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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
COMMISSION FILE NO. 1-12109
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DELTA FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 11-3336165
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1000 WOODBURY ROAD, SUITE 200,
WOODBURY, NEW YORK 11797
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:(516) 364-8500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 19, 2002, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $1.12, was
approximately $6,032,830.
As of March 31, 2002, the Registrant had 15,883,749 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, Items 10, 11, 12 and 13 are incorporated by reference from Delta
Financial Corporation's definitive proxy statement to stockholders which will be
filed with the Securities and Exchange Commission no later than 120 days after
December 31, 2001.
PART I
ITEM 1. BUSINESS
BUSINESS OVERVIEW
Delta Financial Corporation (together with its subsidiaries "Delta" or "we")
is a specialty consumer finance company that originates, securitizes and sells
non-conforming mortgage loans, which are primarily secured by first mortgages on
one- to four-family residential properties. Throughout our 20-year operating
history, we have focused on lending to individuals who generally do not satisfy
the credit, documentation or other underwriting standards set by more
traditional sources of mortgage credit, including those entities that make loans
in compliance with conventional mortgage lending guidelines established by
Fannie Mae and Freddie Mac. We make loans to these borrowers for such purposes
as debt consolidation, refinancing, education and home improvement.
Our mortgage business has two principal components. First, we make mortgage
loans, which is a cash expense outlay for us, because our cost to originate a
loan exceeds the fees we collect at the time we originate that loan. At the time
we originate a loan, and prior to the time we sell that loan, we finance that
loan by borrowing under a warehouse line of credit. Second, we sell loans,
either through securitization or on a whole loan basis, to generate cash
revenues. We use the proceeds from these loan sales to repay our warehouse line
of credit and for working capital, recording the premiums received from the loan
sales and securitizations as revenue.
ORIGINATION OF MORTGAGE LOANS. We currently make mortgage loans through two
distribution channels - wholesale (or broker) and retail. We receive loan
applications both directly from borrowers and from licensed independent third
party mortgage brokers who submit applications on a borrower's behalf. We
process and underwrite the submission and, if the loan comports with our
underwriting criteria, approve the loan and lend the money to the borrower.
While we generally collect points and fees from the borrower when a loan closes,
our cost to originate a loan typically far outweighs any fees we may collect
from the borrower.
Through our wholesale distribution channel, we originate mortgage loans
indirectly through licensed mortgage brokers and other real estate professionals
who submit loan applications on behalf of borrowers ("brokered loans"). Prior to
July 2000, we also purchased loans from mortgage bankers and smaller financial
institutions that satisfied our underwriting guidelines ("correspondent loans"),
but discontinued our correspondent operations in July 2000 to focus on our less
cash intensive broker and retail channels. We currently originate the majority
of our brokered loans in 20 states, through our network of approximately 1,500
brokers.
Through our retail distribution channel, we develop retail loan leads
("retail loans") primarily through our telemarketing system and our network of
11 retail offices located in seven states. In 2001, we closed four
under-performing retail offices - two in Florida, one in Ohio and one in Indiana
- - and opened our second retail call center, in Pittsburgh, Pennsylvania.
In 2001, we originated approximately $622 million of loans, of which
approximately $346 million were brokered loans and $276 million were retail
loans, compared to 2000, when we originated or purchased approximately $933
million of loans, of which $604 million were brokered loans, $260 million were
retail loans and $69 million were correspondent loans.
POOLING OF LOANS PRIOR TO SALE. After we close or fund a loan, we typically
pledge the loan as collateral under a warehouse line of credit to obtain
financing against the loan. By doing so, we replenish our capital so we can make
new loans. Typically, loans are financed through a warehouse line of credit for
only a limited time - generally not more than three months - until such time as
we can pool enough loans and sell the pool of loans either through
securitization or on a whole-loan basis. During this time, we earn interest paid
by the borrower as income, but this income is offset in part by the interest we
pay to the warehouse creditor for providing us with financing.
SALE OF LOANS. We derive the majority of our revenues and cash flows
primarily from selling mortgage loans (through securitization or on a whole loan
basis) and selling securitization servicing rights on newly-originated pools of
home-equity loans. We generally sell loans in one of two manners - either
through securitization or on a whole loan basis.
We securitized the majority of our loans in two securitizations (completed in
the second and fourth quarters of 2001) totaling $345 million. We also sold $261
million of loans in 2001 for a cash premium, on a whole loan
servicing-released basis (without retaining the right to service the loans). We
plan to continue to utilize a combination of securitization and whole loan sales
for the foreseeable future.
SECURITIZATION. Securitizations effectively provide us with a source of long-
term financing.
In a securitization, we pool together loans, typically each quarter, and sell
these loans to a securitization trust, which is a qualified special purpose
entity. The securitization trust raises money to purchase the mortgage loans
from us by selling securities to the public -known as asset-backed pass-through
securities that are secured by the pool of mortgage loans held by the
securitization trust. These asset-backed securities or senior certificates,
which are usually purchased by insurance companies, mutual funds and/or other
institutional investors, represent senior interests in the cash flows from the
mortgage loans in the trust. Following the securitization, holders of these
senior certificates receive the principal collected, including prepayments of
principal, on the mortgage loans in the trust. In addition, holders receive a
portion of the interest on the loans in the trust equal to the pass-through
interest rate on the remaining principal balance. These securities are typically
sold for a par purchase price, or a slight discount to par - with par
representing the aggregate principal balance of the mortgage loans backing the
asset-backed securities. For example, if a securitization trust contains
collateral of $100 million of mortgage loans, we typically receive close to $100
million in proceeds from the sales of these securities, depending upon the
structure we utilize for the securitization.
In each of the two securitizations we issued in 2001, we derived the
following economic interests:
o we received a cash purchase price from the sale of an interest-only
certificate sold in connection with a securitization. This certificate
entitles the holder to a recurring interest payment over a guaranteed
period of 36 months, and reduces the cash flows we would otherwise
receive as owner of the excess cashflow certificates;
o we received a cash premium from selling the right to service the loans
being securitized. This right entitles the contractual servicer to
service the loans on behalf of the securitization trust, and earn a
contractual servicing fee, and ancillary servicing fees in such
capacity;
o we retained an excess cashflow certificate. This certificate entitles
us to receive the difference between the interest payments due on the
mortgage loans sold to the securitization trust and the interest
payments due, at the pass-through rates, to the holders of the
pass-through securities, less the contractual servicing fee and other
costs and expenses of administering the securitization trust. For any
monthly distribution, we, as the holder of an excess cashflow
certificate, receive payments only after payments have been made on all
the other securities issued by the securitization trust. These cash
flows are received over time, but under existing accounting rules, we
must report at the time of the securitization as income the present
value of all projected cash flows we expect to receive in the future
from these excess cashflow certificates based upon an assumed discount
rate. Our valuation of these excess cashflow certificates is primarily
based on (1) our estimate of the amount of expected losses or defaults
that will take place on the underlying mortgage loans over the life of
the mortgage loans because the excess cashflow certificates are
subordinate in right of payment to all other securities issued by the
securitization trust. Consequently, any losses sustained on mortgage
loans comprising a particular securitization trust are first absorbed
by the excess cashflow certificates, and (2) the expected amount of
prepayments on the mortgage loans due to the underlying borrowers of
the mortgage loans paying off their mortgage loan prior to the loan's
stated maturity.
At the time we completed the 2001 securitizations, we recognized as revenue
each of the three economic interests described above, which was recorded as net
gain on sale of mortgage loans on our consolidated statement of operations.
Our net investment in the pool of loans sold at the date of the
securitization represents the amount originally paid to originate the loans,
adjusted for the following:
o any direct loan origination costs incurred (an increase) and loan
origination fees received (a decrease) in connection with the loans,
which are treated as a component of the initial investment in loans;
o the principal payments received, and the amortization of the net loan
fees or costs, during the period we held the loans prior to their
securitization; and
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o any gains (a decrease in the investment) or losses (an increase in the
investment) we incur on any hedging instruments that we may have
utilized to hedge against the effects of changes in interest rates
during the period we hold the loans prior to their securitization. (See
"-Hedging," beginning on page 39).
We allocate our basis in the mortgage loans and residual interests between
the portion of the mortgage loans sold through the pass-through certificates and
the portion retained (the excess cashflow certificates) based on the relative
fair values of those portions on the date of sale. We may recognize gains or
losses attributable to the changes in fair value of the excess cashflow
certificates, which are recorded at estimated fair value and accounted for as
"trading" securities. Since there is no active market for such excess cashflow
certificates, we determine the estimated fair value of the excess cashflow
certificates by discounting the future expected cash flows.
Although we recognize income from retaining excess cashflow certificates at
the time in which we complete our securitization, we receive cash flows from
these excess cashflow certificates over the life of the loans underlying such
certificates. In each of our two securitizations in 2001, we expect to begin to
receive cash flows from the excess cashflow certificates approximately twelve to
twenty months after each respective securitization issuance, with the specific
timing depending on the structure and performance of the securitization.
Initially, securitization trusts utilize the cash flows from the excess cashflow
certificate to make additional payments of principal to the holders of the
pass-through certificates in order to establish a spread between the principal
amount of the trust's outstanding loans and the amount of outstanding
pass-through certificates. Once a spread of between 1.5% and 3.0% of the initial
securitization principal amount securitized (known as the "overcollateralization
limit") is established, the cash flows generated by the excess cashflow
certificates are distributed to us as the holder of the excess cashflow
certificates.
WHOLE LOAN SALES. We also sell loans, without retaining the right to service
the loans, in exchange for a cash premium. This is recorded as income under net
gain on sale of mortgage loans at the time of sale. The cash premiums ranged
between 3.5% to 6.3% of the principal amount of mortgage loans sold in 2001.
