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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2003
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 No. 000-22474
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 87-0418807
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Penn Square East, Philadelphia, PA 19107
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(Address of principal executive offices) (zip code)
(215) 940-4000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) 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. [X] YES [ ] NO
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). [X] YES [ ] NO
The number of shares outstanding of the registrant's sole class of
common stock as of October 30, 2003 was 2,946,892 shares.
American Business Financial Services, Inc. and Subsidiaries
INDEX
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2003 and June 30, 2003.......................................1
Consolidated Statements of Income for the three months ended September 30, 2003 and 2002.....................2
Consolidated Statement of Stockholders' Equity for the three months ended September 30, 2003.................3
Consolidated Statements of Cash Flow for the three months ended September 30, 2003 and 2002..................4
Notes to Consolidated Financial Statements...................................................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............34
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................................106
Item 4. Controls and Procedures...........................................................................107
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................108
Item 2. Changes in Securities and Use of Proceeds.........................................................108
Item 3. Defaults Upon Senior Securities...................................................................108
Item 4. Submission of Matters to a Vote of Security Holders...............................................108
Item 5. Other Information.................................................................................108
Item 6. Exhibits and Reports on Form 8-K..................................................................109
2
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
American Business Financial Services, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollar amounts in thousands)
September 30, June 30,
2003 2003
------------- -----------
(Unaudited) (Note)
Assets
Cash and cash equivalents $ 27,217 $ 47,475
Loan and lease receivables, net
Available for sale 162,688 271,402
Interest and fees 17,396 15,179
Other 24,681 23,761
Interest-only strips (includes the fair value of
overcollateralization related cash flows of $263,462 and
$279,245 at September 30, 2003 and June 30, 2003) 545,583 598,278
Servicing rights 106,072 119,291
Receivable for sold loans -- 26,734
Prepaid expenses 9,061 3,477
Property and equipment, net 28,314 23,302
Deferred income tax asset 1,042 --
Other assets 28,452 30,452
--------- -----------
Total assets $ 950,506 $ 1,159,351
========= ===========
Liabilities
Subordinated debt $ 687,585 $ 719,540
Warehouse lines and other notes payable 109,410 212,916
Accrued interest payable 43,751 45,448
Accounts payable and accrued expenses 32,725 30,352
Deferred income tax liability -- 17,036
Other liabilities 65,213 91,990
--------- -----------
Total liabilities 938,684 1,117,282
--------- -----------
Stockholders' equity
Preferred stock, par value $.001, authorized, 3,000,000 shares,
issued and outstanding, none -- --
Common stock, par value $.001, authorized, 9,000,000 shares,
issued: 3,653,165 shares (including Treasury shares of 706,273)
at September 30, 2003 and June 30, 2003 4 4
Additional paid-in capital 23,985 23,985
Accumulated other comprehensive income 10,561 14,540
Retained earnings (deficit) (13,164) 13,104
Treasury stock, at cost (8,964) (8,964)
--------- -----------
12,422 42,669
Note receivable (600) (600)
--------- -----------
Total stockholders' equity 11,822 42,069
--------- -----------
Total liabilities and stockholders' equity $ 950,506 $ 1,159,351
========= ===========
Note: The balance sheet at June 30, 2003 has been derived from the audited
financial statements at that date. See accompanying notes to consolidated
financial statements.
1
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Income
(dollar amounts in thousands, except per share data)
(unaudited)
Three Months Ended
September 30,
----------------------------------
2003 2002
--------- ---------
Revenues Gain on sale of loans:
Securitizations $ 799 $ 58,011
Whole loan sales 2,921 35
Interest and fees 4,653 4,133
Interest accretion on interest-only strips 11,109 10,747
Servicing income 718 1,537
Other income 1 4
--------- ---------
Total revenues 20,201 74,467
--------- ---------
Expenses
Interest 16,818 17,083
Provision for credit losses 4,156 1,538
Employee related costs 13,852 9,575
Sales and marketing 2,841 6,688
General and administrative 19,215 20,925
Trading (gains) and losses (5,108) 3,440
Securitization assets valuation adjustment 10,795 12,078
--------- ---------
Total expenses 62,569 71,327
--------- ---------
Income (loss) before provision for income taxes (42,368) 3,140
Provision for income tax expense (benefit) (16,100) 1,319
--------- ---------
Net income (loss) $ (26,268) $ 1,821
========= =========
Earnings (loss) per common share:
Basic (8.91) $ 0.64
========= =========
Diluted $ (8.91) $ 0.61
========= =========
Average common shares (in thousands):
Basic 2,947 2,856
========= =========
Diluted 2,947 2,985
========= =========
See accompanying notes to consolidated financial statements.
2
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
(amounts in thousands)
(unaudited)
Common Stock
----------------------- Accumulated
Number of Additional Other Retained
For the three months ended Shares Paid-In Comprehensive Earnings Treasury
September 30, 2003: Outstanding Amount Capital Income (Deficit) Stock
----------- ------ ---------- ------------- --------- ---------
Balance June 30, 2003 2,947 $ 4 $ 23,985 $ 14,540 $ 13,104 $ (8,964)
Comprehensive income:
Net (loss) -- -- -- -- (26,268) --
Net unrealized loss on
interest-only strips -- -- -- (3,979) -- --
------ ----- -------- -------- -------- --------
Total comprehensive loss -- -- -- (3,979) (26,268) --
------ ----- -------- -------- -------- --------
Balance September 30, 2003 2,947 $ 4 $ 23,985 $ 10,561 $(13,164) $ (8,964)
====== ===== ======== ======== ======== ========
Total
For the three months ended Note Stockholders'
September 30, 2003: Receivable Equity
---------- -------------
Balance June 30, 2003 $ (600) $ 42,069
Comprehensive income:
Net (loss) -- (26,268)
Net unrealized loss on
interest-only strips -- (3,979)
--------- ----------
Total comprehensive loss -- (30,247)
--------- ----------
Balance September 30, 2003 $ (600) $ 11,822
========= ==========
See accompanying notes to consolidated financial statements.
3
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
(dollar amounts in thousands)
(unaudited)
Three Months Ended
September 30,
----------------------------
2003 2002
----------- ----------
Cash flows from operating activities
Net income (loss) $ (26,268) $ 1,821
Adjustments to reconcile net income to net cash used in operating
activities:
Gain on sales of loans (799) (58,011)
Depreciation and amortization 14,647 11,163
Interest accretion on interest-only strips (10,828) (10,747)
Securitization assets valuation adjustment 10,795 12,078
Provision for credit losses 4,156 1,538
Loans originated for sale (158,284) (386,390)
Proceeds from sale of loans 278,523 382,181
Principal payments on loans and leases 4,169 4,382
(Increase) decrease in accrued interest and fees on loan and lease
receivables (2,217) 724
Required purchase of additional overcollateralization on securitized
loans (7,660) (17,128)
Cash flow from interest-only strips 56,222 33,464
(Increase) decrease in prepaid expenses (5,584) 199
(Decrease) increase in accrued interest payable (1,696) 2,427
Increase in accounts payable and accrued expenses 2,372 5,929
Accrued interest payable reinvested in subordinated debt 9,686 7,863
Decrease in deferred income taxes (16,097) (598)
Increase in loans in process (24,148) (529)
Other, net 1,415 1,106
----------- ----------
Net cash provided by (used in) operating activities 128,404 (8,528)
----------- ----------
Cash flows from investing activities
Purchase of property and equipment, net (6,774) (1,031)
Principal receipts and maturity of investments 11 8
----------- ----------
Net cash used in investing activities (6,763) (1,023)
----------- ----------
4
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow (continued)
(dollar amounts in thousands)
(unaudited)
Three Months Ended
September 30,
----------------------------
2003 2002
----------- ----------
Cash flows from financing activities
Proceeds from issuance of subordinated debt $ 1,576 $ 40,006
Redemptions of subordinated debt (43,217) (33,898)
Net borrowings on revolving lines of credit (77,271) 3,110
Principal payments on lease funding facility -- (931)
Principal payments under capital lease obligations (77) --
Net repayments of other notes payable (26,158) --
Financing costs incurred (314) (233)
Lease incentive receipts 3,562 --
Exercise of non-employee stock options -- 50
Cash dividends paid -- (229)
----------- ----------
Net cash provided by (used in) financing activities (141,899) 7,875
----------- ----------
Net (decrease) increase in cash and cash equivalents (20,258) (1,676)
Cash and cash equivalents at beginning of year 47,475 108,599
----------- ----------
Cash and cash equivalents at end of year $ 27,217 $ 106,923
=========== ==========
Supplemental disclosures:
Noncash transaction recorded for capitalized lease agreement:
Increase in property and equipment $ -- $ (1,022)
Increase in warehouse lines and other notes payable $ -- $ 1,022
Cash paid during the period for:
Interest $ 8,828 $ 6,793
Income taxes $ 40 $ 700
See accompanying notes to consolidated financial statements.
