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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, 1997
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:
COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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. [_]
As of March 24, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $18.50, was
approximately $90,172,830.
As of March 24, 1998, the Registrant had 15,372,688 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, items 10, 11, 12 and 13 are incorporated by reference to 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, 1997.
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PART I
ITEM 1. BUSINESS
Delta Financial Corporation, together with its subsidiaries ( the "Company"
or "Delta"), is a consumer finance company that has engaged in originating,
acquiring, selling and servicing non-conforming home equity loans since 1982.
Throughout its 16 years of operating history, Delta has focused on lending to
individuals who generally have impaired or limited credit profiles or higher
debt-to-income ratios and typically have substantial equity in their homes.
Management believes that these borrowers have largely been unsatisfied by the
more traditional sources of mortgage credit which underwrite loans to
conventional guidelines established by the Federal National Mortgage
Associations ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
The Company makes loans to these borrowers for such purposes as debt
consolidation, home improvement, mortgage refinancing or education, and these
loans are primarily secured by first mortgages on one- to four-family
residential properties.
Through its wholly-owned subsidiary, Delta Funding Corporation, the Company
originates home equity loans indirectly through licensed mortgage brokers and
other real estate professionals who submit loan applications on behalf of the
borrower ("Brokered Loans") and also purchases loans from mortgage bankers and
smaller financial institutions that satisfy Delta's underwriting guidelines
("Correspondent Loans"). Delta Funding Corporation currently originates and
purchases the majority of its loans in 22 states, through its network of
approximately 1,150 brokers and correspondents.
In February 1997, in an effort to broaden its origination sources and to
expand its geographic presence, the Company acquired two related retail
originators of home equity loans, Fidelity Mortgage Inc., based in Cincinnati,
Ohio, and Fidelity Mortgage (Florida), Inc., based in West Palm Beach, Florida,
and subsequently merged the two companies into Fidelity Mortgage Inc. ("Fidelity
Mortgage"). Fidelity Mortgage develops retail loan leads primarily through its
telemarketing system and its network of 15 retail offices located in Florida
(3), Georgia, Illinois, Indiana, Missouri, North Carolina, Ohio (4),
Pennsylvania (2) and Tennessee.
For the year ended December 31, 1997, the Company originated and purchased
approximately $1.25 billion of loans, of which approximately $482 million were
originated through its network of brokers, $633 million were purchased from its
network of correspondents and $140 million were originated through its Fidelity
Mortgage retail network.
Substantially all of the loans originated and purchased by the Company were
sold in securitizations in which the loans were transferred to a trust which had
raised the cash payment to purchase the loans through the sale of asset-backed
pass-through securities. For the year ended December 31, 1997, Delta sold a
total of $1.24 billion of loans through four real estate mortgage investment
conduit ("REMIC") securitizations. Each of these four securitizations were
credit-enhanced, by either an insurance policy provided through a monoline
insurance company or a senior-subordinated structure, to receive ratings of Aaa
from Moody's Investors Service, Inc. ("Moody's") and AAA from Standard & Poor's
Ratings Group, a division of The McGraw-Hill Companies, Inc. ("S&P"). The
Company sells loans through securitizations to enhance its operating leverage
and liquidity, to minimize financing costs and to reduce its exposure to
fluctuations in interest rates.
The majority of the Company's revenues and cash flows result from its
securitizations and servicing of home-equity loans that it has originated or
purchased. In a securitization, the Company sells the loans to a trust for a
cash payment while retaining (i) the right to service the loans, and receive its
contractual servicing fee and (ii) interest-only and residual certificates in
the trust, which entitle the Company to receive the "Excess Servicing" income,
consisting of any cash flows collected by the trust from principal, and interest
payments on its loans after the trust has first paid (a) all principal and
interest required to be passed through to holders of the trust's securities, (b)
all contractual servicing fees, and (c) other recurring fees and costs of
administering the trust. Upon securitizating a pool of loans, the Company
recognizes a gain on sale of loans ("net gain on sale of mortgage loans") equal
to the difference between cash received from the trust and the investment in the
loans remaining after the allocation of portions of that investment to record
the servicing rights and interest-only and residual certificates received in the
securitization. The majority of the net gain on the sale of mortgage loans
results from, and is initially realized in the form of, the retention of the
mortgage servicing rights and interest-only and residual certificates. The
servicing rights and interest-only and residual certificates are each recorded
based on their fair values, estimated based on a discount rate which management
believes reflects the rate market participants would utilize in purchasing
similar
1
servicing rights and interest-only and residual certificates, and the
stated terms of the transferred loans adjusted for estimates of future
prepayments rates and defaults among those loans. If actual prepayments and/or
defaults exceed the Company's estimates, the future cash flows from the
servicing rights and interest-only and residual certificates would be negatively
affected. (See "Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Accounting Considerations.")
