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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
COMMISSION FILE NO. 1-12109
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DELTA FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 11-3336165
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1000 WOODBURY ROAD, SUITE 200,
WOODBURY, NEW YORK 11797
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:(516) 364-8500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 26, 2003, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $2.14, was
approximately $12,241,157.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2. Yes [__] No [X]
As of March 17, 2003, the Registrant had 15,905,549 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, Items 10, 11, 12 and 13 are incorporated by reference from Delta
Financial Corporation's definitive proxy statement to stockholders which will be
filed with the Securities and Exchange Commission no later than 120 days after
December 31, 2002.
PART I
ITEM 1. BUSINESS
BUSINESS OVERVIEW
Delta Financial Corporation (together with its subsidiaries "Delta" or "we")
is a specialty consumer finance company that originates, securitizes and sells
(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 21-year operating history, we have focused on lending
to individuals who generally do not satisfy the credit, documentation or other
underwriting standards set by more traditional sources of mortgage credit,
including those entities that make loans in compliance with conventional
mortgage lending guidelines established by Fannie Mae and Freddie Mac. We make
loans to these borrowers for such purposes as debt consolidation, refinancing,
education and home improvement. Our corporate offices are located at 1000
Woodbury Road, Woodbury, NY 11797 and we can be contacted at (516) 364-8500 or
through our internet web site at HTTP://WWW.DELTAFINANCIAL.COM. Our Exchange Act
filings can be accessed on the Investor Relations page of our web site, through
a link to EDGAR.
Our mortgage business has two principal components. First, we make mortgage
loans to individual borrowers, which is a cash and expense outlay for us,
because our cost to originate a loan exceeds the fees we collect at the time we
originate that loan. At the time we originate a loan, and prior to the time we
sell that loan, we finance that loan by borrowing under 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 revenues. 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. 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.
In 2002, we originated approximately $872 million of loans, of which
approximately $535 million were brokered loans and $337 million were retail
loans, compared to 2001, when we originated approximately $622 million of loans,
of which $346 million were brokered loans and $276 million were retail loans.
INDEPENDENT MORTGAGE BROKER (WHOLESALE) CHANNEL. 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. We currently originate the majority of our
wholesale loans in 26 states, through our network of approximately 1,500
brokers. The broker's role is to source the business, identify the applicant,
assist in completing the loan application, gather necessary information and
documents and serve as the liaison between us and the borrower through the
entire origination process. We review, process and underwrite the applications
submitted by the broker, approve or deny the application, set the interest rate
and other terms of the loan and, upon acceptance by the borrower and
satisfaction of all conditions imposed by us as the lender, lend the money to
the borrower. Because brokers conduct their own marketing and employ their own
personnel to complete loan applications (and hence charge a broker fee that is
commensurate with their services) and maintain contact with borrowers,
originating loans through our broker network allows us to increase our loan
volume without incurring the higher marketing and employee costs associated with
increased retail originations.
RETAIL LOAN CHANNEL. 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 (which are
typically staffed with considerably more loan officers and cover a broader area
than retail offices) located in eight states. In 2002, we converted our
Charlotte, North Carolina retail office into an origination center and opened an
additional origination center in Phoenix, Arizona. We continually monitor our
retail operations and evaluate current and potential retail offices on the basis
of selected demographic statistics, marketing analyses and other criteria
developed by us. Typically, contact with the customer is initially handled
through our telemarketing center. On the basis of an initial screening conducted
at the time of the call, our telemarketer makes a preliminary determination of
whether the customer and the property meet our lending criteria. If the customer
does meet our criteria, the telemarketer will forward the customer to one of our
local branches or origination centers. The mortgage analyst at the local branch
or origination center may complete the application over the telephone, or
schedule an appointment in the retail loan office most conveniently located to
the customer or in the customer's home, depending on the customer's needs. The
mortgage analyst assists the applicant in completing the loan application,
ensures that an
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appraisal has been ordered from an independent third party appraisal company,
orders a credit report from an independent, nationally recognized credit
reporting agency and performs various other tasks in connection with the
completion of the loan package. Our mortgage analysts are trained to structure
loans that meet the applicant's needs while satisfying our lending guidelines.
The loan package is underwritten for loan approval on a centralized basis. If
the loan package is approved, we will fund the loan.
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, we replenish our capital so we can
make new loans. Typically, loans are financed through 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 through one of two outlets: (i) securitization, which
involves the public offering by a securitization trust of asset-backed
pass-through securities (and related interests including securitization
servicing rights on newly-originated pools of mortgage loans); and (ii) whole
loan sales, which includes the sale of pools of individual loans to
institutional investors, banks, and consumer finance-related companies on a
servicing released basis. We select the outlet depending on market conditions,
relative profitability and cash flows. We generally realize higher gain on sale
when we securitize than we do when we sell whole loans. We apply the proceeds
from loan sales, whether through securitizations or whole loan basis, to repay
our warehouse lines of credit - in order to make available capacity under these
facilities for future funding of mortgage loans - and utilize any additional
funds for working capital.
In 2002, securitizations and whole loan sales comprised approximately 89% and
11%, respectively, of our loan sales. Going forward, we expect to continue to
use a combination of securitizations and whole loan sales, with the amounts of
each dependent upon the marketplace and our goal of maximizing earnings and
liquidity.
The following table sets forth certain information regarding the Company's
securitizations and whole loan sales during the periods presented:
YEAR ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
2002 2001 2000
------------------------------------
Loan securitizations $ 850,000 $ 345,000 $ 840,000
Whole loan sales 102,947 261,110 58,321
------------------------------------
Total securitizations
and loans sold $ 952,947 $ 606,110 $ 898,321
====================================
In 2002, we securitized the majority of our loans in four securitizations
totaling $850 million, of which we delivered a total of $819 million of mortgage
loans during 2002 (and delivered the remaining $31 million of mortgage loans in
January 2003, pursuant to a pre-funding mechanism). We plan to continue to
utilize a combination of securitization and whole loan sales for the foreseeable
future.
SECURITIZATION. Securitizations are off balance sheet transactions that
effectively provide us with a source of long-term financing.
In a securitization, we pool together loans, typically each quarter, and sell
these loans to a securitization trust, which is a qualified special purpose
entity or QSPE. 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. 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". Following the securitization, 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
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or a BIO certificate (referred to as an excess cashflow certificate), which
entitles the holder to receive the excess cash flows after making all required
payments to all other securities issued by the securitization trust, covering
losses incurred by the trust and other costs and expenses of the trust. In
addition, the securitization trust also issues a P certificate (representing the
right to receive prepayment penalties from borrowers who payoff their loans
early in their life). In each of our 2002 securitizations, we sold the excess
cashflow certificate and P certificate (which entitles the holder to all
prepayment penalties collected by the servicer of the underlying securitization
trust) to a net interest margin trust, or NIM trust (QSPE), which in turn,
issued interest-bearing NIM note(s) and a NIM owner trust certificate. We sell
the excess cashflow certificate and P certificate without recourse except that
we provide normal representations and warranties to the NIM trust. One or more
investors purchase the NIM note(s) for a cash price and we receive the proceeds
of the sale of the note(s), together with the NIM owner trust certificate in
consideration of our selling the excess cashflow certificate and P certificates
to the NIM Trust. The NIM note(s) entitles the holder(s) to receive all cash
flows generated by the excess cashflow certificate and P certificate owned by
the NIM trust, until the holder(s) are paid in full (all principal and
interest). The NIM owner trust certificates entitle the holder to all cash flows
generated by the excess cashflow certificate and P certificate after the NIM
note(s) have been paid in full.
At the time we completed the 2002 securitizations, we recognized as revenue
the following three economic interests:
o The cash purchase price from the sale of the NIM note(s) issued by a NIM
Trust;
o The value of the excess cashflow certificates (initially, the NIM owner
trust certificate) that we retained; and
o The cash premium we received from selling the right to service the
loans being securitized.
These economic interests were recorded as net gain on sale of mortgage loans
on our consolidated statement of operations.
WHOLE LOAN SALES WITHOUT RECOURSE. We also sell loans, without retaining the
right to service the loans, in exchange for a cash premium. The premiums we
receive from the loans sales are recorded as revenue under net gain on sale of
mortgage loans at the time of sale. The cash premiums ranged between 2.0% to
5.5% of the principal amount of mortgage loans sold in 2002.
OTHER. In addition to the income and cash flows we earn from securitizations
and whole loan sales, we also earn income and generate cash flows from:
o the net interest spread earned on mortgage loans while we hold the
mortgage loans for sale (the difference between the interest rate on the
mortgage loan paid by the underlying borrower less the financing costs we
pay to our warehouse 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 (the "LLC") (described below in
"-Debt Modification and Debt Restructuring").
BUSINESS STRATEGY
Our core business strategy is to continue to increase profitability and
generate cash revenues in excess of our cash expenses through an increase in our
overall loan production and average loan size, such that we can continue to
maintain our profitability and operate on a cash flow neutral to positive basis.
We believe we have the infrastructure in place to expand loan production
significantly (on a percentage basis) in both our wholesale and retail channels,
without having to invest significantly in our infrastructure. We plan to
increase loan production by:
o increasing the number of commissioned-based account executives
responsible for generating new wholesale business;
o continuing to provide top quality service to our network of brokers and
retail clients;
o maintaining our loan underwriting standards;
o penetrating further our established and recently-entered markets and
expanding into new geographic markets;
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o expanding our retail loan origination capabilities through larger call
centers; and
o continuing to leverage off of our proprietary web-based and workflow
technology platform.
CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING
In 2000, we began a corporate restructuring - by reducing our workforce and
modifying the terms of the indenture governing our senior notes due 2004 (the
"senior notes") - as part of our continuing efforts to improve operating
efficiencies and to address our negative cash flow from operations. Entering
2001, management still had several concerns, which we believed needed to be
addressed for us to remain a viable company. Our principal concerns were:
o the cash drain created by our ongoing monthly delinquency and servicing
advance requirements as servicer for securitization trusts (known as
"securitization advances");
o the high cost of servicing a seasoned loan portfolio, including the
capital charges associated with making securitization advances;
o our ability to make timely interest payments on our senior notes and
senior secured notes due 2004 (the "senior secured notes"); and
o our ability to effectuate a successful business model given the
overhang of corporate ratings of "Caa2" by Moody's and "CC" by Fitch.
Therefore in the first quarter of 2001, we embarked upon a business plan
aimed at alleviating some of these concerns and issues.
CORPORATE RESTRUCTURING
In January 2001, we announced that we had entered into an agreement with
Ocwen Financial Corporation ("Ocwen") to transfer our servicing portfolio to
Ocwen. In May 2001, we physically transferred our entire servicing portfolio to
Ocwen, and laid-off the majority of our servicing staff - a total of 128
employees. We recorded a $0.5 million pre-tax charge related to this
restructuring, which is included in the line item called "restructuring and
other special charges" on our consolidated statements of operations. This charge
relates to employee severance associated with closing our servicing operations.
We no longer service loans nor do we have a servicing operation.
DEBT MODIFICATION AND DEBT RESTRUCTURING
In August 2000, we announced an agreement to modify the terms of the
indenture governing our senior notes (the "Debt Modification"). With the consent
of the holders of greater than fifty percent of our senior notes, we modified a
negative pledge covenant in the senior notes indenture, which had previously
prevented us from selling or otherwise obtaining financing by using our excess
cashflow certificates as collateral. In consideration for the senior
noteholders' consent, we agreed, in an exchange offer (the "First Exchange
Offer"), to offer then current holders the opportunity to exchange their then
existing senior notes for (a) new senior secured notes and (b) ten-year warrants
to buy approximately 1.6 million shares of common stock, at an initial exercise
price of $9.10 per share, subject to upward or downward adjustment in certain
circumstances. In December 2002, the exercise price for the warrants issued by
us was adjusted downward to $0.01 per share in accordance with the agreement.
The senior secured notes have the same coupon, face amount and maturity date as
the senior notes and, up until the Second Debt Restructuring (see below) were
secured by at least $165 million of our excess cashflow certificates. The First
Exchange Offer was consummated in December 2000, with holders of greater than
$148 million (of $150 million) of senior notes tendering in the exchange.
In February 2001, we entered into a letter of intent with the beneficial
holders of over fifty percent of our senior secured notes to restructure, and
ultimately extinguish, the senior secured notes (the "Second Debt
Restructuring"). In March 2001, we obtained the formal consent of these
beneficial holders of the senior secured notes through a consent solicitation
that modified certain provisions of the senior secured notes indenture to, among
other things, allow for the release of two excess cashflow certificates then
securing the senior secured notes. We were able to first finance and ultimately
sell the excess cashflow certificates underlying five securitizations (including
two excess cashflow certificates that were released as part of the Second Debt
Restructuring) for a $15 million cash purchase price to provide working capital.
In consideration for their consent, we agreed to offer the holders of the
senior secured notes (and the senior notes, collectively, the "notes"), an
opportunity to exchange their notes for new securities described immediately
4
below (the "Second Exchange Offer"). The Second Exchange Offer was consummated
on August 29, 2001, pursuant to which holders of approximately $138.1 million
(of $148.2 million) in principal amount of our senior secured notes and $1.1
million (of $1.8 million) in principal amount of our senior notes, exchanged
their notes for commensurate interests in:
o voting membership interests in the LLC, a newly-formed limited
liability company (unaffiliated with us), to which we transferred all of
the mortgage-related securities previously securing the senior secured
notes (primarily comprised of excess cashflow certificates);
o shares of common stock of a newly-formed management corporation that will
manage the LLC's assets; and
o shares of our newly-issued Series A preferred stock having an aggregate
preference amount of $13.9 million.
The LLC is controlled by the former noteholders that now hold all the voting
membership interests in the LLC. As part of the transaction, we obtained a
non-voting membership interest in the LLC, which entitles us to receive 15% of
the net cash flows from the LLC for the first three years (through June 2004)
and, thereafter, 10% of the net cash flows from the LLC. The net cash flows from
the LLC are equal to the total cash flows generated by the assets held by the
LLC for a particular period, less (a) all expenses of the LLC, (b) certain
related income tax payments, and (c) the New York State Banking Department (the
"NYSBD") subsidy payments (See "Regulations"). We began receiving distributions
from the LLC in the first quarter of 2002 from a fourth quarter 2001
distribution.
As part of the Second Exchange Offer, all tendering noteholders waived their
right to receive any future interest coupon payments on the tendered notes
beginning with the August 2001 interest coupon payment. With the closing of the
Second Exchange Offer, we recorded a charge of $19.3 million related to the
extinguishment of debt and paid the August 2001 interest coupon payment on the
approximately $10.8 million of notes that did not tender in the Second Exchange
Offer. The notes bear interest at a rate of 9.5% per annum, payable
semi-annually (on February 1st and August 1st) and a maturity date of August 1,
2004 when all outstanding principal is due.
By extinguishing substantially all of our long-term debt, the rating agencies
that previously rated us and our long-term debt have withdrawn their corporate
ratings.
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Our consumer finance activities consist of originating, securitizing, selling
(and, prior to May 2001, servicing) non-conforming mortgage loans. These loans
are primarily secured by first mortgages on one- to four-family residences. Once
loan applications have been received, the underwriting process completed and the
loans funded or purchased, we typically package the loans in a portfolio and
sell the loan portfolio through a securitization or on a whole loan, servicing
released basis.
We provide our customers with an array of loan products designed to meet
their needs, using a risk-based pricing strategy to develop products for various
risk categories. Historically, we have offered fixed-rate loan products and, to
date, the majority of our loan production is fixed-rate. As we have expanded
geographically, we have expanded our product offerings to include hybrid
mortgages, in which the interest rate remains fixed for the first two or three
years and then adjusts thereafter.
We primarily conduct our broker lending operations out of our Woodbury, New
York headquarters. Final underwriting approval for brokered loans is centralized
and required from the Woodbury, New York headquarters. We conduct our retail
operations out of 4 call centers, 7 retail offices and a telemarketing hub,
located in eight states. Final underwriting approval for retail loans is
required from either our retail underwriting office in Cincinnati, Ohio, which
has full underwriting authority or from our Woodbury, New York headquarters.
We adhere to our Best Practice Lending Program aimed at ensuring the
origination of quality loans and helping to better protect consumers. This Best
Practice Lending Program includes:
o fair lending initiatives aimed at ensuring all borrowers are treated
fairly and similarly regardless of race, color, creed, religion, national
origin, sex, sexual orientation, marital status, age, disability, and the
applicant's exercise, in good faith, of any right under the Consumer
Credit Protection Act;
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o increased oversight of mortgage brokers and closing agents;
o enhanced fraud detection and protection;
o enhanced plain English disclosures; and
o other originations and underwriting initiatives which we believe help
protect consumers.
LOAN ORIGINATIONS AND PURCHASES
Our loan originations increased by 40% to $872 million in 2002 from $622
million in 2001. The following table shows certain data regarding our loans,
presented by channel of loan originations, for the years shown:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
Broker:
Principal balance....................... $ 534,999 $ 345,916 $ 603,616
Average principal balance per loan.... $ 116 $ 79 $ 74
Combined weighted average initial loan-
to-value ratio(1)................... 74.6% 71.7% 71.1%
Weighted average interest rate........ 9.5% 11.1% 11.7%
Weighted average credit score........... 601 584 587
Retail:
Principal balance..................... $ 337,191 $ 275,799 $ 260,388
Average principal balance per loan.... $ 97 $ 82 $ 67
Combined weighted average initial loan-
to-value ratio(1)................... 79.5% 77.4% 76.9%
Weighted average interest rate........ 9.1% 9.8% 10.6%
Weighted average credit score........... 631 633 617
Correspondent (2):
Principal balance..................... -- -- $ 69,434
Average principal balance per loan.... -- -- $ 75
Combined weighted average initial loan-
to-value ratio(1)................ -- -- 70.5%
Weighted average interest rate........ -- -- 11.5%
Weighted average credit score........... -- -- 599
Total loan purchases and originations:
Principal balance..................... $ 872,190 $ 621,715 $ 933,438
Average principal balance per loan.... $ 108 $ 81 $ 72
Combined weighted average initial loan-
to-value ratio(1)................... 76.5% 74.2% 72.7%
Weighted average interest rate........ 9.4% 10.5% 11.4%
Weighted average credit score........... 613 606 596
Percentage of loans secured by:
First mortgage........................ 96.3% 94.1% 90.9%
- ---------------
(1) We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio
of a loan secured by a second mortgage by taking the sum of the loan secured
by the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
(2) We discontinued our correspondent operations in July 2000 to focus on our
less cash intensive broker and retail channels.
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The following table shows certain data regarding our loans, presented by
channel of loan originations, on a quarterly basis for 2002:
THREE MONTHS ENDED
-----------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2002 2002 2002 2002
--------- -------- ---------- ------------
(DOLLARS IN THOUSANDS)
Broker:
Number of brokered Loans............. 1,162 1,301 1,100 1,048
Principal balance.................... $ 122,758 $ 141,039 $ 126,651 $ 144,551
Average principal balance per loan... $ 106 $ 108 $ 115 $ 138
Combined weighted average initial loan-
to-value ratio(1).................. 74.3% 73.4% 74.9% 75.7%
Weighted average interest rate....... 9.9% 9.9% 9.5% 8.9%
Weighted average credit score.......... 599 598 596 610
Retail:
Number of retail loans............... 713 793 882 1,078
Principal balance.................... $ 67,235 $ 69,095 $ 87,717 $ 13,144
Average principal balance per loan... $ 94 $ 87 $ 99 $ 105
Combined weighted average initial loan-
to-value ratio(1).................. 78.4% 77.7% 80.3% 80.5%
Weighted average interest rate....... 9.3% 9.5% 9.0% 8.7%
Weighted average credit score.......... 631 628 633 631
Total loan originations:
Total number of loans................ 1,875 2,094 1,982 2,126
Principal balance.................... $ 189,993 $ 210,134 $ 214,368 $ 257,695
Average principal balance per loan... $101 $100 $108 $121
Combined weighted average initial loan-
to-value ratio(1).................. 75.8% 74.8% 77.1% 77.8%
Weighted average interest rate....... 9.7% 9.8% 9.3% 8.8%
Weighted average credit score.......... 610 608 611 620
- ---------------
(1) We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio
of a loan secured by a second mortgage by taking the sum of the loan secured
by the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
The following table shows lien position, weighted average interest rates and
loan-to-value ratios for the years shown:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
FIRST MORTGAGE:
Percentage of total purchases and originations 96.3% 94.1% 90.9%
Weighted average interest rate........ 9.3% 10.5% 11.4%
Weighted average initial loan-to-value ratio(1) 76.4% 74.2% 73.1%
SECOND MORTGAGE:
Percentage of total purchases and originations 3.7% 5.9% 9.1%
Weighted average interest rate........ 10.5% 11.1% 11.5%
Weighted average initial loan-to-value ratio(1) 79.3% 75.4% 71.1%
- ---------------
(1) We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio
of a loan secured by a second mortgage by taking the sum of the loan secured
by the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
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The following table shows the geographic distribution of loan purchases and
originations for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
2000 2001 2002
REGION PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE
- ------ ---------- ------------ ---------- ------------ ---------- ------------
(DOLLARS IN MILLIONS)
NY, NJ and PA........ 43.9% $ 409.7 40.0% $ 248.4 43.1% $ 376.1
Midwest.............. 27.7 258.7 34.1 212.2 25.5 222.1
Mid-Atlantic*........ 10.5 97.6 11.8 73.1 13.5 118.2
Southeast............ 9.4 87.5 7.5 46.8 9.5 82.5
New England.......... 7.1 66.6 5.6 34.9 7.3 64.0
West................. 1.4 13.3 1.0 6.3 1.1 9.3
- ------------
* Excluding New York (NY), New Jersey (NJ) and Pennsylvania (PA).
WHOLESALE MARKETING. Throughout our history, we have established and
maintained relationships with brokers (and, prior to July 2000, correspondents)
offering non-conforming mortgage products.
Typically, we initiate contact with a broker through our Business Development
Department, supervised by a senior officer with over ten years of sales and
marketing experience in the industry. We usually hire business development
representatives, or account executives, who have contacts with brokers that
originate non-conforming mortgage loans within their geographic territory. The
account executives are responsible for developing and maintaining our broker
network within their geographic territory by frequently visiting the broker,
communicating our underwriting guidelines, disseminating new product information
and pricing changes, and by demonstrating a continuing commitment to
understanding the needs of the customer. The account executives attend industry
trade shows and inform us about the products and pricing being offered by
competitors and new market entrants. This information assists us in refining our
programs and product offerings in order to remain competitive. Account
executives are compensated with a base salary and commissions based on the
volume of loans originated as a result of their efforts.
