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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 28050
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ONYX ACCEPTANCE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0577635
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
ONYX ACCEPTANCE CORPORATION
27051 TOWNE CENTRE DRIVE, SUITE 100
FOOTHILL RANCH, CA 92610
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(949) 465-3900
(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK ($0.01 PAR VALUE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [ ]
The number of shares outstanding of the Company's Common Stock as of the
closing of the market on March 16, 1999 was 6,171,034. The registrant does not
have different classes of Common Stock. Based on the closing sale price of
$6.625, the registrant's Common Stock as quoted on the Nasdaq National Market on
March 16, 1999, the aggregate market value of such stock held by non-affiliates
of the registrant was approximately $21,525,924 on that date.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for the Annual Meeting of
Stockholders currently expected to be held on May 27, 1999, as filed with the
Commission pursuant to Regulation 14A, are incorporated by reference in Part III
of this Report.
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ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 15
Item 3. Litigation.................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders......... 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholders Matters --
Price Range of Common Stock and Dividend Policy............. 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 28
Item 8. Financial Statements and Supplementary Data................. 28
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 28
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 28
Item 11. Executive Compensation...................................... 29
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 29
Item 13. Certain Relationships and Related Transactions.............. 29
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 29
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PART I
FORWARD-LOOKING STATEMENTS
When used throughout this Annual Report, the words "believes",
"anticipates" and "expects" and similar expressions are intended to identify
forward-looking statements. Such statements are subject to the many risks and
uncertainties which affect the Company's business, and actual results could
differ materially from those projected and forecasted. These uncertainties,
which include competition within the automobile finance industry, the effect of
economic conditions, and the availability of capital to finance planned growth,
are described but are not limited to those disclosed in this Annual Report.
These and other factors which could cause actual results to differ materially
from those in the forward-looking statements are discussed under the heading
"Risk Factors". Given these uncertainties, readers are cautioned not to place
undue reliance on such statements. The Company also undertakes no obligation to
publicly release the result of any revisions to these forward-looking
statements. The Company also undertakes no obligation to publicly release the
result of any revisions to these forward-looking statements that may be made to
reflect any future events or circumstances.
ITEM 1. BUSINESS
GENERAL
Onyx Acceptance Corporation ("Onyx" or the "Company") is a specialized
consumer finance company engaged in the purchase, securitization and servicing
of motor vehicle retail installment contracts originated by franchised and
select independent automobile dealerships and to a lesser extent the origination
or purchase of motor vehicle loans on a direct basis through its subsidiaries,
to consumers throughout the United States (collectively the "Contracts"). The
Company focuses its efforts on acquiring Contracts collateralized by late model
used and, to a lesser extent, new motor vehicles, entered into with purchasers
whom the Company believes have a favorable credit profile. Since commencing the
purchase, origination and servicing of Contracts in February 1994, the Company
has purchased or originated in excess of $2.2 billion in Contracts from
approximately 5,400 dealerships and has expanded its operations from a single
office in Orange County, California to 14 auto finance centers (the "Auto
Finance Centers") serving many regions of the United States.
BACKGROUND
The Company was founded in August 1993 by a team of executives with
extensive automobile finance experience including responsibility for the major
aspects of near-prime auto lending, including underwriting, servicing,
information systems implementation, interest rate management, securitizations
and dealer center management.
The Company was initially capitalized by three venture capital firms in
November 1993. In February 1994, the Company began building its portfolio of
near-prime quality Contracts collateralized by new and used motor vehicles
pursuant to its managed growth strategy. Within its first five years of
operations, the Company expanded to 14 Auto Finance Centers, purchased or
originated over $2.2 billion in Contracts and completed 14 securitizations.
MARKET AND COMPETITION
The Company operates in a highly competitive market. The automobile finance
market has historically been serviced by a variety of financial entities
including the captive finance affiliates of major automotive manufacturers,
banks, savings associations, independent finance companies, credit unions and
leasing companies. Several of these competitors have greater financial resources
than the Company. Many of these competitors also have long-standing
relationships with automobile dealerships and may offer dealerships or their
customers other forms of financing or services not provided by the Company.
However, in the past two years, and during the 3rd and 4th quarters of 1998 in
particular, many of these auto finance companies have experienced significant
liquidity and performance challenges.
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The Company competes for the purchase of Contracts which meet its
underwriting criteria on the basis of emphasizing strong relationships with its
dealership customer base through its local presence. The Company supports its
dealership customer base with an operation that is open seven days a week and
has the ability to finalize purchases of Contracts on weekends. The Company
believes that its strong personal relationships with and its level of service to
the dealerships in its customer base provide a competitive advantage to the
Company.
BUSINESS STRATEGY
The Company's principal objective remains to become one of the leading
sources of near-prime auto lending in the United States by leveraging the
experience of its senior management team in this industry. The Company seeks to
attain and increase profitability through the implementation of the following
strategies:
Targeted Market and Product Focus. The Company targets the near-prime
auto lending market because it believes that near-prime lending produces
greater origination and operating efficiency than does sub-prime lending.
The Company focuses on late model used rather than new vehicles, as
management believes the risk of loss on used vehicles is lower due to lower
depreciation rates, while interest rates are typically higher. In addition,
the Company believes that the late model used motor vehicle finance market
is growing at a faster rate than is the finance market for new motor
vehicles.
Localized Dealership Service. The Company provides a high level of
service to its dealership base by underwriting and purchasing Contracts and
marketing to and servicing dealerships on a local level through its Auto
Finance Centers. The Company strategically locates its Auto Finance Centers
in geographic areas of high dealership concentration to facilitate personal
service in the local markets, including consistent buying practices,
operations open seven days a week, competitive rates, a dedicated customer
service staff, fast turnaround time and systems designed to expedite the
processing of Contract applications. This personal service is provided by a
team of experienced account managers (the "Account Managers") with an
established reputation for responsiveness and integrity who call on
dealerships in a consistent and professional manner. The Company believes
that its local presence and service provide the opportunity to build strong
and lasting relationships with dealerships.
Expansion of Dealership Customer Base. The Company establishes active
relationships with a substantial percentage of franchised dealerships in
the regions in which it does business through its 14 existing Auto Finance
Centers. The Company expects to establish additional relationships as it
expands into other states during 1999.
Maintenance of Underwriting Standards and Portfolio Performance. The
Company has developed an underwriting process that is designed to achieve
attractive yields while minimizing delinquencies and losses. Based on its
belief that a credit scoring system is a less effective means of assessing
credit risk, especially in the near-prime sector, the Company employs
experienced credit managers (the "Credit Managers") in the local Auto
Finance Centers to purchase Contracts satisfying the underwriting criteria
developed by the Company. The Company's Credit Managers and Account
Managers are compensated as a team and their compensation relies, in part,
upon the quality of underwriting of the Contracts they approve. The Company
is one of only a few that has developed a credit review process where a
post funding audit is performed on most originations. This audit provides
an invaluable tool to provide feedback to enhance the underwriting process.
To further monitor the integrity of the underwriting process, management
regularly tracks the delinquency and loss rates of Contracts purchased by
each Credit Manager and Account Manager team and reviews Contracts against
the Company's underwriting standards shortly after they have been
purchased.
Technology-Supported Operational Controls. The Company has developed
and instituted control and review systems that enable it to monitor both
the operations of the Company and the performance of the servicing
portfolio. These systems allow senior management to monitor Contract
production, yields and performance on a real-time basis. The Company
believes that its information systems not only enhance its internal
controls but also allow it to significantly expand its Servicing Portfolio
without a corresponding increase in its labor costs.
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Liquidity Through Warehousing and Securitizations. The Company's
strategy is to complete securitizations on a regular basis and to use
warehousing credit facilities, to fund Contracts prior to securitization.
To fund dealer participation and finance daily operations, the Company
relies to a significant extent on credit facilities that are collateralized
by the Company's retained interest in securitized assets ("RISA"). The
Company also utilizes both securitization and hedging strategies to
leverage its capital efficiently and substantially reduce its interest rate
risk.
OPERATIONS
Dealership Marketing and Service. As of December 31, 1998, the Company has
14 Auto Finance Centers located through out the United States and had
approximately 5,400 active dealerships in its dealership customer base located
in these regions. Of these dealerships, approximately 86% are franchised and
approximately 14% are independent automobile dealerships. The Company believes
that franchised and select independent automobile dealerships are most likely to
provide the Company with Contracts that meet the Company's underwriting
standards.
The Company has significantly expanded its customer base of automobile
dealerships, and has substantially increased both monthly Contract purchases and
originations and the size of its servicing portfolio. The following table sets
forth information about the Company's Contracts and Auto Finance Centers as of
the dates indicated:
FOR THE YEARS ENDED
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DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1997 1998
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(DOLLARS IN THOUSANDS)
Number of auto finance centers................ 5 9 10 14
Number of contracts purchased................. 16,571 26,244 50,214 86,150
Dollar volume of contracts collateralized by
new vehicles................................ $ 39,706 $ 68,654 $129,178 $ 186,654
Dollar volume of contracts collateralized by
used vehicles............................... $159,691 $251,186 $476,727 $ 851,881
Dollar volume of contracts.................... $199,397 $319,840 $605,905 $1,038,535
Average dollar volume of contracts per auto
finance center.............................. $ 39,879 $ 35,538 $ 60,591 $ 74,181
Number of active dealerships.................. 769 1,471 2,846 5,401
Servicing portfolio........................... $218,207 $400,665 $757,277 $1,345,961
The Company's growth objectives over the next 12 months are to open
additional Auto Finance Centers in metropolitan areas within the United States
and to further develop relationships with existing franchised dealerships in the
states where the Company is currently doing business.
The Account Managers work from the Auto Finance Centers to solicit, enroll
and educate new dealerships as well as to maintain relationships with the
Company's existing dealership customer base. Each Account Manager visits
dealership finance managers at each targeted dealership in his or her territory
and presents information about the Company's dealership services. The Company's
services include service hours seven days a week and the ability to rapidly
respond to credit applications. The Account Managers educate the dealership
finance managers about the Company's underwriting philosophy, including its
preference for near-prime quality Contracts collateralized by late model used
motor vehicles and its practice of using experienced Credit Managers (rather
than sole reliance upon computerized scoring systems) to review applications.