Although the Company recognizes income from the securitization of loans at
the time of the securitization, the Company receives cash flows from the
securitization, in particular the retained servicing rights and interest-only
and residual certificates, over the life of the transferred loans.
The Company services substantially all of the loans it has originated or
purchased, including all of the loans sold through securitizations. As of
December 31, 1997, the Company has a loan servicing portfolio of $1.84 billion.
The Company begins to receive cash flows from monthly contractual servicing
fees in the month following the securitization. The Company's servicing fees
range from 0.50% to 0.65% per annum of the outstanding balance of the loans
being serviced.
Cash flows from the interest-only and residual certificates retained upon
securitization generally begin eight to twelve months after the securitization,
with the specific period depending on the structure and performance of the
securitization. Initially, securitization trusts utilize the Excess Servicing
cash flows to make additional payments of principal on the pass-through
certificates in order to establish a spread between the principal amount of the
trust's outstanding loans and the amount of outstanding pass-through
certificates. Once a spread of between 2% and 3% of the initial securitization
principal (the "overcollateralization limit") is established, the Excess
Servicing cash flows are distributed to Delta as the holder of the interest-only
and residual certificates.
In addition to the income and cash flows earned from the Company's
securitizations, the Company also earns income and generates cash flows from the
net interest spread earned on loans while they are held for sale, and from loan
origination fees on Brokered Loans and retail loans.
The Company's business strategy is to increase profitably the volume of its
loan originations and purchases and the size of its servicing portfolio by (i)
continuing to provide top quality service to its network of brokers and
correspondents, as well as to its retail clients, (ii) maintaining its
underwriting standards, (iii) further penetrating its established and
recently-entered markets and expanding into new geographic markets, (iv)
expanding its retail origination capabilities; (v) leveraging and continuing its
investment in information and processing technologies, and (vi) strengthening
its loan production capabilities through acquisitions.
Delta Financial Corporation was incorporated in 1996 to acquire all of the
outstanding stock of Delta Funding Corporation, which has operated since 1982.
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Delta's consumer finance activities consist of originating, acquiring,
selling and servicing non-conforming mortgage loans. These loans are primarily
secured by first mortgages on one- to four-family residences. Once loan
applications have been received, the underwriting process completed and the
loans funded or purchased, Delta typically packages the loans in a portfolio and
sells the portfolio through a securitization. Delta retains the right to service
the loans that it securitizes.
The Company focuses on providing its customers with an array of loan products
designed to meet their needs. The Company uses a risk-based pricing strategy and
has developed products for various risk categories. Historically, the Company
offered fixed-rate loan products and, to date, the majority of the Company's
loan production is fixed-rate. However, as the Company has expanded
geographically, it has expanded its product offerings to include adjustable-rate
mortgages and fixed/adjustable-rate mortgages.
Historically, the Company conducted substantially all of its broker and
correspondent lending operations out of its Woodbury, New York headquarters.
Recently, however, the Company has begun opening regional branch offices, which
include loan processing, underwriting and business development functions, to
bring it in closer
2
contact with brokers and correspondents, enhance customer service and
underscore Delta's long-term commitment in newer regions. Typically, these
offices are staffed with a combination of experienced Delta personnel who
oversee the implementation of Delta's operating methods and local employees with
established relationships in, and specific knowledge of, the local market.
Currently, the Company's Southeast regional office (Atlanta, Georgia), which is
staffed by two members of Delta's senior management, including a Vice President
of Underwriting, is the only "full service" regional branch with full
underwriting authority. Delta's Midwest (Chicago, Illinois) and New England
(Warwick, Rhode Island) regional offices are "full processing" regional
branches, for which final underwriting approval is required from the Woodbury,
New York headquarters for all mortgage loans. As these branches mature and
demonstrate their ability to meet Delta's operating standards, the Company
intends to further strengthen their operations by delegating full underwriting
authority, thereby increasing the Company's long-term growth potential. The
Fidelity Mortgage offices have full underwriting authority.
