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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NO. 1-12109
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DELTA FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 11-3336165
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1000 WOODBURY ROAD, SUITE 200,
WOODBURY, NEW YORK 11797
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (516) 364-8500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of March 24, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $18.50, was
approximately $90,172,830.
As of March 24, 1998, the Registrant had 15,372,688 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, items 10, 11, 12 and 13 are incorporated by reference to 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, 1997.
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PART I
ITEM 1. BUSINESS
Delta Financial Corporation, together with its subsidiaries ( the "Company"
or "Delta"), is a consumer finance company that has engaged in originating,
acquiring, selling and servicing non-conforming home equity loans since 1982.
Throughout its 16 years of operating history, Delta has focused on lending to
individuals who generally have impaired or limited credit profiles or higher
debt-to-income ratios and typically have substantial equity in their homes.
Management believes that these borrowers have largely been unsatisfied by the
more traditional sources of mortgage credit which underwrite loans to
conventional guidelines established by the Federal National Mortgage
Associations ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
The Company makes loans to these borrowers for such purposes as debt
consolidation, home improvement, mortgage refinancing or education, and these
loans are primarily secured by first mortgages on one- to four-family
residential properties.
Through its wholly-owned subsidiary, Delta Funding Corporation, the Company
originates home equity loans indirectly through licensed mortgage brokers and
other real estate professionals who submit loan applications on behalf of the
borrower ("Brokered Loans") and also purchases loans from mortgage bankers and
smaller financial institutions that satisfy Delta's underwriting guidelines
("Correspondent Loans"). Delta Funding Corporation currently originates and
purchases the majority of its loans in 22 states, through its network of
approximately 1,150 brokers and correspondents.
In February 1997, in an effort to broaden its origination sources and to
expand its geographic presence, the Company acquired two related retail
originators of home equity loans, Fidelity Mortgage Inc., based in Cincinnati,
Ohio, and Fidelity Mortgage (Florida), Inc., based in West Palm Beach, Florida,
and subsequently merged the two companies into Fidelity Mortgage Inc. ("Fidelity
Mortgage"). Fidelity Mortgage develops retail loan leads primarily through its
telemarketing system and its network of 15 retail offices located in Florida
(3), Georgia, Illinois, Indiana, Missouri, North Carolina, Ohio (4),
Pennsylvania (2) and Tennessee.
For the year ended December 31, 1997, the Company originated and purchased
approximately $1.25 billion of loans, of which approximately $482 million were
originated through its network of brokers, $633 million were purchased from its
network of correspondents and $140 million were originated through its Fidelity
Mortgage retail network.
Substantially all of the loans originated and purchased by the Company were
sold in securitizations in which the loans were transferred to a trust which had
raised the cash payment to purchase the loans through the sale of asset-backed
pass-through securities. For the year ended December 31, 1997, Delta sold a
total of $1.24 billion of loans through four real estate mortgage investment
conduit ("REMIC") securitizations. Each of these four securitizations were
credit-enhanced, by either an insurance policy provided through a monoline
insurance company or a senior-subordinated structure, to receive ratings of Aaa
from Moody's Investors Service, Inc. ("Moody's") and AAA from Standard & Poor's
Ratings Group, a division of The McGraw-Hill Companies, Inc. ("S&P"). The
Company sells loans through securitizations to enhance its operating leverage
and liquidity, to minimize financing costs and to reduce its exposure to
fluctuations in interest rates.
The majority of the Company's revenues and cash flows result from its
securitizations and servicing of home-equity loans that it has originated or
purchased. In a securitization, the Company sells the loans to a trust for a
cash payment while retaining (i) the right to service the loans, and receive its
contractual servicing fee and (ii) interest-only and residual certificates in
the trust, which entitle the Company to receive the "Excess Servicing" income,
consisting of any cash flows collected by the trust from principal, and interest
payments on its loans after the trust has first paid (a) all principal and
interest required to be passed through to holders of the trust's securities, (b)
all contractual servicing fees, and (c) other recurring fees and costs of
administering the trust. Upon securitizating a pool of loans, the Company
recognizes a gain on sale of loans ("net gain on sale of mortgage loans") equal
to the difference between cash received from the trust and the investment in the
loans remaining after the allocation of portions of that investment to record
the servicing rights and interest-only and residual certificates received in the
securitization. The majority of the net gain on the sale of mortgage loans
results from, and is initially realized in the form of, the retention of the
mortgage servicing rights and interest-only and residual certificates. The
servicing rights and interest-only and residual certificates are each recorded
based on their fair values, estimated based on a discount rate which management
believes reflects the rate market participants would utilize in purchasing
similar
1
servicing rights and interest-only and residual certificates, and the
stated terms of the transferred loans adjusted for estimates of future
prepayments rates and defaults among those loans. If actual prepayments and/or
defaults exceed the Company's estimates, the future cash flows from the
servicing rights and interest-only and residual certificates would be negatively
affected. (See "Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Accounting Considerations.")
Although the Company recognizes income from the securitization of loans at
the time of the securitization, the Company receives cash flows from the
securitization, in particular the retained servicing rights and interest-only
and residual certificates, over the life of the transferred loans.
The Company services substantially all of the loans it has originated or
purchased, including all of the loans sold through securitizations. As of
December 31, 1997, the Company has a loan servicing portfolio of $1.84 billion.
The Company begins to receive cash flows from monthly contractual servicing
fees in the month following the securitization. The Company's servicing fees
range from 0.50% to 0.65% per annum of the outstanding balance of the loans
being serviced.
Cash flows from the interest-only and residual certificates retained upon
securitization generally begin eight to twelve months after the securitization,
with the specific period depending on the structure and performance of the
securitization. Initially, securitization trusts utilize the Excess Servicing
cash flows to make additional payments of principal on the pass-through
certificates in order to establish a spread between the principal amount of the
trust's outstanding loans and the amount of outstanding pass-through
certificates. Once a spread of between 2% and 3% of the initial securitization
principal (the "overcollateralization limit") is established, the Excess
Servicing cash flows are distributed to Delta as the holder of the interest-only
and residual certificates.
In addition to the income and cash flows earned from the Company's
securitizations, the Company also earns income and generates cash flows from the
net interest spread earned on loans while they are held for sale, and from loan
origination fees on Brokered Loans and retail loans.
The Company's business strategy is to increase profitably the volume of its
loan originations and purchases and the size of its servicing portfolio by (i)
continuing to provide top quality service to its network of brokers and
correspondents, as well as to its retail clients, (ii) maintaining its
underwriting standards, (iii) further penetrating its established and
recently-entered markets and expanding into new geographic markets, (iv)
expanding its retail origination capabilities; (v) leveraging and continuing its
investment in information and processing technologies, and (vi) strengthening
its loan production capabilities through acquisitions.
Delta Financial Corporation was incorporated in 1996 to acquire all of the
outstanding stock of Delta Funding Corporation, which has operated since 1982.
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Delta's consumer finance activities consist of originating, acquiring,
selling and servicing non-conforming mortgage loans. These loans are primarily
secured by first mortgages on one- to four-family residences. Once loan
applications have been received, the underwriting process completed and the
loans funded or purchased, Delta typically packages the loans in a portfolio and
sells the portfolio through a securitization. Delta retains the right to service
the loans that it securitizes.
The Company focuses on providing its customers with an array of loan products
designed to meet their needs. The Company uses a risk-based pricing strategy and
has developed products for various risk categories. Historically, the Company
offered fixed-rate loan products and, to date, the majority of the Company's
loan production is fixed-rate. However, as the Company has expanded
geographically, it has expanded its product offerings to include adjustable-rate
mortgages and fixed/adjustable-rate mortgages.
Historically, the Company conducted substantially all of its broker and
correspondent lending operations out of its Woodbury, New York headquarters.
Recently, however, the Company has begun opening regional branch offices, which
include loan processing, underwriting and business development functions, to
bring it in closer
2
contact with brokers and correspondents, enhance customer service and
underscore Delta's long-term commitment in newer regions. Typically, these
offices are staffed with a combination of experienced Delta personnel who
oversee the implementation of Delta's operating methods and local employees with
established relationships in, and specific knowledge of, the local market.
Currently, the Company's Southeast regional office (Atlanta, Georgia), which is
staffed by two members of Delta's senior management, including a Vice President
of Underwriting, is the only "full service" regional branch with full
underwriting authority. Delta's Midwest (Chicago, Illinois) and New England
(Warwick, Rhode Island) regional offices are "full processing" regional
branches, for which final underwriting approval is required from the Woodbury,
New York headquarters for all mortgage loans. As these branches mature and
demonstrate their ability to meet Delta's operating standards, the Company
intends to further strengthen their operations by delegating full underwriting
authority, thereby increasing the Company's long-term growth potential. The
Fidelity Mortgage offices have full underwriting authority.
LOAN ORIGINATION AND PURCHASES
The Company increased its loan originations and purchases by 90% to $1.25
billion in 1997 from $659 million in 1996, which was an increase of 129% over
1995 production of $288 million.
Delta currently originates and purchases the majority of its loans in 22
states through its network of approximately 1,150 brokers and correspondents,
and its network of 15 retail branches.
The following table shows the channels of the Company's loan originations and
purchases for the years shown:
YEAR ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
Broker:
Principal balance...................... $ 481,586 $ 321,733 $ 175,738
Average principal balance per loan..... $ 87 $ 85 $ 76
Combined weighted average initial loan-
to-value ratio(1).................... 69.9% 67.7% 62.3%
Weighted average interest rate......... 10.8% 11.1% 11.4%
Correspondent:
Principal balance...................... $ 632,639 $ 337,033 $ 112,065
Average principal balance per loan..... $ 77 $ 73 $ 70
Combined weighted average initial loan-
to-value ratio(1).................... 72.8% 69.8% 64.5%
Weighted average interest rate......... 11.3% 11.7% 12.4%
Retail:
Principal balance...................... $ 140,386 $ n/a $ n/a
Average principal balance per loan..... $ 69 $ n/a $ n/a
Combined weighted average initial loan-
to-value ratio(1).................... 80.1% n/a n/a
Weighted average interest rate......... 10.1% n/a n/a
Total loan purchases and originations:
Principal balance...................... $1,254,611 $ 658,766 $ 287,803
Average principal balance per loan..... $ 80 $ 78 $ 74
Combined weighted average initial loan-
to-value ratio(1).................... 72.5% 68.8% 63.2%
Weighted average interest rate......... 11.0% 11.4% 11.8%
Percentage of loans secured by:
First mortgage......................... 94.0% 93.8% 89.6%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of a loan
secured by a second mortgage is determined by taking the sum of the loan
secured by the first and second mortgages and dividing by the lesser of the
purchase price or the appraised value of the mortgage property at
origination.
3
The following table shows the channels of loan originations and purchases
on a quarterly basis for 1997:
THREE MONTHS ENDED
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DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1997 1997 1997 1997
------------ ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
Broker:
Number of Brokered Loans ............................... 1,562 1,506 1,247 1,205
Principal balance ...................................... $138,339 $133,965 $103,276 $106,006
Average principal balance per loan ..................... $ 89 $ 89 $ 83 $ 88
Combined weighted average initial loan-
to-value ratio(1) ...................................... 70.7% 70.5% 68.6% 69.4%
Weighted average interest rate ......................... 10.4% 10.7% 11.2% 11.1%
Correspondent:
Number of Correspondent Loans .......................... 2,594 2,190 1,817 1,615
Principal balance ...................................... $200,883 $170,840 $138,237 $122,679
Average principal balance per loan ..................... $ 77 $ 78 $ 76 $ 76
Combined weighted average initial loan-
to-value ratio(1) ...................................... 73.5% 73.3% 72.0% 71.9%
Weighted average interest rate ......................... 11.0% 11.2% 11.6% 11.6%
Retail:
Number of retail loans ................................. 825 738 367 111
Principal balance ...................................... $ 57,239 $ 51,187 $ 23,903 $ 8,057
Average principal balance per loan ..................... $ 69 $ 69 $ 65 $ 73
Combined weighted average initial loan-
to-value ratio(1) ...................................... 79.8% 80.7% 79.9% 79.7%
Weighted average interest rate ......................... 10.0% 10.1% 10.1% 9.9%
Total loan purchases and originations:
Total number of loans .................................. 4,981 4,434 3,431 2,931
Principal balance ...................................... $396,461 $355,992 $265,416 $236,742
Average principal balance per loan ..................... $ 80 $ 80 $ 77 $ 81
Combined weighted average initial loan-
to-value ratio(1) ...................................... 73.5% 73.3% 71.4% 71.0%
Weighted average interest rate ......................... 10.7% 10.9% 11.3% 11.3%
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(1)The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of a loan
secured by a second mortgage is determined by taking the sum of the loan
secured by the first and second mortgages and dividing by the lesser of
the purchase price or the appraised value of the mortgage property at
origination.
4
The following table shows lien position, weighted average interest rates and
loan-to-value ratios for the years shown:
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995
---- ---- ----
First mortgage:
Percentage of total purchases and originations 94.0% 93.8% 89.6%
Weighted average interest rate........ 11.0% 11.4% 11.8%
Weighted average initial loan-to-value ratio(1) 72.6% 68.9% 63.2%
Second mortgage:
Percentage of total purchases and originations 6.0% 6.2% 10.4%
Weighted average interest rate........ 11.3% 11.5% 11.9%
Weighted average initial loan-to-value ratio(1) 71.1% 66.6% 62.9%
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(1)The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of a loan
secured by a second mortgage is determined by taking the sum of the loan
secured by the first and second mortgages and dividing by the lesser of the
purchase price or the appraised value of the mortgage property at
origination.
The following table shows the geographic distribution of loan purchases and
originations for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
1997 1996 1995
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REGION PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE
- ------ ---------- ------------ ---------- ------------ ---------- ------------
(DOLLARS IN MILLIONS)
NY, NJ and PA ......................... 52.9% $ 664.3 66.3% $ 436.9 86.2% $ 248.0
Midwest ............................... 23.8 298.2 17.0 112.0 5.4 15.7
Southeast ............................. 9.7 121.4 4.2 27.6 0.8 2.2
New England ........................... 7.1 89.3 5.9 38.6 2.2 6.2
Mid-Atlantic* ......................... 6.5 81.3 6.6 43.7 5.4 15.7
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* Excluding New York (NY), New Jersey (NJ) and Pennsylvania (PA).
BROKER AND CORRESPONDENT MARKETING. Throughout its history Delta has been
successful in establishing and maintaining relationships with brokers and
correspondents offering non-conforming mortgage products to their clientele, and
management believes that this success is primarily attributable to the quality
of service the Company provides to its network of brokers and correspondents.
Delta typically initiates contact with a broker or correspondent through
Delta's Business Development Department, comprised of 27 business development
representatives supervised by a senior officer with over ten years of sales and
marketing experience in the industry. The Company usually hires business
development representatives who have contacts with brokers and correspondents
that originate nonconforming mortgage loans within their geographic territory.
The business development representatives are responsible for developing and
maintaining the Company's broker and correspondent networks within their
geographic territory by frequently visiting the broker or correspondent,
communicating the Company's underwriting guidelines, disseminating new product
information and pricing changes, and by demonstrating a continuing commitment to
understanding the needs of the customer. The business development
representatives attend industry trade shows and inform Delta about the products
and pricing being offered by competitors and new market entrants. This
information assists Delta in refining its programs and product offerings in
order to remain competitive. Business development representatives are
compensated with a base salary and commissions based on the volume of loans
originated or purchased as a result of their efforts.
APPROVAL PROCESS. Before a broker or correspondent becomes part of Delta's
network, it must go through an approval process. Once approved, brokers and
correspondents may immediately begin submitting applications and/or loans to
Delta.
5
To be approved, a broker must demonstrate that it is properly licensed and
registered in the state in which it seeks to transact business, submit to a
credit check, and sign a standard broker agreement with Delta. A correspondent
is eligible to submit loans to Delta for purchase only after an extensive
investigation of the prospective correspondent's lending operations including an
on-site visit, a review of the correspondent's financial statements for the
prior two years, a credit report on the correspondent, a review of sample loan
documentation and business references provided by the correspondent. Once
approved, Delta requires that each correspondent sign an Agreement of Purchase
and Sale in which the correspondent makes representations and warranties
governing both the mechanics of doing business with Delta and the quality of the
loan submissions themselves. Delta also performs an annual review of each
approved correspondent in order to ensure continued compliance with legal
requirements and that lending operations and financial information continue to
meet Delta's standards. In addition, Delta regularly reviews the performance of
loans originated or purchased through its brokers or correspondents.
BROKERS. For the year ended December 31, 1997, the Company's broker network
accounted for $481.6 million, or 38%, of Delta's loan purchases and originations
compared to $321.7 million, or 49%, of Delta's loan purchases and originations
for the year ended December 31, 1996 and $175.7 million, or 61%, of Delta's loan
purchases and originations for the year ended December 31, 1995. No single
broker contributed more than 5.8%, 11.4% or 6.2% of Delta's total purchases or
originations in the years ended December 31, 1997, 1996 and 1995, respectively.