APPROVAL PROCESS. Before a broker becomes part of our network, it must go
through an approval process. Once approved, brokers may begin submitting
applications and/or loans to us.
To be approved, a broker must:
o demonstrate that it is properly licensed and registered in the state in
which it seeks to transact business;
o submit to and pass a credit check; and
o sign a standard broker agreement with us that requires brokers to, among
other things:
>> abide by our fair lending policy;
>> follow the National Association of Mortgage Brokers Best Practices
Policies;
>> comply with all state and federal laws; and
>> submit only true and accurate documents and disclosures.
We also perform searches on all new brokers using a third party database that
contains public and nonpublic information on individuals and companies that have
incidents of potential fraud and misrepresentation. In addition, we regularly
review the performance of loans originated through our brokers.
BROKERED LOANS. For the year ended December 31, 2002, our broker network
accounted for $535.0 million, or 61%, of our loan originations, compared to
$345.9 million, or 56%, of our loan originations for the year ended December 31,
2001 and $603.6 million, or 65%, of our loan purchases and originations for the
year ended December 31, 2000. No single broker contributed more than 2.2%, 1.3%
or 2.0% of our total loan production in the years ended December 31, 2002, 2001
and 2000, respectively.
Once approved, a broker may submit loan applications for prospective
borrowers. To process broker submissions, our broker originations channel is
organized by geographic regions and into teams, each consisting of account
executives, account managers and processors, which are generally assigned to
specific brokers. Because we
8
operate in a highly competitive environment where brokers often submit the same
loan application to several prospective lenders simultaneously, we strive to
provide brokers with a rapid and informed response. Account executives analyze
the application and provide the broker with a preliminary approval, subject to
final underwriting approval, or a denial, typically within one business day. The
application is logged into our proprietary originations software program -
called Click & Close - which automatically queues the loan over to an
underwriter from the team covering that geographic area and/or broker. If the
application is approved by our underwriter, a "conditional approval" will be
issued to the broker with a list of specific conditions to be met and additional
documents to be supplied prior to funding the loan. The file is then queued back
to the account manager and processor, who work directly with the submitting
broker to collect the requested information, meet all underwriting conditions
and send out all appropriate documentation and disclosures. In most cases, we
fund loans within 14 to 21 days after preliminary approval of the loan
application. In the case of a denial, we will make all reasonable attempts to
ensure that there is no missing information concerning the borrower or the
application that might change the decision on the loan.
We compensate our account executives, who are the primary relationship
contacts with the brokers, predominantly on a commission basis. We strive to
have our account executives maintain the level of knowledge and experience
integral to our commitment to providing the highest quality service for brokers.
We believe that by maintaining an efficient, trained and experienced staff, we
have addressed four central factors that determine where a broker sends its
business:
o the service and support a lender provides;
o product offerings and pricing;
o the turn-around time, or speed with which a lender closes loans; and
o the lender's knowledge concerning the broker and his business.
RETAIL LOANS. We develop retail loan leads primarily through our automated
telemarketing system and our network of 4 call centers and 7 retail offices
located in eight states. For the year ended December 31, 2002, the retail
channel accounted for $337.2 million, or 39%, of our loan originations, compared
to $275.8 million, or 44%, of our loan originations for the year ended December
31, 2001 and $260.4 million, or 28%, of our loan purchases and originations for
the year ended December 31, 2000. Through our marketing efforts, the retail loan
channel is able to identify, locate and focus on individuals who, based on
historic customer profiles, are likely customers for our products. Our
telemarketing representatives identify interested customers and forward these
potential borrowers to a branch manager through our Click & Close system. The
branch managers, in turn, distribute these leads to mortgage analysts via Click
& Close by queuing the loan to a mortgage analyst's to do list in Click & Close.
The assigned mortgage analyst discusses the applicant's qualifications and
available loan products, negotiates loan terms with the borrower and processes
the loan through completion. Click & Close is utilized to queue the loan to
underwriters at the appropriate times for approvals and help facilitate the loan
application process through closing.
We compensate our mortgage analysts, who are the primary relationship
contacts with our borrowers, predominantly on a commission basis.
CORRESPONDENT LOANS. We discontinued our correspondent operations in July
2000 to focus on our less cash intensive broker and retail channels. As such, we
had no correspondent purchases in 2002 or 2001. For the year ended December 31,
2000, our correspondent network accounted for $69.4 million, or 7%, of our loan
purchases and originations. No single correspondent contributed more than 1.5%
of our total loan production in 2000.
LOAN UNDERWRITING
We maintain written underwriting guidelines that are utilized by all
employees associated with the underwriting process. Throughout our 21 years in
existence, these guidelines have been continually reviewed and updated by senior
underwriters and the head of risk management. We provide our underwriting
guidelines to all of the brokers from whom we accept loan applications. Loan
applications received from brokers are classified according to particular
characteristics including, but not limited to, the applicant's:
o ability to pay;
o credit history (with emphasis on the applicant's existing mortgage
payment history);
o credit score;
o income documentation type;
9
o lien position;
o loan-to-value ratio;
o property type; and
o general stability, in terms of employment history, time in residence,
occupancy and condition and location of the collateral.
We have established classifications with respect to the credit profile of the
applicant, and each loan is placed into one of four letter ratings "A" through
"D," with subratings within those categories. Terms of loans that we make, as
well as maximum loan-to-value ratios and debt-to-income ratios, vary depending
on the classification of the applicant and the borrower's credit score. Loan
applicants with less favorable credit ratings and/or lower credit scores are
generally offered loans with higher interest rates and lower loan-to-value
ratios than applicants with more favorable credit ratings and/or higher credit
scores. The general criteria our underwriting staff uses in classifying loan
applicants are set forth in the following table.
REST OF PAGE INTENTIONALLY LEFT BLANK
10
DELTA FUNDING CORPORATION
UNDERWRITING GUIDELINE MATRIX
- ------------------------------- ----------------------------------------------------------------------------------------------
FIRST MORTGAGE
- ------------------------------- ------------------------------------------------ ---------------------------------------------
OWNER OCCUPIED NON OWNER OCCUPIED
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
CREDIT MIN FULL LIMITED INCOME FULL LIMITED
PROGRAM CREDIT INCOME & NO INCOME INCOME INCOME & NO
~ MAX LOAN AMOUNT SCORE CHECK CHECK AS STATED CHECK INCOME CHECK AS STATED
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
LTV >80%:
LTV >90%: LTV >85%: LTV >80%: 1-4 FAMILY
PROPERTY 1-2 FAMILY 1-2 FAMILY 1-2 FAMILY LTV >85%:
RESTRICTIONS DETACHED DETACHED DETACHED 1-2 FAMILY
& CONDO'S & CONDO'S & CONDO'S DETACHED
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
A+ 675 100% 1st Mtg 95% 1st Mtg 90% 1st Mtg 90% 1st Mtg 75% 1st Mtg 70% 1st Mtg
650 100% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg 70% 1st Mtg
625 95% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg 70% 1st Mtg
~ UP TO $600,000 550 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
525 85% 1st Mtg 80% 1st Mtg NA 80% 1st Mtg 70% 1st Mtg NA
500 80% 1st Mtg 75% 1st Mtg NA 75% 1st Mtg 65% 1st Mtg NA
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
A1 675 100% 1st Mtg 95% 1st Mtg 90% 1st Mtg 90% 1st Mtg 75% 1st Mtg 70% 1st Mtg
650 100% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg 70% 1st Mtg
625 95% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg 70% 1st Mtg
~ UP TO $600,000 550 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
525 85% 1st Mtg 75% 1st Mtg NA 75% 1st Mtg 65% 1st Mtg NA
500 80% 1st Mtg 70% 1st Mtg NA 70% 1st Mtg 60% 1st Mtg NA
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
575 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
A2 550 85% 1st Mtg 80% 1st Mtg 75% 1st Mtg 80% 1st Mtg 70% 1st Mtg 65% 1st Mtg
~ UP TO $500,000 525 80% 1st Mtg 75% 1st Mtg NA 75% 1st Mtg 65% 1st Mtg NA
500 75% 1st Mtg 70% 1st Mtg NA 70% 1st Mtg 60% 1st Mtg NA
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
600 90% 1st Mtg 80% 1st Mtg 75% 1st Mtg 80% 1st Mtg 70% 1st Mtg
B1 575 85% 1st Mtg 80% 1st Mtg 75% 1st Mtg 80% 1st Mtg 70% 1st Mtg
~ UP TO $450,000 550 85% 1st Mtg 75% 1st Mtg 70% 1st Mtg 75% 1st Mtg 65% 1st Mtg
525 80% 1st Mtg NA NA NA NA
500 75% 1st Mtg NA NA NA NA
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
B2 575 85% 1st Mtg 75% 1st Mtg 70% 1st Mtg 75% 1st Mtg
~ UP TO $450,000 550 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg
525 75% 1st Mtg NA NA NA
500 70% 1st Mtg NA NA NA
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
575 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg
C1 550 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
~ UP TO $300,000 525 75% 1st Mtg NA NA
500 70% 1st Mtg NA NA
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
C2 550 75% 1st Mtg
~ UP TO $300,000 525 70% 1st Mtg
500 65% 1st Mtg
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
D1 550 70% 1st Mtg
~ UP TO $250,000 500 65% 1st Mtg
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
***D2 525 65% 1st Mtg
~ UP TO $250,000 500 60% 1st Mtg
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
***D3 550 60% 1st Mtg
~ UP TO $250,000
- -------------------- ---------- ---------------- ---------------- -------------- ---------------- -------------- -------------
BANKRUPTCY
DTI MORTGAGE PAYMENT HISTORY INFORMATION
-------- -------------------------------------------- -----------------------------
**55% EXCELLENT MORTGAGE HISTORY 0x30 on *** MINIMUM 3 YEARS OLD
mortgages within last 12 months. * For Chapter 7 discharge or
extended LTV's with credit score < 575, Chapter 13 filing. Chapter
0x60 months 13 to 24. No foreclosures 13 discharge must be 1 year
last 3 years. old at closing
-------- -------------------------------------------- -----------------------------
**55% EXCELLENT MORTGAGE HISTORY 1x30 on *** MINIMUM 3 YEARS OLD
mortgages within last 12 months. * For Chapter 7 discharge or
extended LTV's with credit score < 575, Chapter 13 filing. Chapter
0x60 months 13 to 24. No foreclosures last 13 discharge must be 1 year
3 years. old at closing
-------- -------------------------------------------- -----------------------------
EXCELLENT MORTGAGE HISTORY 2x30 on *** MINIMUM 2 YEARS OLD
mortgages within last 12 months. * For Chapter 7 discharge or
**55% extended LTV's with credit score < 575, Chapter 13 filing. Chapter
0x90 months 13 to 24. No foreclosures last 13 must be discharged
2 years. before closing.
-------- -------------------------------------------- -----------------------------
**55% GOOD MORTGAGE HISTORY *** MINIMUM 2 YEARS OLD
3x30 on mortgages within last 12 months. Chapter 7 discharge or
No foreclosures last 2 years. If mortgage Chapter 13 filing. Chapter
history(s) for the past 12 months is 0x30, 13 must be discharged
the foreclosure/NOD restriction will be before closing.
lowered to 18 months.
-------- -------------------------------------------- -----------------------------
**55% GOOD MORTGAGE HISTORY *** MINIMUM 18 MONTHS OLD
2x30 & 1x60 or Unlimited 30's, 0x60 on Chapter 7 discharge or
mortgages within last 12 months. No Chapter 13 filing. Open
foreclosures last 18 months. If mortgage Chapter 13 considered.
history(s) for the past 12 months is 0x30, Mortgage must be paid as
the foreclosure/NOD restriction will be agreed since filing.
lowered to 12 months.
-------- -------------------------------------------- -----------------------------
**55% FAIR MORTGAGE HISTORY *** MINIMUM 1 YEAR OLD
0x90 on mortgages within last 12 months. Chapter 7 discharge or
No worse than D-30 at closing. No Chapter 13 filing. No late
foreclosures last 12 months. payments on mortgages since
Chapter 7 or 13 filing.
-------- -------------------------------------------- -----------------------------
**55% FAIR MORTGAGE HISTORY Chapter 7 must be
1x90 on mortgages within last 12 months. discharged by closing. Open
No worse than D-60 at closing. Chapter 13 considered.
-------- -------------------------------------------- -----------------------------
POOR MORTGAGE HISTORY Chapter 7 must be
**55% 1x120 on mortgages within last 12 months. discharged by closing. Open
No worse than D-90 at closing. Chapter 13 considered.
-------- -------------------------------------------- -----------------------------
POOR MORTGAGE HISTORY Chapter 7 must be
**55% No worse than D-119 at closing. Mortgage discharged by closing.
NOT in foreclosure. Open Chapter 13 considered.
-------- -------------------------------------------- -----------------------------
Chapter 7 must be
**55% POOR MORTGAGE HISTORY discharged by closing. Open
Open foreclosures considered case-by-case Chapter 13 considered.
-------- -------------------------------------------- -----------------------------
- - MAXIMUM LOAN AMOUNTS AVAILABLE ARE SUBJECT TO LTV, INCOME CLASSIFICATION AND OCCUPANCY REQUIREMENTS.
NOTE: MINIMUM 2 YEARS EMPLOYMENT HISTORY FOR PROGRAMS A+ THROUGH B2.
NOTE: Minimum MARKET VALUE for: OO FIC, LIC & NIC > 90%, OO As Stated > 85% and NOO FIC > 85% is $80,000.
- ------------------------------------------------------------------------------------------------------------------------------
* Extended LTV's are defined as: OO > 80% and NOO > 75%. For Credit Programs A+ through A2, if Credit Score is < 575,
must obtain 24 month mortgage history.
If mortgage history is not reporting and Credit Score is > = 575, must obtain 12 months mortgage history.
For LTV's > 90%, As Stated > 85%, All NOO's > 85%, months 13-24 must be 0x60 if reporting to credit.
- ------------------------------------------------------------------------------------------------------------------------------
** For LTV's above 80% and/or income under $25K/yr, maximum DTI = 50% for programs A+ through D3.
- ------------------------------------------------------------------------------------------------------------------------------
*** Lower LTV by 5% for programs D2 & D3 in: Connecticut, Idaho, Illinois, Indiana, Iowa, Maine, Massachusetts, New Jersey,
New York, Oklahoma, Vermont & Wisconsin.
- ------------------------------------------------------------------------------------------------------------------------------
**** Chapter 13 involuntary dismissal date follows same guidelines as Chapter 7 discharge.
- ------------------------------------------------------------------------------------------------------------------------------
11
DELTA FUNDING CORPORATION
UNDERWRITING GUIDELINE MATRIX
- -------------------------------------------- ------------------------------------------------------------------------------
SECOND MORTGAGE
- -------------------------------------------- ---------------------------------------------------- -------------------------
OWNER OCCUPIED NON OWNER OCCUPIED
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
CREDIT PROGRAM MIN CREDIT FULL INCOME LIMITED INCOME & NO
~ MAX LOAN AMOUNT SCORE CHECK INCOME CHECK FULL INCOME CHECK
- --------------------------- ---------------- ------------------------------------------------------------------------------
PROPERTY RESTRICTIONS 2ND MORTGAGES NOT AVAILABLE FOR: SCORES < 550, AS STATED LOANS, NPO LOANS,
MIXED USE/MULTI-FAMILY & DOUBLE WIDE MANUFACTURED HOMES OR "UNIQUE
PROPERTIES".
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
A+ 675 #100% 2ND MTG 80% 2nd Mtg 75% 2nd Mtg
650 #100% 2ND MTG 80% 2nd Mtg 75% 2nd Mtg
625 90% 2nd Mtg 80% 2nd Mtg 75% 2nd Mtg
550 85% 2nd Mtg 80% 2nd Mtg 75% 2nd Mtg
~ UP TO $600,000 525 NA NA NA
500 NA NA NA
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
A1 675 #100% 2ND MTG 80% 2nd Mtg 75% 2nd Mtg
650 #100% 2ND MTG 80% 2nd Mtg 75% 2nd Mtg
625 90% 2nd Mtg 80% 2nd Mtg 75% 2nd Mtg
550 85% 2nd Mtg 80% 2nd Mtg 75% 2nd Mtg
~ UP TO $600,000 525 NA NA NA
500 NA NA NA
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
A2 575 85% 2nd Mtg 80% 2nd Mtg 75% 2nd Mtg
550 85% 2nd Mtg 80% 2nd Mtg 75% 2nd Mtg
525 NA NA NA
500 NA NA NA
~ UP TO $500,000
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
600 80% 2nd Mtg 80% 2nd Mtg 70% 2nd Mtg
B1 575 80% 2nd Mtg 80% 2nd Mtg 70% 2nd Mtg
~ UP TO $450,000 550 80% 2nd Mtg 75% 2nd Mtg 70% 2nd Mtg
525 NA NA NA
500 NA NA NA
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
B2 575 80% 2nd Mtg
~ UP TO $450,000 550 80% 2nd Mtg
525 NA
500 NA
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
575 75% 2nd Mtg
C1 550 75% 2nd Mtg
~ UP TO $300,000 525 NA
500 NA
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
C2 550
~ UP TO $300,000 525
500
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
D1 550
~ UP TO $250,000 500
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
***D2 525
~ UP TO $250,000 500
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
***D3 550
~ UP TO $250,000
- --------------------------- ---------------- ------------------------ --------------------------- -------------------------
DTI MORTGAGE PAYMENT HISTORY BANKRUPTCY INFORMATION
---------- --------------------------------------- -----------------------------------
**55% EXCELLENT MORTGAGE HISTORY *** MINIMUM 3 YEARS OLD
0x30 on mortgages within last 12 Chapter 7 discharge or Chapter 13
months. filing.
* For extended LTV's with credit Chapter 13 discharge must be
score < 575, 1 year old at closing
0X60 months 13 to 24.
No foreclosures last 3 years.
---------- --------------------------------------- -----------------------------------
**55% EXCELLENT MORTGAGE HISTORY *** MINIMUM 3 YEARS OLD
1x30 on mortgages within last 12 Chapter 7 discharge or Chapter 13
months. filing.
* For extended LTV's with credit Chapter 13 discharge must be 1
score < 575, year old at closing
0X60 months 13 to 24.
No foreclosures last 3 years.
---------- --------------------------------------- -----------------------------------
**55% EXCELLENT MORTGAGE HISTORY *** MINIMUM 2 YEARS OLD
2x30 on mortgages within last 12 Chapter 7 discharge or Chapter 13
months. filing.
* For extended LTV's with credit Chapter 13 must be discharged
score < 575, before closing.
0X90 months 13 to 24.
No foreclosures last 3 years.
---------- --------------------------------------- -----------------------------------
GOOD MORTGAGE HISTORY *** MINIMUM 2 YEARS OLD
3X30 on mortgages within last 12 Chapter 7 discharge or Chapter 13
months. filing.
No foreclosures last 2 years. Chapter 13 must be discharged
**55% IF MORTGAGE HISTORY(S) FOR THE PAST before closing.
12 MONTHS IS 0X30, THE FORECLOSURE/NOD
RESTRICTION WILL BE LOWERED TO 18
MONTHS.
---------- --------------------------------------- -----------------------------------
**55% GOOD MORTGAGE HISTORY *** MINIMUM 18 MONTHS OLD
2x30 & 1x60 or Unlimited 30's, 0x60 Chapter 7 discharge or Chapter 13
on mortgages within last 12 months. filing.
No foreclosures last 18 months. Open Chapter 13 considered.
IF MORTGAGE HISTORY(S) FOR THE PAST Mortgage must be paid as agreed
12 MONTHS IS 0X30, THE FORECLOSURE/NOD since filing.
RESTRICTION WILL BE LOWERED TO 12 months.
---------- --------------------------------------- -----------------------------------
FAIR MORTGAGE HISTORY *** MINIMUM 1 YEAR OLD
0x90 on mortgages within last 12 Chapter 7 discharge or Chapter 13
**55% months. filing.
No worse than D-30 at closing. No late payments on mortgages
No foreclosures last 12 months. since Chapter 7 or 13 filing.
---------- --------------------------------------- -----------------------------------
**55% FAIR MORTGAGE HISTORY
1x90 on mortgages within last 12 Chapter 7 must be discharged by
months. closing
No worse than D-60 at closing. Open Chapter 13 considered.
---------- --------------------------------------- -----------------------------------
POOR MORTGAGE HISTORY
1x120 on mortgages within last 12 Chapter 7 must be discharged by
**55% months. closing.
No worse than D-90 at closing. Open Chapter 13 considered.
---------- --------------------------------------- -----------------------------------
POOR MORTGAGE HISTORY Chapter 7 must be discharged by
**55% No worse than D-119 at closing. closing.
Mortgage NOT in foreclosure. Open Chapter 13 considered.
---------- --------------------------------------- -----------------------------------
POOR MORTGAGE HISTORY Chapter 7 must be discharged by
**55% Open foreclosures considered closing.
case-by-case Open Chapter 13 considered.
---------- --------------------------------------- -----------------------------------
#100% LTV 2ND MORTGAGE REQUIREMENTS ARE AS FOLLOWS: (SEE GUIDELINES FOR
ADDITIONAL REQUIREMENTS)
[] Minimum 650 middle credit score.
[] FIC only (24 month bank statements not allowed in this program).
[] Min 4 yrs bankruptcy discharge or foreclosure. Consumer Credit Counseling not
allowed in this program.
[] 1 family detached only. No condos.
[] REFINANCES only. No purchase money.
[] Minimum loan amount $40,000 as a stand alone 2nd. As a simultaneous 1st and
2nd, minimum $20,000.
[] Maximum loan amount $250,000.
[] Minimum market value $100,000.
[] 12 month mortgage history required. If 24 months reports to credit, 0x60 in
months 13-24.
- --------------------------------------------------------------------------------
12
We use these categories and characteristics as guidelines only. On a
case-by-case basis, we may determine that the prospective borrower warrants an
exception from the guidelines, if sufficient compensating factors exist.
Examples of compensating factors we consider are:
o low debt ratio;
o long-term stability of employment and/or residence;
o excellent payment history on past mortgages;
o a significant reduction in monthly expenses; or
o low loan-to-value ratio.
The following table sets forth certain information with respect to our
originations and purchases of first and second mortgage loans by borrower
classification, along with weighted average coupons, for the periods shown and
highlights the improved credit quality of our originations and purchases.