The Account Managers also advise the dealership finance managers regarding
the Company's commitment to serve a broad scope of qualified borrowers through
its three near-prime auto lending programs: the "Premier", the "Preferred," and
the "Standard" Programs. The Premier Program allows the Company to market lower
interest rates in order to capture customers of superior credit quality. The
Preferred Program allows the Company to offer Contracts at higher interest rates
to borrowers with proven credit quality. The
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Standard Program allows the Company to assist qualified borrowers, who may have
experienced previous credit problems or have not yet established a significant
credit history, at interest rates higher than the Company's other programs.
The Company enters into a non-exclusive dealership agreement containing
certain representations and warranties by the dealership about the Contracts.
After this relationship is established, the Account Managers continue to
actively monitor the relationship to meet the Company's objectives with respect
to the volume of applications satisfying the Company's underwriting standards.
Due to the non-exclusive nature of the Company's relationships with dealerships,
the dealerships retain discretion to determine whether to solicit financing from
the Company for a customer seeking to finance a vehicle purchase. The Account
Managers regularly telephone and visit finance managers to reinforce to them the
Company's objectives and to answer any questions they may have. To increase the
effectiveness of these contacts, the Account Managers can obtain from the
Company's management information systems real-time information listing by
dealership the number of applications submitted, the Company's response and the
reasons why a particular application was rejected. The Company believes that the
personal relationships its Account Managers, Credit Managers and Auto Finance
Center Managers establish with the finance managers at the dealerships are a
significant factor in creating and maintaining productive relationships with its
dealership customer base.
UNDERWRITING AND PURCHASING OF CONTRACTS
The Company's underwriting standards are applied by experienced Credit
Managers with a personal, hands-on analysis of the creditworthiness of each
applicant, rather than sole reliance upon credit scoring systems used by several
of the Company's competitors. The Company believes that credit-scoring systems
may approve applicants who are in fact not creditworthy while denying credit to
others whom may have acceptable credit risk for the interest rate being charged.
In addition, the Company believes that it can enhance the relationship with its
dealership and consumer customer base by having its Credit Managers utilize a
rules/exception based credit/audit system to personally review each application
and communicate to the submitting dealership or, in the case of contracts
directly originated or purchased, communicate to the consumer or the Company's
authorized loan processor, the results of the review, including the reasons why
a particular application may have been declined. This practice encourages the
dealership finance managers to submit Contracts meeting the Company's
underwriting standards, thereby increasing the Company's operating efficiency.
In order to ensure consistent application of its underwriting standards as its
volume of Contract purchases increases, the Company has adopted a formal
internal training program for new and existing Account Managers and Credit
Managers.
The underwriting process begins when an application is telecopied by a
dealership or, in the case of Contracts directly originated or purchased, when
the application received from the obligor via the internet, mail or telephone,
to a central toll-free number, at the corporate headquarters where it is input
into the Company's front-end application processing system. Each application is
evaluated by a Credit Manager in the local Auto Finance Center, or at the
Company's authorized processor's office in the case of Contracts directly
originated or purchased, using uniform underwriting standards developed by the
Company. These underwriting standards are intended to assess the applicant's
ability to timely repay all amounts due under the Contract and the adequacy of
the financed vehicle as collateral. To evaluate credit applications, the Credit
Manager reviews, among other things, on-line information, including reports of
credit reporting agencies, nationally recognized vehicle valuation services, and
ownership of real estate listed on an application. The Company's wide area
network permits a Credit Manager in any Auto Finance Center, or the corporate
headquarters, to access an application on a real-time basis. This computer
network enables senior management to efficiently review and approve Contracts
requiring approval and permits the Company to seamlessly shift underwriting work
among any of the Auto Finance Centers to increase operating efficiency. Finally,
the Company's computer network permits real-time review by senior management of
operating results sorted by any number of variables, including by Credit
Manager, Auto Finance Center, or auto dealership.
The funds advanced by the Company to purchase a Contract generally do not
exceed: (i) for a new financed vehicle, the dealer's invoice plus taxes, title
and license fees, any extended warranty and credit insurance; or (ii) for a used
financed vehicle, the wholesale value assigned by a nationally recognized
vehicle
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valuation service value guide, plus taxes, title and license fees, any extended
warranty and credit insurance. However, the actual amount advanced for a
Contract may be limited by a number of factors, including the length of the
Contract term, the make, model and year of the financed vehicle and the
creditworthiness of the obligor. These adjustments are made to insure that the
financed vehicle constitutes adequate collateral to secure the Contract.
Contracts purchased or originated in 1998 had an average loan to value ratio at
purchase or origination of 104% which the Company believes is one of the lowest
in the industry.
Once review of an application is completed, the Credit Manager communicates
his or her decision to the dealership, or in the case of Contracts directly
originated or purchased by phone or otherwise, to the consumer or the Company's
authorized loan processor, specifying approval, conditional approval (such as an
increase in the downpayment, reduction in the term of the financing, or the
addition of a co-signer to the Contract), or denial.
The dealership is required to deliver the necessary documentation for each
Contract approved for purchase by the Company to the originating Auto Finance
Center. The Company audits such documents for completeness and consistency with
the application, providing final approval for purchase of the Contract once
these requirements have been satisfied. The completed Contract file is then
promptly forwarded to the corporate headquarters.
The Auto Finance Center purchasing the Contract funds the purchase and pays
dealer participation, if any. The dealership can receive 100% of the dealer
participation, at purchase or at month-end, and the Company is entitled to
recover from the dealership over the life of the Contract the unearned portion
of the dealer participation in the event of a prepayment of the purchased
Contract or charge-off of the Contract. The Company also offers three other
participation methods, in which the Company pays less than 100% of the dealer
participation but for which the dealership is under no obligation to refund any
unearned participation if the contract defaults or pre-pays after the expiration
of a set period of time after the Contract purchase date.
The Company conducts a post-funding credit review of a majority of its
Contracts. In the review, the approved application is re-examined to be certain
it complies with the Company's underwriting requirements. The results of these
reviews are then reviewed by senior management to ensure consistent application
of the Company's underwriting standards.
The Company employs a compensation system for its Credit Managers, Account
Managers and Auto Finance Center Managers designed to reward those employees
whose Contract purchases meet the Company's volume and yield objectives while
preserving credit quality. Generally, these bonuses, which are payable monthly,
may constitute up to 40% of an employee's compensation and are initially
calculated based on the volume of Contracts purchased and the yield on such
Contracts. This bonus amount is reduced if the Company's post-funding credit
review reveals that a portion of the purchased Contracts did not satisfy the
Company's underwriting standards. Under this system, 50% of the bonus payment is
based on attainment of Account Manager/Credit Manager team objectives and 50% is
based on attainment of the Auto Finance Center objectives. The Company believes
this incentive compensation system motivates employees to purchase only those
near-prime quality Contracts that meet the Company's objectives of increasing
volume at targeted yields while preserving credit quality.
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The following table sets forth information about the Company's Contracts as
of the dates indicated:
FOR THE YEARS ENDED
DECEMBER 31
(DOLLARS IN THOUSANDS)
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1995 1996 1997 1998
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Contracts purchased during the period......... $199,397 $319,840 $605,905 $1,038,535
Average contract amount....................... $ 12,033 $ 12,187 $ 12,066 $ 12,055
Weighted average initial term (months)........ 55.5 56.2 57.0 57.5
Weighted average A.P.R. ...................... 15.00% 14.69% 14.59% 14.75%
Percentage of dollar amount of contracts
collateralized by new motor vehicles
purchased during the period................. 19.91% 21.47% 21.32% 17.97%
Percentage of dollar amount of contracts
collateralized by used motor vehicles
purchased during the period................. 80.09% 78.53% 78.68% 82.03%
Periodically the Company performs an analysis of its servicing portfolio to
evaluate the effectiveness of its underwriting guidelines. If external economic
factors, credit delinquencies or credit losses change, the Company may adjust
its underwriting guidelines to maintain the asset quality deemed acceptable by
the Company's management.
SERVICING AND COLLECTION PROCEDURES
The Company services all Contracts in its servicing portfolio. To reduce
the costs of its servicing operations, the Company has outsourced certain data
processing and billing functions related to its servicing of Contracts. This
includes a three-year contract expiring in February 2000 with a service bureau
to provide certain loan accounting, reporting and servicing functions. Through
these service providers, the Company mails to each obligor a monthly billing
statement 20 days prior to the due date. The Company believes this method has
proven to be more effective in controlling delinquency, and therefore losses,
than payment coupon books which are delivered to the obligor at the time the
Contract is purchased. The Company charges a late fee, where allowed by law, on
any payment received after the expiration of the statutory or contractual grace
period. Most payments from obligors are deposited directly into a lockbox
account while the remainder of payments is received directly by the Company and
promptly deposited by the Company into the lockbox account.
Under the terms of its credit facilities and securitization trusts, the
Company acts as servicer with respect to all Contracts purchased or originated
in its servicing portfolio. The Company receives servicing fees for servicing
securitized Contracts equal to one percent per annum of the outstanding
principal balance of such Contracts. The Company services the securitized
Contracts by collecting payments due from obligors and remitting such payments
to the trustee in accordance with the terms of the servicing agreements. The
Company maintains computerized records with respect to each Contract to record
receipts and disbursements and to prepare related servicing reports.
COLLECTION PROCEDURES
Collection activities with respect to delinquent Contracts are performed by
the Company at its Foothill Ranch Collection Center. Collection activities
include prompt investigation and evaluation of the causes of any delinquency. An
obligor is considered delinquent when he or she has failed to make a scheduled
payment under the Contract within 30 days of the related due date (each a "Due
Date").
To automate its collection procedures, the Company uses features of the
computer system of its third party service bureau to provide tracking and
notification of delinquencies. The collection system provides relevant obligor
information (for example, current addresses, phone numbers and loan information)
and records of all Contracts. The system also records an obligor's promise to
pay and affords supervisors the ability to review collection personnel activity
and to modify collection priorities with respect to Contracts. The Company
utilizes a predictive dialing system located at the Foothill Ranch Collection
Center to make phone
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calls to obligors whose payments are past due by more than eight days but less
than 24 days. The predictive dialer is a computer-controlled telephone dialing
system which dials phone numbers of obligors from a file of records extracted
from the Contract database. By eliminating time wasted on attempting to reach
obligors, the system gives a single collector, on average, the ability to speak
with and work 200 to 250 accounts per day. Once a live voice responds to the
automated dialer's call, the system automatically transfers the call to a
collector and the relevant account information to the collector's computer
screen. The system also tracks and notifies collections management of phone
numbers that the system has been unable to reach within a specified number of
days, thereby promptly identifying for management all obligors who cannot be
reached by telephone.