5
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2003
1. Summary of Significant Accounting Policies
Business
American Business Financial Services, Inc. ("ABFS"), together with its
subsidiaries (the "Company"), is a diversified financial services organization
operating predominantly in the eastern and central portions of the United
States. The Company originates, sells and services home equity loans and,
subject to market conditions in the secondary loan market, business purpose
loans through its principal direct and indirect subsidiaries. The Company also
processes and purchases home equity loans from other financial institutions
through the Bank Alliance Services program.
The Company's loans primarily consist of fixed interest rate loans secured by
first or second mortgages on one-to-four family residences. The Company's
customers are primarily credit-impaired borrowers who are generally unable to
obtain financing from banks or savings and loan associations and who are
attracted to our products and services. The Company originates loans through a
combination of channels including a national processing center located at its
centralized operating office in Philadelphia, Pennsylvania and a small
processing center in Roseland, New Jersey. The Company's centralized operating
office was located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. Prior to
June 30, 2003, the Company also originated home equity loans through several
retail branch offices. Effective June 30, 2003, the Company no longer originates
home equity loans through retail branch offices. In addition, the Company offers
subordinated debt securities to the public, the proceeds of which are used for
repayment of existing debt, loan originations, operations (including repurchases
of delinquent assets from securitization trusts), investments in systems and
technology and for general corporate purposes including funding our operating
cash requirements and loan over collateralization requirements under the
Company's credit facilities.
Effective December 31, 1999, the Company de-emphasized and subsequent to that
date, discontinued the equipment leasing origination business but continues to
service the remaining portfolio of leases.
Business Conditions
For its ongoing operations, the Company depends upon frequent financings,
including the sale of unsecured subordinated debt securities, borrowings under
warehouse credit facilities or lines of credit and the sale of loans on a whole
loan basis or through publicly underwritten or privately placed securitizations.
If the Company is unable to renew or obtain adequate funding on acceptable terms
through its sale of subordinated debt securities or under a warehouse credit
facility, or other borrowings, the lack of adequate funds would adversely impact
liquidity and reduce profitability or result in losses. If the Company is unable
to sell or securitize its loans, its liquidity would be reduced and it may incur
losses. To the extent that the Company is not successful in maintaining or
replacing existing subordinated debt securities upon maturity, or maintaining
adequate warehouse credit facilities or lines of credit, or securitizing and
selling its loans, it may
6
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
have to limit future loan originations and further restructure its operations.
Limiting loan originations or restructuring operations could impair the
Company's ability to repay subordinated debt at maturity and may result in
losses.
The Company has historically experienced negative cash flow from operations
since 1996 primarily because, in general, its business strategy of selling loans
through securitization has not generated cash flow immediately. For the three
months ended September 30, 2003, the Company experienced positive cash flow from
operations of $128.4 million due to its sales of loans originated in prior
periods that were carried on its balance sheet at June 30, 2003. During the
three months ended September 30, 2003, the Company received cash on whole loan
sales of $245.2 million of loans.
For the three months ended September 30, 2003, the Company recorded a net loss
of $26.3 million. The loss primarily resulted from liquidity issues described
below, which substantially reduced the Company's ability to originate loans and
generate revenues during the first quarter of fiscal 2004, its inability to
complete a securitization of loans during the first quarter of fiscal 2004, and
$10.8 million of pre-tax charges for valuation adjustments on its securitization
assets. For the three months ended September 30, 2003, the Company originated
$124.1 million of loans, which represents a significant reduction as compared to
$370.7 million of loans originated in the same period of the prior fiscal year.
The valuation adjustments reflect the impact of higher than anticipated
prepayments on securitized loans experienced during the first three months of
fiscal 2004 due to the continuing low interest rate environment.
For the fiscal year ended June 30, 2003, the Company recorded a loss of $29.9
million. The loss in fiscal 2003 was primarily due to the Company's inability to
complete a securitization of loans during the fourth quarter of fiscal 2003 and
to $45.2 million of net pre-tax charges for net valuation adjustments recorded
on securitization assets.
Several recent events negatively impacted the Company's short-term liquidity.
Its inability to complete a securitization during the fourth quarter of fiscal
2003 contributed to the loss for fiscal 2003 and adversely impacted the
Company's short-term liquidity position. In addition, further advances under a
non-committed portion of one of the Company's credit facilities were subject to
the discretion of the lender and subsequent to June 30, 2003, no new advances
took place under the non-committed portion. Additionally, on August 20, 2003,
amendments to this credit facility eliminated the non-committed portion of this
facility and reduced the committed portion to $50.0 million and accelerated the
expiration date from November 2003 to September 30, 2003. Also a $300.0 million
mortgage conduit facility with a financial institution that enabled the Company
to sell its loans into an off-balance sheet facility, expired pursuant to its
terms on July 5, 2003. In addition we were unable to borrow under the Company's
$25.0 million warehouse facility after September 30, 2003 and this facility
expired on October 31, 2003.
At June 30, 2003, of the $516.1 million in revolving credit and
7
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
conduit facilities available, $453.4 million was drawn upon. The Company's
revolving credit facilities and mortgage conduit facility had $62.7 million of
unused capacity available at June 30, 2003, which significantly reduced its
ability to fund future loan originations until it sells existing loans, extends
or expands existing credit facilities, or adds new credit facilities. In
addition, the Company was unable to borrow under its $25.0 million warehouse
facility after September 30, 2003 and this facility expired on October 31, 2003.
At September 30, 2003, the Company had $147.0 million in revolving credit
facilities available to the Company, of which $108.6 million was drawn upon. In
addition, the Company's temporary discontinuation of sales of new subordinated
debt for approximately a six week period during the first quarter of fiscal
2004 further impaired its liquidity.
As a result of these liquidity issues, since June 30, 2003, the Company
substantially reduced its loan origination volume. From July 1, 2003 through
September 30, 2003, the Company originated $124.1 million of loans which
represents a significant reduction as compared to originations of $370.7 million
of loans for the same period in fiscal 2003. The Company also experienced a loss
in loan origination employees. The Company's inability to originate loans at
previous levels adversely impacted the relationships its subsidiaries have or
are developing with their brokers and its ability to retain employees. As a
result of the decrease in loan originations and liquidity issues described
above, the Company incurred a loss for the first quarter of fiscal 2004 and
anticipates incurring losses in future periods.
The combination of the Company's current cash position and expected sources of
operating cash over the second and third quarters of fiscal 2004 may not be
sufficient to cover its operating cash requirements, and the Company anticipates
incurring operating losses through at least the third quarter of fiscal 2004. On
October 24, 2003, the Company had cash of approximately $32.4 million and up to
$437.3 million available under its new credit facilities. Advances under these
new credit facilities can only be used to fund loan originations and not for any
other purposes. The Company anticipates that it will need to increase loan
originations to approximately $700.0 million to $800.0 million per quarter to
return to profitable operations. The Company's short-term plan to achieve these
levels of loan originations includes replacing the loan origination employees
recently lost and creating an expanded broker initiative. Beyond the short-term,
the Company expects to increase originations through the application of the
business strategy adjustments discussed below. The Company's ability to achieve
those levels of loan originations could be hampered by a failure to implement
its short-term plans and funding limitations expected during the start up of its
new credit facilities.
For the next three to six months the Company expects to augment its sources of
operating cash with proceeds from the issuance of subordinated debt. In addition
to repaying maturing subordinated notes, proceeds from the issuance of
subordinated debt will be used to fund overcollateralization requirements in
connection with loan originations. Under the terms of the Company's credit
facilities, these credit facilities will advance 75% to 97% of the value of
loans the Company originates. As a result of this limitation, the Company must
fund the difference
8
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
between the loan value and the advances, referred to as the
overcollateralization requirement, from the Company's operating cash and fund
its operating losses.
In light of the loss for the quarter ended September 30, 2003, the Company
requested and obtained waivers for its non-compliance with financial covenants
in its credit facilities and Pooling and Servicing Agreements. See Note 6 for
more detail.
The Company undertook specific remedial actions to address short-term liquidity
concerns including entering into an agreement on June 30, 2003 with an
investment bank to sell up to $700.0 million of mortgage loans, subject to the
satisfactory completion of the purchaser's due diligence review and other
conditions, and soliciting bids and commitments from other participants in the
whole loan sale market. In total, from June 30, 2003 through September 30, 2003,
the Company sold approximately $493.3 million (which includes $222.3 million of
loans sold by the expired mortgage conduit facility) of loans through whole loan
sales. The process of selling loans is continuing. The Company also suspended
paying quarterly dividends on its common stock.
