ITEM 1. BUSINESS
In this Form 10-K, "Advanta", "we", "us", "our" and the "Company" refer to Advanta Corp. and its subsidiaries, unless the context otherwise requires.
OVERVIEW
Advanta is a highly focused financial services company. We have been providing innovative financial products and solutions since 1951. Over the past five years, we have become one of the nation's largest issuers of Mastercard(R)* business credit cards to small businesses.
Currently, our lending business consists of Advanta Business Cards. In addition to Advanta Business Cards, our other businesses include Advanta Insurance and our venture capital investment business. We own two depository institutions, or banks, Advanta National Bank and Advanta Bank Corp. Our banks are able to offer a variety of deposit products, such as retail and large denomination certificates of deposit, that are insured by the Federal Deposit Insurance Corporation, also referred to as the "FDIC." During the year ended December 31, 2000, our businesses also included Advanta Mortgage and Advanta Leasing. We primarily funded and operated our business credit card, mortgage and leasing businesses through our banks.
At December 31, 2000 we had approximately $20 billion in assets, consisting of approximately $12 billion in managed assets and approximately $8 billion in assets serviced for third parties.
Advanta Corp. was incorporated in Delaware in 1974 as Teachers Service Organization, Inc., the successor to a business originally founded in 1951. In January 1988, we changed our name from TSO Financial Corp. to Advanta Corp. Our principal executive office is located at Welsh & McKean Roads, P.O. Box 844, Spring House, Pennsylvania 19477-0844. Our telephone number at our principal executive office is (215) 657-4000.
RECENT DEVELOPMENTS
Pursuant to the terms of the purchase and sale agreement, dated January 8, 2001, by and between Advanta and Chase Manhattan Mortgage Corporation, a New Jersey corporation ("Buyer"), Advanta and certain of its subsidiaries transferred and assigned to Buyer and certain of its affiliates substantially all of the assets and operating liabilities associated with Advanta's mortgage business. This transaction is referred to throughout this Form 10-K as the "Mortgage Transaction." The Mortgage Transaction was consummated on March 1, 2001, effective as of February 28, 2001 (the "Closing Date").
The assets acquired by Buyer in the Mortgage Transaction consist of loans receivable, retained interests in securitizations and other receivables, contractual mortgage servicing rights and other contractual rights, property and equipment, and prepaid assets. The liabilities assumed by Buyer in the Mortgage Transaction consist primarily of certain of our contractual obligations and other liabilities that appeared on our balance sheet, as well as specified contingent liabilities arising out of the operation of the mortgage business before closing that are identified in the purchase and sale agreement.
Following the Mortgage Transaction, we no longer operate a mortgage business. However, we have retained contingent liabilities, primarily relating to litigation, arising out of our operation of the mortgage business before the Closing Date that were not specifically assumed by Buyer in the Mortgage Transaction.
On January 23, 2001, after a thorough review of strategic alternatives available to our leasing business, we announced that we would cease originating new equipment leases. We will, however, continue to service the existing leasing portfolio rather than sell the business or the portfolio.
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* MasterCard(R) is a federally registered servicemark of MasterCard International, Inc.
As a result of the recent developments described above, during the year 2001 our continuing operations will focus primarily on Advanta Business Cards, our business credit card business. Additionally, we will continue to operate our other financial services businesses, the products of which include insurance and deposit products, and to make venture capital investments through our affiliates, including Advanta Partners LP. As described above, we will continue to service the existing leases in our small ticket equipment leasing portfolio.
Prior to February 20, 1998, Advanta also issued consumer credit cards. Under the terms of a contribution agreement, dated October 27, 1997 and amended on February 20, 1998, we and Fleet Financial Group, Inc. each contributed substantially all of the assets of our respective consumer credit card businesses, subject to liabilities, to Fleet Credit Card, LLC, a newly formed Rhode Island limited liability company controlled by Fleet Financial Group, Inc. We acquired a 4.99% minority interest in Fleet Credit Card, LLC at the date of the closing of the transaction. This transaction is referred to throughout this Form 10-K as the "Consumer Credit Card Transaction."
CONTINUING BUSINESSES
ADVANTA BUSINESS CARDS
Overview
Advanta Business Cards, a business unit of Advanta, is one of the nation's leading providers of business credit cards to small businesses. Advanta Business Cards offers MasterCard business credit cards to small businesses using targeted direct mail, the Internet and telemarketing solicitation of potential cardholders. The "Advanta Business Card" is issued and funded by Advanta Bank Corp. MasterCard licenses banks and other financial institutions, such as Advanta Bank Corp., to issue business credit cards using its trademark and to use its interchange network. Advanta Bank Corp. receives an interchange fee as compensation for the funding and credit and fraud risk it assumes when its cardholders use the Advanta Business Card. MasterCard sets the interchange fee as a percentage of each card transaction (currently averaging approximately 2.1%).
Our principal objectives are to use our information based strategy to continue to prudently grow our business while increasing profitability. Based on our experience and expertise in analyzing the credit behavior and characteristics of consumers and small businesses, we have developed an extensive database of customer information and attributes. We use this information in conjunction with proprietary credit scoring, targeting and other sophisticated analytical models we have developed to market our products to prospective customers. We measure the expected behavior of our prospects through an integrated analysis of a prospect's responsiveness, creditworthiness and sensitivity to price. We continually validate our models based on actual results from marketing campaigns, and use this information to refine and improve our analytical assumptions. The information we gather and analyze allows us to market directly to specific customer segments, target prospects effectively, anticipate customer needs, customize our products to meet those needs and price our products in accordance with anticipated risk.
Our principal product is a MasterCard business credit card that provides our customers with access, through merchants, banks and ATMs, to an instant unsecured revolving business credit line. Under the terms of our cardholder agreements, our business cards may be used for business purposes only. We offer a number of benefits that we believe are important to small business owners including:
- personalized company checks;
- additional cards for employees at no fee with the ability to set individual spending limits; and
- detailed quarterly and annual expense management reports that categorize purchases and itemize charges for record keeping and tax purposes.
Our business credit card also offers free auto rental insurance, free purchase protection service for a specified time period and several free emergency assistance and referral services.
On a limited basis, we also offer a bonus miles program for an annual fee. Under this program, the cardholder receives credit toward the purchase of airline tickets with each card purchase. Additionally, we offer a travel card. Use of the travel card entitles the cardholder to discounts at various hotels and restaurants along with all of the benefits described above. We expect to continue to expand our business credit card product offerings and look for innovative ways to tailor products to the unique needs of small businesses.
The interest rate and credit line size we offer vary and are ultimately determined based upon the credit history and creditworthiness of the borrower. At December 31, 2000, the average credit line was approximately $10,000. The interest rate is based on a LIBOR (London Interbank Offered Rate) index. In most cases, the rate will change with changes in LIBOR and is subject to a minimum below which the rate cannot fall.
We generate interest and other income through finance charges assessed on outstanding loans, interchange income, and cash advance and other credit card fees.
The managed portfolio of Advanta Business Cards grew from $1.04 billion at December 31, 1999 to $1.66 billion at December 31, 2000. In 2000, approximately 45% of Advanta's total revenues were derived from Advanta Business Cards. See Note 18 to the consolidated financial statements for additional segment financial information about Advanta Business Cards.
Originations
We originate substantially all of our business credit card accounts using direct marketing techniques, including direct mail, telemarketing solicitation and the Internet. We currently mail solicitations monthly, inviting potential applicants to apply for an Advanta MasterCard business credit card. Similarly, we use inbound and outbound telemarketing to invite potential applicants to apply. In July 1999, we became one of the first in the business credit card market to offer instant credit decisions online.
Our marketing program is the result of extensive ongoing testing of various marketing campaigns that target different segments of the small business market, with the success of each campaign measured by both the cost of acquisition of new business and the credit performance of the resulting business. We originated over 311,000 new business credit card accounts during the year ended December 31, 2000.
In an effort to expand our customer reach, we are testing new sources by which to identify potential customers. These sources include the use of other external credit reporting agencies, as well as the purchase of customer lists from establishments with a small business customer base and linking with other websites on the Internet that serve small businesses.
Underwriting
We have developed sophisticated modeling techniques for assessing the creditworthiness of potential cardholders. Because the owner of the business is the ultimate obligor on our business credit card, we consider credit-related and other relevant data about both the business and the individual owner of the business in our assessment of the creditworthiness of potential cardholders. Through the application process, we verify the applicant's demographic information and collect current sales and income statistics. This information, coupled with credit reports received from external credit reporting agencies, forms the basis for our decision to extend credit. Using a proprietary scoring system, we rank our prospective cardholders based upon their expected creditworthiness and profitability potential.
When a cardholder is first approved, our profile of that cardholder is limited and based solely on historical information generated by third parties. As we compile information regarding each cardholder's behavior over time, we maintain and continually update our performance database. We believe that the information we gather over time regarding actual account performance and cardholder behavior becomes a better indicator of future performance than the criteria initially used to score the cardholder. Therefore, we periodically re-score
the cardholder based on all of the information we accumulate, and use this information to evaluate and potentially adjust the interest rate and the credit line size that we make available to the cardholder.
Risk Based Pricing
Upon the completion of credit assessment and identification of potential cardholders who meet our criteria via the prescreening process, we will offer a range of potential interest rates for which the cardholder may be eligible. The offer is not pre-approved and is subject to verification of information provided by the potential cardholder through the application process. If the applicant is approved, the actual interest rate and credit line size assigned will reflect the level of risk in the cardholder's creditworthiness. We offer primarily variable rate credit card accounts. The periodic finance charge assessed on balances in most of these accounts is indexed to LIBOR plus an add-on percentage or spread. The interest rate will typically range from approximately 9.9% to 20.99%. In most cases, the rate will change with changes in LIBOR and is subject to a minimum below which the rate cannot fall. Currently our typical business credit card interest rate is between 15% and 20%. With minimal notice, we may reprice any account at our discretion, typically based upon changes in a cardholder's credit standing. The credit line size may also be adjusted up or down based on our continual credit monitoring. To discourage delinquent payments, we use "penalty pricing" and automatically apply a 3% increase to the interest rate on any account that is two payment cycles delinquent.
Servicing and Collections
We perform most of the servicing for our business credit card accounts in-house. Other data processing and administrative functions associated with the servicing of our business credit card portfolio are outsourced to First Data Resources, Inc. Services performed by First Data Resources include: authorizing transactions through the MasterCard system; performing billing and settlement processes; generating and monitoring monthly billing statements; and issuing credit card plastics and new account agreements.
We have a collections staff that performs the collection activities for our business credit cards. Accounts are "contractually delinquent" if the minimum payment is not received by the due date. We discourage delinquent payments by assessing a late fee and the collections staff pursues late payments aggressively and immediately.
Efforts to collect contractually delinquent credit cards currently are made by our servicing and collections personnel or their designees. Collection activities include statement messages, formal collection letters and telephone calls. Collection personnel initiate telephone contact with delinquent cardholders as early as the first day the cardholder becomes contractually delinquent. The intensity at which collection activity is pursued depends on the risk the account presents us, which is determined by behavioral scoring and adaptive control techniques. If initial telephone contact fails to resolve the delinquency, we continue to contact the cardholder by telephone and by mail.
Delinquency levels are monitored by management of both our collections and asset quality departments and information is reported daily to Advanta senior management. Accounts are charged-off when they become 180 days contractually delinquent, at which time delinquent accounts of cardholders who have not filed bankruptcy are generally referred to outside collection agencies. We charge-off accounts suspected of being fraudulent after a 90-day investigative period unless our investigation shows no evidence of fraud.
Beginning in the fourth quarter of 2000, we changed our charge-off policy for accounts for which we have received a notice of the cardholder's bankruptcy. Under the new policy, the accounts of customers who become debtors in bankruptcy cases are charged-off when they become 180 days contractually delinquent or within 60 days of receipt of notification of filing from the bankruptcy court, whichever is shorter. In the past, instead of a 60-day investigation period we used a 90-day investigation period prior to charge-off to determine whether we should challenge the cardholder's bankruptcy petition or the discharge of amounts owed to us. Once an account is charged-off, it cannot revert to non-charged-off status. Our credit evaluation, servicing and charge-off policies and collection practices may change from time to time in accordance with our business judgment and applicable laws and regulations.
OTHER CONTINUING BUSINESSES
Advanta Insurance Companies
Our life/health and property/casualty insurance subsidiaries, Advanta Life Insurance Company and Advanta Insurance Company, respectively, provide insurance and related products to two distinct markets, existing Advanta customers and the public at large.
Together with unaffiliated insurance carriers, we offer specialty credit-related insurance products and services to our existing business credit card and leasing customers and to our former mortgage customers. Advanta Insurance uses direct mail marketing and telemarketing to enroll customers in these programs. The focus of these products is on the customers' ability to repay their debt. These products include coverage for loss of life, disability, involuntary unemployment, accidental death, and lost or damaged equipment. Our insurance subsidiaries generally reinsure all or a portion of the risks associated with these products or services. Under reinsurance agreements, our insurance subsidiaries assume a proportional quota share of the risk from the unaffiliated insurance carriers. In consideration for assuming these risks, our insurance subsidiaries receive reinsurance premiums equal to the proportional percentage of the net premiums collected by the insurance carriers, less a ceding fee as defined by the reinsurance treaties, and proportional acquisition expenses, premium taxes and loss payments made by the carriers on these risks.
Advanta Insurance also markets insurance and related products and services of third parties to the public at large. Through a strategic alliance with Progressive Casualty Insurance Company formed in 1996 for an initial term of 5 years, Advanta Insurance provides its direct marketing expertise to market Progressive's automobile insurance policies nationwide. Generally, Progressive's automobile policies provide for automobile liability protection up to $500,000 and automobile physical damage protection up to $100,000, as defined under specific policy and customer requirements. As part of the alliance, Advanta Insurance Company and Progressive are each entitled to 50% of the written premiums. Advanta Insurance Company and Progressive also entered into a quota share reinsurance agreement that provides that Advanta Insurance Company assumes 50% of all risks and expenses on automobile policies written by Progressive under the insurance programs being marketed. We have been notified by Progressive that it does not intend to renew the strategic alliance with Advanta Insurance when the original five-year term for the alliance expires during 2001. The agreement governing the relationship between Advanta Insurance and Progressive requires that upon termination, we transfer our interest in the assets and liabilities of the strategic alliance to Progressive and that Progressive make certain payments to us, subject to adjustments. Advanta Insurance and Progressive are currently pursuing alternative termination structures for the strategic alliance that would allow for early termination and financial settlement.
In addition, prior to the closing of the Consumer Credit Card Transaction, we offered credit-related insurance products to our consumer credit card customers. Our insurance subsidiaries no longer reinsure these insurance risks. Our insurance subsidiaries are, however, obligated to reimburse the unaffiliated insurance carriers for losses and loss adjustment expenses paid and our insurance subsidiaries maintain loss and loss expense reserves on losses incurred on risks assumed on or before February 20, 1998.
Venture Capital Investments
We make venture capital investments through our affiliates, including Advanta Partners LP and Advanta Growth Capital Fund L.P. Advanta Partners LP focuses primarily on growth capital financings, restructurings and management buyouts in the financial services, electronic commerce relationship management services and other consumer and data information management services industries. Our smaller fund, Advanta Growth Capital Fund L.P., focuses primarily on earlier stage investment opportunities in the technology and information services sectors, including the areas of wireless services, electronic commerce and direct marketing. The investment objective of our investment affiliates is to earn attractive returns by building the long-term values of the businesses in which they invest. Our investment affiliates combine transaction expertise, management skills and a broad contact base with strong industry-specific knowledge.
DEPOSITORY INSTITUTIONS
We own two depository institutions, Advanta National Bank and Advanta Bank Corp. Advanta National Bank is a national banking association organized under the laws of the United States of America with its headquarters and sole branch currently located in Wilmington, Delaware. During 2000, we conducted a large portion of our mortgage business through Advanta National Bank. Before February 20, 1998, we also conducted a large portion of our consumer credit card business through Advanta National Bank.
Advanta Bank Corp. is an industrial loan corporation organized under the laws of the State of Utah with its principal executive offices located in Salt Lake City, Utah. Currently, Advanta Bank Corp.'s principal activity consists of the issuance of the "Advanta Business Card" credit card to small businesses. Prior to first quarter 2001, Advanta Bank Corp. was involved in our small ticket equipment leasing business and our mortgage business. We no longer operate a mortgage business or originate new equipment leases. However, Advanta Bank Corp. continues to be involved in the small ticket equipment leasing business because we are continuing to service our existing lease portfolio. See "DISCONTINUED OPERATIONS."
DEPOSIT, SAVINGS AND INVESTMENT PRODUCTS
Deposits with each of our bank subsidiaries are insured by the FDIC. Through our banks we are able to offer a range of insured deposit products. Advanta National Bank's deposit products have included money market savings accounts, retail certificates of deposit and large denomination certificates of deposit of $99,000 or more. Advanta Bank Corp.'s deposit products include retail certificates of deposit and large denomination certificates of deposit of $99,000 or more. At December 31, 2000, we had total deposits of $1.3 billion at our banks, compared to $1.5 billion as of December 31, 1999. The banks generate retail deposits from repeat deposits from existing customers and from new depositors attracted by direct mail solicitations, newspaper and other media advertising and the Internet.
Since 1951, Advanta Corp. and its predecessor, Teachers Service Organization, Inc., have offered unsecured debt securities of Advanta Corp., in the form of RediReserve Certificates and Investment Notes to retail investors through Advanta's retail note programs. These debt securities, also referred to in this Form 10-K as "retail notes," have been sold predominantly on a direct basis by Advanta in select states. The RediReserve Variable Rate Certificates are payable on demand and the maturities on the Investment Notes range from 90 days to ten years. The RediReserve Certificates and Investment Notes generally require an initial minimum investment of $5,000 and are obligations of Advanta Corp. and are not insured or guaranteed by any public or private entity. We change the interest rates that we offer frequently, depending on market conditions and our funding needs. The rates also vary depending on the size of each investment. At December 31, 2000, $404.9 million of RediReserve Certificates and Investment Notes were outstanding with interest rates ranging from 6.02% to 11.47%.
Following the Mortgage Transaction, Advanta Corp. and Advanta National Bank each have excess cash liquidity. As a result, Advanta National Bank has suspended originating deposit accounts and Advanta Corp. is temporarily not originating or renewing Investment Notes.
DISCONTINUED OPERATIONS
ADVANTA LEASING SERVICES
Overview
On January 23, 2001, after a thorough review of strategic alternatives available to our leasing business, we decided to cease originating new equipment leases. We will, however, continue to service the existing leasing portfolio rather than sell the business or the portfolio.
Prior to January 23, 2001, Advanta Leasing Services, a business unit of Advanta, offered flexible lease financing programs to small businesses. The primary products that we offered through our leasing business consisted of leases for small-ticket items such as computers, copiers, fax machines and other office equipment.
Advanta Leasing Services originated and funded its leases and other equipment financing arrangements through Advanta Bank Corp. Advanta Business Services Corp. conducted the marketing, lease originations, customer service and collections for our leasing business.
Our leases are generally priced on a fixed rate basis. At December 31, 2000, the leases in our portfolio had an average lease size of approximately $7,800 and an average lease term remaining of 33 months.
Managed lease receivables at December 31, 2000 totaled approximately $758 million, compared to approximately $796 million at December 31, 1999. Advanta Leasing Services originated leases in the amount of approximately $320 million for the year ended December 31, 2000 and approximately $454 million for the year ended December 31, 1999. In 2000, approximately 5% of Advanta's revenues were derived from Advanta Leasing Services. See Note 18 to consolidated financial statements for additional segment financial information about Advanta Leasing Services.
Originations
Prior to January 23, 2001, Advanta Leasing Services originated leases through marketing programs, vendors, brokers and bulk or portfolio purchases.
Underwriting
In connection with the origination or acquisition of leases, Advanta Leasing Services performed a thorough credit review of all prospective customers. The credit review process typically began when the prospective customer completed a credit application. We would enter the completed credit application into our computerized application processing system. Our credit decisions were based on several credit-related attributes using our customized, proprietary credit scoring model.
Credit applications could be automatically approved or rejected based on the dollar amount of the application and a credit score falling within a range in the model. For those credit applications not falling within a specified dollar amount and/or credit score, we based our credit decision on an analysis by our credit staff utilizing criteria developed by Advanta Leasing Services. In addition, personnel in our credit department were dedicated to performing reviews of potential new vendors and brokers and were responsible for ensuring compliance with our overall credit policies and procedures.