(DOLLARS IN THOUSANDS)
PERCENT
YEAR CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
- ---- ---- ---- ------ ----- ------
2002 A $ 752,920 86.3% 9.1% 78.1%
B 57,186 6.6 10.3 70.3
C 42,903 4.9 11.1 66.0
D 19,181 2.2 12.1 55.5
--------- ---- ---- ----
Totals $ 872,190 100.0% 9.4% 76.5%
=========== ====== ==== =====
2001 A $ 478,485 77.0% 10.0% 76.7%
B 59,729 9.6 11.5 68.6
C 61,498 9.9 12.2 66.7
D 22,003 3.5 13.2 57.4
--------- ---- ---- ----
Totals $ 621,715 100.0% 10.5% 74.2%
=========== ====== ===== =====
2000 A $ 596,946 63.9% 10.8% 75.7%
B 164,024 17.6 11.7 70.2
C 127,041 13.6 12.6 67.3
D 45,427 4.9 13.8 56.9
--------- ---- ---- ----
Totals $ 933,438 100.0% 11.4% 72.7%
=========== ====== ===== =====
- ------------------
(1) Weighted Average Coupon ("WAC").
(2) Weighted Average Initial Loan-to-Value Ratio ("WLTV").
The mortgage loans we originate have amortization schedules ranging from 5
years to 30 years, generally bear interest at fixed rates and require equal
monthly payments which are due as of a scheduled day of each month which is
fixed at origination. Substantially all of our mortgage loans are fully
amortizing loans. We primarily originate fixed rate loans, which amortize over a
period not to exceed 30 years. The principal amounts of the loans we originate
generally range from a minimum of $25,000 to a maximum of $600,000 and we will
lend up to 100% of the combined loan-to-value ratio. Our loans are generally
secured by one- to four-family residences, including condominiums and
town-houses, and these properties are usually occupied by the owner. It is our
policy not to accept commercial properties or unimproved land as collateral.
However, we will accept mixed-use properties, such as a property where a portion
of the property is used for residential purposes and the balance is used for
commercial purposes, and will accept small multifamily properties of 5 to 8
units, both at reduced loan-to-value ratios. We do not originate loans where any
senior mortgage contains open-end advance, negative amortization or shared
appreciation provisions - all of which could have the effect of increasing the
amount of the senior mortgage, thereby increasing the combined LTV, and making
the loan more risky for us.
Our mortgage loan program includes:
o a full documentation program;
13
o a limited documentation program;
o a no income verification program for self-employed borrowers; and
o a stated income program.
Our borrowers' total monthly debt obligations - which include principal and
interest on the new loan and all other mortgages, loans, charge accounts and
scheduled indebtedness - generally are 50% or less of the borrower's monthly
gross income, although some of our borrowers will qualify using our maximum
debt-to-income ratio of 55%. For loans to borrowers who are salaried employees,
we require current employment information in addition to employment history. We
verify this information based on one or more of the following items: written
confirmation from employers, recent pay-stubs, recent W-2 tax forms, recent tax
returns, bank statements and telephone confirmation from the employer. For our
limited documentation program, we require either 6 months of bank statements or
a job letter to be submitted which contains substantially the same information
one would find on a standard verification of employment form, including:
o job position;
o length of time on job;
o current salary; and
o the job letter should appear on the employer's letterhead and include
the telephone number and signature of the individual completing the
letter on behalf of the employer.
For our no income verification program, we require proof of self-employment
in the same business for 2 years. We only offer our stated income program, which
represents a very small percentage of our loans, for better credit quality
borrowers where a telephone verification is done by an underwriter to verify
that the borrower is employed. We usually require lower combined loan-to-value
ratios with respect to loans made under programs other than the full
documentation program.
We assess a borrower's credit worthiness primarily based on his or her
mortgage history and credit score, and generally adjust our pricing and loan to
value ratios based on many other risk parameters. Our borrowers often have
either (a) mortgage or other credit delinquencies, (b) problems providing
documentation required by traditional lenders, and/or (c) collateral types that
traditional lenders will not lend against. As such, we employ experienced
non-conforming mortgage loan credit underwriters to review the applicant's
credit profile and to evaluate whether an impaired credit history is a result of
adverse circumstances or a continuing inability or unwillingness to meet credit
obligations in a timely manner. An applicant's credit record will often be
impaired by personal circumstances including divorce, family illnesses or deaths
and temporary job loss due to layoffs and corporate downsizing.
As part of our settlement agreements with New York State regulators - I.E.,
the Remediation Agreement and Stipulated Order on Consent - we agreed to modify
certain aspects of our underwriting guidelines. Even though these agreements
terminated in September 2002, we have not eliminated the underwriting changes we
agreed to and, in fact, intend to continue to originate loans in accordance with
these agreements.
We have a staff of 43 underwriters with an average of 11 years of
non-conforming lending experience. All underwriting functions for broker
originations are centralized in our Woodbury, New York headquarters. All
underwriting functions for retail originations are centralized in our retail
underwriting "hub," located in Cincinnati, Ohio, and our Woodbury, New York
headquarters. We do not delegate underwriting authority to any third party. Our
underwriting department functions independently of our business development and
sales departments and does not report to any individual directly involved in the
sales origination process. None of our underwriters are compensated on an
incentive or commission basis. Our underwriters are trained to review all
components of the loan to determine its compliance with our underwriting
guidelines.
We have instituted underwriting checks and balances that are designed to
ensure that loans are generally reviewed and approved by a minimum of two
underwriters. The Underwriting Department employs underwriters with different
levels of experience and authority and loans generally must receive a secondary
review by an underwriter of equal or higher rank. Although the most senior
underwriters do not require a secondary review in certain circumstances, the
vast majority of our loans are reviewed by at least two underwriters. Similarly,
maximum loan amount and loan-to-value approval authorities are assigned to each
level, ensuring that loans at the highest dollar or LTV-limits we offer are
reviewed and approved only by the Department's most senior members.
We underwrite every loan submitted by not only thoroughly reviewing credit,
but also by performing the following:
14
o a separate appraisal review conducted by our underwriter and/or
appraisal review department; and
o a full compliance review, to ensure that all documents have been
properly prepared, all applicable disclosures given in a timely
fashion, and proper compliance with all federal and state
regulations.
We require appraisals to be performed by third party, fee-based appraisers or
by our approved appraisers and to conform generally to current Fannie Mae and
Freddie Mac secondary market requirements for residential property appraisals.
Each appraisal includes, among other things, an inspection of both the exterior
and interior of the subject property and data from sales within the preceding 12
months of similar properties within the same general location as the subject
property. We perform an appraisal review on each loan prior to closing. We do
not believe that the general quality control practices of many conventional
mortgage lenders, which is to perform only drive-by appraisals after closings,
provides sufficient protection. As such, in addition to reviewing each appraisal
for accuracy, we access alternate sources to validate sales used in the
appraisal to determine market value. These sources include:
o Multiple Listing Services;
o assessment and sales services, such as Comps, Inc., Pace, 1st
American and Transamerica;
o on-line internet services such as Realtor.com; and
o other sources for verification, including broker price opinions and
market analyses by local real estate agents.
We actively track and grade (based upon criteria that we have developed over
time) all appraisers from which we accept appraisals for quality control
purposes and do not accept work from appraisers who have not conformed to our
review standards.
After completing the underwriting and processing of a brokered loan, we
schedule the closing of the loan with an approved closing attorney or settlement
agent. We hold the closing attorney or settlement agent responsible for
completing the loan closing transaction in accordance with applicable law and
our operating procedures. We also require title insurance that insures our
interest as mortgagee and evidence of adequate homeowner's insurance naming us
as an additional insured party on all loans.
We perform a post-funding quality control review to monitor and evaluate our
loan origination policies and procedures. The quality control department is
separate from the underwriting department and reports directly to a member of
senior management.
We subject at least 10% of all loan originations to a full quality control
re-underwriting and review, the results of which are reported to senior
management on a quarterly basis. On a daily basis, should the need arise, the
AVP in charge of QC Underwriting will e-mail senior management any critical loan
findings. The sample of loans reviewed are selected in the following manner:
o All early default payments and customer complaints;
o At least 5% of the loans received are randomly sample; and
o Targets which may be based on sources of business (both internal
branches/teams and external brokers, areas or other third parties)
and products (perceived riskier products and newly offered products).
If any discrepancies are discovered during the review process, a senior
quality control underwriter re-reviews the loan and proceeds with any necessary
follow-up actions. Discrepancies noted by the review are analyzed and corrective
actions are instituted. A typical quality control underwriting review currently
includes:
o obtaining a new verification of value and/or photo for each property;
o re-verifying the credit report;
o reviewing loan applications for completeness, signatures, and for
consistency with other processing documents;
o obtaining new written and/or verbal verification of income and
employment from employer;
o obtaining new written and/or verbal verification of mortgage to
re-verify any outstanding mortgages, if necessary; and
o analyzing the underwriting and program selection decisions.
We update the quality control process from time to time as our policies and
procedures change.
15
CLICK & CLOSE. Click & Close is a proprietary web-based system that we
developed internally to streamline and integrate our origination's process.
Click & Close, or C&C, opens an online channel of communications between us,
brokers, borrowers and a wide range of other mortgage information sources. We
already utilize C&C to automate and facilitate many of our origination
processes, including but not limited to:
o logging in and tracking applications in our retail and wholesale
channels;
o increasing the amount of internal loan origination processes that can
be handled electronically, thereby reducing paper flow between account
managers, loan processors and underwriters and allowing us to become
more paperless;
o generating pre-approvals utilizing our risk-based pricing model;
o generating stipulation sheets, preliminary disclosures and other
documents; and
o easy, real time supervisory oversight to ensure all applications are
being worked on in a timely manner.
We are continuing to work to improve C&C to further streamline our processes
and reduce the paper flow required throughout the mortgage origination process,
with a goal of ultimately lowering our cost to originate.
LOAN SALES
We sell virtually all the loans we originate through one of two outlets: (i)
securitizations, which involve the public offering by a securitization trust of
asset-backed pass-through securities; and (ii) whole loan sales, which include
the sale of pools of individual loans to institutional investors, banks, and
consumer finance-related companies on a servicing released basis. In 2002,
securitizations and whole loan sales comprised approximately 89% and 11%,
respectively, of our loan sales. Going forward, we expect to continue to use a
combination of securitizations and whole loan sales, with the amounts of each
dependent upon the marketplace and our goal of maximizing earnings and
liquidity.
SECURITIZATIONS. During 2002, we completed four securitizations totaling $850
million, of which we delivered a total of $819 million of mortgage loans during
2002 (and delivered the remaining $31 million of mortgage loans in January 2003,
pursuant to a pre-funding mechanism). During 2001, we completed two
securitizations totaling $345 million of mortgage loans. The following table
sets forth certain information with respect to our 2002 securitizations (all of
which contained ratings on various classes of securities ranging from AAA/Aaa to
BBB/Baa2 by S&P, Fitch, and Moody's, respectively) by offering size, which
includes pre-funded amounts, duration weighted average pass-through rate and
type of credit enhancement.
INITIAL DURATION
OFFERING SIZE WEIGHTED AVERAGE CREDIT
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE ENHANCEMENT
--------- --------- ------------ --------------------- -----------
2002-1........... 03/28/02 $175.0 4.08% Hybrid *
2002-2........... 06/27/02 $200.0 2.46% Senior/Sub
2002-3........... 09/27/02 $250.0 2.61% Hybrid *
2002-4........... 12/30/02 $225.0 2.73% Hybrid*
* SENIOR/SUB STRUCTURE WITH A "AAA" RATED MONOLINE INSURER INSURING THE SENIOR
OR "AAA" RATED PASS-THROUGH CERTIFICATES
When we securitize loans, we create trusts 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
16
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 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. (See "-
Management's Discussion & Analysis - Loan Securitizations" beginning on page 26
for a more complete discussion on the "waterfall" and securitizations in
general.)
A summary of the gain on sale and cash flow we received from our aggregate
securitizations in 2002 and 2001 is presented below. "Loans sold" represents the
amount of loans actually transferred to the respective securitization trusts
during each year:
YEAR ENDED DECEMBER 31,
2002 2001
---- ----
GAIN ON SALE SUMMARY (DOLLARS IN THOUSANDS)
- --------------------
Loans Sold $ 819,042 $ 345,000
NIM Proceeds, Net of the Upfront Overcollateralization 5.13% --%
Interest Only Certificate Proceeds........ --% 3.86%
Excess Cashflow Certificate (owner trust certificates)(1) 1.28% 3.21%
Mortgage Servicing Rights(2).............. 0.88% 1.51%
Less: Transaction Costs.................. (0.67%) (0.60%)
----------- ------------
Net gain on sale recorded.............. 6.62% 7.98%
=========== ============
CASH FLOW SUMMARY
- -----------------
NIM Proceeds, Net of the Upfront Overcollateralization 5.13% --%
Interest Only Certificate Proceeds........ --% 3.86%
Mortgage Servicing Rights (2)............. 0.88% 1.51%
Less: Transaction Costs................... (0.67%) (0.60%)
----------- -----------
Net Cash Flow at Closing............ 5.34% 4.77%
=========== ===========
- ----------
(1)The reduction in value of the excess cashflow certificates in 2002 compared
to 2001 is primarily due to changes we made to our fair value assumptions of
our excess cashflow certificates (see "- Excess Cashflow Certificate, Net").
(2)In 2001, the mortgage servicer purchased the P Certificate; in 2002, we
transferred the P Certificate to the NIM Trust, which accounts for the
reduced gain from the sale of mortgage servicing rights in 2002.
At the time we completed the 2002 securitizations, we recognized as revenue
each the economic interests listed above, which was recorded as net gain on sale
of mortgage loans on our consolidated statement of operations.
WHOLE LOAN SALES WITHOUT RECOURSE. We have found that, at times, we can
receive better economic results by selling certain mortgage loans on a whole
loan, without retaining servicing rights, generally in private transactions to
financial institutions or consumer finance companies. We recognize a gain or
loss when we sell loans on a whole loan basis equal to the difference between
the cash proceeds received for the loans and our investment in the loans,
including any unamortized loan origination fees and costs. We generally sell
these loans without recourse, except that we provide normal representations and
warranties to the purchasers of such loans.
In 2002 and 2001, we sold whole loans without recourse on a
servicing-released basis of $102.9 million and $261.1 million, respectively.
LOAN SERVICING
17
Prior to May 2001, we serviced substantially all of the loans that we
originated and purchased since our inception in 1982.
In January 2001, we announced that we had entered into an agreement with
Ocwen to transfer our servicing portfolio to Ocwen. In May 2001, we physically
transferred our entire servicing portfolio to Ocwen, and laid-off our servicing
staff. We no longer service loans nor do we have a servicing operation. We do,
however, maintain several employees to assist third parties with delinquent and
defaulted loans, as well as portfolio retention.
COMPETITION
As an originator of mortgage loans, we face intense competition, primarily
from diversified consumer financial companies and other diversified financial
institutions, mortgage banking companies, commercial banks, credit unions,
savings and loans, credit card issuers and finance companies. Many of these
competitors in the financial services business are substantially larger and have
more capital and other resources than we do. Competition can take many forms,
including interest rates and costs of the loan, convenience in obtaining a loan,
service, marketing and distribution channels. Furthermore, the level of gains
realized by us and our competitors on the sale of the type of loans originated
has attracted additional competitors into this market with the effect of
lowering the gains that may be realized by us on future loan sales. In addition,
efficiencies in the asset-backed market have generally created a desire for even
larger transactions giving companies with greater volumes of originations a
competitive advantage.
Competition may be affected by fluctuations in interest rates and general
economic conditions. During periods of rising rates, competitors which have
"locked in" low borrowing costs may have a competitive advantage. During periods
of declining rates, competitors may solicit borrowers underlying our excess
cashflow certificates to refinance their loans. During economic slowdowns or
recessions, these borrowers may have new financial difficulties and may be
receptive to offers by our competitors.
Over the past several years, many of the independent mortgage banking
companies, which previously were among our most intense competitors, have either
gone out of business or been acquired by larger, more diversified national
financial institutions. At the same time, many larger finance companies,
financial institutions and conforming mortgage originators have adapted their
conforming origination programs and allocated resources to the origination of
non-conforming loans and/or have otherwise begun to offer products similar to
those offered by us, targeting customers similar to those we do. Fannie Mae and
Freddie Mac also have expressed interest in adapting their programs to include
products similar to those offered by us and have begun to expand their programs
and presence into the non-conforming market. The entrance of these larger and
better-capitalized competitors into our market may have a material adverse
effect on our results of operations and financial condition.
REGULATION
Our business is subject to extensive regulation, supervision and licensing by
federal, state and local governmental authorities and is subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on part or all of our operations. Our consumer lending activities are subject
to, among other laws and regulations:
o the Federal Truth-in-Lending Act and Regulation Z (including the Home
Ownership and Equity Protection Act of 1994);
o the Equal Credit Opportunity Act of 1974, as amended (ECOA);
o the Fair Credit Reporting Act of 1970, as amended;
o the Real Estate Settlement Procedures Act (RESPA), and Regulation X;
o the Home Mortgage Disclosure Act;
o the Federal Debt Collection Practices Act; and
o other federal, state and local statutes and regulations affecting our
activities.
We also are subject to the rules and regulations of, and examinations by the
Department of Housing and Urban Development ("HUD") and state regulatory
authorities with respect to originating, processing and underwriting loans (and
servicing loans prior to May 2001). These rules and regulations, among other
things:
18
o impose licensing obligations on us;
o establish eligibility criteria for mortgage loans;
o prohibit discrimination;
o provide for inspections and appraisals of properties;
o require credit reports on loan applicants;
o regulate assessment, collection, foreclosure and claims handling,
investment and interest payments on escrow balances and payment
features;
o mandate certain disclosures and notices to borrowers; and
o in some cases, fix maximum interest rates, fees and mortgage loan
amounts.
Failure to comply with these requirements can lead to, among other things,
loss of approved status, demands for indemnification or mortgage loans
repurchases, certain rights of rescission for mortgage loans, class action and
other lawsuits, and administrative enforcement actions.
Several states and local municipalities have recently enacted so-called "high
cost" mortgage laws and/or regulations. While many of these laws and regulations
contain some provisions that are similar to one another, there are a variety of
provisions that vary from state to state and municipality to municipality, which
has significantly increased the costs of compliance. In addition, dozens of
other state and local laws and regulations are currently under consideration,
with even more likely to be proposed on the horizon, that are intended to
further regulate our industry. Many of these laws and regulations seek to impose
broad restrictions on certain commonly accepted lending practices, including
some of our practices. There can be no assurance that these proposed laws, rules
and regulations, or other similar laws, rules or regulations, will not be
adopted in the future. Adoption of these laws, rules and regulations could have
a material adverse impact on our business by:
o substantially increasing the costs of compliance with a variety of
potentially inconsistent federal, state and local laws;
o substantially increasing the risk of litigation or administrative
action associated with complying with these proposed federal, state and
local laws, particularly those aspects of such proposed laws that
contain subjective (as opposed to objective) requirements, among other
things;
o restricting our ability to charge rates and fees adequate to compensate
us for the risk associated with certain loans; or
o if the law, rule or regulation is too onerous, potentially limiting our
ability or willingness to operate in a particular geographic area.
There are also several potential federal bills being proposed, at least one
of which may provide for federal preemption over these myriad existing and
proposed state and local laws and regulations. There can be no assurance that
any federal law will be passed addressing this matter, or that, if passed, it
will contain a provision that preempts these myriad state and local laws and
regulations.
In September 1999, we settled allegations by the NYSBD and a lawsuit by the
New York State Office of the Attorney General (the "NYOAG") alleging that we had
violated various state and federal lending laws. The global settlement was
evidenced by (a) a Remediation Agreement by and between Delta Funding and the
NYSBD, dated as of September 17, 1999 and (b) a Stipulated Order on Consent by
and among Delta Funding, Delta Financial and the NYOAG, dated as of September
17, 1999. As part of the Settlement, we, among other things, implemented agreed
upon changes to our lending practices; are providing reduced loan payments
aggregating $7.25 million to certain borrowers identified by the NYSBD; and have
created a fund managed by the NYSBD and financed by the grant of 525,000 shares
of Delta Financial's common stock.
Each month, on behalf of borrowers designated by the NYSBD, we make subsidy
payments to the related securitization trusts. These subsidy payments fund the
differential between the original loan payments and the reduced loan payments.
As part of the Second Exchange Offer we completed in August 2001 (see Note 2
"Summary of Regulatory Settlement" and Note 3 "Corporate Restructuring, Debt
Modification and Debt Restructuring" to Notes to the Consolidated Financial
Statements), the LLC - an unaffiliated, newly-formed entity, the voting
membership interests of which are owned by former holders of our notes - is
obligated to satisfy these
19
payment subsidies out of the cash flows generated by the mortgage related
securities (primarily from the excess cashflow certificates) it owns. If the
LLC's cash flows are insufficient to pay this obligation, we remain responsible
to satisfy our obligations under the Remediation Agreement.
The proceeds of the stock fund will be used to pay borrowers and to finance a
variety of consumer educational and counseling programs. We do not manage the
fund created for this purpose. The number of shares of common stock deposited in
the fund does not adjust to account for fluctuations in the market price of our
common stock. Changes to the market price of these shares of common stock
deposited in the fund do not have any impact on our financial statements. We did
not make any additional financial commitments between the settlement date and
March 2000. The Stipulated Order on Consent and the Remediation Agreement both
terminated by their respective terms, in September 2002. We remain obligated as
discussed above to continue to make subsidy payments on behalf of borrowers
identified by the NYSBD for so long as such borrowers continue to make payments
under the mortgage loans.
We believe we are in compliance in all material respects with applicable
federal and state laws and regulations.
ENVIRONMENTAL MATTERS
To date, we have not been required to perform any investigation or clean up
activities, nor have we been subject to any environmental claims. There can be
no assurance, however, that this will remain the case in the future. Although we
primarily lend to owners of residential properties, in the course of our
business, we may acquire properties securing loans that are in default. There is
a risk that we could be required to investigate and clean-up hazardous or toxic
substances or chemical releases at such properties, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
EMPLOYEES
As of December 31, 2002, we had a total of 693 employees (full-time and
part-time). None of our employees are covered by a collective bargaining
agreement. We consider our relations with our employees to be good.
ITEM 2. PROPERTIES
Our executive and administrative offices are located at 1000 Woodbury Road,
Woodbury, New York 11797, where we lease approximately 107,000 square feet of
office space at an aggregate annual rent of approximately $2.0 million. The
lease provides for certain scheduled rent increases and expires in 2008.
