SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30,
2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission File Number: 1-12109
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 registrant's principal executive offices including ZIP Code)
(516) 364 - 8500
----------------
(Registrant's telephone number, including area code)
NO CHANGE
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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 [ ]
As of September 30, 2002, 15,904,049 shares of the Registrant's common
stock, par value $0.01 per share, were outstanding.
INDEX TO FORM 10-Q
PART I - FINANCIAL INFORMATION Page No.
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2002 and
December 31, 2001.................................................. 1
Consolidated Statements of Operations for the three and nine
months ended September 30, 2002 and September 30, 2001............. 2
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and September 30, 2001.................... 3
Notes to Consolidated Financial Statements......................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................9
Item 4. Controls and Procedures............................................35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings..................................................35
Item 2. Changes in Securities and Use of Proceeds..........................37
Item 3. Defaults Upon Senior Securities....................................37
Item 4. Submission of Matters to a Vote of Security Holders................37
Item 5. Other Information..................................................37
Item 6. Exhibits and Current Reports on Form 8-K.......................... 37
Signatures....................................................................39
Certifications pursuant to the Sarbanes-Oxley Act of 2002.....................40
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS (UNAUDITED)
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001
---------- -----------
ASSETS
Cash and interest-bearing deposits $ 3,896 $ 6,410
Accounts receivable 4,294 4,062
Loans held for sale, net 31,177 94,407
Accrued interest receivable 8 812
Excess cash flow certificates, net 23,235 16,765
Equipment, net 2,884 4,998
Prepaid and other assets 2,659 752
Deferred tax asset, net 5,600 5,600
-------- --------
Total assets $ 73,753 $ 133,806
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank payable $ 610 1,267
Warehouse financing and other borrowings 20,359 89,628
Senior Notes 10,844 10,844
Accounts payable and accrued expenses 17,166 20,217
-------- --------
Total liabilities 48,979 121,956
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, Series A, $.01 par value.
Authorized 150,000 Shares, 139,156 shares
outstanding at September 30, 2002 and
December 31, 2001 13,916 13,916
Common stock, $.01 par value. Authorized
49,000,000 shares; 16,020,849 shares
issued and 15,904,049 shares outstanding
at September 30, 2002 and 16,000,542 shares
issued and 15,883,749 shares outstanding at
December 31, 2001 160 160
Additional paid-in capital 99,481 99,472
Retained deficit (87,465) (100,380)
Treasury stock, at cost (116,800 shares) (1,318) (1,318)
--------- ---------
Total stockholders' equity 24,774 11,850
--------- ---------
Total liabilities and stockholders' equity $ 73,753 133,806
========= =========
See accompanying notes to consolidated financial statements.
1
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
------- ------- ------- -------
REVENUES
Net gain on sale of mortgage loans $ 15,716 2,570 42,779 23,773
Interest 2,267 (16,075) 9,394 (25,621)
Servicing fees -- -- -- 2,983
Net origination fees and other income 3,723 3,141 10,641 10,529
-------- -------- ------- --------
Total revenues 21,706 (10,364) 62,814 11,664
-------- -------- ------- --------
EXPENSES
Payroll and related costs 10,211 9,945 29,987 33,228
Interest expense 1,223 2,928 4,239 14,749
General and administrative 5,710 7,125 17,557 42,518
Restructuring and other special charges -- 1,432 -- 2,678
-------- -------- ------- --------
Total expenses 17,144 21,430 51,783 93,173
-------- -------- ------- --------
Income (loss) before income tax expense
(benefit) and extraordinary item 4,562 (31,794) 11,031 (81,509)
Provision for income tax (benefit) expense (2,136) 1,861 (1,884) 2,426
-------- --------- ------- --------
Income (loss) before extraordinary item 6,698 (33,655) 12,915 (83,935)
Extraordinary item, net of tax -
Loss on early extinguishment of debt -- (19,255) -- (19,255)
-------- --------- ------- ---------
Net income (loss) $ 6,698 (52,910) 12,915 (103,190)
======== ========= ======= =========
Basic earnings per common share:
Income (loss) before extraordinary item $ 0.42 $ (2.12) $ 0.81 $ (5.28)
Extraordinary item, net of tax -- (1.21) -- (1.21)
-------- ---------- ------- ---------
Net income (loss) per share $ 0.42 (3.33) $ 0.81 $ (6.49)
======== ========== ======= =========
Diluted earnings per common share:
Income (loss) before extraordinary item $ 0.39 $ (2.12) $ 0.76 $ (5.28)
Extraordinary item, net of tax -- (1.21) -- (1.21)
-------- ---------- ------- ---------
Net income (loss) per share $ 0.39 (3.33) 0.76 (6.49)
======== ========== ======= =========
Basic -weighted average number of
shares outstanding 15,904,049 15,883,749 15,892,012 15,883,749
========== ========== ========== ==========
Diluted -weighted average number of
shares outstanding 17,112,868 15,902,309 16,966,217 15,908,496
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
2
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 2002 2001
------- -------
Cash flows from operating activities:
Net income (loss) $12,915 (103,190)
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Provision for loan and recourse losses 453 2,293
Depreciation and amortization 2,585 7,260
Extraordinary loss on early extinguishment of debt -- 19,255
Deferred origination costs 571 12
Excess cash flow certificates received in
securitization transactions, net (6,470) 50,472
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (232) 17,101
Decrease (increase) in loans held for sale, net 62,263 (91,613)
Decrease in accrued interest receivable 804 9,906
(Increase) decrease in prepaid and other assets (1,907) 32,556
Decrease in accounts payable and accrued expenses (3,108) (188)
Decrease in investor payable -- (69,489)
Decrease in advance payments by borrowers for taxes and insurance -- (12,940)
--------- ---------
Net cash provided by (used in) operating activities 67,874 (138,565)
--------- ---------
Cash flows from investing activities:
(Purchase) disposition of equipment (471) 1,749
--------- ---------
Net cash (used in) provided by investing activities (471) 1,749
--------- ---------
Cash flows from financing activities:
(Repayments of) proceeds from warehouse financing and
other borrowings (69,269) 78,514
(Decrease) increase in bank payable, net (657) 426
Proceeds from exercise of stock options 9 --
---------- ---------
Net cash used in financing activities (69,917) (78,940)
---------- ---------
Net decrease in cash and interest-bearing deposits (2,514) (57,876)
Cash and interest-bearing deposits at beginning of period 6,410 62,270
--------- ---------
Cash and interest-bearing deposits at end of period $ 3,896 4,394
========= =========
SUPPLEMENTAL INFORMATION:
Cash paid during the period for:
Interest $ 4,531 11,551
========= ========
Income taxes $ 208 80
========= ========
See accompanying notes to consolidated financial statements
3
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Delta Financial Corporation (together with its subsidiaries "Delta" or "we"
or "the Company") is a Delaware corporation, which was organized in August 1996.
The accompanying unaudited consolidated financial statements include the
accounts of Delta and its wholly owned subsidiaries. In consolidation, we have
eliminated all significant inter-company accounts and transactions.
We have prepared the accompanying unaudited consolidated financial statements
in accordance with accounting principles generally accepted in the United States
of America (GAAP) for interim financial information and the instructions to Form
10-Q. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with GAAP have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. You should read the accompanying unaudited consolidated financial
statements and the information included under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
conjunction with our audited consolidated financial statements and related notes
for the year ended December 31, 2001. The results of operations for the three-
and nine-month periods ended September 30, 2002 is not necessarily indicative of
the results that will be expected for the entire year.