Servicing and Collections
We are continuing to service our existing portfolio of equipment leases. As part of our servicing we will continue to perform collection activities with respect to delinquent contracts. Each lease contract has a provision for assessing late charges in the event that a customer fails to make a payment on the contract on the related due date. We typically initiate telephone contact when an account is between one and 16 days past due, depending on certain established criteria. Telephone contact is continued throughout the delinquency period. If the account continues to be delinquent, Advanta Leasing Services may exercise any remedies available to it under the terms of the contract, including termination and acceleration of the lease contract. We evaluate each contract on the merits of the individual situation taking into consideration the equipment value and the current financial strength of the customer.
If collection activities are unsuccessful, we typically charge-off the account at 120 days past due. An account may be charged-off prior to 120 days if we determine that no further payments will be made.
At the time an account is charged-off, the account is referred to our in-house litigation department to determine whether we will pursue the customer or any personal guarantor on the contract through litigation. If we determine not to pursue an account through litigation it may be referred to a third party collection agency to enforce the original terms of the contract. In cases where the customer files for bankruptcy, the Advanta Leasing Services' Legal Recovery Department follows up with the debtor to determine whether the debtor intends to assume or reject the contract. In many cases, although the customer has filed for bankruptcy protection from its creditors, it continues to make regular payments on its contract.
ADVANTA MORTGAGE
Effective February 28, 2001, we closed the Mortgage Transaction and no longer operate a mortgage business. In accordance with the terms of the purchase and sale agreement, Buyer acquired substantially all of the assets and operating liabilities associated with our mortgage business for a purchase price, net of operating liabilities assumed by Buyer, exceeding $1.0 billion. Following the Mortgage Transaction, we retained contingent liabilities, primarily relating to litigation arising out of the operation of the mortgage business through the Closing Date, that were not specifically assumed by Buyer. See "-- Overview -- Recent Developments."
Prior to the closing of the Mortgage Transaction, Advanta Mortgage, a business unit of Advanta, offered a broad range of mortgage products and services to consumers throughout the country. Advanta Mortgage originated and serviced non-conforming credit first and second lien mortgage loans, including home equity lines of credit. During the year ended December 31, 2000, we funded and operated our mortgage business primarily through our banks, Advanta National Bank and Advanta Bank Corp.
Advanta Mortgage's portfolio of managed receivables included owned loans and securitized loans which we serviced and in which we retained an interest. At December 31, 2000, Advanta Mortgage had total owned loans receivables of $293.3 million and total managed receivables of $7.9 billion.
In addition to servicing and managing the loans we originated, Advanta Mortgage serviced the home equity loans of unaffiliated third parties through our subservicing business. Subserviced loans are not included in our portfolio of managed receivables and we did not bear the risk of credit loss on our subserviced portfolio. Advanta Mortgage's portfolio of subserviced loans totaled approximately $7.9 billion at December 31, 2000. Our total serviced portfolio, including the "subserviced" portfolio, was $15.8 billion at December 31, 2000, compared to $20.3 billion at December 31, 1999.
In 2000, approximately 39% of Advanta's total revenues were derived from Advanta Mortgage. See Note 18 to consolidated financial statements for additional segment financial information about Advanta Mortgage.
GOVERNMENT REGULATION
ADVANTA CORP.
Advanta Corp. is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA"). We own Advanta National Bank, which is a "bank" as defined under the BHCA as amended by the Competitive Equality Banking Act of 1987 ("CEBA"). However, under grandfathering provisions of CEBA, we are not required to register as a bank holding company because Advanta National Bank, which takes demand deposits but does not make commercial loans, did not come within the BHCA definition of the term "bank" prior to the enactment of CEBA. Under CEBA, our other banking subsidiary, Advanta Bank Corp., also is not considered a "bank" for purposes of the BHCA. Accordingly, our ownership of Advanta Bank Corp. does not impact our exempt status under the BHCA.
Under CEBA, Advanta National Bank is subject to certain restrictions, such as the limitation that it may either take demand deposits or make commercial loans, but may not do both. In addition, under CEBA Advanta National Bank may not acquire control of more than 5% of the stock or assets of an additional "bank" or "savings association," as these terms are defined in the BHCA. Because we are not a bank holding company, we are not subject to examination by the Federal Reserve Board, other than for purposes of assuring continued compliance with the CEBA restrictions discussed above. Prior to the enactment of the Gramm- Leach-Bliley Financial Modernization Act, if Advanta Corp. or Advanta National Bank had ceased complying with the restrictions set forth in CEBA, registration as a bank holding company under the BHCA would have been required. Registration as a bank holding company is not automatic and, if we were to register, it would subject us and our subsidiaries to inspection and regulation by the Federal Reserve Board. The Gramm-Leach-Bliley Financial Modernization Act of 1999 was adopted on November 12, 1999 and became effective on May 12, 2000. Under the Gramm-Leach-Bliley Financial Modernization Act, should Advanta Corp. or Advanta National Bank fail to comply with any of the restrictions applicable to them under CEBA, there is a 180-day right to cure period following receipt of a notice from the Federal Reserve Board. During the cure
period we would be required to either cease or correct the activity that is not in compliance or submit to the Federal Reserve Board a plan to cease the activity within a timely manner that is not in excess of one year and implement procedures that would avoid a reoccurrence of the activity. The opportunity to cure or remediate an activity that is out of compliance significantly reduces the risk that Advanta Corp. will be required to register as a bank holding company under the BHCA.
ADVANTA NATIONAL BANK
Advanta National Bank is subject to regulation and periodic examination, primarily by the Office of the Comptroller of the Currency (the "OCC"). The OCC's regulations relate to the maintenance of reserves for certain types of deposits and other products offered by a bank, the maintenance of certain financial ratios, the terms on which a bank may engage in transactions with its affiliates and a broad range of other banking practices. As a national bank, Advanta National Bank is also subject to provisions of federal law which restrict its ability to extend credit to its affiliates or pay dividends to Advanta Corp.
Advanta National Bank is subject to capital adequacy guidelines issued by the Federal Financial Institutions Examination Council (the "FFIEC"). These guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and consider off-balance sheet exposures in determining capital adequacy. Under the rules and regulations of the FFIEC, at least half of a bank's total capital is required to be "Tier I capital," comprised of common equity, retained earnings and a limited amount of non-cumulative perpetual preferred stock. The remaining capital, "Tier II capital," may consist of other preferred stock, certain hybrid debt/equity instruments, a limited amount of term subordinated debt or a limited amount of the reserve for possible credit losses. The FFIEC has also adopted minimum leverage ratios for national banks, which are calculated by dividing Tier I capital by total average assets. Recognizing that the risk-based capital standards address only credit risk, and not interest rate, liquidity, operational or other risks, many national banks are expected to maintain capital in excess of the minimum standards. See "-- Regulatory Agreements"
In addition, pursuant to provisions of the FDIC Improvement Act of 1991 (the "FDICIA") and related regulations with respect to prompt corrective action, FDIC insured institutions such as Advanta National Bank may only accept brokered deposits without FDIC permission if they meet specified capital standards, and are subject to restrictions with respect to the interest they may pay on deposits unless they are "well-capitalized." To be "well-capitalized," a bank must have a ratio of combined Tier I and Tier II capital to risk-weighted assets of not less than 10%, Tier I capital to risk-weighted assets of not less than 6%, and a Tier I leverage ratio of not less than 5%. See "-- Regulatory Agreements."
Advanta National Bank's ratio of combined Tier I and Tier II capital to risk-weighted assets was 15.08% at December 31, 2000, and 14.86% at December 31, 1999. In each case, Advanta National Bank had capital at levels a bank is required to maintain to be classified as well-capitalized under the regulatory framework for prompt corrective action. However, Advanta National Bank does not meet the definition of "well-capitalized" because of the existence of our agreement with the OCC, even though we have achieved the higher imposed ratios required by the agreement with the OCC. See " -- Regulatory Agreements."
ADVANTA BANK CORP.
Advanta Bank Corp., a Utah-chartered industrial loan corporation, is a depository institution subject to regulatory oversight and examination by both the FDIC and the Utah Department of Financial Institutions. See "-- Regulatory Agreements." Under its banking charter, Advanta Bank Corp. may make consumer and commercial loans and may accept all FDIC-insured deposits other than demand deposits such as checking accounts. Advanta Bank Corp. is subject to the same regulatory and supervisory processes as commercial banks.
Advanta Bank Corp. is subject to provisions of federal law which restrict and control its ability to extend credit and provide or receive services between affiliates. Advanta Bank Corp. is subject to the same FFIEC capital adequacy guidelines as Advanta National Bank. See "-- Advanta National Bank." In addition, the
FDIC has regulatory authority to prohibit Advanta Bank Corp. from engaging in any unsafe or unsound practice in conducting its business.
Advanta Bank Corp.'s combined total capital ratio of Tier I and Tier II capital to risk-weighted assets was 14.60% as of December 31, 2000 and 13.28% as of December 31, 1999. In each case, Advanta Bank Corp. met the capital requirements of the FDICIA, and was categorized as well-capitalized under the regulatory framework for prompt corrective action.
REGULATORY AGREEMENTS
In June 2000, we announced that our banking subsidiaries, Advanta National Bank and Advanta Bank Corp., reached agreements with their respective bank regulatory agencies, primarily relating to the banks' subprime lending operations. The agreements outlined a series of steps to modify processes and formalize and document certain practices and procedures for the banks' subprime lending operations. The agreements also required us to change our charge-off policy for delinquent mortgages to 180 days and to modify our accounting processes and estimate of our allowance for credit losses and valuation of residual assets.
The agreement between Advanta Bank Corp. and the FDIC established temporary deposit growth limits at Advanta Bank Corp. and provides for prior FDIC approval of the payment by Advanta Bank Corp. of any future dividends. The agreement between Advanta National Bank and the OCC established temporary asset growth limits at Advanta National Bank and imposed restrictions on taking brokered deposits at Advanta National Bank. The agreement with the OCC required that by September 30, 2000 Advanta National Bank achieve and thereafter maintain a ratio of 14% of Tier 1 capital to risk-weighted assets and a ratio of 17% of Tier 1 capital to adjusted total assets.
In July 2000, we announced that Advanta National Bank signed a second agreement with the OCC regarding the carrying value of Advanta National Bank's retained interests in mortgage securitizations and allowance for mortgage credit losses. The agreement required that, based on assumptions specified in the agreement, the carrying value of Advanta National Bank's contractual mortgage servicing rights be reduced by $13 million and the carrying value of Advanta National Bank's subordinated trust assets and retained interest-only strip be reduced by a total amount of $201 million. The agreement further required that Advanta National Bank's allowance for credit losses be increased by $22 million. The agreement also contained provisions regarding the use of similar assumptions for the calculation of the carrying value of the residual assets in future periods. Beginning with the third quarter of 2000, the agreement required ANB to maintain its allowance for loan losses at a level of at least 5.38% of the unpaid principal balance of all loans owned by ANB or reported on its books, less any loans held for sale. See Note 3 to consolidated financial statements.
Management believes that Advanta National Bank and Advanta Bank Corp. were each in compliance with their respective regulatory agreements at December 31, 2000.
In connection with the Mortgage Transaction, Advanta National Bank sought approval of the OCC for a return of capital to Advanta Corp. in the amount of $261 million. On February 28, 2001, the OCC approved the amount requested and, at the same time, Advanta National Bank entered into an agreement with the OCC regarding restrictions on new business activities and product lines at Advanta National Bank after the sale of the mortgage business and the resolution of outstanding Advanta National Bank liabilities. The agreement also reduces the existing capital requirements for Advanta National Bank to 12.7% for Tier 1 capital and Total capital to risk-weighted assets, and to 5% for Tier 1 capital to adjusted total assets, as defined in the agreement. The agreement requires that Advanta National Bank obtain prior OCC approval of any future dividends. Advanta Bank Corp. is unaffected by Advanta National Bank's agreements with the OCC.
LENDING AND LEASING ACTIVITIES
Although our current lending activities are principally directed to small businesses, certain aspects of various federal and state laws, including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Community Reinvestment Act, the Electronic Funds Transfer Act and the Fair Credit Reporting Act, apply to us. Provisions of these statutes and related regulations require disclosure to borrowers of finance charges in
terms of an annual percentage rate, prohibit discriminatory practices in extending credit, require our FDIC-insured banking institutions to serve the banking needs of their local communities and regulate the dissemination and use of information relating to a borrower's creditworthiness.
Additionally, the Gramm-Leach-Bliley Financial Modernization Act imposes new privacy requirements dealing with the use of nonpublic information about consumer customers. Retail deposit customers of Advanta National Bank and Advanta Bank Corp. as well as investors who purchase Advanta Corp.'s retail notes are subject to the Act and its accompanying regulations. This statute is not preemptive and states may impose additional and more burdensome privacy requirements.
DIVIDENDS
There are various legal limitations on the extent to which Advanta National Bank can supply funds through dividends to us and our affiliates. The prior approval of the OCC is required if the total of all dividends declared by Advanta National Bank in any calendar year exceeds its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus accounts. In addition, Advanta National Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts. The OCC also has authority under the Financial Institutions Supervisory Act to prohibit a national bank from engaging in any unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the OCC, pursuant to its authority under the Financial Institutions Supervisory Act, could claim that a dividend payment might under some circumstances be an unsafe or unsound practice.
In February 2001, in connection with the Mortgage Transaction, the OCC approved the payment of a return of capital in the amount of $261 million from Advanta National Bank to Advanta Corp. Under Advanta National Bank's current agreement with the OCC, Advanta National Bank will not be eligible to pay any dividends without the OCC's prior approval. In addition, as a result of Advanta Bank Corp.'s agreement with the FDIC, Advanta Bank Corp. may not pay dividends without prior FDIC approval. See "-- Regulatory Agreements."
TRANSFERS OF FUNDS
Sections 23A and 23B of the Federal Reserve Act also impose restrictions on Advanta National Bank and Advanta Bank Corp. These restrictions limit the transfer of funds by the depository institution to certain of its affiliates, including Advanta Corp., in the form of loans, extensions of credit, investments or purchases of assets. These transfers by any one depository institution to us or any other single affiliate are limited in amount to 10% of the depository institution's capital and surplus, and transfers to all affiliates are limited in the aggregate to 20% of the depository institution's capital and surplus. These loans and extensions of credit are also subject to various collateral requirements. Sections 23A and 23B of the Federal Reserve Act also require generally that the depository institution's transactions with its affiliates be on terms no less favorable to the bank than comparable transactions with unrelated third parties. In addition, in order for us to maintain our grandfathered exemption under CEBA, Advanta National Bank is not permitted to make any loans to us or any of our subsidiaries.
REGULATION OF INSURANCE
Our insurance subsidiaries are subject to the laws and regulations of, and supervision by, the states in which they are domiciled or have obtained authority to transact insurance business. These states have adopted laws and regulations which govern all insurance policy underwriting, rating, licensing, marketing, administration and financial operations of an insurance company, including dividend payments and financial solvency. In addition, our insurance subsidiaries have registered as an Arizona Holding Company which requires an annual registration and the approval of certain transactions between all affiliated entities.
The maximum dividend that any of our insurance subsidiaries can distribute to Advanta Corp., in any twelve-month period without prior approval of the State of Arizona Department of Insurance, is the lesser of:
- 10% of the subsidiary's statutory surplus; or
- for any given twelve-month period, the subsidiary's net income, if it is a life insurance company; or
- for any given twelve-month period, the subsidiary's net investment income, if it is a property and casualty insurance company.
There were no dividends paid to Advanta Corp. by its insurance subsidiaries during 2000. The State of Arizona has adopted minimum risk-based capital standards as developed by the National Association of Insurance Commissioners. Risk-based capital is the quantification of an insurer's investment, underwriting, reserve and business risks in relation to its total adjusted capital and surplus. The ratio of an insurer's total adjusted capital and surplus is compared to various levels of risk-based capital to determine what intervention, if any, is required by either the insurance company or an insurance department. At December 31, 2000, our insurance subsidiaries met all risk-based capital standards and required no intervention by any party.
Our insurance subsidiaries reinsure risks using underwriting insurance practices and rates, which are regulated in part or fully by state insurance departments. State insurance departments continually review and modify these rates based on prior historical experience. Any modifications may impact the future profitability of our insurance subsidiaries.
LEGISLATIVE AND REGULATORY DEVELOPMENTS
The banking and finance businesses in general are the subject of the extensive regulation described above at both the state and federal levels, and numerous legislative and regulatory proposals are advanced each year which, if adopted, could affect our profitability or the manner in which we conduct our activities. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives, or whether any of the federal or state proposals will become law and, if so, what impact they will have on us.
On January 31, 2001, the FFIEC agencies issued a "Guidance" related to capital requirements of subprime loans. Under the Guidance, regulatory capital required to be held for certain loans that are considered subprime is expected to increase. In a separate draft proposal issued jointly by the regulatory agencies, dated August 7, 2000, capital requirements associated with certain residual interests would be amended to require capital equal to the residual retained, regardless of retained recourse levels. Further, the draft proposal requires residuals in excess of 25% of Tier 1 capital to be treated as a deduction of Tier 1 capital for purposes of risk-based and leverage capital calculations. In another draft proposal recently issued jointly by the federal bank regulatory agencies, the agencies would use credit ratings and certain alternative approaches to match the risk based capital requirement more closely to a banking organization's relative risk of loss in asset securitizations. This draft proposal also requires the sponsor of a revolving credit securitization that involves an early amortization feature to hold capital against the amount of assets under management (the off-balance sheet securitized receivables) and treats recourse obligations and direct credit substitutes more consistently than under the agencies' current risk-based capital standards.
Other federal legislative proposals and initiatives that could impact Advanta and its businesses include financial privacy initiatives that would restrict the permissible use of customer-specific financial and other credit information and statutory changes to the Truth in Lending Act. In addition, Congress is currently considering legislation to reform the Bankruptcy Code. The bankruptcy reform bills would require that debtors pass a means test to determine eligibility for bankruptcy relief while adding new consumer protections, such as new minimum payment and introductory rate disclosures for credit cards and exemptions for retirement savings in bankruptcy. They also would promote education and credit counseling as alternatives to resolving financial difficulties, allowing more debtors to avoid a bankruptcy filing. Additionally, a number of states are considering, and others likely will consider, legislative and regulatory initiatives related to financial privacy, credit scoring disclosure and credit card lending and marketing.
COMPETITION
As a marketer of credit products, we face intense competition from numerous financial services providers. Many of these companies are substantially larger and have more capital and other resources than we do. Competition among lenders can take many forms, including convenience in obtaining a loan, customer service, size of loans, interest rates, and other types of finance or service charges, the nature of the risk the lender is willing to assume and the type of security, if any, required by the lender. Although we believe we are generally competitive in most of the geographic areas in which we offer our products and services, there can be no assurance that our ability to market our services successfully or to obtain an adequate yield on our loans will not be impacted by the nature of the competition that now exists or may develop.
In seeking investment funds from the public, we face competition from banks, savings institutions, money market funds, mutual funds, credit unions and a wide variety of private and public entities that sell debt securities, some of which are publicly traded. Many of our competitors are larger and have more capital and other resources than we have. Competition relates to matters such as: rate of return, collateral, insurance or guarantees applicable to the investment, if any; the amount required to be invested; convenience and the cost to and conditions imposed upon the investor in investing and liquidating the investment, including any commissions which must be paid or interest forfeited on funds withdrawn; customer service; service charges, if any; and the taxability of interest.
EMPLOYEES
As of December 31, 2000, we had 2,649 employees. We believe that we have good relationships with our employees. None of our employees is represented by a collective bargaining unit. ------------------------
Information or statements provided by the Company from time to time may contain certain "forward-looking information" including information relating to: anticipated earnings per share; anticipated returns on equity; realizability of net deferred tax asset; anticipated growth in loans outstanding and credit card accounts; anticipated net interest margins; anticipated operations costs and employment growth; anticipated payment and prepayment rates of outstanding loans; anticipated marketing expense; estimated values of our retained interests in securitizations and anticipated cash flows; our ability to replace existing credit facilities, when they expire, with appropriate levels of funding on similar terms and conditions; anticipated delinquencies and charge-offs; and anticipated outcome and effects of litigation. The cautionary statements provided below are being made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995 (the "Act") and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act for any such forward-looking information.
We caution readers that any forward-looking information provided by us is not a guarantee of future performance and that actual results may differ materially from those in the forward-looking information as a result of various factors, including but not limited to:
- The ultimate amount of restructuring and other related charges associated with the conclusion of the strategic alternatives process for our mortgage and leasing businesses.
- Increased credit losses and collection costs associated with a worsening of general economic conditions, rising interest rates, shifts in product mix within our portfolio of loans, rising delinquency levels, increases in the number of customers seeking protection under the bankruptcy laws resulting in accounts being charged off as uncollectible, and the effects of fraud by third parties or customers.
- Intense and increasing competition from numerous providers of financial services who may employ various competitive strategies. We face competition from originators of business credit cards, some of which have greater resources than we do.