Once approved, a broker may submit loan applications for prospective
borrowers to Delta. To process broker submissions, Delta's broker originations
area is organized into teams, each consisting of loan officers and processors,
which are generally assigned to specific brokers. Because Delta operates in a
highly competitive environment where brokers may submit the same loan
application to several prospective lenders simultaneously, Delta strives to
provide brokers with a rapid and informed response. Loan officers analyze the
application and provide the broker with a preliminary approval, subject to final
underwriting approval, or a denial, typically within one business day. If the
application is approved by the Company's underwriters, a "conditional approval"
will be issued to the broker with a list of specific conditions to be met and
additional documents to be supplied prior to funding the loan. The loan officer
and processor team will then work directly with the submitting broker to collect
the requested information and meet all underwriting conditions. In most cases,
the Company funds loans within 14 to 21 days after preliminary approval of the
loan application. In the case of a denial, Delta will make all reasonable
attempts to ensure that there is no missing information concerning the borrower
or the application that might change the decision on the loan.
The Company compensates its loan officers, who on a loan-by-loan basis are
the primary relationship contacts with the brokers, predominantly on a
commission basis. All of the Company's loan officers must complete an extensive
9 to 12 month training program to attain the level of knowledge and experience
integral to the Company's commitment to providing the highest quality service
for brokers. Management believes that by maintaining an efficient, trained and
experienced staff, it has addressed three central factors which determine where
a broker sends its business: (i) the speed with which a lender closes loans,
(ii) the lender's knowledge concerning the broker and his business and (iii) the
support a lender provides.
CORRESPONDENTS. For the year ended December 31, 1997, Delta's correspondent
network accounted for $632.6 million, or 51%, of Delta's loans purchases and
originations compared to $337.0 million, or 51%, of Delta's loan purchases and
originations for the year ended December 31, 1996 and $112.1 million, or 39%, of
Delta's loan purchases and originations for the year ended December 31, 1995. No
single correspondent contributed more than 6.5%, 6.3% or 6.3% of Delta's total
loan purchases and originations in 1997, 1996 or 1995, respectively.
An approved correspondent is a licensed mortgage banker or savings and loan
who sells loans to Delta which the correspondent has originated, processed,
closed and funded in its own name in conformity with Delta's underwriting
standards. The loans are sold to Delta either on an individual flow basis or in
block sales. When selling on a flow basis, a correspondent will typically seek a
pre-approval from Delta prior to closing the loan, and Delta will approve the
loan based on a partial or full credit package, stipulating for any items needed
to complete the package in adherence to Delta's underwriting guidelines. On a
block sale, a correspondent will offer a group of loans, generally that have not
been pre-approved, to Delta for sale, and Delta will purchase those loans in the
block that meet Delta's underwriting criteria.
RETAIL LOANS. The Company began retail origination of loans in 1997 with its
acquisition of Fidelity Mortgage, and for the year ended December 31, 1997, this
channel accounted for $140.4 million, or 11%, of Delta's loan
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purchases and originations. Fidelity Mortgage is able, through its marketing
efforts, to identify, locate and focus on individuals who, based on its
historic customer profiles, are likely customers for the Company's products.
Fidelity Mortgage's telemarketing representatives identify interested customers
and refer these to loan officers at the retail branch offices who then proceed
to determine the applicant's qualifications for the Company's loan products,
negotiate loan terms with the borrower and process the loan through completion.
LOAN UNDERWRITING
All of Delta's brokers, correspondents and retail offices are provided with
the Company's underwriting guidelines. Loan applications received from brokers
and correspondents or retail customers are classified according to certain
characteristics, including but not limited to: condition and location of the
collateral, credit history of the applicant, ability to pay, loan-to-value ratio
and general stability of the applicant in terms of employment history and time
in residence. Delta has established classifications with respect to the credit
profile of the applicant, and each loan is placed into one of four letter
ratings "A" through "D", with subratings within those categories. Terms of loans
made by Delta, as well as maximum loan-to-value ratios and debt-to-income
ratios, vary depending on the applicant's classification. Loan applicants with
less favorable credit ratings are generally offered loans with higher interest
rates and lower loan-to-value ratios than applicants with more favorable credit
ratings. The general criteria used by Delta's underwriting staff in classifying
loan applicants are set forth in the following table:
7
DELTA'S UNDERWRITING CRITERIA
"A" RISK "B" RISK "C" RISK "D" RISK
EXCELLENT CREDIT
HISTORY GOOD OVERALL CREDIT GOOD TO FAIR CREDIT FAIR TO POOR CREDIT
---------------- ------------------- ------------------- -------------------
Existing mortgage
history................... Current at Current at Up to 30 days 90 days delinquent
application time application time delinquent at or more
and a maximum of and a maximum of application time
two 30-day late four 30-day late and a maximum of
payments in the payments in the four 30-day late
last 12 months last 12 months payments, two
60-day late
payments and
one 90-day late
payment in the
last 12 months
Other credit................ Minor 30 day Some slow pays Slow pays, some Not a factor.
late items allowed allowed but open delinquencies Derogatory
with a letter of majority of credit allowed. Isolated credit must
explanation; no and installment charge-offs, collec- be paid with
open collection debt paid as agreed. tion accounts or proceeds. Must
accounts, charge- Small isolated judgments case- demonstrate
offs, judgments charge-offs, collec- by-case ability to pay
tion accounts or
judgments case-by-
case
Bankruptcy filings.......... Discharged more Discharged more Discharged more May be open at
than three years than two years than one year closing, but must
prior to closing prior to closing prior to closing be paid off with
and excellent and excellent and good proceeds
reestablished reestablished reestablished
credit credit credit
Debt service to
Income ratio.............. Generally 45% Generally 50% Generally 55% Generally 55%
or less or less or less or less
Maximum loan-to-value
ratio:
Owner-occupied............ Generally 80% Generally 80% Generally 75% Generally 65%
(up to 90%*) for (up to 85%*) for (up to 80%*) for (up to 70%*) for
a one- to four- a one- to four- a one- to four- a one- to four-
family residence family residence family residence family residence
Non-owner
occupied................ Generally 70% Generally 70% Generally 65% Generally 55%
(up to 80%*) for (up to 80%*) for (up to 75%*) for (up to 60%*) for
a one- to four- a one- to four a one- to four- a one- to four-
family residence family residence family residence family residence
Employment.................. Minimum 2 years Minimum 2 years No minimum No minimum
employment in the employment in the required required
same field same field
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* On an exception basis
Delta uses the foregoing categories and characteristics as guidelines only.
On a case-by-case basis, the Company may determine that the prospective borrower
warrants an exception, if sufficient compensating factors exist. Examples of
such compensating factors are a low loan-to-value ratio, a low debt ratio,
long-term stability of employment and/or residence, excellent payment history on
past mortgages, or a significant reduction in monthly housing expenses.
The following table sets forth certain information with respect to Delta's
originations and purchases of first and second mortgage loans by borrower
classification, along with weighted average coupons, for the periods shown.
8
PERCENT
YEAR CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
- ---- ------ ----- -------- ------ -------
1997 A $ 617,724 49.2% 10.4% 76.2%
B 349,166 27.8 11.0 72.0
C 222,854 17.8 11.8 67.7
D 64,867 5.2 13.2 56.7
---------- ----- ---- ----
Totals $1,254,611 100.0% 11.0% 72.5%
========== ===== ==== ====
1996 A $ 219,550 33.4% 10.6% 72.1%
B 234,589 35.6 11.2 70.2
C 156,296 23.7 12.2 65.7
D 48,331 7.3 13.8 56.9
---------- ----- ---- ----
Totals $658,766 100.0% 11.4% 68.8%
========== ===== ==== ====
1995 A $ 89,830 31.3% 10.7% 66.8%
B 124,954 43.4 11.6 64.5
C 37,190 12.9 12.8 59.6
D 35,831 12.4 14.5 53.2
---------- ----- ---- ----
Totals $287,805 100.0% 11.8% 63.2%
========== ===== ==== ====
- ---------------
(1) Weighted Average Coupon ("WAC").
(2) Weighted Average Initial Loan-to-Value Ratio ("WLTV").
Delta employs experienced nonconforming mortgage loan credit underwriters to
scrutinize the applicant's credit profile and to evaluate whether an impaired
credit history is a result of adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. Personal
circumstances including divorce, family illnesses or deaths and temporary job
loss due to layoffs and corporate downsizing will often impair an applicant's
credit record. Assessment of an applicant's ability and willingness to pay is
one of the principal elements that distinguishes Delta's lending practices from
methods employed by traditional lenders, such as savings and loans and
commercial banks. All lenders utilize debt ratios and loan-to-value ratios in
the approval process, however, in contrast to Delta, many lenders simply use
software packages to score an applicant for loan approval and fund the loan
after auditing the data provided by the borrower.
Delta has a staff of 70 underwriters, and its senior underwriters have an
average of more than nine years of non-conforming underwriting experience. Delta
does not delegate underwriting authority to any broker or correspondent. Delta's
Underwriting Department functions independently of its Business Development and
Mortgage Origination Departments and does not report to any individual directly
involved in the origination process. No underwriter at Delta is compensated on
an incentive or commission basis.
Delta has instituted underwriting checks and balances designed to ensure that
every loan is reviewed and approved by a minimum of two underwriters, with
certain higher loan amounts requiring a third approval. Management believes that
by requiring each file be seen by a minimum of two underwriters, a high degree
of accuracy and quality control is ensured throughout the underwriting process.
Delta's underwriting of every loan submitted consists not only of a thorough
credit review, but also (i) a separate appraisal review conducted by Delta's
Appraisal Review Department and (ii) a full compliance review to ensure that all
documents have been properly prepared, all applicable disclosures have been
given in a timely fashion, proper compliance with all federal and state
regulations, the existence of title insurance insuring Delta's interest as
mortgagee and evidence of adequate homeowner's insurance naming Delta as an
additional insured party. Appraisals are performed by third party, fee-based
appraisers or by the Company's staff appraisers and generally conform to current
FNMA/FHLMC secondary market requirements for residential property appraisals.
Each such appraisal includes, among other things, an inspection of the exterior
of the subject property and, where available, data from sales within the
preceding 12 months of similar properties within the same general location as
the subject
9
property.
Delta performs a thorough appraisal review on each loan prior to closing or
prior to purchasing. While Delta recognizes that the general practice by
conventional mortgage lenders is to perform only drive-by appraisals after
closings, management believes this practice does not provide sufficient
protection. In addition to reviewing each appraisal for accuracy, the Company
accesses other sources to validate sales used in the appraisal to determine
market value. These sources include: interfacing with Multiple Listing Services,
Comps, Inc. and other similar databases to access current sales and listing
information; and other sources for verification, including broker price opinions
and market analyses by local real estate agents.
Post closing, in addition to its normal due diligence, the Company selects
one out of every ten appraisals and performs its own drive-by appraisal. This
additional step helps to give the Company an added degree of comfort with
respect to appraisers with which the Company has had limited experience. Delta
actively tracks all appraisers from which it accepts appraisals for quality
control purposes and does not accept work from appraisers who have not conformed
to its review standards.
The Company performs a post-funding quality control review to monitor and
evaluate the Company's loan origination policies and procedures. At least 10% of
all loan originations and purchases are subjected to a full quality control
re-underwriting and review, the results of which are reported to senior
management. Discrepancies noted by this review are analyzed and corrective
actions are instituted. However, to date, this important quality control process
has not revealed material deficiencies in the Company's loan underwriting
procedures. A typical quality control review currently includes: (a) obtaining a
new drive-by appraisal for each property; (b) obtaining a new credit report from
a different credit report agency; (c) reviewing loan applications for
completeness, signatures, and for consistency with other processing documents;
(d) obtaining new written verifications of income and employment; (e) obtaining
new written verification of mortgage to re-verify any outstanding mortgages; and
(f) analyzing the underwriting and program selection decisions. The quality
control process is updated from time to time as the Company's policies and
procedures change.
LOAN SALES
Delta sells substantially all the loans it originates or purchases through
one of two methods: (i) securitizations, which involve the private placement or
public offering of pass-through mortgage-backed securities, and (ii) whole loan
sales, which include the sale of blocks of individual loans to institutional or
individual investors. Since 1991, the Company has sold more than $2.4 billion of
the loans it originated or purchased through securitization and $54 million
through whole loan sales.
SECURITIZATIONS. During 1997, Delta completed 4 securitizations totaling
$1.24 billion. The following table sets forth certain information with respect
to Delta's securitizations (all of which have been rated AAA/Aaa by S&P and
Moody's, respectively) by offering size, which includes prefunded amounts,
weighted average pass-through rate and type of credit enhancement.
INITIAL
OFFERING SIZE WEIGHTED AVERAGE CREDIT
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE ENHANCEMENT
- -------------- --------- ------------- ----------------- -----------
1997-1............ 03/27/97 $235.0 6.72% Insurance Wrap
1997-2............ 06/26/97 $260.0 6.72% Senior/Sub
1997-3............ 09/23/97 $340.0 6.71% Senior/Sub
1997-4............ 12/08/97 $400.0 6.62% Senior/Sub
When Delta securitizes loans, it sells a portfolio of loans to a trust (the
"Home Equity Loan Trust") and issues classes of certificates representing an
undivided ownership interest in the Home Equity Loan Trust. As servicer for each
securitization, the Company collects and remits principal and interest payments
to the appropriate Home Equity Loan Trust which, in turn, passes through
payments to certificateholders. For each of the 1997 securitizations, Delta
retained 100% of the interests in the residual classes of certificates while
selling an interest-only certificate in each of the last three securitizations
for cash. Management contemplates continuing to retain residual certificates in
the future as long as, in management's opinion, this practice maximizes earnings
while
10
remaining within the Company's liquidity requirements.
Each Home Equity Loan Trust has the benefit of either a financial guaranty
insurance policy from a monoline insurance company or a senior-subordination
securitization structure, which insures the timely payment of interest and the
ultimate payment of principal of the credit-enhanced investor certificate. In
"senior-subordination" structures, the senior certificate holders are protected
from losses by subordinated certificates, which absorb any such losses first. In
addition to such credit enhancement, the Excess Servicing is initially applied
as an additional payment of principal of the investor certificates, thereby
accelerating amortization of the investor certificates relative to the
amortization of the loans and creating overcollateralization. Once the
overcollateralization limit is reached, the use of Excess Servicing to create
overcollateralization stops unless it subsequently becomes necessary to obtain
or maintain required overcollateralization limits. Overcollateralization is
intended to create a source of cash (the "extra" payments on the loans) to
absorb losses prior to making a claim on the financial guaranty insurance policy
or the subordinated certificates.
WHOLE LOAN SALES WITHOUT RECOURSE. The Company has in the past determined
from time to time that some of its "A" loans and higher loan-to-value ratio
loans receive better execution by being sold on a whole loan, non-recourse basis
to third party institutions. In 1997, the Company did not sell any loans on a
whole loan basis as management deemed it to be more profitable to securitize all
of its loans. For the years ended December 31, 1996 and 1995, Delta sold $15.3
million and $17.6 million of loans, respectively, on a whole loan, non-recourse
basis, which represents 2.3% and 6.1%, respectively, of its originations and
purchases.
LOAN SERVICING AND COLLECTIONS
Delta has been servicing loans since its inception in 1982, and Delta has
serviced or is servicing substantially all of the loans that it has originated
or purchased. Servicing involves, among other things, collecting payments when
due, remitting payments of principal and interest and furnishing reports to the
current owners of the loans and enforcing such owners' rights with respect to
the loans, including, recovering delinquent payments, instituting foreclosure
and liquidating the underlying collateral. The Company receives a servicing fee
for servicing residential mortgage loans of 0.50% per annum (0.65% per annum on
all securitizations completed before and including the 1996-1 securitization) on
the declining principal balance of all loans sold through securitization and on
the declining principal balance of the loans sold to investors on a recourse
basis, which servicing fees are collected out of the monthly mortgage payments.
Management believes that servicing the Company's own portfolio enhances certain
operating efficiencies and provides an additional and profitable revenue stream
that is less cyclical than the business of originating and purchasing loans. As
of December 31, 1997, Delta had a loan servicing portfolio of $1.84 billion.
Delta services all loans out of its headquarters in Woodbury, New York,
utilizing a leading in-house loan servicing system ("LSAMS") which it
implemented in 1995. LSAMS has provided Delta with considerably more flexibility
to adapt the system to Delta's specific needs as a nonconforming home equity
lender. As such, Delta has achieved significant cost efficiencies by automating
a substantial number of previously manual servicing procedures and functions
since its conversion to LSAMS on July 1, 1995. Management believes that even
greater cost efficiencies can be realized through further automation provided by
LSAMS.