LOAN ORIGINATION AND PURCHASES
The Company increased its loan originations and purchases by 90% to $1.25
billion in 1997 from $659 million in 1996, which was an increase of 129% over
1995 production of $288 million.
Delta currently originates and purchases the majority of its loans in 22
states through its network of approximately 1,150 brokers and correspondents,
and its network of 15 retail branches.
The following table shows the channels of the Company's loan originations and
purchases for the years shown:
YEAR ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
(DOLLARS IN THOUSANDS)
Broker:
Principal balance...................... $ 481,586 $ 321,733 $ 175,738
Average principal balance per loan..... $ 87 $ 85 $ 76
Combined weighted average initial loan-
to-value ratio(1).................... 69.9% 67.7% 62.3%
Weighted average interest rate......... 10.8% 11.1% 11.4%
Correspondent:
Principal balance...................... $ 632,639 $ 337,033 $ 112,065
Average principal balance per loan..... $ 77 $ 73 $ 70
Combined weighted average initial loan-
to-value ratio(1).................... 72.8% 69.8% 64.5%
Weighted average interest rate......... 11.3% 11.7% 12.4%
Retail:
Principal balance...................... $ 140,386 $ n/a $ n/a
Average principal balance per loan..... $ 69 $ n/a $ n/a
Combined weighted average initial loan-
to-value ratio(1).................... 80.1% n/a n/a
Weighted average interest rate......... 10.1% n/a n/a
Total loan purchases and originations:
Principal balance...................... $1,254,611 $ 658,766 $ 287,803
Average principal balance per loan..... $ 80 $ 78 $ 74
Combined weighted average initial loan-
to-value ratio(1).................... 72.5% 68.8% 63.2%
Weighted average interest rate......... 11.0% 11.4% 11.8%
Percentage of loans secured by:
First mortgage......................... 94.0% 93.8% 89.6%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of a loan
secured by a second mortgage is determined 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.
3
The following table shows the channels of loan originations and purchases
on a quarterly basis for 1997:
THREE MONTHS ENDED
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DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1997 1997 1997 1997
------------ ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
Broker:
Number of Brokered Loans ............................... 1,562 1,506 1,247 1,205
Principal balance ...................................... $138,339 $133,965 $103,276 $106,006
Average principal balance per loan ..................... $ 89 $ 89 $ 83 $ 88
Combined weighted average initial loan-
to-value ratio(1) ...................................... 70.7% 70.5% 68.6% 69.4%
Weighted average interest rate ......................... 10.4% 10.7% 11.2% 11.1%
Correspondent:
Number of Correspondent Loans .......................... 2,594 2,190 1,817 1,615
Principal balance ...................................... $200,883 $170,840 $138,237 $122,679
Average principal balance per loan ..................... $ 77 $ 78 $ 76 $ 76
Combined weighted average initial loan-
to-value ratio(1) ...................................... 73.5% 73.3% 72.0% 71.9%
Weighted average interest rate ......................... 11.0% 11.2% 11.6% 11.6%
Retail:
Number of retail loans ................................. 825 738 367 111
Principal balance ...................................... $ 57,239 $ 51,187 $ 23,903 $ 8,057
Average principal balance per loan ..................... $ 69 $ 69 $ 65 $ 73
Combined weighted average initial loan-
to-value ratio(1) ...................................... 79.8% 80.7% 79.9% 79.7%
Weighted average interest rate ......................... 10.0% 10.1% 10.1% 9.9%
Total loan purchases and originations:
Total number of loans .................................. 4,981 4,434 3,431 2,931
Principal balance ...................................... $396,461 $355,992 $265,416 $236,742
Average principal balance per loan ..................... $ 80 $ 80 $ 77 $ 81
Combined weighted average initial loan-
to-value ratio(1) ...................................... 73.5% 73.3% 71.4% 71.0%
Weighted average interest rate ......................... 10.7% 10.9% 11.3% 11.3%
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(1)The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of a loan
secured by a second mortgage is determined 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.