- The effects of interest rate fluctuations on our net interest margin and the value of our assets and liabilities; the continued legal or commercial availability of techniques, including interest rate swaps and similar financial instruments, loan repricing, hedging and other techniques, that we use to manage the risk of those fluctuations and the continuing operational viability of those techniques and the accounting and regulatory treatment of such instruments.
- Difficulties or delays in the securitization of our receivables and the resulting impact on the cost and availability of such funding. Difficulties and delays may result from the current economic, legal, regulatory, accounting and tax environments and adverse changes in the performance of the securitized assets.
- The amount, type and cost of financing available to us, including secured financing, and any changes to that financing including any impact from changes in the current economic, legal, regulatory, accounting and tax environments, adverse changes in the performance of our owned loan portfolio, any impact from changes in our debt ratings and the activities of parties with which we have agreements or understandings, including any activities affecting any investment.
- Changes in our aggregate accounts or loan balances, and the growth rate thereof, including changes resulting from factors such as shifting product mix, amount of actual marketing investment made by us, payment and prepayment of loan balances, changes in relationships with significant customers and general economic conditions and other factors beyond our control.
- The impact of "seasoning" (the average age of a lender's portfolio) on our level of delinquencies and losses which may require a higher allowance for loan losses for on-balance sheet assets and may adversely impact securitization income. The addition of account originations or balances and the attrition of those accounts or balances could significantly impact the seasoning of our overall portfolio.
- The amount of, and rate of growth in, our expenses (including employee and marketing expenses) as our businesses develop or change and we expand into new market areas; the acquisition or disposition of assets (interest-earning, fixed or other); the effects of changes within our organization or in its compensation and benefit plans; and the impact of unusual items resulting from the ongoing evaluation of our business strategies, asset valuations and organizational structures.
- Difficulties or delays in the development, production, testing and marketing of products or services, including, but not limited to, a failure to implement new product or service programs when anticipated, the failure of or delay in customers' acceptance of these products or services, losses associated with the testing of new products or services or financial, legal or other difficulties as may arise in the course of such implementation.
- The effects of, and changes in, tax laws, rates, regulations and policies.
- The effects of, and changes in, social conditions and general economic conditions, including inflation, recession or other adverse economic conditions.
- The effects of, and changes in the level of scrutiny, regulatory requirements and regulatory initiatives resulting from the fact that our banking and finance businesses are highly regulated and subject to periodic review and examination by federal and state regulators, including the OCC and the FDIC.
- The effects of, and changes in, monetary and fiscal policies, federal and state laws and regulations (financial, consumer, regulatory or otherwise), and other activities of governments, agencies and other similar organizations, including the OCC and the FDIC.
- The costs and other effects of legal and administrative cases and proceedings, settlements and investigations, claims and changes in those items, developments or assertions by or against us or any of our subsidiaries; adoptions of new, or changes in existing, accounting policies and practices and the application of such policies and practices.
- Our relationships with significant vendors, business partners and customers.
- Our ability to attract and retain key personnel.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 2000, Advanta owned two buildings in Horsham, Pennsylvania totaling 198,000 square feet. During 2000, these buildings were primarily used by Advanta Mortgage and Advanta Business Cards. Advanta leased 109,511 square feet in Spring House, Pennsylvania for its principal executive offices as well as some of its Advanta Mortgage operations. Advanta leased an additional 39,203 square feet in two buildings in the Pennsylvania suburbs of Philadelphia for certain corporate staff functions. In the adjoining state of New Jersey, at December 31, 2000, Advanta owned one building consisting of 56,196 square feet and leased 24,090 square feet of office space in two buildings for Advanta Leasing Services and a portion of Advanta Business Cards operations. In Delaware, Advanta leased 36,589 square feet of office space for Advanta National Bank. In New York, Advanta leased 7,061 square feet of office space in two buildings for Advanta Partners LP and Advanta Growth Capital Fund, LP. Advanta also leased an additional 164,650 square feet of office space located in two buildings in California for Advanta Mortgage and 50,625 square feet of office space in Utah for Advanta Bank Corp.
In addition to the principal locations in Pennsylvania, New Jersey, New York, Delaware California and Utah, during 2000 Advanta leased approximately 84,923 square feet of office space in twenty-one states to support the mortgage loan production offices. Advanta leased an additional 6,213 square feet of office space in five states to support Advanta Mortgage and Advanta Leasing Services.
At December 31, 2000, the total leased and owned office space was approximately 777,061 square feet. Effective February 28, 2001, upon the closing of the Mortgage Transaction, Advanta leased the 800 and 850 Ridgeview Drive buildings in Horsham, Pennsylvania to Buyer for a two-year term with an option to renew for an additional one year term. In addition, Buyer assumed our leases for the California real estate as of February 28, 2001.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On January 22, 1999, Fleet Financial Group, Inc. and certain of its affiliates ("Fleet") filed a lawsuit against Advanta Corp. and certain of its subsidiaries in Delaware Chancery Court. Fleet's allegations, which we deny, center around Fleet's assertions that we failed to complete certain post-closing adjustments to the value of the assets and liabilities we contributed to Fleet LLC in connection with the Consumer Credit Card Transaction. Fleet seeks damages of approximately $141 million. We have filed an answer to the complaint denying the material allegations of the complaint, but acknowledging that we contributed $1.8 million in excess liabilities in the post-closing adjustment process, after taking into account the liabilities we have already assumed. We also have filed a countercomplaint against Fleet for approximately $101 million in damages we believe have been caused by certain actions of Fleet following the closing of the Consumer Credit Card Transaction. Formal discovery has begun and is ongoing. The court has scheduled trial in this matter to begin in July 2001. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results.
On December 5, 2000, a former executive of Advanta obtained a jury verdict against Advanta in the amount of $3.9 million, in connection with various claims against Advanta related to the executive's termination of employment. Both parties filed post-trial motions. The former executive has filed a motion for a new trial with respect to his claims that were dismissed. The former executive is seeking, among other things, an award of approximately $6 million based upon the jury verdict and additional amounts, including attorney's fees and costs. We will vigorously pursue our post-trial motions, and if necessary, an appeal to the United States Court of Appeals for the Third Circuit and will continue to contest the former executive's positions. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results.
On December 21, 2000, Banc One Financial Services, Inc. and Bank One, N.A (together "Banc One") filed a complaint that alleges, among other things, that Advanta breached two mortgage loan servicing agreements by wrongfully withholding as termination fees an amount in excess of $23 million, from amounts that we had collected under the loan servicing agreements, and by failing to perform under those agreements in certain respects. We dispute these claims and allegations. An answer to the complaint was filed
February 23, 2001 denying liability and raising affirmative defenses. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results.
On February 1, 2001, Fleet and certain of its affiliates filed a complaint in an attempt to block the sale of our mortgage business to Chase Manhattan Mortgage Corp. The complaint alleged that the terms of the proposed sale breach a provision of the 1998 Contribution Agreement with Fleet, as amended (the "Contribution Agreement") which essentially requires a buyer of "substantially all" of our assets to assume any remaining obligations under the Contribution Agreement at the time of the sale of "substantially all" of our assets. In February 2001, we announced that we had reached an agreement with Fleet, with regard to Fleet's attempt to block the sale. As part of the agreement, Fleet dismissed its injunction claim and agreed that it would raise no future issue with respect to the sale of the mortgage business. Under the agreement, $70 million of our reserves in connection with our long-standing litigation with Fleet were funded in an escrow account. The court presiding over the claims will order the funds paid to Advanta or to Fleet depending upon the outcome of that litigation. The amount escrowed, $70 million, represents our maximum exposure to Fleet in the litigation, assuming a court were to rule in favor of Fleet on every claim involved in the litigation.
Advanta and its subsidiaries are involved in other legal proceedings, claims and litigation, including those arising in the ordinary course of business. Management believes that the aggregate liabilities, if any, resulting from those actions will not have a material adverse effect on the consolidated financial position or results of operations of Advanta. However, as the ultimate resolution of these proceedings is influenced by factors outside of Advanta's control, it is reasonably possible that Advanta's estimated liability under these proceedings may change.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Each of the executive officers of Advanta Corp. and its subsidiaries listed below was elected by the applicable Board of Directors, to serve at the pleasure of the Board in the capacities indicated.
Mr. Alter became Executive Vice President and a Director of Advanta Corp.'s predecessor organization in 1967. He was elected President and Chief Executive Officer in 1972, and Chairman of the Board of Directors in August 1985. Mr. Alter has remained as Chairman of the Board since August 1985. In February 1986, he relinquished the title of President, and in August 1995 he relinquished the title of Chief Executive Officer. In October 1997, Mr. Alter reassumed the title of Chief Executive Officer. Mr. Alter is a director of Next Left, Inc. a privately held Internet service company.
Mr. Rosoff joined Advanta Corp. in January 1996 as a Director and Vice Chairman. In October 1999, Mr. Rosoff became President and Vice Chairman of the Board of Advanta Corp. Prior to joining Advanta Corp., Mr. Rosoff was a long time partner of the law firm of Wolf, Block, Schorr and Solis-Cohen LLP, Advanta Corp.'s outside counsel, where he advised Advanta Corp. for over 20 years. While at Wolf, Block, Schorr and Solis-Cohen LLP, he served as Chairman of its Executive Committee and, immediately before joining Advanta Corp., as a member of its Executive Committee and Chairman of its Tax Department. Mr. Rosoff is a Trustee of Atlantic Realty Trust, a publicly held real estate investment trust.
Mr. Browne joined Advanta Corp. in June 1998 as Senior Vice President and Chief Financial Officer. Prior to joining Advanta Corp., he was an Audit and Business Advisory Partner at Arthur Andersen LLP
where, for over sixteen years, he audited public and private companies and provided business advisory and consulting services to financial services companies. Mr. Browne had served as the Arthur Andersen engagement partner for Advanta Corp. since 1994. Mr. Browne is a director of AF&L Insurance Company, a privately held long-term care and home health care insurance company.
Mr. Weinstock joined Advanta Corp. in 1998 and became Vice President and Chief Accounting Officer in March 2001. Mr. Weinstock joined the Company in December 1998 as Controller and he became Vice President of Investor Relations in October 1999. Prior to joining Advanta Corp., Mr. Weinstock served as Senior Manager at Arthur Andersen LLP from 1996 to 1998, where he audited public and private companies and provided business advisory and consulting services to financial services companies.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
COMMON STOCK PRICE RANGES AND DIVIDENDS
The Company's common stock is traded on the National Market System of The Nasdaq Stock Market, Inc. under the symbols ADVNA (Class A voting common stock) and ADVNB (Class B non-voting common stock).
Following are the high, low and closing sale prices and cash dividends declared for the last two years as they apply to each class of stock:
At March 23, 2001, the Company had approximately 287 and 598 holders of record of Class A and Class B common stock, respectively.
Although the Company anticipates that comparable cash dividends will continue to be paid in the future, the payment of future dividends by the Company will be at the discretion of the Board of Directors and will depend on numerous factors including the Company's cash flow, financial condition, capital requirements and such other factors as the Board of Directors deems relevant.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL HIGHLIGHTS SELECTED FINANCIAL DATA
(1) Results through February 1998 include the results of the consumer credit card unit.
(2) 1999 amounts included charges associated with cost reduction initiatives in the first quarter and additional costs associated with products exited in the first quarter of 1998. 1998 amounts included severance and outplacement costs associated with workforce reduction, option exercises and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer, expense associated with exited business/products and asset impairment.
(3) Combined represents a weighted average of Class A and Class B (see Note 1 to consolidated financial statements).
(4) Includes federal funds sold, trading investments and investments available for sale.
(5) Represents company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures of Advanta Corp.
(6) Return on average total equity and equity/owned assets include capital securities as equity. The ratios without capital securities for 2000 were (31.28%) and 15.51%, respectively, for 1999 were 8.82% and 16.66%, respectively, for 1998 were 74.75% and 15.30%, respectively, for 1997 were 8.33% and 13.97%, respectively and for 1996 were 22.31% and 15.55%, respectively.
(7) The dividend payout ratio for the year ended December 31, 2000 is negative and therefore, not meaningful.
(8) Effective October 1, 2000, business credit card charge-off and delinquency statistics reflect the adoption of a new charge-off policy for bankruptcies. Bankrupt business credit cards are charged off within a 60-day investigative period after receipt of notification. The previous policy provided a 90-day investigative period.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
OVERVIEW
During the years ended December 31, 2000, 1999 and 1998, our lending and leasing business units consisted of Advanta Business Cards, Advanta Mortgage and Advanta Leasing. In addition to our lending and leasing businesses, we have an insurance business and venture capital investments. In the first quarter of 2001, we sold our mortgage business and announced the discontinuance of our leasing business. We will continue to service the existing leasing portfolio rather than sell the business or the portfolio. The results of the mortgage and leasing businesses are reported as discontinued operations in all periods presented. Prior to February 20, 1998, we issued consumer credit cards. Results of the consumer credit card business through February 20, 1998 are reported in continuing operations.
For the year ended December 31, 2000, we reported income from continuing operations of $11.2 million or $0.44 per combined common share, assuming dilution, compared to $41.3 million or $1.62 per combined diluted common share for the year ended December 31, 1999. For the year ended December 31, 1998, we reported income from continuing operations of $408.6 million or $14.33 per combined diluted common share. Pretax income for Advanta Business Cards was $71.2 million for the year ended December 31, 2000, $34.2 million for the year ended December 31, 1999, and $15.2 million for the year ended December 31, 1998.
In 2000, income from continuing operations includes pretax investment gains, net, on venture capital investments of $7.7 million, a pretax increase in the provision for credit losses on business credit cards of $18.4 million, and a $7.0 million pretax charge for an increase in litigation reserves.
In 1999, income from continuing operations includes a tax benefit of $50.0 million related to the former consumer credit card business. Income from continuing operations for the year ended December 31, 1999 also includes pretax unusual charges of $6.7 million for severance and outplacement costs associated with cost cutting initiatives implemented in the first quarter of 1999 and $10.0 million of additional costs associated with products exited in the first quarter of 1998. In addition, in 1999 we recognized a pretax investment gain on a venture capital investment of $28.1 million, and non-operating charges of $16.9 million related to our exit from the auto finance business.
In 1998, income from continuing operations includes a $541.3 million gain on the Consumer Credit Card Transaction (see Note 11 to the consolidated financial statements), a $62.3 million pretax charge for severance and outplacement costs associated with workforce reduction, option exercises and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer, a $54.1 million pretax charge for expenses associated with exited businesses and products, $41.8 million of equity securities losses and an $8.7 million pretax charge for facility impairments.
Income (loss) from discontinued operations, net of tax, was ($163.6) million for the year ended December 31, 2000, $8.5 million for the year ended December 31, 1999 and $39.3 million for the year ended December 31, 1998. In addition to the operating results of the discontinued operations, we recorded a loss on the discontinuance of our leasing business of $4.3 million, net of tax, effective December 31, 2000.
ADVANTA BUSINESS CARDS
OVERVIEW
Advanta Business Cards offers MasterCard business credit cards to small businesses using targeted direct mail and the Internet as well as telemarketing solicitation of potential cardholders. This product provides approved customers with access, through merchants, banks, checks and ATMs, to an instant unsecured revolving business credit line. Advanta Business Cards generates interest and other income through finance charges assessed on outstanding balances, interchange income, and cash advance and other credit card fees.
Pretax income for Advanta Business Cards was $71.2 million for the year ended December 31, 2000 as compared to $34.2 million for year ended December 31, 1999. Pretax income for Advanta Business Cards was $15.2 million for the year ended December 31, 1998. The increase in pretax income in both years resulted
from increases in the volume of managed receivables, portfolio yields due to changes in pricing and interchange income. These increases in revenues were partially offset by increases in provisions for credit losses, and increases in operating expenses due to increased marketing and account origination activities.
Pretax income for Advanta Business Cards for the year ended December 31, 2000 includes an increase in the provision for credit losses of $18.4 million. Approximately $8 million of the $18.4 million increase in 2000 is attributable to a revision of our estimate of the allowance for credit losses as a result of the following factors: (1) discussions with our banking regulators relating to the implementation of the agreement between Advanta Bank Corp. and the FDIC that was disclosed in June 2000; (2) changes in the economic environment; and (3) the use of more conservative loss estimates for certain segments of the loan portfolio. The remainder of the increase in allowance is due to the maturing and growth of the portfolio. See further discussion in the "Provision and Allowance for Credit Losses" section of Management's Discussion and Analysis.
Advanta Business Cards originated 311,275 new accounts in the year ended December 31, 2000, 146,436 new accounts in 1999 and 102,181 new accounts in 1998. The increases in new business credit card accounts over prior years resulted from the successful application of our information based strategy to expand the universe of potential business credit card customers.
SECURITIZATION INCOME
Advanta Business Cards recognized securitization income of $70.8 million for the year ended December 31, 2000, $33.5 million for the year ended December 31, 1999, and $18.2 million for the year ended December 31, 1998. Advanta Business Cards sells interests in receivables through securitizations. Advanta Business Cards also sells receivables to existing securitization trusts on a continuous basis to replenish the investors' interest in trust receivables that have been repaid by the card holders. The increase in securitization income in both years was due to increased yields on the securitized receivables and increased volume of securitized receivables. The increase in 2000 was partially offset by increased credit losses on securitized receivables.
The following table provides selected information on a managed loan portfolio basis.
MANAGED PORTFOLIO DATA
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities- a Replacement of FASB Statement No. 125." SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions without amendment. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. We have adopted the disclosure provisions of SFAS No. 140 for the year ended December 31, 2000. We anticipate that the adoption of the accounting provisions of SFAS No. 140 will not have a material effect on our financial position or results of operations.
SERVICING REVENUES
Advanta Business Cards recognized servicing revenue of $17.3 million for the year ended December 31, 2000, $13.8 million for the year ended December 31, 1999, and $12.3 million for the year ended December 31, 1998. The increase in servicing revenue in both years was due to increased volume of securitized receivables.
DISCONTINUED OPERATIONS
On January 8, 2001, we signed an agreement with Chase Manhattan Mortgage Corporation, a subsidiary of J.P. Morgan Chase & Co., to sell our mortgage business, Advanta Mortgage. Advanta Mortgage made nonconforming home equity loans directly to consumers and through brokers. This business unit originated and serviced first and second lien mortgage loans, including home equity lines of credit, through subsidiaries of Advanta. In addition to servicing and managing the loans it originated, Advanta Mortgage contracted with third parties to service their nonconforming home equity loans on a subservicing basis.
Effective February 28, 2001, we completed the sale of our mortgage business to Chase Manhattan Mortgage Corporation. Following the transaction, we no longer operate a mortgage business. The purchase and sale agreement provided for the sale, transfer and assignment of substantially all of the assets and operating liabilities associated with our mortgage business, as well as specified contingent liabilities arising out of our operation of the mortgage business prior to closing that were identified in the purchase and sale agreement. We retained contingent liabilities, primarily relating to litigation, arising out of our operation of the mortgage business before closing that were not specifically assumed by the buyer. The proceeds from the sale exceeded $1 billion, subject to closing adjustments, resulting in an estimated gain of approximately $59.7 million before transaction expenses, severance expenses and other costs. Transaction expenses, severance expenses and other costs associated with the sale are expected to be significant. The gain will also be reduced by a charge of approximately $19.7 million associated with certain equipment, facilities and derivative instruments related to hedging activities not purchased by the buyer. We will use part of the proceeds from the sale of mortgage assets to pay off our outstanding medium-term notes via a tender offer to repurchase the outstanding notes at par value plus accrued interest. We also intend to use the proceeds to reduce a significant portion of our outstanding retail notes, and to provide working capital for our remaining businesses. Although the transaction resulted in a gain for financial reporting purposes, due to book/tax differences we expect that we will not be required to pay any material federal income tax as a result of the sale. We also expect to record a restructuring charge in the first quarter of 2001 as we restructure corporate functions to a size commensurate with the ongoing business after closing.
On January 23, 2001, we announced that after a thorough review of strategic alternatives available for our leasing business, Advanta Leasing Services, we decided to cease originating leases. Advanta Leasing Services offered flexible lease financing programs on small-ticket equipment to small businesses. The primary products financed included office machinery, security systems and computers. The commercial equipment leasing business was generated primarily through third-party referrals from manufacturers or distributors of equipment, as well as independent brokers, direct mail marketing and telemarketing. We will continue to service the existing portfolio rather than sell the business or the portfolio. In connection with the discontinuance of the leasing business, we recorded a $4.3 million pretax loss effective December 31, 2000.
Income (loss) from discontinued operations, net of tax, was ($163.6) million for the year ended December 31, 2000, $8.5 million for the year ended December 31, 1999 and $39.3 million for the year ended December 31, 1998.