At the same time that it upgraded its primary servicing system, Delta
purchased a default management sub-servicing system with separate "modules" for
foreclosure, bankruptcy, and REO to provide it with the ability to more
efficiently monitor and service loans in default. These sub-servicing modules
provide detailed tracking of all key events in foreclosure and bankruptcy on a
loan-by-loan and portfolio-wide basis; the ability to track and account for all
pre- and post-petition payments received in bankruptcy from the borrower and/or
trustee; and the ability to monitor, market and account for all aspects
necessary to liquidate an REO property after foreclosure. Additionally, Delta's
Management Information Systems Department has created a market value analysis
program to run with LSAMS, which provides Delta with the ability to monitor its
equity position on a loan-by-loan and/or portfolio-wide basis. These features
have led to cost savings through greater automation and system upgrades and have
helped mitigate loan losses as the Servicing Department has been able to
identify problem loans earlier, thus allowing for earlier corrective action.
Delta's collections policy is designed to identify payment problems
sufficiently early to permit Delta to quickly address delinquency problems and,
when necessary, to act to preserve equity in a pre-foreclosure property. Delta
11
believes that these policies, combined with the experience level of independent
appraisers engaged by Delta, help to reduce the incidence of charge-offs of a
first or second mortgage loan.
Centralized controls and standards have been established by Delta for the
servicing and collection of mortgage loans in its portfolio. Delta revises such
policies and procedures from time to time in connection with changing economic
and market conditions and changing legal and regulatory requirements.
Borrowers are billed on a monthly basis in advance of the due date.
Collection procedures commence upon identification of a past due account by
Delta's automated servicing system. If timely payment is not received, LSAMS
automatically places the loan in the assigned collector's "auto queue" and
collection procedures are generally initiated on the day immediately following
the payment due date for chronic late payers, or the day immediately following
the end of the grace period for those borrowers who usually pay within the grace
period, or shortly thereafter. LSAMS automatically queues up each loan in the
assigned collector's "auto-queue" at one of these two dates based upon a
particular borrower's payment history over the prior 12 months. The account
remains in the queue unless and until a payment is received, at which point
LSAMS automatically removes the loan from that collector's auto queue until the
next month's payment is due and/or becomes delinquent.
When a loan appears in a collector's auto queue, a collector will telephone
to remind the borrower that a payment is due. Follow-up telephone contacts are
attempted until the account is current or other payment arrangements have been
made. Standard form letters are utilized when attempts to reach the borrower by
telephone fail and/or, in some circumstances, to supplement the phone contacts.
During the delinquency period, the collector will continue to contact the
borrower. Company collectors have computer access to telephone numbers, payment
histories, loan information and all past collection notes. All collection
activity, including the date collection letters were sent and detailed notes on
the substance of each collection telephone call, is entered into a permanent
collection history for each account on LSAMS. Additional guidance with the
collection process is derived through frequent communication with Delta's senior
management.
For those loans in which collection and initial loss mitigation efforts have
been exhausted without success, the loss mitigation team recommends the loans be
sent to foreclosure at one of the Foreclosure Committee Meetings held each
month. At each such committee meeting, the loss mitigation administrator and
team leader meet with the Servicing Manager, the Default Management Manager and
a member of the Executive Department, to determine whether foreclosure
proceedings are appropriate, based upon their analysis of all relevant factors,
including a market value analysis, reason for default and efforts by the
borrower to cure the default.
Regulations and practices regarding the liquidation of properties (e.g.,
foreclosure) and the rights of a borrower in default vary greatly from state to
state. As such, all foreclosures are assigned to outside counsel, located in the
same state as the secured property. Bankruptcies filed by borrowers are
similarly assigned to appropriate local counsel. All aspects of foreclosures and
bankruptcies are closely monitored by Delta through its sub-servicing loan
system described above and through monthly status reports from attorneys.
Prior to foreclosure sale, Delta performs an in-depth market value analysis
on all defaulted loans. This analysis includes: (i) a current valuation of the
property obtained through at least two drive-by appraisals or broker price
opinions conducted by an independent appraiser and/or broker from Delta's
network of real estate brokers, complete with a description of the property,
recent list prices of comparable properties, recent closed comparables,
estimated marketing time, estimated required or suggested repairs and an
estimate of the sales price; (ii) an evaluation of the amount owed, if any, for
real estate taxes; (iii) an evaluation of the amount owed, if any, to a senior
mortgagee; and (iv) estimated carrying costs, broker's fee, repair costs and
other related costs associated with REO properties. Delta bases the amount it
will bid at foreclosure sales on this analysis.
If Delta acquires title to a property at a foreclosure sale or otherwise, the
REO Department immediately begins working the file by obtaining an estimate of
the sale price of the property by sending at least two local real estate brokers
to inspect the premises, and then hiring one to begin marketing the property. If
the property is not vacant when acquired, local eviction attorneys are hired to
commence eviction proceedings and/or negotiations are held with occupants in an
attempt to get them to vacate without incurring the additional time and cost of
eviction. Repairs are performed if it is determined that they will increase the
net liquidation proceeds, taking into consideration the cost of repairs, the
carrying costs during the repair period and the marketability of the property
both before and after the repairs.
12
Delta's loan servicing software also tracks and maintains homeowners'
insurance information and tax and insurance escrow information. Expiration
reports are generated bi-weekly listing all policies scheduled to expire within
the next 15 days. When policies lapse, a letter is issued advising the borrower
of such lapse and notifying the borrower that Delta will obtain force-placed
insurance at the borrower's expense. Delta also has an insurance policy in place
that provides coverage automatically for Delta in the event that Delta fails to
obtain force-placed insurance.
The following table sets forth information relating to the delinquency and
loss experience of the mortgage loans serviced by Delta (primarily for the
securitization trusts) for the periods indicated. Delta is not the holder of the
securitization loans, but generally holds residual or interest-only certificates
of the trusts, as well as the servicing rights, each of which may be adversely
affected by defaults. (See "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations Certain Accounting
Considerations"):
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
---- ---- ----
Total Outstanding Principal Balance
(at period end)............................................. $ 1,840,150,403 $ 932,958,188 $ 468,846,079
Average Outstanding(1).......................................... $ 1,376,108,923 $ 686,465,257 $ 373,384,417
DELINQUENCY (at period end)
30-59 Days:
Principal Balance........................................... $ 90,052,724 $ 54,582,550 $ 35,052,951
Percent of Delinquency(2)................................... 4.89% 5.85% 7.48%
60-89 Days:
Principal Balance........................................... $ 28,864,099 $ 14,272,587 $ 8,086,230
Percent of Delinquency(2)................................... 1.57% 1.53% 1.72%
90 Days or More:
Principal Balance........................................... $ 17,695,594 $ 9,224,525 $ 6,748,061
Percent of Delinquency(2)................................... 0.96% 0.99% 1.44%
Total Delinquencies:
Principal Balance........................................... $ 136,612,417 $ 78,079,663 $ 49,887,242
Percent of Delinquency(2)................................... 7.42% 8.37% 10.64%
FORECLOSURES
Principal Balance........................................... $ 85,500,439 $ 34,765,628 $ 23,506,751
Percent of Foreclosures by Dollar(2)........................ 4.65% 3.73% 5.01%
REO (at end of period).......................................... $ 10,292,208 $ 5,672,811 $ 4,020,295
Net Gains/(Losses) on liquidated loans.......................... $ (4,985,539) $ (2,866,204) $ (2,142,099)
Percentage of Net Gains/(Losses) on liquidated
loans (based on Average Outstanding Balance)................ (0.36%) (0.42%) (0.57%)
- ---------------
(1) Calculated by summing the actual outstanding principal balances at the end
of each month and dividing the total by the number of months in the
applicable period.
(2) Percentages are expressed based upon the total outstanding principal balance
at the end of the indicated period.
COMPETITION
As an originator and purchaser of mortgage loans, the Company faces intense
competition, primarily from 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 the Company. Competition can take
many forms, including convenience in obtaining a loan, service, marketing and
distribution channels and interest rates. Furthermore, the current level of
gains realized by the Company and its competitors on the sale of the type of
loans originated and purchased is attracting additional competitors into this
market with the effect of lowering the gains that may be realized by the Company
on future loan sales. In addition, greater investor acceptance of securities
backed by loans comparable to the Company's mortgage loans and greater
availability of information regarding the prepayment and default
13
experience of such loans creates greater efficiencies in the market for
such securities. Such efficiencies may create a desire for even larger
transactions giving companies with greater volumes of originations a competitive
advantage. In addition, a more efficient market for such securities may lead
certain investors to purchase securities backed by other types of assets where
potential returns may be greater. 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 the
Company's borrowers to refinance their loans. During economic slowdowns or
recessions, the Company's borrowers may have new financial difficulties and may
be receptive to offers by the Company's competitors.
Furthermore, certain large national finance companies and conforming mortgage
originators have announced their intention to adapt their conforming origination
programs and allocate resources to the origination of non-conforming loans. In
addition, certain of these larger mortgage companies and commercial banks have
begun to offer products similar to those offered by the Company, targeting
customers similar to those of the Company. The entrance of these competitors
into the Company's market could have a material adverse effect on the Company's
results of operations and financial condition.
REGULATION
Delta's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is subject to
various laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Delta's consumer lending
activities are subject to the Federal Truth-in-Lending Act and Regulation Z
(including the Home Ownership and Equity Protection Act of 1994), the Equal
Credit Opportunity Act of 1974, as amended (ECOA), the Fair Credit Reporting Act
of 1970, as amended, the Real Estate Settlement Procedures Act (RESPA), and
Regulation X, the Home Mortgage Disclosure Act and the Federal Debt Collection
Practices Act, as well as other federal and state statutes and regulations
affecting Delta's activities. Delta is also subject to the rules and regulations
of, and examinations by HUD and state regulatory authorities with respect to
originating, processing, underwriting and servicing loans. These rules and
regulations, among other things, impose licensing obligations on Delta,
establish eligibility criteria for mortgage loans, prohibit discrimination,
provide for inspections and appraisals of properties, require credit reports on
loan applicants, regulate assessment, collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to
comply with these requirements can lead to loss of approved status, termination
or suspension of servicing contracts without compensation to the servicer,
demands for indemnifications or mortgage loans repurchases, certain rights of
rescission for mortgage loans, class action lawsuits and administrative
enforcement actions. Delta believes it is in compliance in all material respects
with applicable federal and state laws and regulations.
ENVIRONMENTAL MATTERS
To date, Delta has not been required to perform any investigation or clean up
activities, nor has it been subject to any environmental claims. There can be no
assurance, however, that this will remain the case in the future. In the
ordinary course of its business, Delta from time to time forecloses on
properties securing loans. Although Delta primarily lends to owners of
residential properties, there is a risk that Delta could be required to
investigate and clean-up hazardous or toxic substances or chemical releases at
such properties after acquisition by Delta, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
EMPLOYEES
As of December 31, 1997 Delta had a total of 987 employees (full-time and
part-time). None of Delta's employees is covered by a collective bargaining
agreement. Delta considers its relations with its employees to be good.
14
ITEM 2. PROPERTIES
Delta's executive and administrative offices are located at 1000 Woodbury
Road, Woodbury, New York 11797, where Delta leases approximately 120,000 square
feet of office space at an aggregate annual rent of approximately $2.4 million.
The lease provides for certain scheduled rent increases and expires in 2007.
Delta also maintains a full service office in Atlanta, Georgia, full
processing offices in Chicago, Illinois and Warwick, Rhode Island, processing
offices in Deerfield Beach, Florida and Cleveland, Ohio, and business
development offices in Delaware, Michigan (2), Missouri, New Jersey, Ohio,
Pennsylvania and Virginia. Fidelity Mortgage maintains fifteen retail mortgage
origination offices in Florida (3), Georgia, Illinois, Indiana, Missouri, North
Carolina, Ohio (4), Pennsylvania (2) and Tennessee; one telemarketing hub in
Ohio; and two corporate offices in Ohio and Florida. The terms of the leases
vary as to duration and escalation provisions, with the latest expiring in 2001.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of the Company's business involves the collection of
numerous accounts, the validity of liens and compliance with state and federal
lending laws, the Company is subject to numerous claims and legal actions in the
ordinary course of its business. While it is impossible to estimate with
certainty the ultimate legal and financial liability with respect to such claims
and actions, the Company believes that the aggregate amount of such liabilities
will not result in monetary damages which would have a material adverse effect
on the financial condition or results of operations of the Company.
Several class-action lawsuits have been filed against a number of consumer
finance companies alleging that the compensation of mortgage brokers through the
payment of yield spread premiums violates various federal and state consumer
protection laws. On March 18, 1997, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the Eastern
District of New York, alleging that the Company's compensation of mortgage
brokers by means of yield spread premiums violates, among other things, RESPA.
The complaint seeks (i) certification of a class of plaintiffs, (ii) an
injunction against payment of yield spread premiums by the Company and (iii)
unspecified compensatory and punitive damages (including attorney's fees). On
July 7, 1997, the Company filed an answer to the plaintiff's amended complaint.
Management believes the Company has meritorious defenses and intends to defend
this suit, but the Company cannot estimate with any certainty its ultimate legal
or financial liability, if any, with respect to the alleged claims.
On or about February 10, 1998, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the Northern
District of Mississippi - Greenville Division, alleging that the Company's
compensation of mortgage brokers by means of yield spread premiums violates
RESPA. The complaint seeks (i) certification of a class of plaintiffs, and (ii)
unspecified compensatory damages (including attorney's fees). Management
believes the Company has meritorious defenses and intends to defend this suit,
but the Company has not yet answered the complaint and cannot estimate with any
certainty its ultimate legal or financial liability, if any, with respect to the
alleged claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders was held on May 29, 1997. At the meeting,
Richard Blass and Arnold B. Pollard were elected as Class I Directors for a term
of three years. Hugh Miller, Sidney A. Miller and Martin D. Payson continue to
serve as members of the Board of Directors.
Votes cast in favor of Mr. Blass' election totaled 14,363,632 while
12,468 votes were withheld.
Votes cast in favor of Mr. Pollard's election totaled 14,363,682
while 12,418 votes were withheld.
The stockholders also voted to ratify the appointment of KPMG Peat Marwick
LLP as the Company's independent public accountants for the fiscal year ending
December 31, 1997. Votes cast in favor of this ratification were 14,371,038,
while votes cast against were 2,914 and abstentions totaled 2,148.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock was listed on the New York Stock Exchange (the
"NYSE") under the symbol "DFC" on November 1, 1996. The following table sets
forth for the periods indicated the range of the high and low closing sales
prices for the Company's Common Stock on the NYSE.
1997 HIGH LOW
- ---- ---- ----
First Quarter ............................ $24.00 $18.13
Second Quarter ........................... $20.50 $13.38
Third Quarter............................. $22.13 $18.81
Fourth Quarter ........................... $20.69 $13.38
1996 HIGH LOW
- ---- ---- ----
Fourth Quarter (from 11/1/96)............. $25.25 $18.00
On March 24, 1998, the Company had approximately 78 stockholders of record.
This number does not include beneficial owners holding shares through nominee or
"street" names. The Company believes the number of beneficial stockholders is in
excess of 2,500.
DIVIDEND POLICY
The Company did not pay any dividends in 1997 and, in accordance with its
present general policy, has no present intention to pay cash dividends.
16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Income Statement Data: (DOLLARS IN THOUSANDS EXCEPT FOR PER SHARE DATA)
Revenues:
Net gain on sale of mortgage loans............. $ 86,307 $ 46,525 $ 15,383 $ 6,661 $ 7,639
Interest....................................... 22,341 16,372 13,588 9,839 9,156
Servicing fees................................. 7,094 5,368 2,855 2,183 2,101
Origination fees (1) .......................... 18,108 5,266 4,309 3,114 3,617
---------- ---------- ---------- ---------- ----------
Total revenues........................... $ 133,850 $ 73,531 $ 36,135 $ 21,797 $ 22,513
---------- ---------- ---------- ---------- ----------
Expenses:
Payroll and related costs (1).................. $ 38,991 $ 16,509 $ 12,876 $ 8,815 $ 9,268
Interest....................................... 19,972 11,298 7,964 3,735 2,915
General & administrative (1)................... 23,737 12,236 10,709 7,238 6,670
---------- ---------- ---------- ---------- ----------
Total expenses........................... $ 82,700 $ 40,043 $ 31,549 $ 19,788 $ 18,853
---------- ---------- ---------- ---------- ----------
Income before income taxes and
extraordinary item............................. 51,150 33,488 4,586 2,009 3,660
Provision for income taxes(1)...................... 20,739 9,466 -- -- --
---------- ---------- ---------- ---------- ----------
Income before extraordinary item................... 30,411 24,022 4,586 2,009 3,660
Extraordinary item:................................