We have made all adjustments that are, in the opinion of management,
considered necessary for a fair presentation of the financial position and
results of operations for the interim periods presented. We have reclassified
certain prior period amounts in the financial statements to conform to the
current year presentation.
(2) 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
4
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 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.
We have accrued restructuring charges related to the write down of lease
obligations of $0.2 million and $0.6 million at September 30, 2002 and December
31, 2001, respectively. There were no additional accruals recorded during the
nine months ended September 30, 2002.
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 approximately $148.2 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), 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
5
interests 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 Series A 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) New York State Banking Department 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-term debt, the rating
agencies that previously rated us and our long-term debt have withdrawn their
corporate ratings.
(3) EARNINGS PER SHARE
The following is a reconciliation of the denominators used in the
computations of basic and diluted Earnings Per Share ("EPS"). The numerator for
calculating both basic and diluted EPS is net income (loss) from continuing
operations.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------
Net income (loss) from operations $6,698 $(33,655) $12,915 $(83,935)
Basic - weighted-average shares 15,904,049 15,883,749 15,892,012 15,883,749
Basic EPS $0.42 $(2.12) $0.81 $(5.28)
Basic - weighted-average shares 15,904,049 15,883,749 15,892,012 15,883,749
Incremental shares-options 1,208,819 18,560 1,074,205 24,747
- --------------------------------------------------------------------------------------------------------
Diluted - weighted-average shares 17,112,868 15,902,309 16,966,217 15,908,496
Diluted EPS $0.39 $(2.12) $0.76 $(5.28)
(4) IMPACT OF NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of
6
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets," which 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 impact on our financial condition or results of operations
upon adoption of SFAS No. 142 on January 1, 2002.
In June 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The associated asset retirement
costs are to be capitalized as part of the carrying amount of the long-lived
asset and depreciated over the life of the asset. The liability is accreted at
the end of each period through charges to operating expense. If the obligation
is settled for other than the carrying amount of the liability, the Company will
recognize a gain or loss on settlement. The provisions of SFAS No. 143 are
effective for fiscal years beginning after June 15, 2002. Management does not
expect the adoption of SFAS No. 143 will have an impact on the financial
position, results of operations, or cash flows of the Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or 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. There was no impact on our financial condition or
results of operations upon adoption of SFAS No. 144 on January 1, 2002.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." The Statement updates, clarifies and simplifies existing
accounting pronouncements. SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains
and Losses from Extinguishment of Debt," which required all gains and losses
from extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in Accounting Principles Board Opinion (APB) No. 30, "Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," will now be used to classify those gains and
losses. SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements," amended SFAS No. 4, and is no longer necessary because SFAS No. 4
has been rescinded. SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," to
require that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. This amendment is consistent with the FASB's goal
of requiring similar accounting treatment for transactions that have similar
economic effects. SFAS No. 145 also makes technical corrections to existing
pronouncements. While those corrections are not substantive in nature, in some
instances, they may change accounting practice. The provisions of SFAS No. 145
are effective for fiscal years beginning after May 15, 2002. Early application
of SFAS No. 145 is encouraged. There will be
7
no material impact on our financial condition or results of operations upon
adoption of SFAS No. 145.
In July 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which addresses financial accounting and reporting
for costs associated with exit or disposal activities. It nullifies EITF Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The principal difference between SFAS No. 146 and EITF Issue
No. 94-3 relates to the recognition of a liability for a cost associated with an
exit or disposal activity. SFAS No. 146 requires that a liability be recognized
for those costs only when the liability is incurred, that is, when it meets the
definition of a liability in the FASB's conceptual framework. In contrast, under
EITF Issue No. 94-3, a company recognized a liability for an exit cost when it
committed to an exit plan. SFAS No. 146 also establishes fair value as the
objective for initial measurement of liabilities related to exit or disposal
activities. Thus, the Statement affirms FASB's view that fair value is the most
relevant and faithful representation of the economics of a transaction. We
expect that the adoption of SFAS No. 146 on January 1, 2003 will not have a
material impact on our consolidated balance sheet or results of operations.
8
ITEM 2. 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 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SET FORTH
THEREIN.
SUMMARY OF CRITICAL ACCOUNTING POLICIES
EXCESS CASHFLOW CERTIFICATES. Our excess cashflow certificates primarily
consist of the right to receive the future excess cash flows from a pool of
securitized mortgage loans. Our interest in these certificates generally
consists of the following:
o The interest spread between the coupon on the underlying mortgage loans
and the cost of financing (which, when we sell NIM notes, is only received
after the NIM Notes are paid in full);
o On our 2002 securitizations, prepayment penalties received from borrowers
who payoff their loans early in their life (which, when we sell NIM notes,
is only received after the NIM Notes are paid in full ); and
o Overcollateralization, which is designed to protect the securities sold to
the securitization pass-through investors from credit loss on the
underlying mortgage loans (and which we describe in greater detail below
under "Securitization").
The excess cash flow we receive is highly dependent upon the interest rate
environment to the extent basis risk exists between the securitization trust's
assets and liabilities. For instance, in this quarter's securitization, the cost
of financing for the securitized loans is indexed against 1 month LIBOR meaning
that each month the interest rate received by the pass through certificate
holders may adjust (upwards or downwards) as 1 month LIBOR changes(liability),
while a significant amount of the underlying mortgage loans in the
securitization trust have a fixed note rate for at least 3 years (asset). As a
result, as rates rise and fall, the amount of our excess cash flows will fall
and rise, which in turn will increase or decrease the value of our excess
cashflow certificates.
In each of our securitizations in which we sold NIM note(s), we purchased, on
behalf of the NIM owner trust, an interest rate cap for the benefit of the NIM
noteholder(s), which helps mitigate the basis risk for the approximate time that
the NIM notes are outstanding.
We believe the accounting estimates related to the valuation of our excess
cashflow certificates is a "critical accounting estimate" because it can
materially effect net income and require us to forecast interest rates, mortgage
principal payments, prepayments, and loan loss assumptions which are highly
uncertain and require a large degree of judgment. The rate used to discount the
projected cash flows is also critical in the valuation of our excess cashflow
certificates. Management uses internal, historical collateral performance data
and published forward LIBOR curves when modeling future expected excess
cashflows. We believe the value of our excess cashflows certificates is fair,
but can provide no assurance that future prepayment and loss experience or
changes in their required market discount rate will not require write-downs of
the excess cashflow certificate asset. Write-downs would reduce income of future
periods.
9
GENERAL
Delta Financial Corporation (together with its subsidiaries, "Delta" or "we"
or "the Company") is a specialty consumer finance company that originates,
securitizes, and sells (and, prior to May 2001, serviced) non-conforming
mortgage 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 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 improvements.
Our mortgage business has two principal components. First, we make mortgage
loans, 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 warehouse lines of credit. Second, we sell loans,
either through securitization or on a whole loan basis, to generate cash and
non-cash revenues, recording the premiums received as revenue. We use the
proceeds from these sales to repay our warehouse lines of credit and for working
capital.
ORIGINATION OF MORTGAGE LOANS. We 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 and other real estate professionals 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"). 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 7
retail offices and 4 origination centers located in eight states. In 2001, we
closed four under-performing retail offices - two in Florida, one in Ohio and
one in Indiana - and opened an origination center in Pittsburgh, Pennsylvania.
In September 2002, we converted our Charlotte, North Carolina retail office into
an origination center and in October 2002, we opened an additional origination
center in Phoenix, Arizona.
For the three months ended September 30, 2002, we originated $214.4 million
of loans, an increase of 46% over the $146.6 million of loans originated in the
comparable period in 2001. Of these amounts, approximately $126.7 million were
brokered loans and $87.7 million were retail loans during the three months ended
September 30, 2002, compared to $83.4 million and $63.2 million, respectively,
during the three months ended September 30, 2001.