On September 22, 2003, the Company entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding loan originations. On October 14, 2003, the Company entered into
definitive agreements with a warehouse lender for a revolving mortgage loan
warehouse credit facility of up to $250.0 million to fund loan originations. See
Note 6 for information regarding the terms of these facilities.
Although the Company obtained two new credit facilities totaling $450.0 million,
it may only use the proceeds of these credit facilities to fund loan
originations and not for any other purpose. Consequently, the Company will have
to generate cash to fund the balance of its business operations from other
sources, such as whole loan sales, additional financings and sales of
subordinated debt.
On October 16, 2003, the Company refinanced through a mortgage warehouse conduit
facility $40.0 million of loans that were previously held in an off-balance
sheet mortgage conduit facility which expired pursuant to its terms in July
2003. The Company also refinanced an additional $133.5 million of mortgage loans
in the new conduit facility which were previously held in other warehouse
facilities, including the $50.0 million warehouse facility which expired on
October 17, 2003. The more favorable advance rate under this conduit facility as
compared to the expired facilities which previously held these loans, along with
loans fully funded with company cash, resulted in the receipt of $17.0 million
in cash. On October 31, 2003, the Company completed a privately-placed
securitization of the $173.5 million of loans, with servicing released, that had
been transferred to this conduit facility. The terms of this conduit facility
provide that it will terminate upon the disposition of the loans held by it.
9
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
To the extent that the Company fails to maintain its credit facilities or obtain
alternative financing on acceptable terms and increase its loan originations, it
may have to sell loans earlier than intended and further restructure its
operations. While the Company currently believes that it will be able to
restructure its operations, if necessary, it can provide no assurances that such
restructuring will enable it to attain profitable operations or repay the
subordinated debt when due.
After the Company recognized its inability to securitize its loans in the fourth
quarter of fiscal 2003, it adjusted its business strategy to emphasize, among
other things, more whole loan sales. The Company intends to continue to evaluate
both public and privately placed securitization transactions, subject to market
conditions.
At September 30, 2003 there were approximately $288.4 million of subordinated
debentures maturing within twelve months. The Company obtains the funds to repay
the subordinated debentures at their maturities by securitizing loans, selling
whole loans and selling additional subordinated debentures. Cash flow from
operations, the issuance of subordinated debentures and lines of credit fund the
Company's cash needs. The Company expects these sources of funds to be
sufficient to meet its cash needs. The Company could, in the future, generate
cash flows by securitizing, selling, or borrowing against its interest-only
strips and selling servicing rights generated in past securitizations.
In the event the Company is unable to offer additional subordinated debentures
for any reason, the Company has developed a contingent financial restructuring
plan including cash flow projections for the next twelve-month period. Based
on the Company's current cash flow projections, the Company anticipates being
able to make all scheduled subordinated debenture maturities and vendor
payments.
The contingent financial restructuring plan is based on actions that the
Company would take, in addition to those indicated in its adjusted business
strategy, to reduce its operating expenses and conserve cash. These actions
would include reducing capital expenditures, selling all loans originated on a
whole loan basis, eliminating or downsizing various lending, overhead and
support groups, and scaling back less profitable businesses. No assurance can
be given that the Company will be able to successfully implement the contingent
financial restructuring plan, if necessary, and repay the subordinated
debentures when due.
10
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
1. Summary of Significant Accounting Policies (continued)
Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of ABFS and its
subsidiaries (all of which are wholly owned). The consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America. All significant intercompany balances
and transactions have been eliminated. In preparing the consolidated financial
statements, management is required to make estimates and assumptions which
affect the reported amounts of assets and liabilities as of the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. These estimates include, among other things, estimated prepayment,
credit loss and discount rates on interest-only strips and servicing rights,
estimated servicing revenues and costs, valuation of real estate owned, the net
recoverable value of interest and fee receivables and determination of the
allowance for credit losses.
Certain prior period financial statement balances have been reclassified to
conform to current period presentation. All outstanding shares, average common
shares, earnings per common share and stock option amounts have been
retroactively adjusted to reflect the effect of a 10% stock dividend declared
August 21, 2002 and amounts reported for June 30, 2001 and 2000 have been
retroactively adjusted to reflect the effect of a 10% stock dividend declared
October 1, 2001.
Recent Accounting Pronouncements
In January 2003, the FASB issued FIN 46 "Consolidation of Variable Interest
Entities," referred to as FIN 46 in this document. FIN 46 provides guidance on
the identification of variable interest entities that are subject to
consolidation requirements by a business enterprise. A variable interest entity
subject to consolidation requirements is an entity that does not have sufficient
equity at risk to finance its operations without additional support from third
parties and the equity investors in the entity lack certain characteristics of a
controlling financial interest as defined in the guidance. Special Purpose
Entity (SPE) is one type of entity, which under certain circumstances may
qualify as a variable interest entity. Although we use unconsolidated SPEs
extensively in our loan securitization activities, the guidance will not affect
our current consolidation policies for SPEs as the guidance does not change the
guidance incorporated in SFAS No. 140 which precludes consolidation of a
qualifying SPE by a transferor of assets to that SPE. FIN 46 will therefore have
no effect on our financial condition or results of operations and would not be
expected to affect it in the future. In March 2003, the FASB announced that it
is reconsidering the permitted activities of a qualifying SPE. We cannot predict
whether the guidance will change or what effect, if any, changes may have on our
current consolidation policies for SPEs. In October, 2003 the FASB announced
that it was deferring implementation of FIN 46 for all variable interest
entities that were created before February 1, 2003 until the quarter ended
11
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (continued)
December 31, 2003. The requirements of Interpretation of FIN 46 apply
immediately to variable interest entities created after January 31, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" to clarify
the financial accounting and reporting for derivative instruments and hedging
activities. SFAS No. 149 is intended to improve financial reporting by requiring
comparable accounting methods for similar contracts. SFAS No. 149 is effective
for contracts entered into or modified subsequent to June 30, 2003. The
requirements of SFAS No. 149 do not affect the Company's current accounting for
derivative instruments or hedging activities and therefore will have no effect
on the Company's financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
requires an issuer to classify certain financial instruments, such as
mandatorily redeemable shares and obligations to repurchase the issuer's equity
shares, as liabilities. The guidance is effective for financial instruments
entered into or modified subsequent to May 31, 2003, and otherwise is effective
at the beginning of the first interim period after June 15, 2003. The Company
does not have any instruments with such characteristics and does not expect SFAS
No. 150 to have a material impact on the financial condition or results of
operations.
Restricted Cash Balances
The Company held restricted cash balances of $9.4 million and $11.0 million
related to borrower escrow accounts at September 30, 2003 and June 30, 2003,
respectively, and $0.2 million and $6.0 million related to deposits for future
settlement of interest rate swap contracts at September 30, 2003 and June 30,
2003, respectively.
12
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
2. Loan and Lease Receivables
Loan and lease receivables - available for sale were comprised of the following
(in thousands):
September 30, June 30,
2003 2003
----------- ----------
Real estate secured loans (a) $ 164,772 $ 270,096
Leases, net of unearned income of $550 and $668 (b) 3,386 4,154
----------- ----------
168,158 274,250
Less: allowance for credit losses on loan and lease
receivables available for sale 5,470 2,848
----------- ----------
$ 162,688 $ 271,402
=========== ==========
(a) Includes deferred direct loan origination costs of $2.6 million and $6.8
million at September 30, 2003 and June 30, 2003, respectively.
(b) Includes deferred direct lease origination costs of $14 thousand and $28
thousand at September 30, 2003 and June 30, 2003, respectively.
Real estate secured loans have contractual maturities of up to 30 years.
At September 30, 2003 and June 30, 2003, the accrual of interest income was
suspended on real estate secured loans of $11.9 million and $5.4 million,
respectively. The allowance for loan losses includes reserves established for
expected losses on these loans in the amount of $3.7 million and $1.4 million at
September 30, 2003 and June 30, 2003, respectively.
Average balances of non-accrual loans were $9.1 million for the three months
ended September 30, 2003 and $8.6 million for the 2003 fiscal year,
respectively.
Substantially all leases are direct finance-type leases whereby the lessee has
the right to purchase the leased equipment at the lease expiration for a nominal
amount.
Loan and lease receivables - Interest and fees are comprised mainly of accrued
interest and fees on loans and leases that are less than 90 days delinquent. Fee
receivables include, among other types of fees, forbearance and deferment
advances. Under deferment and forbearance arrangements, the Company makes
advances to a securitization trust on behalf of a borrower in amounts equal to
the delinquent principal and interest and may pay fees, including taxes,
insurance and other fees on behalf of the borrower. As a result of these
arrangements the Company resets the contractual status of a loan in its managed
portfolio from delinquent to current based upon the borrower's resumption of
making their loan payments. These amounts are carried at their estimated net
recoverable value.