Gain on extinguishment of debt................. -- 3,168 -- -- --
---------- ---------- ---------- ---------- ----------
Net income......................................... $ 30,411 $ 27,190 $ 4,586 $ 2,009 $ 3,660
========== ========== ========== ========== ==========
Pro forma information (2)(3):
Provision for pro forma income taxes
before extraordinary item...................... $ n/a $ 14,400 $ 1,972 $ 864 $ 1,574
---------- ---------- ---------- ---------- ----------
Pro forma income before
extraordinary item............................. $ 30,411 $ 19,088 $ 2,614 $ 1,145 $ 2,086
========== ========== ========== ========== ==========
Per share data(2)(4)
Earnings per common share -
basic and diluted........................ $ 1.98 $ 1.46 $ 0.21 $ 0.09 $ 0.17
Weighted average number of
shares outstanding....................... 15,359,280 13,066,485 12,629,182 12,629,182 12,629,182
Selected Balance Sheet Data:
Loans held for sale................................ $ 79,247 $ 82,411 $ 63,324 $ 48,833 $ 41,703
Interest-only and residual certificates............ 167,809 83,073 25,310 7,514 2,204
Capitalized mortgage servicing rights.............. 22,862 11,412 3,831 2,421 3,491
Total assets....................................... 393,232 231,616 139,293 98,589 81,143
---------- ---------- ---------- ---------- ----------
Senior notes, warehouse financing and
other borrowings............................... $ 177,540 $ 95,482 $ 82,756 $ 52,491 $ 36,780
Investor payable................................... 40,852 20,869 13,444 11,091 8,687
Total liabilities.................................. 266,779 138,098 109,460 70,425 52,793
---------- ---------- ---------- ---------- ----------
Stockholders' equity............................... $ 126,453 $ 93,518 $ 29,833 $ 28,164 $ 28,350
========== ========== ========== ========== ==========
- ---------------
(1) In connection with the February 1997 acquisition of Fidelity Mortgage, the
Company incurred additional expenses normally associated with a retail
operation. Fidelity Mortgage's loan origination points when recognized are
reported as origination fee income.
(2) Figures for December 31, 1997 are actual; pro forma presentation for the
years 1996, 1995, 1994 and 1993.
(3) Prior to October 31, 1996, Delta Funding Corporation (a wholly-owned
subsidiary) was treated as an S corporation for Federal and state income
tax purposes. The pro forma presentation reflects a provision for income
taxes as if the Company had always been a C corporation at an assumed tax
rate of 43%.
(4) Pro forma earnings per common share has been computed by dividing pro
forma net income by the sum of (a) 10,653,000 shares of Delta Financial
Corporation common stock received by the former shareholders in exchange
for their shares of Delta Funding Corporation, and (b) the effect of the
issuance of 1,976,182 shares of common stock of Delta Financial
Corporation issued in the Company's initial public offering to generate
sufficient cash for certain S corporation distributions paid to the former
shareholders, which shares are treated as if they had always been
outstanding.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS OF THE COMPANY AND ACCOMPANYING NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS SET FORTH THEREIN.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, Delta sells the
majority of its loans through securitization and derives a substantial portion
of its income therefrom. In a securitization, the Company sells a pool of loans
it has originated or purchased to a REMIC trust for a cash price. The trust, in
turn, finances the pool of loans it has acquired by issuing "pass-through
certificates," or bonds, which represent undivided ownership interests in the
trust. The holders of the pass-through certificates are entitled to receive
monthly distributions of all principal received on the underlying mortgages and
a specified amount of interest, as determined at the time of the trust offering.
When the Company sells a pool of loans to the securitization trust, it
receives the following economic interests in the trust: (a) the difference
between the interest payments due on the loans sold to the trust and the
interest rate paid to the pass-through certificateholders, less the Company's
contractual servicing fee and other costs and expenses of administering the
trust, represented by interest-only and residual certificates, and (b) the right
to service the loans on behalf of the trust and earn a contractual servicing
fee, as well as other ancillary servicing related fees directly from the
borrowers on the underlying loans.
The Company's net investment in the pool of sold loans at the date of the
securitization represents the amount originally paid to originate or acquire the
loan adjusted for (i) direct loan origination costs incurred (an increase) and
loan origination fees received (a decrease) in connection with the loans, which
are treated as a component of the initial investment in a loan under Statement
of Financial Accounting Standards ("SFAS") No. 91, "Accounting for
Non-Refundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," and (ii) the principal payments received, and
the amortization of the net loan fees or costs, during the period the Company
held the loans prior to their securitization. The Company's investment in the
loans also reflects adjustments for any gains (a decrease in the investment) or
losses (an increase in the investment) the Company has incurred on treasury rate
lock contracts which the Company has used to hedge against the effects of
changes in interest rates during the period it holds the loans prior to their
securitization. (See - "Hedging.")
Upon the securitization of a pool of loans, the Company (i) recognizes in
income, as origination fees, the unamortized origination fees included in the
investment in the loans sold, and (ii) recognizes a gain on sale of loans for
the difference between cash received from the trust and the investment in the
loans remaining after the allocation of portions of that investment to record
interest-only and residual certificates and mortgage servicing rights received
in the securitization. The majority of the net gain on sale of mortgage loans
results from, and is initially realized in the form of, the retention of
interest-only and residual certificates.
The interest-only and residual certificates received by the Company upon the
securitization of a pool of loans are accounted for as trading securities under
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." In accordance with SFAS No. 115, the amount initially allocated to
the interest-only and residual certificates at the date of a securitization
reflects the fair value of those interests. The amount recorded for the
certificates is reduced for distributions thereon which the Company receives
from the related trust, and is adjusted for subsequent changes in the fair value
of interest-only and residual certificates, which are reflected in the statement
of operations. The Company assesses the fair value of interest-only and residual
certificates based upon updated estimates of prepayment and default rates
relating to loan groups comprised of loans of similar types, terms, credit
quality, interest rates, geographic location and value of loan collateral, which
represent the predominant risk characteristics that would affect prepayments and
default rates.
18
In accounting for the securitization of its loans with the retention of
mortgage servicing rights, the Company adopted the provisions of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" effective January 1, 1997. Previously, the Company followed the
requirements of SFAS No. 122, "Accounting for Mortgage Servicing Rights." The
change from the requirements of SFAS No. 122 to those of SFAS No. 125 did not
have a material impact on the Company's result of operations or financial
position.
In accordance with SFAS No. 125, and previously SFAS No. 122, the amount of
the investment in the loans allocated to the retained servicing rights is
measured at the allocated carrying amount of such servicing rights, based on the
fair value of the rights, which is determined by discounting to a present value
(using a discount rate which management believes reflects the rate market
participants would utilize in purchasing similar loan servicing rights) the
estimated future contractual and ancillary servicing fees the Company will
receive and the estimated costs of servicing the loans. Those estimates are
based on the stated terms of the transferred loans adjusted for estimates of
future prepayment rates made on the basis of interest rate conditions and the
availability of alternative financing, and estimates of future defaults among
those loans, each of which would terminate the servicing of the loan and thus
negatively affect servicing income. This amount, which is classified on the
balance sheet as "capitalized mortgage servicing rights" is then amortized over
the period of the estimated net future cash flows from the servicing income.
SFAS No. 125 also requires that the capitalized mortgage loan servicing rights
be assessed periodically to determine if there has been any impairment of the
asset, based on the fair value of the rights at the date of the assessment. The
Company performs this assessment based on the same prepayment and default
estimates utilized in valuing interest-only and residual certificates. A
valuation allowance is provided for the capitalized servicing rights relating to
any loan group for which the recorded investment exceeds the fair value of the
servicing rights.
In recording and accounting for mortgage servicing rights and interest-only
and residual certificates, the Company makes estimates of rates of prepayments
and defaults, and the value of collateral, which it believes reasonably reflect
economic and other relevant conditions then in effect. The actual rate of
prepayments, defaults and the value of collateral will generally differ from the
estimates used, due to subsequent changes in economic and other relevant
conditions and the implicit imprecision of estimates, and such differences can
be material. Prepayment and default rates which are higher than those estimated
would adversely affect the value of both the mortgage servicing rights (actual
mortgage servicing income will be less, and significant changes could require an
impairment of the capitalized mortgage servicing rights) and the interest-only
and residual certificates, for which changes in fair value are recorded in
operations. Conversely, prepayment and default rates which are lower than those
estimated would increase the servicing income earned over the life of the loans
and positively impact the value of the interest-only and residual certificates.
The Company assumes prepayment rates and defaults based upon the seasoning of
its existing securitization loan portfolio. As of December 31, 1997 and 1996,
the Company's underlying assumptions used in determining the fair value of its
interest-only and residual certificates are as follows:
(a) Estimated annual prepayment rates:
(i) for fixed-rate loan pools of 4.8% beginning in the first month of
seasoning and increasing in equal increments to 24.0% by the twelfth month of
seasoning and thereafter;
(ii) for adjustable-rate loan pools of 5.6% beginning in the first month
of seasoning and increasing in equal increments to 28.0% by the twelfth month of
seasoning and thereafter at December 31, 1997, compared to 5.0% and 25.0%,
respectively, at December 31, 1996;
(b) A default reserve for both fixed- and adjustable-rate loans sold to the
securitizations trusts of 1.90% of the amount initially securitized; and
(c) An annual discount rate of 12.0% in determining the present value of cash
flows from residual certificates, which are the predominant form of retained
interests.
19
The Company uses the same prepayment assumptions in estimating the fair value
of its mortgage servicing rights. To date, actual cash flows from the Company's
securitization trusts have either met or exceeded management's expectations.
The Company has, from time to time, sold its economic interest in the
interest-only certificates for cash proceeds including, most recently, the
interest-only certificates on three of its 1997 securitization transactions. The
Company did not sell any of its interest-only certificates in 1996.
The Company has also, from time to time, sold whole loans on a non-recourse
basis, without retaining servicing rights, generally in private transactions to
individual or institutional investors. Upon the sale of loans on a whole-loan
basis, the Company recognizes a gain or loss for the difference between the cash
proceeds received for the loans and the investment in the loans, including
unamortized loan origination fees and costs.
INTEREST RATE RISK
The Company's primary market risk exposure is interest rate risk.
Profitability may be directly affected by the level of, and fluctuation in,
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its borrowings, which are tied
to various United States Treasury maturities and the London Inter-Bank Offered
Rate ("LIBOR"). The profitability of the Company is likely to be adversely
affected during any period of unexpected or rapid changes in interest rates. A
substantial and sustained increase in interest rates could adversely affect the
Company's ability to purchase and originate loans. A significant decline in
interest rates could increase the level of loan prepayments thereby decreasing
the size of the Company's loan servicing portfolio. To the extent servicing
rights and interest-only and residual classes of certificates have been
capitalized on the books of the Company, higher than anticipated rates of loan
prepayments or losses could require the Company to write down the value of such
servicing rights and interest-only and residual certificates, adversely
impacting earnings. Fluctuating interest rates also may affect the net interest
income earned by the Company resulting from the difference between the yield to
the Company on loans held pending sales and the interest paid by the Company for
funds borrowed under the Company's warehouse facilities, although the Company
undertakes to hedge its exposure to this risk by using treasury rate lock
contracts. (See "Hedging.")
RECENT GROWTH
The Company has experienced significant loan origination and purchase growth
in the last few years, particularly since January 1, 1995. Management believes
that this growth is primarily attributable to the Company's (i) geographic
expansion of its operations, (ii) further penetration into its established
markets, (iii) increased access to capital and additional funding sources
through (a) the capital markets and (b) larger warehouse finance agreements
which have enabled the Company to accumulate larger pools of loans for sales
through securitizations, and (iv) recent expansion of its production channels
through the acquisition of the Fidelity Mortgage, retail operations.
In connection with its geographic expansion, the Company has continued to
focus on developing loan production from brokers and correspondents. In
addition, the Company is also committed to developing and growing the Fidelity
Mortgage retail origination network. There can be no assurance that the Company
will continue to grow significantly in the future. Any future growth will be
limited by, among other things, the Company's need for continued funding
sources, access to capital markets, sensitivity to economic slowdowns, ability
to attract and retain qualified personnel, fluctuations in interest rates and
competition from other consumer finance companies and from new market entrants.
To date, the Company has not experienced any significant seasonal variations in
loan originations and purchases.
The Company's recent and rapid growth may have a somewhat distortive impact
on certain of the Company's ratios and financial statistics and may make
period-to-period comparisons difficult. In light of the Company's growth,
historical performance of the Company's earnings may be of limited relevance in
predicting future performance. Furthermore, the Company's financial statistics
may not be indicative of the Company's results in
20
future periods. Any credit or other problems associated with the large number of
loans originated and purchased in the recent past may not become apparent until
sometime in the future.
The comparability of the results of operations for the twelve months ended,
and financial position as of, December 31, 1997 and 1996 may also be affected by
the Company's acquisition of Fidelity Mortgage. Fidelity Mortgage was acquired
on February 11, 1997 for a combination of cash and stock, with the acquisition
accounted for using the purchase method of accounting.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
REVENUES
Total revenues for the twelve months ended December 31, 1997 increased $60.4
million, or 82%, to $133.9 million from $73.5 million for the comparable period
in 1996. The increase in revenue was primarily attributable to the increase in
net gains recognized on the sale of mortgage loans, reflecting the growth in the
Company's level of loan originations and purchases and securitizations. Revenue
also increased in all other categories including origination fees, servicing
fees, and interest income.
For the twelve months ended December 31, 1997, the Company originated and
purchased $1.25 billion of mortgage loans, representing a 90% increase from $659
million of mortgage loans originated and purchased for the twelve months ended
December 31, 1996. The Company issued four quarterly closed-end home equity loan
securitizations in 1997 totaling $1.24 billion, compared to three
securitizations and loan sales of $630 million in 1996. Total loans serviced at
December 31, 1997 increased 97% to $1.84 billion from $933 million at December
31, 1996.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
represents (i) the sum of (a) the fair value of the interest-only and residual
certificates associated with loans securitized in each period, (b) the fair
value of mortgage servicing rights associated with loans securitized in each
period, and (c) premiums earned on the sale of whole loans on a
servicing-released basis, (ii) less the (x) premiums paid to originate or
acquire mortgage loans, (y) costs associated with securitizations and (z) any
hedge loss (gain).
For the twelve months ended December 31, 1997, net gain on sale of mortgage
loans increased $39.8 million, or 86%, to $86.3 million from $46.5 million for
the twelve months ended December 31, 1996. This increase was primarily due to an
increase in loans securitized in 1997 of $1.24 billion, or 97%, compared to $630
million of loans sold or securitized for the same period in 1996. Net gains from
the sale of loans increased less than the overall increase in loan
securitizations primarily because of increases in the pass-through rates
required by REMIC trust investors in the fourth quarter of 1997, which reduced
the value of the interest-only and residual certificates the Company received in
connection with that quarter's securitization. As previously noted above, the
Company changed its prepayment assumptions on adjustable-rate mortgage loans in
the third quarter of 1997. This change, which affects the valuation of the
Company's existing interest-only and residual certificates and capitalized
mortgage servicing rights, as well as the valuation of those assets in all
future securitizations, was made based upon the Company's on-going analysis of
industry and Company prepayment trends. The change in this assumption did not
have a material effect on net gain on sale. The weighted average gain on sale
ratio for the twelve months ended December 31, 1997, and for the comparable
period in 1996, was 7.0% and 7.4%, respectively. The weighted average gain on
sale ratio is calculated using the net gain on sale divided by the total amount
of loans securitized and sold.
INTEREST INCOME. Interest income primarily represents the sum of (i) interest
earned on loans held for sale, (ii) interest earned on cash collection balances,
and (iii) the difference between the distributions the Company receives on its
interest-only and residual certificates and the adjustments recorded to reflect
the change in the fair value in the interest-only and residual certificates.
21
Interest income for the twelve months ended December 31, 1997 increased $5.9
million, or 36%, to $22.3 million from $16.4 million in the comparable period in
1996. The increase in interest income was primarily due to (a) a higher average
balance of mortgage loans held for sale during the twelve months ended December
31, 1997 driven by higher loan originations and purchases as noted above, and
(b) an increase in excess servicing received from the Company's interest-only
and residual certificates, partially offset by the fair value adjustment to the
interest-only and residual certificates, primarily related to distributions
received from the securitization trusts. The Company changed its prepayment
assumptions on adjustable rate mortgages in the third quarter of 1997, which did
not have a material effect on interest income.
SERVICING FEES. Servicing fees represent all contractual and ancillary
servicing revenue received by the Company less (a) the offsetting amortization
of the capitalized mortgage servicing rights, and any adjustments recorded to
provide valuation allowances for the impairment in mortgage servicing rights
(see - "Accounting Considerations"), and (b) prepaid interest shortfalls.