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 that loan. By doing so,
10
we replenish our capital so we can make new loans. Typically, loans are financed
on warehouse lines 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 creditors for providing us with
financing.
SALE OF LOANS. We derive the majority of our revenues and cash flows from
selling mortgage loans (and related interests including securitization servicing
rights on newly-originated pools of mortgage loans) through securitization or on
a whole loan basis. During the third quarter of 2002, we completed a
securitization of $250 million of mortgage loans, delivering $200 million of
mortgage loans to the securitization trust during the quarter. A pre-funding
mechanism contained in the securitization structure allowed us to deliver the
additional $50 million of mortgage loans in October 2002. The revenues, net of
related expenses, on the additional $50 million of mortgage loans will be
recognized in our fourth quarter results, when the loans were actually
transferred to the securitization trust. Additionally in the third quarter of
2002, we sold $18.5 million of mortgage loans on a whole loan,
servicing-released basis.
During the nine months ended September 30, 2002, we securitized $575.0
million, (excluding the $50 million of mortgage loans that were delivered in
October 2002 as part of the Company's third quarter securitization), and sold
$92.4 million of mortgage loans on a whole loan, servicing-released basis. 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 conjunction with securitization transactions, trusts are
created in the form of off-balance sheet qualified special purpose entities, or
QSPEs. These trusts are established for the limited purpose of buying and
reselling mortgage loans. Typically each quarter, we pool together loans, and
sell these loans to these securitization trusts. We carry no contractual
obligation related to these trusts or the loans sold to them, nor do we have any
direct or contingent liability related to the trusts, except for the standard
representations and warranties made in conjunction with each securitization
trust. Furthermore, we provide no guarantees to investors with respect to cash
flow or performance for these trusts. These entities represent qualified special
purpose entities and are therefore not consolidated for financial reporting
purposes in accordance with SFAS No. 140 "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities".
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 for cash by insurance companies, mutual funds and/or
other institutional investors, represent senior interests in the cash flows from
the mortgage loans in the trust.
The securitization trust issues senior certificates, which entitles the
holders of these senior certificates to 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. The
securitization trust also issues a subordinate certificate or BIO certificate
(referred to as an excess cashflow certificate), and a P certificate
(representing the right to receive prepayment penalties from borrowers who
payoff their loans early in their life). Each month, the P certificate
11
holder is entitled to receive prepayment penalties received from borrowers who
payoff their loans early in their life.
For any monthly distribution, the holder of an excess cashflow certificate
receives payments only after all required payments have been made on all the
other securities issued by the securitization trust. In addition, before the
holder of the excess cash flow certificate receives payments, cash flows from
such excess cashflow certificates are applied in a "waterfall" manner as
follows:
o first, to cover any losses on the mortgage loans in the related mortgage
loan pool, because the excess cashflow certificates are subordinate in
right of payment to all other securities issued by the securitization
trust;
o second, to reimburse the bond 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 provision (described
in more detail immediately below) 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; and
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.
The overcollateralization provision or O/C is a credit enhancement which is
designed to protect the securities sold to the securitization pass-through
investors from credit loss on the underlying mortgage loans. In short,
overcollateralization is when the amount of collateral (I.E., mortgage loans)
owned by a securitization trust exceeds the aggregate amount of senior
pass-through certificates. The O/C is created to absorb losses that the
securitization trust may suffer, as loans are liquidated at a loss.
Historically, we built up the O/C typically over the first 18-24 months of a
securitization (with the specific timing depending upon the structure, amount of
excess spread, and performance of the securitization), by utilizing the cash
flows from the excess cashflow certificates to make additional payments of
principal to the holders of the pass-through certificates until the required O/C
level was reached. Beginning with each of our 2002 securitizations, we created
the O/C by initially selling pass-through securities totaling approximately
98.5% of the total amount of mortgage loans sold to the trust. In doing so, we
create the full amount of the O/C required by the trust up front, at the time we
complete the securitization, instead of over time. For example, if a
securitization trust contains collateral of $100 million of mortgage loans, we
sell approximately $98.5 million in senior pass-through certificates. Prior to
our 2002 securitization transactions, we typically issued pass-through
certificates 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 received close to
$100 million in proceeds from the sales of these certificates, depending upon
the structure we utilize for the securitization.
The O/C is generally expressed as a percentage of the initial mortgage loan
or collateral
12
principal balance sold to the securitization trust. The required O/C is
initially determined by either the rating agencies and/or the bond insurer, if
any, using various factors including (1) characteristics of the mortgage loans
sold to the trust (I.E., FICO scores and loan to value ratios), (2) the amount
of excess spread between the interest rate on the pool of mortgage loans sold to
the securitization trust and the interest paid to the pass-through certificate
holders, less the servicing fee, and other related expenses such as trustee fees
and bond insurer fee, if any, and (3) the structure of the underlying
securitization.
Our securitizations have typically required an O/C of between 1.5% and 3.0%
of the initial mortgage loans sold to the securitization trust. The required O/C
can increase or decrease throughout the life of the transaction depending upon
subordination levels, delinquency and or loss tests and is subject to minimums
and maximums, as defined by the rating agencies and or the bond insurer insuring
the securitization. On our securitizations prior to 2002, after the O/C
requirement is reached, the cash flows from the excess cashflow certificates are
then distributed to us as the holder of the excess cashflow certificates, in
accordance with the "waterfall" described above. Over time, if the cash
collected during the periods exceeds the amount necessary to maintain the
required O/C and all other required distributions have been met, and there is no
shortfall in the related required O/C, the excess is then released to us as
holder of the excess cashflow certificate.
In each of our more recent securitizations prior to our 2002 transactions -
in which the overcollateralization limits were created by the cash flows
generated by the excess cashflow certificates until the required
overcollateralization limits are met - 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 (which includes prepayment
penalties for certain securitization servicing rights we previously sold)
in such capacity; and
o we retained an excess cashflow certificate. Although the cash flows
generated by excess cashflow certificates are received over time, under
existing accounting rules, we must report as income at the time of the
securitization 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, (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, and (3) the London Inter-Bank Offered Rate
("LIBOR") forward curve (using current LIBOR as the floor rate).
We began utilizing a new securitization structure in 2002. In lieu of selling
an interest-only certificate, we sold a net interest margin certificate or NIM.
The NIM is generally structured
13
where we sell the excess cashflow certificate to a QSPE or owner trust (the NIM
trust) and the NIM trust in turn issues (1) interest-bearing NIM note(s) (backed
by the excess cashflow certificate), and (2) NIM owner trust certificate
evidencing ownership in the NIM trust. We sell this excess cashflow certificate
without recourse except that we provide normal representations and warranties to
the NIM trust. One or more investors purchase the NIM note(s) and the proceeds
from the sale of the note(s), along with a owner trust certificate that is
subordinate to the note(s), represent the consideration to us for the sale of
the excess cashflow certificate. In addition, for each of our 2002
securitizations we sold the P certificate to separate QSPEs or owner trusts (the
prepayment penalty trusts), the proceeds from which (representing all prepayment
penalties collected by the prepayment penalty trust) are used to repay the NIM
note(s).