OTHER. In addition to the income and cash flows we earn from securitizations
and whole loan sales, we also earn income and generate cash flows from:
o the net interest spread earned on mortgage loans while we hold the
mortgage loans for sale; (the difference between the interest rate on
the mortgage loan paid by the underlying borrower less the financing
costs we pay to our warehouse lender to fund our loans);
o net loan origination fees on brokered loans and retail loans; and
o retained excess cashflow certificates and distributions from Delta
Funding Residual Exchange Company LLC (described below in "-Debt
Modification and Debt Restructuring").
BUSINESS STRATEGY
Our business strategy is to increase our overall loan production to generate
sufficient cash revenues to become cash flow neutral to positive. We believe we
have the infrastructure in place to expand loan production significantly in both
the wholesale and retail channels, without having to invest significantly in our
infrastructure. We plan to increase loan production by:
o increasing the number of commissioned-based account executives
responsible for generating new business;
o continuing to provide top quality service to our network of brokers and
retail clients;
o maintaining our loan underwriting standards;
o penetrating further our established and recently-entered markets and
expanding into new geographic markets;
o expanding our retail loan origination capabilities through larger call
centers; and
o continuing to leverage off of our proprietary web-based and workflow
technology platform.
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CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING
In 2000, we began a corporate restructuring - by reducing our workforce and
modifying the terms of the indenture governing our senior notes due 2004 (the
"senior notes") - as part of our continuing efforts to improve operating
efficiencies and to address our negative cash flow from operations. Entering
2001, management still had several concerns, which we believed needed to be
addressed for us to remain a viable company. Our principal concerns were:
o the cash drain created by our ongoing monthly delinquency and servicing
advance requirements as servicer for securitization trusts (known as
"securitization advances");
o the high cost of servicing a seasoned loan portfolio, including the
capital charges associated with making securitization advances;
o our ability to make timely interest payments on our senior notes and
senior secured notes due 2004 (the "senior secured notes"); and
o our ability to effectuate a successful business model given the
overhang of corporate ratings of "Caa2" by Moody's and "CC" by Fitch.
Therefore in the first quarter of 2001, we embarked upon a business plan
aimed at alleviating some of these concerns and issues.
CORPORATE RESTRUCTURING
In January 2001, we announced that we had entered into an agreement with
Ocwen Financial Corporation ("Ocwen") to transfer our servicing portfolio to
Ocwen. In May 2001, we physically transferred our entire servicing portfolio to
Ocwen, and laid-off the majority of our servicing staff - a total of 128
employees. We recorded a $0.5 million pre-tax charge related to this
restructuring, which is included in the line item called "restructuring and
other special charges" on our consolidated statements of operations. This charge
relates to employee severance associated with closing our servicing operations.
We no longer service loans nor do we have a servicing operation.
DEBT MODIFICATION AND DEBT RESTRUCTURING
In August 2000, we announced an agreement to modify the terms of the
indenture governing our senior notes (the "Debt Modification"). With the consent
of the holders of greater than fifty percent of our senior notes, we modified a
negative pledge covenant in the senior notes indenture, which had previously
prevented us from selling or otherwise obtaining financing by using our excess
cashflow certificates as collateral. In consideration for the senior
noteholders' consent, we agreed, in an exchange offer (the "First Exchange
Offer"), to offer then current holders the opportunity to exchange their then
existing senior notes for (a) new senior secured notes and (b) ten-year warrants
to buy approximately 1.6 million shares of common stock, at an initial exercise
price of $9.10 per share, subject to upward or downward adjustment in certain
circumstances. The senior secured notes have the same coupon, face amount and
maturity date as the senior notes and, up until the Second Debt Restructuring
(see below) were secured by at least $165 million of our excess cashflow
certificates. The First Exchange Offer was consummated in December 2000, with
holders of greater than $148 million (of $150 million) of senior notes tendering
in the exchange.
In February 2001, we entered into a letter of intent with the beneficial
holders of over fifty percent of our senior secured notes to restructure, and
ultimately extinguish, the senior secured notes (the "Second Debt
Restructuring"). In March 2001, we obtained the formal consent of these
beneficial holders of the senior secured notes through a consent solicitation
that modified certain provisions of the senior secured notes indenture to, among
other things, allow for the release of two excess cashflow certificates then
securing the senior secured notes. We were able to first finance and ultimately
sell the excess cashflow certificates underlying five securitizations (including
two excess cashflow certificates that were released as part of the Second Debt
Restructuring) for a $15 million cash purchase price to provide working capital.
In consideration for their consent, we agreed to offer the holders of the
senior secured notes (and the senior notes, collectively, the "notes"), an
opportunity to exchange their notes for new securities described immediately
below (the "Second Exchange Offer"). The Second Exchange Offer was consummated
on August 29, 2001, pursuant to which holders of approximately $138.1 million
(of $148.2 million) in principal amount of our senior
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secured notes and $1.1 million (of $1.8 million) in principal amount of our
senior notes, exchanged their notes for commensurate interests in:
o voting membership interests in Delta Funding Residual Exchange Company
LLC (the "LLC"), a newly-formed limited liability company (unaffiliated
with us), to which we transferred all of the mortgage-related
securities previously securing the senior secured notes (primarily
comprised of excess cashflow certificates);
o shares of common stock of a newly-formed management corporation that
will manage the LLC's assets; and
o shares of our newly-issued preferred stock having an aggregate
preference amount of $13.9 million.
The LLC is controlled by the former noteholders that now hold all the voting
membership interests in the LLC. As part of the transaction, we obtained a
non-voting membership interest in the LLC, which entitles us to receive 15% of
the net cash flows from the LLC for the first three years (through June 2004)
and, thereafter, 10% of the net cash flows from the LLC. The net cash flows from
the LLC are equal to the total cash flows generated by the assets held by the
LLC for a particular period, less (a) all expenses of the LLC, (b) certain
related income tax payments, and (c) the New York State Banking Department (the
"NYSBD") subsidy payments (See "Regulations"). We began receiving distributions
from the LLC in the first quarter of 2002 from a fourth quarter 2001
distribution.
As part of the Second Exchange Offer, all tendering noteholders waived their
right to receive any future interest coupon payments on the tendered notes
beginning with the August 2001 interest coupon payment. With the closing of the
Second Exchange Offer, we paid the August 2001 interest coupon payment on the
approximately $10.8 million of notes that did not tender in the Second Exchange
Offer. The notes bear interest at a rate of 9.5% per annum, payable
semi-annually (on February 1st and August 1st) and a maturity date of August 1,
2004 when all outstanding principal is due.
By extinguishing substantially all of our long-term debt, the rating agencies
that previously rated us and our long-term debt have withdrawn their corporate
ratings.
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Our consumer finance activities consist of originating, securitizing, selling
(and, prior to May 2001, servicing) non-conforming mortgage loans. These loans
are primarily secured by first mortgages on one- to four-family residences. Once
loan applications have been received, the underwriting process completed and the
loans funded or purchased, we typically package the loans in a portfolio and
sell the loan portfolio through a securitization or on a whole loan, servicing
released basis.
We provide our customers with an array of loan products designed to meet
their needs, using a risk-based pricing strategy to develop products for various
risk categories. Historically, we have offered fixed-rate loan products and, to
date, the majority of our loan production is fixed-rate. As we have expanded
geographically, we have expanded our product offerings to include
adjustable-rate mortgages and fixed/adjustable-rate mortgages.
We primarily conduct our broker lending operations out of our Woodbury, New
York headquarters and a regional branch office in the Southeast. Final
underwriting approval for brokered loans is centralized and required from the
Woodbury, New York headquarters. We conduct our retail operations out of 11
retail offices and a telemarketing hub, located in seven states. Final
underwriting approval for retail loans is required from either our retail
underwriting office in Cincinnati, Ohio, which has full underwriting authority
or from our Woodbury, New York headquarters.
We adhere to our Best Practice Lending Program aimed at ensuring the
origination of quality loans and helping to better protect consumers. This Best
Practice Lending Program includes:
o fair lending initiatives aimed at ensuring all borrowers are treated
fairly and similarly regardless of race, color, creed, religion,
national origin, sex, sexual orientation, marital status, age,
disability, and the applicant's exercise, in good faith, of any right
under the Consumer Credit Protection Act;
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o increased oversight of mortgage brokers and closing agents;
o enhanced fraud detection and protection;
o enhanced plain English disclosures; and
o other originations and underwriting initiatives which we believe help
protect consumers.
LOAN ORIGINATIONS AND PURCHASES
Our loan originations and purchases decreased by 33% to $622 million in 2001
from $933 million in 2000. The decrease in loan production was primarily the
result of management continuing to devote much of its attention to completing
the Second Debt Restructuring/Second Exchange Offer through the end of August
2001, and completing the servicing transfer to Ocwen during the first half of
2001. In addition, our production for the second half of the year was negatively
impacted by the events of September 11th.
The following table shows certain data regarding our loans, presented by
channel of loan originations, for the years shown:
YEAR ENDED DECEMBER 31,
1999 2000 2001
---- ---- ----
(DOLLARS IN THOUSANDS)
Broker:
Principal balance................................ $ 890,822 $ 603,616 $ 345,916
Average principal balance per loan.............. $ 85 $ 74 $ 79
Combined weighted average initial loan-
to-value ratio(1)............................. 72.8% 71.1% 71.7%
Weighted average interest rate.................. 10.4% 11.7% 11.1%
Retail:
Principal balance............................... $ 319,227 $ 260,388 $ 275,799
Average principal balance per loan.............. $ 68 $ 67 $ 82
Combined weighted average initial loan-
to-value ratio(1)............................. 77.6% 76.9% 77.4%
Weighted average interest rate.................. 9.8% 10.6% 9.8%
Correspondent (2):
Principal balance............................... $ 261,289 $ 69,434 --
Average principal balance per loan.............. $ 77 $ 75 --
Combined weighted average initial loan-
to-value ratio(1)............................. 72.0% 70.5% --
Weighted average interest rate.................. 11.0% 11.5% --
Total loan purchases and originations:
Principal balance............................... $1,471,338 $ 933,438 $ 621,715
Average principal balance per loan.............. $ 79 $ 72 $ 81
Combined weighted average initial loan-
to-value ratio(1)............................. 73.7% 72.7% 74.2%
Weighted average interest rate.................. 10.4% 11.4% 10.5%
Percentage of loans secured by:
First mortgage.................................. 94.6% 90.9% 94.1%
- ---------------
(1)We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio of
a loan secured by a second mortgage by taking the sum of the loan secured by
the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
(2)We discontinued our correspondent operations in July 2000 to focus on our
less cash intensive broker and retail channels.