13
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
2. Loan and Lease Receivables (continued)
Loan and lease receivables - Other is comprised of receivables for securitized
loans. In accordance with the Company's securitization agreements, the Company
has the right, but not the obligation, to repurchase a limited amount of
delinquent loans from securitization trusts. Repurchasing delinquent loans from
securitization trusts benefits the Company by allowing it to limit the level of
delinquencies and losses in the securitization trusts and as a result, the
Company can avoid exceeding specified limits on delinquencies and losses that
trigger a temporary reduction or discontinuation of cash flow from its
interest-only strips until the delinquency or loss triggers are no longer
exceeded. The Company's ability to repurchase these loans does not disqualify it
for sale accounting under SFAS No. 140, which was adopted on a prospective basis
in the fourth quarter of fiscal 2001, or other relevant accounting literature
because the Company is not required to repurchase any loan and its ability to
repurchase a loan is limited by contract. In accordance with the provisions of
SFAS No. 140, the Company has recorded an obligation for the repurchase of loans
subject to these removal of accounts provisions, whether or not the Company
plans to repurchase the loans. The obligation for the loans' purchase price is
recorded in other liabilities. A corresponding receivable is recorded at the
lower of the loans' cost basis or fair value.
3. Interest-Only Strips
The activity for interest-only strip receivables for the three months ended
September 30, 2003 and 2002 were as follows (in thousands):
September 30,
2003 2002
-----------------------
Balance at beginning of period $ 598,278 $ 512,611
Initial recognition of interest-only strips 950 44,126
Cash flow from interest-only strips (56,222) (33,464)
Required purchases of additional overcollateralization 7,660 17,128
Interest accretion 10,828 10,747
Net temporary adjustments to fair value (a) (5,960) 4,792
Other than temporary fair value adjustment (a) (9,951) (12,078)
-----------------------
Balance at end of period $ 545,583 $ 543,862
=======================
(a) Net temporary adjustments to fair value are recorded through other
comprehensive income, which is a component of equity. Other than temporary
adjustments to decrease the fair value of interest-only strips are recorded
through the income statement.
14
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
3. Interest-Only Strips (continued)
Interest-only strips include overcollateralization balances that represent
undivided interests in securitizations maintained to provide credit enhancement
to investors in securitization trusts. At September 30, 2003 and 2002, the fair
value of overcollateralization related cash flows were $263.5 million and $251.0
million, respectively.
Beginning in the second quarter of fiscal 2002 and on a quarterly basis
thereafter, the Company increased the prepayment rate assumptions used to value
its securitization assets, thereby decreasing the fair value of these assets.
However, because the Company's prepayment rates as well as those throughout the
mortgage industry continued to remain at higher than expected levels due to
continuous declines in interest rates during this period to 40-year lows, the
Company's prepayment experience exceeded even the revised assumptions. As a
result, over the last eight quarters the Company has recorded cumulative pre-tax
write downs to its interest-only strips in the aggregate amount of
$138.8 million and pre-tax adjustments to the value of servicing rights of
$13.2 million, for total adjustments of $152.0 million, mainly due to the higher
than expected prepayment experience. Of this amount, $95.9 million was expensed
through the income statement and $56.1 million resulted in a write down through
other comprehensive income, a component of stockholders' equity.
During the three months ended September 30, 2003, the Company recorded total
pre-tax valuation adjustments on its securitization assets of $16.7 million, of
which $10.8 million was charged to the income statement and $5.9 million was
charged to other comprehensive income. The breakout of the total adjustments in
the first three months of fiscal 2004 between interest-only strips and servicing
rights was as follows:
o The Company recorded total pre-tax valuation adjustments on its
interest only-strips of $15.8 million, of which, in accordance
with EITF 99-20, $9.9 million was charged to the income statement
and $5.9 million was charged to other comprehensive income. The
valuation adjustment reflects the impact of higher than
anticipated prepayments on securitized loans experienced in the
first quarter of fiscal 2004 due to the continuing low interest
rate environment.
o The Company recorded total pre-tax valuation adjustments on its
servicing rights of $0.8 million, which was charged to the income
statement. The valuation adjustment reflects the impact of higher
than anticipated prepayments on securitized loans experienced in
the first quarter of fiscal 2004 due to the continuing low
interest rate environment.
The long duration of historically low interest rates has given borrowers an
extended opportunity to engage in mortgage refinancing activities which resulted
in elevated prepayment experience. The persistence of historically low interest
rate levels, unprecedented in the last 40 years, has made the forecasting of
15
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
3. Interest-Only Strips (continued)
prepayment levels in future fiscal periods difficult. The Company had assumed
that the decline in interest rates had stopped and a rise in interest rates
would occur in the near term. Consistent with this view, the Company had
utilized derivative financial instruments to manage interest rate risk exposure
on its loan production and loan pipeline to protect the fair value of these
fixed rate items against potential increases in market interest rates. Based on
current economic conditions and published mortgage industry surveys including
the Mortgage Bankers Association's Refinance Indexes available at the time of
the Company's quarterly revaluation of its interest-only strips and servicing
rights, and its own prepayment experience, the Company believes prepayments will
continue to remain at higher than normal levels for the near term before
returning to average historical levels. The Mortgage Bankers Association of
America has forecast as of September 15, 2003 that mortgage refinancings as a
percentage share of total mortgage originations will decline from 71% in the
first quarter of calendar 2003 to 39% in the first quarter of calendar 2004 and
to 25% in the second quarter of calendar 2004. The Mortgage Bankers Association
of America has also projected in its September 2003 economic forecast that the
10-year treasury rate (which generally affects mortgage rates) will increase
over the next three quarters. As a result of the Company's analysis of these
factors, it has increased its prepayment rate assumptions for home equity loans
for the near term, but at a declining rate, before returning to its historical
levels. However, the Company cannot predict with certainty what its prepayment
experience will be in the future. Any unfavorable difference between the
assumptions used to value its actual experience may have a significant adverse
impact on the value of these assets.
The following tables detail the pre-tax write downs of the securitization assets
by quarter and details the impact to the income statement and to other
comprehensive income in accordance with the provisions of SFAS No. 115
"Accounting for Certain Investments in Debt and Equity Securities" and EITF
99-20 as they relate to interest-only strips and SFAS No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
as it relates to servicing rights (in thousands):
Fiscal Year 2004:
-----------------
Income Other
Total Statement Comprehensive
Quarter Ended Write down Impact Income Impact
- --------------------------- ---------- --------- -------------
September 30, 2003 $ 16,658 $ 10,795 $ 5,863
16
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
3. Interest-Only Strips (continued)
Fiscal Year 2003:
-----------------
Income Other
Total Statement Comprehensive
Quarter Ended Write down Impact Income Impact
- --------------------------- ---------- --------- -------------
September 30, 2002 $ 16,739 $ 12,078 $ 4,661
December 31, 2002 16,346 10,568 5,778
March 31, 2003 16,877 10,657 6,220
June 30, 2003 13,293 11,879 1,414
--------- -------- --------
Total Fiscal 2003 $ 63,255 $ 45,182 $ 18,073
========= ======== ========
Fiscal Year 2002:
-----------------
Income Other
Total Statement Comprehensive
Quarter Ended Write down Impact Income Impact
- --------------------------- ---------- --------- -------------
December 31, 2001 $ 11,322 $ 4,462 $ 6,860
March 31, 2002 15,513 8,691 6,822
June 30, 2002 17,244 8,900 8,344
--------- -------- --------
Total Fiscal 2002 $ 44,079 $ 22,053 $ 22,026
========= ======== ========
Note: The impacts of prepayments on our securitization assets in the quarter
ended September 30, 2001 were not significant.
4. Servicing Rights
Activity for the loan and lease servicing rights asset for the three months
ended September 30, 2003 and 2002 were as follows (in thousands):
September 30,
2003 2002
------------------------
Balance at beginning of year $ 119,291 $ 125,288
Initial recognition of servicing rights - 12,193
Amortization (12,375) (8,625)
Write down (844) -
-------------------------
Balance at end of year $ 106,072 $ 128,856
=========================
Servicing rights are valued quarterly by the Company based on the current
estimated fair value of the servicing asset. A review for impairment is
performed by stratifying the serviced loans and leases based on loan type, which
is considered to be the predominant risk characteristic due to their different
prepayment characteristics and fee structures. During the first quarter of
fiscal 2004, we recorded total pre-tax valuation adjustments on our servicing
rights of $0.8 million, which was charged to the income statement.