The NIM note(s) entitles the holder to be paid a specified interest rate, and
further provides for all cash flows generated by the excess cashflow
certificates, including the cash flows generated from the prepayment penalty
trust to be used to pay all principal and interest on the NIM note(s) until paid
in full (estimated to be approximately 22-25 months from the date the NIM
note(s) were issued). As part of the NIM transaction, we received the cash
proceeds from the sale of the NIM note(s) and a subordinate interest in the NIM
owner trust and prepayment penalty trust, represented by the owner trust
certificates. These owner trust certificates entitle us to all cash flows
generated by the excess cashflow certificates and P certificate after the holder
of the NIM note(s) has been paid in full. As such, we classify the NIM owner
trust certificate and prepayment penalty owner trust certificate on our balance
sheet as excess cashflow certificates and value the NIM owner trust certificate
and prepayment penalty owner trust certificate using the same assumptions that
we utilize in valuing excess cashflow certificates.
As part of the NIM transaction, we were required to "fully fund" the O/C at
closing - as opposed to having it build up over time as we had in past
securitizations - which is why we sold senior pass-through certificates that
were approximately 1.25% less than the collateral in the securitization trust.
We use a portion of the proceeds we receive from selling NIM note(s) to make up
for the difference between (1) the value of the mortgage loans sold and (2) the
proceeds from selling the senior pass-through certificates.
In the securitizations that we issued in 2002, we derived the following
economic interests:
o we received a cash purchase price from the sale of the NIM note(s) issued
by a NIM trust, to which we sold the excess cashflow certificates;
o we retained a NIM owner trust certificate, which entitles us to receive
cash flows generated by the excess cashflow certificates and the P
certificate issued in connection with the securitization after the holder
of the NIM note(s) has been paid in full; and
o we received a cash premium from selling the right to service the loans
being securitized.
At the time we completed the 2002 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.
14
A summary of the gain on sale and cash flow from our third quarter 2002
securitization is presented below:
GAIN ON SALE SUMMARY
--------------------
Loans Sold (in thousands) $ 200,010
=========
NIM Proceeds, Net of the Upfront Overcollateralization 6.19%
Excess Cashflow Certificate (owner trust certificates) 1.00%
Mortgage Servicing Rights 0.85%
Less: Transaction Costs (0.63%)
----------
Net gain on sale recorded 7.41%
=========
CASH FLOW SUMMARY
-----------------
NIM Proceeds, Net of the Upfront Overcollateralization 6.19%
Mortgage Servicing Rights 0.85%
Less: Transaction Costs (0.63%)
----------
Net Cash Flow at Closing 6.41%
=========
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 in the investment)
and loan origination fees received (a decrease in the investment) 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
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,").
We allocate our basis in the mortgage loans and excess cashflow certificates
between the portion of the mortgage loans and excess cashflow certificates sold
through securitization and the portion retained (the NIM owner trust certificate
and prepayment penalty owner trust certificate, in 2002) 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.
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. In the third quarter of
2002, we sold $18.5 million loans on a whole loan basis for an average premium
(net of reserve) of 4.5% of the principal amount of mortgage loans sold.
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:
15
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 lenders 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 above in "-Corporate
Restructuring, Debt Modification and Debt Restructuring").
CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING. As
discussed in more detail in "Corporate Restructuring, Debt Modification and Debt
Restructuring" 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 2001 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 the transfer of our servicing portfolio 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 for 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 $10.8 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 "-Forward Looking
Statements and Risk Factors).
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 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 (which, in our 2002
securitizations includes BIO certificates
16
and NIM owner trust 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 - 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
expected maturity;
o credit losses on the mortgage loans - 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;
o the LIBOR forward curve (using current LIBOR as the floor rate) - our
estimate of future interest rates which affects both the rate paid to
the floating rate pass-through security investors (primarily the 1
month LIBOR index) and the adjustable rate mortgage loans sold to the
securitization trust (which provide for a fixed rate of interest for
the first 24 or 36 months and a 6 month variable rate of interest
thereafter using the 6 month LIBOR index); and
o a discount rate used to calculate present value.
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, the LIBOR forward curve 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:
17
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;
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 riginated 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.
The following table shows our most recent changes to the month one and
peak speed components of our prepayment assumptions - in the third quarter
of 2001 and, prior to that, in the third quarter 2000:
LOAN TYPE SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
------------------------------------------------------------
Fixed Rate:
At Month One 4.00% 4.00%
Peak Speed 30.00% 23.00%
Adjustable Rate:
At Month One 4.00% 4.00%
Peak Speed 75.00% 50.00%
18
A higher prepayment speed means that the mortgage loans prepay faster than
anticipated and, as such, we will earn less income in connection with the
mortgage loans and receive less excess cashflow in the future because the
mortgage loans have paid off; conversely, if we have slower prepayment
speeds, the mortgage loans remain outstanding for longer than anticipated
and, as such, we earn more income and more excess cashflow in the future.
(b) DEFAULT RATE. At September 30, 2002 and September 30, 2001, on each newly
issued securitization, we apply a default reserve for both fixed- and
adjustable-rate loans sold to the securitization trusts totaling 5.00% of
the amount initially securitized. We apply a default or loss rate to the
excess cashflow certificate because it is the "first-loss" piece and is
subordinated in right of payment to all other securities issued by the
securitization trust. If defaults are higher than we anticipate, we will
receive less income and less excess cashflow than expected in the future;
conversely, if defaults are lower than we expected, we will receive more
income and more excess cashflow than expected in the future.
(c) LIBOR FORWARD CURVE. The LIBOR forward curve is used to project future
interest rates, which affects both the rate paid to the floating rate
pass-through security investors (primarily the 1 month LIBOR index) and
the adjustable rate mortgage loans sold to the securitization trust (a
fixed rate of interest for either the first 24 or 36 months than a 6 month
variable rate of interest thereafter using the 6 month LIBOR index). As a
result of the change in LIBOR, if excess spread is less than anticipated
we will receive less income and less excess cashflow than expected in the
future; conversely, if excess spread is greater than anticipated, we will
receive more income and more excess cashflow than expected in the future.
In each of our securitizations in which we sold NIM note(s), we purchased,
on behalf of the NIM owner trust, an interest rate cap for the benefit of
the NIM noteholder(s), which helps mitigate the basis risk for the
approximate time that the NIM notes are outstanding.
(d) 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. 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 September 30, 2002 and September 30,
2001 on all excess cashflow certificates. Prior to the quarter ended
September 30, 2001, we used an 18% discount rate on a NIM transaction we
consummated in November 2000. We increased the discount rate on these
excess cashflow certificates during the period that the
19
senior NIM securities remained 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 was subordinated to the multiple senior securities sold in the NIM
transaction. As part of the Second Exchange Offer, all of the excess
cashflow certificates that were subject to the November 2000 NIM
transaction were transferred to the LLC. We did not increase the discount
rate on the excess cashflow certificates from our latest securitizations
despite issuing NIM securities because the NIM securities in the most
recent transactions were:
o issued from a single securitization as compared to the November 2000
NIM transaction, which was backed by a combination of six
securitizations issued between September 1997 and March 1999 resulting
in more volatility or variability in determining the timing of cash
flows to be received by the NIM; and
o issued from a new securitization as compared to the November 2000 NIM
transaction, which was backed by several seasoned securitization
trusts. The predictability in determining the timing of cash flows for
the first two years on a newly issued securitization is typically
higher than securitizations that have been outstanding for a greater
period of time because defaults or losses to the trust within the first
few years of issuance are typically lower and more predictable compared
to a securitization that has been outstanding for a longer period of
time (a more seasoned transaction). Additionally, prepayment speeds are
more predictable compared to more seasoned transactions, which is aided
by the presence of prepayment penalties, which typically expire within
the first few years after a mortgage loan is originated. Therefore,
there is a higher probability in determining the timing of cash flows
to the NIM investor on a new issuance securitization as compared to a
seasoned transaction.