Once an obligor is 20 days or more delinquent, these accounts are assigned
to specific collectors at the Foothill Ranch Collection Center who have primary
responsibility for such delinquent accounts until they are resolved. To expedite
collections from late paying obligors, the Company uses Western Union "Quick
Collect," which allows an obligor to pay, at numerous locations, any late
payments which are in turn wired daily to the Company's lockbox account by
Western Union. The Company also uses a Western Union payment system that allows
an obligor to authorize the Company to present a draft directly to the obligor's
bank for payment to the Company.
Generally, after a scheduled payment under a Contract continues to be past
due for between 45 and 60 days, the Company will initiate repossession of the
financed vehicle. However, if a Contract is deemed uncollectable, if the
financed vehicle is deemed by collection personnel to be in danger of being
damaged, destroyed or made unavailable for repossession, or if the obligor
voluntarily surrenders the financed vehicle, Onyx may repossess it without
regard to the length or existence of payment delinquency. Repossessions are
conducted by third parties that are engaged in the business of repossessing
vehicles for secured parties. Under California law and the laws of most other
states, after repossession, the obligor generally has an additional period of
time to redeem the financed vehicle before the financed vehicle may be resold by
the Company in an effort to recover the balance due under the Contract.
Losses may occur in connection with delinquent Contracts and can arise in
several ways, including inability to locate the financed vehicle or the obligor,
or because of a discharge of the obligor indebtedness in a bankruptcy
proceeding. The current policy of the Company is to recognize losses at the time
a Contract is deemed uncollectible or during the month a scheduled payment under
a Contract becomes 120 days or more past due, whichever occurs first.
Upon repossession and sale of the financed vehicle, any deficiency
remaining is pursued against the obligor to the extent deemed practical by the
Company and to the extent permitted by law. The loss recognition and collection
policies and practices of the Company may change over time in accordance with
the Company business judgment.
MODIFICATIONS AND EXTENSIONS
The Company offers certain credit-related extensions to obligors.
Generally, these extensions are offered only when (i) the Company believes that
the obligor's financial difficulty has been resolved or will no longer impair
the obligor's ability to make future payments, (ii) the extension will result in
the obligor's payments being brought current, (iii) the total number of
credit-related extensions granted on the Contract will not exceed three and the
total credit-related extensions granted on the Contract will not exceed three
months in the aggregate, (iv) there has been no more than one credit-related
extension granted on the Contract in the immediately preceding twelve months,
and (v) Onyx (or its assignee) had held the Contract for at least six months.
Any deviation from this policy requires the concurrence of a Collection
Supervisor and the Company's Collection Manager and the Executive Vice
President, Collections. The total number of annual deferments was less than 3%
of the number of Contracts in the Servicing Portfolio for the years ending
December 31, 1998, and December 31, 1997.
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INSURANCE
Each Contract requires the obligor to obtain comprehensive and collision
insurance with respect to the related financed vehicle with the Company named as
a loss payee. In the event that the obligor fails to maintain the required
insurance, however, the Company has purchased limited comprehensive and
collision insurance, referred to as the "Blanket Insurance Policy" coverage. The
Blanket Insurance Policy provides the Company with protection on each uninsured
or underinsured financed vehicle against total loss, damage or theft. The
Company has obtained its Blanket Insurance Policy from Interstate Indemnity
Insurance Company ("Interstate"). For the Blanket Insurance Policy, the Company
is assessed a premium based on the size of the Servicing Portfolio. In 1998, the
Company created an insurance tracking department at its corporate headquarters.
The Company believes that this function will help reduce its exposure to
uninsured motorists, through its prompt follow up on non-compliant obligors.
FINANCING AND SALE OF CONTRACTS
The Company finances acquisition and origination of Contracts primarily
through its the credit facilities and through securitizations.
CP Facility. As of December 31, 1998, the Company was party to a $375
million auto loan warehousing program (the "CP Facility"), with Triple-A One
Funding ("Triple A"), up from the $200 million level available under the same
facility at December 31, 1997. The CP Facility is used to fund the purchase or
origination of Contracts. Triple-A is a rated commercial paper asset-backed
conduit lender sponsored by MBIA. MBIA provides credit enhancement to Triple-A
by issuing a financial guarantee insurance policy covering all principal and
interest obligations owed by the Company related to borrowings under the CP
Facility. The Company pledges Contracts as collateral to borrow from Triple-A.
The CP Facility term, as amended, was renewed for a three-year period ending in
September 2001, subject to the annual renewal of a liquidity facility provided
by several financial institutions. After maturity in September 2001, the CP
Facility is subject to annual renewals upon mutual consent of the parties.
In an effort to expand and diversify lending relationships, the Company
created a new special finance subsidiary, Onyx Acceptance Funding Corporation
("Fundco"), during the first quarter of 1998 and negotiated additional lending
lines; two with Merrill Lynch Mortgage Capital, Inc. ("MLMCI") and one with
Salomon Smith Barney Realty Corp., ("SBRC").
The Merrill Line. The $100 million line (the "Merrill Line") provides
funding for the purchase or origination of Contracts and is used in concert with
the CP Facility the Company currently has in place. The Merrill Line has a term
of one year and currently matures in February 2000.
The Residual Lines. Fundco has two $50 million residual facilities with
MLMCI and SBRC, respectively, (the "Residual Lines "). The Residual Lines are
used by the Company to finance operating requirements. The lines utilize a
collateral based formula that sets borrowing availability to a percentage of the
value of excess cash flow to be received from certain securitizations, and, with
respect to the MLMCI facility, a percentage of the amount of the Merrill Line
outstanding on a quarterly basis. The facility provided by MLMCI currently
matures in February 2000; the facility provided by SBRC currently matures in
September 1999.
Revolving Facility. As of December 31, 1998, the Company was party to a
collateralized revolving line of credit, ("Revolving Facility"), with a lending
group for up to $45 million, for working capital and other expenditures for
which the Company's CP Facility and Merrill Line are not available. Under the
Revolving Facility, currently maturing in June 1999, the Company may borrow and
repay during the two-year revolving period up to $45 million.
The facilities and lines above contain affirmative, negative and financial
covenants typical of such credit facilities. The Company was in compliance with
these covenants as of December 31, 1998.
Hedging and Interest Rate Risk Management. The Company employs a hedging
strategy that is intended to minimize the risk of interest rate fluctuations and
which historically has involved the execution of
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forward interest rate swaps or use of a pre-funding structure for the Company's
securitizations. The Company is not required to maintain collateral on the
outstanding hedging program.
Securitization. Regular securitizations are an integral part of the
Company's business plan because they allow the Company to increase its
liquidity, provide for redeployment of its capital and reduce risks associated
with interest rate fluctuations. The Company has developed a securitization
program that involves selling interests in pools of its Contracts to investors
through the public issuance of AAA/Aaa rated asset-backed securities. The
Company completed four AAA/Aaa rated publicly underwritten asset-backed
securitizations in the amount of $911.8 million in 1998.
The net proceeds of these securitizations are used to pay down outstanding
indebtedness incurred under the Company's credit facilities to purchase
contracts, thereby creating availability for the purchase of additional
Contracts. Since 1994, the Company has securitized $2.0 billion of its Contracts
in 14 separate transactions. In each of its securitizations, the Company has
sold its Contracts to a newly formed grantor or owner trust which issued
pass-through certificates or notes in an amount equal to the aggregate principal
balance of the Contracts.
To improve the level of profitability from the sale of securitized
Contracts, the Company arranges for credit enhancement to achieve an improved
credit rating on the asset-backed securities issued. This credit enhancement has
taken the form of a financial guaranty issued by MBIA, which issues a financial
guaranty insurance policy (the "Financial Guarantee Insurance Policy") insuring
the payment of principal and interest due on the asset-backed securities.
The Company receives servicing fees for its duties relating to the
accounting for and collection of the Contracts. In addition, the Company is
entitled to the future servicing cash flows. Generally, the Company sells the
Contracts at face value and without recourse, except that certain
representations and warranties with respect to the Contracts are provided by the
Company as the servicer and Onyx Acceptance Financial Corporation ("OAFC") as
the seller to the trusts.
Gains on sale of Contracts in securitizations provide a significant portion
of the Company's revenues. Several factors affect the Company's ability to
complete securitizations of its Contracts, including conditions in the
securities markets generally, conditions in the asset-backed securities market
specifically, the credit quality of the Company's portfolio of Contracts and the
Company's ability to obtain credit enhancement.
GOVERNMENT REGULATION
The Company's operations are subject to regulation, supervision, and
licensing under various federal, state and local statutes, ordinances and
regulations. The Company is required to comply with the laws of those states in
which it conducts operations. Management believes that it is in compliance with
these laws and regulations.
Consumer Protection Laws. Numerous federal and state consumer protection
laws and related regulations impose substantial requirements upon lenders and
servicers involved in consumer finance. These laws include the Truth-in-Lending
Act, the Equal Credit Opportunity Act, the Federal Trade Commission Act, the
Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the
Magnuson-Moss Warranty Act, the Federal Reserve Board's Regulations B and Z,
states' adaptations of the Uniform Consumer Credit Code and of the Uniform
Commercial Code (the "UCC") and state motor vehicle retail installment sales
acts and other similar laws. These laws, among other things, require the Company
to provide certain disclosures to applicants, prohibit misleading advertising
and protect against discriminatory financing or unfair credit practices. The
Truth in Lending Act and Regulation Z promulgated thereunder require disclosure
of, among other things, the payment schedule, the finance charge, the amount
financed, the total of payments and the annual percentage rate charged on each
retail installment contract. The Equal Credit Opportunity Act prohibits
creditors from discriminating against loan applicants (including retail
installment contract obligors) on the basis of race, color, sex, age (provided
the applicant has the capacity to contract), marital status, religion, national
origin, the fact that all or part of the applicant's income derives from a
public assistance program, or the fact that the applicant has in good faith
exercised any right under the Consumer Credit Protection Act. Under the Equal
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Credit Opportunity Act, creditors are required to make certain disclosures
regarding consumer rights and advise consumers whose credit applications are not
approved of the reasons for the rejection. The rules of the Federal Trade
Commission (the "FTC") limit the types of property a creditor may accept as
collateral to secure a consumer loan and its holder in due course rules provide
for the preservation of the consumer's claims and defenses when a consumer
obligation is assigned to a subject holder. With respect to used vehicles
specifically, the FTC's rule on Sale of Used Vehicles requires that all sellers
of used vehicles prepare, complete and display a Buyer's guide which explains
any applicable warranty coverage for such vehicles. Also, some state laws impose
finance charge ceilings and other restrictions on consumer transactions and
require contract disclosures in addition to those required under federal law.