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The following table shows certain data regarding our loans, presented by
channel of loan originations, on a quarterly basis for 2001:
THREE MONTHS ENDED
----------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Broker:
Number of Brokered Loans...................... 1,470 1,077 985 833
Principal balance............................. $ 105,116 $ 82,605 $ 83,406 $ 74,789
Average principal balance per loan............ $ 72 $ 77 $ 85 $ 90
Combined weighted average initial loan-
to-value ratio(1)........................... 70.6% 71.6% 72.0% 73.0%
Weighted average interest rate................ 11.9% 11.2% 10.7% 10.3%
Retail:
Number of retail loans........................ 866 961 770 753
Principal balance............................. $ 65,624 $ 82,541 $ 63,206 $ 64,428
Average principal balance per loan............ $76 $86 $82 $86
Combined weighted average initial loan-
to-value ratio(1)........................... 77.2% 76.9% 77.8% 78.0%
Weighted average interest rate................ 10.2% 9.7% 9.8% 9.5%
Total loan originations:
Total number of loans......................... 2,336 2,038 1,755 1,586
Principal balance............................. $ 170,740 $ 165,146 $ 146,612 $ 139,217
Average principal balance per loan............ $73 $81 $84 $88
Combined weighted average initial loan-
to-value ratio(1)........................... 73.2% 74.2% 74.5% 75.3%
Weighted average interest rate................ 11.2% 10.4% 10.3% 9.9%
- ---------------
(1)We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio of
a loan secured by a second mortgage by taking the sum of the loan secured by
the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
The following table shows lien position, weighted average interest rates and
loan-to-value ratios for the years shown:
YEAR ENDED DECEMBER 31,
1999 2000 2001
---- ---- ----
FIRST MORTGAGE:
Percentage of total purchases and originations........... 94.6% 90.9% 94.1%
Weighted average interest rate........................... 10.3% 11.4% 10.5%
Weighted average initial loan-to-value ratio(1).......... 74.1% 73.1% 74.2%
SECOND MORTGAGE:
Percentage of total purchases and originations........... 5.4% 9.1% 5.9%
Weighted average interest rate........................... 10.8% 11.5% 11.1%
Weighted average initial loan-to-value ratio(1).......... 66.6% 71.1% 75.4%
- ---------------
(1)We determine the weighted average initial loan-to-value ratio of a loan
secured by a first mortgage by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. We determine the weighted average initial loan-to-value ratio of
a loan secured by a second mortgage by taking the sum of the loan secured by
the first and second mortgages and dividing by the lesser of the purchase
price or the appraised value of the mortgage property at origination.
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The following table shows the geographic distribution of loan purchases and
originations for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1999 2000 2001
REGION PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE
- ------ ------- --------- ------- -------- ------- --------
(DOLLARS IN MILLIONS)
NY, NJ and PA............. 50.8% $ 747.9 43.9% $ 409.7 40.0% $248.4
Midwest................... 26.4 388.2 29.1 272.0 35.1 218.5
Mid-Atlantic*............. 8.6 126.7 10.5 97.6 11.8 73.1
Southeast................. 8.4 123.5 9.4 87.5 7.5 46.8
New England............... 5.8 85.1 7.1 66.6 5.6 34.9
- ------------
* Excluding New York (NY), New Jersey (NJ) and Pennsylvania (PA).
WHOLESALE MARKETING. Throughout our history, we have established and
maintained relationships with brokers (and, prior to July 2000, correspondents)
offering non-conforming mortgage products.
Typically, we initiate contact with a broker through our Business Development
Department, supervised by a senior officer with over ten years of sales and
marketing experience in the industry. We usually hire business development
representatives who have contacts with brokers that originate non-conforming
mortgage loans within their geographic territory. The business development
representatives are responsible for developing and maintaining our broker
network within their geographic territory by frequently visiting the broker,
communicating our underwriting guidelines, disseminating new product information
and pricing changes, and by demonstrating a continuing commitment to
understanding the needs of the customer. The business development
representatives attend industry trade shows and inform us about the products and
pricing being offered by competitors and new market entrants. This information
assists us in refining our programs and product offerings in order to remain
competitive. Business development representatives are compensated with a base
salary and commissions based on the volume of loans originated as a result of
their efforts.
APPROVAL PROCESS. Before a broker becomes part of our network, it must go
through an approval process. Once approved, brokers may begin submitting
applications and/or loans to us.
To be approved, a broker must:
o demonstrate that it is properly licensed and registered in the state in
which it seeks to transact business;
o submit to and pass a credit check; and
o sign a standard broker agreement with us that requires brokers to,
among other things:
>> abide by our fair lending policy;
>> follow the National Association of Mortgage Brokers Best
Practices Policies;
>> comply with all state and federal laws; and
>> submit only true and accurate documents and disclosures.
We also perform searches on all new brokers using a third party database that
contains public and nonpublic information on individuals and companies that have
incidents of potential fraud and misrepresentation. In addition, we regularly
review the performance of loans originated through our brokers.
BROKERED LOANS. For the year ended December 31, 2001, our broker network
accounted for $345.9 million, or 56%, of our loan originations, compared to
$603.6 million, or 65%, of our loan purchases and originations for the year
ended December 31, 2000 and $890.8 million, or 60%, of our loan purchases and
originations for the year ended December 31, 1999. No single broker contributed
more than 1.3%, 2.0% or 3.1% of our total loan production in the years ended
December 31, 2001, 2000 and 1999, respectively.
Once approved, a broker may submit loan applications for prospective
borrowers. To process broker submissions, our broker originations channel is
organized by geographic regions and into teams, each consisting of
8
account executives, account managers and processors, which are generally
assigned to specific brokers. Because we operate in a highly competitive
environment where brokers may submit the same loan application to several
prospective lenders simultaneously, we strive to provide brokers with a rapid
and informed response. Account executives analyze the application and provide
the broker with a preliminary approval, subject to final underwriting approval,
or a denial, typically within one business day. If the application is approved
by our underwriters, a "conditional approval" will be issued to the broker with
a list of specific conditions to be met and additional documents to be supplied
prior to funding the loan. The account executive, account manager and processor
team will then work directly with the submitting broker to collect the requested
information and meet all underwriting conditions. In most cases, we funds loans
within 14 to 21 days after preliminary approval of the loan application. In the
case of a denial, we will make all reasonable attempts to ensure that there is
no missing information concerning the borrower or the application that might
change the decision on the loan.
We compensate our account executives, who are the primary relationship
contacts with the brokers, predominantly on a commission basis. All of our
account executives maintain the level of knowledge and experience integral to
our commitment to providing the highest quality service for brokers. We believe
that by maintaining an efficient, trained and experienced staff, we have
addressed four central factors that determine where a broker sends its business:
o the service and support a lender provides;
o product offerings and pricing
o the turn-around time, or speed with which a lender closes loans; and
o the lender's knowledge concerning the broker and his business.
RETAIL LOANS. We develop retail loan leads primarily through our automated
telemarketing system and our network of 11 retail offices located in seven
states. For the year ended December 31, 2001, the retail channel accounted for
$275.8 million, or 44%, of our loan originations, compared to $260.4 million, or
28%, of our loan purchases and originations for the year ended December 31, 2000
and $319.2 million, or 22%, of our loan purchases and originations for the year
ended December 31, 1999. Through our marketing efforts, the retail loan channel
is able to identify, locate and focus on individuals who, based on historic
customer profiles, are likely customers for our products. Our telemarketing
representatives identify interested customers and refer these customers to loan
officers at the retail branch offices and call centers who then proceed to
determine the applicant's qualifications for our loan products, negotiate loan
terms with the borrower and process the loan through completion.
CORRESPONDENT LOANS. We decided to discontinue our correspondent operations
in July 2000 to focus on our less cash intensive broker and retail channels. As
such, we had no correspondent purchases in 2001. For the year ended December 31,
2000, our correspondent network accounted for $69.4 million, or 7%, of our loan
purchases and originations, compared to $261.3 million, or 18%, of our loan
purchases and originations for the year ended December 31, 1999. No single
correspondent contributed more than 1.5% and 1.9% of our total loan production
in 2000 and 1999, respectively.
LOAN UNDERWRITING
We provide all of the brokers from whom we accept loan applications with our
underwriting guidelines. Loan applications received from brokers are classified
according to particular characteristics, including but not limited to:
o ability to pay;
o credit history of the applicant (with emphasis on the applicant's
existing mortgage payment history);
o credit score;
o loan-to-value ratio; and
o general stability of the applicant in terms of employment history, time
in residence, occupancy and condition and location of the collateral.
We have established classifications with respect to the credit profile of the
applicant, and each loan is placed into one of four letter ratings "A" through
"D," with subratings within those categories. Terms of loans that we make, as
well as maximum loan-to-value ratios and debt-to-income ratios, vary depending
on the classification of the applicant and the borrower's credit score. Loan
applicants with less favorable credit ratings and/or lower credit
9
scores are generally offered loans with higher interest rates and lower
loan-to-value ratios than applicants with more favorable credit ratings and/or
higher credit scores. The general criteria our underwriting staff uses in
classifying loan applicants are set forth below.