At March 31, 2002, we recorded a charge to interest income to reflect a fair
value adjustment to our excess cashflow certificates, totaling $2.1 million,
relating to the timing of excess cashflows that are to be received by the excess
cashflow certificate after the release or "stepdown" of the
overcollateralization account.
The following table summarizes the excess cashflow activity for the nine
months ended September 30, 2002 and 2001 (dollars in thousands):
2002 2001
-------- --------
Balance, beginning of period $16,765 $216,907
New excess cashflow certificates 8,059 7,031
Cash received from excess cashflow certificates (995) (8,713)
Net accretion excess cashflow certificates 1,491 11,949
Fair Value Adjustment (2,085) (20,337)
Sales -- (193,492)
--------- ---------
Balance, end of period 23,235 13,345
========= =========
Our valuation of retained excess cashflow certificates is highly dependent
upon the reasonableness of our assumptions and the predictiveness of the
relationships that drive the results of our valuation model. The assumptions we
utilize, described above, are complex, as we must make judgment calls about the
effect of matters that are inherently uncertain. As the number of variables and
assumptions affecting the possible future resolution of the uncertainties
increase, those judgments become even more complex.
20
In volatile markets, like those we have experienced in 2001 and in 2002,
there is increased risk that our actual results may vary significantly from our
assumed results. And the greater the time period over which the uncertainty will
exist, the greater the potential volatility for our valuation assumptions.
For example, assumptions regarding prepayment speeds, defaults, and LIBOR
rates are used in estimating fair values of our excess cashflow certificates. If
loans prepay faster than estimated, or loan loss levels are higher than
anticipated, or LIBOR is higher than anticipated, we may be required to write
down the value of such certificates. While we believe that our assumptions are
reasonable estimates using our historical loan performance and the performance
of similar mortgage pools from other lenders - in addition to accessing other
public information about market factors such as interest rates, inflation,
recession, unemployment and real estate market values, among other things -
these are just estimates and it is virtually impossible to predict the actual
level of prepayments and losses, which are also driven by consumer behavior.
DEFERRED TAX ASSET
As of September 30, 2002, we carried a deferred tax asset, net of $5.6
million on our consolidated financial statements - comprised primarily of
federal and state net operating losses or "NOLs" less the tax impact and a
valuation allowance.
As of September 30, 2002, we have a gross deferred tax asset of $49.8 million
(assuming a 40% effective tax rate) and a valuation allowance of $44.2 million.
We established this valuation allowance in 2001, in the midst of two successive
years of posting significant losses (2000 and 2001), and the modest amount of
earnings we projected to earn over the ensuing several quarters. We believe it
was appropriate to establish this valuation allowance under GAAP. Since then, we
have now posted 4 consecutive quarters of profitability. If we are able to
continue to record earnings over the next several quarters, 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 September 30, 2002, federal and state NOL carryforwards totaled $95.2
million, with $9.9 million expiring in 2019, $11.9 million expiring in 2020, and
$73.4 million expiring in 2021.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2001
GENERAL
Our net income for the three months ended September 30, 2002 was $6.7
million, or $0.42 per share, basic and $0.39 per share, diluted, compared to a
net loss of $52.9 million, or $3.33 per share, basic and diluted, for the three
months ended September 30, 2001.
21
Our net income for the three months ended September 30, 2002 includes a
special tax benefit of $2.2 million, or $0.14 per share basic and $0.13 per
share diluted, which primarily relates to us obtaining favorable resolutions to
tax issues for which we had previously reserved. Our net income for the three
month period excluding this special tax benefit was $4.5 million, or $0.28 per
share basic and $0.26 per share diluted.
The third quarter 2001 net loss was primarily attributable to (1) an
extraordinary loss, net of tax, totaling $19.3 million, or $1.21 per share
(basic and diluted) and professional fees associated with our debt
extinguishment in August 2001 totaling $1.4 million, or $0.09 per share (basic
and diluted); (2) a fair value adjustment to our remaining excess cashflow
certificates related to changes in our valuation assumptions totaling $19.7
million, or $1.24 per share (basic and diluted); and (3) our not securitizing in
the third quarter 2001, which significantly reduced our revenues for the
quarter.
Comments regarding the components of net income are detailed in the following
paragraphs.
REVENUES
Total revenues increased $32.1 million, or 309% to $21.7 million for the
three months ended September 30, 2002, from a loss of $10.4 million for the
comparable period in 2001. During the three months ended September 30, 2001, we
recorded a charge to interest income to reflect a fair value adjustment to our
excess cashflow certificates and earned a lower net gain on sale of mortgages
due to us not executing a securitization.
We originated $214.4 million of mortgage loans for the three months ended
September 30, 2002, representing a 46% increase from $146.6 million of mortgage
loans originated for the comparable period in 2001. We securitized $200.0
million (net of $50.0 million pre-funding) of mortgage loans and sold $18.5
million of mortgage loans on a servicing-released basis during the three months
ended September 30, 2002. We sold $59.0 million of loans on a servicing-released
basis and did not execute a securitization during the same period in 2001.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
represents (1) the sum of (a) the fair value of the non-cash excess cashflow
certificates retained by us in a securitization for each period, (b) (i) the
cash premium purchase price we receive in connection with selling an
interest-only certificate in a securitization for each period, or (ii) the cash
purchase price we receive in connection with selling a NIM note, net of
overcollateralization amount and interest rate cap, (c) the cash premium
received from selling mortgage servicing rights in connection with each
securitization, and (d) the cash premiums earned from selling whole loans on a
servicing-released basis, (2) less the (i) costs associated with
securitizations, (ii) any hedge loss (gain) associated with a particular
securitization, and (iii) any loss associated with loans sold at a discount.
Net gain on sale of mortgage loans increased $13.1 million, or 504%, to $15.7
million for the three months ended September 30, 2002, from $2.6 million for the
comparable period in 2001. The Company did not execute a securitization in the
2001 quarter due to adverse market conditions resulting from the events of
September 11, 2001, the results of which significantly reduced its revenue
during this period. During the same period in 2001, the Company recorded cash
premiums earned on whole loan sales totaling $2.6 million. For the three months
ended September 30, 2002, 87% of the net gain on sale of mortgage loans
represented cash proceeds.
22
INTEREST INCOME. Interest income primarily represents the sum of (1) the
gross 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, (4) the interest earned on bank accounts, and (5) miscellaneous
interest income including prepayment penalties received on certain of our
securitizations prior to 2002.
Interest income increased $18.4 million, or 114%, to $2.3 million for the
three months ended September 30, 2002, from ($16.1) million for the comparable
period in 2001. During the three months ended September 30, 2001, we recorded a
charge of $19.7 million reflecting a fair value adjustment to our excess
cashflow certificates related to changes we made in the valuation assumptions we
used to estimate fair value (see "-Fair Value Adjustments").
NET ORIGINATION FEES AND OTHER INCOME. Net origination fees and other income
represent (1) fees earned on broker and retail originated loans, (2) premiums
paid to originate mortgage loans, (3) distributions from the Delta Funding
Residual Exchange Company, LLC and (4) other miscellaneous income, if any.
Net origination fees and other income increased $0.6 million, or 19%, to $3.7
million for the three months ended September 30, 2002, from $3.1 million for the
comparable period in 2001. The increase was primarily the result of (1) a 52%
increase in broker origination loans and (2) a 38% increase in retail
origination loans, partially offset by a decrease in average net originations
fees, particularly in the broker originations.