Loss from discontinued operations for the year ended December 31, 2000 includes charges which were made in response to our regulatory review process, including the implementation of the agreements with the bank regulators that were signed during the second and third quarters of 2000, and changes during the second quarter in the market and the political and regulatory environment for subprime lending. These charges include a pretax reduction in the valuation of Advanta National Bank's retained interests in mortgage securitizations of $214.0 million and an increase in Advanta National Bank's on-balance sheet allowance for credit losses related to mortgage loans of $22.0 million. These Advanta National Bank charges reduced net income by $236.0 million or $9.31 per combined common diluted share.
In addition, loss from discontinued operations for the year ended December 31, 2000 includes $20.3 million of pretax charges resulting from changes in valuation assumptions related to retained interests in leasing securitizations, primarily due to higher credit losses associated with certain unprofitable segments of broker originations from prior periods. These charges reduced net income by $20.3 million or $.80 per combined common diluted share. Loss from discontinued operations for the year ended December 31, 2000 also includes $25.3 million of revenues related to termination fees received under a mortgage servicing agreement. See Note 12 to the consolidated financial statements.
Income from discontinued operations for the year ended December 31, 1999 includes $28.8 million of pretax valuation adjustments to the retained interests in mortgage securitizations and contractual mortgage servicing rights, which decreased net income by $17.4 million or $0.73 per combined diluted share. Of the total valuation adjustment, $10 million was recorded in the second quarter of 1999, which resulted from an increase in credit losses expected in the off-balance sheet mortgage loan portfolio based on portfolio trends and experience. The majority of the remaining charge was recorded in the fourth quarter of 1999 and resulted from an increase in the discount rate on the retained interest-only strip and an increase in the credit loss assumption. The discount rate was increased due to an increase in market interest rates and an observed trend toward higher discount rates in available public disclosures relating to comparable instruments. The increase in the loss assumption was due to an additional increase in credit losses expected in the off-balance sheet mortgage loan portfolio based on trends and experience. The decrease in the valuation caused by the increased discount rate and credit loss assumption was slightly offset by a decrease in prepayment speeds experienced.
Additionally, in the first quarter of 1999, we recorded pretax valuation adjustments to the retained interests in auto loan securitizations of $12 million, which decreased net income by $7.4 million, or $0.31 per combined diluted share. In the first quarter of 1999, management implemented a plan to exit the auto finance business and engaged an investment banker to solicit bids for the business as a whole, including our retained interests in auto securitizations and certain auto loan receivables. Although management did not ultimately accept any offers to acquire the retained interests, the informal bids received were considered as part of our fair value analysis of the retained interests, which resulted in a decrease in the valuation of the assets as of March 31, 1999.
Income from discontinued operations for the year ended December 31, 1998 includes $59.3 million of pretax valuation adjustments to the retained interests in mortgage securitizations and contractual mortgage servicing rights, which decreased net income by $41.5 million or $1.46 per combined diluted share. This charge resulted from an increase in prepayment speeds experienced.
INTEREST INCOME AND EXPENSE
Interest income on receivables and investments increased by $31.5 million for the year ended December 31, 2000 as compared to the year ended December 31, 1999. During the same period, interest expense increased by $5.7 million. The increase in interest income was due to an increase in yields on business credit card receivables as well as an increase in average on-balance sheet business credit card receivables. The increase in interest expense was due to an increase in the cost of funds.
Interest income on receivables and investments decreased $6.9 million for the year ended December 31, 1999 as compared to 1998. During the same period, interest expense decreased by $20.4 million. The decrease in interest income was mainly attributable to the decrease in average interest-earning assets as a result of the transfer of consumer credit card receivables in the Consumer Credit Card Transaction in 1998. This decrease was partially offset by an increase in yields on business credit card receivables and an increase in average on-balance sheet business credit card receivables. The decrease in interest expense was due to a decrease in the cost of funds, as well as a reduction in interest-bearing liabilities in connection with the Consumer Credit Card Transaction in 1998.
Our cost of funds increased to 6.89% in 2000 from 5.87% in 1999. Our cost of funds was 6.26% in 1998. The increase in the cost of funds in 2000 as compared to 1999 was primarily attributable to rising market interest rates. The decrease in the cost of funds in 1999 as compared to 1998 was primarily attributable to the
increase in the use of deposits as a funding source. Deposits represented 68% of total average interest-bearing liabilities for the year ended December 31, 2000 as compared to 66% in 1999 and 50% in 1998.
The following table provides an analysis of owned interest income and expense data, average balance sheet data, net interest spread, and net interest margin. Net interest spread represents the difference between the yield on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin represents the difference between the yield on interest-earning assets and the average rate paid to fund interest-earning assets. Average owned loans and the related interest revenues include certain loan fees and costs.
INTEREST RATE ANALYSIS
(1) Includes consumer credit cards through February 20, 1998. (2) Interest and average rate for tax-free securities are computed on a tax equivalent basis using a statutory rate of 35%. (3) Includes assets held and available for sale and nonaccrual loans. (4) Includes funding of assets for both continuing and discontinued operations.
INTEREST VARIANCE ANALYSIS: ON-BALANCE SHEET
The following table presents the effects of changes in average volume and interest rates on individual financial statement line items on a tax equivalent basis and including certain loan fees. Changes not solely due to volume or rate have been allocated on a pro rata basis between volume and rate. The effects on individual financial statement line items are not necessarily indicative of the overall effect on net interest income.
- -------------------------------------------------------------------------------- (1) Includes consumer credit cards through February 20, 1998.
(2) Includes income from assets held and available for sale.
GAIN ON TRANSFER OF CONSUMER CREDIT CARD BUSINESS
In 1998 we recognized a gain of $541.3 million which represented the excess of liabilities transferred to Fleet Credit Card LLC ("Fleet LLC") over the net basis of the assets transferred and our retained minority membership interest in Fleet LLC. At the closing date of the Consumer Credit Card Transaction, the minority interest was a 4.99% ownership interest in Fleet LLC valued at $20 million. See Note 11 to the consolidated financial statements.
OTHER REVENUES
Business credit card interchange income increased by $27.9 million for the year ended December 31, 2000 as compared to the year ended December 31, 1999 and increased by $13.0 million for the year ended December 31, 1999 as compared to the year ended December 31, 1998. The increase in both periods was due to higher purchase volume related to the increase in average managed business credit card accounts and receivables. In addition, an increase in interchange rates contributed to the increase for the year ended December 31, 1999. The average interchange rate was 2.1% in 2000 and 1999 and 2.0% in 1998.
Investment securities gains (losses) include changes in the fair value and realized gains (losses) on venture capital investments. Investment securities gains (losses) for the year ended December 31, 2000 include $11.4 million in gains on the sale of venture capital investments, ($3.7) million of net decrease in valuations of venture capital investments, and ($2.2) million of realized losses on other investments. Investment securities gains (losses) for the year ended December 31, 1999 include a $28.1 million gain on a venture capital investment. Most of the loss in the year ended December 31, 1998 relates to venture capital investments not publicly traded for which we decided to expedite a disposal plan.
Insurance revenues, net and other for the year ended December 31, 2000 includes a charge of approximately $3 million relating to the settlement of a large policy claim. We have been notified by Progressive Casualty Insurance Company that it does not intend to renew the strategic alliance with Advanta Insurance when the original five-year term for the alliance expires during 2001. The agreement governing the relationship between Advanta Insurance and Progressive requires that upon termination, we transfer our interest in the assets and liabilities of the strategic alliance to Progressive and that Progressive make certain payments to us, subject to adjustments. Advanta Insurance and Progressive are currently pursuing alternative termination structures for the strategic alliance that would allow for early termination and financial settlement.
The decline in consumer credit card interchange income, consumer credit card overlimit fees, insurance revenues and certain other revenues for the year ended December 31, 1999 as compared to the year ended December 31, 1998 was attributable to the transfer of the consumer credit card portfolio in the Consumer Credit Card Transaction in February 1998.
OPERATING EXPENSES
Salaries and employee benefits, amortization of credit card deferred origination costs, net, external processing expense, marketing expense and equipment expense have increased for the year ended December 31, 2000 as compared to the year ended December 31, 1999 due primarily to increased marketing and account origination activities in Advanta Business Cards as well as the resulting growth in managed business credit card receivables. Business credit card new account originations increased by 113% for the year ended December 31, 2000 as compared to 1999, and average managed business credit card receivables grew by 54% in the same period. The increase in equipment expense for the year ended December 31, 2000 as compared to 1999 also includes an increase in depreciation expense associated with information technology upgrades placed in service during 1999. The increase in other expenses for the year ended December 31, 2000 as compared to 1999 was primarily due to an increase in litigation reserves of $7.0 million in 2000.
The decreases in salaries and employee benefits, amortization of credit card deferred origination costs, net, external processing expense, marketing expense, equipment expense, and other expenses for the year
ended December 31, 1999 as compared to 1998 were due to consumer credit card expenses incurred through February 1998 that are included in the 1998 amounts, as well as to cost reduction measures implemented in the first quarter of 1999.
Professional fees increased by $6.3 million for the year ended December 31, 2000 as compared to the year ended December 31, 1999 and increased by $5.6 million for the year ended December 31, 1999 as compared to the year ended December 31, 1998. The increase in 2000 was due to increased legal activity and consulting costs, including consulting costs associated with the implementation of the regulatory agreements. The increase in 1999 was due, in part, to increased legal activity, as well as consulting and outsourcing costs associated with our strategic management of capacity and resources.
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is established as losses are estimated to have occurred through a provision for credit losses charged to earnings. The allowance for credit losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility in light of historical experience by loan type, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay and prevailing economic conditions. Since our loan portfolio is comprised of large groups of smaller balance homogeneous loans, we evaluate each group collectively for impairment. The allowance is determined primarily based on a migration analysis of delinquent and current accounts and certain qualitative factors consistent with applicable bank regulatory guidelines. As part of our evaluation, we compare actual credit loss performance to previously estimated credit losses, and make modifications to estimates as needed. This allowance for credit loss evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance for credit losses is maintained for on-balance sheet receivables and is intended to cover all credit losses inherent in the owned loan portfolio. Anticipated losses on securitized assets are reflected in the calculations of securitization income and retained interests in securitizations. See Note 1 to the consolidated financial statements. Such loss estimates are intended to cover all probable credit losses over the life of the securitized receivables. Management continually evaluates both its on-balance sheet and off-balance sheet estimates and, as appropriate, effects changes to these amounts.
Nonperforming assets include loans past due 90 days or more, and bankrupt, decedent and fraudulent business credit card accounts. We charge losses on business credit card accounts against the allowance at 180 days contractually delinquent. Business credit card accounts suspected of being fraudulent are charged-off after a 90-day investigative period, unless our investigation shows no evidence of fraud. Effective October 1, 2000, bankrupt business credit cards are charged off within a 60-day investigative period after receipt of notification. The previous policy provided a 90-day investigative period.
Loans are put on nonaccrual status when they become 90 days past due. Gross interest income that would have been recorded for owned nonperforming assets, had interest been accrued throughout the year in accordance with the assets' original terms, was $1.3 million in 2000.
At December 31, 2000, the allowance for credit losses on a consolidated basis was $33.4 million, or 9.3% of owned receivables, compared to $14.9 million, or 4.9%, at December 31, 1999. The allowance for credit losses on business credit card receivables was $33.2 million, or 9.9% of owned receivables, at December 31, 2000, as compared to $14.7 million, or 5.3%, at December 31, 1999. As of September 30, 2000, we modified our estimate of the allowance for credit losses on business credit card receivables. The revised estimate for the overall portfolio was developed based on discussions with our banking regulators, changes in the economic environment and the use of more conservative loss estimates for certain segments of the loan portfolio. Those segments included accounts with lower credit scores, accounts held by businesses in operation less than twelve months, and accounts in which cash borrowings comprise a significant portion of the outstanding balance. As a result of these changes in estimate, we increased our allowance for credit losses by approximately $8 million, which decreased net income by approximately $8 million or $0.32 per diluted combined share. The remainder of the increase in allowance for credit losses on business credit card receivables is due to the maturing and growth of the portfolio. The maturing of the portfolio was reflected in the delinquency rates. Total owned
business credit card receivables 30 days or more delinquent increased from 3.8% at December 31, 1999 to 5.5% at December 31, 2000. The charge-off rate on owned business credit card receivables for the year ended December 31, 2000 of 4.5% was slightly less than the rate for the year ended December 31, 1999 of 4.8%; however, we did experience a trend of increasing charge-off rates in the second half of 2000 due to the maturing of the portfolio. Charge-off rates on owned business credit card receivables by quarter were 4.1% for the first quarter of 2000, 3.7% for the second quarter of 2000, 4.9% for the third quarter of 2000 and 5.1% for the fourth quarter of 2000. The fourth quarter charge-off rate includes a 0.5% acceleration of charge-offs to adopt the 60 day charge-off policy for bankrupt accounts. See discussion above.
The allowance on other loans was $202 thousand at both December 31, 2000 and 1999 and was relatively consistent as a percentage of other loans at 0.8% on December 31, 2000 as compared to 0.7% at December 31, 1999. There were no significant changes or trends in credit quality statistics of other loans in 1998 through 2000.
For the year ended December 31, 2000, the provision for credit losses increased by $13.8 million as compared to 1999. The increase in the provision was primarily due to a change in estimate of the allowance for credit losses for business credit cards and the maturing and growth of the business credit card portfolio in 2000 as discussed above. Average on-balance sheet business credit card receivables increased 88% in 2000 as compared with 1999. For the year ended December 31, 1999, the provision for credit losses decreased by $15.8 million as compared to the year ended December 31, 1998. This decrease was comprised of a $28.3 million decrease in the provision on consumer credit cards due to the Consumer Credit Card Transaction in 1998, a $7.9 million increase in the provision on business credit cards, and a $4.6 million increase in the provision on other loans. The increase in the provision on business credit cards was due to the expansion of the business credit card customer base during 1999. Average on-balance sheet business credit card receivables increased 45% in 1999 as compared with 1998. The provision for credit losses on other loans in 1999 included a $3.7 million provision related to our exit from the auto finance business.
CREDIT QUALITY
The following table provides a summary of allowances for credit losses, nonperforming assets, delinquencies and charge-offs for the past five years. Consolidated data includes business credit cards, consumer credit cards through February 1998, and other loans.
(1) Effective October 1, 2000, business credit card charge-off and delinquency statistics reflect the adoption of a new charge-off policy for bankruptcies. Bankrupt business credit cards are charged off within a 60-day investigative period after receipt of notification. The previous policy provided a 90-day investigative period.
UNUSUAL CHARGES
In connection with the Consumer Credit Card Transaction in the first quarter of 1998, we made major organizational changes to reduce corporate expenses incurred in the past: (a) to support the business contributed to Fleet LLC in the Consumer Credit Card Transaction, and (b) associated with the business and products no longer being offered or not directly associated with our mortgage, business credit card and leasing units. In addition, in 1999, we implemented a plan to exit the auto finance business and to implement cost reduction initiatives throughout the organization including the consolidation of support functions. Unusual charges associated with these restructuring activities included employee costs, other expenses associated with exited businesses/products, and asset impairments.
These restructuring activities had no significant impact on operations while they were ongoing. As a result of the restructuring activities, we realized lower personnel expenses in the 12 months following the charges, and expect to realize lower depreciation and amortization expense over the next 5-7 years. These decreases were due to the termination of employees and the write-off or write-down of assets previously deployed in connection with exited businesses. We also expected and realized the elimination of the costs of the contractual commitments associated with exited business products from future operating results over the estimated timeframe of the contracts.
Employee costs associated with staff reductions
In the first quarter of 1999, in connection with cost reduction initiatives and the consolidation of support functions, we recorded a $3.3 million charge for costs associated with staff reductions. These expenses included severance and outplacement costs. There were 121 employees severed who were entitled to benefits. This staff reduction was substantially complete by June 30, 1999. The final payment outstanding related to these employee costs was paid in the three months ended March 31, 2000.
Employee costs associated with Consumer Credit Card Transaction/Tender Offer
In connection with the organizational changes in 1998, we incurred approximately $26.8 million of severance and related costs classified as employee costs associated with the Consumer Credit Card Transaction/Tender Offer. These expenses included severance and outplacement costs associated with the workforce reduction, option exercise and re-measurement costs, and other employee costs directly attributable to the Consumer Credit Card Transaction/Tender Offer.
In connection with these organizational changes, 255 employees who ceased to be employed by us were entitled to benefits, of which 190 employees were directly associated with the business contributed to Fleet LLC and 65 employees were associated with the workforce reduction.
Additionally, during the first quarter of 1998, we incurred approximately $35.5 million of other compensation charges. This amount includes $21.3 million attributable to payments under change of control plans and $14.2 million associated with the execution of the Tender Offer.
The final payment outstanding related to these employee costs was paid in the three months ended March 31, 2000.
Expenses associated with exited businesses/products
In the first quarter of 1999, we implemented a plan to cease the origination of auto loans and recorded a $3.4 million charge for costs associated with exited businesses/products. The charges included severance and outplacement costs for 22 employees in the auto origination group, and professional fees associated with exited businesses/products not directly associated with our mortgage, business credit card and leasing units. We completed the closing of the auto loan origination center and termination of related employees during the second quarter of 1999. We expect to complete the payment of the remaining professional fees during the first half of 2001.
During the first quarter of 1998, we implemented a plan to exit certain businesses and product offerings not directly associated with our mortgage, business credit card and leasing units. In connection with this plan, contractual vendor commitments of approximately $10.0 million associated with discontinued development and other activities were accrued. We have substantially completed the settlement of these contractual commitments.
We also have contractual commitments to certain customers, and non-related financial institutions that are providing benefits to those customers, under a product that is no longer offered and for which no future revenues or benefits will be received. In 1998, we recorded a charge of $22.8 million associated with these commitments, and an $8.3 million charge associated with the write-off of assets associated with this program that became unrealizable when the product was exited. In 1999, an additional charge of $10.0 million was recorded based on a change in the estimate of total expected costs for the contractual commitments related to the exited product. Updated information regarding future benefits to be provided in connection with these contractual commitments indicated a higher level of benefits than originally estimated. The actions required to complete this plan include the settlement of contractual commitments and the payment of customer benefits. The liabilities associated with these commitments were assumed by a third party in the first quarter of 2001.
In connection with the Consumer Credit Card Transaction/Tender Offer and the other exited business and product offerings, we also incurred $11.5 million of related professional fees and $1.5 million of other expenses related to these plans.
Asset Impairments
In connection with Advanta's plans to reduce corporate expenses and exit certain business and product offerings, certain assets previously deployed in connection with these exited business or product offerings were identified and the carrying costs thereof were written off or written down to estimated realizable value in 1998 resulting in a charge of $8.7 million. This charge included $6.0 million from the write-off of certain leasehold improvements and furniture and fixtures due to the refit of corporate headquarters. In addition, this charge included a $2.7 million write-down to estimated fair value of capitalized software costs. The write-down to fair value of software was determined based on an estimate of costs associated with the additional functionality of the software, which would not be of use subsequent to the exit of certain business and product offerings.
INCOME TAXES
As a result of the carrying value adjustments in the three months ended June 30, 2000, described in Note 3 to the consolidated financial statements, we reported a pretax loss for the year ended December 31, 2000. A
valuation allowance has been provided against the resulting deferred tax asset given our pre-existing net operating loss carryforwards and the uncertainty of the realizability of the incremental deferred tax asset. In establishing the valuation allowance, management considered (1) the level of expected future taxable income, (2) existing and projected book/tax differences, (3) tax planning strategies available, and (4) the general and industry specific economic outlook. Based on this analysis, management believes the net deferred tax asset will be realized.
The gain on the Consumer Credit Card Transaction in 1998 was not subject to income tax and no tax provision was recorded. The Consumer Credit Card Transaction also resulted in additional book/tax differences, which were quantified during 1999 in connection with the filing of the 1998 tax return. These book/tax differences, when combined with certain less significant recurring differences, resulted in net operating loss carryforwards of approximately $521 million at December 31, 1999. This amount is net of $96 million carried back to prior years, and includes $500 million that pertains to losses incurred on the consumer credit card portfolio after the date of the Consumer Credit Card Transaction. A deferred tax asset of $50 million, net of valuation allowance, resulting from the net operating loss carryforwards was recorded as an income tax benefit in the fourth quarter of 1999.
In 2000, we utilized net operating loss carryforwards of $85 million. Additionally, $29 million was carried back to prior years. At December 31, 2000, remaining net operating loss carryforwards were $406 million, of which $390 million expire in 2018 and $16 million expire in 2019.
In 1998, we recorded a consolidated income tax benefit of approximately $9.0 million, as a result of the federal tax treatment of the contribution of assets associated with the Consumer Credit Card Transaction.
ASSET/LIABILITY MANAGEMENT
We manage our financial condition with a focus on maintaining high credit quality standards, disciplined management of market risks and prudent levels of leverage and liquidity.