REST OF PAGE INTENTIONALLY LEFT BLANK
10
LTD DOC/ LTD DOC/
FULL DOC NIV FULL DOC STATED NIV
CREDIT PROGRAM/ MINIMUM OO OO NOO INCOME-OO NOO
MAX LOAN AMOUNT CREDIT SCORE (1) (2) (3) (4) (5)
- ---------------------------------------------------------------------------------------------------------------------
A+ 625 95% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg
TO $500,000++ 550 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg
525 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 80% 1st Mtg 70% 1st Mtg
500 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg 75% 1st Mtg 65% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
A1 625 95% 1st Mtg 90% 1st Mtg 85% 1st Mtg 85% 1st Mtg 75% 1st Mtg
UP TO $500,000++ 550 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg
525 85% 1st Mtg 75% 1st Mtg 75% 1st mtg 75% 1st Mtg 65% 1st Mtg
500 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
A2 575 90% 1st Mtg 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg
UP TO $500,000++ 550 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 80% 1st Mtg 70% 1st Mtg
525 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg 75% 1st Mtg 65% 1st Mtg
500 75% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
B1 600 90% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
UP TO $450,000++ 575 85% 1st Mtg 80% 1st Mtg 80% 1st Mtg 75% 1st Mtg 70% 1st Mtg
550 85% 1st Mtg 75% 1st Mtg 75% 1st Mtg 70% 1st Mtg 65% 1st Mtg
525 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 65% 1st Mtg 60% 1st Mtg
500 75% 1st Mtg 65% 1st Mtg 65% 1st Mtg 60% 1st Mtg 55% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
B2 575 85% 1st Mtg 75% 1st Mtg 75% 1st Mtg 70% 1st Mtg
UP TO $450,000++ 550 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg 70% 1st Mtg
525 75% 1st Mtg 65% 1st Mtg 65% 1st Mtg 65% 1st Mtg
500 70 % 1st Mtg 60% 1st Mtg 60% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
C1 575 80% 1st Mtg 75% 1st Mtg 75% 1st Mtg
UP TO $300,000++ 550 80% 1st Mtg 70% 1st Mtg 70% 1st Mtg
525 75% 1st Mtg 65% 1st Mtg 65% 1st Mtg
500 70% 1st Mtg 60% 1st Mtg 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
C2 550 75% 1st Mtg
UP TO $300,000++ 525 70% 1st Mtg
500 65% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
D1 550 70% 1st Mtg
UP TO $250,000++ 500 65% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
D2*** 525 65% 1st Mtg
UP TO $250,000++ 500 60% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
D3*** 525 60% 1st Mtg
UP TO $250,000++ 500 55% 1st Mtg
- ---------------------------------------------------------------------------------------------------------------------
(Chart continued on next page
11a
STATED
CREDIT PROGRAM/ INCOME-NOO
MAX LOAN AMOUNT (6) DTI MORTGAGE PAYMENT HISTORY BANKRUPTCY INFORMATION
- ------------------------------------------------------------------------------------------------------------------------------------
A+ 70% 1st Mtg 55%** EXCELLENT MORTGAGE HISTORY **** MIN 3 YEARS OLD:
--------------------------
UP TO $500,000++ 70% 1st Mtg 0x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
70% 1st Mtg *For extended LTV's, 0x60 13 to 24 months Ch 13 disc must be 1 yr old at closing.
65% 1st Mtg No foreclosures last 3 years.
- ------------------------------------------------------------------------------------------------------------------------------------
A1 70% 1st Mtg 55%** EXCELLENT MORTGAGE HISTORY **** MIN 3 YEARS OLD:
--------------------------
UP TO $500,000++ 70% 1st Mtg 1x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
65% 1st Mtg *For extended LTV's, 0x60 13 to 24 mos. Ch 13 disc must be 1 yr old at closing.
60% 1st Mtg No foreclosures last 3 years.
- ------------------------------------------------------------------------------------------------------------------------------------
A2 70% 1st Mtg 55%** EXCELLENT MORTGAGE HISTORY **** MIN 2 YEARS OLD:
--------------------------
UP TO $500,000++ 70% 1st Mtg 2x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
65% 1st Mtg *For extended LTV's, 0x90 13 to 24 months. Ch 13 must be disc before closing.
60% 1st Mtg No foreclosures last 2 years.
- ------------------------------------------------------------------------------------------------------------------------------------
B1 65% 1st Mtg 55%** GOOD MORTGAGE HISTORY **** MIN 2 YEARS OLD:
---------------------
UP TO $450,000++ 65% 1st Mtg 3x30 on mortgages within last 12 months. Ch 7 disc or Ch 13 filing.
65% 1st Mtg *For extended LTV's, 0x120 13 to 24 months. Ch 13 must be disc before closing.
60% 1st Mtg No foreclosures last 2 years.
55% 1st Mtg
- ------------------------------------------------------------------------------------------------------------------------------------
B2 55%** GOOD MORTGAGE HISTORY **** MIN 18 MONTHS OLD:
---------------------
UP TO $450,000++ 0x60 or 2x30, 1x60 on mortgages. Ch 7 disc or Ch 13 filing.
within last 12 months. Open Ch 13 considered. Mortgage
*For extended LTVs, 0x120 13 to 18 months. Must be paid as agreed since filing.
No foreclosures last 18 months.
- ------------------------------------------------------------------------------------------------------------------------------------
C1 55%** FAIR MORTGAGE HISTORY **** MIN 1YEAR OLD:
---------------------
UP TO $300,000++ 0x90 within last 12 months. Ch 7 disc or Ch 13 filing. No derogs
No worse than D-30 at closing. since Ch 7 disc or Ch 13 filing.
No foreclosures last 12 months.
- ------------------------------------------------------------------------------------------------------------------------------------
C2 55%** FAIR MORTGAGE HISTORY Ch 7 must be discharged by close.
---------------------
UP TO $300,000++ 1x90 on mortgages within last 12 months. Open Ch 13 considered with good
No worse than D-60 at closing. re-established credit.
- ------------------------------------------------------------------------------------------------------------------------------------
D1 55%** POOR MORTGAGE HISTORY
---------------------
UP TO $250,000++ 1x120 on mortgages within last 12 months.
No worse than D-90 at closing.
- ------------------------------------------------------------------------------------------------------------------------------------
D2*** 55%** POOR MORTGAGE HISTORY
---------------------
UP TO $250,000++ No worse than D-119 at closing.
Mortgage NOT in foreclosure.
- ------------------------------------------------------------------------------------------------------------------------------------
D3*** 55%** POOR MORTGAGE HISTORY
---------------------
UP TO $250,000++ Open foreclosures case-by-case.
- ------------------------------------------------------------------------------------------------------------------------------------
+ Minimum credit score requirement for all loans is 500. Minimum credit score
for all 2nd mortgages is 550. Minimum credit score for 90% LTV A+ & A1 of 625.
Consult guidelines for maximum LTV's.
++ Maximum loan amounts available are subject to LTV, income classification and
occupancy requirements.
Note: Minimum 2 years employment history for programs A+ through B2.
11b
* Extended LTV's are defined as: FIC, 00> 80%, NIC/LIC > 75% & NOO > 75%.
** For LTV's above 80% and/or income under 25K/yr, maximum DTI = 50% for
programs A+ through D3.
*** Lower LTV by 5% for programs D2 & D3 in: CT, ID, IL, IA, ME, MA, NJ, NY,
OK VT & WI.
**** Chapter 13 dismissal date follows same guidelines as Chapter 7 discharge.
- --------------------------------------------------------------------------------
(1) Full documentation/owner occupied
(2) Limited documentation/no income verification/owner occupied
(3) Fulldocumentation/non-owner occupied
(4) Stated income/owner occupied
(5) Limited documentation/no income verification/non-owner occupied
(6) Stated income/non-owner occupied
- --------------------------------------------------------------------------------
We use these categories and characteristics as guidelines only. On a
case-by-case basis, we may determine that the prospective borrower warrants an
exception from the guidelines, if sufficient compensating factors exist.
Examples of compensating factors we consider are:
o low debt ratio;
o long-term stability of employment and/or residence;
o excellent payment history on past mortgages;
o a significant reduction in monthly expenses; or
o low loan-to-value ratio.
The following table sets forth certain information with respect to our
originations and purchases of first and second mortgage loans by borrower
classification, along with weighted average coupons, for the periods shown and
highlights the improved credit quality of our originations and purchases.
(DOLLARS IN THOUSANDS)
PERCENT
YEAR CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
- ---- ---- ---- ------ ----- ------
2001 A $ 478,485 77.0% 10.0% 76.7%
B 59,729 9.6 11.5 68.6
C 61,498 9.9 12.2 66.7
D 22,003 3.5 13.2 57.4
--------- ---- ---- ----
Totals $ 621,715 100.0% 10.5% 74.2%
========= ==== ==== ====
2000 A $ 596,946 63.9% 10.8% 75.7%
B 164,024 17.6 11.7 70.2
C 127,041 13.6 12.6 67.3
D 45,427 4.9 13.8 56.9
--------- ---- ---- ----
Totals $ 933,438 100.0% 11.4% 72.7%
========= ==== ==== ====
1999 A $ 859,935 58.4% 9.8% 76.4%
B 298,253 20.3 10.7 72.9
C 245,862 16.7 11.3 69.5
D 67,288 4.6 13.0 57.3
--------- ---- ---- ----
Totals $ 1,471,338 100.0% 10.4% 73.7%
========= ==== ==== ====
- ------------------
(1) Weighted Average Coupon ("WAC").
(2) Weighted Average Initial Loan-to-Value Ratio ("WLTV").
12
The mortgage loans we originate have amortization schedules ranging from 5
years to 30 years, generally bear interest at fixed rates and require equal
monthly payments which are due as of a scheduled day of each month which is
fixed at origination. Substantially all of our mortgage loans are fully
amortizing loans. We primarily originate fixed rate loans, which amortize over a
period not to exceed 30 years. The principal amounts of the loans we originate
generally range from a minimum of $25,000 to a maximum of $500,000. We generally
do not originate any mortgage loans where the combined loan-to-value ratio on
the loan exceeds 90%. Our loans are generally secured by one- to four-family
residences, including condominiums and town-houses, and these properties may or
may not be occupied by the owner. It is our policy not to accept commercial
properties or unimproved land as collateral. However, we will accept mixed-use
properties, such as a property where a portion of the property is used for
residential purposes and the balance is used for commercial purposes, and will
accept small multifamily properties of 5 to 8 units, both at reduced
loan-to-value ratios. We do not originate loans where any senior mortgage
contains open-end advance, negative amortization or shared appreciation
provisions - all of which could have the effect of increasing the amount of the
senior mortgage, thereby increasing the combined LTV, and making the loan more
risky for us.