EXPENSES
Total expenses decreased by $4.3 million, or 20%, to $17.1 million for the
three months ended September 30, 2002, from $21.4 million for the comparable
period in 2001. The decrease was primarily related to (1) the significantly
lower interest expense resulting from our extinguishing approximately $139.2
million of Notes in the Second Exchange Offer in 2001 (see "-Corporate
Restructuring, Debt Modification and Debt Restructuring"), (2) our recording
lower warehouse financing costs due to lower borrowing costs during 2002, and
(3) the decrease in general and administrative expenses and restructuring and
other special charges due to our restructuring.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees.
Payroll and related costs increased by $0.3 million, or 3%, to $10.2 million
for the three months ended September 30, 2002, from $9.9 million for the
comparable period in 2001. As of September 30, 2002 the Company employed 661
full- and part-time employees, compared to 614 full- and part-time employees as
of September 30, 2001.
INTEREST EXPENSE. Interest expense includes the borrowing costs under our
warehouse credit facilities to finance loan originations, equipment financing
and the Notes.
Interest expense decreased by $1.7 million, or 59%, to $1.2 million for the
three months ended September 30, 2002 from $2.9 million for the comparable
period in 2001. The decrease was primarily due to (i) our extinguishing $139.2
million of Notes, and the corresponding interest expense related thereto, and
(ii) lower warehouse financing costs due to lower borrowing
23
costs. The average one-month LIBOR rate, which is the benchmark index used to
determine our cost of borrowed funds, decreased on average to 1.8% for the three
months ended September 30, 2002, compared to an average of 3.5% for the same
period in 2001.
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 decreased $1.4 million, or 20%, to $5.7
million for the three months ended September 30, 2002, from $7.1 million for the
comparable period in 2001. The decrease primarily resulted from the cost savings
related to the Company's corporate restructuring.
RESTRUCTURING AND OTHER SPECIAL CHARGES. In 2001, we recorded $1.4 million of
restructuring and other special charges relating to professional fees incurred
in connection with the Second Exchange Offer 2001 (see "-Corporate
Restructuring, Debt Modification and Debt Restructuring").
INCOME TAXES. Deferred tax assets and liabilities are recognized based upon
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 special tax benefit of $2.2 million related to us obtaining
favorable resolution to tax issues for which we had previously reserved and do
not expect to recur. This was offset by a tax provision of $0.1 million
primarily related to excess inclusion income generated by our excess cashflow
certificates, for the period ended September 30, 2002 and $1.9 million for the
same period in 2001. Excess inclusion income (also referred to as "phantom
income") cannot be offset by our NOL's under the REMIC tax laws. It is 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, to create and/or maintain
overcollateralization by artificially paying down the principal balance of the
asset-backed securities.
Going forward, we expect to continue to incur a modest amount of excess
inclusion income, which we will be unable to offset with our NOL's.
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2001
GENERAL
Our net income for the nine months ended September 30, 2002 was $12.9
million, or $0.81 per share, basic and $0.76 per share, diluted, compared to net
loss of $103.2 million, or $6.49 per share, basic and diluted, for the nine
months ended September 30, 2001.
Our net income for the nine months ended September 30, 2002 includes a
special tax benefit of $2.2 million, or $0.14 per share basic and $0.13 per
share diluted, which primarily relates to us obtaining favorable resolutions to
tax issues for which we had previously reserved. Our net income for the nine
month period excluding this special tax benefit was $10.7 million, or $0.67 per
share basic and $.63 per share diluted.
Comments regarding the components of net income are detailed in the following
paragraphs.
24
REVENUES
Total revenues increased $51.1 million, or 437%, to $62.8 million for the
nine months ended September 30, 2002, from $11.7 million for the comparable
period in 2001. In 2001, we recorded a $25.4 million write down of five excess
cashflow certificates sold for a cash purchase price significantly below our
carrying value of such excess cashflow certificates. In addition, we recorded a
fair value adjustment to our remaining excess cashflow certificates due to
changes in our valuation assumptions totaling $19.7 million. The increase in
revenues during the period was also attributable to a higher net gain on sale
due to us completing securitizations, net of pre-funding, of $575.0 million in
2002, compared to $165.0 million in 2001. These increases in revenue were
partially offset by a decrease in interest income from our retained excess
cashflow certificates, as we transferred the majority of these certificates as
part of our Second Exchange Offer in 2001 and by us not receiving any servicing
fees following the transfer of our servicing portfolio to Ocwen in May 2001.
(See "-Corporate Restructuring, Debt Modification and Debt Restructuring").
We originated $614.5 million of mortgage loans for the nine months ended
September 30, 2002, representing a 27% increase from $482.5 million of mortgage
loans originated for the comparable period in 2001. We securitized (net of
pre-funding) and sold $667.4 million in loans during the nine months ended
September 30, 2002, representing a 72% increase from $389.0 million securitized
or sold in the comparable period in 2001.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
increased $19.0 million, or 80%, to $42.8 million for the nine months ended
September 30, 2002, from $23.8 million for the comparable period in 2001. This
increase was primarily due to (i) an increase in the amount of loans
securitized, net of pre-funding, compared to 2001 and (ii) us securitizing a
higher percentage of mortgage loans in 2002, instead of selling whole loans
servicing-released, which typically results in a higher net gain on sale
percentage than whole loan sales. We securitized (net of pre-funding) $575.0
million and sold $92.4 million of mortgage loans on a servicing-released basis
in 2002, compared to $165.0 million of loans securitized and $224.0 million of
mortgage loans sold during the same period in 2001.
INTEREST INCOME. Interest income increased $35.0 million, or 137%, to $9.4
million for the nine months ended September 30, 2002, from $(25.6) million for
the comparable period in 2001. In 2001, we recorded a $25.4 million write down
of five excess cashflow certificates sold for a cash purchase price
significantly below our carrying value of such excess cashflow certificates. In
addition, we recorded a fair value adjustment to our remaining excess cashflow
certificates due to changes in our valuation assumptions totaling $19.7 million.
The increase was also attributed to a higher average loan balance (and,
consequently, more interest earned on loans held for sale) in 2002 compared to
the same period in 2001. The increase was partially offset by a decrease in
revenues from our excess cashflow certificates, as we transferred the majority
of these certificates as part of our Second Exchange Offer in 2001 (See
"-Corporate Restructuring, Debt Modification and Debt Restructuring").
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. We did not
receive any servicing fees during the nine months ended September 30, 2002,
25
as a result of us transferring our entire servicing portfolio to Ocwen in May of
2001. For the nine months ended September 30, 2001, servicing fees totaled $3.0
million.
EXPENSES
Total expenses decreased by $41.4 million, or 44%, to $51.8 million for the
nine months ended September 30, 2002, from $93.2 million for the comparable
period in 2001. The nine months ended September 2001 included expenses
associated primarily with: (1) our disposition and transfer of our servicing
portfolio to Ocwen in May 2001, (2) capital charges associated with repurchasing
our interest and servicing advance securitizations prior to the sale of the
servicing portfolio, (3) a change in accounting estimates regarding the life
expectancy of our computer-related equipment in 2001, and (4) a charge for
reserves primarily against a pool of non-performing loans, which we ultimately
sold in July 2001. In addition, in 2002, we had a significantly lower interest
expense resulting from our extinguishing approximately $139.2 million of Notes
in the Second Exchange Offer (see "-Corporate Restructuring, Debt Modification
and Debt Restructuring"). Lastly, we recorded lower warehouse financing costs
due to lower borrowing costs during 2002.
PAYROLL AND RELATED COSTS. Payroll and related costs decreased by $3.2
million, or 10%, to $30.0 million for the nine months ended September 30, 2002,
from $33.2 million for the comparable period in 2001. The decrease was primarily
the result of a downsizing effectuated, as part of our overall corporate
restructuring, related to our transfer of our servicing operations in May 2001.