These requirements impose specific statutory liabilities upon creditors who fail
to comply with their provisions. In some cases, these provisions could affect
the Company's ability to enforce Contracts it purchases or originates.
EMPLOYEES
The Company employs personnel experienced in all areas of loan
originations, documentation, collection and administration. The Company employs
and trains specialists in loan processing and servicing with minimal crossover
of duties. At December 31, 1998, the Company had 526 full-time employees, none
of whom were covered by collective bargaining agreements. The Company believes
it has good relationships with its employees.
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RISK FACTORS
You should carefully consider the following risks in your evaluation of us
and our common stock. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties, including but
not limited to credit, economic, competitive, governmental and financial factors
affecting our operations, markets, financial products, and services and other
factors discussed in our filings with the Securities and Exchange Commission,
may also adversely impact and impair our business. If any of these risks
actually occur, our business, results of operations, cash flows or financial
condition would likely suffer. In such case, the trading price of our common
stock could decline, and you may lose all or part of the money you paid to buy
our common stock.
WE NEED SUBSTANTIAL LIQUIDITY.
We require a substantial amount of liquidity to operate our business. Among
other things, we use such liquidity to:
- acquire Contracts;
- pay dealer participation;
- pay securitization costs and fund spread accounts;
- settle hedge transactions;
- satisfy working capital requirements and pay operating expenses; and
- pay interest expense.
A substantial portion of our revenues in any period is represented by gain
on sale of Contracts generated by a securitization in such period but the cash
underlying such revenues is received over the life of the Contracts. In
addition, cash paid by us for dealer participation is not recovered at the time
of securitizations, but over the life of the Contract.
We have operated and expect to continue to operate on a negative cash flow
basis and expect to do so in the future as long as the volume of Contract
purchases continues to grow. We have historically funded these negative
operating cash flows principally through borrowings from financial institutions,
sales of equity securities and sales of subordinated notes. We cannot assure
you, however, that (1) we will have access to the capital markets in the future
for equity, debt issuances or securitizations, or (2) financing through
borrowings or other means will be available on acceptable terms to satisfy our
cash requirements. If we are unable to access the capital markets or obtain
acceptable financing, our results of operations, financial condition and cash
flows would be materially and adversely affected. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
WE DEPEND ON WAREHOUSE FINANCING.
We depend on warehousing facilities with financial institutions to finance
the purchase or origination of Contracts pending securitization. See
"Business--Financing and Sale of Contracts." Our business strategy requires that
such financing continue to be available during the warehousing period.
Whether the CP Facility continues to be available to us depends on, among
other things, whether we maintain a target net yield for the Contracts financed
under the CP Facility and comply with certain financial covenants contained in
the sale and servicing agreement between us, as seller, and our wholly-owned
special purpose finance subsidiary, OAFC, as purchaser. These financial
covenants include:
- a minimum ratio of net worth to total assets;
- a maximum ratio of credit enhancement assets to tangible net worth;
- earnings before interest, depreciation and taxes coverage ratio; and
- minimum cash on hand.
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We also have a warehouse line of credit with Merrill Lynch. Whether the
Merrill Line continues to be available to us depends on whether we meet certain
debt to equity ratios and minimum equity requirements.
We cannot assure you that our CP Facility or Merrill Line will be available
to us or that it will be available on favorable terms. If we are unable to
arrange new warehousing credit facilities or extend our existing credit
facilities when they expire, our results of operations, financial condition and
cash flows could be materially and adversely affected.
WE DEPEND ON RESIDUAL FINANCING.
When we sell our Contracts in securitizations, we receive cash and a
residual interest in the securitized assets ("RISA"). The RISA represents the
future cash flows to be generated by the Contracts in excess of the interest
paid on the securities issued in the securitization and other costs of servicing
the Contracts and completing the securitization. (See "Management's Discussion
and Analysis of Financial Condition and Results of
Operations--Securitizations"). We use the RISA from each securitization as
collateral to borrow cash to finance our operations. The amount of cash advanced
by our lenders under our residual lines of credit depends on a collateral
formula that is determined in large part by how well our securitized Contracts
perform. If our portfolio of securitized Contracts experienced higher
delinquency and loss ratios than expected, then the amount of money we could
borrow under the residual lines would be reduced. The reduction in availability
under these residual lines could materially and adversely affect our operations,
financial condition and cash flows.
Whether our Revolving Facility continues to be available to us depends on,
among other things, whether we meet financial covenants that are substantially
similar to those of the CP Facility, except that leverage is measured as the
ratio of net worth plus subordinated debt to total liabilities plus net worth.
Additionally, we are subject under the documentation governing the Residual
Lines, to minimum net worth and subordinated debt plus net worth tests, a
limitation on quarterly operating losses and covenants restricting
delinquencies, losses, prepayments and net yields of Contracts included in a
securitization. The loss of access to these Residual Lines could materially and
adversely affect our operations, financial condition and cash flows.
WE DEPEND ON SECURITIZATIONS TO GENERATE REVENUE.
We rely significantly upon securitizations to generate cash proceeds for
repayment of our warehouse credit facilities and to create availability to
purchase additional Contracts. Further, gain on sale of Contracts generated by
our securitizations represents a significant portion of our revenues. Our
ability to complete securitizations of our Contracts is affected by the
following factors, among other things:
- conditions in the securities markets generally;
- conditions in the asset-backed securities market specifically;
- the credit quality of our portfolio of Contracts; and
- our ability to obtain credit enhancement.
If we were unable to profitably securitize a sufficient number of our
Contracts in a particular financial reporting period, then our revenues for such
period could decline and could result in lower income or a loss for such period.
In addition, unanticipated delays in closing a securitization could also
increase our interest rate risk by increasing the warehousing period for our
Contracts. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition--Liquidity and Capital Resources," and "Business
Financing and Sale of Contracts."
WE DEPEND ON CREDIT ENHANCEMENT.
From inception through December 31, 1998, each of our securitizations has
utilized credit enhancement in the form of a financial guarantee insurance
policy issued by MBIA, or its predecessor in order to achieve "AAA/Aaa" ratings.
This form of credit enhancement reduces the costs of the securitizations
relative to
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alternative forms of credit enhancements currently available to us. MBIA is not
required to insure future securitizations and we are not restricted in our
ability to obtain credit enhancement from providers other than MBIA or to use
other forms of credit enhancement. We cannot assure you that:
- we will be able to continue to obtain credit enhancement in any form from
MBIA;
- we will be able to obtain credit enhancement from any other provider of
credit enhancement on acceptable terms; or
- future securitizations will be similarly rated.
We also rely on MBIA's financial guarantee insurance policy to reduce our
borrowing cost under the CP Facility. If MBIA's credit rating is downgraded or
if it withdraws our credit enhancement, we could be subject to higher interest
costs for our future securitizations and financing costs during the warehousing
period. Such events could have a material adverse effect on our results of
operations, financial condition and cash flows.
WE ARE SUBJECT TO INTEREST RATE FLUCTUATIONS.
Our profitability is largely determined by the difference, or "spread,"
between the effective rate of interest received by us on the Contracts acquired
and the interest rates payable under our credit facilities during the
warehousing period and for certificates issued in securitizations.
Several factors affect our ability to manage interest rate risk. First, the
Contracts are purchased or originated at fixed interest rates, while amounts
borrowed under our credit facilities bear interest at variable rates that are
subject to frequent adjustment to reflect prevailing rates for short-term
borrowings. Our policy is to increase the buy rates we issue to dealerships or
to increase rates we use to solicit consumers for Contracts in response to
increases in our cost of funds during the warehousing period. However, there is
generally a time lag before such increased borrowing costs can be offset by
increases in the buy rates for Contracts and, in certain instances, the rates
charged by our competitors may limit our ability to pass through our increased
costs of warehousing financing.
Second, the spread can be adversely affected after a Contract is purchased
or originated and while it is held during the warehousing period by increases in
the prevailing rates in the commercial paper markets. While the CP Facility
permits us to select maturities of up to 270 days for commercial paper issued
under the CP Facility, if we selected a shorter maturity or had a delay in
completing a securitization, we would face this risk.
Third, the interest rate demanded by investors in securitizations is a
function of prevailing market rates for comparable transactions and the general
interest rate environment. Because the Contracts purchased or originated by us
have fixed rates, we bear the risk of spreads narrowing because of interest-rate
increases during the period from the date the Contracts are purchased until the
pricing of our securitization of such Contracts. We employ a hedging strategy
that is intended to minimize this risk and which historically has involved the
execution of forward interest rate swaps or use of a pre-funding structure for
our securitizations. However, we cannot assure you that this strategy will
consistently or completely offset adverse interest-rate movements during the
warehousing period or that we will not sustain losses on hedging transactions.
Our hedging strategy requires estimates by management of monthly Contract
acquisition volume and timing of our securitizations. If such estimates are
materially inaccurate, then our gains on sales of Contracts, results of
operations and cash flows could be materially and adversely affected.
We also have exposure to interest rate fluctuations under the Residual
Lines. The interest rates are based on a LIBOR and Prime Rate. The LIBOR lines
reset each month while the Prime Rate line is reset at any change in the Prime
rates. In periods of increasing interest rates our cash flows, results of
operations and financial condition could be adversely affected.
In addition, we have some interest rate exposure to falling interest rates
to the extent that the interest rates charged on Contracts sold in a
securitization with a pre-funding structure decline below the rates prevailing
at the time that the securitization prices. Such a rate decline would reduce the
interest rate spread because the interest rate on the notes and/or the
certificates would remain fixed. In time, this would negatively impact the gains
on sale of Contracts and our results of operations and cash flows.
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WE WILL BE ADVERSELY AFFECTED WHEN CONTRACTS ARE PREPAID OR DEFAULTED.
Our results of operations, financial condition, cash flows, and liquidity
depend, to a material extent, on the performance of Contracts purchased,
originated, warehoused, and securitized by us. A portion of the Contracts
acquired by us may default or prepay during the warehousing period. We bear the
risk of losses resulting from payment defaults during the warehousing period. In
the event of payment default, the collateral value of the financed vehicle may
not cover the outstanding Contract balance and costs of recovery. We maintain an
allowance for credit losses on Contracts held during the warehousing period
which reflects management's estimates of anticipated credit losses during such
period. If the allowance is inadequate, then we would recognize as an expense
the losses in excess of such allowance and our results of operations could be
adversely affected. In addition, under the terms of the CP Facility, we are not
able to borrow against defaulted Contracts.