Our mortgage loan program includes:
o a full documentation program for salaried borrowers;
o a limited documentation program;
o a no income verification program for self-employed borrowers; and
o a stated income program.
We generally limit total monthly debt obligations - which include principal
and interest on the new loan and all other mortgages, loans, charge accounts and
scheduled indebtedness - to 50% or less of the borrower's monthly gross income.
For loans to borrowers who are salaried employees, we require current employment
information in addition to employment history. We verify this information for
salaried borrowers based on written confirmation from employers, one or more
recent pay-stubs, recent W-2 tax forms, recent tax returns or telephone
confirmation from the employer. For our limited documentation program, we
require a job letter to be submitted which contains substantially the same
information one would find on a standard verification of employment form,
including:
o job position;
o length of time on job;
o current salary; and
o the job letter should appear on the employer's letterhead and include
the telephone number and signature of the individual completing the
letter on behalf of the employer.
For our no income verification program, we require proof of self-employment
in the same business plus proof of current self-employed status. We only offer
our stated income program, which represents a very small percentage of our
loans, for better credit quality borrowers where a telephone verification is
done by an underwriter to verify that the borrower is employed. We usually
require lower combined loan-to-value ratios with respect to loans made under
programs other than the full documentation program.
We assess an applicant's ability and willingness to pay, which is one of the
principal elements in distinguishing our lending specialty from methods employed
by traditional lenders, such as savings and loans and commercial banks. All
lenders utilize debt ratios and loan-to-value ratios in the approval process.
Many lenders simply use software packages to score an applicant for loan
approval and fund the loan after auditing the data provided by the borrower. In
contrast, we employ experienced non-conforming mortgage loan credit underwriters
to scrutinize the applicant's credit profile and to evaluate whether an impaired
credit history is a result of adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. An applicant's
credit record will often be impaired by personal circumstances including
divorce, family illnesses or deaths and temporary job loss due to layoffs and
corporate downsizing.
We have a staff of 45 underwriters with an average of 10 years of
non-conforming lending experience. With the exception of our Atlanta, Georgia
office, all underwriting functions for broker originations are centralized in
our Woodbury, New York headquarters. All underwriting functions for retail
originations are centralized in our retail
13
underwriting "hub", located in Cincinnati, Ohio, and our Woodbury, New York
headquarters. We do not delegate underwriting authority to any broker. Our
underwriting department functions independently of our business development and
sales departments and does not report to any individual directly involved in the
sales origination process. None of our underwriters are compensated on an
incentive or commission basis.
We have instituted underwriting checks and balances that are designed to
ensure that every loan is reviewed and approved by a minimum of two
underwriters, with some higher loan amounts requiring a third approval. We
believe that by requiring each loan to be seen by a minimum of two underwriters,
a high degree of accuracy and quality control is ensured throughout the
underwriting process and before funding.
We underwrite every loan submitted by not only thoroughly reviewing credit,
but also by performing the following:
o a separate appraisal review conducted by our appraisal review
department; and
o a full compliance review, to ensure that all documents have been
properly prepared, all applicable disclosures given in a timely
fashion, and proper compliance with all federal and state regulations.
We require appraisals to be performed by third party, fee-based appraisers or
by our approved appraisers and to conform generally to current Fannie Mae and
Freddie Mac secondary market requirements for residential property appraisals.
Each appraisal includes, among other things, an inspection of both the exterior
and interior of the subject property and data from sales within the preceding 12
months of similar properties within the same general location as the subject
property. We perform an appraisal review on each loan prior to closing. We do
not believe that the general quality control practices of many conventional
mortgage lenders, which is to perform only drive-by appraisals after closings,
provides sufficient protection. As such, in addition to reviewing each appraisal
for accuracy, we access alternate sources to validate sales used in the
appraisal to determine market value. These sources include:
o Multiple Listing Services in eight states;
o assessment and sales services, such as Comps, Inc., Pace, 1st American
and Transamerica;
o on-line internet services such as Realtor.com; and
o other sources for verification, including broker price opinions and
market analyses by local real estate agents.
We actively track and grade (based upon criteria that we have developed over
time) all appraisers from which we accept appraisals for quality control
purposes and do not accept work from appraisers who have not conformed to our
review standards.
After completing the underwriting and processing of a brokered loan, we
schedule the closing of the loan with an approved closing attorney or settlement
agent. We hold the closing attorney or settlement agent responsible for
completing the loan closing transaction in accordance with applicable law and
our operating procedures. We also require title insurance that insures our
interest as mortgagee and evidence of adequate homeowner's insurance naming us
as an additional insured party on all loans.
We perform a post-funding quality control review to monitor and evaluate our
loan origination policies and procedures. The quality control department is
separate from the underwriting department, and reports directly to a member of
senior management.
We subject at least 10% of all loan originations to a full quality control
re-underwriting and review, the results of which are reported to senior
management on a monthly basis. We analyze discrepancies noted by the audit and
institute corrective actions. A typical quality control review currently
includes:
o obtaining a new drive-by appraisal for each property;
o running a new credit report from a different credit report agency;
o reviewing loan applications for completeness, signatures, and for
consistency with other processing documents;
o obtaining new written verification of income and employment;
o obtaining new written verification of mortgage to re-verify any
outstanding mortgages; and
14
o analyzing the underwriting and program selection decisions.
We update the quality control process from time to time as our policies and
procedures change.
LOAN SALES
We sell virtually all the loans we originate through one of two methods: (i)
securitizations, which involve the public offering by a securitization trust of
asset-backed pass-through securities; and (ii) whole loan sales, which include
the sale of pools of individual loans to institutional investors, banks, and
consumer finance-related companies on a servicing released basis. In 2001, we
securitized approximately 56% of our loan originations and sold whole loans of
approximately 42% of our loan originations. Going forward, we expect to continue
to use a combination of securitizations and whole loan sales, with the amounts
of each dependent upon the marketplace and our goal of maximizing earnings and
liquidity.
SECURITIZATIONS. During 2001, we completed two securitizations totaling $345
million. The following table sets forth certain information with respect to our
securitizations (both of which were rated AAA/Aaa by S&P Fitch, and/or Moody's,
respectively) by offering size, which includes pre-funded amounts, duration
weighted average pass-through rate and type of credit enhancement.
INITIAL DURATION
OFFERING SIZE WEIGHTED AVERAGE CREDIT
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE ENHANCEMENT
- --------- -------- ---------- ----------- ----------
2001-1................... 05/31/01 $165.0 6.15% Hybrid *
2001-2................... 10/16/01 $180.0 4.66% Hybrid*
* SENIOR/SUB STRUCTURE WITH A "AAA" RATED MONOLINE INSURER INSURING THE SENIOR
OR "AAA" RATED PASS-THROUGH CERTIFICATES
When we securitize loans, we sell a portfolio of loans to a trust (a "Home
Equity Loan Trust"), which is a qualified special purpose entity, for a cash
payment and the Home Equity Loan Trust sells various classes of pass-through
certificates representing undivided ownership interests in such Home Equity Loan
Trust. The servicer of each securitization will collect and remit principal and
interest payments to the appropriate Home Equity Loan Trust which, in turn,
passes through such payments to certificateholders. For each of the 2001
securitizations, we retained 100% of the interests in the excess cashflow
certificates while selling interest-only certificates for an up-front cash
premium. We contemplate continuing to retain excess cashflow certificates in the
future as long as, in management's opinion, this practice maximizes earnings
while satisfying our liquidity objectives.
Each Home Equity Loan Trust has the benefit of either a financial guaranty
insurance policy from a monoline insurance company or a senior-subordinated
securitization structure, which insures the timely payment of interest and the
ultimate payment of principal of the credit-enhanced investor certificate, or
both (known as a "hybrid"). In "senior-subordinated" structures, the senior
certificate holders are protected from losses by subordinated certificates,
which absorb any such losses first. In addition to such credit enhancement, the
excess cash flows that would otherwise be paid to us as holder of the excess
cashflow certificate is initially applied as additional payments of principal
for the investor certificates, thereby accelerating amortization of the investor
certificates relative to the amortization of the loans and creating
overcollateralization. Once the overcollateralization limit is reached, the use
of excess cash flows to create overcollateralization stops unless it
subsequently becomes necessary to obtain or maintain required
overcollateralization limits. Overcollateralization is intended to create a
source of cash (the "extra" payments on the loans) to absorb losses prior to
making a claim on the financial guaranty insurance policy or the subordinated
certificates.
WHOLE LOAN SALES WITHOUT RECOURSE. We have found that, at times, we can
receive better economic results by selling certain mortgage loans on a whole
loan, non-recourse basis, without retaining servicing rights, generally in
private transactions to financial institutions or consumer finance companies. We
recognize a gain or loss when we sell loans on a whole loan basis equal to the
difference between the cash proceeds received for the loans and our investment
in the loans, including any unamortized loan origination fees and costs.
15
In 2001 and 2000, we sold whole loans on a servicing-released basis of $261.1
million and $58.3 million, respectively. In 1999, we did not sell loans on a
whole loan basis.
LOAN SERVICING
Prior to May 2001, we serviced substantially all of the loans that we
originated and purchased since our inception in 1982.
In January 2001, we announced that we had entered into an agreement with
Ocwen to transfer our servicing portfolio to Ocwen. In May 2001, we physically
transferred our entire servicing portfolio to Ocwen, and laid-off our servicing
staff. We no longer service loans nor do we have a servicing operation. We do,
however, maintain a handful of employees to assist third parties with delinquent
and defaulted loans, as well as portfolio retention.