INTEREST EXPENSE. Interest expense decreased by $10.5 million, or 71%, to
$4.2 million for the nine months ended September 30, 2002 from $14.7 million for
the comparable period in 2001. The decrease was primarily due to (i) our
extinguishing $139.2 million of Notes, and the corresponding interest expense
related thereto, and (ii) lower warehouse financing costs due to lower borrowing
costs. The average one-month LIBOR rate, which is the benchmark index used to
determine our cost of borrowed funds, decreased on average to 1.8% for the nine
months ended September 30, 2002, compared to an average of 4.4% for the same
period in 2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased $24.9 million, or 59%, to $17.6 million for the nine months ended
September 30, 2002, from $42.5 million for the comparable period in 2001. The
nine months ended September 2001 included expenses primarily associated with (1)
our disposition and transfer of our servicing portfolio in May 2001 to Ocwen (2)
capital charges previously associated with our interest and servicing advance
securitizations prior to the sale of the servicing portfolio, (3) a change in
accounting estimates regarding the life expectancy of our computer-related
equipment, and (4) a charge for reserves primarily against a pool of
non-performing loans, which we ultimately sold in July 2001.
RESTRUCTURING AND OTHER SPECIAL CHARGES. In 2001, we recorded $2.7 million of
restructuring and other special charges relating to professional fees incurred
in connection with the Second Exchange Offer 2001 (see "-Corporate
Restructuring, Debt Modification and Debt Restructuring") and charges relating
to the disposition of branches and severance costs associated with closing of
our servicing operation.
26
INCOME TAXES. During the nine months ended September 30, 2002, we recorded a
special tax benefit of $2.2 million related to us obtaining favorable resolution
to tax issues for which we had previously reserved and do not expect to recur.
This was offset by a tax provision of $0.3 million primarily related to excess
inclusion income generated by our excess cashflow certificates, for the period
ended September 30, 2002 and $2.4 million for the same period in 2001.
FINANCIAL CONDITION
SEPTEMBER 30, 2002 COMPARED TO DECEMBER 31, 2001
CASH AND INTEREST-BEARING DEPOSITS. Cash and interest-bearing deposits
decreased $2.5 million, or 39%, to $3.9 million at September 30, 2002, from $6.4
million at December 31, 2001. The decrease is primarily due to us utilizing
operating cash to fund our production of mortgage loans.
LOANS HELD FOR SALE, NET. Loans held for sale, net decreased $63.2 million,
or 67%, to $31.2 million at September 30, 2002, from $94.4 million at December
31, 2001. This represents mortgage loans held in inventory awaiting either a
whole loan sale or securitization. This decrease was primarily due to the net
difference between loan originations and loans securitized or sold during the
nine months ended September 30, 2002.
ACCRUED INTEREST RECEIVABLE. Accrued interest receivable decreased $0.8
million, or 100%, to $8 thousand at September 30, 2002, from $0.8 million at
December 31, 2001. This decrease was primarily due us collecting short-term
interest at time of mortgage loan closing in 2002, compared to 2001 when we did
not and therefore accrued for short-term interest earned, but not yet collected,
as interest is paid in arrears by the borrower.
EXCESS CASHFLOW CERTIFICATES, NET. Excess cashflow certificates, net
increased $6.4 million, or 38%, to $23.2 million at September 30, 2002, from
$16.8 million at December 31, 2001. This increase was primarily due to us
recording new excess cashflow certificates, totaling $8.1 million from loans
securitized in 2002. This increase was partially offset by a fair value
mark-to-market adjustment of our excess cashflow certificates, reflecting the
change in fair value of such excess cashflow certificates.
EQUIPMENT, NET. Equipment, net, decreased $2.1 million, or 42%, to $2.9
million at September 30, 2002, from $5.0 million at December 31, 2001. This
decrease primarily reflects the periodic depreciation of our fixed assets.
PREPAID AND OTHER ASSETS. Prepaid and other assets increased by $1.9 million,
or 238%, to $2.7 million at September 30, 2002, from $0.8 million at December
31, 2001. This increase is primarily due to the capitalization of securitization
costs associated with the $50.0 million pre-funding that was completed during
the fourth quarter of 2002. The third quarter securitization structure had a
pre-funding mechanism which allowed us to deliver and close on approximately
$200.0 million by September 30, 2002, and deliver the additional $50.0 million
of mortgage loans in October 2002.
WAREHOUSE FINANCING AND OTHER BORROWINGS. Warehouse financing and other
borrowings decreased $69.2 million, or 77%, to $20.4 million at September 30,
2002, from $89.6 million at December 31, 2001. This decrease was primarily
attributable to a lower amount of mortgage
27
loans held for sale (mortgage loans held in inventory awaiting either a whole
loan sale or securitization) to be financed under our warehouse credit
facilities.
SENIOR NOTES. Senior notes totaled $10.8 million at September 30, 2002 and
December 31, 2001. The senior notes accrue interest at a rate of 9.5% per annum,
payable semi-annually on February 1 and August 1.
ACCOUNTS PAYABLE AND ACCRUED EXPENSE. Accounts payable and accrued expense
decreased $3.0 million, or 15%, to $17.2 million at September 30, 2002 from
$20.2 million at December 31, 2001. This decrease was primarily related to our
obtaining favorable resolutions to tax issues in the amount of $2.2 million, for
which we had previously reserved. The decrease was also the result of timing of
various operating accruals and payables.
LIQUIDITY AND CAPITAL RESOURCES
We require substantial amounts of cash to fund our loan originations,
securitization activities and operations. We have historically operated on a
negative cash flow basis due primarily to increases in the volume of loan
originations and the growth of our securitization program. During the first
three quarters of 2002, we reduced our negative cash flow and essentially
generated slightly positive cash flow from operations. Two significant factors
contributed to this phenomena. First, the securitization market was extremely
favorable, which resulted in better securitization execution (I.E., a lower cost
of funds). This provided us with a wider spread between our cost of funds and
the coupons on the mortgage loans underlying our securitizations, which
translated into better-than-expected cash proceeds at the time of
securitization. Second, we sold more loans in securitization and on a whole loan
basis than we originated. Had these two factors not been present, we would have
continued to operate on a slightly negative cash flow basis, because while we
increased originations, we did not do so sufficiently to offset our cost
structure.
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 continue to increase our loan production to generate
sufficient additional revenues from our securitizations and loan sales to offset
our current cost structure and negative cash flow, we believe we can continue to
generate positive cash flow within the foreseeable future, as we have thus far
this year. There can be no assurance, however, that we will continue generating
positive cash flow within the foreseeable future or at all.
Currently, our primary sources of cash - the vast majority of which we
typically generate towards the end of the quarter when we securitize and/or sell
our mortgage loans on whole loan basis - include:
o the premiums we receive from selling NIM (and/or interest-only)
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 cash flows from excess cashflow certificates we retain in connection
with our securitizations;
28
o the interest income we receive on our loans held for sale prior to
securitization; and
o distributions from the LLC (an unaffiliated entity to us).
Currently, our primary uses of cash, which are generally incurred
continuously throughout the quarter include:
o the equity in our mortgage loans held for sale, for which we receive
financing on from our warehouse lender up to only 98% of the total amount
of the mortgage loan's principal balance (E.G., the warehouse lender will
provide financing to us equal to $98,000 on a mortgage loan with a
principal balance of $100,000, leaving us with our $2,000 tied up in the
equity of the mortgage loan);
o interest expense on warehouse lines of credit, the remaining notes and
other financing;
o scheduled principal paydowns on 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.