Our servicing income can also be adversely affected by prepayment of or
defaults under Contracts in the servicing portfolio. Our contractual servicing
revenue is based on a percentage of the outstanding principal balance of such
Contracts. Thus, if Contracts are prepaid or charged-off, then our servicing
revenue will decline to the extent of such prepaid or charged-off Contracts.
The gain on sale of Contracts recognized by us in each securitization and
the value of the retained interest in securitized assets ("RISA") in each
transaction reflects management's estimate of future credit losses and
prepayments for the Contracts included in such securitization. If actual rates
of credit loss or prepayments, or both, on such Contracts exceed those
estimated, the value of the RISA would be impaired. We periodically review our
credit loss and prepayment assumptions relative to the performance of the
securitized Contracts and to market conditions. In this event, our results of
operations and liquidity could be adversely affected if credit loss or
prepayment levels on securitized Contracts substantially exceed anticipated
levels. If necessary, we would write-down the value of the RISA through a
reduction to servicing fee income. Further, any write down of RISA would reduce
the amount available to us under our residual lines, thus requiring us to pay
down amounts outstanding under the facilities or provide additional collateral
to cure the borrowing base deficiency.
WE WILL BE ADVERSELY AFFECTED IF WE LOSE SERVICING RIGHTS.
Our results of operations, financial condition and cash flows would be
materially and adversely affected if any of the following were to occur:
- loss of the servicing rights under our sale and servicing agreement for
the CP Facility;
- loss of the servicing rights under the applicable pooling and servicing
or sale and servicing agreement of a grantor trust and owner trust,
respectively; or
- a trigger event that would block release of future servicing cash flows
from the grantor trusts' or owner trusts' respective spread accounts.
We are entitled to receive servicing income only while we act as servicer
under the applicable sales and servicing agreement or pooling and servicing
agreement for securitized Contracts. Under the CP Facility ur right to act as
servicer can be terminated by MBIA, as program manager, upon the occurrence of
certain event.
OUR QUARTERLY EARNINGS MAY FLUCTUATE.
Our revenues and losses have fluctuated in the past and are expected to
fluctuate in the future principally as a result of the following factors:
- the timing and size of our securitizations;
- variations in the volume of our Contract acquisitions;
- the interest rate spread between our cost of funds and the average
interest rate of purchased Contracts;
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- the effectiveness of our hedging strategies; and
- the investor rate for securitizations.
Any significant decrease in our quarterly revenues could have a material
adverse effect on our results of operations, financial condition and cash flows.
WE DEPEND ON KEY PERSONNEL.
Our future operating results depend in significant part upon the continued
service of our key senior management personnel, none of whom is bound by an
employment agreement. Our future operating results also depend in part upon our
ability to attract and retain qualified management, technical, and sales and
support personnel for our operations. Competition for such personnel is intense.
We cannot assure you that we will be successful in attracting or retaining such
personnel. The loss of any key employee, the failure of any key employee to
perform in his or her current position or our inability to attract and retain
skilled employees, as needed, could materially and adversely affect our results
of operations, financial condition and cash flows. We presently maintain a key
man life insurance policy on John W. Hall, our president and chief executive
officer, in the amount of $3 million.
OUR INDUSTRY IS HIGHLY COMPETITIVE.
Competition in the field of financing retail motor vehicle sales is
intense. The automobile finance market is highly fragmented and historically has
been serviced by a variety of financial entities including the captive finance
affiliates of major automotive manufacturers, banks, savings associations,
independent finance companies, credit unions and leasing companies. Several of
these competitors have greater financial resources than we do. Many of these
competitors also have long-standing relationships with automobile dealerships
and offer dealerships or their customers other forms of financing or services
not provided by us. Our ability to compete successfully depends largely upon our
relationships with dealerships and the willingness of dealerships to offer those
Contracts that meet our underwriting criteria to us for purchase. We cannot
assure you that we will be able to continue to compete successfully in the
markets we serve.
WE MAY BE HARMED BY ADVERSE ECONOMIC CONDITIONS.
We are a motor vehicle consumer auto finance company whose activities are
dependent upon the sale of motor vehicles. Our ability to continue to acquire
Contracts in the markets in which we operate and to expand into additional
markets is dependent upon the overall level of sales of new and used motor
vehicles in those markets. A prolonged downturn in the sale of new and used
motor vehicles, whether nationwide or in the California markets, could have an
adverse impact upon us, our results of operations and our ability to implement
our business strategy. See "Business--Competition."
The automobile industry generally is sensitive to adverse economic
conditions both nationwide and in California. Periods of rising interest rates,
reduced economic activity or higher rates of unemployment generally result in a
reduction in the rate of sales of motor vehicles and higher default rates on
motor vehicle loans. We cannot assure you that such economic conditions will not
occur, or that such conditions will not result in severe reductions in our
revenues or the cash flows available to us to permit us to remain current on our
credit facilities. See "Risk Factors--We Need Substantial Liquidity."
WE ARE SUBJECT TO MANY REGULATIONS.
Our business is subject to numerous federal and state consumer protection
laws and regulations, which, among other things:
- require us to obtain and maintain certain licenses and qualifications;
- limit the interest rates, fees and other charges we are allowed to
charge;
- limit or prescribe certain other terms of our Contracts;
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- require specific disclosures; and
- define our rights to repossess and sell collateral.
We believe that we are in compliance in all material respects with all such
laws and regulations, and that such laws and regulations have had no material
adverse effect on our ability to operate our business. However, we will be
materially and adversely affected if we fail to comply with:
- applicable laws and regulations;
- changes in existing laws or regulations;
- changes in the interpretation of existing laws or regulations; or
- any additional laws or regulations that may be enacted in the future.
WE MAY HAVE COMPUTER PROBLEMS RELATED TO THE YEAR 2000.
Because of the nature of our consumer finance business and the increasing
number of electronic transactions in this industry, we have come to rely heavily
on our and third party computer systems, business applications and other
information technology systems ("IT systems"). Historically, many IT systems
were developed to recognize the year as a two-digit number, with the digit "00"
being recognized as the year 1900. The year 2000 presents a number of potential
problems for such systems, including potentially significant processing errors
or failure. Given our reliance on computer systems, our results of operations
and cash flows could be materially adversely affected by any significant errors
or failures. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Year 2000 Compliance."
ITEM 2. PROPERTIES
The Company did not own any real property at December 31, 1998. In December
1998, the Company began moving into it new headquarters in Foothill Ranch,
California after signing a 10-year lease for approximately 82,000 square feet of
office space. The Company also leases office space for its 14 Auto Finance
Centers.
ITEM 3. LITIGATION
The Company is currently not a party to any material litigation, although
it is involved from time to time in routine litigation incident to its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year
covered by this Annual Report on Form 10-K to a vote of security holders,
through the solicitation of proxies or otherwise.
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PART II
ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the NASDAQ under the symbol "ONYX".
The following table provides quarterly high and low closing prices for the
Company's Common Stock for the years ended December 31, 1998, and December 31,
1997.
HIGH LOW
------ -----
1998
First quarter............................................... $11.50 $7.25
Second quarter.............................................. $12.63 $8.88
Third quarter............................................... $10.31 $5.63
Fourth quarter.............................................. $ 6.75 $4.88
1998
First quarter............................................... $10.63 $7.25
Second quarter.............................................. $ 8.50 $6.50
Third quarter............................................... $ 8.00 $7.00
Fourth quarter.............................................. $ 7.88 $6.38
At March 16, 1999, there were approximately 955 holders of the Company's
Common Stock.
DIVIDEND POLICY
The Company has never declared or paid dividends on its Common Stock. The
Company currently intends to retain any future earnings for its business and
does not anticipate declaring or paying any dividends on the Common Stock in the
foreseeable future. In addition, the Company's ability to declare or pay
dividends is restricted by the terms of the credit facilities.
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
the Consolidated Financial Statements of the Company and the notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere herein.
As required by the Financial Accounting Standards Board's Special Report,
"A Guide to Implementation of Statement 125 on Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, Second
Edition," dated December 1998, and related guidance set forth in statements made
by the staff of the Securities and Exchange Commission on December 8, 1998, Onyx
has restated its 1996 and 1997 consolidated financial statements to reflect the
change in the method of measuring and accounting for credit enhancement assets
on its securitization transactions to the cash-out method from the cash-in
method.
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA:
Net interest income............................ $ 1,311 $ 2,225 $ 4,140 $ 5,036 $ 7,312
Servicing fee income........................... 269 1,381 3,236 9,189 16,663
Gain on sale of contracts...................... 515 2,012 15,251 19,586 36,417
------- -------- -------- -------- ----------
Total revenues................................. 2,095 5,618 22,627 33,811 60,392
------- -------- -------- -------- ----------
Provision for credit losses.................... 208 465 266 785 1,580
Operating expenses............................. 5,392 8,340 15,394 30,740 48,427
------- -------- -------- -------- ----------
Total expenses................................. 5,600 8,805 15,660 31,525 50,007
------- -------- -------- -------- ----------
Income (loss) before income taxes.............. (3,505) (3,187) 6,967 2,286 10,385
Income taxes................................... 0 0 851 984 4,310
------- -------- -------- -------- ----------
Net income (loss).............................. $(3,505) $ (3,187) $ 6,116 $ 1,302 $ 6,075
======= ======== ======== ======== ==========
Net income (loss) available to common
stockholders................................. $(4,081) $ (3,763) $ 6,116 $ 1,302 $ 6,075
======= ======== ======== ======== ==========
Net income (loss) per share of Common Stock:
Basic........................................ $ (1.89) $ (1.68) $ 1.19 $ 0.22 $ 0.99
Diluted...................................... $ (1.89) $ (1.68) $ 1.09 $ 0.21 $ 0.95
Basic shares outstanding....................... 2,158 2,234 5,159 6,000 6,112
Diluted shares outstanding..................... 2,158 2,234 5,585 6,294 6,425
OPERATING DATA:
Contracts purchased during the period.......... $85,723 $199,397 $319,840 $605,905 $1,038,535
Number of Contracts purchased during the
period....................................... 7,619 16,571 26,244 50,214 86,150
Contracts securitized during the period........ $38,601 $105,000 $405,514 $527,276 $ 911,760
Number of active dealerships (at end of
period)...................................... 380 769 1,471 2,846 5,401
Operating expenses as percentage of average
servicing portfolio during the period(1)..... 19.1% 5.9% 4.9% 5.5% 4.7%
SELECTED PORTFOLIO DATA:
Servicing portfolio (at end of period)......... $74,581 $218,207 $400,665 $757,277 $1,345,961
Average servicing portfolio during the
period(1).................................... $28,291 $141,029 $311,340 $563,343 $1,023,237
Number of contracts in servicing portfolio (at
end of period)............................... 6,893 20,156 38,275 73,502 131,862
Weighted average annual percentage rate (at end
of period)(2)................................ 14.01% 15.00% 14.69% 14.66% 14.72%
Delinquencies as a percentage of the dollar
amount of servicing portfolio (at end of
period)(3)................................... 0.07% 1.20% 2.03% 2.51% 2.83%
Net charge-offs as a percentage of the average
servicing portfolio during the period(1)..... 0.00% 0.37% 1.63% 2.03% 1.72%
18
21
AS OF DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- -------- ------- -------- --------
BALANCE SHEET DATA:
Cash and cash equivalents................ $10,252 $ 1,623 $ 603 $ 991 $ 1,929
Contracts held for sale(4)............... 40,313 116,893 12,238 63,380 151,952
Credit enhancement assets................ 3,085 12,390 37,144 71,736 112,953
Total assets............................. 57,095 136,077 54,083 141,836 275,422
Warehouse borrowings..................... 40,850 112,380 10,108 60,506 150,044
Revolving credit and residual lines...... 0 9,569 2,500 30,000 49,556
Subordinated debt........................ 10,000 10,000 0 0 10,000
Redeemable series A preferred stock...... 8,803 9,379 0 0 0
Stockholders' equity (deficit)........... (4,122) (7,896) 36,358 37,717 43,824
- ---------------
(1) Averages are based on daily balances.