MARKET RISK SENSITIVITY
Market risk is the potential for loss or diminished financial performance arising from adverse changes in market forces including interest rates and market prices. Market risk sensitivity is the degree to which a financial instrument, or a company that owns financial instruments, is exposed to market forces. We regularly evaluate our market risk profile and attempt to minimize the impact of market risks on net interest income and net income.
Our exposure to equity price risk is immaterial relative to expected overall financial performance. Fluctuations in interest rates, changes in economic conditions, shifts in customer behavior, and other factors can, however, affect our financial performance. Changes in economic conditions and shifts in customer behavior are difficult to predict, and our financial performance generally cannot be insulated from these forces.
Financial performance variability as a result of fluctuations in interest rates is commonly called interest rate risk. Interest rate risk generally results from mismatches in the timing of asset and liability repricing (gap risk) and from differences between the repricing indices of assets and liabilities (basis risk).
We attempt to analyze the impact of interest rate risk by regularly evaluating the perceived risks inherent in our asset and liability structure, including securitized instruments and off-balance sheet instruments. Risk exposure levels vary continuously, as changes occur in our asset/liability mix, market interest rates and other factors affecting the timing and magnitude of cash flows. Computer simulations are used to generate expected financial performance in a variety of interest rate environments. Those results are analyzed to determine if actions need to be taken to mitigate our interest rate risk.
In managing interest rate risk exposure, we periodically securitize receivables, sell and purchase assets, alter the mix and term structure of our funding base, change our investment portfolio and use derivative financial instruments. Derivative instruments, by Company policy, are not used for speculative purposes. See discussion in Note 26 to the consolidated financial statements.
We measure our interest rate risk using a rising rate scenario and a declining rate scenario. Net interest income is estimated using a third party software model that uses standard income modeling techniques. We estimate that at December 31, 2000, our net interest income over a twelve-month period would increase by approximately 13% if interest rates were to rise by 200 basis points, and that our net interest income over a twelve-month period would decrease by approximately 2% if interest rates were to fall by 200 basis points. We also measure the effect of interest rate risk on our managed interest income, which includes net interest income on owned loans and net interest income on securitized loans. We estimate that at December 31, 2000, our managed net interest income over a twelve-month period would increase by approximately 4% if interest rates were to rise by 200 basis points, and that our managed net interest income over a twelve-month period would increase by approximately 13% if interest rates were to fall by 200 basis points. Our business credit card receivables include interest rate floors that cause our managed net interest income to rise in the declining rate scenario. Both increasing and decreasing rate scenarios assume an instantaneous shift in rates and measure the corresponding change in expected net interest income over one year.
The above estimates of net interest income sensitivity alone do not provide a comprehensive view of our exposure to interest rate risk. The quantitative risk information is limited by the parameters and assumptions utilized in generating the results. These analyses are useful only when viewed within the context of the parameters and assumptions used. The above rate scenarios in no way reflect management's expectation regarding the future direction of interest rates, and they depict only two possibilities out of a large set of possible scenarios.
DERIVATIVES ACTIVITIES
We have a number of mechanisms in place that enable us to monitor and control both market and credit risk from our derivatives activities. All derivatives strategies are managed under a hedging policy approved by the Board of Directors that details the use of derivatives and the individuals authorized to execute derivatives transactions. Our senior management must approve all derivatives strategies. As part of this approval process, we complete a market risk analysis to determine the potential impact that would result from severe negative (i.e., stressed) movements in market rates. By policy, derivatives transactions may only be used to manage our exposure to interest rate risk or for cost reduction and may not be used for speculative purposes. The impact of any derivatives transaction is calculated using our asset/liability model to determine its suitability.
For each counterparty, the total credit exposure amount is calculated by aggregating credit exposure from all derivatives and other capital market transactions with that counterparty. The amount of exposure that we are willing to accept from any single counterparty is based on that counterparty's credit rating and is determined as a percentage of our equity. To manage counterparty exposure, we also use negotiated agreements that establish threshold exposure amounts for each counterparty above which we have the right to call for and receive collateral for the amount of the excess, thereby limiting our exposure to the threshold amount. The threshold levels can be fixed or may change as the credit rating of the counterparty changes, and in all cases, the threshold levels are well below the maximum allowable exposure amounts described above. Similarly, under the terms of the negotiated agreements, counterparties have the right to call for and receive collateral from us for the amount of the excess of their credit exposure to us over applicable threshold levels. To date, substantially all agreements with counterparties have included bilateral collateral agreements.
We have a treasury department that is independent of the trading function, which measures, monitors, and reports on credit, market, and liquidity risk exposures from capital markets, hedging and derivative product activities. The department is responsible for ensuring compliance with our hedging policy, including the counterparty transaction limits, transaction terms and trader authorizations. In addition, this department marks each derivatives position to market on a weekly basis using both internal and external models. These models have been benchmarked against a sample of derivatives dealers' valuation models for accuracy. Position and counterparty exposure reports are generated and used to manage collateral requirements of the counterparty and Advanta.
All of these procedures and processes are designed to provide reasonable assurance that, before and after the execution of any derivatives strategy, market, credit and liquidity risks are fully analyzed and incorporated into Advanta's asset/liability and risk measurement models.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133, as amended by SFAS No. 137 and SFAS No. 138, cannot be applied retroactively and will be adopted as required January 1, 2001. We have determined that the adoption of SFAS No. 133 will not have a material effect on our financial position or results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Our goal is to maintain an adequate level of liquidity, for both long-term and short-term needs, through active management of both assets and liabilities. During the year ended December 31, 2000, we securitized or sold approximately $543 million of business credit card receivables. We temporarily invested cash generated from these transactions in short-term, high quality investments at money market rates pending redeployment to pay down borrowings and to fund future receivable growth. At December 31, 2000, we had $108 million of federal funds sold, $154 million of loans held for sale, and $605 million of investments, which could be sold to generate additional liquidity. Equity, including capital securities, was $541 million at December 31, 2000.
At December 31, 2000, we had a $280 million committed commercial paper conduit facility secured by business credit card receivables, of which $150 million was unused at December 31, 2000. We also had an uncommitted securities repurchase agreement facility secured by business credit card receivables of $200 million, all of which was unused at December 31, 2000.
At December 31, 2000, after paying down $194 million in medium-term notes in the year ended December 31, 2000, we had over $180 million of unrestricted cash, cash equivalents and marketable securities at the parent company and nonbank subsidiaries. The sale of the mortgage business in the first quarter of 2001 further strengthened our liquidity. Under the purchase and sale agreement, we received in excess of $1 billion in cash. We will use part of the proceeds from the sale of mortgage assets to pay off our outstanding medium-term notes via a tender offer to repurchase the outstanding notes at par value plus accrued interest. We also intend to use the proceeds to significantly reduce our outstanding retail notes, and to provide working capital for our remaining businesses. In addition, as a result of the liquidity resulting from the sale of the mortgage business in the first quarter of 2001, Advanta Corp. is temporarily not originating or renewing retail notes and Advanta National Bank has suspended originations of deposit accounts.
Components of funding were as follows at December 31:
During 2000, we completed our first two public business credit card securitizations, which enabled us to grow off-balance sheet business credit card receivables as a component of our funding. There were no other significant changes in the components of funding during 1999 or 2000. See discussion above regarding intended use of proceeds from the first quarter sale of our mortgage business in 2001.
At December 31, 2000, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 15.08%, and Advanta Bank Corp.'s combined total capital ratio was 14.60%. At
December 31, 1999, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 14.86% and Advanta Bank Corp.'s combined total capital ratio was 13.28%. In each case, Advanta National Bank and Advanta Bank Corp. had capital at levels a bank is required to maintain to be classified as "well-capitalized" under the regulatory framework for prompt corrective action. However, Advanta National Bank does not meet the definition of "well-capitalized" because of the existence of our agreement with the Office of the Comptroller of the Currency, even though we have achieved the higher imposed capital ratios required by the agreement. Our regulatory agreement with the Office of the Comptroller of the Currency required that Advanta National Bank achieve by September 30, 2000 and thereafter maintain a ratio of 14% of Tier 1 capital to risk-weighted assets and a ratio of 17% of Tier 1 capital to adjusted total assets. We achieved these ratios, as defined within the agreement, through a combination of decreasing the assets and deposits at Advanta National Bank and making aggregate capital contributions and other investments in Advanta National Bank of approximately $70 million.
In connection with the sale of our mortgage business discussed in Note 2 to the consolidated financial statements, Advanta National Bank sought approval of the OCC for a return of capital to Advanta Corp. in the amount of $261 million. On February 28, 2001, the OCC approved the amount requested and, at the same time, Advanta National Bank entered into an agreement with the OCC regarding restrictions on new business activities and product lines at Advanta National Bank after the sale of the mortgage business and the resolution of outstanding Advanta National Bank liabilities. The agreement also reduces the existing capital requirements for Advanta National Bank to 12.7% for Tier 1 and Total capital to risk-weighted assets, and to 5% for Tier 1 capital to adjusted total assets as defined in the agreement. In addition, the agreement provides for prior OCC approval of any future dividends. Advanta Bank Corp. is unaffected by the agreement with the OCC.
Recently, guidelines were issued jointly by the federal bank regulatory agencies regarding additional requirements for subprime lenders, including additional capital requirements. Under the guidelines, regulatory capital required to be held for certain loan classes included in Advanta Bank Corp.'s portfolio could be increased.
In addition, in a draft proposal recently issued jointly by the federal bank regulatory agencies, capital requirements associated with certain residual interests would be amended to require capital equal to the residual retained, regardless of retained recourse levels. Further, the proposal requires residuals in excess of 25% of Tier 1 capital to be treated as a deduction of Tier 1 capital for purposes of risk based and leverage capital calculations. In another draft proposal recently issued jointly by the federal bank regulatory agencies, the agencies would use credit ratings and certain alternative approaches to match the risk based capital requirement more closely to a banking organization's relative risk of loss in asset securitizations. The proposal also requires the sponsor of a revolving credit securitization that involves an early amortization feature to hold capital against the amount of assets under management (the off-balance sheet securitized receivables). The proposal treats recourse obligations and direct credit substitutes more consistently than under the agencies' current risk based capital standards. The ultimate resolution of these proposals and their impact on financial results is uncertain at this time.
Advanta National Bank and Advanta Bank Corp. are prevented by regulatory restrictions from lending to Advanta Corp. and its affiliates unless these extensions of credit are secured by U.S. Government obligations or other specified collateral. Further, secured extensions of credit are limited in amount: (a) as to Advanta Corp. or any affiliate, to 10% of each bank's capital and surplus, and (b) as to Advanta Corp. and all affiliates in the aggregate, to 20% of each bank's capital and surplus. See "Part I -- Government Regulation."
Advanta National Bank is also subject to various legal limitations on the amount of dividends that can be paid to its parent, Advanta Corp. Advanta National Bank is eligible to declare a dividend provided that it is not greater than the current year's net profits plus net profits of the preceding two years. See "Part I -- Government Regulation." However, our regulatory agreements with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation prohibit the payment of dividends by Advanta National Bank or Advanta Bank Corp. without prior regulatory approval.
Our insurance subsidiaries are also subject to certain capital, deposit and dividend rules and regulations as prescribed by state jurisdictions in which they are authorized to operate.
Total stockholders' equity of our banking and insurance affiliates was $572 million at December 31, 2000, of which $566 million was restricted. At January 1, 2001, $5.4 million of stockholders' equity of our banking and insurance affiliates was available for payment of dividends under applicable regulatory guidelines without prior regulatory approval.
In addition to dividend restrictions at banking subsidiaries, certain non-bank subsidiaries are subject to minimum equity requirements as part of securitization agreements or financing facility agreements. The total minimum equity requirement of non-bank subsidiaries was $40 million at December 31, 2000. Management believes that these restrictions, for both bank and non-bank subsidiaries, will not have an adverse effect on the Advanta Corp.'s ability to meet its cash obligations due to the current levels of liquidity, diversity of funding sources and the proceeds received from the sale of our mortgage business in the first quarter of 2001.
The following tables detail the composition of the deposit base and the composition of debt and other borrowings at year end for each of the past five years.
COMPOSITION OF DEPOSIT BASE
COMPOSITION OF DEBT AND OTHER BORROWINGS
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations -- ASSET/LIABILITY MANAGEMENT."
ITEM 8.
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
See Notes to Consolidated Financial Statements.
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
($ IN THOUSANDS)
See Notes to Consolidated Financial Statements.
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ($ IN THOUSANDS EXCEPT PER SHARE DATA, UNLESS OTHERWISE NOTED)
In these notes to consolidated financial statements, "Advanta", "we", "us", and "our" refer to Advanta Corp. and its subsidiaries, unless the context otherwise requires.
Advanta is a highly focused financial services company. We have been providing innovative financial products and solutions since 1951. Over the past five years, we have become one of the nation's largest issuers of Mastercard(R)* business credit cards to small businesses. During the year ended December 31, 2000, our lending and leasing business units consisted of Advanta Business Cards, Advanta Mortgage and Advanta Leasing. In addition to our lending and leasing businesses, we have an insurance business and venture capital investments. We own two depository institutions, or banks, Advanta National Bank and Advanta Bank Corp. Our banks offer a variety of deposit products, such as retail and large denomination certificates of deposit, that are insured by the Federal Deposit Insurance Corporation. During the year ended December 31, 2000, we primarily funded and operated our mortgage, business credit card and leasing businesses through our banks. At December 31, 2000, we serviced approximately 900,000 customers and managed receivables of approximately $10.4 billion. We also serviced mortgage loans for third parties. In the first quarter of 2001, we discontinued our mortgage and equipment leasing businesses. See Note 2. The mortgage and equipment leasing businesses represented 26% of our customers and 84% of our managed receivables at December 31, 2000. Prior to February 20, 1998, we issued consumer credit cards.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of Advanta Corp. and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current year's presentation.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates are used when accounting for securitization income, retained interests in securitizations, the fair value of certain financial instruments, the allowance for credit losses, litigation and income taxes, among others. Actual results could differ from those estimates.
INVESTMENTS
Investments available for sale include securities that we sell from time to time to provide liquidity and in response to changes in the market. Debt and equity securities classified as available for sale are reported at market value and unrealized gains and losses on these securities are reported in other comprehensive income, net of income taxes.
Investments of our venture capital unit are included in investments available for sale and carried at estimated fair value following the specialized industry accounting principles of this unit. Management makes fair value determinations based on quoted market prices, when available, and considers the investees' financial results, conditions and prospects when market prices are not available. In accordance with the specialized industry accounting principles of venture capital investment companies, the unrealized and realized gains and losses on these investments are included in other revenues rather than other comprehensive income and the equity method of accounting for investments is not applied.
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* MasterCard(R) is a federally registered servicemark of MasterCard International, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Trading investments are securities that are bought and held principally for the purpose of selling them in the near term. Trading investments are reported at fair value, with unrealized gains and losses included in earnings.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
LOANS HELD FOR SALE
Loans held for sale represent receivables currently on the balance sheet that we intend to sell or securitize within the next six months. These assets are reported at the lower of aggregate cost or fair market value by loan type. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is established as losses are estimated to have occurred through a provision for credit losses charged to earnings. The allowance for credit losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility in light of historical experience by loan type, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Since our loan portfolio is comprised of large groups of smaller balance homogeneous loans, we evaluate each group collectively for impairment. Accordingly, we do not separately identify individual loans for impairment disclosures.
Credit losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Our charge-off policy for business credit card accounts is to charge-off an unpaid receivable at 180 days contractually delinquent. Business credit card accounts suspected of being fraudulent are charged-off after a 90-day investigative period, unless our investigation shows no evidence of fraud. Effective October 1, 2000, bankrupt business credit cards are charged off within a 60-day investigative period after receipt of notification. The previous policy provided a 90-day investigative period.
INTEREST INCOME ON LOANS AND ORIGINATION COSTS AND FEES
Interest income is accrued on the unpaid principal balance of loans. The accrual of interest is discontinued when the related receivable becomes 90 days past due. Interest income is subsequently recognized only to the extent cash payments are received.
We engage third parties to solicit and originate business credit card account relationships. Amounts paid to third parties to acquire business credit card accounts and certain other origination costs are deferred and netted against any related business credit card fee, and the net amount is amortized on a straight-line basis over the privilege period of one year.
SECURITIZATION ACTIVITIES
Through our subsidiaries, we sell receivables through securitizations with servicing retained. The transfer of financial assets in which we surrender control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. Liabilities and derivatives incurred or obtained as part of a transfer of financial assets are initially measured at fair value, if practicable. We allocate the previous carrying amount of the receivables securitized between the assets sold and the retained interests, including the servicing relationship, interests in the receivables, and an interest-only strip, based on their relative estimated fair values at the date of sale. Securitization income is recognized at the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
time of the sale, equal to the excess of the fair value of the assets obtained (principally cash) over the allocated cost of the assets sold and transaction costs. The retained interest-only strip represents the estimated fair value of the remaining interest to be collected from the borrowers on the underlying loans after the payment of interest to the certificate holders and the payment of a servicing fee to us in our role as servicer reduced by the estimated fair value of our obligation for anticipated charge-offs.
During the revolving period of each business credit card securitization trust, securitization income is recorded representing estimated gains on the sale of new receivables to the trusts on a continuous basis to replenish the investors' interest in trust receivables that have been repaid by the business credit card holders. These estimates require certain assumptions of payment, default and interest rates and cost of funds. To the extent actual results are different than those estimates, the effect is included as part of securitization income.
RETAINED INTERESTS IN SECURITIZATIONS
Retained interests in securitizations include the retained interest-only ("IO") strip and subordinated trust assets related to securitizations. Restricted cash reserve accounts related to securitizations are classified as restricted interest-bearing deposits. Retained interest-only strips are measured in accordance with the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). We account for the retained interest-only strips from securitizations as trading securities. These assets are recorded at estimated fair value and the resulting unrealized gain or loss from the valuation of the receivable is included in securitization income.
We estimate the fair value of retained interest-only strips based on a discounted cash flow analysis. The cash flows are estimated as the excess of the weighted average yield on each pool of the receivables sold over the sum of the interest rate paid to the certificate holder plus the servicing fee, credit enhancement costs and an estimate of future credit losses over the life of the receivables. Cash flows are discounted from the date the cash is expected to become available to us (the "cash-out" method). These cash flows are projected over the life of the receivables using payment, default, and interest rate assumptions that management believes would be used by market participants for similar financial instruments subject to prepayment, credit and interest rate risk. The cash flows are discounted using an interest rate that management believes a purchaser unrelated to the seller of the financial instrument would demand. As all estimates used are influenced by factors outside our control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. Interest income is recognized over the life of the retained interest-only strip using the discount rate used in the valuation.
Subordinated trust assets, together with the related retained interest-only strip, serve as a form of credit enhancement for the transactions, and excess losses, if any, on the collateral would be absorbed by these amounts. These assets are classified as trading securities and are carried at estimated fair value.
SERVICING RIGHTS
Servicing assets associated with business credit card securitization transactions are not material as the benefits of servicing are not expected to be more or less than adequate compensation to us for performing the servicing.
PREMISES AND EQUIPMENT
Premises, equipment, computers and software are stated at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Repairs and maintenance are charged to expense as incurred.
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Securities sold under agreements to repurchase are accounted for as secured borrowings because we maintain effective control over the transferred assets. Securities sold under agreements to repurchase are reflected at the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amount of cash received in connection with the transaction. We may be required to provide additional collateral based on the fair value of the underlying securities.
DERIVATIVE FINANCIAL INSTRUMENTS
We use various derivative financial instruments, including interest rate swaps, interest rate caps, options and forward contracts, as part of our risk management strategy to reduce interest rate risk. Derivatives are not used for trading or speculative activities. Derivatives are classified as hedges or synthetic alterations of specific on-balance sheet items or anticipated transactions. In order for derivatives to qualify for hedge accounting treatment, the following conditions must be met:
1) the underlying item being hedged must expose us to interest rate risk;
2) the derivative used serves to reduce our sensitivity to interest rate risk; and
3) the derivative used is designated and deemed effective in hedging our exposure to interest rate risk.
In addition to meeting these conditions, anticipatory hedges must demonstrate that the anticipated transaction being hedged is probable to occur and the expected terms of the transaction are identifiable.
Gains or losses on derivatives designated as hedges of balance sheet items not carried at fair value are deferred and are ultimately recognized in income as part of the carrying amount of the related balance sheet item exposing us to interest rate risk. Accrual accounting is applied for derivatives designated as synthetic alterations with income and expense recorded in the same category as the related underlying on-balance sheet or off-balance sheet item synthetically altered. Gains or losses resulting from early terminations of derivatives are deferred and amortized over the shorter of the remaining term of the underlying balance sheet item or the remaining term of the derivative. If the underlying balance sheet item is sold, matures or is extinguished, or the anticipated transaction is no longer likely to occur, any unrecognized gain or loss on the derivative is recognized currently in earnings.