COMPETITION
As an originator of mortgage loans, we face intense competition, primarily
from diversified consumer financial companies and other diversified financial
institutions, mortgage banking companies, commercial banks, credit unions,
savings and loans, credit card issuers and finance companies. Many of these
competitors in the financial services business are substantially larger and have
more capital and other resources than we do. Competition can take many forms,
including interest rates and costs of the loan, convenience in obtaining a loan,
service, marketing and distribution channels. Furthermore, the level of gains
realized by us and our competitors on the sale of the type of loans originated
has attracted additional competitors into this market with the effect of
lowering the gains that may be realized by us on future loan sales. In addition,
efficiencies in the asset-backed market have generally created a desire for even
larger transactions giving companies with greater volumes of originations a
competitive advantage.
Competition may be affected by fluctuations in interest rates and general
economic conditions. During periods of rising rates, competitors which have
"locked in" low borrowing costs may have a competitive advantage. During periods
of declining rates, competitors may solicit borrowers underlying our excess
cashflow certificates to refinance their loans. During economic slowdowns or
recessions, these borrowers may have new financial difficulties and may be
receptive to offers by our competitors.
Over the past several years, many of the independent mortgage banking
companies, which previously were among our most intense competitors, have either
gone out of business or been acquired by larger, more diversified national
financial institutions. At the same time, many larger finance companies,
financial institutions and conforming mortgage originators have adapted their
conforming origination programs and allocated resources to the origination of
non-conforming loans and/or have otherwise begun to offer products similar to
those offered by us, targeting customers similar to those we do. Fannie Mae and
Freddie Mac also have expressed interest in adapting their programs to include
products similar to those offered by us and have begun to expand their programs
and presence into the subprime market. The entrance of these larger and
better-capitalized competitors into our market may have a material adverse
effect on our results of operations and financial condition.
REGULATION
Our business is subject to extensive regulation, supervision and licensing by
federal, state and local governmental authorities and is subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on part or all of our operations. Our consumer lending activities are subject
to, among other laws and regulations:
o the Federal Truth-in-Lending Act and Regulation Z (including the Home
Ownership and Equity Protection Act of 1994);
o the Equal Credit Opportunity Act of 1974, as amended (ECOA);
o the Fair Credit Reporting Act of 1970, as amended;
o the Real Estate Settlement Procedures Act (RESPA), and Regulation X;
o the Home Mortgage Disclosure Act;
16
o the Federal Debt Collection Practices Act; and
o other federal, state and local statutes and regulations affecting our
activities.
We also are subject to the rules and regulations of, and examinations by the
Department of Housing and Urban Development ("HUD") and state regulatory
authorities with respect to originating, processing and underwriting loans (and
servicing loans prior to May 2001). These rules and regulations, among other
things:
o impose licensing obligations on us;
o establish eligibility criteria for mortgage loans;
o prohibit discrimination;
o provide for inspections and appraisals of properties;
o require credit reports on loan applicants;
o regulate assessment, collection, foreclosure and claims handling,
investment and interest payments on escrow balances and payment
features;
o mandate certain disclosures and notices to borrowers; and
o in some cases, fix maximum interest rates, fees and mortgage loan
amounts.
Failure to comply with these requirements can lead to, among other things,
loss of approved status, demands for indemnification or mortgage loans
repurchases, certain rights of rescission for mortgage loans, class action and
other lawsuits, and administrative enforcement actions.
Several federal, state and local laws and regulations are currently under
consideration, with more likely to be proposed on the horizon, that are intended
to further regulate our industry. Many of these laws and regulations seek to
impose broad restrictions on certain commonly accepted lending practices,
including some of our practices. There can be no assurance that these proposed
laws, rules and regulations, or other similar laws, rules or regulations, will
not be adopted in the future. Adoption of these laws, rules and regulations
could have a material adverse impact on our business by:
o substantially increasing the costs of compliance with a variety of
potentially inconsistent federal, state and local laws;
o substantially increasing the risk of litigation or administrative
action associated with complying with these proposed federal, state and
local laws, particularly those aspects of such proposed laws that
contain subjective (as opposed to objective) requirements, among other
things; or
o restricting our ability to charge rates and fees adequate to compensate
us for the risk associated with certain loans.
In September 1999, we settled allegations by the NYSBD and a lawsuit by the
New York State Office of the Attorney General (the "NYOAG") alleging that we had
violated various state and federal lending laws. The global settlement was
evidenced by (a) a Remediation Agreement by and between Delta Funding and the
NYSBD, dated as of September 17, 1999 and (b) a Stipulated Order on Consent by
and among Delta Funding, Delta Financial and the NYOAG, dated as of September
17, 1999. As part of the Settlement, we, among other things, implemented agreed
upon changes to our lending practices; are providing reduced loan payments
aggregating $7.25 million to certain borrowers identified by the NYSBD; and have
created a fund managed by the NYSBD and financed by the grant of 525,000 shares
of Delta Financial's common stock.
Each month, on behalf of borrowers designated by the NYSBD, we make subsidy
payments to the related securitization trusts. These subsidy payments fund the
differential between the original loan payments and the reduced loan payments.
As part of the Second Exchange Offer (see "-Note No. 2 "Summary of Regulatory
Settlement" and Note No. 3 "Corporate Restructuring, Debt Modification and Debt
Restructuring" to Notes to the Consolidated Financial Statements" ), the LLC -
an unaffiliated, newly-formed entity, the voting membership interests of which
are owned by the former holders of our notes - is obligated to satisfy these
payment subsidies out of the cash flows generated by the mortgage related
securities (primarily from the excess cashflow certificates) it
17
owns. If the LLC's cash flows are insufficient to pay this obligation, we remain
responsible to satisfy our obligations under the Remediation Agreement.
The proceeds of the stock fund will be used to pay borrowers and to finance a
variety of consumer educational and counseling programs. We do not manage the
fund created for this purpose. The number of shares of common stock deposited in
the fund does not adjust to account for fluctuations in the market price of our
common stock. Changes to the market price of these shares of common stock
deposited in the fund do not have any impact on our financial statements. We did
not make any additional financial commitments between the settlement date and
March 2000.
In March 2000, we finalized an agreement with the U.S. Department of Justice,
the Federal Trade Commission and HUD, to complete the global settlement we had
reached with the NYSBD and NYOAG. The Federal agreement mandates some additional
compliance efforts for us, but it does not require any additional financial
commitment by us.
We believe we are in compliance in all material respects with applicable
federal and state laws and regulations.
ENVIRONMENTAL MATTERS
To date, we have not been required to perform any investigation or clean up
activities, nor have we been subject to any environmental claims. There can be
no assurance, however, that this will remain the case in the future. Although we
primarily lend to owners of residential properties, in the course of our
business, we may acquire properties securing loans that are in default. There is
a risk that we could be required to investigate and clean-up hazardous or toxic
substances or chemical releases at such properties, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
EMPLOYEES
As of December 31, 2001, we had a total of 609 employees (full-time and
part-time). None of our employees are covered by a collective bargaining
agreement. We consider our relations with our employees to be good.
ITEM 2. PROPERTIES
Our executive and administrative offices are located at 1000 Woodbury Road,
Woodbury, New York 11797, where we lease approximately 107,000 square feet of
office space at an aggregate annual rent of approximately $2.1 million. The
lease provides for certain scheduled rent increases and expires in 2008.
We also maintain a full service office in Atlanta, Georgia and business
development offices in New Jersey, Ohio, Pennsylvania and Virginia. Our retail
operation currently maintains nine retail mortgage origination offices in
Illinois, Missouri, North Carolina, Ohio (3), Pennsylvania (2) and Tennessee and
two retail call centers one at our headquarters in Woodbury, New York and the
second in Pittsburgh, Pennsylvania. We also maintain one telemarketing hub in
Ohio. The terms of these leases vary as to duration and escalation provisions,
with the latest expiring in 2004.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of our business involves the collection of numerous
accounts, the validity of liens and compliance with various state and federal
lending laws, we are subject, in the normal course of business, to numerous
claims and legal proceedings. Our lending practices have been the subject of
several lawsuits styled as class actions and of investigations by various
regulatory agencies including the NYSBD, the NYOAG and the United States
Department of Justice (the "DOJ"). The current status of these actions is
summarized below.
o In or about November 1998, we received notice that we had been named in
a lawsuit filed in the United States District Court for the Eastern
District of New York. In December 1998, plaintiffs filed an amended
complaint alleging that we had violated the Home Ownership and Equity
Protection Act ("HOEPA"), the
18
Truth in Lending Act ("TILA") and New York State General Business
Lawss.349. The complaint seeks (a) certification of a class of
plaintiffs, (b) declaratory judgment permitting rescission, (c)
unspecified actual, statutory, treble and punitive damages (including
attorneys' fees), (d) certain injunctive relief, and (e) declaratory
judgment declaring the loan transactions as void and unconscionable. On
December 7, 1998, plaintiff filed a motion seeking a temporary
restraining order and preliminary injunction, enjoining us from
conducting foreclosure sales on 11 properties. The District Court Judge
ruled that in order to consider such a motion, plaintiff must move to
intervene on behalf of these 11 borrowers. Thereafter, plaintiff moved
to intervene on behalf of 3 of these 11 borrowers and sought injunctive
relief on their behalf. We opposed the motions. On December 14, 1998,
the District Court Judge granted the motion to intervene and on
December 23, 1998, the District Court Judge issued a preliminary
injunction that enjoined us from proceeding with the foreclosure sales
of the three intervenors' properties. We filed a motion for
reconsideration of the December 23, 1998 order. In January 1999, we
filed an answer to plaintiffs' first amended complaint. In July 1999,
plaintiffs were granted leave, on consent, to file a second amended
complaint. In August 1999, plaintiffs filed a second amended complaint
that, among other things, added additional parties but contained the
same causes of action alleged in the first amended complaint. In
September 1999, we filed a motion to dismiss the complaint, which was
opposed by plaintiffs and, in June 2000, was denied in part and granted
in part by the Court. In or about October 1999, plaintiffs filed a
motion seeking an order preventing us, our attorneys and/or the NYSBD
from issuing notices to certain of our borrowers, in accordance with a
settlement agreement entered into by and between Delta and the NYSBD.
