourse basis, without retaining servicing rights, generally in
private transactions to financial institutions or consumer finance companies. We
recognize a gain or loss when we sell loans on a whole loan basis equal to the
difference between the cash proceeds received for the loans and our investment
in the loans, including any unamortized loan origination fees and costs.
15
In 2001 and 2000, we sold whole loans on a servicing-released basis of $261.1
million and $58.3 million, respectively. In 1999, we did not sell loans on a
whole loan basis.
LOAN SERVICING
Prior to May 2001, we serviced substantially all of the loans that we
originated and purchased since our inception in 1982.
In January 2001, we announced that we had entered into an agreement with
Ocwen to transfer our servicing portfolio to Ocwen. In May 2001, we physically
transferred our entire servicing portfolio to Ocwen, and laid-off our servicing
staff. We no longer service loans nor do we have a servicing operation. We do,
however, maintain a handful of employees to assist third parties with delinquent
and defaulted loans, as well as portfolio retention.
COMPETITION
As an originator of mortgage loans, we face 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 we do. 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 us and our competitors on the sale of the type of loans originated
has attracted additional competitors into this market with the effect of
lowering the gains that may be realized by us 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 borrowers underlying our excess
cashflow certificates to refinance their loans. During economic slowdowns or
recessions, these borrowers may have new financial difficulties and may be
receptive to offers by our competitors.
Over the past several years, many of the independent mortgage banking
companies, which previously were among our 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 us, targeting customers similar to those we do. Fannie Mae and
Freddie Mac also have expressed interest in adapting their programs to include
products similar to those offered by us and have begun to expand their programs
and presence into the subprime market. The entrance of these larger and
better-capitalized competitors into our market may have a material adverse
effect on our results of operations and financial condition.
REGULATION
Our 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 our operations. Our consumer lending activities are subject
to, among other laws and regulations:
o the Federal Truth-in-Lending Act and Regulation Z (including the Home
Ownership and Equity Protection Act of 1994);
o the Equal Credit Opportunity Act of 1974, as amended (ECOA);
o the Fair Credit Reporting Act of 1970, as amended;
o the Real Estate Settlement Procedures Act (RESPA), and Regulation X;
o the Home Mortgage Disclosure Act;
16
o the Federal Debt Collection Practices Act; and
o other federal, state and local statutes and regulations affecting our
activities.
We also are subject to the rules and regulations of, and examinations by the
Department of Housing and Urban Development ("HUD") and state regulatory
authorities with respect to originating, processing and underwriting loans (and
servicing loans prior to May 2001). These rules and regulations, among other
things:
o impose licensing obligations on us;
o establish eligibility criteria for mortgage loans;
o prohibit discrimination;
o provide for inspections and appraisals of properties;
o require credit reports on loan applicants;
o regulate assessment, collection, foreclosure and claims handling,
investment and interest payments on escrow balances and payment
features;
o mandate certain disclosures and notices to borrowers; and
o in some cases, fix maximum interest rates, fees and mortgage loan
amounts.
Failure to comply with these requirements can lead to, among other things,
loss of approved status, demands for indemnification or mortgage loans
repurchases, certain rights of rescission for mortgage loans, class action and
other lawsuits, and administrative enforcement actions.
Several federal, state and local laws and regulations are currently under
consideration, with more likely to be proposed on the horizon, that are intended
to further regulate our industry. Many of these laws and regulations seek to
impose broad restrictions on certain commonly accepted lending practices,
including some of our practices. There can be no assurance that these proposed
laws, rules and regulations, or other similar laws, rules or regulations, will
not be adopted in the future. Adoption of these laws, rules and regulations
could have a material adverse impact on our business by:
o substantially increasing the costs of compliance with a variety of
potentially inconsistent federal, state and local laws;
o substantially increasing the risk of litigation or administrative
action associated with complying with these proposed federal, state and
local laws, particularly those aspects of such proposed laws that
contain subjective (as opposed to objective) requirements, among other
things; or
o restricting our ability to charge rates and fees adequate to compensate
us for the risk associated with certain loans.
In September 1999, we settled allegations by the NYSBD and a lawsuit by the
New York State Office of the Attorney General (the "NYOAG") alleging that we had
violated various state and federal lending laws. The global settlement was
evidenced by (a) a Remediation Agreement by and between Delta Funding and the
NYSBD, dated as of September 17, 1999 and (b) a 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, we, among other things, implemented agreed
upon changes to our lending practices; are providing reduced loan payments
aggregating $7.25 million to certain borrowers identified by the NYSBD; and have
created a fund managed by the NYSBD and financed by the grant of 525,000 shares
of Delta Financial's common stock.
Each month, on behalf of borrowers designated by the NYSBD, we make subsidy
payments to the related securitization trusts. These subsidy payments fund the
differential between the original loan payments and the reduced loan payments.
As part of the Second Exchange Offer (see "-Note No. 2 "Summary of Regulatory
Settlement" and Note No. 3 "Corporate Restructuring, Debt Modification and Debt
Restructuring" to Notes to the Consolidated Financial Statements" ), the LLC -
an unaffiliated, newly-formed entity, the voting membership interests of which
are owned by the former holders of our notes - is obligated to satisfy these
payment subsidies out of the cash flows generated by the mortgage related
securities (primarily from the excess cashflow certificates) it
17
owns. If the LLC's cash flows are insufficient to pay this obligation, we remain
responsible to satisfy our obligations under the Remediation Agreement.
The proceeds of the stock fund will be used to pay borrowers and to finance a
variety of consumer educational and counseling programs. We do not manage the
fund created for this purpose. The number of shares of common stock deposited in
the fund does not adjust to account for fluctuations in the market price of our
common stock. Changes to the market price of these shares of common stock
deposited in the fund do not have any impact on our financial statements. We did
not make any additional financial commitments between the settlement date and
March 2000.
In March 2000, we finalized an agreement with the U.S. Department of Justice,
the Federal Trade Commission and HUD, to complete the global settlement we had
reached with the NYSBD and NYOAG. The Federal agreement mandates some additional
compliance efforts for us, but it does not require any additional financial
commitment by us.
We believe we are in compliance in all material respects with applicable
federal and state laws and regulations.
ENVIRONMENTAL MATTERS
To date, we have not been required to perform any investigation or clean up
activities, nor have we been subject to any environmental claims. There can be
no assurance, however, that this will remain the case in the future. Although we
primarily lend to owners of residential properties, in the course of our
business, we may acquire properties securing loans that are in default. There is
a risk that we could be required to investigate and clean-up hazardous or toxic
substances or chemical releases at such properties, 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, 2001, we had a total of 609 employees (full-time and
part-time). None of our employees are covered by a collective bargaining
agreement. We consider our relations with our employees to be good.
ITEM 2. PROPERTIES
Our executive and administrative offices are located at 1000 Woodbury Road,
Woodbury, New York 11797, where we lease approximately 107,000 square feet of
office space at an aggregate annual rent of approximately $2.1 million. The
lease provides for certain scheduled rent increases and expires in 2008.
We also maintain a full service office in Atlanta, Georgia and business
development offices in New Jersey, Ohio, Pennsylvania and Virginia. Our retail
operation currently maintains nine retail mortgage origination offices in
Illinois, Missouri, North Carolina, Ohio (3), Pennsylvania (2) and Tennessee and
two retail call centers one at our headquarters in Woodbury, New York and the
second in Pittsburgh, Pennsylvania. We also maintain one telemarketing hub in
Ohio. The terms of these leases vary as to duration and escalation provisions,
with the latest expiring in 2004.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of our business involves the collection of numerous
accounts, the validity of liens and compliance with various state and federal
lending laws, we are subject, in the normal course of business, to numerous
claims and legal proceedings. Our lending practices have been the subject of
several lawsuits styled as class actions and of investigations by various
regulatory agencies including the NYSBD, the NYOAG and the United States
Department of Justice (the "DOJ"). The current status of these actions is
summarized below.
o In or about November 1998, we received notice that we 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 we had violated the Home Ownership and Equity
Protection Act ("HOEPA"), the
18
Truth in Lending Act ("TILA") and New York State General Business
Lawss.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 us 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 injunctive
relief on their behalf. We 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 that enjoined us from proceeding with the foreclosure sales
of the three intervenors' properties. We filed a motion for
reconsideration of the December 23, 1998 order. In January 1999, we
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, we 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 us, our attorneys and/or the NYSBD
from issuing notices to certain of our 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, we and the
NYSBD submitted opposition to plaintiffs' motion. In March 2000, the
Court issued an order that permitted us to issue an approved form of
the notice. In September 1999, plaintiffs filed a motion for class
certification, which we opposed in February 2000, and was ultimately
withdrawn without prejudice by plaintiffs in January 2001. In February
2002, we executed a settlement agreement with plaintiffs, pursuant to
which we denied all wrongdoing, but agreed to resolve the litigation on
a class-wide basis. A fairness hearing has been scheduled for May 2002,
at which point, we anticipate that the Court will approve the
settlement. If the settlement is not approved, we believe that we have
meritorious defenses and intend to defend this suit, but cannot
estimate with any certainty our ultimate legal or financial liability,
if any, with respect to the alleged claims.
o In or about March 1999, we received notice that we had been named in a
lawsuit filed in the Supreme Court of the State of New York, New York
County, alleging that we 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, we filed an answer to the complaint. In September 1999, we
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, we filed a motion to change venue and
plaintiffs opposed the motion. In July 1999, the Court denied the
motion to change venue. We appealed and in March 2000, the Appellate
Court granted our appeal to change venue from New York County to Nassau
County. In August 1999, plaintiffs filed a motion for class
certification, which we opposed in July 2000. In or about September
2000, the Court granted plaintiffs' motion for class certification,
from which we filed a Notice of Appeal. In or about June 2001, we filed
a motion for summary judgment to dismiss the complaint, which was
denied by the Court in October 2001. We have appealed that decision as
well, and the trial court agreed to stay the action pending the result
of that appeal. We believe that we have meritorious defenses and intend
to defend this suit, but cannot estimate with any certainty our
ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about July 1999, we received notice that we 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
us 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 our
practices violated applicable statutes and/or the mortgage agreements,
(c) injunctive relief, and (d) unspecified compensatory and punitive
damages (including attorneys' fees). In October 1999, we filed a motion
to dismiss the complaint.
19
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 our motion to dismiss. In March
2000, the Court granted our motion to dismiss in part, and denied it in
part. In February 2002, we executed a settlement agreement with
plaintiffs pursuant to which we denied all wrongdoing, but agreed to
resolve the litigation on a class-wide basis. A fairness hearing has
been scheduled for June 2002, at which point we anticipate that the
Court will approve the settlement. If the settlement is not approved,
we believe that we have meritorious defenses and intend to defend this
suit, but cannot estimate with any certainty our 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 us alleging
violations of (a) RESPA (by paying yield spread premiums), (b) HOEPA
and TILA, (c) ECOA, (d) New York Executive Lawss. 296-a, and (e) New
York Executive Lawss. 63(12). In September 1999, we settled the lawsuit
with the NYOAG, as part of a global settlement by and among us, the
NYOAG and the NYSBD, evidenced by that certain (a) Remediation
Agreement by and between us and the NYSBD, dated as of September 17,
1999 and (b) Stipulated Order on Consent by and among us and the NYOAG,
dated as of September 17, 1999. As part of the Settlement, we, among
other things, have implemented agreed upon changes to our lending
practices; are providing reduced loan payments aggregating $7.25
million to certain borrowers identified by the NYSBD; and have created
a fund financed by the grant of 525,000 shares of our 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. As a result, the NYOAG lawsuit has been dismissed as against
us. The Remediation Agreement and Stipulated Order on Consent supersede
our previously announced settlements with the NYSBD and the NYOAG. In
March 2000, we 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, but it does not require any additional
financial commitment.
o In November 1999, we received notice that we 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
our initial public offering in 1996 and our reports subsequently filed
with the Securities and Exchange Commission. The complaint alleges that
the scope of the violations alleged in the consumer lawsuits and
regulatory actions brought in or around 1999 indicate a pervasive
pattern of action and risk that should have been more thoroughly
disclosed to investors in our common stock. In May 2000, the Court
consolidated this case and several other lawsuits that purportedly
contain the same or similar allegations against us and in August 2000
plaintiffs filed their Consolidated Amended Complaint. In October 2000,
we filed a motion to dismiss the Complaint in its entirety, which was
opposed by plaintiffs in November 2000, and denied by the Court in
September 2001. We believe that we have meritorious defenses and intend
to defend this suit, but cannot estimate with any certainty our
ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about April 2000, we received notice that we had been named in a
lawsuit filed in the Supreme Court of the State of New York, Nassau
County, alleging that we had improperly charged and collected from
borrowers certain fees when they paid off their mortgage loans with us.
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. We answered the
complaint in June 2000. In March 2001, we filed a motion for summary
judgment, which was opposed by plaintiffs in March 2001, and we filed
reply papers in April 2001. In June 2001, our motion for summary
judgment dismissing the complaint was granted. In August 2001,
plaintiffs appealed the decision. We believe that we have meritorious
defenses and intend to defend this suit, but cannot estimate with any
certainty our ultimate legal or financial liability, if any, with
respect to the alleged claims.
20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock trades on the Over-The-Counter Bulletin Board ("OTCBB")
under the symbol "DLTO". The following table sets forth for the periods
indicated the range of the high and low closing sales prices for our common
stock.
2001 HIGH LOW
---- ---- ----
First Quarter ................... $ 0.63 $ 0.36
Second Quarter .................. 0.43 0.24
Third Quarter.................... 0.51 0.28
Fourth Quarter .................. 1.06 0.38
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
Our common stock previously was listed on the New York Stock Exchange (the
"NYSE") under the symbol "DFC", but in May 2001, the NYSE de-listed our common
stock. The NYSE stated that it took this action because we were unable to meet
the NYSE's continued listing standards of maintaining a minimum of $15 million
in market capitalization and a minimum share price of $1 over a 30-day trading
period. When our common stock was de-listed in May 2001, it began trading on the
OTCBB under the ticker symbol "DLTO".
On December 31, 2001, we had approximately 74 stockholders of record. This
number does not include beneficial owners holding shares through nominee or
"street" names. We believe the number of beneficial stockholders is
approximately 1,900.
DIVIDEND POLICY
We did not pay any dividends in 2001 and, in accordance with our present
general policy, we have no present intention to pay cash dividends on our common
stock. Under the terms of our Certificate of Designations for our newly-issued
preferred stock, we are obligated to commence paying dividends to holders of our
Series A preferred stock in July 2003, and are limited in our ability to pay
dividends to holders of our common stock.
21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Income Statement Data: (DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
Revenues:
Net gain on sale of mortgage loans............ $ 38,638 51,031 84,010 98,396 89,687
Interest...................................... (22,146) 32,287 31,041 12,458 22,341
Servicing fees................................ 2,983 14,190 16,341 10,464 7,511
Net origination fees and other income......... 13,450 21,463 23,427 18,257 14,311
---------------------------------------------------------------------
Total revenues........................... 32,925 118,971 154,819 139,575 133,850
---------------------------------------------------------------------
Expenses
Payroll and related costs .................... 42,896 56,525 65,116 56,709 41,214
Interest...................................... 16,132 30,386 26,656 30,019 19,964
General & administrative 48,878 45,066 55,318 34,351 21,522
Capitalized mortgage servicing impairment .... -- 38,237 -- -- --
Restructuring and other special charges....... 2,678 11,382 -- -- --
-------------------------------------------------------------------
Total expenses.......................... 110,584 181,596 147,090 121,079 82,700
-------------------------------------------------------------------
Income (loss) before income tax expense (benefit)
and extraordinary item........................ (77,659) (62,625) 7,729 18,496 51,150
Provision for income tax expense (benefit) ....... 2,876 (13,208) 3,053 7,168 20,739
-------------------------------------------------------------------
Income (loss) before extraordinary item........... (80,535) (49,417) 4,676 11,328 30,411
Extraordinary item, net of tax loss on early
extinguishment of debt........................ (19,255) -- -- -- --
-------------------------------------------------------------------
Net income (loss)................................. $ (99,790) (49,417) 4,676 11,328 30,411
------------------------------------------------------------------
BASIC AND DILUTED EARNINGS PER SHARE:
Income (loss) before extraordinary item......... $ (5.07) (3.11) 0.30 0.74 1.98
Extraordinary item, net of tax.................. (1.21) -- -- -- --
Net income (loss) per share......................... $ (6.28) (3.11) 0.30 0.74 1.98
Weighted average number of
shares outstanding...................... 15,883,749 15,883,749 15,511,214 15,382,161 15,359,280
Selected Balance Sheet Data:
Loans held for sale, net.......................... $ 94,407 82,698 89,036 87,170 79,247
Capitalized mortgage servicing rights............. -- -- 45,927 33,490 22,862
Excess cashflow certificates, net................. 16,765 216,907 224,659 203,803 167,809
Total assets...................................... 132,398 451,245 555,395 480,537 393,232
Senior notes, warehouse financing and
other borrowings.............................. 100,472 238,203 258,493 229,660 177,540
Investor payable.................................. -- 69,489 82,204 63,790 40,852
Total liabilities................................. 120,548 353,521 408,254 342,849 266,779
Stockholders' equity.............................. 11,850 97,724 147,141 137,688 126,453
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SET FORTH THEREIN.