Because of the timing of our cash inflows and cash uses, we typically expend
cash throughout the quarter and replenish it towards the end of the quarter.
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 and/or NIM (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;
29
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 $15.0 million cash purchase price. As customary with
sales of similar assets, the cash settlement did not occur until the pools
of mortgage loans 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 NIM
and/or interest-only 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 retained
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. At
September 30, 2002 we had two $200 million committed credit line warehouse
facilities each with a variable interest rate and a maturity date of May 2003.
There can be no assurance that we will be able to renew these warehouse
facilities at their maturity, or obtain new ones, at terms satisfactory to us or
at all.
In addition to our common stock, we currently have the following securities
outstanding:
o Series A preferred stock having an aggregate preference of $13.9 million,
for which we are required to pay 10% annual dividends, payable
semi-annually, commencing in July 2003;
30
o Ten-year warrants to purchase approximately 1.6 million shares of our
common stock, currently at an exercise price of $9.10 per share, subject
to upward or downward adjustment in certain circumstances; and
o Approximately $10.8 million of senior notes due 2004, paying 9.5% annual
interest, payable semi-annually.
We are required to comply with various operating and financial covenants as
provided in our warehouse agreements, which are customary for agreements of
their type. The continued availability of funds provided to us under these
agreements 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 September 30, 2002.
We have repurchase agreements with certain institutions that have purchased
mortgages loans from us. 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 $2.9 million at September 30, 2002 and $3.5 million at December 31,
2001. We have an allowance for recourse losses of $1.3 million at September 30,
2002 and $1.4 million at December 31, 2001, respectively.
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/or 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 using historical data and
identify and modify those products, on a go-forward basis, that we believe have
been more adversely impacted due to changes in interest rates. However, there
can be no assurance that these modifications to our product line will mitigate
effectively interest rate risk in the future.
31
Periods of unexpected or rapid changes in interest rates, and/or other
volatility or uncertainty regarding interest rates, also can adversely affect 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.
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 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
32
mortgage originations. If we decide to hedge, 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
sale 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 sale 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 to best mitigate risk pending
securitization or loan sales.
We did not hedge over the past several quarters, including during the
quarters ended September 30, 2002 and 2001. We have not yet engaged in a hedging
transaction in the 4th quarter, but may do so depending upon market conditions.
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 4 of Notes to the Consolidated Financial Statements.
33
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Except for historical information contained herein, certain matters discussed
in this Form 10-Q 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 wish 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 our practice of securitizing mortgage
loans held for sale, as well as our ability to utilize optimal
securitization structures (including the sale of NIM or interest-only
certificates, and the sale of servicing rights, at the time of
securitization) at terms favorable to us;
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 monetizing our excess cashflow
certificates, including without limitation, selling, financing or
securitizing (through NIM transactions) such assets;
o The effect that the adoption of new, or changes in federal, state or
local lending laws and regulations and the application of such laws and
regulations may have on our ability to originate loans within a particular
area. Many states and local municipalities have adopted and/or are
considering adopting laws 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. In some cases, the restrictions and/or costs and
risks associated with complying with the laws have been so onerous that we
have decided to not lend in a state (I.E., Georgia) or municipality (I.E.,
Oakland). In those cases where we continue to do business, our costs of
complying with a variety of potentially inconsistent federal, state and
local laws has increased our compliance costs, as well as the risk of
litigation or administrative action associated with complying with these
proposed and enacted federal, state and local laws, particularly those
aspects of such proposed and enacted laws that contain subjective (as
opposed to objective) requirements, among other things.
o Costs associated with litigation 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
34
and/or environmental compliance 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;
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; and
o Regulatory actions which may have an adverse impact on our lending.
ITEM 4. CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer, based on their
evaluation of our disclosure controls and procedures within the past 90 days,
have concluded that such disclosure controls and procedures were effective to
ensure that material information relating to the Company and required to be
disclosed by us has been made known to them and has been recorded, processed,
summarized and reported timely. There have not been any significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of evaluation.
PART II - OTHER INFORMATION
ITEM 1. 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, including several lawsuits styled
35
as class actions. We summarize updates to the status of these actions below.
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 appealed, and the appellate court upheld the
lower court's decision. 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 discovery in the action pending the result of that
appeal. The appeal has been fully briefed and was argued in September
2002. 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. 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 was held June 2002, at which point
the Court approved the settlement. The settlement was fully administered
and the case concluded during the third quarter of 2002.
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
36
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. In
October 2002, we executed a settlement agreement with plaintiffs and our
insurer, pursuant to which we denied all wrongdoing, and our insurer
agreed to resolve the litigation on a class-wide basis with plaintiffs. We
expect that a fairness hearing will be scheduled within the next several
months, at which time we further anticipate that the Court will approve
the settlement. In the event that 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 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. In September
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. We anticipate that a fairness hearing will be scheduled
in the upcoming months, at which time we further anticipate that the Court
will approve the settlement. In the event 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None
ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS. None
ITEM 5. OTHER INFORMATION. None
ITEM 6. EXHIBITS AND CURRENT REPORTS ON FORM 8-K.
(a) Exhibits:
37
EXH.
NO. DESCRIPTION
--- ----------
10.1 Employment Agreement dated September 12, 2002 between the Registrant
and Sidney A. Miller
(b) Reports on Form 8-K: None
38
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the Registrant has duly caused this Report on Form 10-Q to be signed on
its behalf by the undersigned, thereunto duly authorized.
DELTA FINANCIAL CORPORATION
(Registrant)
Dated: November 13, 2002
By: /S/ HUGH MILLER
-----------------------------
Hugh Miller
PRESIDENT &
CHIEF EXECUTIVE OFFICER
By: /S/ RICHARD BLASS
-----------------------------
Richard Blass
EXECUTIVE VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
39
CERTIFICATION
I, Hugh Miller, Chief Executive Officer of Delta Financial Corporation
(the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of the Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Company as of, and for, the periods presented in this
quarterly report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we
have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee
of the Company's board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for
the Company's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
controls; and
40
6. The Company's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 13, 2002
By:/S/ HUGH MILLER
-----------------------------
Hugh Miller
CHIEF EXECUTIVE OFFICER
41
CERTIFICATION
I, Richard Blass, Chief Financial Officer of Delta Financial Corporation
(the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of the Company;
2 Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Company as of, and for, the periods presented in this
quarterly report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we
have:
(c) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(d) evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(e) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee
of the Company's board of directors (or persons performing the equivalent
function):
(f) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability
to record, process, summarize and report financial data and have
identified for the Company's auditors any material weaknesses in
internal controls; and
(g) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
controls; and
42
6. The Company's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 13, 2002
By: /S/ RICHARD BLASS
-----------------------------
Richard Blass
CHIEF FINANCIAL OFFICER
43
CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Hugh Miller, President and Chief Executive Officer of Delta Financial
Corporation (the "Company"), pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002, do hereby certify as follows:
1. The quarterly report on Form 10-Q of the Company for the period ended
September 30, 2002 fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in such Form 10-Q fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
IN WITNESS WHEREOF, I have executed this Certification this 13 day of November,
2002.
/s/HUGH MILLER
-------------------------------------
Hugh Miller
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
44
CERTIFICATION OF EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Richard Blass, Executive Vice President and Chief Financial Officer of
Delta Financial Corporation (the "Company"), pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, do hereby certify as follows:
1. The quarterly report on Form 10-Q of the Company for the period ended
September 30, 2002 fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in such Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of the Company.
IN WITNESS WHEREOF, I have executed this Certification this 13 day of November,
2002.
/s/RICHARD BLASS
-------------------------------------
Richard Blass
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
45