In or about October 1999 and November 1999, respectively, we and the
NYSBD submitted opposition to plaintiffs' motion. In March 2000, the
Court issued an order that permitted us to issue an approved form of
the notice. In September 1999, plaintiffs filed a motion for class
certification, which we opposed in February 2000, and was ultimately
withdrawn without prejudice by plaintiffs in January 2001. In February
2002, we executed a settlement agreement with plaintiffs, pursuant to
which we denied all wrongdoing, but agreed to resolve the litigation on
a class-wide basis. A fairness hearing has been scheduled for May 2002,
at which point, we anticipate that the Court will approve the
settlement. If the settlement is not approved, we believe that we have
meritorious defenses and intend to defend this suit, but cannot
estimate with any certainty our ultimate legal or financial liability,
if any, with respect to the alleged claims.
o In or about March 1999, we received notice that we had been named in a
lawsuit filed in the Supreme Court of the State of New York, New York
County, alleging that we had improperly charged certain borrowers
processing fees. The complaint seeks (a) certification of a class of
plaintiffs, (b) an accounting, and (c) unspecified compensatory and
punitive damages (including attorneys' fees), based upon alleged (i)
unjust enrichment, (ii) fraud, and (iii) deceptive trade practices. In
April 1999, we filed an answer to the complaint. In September 1999, we
filed a motion to dismiss the complaint, which was opposed by
plaintiffs, and in February 2000, the Court denied the motion to
dismiss. In April 1999, we filed a motion to change venue and
plaintiffs opposed the motion. In July 1999, the Court denied the
motion to change venue. We appealed and in March 2000, the Appellate
Court granted our appeal to change venue from New York County to Nassau
County. In August 1999, plaintiffs filed a motion for class
certification, which we opposed in July 2000. In or about September
2000, the Court granted plaintiffs' motion for class certification,
from which we filed a Notice of Appeal. In or about June 2001, we filed
a motion for summary judgment to dismiss the complaint, which was
denied by the Court in October 2001. We have appealed that decision as
well, and the trial court agreed to stay the action pending the result
of that appeal. We believe that we have meritorious defenses and intend
to defend this suit, but cannot estimate with any certainty our
ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about July 1999, we received notice that we had been named in a
lawsuit filed in the United States District Court for the Western
District of New York, alleging that amounts collected and maintained by
us in certain borrowers' tax and insurance escrow accounts exceeded
certain statutory (RESPA) and/or contractual (the respective borrowers'
mortgage agreements) ceilings. The complaint seeks (a) certification of
a class of plaintiffs, (b) declaratory relief finding that our
practices violated applicable statutes and/or the mortgage agreements,
(c) injunctive relief, and (d) unspecified compensatory and punitive
damages (including attorneys' fees). In October 1999, we filed a motion
to dismiss the complaint.
19
In or about November 1999, the case was transferred to the United
States District Court for the Northern District of Illinois. In
February 2000, the plaintiff opposed our motion to dismiss. In March
2000, the Court granted our motion to dismiss in part, and denied it in
part. In February 2002, we executed a settlement agreement with
plaintiffs pursuant to which we denied all wrongdoing, but agreed to
resolve the litigation on a class-wide basis. A fairness hearing has
been scheduled for June 2002, at which point we anticipate that the
Court will approve the settlement. If the settlement is not approved,
we believe that we have meritorious defenses and intend to defend this
suit, but cannot estimate with any certainty our ultimate legal or
financial liability, if any, with respect to the alleged claims.
o In or about August 1999, the NYOAG filed a lawsuit against us alleging
violations of (a) RESPA (by paying yield spread premiums), (b) HOEPA
and TILA, (c) ECOA, (d) New York Executive Lawss. 296-a, and (e) New
York Executive Lawss. 63(12). In September 1999, we settled the lawsuit
with the NYOAG, as part of a global settlement by and among us, the
NYOAG and the NYSBD, evidenced by that certain (a) Remediation
Agreement by and between us and the NYSBD, dated as of September 17,
1999 and (b) Stipulated Order on Consent by and among us and the NYOAG,
dated as of September 17, 1999. As part of the Settlement, we, among
other things, have implemented agreed upon changes to our lending
practices; are providing reduced loan payments aggregating $7.25
million to certain borrowers identified by the NYSBD; and have created
a fund financed by the grant of 525,000 shares of our common stock, the
proceeds of which will be used, for among other things, to pay
borrowers and for a variety of consumer educational and counseling
programs. As a result, the NYOAG lawsuit has been dismissed as against
us. The Remediation Agreement and Stipulated Order on Consent supersede
our previously announced settlements with the NYSBD and the NYOAG. In
March 2000, we finalized a settlement agreement with the United States
Department of Justice, the Federal Trade Commission and the Department
of Housing and Urban Renewal, to complete the global settlement it had
reached with the NYSBD and NYOAG. The federal agreement mandates some
additional compliance efforts, but it does not require any additional
financial commitment.
o In November 1999, we received notice that we had been named in a
lawsuit filed in the United States District Court for the Eastern
District of New York, seeking certification as a class action and
alleging violations of the federal securities laws in connection with
our initial public offering in 1996 and our reports subsequently filed
with the Securities and Exchange Commission. The complaint alleges that
the scope of the violations alleged in the consumer lawsuits and
regulatory actions brought in or around 1999 indicate a pervasive
pattern of action and risk that should have been more thoroughly
disclosed to investors in our common stock. In May 2000, the Court
consolidated this case and several other lawsuits that purportedly
contain the same or similar allegations against us and in August 2000
plaintiffs filed their Consolidated Amended Complaint. In October 2000,
we filed a motion to dismiss the Complaint in its entirety, which was
opposed by plaintiffs in November 2000, and denied by the Court in
September 2001. We believe that we have meritorious defenses and intend
to defend this suit, but cannot estimate with any certainty our
ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about April 2000, we received notice that we had been named in a
lawsuit filed in the Supreme Court of the State of New York, Nassau
County, alleging that we had improperly charged and collected from
borrowers certain fees when they paid off their mortgage loans with us.
The complaint seeks (a) certification of a class of plaintiffs, (b)
declaratory relief finding that the payoff statements used include
unauthorized charges and are deceptive and unfair, (c) injunctive
relief, and (d) unspecified compensatory, statutory and punitive
damages (including legal fees), based upon alleged violations of Real
Property Law 274-a, unfair and deceptive practices, money had and
received and unjust enrichment, and conversion. We answered the
complaint in June 2000. In March 2001, we filed a motion for summary
judgment, which was opposed by plaintiffs in March 2001, and we filed
reply papers in April 2001. In June 2001, our motion for summary
judgment dismissing the complaint was granted. In August 2001,
plaintiffs appealed the decision. We believe that we have meritorious
defenses and intend to defend this suit, but cannot estimate with any
certainty our ultimate legal or financial liability, if any, with
respect to the alleged claims.
20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock trades on the Over-The-Counter Bulletin Board ("OTCBB")
under the symbol "DLTO". The following table sets forth for the periods
indicated the range of the high and low closing sales prices for our common
stock.
2001 HIGH LOW
---- ---- ----
First Quarter ................... $ 0.63 $ 0.36
Second Quarter .................. 0.43 0.24
Third Quarter.................... 0.51 0.28
Fourth Quarter .................. 1.06 0.38
2000 HIGH LOW
---- ---- ----
First Quarter ................... $ 4.13 $ 2.00
Second Quarter .................. 2.31 1.25
Third Quarter.................... 1.63 0.50
Fourth Quarter .................. 0.69 0.22
Our common stock previously was listed on the New York Stock Exchange (the
"NYSE") under the symbol "DFC", but in May 2001, the NYSE de-listed our common
stock. The NYSE stated that it took this action because we were unable to meet
the NYSE's continued listing standards of maintaining a minimum of $15 million
in market capitalization and a minimum share price of $1 over a 30-day trading
period. When our common stock was de-listed in May 2001, it began trading on the
OTCBB under the ticker symbol "DLTO".
On December 31, 2001, we had approximately 74 stockholders of record. This
number does not include beneficial owners holding shares through nominee or
"street" names. We believe the number of beneficial stockholders is
approximately 1,900.
DIVIDEND POLICY
We did not pay any dividends in 2001 and, in accordance with our present
general policy, we have no present intention to pay cash dividends on our common
stock. Under the terms of our Certificate of Designations for our newly-issued
preferred stock, we are obligated to commence paying dividends to holders of our
Series A preferred stock in July 2003, and are limited in our ability to pay
dividends to holders of our common stock.