(2) The weighted averages are based on the serviced portfolio outstanding at the
end of the period.
(3) Excludes repossessed inventory.
(4) Contracts held for sale excludes dealer participation and allowance for
credit losses. See Note 5 to the Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Onyx is a specialized consumer finance company engaged in the purchase,
origination, securitization and servicing of Contracts originated by franchised
and select independent automobile dealerships in the United States and to a
lesser extent the origination or purchase of motor vehicle loans through a
subsidiary of Onyx on a direct basis to consumers (collectively the
"Contracts"). The Company focuses its efforts on acquiring Contracts that are
collateralized by late model used and, to a lesser extent, new automobiles, that
are entered into with purchasers whom the Company believes have a favorable
credit profile. Since commencing the purchase of Contracts in February 1994, the
Company has acquired more than $2.2 billion in Contracts from over 5,400
dealerships and has expanded its operations from a single office in California
to 14 Auto Finance Centers serving many regions of the United States.
The Company generates revenues primarily through the purchase, origination,
warehousing, subsequent securitization and ongoing servicing of Contracts. The
Company earns net interest income on Contracts held during the warehousing
period. Upon the securitization and sale of Contracts, the Company recognizes a
gain on sale of Contracts, receives future servicing cash flows and earns fees
from servicing the securitized Contracts.
As required by the Financial Accounting Standards Board's Special Report,
"A Guide to Implementation of Statement 125 on Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, Second
Edition," dated December 1998, and related guidance set forth in statements made
by the staff of the Securities and Exchange Commission on December 8, 1998, the
Company restated its 1997 and 1996 consolidated financial statements to reflect
the change in the method of measuring and accounting for credit enhancement
assets on its securitization transactions to the cash-out method from the
cash-in method.
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22
The following table illustrates the changes in the Company's Contract
acquisition volume, total revenue, securitization activity and servicing
portfolio during the past three fiscal years.
SELECTED FINANCIAL INFORMATION
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
-------- -------- ----------
(DOLLARS IN THOUSANDS)
Contracts purchased during year........................... $319,840 $605,905 $1,038,535
Average monthly purchases during the year................. 26,653 50,492 86,544
Gain on sale of contracts................................. 15,251 19,586 36,417
Total revenue(1).......................................... 22,627 33,811 60,392
Contracts securitized during the year..................... 405,514 527,276 911,760
Servicing portfolio at year end........................... 400,665 757,277 1,345,961
- ---------------
(1) Total revenue is comprised of net interest income, servicing fee income and
gain on sale of contracts.
CONTRACTS PURCHASED AND SERVICING PORTFOLIO
Since its inception, the Company has experienced significant growth in its
purchased volume of Contracts. Acquisition volume for the year ended December
31, 1998, was $1,039 million compared to $605.9 million for the year ended
December 31, 1997, representing an increase of 71.0% from 1997 to 1998. This
growth in acquisition volume is attributable primarily to (i) the opening of
four additional Auto Finance Centers during 1998 and (ii) an increased
penetration of existing dealers due to the maturation of existing relationships.
The Company's increase in Contract acquisition volume has resulted in the
growth in the Company's servicing portfolio. The servicing portfolio at December
31, 1998, was $1,346 million compared to $757.3 million at December 31, 1997, an
increase of 78%.
NET INTEREST INCOME
Net interest income consists primarily of the difference between the rate
earned on Contracts held on the balance sheet during the warehousing period and
the interest costs associated with the Company's borrowings to finance the
warehousing of such Contracts. The following table illustrates the weighted
average rate earned on Contracts, the weighted average rate paid on borrowings
and the corresponding net interest rate spread.
NET INTEREST RATE SPREAD
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1996 1997 1998
------- ------- -------
Yield on contracts(1)........................... 13.66% 13.85% 13.96%
Cost of borrowings.............................. 7.14 7.03 7.45
Net interest rate spread........................ 6.52 6.82 6.51
- ---------------
(1) The yield on Contracts is net of dealer participation amortized expenses.
GAIN ON SALE OF CONTRACTS
The Company computes a gain on sale with respect to contracts securitized
based on the present value of the estimated future excess cash flows to be
received from such contracts using a market discount rate. Gain on sale is
recorded as a credit enhancement asset on the statement of financial condition
and is amortized against servicing income over the life of the contracts. The
gain recorded in the statement of income is adjusted for prepaid dealer
participation, issuance costs and the effect of hedging activities.
20
23
The Company recorded gains on sale of Contracts of $36.4 million on the
sale of $911.8 million of Contracts in 1998 for its securitizations. The gain on
sale of Contracts is affected by the amount of Contracts securitized and the net
interest rate spread on those Contracts. The following table illustrates the net
interest rate spread for each of the Company's securitizations:
SECURITIZATION TRANSACTIONS
-----------------------------------------------------------------------
REMAINING WEIGHTED WEIGHTED
BALANCE AT AVERAGE AVERAGE
ORIGINAL DECEMBER 31, CONTRACT INVESTOR GROSS NET
SECURITIZATION BALANCE 1998 RATE(1) RATE SPREAD(2) SPREAD(3)
-------------- ---------- ------------ -------- -------- --------- ---------
(DOLLARS IN THOUSANDS)
1996-1 Grantor Trust.............. $ 100,500 $ 16,683 15.07% 5.40% 9.67% 3.83%
1996-2 Grantor Trust.............. 85,013 19,967 14.84 6.40 8.44 3.61
1996-3 Grantor Trust.............. 120,000 35,750 14.54 6.45 8.09 3.14
1996-4 Grantor Trust.............. 100,000 36,586 14.80 6.20 8.60 3.28
1997-1 Grantor Trust.............. 90,000 38,147 13.86 6.55 7.31 2.78
1997-2 Grantor Trust.............. 121,676 59,963 14.85 6.35 8.50 3.11
1997-3 Grantor Trust.............. 149,600 85,408 14.77 6.35 8.42 3.30
1997-4 Grantor Trust.............. 166,000 107,271 14.69 6.30 8.39 3.27
1998-1 Grantor Trust.............. 173,000 124,361 14.91 5.95 8.96 3.40
1998-A Owner Trust................ 208,759 168,442 14.73 5.87 8.86 3.34
1998-B Owner Trust................ 250,000 223,903 14.73 5.78 8.95 3.18
1998-C Owner Trust................ 280,000 266,677 14.89 5.72 9.17 3.51
---------- ----------
Total................... $1,844,548 $1,183,158
========== ==========
- ---------------
(1) As of issue date.
(2) Difference between weighted average contract rate and weighted average
investor rate as of the issue date.
(3) Difference between weighted average contract rate and weighted average
investor rate, net of underwriting costs, other issuance costs, servicing
fees, estimated credit losses, ongoing financial guarantee insurance policy
premiums, and the hedging gain or loss.
(4) The Company assumes an average prepayment speed of 1.75% ABS, a discount
rate of 350bp above the weighted average investor rate, and utilizes a
lifetime loss rate ranging from 3.5% to 4.0% of the original balance.
SERVICING FEE INCOME
Contractual servicing is earned at a rate of 1.0% per annum on the
outstanding principal balance of Contracts securitized and is consistent with
industry standards. Excess servicing income is dependent upon the average excess
spread on the Contracts sold and the performance of the Contracts. Servicing fee
income is related to the size of the serviced portfolio and also includes
investment interest, extension fees, document fees and other fees charged to
customer accounts.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The Company had net income of $6.1 million for the year ended December 31,
1998, compared to net income of $1.3 million and $6.1 million for the years
ended December 31, 1997 and 1996. The increase in net income from 1997 to 1998
is attributable to several factors, including (i) a 73% increase in the dollar
volume of Contracts securitized, resulting in an 86% increase in gain on sale,
(ii) higher servicing fee income due to improved performance of Contracts
securitized and an increase in the serviced portfolio and (iii) improvements in
the cost structure of the Company which resulted in a decline in operating
expenses as a percentage of average servicing portfolio to 4.73% from 5.46% in
1997. The reduction in net income from 1996
21
24
to 1997 was attributable to several factors, most notably to the Company's
commitment to build reserves in the face of increasing delinquency and credit
loss ratios related to purchases of Contracts in the second half of 1995 and the
first half of 1996 by one of the Company's Auto Finance Centers. Management
believes that the Company is adequately reserved at this time. Additionally, the
losses incurred by the Company during its start-up phase (calendar years 1994
and 1995) generated net operating loss carryforwards which were fully utilized
in 1996. The unavailability of these carryforwards in 1997 accounted for a
significant portion of the net income differential between 1997 and 1996.
Net Interest Income. Net interest income increased by 46% to $7.3 million
for the year ended December 31, 1998, from $5.0 million for the year ended
December 31, 1997, and from $4.1 million for the year ended December 31, 1996.