GENERAL
As discussed in more detail in the "Business Overview" in Part I, beginning
on page 1, Delta Financial Corporation ("Delta" or "we"), through its
wholly-owned subsidiaries, originates, securitizes and sells (and, prior to May
2001, serviced) non-conforming home equity loans, which are primarily secured by
first mortgages on one- to four-family residential properties. Throughout our 20
years of operating history, we have 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. These borrowers generally do not satisfy the credit,
documentation or other underwriting standards set by more traditional sources of
mortgage credit, including those that make loans in compliance with conventional
mortgage lending guidelines established by Fannie Mae and Freddie Mac. We make
loans to these individuals for such purposes as debt consolidation, refinancing,
education or home improvements.
Our mortgage business has two principal components. First, we make mortgage
loans to individual borrowers, which is a cash and expense outlay for us,
because our cost to originate a loan exceeds the fees we collect at the time we
originate that loan. At the time we originate a loan, and prior to the time we
sell that loan, we finance that loan by borrowing under a warehouse line of
credit. Second, we sell loans, either through securitization or on a whole loan
basis, to generate cash and non-cash revenues. We use the proceeds from these
sales to repay our warehouse line of credit and for working capital, recording
the premiums we receive from the loan sales and securitizations as revenue.
CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING. As
discussed in more detail in "Corporate Restructuring, Debt Modification and Debt
Restructuring" in Part I, beginning on page 4, we engaged in a series of
transactions beginning in 2000, and concluding in the third quarter of 2001,
aimed at improving operating efficiencies and reducing our negative cash flow.
We spent much of the year working on two transactions in particular, which we
believe were of tantamount importance in this regard - selling our servicing
portfolio and extinguishing most of our long term debt.
o In May 2001, we completed our transfer of servicing to Ocwen, which
freed us from the significant cash drain associated with making
securitization advances (and the capital costs associated with making
such advances), and of servicing a highly seasoned portfolio following
three successive quarters of selling the securitization servicing
rights associated with newly originated mortgage loans;
o In August 2001, we completed our Second Exchange Offer, which
extinguished substantially all of our long-term debt, leaving
approximately $10 million out of $150 million of our notes still
outstanding. This debt extinguishment helped us threefold. First, it
eliminated nearly $140 million of principal which we otherwise would
have had to repay in 2004. Second, it eliminated more than $13 million
of yearly interest expense that we would have had to pay to the former
noteholders had they still held their notes. Third, the ratings
agencies that previously rated us and our notes have withdrawn their
corporate ratings.
We believe that our transfer of servicing to Ocwen and the Second Exchange
Offer were essential steps in our continuing effort to restructure our
operations and reduce our negative cash flow previously associated with our
servicing operations and the notes. There can be no assurances, however, that
these or other factors described herein will not have a material adverse effect
on our results of operations and financial condition. (See "-Competition,"
"-Regulation" and "-Forward Looking Statements and Risk Factors," among other
sections).
OTHER. In May 2001, the NYSE de-listed our Common Stock. The Exchange stated
that it took this action because we were unable to meet the NYSE's continued
listing standards of maintaining a minimum of $15 million in market
capitalization and a minimum share price of $1 over a 30-day trading period.
When our Common Stock was de-listed in May, it began trading on the OTCBB under
the ticker symbol "DLTO".
23
EXCESS CASHFLOW CERTIFICATES
We classify excess cashflow certificates that we receive upon the
securitization of a pool of loans as "trading securities." The amount initially
allocated to the excess cashflow certificates at the date of a securitization
reflects their fair value. The amount recorded for the excess cashflow
certificates is reduced for distributions which we receive as the holder of
these excess cashflow certificates and is adjusted for subsequent changes in the
fair value of the excess cashflow certificates we hold.
At the time each securitization transaction closes, we determine the present
value of the related excess cashflow certificates using certain assumptions we
make regarding the underlying mortgage loans. The excess cashflow certificate is
then recorded on our consolidated financial statements at an estimated fair
value. Our estimates primarily include the following:
o future rate of prepayment of the mortgage loans;
o credit losses on the mortgage loans;
o a discount rate used to calculate present value; and
o the London Inter-Bank Offered Rate ("LIBOR") forward curve (using
current LIBOR as the floor rate).
The value of each excess cashflow certificate represents the cash flow we
expect to receive in the future from such certificate based upon our best
estimate. We monitor the performance of the loans underlying each excess
cashflow certificate, and any changes in our estimates (and consequent changes
in value of the excess cashflow certificates) is reflected in the line item
called "interest income" in the quarter in which we make any such change in our
estimate. Although we believe that the assumptions we use are reasonable, there
can be no assurance as to the accuracy of the assumptions or estimates.
In determining the fair value of each of the excess cashflow certificates, we
make the following underlying assumptions regarding mortgage loan prepayments,
mortgage loan default rates and discount rates:
(A) PREPAYMENTS. We base our prepayment rate assumptions upon our on-going
analysis of the performance of mortgage pools we previously securitized,
and the performance of similar pools of mortgage loans securitized by
others in the industry. We apply different prepayment speed assumptions to
different loan product types because it has been our experience that
different loan product types exhibit different prepayment patterns.
Generally, our loans can be grouped into two loan products - fixed rate
loans and adjustable rate loans. With fixed rate loans, an underlying
borrower's interest rate remains fixed throughout the life of the loan. Our
adjustable rate loans are really a "hybrid" between fixed and adjustable
rate loans, in that the rate generally remains fixed typically for the
first three years of the loan, and then adjusts typically every six months
thereafter. Within each product type, other factors can affect prepayment
rate assumptions. Some of these factors, for instance, include:
o whether or not a loan contains a prepayment penalty - an amount that a
borrower must pay to a lender if the borrower prepays the loan within a
certain time after the loan was originated. Loans containing a
prepayment penalty typically do not prepay as quickly as those without
such a penalty;
o as is customary with adjustable rate mortgage loans, the introductory
interest rate charged to the borrower is artificially lower, between
one and two full percentage points, than the rate for which the
borrower would have otherwise qualified. Generally, once the adjustable
rate mortgage begins adjusting on the first adjustment date, the
interest rate payable on that loan increases, at times fairly
substantially. This interest rate increase can be exacerbated if there
is an absolute increase in interest rates. As a result of these
increases and the potential for future increases, adjustable rate
mortgage loans typically are more susceptible to early prepayments.
There are several reasons why a loan will prepay prior to its maturity,
including (but not limited to):
o a decrease in interest rates;
24
o improvement in the borrower's credit profile, which may allow them to
qualify for a lower interest rate loan;
o competition in the mortgage market, which may result in lower interest
rates being offered;
o the borrower's sale of his or her home; and
o a default by the borrower, resulting in foreclosure by the lender.
It is unusual for a borrower to prepay a mortgage loan during the first
few months because of the following:
o it typically takes at least several months after the mortgage loans are
originated for any of the above events to occur;
o there are costs involved with refinancing a loan; and
o the borrower does not want to incur prepayment penalties.
Thereafter, we have found that the rate at which loans prepay will slowly
increase and stabilize, then decrease and eventually level off.
Historically, we used a "ramp" prepayment curve, in which we projected that
a loan would initially begin prepaying at a certain rate, and that rate
would incrementally increase (or "ramp up") over its first 12 months, and
level off thereafter. Commencing in 1998, we began using a "vector" curve,
which is similar to a "ramp curve" in that prepayment rates incrementally
increase over a longer period of time and then stabilize. However, as
opposed to a ramp curve (which remains constant once prepayments
stabilize), we believe that a vector curve is more representative of
projected future loan prepayment experience, as it thereafter decreases and
then eventually levels off.
The following table shows our most recent changes to our prepayment
assumptions - in the third quarter of 2001 and, prior to that, in the third
quarter 2000:
LOAN TYPE AT SEPTEMBER 30, 2001 AT SEPTEMBER 30, 2000
-------------------------------------------------------------
Fixed Rate:
At Month 4.00% 4.00%
Peak Speed 30.00% 23.00%
Adjustable Rate:
At Month 4.00% 4.00%
Peak Speed 75.00% 50.00%
(B) DEFAULT RATE. A default reserve for both fixed- and adjustable-rate
loans sold to the securitization trusts of 5.00% of the amount initially
securitized at December 31, 2001 compared to 3.50% at December 31, 2000.
Our loan loss assumption reflects our belief that:
o prepayment speeds generally will be slower in the future than in the
past;
o the rise in home values will be flat or slightly moderate as compared
to the past few years; and
o borrowers will therefore be less able to refinance their mortgages to
avoid default which may have an adverse effect on the non-performing
loans in the securitizations trusts underlying our excess cashflow
certificates.
(C) DISCOUNT RATE. We use a discount rate that we believe reflects the risks
associated with our excess cashflow certificates. While quoted market
prices on comparable excess cashflow certificates are not available, we
compare our valuation assumptions and performance experience to our
competitors' in the non-conforming mortgage industry. Our discount rate
takes into account the asset quality and the performance of our securitized
mortgage loans compared to that of the industry and other characteristics
of our securitized loans. We quantify the risks associated with our excess
cashflow certificates by comparing the asset quality and payment and loss
performance experience of the underlying securitized mortgage pools to
comparable industry performance. We believe that the practice of many
companies in the non-conventional mortgage industry has been to add a
spread for risk to the all-in cost of securitizations to
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determine their discount rate. From these comparisons, we have identified a
spread that we add to the all-in cost of our mortgage loan securitization
trusts' investor certificates. The discount rate we use to determine the
present value of cash flows from excess cashflow certificates reflects
increased uncertainty surrounding current and future market conditions,
including without limitation, uncertainty concerning inflation, recession,
home prices, interest rates and equity markets.
We utilized a discount rate of 15% at December 31, 2001 compared to 13% at
December 31, 2000 on "senior" excess cashflow certificates (I.E., those
excess cashflow certificates that were not subject to a Net Interest
Margin, or "NIM," transaction). Prior to the quarter ending September 30,
2001, some of our excess cashflow certificates were subject to a NIM
transaction, for which we applied an 18% discount rate. As part of the
Second Exchange Offer, all of the excess cashflow certificates subject to
the NIM transaction were transferred to the LLC. As such, at December 31,
2001, we retain only "senior" excess cashflow certificates.
In the third quarter of 2000, we increased the discount rate we used on
those excess cashflow certificates included in the NIM transaction to 18%
(from 12%) and recorded an $8.8 million valuation adjustment. The
adjustment reflected a reduction in the present value of those excess
cashflow certificates sold in connection with our NIM transaction completed
in the fourth quarter of 2000. We increased the discount rate on these
excess cashflow certificates during the period that the senior NIM
securities remain outstanding, to account for the potentially higher risk
associated with the residual cash flows expected to be received by the
holder of the certificated interest in the NIM trust, which is subordinated
to the multiple senior securities sold in the NIM transaction.
In the fourth quarter of 2000, we increased the discount rate we used in
determining the present value of our "senior" excess cashflow certificates
to 13% from 12%, and recorded a $7.1 million valuation adjustment. The
adjustment reflected 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.
At September 30, 2001, we recorded a charge to interest income to reflect a
fair value adjustment to our remaining excess cashflow certificates totaling
$19.7 million. Our change in assumptions at September 30, 2001, primarily
reflect recent unforeseen market events relating to the terrorist attacks on
September 11, 2001, that further accelerated an economic downturn in the U.S.
economy, and which we believe may have a significant adverse impact on the
economy for the foreseeable future.
Our current prepayment rate and default rate assumptions primarily reflect
our current and future expectation for:
o a continuing relatively low interest rate environment based upon, among
other things, the Eurodollar futures curve. At June 30, 2001, the
Eurodollar futures market, an indicator of future interest rates,
projected that 1-month LIBOR and 6-month LIBOR rates at December 31,
2001 would be 4.13% and 4.41%, respectively. However, as a result of
the unexpected events of September 11, 2001, actual 1-month LIBOR and
6-month LIBOR for December 31, 2001 were significantly lower at 1.87%
and 1.98%, respectively.
o a potential for an adverse economic environment. According to the
Mortgage Bankers Association, the percentage of U.S. homeowners behind
on their mortgages in the third quarter of 2001 rose to the highest
levels since the last recession in the early 1990s, citing a shrinking
economy and higher unemployment as among the causes. In addition, the
National Bureau of Economic research, the unofficial arbiter of
expansions and contractions, reported in November 2001, its belief that
the United States economy had officially entered into a recession back
in March 2001. Lastly, we revised our discount rate to reflect current
market conditions and the rate of return management believes to be
appropriate given the significant uncertainty regarding future economic
events, thus increasing the inherent risk and volatility of our excess
cashflow certificates.
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For 2000, we recorded a non-cash increase of $9.6 million to interest income
for a fair value adjustment to our excess cashflow certificates, due to the
decrease in one-month LIBOR. Some of the our excess cashflow 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.
DEFERRED TAX ASSET
As of December 31, 2001, we carried a deferred tax asset, net of $5.6 million
on our consolidated financial statements - comprised of federal and state net
operating losses or "NOLs" less the tax impact and a valuation allowance.
As of December 31, 2001, we have a gross deferred tax asset of $52.3 million
and a valuation allowance of $46.7 million. Following two successive years of
posting significant losses, and the modest amount of earnings we project over
the next two years, it was appropriate for us to establish this valuation
allowance under Accounting Principals Generally Accepted in the United States of
America (refer to as "GAAP"). In the event we are able to continue to record
earnings in upcoming years, we expect to:
o utilize a larger amount of the gross deferred tax asset to offset the
majority of such earnings; and
o potentially decrease the amount of, and/or eliminate, the valuation
allowance in accordance with GAAP.
As of December 31, 2001, Federal and State net operating loss carryforwards
("NOLs") totaled $107.2 million, with $1.1 million expiring in 2018, $21.1
million expiring in 2019, $12.4 million expiring in 2020, and $72.6 million
expiring in 2021. (See "Notes to the Consolidated Financial Statements - Note
No. 16 Income Taxes").
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001, COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
GENERAL
Our loss before extraordinary item for the year ended December 31, 2001 was
$80.5 million, or $5.07 per share (basic and diluted), compared to a net loss of
$49.4 million, or $3.11 per share (basic and diluted), for the year ended
December 31, 2000. The extraordinary loss on early extinguishment of debt, net
of tax, in 2001 totaled $19.3 million, or $1.21 per share (basic and diluted).
For the year ended December 31, 2001, the net loss included:
o a $25.4 million, or $1.60 per share (basic and diluted), write down of
excess cashflow certificates relating to a sale agreement we entered
into in the first quarter of 2001 (that closed in May 2001), for a cash
purchase price of $15 million, which reflected a significant discount
to our carrying value of such excess cashflow certificates;
o a charge (loss) to interest income of $19.7 million, or $1.24 per share
(basic and diluted), in the third quarter, reflecting a fair value
adjustment to our remaining excess cashflow certificates, due to our
changing the valuation assumptions we use to estimate fair value (see
"-Notes to the Consolidated Financial Statements - Excess Cashflow
Certificates, Net");
o a charge of $10.7 million, or $0.67 per share (basic and diluted),
relating to our disposition and transfer to Ocwen of our servicing
platform in May 2001;
o a charge of $3.6 million, or $0.23 per share (basic and diluted), in
the second quarter relating to a change in accounting estimates
regarding the life expectancy of our computer-related equipment;
o a charge of $1.4 million, or $0.09 per share (basic and diluted) in the
third quarter relating to professional fees incurred in connection with
the Second Exchange Offer; and
o a charge of $1.5 million, or $0.09 per share (basic and diluted), in
the second quarter for establishing a reserve for non-performing
mortgage loans.
27
Results for the year ended December 31, 2001 were also negatively impacted by
(a) our not executing a securitization in either the first or third quarters,
which significantly reduced our revenues for the year ended December 31, 2001
and (b) a lower level of originations, compared to 2000.
For the year ended December 31, 2000, we reported a net loss of $49.4
million, or $3.11 per share (basic and diluted). The majority of the net loss
incurred related to:
o the write-down of our capitalized mortgage servicing rights of $31.4
million;
o restructuring and debt modification charges of $7.7 million;
o a reduction in the carrying value of a portion of our excess cashflow
certificates related to an increase in the discount rate of such
certificates included in our NIM transaction, totaling $6.9 million;
o costs associated with our NIM transaction in November 2000 totaling
$3.2 million; and
o the write-down of goodwill relating to our 1997 purchase of Fidelity
Mortgage totaling $1.4 million
This was partially offset by income associated with the sale of one of our
domain names for $1.7 million.