Servicing fees for the twelve months ended December 31, 1997 increased $1.7
million, or 31%, to $7.1 million from $5.4 million in the comparable period in
1996. This increase was primarily due to a higher average loan servicing
portfolio, which resulted in increased contractual and ancillary service fees,
partially offset by a $2.9 million increase in amortization of the Company's
capitalized mortgage servicing rights in 1997, compared to 1996. During the
twelve months ended December 31, 1997, the average balance of mortgage loans
serviced by the Company increased 107% to $1.38 billion from $667 million during
the comparable period in 1996. The amount of mortgage loans serviced by the
Company increased at a faster rate than the amount of servicing fees, primarily
as a result of a reduction in the contractual servicing fee rate from 0.65% to
0.50% per annum beginning with the 1996-2 securitization in September 1996.
ORIGINATION FEES. Origination fees represent fees earned on brokered and
retail originated loans. Origination fees for the twelve months ended December
31, 1997 increased $12.8 million, or 242%, to $18.1 million from $5.3 million in
the comparable period in 1996. The increase is primarily the result of (a) the
1997 acquisition of Fidelity Mortgage and the subsequent expansion of its retail
network which accounted for $11.4 million of origination fees in 1997, and (b) a
50% increase in broker originated loans and commensurate increase in broker loan
origination fees.
EXPENSES
Total expenses increased $42.7 million, or 107%, to $82.7 million for the
twelve months ended December 31, 1997, from $40.0 million for the comparable
period in 1996. The increase in expenses was primarily the result of (i)
increased interest expense due to (a) higher interest costs generated by the
growth in the Company's loan origination and purchase activities, which
increased the level of debt needed throughout 1997 to finance the resulting
higher inventory of loans held for resale, (b) the Company's issuance in July
1997 of $150 million aggregate principal amount of 9.5% Senior Notes due August
1, 2004 (the "Senior Notes") and (c) financing the Company's investment in
interest-only and residual certificates (which was subsequently eliminated using
a portion of the proceeds from the Senior Notes), (ii) an increase in the
Company's personnel related to higher loan origination growth, including the
Company's Fidelity Mortgage retail division and (iii) costs associated with the
expansion of the Company's retail, broker and correspondent divisions.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees. For the twelve months ended
December 31, 1997, payroll and related costs expense increased $22.5 million, or
136%, to $39.0 million from $16.5 million for the comparable period in 1996.
This increase is primarily related to staff increases related to the acquisition
and subsequent expansion of Fidelity Mortgage and the increase in loan
originations and purchases at the Company. As of December 31, 1997, the Company
employed 987 full- and part-time employees, 447 of which are employees of
Fidelity Mortgage, compared to 346 full- and part-time employees as of December
31, 1996.
22
INTEREST EXPENSE. Interest expense includes the borrowing costs to finance
loan originations and purchases under (i) the Company's credit facilities, (ii)
the Senior Notes, and (iii) its investment in interest-only and residual
certificates.
For the twelve months ended December 31, 1997, interest expense increased
$8.7 million, or 77%, to $20.0 million from $11.3 million for the comparable
period in 1996. The increase in interest expense was attributable to (i) growth
in loan activity, which increased the level of debt needed throughout 1997 to
finance the inventory of loans held for sale prior to their securitization, (ii)
the Company's issuance in July 1997 of the Senior Notes, (iii) financing of the
Company's interest-only and residual certificates (which was subsequently
eliminated using a portion of the proceeds from the Senior Notes), and (iv) a
higher cost of funds on the Company's credit facilities which were tied to
one-month LIBOR. The one-month LIBOR index increased to an average interest rate
of 5.7% in 1997, compared to an average interest rate of 5.4% in 1996.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, goodwill
amortization, real estate owned expenses, license fees, legal and 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.
For the twelve months ended December 31, 1997, general and administrative
expenses increased $11.5 million, or 94%, to $23.7 million from $12.2 million
for the comparable period in 1996. This increase was primarily attributable to
(i) the amortization of acquisition costs (goodwill) associated with the
Company's purchase of Fidelity Mortgage; (ii) the expansion costs associated
with the Company's increasing the number of Fidelity Mortgage retail branch
offices from five to thirteen during 1997, and (iii) an increase in expenses
associated with the Company's increase in loan origination and purchases in
1997.
INCOME TAXES. Income taxes are accounted for under SFAS No. 109, "Accounting
for 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.
Prior to October 31, 1996, the Company was an S corporation pursuant to the
Internal Revenue Code of 1986, as amended, and, as such, did not incur any
Federal income tax expense. On October 31, 1996 the Company became a C
corporation for Federal and state income tax purposes and, as such, is subject
to Federal and state income tax on its taxable income for the period beginning
on November 1, 1996.
The Company recorded a tax provision of $20.7 million and $9.5 million (which
included a $3.9 million deferred tax charge in connection with its change in
status from an S corporation to a C corporation in 1996) for the years ended
December 31, 1997 and 1996, respectively.
Income taxes provided a 40.5% effective tax rate for the year ended December
31, 1997, compared to a 42.5% assumed effective tax rate for the year ended
December 31, 1996 if the Company would have been a C corporation for the entire
period. The reduction in the effective tax rate is primarily attributable to the
Company's expansion into lower taxing state and local jurisdictions.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
REVENUES
Total revenues increased $37.4 million, or 104%, to $73.5 million in 1996
from $36.1 million in 1995. The increase in revenues was primarily due to the
increase in loan originations and purchases and a corresponding increase in the
amount of loans sold through securitizations.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
increased $31.1 million, or 202%, to $46.5 million in 1996 from $15.4 million in
1995. This increase was the result of higher loan originations and purchases,
resulting in an increased amount of loans sold through securitizations. Total
loan originations and
23
purchases increased $371.0 million, or 129%, to $658.8 million in 1996
from $287.8 million in 1995. The Company sold or securitized $630.4 million of
loans in 1996 compared to $247.6 million in 1995, with a weighted average net
gain on sale ratio of 7.4% and 6.2%, respectively.
INTEREST INCOME. Interest income increased $2.8 million, or 21%, to $16.4
million in 1996 from $13.6 million in 1995. The increase in interest income was
primarily due to a higher average balance of loans held for sale during 1996
resulting from the increases in loan originations and purchases, but was
partially offset by the shorter holding period in which the mortgage loans
remained in inventory during 1996. The Company completed three securitizations
during 1996 compared to two securitizations in 1995.
SERVICING FEES. Servicing fees increased $2.5 million, or 86%, to $5.4
million in 1996 from $2.9 million in 1995. This increase was primarily due to
higher loan servicing volume, which resulted in increased contractual and
ancillary service fees. During 1996, the average balance of mortgage loans
serviced by the Company increased 79% to $667.4 million from $373.4 million
during 1995.
ORIGINATION FEES. Origination fees increased $1.0 million, or 23%, to $5.3
million in 1996 from $4.3 million in 1995. This increase was primarily due to an
83% increase in broker loan originations to $321.7 million in the year ended
1996 from $175.7 million in comparable period of 1995. Loan origination fees
increased at a slower rate than broker loan originations primarily because the
Company earned lower average origination fees per loan.
EXPENSES
Total expenses increased $8.5 million, or 27%, to $40.0 million for 1996 from
$31.5 million in 1995. The increase in expenses was primarily the result of
increased interest expense on loans held for sale and higher operating expenses
associated with the additional personnel required to process the greater number
of loan originations and purchases. Total expenses increased at a slower rate
than total revenues, primarily due to efficiencies realized from the Company's
investment in technology, experienced staff and economies of scale.
PAYROLL AND RELATED COSTS. Payroll and related costs increased $3.6 million,
or 28%, to $16.5 million for 1996 from $12.9 million for 1995. The increase was
primarily due to increased staffing in the Company's originations area
associated with the increase in loan originations and purchases, as well as the
Company's expansion into new and existing markets. As of December 31, 1996, the
Company employed 346 full- and part-time persons as compared to 255 full- and
part-time persons as of December 31, 1995.
INTEREST EXPENSE. Interest expense increased $3.3 million, or 41%, to $11.3
million in 1996 from $8.0 million in 1995. The increase in interest expense was
attributable to the interest costs associated with both a higher balance of
loans pending sale during 1996, resulting from increases in loan originations
and purchases during the period, and an increase in the excess servicing
receivable financing during 1996. The Company had financings against its
interest-only and residual certificates of $47.0 million as of December 31, 1996
compared to $16.2 million as of December 31, 1995. Interest expense was
partially offset by lower cost of funds on the Company's floating-rate
borrowings which are based on one-month LIBOR. The average one-month LIBOR
decreased to an average rate of 5.4% in 1996, compared to an average rate of
5.9% in 1995.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses,
which consist primarily of office and administration, rent, and health care and
insurance, increased $1.5 million, or 14%, to $12.2 million in 1996 from $10.7
million in 1995. The increase in general and administrative expenses was
primarily due to expenses incurred in connection with the increases in loan
originations and purchases, and increased employee benefit expenses.
EXTRAORDINARY GAIN. In May 1996, the Company closed out its long-term $31.7
million warehouse facility with a European financial institution at a 10%
discount. As a result, the Company realized an extraordinary gain of $3.17
million for the year ended December 31, 1996.
INCOME TAXES. Prior to October 31, 1996, Delta Funding Corporation was
treated as an S corporation for
24
Federal and state income tax purposes. As a result, the Company's historical
earnings prior to such date had been taxed directly to the former shareholders
of Delta Funding and not to the Company.
On October 31, 1996, Delta Funding Corporation's status as an S corporation
was terminated and the Company became a C corporation for Federal and state
income tax purposes and as such was subject to Federal and state income tax on
its taxable income for the months of November and December 1996. During 1996,
the Company recorded a tax provision of $9.5 million. This includes a $4.2
million provision for November and December earnings at the statutory rate of
42% and a deferred tax expense of $3.9 million in connection with the change in
tax status from an S corporation to a C corporation.
FINANCIAL CONDITION
DECEMBER 31, 1997 COMPARED TO DECEMBER 31, 1996
Cash and interest-bearing deposits increased $14.2 million, or 76%, to $32.9
million at December 31, 1997 from $18.7 million at December 31, 1996. The
increase was primarily the result of additional monies held in securitization
trust accounts by the Company, acting as servicer for its ongoing securitization
program.
Accounts receivable increased $20.7 million, or 197%, to $31.2 million at
December 31, 1997 from $10.5 million at December 31, 1996. The increase was
attributable to (i) a higher average loan servicing portfolio, which resulted in
increased reimbursable servicing advances made by the Company, acting as
servicer on its securitizations, and (ii) a $14.8 million income tax receivable
related to current tax assets.
Loans held for sale decreased $3.2 million, or 3.9%, to $79.2 million at
December 31, 1997 from $82.4 million at December 31, 1996. This decrease was
primarily the result of a larger percentage of loans securitized, compared to
loans originated and purchased, in 1997.
Accrued interest and late charges receivable increased $11.1 million, or 60%,
to $29.6 million at December 31, 1997 from $18.5 million at December 31, 1996.
This increase was primarily due to a higher average loan servicing portfolio
which resulted in increased reimbursable interest advances made by the Company,
acting as servicer on its securitizations. The Company's average servicing
portfolio increased 107% to $1.38 billion as of December 31, 1997 from $667
million as of December 31, 1996.
Capitalized mortgage servicing rights increased $11.5 million, or 101%, to
$22.9 million at December 31, 1997, from $11.4 million at December 31, 1996.
This increase was directly attributable to the Company's capitalizing the fair
market value of the servicing assets, totaling $15.1 million, resulting from the
Company's completion of four securitizations during 1997, partially offset by
the amortization of capitalized mortgage servicing rights.
Interest-only and residual certificates increased $84.7 million, or 102%, to
$167.8 million at December 31, 1997 from $83.1 million at December 31, 1996. The
Company received interest-only and residual certificates initially valued and
recorded at $102.1 million in its four securitizations in 1997. Offsetting
adjustments to reflect distributions, and changes in fair value, totaled $17.4
million.
Prepaid and other assets increased $4.6 million, or 288%, to $6.2 million at
December 31, 1997 from $1.6 million at December 31, 1996. The increase was
primarily due to the capitalized issuance costs related to the Company's $150
million Senior Note offering in the third quarter of 1997 which is being
amortized over the seven year life of the Senior Notes.
Warehouse financing and other borrowings decreased $67.3 million, or 70%, to
$28.2 million at December 31, 1997 from $95.5 million at December 31, 1996.
During the third quarter of 1997, the Company used the net proceeds from its
Senior Notes offering to pay down its warehouse facility and interest-only and
residual financings.
The aggregate principal balance of the Senior Notes totaled $149.3 million at
December 31, 1997, net of unamortized bond discount. The Senior Notes accrue
interest at a rate of 9.5% per annum, payable semi-annually
25
on February 1 and August 1, commencing on February 1, 1998. The Company did not
have any Senior Notes outstanding prior to July 1997.
Investor payable increased $20.0 million, or 96%, to $40.9 million at
December 31, 1997 from $20.9 million at December 31, 1996. This increase was
primarily due to the 97% increase in the Company's portfolio of serviced loans
to $1.84 billion at December 31, 1997 from $933 million at December 31, 1996.
Investor payable is comprised of all principal collected on mortgage loans and
accrued interest. Variability in this account is primarily due to the principal
payments collected within a given collection period.
Stockholders' equity increased $33.0 million, or 35%, to $126.5 million at
December 31, 1997 from $93.5 million at December 31, 1996. This increase is due
to net income for the twelve month period of $30.4 million and the issuance of
119,288 additional shares of common stock valued at $2.5 million in connection
with the Company's acquisition of Fidelity Mortgage.
LIQUIDITY AND CAPITAL RESOURCES
The Company has operated, and expects to continue to operate on a negative
cash flow basis due to increases in the volume of loan purchases and
originations, the growth of its securitization program, and potential
acquisitions. Currently, the Company's primary cash requirements include the
funding of (i) mortgage originations and purchases pending their pooling and
sale, (ii) the points and expenses paid in connection with the acquisition of
correspondent loans, (iii) interest expense on its Senior Notes and warehouse
and other financings, (iv) fees, expenses and tax payments incurred in
connection with its securitization program, and (v) ongoing administrative and
other operating expenses. The Company has relied upon a few lenders to provide
the primary credit facilities for its loan originations and purchases.
The Company must be able to sell loans and obtain adequate credit facilities
and other sources of funding in order to continue to originate and purchase
loans. As a result of increased loan originations and purchases and the
expansion of its securitization program, the Company, during 1997, 1996 and
1995, had an operating cash flow deficit of approximately $53.5 million, $42.0
million and $23.9 million, respectively.
Historically, the Company has utilized various financing facilities and an
equity financing to offset negative operating cash flows and support the
continued growth of its loan originations and purchases, securitizations and
general operating expenses. On July 23, 1997, the Company completed an offering
of the Senior Notes. A portion of the Senior Notes proceeds were used to pay
down various financing facilities with the remainder to be used to fund the
Company's growth in loan originations and purchases and its ongoing
securitization program. The Company's primary sources of liquidity continue to
be warehouse and other financing facilities, securitizations and, subject to
market conditions, sales of whole loans and additional debt and equity
securities.
To accumulate loans for securitization, the Company borrows money on a
short-term basis through warehouse lines of credit. The Company has three
warehouse facilities for this purpose. One warehouse facility is a $400 million
committed credit line with a variable rate of interest and a maturity date of
February 1999. This facility was converted from an uncommitted to a committed
line during the three months ended March 31, 1997 and, subsequent to December
31, 1997, the maturity date was extended from February 1998 to February 1999.
The Company's second warehouse facility is a $200 million committed revolving
line with a variable rate of interest and a maturity date of February 1998. In
February 1998, management elected not to renew this line. The Company's third
warehouse facility is a syndicated $140 million committed revolving line with a
variable rate of interest and a maturity date of June 1998. This facility was
increased from $100 million to $140 million subsequent to December 31, 1997. The
outstanding balances on the $400 million facility, $250 million facility and
$140 million facility as of December 31, 1997 were $23.9 million, $0 and $0,
respectively.
In February 1998, a new $250 million committed revolving line with a variable
rate of interest was secured by the Company to replace the Company's second
warehouse facility which expired in February 1998. This new facility has a
maturity date of February 1999.
26
The Company has in the past obtained financing facilities for interest-only
and residual certificates acquired as part of its securitizations. As of
December 31, 1997, the Company did not have any indebtedness secured by
interest-only and residual certificates. In addition, the Company is limited by
the terms of the Indenture governing the Senior Notes as to the amount of future
indebtedness permitted to be secured by interest-only and residual certificates.
The Company had a $1.0 million line of credit with a financial institution to
support its daily operating requirements, which it elected to let expire in
September 1997.