We also maintain business development offices in New Jersey, Ohio,
Pennsylvania and Virginia. Our retail operation currently maintains four retail
call centers in Woodbury, New York, Pittsburgh, Pennsylvania, Charlotte, North
Carolina and Phoenix, Arizona, and seven retail mortgage origination offices in
Illinois, Missouri, Ohio (3), Pennsylvania and Tennessee. We also maintain one
telemarketing hub and one underwriting hub in Ohio. The terms of these leases
vary as to duration and escalation provisions, with the latest expiring in 2008.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of our business involves the collection of numerous
accounts, the validity of liens and compliance with various state and federal
lending laws, we are subject, in the normal course of business, to numerous
claims and legal proceedings. Our lending practices have been the subject of
several lawsuits styled as class actions and of investigations by various
regulatory agencies including the NYSBD, the NYOAG and the United States
Department of Justice (the "DOJ"). The current status of these actions is
summarized below.
o In or about November 1998, we received notice that we had been named in
a lawsuit filed in the United States District Court for the Eastern
District of New York. In December 1998, plaintiffs filed an amended
complaint alleging that we had violated the Home Ownership and Equity
Protection Act ("HOEPA"), the Truth in Lending Act ("TILA") and New
York State General Business Lawss.349. The complaint seeks (a)
certification of a class of plaintiffs, (b) declaratory judgment
permitting rescission, (c) unspecified actual, statutory, treble and
punitive damages (including attorneys' fees), (d) certain injunctive
relief, and (e)
20
declaratory judgment declaring the loan transactions as void and
unconscionable. On December 7, 1998, plaintiff filed a motion seeking a
temporary restraining order and preliminary injunction, enjoining us
from conducting foreclosure sales on 11 properties. The District Court
Judge ruled that in order to consider such a motion, plaintiff must
move to intervene on behalf of these 11 borrowers. Thereafter,
plaintiff moved to intervene on behalf of 3 of these 11 borrowers and
sought injunctive relief on their behalf. We opposed the motions. On
December 14, 1998, the District Court Judge granted the motion to
intervene and on December 23, 1998, the District Court Judge issued a
preliminary injunction that enjoined us from proceeding with the
foreclosure sales of the three intervenors' properties. We filed a
motion for reconsideration of the December 23, 1998 order. In January
1999, we filed an answer to plaintiffs' first amended complaint. In
July 1999, plaintiffs were granted leave, on consent, to file a second
amended complaint. In August 1999, plaintiffs filed a second amended
complaint that, among other things, added additional parties but
contained the same causes of action alleged in the first amended
complaint. In September 1999, we filed a motion to dismiss the
complaint, which was opposed by plaintiffs and, in June 2000, was
denied in part and granted in part by the Court. In or about October
1999, plaintiffs filed a motion seeking an order preventing us, our
attorneys and/or the NYSBD from issuing notices to certain of our
borrowers, in accordance with a settlement agreement entered into by
and between Delta and the NYSBD. In or about October 1999 and November
1999, respectively, we and the NYSBD submitted opposition to
plaintiffs' motion. In March 2000, the Court issued an order that
permitted us to issue an approved form of the notice. In September
1999, plaintiffs filed a motion for class certification, which we
opposed in February 2000, and was ultimately withdrawn without
prejudice by plaintiffs in January 2001. In February 2002, we executed
a settlement agreement with plaintiffs, pursuant to which we denied all
wrongdoing, but agreed to resolve the litigation on a class-wide basis.
The Court preliminarily approved the settlement and a fairness hearing
was held in May 2002. We are awaiting a decision from the Court on the
fairness hearing. We believe that the Court will approve the
settlement, but if it does not, we believe that we have meritorious
defenses and intend to defend this suit, but cannot estimate with any
certainty our ultimate legal or financial liability, if any, with
respect to the alleged claims.
o In or about March 1999, we received notice that we had been named in a
lawsuit filed in the Supreme Court of the State of New York, New York
County, alleging that we had improperly charged certain borrowers
processing fees. The complaint seeks (a) certification of a class of
plaintiffs, (b) an accounting, and (c) unspecified compensatory and
punitive damages (including attorneys' fees), based upon alleged (i)
unjust enrichment, (ii) fraud, and (iii) deceptive trade practices. In
April 1999, we filed an answer to the complaint. In September 1999, we
filed a motion to dismiss the complaint, which was opposed by
plaintiffs, and in February 2000, the Court denied the motion to
dismiss. In April 1999, we filed a motion to change venue and
plaintiffs opposed the motion. In July 1999, the Court denied the
motion to change venue. We appealed and in March 2000, the Appellate
Court granted our appeal to change venue from New York County to Nassau
County. In August 1999, plaintiffs filed a motion for class
certification, which we opposed in July 2000. In or about September
2000, the Court granted plaintiffs' motion for class certification,
from which we appealed. The Appellate Court denied our appeal in
December 2001. 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 appealed that decision, but the appellate court denied
our appeal in November 2002. We filed a motion to reargue in December
2002, which was denied by the Court in January 2003. Discovery will now
continue in the lower court. 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 November 1999, we received notice that we had been named in a
lawsuit filed in the United States District Court for the Eastern
District of New York, seeking certification as a class action and
alleging violations of the federal securities laws in connection with
our initial public offering in 1996 and our reports subsequently filed
with the Securities and Exchange Commission. The complaint alleges that
the scope of the violations alleged in the consumer lawsuits and
regulatory actions brought in or around 1999 indicate a pervasive
pattern of action and risk that should have been more thoroughly
disclosed to investors in our common stock. In May 2000, the Court
consolidated this case and several other lawsuits that purportedly
contain the same or similar allegations against us and in August 2000
plaintiffs filed their Consolidated Amended Complaint. In October 2000,
we filed a motion to dismiss the Complaint in its entirety, which was
opposed by plaintiffs in November 2000, and denied by the Court in
September 2001. We reached an agreement in principal with plaintiffs'
counsel and our insurer to settle the action on a class-
21
wide basis in or about August 2002 and executed a settlement agreement
in January 2003 (pursuant to which we denied all wrongdoing). The
settlement has been preliminarily approved by the Court and a fairness
hearing has been scheduled for April 2003, 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 held in the upcoming
months, at which point 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock trades on the Over-The-Counter Bulletin Board ("OTCBB")
under the symbol "DLTO". The following table sets forth for the periods
indicated the range of the high and low closing sales prices for our common
stock.
2002 HIGH LOW
---- ---- ----
First Quarter ......................... $ 1.54 $ 0.85
Second Quarter ........................ 2.76 0.91
Third Quarter.......................... 2.74 1.65
Fourth Quarter ........................ 1.50 0.95
2001 HIGH LOW
---- ---- ----
First Quarter ......................... $ 0.63 $ 0.36
Second Quarter ........................ 0.43 0.24
Third Quarter.......................... 0.51 0.28
Fourth Quarter ........................ 1.06 0.38
Our common stock previously was listed on the New York Stock Exchange (the
"NYSE") under the symbol "DFC", but in May 2001, the NYSE de-listed our common
stock. The NYSE stated that it took this action because we were unable to meet
the NYSE's continued listing standards of maintaining a minimum of $15 million
in market capitalization and a minimum share price of $1 over a 30-day trading
period. When our common stock was de-listed in May 2001, it began trading on the
OTCBB under the ticker symbol "DLTO".
On December 31, 2002, we had approximately 76 stockholders of record. This
number does not include beneficial owners holding shares through nominee or
"street" names. We believe the number of beneficial stockholders is
approximately 1,200.
DIVIDEND POLICY
We did not pay any dividends in 2002 and, in accordance with our present
general policy, we have no present intention to pay cash dividends on our common
stock. Under the terms of our Certificate of Designations for our newly-issued
preferred stock, we are obligated to commence paying dividends to holders of our
Series A preferred stock in July 2003, and are limited in our ability to pay
dividends to holders of our common stock.
23
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Income Statement Data: (DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
Revenues:
Net gain on sale of mortgage loans............ $ 58,805 38,638 52,590 90,588 131,101
Interest....................................... 11,691 (22,146) 32,287 31,041 12,458
Servicing fees................................. -- 2,983 14,191 16,341 10,464
Net origination fees and other income.......... 15,647 13,673 20,376 17,401 (13,589)
--------------------------------------------------------------
Total revenues............................ 86,143 33,148 119,444 155,371 140,434
--------------------------------------------------------------
Expenses
Payroll and related costs ..................... 41,306 42,896 56,525 65,116 56,709
Interest....................................... 5,273 16,132 30,386 26,656 30,019
General and administrative 23,696 49,101 45,539 55,870 35,210
Capitalized mortgage servicing impairment ..... -- -- 38,237 -- --
Restructuring and other special charges........ -- 2,678 11,382 -- --
Extinguishment of debt......................... -- 19,255 -- -- --
---------------------------------------------------------------
Total expenses........................... 70,275 130,062 182,069 147,642 121,938
---------------------------------------------------------------
Income (loss) before income tax expense (benefit) 15,868 (96,914) (62,625) 7,729 18,496
Provision for income tax expense (benefit) ........ (1,769) 2,876 (13,208) 3,053 7,168
---------------------------------------------------------------
Net income (loss)............................... $ 17,637 (99,790) (49,417) 4,676 11,328
---------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income (loss) per share.......................... $ 1.11 (6.28) (3.11) 0.30 0.74
DILUTED EARNINGS PER SHARE(1):
Net income (loss) per share.......................... $ 1.04 (6.28) (3.11) 0.30 0.74
Basic weighted average number of
shares outstanding....................... 15,894,913 15,883,749 15,883,749 15,511,214 15,382,161
Diluted weighted average number of
shares outstanding....................... 16,971,028 15,883,749 15,883,749 15,512,457 15,404,880
Selected Balance Sheet Data:
Loans held for sale, net........................... $ 33,984 94,407 82,698 89,036 87,170
Capitalized mortgage servicing rights.............. -- -- -- 45,927 33,490
Excess cashflow certificates, net.................. 24,565 16,765 216,907 224,659 203,803
Total assets....................................... 73,544 133,806 452,697 556,835 481,907
Senior notes, warehouse financing and
other borrowings............................... 27,196 100,472 238,203 258,493 229,660
Investor payable................................... -- -- 69,489 82,204 63,790
Total liabilities.................................. 44,047 121,956 354,973 409,694 344,219
Stockholders' equity............................... $ 29,497 11,850 97,724 147,141 137,688
(1) For 2001 and 2000, stock options of approximately 23,000 and 37,000,
respectively are excluded from the calculation of diluted EPS because their
effect is antidiluted in periods where losses are reported.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SET FORTH THEREIN.
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 "Loan Securitizations").
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 each of our securitizations in 2002,
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 the majority 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 affect 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.
GENERAL
As discussed in more detail in the "Business Overview" in Part I, beginning
on page 1, Delta Financial Corporation ("Delta" or "we"), through its
wholly-owned subsidiaries, originates, securitizes and sells (and, prior to May
2001, serviced) non-conforming home equity loans, which are primarily secured by
first mortgages on one- to four-family residential properties. Throughout our 21
years of operating history, we have focused on lending to individuals who
generally have impaired or limited credit profiles or higher debt-to-income
ratios for such purposes as debt consolidation, home improvement, mortgage
refinancing or education. These borrowers generally do not satisfy the credit,
documentation or other underwriting standards set by more traditional sources of
mortgage credit, including those that make loans in compliance with conventional
mortgage lending guidelines established by Fannie Mae and Freddie Mac.
Our mortgage business has two principal components. First, we make mortgage
loans to individual borrowers, which is a cash and expense outlay for us,
because our cost to originate a loan exceeds the fees we collect at the time we
originate that loan. At the time we originate a loan, and prior to the time we
sell that loan, we finance that loan by borrowing under 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 we receive
as revenues. We use the proceeds from these sales to repay our warehouse lines
of credit and for working capital.
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CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING. As
discussed in more detail in "Corporate Restructuring, Debt Modification and Debt
Restructuring" in Part I, beginning on page 3, 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 our transfer of servicing to Ocwen, which
freed us from the significant cash drain associated with making
securitization advances (and the capital costs associated with making
such advances), and of servicing a highly seasoned portfolio following
three successive quarters of selling the securitization servicing
rights associated with newly originated mortgage loans.
o In August 2001, we completed our Second Exchange Offer, which
extinguished substantially all of our long-term debt, leaving
approximately $11 million out of $150 million of our notes still
outstanding and resulted in us recording a $19.3 million charge to our
statement of operations. This debt extinguishment helped us threefold.
First, it eliminated nearly $139 million of principal which we
otherwise would have had to repay in 2004. Second, it eliminated more
than $14 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 effort to restructure our operations and
reduce our negative cash flow previously associated with our servicing
operations and the notes.
LOAN SECURITIZATIONS
When we securitize loans, we create trusts 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 entitle 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 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;
26
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 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., credit 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 1.25% 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.
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 where we sell the excess cashflow certificate
and P certificate (which entitles the holder to all prepayment penalties
collected by the securitization trust) 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 P certificate), and (2) NIM owner trust
certificate evidencing ownership in the NIM trust. We sell the excess cashflow
certificate and P 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.
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 certificate
and P certificate to be used to pay all principal and interest on the NIM
note(s) until paid in full. This typically occurs 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
27
subordinate interest in the NIM owner trust, represented by the owner trust
certificate. The owner trust certificate entitles us to all cash flows generated
by the excess cashflow certificate 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 on our balance sheet as an excess cashflow certificate and value the
NIM 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 1.5% 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 each of the four 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. 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, (3) the London Inter-Bank
Offered Rate ("LIBOR") forward curve (using current LIBOR as the floor
rate) and (4) a discount rate; and
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.
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.
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.
Each securitization trust has the benefit of either a financial guaranty
insurance policy from a monoline insurance company or a senior-subordinated
securitization structure, which insures the timely payment of interest
28
and the ultimate payment of principal of the credit-enhanced investor
certificate, or both (known as a "hybrid"). In "senior-subordinated" structures,
the senior certificate holders are protected from losses by subordinated
certificates, which absorb any such losses first. In addition to such credit
enhancement, the excess cash flows that would otherwise be paid to the holder of
the excess cashflow certificate is used when if it subsequently becomes
necessary to obtain or maintain required overcollateralization limits.
Overcollateralization, which is created when the amount of collateral (I.E.,
mortgage loans) owned by a securitization trust exceeds the aggregate amount of
senior pass-through certificates, is used to absorb losses prior to making a
claim on the financial guaranty insurance policy or the subordinated
certificates.
EXCESS CASHFLOW CERTIFICATES, NET
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 the fourth 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 affect 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, changes
in the LIBOR rate, 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.
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 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;
29
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) are 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:
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 the
borrower 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;
o the borrower's need for additional monies; and
o a default by the borrower, resulting in foreclosure by the lender.
30
It is unusual for a borrower to prepay a mortgage loan during the first
few months because of the following:
o it typically takes at least several months after the mortgage loans
are originated for any of the above events to occur;
o there are costs involved with refinancing a loan; and
o the borrower does not want to incur prepayment penalties.
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 AT SEPTEMBER 30, 2001 AT 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%
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 December 31, 2002 and December 31, 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 cash flow than expected in the
future; conversely, if defaults are lower than we expected, we will
receive more income and more excess cash flow 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 then a 6
month variable rate of interest thereafter using the 6 month LIBOR
index). A significant portion of our loans are fixed rate mortgages and
a significant amount of these fixed rate loans are backed by floating
rate securities (I.E., 1 month LIBOR). As such, our excess cashflow
certificates are subject to significant basis risk and a change in LIBOR
will, therefore, impact our excess spread. If LIBOR is lower than
anticipated we will receive more income and more excess cash flows than
expected in the future; conversely, if LIBOR is higher than expected, we
will receive less income and less excess cash flows 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.
31
We utilized a discount rate of 15% at December 31, 2002 and December 31,
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 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 cash flows that are to be received by the
excess cashflow certificate after the release or "step-down" of the
overcollateralization account.
The following table summarizes the excess cashflow activity for the year
ended December 31, 2002 and 2001:
(DOLLARS IN THOUSANDS) 2002 2001 2000
- ------------------------------------------------------------------------------------------
Balance, beginning of year $ 16,765 216,907 224,659
New excess cashflow certificates 10,499 11,081 32,716
New NIM certificates -- -- 73,658
Cash received from excess cashflow certificates (2,588) (9,990) (28,444)
Net accretion of excess cashflow certificates 1,974 11,935 35,224
Fair value adjustments (2,085) (19,676) (6,324)
Sales -- (40,402) (2,131)
NIM certificate sales -- -- (112,451)
Second Exchange Offer -- (153,090) --
- ------------------------------------------------------------------------------------------
Balance, end of year $ 24,565 16,765 216,907
- ------------------------------------------------------------------------------------------
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.
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. 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.
32
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 December 31, 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 December 31, 2002, we have a gross deferred tax asset of $47.9 million
(assuming a 40% effective tax rate) and a valuation allowance of $42.3 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 in accordance with GAAP.
Since then, we have now posted five consecutive quarters of profitability. If we
are able to continue to record positive earnings over the next several quarters
and demonstrate a reliable future earnings stream, we expect to:
o utilize a larger amount of the gross deferred tax asset to offset the
tax that would otherwise be recorded on the majority of such earnings;
and
o potentially reduce the amount of, and/or eliminate, the valuation
allowance in accordance with GAAP (upon any reduction or elimination of
the valuation allowance net earnings and retained earnings will
increase; however, in subsequent quarters net earnings and retained
earnings will be reduced by the amount of the tax provision).
As of December 31, 2002, federal and state NOL carryforwards totaled
approximately $77.2 million, with $3.9 million expiring in 2020, and $73.3
million expiring in 2021.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002, COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
GENERAL
We recorded net income for the year ended December 31, 2002 of $17.6 million,
or $1.11 per share basic and $1.04 per share diluted, compared to a net loss of
$99.8 million, or $6.28 per share basic and diluted, for the year ended December
31, 2001. Our net income for 2002 included a special tax benefit of $2.2
million, or $0.14 per share basic and $0.13 diluted, which primarily relates to
our obtaining favorable resolutions to tax issues for which we had previously
reserved.
The majority of the net loss related to (1) a $25.4 million write down of
excess cashflow certificates relating to a sale agreement we entered into in
2001; (2) a charge (loss) to interest income of $19.7 million reflecting a fair
value adjustment to our excess cashflow certificates; (3) a charge of $19.3
million related to the extinguishment of debt; (4) a charge of $10.7 million
relating to our disposition and transfer to Ocwen of our servicing platform in
May 2001; (5) a charge of $3.6 million relating to a change in accounting
estimates regarding the life expectancy of our computer-related equipment; (6) a
charge of $1.4 million relating to professional fees incurred in connection with
the Second Exchange Offer; and (7) a charge of $1.5 million for establishing a
reserve for non-performing mortgage loans that were ultimately sold.
REVENUES
Total revenues increased $53.0 million, or 160%, to $86.1 million for the
year ended December 31, 2002, from $33.1 million for the year ended December 31,
2001. The increase in revenues was primarily the result of two charges we
incurred in 2001 that significantly reduced revenues in that year. First, 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. Second, 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 in 2002 was also
attributable to higher net gain on sale due to us completing securitizations,
net of pre-funding, of $819.0 million
33
in 2002, compared to $345.0 million in 2001. The increase in revenue was
partially offset by (1) a decrease in interest income from our retained excess
cashflow certificates, as we transferred the majority of these certificates in
connection with our Second Exchange Offer in 2001 and (2) our 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 $872.2 million of mortgage loans for the year ended December
31, 2002, representing a 40% increase from $621.7 million of mortgage loans
originated for the year ended December 31, 2001. We securitized, net of
pre-funding, $819.0 million of loans during the year ended December 31, 2002,
representing a 137% increase from the $345.0 million of loans we securitized
during 2001. Our whole loan sales amounted to $103.0 million during the year
ended December 31, 2002, representing a 61% decrease from the $261.1 million of
whole loans sold for the year ended December 31, 2001.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans is
represented by the following:
(1) the sum of:
(a) the cash purchase price we receive in connection with selling one of
the following securities in connection with our securitization(s)
for a particular period: (i) a NIM note, net of
overcollateralization amount and interest rate cap or (ii) an
interest-only certificate;
(b) the fair value of the non-cash excess cashflow certificates we
retain in a securitization for each period;
(c) the cash premium received from selling mortgage servicing rights in
connection with each securitization; and
(d) the cash premium 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 $20.2 million, or 52%, to $58.8
million for the year ended December 31, 2002, from $38.6 million for the year
ended December 31, 2001. This increase was primarily due to (a) higher loan
production resulting in a greater amount of loans securitized and sold on a
whole loan basis in 2002 as compared to 2001, (b) our 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 and (c) our selling approximately $60 million
of mortgage loans we had held in inventory at December 31, 2001 in addition to
the mortgage loans we originated during 2002. We securitized, net of
pre-funding, $819.0 million in 2002 and sold $103.0 million of mortgage loans on
a servicing-released basis in 2002, compared to $345.0 million of loans
securitized and $261.1 million of mortgage loans sold in 2001.
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) cash 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 $33.8 million, or 153%, to $11.7 million for the
year ended December 31, 2002, from $(22.1) million for the year ended December
31, 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 higher average loan balance (and, consequently, more interest
earned on loans held for sale) in 2002 compared to 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
34
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 2002 as a result of us
transferring our entire servicing portfolio to Ocwen in May of 2001. In 2001,
servicing fees totaled $3.0 million.
NET ORIGINATION FEES AND OTHER INCOME. Origination fees represent (1) fees
earned on broker and retail originated loans, (2) premiums paid to originate
mortgage loans, (3) distributions from Delta Funding Residual Exchange Company,
LLC (the "LLC"), and (4) other miscellaneous income, if any.
Net origination fees and other income increased $1.9 million, or 14%, to
$15.6 million for the year ended December 31, 2002, from $13.7 million for the
year ended December 31, 2001. The increase in the net origination fees and other
income during the twelve months ended December 31, 2002 is primarily due to us
starting to receive distributions from the LLC (an unaffiliated entity to us) in
the first quarter of 2002. In addition, our retail origination fees increased
during the period due to higher production.
EXPENSES
Total expenses decreased by $40.5 million, or 37%, to $70.3 million for the
year ended December 31, 2002, from $110.8 million for the year ended December
31, 2001. The decrease in revenues primarily resulted from expenses we incurred
in 2001 that did not recur in 2002, including 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, (4) a charge for reserves primarily against
a pool of non-performing loans, which we ultimately sold in July 2001, and (5) a
charge related to professional fees incurred with the second exchange offer. The
decrease also resulted from (a) a significantly lower interest expense in 2002
resulting from (1) our extinguishing approximately $139.2 million of Notes in
the Second Exchange Offer (see "-Corporate Restructuring, Debt Modification and
Debt Restructuring"), and (2) lower warehouse financing costs due to lower
borrowing costs during 2002, as well as (b) a special tax benefit in 2002
related to a favorable resolution to tax issues for which we had previously
reserved and do not expect to recur.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees.
Payroll and related costs decreased by $1.6 million, or 4%, to $41.3 million
for the year ended December 31, 2002, from $42.9 million for the year ended
December 31, 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 includes the borrowing cost under our
warehouse credit facility to finance loan originations, equipment financing and
the notes.