REVENUES
Total revenues decreased $86.1 million, or 72%, to $32.9 million for the year
ended December 31, 2001, from $119.0 million for the year ended December 31,
2000. The decrease in revenue was primarily attributable to:
o a decrease in interest income due to:
(1) a $25.4 million write-down in the first quarter of five excess
cashflow certificates, and
(2) a $19.7 million charge in the third quarter reflecting a fair
value adjustment to our remaining excess cashflow certificates, due
to our changing the valuation assumptions we use to estimate fair
value (See "-Notes to the Consolidated Financial Statements - Note
No. 7 - Excess Cashflow Certificates, net");
o a lower net gain recognized on the sale of mortgage loans;
o lower origination fees and interest income due to a decrease in total
loan production; and
o lower servicing fees due to our agreement in January 2001 to transfer
our servicing portfolio to Ocwen, pursuant to which Ocwen immediately
began receiving all servicing related fees and, in turn, paid us an
interim servicing fee, until the servicing portfolio was physically
transferred to Ocwen in May 2001.
We originated $621.7 million of mortgage loans for the year ended December
31, 2001, representing a 33% decrease from $933.4 million of mortgage loans
originated and purchased for year ended December 31, 2000. The decrease in
mortgage loans originated in 2001, was primarily due to senior management's
attention being diverted to completing our necessary corporate and debt
restructuring (See "-Notes to the Consolidated Financial Statements - Note No. 3
Corporate Restructuring, Debt Modification and Debt Restructuring"). We
securitized $345.0 million of loans during the year ended December 31, 2001,
representing a 61% decrease from the $880.0 million of loans we securitized
during 2000. Our whole loan sales amounted to $261.1 million during the year
ended December 31, 2001, representing a 348% increase from the $58.3 million of
whole loans sold for the year ended December 31, 2000. This increase in whole
loan sales reflects our present strategy to diversify our funding sources
between securitizations and whole loan sales, in order to maximize cash flow and
profitability.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
is represented by the following:
(1) the sum of
(a) the fair value of the non-cash excess cashflow certificates we retain
in a securitization for each period;
(b) the cash premium purchase price we receive in connection with selling
an interest-only certificate in a securitization for each period;
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(c) the cash premium received from selling mortgage servicing rights in
connection with each securitization, and/or the fair value of the
non-cash capitalized mortgage servicing rights associated with loans
securitized in each period (if we retain mortgage servicing rights ,
which we do not anticipate doing in the foreseeable future,
particularly considering that we no longer have a servicing platform);
and
(d) the cash premium earned from selling whole loans on a
servicing-released basis,
(2) less the (i) costs associated with securitizations and (ii) any hedge loss
(gain) associated with a particular securitization.
Net gain on sale of mortgage loans decreased $12.4 million, or 24%, to $38.6
million for the year ended December 31, 2001, from $51.0 million for the year
ended December 31, 2000. This decrease was primarily due to a 35% decrease in
the amount of loans securitized or sold to $606.1 million in 2001, compared to
$938.3 million of loans securitized or sold in 2000. The decrease in loans
securitized or sold was due to an overall 33% decrease in total loan production
in 2001, compared to 2000. The decrease in net gain on sale on a comparable
basis was partially offset by (1) a higher gross profit margin recorded on our
securitizations in 2001 versus 2000, and (2) no correspondent premiums (negative
revenue) to acquire loans in 2001 - because we closed our correspondent channel
in June 2000 - compared to the $1.6 million we paid during the first half of
2000. The weighted average net gain on sale ratio was 6.4% for the year ended
December 31, 2001 compared to 5.4% for the year ended December 31, 2000.
INTEREST INCOME. Interest primarily represents the sum of:
(1) the gross cash interest we earn on loans held for sale;
(2) the cash we receive from our excess cashflow certificates;
(3) the non-cash mark-to-market or non-cash valuation adjustments to
our excess cashflow certificates to reflect changes in fair value;
and
(4) cash interest earned on bank accounts.
Interest income decreased $54.4 million, or 168%, to $(22.1) million for the
year ended December 31, 2001, from $32.3 million for the year ended December 31,
2000. The decrease in interest income was primarily due to:
o our $25.4 million write down of excess cashflow certificates that we
sold for a cash purchase price of $15 million under a sale agreement we
entered into in the first quarter of 2001;
o a charge to interest income of $19.7 million in the third quarter,
reflecting a fair value adjustment to our remaining excess cashflow
certificates, due to the changes we made to the valuation assumptions
we use to estimate fair value (see "-Notes to Financial Statements -
Note No. 7-Excess Cashflow Certificates, Net");
o a 33% decrease in loan production for the year ended December 31, 2001,
compared to the year ended December 31, 2000, which resulted in a lower
amount of mortgage loans generating interest income while held for
sale;
o a lower average mortgage coupon rate charged to the borrower of 10.5%
from 11.4% reflecting a lower economic interest rate environment; and
o a decrease in interest earned on interest bearing accounts that we
received as servicer on our securitizations. We will continue to earn
less interest income on our interest bearing accounts on a go-forward
basis because substantially all of those accounts were transferred to
Ocwen in connection with the sale of our servicing portfolio to Ocwen
in May 2001.
SERVICING FEES. Servicing fees represent all contractual and ancillary
servicing revenue we receive, less the offsetting amortization of the
capitalized mortgage servicing rights, and any adjustments recorded to reflect
valuation allowances for the impairment in mortgage servicing rights.
Servicing fees decreased $11.2 million, or 79%, to $3.0 million for the year
ended December 31, 2001, from $14.2 million for the year ended December 31,
2000. This decrease was the result of our agreement to transfer our
29
servicing portfolio to Ocwen in January 2001, pursuant to which Ocwen
immediately began receiving all servicing related fees and, in turn, paid us an
interim servicing fee, until the servicing portfolio was physically transferred
to Ocwen in May 2001. As a result of this transfer, we do not expect to earn any
servicing fees in 2002, or thereafter.
NET ORIGINATION FEES AND OTHER INCOME. Origination fees represent (1) fees
earned on broker and retail originated loans, (2) premiums paid to originate
mortgage loans and (3) other miscellaneous income, if any.
Net origination fees and other income decreased $8.0 million, or 37%, to
$13.4 million for the year ended December 31, 2001, from $21.4 million for the
year ended December 31, 2000. The decrease was primarily the result of a 33%
decrease in loan originations and our sale of a domain name in July 2000.
EXPENSES
Total expenses decreased by $71.0 million, or 39%, to $110.6 million for the
year ended December 31, 2001, from $181.6 million for the year ended December
31, 2000. The decrease was primarily due to a decrease in personnel costs due to
our restructuring and our sale of our servicing portfolio and a decrease in
interest expense. The decrease in expenses was also the result of our incurring
higher expenses for the year ended 2000 relating to charges associated with a
corporate restructuring and debt modification in the third quarter of 2000. The
decrease in expenses was partially offset by charges principally incurred in
connection with:
o our disposition and transfer of our servicing platform to Ocwen in May
2001;
o a change in our accounting estimates regarding the life expectancy of
computer-related equipment in the second quarter of 2001; and
o our recording a reserve for non-performing mortgage loans in the second
quarter of 2001.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees.
Payroll and related costs decreased by $13.6 million, or 24%, to $42.9
million for the year ended December 31, 2001, from $56.5 million for the year
ended December 31, 2000. The decrease was primarily the result of (1) the
downsizing we effectuated as part of our overall corporate restructuring
beginning in the second half of 2000 and culminating with the physical transfer
of our servicing operation in May 2001; and (2) a lower amount of commissions
paid due to the decrease in originations. We employed 609 full- and part-time
employees as of December 31, 2001, compared to 851 full- and part-time employees
as of December 2000.
INTEREST EXPENSE. Interest expense includes the borrowing cost under our
warehouse credit facility to finance loan originations, equipment financing and
the notes.
Interest expense decreased by $14.3 million, or 47%, to $16.1 million for the
year ended December 31, 2001 from $30.4 million for the year ended December 31,
2000. The decrease was primarily attributable to the $12.1 million of interest
expense we saved in 2001 by extinguishing $139.2 million of notes in August 2001
and, to a lesser extent, to our lower loan production in 2001, which resulted in
lower warehouse financing, and lower financing costs. The average one-month
LIBOR rate, which is the benchmark used to determine our cost of borrowed funds,
decreased on average to 3.9% for the year ended December 31, 2001, compared to
an average of 6.4% for the year ended December 31, 2000.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, 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 increased $3.8 million, or 8%, to $48.9
million for the year ended December 31, 2001, from $45.1 million for the year
ended December 31, 2000. The increase primarily resulted from:
o the cost of maintaining an unprofitable servicing platform until we
physically transferred it to Ocwen in May 2001, plus the associated
costs of transferring our servicing portfolio to Ocwen;
30
o a change in the useful life of computer-related equipment from five
years to three years;
o a fair value adjustment to a pool of non-performing loans, which we
ultimately sold in July 2001;
o partially offset by the cost savings related to our corporate
restructuring, including the disposition of our servicing portfolio to
Ocwen in May 2001 and elimination of capital charges associated with
making securitization advances prior to the sale of the servicing
portfolio.
RESTRUCTURING AND OTHER SPECIAL CHARGES. We recorded the following
restructuring and other special charges in 2001 and 2000:
o In 2001, $2.7 million of restructuring and other special charges
relating to our disposition of branches and severance costs associated
with closing our servicing operation.
o In the fourth quarter of 2000, a $38.2 million write-down of our
capitalized mortgage servicing rights coupled with a $1.6 million
write-down of other servicing receivable assets.
o In the third quarter of 2000, $3.1 million of debt modification charges
primarily related to legal fees, and the noteholders' financial advisor
fees associated with the Debt Modification and Exchange Offering. We
also recorded $6.7 million of charges related to our restructuring of
our operations, primarily related to employee severance associated with
the layoffs, a reduction to goodwill and office equipment write-offs.
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.
We recorded a tax provision of $2.9 million primarily related to excess
inclusion income generated by our excess cashflow certificates and a tax benefit
of $13.2 million for the year ended December 31, 2001 and 2000, respectively.
Excess inclusion income cannot be offset by our NOL's under the REMIC tax laws.
In 2001, it was primarily caused by the REMIC securitization trust utilizing
cash, that otherwise would have been paid to us as holder of the excess cashflow
certificate, to make payments to other security holders:
o to create and/or maintain overcollateralization by artificially paying
down the principal balance of the asset-backed securities; and
o in connection with our NIM transaction, executed in November 2000, to
pay down the debt collateralized by our excess cashflow certificates.
Going forward, we expect to continue to incur a modest amount of excess
inclusion income, which we will be unable to offset using our NOL's.
YEAR ENDED DECEMBER 31, 2000, COMPARED TO THE YEAR ENDED DECEMBER 31, 1999
GENERAL
We reported a net loss for the year ended December 31, 2000 of $49.4 million,
or $3.11 per share (basic and diluted), compared to net income of $4.7 million,
or $0.30 per share (basic and diluted), for the year ended December 31, 1999.
The net loss for 2000 included the following items totaling $46.9 million on an
after-tax basis:
o a $31.4 million write-down or our capitalized mortgage servicing rights
based upon our realization, in connection with the bidding process that
led to our agreement with Ocwen, that we could not sell our then
existing loan servicing portfolio for a premium;
o $7.7 million of restructuring and debt modification charges;
o a $4.9 million reduction in the carrying value of the excess cashflow
certificates due to an increase in the discount rate assumption used to
present value the future expected excess cash flows. This was partially
offset by an increase to the carrying value of the excess cashflow
certificates due to a decrease in the variable interest rate paid to
the pass-through investor in the securitization which is tied to the
one-month LIBOR index;
31
o $3.2 million of costs associated with our NIM transaction in November
2000;
o a $1.4 million write-down of our goodwill relating to the 1997 purchase
of Fidelity Mortgage;
o a $1.7 million gain from the sale of one of our domain names.
The net loss for the year ended December 31, 1999 included a $12.0 million
charge relating to our settlement with the NYSBD and the NYOAG totaling $7.3
million on an after-tax basis. 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 year ended December
31, 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.
We originated and purchased $933 million of mortgage loans for the year ended
December 31, 2000, representing a 37% decrease from $1.47 billion of mortgage
loans originated and purchased for the year ended December 31, 1999. We
securitized $880 million in loans (and sold the related servicing rights on our
second, third and fourth quarter 2000 securitizations, respectively) during the
year 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 year ended December 31, 1999. We also sold $58.3 million of
loans on a whole loan servicing released basis for the year December 31, 2000,
after having not sold any whole loans 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 decreased $33.0 million, or 39%, to $51.0
million for the year ended December 31, 2000, from $84.0 million for the year
ended December 31, 1999. This decrease was primarily due to (1) a 40% decrease
in the amount of loans securitized or sold and (2) revisions to our loan loss
reserve and discount rate assumptions in the fourth quarter of 1999 and fourth
quarter of 2000, respectively (see "-Notes to the Consolidated Financial
Statements - Note No. 7 - Excess Cashflow Certificates, Net"). The decrease was
partially offset by:
o 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;
o our not executing a securitization in the third quarter of 1999 and
instead opting to sell our loan production into a conduit facility,
where the net gain on sale was lower than if we would have sold our
loans through securitization; and
o 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.
We also lowered our prepayment speed assumptions in the third quarter of
2000, while at the same time increased our loss reserve initially established
for both fixed and adjustable-rate loans sold to the securitizations trusts (see
"-Notes to the Consolidated Financial Statements - Note No. 7 - Excess Cashflow
Certificates, Net"). 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 5.1% for the year ended December 31, 2000 compared to
5.4% for the year ended December 31, 1999.
Interest income increased $1.3 million, or 4%, to $32.3 million for the year
ended December 31, 2000, from $31.0 million for the year ended December 31,
1999. The increase was primarily due to our utilizing a mortgage loan conduit
(special purpose vehicle) prior to securitization in 1999 (a short-term credit
facility - similar to our other warehouse finance facilities) - in which we
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 - that we did not use at all in
2000.
Servicing fees decreased $2.1 million, or 13%, to $14.2 million for the year
ended December 31, 2000, from $16.3 million for the year ended December 31,
1999. The decrease in servicing income was primarily due to (1)
32
lower ancillary fees collected (primarily prepayment penalties as mortgage loan
prepayments were comparably lower in 2000) and (2) lower servicing fees
collected due to a more seasoned (I.E., more delinquent) portfolio in 2000, due
in part to our selling servicing rights on $590 million of newly originated or
purchased mortgage loans securitized in 2000.
Net origination fees and other income decreased $2.0 million, or 9%, to
$21.4 million for the year ended December 31, 2000, from $23.4 million for the
year ended December 31, 1999. The decrease was primarily the result of 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 our domain names in July
2000.
EXPENSES
Total expenses increased by $34.5 million, or 23%, to $181.6 million for the
year ended December 31, 2000, from $147.1 million for the year ended December
31, 1999, primarily resulting from:
o the complete write down of our capitalized mortgage servicing rights of
$38.2 million;
o corporate restructuring and debt modification charges in the third
quarter of 2000, totaling $6.7 million and $3.1 million, respectively;
and
o a write-down of goodwill in the fourth quarter of 2000 of $1.8 million;
o partially offset by:
>> a decrease in general and administrative costs, primarily relating to
the $12 million we expensed in 1999 for the settlement we entered
into with the NYSBD, NYOAG and DOJ; and
>> a decrease in personnel costs attributable to our initiative to lower
costs through a corporate restructuring in the third quarter of 2000
that included a workforce reduction.
Payroll and related costs decreased by $8.6 million, or 13%, to $56.5 million
for the year ended December 31, 2000, from $65.1 million for the year ended
December 31, 1999. The decrease was primarily the result of (1) a lower number
of employees in 2000 compared to 1999 relating to our restructuring in the third
quarter of 2000 (see "-Corporate Restructuring, Debt Modification and Debt
Restructuring"), and (2) a lower amount of commissions paid because of a lower
amount of loan originations in 2000 compared to 1999. As of December 31, 2000,
we employed 851 full- and part-time employees, compared to 1,134 full- and
part-time employees as of December 31, 1999.
Interest expense increased by $3.8 million, or 14%, to $30.4 million for the
year ended December 31, 2000 from $26.6 million for the year ended December 31,
1999. The increase was primarily attributable to the accounting for loans sold
through a mortgage loan conduit prior to their securitization during the year
ended December 31, 1999, in which we 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 our other warehouse financing
and borrowings are recorded directly to interest expense and we did not utilize
our mortgage loan conduit during 2000. In addition, the cost of funds on our
credit facilities (which were tied to the one-month LIBOR) increased. The
one-month LIBOR index increased to an average interest rate of 6.4% in the year
ended December 31, 2000, compared to an average interest rate of 5.2% for the
year ended December 31, 1999.
General and administrative expenses decreased $10.2 million, or 18%, to $45.1
million for the year ended December 31, 2000, from $55.3 million for the year
ended December 31, 1999. The decrease was primarily the result of the $12
million settlement we expensed in the year ended December 31, 1999, in
connection with our settlement with the NYSBD, NYOAG and DOJ.
