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