17
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
5. Other Assets and Other Liabilities
Other assets were comprised of the following (in thousands):
September 30, June 30,
2003 2003
---------- ---------
Goodwill $ 15,121 $ 15,121
Real estate owned 4,566 4,776
Financing costs, debt offerings 3,803 3,984
Due from securitization trusts for
servicing related activities 1,202 1,344
Investments held to maturity 870 881
Other 2,890 4,346
---------- ---------
$ 28,452 $ 30,452
========== =========
Other liabilities were comprised of the following (in thousands):
September 30, June 30,
2003 2003
---------- ---------
Obligation for repurchase of securitized loans $ 29,036 $ 27,954
Unearned lease incentives 13,027 9,465
Commitments to fund closed loans 11,039 35,187
Escrow deposits held 9,386 10,988
Deferred rent incentive 1,314 -
Hedging liabilities, at fair value - 6,335
Periodic advance guarantee 450 650
Trading liabilities, at fair value 157 334
Other 804 1,077
---------- ---------
$ 65,213 $ 91,990
========== =========
See Note 2 for an explanation of the obligation for the repurchase of
securitized loans.
18
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
6. Subordinated Debt and Warehouse Lines and Other Notes Payable
Subordinated debt was comprised of the following (in thousands):
September 30, June 30,
2003 2003
---------- ---------
Subordinated debt (a) $ 672,252 $ 702,423
Subordinated debt - money market notes (b) 15,333 17,117
---------- ---------
Total subordinated debt $ 687,585 $ 719,540
========== =========
Warehouse lines and other notes payable were comprised of the following (in
thousands):
September 30, June 30,
2003 2003
---------- ---------
Warehouse and operating revolving line of credit (c) $ 46,626 $ --
Warehouse and operating revolving line of credit (d) -- 30,182
Warehouse revolving line of credit (e) 38,248 136,098
Warehouse revolving line of credit (f) 23,806 19,671
Capitalized leases (g) 730 807
Bank overdraft (h) -- 26,158
---------- ---------
Total warehouse lines and other notes payable $ 109,410 $ 212,916
========== =========
(a) Subordinated debt due October 2003 through October 2013, interest rates
ranging from 3.50% to 13.00%; average rate at September 30, 2003 was 8.89%,
average remaining maturity was 19.9 months, subordinated to all of the
Company's senior indebtedness. The average rate on subordinated debt
including money market notes was 8.78% at September 30, 2003.
(b) Subordinated debt - money market notes due upon demand, interest rate at
4.0%; subordinated to all of the Company's senior indebtedness.
(c) $200.0 million warehouse and operating revolving line of credit with
JPMorgan Chase Bank entered into on September 22, 2003, but limited to
$80.0 million borrowing capacity at September 30, 2003 and contingent upon
the closing of an additional credit facility. Once the additional credit
facility was closed on October 14, 2003, the full $200.0 million became
available. Interest rates on the advances under this facility are based
upon one-month LIBOR plus a margin. Obligations under the facility are
collateralized by pledged loans.
(d) $50.0 million warehouse and operating revolving line of credit with JPMorgan
Chase Bank, collateralized by certain pledged loans, advances to
securitization trusts, real estate owned and certain interest-only strips
which was replaced, for warehouse lending purposes, by the $200.0 million
facility on September 22, 2003. Pursuant to an amendment, this facility
remained in place as an $8.0 million letter of credit facility to secure
lease obligations for corporate office space. The amount of the letter of
credit was $8.0 million at September 30, 2003 and will decrease over the
term of the lease.
19
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
6. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
(e) Originally a $200.0 million warehouse line of credit with Credit Suisse
First Boston Mortgage Capital, LLC. $100.0 million of this facility was
continuously committed for the term of the facility while the remaining
$100.0 million of the facility was available at Credit Suisse's discretion.
Subsequent to June 30, 2003, there were no new advances under the
non-committed portion. On August 20, 2003, this credit facility was amended
to reduce the committed portion to $50.0 million (from $100.0 million),
eliminate the non-committed portion and accelerate its expiration date from
November 2003 to September 30, 2003. The expiration date was subsequently
extended to October 17, 2003, but no new advances were permitted under this
facility subsequent to September 30, 2003. This facility was paid down in
full on October 16, 2003. The interest rate on the facility was based on
one-month LIBOR plus a margin. Advances under this facility were
collateralized by pledged loans.
(f) $25.0 million warehouse line of credit facility from Residential Funding
Corporation. Under this warehouse facility, advances may be obtained,
subject to specific conditions described in the agreements. However, we
were not in compliance with the financial covenants in this facility at
September 30, 2003 and as a condition of obtaining a waiver for
non-compliance, the Company was not permitted further advances under this
line. Interest rates on the advances were based on one-month LIBOR plus a
margin. The obligations under this agreement were collateralized by pledged
loans. This facility was paid down in full on October 16, 2003 and it
expired pursuant to its terms on October 31, 2003.
(g) Capitalized leases, maturing through January 2006, imputed interest rate of
8.0%, collateralized by computer equipment.
(h) Overdraft amount on bank accounts paid on the following business day.
Principal payments on subordinated debt, warehouse lines and other notes payable
for the next five years are as follows (in thousands): period ending September
30, 2004 - $397,390; 2005 - $167,464; 2006 - $163,379; 2007 - $27,616; and, 2008
- - $14,043.
At September 30, 2003, warehouse lines and other notes payable were
collateralized by $123.2 million of loan and lease receivables and $1.0 million
of computer equipment.
In addition to the above, the Company had available a $5.0 million operating
line of credit expiring January 2004, fundings to be collateralized by
investments in the 99-A lease securitization trust and Class R and X
certificates of Mortgage Loan Trust 2001-2. This line was unused at September
30, 2003. Until its expiration, the Company also had available a $300.0 million
mortgage conduit facility. This facility expired pursuant to its terms on July
5, 2003. At September 30, 2003, $36.0 million was outstanding under this
facility. The facility provided for the sale of loans into an off-balance sheet
facility with UBS Principal Finance, LLC, an affiliate of UBS Warburg. This
facility was paid down in full on October 16, 2003.
20
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
6. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
Interest rates paid on the revolving credit facilities range from London
Inter-Bank Offered Rate ("LIBOR") plus 0.95% to LIBOR plus 1.75%. The
weighted-average interest rate paid on the revolving credit facilities was 2.80%
and 2.24% at September 30, 2003 and June 30, 2003, respectively.
The warehouse credit agreements require that the Company maintain specific
financial covenants regarding net worth, leverage, net income, liquidity, total
debt and other standards. Each agreement has multiple individualized financial
covenant thresholds and ratio of limits that the Company must meet as a
condition to drawing on a particular line of credit. Pursuant to the terms of
these credit facilities, the failure to comply with the financial covenants
constitutes an event of default and at the option of the lender, entitles the
lender to, among other things, terminate commitments to make future advances to
the Company, declare all or a portion of the loan due and payable, foreclose on
the collateral securing the loan, require servicing payments be made to the
lender or other third party or assume the servicing of the loans securing the
credit facility. An event of default under these credit facilities would result
in defaults pursuant to cross-default provisions of our other agreements,
including but not limited to, other loan agreements, lease agreements and other
agreements. The failure to comply with the terms of these credit facilities or
to obtain the necessary waivers would have a material adverse effect on the
Company's liquidity and capital resources.
As a result of the loss experienced during fiscal 2003, the Company was not in
compliance with the terms of certain financial covenants related to net worth,
consolidated stockholders' equity and the ratio of total liabilities to
consolidated stockholders' equity under two of its principal credit facilities
at June 30, 2003 (one for $50.0 million and the other for $200.0 million, which
was reduced to $50.0 million). The Company has requested and obtained waivers
from these covenant provisions from both lenders. The lender under the
$50.0 million warehouse credit facility has granted the Company a waiver for its
non-compliance with a financial covenant in that credit facility through
September 30, 2003. The Company also entered into an amendment to the
$200.0 million credit facility which provides for the waiver of its
non-compliance with the financial covenants in that facility, the reduction of
the committed portion of this facility from $100.0 million to $50.0 million, the
elimination of the $100.0 million non-committed portion of this credit facility
and the acceleration of the expiration date of this facility from November 2003
to September 30, 2003. The Company entered into subsequent amendments to this
credit facility which extended the expiration date until October 17, 2003. This
facility was paid down in full on October 16, 2003 and expired on October 17,
2003.
In addition, in light of the loss for the first quarter of fiscal 2004, the
Company requested and obtained waivers or amendments to several credit
facilities to address its non-compliance with certain financial covenants as of
September 30, 2003.
21
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
6. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
The lender under the $25.0 million credit facility agreed to amend such facility
in light of the Company's non-compliance at September 30, 2003 with the
requirement that its net income not be less than zero for two consecutive
quarters. Pursuant to the revised terms of the Company's agreement with this
lender, no additional advances may be made under this facility after September
30, 2003. This facility was paid down in full on October 16, 2003 and expired
pursuant to its terms on October 31, 2003.