We recorded the following restructuring and other special charges in 2000:
o In the fourth quarter of 2000, a $38.2 million write-down of our
capitalized mortgage servicing rights, coupled with a $1.6 million
write-down of other servicing receivable assets;
33
o In the third quarter of 2000, $3.1 million of debt modification charges
primarily related to legal fees, and the noteholders' financial advisor
fees associated with the Debt Modification and proposed Exchange
Offering. We also recorded $6.7 million of charges related to the
restructuring of our operations, primarily related to employee
severance associated with the layoffs, a reduction to goodwill and
office equipment write-offs (see "-Corporate Restructuring, Debt
Modification and Debt Restructuring").
We 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.
FINANCIAL CONDITION
DECEMBER 31, 2001 COMPARED TO DECEMBER 31, 2000
Cash and interest-bearing deposits decreased $55.9 million, or 90%, to $6.4
million at December 31, 2001, from $62.3 million at December 31, 2000. This
decrease was primarily related to the transfer of our servicing portfolio, which
resulted in the transfer of all the securitization trusts' collection accounts
to Ocwen.
Accounts receivable decreased $17.8 million, or 87%, to $2.7 million at
December 31, 2001, from $20.5 million at December 31, 2000. This decrease was
primarily due to the sale of some of our servicing advance receivables to Ocwen,
and the write-down of any servicing advance receivable determined to be
non-recoverable, in connection with our transfer of servicing to Ocwen.
Loans held for sale, net, increased $11.7 million, or 14%, to $94.4 million
at December 31, 2001, from $82.7 million at December 31, 2000. This increase was
primarily due to the net difference between loan originations and loans sold or
securitized during 2001.
Accrued interest receivable decreased $9.6 million, or 92%, to $0.8 million
at December 31, 2001, from $10.4 million at December 31, 2000. This decrease was
primarily due to the sale of the interest receivable asset (monthly delinquency
advances) to Ocwen, in connection with our transfer of servicing.
Excess cashflow certificates, net decreased $200.1 million, or 92%, to $16.8
million at December 31, 2001, from $216.9 million at December 31, 2000. This
decrease was primarily due to:
o the transfer of $153.1 million of excess cashflow certificates to the
LLC in connection with the Second Exchange Offer;
o our sale of five excess cashflow certificates with a carrying value of
$40.4 million, pursuant to a sale agreement entered into in the first
half of 2001, for a cash purchase price of $15 million (which
represented a $25.4 million write-down that was recorded as a reduction
in interest in our consolidated statement of operations); and
o a $19.7 million fair value adjustment in the third quarter of 2001 to
our remaining excess cashflow certificates, as we changed the valuation
assumptions we use to estimate fair value (see "-Notes to the
Consolidated Financial Statements - Note No. 7 - Excess Cashflow
Certificates, Net").
The decrease was partially offset by:
o a $2.0 million fair value mark-to-market adjustment of our excess
cashflow certificates, reflecting the change in fair value of such
excess cashflow certificates (which incorporates any change in value
(accretion or reduction) in the carrying value of the excess cashflow
certificates and the cash distributions we received from such excess
cashflow certificates);
o an $11.1 million increase from recording new excess cashflow
certificates from loans securitized in 2001.
Equipment, net, decreased $10.0 million, or 67%, to $5.0 million at December
31, 2001, from $15.0 million at December 31, 2000. This decrease primarily
reflects our changing the estimated life on our computer-related equipment
during the second quarter of 2001, the disposition of servicing-related
equipment relating to our transfer of servicing, and the closing of some retail
loan origination centers.
34
Prepaid and other assets decreased $37.1 million, or 98%, to $0.7 million at
December 31, 2001, from $37.8 million at December 31, 2000. This decrease was
primarily attributable to:
o the extinguishment of our wholly-owned special purpose entities (and
the equity (capital) in such special purpose entity) used as the
issuers for delinquency and servicing advance securitizations, in
connection with the sale of servicing to Ocwen, upon our repurchase of
such securitizations using the proceeds we received from selling the
underlying delinquency and servicing advance receivables to Ocwen;
o our payment of the notes interest coupon in February 2001, which was
held in escrow, and therefore reflected as a prepaid asset at December
31, 2000;
o the transfer of a non-performing loan trust to the LLC (an unaffiliated
entity to us) as part of the Second Exchange Offer; and
o our recognizing previously capitalized notes issuance costs in
connection with the Second Exchange Offer.
We have a deferred tax asset, net, of $5.6 million at December 31, 2001 and
2000, which was primarily attributable to the net operating losses we incurred
in 2000. Embedded in the deferred tax asset, net, is a valuation allowance
established in 2000 and increased in 2001. (See "-Notes to Financial Statements
- - Note No. 16 - Income Taxes").
Warehouse financing and other borrowings increased $1.0 million, or 1%, to
$89.6 million at December 31, 2001, from $88.6 at December 31, 2000. The
increase was primarily attributable to our borrowing a higher amount under our
warehouse credit facility.
Senior notes decreased $138.8 million, or 93%, to $10.8 million at December
31, 2001 from $149.6 million at December 31, 2000. This decrease was primarily
attributable to the extinguishment of substantially all our notes in the Second
Exchange Offer (see "-Corporate Restructuring, Debt Modification, and Debt
Restructuring").
Accounts payable and accrued expenses decreased $13.2 million, or 41%, to
$18.8 million at December 31, 2001 from $32.0 million at December 31, 2000. This
decrease was primarily attributable to (1) our reversing a previously recorded
accrual for the August 2001 semi-annual interest coupon payment due on the
notes. As part of the Second Exchange Offer, all tendering noteholders agreed to
waive the August 2001 interest payment for all notes being tendered, and (2) the
LLC's becoming obligated to satisfy our NYSBD subsidy payments from the proceeds
of the mortgage-related securities transferred to the LLC as part of the Second
Exchange Offer.
Investor payable decreased to $0 at December 31, 2001, from $69.5 million at
December 31, 2000. The decrease was the result of our transferring our servicing
portfolio to Ocwen. Investor payable previously reflected the amount of
principal collected at the end of a reporting period and the accrued interest
that was due the securitization trusts in the following period by us as
servicer.
Advance payments by borrowers for taxes and insurance decreased to $0 at
December 31, 2001, from $12.9 million at December 31, 2000. The decrease was the
result of our transferring our servicing portfolio to Ocwen. Advance payments
previously reflected the payments collected and held in escrow trust accounts by
us, as servicer, before distribution to third parties.
Stockholders' equity decreased $85.9 million, or 88%, to $11.8 million at
December 31, 2001 from $97.7 million at December 31, 2000. This decrease was
primarily due to the net loss for 2001 of $99.8 million. This was partially
offset by our issuance of Series A Preferred Stock in connection with the Second
Exchange Offer having an aggregate preference amount of $13.9 million.
LIQUIDITY AND CAPITAL RESOURCES
We require substantial amounts of cash to fund our loan originations,
securitization activities and operations. In the past, we have operated
generally on a negative cash flow basis. Embedded in our current cost structure
are many fixed costs, which are not likely to be significantly affected by a
relatively substantial increase in loan originations. If we can increase our
loan production to generate sufficient additional revenues from our
securitizations and sales of such loans to offset our current cost structure and
negative cash flow, we believe we can
35
generate positive cash flow within the foreseeable future. However, there can be
no assurance we will be successful in this regard. To do so, we must generate
sufficient cash from:
o the premiums we receive from selling interest-only or NIM certificates
and mortgage servicing rights in connection with our securitizations;
o the premiums we receive from selling whole loans, servicing released;
o origination fees on newly closed loans;
o excess cashflow certificates we retain in connection with our
securitizations; and
o distributions from the LLC.
There can be no assurance, however, that we will begin generating positive cash
flow within the foreseeable future or at all.
Currently, our primary cash requirements include the funding of:
o loan originations pending their pooling and sale, net of warehouse
financing;
o interest expense on warehouse lines of credit, the remaining notes
and other financing;
o fees, expenses, and tax payments on excess inclusion income incurred
in connection with our securitization program; and
o general ongoing administrative and operating expenses.
Historically, we have financed our operations utilizing various secured
credit financing facilities, issuance of corporate debt (I.E., senior notes),
issuance of equity, and the sale of interest-only certificates (sold in
conjunction with each of our securizations) to offset our negative operating
cash flow and support our originations, securitizations, servicing (prior to May
2001) and general operating expenses. Over the past few years, we have engaged
in a series of transactions to further address our negative cash flow, including
the following:
o in 2000, completing three securitizations of interest (delinquency) and
servicing advances, in which we sold our rights to be reimbursed for
our outstanding delinquency and servicing advances that we made as
servicer for a cash purchase price. We used the proceeds from these
securitizations to (1) repay a $25 million working capital sub-line of
our former bank syndicate warehouse facility that expired in June 2000,
which was secured by our delinquency and servicing advance receivables,
and (2) for working capital to finance our operations, including the
funding of new delinquency and servicing advances. We ultimately
repurchased these securitizations in 2001, in connection with the sale
of servicing to Ocwen, using the proceeds we received from selling the
underlying delinquency and servicing advance receivables to Ocwen;
o modifying our senior notes in 2000 as part of the Debt Modification
(see "-Corporate Restructuring, Debt Modification and Debt
Restructuring"), which enabled us to monetize a portion of our excess
cashflow certificates, first by obtaining $17 million in residual
financing in August 2000, secured by some of our excess cashflow
certificates. Shortly thereafter, in November 2000, we sold six excess
cashflow certificates through a private placement NIM transaction to an
owner trust that issued senior certificates to institutional investors
for a cash purchase. The net proceeds of the NIM transaction, after
expenses, was used entirely to repay the $17 million of residual
financing we 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 on the notes in February 2001;
o as part of our Second Debt Restructuring, at the time of the signing of
the Letter of Intent in February 2001, we obtained approximately $2.5
million of residual financing secured by several of our excess cashflow
certificates. We received approximately $7.1 million of additional
residual financing secured primarily by additional excess cashflow
certificates following the consummation of the consent solicitation and
the execution of the third supplemental indenture in March 2001. Also
in March 2001, we entered into a sale agreement to sell five excess
cashflow certificates for a $15 million cash purchase price. As
customary with sales of similar assets, the cash settlement did not
occur until the pools of mortgage loans
36
underlying the six excess cashflow certificates were transferred to an
agreed upon servicer to service the pool of mortgage loans for the
benefit of the purchaser. The purchaser of these five excess cashflow
certificates provided bridge financing, in the form of residual
financing described above, until the transfer of servicing in May 2001.
We used these proceeds to repay the residual financing and have been
using the balance of the proceeds, together with the initial residual
financing, for working capital. Because these excess cashflow
certificates were sold at a significant discount to our book value for
such excess cashflow certificates, we recorded $25.4 million pre-tax
non-cash charge in the first quarter of 2001.
Currently, our primary sources of liquidity continue to be, subject to market
conditions:
o on-balance sheet warehouse financing and other secured financing
facilities (e.g., capital leasing);
o securitizations of mortgage loans and our corresponding sale of
interest-only certificates (or NIM certificates, depending upon the
securitization structure) and mortgage servicing rights;
o sales of whole loans;
o cash flows from retained excess cashflow certificates;
o distributions from the LLC (an unaffiliated entity to us) (see "-
Corporate Restructuring, Debt Modification and Debt Restructuring");
and
o utilizing NIM securitizations and/or selling or financing our excess
cashflow certificates.
If we are not able to obtain financing, we will not be able to originate new
loans and our business and results of operations will be materially and
adversely affected.
To accumulate loans for securitization or sale, we borrow money on a
short-term basis through warehouse lines of credit. We have relied upon a few
lenders to provide the primary credit facilities for our loan originations and
currently have one warehouse facility as of December 31, 2001 for this purpose.
The warehouse facility is a $200 million credit facility that has a variable
rate of interest and expires on April 30, 2002. There can be no assurance that
we will be able to renew this warehouse facility at its maturity at terms
satisfactory to us or at all. We are currently in the process of seeking
additional warehouse lines of credit, but there can be no assurance that we will
be successful in our attempt to secure an additional warehouse line of credit on
terms reasonably satisfactory to us, if at all.
We are required to comply with various operating and financial covenants as
provided in our warehouse agreement, which are customary for agreements of their
type. The continued availability of funds provided to us under this agreement is
subject to, among other conditions, our continued compliance with these
covenants. Additionally, we are required to comply with restrictive covenants in
connection with our Series A preferred stock and our warrants. We believe we are
in compliance with such covenants as of December 31, 2001.
We have repurchase agreements with certain of the institutions that have
purchased mortgages. Currently, some of the agreements provide for the
repurchase by us of any of the mortgage loans that go to foreclosure sale. At
the foreclosure sale, we will repurchase the mortgage, if necessary, and make
the institution whole. The dollar amount of loans, which were sold with
recourse, is $3.5 million at December 31, 2001 and $6.2 million at December 31,
2000. Included in accounts receivable is an allowance for recourse losses of
$1.4 million at December 31, 2001 and $1.5 million at December 31, 2000,
respectively.
Future contractual obligations related to principal balances for capital
leases as of December 31, 2001 are as follows:
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Period Amount
- --------------------------------------------------------------------------------
Less than 1 year $ 4,704
1-3 years 2,033
- --------------------------------------------------------------------------------
Total $ 6,737
- --------------------------------------------------------------------------------
37
We may, from time to time, if opportunities arise that we deem to be
appropriate, repurchase in the open market some of our outstanding preferred
stock and senior notes. The funds for any such repurchases would be expected to
come from our existing cash. There is no assurance that we will effectuate any
such repurchases or the terms thereof.
Subject to our ability to execute our business strategy and the various
uncertainties described above (and described in more detail in "-Forward Looking
Statements and Risk Factors" below), we anticipate that we will have sufficient
cash flows, short-term funding and capital resources to meet our liquidity
obligations for the foreseeable future.
INTEREST RATE RISK
Our primary market risk exposure is interest rate risk. Profitability may be
directly affected by the level of, and fluctuation in, interest rates, which
affect our ability to earn a spread between interest received on our loans and
the costs of our borrowings, which are tied to various interest rate swap
maturities, commercial paper rates and LIBOR. Our profitability 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 our ability to originate loans. A significant decline in interest rates
could increase the level of loan prepayments thereby decreasing the size of the
loan servicing portfolio underlying our securitizations. To the extent excess
cashflow certificates have been capitalized on our financial statements, higher
than anticipated rates of loan prepayments or losses could require us to write
down the value of such excess cashflow certificates, adversely impacting our
earnings. In an effort to mitigate the effect of interest rate risk, we
periodically review our various mortgage products and identify and modify those
that have proven historically more susceptible to prepayments. However, there
can be no assurance that these modifications to our product line will mitigate
effectively interest rate risk in the future.
Periods of unexpected or rapid changes in interest rates, and/or other
volatility or uncertainty regarding interest rates, also can affect adversely us
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 excess cashflow certificates we receive in connection with a
securitization.
Fluctuating interest rates also may affect the net interest income we earn,
resulting from the difference between the yield we receive on loans held pending
sales and the interest paid by us for funds borrowed under our warehouse
facility. We do, however, undertake to hedge our exposure to this risk by using
various hedging strategies, including Fannie Mae mortgage securities, treasury
rate lock contracts and/or interest rate swaps. (See "--Hedging"). Fluctuating
interest rates also may affect net interest income as certain of our
asset-backed securities are priced based on 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 two or three
years of the mortgage loan, and adjusting thereafter every six months - which
creates basis risk (See "--Notes to the Consolidated Financial Statements - Note
No. 7 - Excess Cashflow Certificates, Net").
HEDGING
We 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. There was no
impact on our financial condition or results of operations upon the adoption of
SFAS No. 133, as amended.
We originate mortgage loans and then sell them through a combination of whole
loan sales and securitizations. Between the time we originate the mortgage and
sell it in the secondary market, we may hedge the risk of fluctuations in
interest rates. Our risk begins subsequent to originating mortgage loans and
prior to selling or securitizing such mortgage loans. Since we have a closed
(and funded) mortgage loan at a specified interest rate with an expected gain at
time of sale, our exposure is to a higher interest rate environment due to
market conditions. A higher interest rate market implies that we will have a
higher cost of funds, which decreases the net spread we
38
would earn between the mortgage interest rate on each mortgage loan less the
cost of funds. As a result, we may experience a lower gain on sale.
The cost of funds is generally composed of two components, the interest rate
swap with a similar duration and average life and the swaps spread or profit
margin required by the investors. We had previously used a "Treasury Rate Lock"
and 15-year Fannie Mae mortgage securities ("FNMA Securities") to hedge our cost
of funds exposure. However recently, the securitizations are priced to the
investor using the interest rate swaps curve. As such, our cost of funds is more
closely tied to interest rate swaps and we will likely use interest rate swaps
to hedge our mortgage loans in inventory pending securitization pricing. While
none of the above are perfect hedges, we believe interest rate swaps will
demonstrate the highest correlation to our cost of funds on a go-forward basis.