The Company is required to comply with various operating and financial
covenants as provided in the agreements described above which are customary for
agreements of their type. The Company does not believe that its existing
financial covenants will restrict its operations or growth. The continued
availability of funds provided to the Company under these agreements is subject
to the Company's continued compliance with these covenants. Management believes
that the Company is in compliance with all such covenants under these agreements
as of December 31, 1997.
HEDGING
The Company originates and purchases mortgage loans and then sells them
primarily through securitizations. At the time of securitization and delivery of
the loans, the Company recognizes gain on sale based on a number of factors
including the difference, or "spread" between the interest rate on the loans and
the interest rate on treasury securities with maturities corresponding to the
anticipated life of the loans. If interest rates rise between the time the
Company originates or purchases the loans and the time the loans are sold at
securitization, the excess spread narrows, resulting in a loss in value of the
loans. The Company has implemented a strategy to protect against such losses and
to reduce interest rate risk on loans originated and purchased that have not yet
been securitized through the use of treasury rate lock contracts with various
durations (which are similar to selling a combination of United States Treasury
securities), which equate to a similar duration of the underlying loans. The
nature and quantity of hedging transactions are determined by the Company based
upon various factors including, without limitation, market conditions and the
expected volume of mortgage originations and purchases. The Company will enter
into treasury rate lock contracts through one of its warehouse lenders and/or
one of the investment bankers which underwrite the Company's securitizations.
These contracts are designated as hedges in the Company's records and are closed
out when the associated loans are sold through securitization.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, the Company, upon settlement with its counterparty, will pay the
hedge loss in cash and realize the corresponding increase in the value of the
loans as part of its net gain on sale of mortgage loans and its corresponding
interest-only and residual certificates. Conversely, if the value of the hedges
increase, offsetting a decrease in the value of the loans, the Company, upon
settlement with its counterparty, will receive the hedge gain in cash and
realize the corresponding decrease in the value of the loans through a reduction
in the value of the corresponding interest-only and residual certificates.
The Company believes that its current hedging strategy of using treasury rate
lock contracts is the most effective way to manage its interest rate risk on
loans prior to securitization. As of December 31, 1997, the Company's
mark-to-market unrealized hedge loss was $0.5 million.
INFLATION
Inflation affects the Company most significantly in the area of loan
originations and can have a substantial effect on interest rates. Interest rates
normally increase during periods of high inflation and decrease during periods
of low inflation. (See - "Interest Rate Risk.")
27
OTHER ACCOUNTING CONSIDERATIONS
SFAS NO. 130
SFAS No. 130, "Reporting on Comprehensive Income" was issued in June 1997 and
is effective for fiscal years beginning after December 15, 1997. SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. The Statement requires all items that are
required to be recognized under accounting standards as components of
comprehensive income to be reported in a financial statement that is displayed
with the same prominence as other financial statements. The Company has not
completed its analysis of this Statement. However, the implementation of the
requirements of SFAS No.130 will not affect the Company's net income, cash flows
or financial position.
SFAS NO. 131
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information" was issued in June 1997 and is effective for fiscal years beginning
after December 15, 1997. SFAS No. 131 establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. The Statement requires a public business enterprise to report a
measure of segment profit or loss, certain specific revenue and expense items
and segment assets. The Company has not completed its analysis of this
Statement. However, the implementation of the requirements of SFAS No. 131 will
not affect the Company's net income, cash flows or financial position.
RISK FACTORS
Except for historical information contained herein, certain matters discussed
in this Form 10-K are "forward-looking statements" as defined in the Private
Securities Litigation Reform Act (PSLRA) of 1995, which involve risk and
uncertainties that exist in the Company's operations and business environment,
and are subject to change on various important factors. The Company wishes to
take advantage of the "safe harbor" provisions of the PSLRA by cautioning
readers that numerous important factors discussed below, among others, in some
cases have caused, and in the future could cause the Company's actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, the Company. The following include some, but not all, of
the factors or uncertainties that could cause actual results to differ from
projections:
* A general economic slowdown.
* The effects of interest rate fluctuations and the Company's ability
or inability to hedge effectively against such fluctuations in
interest rates; the effects 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.
* The Company's ability or inability to continue its practice of
securitization of mortgage loans held for sale.
* Increased competition within the Company's markets.
* The unanticipated expenses of assimilating newly-acquired businesses
into the Company's structure; as well as the impact of unusual
expenses from ongoing evaluations of business strategies, asset
valuations, acquisitions, divestitures and organizational
structures.
* Unpredictable delays or difficulties in the development of new
product programs.
28
* Rapid or unforeseen escalation of the cost of regulatory compliance
and/or litigation, including but not limited to, environmental
compliance, licenses, adoption of new, or changes in accounting
policies and practices and the application of such policies and
practices.
YEAR 2000
In 1997, the Company developed a plan to address the ability of its computer
systems to process Year 2000 transactions and data and began the process of
making its systems Year 2000 compliant. The plan provides for the conversion
efforts to be completed by the end of 1998, and is currently estimated to cost
approximately $200,000. The Company is expensing the costs as incurred; costs
incurred in 1997 were not material.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Delta Financial Corporation:
We have audited the accompanying consolidated balance sheets of Delta Financial
Corporation and subsidiaries (the "Company") as of December 31, 1997 and 1996,
and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1997. 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 generally accepted auditing
standards. 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 the Company as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 1997 in
conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
February 18, 1998
30
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
(DOLLARS IN THOUSANDS) 1997 1996
- --------------------------------------------------------------------------------
ASSETS
Cash and interest bearing deposits.................. $ 32,858 $ 18,741
Accounts receivable................................. 31,209 10,501
Loans held for sale................................. 79,247 82,411
Accrued interest and late charges receivable........ 29,598 18,459
Capitalized mortgage servicing rights............... 22,862 11,412
Interest-only and residual certificates............. 167,809 83,073
Equipment, net...................................... 11,211 2,836
Cash held for advance payments...................... 6,325 2,488
Real estate owned................................... -- 135
Prepaid and other assets............................ 6,224 1,560
Goodwill ........................................... 5,889 --
- --------------------------------------------------------------------------------
Total assets................................... $ 393,232 $ 231,616
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank payable........................................ $ 2,222 $ 2,295
Warehouse financing and other borrowings............ 28,233 95,482
Senior Notes........................................ 149,307 --
Accounts payable and accrued expenses............... 15,503 7,781
Investor payable.................................... 40,852 20,869
Advance payment by borrowers for taxes and insurance 5,750 2,255
Income taxes payable................................ 24,912 9,416
- --------------------------------------------------------------------------------
Total liabilities.............................. $ 266,779 $ 138,098
- --------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Capital stock, $.01 par value. Authorized
49,000,000 shares; issued and outstanding
15,372,688 shares and 15,253,000 shares in 1997
and 1996, respectively. $ 154 $ 153
Additional paid-in capital........................ 93,476 90,953
Retained earnings................................. 32,823 2,412
- --------------------------------------------------------------------------------
Total stockholders' equity..................... 126,453 93,518
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity..... $ 393,232 $ 231,616
================================================================================
See accompanying notes to consolidated financial statements.
31
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996 and 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995
- -------------------------------------------------------------------------------------------------
REVENUES:
Net gain on sale of mortgage loans................ $ 86,307 $ 46,525 $ 15,383
Interest.......................................... 22,341 16,372 13,588
Servicing fees.................................... 7,094 5,368 2,855
Origination fees.................................. 18,108 5,266 4,309
- -------------------------------------------------------------------------------------------------
Total revenues................................. 133,850 73,531 36,135
- -------------------------------------------------------------------------------------------------
EXPENSES:
Payroll and related costs......................... 38,991 16,509 12,876
Interest expense.................................. 19,972 11,298 7,964
General and administrative........................ 23,737 12,236 10,709
- -------------------------------------------------------------------------------------------------
Total expenses................................. 82,700 40,043 31,549
- -------------------------------------------------------------------------------------------------
Income before income taxes and extraordinary item..... 51,150 33,488 4,586
Provision for income taxes............................ 20,739 9,466 --
- -------------------------------------------------------------------------------------------------
Income before extraordinary item...................... 30,411 24,022 4,586
Extraordinary item:
Gain on extinguishment of debt.................... -- 3,168 --
- -------------------------------------------------------------------------------------------------
Net income..................................... $ 30,411 $ 27,190 $ 4,586
=================================================================================================
Unaudited pro forma information:
Provision for pro forma income taxes
before extraordinary item.................... $ n/a $ 14,400 $ 1,972
- -------------------------------------------------------------------------------------------------
Pro forma income before extraordinary item..... 30,411 $ 19,088 $ 2,614
=================================================================================================
Per share data (1):
Earnings per common share - basic and diluted .... $ 1.98 $ 1.46 $ 0.21
Weighted average number of shares outstanding..... 15,359,280 13,066,485 12,629,182
=================================================================================================
(1) Unaudited pro forma presentation for the years ended 1996 and 1995
See accompanying notes to consolidated financial statements.
32
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS'
EQUITY
Years ended December 31, 1997, 1996 and 1995
ADDITIONAL
PAID-IN RETAINED
(DOLLARS IN THOUSANDS) CAPITAL STOCK CAPITAL EARNINGS TOTAL
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1994.................. $ 107 $ 3,225 $ 24,831 $ 28,163
Net income................................ -- -- 4,586 4,586
Distributions............................. -- -- (2,916) (2,916)
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1995.................. $ 107 $ 3,225 $ 26,501 $ 29,833
Proceeds from initial public offering of
common stock........................ 46 69,656 -- 69,702
Reclassification of undistributed S
corporation earnings................ -- 18,072 (18,072) --
Net income.................................... -- -- 27,190 27,190
Distributions............................. -- -- (33,207) (33,207)
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1996.................. $ 153 $ 90,953 $ 2,412 $ 93,518
Issuance of common stock to acquire
Fidelity Mortgage.................... 1 2,516 -- 2,517
Proceeds from exercise of stock options....... -- 7 -- 7
Net income.................................... -- -- 30,411 30,411
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1997.................. $ 154 $ 93,476 $ 32,823 $ 126,453
=================================================================================================
See accompanying notes to consolidated financial statements.
33
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
(DOLLARS IN THOUSANDS) 1997 1996 1995
- --------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income.................................................. $ 30,411 $ 27,190 $ 4,586
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan and recourse losses................... 100 101 100
Depreciation and amortization............................ 2,603 997 564
Capitalized mortgage servicing rights, net
of amortization........................................ (11,451) (7,581) (1,410)
Deferred origination fees................................ (88) (2,399) (61)
Interest only and residual certificates received in
securitization transactions, net....................... (84,736) (57,763) (17,796)
Changes in operating assets and liabilities:
Increase in accounts receivable, net.................. (20,677) (1,654) (3,138)
Decrease (increase) in loans held for sale, net....... 3,222 (17,719) (13,459)
Increase in accrued interest and late
charges receivable.................................. (11,139) (3,340) (2,397)
(Increase) decrease in cash held for advance payments (3,836) 631 167
Decrease in real estate owned......................... 135 116 449
(Increase) decrease in prepaid and other assets....... (4,630) (244) 1,754
Decrease in due from stockholders..................... -- 990 2,165
Increase in accounts payable and accrued expenses 7,574 2,359 2,341
Increase in investor payable.......................... 19,984 7,427 2,353
Increase (decrease) in advance payment by borrowers
for taxes and insurance............................. 3,482 (552) (120)
Increase in income taxes payable...................... 15,538 9,416 --
- ---------------------------------------------------------------------------------------------------
Net cash used in operating activities........................ (53,508) (42,025) (23,902)
- ---------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Acquisition of Fidelity Mortgage........................... (4,150) -- --
Purchase of equipment...................................... (9,933) (2,283) (1,208)
- ---------------------------------------------------------------------------------------------------
Net cash used in investing activities:....................... (14,083) (2,283) (1,208)
- ---------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net proceeds from initial public offering.................. -- 69,701 --
Proceeds from (repayments of) warehouse
financing and other borrowings, net..................... (67,481) 12,725 30,266
Proceeds from Senior Notes................................. 149,307 -- --
(Decrease) increase in bank payable, net................... (125) (2,805) 4,124
Proceeds from exercise of stock options.................... 7 -- --
Distributions.............................................. -- (33,207) (2,916)
Payments received from affiliates.......................... -- -- 914
- ---------------------------------------------------------------------------------------------------
Net cash provided by financing activities.................... 81,708 46,414 32,388
- ---------------------------------------------------------------------------------------------------
Net increase in cash and interest-bearing deposits........... 14,117 2,106 7,278
Cash and interest-bearing deposits at beginning of year...... 18,741 16,635 9,357
- ---------------------------------------------------------------------------------------------------
Cash and interest-bearing deposits at end of year............ $ 32,858 $ 18,741 $ 16,635
===================================================================================================
Supplemental Information:
Cash paid during the year for:
Interest ................................................... $ 14,314 $ 10,453 $ 7,659
Income taxes ............................................... 19,972 202 --
===================================================================================================
See accompanying notes to consolidated financial statements.
34
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) ORGANIZATION
Delta Financial Corporation (the "Company") is a Delaware corporation which was
organized in August 1996. On October 31, 1996, the Company acquired all of the
outstanding common stock of Delta Funding Corporation ("Delta Funding"), a New
York corporation which had been organized on January 8, 1982 for the purpose of
originating, selling, servicing and investing in residential first and second
mortgages. On November 1, 1996, the Company completed an initial public offering
of 4,600,000 shares of common stock, $.01 par value (see note 2).
On February 11, 1997, the Company acquired Fidelity Mortgage Inc. and Fidelity
Mortgage (Florida), Inc. (together referred to herein as "Fidelity Mortgage"),
retail residential mortgage origination companies, for a combination of cash and
stock with a value of $6.3 million. These transactions were accounted for under
the purchase method of accounting. Accordingly, the results of operations of
Fidelity Mortgage from February 11, 1997 have been included in the Company's
consolidated financial statements. In connection with these acquisitions the
Company recorded goodwill of approximately $6.3 million, which is being
amortized on a straight-line basis over seven years. On October 1, 1997, the
acquired operations were merged and will continue to operate as Fidelity
Mortgage Inc. going forward.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
(C) USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management of the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
(D) LOAN ORIGINATION FEES AND COSTS
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 91,
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases," 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 subsequently
amortized over the life of the loan, using the level yield method, and are
eliminated together with the loan at the time a loan is securitized or sold.
(E) LOANS HELD FOR SALE
Loans held for sale are accounted for at the lower of cost or estimated market
value, determined on a net aggregate basis. Cost includes unamortized loan
origination fees and costs. Net unrealized losses are provided for in a
valuation allowance created through a charge to operations. Losses are
recognized when the market value is less than cost.
(F) SECURITIZATION AND SALE OF MORTGAGE LOANS
In accounting for the securitization of its loans with the retention of mortgage
servicing rights, the Company adopted the provisions of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" effective January 1, 1997. Previously, the Company followed the
requirements of SFAS No. 122, "Accounting for Mortgage Servicing Rights." The
adoption of SFAS No. 125 did not have a material impact on the Company's results
of operations or financial position.
35
The Company sells loans to a loan securitization trust and receives the excess
value of the loans' economic interests for (i) the difference between the
interest payments due on the sold loans and the interest payments due, at the
pass-through rates, to the holders of the pass-through certificates, less the
Company's contractual servicing fee and other costs and expenses of
administering the trust, represented by interest-only and residual certificates,
and (b) the right to service the loans on behalf of the trust and earn a
contractual servicing fee, as well as other ancillary servicing related fees
directly from the borrowers on the underlying loans.
Upon the securitization of a pool of loans, the Company recognizes as
origination fees any then unamortized origination fees which had initially been
recorded as adjustments to the investment in the loans, and additionally
allocates portions of the remaining investment in the loans sold to each of (i)
the servicing rights retained by the Company and (ii) the interest-only and
residual certificates received from the trust. The retained servicing rights and
interest-only and residual certificates are initially recorded based upon their
fair value, which is estimated based on the stated terms of the transferred
loans adjusted for estimates of future prepayments or defaults among those
loans. The Company recognizes a gain for the difference between the investment
in the loans remaining after this allocation and the cash payment received from
the trust.
Prior to January 1, 1997, the Company sold whole loans with servicing retained.
Gains or losses on such sales were recognized at the time of the sale and were
determined by the differences between net sales proceeds and the unpaid
principal balance of the loans sold as adjusted for by the present value of any
yield differential.