Interest expense decreased by $10.8 million, or 67%, to $5.3 million for the
year ended December 31, 2002 from $16.1 million for the year ended December 31,
2001. The decrease was primarily attributable to (i) our extinguishing $139.2
million of Senior notes in August 2001 and the corresponding interest related
thereto, and (ii) lower warehouse financing costs due to lower borrowing costs.
The average one-month LIBOR rate, which is the benchmark used to determine our
cost of borrowed funds, decreased on average to 1.8% for the year ended December
31, 2002, compared to an average of 3.9% for the year ended December 31, 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 $25.4 million, or 52%, to $23.7
million for the year ended December 31, 2002, from $49.1 million for the year
ended December 31, 2001. The year ended December 31, 2001 included expenses
primarily associated with (1) our disposition and transfer of our servicing
portfolio in May 2001
35
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 in 2001 (see "-Corporate
Restructuring, Debt Modification and Debt Restructuring") and charges relating
to the disposition of branches and severance costs associated with closing our
servicing operation.
EXTINGUISHMENT OF DEBT. In 2001, we recorded a charge of $19.3 million,
related to the extinguishment of debt associated with our notes. (see
"-Corporate Restructuring, Debt Modification and Debt Restructuring")
INCOME TAXES. Deferred tax assets and liabilities are recognized on the
income reported in the financial statements regardless of when such taxes are
paid. These deferred taxes are measured by applying current enacted tax rates.
We recorded a tax benefit of $1.8 million for the year ended December 31,
2002 primarily due to us recording a special tax benefit of $2.2 million related
to our obtaining a 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 $0.4 million primarily related to excess inclusion income generated
by our excess cashflow certificates. In 2001, we recorded a tax provision of
$2.9 million which was primarily related to excess inclusion income.
We have less taxable excess inclusion income in 2002, as compared to 2001,
due to our holding lower excess cashflow certificates during the period. Excess
inclusion income cannot be offset by our NOLs under the REMIC tax laws. Going
forward, we expect to continue to incur a modest amount of excess inclusion
income, which we will be unable to offset using our NOLs.
YEAR ENDED DECEMBER 31, 2001, COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
GENERAL
We reported a net loss for the year ended December 31, 2001 of $99.8 million,
or $6.28 per share (basic and diluted), compared to a net loss of $49.4 million,
or $3.11 per share (basic and diluted), for the year ended December 31, 2000.
For the year ended December 31, 2001, the net loss included:
o a $25.4 million, or $1.60 per share (basic and diluted), write down of
excess cashflow certificates relating to a sale agreement we entered
into in the first quarter of 2001 (that closed in May 2001), for a cash
purchase price of $15 million, which reflected a significant discount
to our carrying value of such excess cashflow certificates;
o a charge (loss) to interest income of $19.7 million, or $1.24 per share
(basic and diluted), in the third quarter, reflecting a fair value
adjustment to our remaining excess cashflow certificates, due to our
changing the valuation assumptions we use to estimate fair value (see
Notes to the Consolidated Financial Statements - "Excess Cashflow
Certificates, Net");
o a charge of $19.3 million, or $1.21 per share (basic and diluted)
related to the extinguishment of debt associated with our notes;
o a charge of $10.7 million, or $0.67 per share (basic and diluted),
relating to our disposition and transfer to Ocwen of our servicing
platform in May 2001;
o a charge of $3.6 million, or $0.23 per share (basic and diluted), in
the second quarter relating to a change in accounting estimates
regarding the life expectancy of our computer-related equipment;
o a charge of $1.5 million, or $0.09 per share (basic and diluted), in
the second quarter for establishing a reserve for non-performing
mortgage loans; and
o a charge of $1.4 million, or $0.09 per share (basic and diluted) in the
third quarter relating to professional fees incurred in connection with
the Second Exchange Offer.
36
Results for the year ended December 31, 2001 were also negatively impacted by
(a) our not executing a securitization in either the first or third quarters,
which significantly reduced our revenues for the year ended December 31, 2001
and (b) a lower level of originations, compared to 2000.
For the year ended December 31, 2000, we reported a net loss of $49.4
million, or $3.11 per share (basic and diluted). The majority of the net loss
incurred related to:
o the write-down of our capitalized mortgage servicing rights of $31.4
million;
o restructuring and debt modification charges of $7.7 million;
o a reduction in the carrying value of a portion of our excess cashflow
certificates related to an increase in the discount rate of such
certificates included in our NIM transaction, totaling $6.9 million;
o costs associated with our NIM transaction in November 2000 totaling
$3.2 million; and
o the write-down of goodwill relating to our 1997 purchase of Fidelity
Mortgage totaling $1.4 million.
This was partially offset by income associated with the sale of one of our
domain names for $1.7 million.
REVENUES
Total revenues decreased $86.3 million, or 72%, to $33.1 million for the year
ended December 31, 2001, from $119.4 million for the year ended December 31,
2000. The decrease in revenue was primarily attributable to:
o a decrease in interest income due to:
(1) a $25.4 million write-down in the first quarter of five excess
cashflow certificates, and
(2) a $19.7 million charge in the third quarter reflecting a fair
value adjustment to our remaining excess cashflow certificates,
due to our changing the valuation assumptions we use to estimate
fair value (See Notes to the Consolidated Financial Statements -
"Excess Cashflow Certificates, Net");
o a lower net gain recognized on the sale of mortgage loans;
o lower origination fees and interest income due to a decrease in total
loan production; and
o lower servicing fees due to our agreement in January 2001 to transfer
our servicing portfolio to Ocwen, pursuant to which Ocwen immediately
began receiving all servicing related fees and, in turn, paid us an
interim servicing fee, until the servicing portfolio was physically
transferred to Ocwen in May 2001.
We originated $621.7 million of mortgage loans for the year ended December
31, 2001, representing a 33% decrease from $933.4 million of mortgage loans
originated and purchased for year ended December 31, 2000. The decrease in
mortgage loans originated in 2001, was primarily due to senior management's
attention being diverted to completing our necessary corporate and debt
restructuring (See Notes to the Consolidated Financial Statements - "Corporate
Restructuring, Debt Modification and Debt Restructuring"). We securitized $345.0
million of loans during the year ended December 31, 2001, representing a 61%
decrease from the $880.0 million of loans we securitized during 2000. Our whole
loan sales amounted to $261.1 million during the year ended December 31, 2001,
representing a 348% increase from the $58.3 million of whole loans sold for the
year ended December 31, 2000. This increase in whole loan sales reflects our
present strategy to diversify our funding sources between securitizations and
whole loan sales, in order to maximize cash flow and profitability.
Net gain on sale of mortgage loans decreased $14.0 million, or 27%, to $38.6
million for the year ended December 31, 2001, from $52.6 million for the year
ended December 31, 2000. This decrease was primarily due to a 35% decrease in
the amount of loans securitized or sold to $606.1 million in 2001, compared to
$938.3 million of loans securitized or sold in 2000. The decrease in loans
securitized or sold was due to an overall 33% decrease in total loan production
in 2001, compared to 2000. The decrease in net gain on sale on a comparable
basis was partially offset by (1) a higher gross profit margin recorded on our
securitizations in 2001 versus 2000, and (2) no correspondent premiums (negative
revenue) to acquire loans in 2001 - because we closed our correspondent channel
in June 2000 - compared to the $1.6 million we paid during the first half of
2000. The weighted average net gain on sale ratio was 6.4% for the year ended
December 31, 2001 compared to 5.6% for the year ended December 31, 2000.
Interest income decreased $54.4 million, or 168%, to $(22.1) million for the
year ended December 31, 2001, from $32.3 million for the year ended December 31,
2000. The decrease in interest income was primarily due to:
37
o our $25.4 million write down of excess cashflow certificates that we sold
for a cash purchase price of $15 million under a sale agreement we
entered into in the first quarter of 2001;
o a charge to interest income of $19.7 million in the third quarter,
reflecting a fair value adjustment to our remaining excess cashflow
certificates, due to the changes we made to the valuation assumptions we
use to estimate fair value (see "-Notes to Financial Statements - Note
No. 8-Excess Cashflow Certificates, Net");
o a 33% decrease in loan production for the year ended December 31, 2001,
compared to the year ended December 31, 2000, which resulted in a lower
amount of mortgage loans generating interest income while held for sale;
o a lower average mortgage coupon rate charged to the borrower of 10.5%
from 11.4% reflecting a lower economic interest rate environment; and
o a decrease in interest earned on interest bearing accounts that we
received as servicer on our securitizations.
Servicing fees decreased $11.2 million, or 79%, to $3.0 million for the year
ended December 31, 2001, from $14.2 million for the year ended December 31,
2000. This decrease was the result of our agreement to transfer our servicing
portfolio to Ocwen in January 2001, pursuant to which Ocwen immediately began
receiving all servicing related fees and, in turn, paid us an interim servicing
fee, until the servicing portfolio was physically transferred to Ocwen in May
2001.
Net origination fees and other income decreased $6.7 million, or 33%, to
$13.7 million for the year ended December 31, 2001, from $20.4 million for the
year ended December 31, 2000. The decrease was primarily the result of a 33%
decrease in loan originations and our sale of a domain name in July 2000.
EXPENSES
Total expenses decreased by $71.3 million, or 39%, to $110.8 million for the
year ended December 31, 2001, from $182.1 million for the year ended December
31, 2000. The decrease was primarily due to a decrease in personnel costs due to
our restructuring and our sale of our servicing portfolio and a decrease in
interest expense. The decrease in expenses was also the result of our incurring
higher expenses for the year ended 2000 relating to charges associated with a
corporate restructuring and debt modification in the third quarter of 2000. The
decrease in expenses was partially offset by charges principally incurred in
connection with:
o our disposition and transfer of our servicing platform to Ocwen in May
2001;
o a change in our accounting estimates regarding the life expectancy of
computer-related equipment in the second quarter of 2001; and
o our recording a reserve for non-performing mortgage loans in the second
quarter of 2001.
Payroll and related costs decreased by $13.6 million, or 24%, to $42.9
million for the year ended December 31, 2001, from $56.5 million for the year
ended December 31, 2000. The decrease was primarily the result of (1) the
downsizing we effectuated as part of our overall corporate restructuring
beginning in the second half of 2000 and culminating with the physical transfer
of our servicing operation in May 2001; and (2) a lower amount of commissions
paid due to the decrease in originations. We employed 609 full- and part-time
employees as of December 31, 2001, compared to 851 full- and part-time employees
as of December 2000.
Interest expense decreased by $14.3 million, or 47%, to $16.1 million for the
year ended December 31, 2001 from $30.4 million for the year ended December 31,
2000. The decrease was primarily attributable to the $12.1 million of interest
expense we saved in 2001 by extinguishing $139.2 million of notes in August 2001
and, to a lesser extent, to our lower loan production in 2001, which resulted in
lower warehouse financing, and lower financing costs. The average one-month
LIBOR rate, which is the benchmark used to determine our cost of borrowed funds,
decreased on average to 3.9% for the year ended December 31, 2001, compared to
an average of 6.4% for the year ended December 31, 2000.
General and administrative expenses increased $3.6 million, or 8%, to $49.1
million for the year ended December 31, 2001, from $45.5 million for the year
ended December 31, 2000. The increase primarily resulted from:
o the cost of maintaining an unprofitable servicing platform until we
physically transferred it to Ocwen in May 2001, plus the associated costs
of transferring our servicing portfolio to Ocwen;
38
o a change in the useful life of computer-related equipment from five years
to three years;
o a fair value adjustment to a pool of non-performing loans, which we
ultimately sold in July 2001;
o partially offset by the cost savings related to our corporate
restructuring, including the disposition of our servicing portfolio to
Ocwen in May 2001 and elimination of capital charges associated with
making securitization advances prior to the sale of the servicing
portfolio.
We recorded the following restructuring and other special charges in 2001 and
2000:
o In 2001, $2.7 million of restructuring and other special charges relating
to our disposition of branches and severance costs associated with
closing our servicing operation.
o In the fourth quarter of 2000, a $1.6 million write-down of other
servicing receivable assets.
o In the third quarter of 2000, $3.1 million of debt modification charges
primarily related to legal fees and the noteholders' financial advisor
fees associated with the Debt Modification and Exchange Offering. We also
recorded $6.7 million of charges related to our restructuring of our
operations, primarily related to employee severance associated with the
layoffs, a reduction to goodwill and office equipment write-offs.
We recorded a charge to extinguishment of debt in 2001 of $19.3 million,
related to the extinguishment of debt associated with our notes.
We recorded a tax provision of $2.9 million primarily related to excess
inclusion income generated by our excess cashflow certificates and a tax benefit
of $13.2 million for the year ended December 31, 2001 and 2000, respectively.
Excess inclusion income cannot be offset by our NOLs under the REMIC tax laws.
In 2001, excess inclusion income was primarily caused by the REMIC
securitization trust utilizing cash, that otherwise would have been paid to us
as holder of the excess cashflow certificate, to make payments to other security
holders:
o to create and/or maintain overcollateralization by artificially paying
down the principal balance of the asset-backed securities; and
o in connection with our NIM transaction, executed in November 2000, to pay
down the debt collateralized by our excess cashflow certificates.
FINANCIAL CONDITION
DECEMBER 31, 2002 COMPARED TO DECEMBER 31, 2001
Cash and interest-bearing deposits decreased $3.0 million, or 47%, to $3.4
million at December 31, 2002, from $6.4 million at December 31, 2001. This
decrease was primarily related to our utilizing operating cash to fund our
production of mortgage loans rather than finance the mortgage loans through our
warehouse facilities.
Accounts receivable decreased $2.4 million, or 59%, to $1.7 million at
December 31, 2002, from $4.1 million at December 31, 2001. This decrease was
primarily due to the settlement of cash surrender value of an officer's life
insurance policies in December of 2002.
Loans held for sale, net, decreased $60.4 million, or 64%, to $34.0 million
at December 31, 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 sold or securitized during 2002.
Excess cashflow certificates, net increased $7.8 million, or 46%, to $24.6
million at December 31, 2002, from $16.8 million at December 31, 2001. This
increase was primarily due to us recording new excess cashflow certificates
totaling $10.5 million from loans securitized in 2002. This increase was
partially offset by a $2.1 million fair value mark-to-market adjustment of our
excess cashflow certificates, reflecting the change in fair value of such excess
cashflow certificates - which incorporates any change in value (accretion or
reduction) in the carrying value of the excess cashflow certificates and the
cash distributions we received from such excess cashflow certificates.
Equipment, net, decreased $2.4 million, or 48%, to $2.6 million at December
31, 2002, from $5.0 million at December 31, 2001. This decrease primarily
reflects the periodic depreciation of fixed assets.
39
We have a deferred tax asset, net, of $5.6 million at December 31, 2002 and
2001, which was primarily attributable to the net operating losses we incurred
in 2000 and 2001. Included in the deferred tax asset, net, is a valuation
allowance established in 2000 (See Notes to Financial Statements - "Income
Taxes").
Warehouse financing and other borrowings decreased $73.2 million, or 82%, to
$16.4 million at December 31, 2002, from $89.6 at December 31, 2001. This
decrease was primarily attributable to a lower amount of mortgage 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 totaled $10.8 million at December 31, 2002 and 2001. The senior
notes accrue at a rate of 9.5% per annum, payable semi-annually on February 1,
and August 1.
Accounts payable and accrued expenses decreased $2.7 million, or 18%, to
$12.3 million at December 31, 2002 from $15.0 million at December 31, 2001. This
decrease was primarily the result of the timing of various operating accruals
and payables.
Income taxes payable decreased $2.0 million, or 38%, to $3.2 million at
December 31, 2002 from $5.2 million at December 31, 2001. This decrease was
primarily the result of us obtaining a favorable tax resolution to tax issues in
the amount of $2.2 million, for which we had previously reserved and do not
expect to recur.
Stockholders' equity increased $17.6 million, or 148%, to $29.5 million at
December 31, 2002 from $11.9 million at December 31, 2001. This increase
represents our positive earnings for the period.
LIQUIDITY AND CAPITAL RESOURCES
We require substantial amounts of cash to fund our loan originations,
securitization activities and operations. In 2002, we operated on a positive
cash flow basis. In the past, however, we have operated generally on a negative
cash flow basis. Embedded in our current cost structure are many fixed costs,
which are not likely to be significantly affected by a relatively substantial
increase in loan originations. If we can increase our loan production to
generate sufficient additional revenues from our securitizations and sales of
such loans to offset our current cost structure and cash uses, we believe we can
continue to generate positive cash flow in 2003. However, there can be no
assurance we will be successful in this regard. To do so, we must generate
sufficient cash from:
o the premiums we receive from selling NIM 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 excess cashflow certificates we retain in connection with our
securitizations;
o interest income we receive on our loans held for sale prior to
securitization and/or whole loan sale; and
o distributions from the LLC.
There can be no assurance, however, that we will continue generating positive
cash flow in 2003 or at all.
Currently, our primary cash requirements include the funding of:
o the equity in our mortgage loans held for sale, for which we receive
financing on from our warehouse lenders up to only 98% of the total
amount of the mortgage loan's principal balance (e.g., our warehouse
lenders 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 expenses incurred in connection with our securitization program;
o tax payments on excess inclusion income generated from our excess
cashflow certificates; and
o general ongoing administrative and operating expenses, including the
cost to originate loans.
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 notes
(sold
40
in conjunction with each of our securitizations) to offset our negative
operating cash flow and support our originations, securitizations, servicing
(prior to May 2001) and general operating expenses. Over the past few years, we
have engaged in a series of transactions to further address our negative cash
flow, including the following:
o in 2000, completing three securitizations of interest (delinquency) and
servicing advances, in which we sold our rights to be reimbursed for our
outstanding delinquency and servicing advances that we made as servicer
for a cash purchase price. We used the proceeds from these securitizations
to (1) repay a $25 million working capital sub-line of our former bank
syndicate warehouse facility that expired in June 2000, which was secured
by our delinquency and servicing advance receivables, and (2) for working
capital to finance our operations, including the funding of new
delinquency and servicing advances. We ultimately repurchased these
securitizations in 2001, in connection with the sale of servicing to
Ocwen, using the proceeds we received from selling the underlying
delinquency and servicing advance receivables to Ocwen;
o modifying our senior notes in 2000 as part of the Debt Modification (see
"-Corporate Restructuring, Debt Modification and Debt Restructuring"),
which enabled us to monetize a portion of our excess cashflow
certificates, first by obtaining $17 million in residual financing in
August 2000, secured by some of our excess cashflow certificates. Shortly
thereafter, in November 2000, we sold six excess cashflow certificates
through a private placement NIM transaction to an owner trust that issued
senior certificates to institutional investors for a cash purchase. The
net proceeds of the NIM transaction, after expenses, was used entirely to
repay the $17 million of residual financing we borrowed in August 2000 and
to create a $7.125 million cash escrow account to be used to pay the
semi-annual interest payment due on the notes in February 2001;
o as part of our Second Debt Restructuring, at the time of the signing of
the Letter of Intent in February 2001, we obtained approximately $2.5
million of residual financing secured by several of our excess cashflow
certificates. We received approximately $7.1 million of additional
residual financing secured primarily by additional excess cashflow
certificates following the consummation of the consent solicitation and
the execution of the third supplemental indenture in March 2001. Also in
March 2001, we entered into a sale agreement to sell five excess cashflow
certificates for a $15 million cash purchase price. As customary with
sales of similar assets, the cash settlement did not occur until the pools
of mortgage loans underlying the five 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
Certificates (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");
o origination fees, interest income and other cash revenues; and
o utilizing NIM securitizations and/or selling or financing our existing
excess cashflow certificates.
If we are not able to obtain financing, we will not be able to originate new
loans and our business and results of operations will be materially and
adversely affected.
To accumulate loans for securitization or sale, we borrow money on a
short-term basis through warehouse lines of credit. We have relied upon a few
lenders to provide the primary credit facilities for our loan originations and
currently have two warehouse facilities as of December 31, 2002 for this
purpose. We have two $200 million credit
41
facilities that have a variable rate of interest and expire in May 2003. There
can be no assurance that we will be able either to renew or replace these
warehouse facilities at their maturities 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;
o Ten-year warrants to purchase approximately 1.6 million shares of our
common stock, currently at an exercise price of $0.01 per share; 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 December 31, 2002.
We have repurchase agreements with certain of the 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 that were sold with recourse
and still outstanding totaled $2.6 million at December 31, 2002 and $3.5 million
at December 31, 2001. Included in accounts payable is an allowance for recourse
losses of $1.2 million at December 31, 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 senior notes. The funds for any such repurchases would be expected to
come from our existing cash. There is no assurance that we will effectuate any
such repurchases or the terms thereof.
Subject to our ability to execute our business strategy and the various
uncertainties described above (and described in more detail in "-Forward Looking
Statements and Risk Factors" below), we anticipate that we will have sufficient
cash flows, short-term funding and capital resources to meet our liquidity
obligations for the foreseeable future.
INTEREST RATE RISK
Our primary market risk exposure is interest rate risk. Profitability may be
directly affected by the level of, and fluctuation in, interest rates, which
affect our ability to earn a spread between interest received on our loans and
the costs of our borrowings, which are tied to various interest rate swap
maturities, commercial paper rates and LIBOR. Our profitability is likely to be
adversely affected during any period of unexpected or rapid changes in interest
rates. A substantial and sustained increase in interest rates could adversely
affect our ability to originate loans. A significant decline in interest rates
could increase the level of loan prepayments thereby decreasing the size of the
loan servicing portfolio underlying our securitizations. To the extent excess
cashflow certificates have been capitalized on our financial statements, higher
than anticipated rates of loan prepayments or losses could require us to write
down the value of such excess cashflow certificates, adversely impacting our
earnings. In an effort to mitigate the effect of interest rate risk, we
periodically review our various mortgage products and identify and modify those
that have proven historically more susceptible to prepayments. However, there
can be no assurance that these modifications to our product line will mitigate
effectively interest rate risk in the future.
Periods of unexpected or rapid changes in interest rates, and/or other
volatility or uncertainty regarding interest rates, also can affect adversely us
by increasing the likelihood that asset-backed investors will demand higher
spreads than normal to offset the volatility and/or uncertainty, which decreases
the value of the excess cashflow certificates we receive in connection with a
securitization.
Fluctuating interest rates also may affect the net interest income we earn,
resulting from the difference between the yield we receive on loans held pending
sales and the interest paid by us for funds borrowed under our warehouse
facility. We may, 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 "--
42
Hedging"). Fluctuating interest rates also may significantly affect net interest
income (the excess cash flows from our excess cashflow certificates) as certain
of our asset-backed securities are priced based on one-month LIBOR, but the
collateral underlying such securities are comprised of mortgage loans with
either fixed interest rates or "hybrid" interest rates - fixed for the initial
two or three years of the mortgage loan, and adjusting thereafter every six
months - which creates basis risk (See Notes to the Consolidated Financial
Statements - "Excess Cashflow Certificates, Net").