We determine the nature and quantity of hedging transactions based upon various
factors including, without limitation, market conditions and the expected volume
of mortgage originations. We will enter into these hedging strategies through
one of our warehouse lenders and/or one of the investment bankers that
underwrite our securitizations. These strategies are designated as hedges on our
financial statements and are closed out when we sell the associated loans.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, upon settlement with our hedge counterparty, we will pay the hedge
loss in cash and then realize the corresponding increase in the value of the
loans as part of our net gain on sale of mortgage loans through either the
excess cashflow certificates we retain from securitization or from whole loan
premiums. Conversely, if the value of the hedges increase, offsetting a decrease
in the value of the loans, upon settlement with our hedge counterparty, we 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
excess cashflow certificates or whole loan premiums.
We believe our hedging strategy has largely been an effective tool to manage
our interest rate risk on loans prior to securitization, by providing us with a
cash gain (or loss) to largely offset the reduced (increased) 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.
We make decisions concerning the nature of our hedging transactions based
upon various factors including, without limitation, market conditions and the
expected volume of mortgage originations. We may enter into these hedging
strategies through one of our warehouse lenders and/or an investment bank that
underwrites our securitizations. We will review continually the frequency and
effectiveness of our hedging strategy to mitigate risk pending a securitization
or loan sale.
If a hedging transaction is deemed to be appropriate, and can be properly
documented and mathematically shown to meet the appropriate effectiveness
criteria, we will account for these hedges as fair value hedges in accordance
with SFAS No. 133, as amended.
We will continue to review our hedging strategy in order to best mitigate
risk pending securitization or loan sales.
We did not hedge during the year ended December 31, 2001. For the year ended
December 31, 2000 and 1999, we 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 our net gain on sale of loans.
INFLATION
Inflation most significantly affects our loan originations and values of our
excess cashflow certificates, because of the substantial effect inflation can
have 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 No. 1 and Note No. 8 of Notes to the Consolidated Financial Statements.
39
FORWARD-LOOKING STATEMENTS AND 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 our operations and business environment, and are
subject to change on various important factors. We wishe to take advantage of
the "safe harbor" provisions of the PSLRA by cautioning readers that numerous
important factors discussed below, among others, in some cases have caused, and
in the future could cause our actual results to differ materially from those
expressed in any forward- looking statements made by us, or on our behalf. The
following include some, but not all, of the factors or uncertainties that could
cause actual results to differ from projections:
o Our ability or inability to increase our loan originations to specified
levels (and subsequent sale or securitization of such loans) to offset
our current cost structure and negative cash flow;
o Our 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 Our ability or inability to continue our practice of securitizing
mortgage loans held for sale, as well as our ability to utilize optimal
securitization structures (including the sale of interest-only or NIM
certificates, and the sale of servicing rights, at the time of
securitization) at terms favorable to us;
o Our ability or inability to continue monetizing our excess cashflow
certificates, 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 federal,
state or local 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 us;
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 our 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 our ability to securitize or sell loans in the secondary market;
o The effects of interest rate fluctuations and our 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 our 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. We are
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; and
o The unanticipated expenses of assimilating newly-acquired businesses
into our structure, as well as the impact of unusual expenses from
ongoing evaluations of business strategies, asset valuations,
acquisitions, divestitures and organizational structures.
40
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We originate mortgage loans and then sell the mortgage loans through a
combination of whole loan sales and securitizations. As a result, our primary
market risk is interest rate risk. In turn, interest rates are highly sensitive
to many factors, including:
o governmental monetary and tax policies;
o domestic and international economic and political considerations; and
o other factors beyond our control.
Changes in the general interest rate levels between the time we originate
mortgage loans and the time when we sell such mortgage loans in securitization
transactions can affect the value of our mortgage loans held for sale and,
consequently, our 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 we originate the
loans and the time we sell the loans in a securitization transaction, the excess
spread generally narrows, resulting in a loss in value of the loans and a lower
net gain on sale for us. Since we close and fund mortgage loans at a specified
interest rate with an expected gain on sale to be booked at the time of their
sale, our exposure to decreases in the fair value of the mortgage loans arises
when moving from a lower to a higher interest rate environment. A higher
interest rate environment results in our having higher cost of funds. This
decreases both the fair value of the mortgage loans, and the net spread we earn
between the mortgage interest rate on each mortgage loan and our cost of funds
under available warehouse lines of credit used to finance the loans prior to
their sale in a securitization transaction. As a result, we may experience a
lower gain on sale.
The following table illustrates the impact on our earnings resulting from a
hypothetical 10 basis point change in interest rates. Historically, such a basis
point increase has resulted in an approximately 10 basis point change in the
excess spread or "yield." The product of 10 basis points in yield (0.10%) and
the duration of 2.5 years equals a 25.0 basis point or 0.25% change in the net
gain on sale as shown below.
10 BASIS POINT DECREASE IN 10 BASIS POINT INCREASE IN
DESCRIPTION INTEREST RATES BASE INTEREST RATES
- --------------------------------------------------------------------------------------------
Securitization amount $100,000,000 $100,000,000 $100,000,000
Net gain on sale % 5.25% 5.00% 4.75%
Net gain $5,250,000 $5,000,000 $4,750,000
The table below demonstrates the sensitivity, at December 31, 2001, of the
estimated fair value of our excess cashflow certificates caused by an immediate
10% and 20%, respectively, adverse change in the key assumptions we use to
estimate fair value:
Fair value of excess Impact to
(Dollars in thousands) cashflow certificates earnings
- --------------------------------------------------------------------------------
Fair value as of 12/31/01: $ 16,765
10% increase in prepayment speed 13,838 $2,927
20% increase in prepayment speed 11,293 5,472
10% increase in credit losses 13,547 3,218
20% increase in credit losses 10,476 6,289
10% increase in discount rates 15,860 905
20% increase in discount rates 15,048 1,717
41
These sensitivities are hypothetical and are presented for illustrative
purposes only. Changes in the fair value resulting from a change in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the resulting change in fair value may not be linear. Each change
in assumptions presented above was calculated independently without changing any
other assumption. However, in reality, changes in one assumption may result in
changes in another assumption, which may magnify or counteract the
sensitivities. For example, a change in market interest rates may simultaneously
impact prepayment speeds, credit losses and the discount rate. It is impossible
to predict how one change in a particular assumption may impact other
assumptions.
To reduce our financial exposure to changes in interest rates, we generally
hedge our mortgage loans held for sale through hedging products that are
correlated to the pass-though certificates issued in connection with the
securitization of our mortgage loans (I.E., interest rate swaps) (See
- -"Hedging"). We believe our hedging strategy has largely been an effective tool
to manage our interest rate risk on loans prior to securitization, by providing
us with a cash gain (or loss) to largely offset the reduced (increased) 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.
We make decisions concerning the nature of our hedging transactions based
upon various factors including, without limitation, market conditions and the
expected volume of mortgage originations. We may enter into these hedging
strategies through one of our warehouse lenders and/or an investment bank that
underwrites our securitizations. We will review continually the frequency and
effectiveness of our hedging strategy to mitigate risk pending a securitization
or loan sale.
If a hedging transaction is deemed to be appropriate, and can be properly
documented and mathematically shown to meet the appropriate effectiveness
criteria, we will account for these hedges as fair value hedges in accordance
with SFAS No. 133, as amended. Under SFAS No. 133 changes in the fair value of
both the derivative and hedged mortgage loans will be recorded through
earnings-offsetting each other for the effectiveness of the hedge, with the
ineffective portion of the fair value changes recorded in earnings with no
corresponding offset. We adopted SFAS No. 133 as of January 1, 2001. There was
no impact on our financial condition or results of operations upon the adoption
of SFAS No. 133, as amended.
For the year ended December 31, 2001, we did not have a hedge gain or loss.
During 2000, we recorded a hedge loss of $2.1 million. As of December 31, 2001,
we had no derivative instruments or hedging relationships of any kind
outstanding.
Changes in interest rates also could adversely affect our ability to
originate loans and/or could affect the level of loan prepayments thereby
impacting the size of the loan portfolio underlying our excess cashflow
certificates and, consequently, the value of our excess cashflow certificates.
(See "-Interest Rate Risk" and "-Risk Factors - Interest Rate Risk").
42
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, 2001 and 2000, 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, 2001.
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, 2001 and 2000, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Melville, New York
February 27, 2002
43
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
(DOLLARS IN THOUSANDS) 2001 2000
- ---------------------------------------------------------------------------------------------------------
ASSETS
Cash and interest-bearing deposits.................................... $ 6,410 62,270
Accounts receivable.................................................... 2,654 20,502
Loans held for sale, net............................................... 94,407 82,698
Accrued interest receivable............................................ 812 10,388
Excess cashflow certificates, net...................................... 16,765 216,907
Equipment, net......................................................... 4,998 15,034
Prepaid and other assets............................................... 752 37,846
Deferred tax asset, net................................................ 5,600 5,600
- ----------------------------------------------------------------------------------------------------------
Total assets.................................................... $ 132,398 451,245
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank payable........................................................... $ 1,267 927
Warehouse financing and other borrowings............................... 89,628 88,632
Senior notes........................................................... 10,844 149,571
Accounts payable and accrued expenses.................................. 18,809 31,962
Investor payable....................................................... -- 69,489
Advance payment by borrowers for taxes and insurance................... -- 12,940
- ----------------------------------------------------------------------------------------------------------
Total liabilities............................................... 120,548 353,521
- ----------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Preferred stock, Series A, $.01 par value. Authorized 150,000 shares,
139,156 shares outstanding and 0 shares authorized and outstanding
at December 31, 2001 and December 31, 2000, respectively............ 13,916 --
Common stock, $.01 par value. Authorized 49,000,000 shares;
16,000,549 shares issued and 15,883,749 shares outstanding at
December 31, 2001 and December 31, 2000, respectively.................. 160 160
Additional paid-in capital............................................. 99,472 99,472
Retained deficit....................................................... (100,380) (590)
Treasury stock, at cost (116,800 shares)............................... (1,318) (1,318)
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity...................................... 11,850 97,724
- ----------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity...................... $ 132,398 451,245
- ----------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
44
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2001, 2000 and 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------
REVENUES:
Net gain on sale of mortgage loans................ $ 38,638 51,031 84,010
Interest.......................................... (22,146) 32,287 31,041
Servicing fees.................................... 2,983 14,190 16,341
Net origination fees and other income............. 13,450 21,463 23,427
- -------------------------------------------------------------------------------------------------------------------
Total revenues 32,925 118,971 154,819
- -------------------------------------------------------------------------------------------------------------------
EXPENSES:
Payroll and related costs......................... 42,896 56,525 65,116
Interest expense.................................. 16,132 30,386 26,656
General and administrative........................ 48,878 45,066 55,318
Capitalized mortgage servicing impairment......... -- 38,237 --
Restructuring and other special charges............ 2,678 11,382 --
- -------------------------------------------------------------------------------------------------------------------
Total expenses 110,584 181,596 147,090
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income tax expense (benefit)
and extraordinary item................................ (77,659) (62,625) 7,729
Income taxes expense (benefit)........................ 2,876 (13,208) 3,053
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary item............... (80,535) (49,417) 4,676
Extraordinary item, net of tax on early
extinguishment of debt................................ (19,255) -- --
- -------------------------------------------------------------------------------------------------------------------
Net income (loss).............................. $ (99,790) (49,417) 4,676
- -------------------------------------------------------------------------------------------------------------------
BASIC AND DILUTED EARNINGS PER SHARE:
Income (loss) before extraordinary item........... $ (5.07) (3.11) 0.30
Extraordinary item, net of tax.................... (1.21) -- --
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) per share...................... $ (6.28) (3.11) 0.30
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
45
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 2001, 2000 and 1999
ADDITIONAL
PREFERRED CAPITAL PAID-IN RETAINED TREASURY
(DOLLARS IN THOUSANDS) STOCK STOCK CAPITAL EARNINGS STOCK TOTAL
- -------------------------------------------------------------------------------------------------------------------
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
Issuance of preferred stock related to
debt exchange.............................. 13,916 -- -- -- -- 13,916
Net loss................................... -- -- -- (99,790) -- (99,790)
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001............... $ 13,916 160 99,472 (100,380) (1,318) 11,850
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
46
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2001, 2000 and 1999
(DOLLARS IN THOUSANDS) 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss)................................................ $ (99,790) (49,417) 4,676
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Provision for loan and recourse losses........................ 2,431 670 100
Depreciation and amortization................................. 8,361 12,912 5,841
Extraordinary loss on early extinguishment of debt............ 19,255 -- --
Issuance of common stock related to legal settlement.......... -- -- 4,777
Deferred tax benefit.......................................... -- (16,011) (8,437)
Capitalized mortgage servicing rights, net
of amortization............................................. -- 45,927 (12,437)
Deferred origination costs ................................... 578 174 114
Excess cashflow certificates received in
securitization transactions, net............................ 47,052 7,752 (20,856)
Changes in operating assets and liabilities:
Decrease (increase)in accounts receivable, net................ 17,188 10,413 (9,818)
(Increase) decrease in loans held for sale, net............... (14,263) 6,159 (2,010)
Decrease (increase) in accrued interest receivable............ 9,576 52,921 (16,412)
Decrease (increase) in prepaid and other assets............... 32,551 (33,071) 411
Increase (decrease) in accounts payable
and accrued expenses......................................... 559 (10,205) 22,571
(Decrease) increase in investor payable....................... (69,489) (12,715) 18,414
(Decrease) increase in advance payment by borrowers
....................................for taxes and insurance (12,940) (844) 4,225
- -------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities............... (58,931) 14,665 (8,841)
- -------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
DISPOSITION (PURCHASE) OF EQUIPMENT........................... 1,735 (1,297) (9,330)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities............... 1,735 (1,297) (9,330)
- -------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from (repayment of) warehouse
financing and other borrowings, net........................... 996 (20,387) 28,746
Increase (decrease) in bank payable, net...................... 340 (268) (201)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities............... 1,336 (20,655) 28,545
- -------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and interest-bearing deposits (55,860) (7,287) 10,374
Cash and interest-bearing deposits at beginning of year.............. 62,270 69,557 59,183
- -------------------------------------------------------------------------------------------------------------------------
Cash and interest-bearing deposits at end of year................... $ 6,410 62,270 69,557
- -------------------------------------------------------------------------------------------------------------------------
Supplemental Information:
Cash paid during the year for:
Interest ......................................................... $ 14,605 29,974 24,085
Income taxes ..................................................... 888 2,010 11,489
- -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
47
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000, AND 1999
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) ORGANIZATION
Delta Financial Corporation ("Delta" or "we") is a Delaware corporation,
which was organized in August 1996. On October 31, 1996, we 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, we 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 our accounts and those of our
wholly-owned subsidiaries. All significant inter-company 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 our
management 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
and assumptions.
(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 fair
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 fair value is less than cost.
(F) SECURITIZATION AND SALE OF MORTGAGE LOANS
In a securitization, we pool together loans, typically each quarter, and sell
these loans to a securitization trust, which is a qualified special purpose
entity. The securitization trust raises money to purchase the mortgage loans
from us by selling securities to the public - known as asset-backed pass-through
securities that are secured by the pool of mortgage loans held by the
securitization trust. These asset-backed securities or senior certificates,
which are usually purchased by insurance companies, mutual funds and/or other
institutional investors represent senior interests in the mortgage loans in the
trust. Following the securitization, holders of these senior certificates
receive the principal collected, including prepayments of principal, on the
mortgage loans in the trust. In addition, holders receive a portion of the
interest on the loans in the trust equal to the pass-through interest rate on
the remaining principal balance. These securities are typically sold for a par
purchase price, or a slight discount to par - with par representing the
aggregate principal balance of the mortgage loans backing the asset-backed
securities. For example, if a securitization trust contains collateral of $100
million of mortgage loans, we typically receive close to $100 million in
proceeds from the sales of these securities, depending upon the structure we
utilize for the securitization.
We allocate our basis in the mortgage loans and residual interests between
the portion of the mortgage loans sold through the pass-through certificates and
the portion retained (the excess cashflow certificates) based on the relative
fair values of those portions on the date of sale. We may recognize gains or
losses attributable to the changes in fair value of the excess cashflow
certificates, which are recorded at estimated fair value and accounted
48
for as "trading" securities. Since this is not an active market for such excess
cashflow certificates, we determine the estimated fair value of the excess
cashflow certificates by discounting the future expected cash flows.
We have found that, at times, we can receive better economic results by
selling certain mortgage loans on a whole loan, non-recourse basis, without
retaining servicing rights, generally in private transactions to financial
institutions or consumer finance companies. We recognize a gain or loss when we
sell loans on a whole loan basis equal to the difference between the cash
proceeds received for the loans and our investment in the loans, including any
unamortized loan origination fees and costs.
(G) EXCESS CASHFLOW CERTIFICATES, NET
The excess cashflow certificates represent an ownership interest in a
securitization trust. The assets of each securitization trust consist primarily
of two groups of mortgage loans: a group of fixed rate mortgage loans and a
group of hybrid/adjustable rate mortgage loans. The mortgage loans in each
mortgage pool underlying each excess cashflow certificate consist of fully
amortizing and balloon mortgage loans secured by first or second liens primarily
on one- to four-family residential real properties having original terms to
stated maturity of not greater than 30 years.