(G) INTEREST-ONLY AND RESIDUAL CERTIFICATES
The interest-only and residual certificates, received by the Company upon the
securitization of a pool of loans to the securitization trust, are accounted for
as trading securities under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." In accordance with SFAS No. 115, the amount
initially allocated to the interest-only and residual certificates at the date
of a securitization reflects the fair value of those interests. The amount
recorded for the certificates is reduced for distributions thereon which the
Company receives from the related trust, and is adjusted for the subsequent
changes in the fair value of these certificates which are reflected in the
statement of income. The fair value of interest-only and residual certificates
is determined using the same prepayment and default estimates utilized in
valuing servicing rights, together with the consideration of the geographic
location and value of loan collateral, the value of which would affect the
credit loss sustained by a trust upon the default of a loan.
(H) CAPITALIZED MORTGAGE SERVICING RIGHTS
Effective January 1, 1997, the Company adopted SFAS No. 125, which supersedes
SFAS No. 122 and SFAS No. 65,"Accounting for Certain Banking Activities" to
require that a mortgage banking enterprise recognize as separate assets the
rights to service mortgage loans for others, however those servicing rights are
acquired. The Statement requires the assessment of capitalized mortgage
servicing rights for impairment. Mortgage servicing rights are amortized in
proportion to and over the period of the estimated net servicing income (see
note 5).
(I) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments," requires
the Company to disclose the fair value of financial instruments for which it is
practicable to estimate fair value. Fair value is defined as the amount at which
a financial instrument could be exchanged in a current transaction between
willing parties, other than in a forced sale or liquidation, and is best
evidenced by a quoted market price. Other than interest-only and residual
certificates which are reported at fair value, and capitalized mortgage
servicing rights, substantially all the Company's assets and liabilities deemed
to be financial instruments are carried at cost, which approximates their fair
value. The fair value of capitalized mortgage servicing rights represents the
Company's estimate of the expected future net servicing revenue based on common
industry assumptions, as well as on the Company's historical experience.
(J) GOODWILL
Goodwill, which represents the excess of the purchase price over the fair value
of the net assets acquired from Fidelity Mortgage, is being amortized on a
straight-line basis over seven years.
36
(K) REAL ESTATE OWNED
Properties acquired through foreclosure or a deed in lieu of foreclosure are
recorded at the lower of the unpaid loan balance, or fair value, at the date of
acquisition. The carrying value of the individual properties is subsequently
adjusted to the extent it exceeds estimated fair value less costs to sell, at
which time a provision for losses on such real estate is charged to operations.
(L) EQUIPMENT, NET
Equipment, including leasehold improvements, is stated at cost, less
accumulated depreciation and amortization. Depreciation of equipment is computed
using the straight-line or accelerated method over the estimated useful lives of
three to seven years. Leasehold improvements are amortized over the lesser of
the terms of the lease or the estimated useful lives of the improvements.
Expenditures for betterments and major renewals are capitalized and ordinary
maintenance and repairs are charged to operations as incurred.
(M) SERVICING FEES
Servicing fees includes servicing income, prepayment penalties and late payment
charges earned for servicing mortgage loans owned by investors. All fees and
charges are recognized into income when earned.
(N)INCOME TAXES
The Company accounts for income taxes in conformity with SFAS No. 109,
"Accounting for Income Taxes," under which 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.
Through October 31, 1996, the Company was an S corporation pursuant to the
Internal Revenue Code of 1986, as amended. On October 31, 1996, the Company
became a C corporation for Federal and state income tax purposes and as such is
subject to Federal and state income tax on its taxable income for the period
beginning on November 1, 1996.
In order to provide information on results of operations comparable to that for
the periods during which the Company has been taxed as a C corporation,
unaudited pro forma income taxes, which were computed at an assumed rate of 43%,
and unaudited pro forma net income are presented on the accompanying
consolidated statement of income.
(O) EARNINGS PER SHARE
Effective December 15, 1997, the Company adopted SFAS No. 128, "Earnings Per
Share." SFAS No. 128 establishes standards for computing and presenting earnings
per share (EPS) and applies to entities with publicly held common stock or
potential common stock. SFAS No. 128 simplifies the standards for computing EPS
previously found in Accounting Principles Board Opinion No. 15, "Earnings Per
Share" and makes them comparable to international EPS standards. SFAS No. 128
replaces the presentation of primary EPS with a presentation of basic EPS and
replaces fully diluted EPS with diluted EPS. SFAS No. 128 requires dual
presentation of basic and diluted EPS on the face of the income statement for
all entities with complex capital structures and requires a reconciliation of
the numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation (see note 17).
Basic 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. Diluted EPS is completed similar to fully diluted
EPS pursuant to Opinion No. 15. SFAS No. 128 requires restatement of all
prior-period EPS data presented.
EPS data for the period November 1, 1996 to December 31, 1996 has not been
presented in the accompanying consolidated financial statements because
management believes that such data would not be meaningful given the
37
relatively short period and the impact of the recognition of the deferred tax
liability in connection with the change in tax status.
(P) STOCK OPTION PLAN
During 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which permits entities to continue to apply provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and provide pro
forma net income and pro forma earnings per share disclosures for employee stock
option grants as if the fair-value based method defined in SFAS No. 123 had been
applied. The Company elected to continue to apply the provisions of APB Opinion
No. 25 and provide the pro forma disclosure provisions of SFAS No. 123 (see note
15).
(Q) RECLASSIFICATIONS
Certain prior period amounts in the financial statements and notes have been
reclassified to conform with the current year presentation.
(2) REORGANIZATION AND INITIAL PUBLIC OFFERING
On October 31, 1996, the Company acquired all of the outstanding stock of Delta
Funding Corporation in exchange for 10,653,000 shares of common stock of the
Company. Prior to the exchange, Delta Funding Corporation was treated for
Federal income tax purposes as an S corporation under Subchapter S of the
Internal Revenue Code of 1986, as amended, and as such, the historical earnings
of Delta Funding Corporation through October 31, 1996 were taxed directly to the
stockholders of Delta Funding Corporation. As a result of the exchange, the
Company and Delta Funding Corporation, which became a wholly-owned subsidiary of
the Company, became subject to Federal and state income taxes and the Company
recorded a deferred tax liability on its balance sheet relating to the tax
effect of temporary differences between book and tax accounting, principally
relating to recognition of gain on sale of mortgage loans.
On November 1, 1996, the Company completed an initial public offering (IPO) of
4,600,000 shares of common stock at an offering price of $16.50 per share. The
net proceeds of the offering to the Company, exclusive of underwriting discounts
and commissions and other expenses, was $69.7 million. In November 1996, $32.6
million of the proceeds raised in the offering was distributed to the former S
corporation shareholders with respect to declared distributions of undistributed
S corporation earnings. Remaining undistributed S corporation earnings of $18.1
million were reclassified as additional paid-in capital.
(3) LOANS HELD FOR SALE
The Company originates and purchases first and second mortgages which had a
weighted average interest rate of 10.79% at December 31, 1997. These mortgages
are being held as inventory, at the lower of cost or estimated market value, for
future sale. Certain of these mortgages are pledged as collateral for a portion
of the warehouse financing and other borrowings.
Included in loans held for sale are deferred origination fees and purchase
premiums in the amount of $3.5 million and $3.4 million at December 31, 1997 and
1996, respectively and an allowance for loan losses of $0.3 million at December
31, 1997 and 1996. Mortgages are payable in monthly installments of principal
and interest and have terms varying from five to thirty years.
Activity in the allowance for loan losses for the years ended December 31 is as
follows:
(DOLLARS IN THOUSANDS) 1997 1996 1995
- --------------------------------------------------------------------------------
Balance at beginning of year $270 $240 $260
Provisions 30 31 30
Charge-offs - (1) (50)
- --------------------------------------------------------------------------------
Balance at end of year $300 $270 $240
- --------------------------------------------------------------------------------
38
The Company also maintained an allowance for recourse losses of $650,000,
$580,000 and $510,000 at December 31, 1997, 1996 and 1995, respectively, which
is included in accounts payable and accrued expenses (see note 14).
(4) ACCOUNTS RECEIVABLE
Accounts receivable as of December 31 consist of the following:
(DOLLARS IN THOUSANDS) 1997 1996
- --------------------------------------------------------------------------------
Securitization advances $ 6,747 $ 6,237
Escrow receivable 1,765 764
Prepaid insurance premiums 1,478 1,244
Current tax assets 14,803 -
Other 6,416 2,256
- --------------------------------------------------------------------------------
Total accounts receivable $31,209 $10,501
- --------------------------------------------------------------------------------
(5) CAPITALIZED MORTGAGE SERVICING RIGHTS
The Company sells mortgage loans and retains the servicing rights which generate
servicing income and provide funds for additional investment and lending
activities. Effective January 1, 1997, the Company adopted SFAS No. 125, which
superseded SFAS No. 122 and SFAS No. 65. SFAS No. 125 prospectively changed the
methodology for capitalized mortgage servicing rights and the methodology used
to measure impairment of its capitalized mortgage servicing rights asset. These
Statements require that upon the sale or securitization of a loan, an asset be
recognized for any retained servicing rights based on the present value of the
future servicing cash flows. The cash flow has been computed over the average
estimated life of the mortgages, adjusted for prepayments and recorded as
capitalized mortgage servicing rights.
Capitalized mortgage servicing rights are assessed periodically to determine if
there has been any impairment of the asset, based on the fair value of the
rights at the date of the assessment. The Company performs this assessment on
the basis of the Company's historical experience, and updated estimates of
prepayment and default rates for servicing rights relating to loan groups
comprised of loans of similar types, terms, credit quality and interest rates,
which represent the predominant risk characteristics affecting prepayment and
default rates. A valuation allowance is provided for the capitalized servicing
rights relating to any loan group for which the recorded investment exceeds the
fair value. At December 31, 1997 and 1996, the fair value of the capitalized
mortgage servicing rights approximated their recorded amounts and, accordingly,
no valuation allowance was recorded.
The activity related to the Company's capitalized mortgage servicing rights for
the years ended December 31 is as follows:
(DOLLARS IN THOUSANDS) 1997 1996 1995
- --------------------------------------------------------------------------------
Balance, beginning of year $11,412 $3,831 $2,421
Additions 15,118 8,336 2,118
Amortization (3,668) (755) (708)
- --------------------------------------------------------------------------------
Balance, end of year $22,862 $11,412 $3,831
- --------------------------------------------------------------------------------
(6) INTEREST-ONLY AND RESIDUAL CERTIFICATES
The interest that the Company receives upon sales through securitizations is in
the form of interest-only and residual mortgage securities which are classified
as interest-only and residual certificates.
In accordance with SFAS No. 125, upon the sale or securitization of a loan, a
gain on sale and a corresponding asset is recognized for any interest-only and
residual certificates. This asset is classified as "trading securities" and, as
such, they are recorded at their fair value. Fair value of these certificates
has been determined by the Company based on various economic factors, including
loan type, sizes, interest rates, dates of origination, terms and
39
geographic locations. The Company also uses other available information such
as reports on prepayment rates, interest rates, collateral value, economic
forecasts and historical default and prepayment rates of the portfolio under
review. In accordance with SFAS No. 115, any fair value adjustment of the
interest-only and residual certificates is recognized in the statement of income
and is reflected as a component of interest income.
Although the Company believes it has made reasonable estimates of the fair value
of the interest-only and residual certificates likely to be realized, the rate
of prepayments and the amount of defaults utilized by the Company are estimates
and actual experience may vary. The gain on securitization recognized by the
Company upon the sale of loans through securitizations will be overstated if
prepayments or losses are greater than anticipated. Higher than anticipated
rates of loan prepayments or losses would require the Company to write down the
fair value of the interest-only and residual certificates, adversely impacting
earnings. Similarly, if delinquencies, liquidations or interest rates were to be
greater than was initially assumed, the fair value of the interest-only and
residual certificates would be negatively impacted, which would have an adverse
effect on income for the period in which such events occurred. Should the
estimated loan life assumed for this purpose be shorter than the actual life,
the amount of cash actually received over the lives of the loans would exceed
the gain previously recognized at the time the loans were sold through
securitizations and would result in additional income.
The Company assumes prepayment rates and defaults based upon the seasoning of
its existing securitization loan portfolio. As of December 31, 1997 and 1996,
the Company's underlying assumptions used in determining the fair value of its
interest-only and residual certificates are as follows:
(a) Estimated annual prepayment rates:
(i) for fixed-rate loan pools of 4.8% beginning in the first month of
seasoning and increasing in equal increments to 24.0% by the 12th month of
seasoning and thereafter;
(ii) for adjustable-rate loan pools of 5.6% beginning in the first month
of seasoning and increasing in equal increments to 28.0% by the 12th month of
seasoning and thereafter at December 31, 1997, compared to 5.0% and 25.0%,
respectively, at December 31, 1996. This change in assumptions was based upon
the Company's on-going analysis of industry and Company prepayment trends;
(b) A default reserve for both fixed- and adjustable-rate loans sold to the
securitization trusts of 1.90% of the amount initially securitized;
(c) An annual discount rate of 12.0% in determining the present value of cash
flows from residual certificates, which represent the predominant form of
retained interest.
To date, actual cash flows from the Company's securitization trusts have either
met or exceeded management's expectations.
The activity related to the Company's interest-only and residual certificates
for the years ended December 31 is as follows:
(DOLLARS IN THOUSANDS) 1997 1996 1995
- --------------------------------------------------------------------------------
Balance, beginning of year $ 83,073 $ 25,310 $ 7,514
Additions 102,072 57,456 16,750
Cash remittances, accretion
of discount and FMV
adjustments, net (17,336) 307 1,046
- --------------------------------------------------------------------------------
Balance, end of year $167,809 $83,073 $25,310
- --------------------------------------------------------------------------------
40
(7) HEDGING TRANSACTIONS
The Company regularly securitizes and sells fixed-rate mortgage loans. To offset
the effects of interest rate fluctuations on the value of its fixed-rate loans
held for sale, the Company in certain cases will hedge its interest rate risk
related to loans held for sale through the use of treasury lock contracts which
function similar to a short-sale of US Treasury securities. The Company accounts
for these contracts as hedges of specific loans held for sale. The gain or loss
derived from these contracts is deferred and recognized as an adjustment to the
carrying amounts of the loans for which the contracts were interest rate hedges.
As of December 31, 1997, the Company had open hedge loss positions of $0.5
million. As of December 31, 1996 and 1995, the Company did not have open hedge
positions. The Company included losses of $2.0 million, $0.5 million and $1.7
million on the treasury lock contracts as part of gains on sale of loans in
1997, 1996 and 1995, respectively.
(8) WAREHOUSE FINANCING AND OTHER BORROWINGS
The Company has three warehouse credit facilities for a combined amount of
$700.0 million as of December 31, 1997. These 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):
Facility Balance Expiration
Facility Description Amount Rate 1997 1996 Date
- ---------------------------------------------------------------------------------------------
Warehouse line of credit $400.0 LIBOR + 0.75% $23.9 $45.8 February 1998
Warehouse line of credit 200.0 LIBOR + 0.75% - - February 1998
Warehouse line of credit 100.0 LIBOR + 0.63% - - June 1998
Term loan n/a Prime + 1.00% 0.2 0.5 Apr. 1998 - June 1998
Capital leases n/a 7.11% - 8.97% 4.1 2.2 Sept. 1998 - Dec. 2001
I/O and residual financing n/a 6.44% - 7.75% - 47.0 Oct. 1997 - Dec. 1999
- ---------------------------------------------------------------------------------------------
Balance at December 31, $ 700.0 $28.2 $95.5
- ---------------------------------------------------------------------------------------------
Subsequent to year end, the combined amount of the Company's warehouse
facilities was increased to $790.0 million and certain expiration dates were
extended. In February 1998, the first warehouse line of credit ("line") was
renewed at similar terms for a period of one year, management elected not to
renew the second line and the third line was increased to $140.0 million under
similar terms. A new $250.0 million committed line, maturing February 1999 with
an interest rate of 0.70% above LIBOR, was secured by the Company to replace the
second line.
The Company had an additional line in the aggregate amount of $45.0 million in
1996. This line was collateralized by specific mortgage receivables, which were
equal to or greater than the outstanding balances under the line at any point in
time. The terms provided for interest at a rate of 2.00% above LIBOR. In May,
1996, the Company extinguished this line of credit at a discount. An
extraordinary gain of $3.2 million was recorded in connection with this
extinguishment of debt.
During 1996, the Company had lines of credit in the aggregate amount of $3.5
million with separate banks. The individual lines available and their interest
rates, were as follows: $2.5 million at 0.50% above the prime rate its and $1.0
million at 2.90% above the 30-day dealer commercial paper rate. During 1996, the
$2.5 million line of credit expired and, at the Company's option, was not
renewed. At December 31, 1996, the Company had approximately $5,000 outstanding
on the $1.0 million line of credit.
In the past, the Company had obtained financing facilities for its interest-only
and residual certificates. These facilities were paid down with proceeds from
the Senior Note offering (see note 9).