HEDGING
We adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as of January 1, 2001. The Standard requires that all derivative
instruments be recorded in the balance sheet at fair value. However, the
accounting for changes in fair value of the derivative instrument depends on
whether the derivative instrument qualifies as a hedge. If the derivative
instrument does not qualify as a hedge, changes in fair value are reported in
earnings when they occur. If the derivative instrument qualifies as a hedge, the
accounting treatment varies based on the type of risk being hedged. There was no
impact on our financial condition or results of operations upon the adoption of
SFAS No. 133, as amended.
We originate mortgage loans and then sell them through a combination of whole
loan sales and securitizations. Between the time we originate the mortgage and
sell it in the secondary market, we may hedge the risk of fluctuations in
interest rates. Our risk begins subsequent to originating mortgage loans and
prior to selling or securitizing such mortgage loans. Since we have a closed
(and funded) mortgage loan at a specified interest rate with an expected gain at
time of sale, our exposure is to a higher interest rate environment due to
market conditions. A higher interest rate market implies that we will have a
higher cost of funds, which decreases the net spread we 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 benchmark
interest rate (I.E., the treasury rate or interest rate swap with a similar
duration and average life) and the 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, to the extent we hedge, 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 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. These strategies are designated as hedges on
our financial statements and are closed out when we sell the associated loans.
We will review continually the frequency and effectiveness of our hedging
strategy to mitigate risk pending a securitization or loan sale.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, upon settlement with our hedge counterparty, we will pay the hedge
loss in cash and then realize the corresponding increase in the value of the
loans as part of our net gain on sale of mortgage loans through either the
excess cashflow certificates we retain from securitization or from whole loan
premiums. Conversely, if the value of the hedges increase, offsetting a decrease
in the value of the loans, upon settlement with our hedge counterparty, we will
receive the hedge gain in cash and realize the corresponding decrease in the
value of the loans through a reduction in either the value of the corresponding
excess cashflow certificates or whole loan premiums.
We believe our hedging strategy has historically 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.
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.
43
We did not hedge during the year ended December 31, 2002 nor during the year
ended December 31, 2001, primarily due to the tremendous uncertainty in the
United States economy resulting from an overall weakened economy, depressed
stock market, threat of war and terrorism, among other things, that has caused
U.S. interest rates to remain at or near 40 year historical lows. For the year
ended December 31, 2000, we recorded a hedge loss of $2.1 million, which largely
offset a change in the value of mortgage loans being hedged, as part of our net
gain on sale of loans.
We will continue to review our hedging strategy in order to best mitigate
risk pending securitization or loan sales.
INFLATION
Inflation most significantly affects our loan originations and values of our
excess cashflow certificates, because of the substantial effect inflation can
have on interest rates. Interest rates normally increase during periods of high
inflation and decrease during periods of low inflation. (See "--Interest Rate
Risk.").
IMPACT OF NEW ACCOUNTING STANDARDS
For discussion regarding the impact of new accounting standards, refer to
Note No. 1 of Notes to the Consolidated Financial Statements.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Except for historical information contained herein, certain matters discussed
in this Form 10-K are "forward-looking statements" as defined in the Private
Securities Litigation Reform Act ("PSLRA") of 1995, which involve risk and
uncertainties that exist in our operations and business environment, and are
subject to change on various important factors. We 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 cash uses;
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 The potential effect that a possible war with Iraq, or other similar
conflicts or terrorist acts and/or threats, may have on the capital markets,
and in particular the asset-backed market;
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
and/or environmental compliance
44
can lead to loss of approved status, certain rights of rescission for mortgage
loans, class action lawsuits and administrative enforcement action against us;
o Our ability or inability to continue monetizing our existing excess cashflow
certificates, including without limitation, selling, financing or
securitizing (through NIM transactions) such assets;
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We originate mortgage loans and then sell the mortgage loans through a
combination of whole loan sales and securitizations. As a result, our primary
market risk is interest rate risk. In turn, interest rates are highly sensitive
to many factors, including:
o governmental monetary and tax policies;
o domestic and international economic and political considerations; and
o other factors beyond our control.
Changes in the general interest rate levels between the time we originate
mortgage loans and the time when we sell such mortgage loans in securitization
transactions can affect the value of our mortgage loans held for sale and,
consequently, our net gain on sale revenue by affecting the "excess spread"
between the interest rate on the mortgage loans and the interest rate paid to
asset-backed investors who purchase pass-through certificates issued by the
securitization trusts. If interest rates rise between the time we originate the
loans and the time we sell the loans in a securitization transaction, the excess
spread generally narrows, resulting in a loss in value of the loans and a lower
net gain on sale for us. Since we close and fund mortgage loans at a specified
interest rate with an expected gain on sale to be booked at the time of their
sale, our exposure to decreases in the fair value of the mortgage loans arises
when moving from a lower to a higher interest rate environment. A higher
interest rate environment results in our having higher cost of funds. This
decreases both the fair value of the mortgage loans, and the net spread we earn
between the mortgage interest rate on each mortgage loan and our cost of funds
under available warehouse lines of credit used to finance the loans prior to
their sale in a securitization transaction. As a result, we may experience a
lower gain on sale.
The following table illustrates the impact on our earnings resulting from a
hypothetical 10 basis point change in interest rates. Historically, such a basis
point increase has resulted in an approximately 10 basis point change in the
excess spread or "yield." The product of 10 basis points in yield (0.10%) and
the duration of 2.5 years equals a 25.0 basis point or 0.25% change in the net
gain on sale as shown below.
45
10 BASIS POINT DECREASE IN 10 BASIS POINT INCREASE IN
DESCRIPTION INTEREST RATES BASE INTEREST RATES
- --------------------------------------------------------------------------------------------
Securitization amount $100,000,000 $100,000,000 $100,000,000
Net gain on sale % 5.25% 5.00% 4.75%
Net gain $5,250,000 $5,000,000 $4,750,000
The table below demonstrates the sensitivity, at December 31, 2002, of the
estimated fair value of our excess cashflow certificates caused by an immediate
10% and 20%, respectively, adverse change in the key assumptions we use to
estimate fair value:
Fair value of excess Impact to
(Dollars in thousands) cashflow certificates earnings
- ---------------------------- --------------------- -------------
Fair value as of 12/31/02: $ 24,565
10% increase in prepayment speed 19,011 $ 5,554
20% increase in prepayment speed 15,476 9,089
10% increase in credit losses 19,012 5,553
20% increase in credit losses 14,448 10,117
10% increase in discount rates 23,032 1,533
20% increase in discount rates 21,676 2,889
10% increase in one- & six-month LIBOR 21,809 2,756
20% increase in one- & six-month LIBOR 19,227 5,338
These sensitivities are hypothetical and are presented for illustrative
purposes only. Changes in the fair value resulting from a change in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the resulting change in fair value may not be linear. Each change
in assumptions presented above was calculated independently without changing any
other assumption. However, in reality, changes in one assumption may result in
changes in another assumption, which may magnify or counteract the
sensitivities. For example, a change in market interest rates may simultaneously
impact prepayment speeds, credit losses and the discount rate. It is impossible
to predict how one change in a particular assumption may impact other
assumptions.
To reduce our financial exposure to changes in interest rates, we may hedge
our mortgage loans held for sale through hedging products that are correlated to
the pass-though certificates issued in connection with the securitization of our
mortgage loans (I.E., interest rate swaps) (See "-Hedging"). Changes in interest
rates also could adversely affect our ability to originate loans and/or could
affect the level of loan prepayments thereby impacting the size of the loan
portfolio underlying our excess cashflow certificates and, consequently, the
value of our excess cashflow certificates. (See "-Interest Rate Risk" and "-Risk
Factors - Interest Rate Risk").
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders of
Delta Financial Corporation:
We have audited the accompanying consolidated balance sheets of Delta Financial
Corporation and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2002.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Delta Financial
Corporation and subsidiaries as of December 31, 2002 and 2001, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted FASB Statement No. 145, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical Corrections" as of
December 31, 2002.
/s/ KPMG LLP
Melville, New York
February 3, 2003
47
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
(DOLLARS IN THOUSANDS) 2002 2001
- --------------------------------------------------------------------------------
ASSETS
Cash and interest-bearing deposits............. $ 3,405 6,410
Accounts receivable............................. 1,700 4,062
Loans held for sale, net........................ 33,984 94,407
Excess cashflow certificates, net............... 24,565 16,765
Equipment, net.................................. 2,553 4,998
Prepaid and other assets........................ 1,737 1,564
Deferred tax asset, net......................... 5,600 5,600
- --------------------------------------------------------------------------------
Total assets............................... $ 73,544 133,806
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank payable.................................... $ 1,369 1,267
Warehouse financing and other borrowings........ 16,352 89,628
Senior notes.................................... 10,844 10,844
Accounts payable and accrued expenses........... 12,327 15,015
Income taxes payable............................ 3,155 5,202
- --------------------------------------------------------------------------------
Total liabilities.......................... 44,047 121,956
- --------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Preferred stock, Series A, $.01 par value.
Authorized 150,000 shares, 139,156 shares
authorized and outstanding .................. 13,916 13,916
Common stock, $.01 par value. Authorized
49,000,000 shares; 16,022,349 shares issued
and 15,905,549 shares outstanding at December 31,
2002 and 16,000,549 shares issued and 15,883,749
shares outstanding at December 31, 2001......... 160 160
Additional paid-in capital...................... 99,482 99,472
Accumulated deficit............................. (82,743) (100,380)
Treasury stock, at cost (116,800 shares)........ (1,318) (1,318)
- --------------------------------------------------------------------------------
Total stockholders' equity................. 29,497 11,850
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity. $ 73,544 133,806
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
48
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2002, 2001 and 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------
REVENUES:
Net gain on sale of mortgage loans................ $ 58,805 38,638 52,590
Interest.......................................... 11,691 (22,146) 32,287
Servicing fees.................................... -- 2,983 14,191
Net origination fees and other income............. 15,647 13,673 20,376
- --------------------------------------------------------------------------------------------------------
Total revenues 86,143 33,148 119,444
- --------------------------------------------------------------------------------------------------------
EXPENSES:
Payroll and related costs......................... 41,306 42,896 56,525
Interest expense.................................. 5,273 16,132 30,386
General and administrative........................ 23,696 49,101 45,539
Capitalized mortgage servicing impairment......... -- -- 38,237
Restructuring and other special charges............ -- 2,678 11,382
Extinguishment of debt............................. -- 19,255 --
- ---------------------------------------------------------------------------------------------------------
Total expenses 70,275 130,062 182,069
- ---------------------------------------------------------------------------------------------------------
Income (loss) before income tax expense (benefit)..... 15,868 (96,914) (62,625)
Provision for income tax expense (benefit)............ (1,769) 2,876 (13,208)
- ---------------------------------------------------------------------------------------------------------
Net income (loss).............................. $ 17,637 (99,790) (49,417)
- ---------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income (loss) per share.......................... $ 1.11 (6.28) (3.11)
DILUTED EARNINGS PER SHARE:
Net income (loss) per share.......................... $ 1.04 (6.28) (3.11)
See accompanying notes to consolidated financial statements.
49
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 2002, 2001 and 2000
ADDITIONAL
PREFERRED CAPITAL PAID-IN ACCUMULATED TREASURY
(DOLLARS IN THOUSANDS) STOCK STOCK CAPITAL DEFICIT STOCK TOTAL
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999............... $ -- 160 99,472 48,827 (1,318) 147,141
Net loss................................... -- -- -- (49,417) -- (49,417)
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000............... -- 160 99,472 (590) (1,318) 97,724
Issuance of preferred stock related to
debt exchange.......................... 13,916 -- -- -- -- 13,916
Net loss................................... -- -- -- (99,790) -- (99,790)
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001............... 13,916 160 99,472 (100,380) (1,318) 11,850
Stock options exercised.................... -- -- 10 -- -- 10
Net income................................. -- -- -- 17,637 -- 17,637
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002............... $ 13,916 160 99,482 (82,743) (1,318) 29,497
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
50
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002, 2001 and 2000
(DOLLARS IN THOUSANDS) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss)...................................... $ 17,637 (99,790) (49,417)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Provision for loan and recourse losses............... 603 2,431 670
Depreciation and amortization........................ 3,236 8,361 12,912
Extinguishment of debt............................... -- 19,255 --
Deferred tax benefit................................. -- -- (16,011)
Capitalized mortgage servicing rights, net
of amortization.................................... -- -- 45,927
Deferred origination costs .......................... 545 578 174
Excess cashflow certificates received in
securitization transactions, net................... (7,800) 47,052 7,752
Changes in operating assets and liabilities:
Decrease in accounts receivable...................... 2,362 17,542 10,413
Decrease (increase) in loans held for sale, net...... 59,348 (14,263) 6,159
(Increase) decrease in prepaid and other assets...... (173) 42,127 19,850
Decrease in accounts payable and accrued expenses.... (2,761) (1,212) (10,723)
(Decrease) increase in income taxes payable.......... (2,047) 1,417 518
Decrease in investor payable......................... -- (69,489) (12,715)
Decrease in advance payment by borrowers
for taxes and insurance.......................... -- (12,940) (844)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities.... 70,950 (58,931) 14,665
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
(PURCHASE) DISPOSITION OF EQUIPMENT..................... (791) 1,735 (1,297)
- -------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities..... (791) 1,735 (1,297)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
(Repayment of) proceeds from warehouse
financing and other borrowings, net.................. (73,276) 996 (20,387)
Increase (decrease) in bank payable, net................ 102 340 (268)
- ------------------------------------------------------------------------------------------------------------------
Proceeds from exercise of stock options................. 10 -- --
Net cash (used in) provided by financing activities..... (73,164) 1,336 (20,655)
- -------------------------------------------------------------------------------------------------------------------
Net decrease in cash and interest-bearing deposits...... (3,005) (55,860) (7,287)
Cash and interest-bearing deposits at beginning of year.... 6,410 62,270 69,557
- -------------------------------------------------------------------------------------------------------------------
Cash and interest-bearing deposits at end of year......... $ 3,405 6,410 62,270
- -------------------------------------------------------------------------------------------------------------------
Supplemental Information:
Cash paid during the year for:
Interest ............................................... $ 5,435 14,605 29,974
Income taxes ........................................... 278 888 2,010
See accompanying notes to consolidated financial statements.
51
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001, AND 2000
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) ORGANIZATION
Delta Financial Corporation ("Delta" or "we") is a Delaware corporation,
which was organized in August 1996. On October 31, 1996, we acquired all of the
outstanding common stock of Delta Funding Corporation ("Delta Funding"), a New
York corporation which had been organized on January 8, 1982 for the purpose of
originating, selling, servicing and investing in residential first and second
mortgages. On November 1, 1996, we completed an initial public offering of
4,600,000 shares of common stock, $.01 par value.
(B) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements are prepared on the
accrual basis of accounting and include our accounts and those of our
wholly-owned subsidiaries. All significant inter-company accounts and
transactions have been eliminated.
Certain prior period amounts in the consolidated financial statements and
notes have been reclassified to conform with the current year presentation.
(C) USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires our management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting periods.
Significant items subject to such estimates and assumptions include the carrying
amount of excess cashflow certificates and a valuation allowance on deferred tax
assets. Actual results could differ from those estimates and assumptions.
(D) LOAN ORIGINATION FEES AND COSTS
Loan origination fees received, net of direct costs of originating or
acquiring mortgage loans, are recorded as adjustments to the initial investment
in the loan. Such fees are deferred until the loans are securitized or sold.
(E) LOANS HELD FOR SALE, NET
Loans held for sale are accounted for at the lower of cost or estimated fair
value, determined on a net aggregate basis. Cost includes unamortized loan
origination fees and costs. Net unrealized losses are provided for in a
valuation allowance created through a charge to operations. Losses are
recognized when the fair value is less than cost.
(F) SECURITIZATION AND SALE OF MORTGAGE LOANS
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 a
securitization trust. 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
Statement of Financial Accounting Standards ("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 flow from
the mortgage loans in the trust.
The securitization trust issues senior certificates, which entitle 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
52
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 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 (see Note
6 "Securitization Transaction").
We have found that, at times, we can receive better economic results by
selling certain mortgage loans on a whole loan, non-recourse basis, without
retaining servicing rights, generally in private transactions to financial
institutions or consumer finance companies. We recognize a gain or loss when we
sell loans on a whole loan basis equal to the difference between the cash
proceeds received for the loans and our investment in the loans, including any
unamortized loan origination fees and costs.
(G) EXCESS CASHFLOW CERTIFICATES, NET
We classify excess cashflow certificates that we receive upon the
securitization of a pool of loans as "trading securities." The excess cashflow
certificates represent an ownership interest in a securitization trust. The
assets of each securitization trust consist primarily of two groups of mortgage
loans: a group of fixed rate mortgage loans and a group of hybrid/adjustable
rate mortgage loans. The mortgage loans in each mortgage pool underlying each
excess cashflow certificate consist of fully amortizing and balloon mortgage
loans secured by first or second liens primarily on one- to four-family
residential real properties having original terms to stated maturity of not
greater than 30 years.
The amount initially allocated to the excess cashflow certificates at the
date of a securitization reflects their fair value. At the time each
securitization transaction closes, we determine the present value of the related
excess cashflow certificates using certain assumptions we make regarding the
underlying mortgage loans. The excess cashflow certificate is then recorded on
our consolidated financial statements at an estimated fair value. Our estimates
primarily include the following:
o future rate of prepayment of the mortgage loans - 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 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. 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. (see Note 8 "Excess Cashflow Certificates,
Net").
53
(H) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosure
About Fair Value of Financial Instruments," requires us to disclose the fair
value of financial instruments for which it is practicable to estimate fair
value. Fair value is defined as the amount at which a financial instrument could
be exchanged in a current transaction between willing parties, other than in a
forced sale or liquidation, and is best evidenced by a quoted market price.
Other than excess cashflow certificates which are reported at fair value,
substantially all our assets and liabilities deemed to be financial instruments
are carried at cost, which approximates their fair value.
(I) CASH AND INTEREST-BEARING DEPOSITS
The fair value of cash and interest-bearing deposits consist of money market
accounts which approximates the carrying value reported in our consolidated
balance sheet.
(J) EQUIPMENT, NET
Equipment, including leasehold improvements, is stated at cost, less
accumulated depreciation and amortization. Depreciation of equipment is computed
using the straight-line method over the estimated useful lives of three to seven
years. Leasehold improvements are amortized over the lesser of the terms of the
lease or the estimated useful lives of the improvements. Expenditures for
betterments and major renewals are capitalized and ordinary maintenance and
repairs are charged to operations as incurred.
(K) INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
effects of differences between the financial reporting and tax bases of assets
and liabilities. These deferred taxes are measured by applying current enacted
tax rates.
(L) EARNINGS PER SHARE
Basic Earnings Per Share ("EPS") excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity.
(M) STOCK OPTION PLANS
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, and related interpretations including FASB
Interpretation No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK
COMPENSATION, AN INTERPRETATION OF APB OPINION NO. 25, issued in March 2000, to
account for its fixed-plan stock options. Under this method, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION, established accounting and disclosure requirements
using a fair-value-based method of accounting for stock-based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic-value-based method of accounting described
above, and has adopted only the disclosure requirements of SFAS No. 123. The
following table illustrates the effect on net income if the fair-value-based
method had been applied to all outstanding and unvested awards in each period.
(Dollars in thousands, except share data) 2002 2001 2000
-------- -------- --------
Net income (loss), as reported $ 17,637 (99,790) (49,417)
Deduct total stock-based employee
compensation expense determined
under fair-value-based method for
all rewards, net of tax (997) (2,000) (4)
-------- -------- --------
Pro forma net income(loss) $ 16,640 (101,790) (49,421)
======== ======== ========
54
Earnings (loss) per share:
Basic - as reported $ 1.11 (6.28) (3.11)
======== ======== ========
Basic - pro forma $ 1.05 (6.41) (3.11)
======== ======== ========
Diluted - as reported $ 1.04 (6.28) (3.11)
======== ======== ========
Diluted - pro forma $ 0.98 (6.41) (3.11)
======== ======== ========
(N) SEGMENT REPORTING
We operate as one reporting segment, as such, the segment disclosure
requirements, are not applicable to us.
(O) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46 ("FIN No. 46"), "Consolidation of Variable Interest
Entities," which is an interpretation of ARB No. 51. This Interpretation
addresses consolidation by business enterprises of variable interest entities.
The Interpretation applies immediately to variable interest entities created
after January 31, 2003, and to variable interest entities in which an enterprise
obtains an interest after that date. It applies in the first fiscal year or
interim period beginning after June 15, 2003, to various interest entities in
which an enterprise holds a variable interest that it acquired before February
1, 2003. Management does not expect that the provisions of FIN No. 46 will
impact our results of operations or financial condition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
compensation - Transition and Disclosure, which amends FASB No. 123, Accounting
for Stock-Based compensation." SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No.148 amends the
disclosure requirements of SFAS No. 123 to require more permanent disclosure in
both interim and annual financial statements. Certain of the disclosure
modifications are required for December 31,2002 and are included in the notes in
the financial statements.. Management does not expect that the provisions of
SFAS No. 148 will impact our results of operations or financial condition.
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)." 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. There was no
impact on the Company's consolidated balance sheet or consolidated statement of
operations upon the adoption of SFAS No. 146 on January 1, 2003.
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." Among other things, the standard changes the income statement
classification of gains and losses from early extinguishments of debts. The
provisions of SFAS No. 145 are effective for fiscal years beginning after May
15, 2002. There was no material impact on our financial condition or results of
operations upon the adoption of SFAS No. 145.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaced SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." SFAS No. 144 established a single accounting model, based on
the framework established in SFAS No. 121, for long-lived assets to be disposed
of by sale. SFAS No. 144 also resolved significant implementation issues related
to SFAS No. 121. The provisions of SFAS No. 144 are effective for financial
statements issued for fiscal years beginning after December 15, 2001. There was
no impact on the Company's consolidated balance sheet or consolidated statements
of operations upon adoption of SFAS No. 144 on January 1, 2002.
In June 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. The provisions of SFAS No. 143 are effective for fiscal
years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have
an impact on the financial position, results of operations, or cash flows of the
Company.