Excess cashflow certificates represent a subordinate right to receive excess
cash flow, if any, generated by the related mortgage pool. A holder of an excess
cashflow certificate has the right to receive the difference, if any, between
the interest payments due on the mortgage loans sold to the securitization trust
and the interest payments due, at the pass-through rates, to the holders of the
pass-through certificates of the same series, less contractual servicing fees,
trustee fees and any insurer premiums, reimbursements and other costs and
expenses of administering the securitization trust. The holder of an excess
cashflow certificate will receive cash payments only if there are any amounts
remaining following payment by the securitization trust of all amounts owing on
all other securities issued by that securitization trust in the securitization
and the payment of expenses.
The excess cash flow of a securitization trust in any month is applied:
o first, to cover any losses on the mortgage loans in the related
mortgage pool;
o second, to reimburse the insurer, if any, of the related series of
pass-through certificates for amounts paid by or otherwise owing to
that insurer;
o third, to build or maintain the overcollateralization for that
securitization trust at the required level by being applied as an
accelerated payment of principal to the holders of the pass-through
certificates of the related series;
o fourth, to reimburse holders of the subordinated certificates of the
related series of pass-through certificates for unpaid interest and for
any losses previously allocated to those certificates;
o fifth, to pay interest on the related pass-through certificates which
was not paid because of the imposition of a cap on their pass-through
rates-- these payments being called basis risk shortfall amounts; and
o sixth, to the related excess cashflow certificates.
Typically, the excess cashflow certificates begin to receive cash flow
approximately eighteen to twenty-four months after the completion of a
securitization, with the specific timing of the cash flows depending on the
structure and performance of the securitization. Initially, securitization
trusts utilize any available excess 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 securitization trust's outstanding loans and
the amount of outstanding pass-through certificates.
The fair value of excess cashflow certificates is determined by using
certain assumptions regarding the underlying mortgage loans. These estimates
primarily include: future rate of prepayment, credit losses, discount rate used
to calculate present value and the London Inter-Bank Offered Rate (the "LIBOR")
forward curve (using current LIBOR as the floor rate). The values of excess
cashflow certificates represent the future expected cash flow from such
certificate based upon management's best estimate. Management monitors the
performance of the loans underlying each certificate and any changes in the
estimates and assumptions (and consequent changes in value of the excess
cashflow certificates) is reflected in interest income in the quarter in which
any such change in estimate is made. Although management believes that the
assumptions it uses are reasonable, there can be no assurance as to the accuracy
of the assumptions or estimates.
49
(H) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosure About
Fair Value of Financial Instruments," requires us 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 excess cashflow certificates which are reported at fair value,
substantially all our assets and liabilities deemed to be financial instruments
are carried at cost, which approximates their fair value.
(I) CASH AND INTEREST-BEARING DEPOSITS
The fair value of cash and cash equivalents approximates the carrying value
reported in our consolidated balance sheet. During 2000, a significant amount of
the cash and interest-bearing deposits balance represented the collection of
mortgage payments by us as a servicer, from mortgagors, which were due to the
investors, representing primarily securitization trusts. These funds, when
collected were placed in segregated bank accounts as provided by the related
servicing agreement.
(J) EQUIPMENT, NET
Equipment, including leasehold improvements, is stated at cost, less
accumulated depreciation and amortization. Depreciation of equipment is computed
using the straight-line 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.
(K) 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.
(L) 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.
(M) 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 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.
(N) STOCK OPTION PLANS
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation,"
we continue 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.
(O) SEGMENT REPORTING
We operate as one reporting segment, as such, the segment disclosure
requirements, are not applicable to us.
(P) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2000, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - an amendment of
FASB Statement No. 133." This statement supersedes and amends certain paragraphs
of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
The effective date for SFAS No. 138 is for fiscal years beginning after June 15,
2000. SFAS Nos. 138 and 133 apply to quarterly and annual financial statements.
There was no impact on our financial condition or results of operations upon
adoption of SFAS Nos. 138 and 133.
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
50
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
component 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. Certain provisions of this Statement, including relevant disclosures,
are effective for fiscal years ending after December 15, 2000. The remaining
provisions were effective for transfer transactions occurring after March 31,
2001. SFAS No. 140 does not require restatement of prior periods. In July of
2001, FASB Technical Bulletin No. 01-1, "Effective Date for Certain Financial
Institutions of Certain Provisions of Statement 140 Related to the Isolation of
Transferred Financial Assets," was issued which delays the effective date for
the isolation standards and related guidance under SFAS No. 140 to transfers of
financial assets occurring after December 31, 2001, instead of March 31, 2001.
The implementation of SFAS No. 140 provisions did not have a material impact on
our financial condition or results of operations. The implementation of the
remaining provisions, subsequent to December 31, 2001, is not expected to have a
material impact on our financial condition or results of operations.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to be recognized
and reported apart from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provision of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values. The amortizing intangible assets will
also be reviewed for impairment at least annually. SFAS No. 142 is applicable to
fiscal years beginning after December 15, 2001 and is required to be applied at
the beginning of the entity's fiscal year. There was no material impact on our
financial condition or results of operations upon adoption of SFAS No. 141 on
July 1, 2001. We believe that there will be no impact on our financial condition
or results of operations upon adoption of SFAS No. 142 on January 1, 2002.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
of Disposal of Long-Lived Assets," which replaces SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." The provisions of SFAS No. 144 are effective for financial statements
issued for fiscal years beginning after December 15, 2001 and, generally, are to
be applied prospectively. We do not believe that there will be a material impact
on our financial condition or results of operations upon adoption of SFAS No.
144.
(2)SUMMARY OF REGULATORY SETTLEMENTS
In September 1999, we settled allegations by the New York State Banking
Department (the "NYSBD") and a lawsuit by the New York State Office of the
Attorney General (the "NYOAG") alleging that we had violated various state and
federal lending laws. The global settlement was evidenced by (a) a Remediation
Agreement by and between Delta Funding and the NYSBD, dated as of September 17,
1999 and (b) a 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, we, among other things, implemented agreed upon changes to our
lending practices; are providing reduced loan payments aggregating $7.25 million
to certain borrowers identified by the NYSBD; and have created a fund managed by
the NYSBD and financed by the grant of 525,000 shares of Delta Financial's
common stock, with an agreed upon fixed value of $9.10 per share which
approximates the stock's book value at the time of the settlement.
Each month, on behalf of borrowers designated by the NYSBD, we make subsidy
payments to the related securitization trusts. These subsidy payments fund the
differential between the original loan payments and the reduced loan payments.
As part of the second exchange offer we completed in August 2001 (see Note No. 3
"-Corporate Restructuring, Debt Modification, and Debt Restructuring"), Delta
Funding Residual Exchange Company, LLC (the "LLC") (an unaffiliated entity to
us) - a newly-formed entity, the voting membership interests of which are owned
by the former holders of our Senior Secured Notes and senior notes due 2004 (the
"Notes") who tendered their Notes for such membership interests and other
securities - is obligated to satisfy these payment subsidies out of
51
the cash flows generated by the mortgage related securities (primarily from the
excess cashflow certificates) it owns. Management believes the LLC will have
sufficient cash flows from its assets to satisfy these payment subsidies.
However, if the LLC's cash flows are insufficient to pay this obligation, we
remain responsible to satisfy our obligations under the Remediation Agreement.
The proceeds of the stock fund will be used to pay borrowers and to finance a
variety of consumer educational and counseling programs. We do not manage the
fund created for this purpose. The number of shares of common stock deposited in
the fund does not adjust to account for fluctuations in the market price of our
common stock. Changes to the market price of these shares of common stock
deposited in the fund do not have any impact on our financial statements. We did
not make any additional financial commitments between the settlement date and
March 2000.
In March 2000, we 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 we had reached with the NYSBD and
NYOAG. The federal agreement mandates some additional compliance efforts for us,
but it does not require any additional financial commitment by us.
(3)CORPORATE RESTRUCTURING, DEBT MODIFICATION, AND DEBT RESTRUCTURING
In 2000, we began a corporate restructuring - by reducing our workforce and
modifying the terms of the indenture governing our senior notes due 2004 (the
"senior notes") - as part of our continuing efforts to improve operating
efficiencies and to address our negative cash flow from operations. Entering
2001, management still had several concerns, which we believed needed to be
addressed for us to remain a viable company. Our principal concerns were:
o the cash drain created by our ongoing monthly delinquency and servicing
advance requirements as servicer (known as "securitization advances");
o the high cost of servicing a seasoned loan portfolio, including the
capital charges associated with making securitization advances;
o our ability to make timely interest payments on our senior notes and
senior secured notes due 2004 (the "senior secured notes"); and
o our 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, we embarked upon a business plan aimed
at alleviating some of these concerns and issues.
CORPORATE RESTRUCTURING
In January 2001, we entered into an agreement with Ocwen Financial
Corporation ("Ocwen") to transfer our servicing portfolio to Ocwen. In May 2001,
we physically transferred our entire servicing portfolio to Ocwen, and laid-off
the majority of our servicing staff - a total of 128 employees. We recorded a
$0.5 million pre-tax charge relating to this restructuring which is included in
the line item call "restructuring and other special charges" in our consolidated
statements of operations. This charge relates to employee severance associated
with closing our servicing operations. We no longer service loans nor do we have
a servicing operation.
The following table sets forth the components of our accrual restructuring
charges:
ACCRUAL BALANCE AT ACCRUAL EXPENSE ACCRUAL BALANCE AT
(DOLLARS IN THOUSANDS) DECEMBER 31, 2000 INCREASE RECOGNIZED DECEMBER 31, 2001
- ----------------------------------------------------------------------------------------------------------------------
Write down of lease obligations $1,163 -- (581) 582
Employment termination payments 180 473 (653) --
- ----------------------------------------------------------------------------------------------------------------------
Total Accrual Restructuring Charges $1,343 473 (1,234) 582
- ----------------------------------------------------------------------------------------------------------------------
52
The unpaid accrued restructuring charge was initially recorded under the exit
plan. No charges under this exit plan are associated with or benefit from
activities that will be continued at the commitment date.
DEBT MODIFICATION AND DEBT RESTRUCTURING
In August 2000, we announced an agreement to modify the terms of the
indenture governing our senior notes (the "Debt Modification"). With the consent
of the holders of greater than fifty percent of our senior notes, we modified a
negative pledge covenant in the senior notes indenture, which had previously
prevented us from selling or otherwise obtaining financing by using our excess
cashflow certificates as collateral. In consideration for the senior
noteholders' consent, we agreed, in an exchange offer (the "First Exchange
Offer"), to offer then current holders the opportunity to exchange their then
existing senior notes for (a) new senior secured notes due 2004 (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 below) were secured by at least
$165 million of the our excess cashflow certificates. The First Exchange Offer
was consummated in December 2000, with holders of greater than $148 million (of
$150 million) of senior notes tendering in the exchange.
In February 2001, we entered into a letter of intent with the beneficial
holders of over fifty percent of our senior secured notes to restructure, and
ultimately extinguish, the senior secured notes (the "Second Debt
Restructuring"). In March 2001, we 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 excess cashflow certificates then
securing the senior secured notes. We were first able to finance and then
ultimately sell the excess cashflow certificates underlying five securitizations
(including two excess cashflow certificates that were released as part of the
Second Debt Restructuring) for a $15 million cash purchase price to provide
working capital.
In consideration for their consent, we agreed to offer the holders of the
senior secured notes (and the senior notes, collectively, the "notes"), an
opportunity to exchange their notes for new securities described immediately
below (the "Second Exchange Offer"). The Second Exchange Offer was consummated
on August 29, 2001, pursuant to which holders of approximately $138.1 million
(of $148.2 million) in principal amount of our senior secured notes and $1.1
million (of $1.8 million) in principal amount of our senior notes, exchanged
their notes for commensurate interests in:
o voting membership interests in Delta Funding Residual Exchange Company
LLC (the "LLC"), a newly-formed limited liability company (unaffiliated
with us), to which we transferred all of the mortgage-related
securities previously securing the senior secured notes (primarily
comprised of excess cashflow certificates);
o shares of common stock of a newly-formed management corporation that
will manage the LLC's assets; and
o shares of our newly-issued Series A preferred stock having an aggregate
preference amount of $13.9 million.
The LLC is controlled by the former noteholders that now hold membership
interest in the LLC. As part of the transaction, we obtained a non-voting
membership interest in the LLC, which entitles us to receive 15% of the net cash
flows from the LLC for the first three years (through June 2004) and,
thereafter, 10% of the net cash flows from the LLC. The net cash flows from the
LLC are equal to the total cash flows generated by the assets held by the LLC
for a particular period, less (a) all expenses of the LLC, (b) certain related
income tax payments, and (c) the NYSBD subsidy payments. We began receiving
distributions from the LLC in the first quarter of 2002 from a fourth quarter
2001 distribution.
As part of the Second Exchange Offer, all tendering noteholders waived their
right to receive any future interest coupon payments on the tendered notes
beginning with the August 2001 interest coupon payment. With the closing of the
Second Exchange Offer, we paid the August 2001 interest coupon payment on the
approximately $10.8 million of notes that did not tender in the Second Exchange
Offer. By extinguishing substantially all of our long-
53
term debt, the rating agencies that previously rated us and our long-term debt
have withdrawn their corporate ratings.
(4)LOANS HELD FOR SALE, NET
Our inventory consists of first and second mortgages, which had a weighted
average interest rate of 10.11% at December 31, 2001. These mortgages are being
held, at the lower of cost or estimated fair 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 $0.8 million and $1.4 million at December 31, 2001 and
2000, respectively, and a valuation allowance of approximately $0.7 million at
December 31, 2001 and $34,000 as of December 31, 2000. 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) 2001 2000
- -------------------------------------------------------------------
Securitization servicing advances $ -- 12,518
Prepaid insurance premiums 2,227 2,047
Current tax assets -- 572
Other 427 5,365
- -------------------------------------------------------------------
Total accounts receivable $ 2,654 20,502
- -------------------------------------------------------------------
Funds due to us for accounts receivable are tracked through various asset
accounts. These accounts are reconciled monthly, at which time we perform
research and resolution on the receivables. All aged items are identified and
reported to management and management decides whether to write-off any aged
items. We evaluate accounts receivable items on an individual basis and an item
is not written off until all options for payment have been exhausted.
Activity in Accounts Receivable for the years ended December 31, is as
follows (dollars in thousands):
Securitization Prepaid Insurance Current Tax
2001 Servicing Advances Premiums Asset Other Total
- --------------------------------------------------------------------------------------------------------
Beginning balance $ 12,518 2,047 572 5,365 20,502
Additions 69,613 180 -- 45,664 115,457
Payments (81,967) -- (572) (49,505) (132,044)
Write offs (164) -- -- (1,097) (1,261)
- ---------------------------------------------------------------------------------------------------------
Ending balance $ -- 2,227 -- 427 2,654
- ---------------------------------------------------------------------------------------------------------
Securitization Prepaid Insurance Current Tax
2001 Servicing Advances Premiums Asset Other Total
- ---------------------------------------------------------------------------------------------------------
Beginning balance $ 24,727 1,868 846 3,486 30,927
Additions 45,621 179 -- 59,645 105,445
Payments (57,200) -- (274) (57,537) (115,011)
Write offs (630) -- -- (229) (859)
- ---------------------------------------------------------------------------------------------------------
Ending balance $ 12,518 2,047 572 5,365 20,502
- ---------------------------------------------------------------------------------------------------------
(6) CAPITALIZED MORTGAGE SERVICING RIGHTS
Prior to 2001, we recognized rights to service mortgage loans as separate
assets. Subsequent to 2001, we do not recognize rights to service mortgage loans
because we sell our servicing rights in connection with our whole loan sales or
securitizations. The total cost of mortgage loans sold or securitized was
allocated between the loans and the servicing rights based upon the relative
fair values of each. Purchased Mortgage Servicing Rights ("MSRs") were
54
initially recorded at cost. All MSRs were subsequently carried at the lower of
the initial carrying value, adjusted for amortization and deferred hedge
gains/losses, or fair value. Fair values were 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, we stratified 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 exceeded fair value
by individual stratum, a valuation reserve was established, which was adjusted
in the future as the value of MSRs increased or decreased. The cost of MSRs was
amortized in proportion to, and over the period of, estimated net servicing
income.
We recognized a $38.2 million write-down, which represented the entire
carrying value of our MSR at December 31, 2000. In December 2000, we entered
into discussions with three third-party sub-prime servicers to either purchase
or sub-service our entire $3.31 billion servicing portfolio. Based upon the
seasoning of our 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 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 our
mortgage servicing rights on newly issued securitizations (beginning in the
second quarter of 2000) for a cash premium, we were 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, management felt
this write-down was necessary to reflect the current market price we would have
received at December 31, 2000 for our servicing portfolio. Prior to soliciting
bids in December 2000, management believed that the carrying value of our MSR
was validated as the cash purchase price (premium) we received from selling the
servicing rights associated with our securitizations in June 2000 and September
2000 exceeded the carrying value of the MSR stated as a percentage of our 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 our capitalized mortgage servicing rights for the
years ended December 31, is as follows:
(DOLLARS IN THOUSANDS) 2001 2000 1999
- --------------------------------------------------------------------------------
Balance, beginning of year $ -- 45,927 33,490
Additions -- 11,611 20,542
Amortization and FV adjustments -- (8,916) (8,105)
Sales -- (10,385) --
Write-down -- (38,237) --
- --------------------------------------------------------------------------------
Balance, end of year $ -- -- 45,927
- --------------------------------------------------------------------------------
(7) EXCESS CASHFLOW CERTIFICATES, NET
We classify excess cashflow certificates that we receive upon the
securitization of a pool of loans as "trading securities". The amount initially
allocated to the excess cashflow certificates at the date of a securitization
reflects their fair value. The amount recorded for the excess cashflow
certificates is reduced for distributions which we receive from the
securitization trusts as holder of these excess cashflow certificates and is
adjusted for subsequent changes in fair value of excess cashflow certificates
held by us.