For derivatives designated as hedges of balance sheet items where changes in fair value are recognized currently in earnings, the related derivative is included in the balance sheet at fair value, and changes in the fair value of the derivative are also recognized currently in earnings.
Derivatives not qualifying for hedge or synthetic accounting treatment would be carried at market value with realized and unrealized gains and losses included in operating results. During 2000, 1999 and 1998, all of our derivatives qualified as hedges or synthetic alterations. For purposes of reporting cash flows, cash flows from derivatives accounted for as hedges or synthetic alterations are classified in the same category as the item being hedged.
INSURANCE
Insurance premiums are earned ratably over the period of insurance coverage provided. Reinsurance premiums, net of commissions, on credit life, disability and unemployment policies, are earned monthly based upon the outstanding balance of the underlying receivables. The cost of acquiring new reinsurance is deferred and amortized over the period the related premiums are earned in order to match the expense with the anticipated revenue.
Insurance loss reserves are based on estimated settlement amounts for both reported losses, incurred but not reported losses and loss adjustment expenses.
STOCK-BASED COMPENSATION
We have elected to account for stock-based compensation following Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" as permitted by SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). We have adopted the disclosure-only provisions of SFAS 123.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAXES
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and gives current recognition to changes in tax rates and laws.
EARNINGS PER SHARE
Basic earnings per common share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Income available to common stockholders is computed by deducting Class A and Class B Preferred Stock dividends from net income. Diluted earnings per common share is computed by dividing income available to common stockholders, increased by dividends on dilutive Class B Preferred Stock for the period, by the sum of average common shares outstanding plus dilutive common shares for the period. Potentially dilutive common shares include stock options, restricted stock issued under incentive plans and, through September 15, 1999, Class B Preferred Stock. Since the cash dividends declared on our Class B Common Stock were higher than the dividends declared on the Class A Common Stock, basic and diluted earnings per common share have been calculated using the "two-class" method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock according to dividends declared and participation rights in undistributed earnings. We have also presented combined earnings per common share, which represents a weighted average of Class A and Class B earnings per common share.
CASH FLOW REPORTING
Cash paid for interest was $182.4 million during 2000, $161.0 million during 1999, and $218.3 million during 1998. Cash paid for taxes was $4.1 million during 2000, $8.9 million during 1999, and $28.2 million during 1998. See Note 11 for discussion of noncash transfer of assets and liabilities in the Consumer Credit Card Transaction in 1998. Noncash transactions in 1998 also included the retention of $795 million of trust certificates at the time of receivable securitization. These securities were classified as trading investments. In 1999, $315 million of these securities were reclassified from trading to available-for-sale securities.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133, as amended by SFAS No. 137 and SFAS No. 138, cannot be applied retroactively and will be adopted as required January 1, 2001. We have determined that the adoption of SFAS No. 133 will not have a material effect on our financial position or results of operations.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a Replacement of FASB Statement No. 125." SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions without amendment. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. We have adopted the disclosure provisions of SFAS 140 for the year ended December 31, 2000. We anticipate that the adoption of the accounting provisions of SFAS No. 140 will not have a material effect on our financial position or results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. DISCONTINUED OPERATIONS
On January 8, 2001, we signed an agreement with Chase Manhattan Mortgage Corporation, a subsidiary of J.P. Morgan Chase & Co., to sell our mortgage business, Advanta Mortgage. Advanta Mortgage made nonconforming home equity loans directly to consumers and through brokers. This business unit originated and serviced first and second lien mortgage loans, including home equity lines of credit, through subsidiaries of Advanta. In addition to servicing and managing the loans it originated, Advanta Mortgage contracted with third parties to service their nonconforming home equity loans on a subservicing basis.
Effective February 28, 2001, we completed the sale of our mortgage business to Chase Manhattan Mortgage Corporation. Following the transaction, we no longer operate a mortgage business. The purchase and sale agreement provided for the sale, transfer and assignment of substantially all of the assets and operating liabilities associated with our mortgage business, as well as specified contingent liabilities arising from our operation of the mortgage business prior to closing that were identified in the purchase and sale agreement. We retained contingent liabilities, primarily relating to litigation, arising from our operation of the mortgage business before closing that were not specifically assumed by the buyer. The proceeds from the sale exceeded $1 billion, subject to closing adjustments, resulting in an estimated gain of approximately $59.7 million before transaction expenses, severance expenses and other costs. Transaction expenses, severance expenses and other costs associated with the sale are expected to be significant. The gain will also be reduced by a charge of approximately $19.7 million associated with certain equipment, facilities and derivative instruments related to hedging activities not purchased by the buyer. We will use part of the proceeds from the sale of mortgage assets to pay off our outstanding medium-term notes via a tender offer to repurchase the outstanding notes at par value plus accrued interest. We also intend to use the proceeds to significantly reduce our outstanding retail notes, and to provide working capital for our remaining businesses. Although the transaction resulted in a gain for financial reporting purposes, due to book/tax differences we expect that we will not be required to pay any material federal income tax as a result of the sale. We also expect to record a restructuring charge in the first quarter of 2001 as we restructure corporate functions to a size commensurate with the ongoing business after closing.
On January 23, 2001, we announced that after a thorough review of strategic alternatives available for our leasing business, Advanta Leasing Services, we decided to cease originating leases. Advanta Leasing Services offered flexible lease financing programs on small-ticket equipment to small businesses. The primary products financed included office machinery, security systems and computers. The commercial equipment leasing business was generated primarily through third-party referrals from manufacturers or distributors of equipment, as well as independent brokers, direct mail marketing and telemarketing. We will continue to service the existing portfolio rather than sell the business or the portfolio. In connection with the discontinuance of the leasing business, we recorded a $4.3 million pretax loss effective December 31, 2000.
The sale of the mortgage business and discontinuance of the leasing business represent the disposal of business segments following Accounting Principles Board ("APB") Opinion No. 30. Accordingly, results of these operations are classified as discontinued in all periods presented.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenues and expenses from discontinued operations were as follows for the years ended December 31:
Per share data was as follows for the years ended December 31:
Net assets of discontinued operations were as follows at December 31:
We allocated interest expense to the discontinued operations based on the ratio of net assets of discontinued operations to the total net assets of the consolidated company. The loss on discontinuance of the leasing business includes estimated interest expense of $12.5 million for the period from December 31, 2000 through the remaining life of the lease portfolio.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As discussed above, we will continue to service the existing lease portfolio. At December 31, 2000, there were $658 million of securitized leases outstanding, and we had retained interests in leasing securitizations, including restricted cash reserves, of $78 million. At December 31, 1999, there were $663 million of securitized leases outstanding, and we had retained interests in leasing securitizations, including restricted cash reserves, of $51 million. The retained interests in leasing securitizations are included in net assets of discontinued operations on the consolidated balance sheet. At December 31, 2000, the fair value of the retained interests in leasing securitizations was estimated using a 9% discount rate, a 4% loss rate and a weighted average life of 1.4 years. Actual results may vary from our estimates, and the impact of any differences will be recognized in income when determined.
NOTE 3. REGULATORY DEVELOPMENTS
In June 2000, we announced that our banking subsidiaries, Advanta National Bank and Advanta Bank Corp., reached agreements with their respective bank regulatory agencies, primarily relating to the banks' subprime lending operations. The agreements outlined a series of steps to modify processes and formalize and document certain practices and procedures for the banks' subprime lending operations. The agreements also established temporary asset growth limits at Advanta National Bank and deposit growth limits at Advanta Bank Corp., imposed restrictions on taking brokered deposits at Advanta National Bank, and required that by September 30, 2000 Advanta National Bank's capital ratios be maintained at approximately the levels at March 31, 2000. We achieved these ratios through a combination of decreasing the assets at Advanta National Bank and making aggregate capital contributions and other investments in Advanta National Bank of approximately $70 million. The agreements also required us to change our charge-off policy for delinquent mortgages to 180 days and to modify our accounting processes and estimate of our allowance for credit losses and valuation of residual assets.
In July 2000, we announced that Advanta National Bank signed an agreement with the Office of the Comptroller of the Currency (the "OCC") regarding the carrying value of Advanta National Bank's retained interests in mortgage securitizations and allowance for mortgage credit losses. For Advanta National Bank's June 30, 2000 Call Report, in accordance with the provisions of the agreement, we calculated the valuation of the retained interests based on an 18% discount rate on the interest-only strip and subordinated trust assets, a 15% discount rate on the contractual mortgage servicing rights, a prepayment rate that represents the average prepayment experience for the six months ended February 29, 2000 and cumulative loss rates as a percentage of original principal balance of 6% on closed end mortgage loans and 8% for HELOC (open end) mortgage loans. The agreement required that, based on these assumptions, the carrying value of Advanta National Bank's contractual mortgage servicing rights be reduced by $13 million and the carrying value of Advanta National Bank's subordinated trust assets and retained interest-only strip be reduced by a total amount of $201 million. The agreement further required that Advanta National Bank's allowance for credit losses be increased by $22 million. The agreement contains provisions regarding the use of similar discount rate and credit loss assumptions for the calculation of the carrying value of the residual assets in future periods. These valuation adjustments and provisions for credit losses are included in the results of Advanta Mortgage in discontinued operations. See Note 2 for discussion of discontinued operations.
Management believes that we are in compliance with our regulatory agreements at December 31, 2000.
In connection with the sale of our mortgage business discussed in Note 2, Advanta National Bank sought approval of the OCC for a return of capital to Advanta Corp, in the amount of $261 million. On February 28, 2001, the OCC approved the amount requested and, at the same time, Advanta National Bank entered into an agreement with the OCC regarding restrictions on new business activities and product lines at Advanta National Bank after the sale of the mortgage business and the resolution of outstanding Advanta National Bank liabilities. The agreement also reduces the existing capital requirements for Advanta National Bank and provides for prior OCC approval of any future dividends. Advanta Bank Corp. is unaffected by the agreement with the OCC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. INVESTMENTS
Investments available for sale consisted of the following:
(1) Includes venture capital investments of $45.3 million at December 31, 2000 and $36.4 million at December 31, 1999. The amount shown as amortized cost represents fair value for these investments. See Note 1.
Maturities of investments available for sale at December 31, 2000 were as follows:
Net realized gains on the sale of investments are included in other revenues in the consolidated income statements. Realized gains and losses on sales of investments available for sale were as follows for the years ended December 31:
Investment securities deposited with insurance regulatory authorities to meet statutory requirements or held by a trustee for the benefit of primary insurance carriers were $6.5 million at December 31, 2000 and $7.3 million at December 31, 1999. The carrying value of securities pledged to secure repurchase agreements was $0 at December 31, 2000 and $111.3 million at December 31, 1999. The carrying value of securities pledged to secure Federal Home Loan Bank ("FHLB") advances was $0 at December 31, 2000 and $276.2 million at December 31, 1999. The carrying amount of other pledged securities was $2.7 million at December 31, 2000 and $0 at December 31, 1999. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
There were no investments classified as trading at December 31, 2000 or December 31, 1999. Net realized and unrealized gains on trading investments were $1,471 thousand in 1998, and were included in other revenues.
NOTE 5. LOANS
Loans on the balance sheet, including those held for sale, consisted of the following:
Gross managed receivables (owned receivables and securitized receivables) and managed credit quality data were as follows:
The geographic concentration of managed receivables was as follows:
In the normal course of business, we make commitments to extend credit to our business credit card customers. Commitments to extend credit are agreements to lend to a customer subject to certain conditions established in the contract. We do not require collateral to support business credit card commitments. We had commitments to extend credit outstanding for which there was potential credit risk of $5.9 billion at December 31, 2000 and $3.6 billion at December 31, 1999. We believe that our customers' utilization of these lines of credit will continue to be substantially less than the amount of the commitments, as has been our
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
experience to date. Of these total commitments, $4.2 billion were unused at December 31, 2000 and $2.5 billion were unused at December 31, 1999.
NOTE 6. ALLOWANCE FOR CREDIT LOSSES
The following table displays five years of allowance history:
As of September 30, 2000, we modified our estimate of the allowance for credit losses on business credit card receivables. The revised estimate for the overall portfolio was developed based on discussions with our banking regulators, changes in the economic environment and the use of more conservative loss estimates for certain segments of the loan portfolio. Those segments included accounts with lower credit scores, accounts held by businesses in operation less than twelve months, and accounts in which cash borrowings comprise a significant portion of the outstanding balance. As a result of these changes in estimate, we increased our allowance for credit losses by approximately $8 million, which decreased net income from continuing operations by approximately $8 million or $0.32 per diluted combined share.
NOTE 7. SECURITIZATION ACTIVITIES
The following represents business credit card securitization data by quarter for the year 2000 and the key assumptions used in measuring the fair value of retained interests at the time of each new securitization or replenishment during those periods.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
There were no purchases of delinquent accounts during 2000.
Retained interests in securitizations and restricted cash reserves serve as credit enhancements for securitization transactions. Retained interests in business credit card securitization transactions were $53.1 million at December 31, 2000 and $24.9 million at December 31, 1999. The restricted cash reserves are included in restricted interest-bearing deposits on the consolidated balance sheet and were $19.9 million at December 31, 2000 and $14.4 million at December 31, 1999. The following assumptions were used in measuring the fair value of retained interests in securitizations and restricted cash reserves at December 31, 2000. The assumptions listed represent weighted averages of assumptions used for each securitization.
We have prepared sensitivity analyses of the valuations of retained interests in securitizations and restricted cash reserves. The sensitivity analyses show the hypothetical effect on the fair value of those assets of two unfavorable variations from the expected levels for each key assumption, independently from any change in another key assumption. The following are the results of those sensitivity analyses on the valuation at December 31, 2000.
The objective of these hypothetical analyses is to measure the sensitivity of the fair value of the retained interests to changes in assumptions. The methodology used to calculate the fair value in the analyses is a discounted cash flow analysis, the same methodology used to estimate fair value as described in Note 1. These estimates do not factor in the impact of simultaneous changes in other key assumptions. The above scenarios
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
do not reflect management's expectation regarding the future direction of these rates, and they depict only certain possibilities out of a large set of possible scenarios.
NOTE 8. SELECTED BALANCE SHEET INFORMATION
Other assets consisted of the following:
Other liabilities consisted of the following:
NOTE 9. LONG-TERM DEBT
Long-term debt consists of borrowings having an original maturity of over one year. The composition of long-term debt at December 31, 2000 and 1999, was as follows:
We have priced our floating rate medium-term notes based on a spread over LIBOR. At December 31, 2000, the rates on these notes varied from 7.19% to 7.30%. At December 31, 2000 and 1999, we used
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
derivative financial instruments to effectively convert certain fixed rate debt to a LIBOR-based variable rate. See Note 26.
The annual contractual maturities of long-term debt at December 31, 2000 for the years ending December 31 are as follows: $592.0 million in 2001; $131.6 million in 2002; $10.5 million in 2003; $13.3 million in 2004; and $7.8 million in 2005. The average interest cost of our long-term debt was 8.17% during 2000, 6.53% during 1999, and 6.52% during 1998. We will use part of the proceeds from the sale of our mortgage business in the first quarter of 2001 to pay off our outstanding medium-term notes and to significantly reduce our other outstanding long-term debt. See discussion in Note 2.
NOTE 10. OTHER BORROWINGS
The composition of other borrowings was as follows:
At December 31, 2000, we had commercial paper conduit and securities repurchase agreement facilities secured by business credit card receivables totaling $480.3 million. Of the total, $280.3 million was committed. These commitments can be withdrawn under certain conditions, including a failure to make payments under the terms of the agreements. We pay a monthly facility fee on the unused commitments of up to 15 basis points. These facilities provide for on-balance sheet and off-balance sheet funding. At December 31, 2000, we had $350 million available under these facilities, as there were $130.3 million of business credit card receivables funded through these facilities, none of which were accounted for as secured borrowings. At December 31, 1999, there were $730.3 million of business credit card receivables funded through these facilities, none of which were accounted for as secured borrowings. These facilities are generally renewable annually. Upon the expiration of these facilities, management expects to obtain the appropriate levels of replacement funding under similar terms and conditions.
The following table displays information related to selected types of short-term borrowings:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average interest rates were calculated by dividing the interest expense for the period by the average amount of short-term borrowings outstanding during the period, calculated as an average of daily amounts.
NOTE 11. DISPOSITION OF CONSUMER CREDIT CARD ASSETS
In accordance with the terms of the contribution agreement, dated as of October 28, 1997, as amended February 20, 1998, by and between Advanta Corp. and Fleet Financial Group, Inc. ("Fleet"), Advanta Corp. and certain of its subsidiaries and Fleet and certain of its subsidiaries each contributed certain assets and liabilities of their respective consumer credit card businesses to Fleet Credit Card LLC ("Fleet LLC") in exchange for an ownership interest in Fleet LLC. Subsequent to February 20, 1998, Fleet Credit Card Services LP became the successor in interest to Fleet LLC. References to Fleet LLC include its successor in interest, Fleet Credit Card Services LP.
We recognized a gain on the transfer of the consumer credit card business (the "Consumer Credit Card Transaction") representing the excess of liabilities transferred to Fleet LLC over the net basis of the assets transferred. The gain also included our ownership interest in Fleet LLC. The gain on the transfer was not subject to income tax and no tax provision was recorded. The contribution agreement provides for the parties to make a final determination of the transferred assets and liabilities. As further described in Note 12, Advanta and Fleet are parties to a lawsuit concerning disputes regarding the final determination of the transferred assets and liabilities. It is possible that the outcome of the litigation will result in an increase or decrease to the gain recorded.
We retained certain immaterial assets of our consumer credit card business, which are not required in the operation of that business, and certain liabilities related to our consumer credit card business. These retained assets and liabilities include among others, all reserves relating to our credit insurance business and any liability or obligation relating to certain consumer credit card accounts generated in specific programs which comprised a very small portion of our consumer credit card receivables as of February 20, 1998. The assets and liabilities retained have been classified in other assets and other liabilities.
The contribution was accounted for as: (1) the transfer of financial assets (cash, loans, and other receivables) and an extinguishment of financial liabilities (deposits, debt, other borrowings and other liabilities) following SFAS 125; and (2) the sale of non-financial assets and liabilities (principally property and equipment, prepaid assets, deferred costs and certain contractual obligations). The financial assets, non-financial assets and liabilities of our consumer credit card business that were contributed were removed from the balance sheet. We were legally released as primary obligor under all of the financial liabilities contributed and, accordingly, they were removed from the balance sheet.
Concurrently with the Consumer Credit Card Transaction, we purchased 7,882,750 shares of our Class A Common Stock and 12,482,850 shares of our Class B Common Stock, each at $40 per share net, and 1,078,930 of our depositary shares, each representing one one-hundredth interest in a share of 6 3/4% Convertible Class B Preferred Stock, Series 1995 Stock Appreciated Income Linked Securities, at $32.80 per share net, through an issuer tender offer (the "Tender Offer") which was completed on February 20, 1998. The Office of the Comptroller of the Currency approved the payment of a special dividend/return of capital from Advanta National Bank to Advanta Corp., its parent company, to effect the purchase of the shares.
NOTE 12. COMMITMENTS AND CONTINGENCIES
On January 22, 1999, Fleet and certain of its affiliates filed a lawsuit against Advanta Corp. and certain of its subsidiaries in Delaware Chancery Court. Fleet's allegations, which we deny, center around Fleet's assertions that we failed to complete certain post-closing adjustments to the value of the assets and liabilities we contributed to Fleet LLC in connection with the Consumer Credit Card Transaction. Fleet seeks damages of approximately $141 million. We have filed an answer to the complaint denying the material allegations of the complaint, but acknowledging that we contributed $1.8 million in excess liabilities in the post-closing NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adjustment process, after taking into account the liabilities we have already assumed. We also have filed a countercomplaint against Fleet for approximately $101 million in damages we believe have been caused by certain actions of Fleet following the closing of the Consumer Credit Card Transaction. Formal discovery has begun and is ongoing. The court has scheduled trial in this matter to begin in July 2001. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results.
On December 5, 2000, a former executive of Advanta obtained a jury verdict against Advanta in the amount of $3.9 million, in connection with various claims against Advanta related to the executive's termination of employment. Both parties filed post-trial motions. The former executive has filed a motion for a new trial with respect to his claims that were dismissed. The former executive is seeking, among other things, an award of approximately $6 million based upon the jury verdict and additional amounts, including attorney's fees and costs. We will vigorously pursue our post-trial motions, and if necessary, an appeal to the United States Court of Appeals for the Third Circuit and will continue to contest the former executive's positions. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results.