55
(2) SUMMARY OF REGULATORY SETTLEMENTS
In September 1999, we settled allegations by the New York State Banking
Department (the "NYSBD") and a lawsuit by the New York State Office of the
Attorney General (the "NYOAG") alleging that we had violated various state and
federal lending laws. The global settlement was evidenced by (a) a Remediation
Agreement by and between Delta Funding and the NYSBD, dated as of September 17,
1999 and (b) a Stipulated Order on Consent by and among Delta Funding, Delta
Financial and the NYOAG, dated as of September 17, 1999. As part of the
Settlement, we, among other things, implemented agreed upon changes to our
lending practices; are providing reduced loan payments aggregating $7.25 million
to certain borrowers identified by the NYSBD; and have created a fund managed by
the NYSBD and financed by the grant of 525,000 shares of Delta Financial's
common stock.
Each month, on behalf of borrowers designated by the NYSBD, we make subsidy
payments to the related securitization trusts. These subsidy payments fund the
differential between the original loan payments and the reduced loan payments.
As part of the second exchange offer we completed in August 2001 (see Note No. 3
"-Corporate Restructuring, Debt Modification, and Debt Restructuring"), Delta
Funding Residual Exchange Company, LLC (the "LLC") (an unaffiliated entity to
us) - a newly-formed entity, the voting membership interests of which are owned
by former holders of our senior secured notes and senior notes due 2004 (the
"Notes") who tendered their Notes for such membership interests and other
securities - is obligated to satisfy these payment subsidies out of the cash
flows generated by the mortgage related securities (primarily from the excess
cashflow certificates) it owns. If the LLC's cash flows are insufficient to pay
this obligation (which we believe is unlikely), we remain responsible to satisfy
our obligations under the Remediation Agreement.
The proceeds of the stock fund will be used to pay borrowers and to finance
a variety of consumer educational and counseling programs. We do not manage the
fund created for this purpose. The number of shares of common stock deposited in
the fund does not adjust to account for fluctuations in the market price of our
common stock. Changes to the market price of these shares of common stock
deposited in the fund do not have any impact on our financial statements. We did
not make any additional financial commitments between the settlement date and
March 2000. The Stipulated Order on Consent and the Remediation Agreement both
terminated by their respective terms, in September 2002. We remain obligated as
discussed above to continue to make subsidy payments on behalf of borrowers
identified by the NYSBD for so long as such borrowers continue to make payments
under the mortgage loans.
In March 2000, we finalized an agreement with the U.S. Department of
Justice, the Federal Trade Commission and the Department of Housing and Urban
Development, to complete the global settlement we had reached with the NYSBD and
NYOAG. The federal agreement mandates some additional compliance efforts for us,
but it does not require any additional financial commitment by us.
We believe we are in compliance in all material respects with applicable
federal and state laws and regulations.
(3) CORPORATE RESTRUCTURING, DEBT MODIFICATION, AND DEBT RESTRUCTURING
In 2000, we began a corporate restructuring - by reducing our workforce and
modifying the terms of the indenture governing our senior notes due 2004 (the
"senior notes") - as part of our continuing efforts to improve operating
efficiencies and to address our negative cash flow from operations. Entering
2001, management still had several concerns, which we believed needed to be
addressed for us to remain a viable company. Our principal concerns were:
o the cash drain created by our ongoing monthly delinquency and servicing
advance requirements as servicer for securitization trust (known as
"securitization advances");
o the high cost of servicing a seasoned loan portfolio, including the
capital charges associated with making securitization advances;
o our ability to make timely interest payments on our senior notes and
senior secured notes due 2004 (the "senior secured notes"); and
o our ability to effectuate a successful business model given the overhang
of corporate ratings of "Caa2" by Moody's and "CC" by Fitch.
Therefore in the first quarter of 2001, we embarked upon a business plan aimed
at alleviating some of these concerns and issues.
56
CORPORATE RESTRUCTURING
In January 2001, we announced that we had entered into an agreement with
Ocwen Financial Corporation ("Ocwen") to transfer our servicing portfolio to
Ocwen. In May 2001, we physically transferred our entire servicing portfolio to
Ocwen, and laid-off the majority of our servicing staff - a total of 128
employees. We recorded a $0.5 million pre-tax charge relating to this
restructuring which is included in the line item call "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 $0.1 million and $0.6 million at December 31, 2002 and December
31, 2001. The unpaid accrued restructuring charge was initially recorded under
the exit plan. No charges under this exit plan are associated with or benefit
from activities that will be continued at the commitment date.
DEBT MODIFICATION AND DEBT RESTRUCTURING
In August 2000, we announced an agreement to modify the terms of the
indenture governing our senior notes (the "Debt Modification"). With the consent
of the holders of greater than fifty percent of our senior notes, we modified a
negative pledge covenant in the senior notes indenture, which had previously
prevented us from selling or otherwise obtaining financing by using our excess
cashflow certificates as collateral. In consideration for the senior
noteholders' consent, we agreed, in an exchange offer (the "First Exchange
Offer"), to offer then current holders the opportunity to exchange their then
existing senior notes for (a) new senior secured notes due 2004 (the "senior
secured notes") and (b) ten-year warrants to buy approximately 1.6 million
shares of common stock, at an initial exercise price of $9.10 per share, subject
to upward or downward adjustment in certain circumstances. In December 2002, the
exercise price for the warrants issued by us was adjusted downward to $0.01 per
share in accordance with our agreement. The senior secured notes have the same
coupon, face amount and maturity date as the senior notes and, up until the
Second Debt Restructuring (see below) were secured by at least $165 million of
the our excess cashflow certificates. The First Exchange Offer was consummated
in December 2000, with holders of greater than $148 million (of $150 million) of
senior notes tendering in the exchange.
In February 2001, we entered into a letter of intent with the beneficial
holders of over fifty percent of our senior secured notes to restructure, and
ultimately extinguish, the senior secured notes (the "Second Debt
Restructuring"). In March 2001, we obtained the formal consent of these
beneficial holders of the senior secured notes through a consent solicitation
that modified certain provisions of the senior secured notes indenture to, among
other things, allow for the release of two excess cashflow certificates then
securing the senior secured notes. We were first able to finance and then
ultimately sell the excess cashflow certificates underlying five securitizations
(including two excess cashflow certificates that were released as part of the
Second Debt Restructuring) for a $15 million cash purchase price to provide
working capital.
In consideration for their consent, we agreed to offer the holders of the
senior secured notes (and the senior notes, collectively, the "notes"), an
opportunity to exchange their notes for new securities described immediately
below (the "Second Exchange Offer"). The Second Exchange Offer was consummated
on August 29, 2001, pursuant to which holders of approximately $138.1 million
(of $148.2 million) in principal amount of our senior secured notes and $1.1
million (of $1.8 million) in principal amount of our senior notes, exchanged
their notes for commensurate interests in:
o voting membership interests in Delta Funding Residual Exchange Company LLC
(the "LLC"), a newly-formed limited liability company (unaffiliated with
us), to which we transferred all of the mortgage-related securities
previously securing the senior secured notes (primarily comprised of
excess cashflow certificates);
o shares of common stock of a newly-formed management corporation that will
manage the LLC's assets; and
o shares of our newly-issued Series A preferred stock having an aggregate
preference amount of $13.9 million.
The LLC is controlled by the former noteholders that now hold all the voting
membership interest in the LLC. As part of the transaction, we obtained a
non-voting membership interest in the LLC, which entitles us to receive 15% of
the net cash flows from the LLC for the first three years (through June 2004)
and, thereafter, 10% of the net
57
cash flows from the LLC. The net cash flows from the LLC are equal to the total
cash flows generated by the assets held by the LLC for a particular period, less
(a) all expenses of the LLC, (b) certain related income tax payments, and (c)
the NYSBD subsidy payments (see "- Note No. 2 Summary of Regulatory
Settlement"). 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 recorded a charge of $19.3 million related to the
extinguishment of debt and paid the August 2001 interest coupon payment on the
approximately $10.8 million of notes that did not tender in the Second Exchange
Offer. The notes bear interest at a rate of 9.5% per annum, payable
semi-annually (on February 1st and August 1st) and a maturity date of August 1,
2004 when all outstanding principal is due.
By extinguishing substantially all of our long-term debt, the rating agencies
that previously rated us and our long-term debt withdrew their corporate ratings
in 2001.
(4) LOANS HELD FOR SALE, NET
Our inventory consists of first and second mortgages, which had a weighted
average interest rate of 8.45% at December 31, 2002 and 10.11% at December 31,
2001. These mortgages are being held, at the lower of cost or estimated fair
value, for future sale. Certain of these mortgages are pledged as collateral for
a portion of the warehouse financing and other borrowings.
Included in loans held for sale are deferred origination fees and purchase
premiums in the amount of $0.2 million and $0.8 million at December 31, 2002 and
2001, respectively, and a valuation allowance of approximately $0.4 million at
December 31, 2002 and $0.7 million as of December 31, 2001. Mortgages are
payable in monthly installments of principal and interest and have terms varying
from five to thirty years.
(5) ACCOUNTS RECEIVABLE
Accounts receivable as of December 31, consist of the following:
(DOLLARS IN THOUSANDS) 2002 2001
- --------------------------------------------------------------------------------
Prepaid insurance premiums $ -- 2,227
Advances on loans sold with recourse 1,335 1,550
Other 365 285
- --------------------------------------------------------------------------------
Total accounts receivable $ 1,700 4,062
- --------------------------------------------------------------------------------
Funds due to us for accounts receivable are tracked through various asset
accounts. These accounts are reconciled monthly, at which time we perform
research and resolution on the receivables. All aged items are identified and
reported to management and management decides whether to write-off any aged
items. We evaluate accounts receivable items on an individual basis and an item
is not written off until all options for payment have been exhausted.
Activity in Accounts Receivable for the years ended December 31, is as
follows (dollars in thousands):
Securitization Prepaid Insurance Current Tax Adv on Loans
2002 Servicing Advances Premiums Asset Sold w/Recourse Other Total
- -------------------------------------------------------------------------------------------------------------------------
Beginning balance $ -- 2,227 -- 1,550 285 4,062
Additions -- 168 -- 1,467 5,227 6,862
Payments -- (2,395) -- (1,653) (5,122) (9,170)
Write offs -- -- -- (29) (25) (54)
- -------------------------------------------------------------------------------------------------------------------------
Ending balance $ -- -- -- 1,335 365 1,700
- -------------------------------------------------------------------------------------------------------------------------
Securitization Prepaid Insurance Current Tax Adv on Loans
2001 Servicing Advances Premiums Asset Held w/Recourse Other Total
- -------------------------------------------------------------------------------------------------------------------------
Beginning balance $ 12,518 2,047 572 1,811 5,006 21,954
Additions 69,613 180 -- 2,604 42,688 115,085
Payments (81,967) -- (572) (2,863) (46,314) (131,716)
Write offs (164) -- -- (2) (1,095) (1,261)
- -------------------------------------------------------------------------------------------------------------------------
Ending balance $ -- 2,227 -- 1,550 285 4,062
- -------------------------------------------------------------------------------------------------------------------------
58
6) SECURITIZATION TRANSACTION
During 2002, we completed four securitizations totaling $850 million, of
which we delivered a total of $819 million of mortgage loans during 2002 (and
delivered the remaining $31 million of mortgage loans in January 2003, pursuant
to a pre-funding mechanism). During 2001, we completed two securitizations
totaling $345 million of mortgage loans. The following table sets forth certain
information with respect to our 2002 securitizations (all of which contained
ratings on various classes of securities ranging from AAA/Aaa to BBB/Baa2 by
S&P, Fitch, and Moody's, respectively) by offering size, which includes
pre-funded amounts, duration weighted average pass-through rate and type of
credit enhancement.
INITIAL DURATION
OFFERING SIZE WEIGHTED AVERAGE CREDIT
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE ENHANCEMENT
-------------- --------- ------------ --------------------- -----------
2002-1........... 03/28/02 $175.0 4.08% Hybrid *
2002-2........... 06/27/02 $200.0 2.46% Senior/Sub
2002-3........... 09/27/02 $250.0 2.61% Hybrid *
2002-4........... 12/30/02 $225.0 2.73% Hybrid*
* SENIOR/SUB STRUCTURE WITH A "AAA" RATED MONOLINE INSURER INSURING THE SENIOR
OR "AAA" RATED PASS-THROUGH CERTIFICATES.
When we securitize loans, we create trusts 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.
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
59
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.
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.
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 where we sell the excess cashflow certificate
and P certificate (which entitles the holder to all prepayment penalties
collected by the trust) 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) a NIM owner trust certificate evidencing
ownership in the NIM trust. We sell the excess cashflow certificate and P
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 and P certificate.
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 certificate
and P certificate to be used to pay all principal and interest on the NIM
note(s) until paid in full. This is estimated to occur 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, represented by the owner trust
certificate. The owner trust certificate entitles us to all cash flows generated
by the excess cashflow certificate 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 on our balance sheet as an excess cashflow certificate and value the
NIM 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 each of the four 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. 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, (3) the London Inter-Bank Offered Rate
("LIBOR") forward curve (using current LIBOR as the floor rate), and (4) a
discount rate; and
60
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.
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.
A summary of the gain on sale and cash flow we received from our aggregate
securitizations in 2002 and 2001 is presented below. "Loans sold" represents the
amount of loans actually transferred to the respective securitization trust or
trusts during each year:
YEAR ENDED DECEMBER 31,
2002 2001
---- ----
GAIN ON SALE SUMMARY (DOLLARS IN THOUSANDS)
- --------------------
Loans Sold.................................................... $ 819,042 $ 345,000
NIM Proceeds, Net of the Upfront Overcollateralization....... 5.13% --%
Interest Only Certificate Proceeds............................ --% 3.86%
Excess Cashflow Certificate (owner trust certificates) (1).... 1.28% 3.21%
Mortgage Servicing Rights (2)................................. 0.88% 1.51%
Less: Transaction Costs...................................... (0.67%) (0.60%)
---------- ----------
Net gain on sale recorded.................................. 6.62% 7.98%
========== ==========
CASH FLOW SUMMARY
NIM Proceeds, Net of the Upfront Overcollateralization........ 5.13 % -- %
Interest Only Certificate Proceeds............................ -- % 3.86%
Mortgage Servicing Rights(2).................................. 0.88 % 1.51 %
Less: Transaction Costs....................................... (0.67%) (0.60%)
---------- -----------
Net Cash Flow at Closing................................. 5.34% 4.77%
========== ===========
- ----------
(1) The reduction in value of the excess cashflow certificates in 2002 compared
to 2001 is primarily due to changes we made to our fair value assumptions of
our excess cashflow certificates (see Note 8 "Excess Cashflow Certificate,
Net").
(2) In 2001, the mortgage servicer purchased the P Certificate; in 2002, we
transferred the P Certificate to the NIM Trust, which accounts for the
reduced gain from the sale of mortgage servicing rights in 2002.
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 "Note 9").
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
certificates 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.
Each securitization trust has the benefit of either a financial guaranty
insurance policy from a monoline insurance company or a senior-subordinated
securitization structure, which insures the timely payment of interest
61
and the ultimate payment of principal of the credit-enhanced investor
certificate, or both (known as a "hybrid"). In "senior-subordinated" structures,
the senior certificate holders are protected from losses by subordinated
certificates, which absorb any such losses first. In addition to such credit
enhancement, the excess cash flows that would otherwise be paid to the holder of
the excess cashflow certificate is used when it subsequently becomes necessary
to obtain or maintain required overcollateralization limits.
Overcollateralization is intended to create an additional source of credit
enhancement to absorb losses prior to making a claim on the financial guaranty
insurance policy or the subordinated certificates.
(7) CAPITALIZED MORTGAGE SERVICING RIGHTS
Prior to 2001, we recognized rights to service mortgage loans as separate
assets. Subsequent to 2001, we do not recognize rights to service mortgage loans
because we sell our servicing rights in connection with our whole loan sales or
securitizations.
We recognized a $38.2 million write-down, which represented the entire
carrying value of our MSR at December 31, 2000. In December 2000, we entered
into discussions with three third-party non-conforming servicers to either
purchase or sub-service our entire $3.31 billion servicing portfolio. Management
felt this write-down was necessary to reflect the current market price we would
have received at December 31, 2000 for our servicing portfolio. We sold all of
our mortgage servicing rights for the years ended December 31, 2002 and 2001 and
as such had no activity or carrying values for those assets during the periods.
The activity related to our capitalized mortgage servicing rights for the year
ended December 31, 2000 is as follows:
(DOLLARS IN THOUSANDS) 2000
- --------------------------------------------------------------------------------
Balance, beginning of year $ 45,927
Additions 11,611
Amortization and FV adjustments (8,916)
Sales (10,385)
Write-down (38,237)
- --------------------------------------------------------------------------------
Balance, end of year $ --
- --------------------------------------------------------------------------------
(8) EXCESS CASHFLOW CERTIFICATES, NET
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 in Note
6).
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.
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.
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) are 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.
62
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 ongoing
analysis of the performance of mortgage pools we previously securitized,
and the performance of similar pools of mortgage loans securitized by
others in the industry. We apply different prepayment speed assumptions to
different loan product types because it has been our experience that
different loan product types exhibit different prepayment patterns.
Generally, our loans can be grouped into two loan products - fixed rate
loans and adjustable rate loans. With fixed rate loans, an underlying
borrower's interest rate remains fixed throughout the life of the loan.
Our adjustable rate loans are really a "hybrid" between fixed and
adjustable rate loans, in that the rate generally remains fixed for
typically the first three years of the loan, and then adjusts typically
every six months thereafter. Within each product type, other factors can
affect prepayment rate assumptions.
The following table shows our most recent changes to 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 AT SEPTEMBER 30, 2001 AT SEPTEMBER 30, 2000
---------------------------------------------------------------------
Fixed Rate:
At Month 4.00% 4.00%
Peak Speed 30.00% 23.00%
Adjustable Rate:
At Month 4.00% 4.00%
Peak Speed 75.00% 50.00%
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 December 31, 2002 and December 31, 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 then a 6 month
variable rate of interest thereafter using the 6 month LIBOR index). A
significant portion of our loans are fixed rate mortgages and a
significant amount of these fixed rate loans are backed by floating rate
securities (I.E., 1 month LIBOR). As such, our excess cashflow
certificates are subject to significant basis risk and a change in LIBOR
will, therefore, impact our excess spread. If LIBOR is lower than
anticipated, we will receive more income and more excess cash flows than
expected in the future; conversely, if LIBOR is higher than anticipated,
we will less income and less excess cash flows 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
63
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 December 31, 2002 and December 31,
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.
In the third quarter of 2000, we had increased the discount rate we used on
those excess cashflow certificates included in the NIM transaction to 18% (from
12%) and recorded an $8.8 million valuation adjustment. The adjustment reflected
a reduction in the present value of those excess cashflow certificates sold in
connection with our NIM transaction completed in the fourth quarter of 2000. We
increased the discount rate on these excess cashflow certificates during the
period that the senior NIM securities remain outstanding, to account for the
potentially higher risk associated with the residual cash flows expected to be
received by the holder of the certificated interest in the NIM trust, which is
subordinated to the multiple senior securities sold in the NIM transaction.
In the fourth quarter of 2000, we had increased the discount rate we used in
determining the present value of our "senior" excess cashflow certificates to
13% from 12%, and recorded a $7.1 million valuation adjustment. The adjustment
reflected an increase in volatility concerning the other underlying assumptions
used in estimating expected future cash flows due to greater uncertainty
surrounding current and future market conditions, including without limitation,
inflation, recession, home prices, interest rates and equity markets.
For 2000, we recorded a non-cash increase of $9.6 million to interest income
for a fair value adjustment to our excess cashflow certificates, due to the
decrease in one-month LIBOR. Some of the our excess cashflow certificates are
backed by floating rate securities, which are susceptible to interest rate risk
(positive or negative) associated with a movement in short-term interest rates.
At September 30, 2001, we recorded a charge to interest income to reflect a
fair value adjustment to our remaining excess cashflow certificates totaling
$19.7 million. Our change in assumptions at September 30, 2001, primarily
reflect recent unforeseen market events relating to the terrorist attacks on
September 11, 2001, that further accelerated an economic downturn in the U.S.
economy, and which we believe may have a significant adverse impact on the
economy for the foreseeable future.
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 "step-down" of the
overcollateralization account.
The activity related to our excess cashflow certificates for the years ended
December 31, is as follows:
(DOLLARS IN THOUSANDS) 2002 2001 2000
- ------------------------------------------------------------------------------------------
Balance, beginning of year $ 16,765 216,907 224,659
New excess cashflow certificates 10,499 11,081 32,716
New NIM certificates -- -- 73,658
Cash received from excess cashflow certificates (2,588) (9,990) (28,444)
Net accretion of excess cashflow certificates 1,974 11,935 35,224
Fair value adjustments (2,085) (19,676) (6,324)
Sales -- (40,402) (2,131)
NIM certificate sales -- -- (112,451)
Second Exchange Offer -- (153,090) --
- ------------------------------------------------------------------------------------------
Balance, end of year $ 24,565 16,765 216,907
- ------------------------------------------------------------------------------------------
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.
64
In volatile markets, like those we have experienced in 2002 and in 2001,
there is increased risk that our actual results may vary significantly from our
assumed results. The greater the time period over which the uncertainty will
exist, the greater the potential volatility for our valuation assumptions.
At December 31, 2002, key economic assumptions and the sensitivity of the
current estimated fair value of retained interests caused by immediate 10% and
20% adverse changes in those assumptions are as follows:
Fair value of excess Impact to
(Dollars in thousands) cashflow certificates earnings
- ----------------------------------------------------------------------------
Fair value as of 12/31/02: $ 24,565
10% increase in prepayment speed 19,011 $5,554
20% increase in prepayment speed 15,476 9,089
10% increase in credit losses 19,012 5,553
20% increase in credit losses 14,448 10,117
10% increase in discount rates 23,032 1,533
20% increase in discount rates 21,676 2,889
10% increase in one- & six-month LIBOR 21,809 2,756
20% increase in one- & six-month LIBOR 19,227 5,338
These sensitivities are hypothetical and are presented for illustrative
purposes only. Changes in carrying amount based on a change in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in carrying amount may not be linear. The changes in
assumptions presented in the above table were calculated without changing any
other assumption; in reality, changes in one assumption may result in changes in
another, which may magnify or counteract the sensitivities. For example, changes
in market interest rates may simultaneously impact repayment speed, credit
losses and the discount rate.
(9) HEDGING TRANSACTIONS
We did not hedge during the years ended December 31, 2002 and December 31,
2001. For the year ended December 31, 2000, we recorded a hedge loss of $2.1
million, which largely offset a change in the value of mortgage loans being
hedged, as part of our net gain on sale of loans.
(10) WAREHOUSE FINANCING AND OTHER BORROWINGS
We have two warehouse credit facilities for a combined amount of $400.0
million as of December 31, 2002. At December 31, 2001 we had one warehouse
credit facility in the amount of $200.0 million. The lines are collateralized by
specific mortgage receivables, which are equal to or greater than the
outstanding balances under the line at any point in time.