The lender on the new $200.0 million credit facility granted the Company a
waiver of its non-compliance at September 30, 2003 with the minimum net worth
covenant contained in this credit facility. The terms of the new $200.0 million
credit facility, as amended, require, among other things, that the registration
statement registering $295.0 million of subordianted debt be declared effective
by the SEC no later than October 31, 2003 and that the Company have a minimum
net worth of $25.0 million at October 31, 2003 and November 30, 2003. An
identical minimum net worth requirement applies to an $8.0 million letter of
credit facility with the same lender. The lender under the $200.0 million
facility agreed to extend the deadline for the Company's registration statement
to be declared effective by the SEC to November 10, 2003. This lender also
verbally agreed (with written documentation pending) to waive the minimum net
worth requirement at October 31, 2003 under the $200.0 million credit facility
and the $8.0 million letter of credit facility. There can be no assurances that
the Company will be able to obtain this waiver in writing or whether the terms
of the written waiver will impose any conditions on the Company.
Some of the Company's financial covenants in other credit facilities have
minimal flexibility and it cannot say with certainty that it will continue to
comply with the terms of all debt covenants. There can be no assurance as to
whether or in what form a waiver or modification of terms of these agreements
would be granted the Company.
On September 22, 2003, the Company entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding its loan originations. Pursuant to the terms of this facility, the
Company is required to, among other things: (i) obtain a written commitment for
another credit facility of at least $200.0 million and close that additional
facility by October 3, 2003 (this condition is satisfied by the closing of the
$250.0 million facility described below); (ii) have a net worth of at least
$28.0 million by September 30, 2003; with quarterly increases of $2.0 million
thereafter; (iii) apply 60% of its net cash flow from operations each quarter to
reduce the outstanding amount of subordinated debt commencing with the quarter
ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the
outstanding principal amount of loans under the facility. This facility has a
term of 12 months expiring in September 2004 and is secured by the mortgage
loans which are funded by advances under the facility with interest equal to
LIBOR plus a margin. This facility is subject to representations and warranties
and covenants, which are customary for a facility of this type, as well as
amortization events and events of default related to the Company's financial
condition. These provisions require, among other things, the Company's
maintenance of a delinquency ratio for the managed portfolio (which represents
the portfolio of securitized loans and leases we service for others) at the end
of each fiscal quarter of less than 12.0%, its subordinated debt not to exceed
$705.0 million at any time, its ownership of an amount of repurchased loans not
to exceed 1.5% of the managed portfolio and its registration statement
registering $295.0 million of subordinated debt be declared effective by the SEC
no later than October 31, 2003.
22
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
6. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
On October 3, 2003, the lender on the new $200.0 million credit facility agreed
to extend the date by which the Company must close an additional credit facility
of at least $200.0 million from October 3, 2003 to October 8, 2003. The Company
subsequently obtained a waiver from this lender which further extended the
required closing date for this additional credit facility to October 14, 2003.
On October 14, 2003, the Company entered into definitive agreements with a
warehouse lender for a revolving mortgage loan warehouse credit facility of up
to $250.0 million to fund loan originations. The $250.0 million facility has a
term of three years with an interest rate on amounts outstanding equal to the
one-month LIBOR plus a margin and the yield maintenance fees (as defined in the
agreements). The Company also agreed to pay fees of $8.9 million upon closing
and approximately $10.3 million annually plus a nonusage fee based on the
difference between the average daily outstanding balance for the current month
and the maximum credit amount under the facility, as well as the lender's
out-of-pocket expenses. Advances under this facility are collateralized by
specified pledged loans and additional credit support was created by granting a
security interest in substantially all of the Company's interest-only strips and
residual interests which the Company contributed to a special purpose entity
organized by it to facilitate this transaction.
This $250.0 million facility contains representations and warranties, events of
default and covenants which are customary for facilities of this type, as well
as our agreement to: (i) restrict the total amount of indebtedness outstanding
under the indenture related to the Company's subordinated debt to $750.0
million or less; (ii) make quarterly reductions commencing in April 2004 of an
amount of subordinated debt pursuant to the formulas set forth in the loan
agreement; (iii) maintain maximum interest rates offered on subordinated debt
securities not to exceed 10 percentage points above comparable rates for FDIC
insured products; and (iv) maintain minimum cash and cash equivalents of not
less than $10.0 million. In addition to events of default which are typical for
this type of facility, an event of default would occur if: (1) the Company is
unable to sell subordinated debt for more than three consecutive weeks or on
more than two occasions in a 12 month period; and (2) certain members of
management are not executive officers and a satisfactory replacement is not
found within 60 days. The definitive agreements grant the lender an option for a
period of 90 days commencing on the first anniversary of entering into the
definitive agreements to increase the credit amount on the $250.0 million
facility to $400.0 million with additional fees and interest payable by the
Company.
On October 16, 2003, the Company refinanced through a mortgage warehouse conduit
facility $40.0 million of loans that were previously held in an off-balance
sheet mortgage conduit facility which expired pursuant to its terms in July
2003. The Company also refinanced an additional $133.5 million of mortgage loans
in the new conduit facility which were previously held in other warehouse
facilities, including the $50.0 million warehouse facility which expired on
October 17, 2003. The more favorable advance rate under this conduit facility as
compared to the expired
23
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
6. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
facilities which previously held these loans resulted in the Company's receipt
of $17.0 million in cash. On October 31, 2003, the Company completed a
privately-placed securitization of the $173.5 million of loans, with servicing
released, that had been transferred to this conduit facility. The terms of this
conduit facility provide that it will terminate upon the disposition of loans
held by it.
Under a registration statement declared effective by the SEC on October 3, 2002,
the Company registered $315.0 million of subordinated debt. This registration
statement expired on October 31, 2003. In June 2003, the Company filed a new
registration statement with the SEC to register an additional $295.0 million of
subordinated debt which had not been declared effective by the SEC as of
October 31, 2003.
In the event the Company is unable to offer additional subordinated debentures
for any reason, the Company has developed a contingent financial restructuring
plan including cash flow projections for the next twelve-month period. Based on
the Company's current cash flow projections, the Company anticipates being able
to make all scheduled subordinated debenture maturities and vendor payments.
The contingent financial restructuring plan is based on actions that the
Company would take, in addition to those indicated in its adjusted business
strategy, to reduce its operating expenses and conserve cash. These actions
would include reducing capital expenditures, selling all loans originated on a
whole loan basis, eliminating or downsizing various lending, overhead and
support groups, and scaling back less profitable businesses. No assurance can be
given that the Company will be able to successfully implement the contingent
financial restructuring plan, if necessary, and repay the subordinated
debentures when due.
The Company's subordinated debt securities are subordinated in right of payment
to, or subordinate to, the payment in full of all senior debt as defined in the
indentures related to such debt, whether outstanding on the date of the
applicable indenture or incurred following the date of the indenture. The
Company's assets, including the stock it holds in its subsidiaries, are
available to repay the subordinated debt in the event of default following
payment to holders of the senior debt. In the event of the Company's default and
liquidation of its subsidiaries to repay the debt holders, creditors of the
subsidiaries must be paid or provision made for their payment from the assets of
the subsidiaries before the remaining assets of the subsidiaries can be used to
repay the holders of the subordinated debt securities.
In September 2002, the Company entered into a series of leases for computer
equipment, which qualify as capital leases. The total principal amount of debt
to be recorded under these leases is $1.0 million. The leases have an imputed
interest rate of 8.0% and mature through January 2006.
The Company paid commitment fees and non-usage fees on warehouse lines and
operating lines of credit of $7.6 million in the three months ended September
30, 2003 and $0.4 million during the fiscal year ended June 30, 2003.
24
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
7. Legal Proceedings
On February 26, 2002, a purported class action titled Calvin Hale v.
HomeAmerican Credit, Inc., No. 02 C 1606, United States District Court for the
Northern District of Illinois, was filed in the Circuit Court of Cook County,
Illinois (subsequently removed by Upland Mortgage to the captioned federal
court) against our subsidiary, HomeAmerican Credit, Inc., which does business as
Upland Mortgage, on behalf of borrowers in Illinois, Indiana, Michigan and
Wisconsin who paid a document preparation fee on loans originated since February
4, 1997. The case consisted of three purported class action counts and two
individual counts. The plaintiff alleged that the charging of, and the failure
to properly disclose the nature of, a document preparation fee were improper
under applicable state law. In November 2002 the Illinois Federal District Court
dismissed the three class action counts and an agreement in principle was
reached in August 2003 to settle the matter. The terms of the settlement have
been finalized and the action was dismissed on September 23, 2003. The matter
did not have a material effect on our consolidated financial position or results
of operations. Our lending subsidiaries, including HomeAmerican Credit, Inc.
which does business as Upland Mortgage, are involved, from time to time, in
class action lawsuits, other litigation, claims, investigations by governmental
authorities, and legal proceedings arising out of their lending and servicing
activities, in addition to the Calvin Hale action described above. Due to our
current expectation regarding the ultimate resolution of these actions,
management believes that the liabilities resulting from these actions will not
have a material adverse effect on its consolidated financial position or results
of operations. However, due to the inherent uncertainty in litigation and
because the ultimate resolution of these proceedings are influenced by factors
outside of our control, our estimated liability under these proceedings may
change or actual results may differ from its estimates.