On December 21, 2000, Banc One Financial Services, Inc. and Bank One, N.A (together "Banc One") filed a complaint that alleges, among other things, that Advanta breached two mortgage loan servicing agreements by wrongfully withholding as termination fees an amount in excess of $23 million, from amounts that we had collected under the loan servicing agreements, and by failing to perform under those agreements in certain respects. We dispute these claims and allegations. An answer to the complaint was filed February 23, 2001 denying liability and raising affirmative defenses. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results.
On February 1, 2001, Fleet and certain of its affiliates filed a complaint in an attempt to block the sale of our mortgage business to Chase Manhattan Mortgage Corp. The complaint alleged that the terms of the proposed sale breach a provision of Fleet's 1998 agreement to acquire our consumer credit card business, as amended (the "Contribution Agreement"), that essentially requires a buyer of "substantially all" of our assets to assume any of our remaining obligations under the Contribution Agreement at the time of the sale of "substantially all" of our assets. In February 2001, we announced that we had reached an agreement with Fleet, with regard to Fleet's attempt to block the sale. As part of the agreement, Fleet dismissed its injunction claim and agreed that it would raise no future issue with respect to the sale of the mortgage business. Under the agreement, $70 million of our reserves in connection with our long-standing litigation with Fleet were funded in an escrow account. The court presiding over the claims will order the funds paid to Advanta or to Fleet depending upon the outcome of that litigation. The amount escrowed, $70 million, represents our maximum exposure to Fleet in the litigation, assuming a court were to rule in favor of Fleet on every claim involved in the litigation.
We have been notified by Progressive Casualty Insurance Company that it does not intend to renew the strategic alliance with Advanta Insurance when the original five-year term for the alliance expires during 2001. The agreement governing the relationship between Advanta Insurance and Progressive requires that upon termination, we transfer our interest in the assets and liabilities of the strategic alliance to Progressive and that Progressive make certain payments to us, subject to adjustments. Advanta Insurance and Progressive are currently pursuing alternative termination structures for the strategic alliance that would allow for early termination and financial settlement.
Advanta Corp. and its subsidiaries are involved in other legal proceedings, claims and litigation, including those arising in the ordinary course of business. Management believes that the aggregate liabilities, if any, resulting from those actions will not have a material adverse effect on the consolidated financial position or results of our operations. However, as the ultimate resolution of these proceedings is influenced by factors
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outside of our control, it is reasonably possible that our estimated liability under these proceedings may change.
We lease office space in several states under leases accounted for as operating leases. Total rent expense related to continuing operations was $5.6 million in 2000, $5.3 million in 1999 and $4.1 million in 1998. The future minimum lease payments of non-cancelable operating leases related to continuing operations are as follows:
NOTE 13. MANDATORILY REDEEMABLE PREFERRED SECURITIES
In December 1996, a newly formed statutory business trust established and wholly-owned by Advanta Corp., issued $100 million of capital securities, representing preferred beneficial interests in the assets of the trust. We used the proceeds from the sale for general corporate purposes. The assets of the trust consist of $100 million of 8.99% junior subordinated debentures issued by Advanta Corp. due December 17, 2026. The capital securities will be subject to mandatory redemption under certain circumstances. These circumstances include the optional prepayment by Advanta Corp. of the junior subordinated debentures at any time on or after December 17, 2006 at an amount per capital security equal to 104.495% of the principal amount plus accrued and unpaid distributions. This amount declines ratably on each December 17 thereafter to 100% on December 17, 2016. Our obligations, in the aggregate, provide a full and unconditional guarantee of payments of distributions and other amounts due on the capital securities. Dividends on the capital securities are cumulative, payable semi-annually in arrears, and are deferrable at our option for up to ten consecutive semi-annual periods. We cannot pay dividends on our preferred or common stocks during deferments. Dividends on the capital securities have been classified as minority interest in income of consolidated subsidiary in the consolidated income statements. The trust has no operations or assets separate from its investment in the junior subordinated debentures. Separate financial statements of the trust are not presented because management has determined that they would not be meaningful to investors.
NOTE 14. CAPITAL STOCK
Class A Preferred Stock is entitled to 1/2 vote per share and a non-cumulative dividend of $140 per share per year, which must be paid prior to any dividend on the common stock. The redemption price of the Class A Preferred Stock is equivalent to its par value.
On February 20, 1998, we purchased 7,882,750 shares of our Class A Common Stock and 12,482,850 shares of our Class B Common Stock at $40 per share net, and 1,078,930 of our depositary shares, each representing one one-hundredth interest in a share of Stock Appreciation Income Linked Securities ("SAILS"), at $32.80 per share net, through the Tender Offer. The SAILS constituted a series of our Class B Preferred Stock, designated as 6 3/4% Convertible Class B Preferred Stock, Series 1995.
In 1998, the Board of Directors authorized the repurchase of up to 2.5 million shares of our Class A and Class B Common Stock and the formation of an Employee Stock Ownership Plan ("ESOP"). In 1998 and 1999, we purchased 1,405,000 shares of Class A Common Stock and 445,600 shares of Class B Common Stock at a total cost of $21.1 million. Of the total shares purchased, 1,000,000 shares of Class A Common Stock were purchased for our ESOP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On September 15, 1999, all of the 1.4 million outstanding depositary shares, each representing one one-hundredth interest in a share of SAILS, mandatorily converted into 1.4 million shares of Class B Common Stock.
In 2000, we retired 405,000 shares of Class A Treasury stock and 445,600 shares of Class B Treasury stock.
NOTE 15. BENEFIT PLANS
RESTRICTED STOCK AWARDS
We have adopted management incentive plans designed to provide incentives to participating employees to remain in our employ and devote themselves to the company's success. Under these plans, eligible employees were given the opportunity to elect to take portions of their anticipated or target bonus payments for future years in the form of restricted shares of common stock (with each plan covering three performance years). To the extent that these elections were made, or were required by the terms of the plans for executive officers, restricted shares were issued to employees. The number of shares granted to employees is determined by dividing the amount of future bonus payments that the employee had elected to receive in stock by the market price as determined under the incentive plans. The restricted shares are subject to forfeiture prior to vesting should the employee terminate employment with us. Restricted shares vest 10 years from the date of grant. Vesting was and may continue to be accelerated annually with respect to up to one-third of the shares granted under the plan covering the particular performance year, based on the extent to which the employee and Advanta met or meet their respective performance goals for that plan performance year. When newly eligible employees elect to participate in a plan, the number of shares issued to them with respect to their target bonus payments for the relevant plan performance years is determined based on the average market price of the stock for the 90 days prior to eligibility. Compensation expense on restricted shares is recognized over the vesting period of the shares. Compensation expense recognized in connection with restricted shares was $5.3 million in 2000, $3.8 million in 1999 and $8.2 million in 1998. The following table summarizes restricted shares outstanding and shares issued. Substantially all restricted shares outstanding at December 31, 2000 and 1999 were Class B common stock.
We have also granted shares of phantom stock to an officer in lieu of restricted shares. There were no shares of phantom stock granted in 2000. In 1999, there were 27,413 shares of phantom stock granted at a price of $10.625. In 1998, there were 50,632 phantom stock shares granted at a price of $10.625. Shares of phantom stock outstanding totaled 78,045 at December 31, 2000 and 1999. There were no phantom shares granted before 1998. Compensation expense (benefit) related to the appreciation (depreciation) on shares of phantom stock was ($268) thousand in 2000, $246 thousand in 1999 and $22 thousand in 1998.
STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
Our incentive plan authorizes an aggregate of 20.0 million shares of Class B Common Stock for the grant of options, awards of shares of stock or awards of stock appreciation rights to employees and directors. Previous plans granted options to purchase Class A Common Stock; however, substantially all of the options outstanding at December 31, 2000 were options to purchase Class B Common Stock. Options generally vest over a four-year period and expire 10 years after the date of grant. Shares available for future grant were 11.6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
million at December 31, 2000 and 2.7 million at December 31, 1999. Transactions under the plans for the three years ended December 31, 2000, were as follows:
The following table summarizes information about stock options outstanding at December 31, 2000.
We account for our stock option plans following Accounting Principles Board Opinion No. 25, under which no compensation expense has been recognized.
Had compensation cost for these plans been determined consistent with SFAS 123, our net income (loss) and net income (loss) per common share would have changed to the following pro forma amounts:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the years ended December 31:
Because SFAS 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.
During 1998, we changed the exercise price of certain options granted during 1996 and 1997 to the market price on the date of the modification. These modifications did not result in additional compensation expense under the accounting prescribed by SFAS 123. Also in 1998, we amended the terms of options granted to employees who became employees of Fleet LLC or whose employment was otherwise terminated in connection with the Consumer Credit Card Transaction to extend the post-employment exercise period. In 1998, we accelerated vesting of 43.15% of outstanding options that were not vested at the time of the Consumer Credit Card Transaction. See discussion in Note 22 of charges to earnings relating to these modifications.
During 2000, 1999 and 1998, we issued stock appreciation rights to certain directors in exchange for or in lieu of stock options. At December 31, 2000, 1,230 rights were outstanding with a strike price of $4.75, 100,000 rights were outstanding with a strike price of $8.50, 27,000 rights were outstanding with a strike price of $10.75, 163,074 rights were outstanding with a strike price of $12.33, 100,000 rights were outstanding with a strike price of $14.50 and 233,675 rights were outstanding with a strike price between $19.00 and $22.13. At December 31, 1999, 1,230 rights were outstanding with a strike price of $4.75, 127,000 rights were outstanding with a strike price of $10.75, 163,074 rights were outstanding with a strike price of $12.33 and 233,675 rights were outstanding with a strike price between $19.00 and $22.13. Compensation expense (benefit) related to stock appreciation rights was ($512) thousand in 2000, $502 thousand in 1999, and $10 thousand in 1998.
EMPLOYEE STOCK PURCHASE PLAN
We have an Employee Stock Purchase Plan, which allows employees and directors to purchase Class B Common Stock at a 15% discount from the market price without paying brokerage fees. We report this 15% discount as compensation expense and incurred expense of $163 thousand in 2000, $162 thousand in 1999, and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$200 thousand in 1998. Shares issued under the plan are issued at the average market price on the day of purchase.
EMPLOYEE SAVINGS PLAN
We have a tax-deferred employee savings plan, which provides employees with savings and investment opportunities, including the ability to invest in Advanta Corp. Class B Common Stock. The employee savings plan provides for discretionary employer contributions equal to a portion of the first 5% of an employee's compensation contributed to the plan. For the three years ended December 31, 2000, 1999 and 1998, our contributions equaled 100% of the first 5% of participating employees' compensation contributed to the plan. The expense for this plan totaled $3.1 million in 2000, $2.7 million in 1999, and $2.4 million in 1998. All shares of Advanta Corp. Class B Common Stock purchased by the plan in the three years ended December 31, 2000, 1999 and 1998 were acquired from Advanta Corp. at the market price on each purchase date or were purchased on the open market.
DEFERRED COMPENSATION PLAN
We offer an elective, nonqualified deferred compensation plan to qualified executives and non-employee directors, which allows them to defer a portion of their cash compensation on a pretax basis. The plan contains provisions related to minimum contribution levels and deferral periods with respect to any individual's participation. The plan participant makes irrevocable elections at the date of deferral as to deferral period and date of distribution. Interest is credited to the participant's account at the rate of 125% of the 10-year rolling average interest rate on 10-Year U.S. Treasury Notes. Distribution from the plan may be either at retirement or at an earlier date, and can be either in a lump sum or in installment payments. We have purchased life insurance contracts with a face value of $46 million to fund this plan.
EMPLOYEE STOCK OWNERSHIP PLAN
On September 10, 1998, our Board of Directors authorized the formation of an Employee Stock Ownership Plan (the "ESOP"), covering all of our employees who have reached age 21 with one year of service. During 1998, the ESOP borrowed approximately $12.6 million from Advanta Corp. and used the proceeds to purchase approximately 1,000,000 shares of Class A Common Stock. The ESOP loan is repayable with an interest rate of 8% over 30 years. We make annual contributions to the ESOP equal to the ESOP's debt service less dividends received on unallocated shares by the ESOP. As the ESOP loan is repaid, shares are allocated to active employees, based on the proportion of debt service paid in the year. We account for the ESOP in accordance with AICPA Statement of Position 93-6, "Employer's Accounting for Employee Stock Ownership Plans." Accordingly, unallocated shares are reported as unearned ESOP shares in the balance sheet. As shares of common stock acquired by the ESOP are committed to be released to each employee, we report compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are used to fund debt service of the ESOP. ESOP compensation expense was $455 thousand for the year ended December 31, 2000, $535 thousand for the year ended December 31, 1999 and $17 thousand for the year ended December 31, 1998. At December 31, 2000, there were 931,945 unearned and unallocated ESOP shares with a fair value of $8.2 million. At December 31, 1999, there were 965,229 unearned and unallocated ESOP shares with a fair value of $17.6 million.
NOTE 16. CAPITAL RATIOS
Advanta National Bank and Advanta Bank Corp. are wholly owned subsidiaries of Advanta Corp. Advanta National Bank and Advanta Bank Corp. are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
effect on the institutions' and our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the institutions must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The institutions' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the institutions to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).
As set forth in the table below, as of December 31, 2000 and 1999, Advanta National Bank and Advanta Bank Corp. had capital at levels a bank is required to maintain to be classified as "well-capitalized" under the regulatory framework for prompt corrective action. However, Advanta National Bank does not meet the definition of "well-capitalized" because of the existence of our agreement with the Office of the Comptroller of the Currency, even though we have achieved the higher imposed capital ratios required by the agreement. Our regulatory agreement with the Office of the Comptroller of the Currency required that Advanta National Bank achieve by September 30, 2000 and thereafter maintain a ratio of 14% of Tier 1 capital to risk-weighted assets and a ratio of 17% of Tier 1 capital to adjusted total assets. We achieved these ratios, as defined within the agreement, through a combination of decreasing the assets and deposits at Advanta National Bank and making aggregate capital contributions and other investments in Advanta National Bank of approximately $70 million.
In connection with the sale of our mortgage business discussed in Note 2, Advanta National Bank sought approval of the OCC for a return of capital to Advanta Corp, in the amount of $261 million. On February 28, 2001, the OCC approved the amount requested and, at the same time, Advanta National Bank entered into an agreement with the OCC regarding restrictions on new business activities and product lines at Advanta National Bank after the sale of the mortgage business and the resolution of outstanding Advanta National Bank liabilities. The agreement also reduces the existing capital requirements for Advanta National Bank to 12.7% for Tier 1 and Total capital to risk-weighted assets, and to 5% for Tier 1 capital to adjusted total assets as defined in the agreement. In addition, the agreement provides for prior OCC approval of any future dividends. Advanta Bank Corp. is unaffected by the agreement with the OCC.
Recently, guidelines were issued jointly by the federal bank regulatory agencies regarding additional requirements for subprime lenders, including additional capital requirements. Under the guidelines, regulatory capital required to be held for certain loan classes included in Advanta Bank Corp.'s portfolio could be increased.
In addition, in a draft proposal recently issued jointly by the federal bank regulatory agencies, capital requirements associated with certain residual interests would be amended to require capital equal to the residual retained, regardless of retained recourse levels. Further, the proposal requires residuals in excess of 25% of Tier 1 capital to be treated as a deduction of Tier 1 capital for purposes of risk based and leverage capital calculations. In another draft proposal recently issued jointly by the federal back regulatory agencies, the agencies would use credit ratings and certain alternative approaches to match the risk based capital requirement more closely to a banking organization's relative risk of loss in asset securitizations. The proposal also requires the sponsor of a revolving credit securitization that involves an early amortization feature to hold capital against the amount of assets under management (the off-balance sheet securitized receivables). The proposal treats recourse obligations and direct credit substitutes more consistently than under the agencies' current risk based capital standards. The ultimate resolution of these proposals and their impact on financial results is uncertain at this time.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17. DIVIDEND AND LOAN RESTRICTIONS
In the normal course of business, Advanta Corp. and its subsidiaries enter into agreements, or are subject to regulatory requirements, that result in dividend and loan restrictions.
FDIC-insured banks are subject to certain provisions of the Federal Reserve Act which impose various legal limitations on the extent to which banks may finance or otherwise supply funds to certain of their affiliates. In particular, Advanta National Bank and Advanta Bank Corp. are subject to certain restrictions on any extensions of credit to, or other covered transactions, such as certain purchases of assets, with Advanta Corp. or its affiliates. Advanta National Bank and Advanta Bank Corp. are prevented by these restrictions from lending to Advanta Corp. and its affiliates unless these extensions of credit are secured by U.S. Government obligations or other specified collateral. Further, secured extensions of credit are limited in amount: (a) as to Advanta Corp. or any affiliate, to 10 percent of each bank's capital and surplus, and (b) as to Advanta Corp. and all affiliates in the aggregate, to 20 percent of each bank's capital and surplus.
Under grandfathering provisions of the Competitive Equality Banking Act of 1987, we are not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended, so long as Advanta Corp. and Advanta National Bank continue to comply with certain restrictions on their activities. These restrictions include limiting the scope of Advanta National Bank's activities to those in which it was engaged prior to March 5, 1987. Since Advanta National Bank was not making commercial loans at that time, it must continue to refrain from making commercial loans -- which would include any loans to Advanta Corp. or any of its subsidiaries -- in order for Advanta Corp. to maintain its grandfathered exemption under the Bank Holding Company Act. We have no present plans to register as a bank holding company under the Bank Holding Company Act.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Advanta National Bank is also subject to various legal limitations on the amount of dividends that can be paid to its parent, Advanta Corp. Advanta National Bank is eligible to declare a dividend provided that it is not greater than the current year's net profits plus net profits of the preceding two years. However, our regulatory agreements with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation prohibit the payment of dividends by Advanta National Bank or Advanta Bank Corp. without prior regulatory approval. In connection with the mortgage business sale in the first quarter of 2001, we sought and received regulatory approval for a return of capital of $261 million from Advanta National Bank. Advanta National Bank paid no dividends to Advanta Corp. during 2000 or 1999. During 1998, the Office of the Comptroller of the Currency approved the payment of a special dividend/return of capital of $1.3 billion from Advanta National Bank to Advanta Corp. to effect the Tender Offer described in Note 11. There were no dividends from Advanta Bank Corp. to Advanta Corp. during 2000, 1999, or 1998.
Our insurance subsidiaries are also subject to certain capital, deposit and dividend rules and regulations as prescribed by state jurisdictions in which they are authorized to operate. At December 31, 2000, the insurance subsidiaries were in compliance with these rules and regulations. Insurance subsidiaries paid dividends to Advanta Corp. of $1.2 million in 1999. Dividends paid to Advanta Corp. in 1998 by insurance subsidiaries were $39 million, including an extraordinary dividend of $35 million that was approved in advance by the applicable state regulators. There were no dividends paid to Advanta Corp. by insurance subsidiaries in 2000.
Total stockholders' equity of our banking and insurance affiliates was $572 million at December 31, 2000, and $584 million at December 31, 1999. Of our total equity in these affiliates, $566 million was restricted at December 31, 2000 and $524 million was restricted at December 31, 1999. At January 1, 2001, $5.4 million of stockholders' equity of our banking and insurance affiliates was available for payment of dividends under applicable regulatory guidelines without prior regulatory approval.
In addition to restrictions at banking subsidiaries, certain non-bank subsidiaries are subject to minimum equity requirements as part of securitization agreements or financing facility agreements. The total minimum equity requirement of non-bank subsidiaries was $40 million at December 31, 2000. At December 31, 2000, the non-bank subsidiaries were in compliance with these minimum equity requirements.
NOTE 18. SEGMENT INFORMATION
Our only reportable segment as of December 31, 2000 was Advanta Business Cards. We evaluate segment performance based largely on the pretax income of the business unit. The Advanta Mortgage and Advanta Leasing Services segments were discontinued in the first quarter of 2001 and their results are classified as discontinued operations in the consolidated income statements. See Note 2. Prior to February 20, 1998, we also had an additional reportable segment, Advanta Personal Payment Services. See Note 11.
Advanta Business Cards offers MasterCard business credit cards to small businesses using targeted direct mail and the Internet as well as telemarketing solicitation of potential cardholders. This product provides approved customers with access, through merchants, banks, checks and ATMs, to an instant unsecured revolving business credit line.
Prior to the Consumer Credit Card Transaction, we offered consumer credit cards through Advanta Personal Payment Services. This business segment issued consumer credit cards nationwide using direct marketing techniques. As of February 20, 1998, this segment had no operations, and the activity below reflects operations through that date.
The accounting policies of the segments are the same as those followed by Advanta. Centrally incurred operating expenses are allocated to the segments based on consumption, where practical, or based on average managed assets. Centrally incurred interest expense is charged to the segments using a funds transfer pricing methodology primarily based on average net assets. During the first quarter of 2000, we made changes to the methods used to allocate centrally incurred interest and operating expenses to the reportable segments in order to better reflect the use of the related assets or personnel by the segments. These changes included the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
allocation of certain expenses based on consumption rather than based on average managed assets, and a change in the classification of certain employee groups. Prior period segment results have been restated to reflect the current allocation methods.