At the time each securitization transaction closes, we determine the present
value of the related excess cashflow certificates using certain assumptions made
by us regarding the underlying mortgage loans. The excess cashflow certificate
is then recorded at an estimated fair value. Our estimates primarily include the
following:
o future rate of prepayment of the mortgage loans;
o credit losses on the mortgage loans;
o a discount rate used to calculate present value; and
o the LIBOR forward curve (using current LIBOR as the floor rate).
55
The value of each excess cashflow certificate represents the cash flow we
expect to receive in the future from such certificate based upon our best
estimate. We monitor the performance of the loans underlying each excess
cashflow certificate, and any changes in our estimates (and consequent changes
in value of the excess cashflow certificates) is reflected in the line item
called "interest income" in the quarter in which we make any such change in our
estimate. Although we believe that the assumptions we use are reasonable, there
can be no assurance as to the accuracy of the assumptions or estimates.
In determining the fair value of each of the excess cashflow certificates, we
make the following underlying assumptions:
(A) PREPAYMENTS. We base our prepayment r ate assumptions upon our ongoing
analysis of the performance of mortgage pools we previously securitized,
and the performance of similar pools of mortgage loans securitized by
others in the industry. We apply different prepayment speed assumptions to
different loan product types because it has been our experience that that
different loan product types exhibit different prepayment patterns.
Generally, our loans can be grouped into two loan products - fixed rate
loans and adjustable rate loans. With fixed rate loans, an underlying
borrower's interest rate remains fixed throughout the life of the loan. Our
adjustable rate loans are really a "hybrid" between fixed and adjustable
rate loans, in that the rate generally remains fixed for typically the
first three years of the loan, and then adjusts typically every six months
thereafter. Within each product type, other factors can affect prepayment
rate assumptions. Some of these factors, for instance, include:
o whether or not a loan contains a prepayment penalty - an amount that a
borrower must pay to a lender if the borrower prepays the loan within a
certain time after the loan was originated. Loans containing prepayment
penalty typically do not prepay as quickly as those without such a
penalty;
o as is customary with adjustable rate mortgage loans, the introductory
interest rate charged to the borrower is artificially lower, between
one and two full percentage points, than the rate for which the
borrower would have otherwise qualified. Generally, once the adjustable
rate mortgage begins adjusting on the first adjustment date, the
interest rate payable on that loan increases, at times fairly
substantially. This interest rate increase can be exacerbated if there
is an absolute increase in interest rates. As a result of these
increases and the potential for future increases, adjustable rate
mortgage loans typically are more susceptible to early prepayments.
There are several reasons why a loan will prepay prior to its
maturity, including (but not limited to):
o a decrease in interest rates;
o improvement in the borrower's credit profile, which may allow them
to qualify for a lower interest rate loan;
o competition in the mortgage market, which may result in lower
interest rates being offered;
o the borrower's sale of his or her home; and
o a default by the borrower, resulting in foreclosure by the lender.
It is unusual for a borrower to prepay a mortgage loan during the first
few months because:
o it typically takes at least several months after the mortgage loans
are originated for any of the above events to occur;
o there are costs involved with refinancing a loan; and
o the borrower does not want to incur prepayment penalties.
Thereafter, we have found that the rate at which loans prepay will slowly
increase and stabilize, then decrease and eventually level off.
Historically, we used a "ramp" prepayment curve, in which we projected
that a loan would initially begin prepaying at a certain rate, and that
rate would incrementally increase (or "ramp up") over its first 12 months,
and level off thereafter. Commencing in 1998, we began using a "vector"
curve, which is similar to a "ramp curve" in that prepayment rates
incrementally increase over a longer period of time and then stabilize.
However, as opposed to a ramp curve (which remains constant
56
once prepayments stabilize), we believe that a vector curve is more
representative of projected future loan prepayment experience, as it
thereafter decreases and then eventually levels off.
The following table shows our most recently changes to our prepayment
assumptions - in the third quarter of 2001 and, prior to that, in the
third quarter 2000:
LOAN TYPE AT SEPTEMBER 30, 2001 AT SEPTEMBER 30, 2000
--------------------------------------------------------------------------
Fixed Rate:
At Month 4.00% 4.00%
Peak Speed 30.00% 23.00%
Adjustable Rate:
At Month 4.00% 4.00%
Peak Speed 75.00% 50.00%
(B) DEFAULT RATE. A default reserve for both fixed- and adjustable-rate loans
sold to the securitization trusts of 5.00% of the amount initially
securitized at December 31, 2001 compared to 3.50% at December 31, 2000.
Our loan loss assumption reflects our belief that:
o prepayment speeds generally will be slower in the future than in the
past;
o the rise in home values will be flat or slightly moderate as compared
to the past few years; and
o borrowers will therefore be less able to refinance their mortgages to
avoid default which may have an adverse effect on the non-performing
loans in the securitizations trusts underlying our excess cashflow
certificates.
(C) DISCOUNT RATE. We use a discount rate that we believe reflects the risks
associated with our excess cashflow certificates. While quoted market
prices on comparable excess cashflow certificates are not available, we
have performed comparisons of our valuation assumptions and performance
experience to our competitors' in the non-conforming mortgage industry.
Our discount rate takes into account the asset quality and the performance
of our securitized mortgage loans compared to that of the industry and
other characteristics of our securitized loans. We quantify the risks
associated with our excess cashflow certificates by comparing the asset
quality and payment and loss performance experience of the underlying
securitized mortgage pools to comparable industry performance. We believe
that the practice of many companies in the non-conventional mortgage
industry has been to add a spread for risk to the all-in cost of
securitizations to determine their discount rate. From these comparisons,
we have identified a spread that we add to the all-in cost of our mortgage
loan securitization trusts' investor certificates. The discount rate we
use to determine the present value of cash flows from excess cashflow
certificates reflects increased uncertainty surrounding current and future
market conditions, including without limitation, uncertainty concerning
inflation, recession, home prices, interest rates and equity markets.
We utilized a discount rate of 15% at December 31, 2001 compared to 13% at
December 31, 2000 on "senior" excess cashflow certificates (i.e., those
excess cashflow certificates that were not subject to a Net Interest
Margin, or "NIM," Transaction). Prior to the quarter ending September 30,
2001, some of our excess cashflow certificates were subject to a NIM
transaction, for which we applied an 18% discount rate. As part of the
Second Exchange Offer, all of the excess cashflow certificates subject to
the NIM transaction were transferred to the LLC. As such, at December 31,
2001, we retain only "senior" excess cashflow certificates.
In the third quarter of 2000, we had increased the discount rate we used
on those excess cashflow certificates included in the NIM transaction to
18% (from 12%) and recorded an $8.8 million valuation adjustment. The
adjustment reflected a reduction in the present value of those excess
cashflow certificates sold in connection with our NIM transaction
completed in the fourth quarter of 2000. We increased the discount rate on
these excess cashflow certificates during the period that the senior NIM
securities remain outstanding, to account for the potentially higher risk
associated with the residual cash flows expected to be received by the
holder of the certificated interest in the NIM trust, which is
subordinated to the multiple senior securities sold in the NIM
transaction.
57
In the fourth quarter of 2000, we had increased the discount rate we used
in determining the present value of our "senior" excess cashflow
certificates to 13% from 12%, and recorded a $7.1 million valuation
adjustment. The adjustment reflected 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.
At September 30, 2001, we recorded a charge to interest income to reflect a
fair value adjustment to our remaining excess cashflow certificates totaling
$19.7 million. Our change in assumptions at September 30, 2001, primarily
reflect recent unforeseen market events relating to the terrorist attacks on
September 11, 2001, that further accelerated an economic downturn in the U.S.
economy, and which we believe may have a significant adverse impact on the
economy for the foreseeable future.
Our current prepayment rate and default rate assumptions primarily reflect
our current and future expectation for:
o a continuing relatively low interest rate environment based upon, among
other things, the Eurodollars future curve. At June 30, 2001, the
Eurodollar futures market, an indicator of future interest rates,
projected that 1-month LIBOR and 6-month LIBOR rates at December 31,
2001 would be 4.13% and 4.41%, respectively. However, as a result of
the unexpected events of September 11, 2001, actual 1-month LIBOR and
6-month LIBOR for December 31, 2001 were significantly lower at 1.87%
and 1.98%, respectively;
o a potential for an adverse economic environment. According to the
Mortgage Bankers Association, the percentage of U.S. homeowners behind
on their mortgages in the third quarter of 2001 rose to the highest
levels since the last recession in the early 1990s, citing a shrinking
economy and higher unemployment as among the causes. In addition, the
National Bureau of Economic research, the unofficial arbiter of
expansions and contractions, reported in November 2001, its belief that
the United States economy had officially entered into a recession back
in March 2001. Lastly, we revised our discount rate to reflect current
market conditions and the rate of return management believes to be
appropriate given the significant uncertainty regarding future economic
events, thus increasing the inherent risk and volatility of our excess
cashflow certificates.
For 2000, we recorded a non-cash increase of $9.6 million to interest income
for a fair value adjustment to our excess cashflow certificates, due to the
decrease in one-month LIBOR. Some of the our excess cashflow 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.
In 1999, we recorded a $6.3 million reduction to our excess cashflow
certificates to reflect changes to our prepayment rate and loan loss reserve
assumptions.
The activity related to our excess cashflow certificates for the years ended
December 31, is as follows:
(DOLLARS IN THOUSANDS) 2001 2000 1999
- --------------------------------------------------------------------------------
Balance, beginning of year $ 216,907 224,659 203,803
Additions 11,081 32,716 48,356
Sales (40,402) -- --
Second Exchange Offer (153,090) -- --
Cash remittances, accretion of
discount and FV adjustments, net (17,731) (40,468) (27,500)
- --------------------------------------------------------------------------------
Balance, end of year $ 16,765 216,907 224,659
- --------------------------------------------------------------------------------
58
At December 31, 2001, 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:
Fair value of excess Impact to
(Dollars in thousands) cashflow certificates earnings
- -------------------------------------------------------------------------------
Fair value as of 12/31/01: $ 16,765
10% increase in prepayment speed 13,838 $2,927
20% increase in prepayment speed 11,293 5,472
10% increase in credit losses 13,547 3,218
20% increase in credit losses 10,476 6,289
10% increase in discount rates 15,860 905
20% increase in discount rates 15,048 1,717
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
We 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. There was no
impact on our financial condition or results of operations upon the adoption of
SFAS No. 133, as amended.
We originate mortgage loans and then sell them through a combination of whole
loan sales and securitizations. Between the time we originate the mortgage and
sell it in the secondary market, we may hedge the risk of fluctuations in
interest rates. Our risk begins subsequent to originating mortgage loans and
prior to selling or securitizing such mortgage loans. Since we have a closed
(and funded) a mortgage loan at a specified interest rate with an expected gain
at the time of sale, our exposure is to a higher interest rate environment due
to market conditions. A higher interest rate market implies that we will have a
higher cost of funds, which decreases the net spread we would earn between the
mortgage interest rate on each mortgage loan less the cost of funds. As a
result, we may experience a lower gain on sale.
The cost of funds is generally composed of two components, the interest rate
swap with a similar duration and average life and the swaps spread or profit
margin required by the investors. We had previously used a "Treasury Rate Lock"
and 15-year Fannie Mae mortgage securities ("FNMA Securities") to hedge our cost
of funds exposure. However recently, the securitizations are priced to the
investor using the interest rate swaps curve. As such, our cost of funds is more
closely tied to interest rate swaps and we will likely use interest rate swaps
to hedge our mortgage loans in inventory pending securitization pricing. While
none of the above are perfect hedges, we believe interest rate swaps will
demonstrate the highest correlation to our cost of funds on a go-forward basis.
We determine the nature and quantity of hedging transactions based upon various
factors including, without limitation, market conditions and the expected volume
of mortgage originations. We will enter into these hedging strategies through
one of our warehouse lenders and/or one of the investment bankers that
underwrite our securitizations. These strategies are designated as hedges on our
financial statements and are closed out when we sell the associated loans.
59
If the value of the hedges decrease, offsetting an increase in the value of
the loans, upon settlement with our hedge counterparty, we will pay the hedge
loss in cash and then realize the corresponding increase in the value of the
loans as part of our net gain on sale of mortgage loans through either the
excess cashflow certificates we retain from securitization or from whole loan
premiums. Conversely, if the value of the hedges increase, offsetting a decrease
in the value of the loans, upon settlement with our hedge counterparty, we 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
excess cashflow certificates or whole loan premiums.
We believe our hedging strategy has largely been an effective tool to manage
our interest rate risk on loans prior to securitization, by providing us with a
cash gain (or loss) to largely offset the reduced (increased) 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.
We make decisions concerning the nature of our hedging transactions based
upon various factors including, without limitation, market conditions and the
expected volume of mortgage originations. We may enter into these hedging
strategies through one of our warehouse lenders and/or an investment bank that
underwrites our securitizations. We will review continually the frequency and
effectiveness of our hedging strategy to mitigate risk pending a securitization
or loan sale.
If a hedging transaction is deemed to be appropriate, and can be properly
documented and mathematically shown to meet the appropriate effectiveness
criteria, we will account for these hedges as fair value hedges in accordance
with SFAS No. 133, as amended.
We will continue to review our hedging strategy in order to best mitigate
risk pending securitization or loan sales.
We did not have open hedge positions as of December 31, 2001, 2000 and 1999.
We did not hedge during the year ended December 31, 2001. We included a loss of
$2.1 million and a gain of $3.3 million on our hedges as part of gains on sale
of loans in 2000 and 1999, respectively.
(9) WAREHOUSE FINANCING AND OTHER BORROWINGS
We have one warehouse credit facility in the amount of $200.0 million as of
December 31, 2001. 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 2001 2000 Date
- ----------------------------------------------------------------------------------------------------------
Warehouse line of credit $200.0 LIBOR + 1.125% $ 80.9 74.9 April 2002
Term loan n/a 8.15% -- 0.3 June 2001
Capital leases n/a 6.63% - 10.25% 6.7 11.4 June 2002 - Nov 2004
Other Borrowings n/a 7.00% - 8.00% 2.0 2.0 --
- ----------------------------------------------------------------------------------------------------------
Balance at December 31, $200.0 $ 89.6 88.6
- ----------------------------------------------------------------------------------------------------------
(10) SENIOR NOTES
In August 2000, we announced an agreement to modify our senior notes (the
"Debt Modification"). With the consent of the holders of greater than fifty
percent of our senior notes, we modified a negative pledge covenant in the
senior notes indenture, which previously prevented us from selling or otherwise
obtaining financing by using our excess cashflow certificates as collateral. In
consideration for the senior noteholders' consent, we agreed, in an exchange
offer (the "First Exchange Offer"), to offer then current holders the
opportunity to exchange their then existing senior notes for (a) new 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
60
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 below) were secured by at least $165 million of our excess
cashflow certificates. The First Exchange Offer was consummated in December
2000, with holders of greater than $148 million (of $150 million) of senior
notes tendering in the exchange.
In February 2001, we entered into a letter of intent with the beneficial
holders of over fifty percent of our senior secured notes to restructure, and
ultimately extinguish, the senior secured notes (the "Second Debt
Restructuring"). In March 2001, we 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 excess cashflow certificates then
securing the senior secured notes. We were first able to finance and then
ultimately sell the excess cashflow certificates underlying five securitizations
(including two excess cashflow certificates that were released as part of the
Second Debt Restructuring) for a $15 million cash purchase price to provide for
working capital.
In consideration for their consent, we agreed to offer the holders of the
senior secured notes (and the senior notes, collectively, the "Notes"), an
opportunity to exchange their Notes for the new securities described immediately
below (the "Second Exchange Offer"). The Second Exchange Offer was consummated
on August 29, 2001, pursuant to which holders of approximately $138.1 million in
principal amount of our senior secured notes and $1.1 million in principal
amount of our senior notes, exchanged their notes for commensurate interest in:
o voting membership interests in Delta Funding Residual Exchange Company
LLC, a newly-formed limited liability company (unaffiliated with us),
to which we transferred all of the mortgage-related securities
previously securing the senior secured notes (primarily comprised of
excess cashflow certificates);
o shares of common stock of a newly-formed management corporation that
will manage the LLC's assets; and
o shares of our newly-issued preferred stock having an aggregate
preference amount of $13.9 million.