The increase is due to an increase in the average amount of Contracts held for
sale during 1998 as compared to 1997 and 1996. This more than offset the effect
of decline in net interest margins in 1998 compared to 1997. Net interest
margins declined to 6.51% in 1998 compared to 6.82% in 1997 and 6.52% in 1996
while the average amount of Contracts held for sale increased to $148.7 million
compared to $85.7 million in 1997 and $80.6 million in 1996. The yield on
contracts held for sale increased by 0.11% to 13.96% for the year ended December
31, 1998, compared to 13.85% for the year ended December 31, 1997, and 13.66%
for the year ended December 31, 1996. In addition, the Company's cost of
borrowings increased by 0.42% to 7.45% compared to 7.03% at December 31, 1997,
and 7.14% at December 31, 1996. In addition to the interest paid on warehouse
borrowings, the Company includes the interest it pays on its residual line
borrowings, subordinated debt, and capitalized lease obligations as components
of its cost of funds. The increase in funding costs in 1998 was due to a mix
shift amongst these lines rather than to an increase in borrowings rates.
Servicing Fee Income. Servicing fee income increased to $16.7 million for
the year ended December 31, 1998, from $9.2 million for the year ended December
31, 1997, and from $3.2 million for the year ended December 31, 1996. The
increase was attributable to a significant increase in the size of the average
servicing portfolio in addition to the improved performance of secured
Contracts. For the year ended December 31, 1998, the size of the average
servicing portfolio increased to $1.02 billion from $563.3 million and from
$311.3 million for the same period in 1997 and 1996.
Gain on Sale of Contracts. The Company completed four securitizations
totaling $911.8 million during the year ended December 31, 1998, resulting in
gains on sale of $36.4 million compared to four securitizations totaling $527.3
million during the year ended December 31, 1997, resulting in gains on sale of
Contracts totaling $19.6 million, and four securitizations for the year ended
December 31, 1996, resulting in gains on sale of Contracts of $15.2 million. The
average net spread on the 1998 securitizations was 3.36% compared to 3.16% in
1997 and 3.44% in 1996.
Provision for Credit Losses. The Company maintains an allowance for credit
losses to cover anticipated losses on the Contracts held on statement of
financial condition. The allowance for credit losses is increased by charging
the provision for credit losses and decreased by actual losses on the Contracts
held on statement of financial condition or by the sale of Contracts held on
statement of financial condition. The level of the allowance is based
principally on the outstanding balance of Contracts held on statement of
financial condition, and historical loss trends. When the Company sells
Contracts in a securitization transaction, it reduces its allowance for credit
losses and factors potential losses into its calculations of gain on sale. The
increase in the provision for credit losses for the year ended December 31, 1998
as compared to December 31, 1997 and 1996 is a result of the increase in
Contracts held for sale at the end of each year.
Salaries and Benefits Expense. The Company incurred salary and benefit
expenses of $26.8 million during the year ended December 31, 1998, compared to
$17.4 million during the year ended December 31, 1997, and $8.5 million for the
year ended December 31, 1996. In order to support the growth of its operations
and the servicing portfolio, the number of employees increased from 221 at
December 31, 1996, to 319 at December 31, 1997, to 526 at December 31, 1998.
Other Operating Expenses. Other operating expenses increased to $21.7
million at December 31, 1998, from $13.3 million at December 31, 1997, and from
$6.8 million for the year ended December 31, 1996. The majority of increases
were due to the growth of the average servicing portfolio from $311.3 million to
22
25
$563.3 million and $1.02 billion at December 31, 1996, 1997 and 1998,
respectively. Additionally, the Company opened additional Auto Finance Centers
during the years ended December 31, 1998, December 31, 1997, and December 31,
1996.
Income Taxes. The Company files federal and certain state tax returns as
part of a consolidated group. Tax liabilities from the consolidated returns are
allocated in accordance with a tax sharing agreement based on the relative
income or loss of each entity on a stand-alone basis. The effective tax rate for
Onyx was 41.5% in 1998 and 43.0% in 1997. The reduction in tax rates between
1998 and 1997 is due to lower tax rates in the states where the Company has
opened new Auto Finance Centers. The Company's effective tax rate in 1996 was
12.2% as the Company had net operating loss carry-forwards that were utilized to
reduce income tax expense.
FINANCIAL CONDITION
CONTRACTS HELD FOR SALE
Contracts held for sale totaled $152.8 million at December 31, 1998,
compared to $64.3 million at December 31, 1997. The number and principal balance
of Contracts held for sale is largely dependent upon the timing and size of the
Company's securitizations. The increase in the Contracts held for sale from year
end 1997 to year end 1998 is primarily attributable to the Company's higher
contract volume during the respective warehousing periods. The Company believes
that the allowance for credit losses is currently adequate to absorb potential
losses in the owned portfolio. The allowance for credit losses as of December
31, 1998, was approximately $1.0 million. See Note 5 to the Company's
Consolidated Financial Statements for Contracts held for sale and allowance for
credit losses.
CREDIT ENHANCEMENT ASSETS
Credit enhancement assets consisted of the following:
AS OF DECEMBER 31,
-----------------------------
1997 1998
----------- ------------
Trust receivable............................... $ 7,377,801 $ 3,712,501
RISA........................................... 64,357,850 109,240,692
----------- ------------
Total................................ $71,735,651 $112,953,193
=========== ============
Investment in trust receivables represent servicer advances and initial
deposits in spread accounts.
RISA consists of the estimated present value of future servicing cash flows
from related securitizations. Future servicing cash flows are computed by taking
into account certain assumptions principally regarding prepayments, losses and
servicing costs. These cash flows are then discounted until they are released by
the spread account and received by the Company at a market-based rate. The
balance is then amortized against actual servicing fee income on a monthly
basis. The following table provides historical data regarding the RISA. Included
in RISA is restricted cash of $32.7 million and $23.5 million for the years
ended December 31, 1998 and 1997 respectively.
23
26
RETAINED INTEREST IN SECURITIZED ASSETS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1998
---------- ----------
(DOLLARS IN THOUSANDS)
Beginning balance.............................. $ 33,530 $ 64,358
Additions...................................... 41,603 80,633
Amortization................................... (10,775) (35,750)
-------- --------
Ending balance................................. $ 64,358 $109,241
======== ========
ASSET QUALITY
The Company monitors and attempts to minimize delinquencies and losses
through timely collections and the use of a predictive dialing system. At
December 31, 1998, delinquencies represented 2.83% of the amount of Contracts in
its servicing portfolio compared to 2.51% at December 31, 1997, and 2.03% at
December 31, 1996. Net charge-offs as a percentage of the average servicing
portfolio were 1.72% for the year ended December 31, 1998, compared to 2.03% and
1.63% for the years ended December 31, 1997, and 1996, respectively. The levels
of delinquencies at December 31, 1998, increased over December 31, 1997,
primarily due to the relocation of the collection and customer service areas in
conjunction with the relocation of the corporate headquarters in December of
1998. The increase in delinquency from 1996 to 1997 is attributable in part to
an increase on a national basis in the level of bankruptcies and consumer
defaults generally, and the tendency of delinquencies and losses with respect to
a pool of automobile loans to increase after a period of seasoning. Loan losses
however have decreased from 1997 to 1998, and the management of the Company
believes that this is a result of the elimination of significant portion of the
portfolio of high delinquency and high loss Contracts purchased through the
third quarter of 1996 by the Company's North Hollywood Auto Finance Center. The
North Hollywood Auto Finance Center had a higher concentration of used car
dealerships than the Company's other Auto Finance Centers, and this
concentration of used car dealerships was principally responsible for the poor
performance of the portion of the Company's portfolio. The runoff of these loans
impacted losses through December 1997.
Management has increased its off balance sheet reserves as a percentage of
the average serviced portfolio sold. Reserves have increased from 2.73% at
December 31, 1996, to 3.68% at December 31, 1997, to 4.31% at December 31, 1998.
Off balance sheet reserves are those reserves established upon the sale of
Contracts to the grantor and owner trusts in connection with securitized
Contracts.
DELINQUENCY EXPERIENCE OF THE SERVICING PORTFOLIO
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
-------- -------- ----------
(DOLLARS IN THOUSANDS)
Servicing portfolio....................... $400,665 $757,277 $1,345,961
Delinquencies(1)(2) 30-59 days............ 5,022 11,902 26,410
60-89 days................................ 1,816 3,370 6,876
90+ days.................................. 1,279 3,743 4,790
Total delinquencies as a percent
of servicing portfolio........ 2.03% 2.51% 2.83%
- ---------------
(1) Delinquencies include principal amounts only, net of repossessed inventory.
(2) The period of delinquency is based on the number of days payments are
contractually past due.
24
27
LOAN LOSS EXPERIENCE OF THE SERVICING PORTFOLIO
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
-------- -------- ----------
(DOLLARS IN THOUSANDS)
Number of contracts..................................... 38,275 73,502 131,862
Period end servicing portfolio.......................... $400,665 $757,277 $1,345,961
Average servicing portfolio(1).......................... $311,340 $563,343 $1,023,237
Number of gross charge-offs............................. 987 2,161 3,761
Gross charge-offs....................................... $ 5,789 $ 13,076 $ 20,640
Net charge-offs(2)...................................... $ 5,066 $ 11,434 $ 17,618
Net charge-offs as a percent of average servicing
portfolio............................................. 1.63% 2.03% 1.72%
On and off balance sheet reserves as a percent of period
end serviced portfolio................................ 2.12% 3.32% 3.90%
- ---------------
(1) Average is based on daily balances.
(2) Net charge-offs are gross charge-offs minus recoveries on Contracts
previously charged off.
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28
The following table illustrates the monthly performance of each of the
securitized pools outstanding for the period from the date of securitization
through December 31, 1998.