21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Income Statement Data: (DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
Revenues:
Net gain on sale of mortgage loans............ $ 38,638 51,031 84,010 98,396 89,687
Interest...................................... (22,146) 32,287 31,041 12,458 22,341
Servicing fees................................ 2,983 14,190 16,341 10,464 7,511
Net origination fees and other income......... 13,450 21,463 23,427 18,257 14,311
---------------------------------------------------------------------
Total revenues........................... 32,925 118,971 154,819 139,575 133,850
---------------------------------------------------------------------
Expenses
Payroll and related costs .................... 42,896 56,525 65,116 56,709 41,214
Interest...................................... 16,132 30,386 26,656 30,019 19,964
General & administrative 48,878 45,066 55,318 34,351 21,522
Capitalized mortgage servicing impairment .... -- 38,237 -- -- --
Restructuring and other special charges....... 2,678 11,382 -- -- --
-------------------------------------------------------------------
Total expenses.......................... 110,584 181,596 147,090 121,079 82,700
-------------------------------------------------------------------
Income (loss) before income tax expense (benefit)
and extraordinary item........................ (77,659) (62,625) 7,729 18,496 51,150
Provision for income tax expense (benefit) ....... 2,876 (13,208) 3,053 7,168 20,739
-------------------------------------------------------------------
Income (loss) before extraordinary item........... (80,535) (49,417) 4,676 11,328 30,411
Extraordinary item, net of tax loss on early
extinguishment of debt........................ (19,255) -- -- -- --
-------------------------------------------------------------------
Net income (loss)................................. $ (99,790) (49,417) 4,676 11,328 30,411
------------------------------------------------------------------
BASIC AND DILUTED EARNINGS PER SHARE:
Income (loss) before extraordinary item......... $ (5.07) (3.11) 0.30 0.74 1.98
Extraordinary item, net of tax.................. (1.21) -- -- -- --
Net income (loss) per share......................... $ (6.28) (3.11) 0.30 0.74 1.98
Weighted average number of
shares outstanding...................... 15,883,749 15,883,749 15,511,214 15,382,161 15,359,280
Selected Balance Sheet Data:
Loans held for sale, net.......................... $ 94,407 82,698 89,036 87,170 79,247
Capitalized mortgage servicing rights............. -- -- 45,927 33,490 22,862
Excess cashflow certificates, net................. 16,765 216,907 224,659 203,803 167,809
Total assets...................................... 132,398 451,245 555,395 480,537 393,232
Senior notes, warehouse financing and
other borrowings.............................. 100,472 238,203 258,493 229,660 177,540
Investor payable.................................. -- 69,489 82,204 63,790 40,852
Total liabilities................................. 120,548 353,521 408,254 342,849 266,779
Stockholders' equity.............................. 11,850 97,724 147,141 137,688 126,453
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SET FORTH THEREIN.
GENERAL
As discussed in more detail in the "Business Overview" in Part I, beginning
on page 1, Delta Financial Corporation ("Delta" or "we"), through its
wholly-owned subsidiaries, originates, securitizes and sells (and, prior to May
2001, serviced) non-conforming home equity loans, which are primarily secured by
first mortgages on one- to four-family residential properties. Throughout our 20
years of operating history, we have focused on lending to individuals who
generally have impaired or limited credit profiles or higher debt-to-income
ratios for such purposes as debt consolidation, home improvement, mortgage
refinancing or education. These borrowers generally do not satisfy the credit,
documentation or other underwriting standards set by more traditional sources of
mortgage credit, including those that make loans in compliance with conventional
mortgage lending guidelines established by Fannie Mae and Freddie Mac. We make
loans to these individuals for such purposes as debt consolidation, refinancing,
education or home improvements.
Our mortgage business has two principal components. First, we make mortgage
loans to individual borrowers, which is a cash and expense outlay for us,
because our cost to originate a loan exceeds the fees we collect at the time we
originate that loan. At the time we originate a loan, and prior to the time we
sell that loan, we finance that loan by borrowing under a warehouse line of
credit. Second, we sell loans, either through securitization or on a whole loan
basis, to generate cash and non-cash revenues. We use the proceeds from these
sales to repay our warehouse line of credit and for working capital, recording
the premiums we receive from the loan sales and securitizations as revenue.
CORPORATE RESTRUCTURING, DEBT MODIFICATION AND DEBT RESTRUCTURING. As
discussed in more detail in "Corporate Restructuring, Debt Modification and Debt
Restructuring" in Part I, beginning on page 4, we engaged in a series of
transactions beginning in 2000, and concluding in the third quarter of 2001,
aimed at improving operating efficiencies and reducing our negative cash flow.
We spent much of the year working on two transactions in particular, which we
believe were of tantamount importance in this regard - selling our servicing
portfolio and extinguishing most of our long term debt.
o In May 2001, we completed our transfer of servicing to Ocwen, which
freed us from the significant cash drain associated with making
securitization advances (and the capital costs associated with making
such advances), and of servicing a highly seasoned portfolio following
three successive quarters of selling the securitization servicing
rights associated with newly originated mortgage loans;
o In August 2001, we completed our Second Exchange Offer, which
extinguished substantially all of our long-term debt, leaving
approximately $10 million out of $150 million of our notes still
outstanding. This debt extinguishment helped us threefold. First, it
eliminated nearly $140 million of principal which we otherwise would
have had to repay in 2004. Second, it eliminated more than $13 million
of yearly interest expense that we would have had to pay to the former
noteholders had they still held their notes. Third, the ratings
agencies that previously rated us and our notes have withdrawn their
corporate ratings.
We believe that our transfer of servicing to Ocwen and the Second Exchange
Offer were essential steps in our continuing effort to restructure our
operations and reduce our negative cash flow previously associated with our
servicing operations and the notes. There can be no assurances, however, that
these or other factors described herein will not have a material adverse effect
on our results of operations and financial condition. (See "-Competition,"
"-Regulation" and "-Forward Looking Statements and Risk Factors," among other
sections).
OTHER. In May 2001, the NYSE de-listed our Common Stock. The Exchange stated
that it took this action because we were unable to meet the NYSE's continued
listing standards of maintaining a minimum of $15 million in market
capitalization and a minimum share price of $1 over a 30-day trading period.
When our Common Stock was de-listed in May, it began trading on the OTCBB under
the ticker symbol "DLTO".
23
EXCESS CASHFLOW CERTIFICATES
We classify excess cashflow certificates that we receive upon the
securitization of a pool of loans as "trading securities." The amount initially
allocated to the excess cashflow certificates at the date of a securitization
reflects their fair value. The amount recorded for the excess cashflow
certificates is reduced for distributions which we receive as the holder of
these excess cashflow certificates and is adjusted for subsequent changes in the
fair value of the excess cashflow certificates we hold.
At the time each securitization transaction closes, we determine the present
value of the related excess cashflow certificates using certain assumptions we
make regarding the underlying mortgage loans. The excess cashflow certificate is
then recorded on our consolidated financial statements at an estimated fair
value. Our estimates primarily include the following:
o future rate of prepayment of the mortgage loans;
o credit losses on the mortgage loans;
o a discount rate used to calculate present value; and
o the London Inter-Bank Offered Rate ("LIBOR") forward curve (using
current LIBOR as the floor rate).
The value of each excess cashflow certificate represents the cash flow we
expect to receive in the future from such certificate based upon our best
estimate. We monitor the performance of the loans underlying each excess
cashflow certificate, and any changes in our estimates (and consequent changes
in value of the excess cashflow certificates) is reflected in the line item
called "interest income" in the quarter in which we make any such change in our
estimate. Although we believe that the assumptions we use are reasonable, there
can be no assurance as to the accuracy of the assumptions or estimates.
In determining the fair value of each of the excess cashflow certificates, we
make the following underlying assumptions regarding mortgage loan prepayments,
mortgage loan default rates and discount rates:
(A) PREPAYMENTS. We base our prepayment rate assumptions upon our on-going
analysis of the performance of mortgage pools we previously securitized,
and the performance of similar pools of mortgage loans securitized by
others in the industry. We apply different prepayment speed assumptions to
different loan product types because it has been our experience that
different loan product types exhibit different prepayment patterns.
Generally, our loans can be grouped into two loan products - fixed rate
loans and adjustable rate loans. With fixed rate loans, an underlying
borrower's interest rate remains fixed throughout the life of the loan. Our
adjustable rate loans are really a "hybrid" between fixed and adjustable
rate loans, in that the rate generally remains fixed typically for the
first three years of the loan, and then adjusts typically every six months
thereafter. Within each product type, other factors can affect prepayment
rate assumptions. Some of these factors, for instance, include:
o whether or not a loan contains a prepayment penalty - an amount that a
borrower must pay to a lender if the borrower prepays the loan within a
certain time after the loan was originated. Loans containing a
prepayment penalty typically do not prepay as quickly as those without
such a penalty;
o as is customary with adjustable rate mortgage loans, the introductory
interest rate charged to the borrower is artificially lower, between
one and two full percentage points, than the rate for which the
borrower would have otherwise qualified. Generally, once the adjustable
rate mortgage begins adjusting on the first adjustment date, the
interest rate payable on that loan increases, at times fairly
substantially. This interest rate increase can be exacerbated if there
is an absolute increase in interest rates. As a result of these
increases and the potential for future increases, adjustable rate
mortgage loans typically are more susceptible to early prepayments.
There are several reasons why a loan will prepay prior to its maturity,
including (but not limited to):
o a decrease in interest rates;
24
o improvement in the borrower's credit profile, which may allow them to
qualify for a lower interest rate loan;
o competition in the mortgage market, which may result in lower interest
rates being offered;
o the borrower's sale of his or her home; and
o a default by the borrower, resulting in foreclosure by the lender.
It is unusual for a borrower to prepay a mortgage loan during the first
few months because of the following:
o it typically takes at least several months after the mortgage loans are
originated for any of the above events to occur;
o there are costs involved with refinancing a loan; and
o the borrower does not want to incur prepayment penalties.
Thereafter, we have found that the rate at which loans prepay will slowly
increase and stabilize, then decrease and eventually level off.
Historically, we used a "ramp" prepayment curve, in which we projected that
a loan would initially begin prepaying at a certain rate, and that rate
would incrementally increase (or "ramp up") over its first 12 months, and
level off thereafter. Commencing in 1998, we began using a "vector" curve,
which is similar to a "ramp curve" in that prepayment rates incrementally
increase over a longer period of time and then stabilize. However, as
opposed to a ramp curve (which remains constant once prepayments
stabilize), we believe that a vector curve is more representative of
projected future loan prepayment experience, as it thereafter decreases and
then eventually levels off.
The following table shows our most recent changes to our prepayment
assumptions - in the third quarter of 2001 and, prior to that, in the third
quarter 2000:
LOAN TYPE AT SEPTEMBER 30, 2001 AT SEPTEMBER 30, 2000
-------------------------------------------------------------
Fixed Rate:
At Month 4.00% 4.00%
Peak Speed 30.00% 23.00%
Adjustable Rate:
At Month 4.00% 4.00%
Peak Speed 75.00% 50.00%
(B) DEFAULT RATE. A default reserve for both fixed- and adjustable-rate
loans sold to the securitization trust