Additionally, court decisions in litigation to which we are not a party may also
affect our lending activities and could subject us to litigation in the future.
For example, in Glukowsky v. Equity One, Inc., (Docket No. A-3202 - 01T3), dated
April 24, 2003, to which we are not a party, the Appellate Division of the
Superior Court of New Jersey determined that the Parity Act's preemption of
state law was invalid and that the state laws precluding some lenders from
imposing prepayment fees are applicable to loans made in New Jersey. This case
has been appealed to the New Jersey Supreme Court which has agreed to hear this
case. We expect that, as a result of the publicity surrounding predatory
lending practices and this recent New Jersey court decision regarding the
Parity Act, we may be subject to other class action suits in the future.
In addition, from time to time, we are involved as plaintiff or defendant in
various other legal proceedings arising in the normal course of our business.
While we cannot predict the ultimate outcome of these various legal proceedings,
management believes that the resolution of these legal actions should not have a
material effect on our financial position, results of operations or liquidity.
25
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
8. Commitments
Lease Agreements
The Company moved its corporate headquarters from Bala Cynwyd, Pennsylvania to
Philadelphia, Pennsylvania on July 7, 2003. The Company leases office space for
its corporate headquarters in Philadelphia, Pennsylvania. The current lease term
expires in June 2014. The terms of the rental agreement require increased
payments annually for the term of the lease with average minimum annual rental
payments of $4.2 million. The Company has entered into contracts, or may engage
parties in the future, related to the relocation of its corporate headquarters
such as contracts for building improvements to the leased space, office
furniture and equipment and moving services. The provisions of the lease and
local and state grants provided the Company with reimbursement of a substantial
amount of its costs related to the relocation, subject to certain conditions and
limitations. The Company does not believe its unreimbursed expenses or
unreimbursed cash outlay related to the relocation will be material to its
operations.
The lease requires the Company to maintain a letter of credit in favor of the
landlord to secure the Company's obligations to the landlord throughout the term
of the lease. The amount of the letter of credit is currently $8.0 million and
will decline over time to $4.0 million. The letter of credit is currently issued
by JPMorgan Chase.
The Company continues to lease some office space in Bala Cynwyd under a
five-year lease expiring in November 2004 at an annual rental of approximately
$0.7 million. The Company performs its loan servicing and collection activities
at this office, but expects to relocate these activities to its Philadelphia
office.
In May 2003, the Company moved its regional processing center to a different
location in Roseland, New Jersey. The Company leases the office space in
Roseland, New Jersey and the nine-year lease expires in January 2012. The terms
of the rental agreement require increased payments periodically for the term of
the lease with average minimum annual rental payments of $0.8 million. The
expenses and cash outlay related to the relocation were not material to the
Company's operations.
Periodic Advance Guarantees
As the servicer of securitized loans, the Company is obligated to advance
interest payments for delinquent loans if we deem that the advances will
ultimately be recoverable. These advances can first be made out of funds
available in a trust's collection account. If the funds available from the
trust's collection account are insufficient to make the required interest
advances, then the Company is required to make the advance from its operating
cash. The advances made from a trust's collection account, if not recovered from
the borrower or proceeds from the liquidation
26
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
8. Commitments
Periodic Advance Guarantees
of the loan, require reimbursement from the Company. However, the Company can
recover any advances the Company makes from its operating cash from the
subsequent month's mortgage loan payments to the applicable trust prior to any
distributions to the certificate holders.
The Company adopted Financial Interpretation No. ("FIN") 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" on a prospective basis for guarantees
that are issued or modified after December 31, 2002. Based on the requirements
of this guidance, the Company has recorded a $0.4 million liability in
conjunction with the sale of mortgage loans to the ABFS 2003-1 securitization
trust which occurred in March 2003. This liability represents its estimate of
the fair value of periodic interest advances that the Company as servicer of the
securitized loans, is obligated to pay to the trust on behalf of delinquent
loans. The fair value of the liability was estimated based on an analysis of
historical periodic interest advances and recoveries from securitization trusts.
9. Derivative Financial Instruments
Hedging Activity
A primary market risk exposure that the Company faces is interest rate risk.
Interest rate risk occurs due to potential changes in interest rates between the
date fixed rate loans are originated and the date of securitization. The Company
may, from time to time, utilize hedging strategies to mitigate the effect of
changes in interest rates between the date loans are originated and the date the
fixed rate pass-through certificates to be issued by a securitization trust are
priced, a period typically less than 90 days.
No derivative financial instruments were utilized for hedging
activities during the three months ended September 30, 2003. The Company
recorded the following gains and losses on the fair value of derivative
financial instruments accounted for as hedges for the three-month periods ended
September 30, 2003 and 2002. Any ineffectiveness related to hedging transactions
during the period was immaterial.
27
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
9. Derivative Financial Instruments (continued)
Hedging Activity (continued)
Ineffectiveness is a measure of the difference in the change in fair value of
the derivative financial instrument as compared to the change in the fair value
of the item hedged (in thousands):
Three Months Ended
September 30,
2002
------
Offset by gains and losses recorded on
securitizations:
Losses on derivative financial instruments $ (2,839)
Offset by gains and losses recorded on the
fair value of hedged items:
Losses on derivative financial instruments $ (967)
Amount settled in cash - paid --
There were no outstanding derivatives contracts accounted for as hedges
on September 30, 2003. At September 30, 2002, the outstanding forward starting
interest rate swap contracts accounted for as hedges and unrealized losses
recorded as liabilities on the balance sheet were as follows (in thousands):
Three Months Ended
September 30,
2002
----------------------
Notional Unrealized
Amount Loss
-------- ----------
Forward starting interest rate
swaps $80,000 $ 967
28
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
9. Derivative Financial Instruments (continued)
Trading Activity
The Company recorded the following gains and losses on forward starting interest
rate swap contracts, which were used to manage interest rate risk on loans in
the Company's pipeline and were therefore classified as trading for the three
month periods ended September 30, 2003 and 2002 (in thousands):
Three Months Ended
September 30,
2003 2002
------ ------
Trading Gains/(Losses) on forward starting
interest rate swaps:
Related to loan pipeline $ -- $ (2,517)
Related to whole loan sales $ 5,097 $ --
Amount settled in cash - (paid) $ (1,212) $ --
At September 30, 2003, there were no outstanding derivative financial
instruments utilized to manage interest rate risk on loans in our pipeline or
expected to be sold in whole loan sale transactions. At September 30, 2002,
outstanding forward starting interest rate swap contracts used to manage
interest rate risk on loans in the Company's pipeline and associated
unrealized losses recorded as liabilities on the balance sheet were as
follows (in thousands):
Three Months Ended
September 30,
2002
---------------------
Notional Unrealized
Amount Loss
-------- ----------
Forward starting interest rate
swaps $ 220,000 $ 2,517
In addition, for the quarter ended September 30, 2003, the Company
recorded a net gain of $11 thousand compared to a net loss of $0.7 million for
the quarter ended September 30, 2002 on an interest rate swap contract which is
not designated as an accounting hedge. This contract was designed to reduce the
exposure to changes in the fair value of certain interest-only strips due to
changes in one-month LIBOR. The loss on the swap contract for the three months
ended September 30, 2002 was due to decreases in the interest rate swap yield
curve during the periods the contract was in place. Included in the $11 thousand
net gain recorded for the three months ended September 30, 2003 were unrealized
gains of $177 thousand representing the net change in the fair value of the
contract during the period and $166 thousand of cash losses paid during the
period. Included in the $0.7 million net loss recorded for the three months
ended September 30, 2002 were unrealized losses of $0.4 million representing the
net change in the fair value of the contract during the prior year period and
$0.3 million of cash losses paid during the prior year period. The cumulative
net unrealized loss of $157 thousand is included as a trading liability in Other
liabilities. Terms of the interest rate swap contract at September 30, 2003 were
as follows (dollars in thousands):
Notional amount $ 29,257
Rate received - Floating (a) 1.20%
Rate paid - Fixed 2.89%
Maturity date April 2004
Unrealized loss $ 157
Sensitivity to 0.1% change in interest rates $ 9
29
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
10. Reconciliation of Basic and Diluted Earnings Per Common Share
Following is a reconciliation of the Company's basic and diluted earnings per
share calculations (in thousands, except per share data):
Three Months Ended
September 30,
-------------------------------
2003 2002
------ ------
Earnings
(a) Net Income (Loss) $ (26,268) $ 1,821
========== ==========
Average Common Shares
(b) Average common shares outstanding 2,947 2,856
Average potentially dilutive shares (i) 129
---------- ----------
(c) Average common and potentially dilutive shares 2,947 2,985
========== ==========
Earnings (Loss) Per Common Share
Basic (a/b) $ (8.91) $ 0.64
Diluted (a/c) $ (8.91) $ 0.61
(i) Anti-dilutive
30
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
11. Stock Option and Stock Incentive Plans
The Company has stock option plans that provide for the periodic granting of
options to key employees and non-employee directors. These plans have been
approved by the Company's shareholders. Options are generally granted to key
employees at the market price of the Company's stock on the date of grant and
expire five to ten years from date of grant. Options either fully vest when
granted or over periods of up to five years.