MONTH 96-1 96-2 96-3 96-4 97-1 97-2 97-3 97-4 98-1 98-A 98-B 98-C
----- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
1......................... 0.00% 0.01% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
2......................... 0.03% 0.07% 0.02% 0.02% 0.00% 0.00% 0.00% 0.00% 0.01% 0.01% 0.00% 0.02%
3......................... 0.05% 0.20% 0.07% 0.05% 0.03% 0.02% 0.02% 0.01% 0.02% 0.03% 0.02%
4......................... 0.11% 0.33% 0.16% 0.14% 0.06% 0.07% 0.09% 0.04% 0.08% 0.07% 0.08%
5......................... 0.23% 0.46% 0.43% 0.24% 0.13% 0.22% 0.13% 0.11% 0.14% 0.14%
6......................... 0.40% 0.78% 0.54% 0.38% 0.26% 0.32% 0.24% 0.20% 0.24% 0.23%
7......................... 0.69% 0.98% 0.74% 0.53% 0.37% 0.59% 0.36% 0.28% 0.40% 0.37%
8......................... 0.82% 1.15% 0.97% 0.81% 0.52% 0.80% 0.47% 0.43% 0.53%
9......................... 0.93% 1.39% 1.13% 0.98% 0.60% 0.91% 0.62% 0.55% 0.68%
10........................ 1.15% 1.52% 1.32% 1.18% 0.76% 1.07% 0.73% 0.72% 0.85%
11........................ 1.25% 1.69% 1.47% 1.43% 0.92% 1.26% 0.81% 0.87%
12........................ 1.47% 1.94% 1.60% 1.63% 1.02% 1.42% 0.94% 0.95%
13........................ 1.65% 2.08% 1.77% 1.73% 1.13% 1.58% 1.10% 1.08%
14........................ 1.79% 2.34% 1.94% 1.87% 1.23% 1.68% 1.23%
15........................ 2.02% 2.52% 2.09% 2.07% 1.40% 1.80% 1.38%
16........................ 2.25% 2.76% 2.27% 2.23% 1.56% 1.97% 1.58%
17........................ 2.43% 2.89% 2.42% 2.33% 1.68% 2.10%
18........................ 2.59% 3.10% 2.57% 2.49% 1.75% 2.23%
19........................ 2.77% 3.14% 2.70% 2.62% 1.85% 2.35%
20........................ 2.93% 3.30% 2.83% 2.73% 1.92%
21........................ 3.06% 3.47% 2.94% 2.84% 1.98%
22........................ 3.15% 3.60% 3.00% 2.93% 2.09%
23........................ 3.21% 3.70% 3.08% 3.02%
24........................ 3.28% 3.81% 3.17% 3.10%
25........................ 3.40% 3.93% 3.28% 3.22%
26........................ 3.43% 4.06% 3.38%
27........................ 3.55% 4.13% 3.43%
28........................ 3.60% 4.22% 3.54%
29........................ 3.73% 4.23%
30........................ 3.75% 4.29%
31........................ 3.79% 4.31%
32........................ 3.85% 4.33%
33........................ 3.88%
34........................ 3.90%
35........................ 3.94%
36........................ 3.94%
LIQUIDITY AND CAPITAL RESOURCES
The Company requires substantial cash and capital resources to operate its
business. Its primary uses of cash include: (i) acquisition of Contracts; (ii)
payment of dealer participation; (iii) securitization costs, including cash held
in spread accounts; (iv) settlements of hedging transactions; (v) maintenance of
working capital requirements and payment of operating expenses; and (vi)
interest expense. The capital resources available to the Company include: (i)
net interest income during the warehousing period; (ii) contractual servicing
fees; (iii) excess servicing cash flows released from spread accounts; (iv)
settlements of hedging transactions; (v) sales of Contracts in securitizations;
and (vi) borrowings under its Credit Facilities. These sources can provide
capital to fund expansion of the Company's Contract purchasing and servicing
capabilities.
The principal determinant of cash usage in a particular year is the
difference between the dollar amount of Contracts purchased and the proceeds
from sale of Contracts. In 1998, $112 million more Contracts were purchased than
sold vs. a $79 million difference in 1997, resulting in net cash used in
operating activities. In
26
29
1996, proceeds from sale of Contracts exceeded contract purchases by $85
million, resulting in net cash provided by operating activities.
Cash used in investing activities increased to $3.8 million in the year
ended December 31, 1998, from $1.8 million and $804,587 in the years ended
December 31, 1997, and 1996 respectively. The increases resulted from higher
capital expenditures by the Company, principally in the purchase of furniture
and equipment, in connection with the Company's continued expansion.
Cash provided by financing activities was $118.4 million for the year ended
December 31, 1998, compared to $77.2 million provided and $90.5 million used for
the years ended December 31, 1997, and 1996 respectively. This increase over
1997 was primarily due to the issuance of subordinated debt, and additional
borrowing under revolving credit facilities. In 1996, the Company used excess
proceeds from sale of Contracts to paydown warehouse lines, resulting in net
cash used in financing activities.
The Company's wholly-owned special purpose subsidiary, OAFC, is party to a
$375 million auto loan warehouse program (the "CP Facility") with Triple-A One
Funding Corporation ("Triple-A"). Triple-A is a commercial paper asset-backed
conduit lender sponsored by MBIA and is currently rated A-1/P1 by Standard &
Poor's Ratings Group, a division of The McGraw Hill Companies Inc., and Moody's
Investors Service, Inc., respectively (such ratings are not recommendations to
invest and are subject to change). This facility provides funds to purchase
Contracts. The advance rate to OAFC was increased during 1998 to 98% from 95% of
adjusted eligible principal balance of each Contract. The advance rate is
subject to reduction by MBIA if the net yield on OAFC's Contract portfolio falls
below a target net yield. The remaining 2% of the purchase price of the
Contracts generally is funded either from net interest income earned by OAFC or
by proceeds from the Revolving Facility or the Residual Lines described below.
Since the CP Facility is commercial paper based, the Company has the ability to
manage its interest rate exposure during the warehouse period between
origination and securitization by determining the maturities (one to 270 days)
of its commercial paper borrowings.
Upon the occurrence of a wind-down event (as defined in the CP Facility
documents), no further borrowings by OAFC from Triple-A will be permitted and
all collections on the Contracts included in the borrowing base are distributed
in substantially the same manner as before the wind-down event except that all
outstanding Triple-A advances must be repaid before any amounts can be paid to
other borrowers or OAFC. Unless earlier terminated upon the occurrence of a
wind-down event, the CP Facility matures in September 2001, subject to the
requirement that the liquidity facility provided by certain banks to Triple-A be
extended annually. After maturity in September 2001, the CP Facility is subject
to annual renewals upon mutual consent of the parties.
Additionally, the Company has a collateralized revolving line of credit
with a lending group (the "Revolving Facility"). The facility maximum at
December 31, 1998, was $45 million compared to $30 million at December 31, 1997.
The Revolving Facility is used for working capital and other expenditures for
which the Company's $375 million CP Facility is not otherwise available. Under
the Revolving Facility, the Company may (subject to borrowing base availability)
borrow and repay during the two-year revolving period up to $45 million based on
a collateral-based formula. The interest rate is based on the lender's Prime
rate. The Company's obligations under the Revolving Facility are collateralized
by a blanket lien on the Company's assets. The Revolving Facility contains
affirmative, negative and financial covenants and other provisions typical of
such credit facilities. The Revolving Facility converts unless renewed by mutual
consent from revolving loans to fully amortizing two-year term loans on June 28,
1999, or, if earlier, upon the occurrence of certain "Credit Triggers."
The $100 million Merrill Line provides funding for the expansion of the
purchase or origination of Contracts and is used in concert with the CP Facility
the Company currently has in place. The interest rate is based on LIBOR. The
Merrill Line has a term of one year and currently matures in February 2000.
The Residual Lines are used by the Company to finance operating
requirements. The amounts available for borrowing under each line are determined
using a collateral based formula which uses a percentage of the value of excess
cash flow to be received from certain securitizations, and, with respect to the
MLMCI facility,
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a percentage of the amount of the Merrill Line outstanding on a quarterly basis.
The interest rates are based on LIBOR and the Residual Lines have a term of one
year. The facility provided by MLMCI matures in February 2000; the facility
provided by SBRC matures in September 1999.
As of December 31, 1998, the Company has subordinated debt outstanding of
$10 million. The term of the subordinated debt is for two years ending February
24, 2000, with an option by the Company to extend the term by three years during
which the loan would fully amortize. The debt bears a fixed interest rate of
9 1/2%. The Company also issued to the lender a warrant for Common Stock in the
amount of 180,529 shares of the Company's Common Stock.
SECURITIZATIONS
The Company has a securitization program that involves selling interests in
pools of its Contracts to investors through the issuance of AAA/Aaa rated
asset-backed securities. The Company believes that its experience in
securitizations coupled with the quality of Contracts acquired and the Company's
management information systems are instrumental in the Company successfully
completing 14 AAA/Aaa rated publicly underwritten securitizations since October
1994. The Company successfully completed four AAA/Aaa rated publicly
underwritten securitizations in 1998 totaling $911.8 million compared to four
securitizations totaling $527.2 million in 1997 and four securitizations
totaling $405.5 million in 1996.
In the first quarter of 1999, the Company securitized contracts in the
amount of $310 million.
These ongoing periodic securitizations are an integral part of the
Company's business plan because they allow the Company to increase its
liquidity, provide for redeployment of its capital and reduce risks associated
with interest rate fluctuations. The net proceeds of these securitizations are
generally used to pay down outstanding loans under the CP Facility and Merrill
Line, thereby creating availability for the acquisition of additional Contracts.
In each of its securitizations, the Company sells its Contracts from OAFC to a
newly formed grantor or owner trust. The trust in turn issues interest-bearing
notes and/or certificates to investors in an amount equal to the aggregate
principal balance of the Contracts. Purchasers of the notes and/or certificates
backed by Contracts receive a fixed rate of interest established at the time of
the sale. The Company retains the servicing and receives a 1% servicing fee.
INTEREST RATE EXPOSURE AND HEDGING
The Company is able through the use of varying maturities on advances from
the CP Facility to lock in rates during the warehousing period, when in
management's judgment it is appropriate, to limit interest rate exposure during
such warehousing period (See "Risk Factors -- Interest Rate Risk").
The Company has the ability to move rates upward in response to rising
borrowing costs because the Company currently does not originate loans near the
maximum rates permitted by law. Further, the Company employs a hedging strategy
which primarily consists of the execution of forward interest rate swaps. These
hedges are entered into by the Company in numbers and amounts which generally
correspond to the anticipated principal amount of the related securitization.
Gains and losses relative to these hedges are recognized in full at the time of
securitization as an adjustment to the gain on sale of the Contracts. The
Company has only used counterparties with investment grade debt ratings from
national rating agencies for its hedging transactions.
Management monitors the Company's hedging activities on a frequent basis to
ensure that the value of hedges, their correlation to the Contracts being hedged
and the amounts being hedged continue to provide effective protection against
interest rate risk. The Company's hedging strategy requires estimates by
management of monthly Contract acquisition volume and timing of its
securitizations. If such estimates are materially inaccurate, then the Company's
gain on sales of Contracts and results of operations and cash flows could be
adversely affected. The amount and timing of hedging transactions are determined
by senior management based upon the amount of Contracts purchased and the
interest rate environment. Senior management currently expects to hedge
substantially all of its Contr