(1) Other includes insurance operations and assets, investment and other activities not attributable to Advanta Business Cards. It also includes net assets of discontinued operations, and corporate overhead previously allocated to the mortgage and leasing business units while they were operating segments. Corporate overhead allocations were removed from the results of the discontinued segments as a result of the restatement for discontinued operations.
(2) Unusual charges in 1999 represent charges associated with cost reduction initiatives in the first quarter and additional costs associated with products exited in the first quarter of 1998.
(3) Unusual charges in 1998 represent severance and outplacement costs associated with workforce reduction, option exercise and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer; expense associated with exited businesses/products; and asset impairment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19. SELECTED INCOME STATEMENT INFORMATION
(1) Investment securities gains (losses), net include changes in the fair value and realized gains on venture capital investments.
NOTE 20. NET INTEREST INCOME
The following table presents the components of net interest income:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21. INCOME TAXES
Income tax (benefit) was as follows:
Income tax (benefit) on income from continuing operations consisted of the following components:
The reconciliation of the statutory federal income tax to income tax (benefit) on income from continuing operations is as follows:
Deferred taxes are provided to reflect the estimated future tax effects of the differences between the financial statement and tax bases of assets and liabilities and enacted tax laws. The net deferred tax asset is comprised of the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of deferred tax assets and liabilities follows:
As a result of the carrying value adjustments discussed in Note 3, we reported a pretax loss for the year ended December 31, 2000. A valuation allowance has been provided against the resulting deferred tax asset given our pre-existing net operating loss carryforwards and the uncertainty of the realizability of the incremental deferred tax asset. In establishing the valuation allowance, management considered (1) the level of expected future taxable income, (2) existing and projected book/tax differences, (3) tax planning strategies available, and (4) the general and industry specific economic outlook. Based on this analysis, management believes the net deferred tax asset will be realized.
The gain on the Consumer Credit Card Transaction in 1998 was not subject to income tax and no tax provision was recorded. The Consumer Credit Card Transaction also resulted in additional book/tax differences, which were quantified during 1999 in connection with the filing of the 1998 tax return. Such book/tax differences, when combined with certain less significant recurring differences, resulted in net operating loss carryforwards of approximately $521 million at December 31, 1999. This amount is net of $96 million carried back to prior years, and includes $500 million that pertains to losses incurred on the consumer credit card portfolio after the date of the transaction. A deferred tax asset of $50 million, net of valuation allowance, resulting from the net operating loss carryforwards was recorded as an income tax benefit in the fourth quarter of 1999.
In 2000, we utilized net operating loss carryforwards of $85 million. Additionally, $29 million was carried back to prior years. At December 31, 2000, remaining net operating loss carryforwards were $406 million, of which $390 million expire in 2018 and $16 million expire in 2019.
The net deferred federal tax asset is presented net with current federal income taxes receivable (payable) for financial reporting purposes, and is included in other assets.
NOTE 22. UNUSUAL CHARGES
In connection with the Consumer Credit Card Transaction more fully discussed in Note 11, we made major organizational changes during the first quarter of 1998 to reduce corporate expenses incurred in the past: (a) to support the business contributed to Fleet LLC in the Consumer Credit Card Transaction, and (b) associated with the business and products no longer being offered or not directly associated with our mortgage, business credit card and leasing units. In addition, in 1999, we implemented a plan to exit the auto
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
finance business and to implement cost reduction initiatives throughout the organization including the consolidation of support functions. Costs associated with these restructuring activities included:
EMPLOYEE COSTS ASSOCIATED WITH STAFF REDUCTIONS
In the first quarter of 1999, in connection with cost reduction initiatives and the consolidation of support functions, we recorded a $3.3 million charge for costs associated with staff reductions. These expenses included severance and outplacement costs. There were 121 employees severed who were entitled to benefits. This staff reduction was substantially complete by June 30, 1999. The final payment outstanding related to these employee costs was paid in the three months ended March 31, 2000.
EMPLOYEE COSTS ASSOCIATED WITH CONSUMER CREDIT CARD TRANSACTION/TENDER OFFER
In connection with the organizational changes in 1998, we incurred approximately $26.8 million of severance and related costs classified as employee costs associated with the Consumer Credit Card Transaction/Tender Offer. These expenses included severance and outplacement costs associated with the workforce reduction, option exercise and re-measurement costs, and other employee costs directly attributable to the Consumer Credit Card Transaction/Tender Offer.
In connection with these organizational changes, 255 employees who ceased to be employed by us were entitled to benefits, of which 190 employees were directly associated with the business contributed to Fleet LLC and 65 employees were associated with the workforce reduction.
Additionally, during the first quarter of 1998, we incurred approximately $35.5 million of other compensation charges. This amount includes $21.3 million attributable to payments under change of control plans and $14.2 million associated with the execution of the Tender Offer.
The final payment outstanding related to these employee costs was paid in the three months ended March 31, 2000.
EXPENSES ASSOCIATED WITH EXITED BUSINESSES/PRODUCTS
In the first quarter of 1999, we implemented a plan to cease the origination of auto loans and recorded a $3.4 million charge for costs associated with exited businesses/products. The charges included severance and outplacement costs for 22 employees in the auto origination group, and professional fees associated with exited businesses/products not directly associated with our mortgage, business credit card and leasing units. We completed the closing of the auto loan origination center and termination of related employees during the second quarter of 1999. We expect to complete the payment of the remaining professional fees during the first half of 2001.
During the first quarter of 1998, we implemented a plan to exit certain businesses and product offerings not directly associated with our mortgage, business credit card and leasing units. In connection with this plan, contractual vendor commitments of approximately $10.0 million associated with discontinued development and other activities were accrued. We have substantially completed the settlement of these contractual commitments. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
We also have contractual commitments to certain customers, and non-related financial institutions that are providing benefits to those customers, under a product that is no longer offered and for which no future revenues or benefits will be received. In 1998, we recorded a charge of $22.8 million associated with these commitments, and an $8.3 million charge associated with the write-off of assets associated with this program that became unrealizable when the product was exited. In 1999, an additional charge of $10.0 million was recorded based on a change in the estimate of total expected costs for the contractual commitments related to the exited product. Updated information regarding future benefits to be provided in connection with these contractual commitments indicated a higher level of benefits than originally estimated. The actions required to complete this plan include the settlement of contractual commitments and the payment of customer benefits. The liabilities associated with these commitments were assumed by a third party in the first quarter of 2001.
In connection with the Consumer Credit Card Transaction/Tender Offer and the other exited business and product offerings, we also incurred $11.5 million of related professional fees and $1.5 million of other expenses related to these plans.
ASSET IMPAIRMENTS
In connection with Advanta's plans to reduce corporate expenses and exit certain business and product offerings, certain assets previously deployed in connection with these exited business or product offerings were identified and the carrying costs thereof were written off or written down to estimated realizable value in 1998 resulting in a charge of $8.7 million. This charge included $6.0 million from the write-off of certain leasehold improvements and furniture and fixtures due to the refit of corporate headquarters. In addition, this charge included a $2.7 million write-down to estimated fair value of capitalized software costs. The write-down to fair value of software was determined based on an estimate of costs associated with the additional functionality of the software, which would not be of use subsequent to the exit of certain business and product offerings.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 23. CALCULATION OF EARNINGS PER SHARE
The following table shows the calculation of basic earnings per common share and diluted earnings per common share for the years ended December 31:
(1) Combined represents a weighted average of Class A and Class B earnings per common share.
(2) Each share of Class B convertible preferred stock was mandatorily converted into one share of Class B Common Stock effective September 15, 1999.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 24. PARENT COMPANY FINANCIAL STATEMENTS
ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED BALANCE SHEETS
(1) Commercial paper equivalent refers to unsecured loans made to Advanta National Bank and Advanta Bank Corp. for terms less than 35 days in maturity which are not automatically renewable, consistent with commercial paper issuance.
The parent company guarantees certain warehouse financing facilities and lease agreements of its subsidiaries. At December 31, 2000, there were $21.1 million of lease obligations guaranteed by the parent and $56.4 million of parent guarantees associated with warehouse financing facilities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF OPERATIONS
(1) Dividends from subsidiaries include only dividends from current year net income of subsidiaries. See Parent Company Only Condensed Statements of Cash Flows for total dividends received from subsidiaries.
The Parent Company Only Statements of Changes in Stockholders' Equity is the same as the Consolidated Statements of Changes in Stockholder's Equity.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF CASH FLOWS
There were no significant noncash transactions of the Parent Company in 2000. In 1999, noncash transactions of the Parent Company included a $4.5 million assumption of liabilities of subsidiaries and a $43.3 million return of investment by subsidiaries through forgiveness of advances. In 1998, the noncash transaction represented capital contributions to subsidiaries through the forgiveness of advances of $143.5 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 25. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of our financial instruments are as follows at December 31:
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for our various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.
We used the following methods and assumptions in estimating fair value disclosures for financial instruments:
CASH, FEDERAL FUNDS SOLD AND RESTRICTED INTEREST-BEARING DEPOSITS
For these short-term instruments, the carrying amount is a reasonable estimate of the fair value.
INVESTMENTS
The fair values of investments available for sale are based on quoted market prices, dealer quotes or estimates using quoted market prices for similar securities. For investments that are not publicly traded, management has made estimates of fair value that consider several factors including the investees' financial results, conditions and prospects, and the values of comparable public companies.
LOANS, NET
The fair values of loans are estimated using a discounted cash flow analysis that incorporates estimates of the excess of the weighted average yield over the aggregate cost of funds, servicing costs and an estimate of future credit losses over the life of the receivables.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RETAINED INTERESTS IN SECURITIZATIONS
The fair values of retained interests in securitizations are estimated based on discounted cash flow analyses as described in Note 1. See Note 7 for the assumptions used in the estimation of fair values of the retained interests in securitizations.
DEMAND AND SAVINGS DEPOSITS
The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date. This fair value does not include any benefit that may result from the low cost of funding provided by these deposits compared to the cost of borrowing funds in the market.
TIME DEPOSITS
The fair value of fixed-maturity certificates of deposit is estimated using discounted cash flow analyses based on the rates currently offered for deposits of similar remaining maturities.
LONG-TERM DEBT
The fair value of our long-term borrowings is estimated using discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements.
OTHER BORROWINGS
The carrying amounts of borrowings under repurchase agreements and other short-term borrowings maturing within ninety days approximate their fair values. The other borrowings are all at variable interest rates and therefore the carrying value approximates a reasonable estimate of the fair value.
INTEREST RATE SWAPS
The fair value of interest rate swaps is the estimated amount that we would pay or receive to terminate the agreement at the reporting date, taking into account current interest rates and the current creditworthiness of the counterparty.
COMMITMENTS TO EXTEND CREDIT
There is no market value associated with our unused commitments to extend credit, since any fees charged are consistent with the fees charged by other companies at the reporting date to enter into similar agreements. Unused commitments to extend credit were $4.2 billion at December 31, 2000 and $2.5 billion at December 31, 1999.
NOTE 26. DERIVATIVE FINANCIAL INSTRUMENTS
In managing our interest rate risk, we may use derivative financial instruments. These instruments are used for the express purpose of managing interest rate exposures and are not used for any trading or speculative activities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes by notional amounts our derivative instruments used in continuing and discontinued operations at December 31:
The notional amounts of derivatives do not represent amounts exchanged by the counterparties and, thus, are not a measure of our exposure through use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivatives contracts.
Credit risk associated with derivatives arises from the potential for a counterparty to default on its obligations. We limit credit risk by only transacting with highly creditworthy counterparties, requiring International Swaps and Derivatives Association agreements for all interest rate swap and interest rate option contracts, and maintaining collateral agreements with substantially all counterparties. All derivative counterparties are associated with organizations having securities rated as investment grade by independent rating agencies. The Investment Committee, a management committee, controls the list of eligible counterparties, setting of counterparty limits, and monitoring of credit exposure. Our credit exposure to derivatives, with the exception of caps written, is represented by contracts with a positive fair value without giving consideration to the value of any collateral exchanged. For caps written, credit exposure does not exist since the counterparty has performed its obligation to pay us a premium payment.
INTEREST RATE SWAPS
Interest rate swap agreements generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. We use interest rate swaps to more effectively manage the impact of fluctuating interest rates on our noninterest revenues and cost of funds. In 2000, 1999 and 1998, we used interest rate swaps to effectively convert fixed rate debt and deposits to a LIBOR-based variable rate and to effectively convert certain off-balance sheet variable securitizations to a fixed rate.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes by notional amounts our interest rate swap activity in both continuing and discontinued operations by major category for the periods presented:
The following table discloses our interest rate swaps used in continuing and discontinued operations by major category, notional value, weighted average interest rates, and annual maturities for the periods presented. Variable rates in the table represent the current LIBOR-based rates.
INTEREST RATE OPTIONS
Interest rate options, which include caps and floors, are contracts that transfer, modify or reduce interest rate risk in exchange for the payment of a premium when the contract is initiated. In exchange for the premium payment, these contracts require the seller (writer) to pay the purchaser at specified future dates the amount by which a specified market interest rate exceeds the cap rate or falls below the floor rate, multiplied against a notional amount.
We purchased interest rate caps as part of certain variable rate receivable securitizations for credit enhancement purposes. In order to achieve our desired interest rate sensitivity structure, we have synthetically altered the interest rate structure on certain off-balance sheet receivable securitizations by writing interest rate NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
caps to offset the purchased rate caps attached to them. The premiums received or paid for writing or purchasing the cap contracts with third parties are included in other assets and are amortized to noninterest revenues over the life of the contract. Any obligations, which may arise under these contracts, are recorded in noninterest revenues on an accrual basis.
PUT OPTIONS
Put options provide the holder the right, but not the obligation, to sell the underlying financial instrument at a specified exercise or strike price at a specific point in time. Put options, therefore, protect us from losses in a rising interest rate environment, but allow for the full appreciation of underlying assets should interest rates fall. We regularly securitize and sell receivables. We may choose to hedge the changes in the market value of the index on which the securitization is priced, relating to the warehouse and/or pipeline of receivables anticipated to be securitized, by purchasing put options on the underlying index. The maximum term of hedges of anticipated loan sales is seven months; the average term is four months. Premiums paid and gains and losses on put options are deferred as other liabilities and included in the measurement of the dollar basis of the loans sold. Deferred gains were $23 thousand and deferred premiums were $304 thousand at December 31, 2000. Deferred gains were $849 thousand and deferred premiums were $986 thousand at December 31, 1999.
FORWARD CONTRACTS
Forward contracts are commitments to either purchase or sell a financial instrument at a future date for a specified price and may be settled in cash or through delivery of the underlying financial instrument. We regularly securitize and sell receivables. We may choose to hedge the changes in the market value of our fixed rate loans and commitments designated for anticipated securitizations by selling U.S. Treasury securities for forward settlement. The maximum term of hedges of anticipated loan sales is seven months; the average term is four months. Gains and losses from forward sales are deferred as other liabilities and included in the measurement of the dollar basis of the loans sold. We had deferred losses of $45 thousand at December 31, 2000 and deferred gains of $5.9 million at December 31, 1999.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Advanta Corp.:
We have audited the accompanying consolidated balance sheets of Advanta Corp. (a Delaware corporation) and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 Advanta Corp. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP Philadelphia, PA March 27, 2001
REPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING
To the Stockholders of Advanta Corp.:
The management of Advanta Corp. and its subsidiaries is responsible for the preparation, content, integrity and objectivity of the consolidated financial statements. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and as such must, by necessity, include amounts based upon estimates and judgments made by management. The other financial information was also prepared by management and is consistent with the financial statements.
Management maintains a system of internal controls that provides reasonable assurance as to the integrity and reliability of the financial statements. This control system includes: (l) organizational and budgetary arrangements which provide reasonable assurance that errors or irregularities would be detected promptly; (2) careful selection of personnel and communications programs aimed at assuring that policies and standards are understood by employees; (3) a program of internal audits; and (4) continuing review and evaluation of the control program itself.
The consolidated financial statements have been audited by Arthur Andersen LLP, independent public accountants. Their audits were conducted in accordance with auditing standards generally accepted in the United States and considered Advanta's system of internal controls to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. Their report is printed herewith.
SUPPLEMENTAL SCHEDULES (UNAUDITED)
QUARTERLY DATA
SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED
QUARTERLY DATA -- CONTINUED
(1) Combined represents a weighted average of Class A and Class B (see Note 1 to consolidated financial statements).
(2) Includes charges associated with cost reduction initiatives in the first quarter and additional costs associated with products exited in the first quarter of 1998.
(3) Net income in the fourth quarter of 1999 included a $50 million tax benefit related to the former consumer credit card business.
SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
COMPOSITION OF GROSS RECEIVABLES
YIELD AND MATURITY OF INVESTMENTS AT DECEMBER 31, 2000
(1) Yield computed on a taxable equivalent basis using a statutory rate of 35%.
(2) Equity investments and other securities without a stated maturity are excluded from this table.
(3) Yields are computed by dividing annualized interest by the amortized cost of the respective investment securities.
SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
COMMON STOCK PRICE RANGES AND DIVIDENDS
Advanta's common stock is traded on the National Market tier of The Nasdaq Stock Market under the symbols ADVNA (Class A voting common stock) and ADVNB (Class B non-voting common stock). Following are the high, low and closing sale prices and cash dividends declared for the last two years as they apply to each class of stock:
At December 31, 2000, Advanta had approximately 295 holders of record of Class A stock and 819 holders of record of Class B stock.
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The text of the Proxy Statement under the captions "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" are hereby incorporated by reference, as is the text in Part I of this Report under the caption, "Executive Officers of the Registrant."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The text of the Proxy Statement under the captions "Executive Compensation," "Report on Executive Compensation" and "Election of Directors "-- Committees, Meetings and Compensation of the Board of Directors, - -- Compensation Committee Interlocks and Insider Participation and -- Other Matters" are hereby incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The text of the Proxy Statement under the captions "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" are hereby incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The text of the Proxy Statement under the captions "Election of Directors -- Compensation Committee Interlocks and Insider Participation in and - -- Other Matters" are hereby incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
The following Financial Statements, Schedules, and Other Information of the Registrant and its subsidiaries are included in this Form 10-K:
- --------------- * Incorporated by reference to the Exhibit with corresponding number constituting part of the Registrant's Registration Statement on Form S-2 (No. 33-00071), filed on September 4, 1985.
+ Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
1. A Report on Form 8-K was filed by the Company on October 10, 2000 announcing preliminary results for the third quarter and revising the Company's outlook for the remainder of 2000. This Report on Form 8-K was amended by a Report on Form 8-K/A filed by the Company on October11, 2000 to correct a technical error in the original Report on Form 8-K.
2. A Report on Form 8-K was filed by the Company on October 24, 2000, announcing that the Company had accepted a proposal to sell it mortgage business to a major financial institution in a cash transaction for a price in excess of book value and announcing final results for the third quarter.
3. A Report on Form 8-K was filed by the Company on November 27, 2000 announcing that the sale of the Company's mortgage business was proceeding on track but that it would take longer than anticipated to execute a definitive agreement.
4. A Report on Form 8-K was filed by the Company on December 29, 2000 announcing that Banc One Financial Services, Inc. and Bank One, N.A. had filed suit against the Company and certain of its subsidiaries alleging, among other things, that Advanta Mortgage Corp. USA had breached the terms of certain loan servicing agreements.
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, thereunto duly authorized.
Advanta Corp.
By: /s/ WILLIAM A. ROSOFF ----------------------------------- William A. Rosoff, President and Vice Chairman of the Board
Dated: March 30, 2001
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned does hereby constitute and appoint Dennis Alter, William A. Rosoff, Philip M. Browne, David Weinstock and Elizabeth H. Mai, or any of them (with full power to each of them to act alone), his or her true and lawful attorney in-fact and agent, with full power of substitution, for him or her and on his or her behalf to sign, execute and file an Annual Report on Form 10-K under the Securities Exchange Act of 1934, as amended, for the fiscal year ended December 31, 2000 relating to Advanta Corp. and any or all amendments thereto, with all exhibits and any and all documents required to be filed with respect thereto, with the Securities and Exchange Commission or any regulatory authority, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises in order to effectuate the same as fully to all intents and purposes as he or she might or could do if personally present, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on the 30(th) day of March, 2001.
EXHIBIT INDEX
- --------------- * Incorporated by reference to the Exhibit with corresponding number constituting part of the Registrant's Registration Statement on Form S-2 (No. 33-00071), filed on September 4, 1985.
+ Management contract or compensatory plan or arrangement.