41
(9) SENIOR NOTES
9.5% Senior Notes due 2004 (the "notes") totaled $149.3 million at December 31,
1997, net of unamortized bond discount. The notes bear interest at a rate of
9.50% per annum, payable semi-annually commencing on February 1, 1998. The notes
were issued on July 23, 1997, and mature on August 1, 2004 when all outstanding
principal is due. On or after August 1, 2001, the notes are redeemable at the
option of the Company, in whole or in part, at the redemption price set forth in
the Indenture, dated July 23, 1997, governing the issuance of the notes (the
"Indenture"), plus accrued and unpaid interest through the date of redemption.
The Company is required to comply with various operating and financial covenants
in the Indenture. These covenants limit or restrict, among other things, the
ability of the Company to consummate assets sales, pay dividends, incur
additional indebtedness and incur additional liens. Costs incurred with the
issuance of the notes, in the amount of $4.8 million, have been deferred and are
being amortized over the seven year term using a method that approximates
level-yield. At December 31, 1997, the unamortized debt issuance cost was $4.6
million.
(10) BANK PAYABLE
In order to maximize its cash management practices, the Company has instituted
a procedure whereby checks written against its operating account are covered as
they are presented to the bank for payment, either by drawing down its lines of
credit or from subsequent deposits of operating cash. Bank payable represents
the checks outstanding at December 31, 1997 and 1996 to be paid in this manner.
(11) INVESTOR PAYABLE
Investor payable represents the collection of mortgage payments by the Company
as servicer, from mortgagors, which are due to the investors. These funds, when
collected, are placed in segregated bank accounts as provided by the related
servicing agreements and are reflected on the Company's balance sheet as a
component of cash and interest-bearing deposits.
(12) RELATED PARTY TRANSACTIONS
Miller Planning Corporation, a company which is wholly-owned by Sidney A.
Miller, Chairman of the Company, acts as the Company's agent in procuring the
Company's group health, disability and life insurance policies from independent
insurance carriers and receives commissions from the insurance companies on the
same which, in 1997, totaled approximately $13,000 and in 1996 totaled
approximately $25,000. Miller Planning Corporation previously offered life and
disability credit insurance to the Company's borrowers for which it received
commissions.
Long Island Closing Corporation, a company wholly owned by Rona V. Miller,
spouse of Sidney A. Miller, was hired by title abstract companies as closing
agent to clear titles on substantially all of the Company's brokered loan
closings held at the Company's headquarters until approximately August 1997. All
fees for these services were paid by the borrowers, which totaled approximately
$84,000 for 1997 and approximately $127,000 for 1996. In or about August 1997,
Long Island Closing ceased acting as closing agent for abstract companies on the
Company's brokered loan closings.
In 1996 the Company had notes due from stockholders in the amount of $990,000
which were repaid prior to December 31, 1996.
(13) EMPLOYEE BENEFIT PLANS
The Company had an employee profit sharing plan covering all eligible employees,
as defined, with at least 30 months of service. The Company contributed $0.2
million and $0.1 million to the plan for the years ended
42
December 31, 1996 and 1995, respectively. Effective January 1, 1997, the
employee profit sharing plan was merged with the Company's 401(k) Retirement
Savings Plan.
The Company sponsors a 401(k) Retirement Savings Plan. Substantially all
employees of the Company who are at least 21 years old are eligible to
participate in the plan after completing one year of service. Contributions are
made from employees' elected salary deferrals. During 1997, the Company elected
to make a discretionary contribution to the Plan of $0.3 million. During 1995
and 1996, the Company made contributions to the Profit Sharing Plan noted in the
preceding paragraph and no contributions to this plan.
(14) COMMITMENTS AND CONTINGENCIES
The Company has repurchase agreements with certain of the institutions that have
purchased mortgages. Currently, some of the agreements provide for the
repurchase by the Company of any of the mortgage loans that go to foreclosure
sale. At the foreclosure sale, the Company will repurchase the mortgage, if
necessary, and make the institution whole. The dollar amount of loans which were
sold with recourse is $13.6 million at December 31, 1997 and $20.0 million at
December 31, 1996.
Included in accounts payable and accrued expenses is an allowance for recourse
losses of $650,000, $580,000 and $510,000 at December 31, 1997, 1996 and 1995,
respectively. During each of the three years then ended, the Company recognized,
as a charge to operations, a provision for recourse losses of $70,000. There
were no charge-offs made to the allowance for recourse losses during these
periods.
The Company previously subleased it Woodbury offices from an affiliated company.
In August 1996, the lease was assigned to the Company. This lease provides for
rent to be paid on a month-to-month basis. Rental expense, net of sublease
income, for the years ended December 31, 1997, 1996 and 1995 amounted to $2.6
million, $1.0 million and $0.5 million, respectively.
Minimum future rentals under non-cancelable operating leases as of December 31,
1997 are as follows:
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Year Amount
- --------------------------------------------------------------------------------
1998 $ 4,269
1999 4,563
2000 4,617
2001 4,578
2002 3,800
Thereafter 16,309
- --------------------------------------------------------------------------------
Total $ 38,136
- --------------------------------------------------------------------------------
In the normal course of business, the Company is subject to various legal
proceedings and claims, the resolution of which, in management's opinion, will
not have a material adverse effect on the financial position or the results of
operations of the Company.
(15) STOCK OPTION PLAN
On October 4, 1996, the Board of Directors ratified the 1996 Stock Option Plan
(the "Plan") and authorized the reserve of 2,200,000 shares of authorized but
unissued common stock for issuance pursuant to the Plan. Substantially all of
the options issued vest over a five-year period at 20% per year and expire seven
years from the grant date.
43
The following table summarizes certain information regarding the Plan at
December 31:
1997 1996
- --------------------------------------------------------------------------------
Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price
- --------------------------------------------------------------------------------
Balance, beginning of year 464,850 $16.50 n/a n/a
Options granted 424,110 $17.67 466,850 $16.50
Options exercised 400 $16.50 -- --
Options canceled 42,300 $18.06 2,000 $16.50
- --------------------------------------------------------------------------------
Balance at end of year 846,260 $17.01 464,850 $16.50
- --------------------------------------------------------------------------------
Options exercisable 96,510 $16.50 6,000 $16.50
- --------------------------------------------------------------------------------
The Company applies APB Opinion No. 25, and related Interpretations in
accounting for the Plan. There was no intrinsic value of the options granted, as
the exercise price was equal to the quoted market price at the grant date.
Accordingly, no compensation cost has been recognized for the years ended
December 31, 1997 and 1996.
Had compensation cost for the Plan been determined based on the fair value at
the grant dates for awards under the Plan consistent with the method of SFAS No.
123, the Company's net income would have been $30.1 million and $27.2 million
for 1997 and 1996, respectively. Earnings per share for 1997 would have been
$1.96.
The weighted-average fair value of options granted during 1997 and 1996 was
$3.54 and $3.69, 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 1997 and 1996 grants:
1997 1996
- --------------------------------------------------------------------------------
Dividend yield 0% 0%
Expected volatility 45% 51%
Risk-free interest rate 5.71% 6.00%
Expected life 5 years 5 years
(16) INCOME TAXES
The provision for income taxes for the years ended December 31, 1997, 1996 and
1995 is as follows:
(DOLLARS IN THOUSANDS) 1997 1996 1995
- --------------------------------------------------------------------------------
Current: Federal $ 75 $3,305 -
State 763 1,150 -
- --------------------------------------------------------------------------------
Total current income taxes $ 838 $4,455 -
- --------------------------------------------------------------------------------
Deferred: Federal $16,982 $3,727 -
State 2,919 1,284 -
- --------------------------------------------------------------------------------
Total deferred income taxes $19,901 $5,011 -
- --------------------------------------------------------------------------------
Total tax provision $20,739 $ 9,466 -
- --------------------------------------------------------------------------------
As discussed in Note 1, the Company was an S corporation through October 30,
1996 pursuant to the Internal Revenue Code of 1986, as amended, and as such did
not incur any Federal income tax expense. The Company was liable for state
minimum taxes and that provision is included above under current state
provision.
On October 31, 1996, the Company became a C corporation for Federal and state
income tax purposes and as such was subject to Federal and state income tax on
its taxable income for the period beginning on November 1, 1996. In
44
connection with the change in its tax status from an S corporation to a
C corporation, the Company incurred deferred income tax expense of $3.9 million
as of October 31, 1996.
The temporary differences in the financial reporting and tax bases of assets and
liabilities, and loss carryforward, that give rise to the Company's net deferred
tax liabilities at December 31, 1997 and 1996 were as follows (DOLLARS IN
THOUSANDS):
DEFERRED TAX LIABILITIES: 1997 1996
---- ----
Capitalized mortgage servicing rights $ 9,631 $ 4,814
Basis in residual and interest-only certificates 16,784 967
Equipment 259 -
Capitalized (loans held for sale) origination fees and costs 1,507 -
- --------------------------------------------------------------------------------
Total deferred tax liabilities $28,181 $ 5,781
- --------------------------------------------------------------------------------
DEFERRED TAX ASSETS: 1997 1996
---- ----
Capitalized mortgage servicing rights $ 278 $ 327
Credit loss reserves 1,270 357
Equipment - 86
Federal net operating loss carryforwards 1,721 -
- --------------------------------------------------------------------------------
Total deferred tax assets $ 3,269 $ 770
- --------------------------------------------------------------------------------
Net deferred tax liabilities $24,912 $ 5,011
- --------------------------------------------------------------------------------
Under SFAS No. 109, the Company is required to maintain a valuation allowance
for all or a portion of its net deferred tax assets if it believed that it was
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
would not be realized. Management believes that, based on the available
evidence, it is more likely than not that the Company will realize the benefit
from its net deferred tax assets and, therefore, no such valuation allowance is
required.
A reconciliation of the statutory income tax rate to the effective income tax
rate, as applied to income for the years ended December 31, 1997 and 1996, is as
follows:
Rate
1997 1996
- --------------------------------------------------------------------------------
Federal statutory tax rate 35.0% 35.0%
Income earned as S corporation n/a (22.6%)
Change in tax status n/a 11.6%
State and local taxes, net of Federal income tax benefit 4.7% 3.0%
Non-deductible expenses and other 0.8% 1.3%
- --------------------------------------------------------------------------------
Effective income tax rate 40.5% 28.3%
- --------------------------------------------------------------------------------
45
(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: Pro forma
(UNAUDITED)
-------------------
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 1997 1996 1995
- --------------------------------------------------------------------------------
Net income $30,411 $19,088 $2,614
Weighted-average shares 15,359 13,066 12,629
Basic EPS $1.98 $1.46 $0.21
Weighted-average shares 15,359 13,066 12,629
Incremental shares-options 32 10 -
- --------------------------------------------------------------------------------
15,391 13,076 12,629
Diluted EPS $1.98 $1.46 $0.21
- --------------------------------------------------------------------------------
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table is a summary of financial data by quarter for the years
ended December 31, 1997 and 1996:
For the quarters ended
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) March 31, June 30, Sept. 30, Dec. 31,
- ----------------------------------------------------------------------------------------------
1997
Revenues $27,305 $30,467 $37,414 $38,664
Expenses 15,064 17,848 23,735 26,053
Net income 6,990 7,225 7,883 8,313
Earnings per common share-basic and diluted 0.45 0.47 0.51 0.54
1996
Revenues $5,303 $25,027 $20,717 $22,484
Expenses 5,616 12,303 10,788 11,336
Net income/(loss) (357) 15,617 10,032 1,898
Earnings per common share-basic and diluted n/a n/a n/a n/a
46
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEMS 10-13
Registrant incorporates by reference herein information in its proxy
statement which complies with the information called for by Items 10-13 of Form
10-K. The proxy will be filed at a later date with the Commission.
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A)(1) FINANCIAL STATEMENTS
PAGE(S)
-------
The following Consolidated Financial Statements of Delta Financial
Corporation and Subsidiaries are included in Part II, Item 8 of
this report
Independent Auditors' Report........................................... 30
Consolidated Balance Sheets--December 31, 1997 and 1996................ 31
Consolidated Statements of Income--Years ended December 31, 1997,
1996 and 1995........................................................ 32
Consolidated Statement of Changes in Stockholders' Equity--Years
ended December 31, 1997, 1996 and 1995............................... 33
Consolidated Statements of Cash Flows--Years ended December 31,
1997, 1996 and 1995.................................................. 34
Notes to Consolidated Financial Statements............................. 35
(A)(2) FINANCIAL STATEMENT SCHEDULES
Exhibits 11.1 and 27 (See - Exhibit List)
(A)(3) EXHIBITS:
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
*3.1 -- Certificate of Incorporation of Delta Financial Corporation
*3.2 -- Bylaws of Delta Financial Corporation
**4.1 -- Indenture dated July 23, 1997, between Delta Financial Corporation,
its subsidiary guarantors and The Bank of New York, as Trustee
*10.1 -- Employment Agreement dated October 1, 1996 between the Registrant
and Sidney A. Miller
*10.2 -- Employment Agreement dated October 1, 1996 between the Registrant
and Hugh Miller
*10.3 -- Employment Agreement dated October 1, 1996 between the Registrant
and Christopher Donnelly
*10.4 -- Employment Agreement dated October 1, 1996 between the Registrant
and Randall F. Michaels
***10.5 -- Employment Agreement dated March 4, 1997 between the Registrant
and Richard Blass
*10.6 -- Lease Agreement between Delta Funding Corporation and the Tilles
Investment Company
+10.7 -- Fifth, Sixth and Seventh Amendments to Lease Agreement between Delta
Funding Corporation and the Tilles Investment Company
*10.8 -- 1996 Stock Option Plan of Delta Financial Corporation
+11.1 -- Statement re: Computation of Per Share Earnings
+21.1 -- Subsidiaries of Registrant
+27 -- Financial Data Schedule
- ---------------
+ Filed herewith
* Incorporated by reference from the Company's Registration Statement on
Form S-1 (No. 333-11289) filed with the Commission on October 9, 1996.
** Incorporated by reference from the Company's Current Report on Form 8-K
(No. 001-12109) filed with the Commission on July 30, 1997.
*** Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 (File No. 1-12109) filed with the
Commission on May 15, 1997.
47
(B) REPORTS ON FORM 8-K
On July 28, 1997, the Company filed a Current Report on Form 8-K in which
it reported the completion of the public issuance and offering of
$150,000,000 aggregate principal amount of its 9.5% Senior Notes due 2004,
and filed as exhibits various documents, including the Underwriting
Agreement, dated July 18, 1997 among the Company and the various
underwriters named therein and the Indenture dated as of July 23, 1997,
among the Company, the Subsidiary Guarantors and the Trustee relating to
the Senior Note offering.
48
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 30, 1998 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 30, 1998
- -----------------------
Sidney A. Miller
/S/ HUGH MILLER Chief Executive Officer, President
- ----------------------- and Director March 30, 1998
Hugh Miller (Principal Executive Officer)
/S/ RICHARD BLASS Senior Vice President, Chief Financial
- ----------------------- Officer and Director March 30, 1998
Richard Blass (Principal Financial Officer)
/S/ MARTIN D. PAYSON Director March 30, 1998
- -----------------------
Martin D. Payson
/S/ ARNOLD B. POLLARD Director March 30, 1998
- -----------------------
Arnold B. Pollard
49
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
*3.1 -- Certificate of Incorporation of Delta Financial Corporation
*3.2 -- Bylaws of Delta Financial Corporation
**4.1 -- Indenture dated July 23, 1997, between Delta Financial Corporation,
its subsidiary guarantors and The Bank of New York, as Trustee
*10.1 -- Employment Agreement dated October 1, 1996 between the Registrant and
Sidney A. Miller
*10.2 -- Employment Agreement dated October 1, 1996 between the Registrant and
Hugh Miller
*10.3 -- Employment Agreement dated October 1, 1996 between the Registrant and
Christopher Donnelly
*10.4 -- Employment Agreement dated October 1, 1996 between the Registrant and
Randall F. Michaels
***10.5 -- Employment Agreement dated March 4, 1997 between the Registrant and
Richard Blass
*10.6 -- Lease Agreement between Delta Funding Corporation and the Tilles
Investment Company
+10.7 -- Fifth, Sixth and Seventh Amendments to Lease Agreement between
Delta Funding Corporation and the Tilles Investment Company
*10.8 -- 1996 Stock Option Plan of Delta Financial Corporation
+11.1 -- Statement re: Computation of Per Share Earnings
+21.1 -- Subsidiaries of Registrant
+27 -- Financial Data Schedule
- ---------------
+ Filed herewith
* Incorporated by reference from the Company's Registration Statement on
Form S-1 (No. 333-11289) filed with the Commission on October 9, 1996.
** Incorporated by reference from the Company's Current Report on Form 8-K
(No. 001-12109) filed with the Commission on July 30, 1997.
***Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 (File No. 1-12109) filed with the
Commission on May 15, 1997.