All of the voting interests in the LLC are held by the former holders of our
senior and senior secured notes. As part of the transaction, we obtained a
non-voting membership interest in the LLC, which entitles us to receive 15% of
the net cash flows from the LLC for the first three years (through June 2004)
and, thereafter, 10% of the net cash flows from the LLC. The net cash flows from
the LLC are equal to the total cash flows generated by the assets held by the
LLC for a particular period, less (a) all expenses of the LLC, (b) certain
related income tax payments, and (c) the NYSBD subsidy payments. We began
receiving distributions from the LLC in the first quarter of 2002 from a fourth
quarter 2001 distribution. By extinguishing substantially all of our long-term
debt, the rating agencies that previously rated us and our long-term debt have
withdrawn their corporate ratings.
As part of the Second Exchange Offer, all tendering Noteholders waived their
right to receive any future interest coupon payments on the tendered Notes
beginning with the August 2001 interest coupon payment. With the closing of the
Second Exchange Offer, we paid the August 2001 interest coupon payment on the
approximately $10.8 million of Notes that did not tender in the Second Exchange
Offer. By extinguishing substantially all of our long-term debt, the rating
agencies that previously rated us and our long-term debt have withdrawn their
corporate ratings.
The senior notes bear interest at a rate of 9.5% per annum, payable
semi-annually (February 1st and August 1st) and a maturity date of August 1,
2004 when all outstanding principal is due. The outstanding balance totaled
$10.8 million as of December 31, 2001. The outstanding balance as of December
31, 2000, prior to the restructuring, totaled $149.6 million, net of unamortized
bond discount.
Costs incurred with the issuance of the original notes, in the amount of $4.8
million, have been deferred and were being amortized over a seven-year term
using a method that approximates level-yield. During 2001, we completed our
Second Exchange Offer and the unamortized issuance cost related to the Senior
Note was written off. We amortized approximately $0.4 million and wrote off
approximately $2.5 million. The unamortized debt issuance cost was $2.9 million
at December 31, 2000.
61
(11) BANK PAYABLE
In order to maximize our cash management practices, we have instituted a
procedure whereby checks written against our operating account are covered as
they are presented to the bank for payment, either by drawing down our lines of
credit or from subsequent deposits of operating cash. Bank payable represents
the checks outstanding at December 31, 2001 and 2000, to be paid in this manner.
(12) INVESTOR PAYABLE
Investor payable represents the collection of mortgage payments by us 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 our balance sheet as a component of cash and interest-bearing
deposits. Investor payable decreased to $0 at December 31, 2001 because we
transferred our servicing portfolio to Ocwen in May 2001, and with it all the
monies that were held in the various servicing accounts we previously maintained
as servicer.
(13) EMPLOYEE BENEFIT PLANS
We have 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 our 401(k) Retirement Savings Plan.
We sponsor a 401(k) Retirement Savings Plan. Substantially all our employees
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. We elected to make discretionary contributions to the Plan of
$0.5 million, $0.7 million and $0.8 million for 2001, 2000 and 1999,
respectively.
(14) COMMITMENTS AND CONTINGENCIES
We have repurchase agreements with certain of the institutions that have
purchased mortgages. Currently, some of the agreements provide for the
repurchase by us of any of the mortgage loans that go to foreclosure sale. At
the foreclosure sale, we will repurchase the mortgage, if necessary, and make
the institution whole. The dollar amount of loans, which were sold with
recourse, is $3.5 million at December 31, 2001 and $6.2 million at December 31,
2000.
Included in accounts receivable is an allowance for recourse losses of $1.4
million at December 31, 2001 and $1.5 million at December 31, 2000,
respectively. We recognized, as a charge to operations, a provision for recourse
losses of approximately $311,000, $11,600 and $70,000 for the years 2001, 2000
and 1999, 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.
Our rental expense, net of sublease income, for the years ended December 31,
2001, 2000 and 1999 amounted to $5.0 million, $7.0 million and $6.4 million,
respectively.
Minimum future rentals under non-cancelable operating leases as of December
31, 2001 are as follows:
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Year Amount
- --------------------------------------------------------------------------------
2002 $ 3,882
2003 2,945
2004 2,579
2005 2,274
2006 2,318
Thereafter 2,868
- --------------------------------------------------------------------------------
Total $ 16,866
- --------------------------------------------------------------------------------
62
Because the nature of our business involves the collection of numerous
accounts, the validity of liens and compliance with various state and federal
lending laws, we are 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 our financial position or results of operations.
(15) STOCK OPTION PLAN
In October 1996, the Board of Directors ratified the 1996 Stock Option Plan
(the "1996 Plan") and authorized the reserve of 2,200,000 shares of authorized
but unissued common stock for issuance pursuant to the 1996 Plan. In May 2001,
the Board of Directors ratified the 2001 Stock Option Plan (the "2001 Plan,"
collectively with the 1996 Plan, the "Plans") and authorized the reserve of
1,500,000 shares of authorized but unissued common stock for issuance pursuant
to the 2001 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 Plans at
December 31:
2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------
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 990,700 $12.38 1,146,050 $12.44 795,060 $16.96
Options granted 1,658,300 0.50 20,000 2.00 495,350 5.84
Options canceled 469,500 8.16 175,350 11.57 144,360 14.70
- -------------------------------------------------------------------------------------------------------------------
Balance at end of year 2,179,500 $ 4.25 990,700 $12.38 1,146,050 $12.44
- -------------------------------------------------------------------------------------------------------------------
Options exercisable 515,650 $13.97 513,120 $15.07 359,200 $16.79
- -------------------------------------------------------------------------------------------------------------------
We apply APB Opinion No. 25, and related Interpretations in accounting for
the Plans. 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, 2001,
2000 and 1999.
Had compensation cost for the Plans been determined based on the fair value
at the grant dates for awards under the Plans consistent with the method of SFAS
No. 123, our net income (loss) would have been $(101.0) million, $(49.4) million
and $4.5 million for 2001, 2000 and 1999, respectively. Earnings (loss) per
share-basic for 2001, 2000 and 1999 would have been $(6.35), $(3.10) and $0.29,
respectively.
The weighted-average fair value of options granted during 2001, 2000 and 1999
was $1.21, $0.34 and $3.86, 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 2001, 2000 and 1999 grants:
2001 2000 1999
- --------------------------------------------------------------------------------
Dividend yield 0% 0% 0%
Expected volatility 164% 145% 78%
Risk-free interest rate 4.22% 6.14% 4.54%
Expected life 5 years 5 years 5 years
63
(16) INCOME TAXES
(DOLLARS IN THOUSANDS) 2001 2000 1999
- ------------------------------------------------------------------------
Current: Federal $ 1,847 2,203 9,777
State & Local 1,029 600 1,713
- ------------------------------------------------------------------------
Total current income taxes $ 2,876 2,803 11,490
- ------------------------------------------------------------------------
Deferred: Federal $ (31,053) (19,860) (7,172)
State & Local (7,393) (4,448) (1,265)
Valuation allowance 38,446 8,297 --
- ------------------------------------------------------------------------
Total deferred income taxes -- (16,011) (8,437)
- ------------------------------------------------------------------------
Total tax provision (benefit) $ 2,876 (13,208) 3,053
- ------------------------------------------------------------------------
Significant components (temporary differences and carryforwards) that give
rise to our net deferred tax asset as of December 31, 2001 and 2000 were as
follows:
2001 2000
DEFERRED TAX ASSETS:
- -------------------------------------------------------------------------------------------
Book/tax difference in excess cashflow
certificates, net carrying amount $ 6,721 --
Loss reserves 2,887 5,306
Book over tax depreciation 159 --
Federal and State net operating loss carryforwards 42,894 25,318
- -------------------------------------------------------------------------------------------
Gross deferred tax assets $ 52,661 30,624
Less: Valuation Allowance 46,743 8,297
- -------------------------------------------------------------------------------------------
Deferred tax assets net of valuation allowance $ 5,918 22,327
- -------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
- -------------------------------------------------------------------------------------------
Book/tax difference in excess cashflow certificates, net
carrying amount $ -- 14,123
Tax over book depreciation -- 2,055
Capitalized origination fees and related cost 318 549
- -------------------------------------------------------------------------------------------
Gross deferred tax liabilities $ 318 16,727
- -------------------------------------------------------------------------------------------
Net deferred tax assets $ 5,600 5,600
- -------------------------------------------------------------------------------------------
We are required to recognize all or a portion of our gross deferred tax
assets if we believe 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 is more likely than not that we will realize
the benefit from our gross deferred tax assets, net of the valuation allowance.
A valuation allowance was established in 2000 and increased in 2001
because we believe that we will have insufficient earnings in the immediate
future to ensure realization of our entire gross deferred tax assets.
As of December 31, 2001, Federal and State net operating loss carryforwards
("NOLs") totaled $107.2 million, with $1.1 million expiring in 2018, $21.1
million expiring in 2019, $12.4 million expiring in 2020, and $72.6 million
expiring in 2021.
64
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, 2001, 2000
and 1999 is as follows:
2001 2000 1999
- -------------------------------------------------------------------------------------------
Tax at statutory rate 35.0% 35.0% 35.0%
State & local taxes, net of Federal benefit 4.3 4.0 1.1
Change in valuation allowance for deferred tax assets (39.7) (13.2) --
Non-deductible expenses and other (2.6) (4.7) 3.4
- -------------------------------------------------------------------------------------------
Total tax rate (3.0)% 21.1% 39.5%
- -------------------------------------------------------------------------------------------
(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) 2001 2000 1999
- --------------------------------------------------------------------------------
Income before extraordinary item $(80,535) (49,417) 4,676
Extraordinary item, net of tax (19,255) -- --
- --------------------------------------------------------------------------------
Net income (loss) $(99,790) (49,417) 4,676
- --------------------------------------------------------------------------------
Weighted-average shares - basic 15,884 15,884 15,511
Incremental shares-options -- -- 1
- --------------------------------------------------------------------------------
Weighted-average shares - diluted 15,884 15,884 15,512
- --------------------------------------------------------------------------------
Basic and diluted earnings per share:
Income before extraordinary item $ (5.07) (3.11) 0.30
Extraordinary item, net of tax (1.21) -- --
- --------------------------------------------------------------------------------
Net income (loss) $ (6.28) (3.11) 0.30
- --------------------------------------------------------------------------------
For 2001 and 2000 Stock Options of approximately 23,000 and 37,000,
respectively, are excluded from the calculation of diluted EPS because their
effect is antidiluted in periods where losses are reported.
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table is a summary of financial data by quarter for the years
ended December 31, 2001 and 2000:
For the quarters ended
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) March 31, June 30, Sept. 30, Dec. 31,
- ------------------------------------------------------------------------------------------------------------
2001
Revenues (a)(c) $(3,037) 25,065 (10,364) 21,261
Expenses (a)(b)(c) 30,243 41,500 21,430 17,411
Extraordinary item, net of taxes -- -- (19,255) --
Net income (loss) (a)(b)(c) (33,752) (16,528) (52,910) 3,400
Earnings (loss) per common share-
basic and diluted (a)(b)(c) (2.12) (1.04) (3.33) 0.21
2000
Revenues (d)((e) $35,945 28,944 27,625 26,457
Expenses (d)(e) 32,820 34,977 43,010 70,789
Net income (loss) (d)(e) 1,826 (3,527) (11,206) (36,510)
Earnings (loss) per common share-
basic and diluted (d)(e) 0.11 (0.22) (0.71) (2.30)
65
- ----------------------------------------
(a)The quarter ended March 31, 2001 includes: (1) a $25.4 million write-down of
excess cashflow certificates relating to a sale agreement entered into by us,
(2) a $0.8 million charge related to disposition of branches, and (3) a $0.5
million related to restructuring charges.
(b)The quarter ended June 30, 2001 includes non-recurring charges principally
incurred in connection with the recognition of cost attributable to the
disposition and transfer of our servicing platform of $10.7 million and a
change in accounting estimate regarding the life expectancy of our equipment
of $3.6 million. In addition, we recorded a $1.5 million charge related to a
fair value adjustment to a pool of non-performing loans.
(c)The quarter ended September 30, 2001 includes a charge of $19.7 million,
which represents a fair value adjustment to our remaining excess cashflow
certificates. We changed the valuation assumptions we use to estimate fair
value. The quarter also includes a non-recurring charge of $1.4 million
relating to professional fees incurred in connection with the Second Exchange
Offer.
(d)The quarter ended September 30, 2000 includes $16.4 million non-recurring
items, in connection with our corporate restructuring and a debt
modification, NIM transaction and sale of a domain name.
(e)The quarter ended December 31, 2000 includes $45.7 million of non-recurring
items, in connection with our write-down of MSRs, NIM transaction costs,
write-down of goodwill and other servicing related receivables.
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........................................................ 43
Consolidated Balance Sheets--December 31, 2001 and 2000............................. 44
Consolidated Statements of Operations--Years ended December 31, 2001, 2000 and 1999. 45
Consolidated Statement of Changes in Stockholders' Equity--Years ended
December 31, 2001, 2000 and 1999................................................ 46
Consolidated Statements of Cash Flows--Years ended December 31, 2001, 2000 and
1999............................................................................ 47
Notes to Consolidated Financial Statements.......................................... 48
(A)(3) EXHIBITS:
EXH.
NO. FILED DESCRIPTION
--- ---- ----------
3.1 (a) -- Certificate of Incorporation of Delta Financial Corporation
3.2 (e) -- Second Amended Bylaws of Delta Financial Corporation
3.3 (m) -- Certificate of Designations, Voting Powers, Preferences and Rights of Series A Preferred Stock 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 (g) -- 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
66
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 (h) -- 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 (i) -- Letter of Intent and Term Sheet, by and among the Delta Financial Corporation and certain beneficial
holders of the Senior Secured Notes, dated as of February 23, 2001.
4.10 (j) -- Third Supplemental Indenture dated March 16, 2001, between Delta Financial Corporation, its subsidiary
guarantors and U.S. Bank Trust National Association, as Trustee
4.11 (l) -- Fourth Supplemental Indenture dated July 31, 2001, between Delta Financial Corporation, its subsidiary
guarantors and U.S. Bank Trust National Association, as Trustee
4.12 (m) -- Fifth Supplemental Indenture dated August 27, 2001, between Delta Financial Corporation, its subsidiary
guarantors and U.S. Bank Trust National Association, as Trustee
10.2 (m) -- Employment Agreement dated February 27, 2002 between the Registrant and Hugh Miller
10.3 (f) -- Employment Agreement dated July 9, 1999 between the Registrant and Christopher Donnelly
10.4 (m) -- Employment Agreement dated September 24, 2001 between the Registrant and Randall F. Michaels
10.5 (m) -- Employment Agreement dated February 27, 2002 between the Registrant and Richard Blass
10.7 (a) -- Lease Agreement between Delta Funding Corporation and the Tilles Investment Company, and the Second, Third
and Fourth Amendments to Lease Agreement
10.8 (c) -- Fifth, Sixth and Seventh Amendments to Lease Agreement between Delta Funding Corporation and the Tilles
Investment Company
10.9 (d) -- Eighth Amendment to Lease Agreement between Delta Funding Corporation and the Tilles Investment Company
10.10 (m) -- Ninth Amendment to Lease Agreement between Delta Funding Corporation and the Tilles Investment
Company
10.11 (a) -- 1996 Stock Option Plan of Delta Financial Corporation
10.12 (m) -- 2001 Stock Option Plan of Delta Financial Corporation
21.1 (m) -- Subsidiaries of Registrant
- ---------------
(a)Incorporated by reference from our Registration Statement on Form S-1 (No.
333-11289), filed with the Commission on October 9, 1996.
(b)Incorporated by reference from our Current Report on Form 8-K(No. 001-12109),
filed with the Commission on July 30, 1997.
(c)Incorporated by reference from our 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.
(d)Incorporated by reference from our 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.
(e)Incorporated by reference from our 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.
(f)Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 1999 (File No. 1-12109), filed with the Commission on
March 31, 2000.
(g)Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on August 4, 2000.
(h)Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on January 10, 2001.
(i)Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on March 2, 2001.
(j)Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on March 22, 2001.
(k)Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 2000 (File No. 1-12109), filed with the Commission on
April 2, 2001.
(l)Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on August 3, 2001.
(m)Filed herewith
(B) REPORTS ON FORM 8-K.
None.
67
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 25, 2002 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 25, 2002
- --------------------------------
Sidney A. Miller
/S/ HUGH MILLER Chief Executive Officer, President and Director March 25, 2002
- ------------------------------- (Principal Executive Officer)
Hugh Miller
/S/ RICHARD BLASS Executive Vice President, Chief Financial Officer March 25, 2002
- ------------------------------- and Director (Principal Financial Officer)
Richard Blass
/S/ MARTIN D. PAYSON Director March 25, 2002
- -------------------------------
Martin D. Payson
/S/ ARNOLD B. POLLARD Director March 25, 2002
- -------------------------------
Arnold B. Pollard
/S/ MARGARET WILLIAMS Director March 25, 2002
- --------------------------------
Margaret Williams
68