The Company accounts for stock options issued under these plans using the
intrinsic value method, and accordingly, no expense is recognized where the
exercise price equals or exceeds the fair value of the common stock at the date
of grant. Had the Company accounted for stock options granted under these plans
using the fair value method, pro forma net income and earnings per share would
have been as follows (in thousands, except per share data):
Three Months Ended
September 30,
--------------------------------
2003 2002
--------------------------------
Net income
As reported $ (26,268) $ 1,821
Stock based compensation costs,
net of tax effects, determined
under fair value method for all
awards (182) (59)
--------- --------
Pro forma $ (26,450) $ 1,762
========= ========
Earnings per share - basic
As reported $ (8.91) $ 0.64
Pro forma $ (8.94) $ 0.62
Earnings per share - diluted
As reported $ (8.91) $ 0.61
Pro forma $ (8.94) $ 0.59
31
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
12. Segment Information
The Company has three operating segments: Loan Origination, Servicing and
Treasury and Funding.
The Loan Origination segment originates business purpose loans secured by real
estate and other business assets, home equity loans typically to credit-impaired
borrowers and loans secured by one-to-four family residential real estate.
The Servicing segment services the loans originated by the Company both while
held as available for sale by the Company and subsequent to securitization.
Servicing activities include billing and collecting payments from borrowers,
transmitting payments to securitization trust investors, accounting for
principal and interest, collections and foreclosure activities and disposing of
real estate owned.
The Treasury and Funding segment offers the Company's subordinated debt
securities pursuant to a registered public offering and obtains other sources of
funding for the Company's general operating and lending activities.
The All Other caption on the following tables mainly represents segments that do
not meet the SFAS No. 131 "Disclosures about Segments of an Enterprise and
Related Information" defined thresholds for determining reportable segments,
financial assets not related to operating segments and is mainly comprised of
interest-only strips, unallocated overhead and other expenses of the Company
unrelated to the reportable segments identified.
The reporting segments follow the same accounting policies used for the
Company's consolidated financial statements as described in the summary of
significant accounting policies. Management evaluates a segment's performance
based upon profit or loss from operations before income taxes.
Reconciling items represent elimination of inter-segment income and expense
items, and are included to reconcile segment data to the consolidated financial
statements.
32
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2003
12. Segment Information (continued)
Treasury
Three months ended Loan and Reconciling
September 30, 2003: Origination Funding Servicing All Other Items Consolidated
----------- -------- --------- --------- ----------- ------------
External revenues:
Gain on sale of loans
Securitizations $ 799 $ - $ - $ - $ - $ 799
Whole loan sales 2,921 - - - - 2,921
Interest income 3,771 7 136 11,109 - 15,023
Non-interest income 605 - 13,219 - (12,366) 1,458
Inter-segment revenues - 18,078 - 4,609 (22,687) -
Operating expenses:
Interest expense 6,723 16,106 (272) 12,339 (18,078) 16,818
Non-interest expense 18,127 1,515 11,296 2,256 - 33,194
Depreciation and amortization 594 16 29 1,123 - 1,762
Securitization assets valuation
adjustments - - - 10,795 - 10,795
Inter-segment expense 16,975 - - - (16,975) -
Income tax expense (benefit) (13,043) 170 875 (4,102) - (16,100)
-------- -------- -------- -------- --------- ---------
Net income (loss) $(21,280) $ 278 $ 1,427 $ (6,693) $ - $ (26,268)
======== ======== ======== ======== ========= =========
Segment assets $216,765 $222,497 $ 96,277 $533,203 $(118,236) $ 950,506
======== ======== ======== ======== ========= =========
Treasury
Three months ended Loan and Reconciling
September 30, 2002: Origination Funding Servicing All Other Items Consolidated
----------- -------- --------- --------- ----------- ------------
External revenues:
Gain on sale of loans
Securitizations $ 58,011 $ - $ - $ - $ - $ 58,011
Whole loan sales 35 - - - - 35
Interest income 1,459 169 217 10,747 - 12,592
Non-interest income 2,143 1 10,277 - (8,592) 3,829
Inter-segment revenues - 18,314 - 18,192 (36,506) -
Operating expenses:
Interest expense 5,721 16,819 (36) 12,893 (18,314) 17,083
Non-interest expense 12,289 2,836 9,809 15,521 - 40,455
Depreciation and amortization 848 31 307 525 - 1,711
Securitization assets valuation
adjustments - - - 12,078 - 12,078
Inter-segment expense 26,784 - - - (26,784) -
Income tax expense (benefit) 6,723 (505) 174 (5,073) - 1,319
-------- -------- -------- -------- --------- ---------
Net income (loss) $ 9,283 $ (697) $ 240 $ (7,005) $ - $ 1,821
======== ======== ======== ======== ========= =========
Segment assets $100,400 $204,732 $126,823 $577,653 $ (90,898) $ 918,710
======== ======== ======== ======== ========= =========
33
American Business Financial Services, Inc. and Subsidiaries
PART I FINANCIAL INFORMATION (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Our consolidated financial information set forth below should be read
in conjunction with the consolidated financial statements and the accompanying
notes to consolidated financial statements included in Item 1 of this Quarterly
Report on Form 10-Q, and the consolidated financial statements, notes to
consolidated financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations and the risk factors contained in
our Annual Report on Form 10-K for the year ended June 30, 2003.
Forward Looking Statements
Some of the information in this Quarterly Report on Form 10-Q may
contain forward-looking statements. You can identify these statements by words
or phrases such as "will likely result," "may," "are expected to," "will
continue to," "is anticipated," "estimate," "believe," "projected," "intends to"
or other similar words. These forward-looking statements regarding our business
and prospects are based upon numerous assumptions about future conditions, which
may ultimately prove to be inaccurate. Factors that could affect our assumptions
include, but are not limited to, general economic conditions, including interest
rate risk, future residential real estate values, regulatory changes
(legislative or otherwise) affecting the real estate market and mortgage lending
activities, competition, demand for American Business Financial Services, Inc.
and its subsidiaries' services, availability of funding, loan payment rates,
delinquency and default rates, changes in factors influencing the loan
securitization market and other risks identified in our Securities and Exchange
Commission filings. Actual events and results may materially differ from
anticipated results described in those statements. Forward-looking statements
involve risks and uncertainties which could cause our actual results to differ
materially from historical earnings and those presently anticipated. When
considering forward-looking statements, you should keep these risk factors in
mind as well as the other cautionary statements in this document. You should not
place undue reliance on any forward-looking statement.
General
We are a diversified financial services organization operating
predominantly in the eastern and central portions of the United States. Through
our principal direct and indirect subsidiaries, we originate, sell and service
home equity, subject to market conditions in the secondary loan market, and
business purpose loans. We also process and purchase home equity loans through
our Bank Alliance Services program.
Our loans primarily consist of fixed interest rate loans secured by
first or second mortgages on one-to-four family residences. Our customers are
primarily credit-impaired borrowers who are generally unable to obtain financing
from banks or savings and loan associations and who are attracted to our
products and services. We originate loans through a combination of channels
including a national processing center located at our centralized operating
office in Philadelphia, Pennsylvania and a small processing center in
Roseland, New Jersey. Our centralized operating office was located in Bala
Cynwyd, Pennsylvania prior to July 7, 2003. Prior to June 30, 2003 we also
originated home equity loans through several retail branch offices. Effective
June 30, 2003, we no longer originate loans through retail branch offices. Our
loan servicing and collection activities are performed at our Bala Cynwyd,
Pennsylvania office, but we expect to relocate these activities to our
Philadelphia office. In addition, we offer subordinated debt securities to the
public, the proceeds of which are used for repayment of existing debt, loan
originations, our operations (including repurchases of delinquent assets from
securitization trusts), investments in systems and technology and for general
corporate purposes, including funding our operating cash requirements and loan
overcollaterization requirements under our credit facilities.
34
Overview
Current Financial Position and Future Liquidity Issues. On Octobe