The following table summarizes certain information regarding warehouse
financing and other borrowings at December 31:
(DOLLARS IN MILLIONS)
BALANCE
Facility ------- Expiration
Facility Description Amount Rate 2002 2001 Date
- -----------------------------------------------------------------------------------------------------------
Warehouse line of credit $200.0 LIBOR + 1.125% $ -- 80.9 May 2003
Warehouse line of credit $200.0 LIBOR + 1.125% 13.8 -- May 2003
Capital leases n/a 3.76% - 12.50% 2.6 6.7 March 2003 - June 2006
Other Borrowings n/a 7.00% - 8.00% -- 2.0 --
- -----------------------------------------------------------------------------------------------------------
Total $400.0 $ 16.4 89.6
- -----------------------------------------------------------------------------------------------------------
65
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. We believe we are in compliance with such covenants as of
December 31, 2002.
Future contractual obligations related to principal balances for capital
leases as of December 31, 2002 and 2001 are as follows:
(Dollars in thousands)
PERIOD 2002 2001
- --------------------------------------------------------------------------------
Less than 1 year $ 1,953 4,704
1-3 years 642 2,033
- --------------------------------------------------------------------------------
Total $ 2,595 6,737
- --------------------------------------------------------------------------------
(11) SENIOR NOTES
In July 1997, we issued $150 million in the aggregate of 9 1/2% senior
notes due 2004. These notes were the subject of two exchange offers (as
described in more detail in Note 3), which modified the terms of the indenture
governing then notes - the second of which resulted in the extinguishment of
approximately $139.2 million of the notes in 2001.
The outstanding balance of the notes totaled $10.8 million as of December
31, 2002 and 2001. The outstanding balance as of December 31, 2000, prior to the
restructuring (as described in Note 3), totaled $149.6 million, net of
unamortized bond discount. During 2001, in connection with the restructuring, we
wrote off the unamortized issuance cost related to the Senior Note of
approximately $2.5 million.
(12) BANK PAYABLE
In order to maximize our cash management practices, we have instituted a
procedure whereby checks written against our operating account are covered as
they are presented to the bank for payment, either by drawing down our lines of
credit or from subsequent deposits of operating cash. Bank payable represents
the checks outstanding at December 31, 2002 and 2001, to be paid in this manner.
(13) EMPLOYEE BENEFIT PLANS
We sponsor a 401(k) Retirement Savings Plan. Substantially all our
employees who are at least 21 years old are eligible to participate in the plan
after completing one year of service. Contributions are made from employees'
elected salary deferrals. We elected to make discretionary contributions to the
Plan of $0.3 million, $0.5 million and $0.7 million for 2002, 2001 and 2000,
respectively.
(14) COMMITMENTS AND CONTINGENCIES
We have repurchase agreements with certain of the institutions that have
purchased mortgages. 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 that were sold with recourse and are still
outstanding totaled $2.6 million at December 31, 2002 and $3.5 million at
December 31, 2001.
Included in accounts payable is an allowance for recourse losses of $1.2
million at December 31, 2002 and $1.4 million at December 31, 2001,
respectively. We recognized, as a charge to operations, a provision for recourse
losses of approximately $73,500, $311,000 and $11,600 for the years 2002, 2001
and 2000, respectively. Additions to the allowance for loan losses are provided
by charges to income based upon various factors, which, in management's
judgment, deserve current recognition in estimating probable losses. The loss
factors are determined by management based upon an evaluation of historical loss
experience, delinquency trends, loan volume and the impact of economic
conditions in our market area.
66
Our rental expense, net of sublease income, for the years ended December
31, 2002, 2001 and 2000 amounted to $4.5 million, $5.0 million and $7.0 million,
respectively.
Minimum future rentals under non-cancelable operating leases as of December
31, 2002 are as follows:
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Year Amount
- --------------------------------------------------------------------------------
2003 $ 3,944
2004 3,511
2005 3,381
2006 3,274
2007 3,130
2008 710
- --------------------------------------------------------------------------------
Total $ 17,950
- --------------------------------------------------------------------------------
Because the nature of our business involves the collection of numerous
accounts, the validity of liens and compliance with various state and federal
lending laws, we are subject, in the normal course of business, to numerous
legal proceedings and claims, including several class action lawsuits. The
resolution of these lawsuits, in management's opinion, will not have a material
adverse effect on our financial position or results of operations.
(15) STOCK OPTION PLAN
The 1996 Stock Option Plan (the "1996 Plan") authorized the reserve of
2,200,000 shares of unissued common stock for issuance pursuant to the 1996
Plan. The 2001 Stock Option Plan (the "2001 Plan," collectively with the 1996
Plan, the "Plans") authorized the reserve of 1,500,000 shares of unissued common
stock for issuance pursuant to the 2001 Plan. Substantially all of the options
issued vest over a five-year period at 20% per year and expire seven years from
the grant date.
The following table summarizes certain information regarding the Plans at
December 31:
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------
Number Wtd-Avg Number Wtd-Avg Number Wtd-Avg
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
- ------------------------------------------------------------------------------------------------------------
Balance, beginning of year 2,179,000 $4.25 990,700 $ 12.38 1,146,050 $ 12.44
Options granted 800,500 1.83 1,658,300 0.50 20,000 2.00
Options exercised 21,800 0.50 -- -- -- --
Options canceled 457,650 12.48 470,000 8.17 175,350 11.57
- ------------------------------------------------------------------------------------------------------------
Balance at end of year 2,500,050 $2.00 2,179,000 $4.25 990,700 $12.38
- ------------------------------------------------------------------------------------------------------------
Options exercisable 519,380 $4.79 515,650 $13.97 513,120 $15.07
- ------------------------------------------------------------------------------------------------------------
The weighted-average fair value of options granted during 2002, 2001 and 2000
was $1.25, $1.21 and $0.34, respectively. For purposes of the pro forma
calculation under SFAS No. 123, the fair value of the options granted is
estimated using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for the 2002, 2001 and 2000 grants:
2002 2001 2000
- --------------------------------------------------------------------------------
Dividend yield 0% 0% 0%
Expected volatility 103% 164% 145%
Risk-free interest rate 2.87% 4.22% 6.14%
Expected life 5 years 5 years 5 years
Average remaining contractual life 5.37 years 5.28 years 3.70 years
67
(16) INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
2002, 2001 and 2000 is as follows:
(DOLLARS IN THOUSANDS) 2002 2001 2000
- --------------------------------------------------------------------------------
Current: Federal $ (1,121) 1,847 2,203
State & Local (648) 1,029 600
- --------------------------------------------------------------------------------
Total current income taxes $ (1,769) 2,876 2,803
- --------------------------------------------------------------------------------
Deferred: Federal $ 3,560 (31,053) (19,860)
State & Local 848 (7,393) (4,448)
Valuation allowance (4,408) 38,446 8,297
- --------------------------------------------------------------------------------
Total deferred income taxes -- -- (16,011)
- --------------------------------------------------------------------------------
Total tax provision (benefit) $ (1,769) 2,876 (13,208)
- --------------------------------------------------------------------------------
Significant components (temporary differences and carryforwards) that give
rise to our net deferred tax asset as of December 31, 2002 and 2001 were as
follows:
(DOLLARS IN THOUSANDS)
DEFERRED TAX ASSETS:
- --------------------------------------------------------------------------------
Book/tax difference in excess cashflow
certificates, net carrying amount $ 14,832 6,721
Loss reserves 1,879 2,887
Book over tax depreciation 419 159
Federal and State net operating loss carryforwards 30,905 42,894
- --------------------------------------------------------------------------------
Gross deferred tax assets $ 48,035 52,661
Less: Valuation Allowance 42,335 46,743
- --------------------------------------------------------------------------------
Deferred tax assets net of valuation allowance $ 5,700 5,918
- --------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
- --------------------------------------------------------------------------------
Capitalized origination fees and related cost $ 100 318
- --------------------------------------------------------------------------------
Gross deferred tax liabilities 100 318
- --------------------------------------------------------------------------------
Net deferred tax assets $ 5,600 5,600
- --------------------------------------------------------------------------------
We are required to recognize all or a portion of our gross deferred tax
assets if we believe that it is more likely than not, given the weight of all
available evidence, that all or a portion of the benefits of the carryforward
losses and other deferred tax assets will be realized. Management believes that,
based on the available evidence, it is more likely than not that we will realize
the benefit from our gross deferred tax assets, net of the valuation allowance.
A valuation allowance was initially established in 2000 and increased in 2001
because, it was unclear whether we would have sufficient earnings in the then
immediate future to ensure realization of our entire gross deferred tax assets,
following two consecutive years of significant losses. We are constantly
evaluating the anticipated amount and recoverability of the gross deferred tax
asset in light of our historical operations and susceptibility to changes in
market conditions.
As of December 31, 2002, Federal and State net operating loss carryforwards
("NOLs") totaled approximately $77.2 million, with $3.9 million expiring in
2020, and $73.3 million expiring in 2021.
68
A reconciliation of the statutory income tax rate to the effective income tax
rate, as applied to income (loss) for the years ended December 31, 2002, 2001
and 2000 is as follows:
2002 2001 2000
- ----------------------------------------------------------------------------------------
Tax at statutory rate 35.0% 35.0% 35.0%
State & local taxes, net of Federal benefit 0.8 4.3 4.0
Change in valuation allowance for deferred tax assets (27.7) (39.7) (13.2)
Non-deductible expenses and other (19.2) (2.6) 4.7
- ----------------------------------------------------------------------------------------
Total tax rate (11.1)% (3.0)% 21.1%
- ----------------------------------------------------------------------------------------
(17) EARNINGS PER SHARE
The following is a reconciliation of the denominators used in the
computations of basic and diluted EPS. The numerator for calculating both basic
and diluted EPS is net income.
For the years ended December 31:
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 2002 2001 2000
- --------------------------------------------------------------------------------
Net income (loss) $17,637 (99,790) (49,417)
- --------------------------------------------------------------------------------
Weighted-average shares - basic 15,895 15,884 15,884
Incremental shares-options 1,076 -- --
- --------------------------------------------------------------------------------
Weighted-average shares - diluted 16,971 15,884 15,884
- --------------------------------------------------------------------------------
Basic earnings per share:
- --------------------------------------------------------------------------------
Net income (loss) $ 1.11 (6.28) (3.11)
- --------------------------------------------------------------------------------
Diluted earnings per share:
- --------------------------------------------------------------------------------
Net income (loss) $ 1.04 (6.28) (3.11)
- --------------------------------------------------------------------------------
For 2001 and 2000 Stock Options of approximately 23,000 and 37,000,
respectively, are excluded from the calculation of diluted EPS because their
effect is antidiluted in periods where losses are reported.
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table is a summary of financial data by quarter for the years
ended December 31, 2002 and 2001:
For the quarters ended
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) March 31, June 30, Sept. 30, Dec. 31,
- ------------------------------------------------------------------------------------------------------
2002
Revenues(a) $ 19,644 21,577 21,823 23,099
Expenses 17,279 17,473 17,261 18,262
Net income(a)(b) 2,245 3,972 6,698 4,722
Earnings per share basic(a)(b) 0.14 0.25 0.42 0.30
Earnings per share diluted(a)(b) 0.14 0.23 0.39 0.28
2001
Revenues (c)(e) $(2,982) 25,106 (10,304) 21,328
Expenses (c)(d)(e) 30,298 41,541 40,745 17,478
Net income (loss) (c)(d)(e) (33,752) (16,528) (52,910) 3,400
Earnings (loss) per share basic and diluted(c)(d)(e) (2.12) (1.04) (3.33) 0.21
- -----------------------------
(a) The quarter ended March 31, 2002 includes a charge of $2.1 million, which
represents a fair value adjustment to our excess cashflow certificates.
(b) The quarter ended September 30, 2002 includes a special tax benefit of $2.2
million related to us obtaining a favorable resolution to tax issue for
which we had previously reserved and do not expect to recur.
69
(c) The quarter ended March 31, 2001 includes: (1) a $25.4 million write-down of
excess cashflow certificates relating to a sale agreement entered into by
us, (2) a $0.8 million charge related to disposition of branches, and (3) a
$0.5 million related to restructuring charges.
(d) The quarter ended June 30, 2001 includes non-recurring charges principally
incurred in connection with the recognition of cost attributable to the
disposition and transfer of our servicing platform of $10.7 million and a
change in accounting estimate regarding the life expectancy of our equipment
of $3.6 million. In addition, we recorded a $1.5 million charge related to a
fair value adjustment to a pool of non-performing loans.
(e) The quarter ended September 30, 2001 includes a charge of $19.7 million,
which represents a fair value adjustment to our remaining excess cashflow
certificates. We changed the valuation assumptions we use to estimate fair
value. The quarter also includes a charge of $19.3 million related to the
extingushment of debt .The quarter also includes a non-recurring charge of
$1.4 million relating to professional fees incurred in connection with the
Second Exchange Offer.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
PART III
ITEM 10.
We incorporate by reference information in our proxy statement that complies
with the information called for by Item 10 of Form 10-K. The proxy will be filed
at a later date with the Commission.
ITEM 11.
We incorporate by reference information in our proxy statement that complies
with the information called for by Item 11 of Form 10-K. The proxy will be filed
at a later date with the Commission.
ITEM 12.
We incorporate by reference information in our proxy statement that complies
with the information called for by Item 12 of Form 10-K. The proxy will be filed
at a later date with the Commission.
The following securities to be issued under our equity compensation plans at
December 31, 2002 have been approved by security holders:
EQUITY COMPENSATION PLAN INFORMATION
- ------------------------------------------------------------------------------------------------------------------
PLAN CATEGORY NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE NUMBER OF SECURITIES REMAINING
ISSUED UPON EXERCISE OF EXERCISE PRICE OF AVAILABLE FOR FUTURE ISSUANCE
OUTSTANDING OPTIONS OUTSTANDING OPTIONS UNDER EQUITY COMPENSATION
PLANS (1)
(A) (B) (C)
- ------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 2,500,050 $ 2.00 1,199,950
Equity compensation plans not
approved by security holders n/a n/a n/a
Total 2,500,050 $ 2.00 1,199,950
- ----------------
(1) Excluding securities reflected in the first column.
ITEMS 13.
We incorporate by reference information in our proxy statement that complies
with the information called for by Item 13 of Form 10-K. The proxy will be filed
at a later date with the Commission.
70
ITEM 14. 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 IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A)(1) FINANCIAL STATEMENTS
PAGE(S)
-------
The following Consolidated Financial Statements of Delta Financial
Corporation and Subsidiaries are included in Part II, Item 8 of this
report
Independent Auditors' Report........................................................... 47
Consolidated Balance Sheets--December 31, 2002 and 2001................................ 48
Consolidated Statements of Operations--Years ended December 31, 2002, 2001 and 2000.... 49
Consolidated Statement of Changes in Stockholders' Equity--Years ended
December 31, 2002, 2001 and 2000................................................... 50
Consolidated Statements of Cash Flows--Years ended December 31, 2002, 2001 and
2000............................................................................... 51
Notes to Consolidated Financial Statements............................................. 52
(A)(3) EXHIBITS:
EXH.
NO. FILED DESCRIPTION
--- ---- ----------
3.1 (a) -- Certificate of Incorporation of Delta Financial Corporation
3.2 (e) -- Second Amended Bylaws of Delta Financial Corporation
3.3 (m) -- Certificate of Designations, Voting Powers, Preferences and Rights of Series A
Preferred Stock of Delta Financial Corporation
4.1 (b) -- Indenture dated July 23, 1997, between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.2 (g) -- First Supplemental Indenture dated August 1, 2000, between
Delta Financial Corporation, its subsidiary guarantors and
The Bank of New York, as Trustee
4.3 (k) -- Second Supplemental Indenture dated October 16, 2000,
between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.4 (k) -- Third Supplemental Indenture dated November 20, 2000
between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.5 (k) -- Fourth Supplemental Indenture dated December 21, 2000
between Delta Financial Corporation, its subsidiary
guarantors and The Bank of New York, as Trustee
4.6 (h) -- Indenture, dated December 21, 2000, relating to the 9 1/2% Senior Secured Notes due
2004 by and between Delta Financial Corporation, its subsidiary guarantors and U.S. Bank
Trust National Association, as Trustee.
4.7 (k) -- First Supplemental Indenture dated January 11, 2001, between Delta Financial
Corporation, its subsidiary guarantors and U.S. Bank Trust National Association, as Trustee
4.8 (k) -- Second Supplemental Indenture dated February 12, 2001, between Delta Financial
Corporation, its subsidiary guarantors and U.S. Bank Trust National Association, as Trustee
4.9 (i) -- Letter of Intent and Term Sheet, by and among the
Delta Financial Corporation and certain beneficial holders
of the Senior Secured Notes, dated as of February 23, 2001.
4.10 (j) -- Third Supplemental Indenture dated March 16, 2001, between Delta Financial Corporation, its
subsidiary guarantors and U.S. Bank Trust National Association, as Trustee
71
4.11 (l) -- Fourth Supplemental Indenture dated July 31, 2001, between Delta Financial Corporation, its
subsidiary guarantors and U.S. Bank Trust National Association, as Trustee
4.12 (m) -- Fifth Supplemental Indenture dated August 27, 2001, between Delta Financial Corporation, its
subsidiary guarantors and U.S. Bank Trust National Association, as Trustee
10.2 (m) -- Employment Agreement dated February 27, 2002 between the Registrant and Hugh Miller
10.3 (n) -- Employment Agreement dated September 12, 2002 between the Registrant and Sidney A. Miller.
10.4 (m) -- Employment Agreement dated September 24, 2001 between the Registrant and Randall F. Michaels
10.5 (m) -- Employment Agreement dated February 27, 2002 between the Registrant and Richard Blass
10.7 (a) -- Lease Agreement between Delta Funding Corporation and the Tilles Investment Company, and the
Second, Third and Fourth Amendments to Lease Agreement
10.8 (c) -- Fifth, Sixth and Seventh Amendments to Lease Agreement between Delta Funding
Corporation and the Tilles Investment Company
10.9 (d) -- Eighth Amendment to Lease Agreement between Delta Funding Corporation and the Tilles
Investment Company
10.10 (m) -- Ninth Amendment to Lease Agreement between Delta Funding Corporation and the Tilles
Investment Company
10.11 (a) -- 1996 Stock Option Plan of Delta Financial Corporation
10.12 (m) -- 2001 Stock Option Plan of Delta Financial Corporation
21.1 (o) -- Subsidiaries of Registrant
23.1 (o) -- Consent of Independent Auditors
- ---------------
(a) Incorporated by reference from our Registration Statement on Form S-1 (No.
333-11289), filed with the Commission on October 9, 1996.
(b) Incorporated by reference from our Current Report on Form 8-K (No.
001-12109), filed with the Commission on July 30, 1997.
(c) Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12109), filed with the Commission on
March 31, 1998.
(d) Incorporated by reference from our Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998 (File No. 1-12109), filed with the Commission
on May 12, 1998.
(e) Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 1998 (File No. 1-12109), filed with the Commission on
March 31, 1999.
(f) Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 1999 (File No. 1-12109), filed with the Commission on
March 31, 2000.
(g) Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on August 4, 2000.
(h) Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on January 10, 2001.
(i) Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on March 2, 2001.
(j) Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on March 22, 2001.
(k) Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 2000 (File No. 1-12109), filed with the Commission on
April 2, 2001.
(l) Incorporated by reference from our Current Report on Form 8-K (File No.
1-12109), filed with the Commission on August 3, 2001.
(m) Incorporated by reference from our Annual Report on Form 10-K for the year
ended December 31, 2001 (File No. 1-12109), filed with the Commission on
April 1, 2002.
(n) Incorporated by reference from our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002 (File No. 1-12109), filed with the
Commission on November 13, 2002.
(o) Filed herewith
(B) REPORTS ON FORM 8-K.
On December 23, 2002, we filed a Current Report on Form 8-K under Item 5,
in which we announced that, effective December 21, 2002, the exercise price for
warrants issued by us under a Warrant Agreement, dated December 21, 2000, by and
between the Company and Mellon Investor Services LLP, as warrant agent, was
adjusted from $9.10 per share to $0.01 per share in accordance with Section 6 of
the Warrant Agreement.
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized.
DELTA FINANCIAL CORPORATION
(Registrant)
Dated: March 27, 2003 By: /S/ HUGH MILLER
--------------------------
Hugh Miller
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
- -------------------------------- --------------------------------------- ----------------
/S/ SIDNEY A. MILLER Chairman of the Board of Directors March 27, 2003
- --------------------------------
Sidney A. Miller
/S/ HUGH MILLER President, Chief Executive Officer and Director March 27, 2003
- ------------------------------- (Principal Executive Officer)
Hugh Miller
/S/ RICHARD BLASS Executive Vice President, Chief Financial Officer March 27, 2003
- ------------------------------- and Director (Principal Financial Officer)
Richard Blass
/S/ MARTIN D. PAYSON Director March 27, 2003
- -------------------------------
Martin D. Payson
/S/ ARNOLD B. POLLARD Director March 27, 2003
- -------------------------------
Arnold B. Pollard
/S/ MARGARET WILLIAMS Director March 27, 2003
- --------------------------------
Margaret Williams
73
I, Hugh Miller, Chief Executive Officer of Delta Financial Corporation
(the "Company"), certify that:
1. I have reviewed this annual report on Form 10-K of the Company;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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:
o 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 annual
report is being prepared;
o 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 annual report (the "Evaluation Date"); and
o presented in this annual 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
6. The Company's other certifying officers and I have indicated in this annual
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: March 27, 2003
By:/S/ HUGH MILLER
-----------------------------------
Hugh Miller
PRESIDENT AND CHIEF EXECUTIVE OFFICER
74
CERTIFICATION
I, Richard Blass, Chief Financial Officer of Delta Financial Corporation
(the "Company"), certify that:
1. I have reviewed this annual report on Form 10-K of the Company;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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:
o 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 annual report
is being prepared;
o 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 annual report (the "Evaluation Date"); and
o presented in this annual 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
6. The Company's other certifying officers and I have indicated in this
annual 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: March 27, 2003
By: /S/ RICHARD BLASS
------------------------------
Richard Blass
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
75
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 annual report on Form 10-K of the Company for the year ended December 31,
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-K 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 27th day of March,
2003.
/s/HUGH MILLER
-------------------------------------
Hugh Miller
PRESIDENT AND CHIEF EXECUTIVE OFFICER
76
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 annual report on Form 10-K of the Company for the year ended December 31,
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-K 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 27th day of March,
2003.
/s/RICHARD BLASS
-------------------------------------
Richard Blass
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
77