4
The following table shows lien position, weighted average interest rates and
loan-to-value ratios for the years shown:
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995
---- ---- ----
First mortgage:
Percentage of total purchases and originations 94.0% 93.8% 89.6%
Weighted average interest rate........ 11.0% 11.4% 11.8%
Weighted average initial loan-to-value ratio(1) 72.6% 68.9% 63.2%
Second mortgage:
Percentage of total purchases and originations 6.0% 6.2% 10.4%
Weighted average interest rate........ 11.3% 11.5% 11.9%
Weighted average initial loan-to-value ratio(1) 71.1% 66.6% 62.9%
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(1)The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser
of the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of a loan
secured by a second mortgage is determined 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 the geographic distribution of loan purchases and
originations for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
1997 1996 1995
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REGION PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE PERCENTAGE DOLLAR VALUE
- ------ ---------- ------------ ---------- ------------ ---------- ------------
(DOLLARS IN MILLIONS)
NY, NJ and PA ......................... 52.9% $ 664.3 66.3% $ 436.9 86.2% $ 248.0
Midwest ............................... 23.8 298.2 17.0 112.0 5.4 15.7
Southeast ............................. 9.7 121.4 4.2 27.6 0.8 2.2
New England ........................... 7.1 89.3 5.9 38.6 2.2 6.2
Mid-Atlantic* ......................... 6.5 81.3 6.6 43.7 5.4 15.7
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* Excluding New York (NY), New Jersey (NJ) and Pennsylvania (PA).
BROKER AND CORRESPONDENT MARKETING. Throughout its history Delta has been
successful in establishing and maintaining relationships with brokers and
correspondents offering non-conforming mortgage products to their clientele, and
management believes that this success is primarily attributable to the quality
of service the Company provides to its network of brokers and correspondents.
Delta typically initiates contact with a broker or correspondent through
Delta's Business Development Department, comprised of 27 business development
representatives supervised by a senior officer with over ten years of sales and
marketing experience in the industry. The Company usually hires business
development representatives who have contacts with brokers and correspondents
that originate nonconforming mortgage loans within their geographic territory.
The business development representatives are responsible for developing and
maintaining the Company's broker and correspondent networks within their
geographic territory by frequently visiting the broker or correspondent,
communicating the Company's underwriting guidelines, disseminating new product
information and pricing changes, and by demonstrating a continuing commitment to
understanding the needs of the customer. The business development
representatives attend industry trade shows and inform Delta about the products
and pricing being offered by competitors and new market entrants. This
information assists Delta in refining its programs and product offerings in
order to remain competitive. Business development representatives are
compensated with a base salary and commissions based on the volume of loans
originated or purchased as a result of their efforts.
APPROVAL PROCESS. Before a broker or correspondent becomes part of Delta's
network, it must go through an approval process. Once approved, brokers and
correspondents may immediately begin submitting applications and/or loans to
Delta.
5
To be approved, a broker must demonstrate that it is properly licensed and
registered in the state in which it seeks to transact business, submit to a
credit check, and sign a standard broker agreement with Delta. A correspondent
is eligible to submit loans to Delta for purchase only after an extensive
investigation of the prospective correspondent's lending operations including an
on-site visit, a review of the correspondent's financial statements for the
prior two years, a credit report on the correspondent, a review of sample loan
documentation and business references provided by the correspondent. Once
approved, Delta requires that each correspondent sign an Agreement of Purchase
and Sale in which the correspondent makes representations and warranties
governing both the mechanics of doing business with Delta and the quality of the
loan submissions themselves. Delta also performs an annual review of each
approved correspondent in order to ensure continued compliance with legal
requirements and that lending operations and financial information continue to
meet Delta's standards. In addition, Delta regularly reviews the performance of
loans originated or purchased through its brokers or correspondents.
BROKERS. For the year ended December 31, 1997, the Company's broker network
accounted for $481.6 million, or 38%, of Delta's loan purchases and originations
compared to $321.7 million, or 49%, of Delta's loan purchases and originations
for the year ended December 31, 1996 and $175.7 million, or 61%, of Delta's loan
purchases and originations for the year ended December 31, 1995. No single
broker contributed more than 5.8%, 11.4% or 6.2% of Delta's total purchases or
originations in the years ended December 31, 1997, 1996 and 1995, respectively.
Once approved, a broker may submit loan applications for prospective
borrowers to Delta. To process broker submissions, Delta's broker originations
area is organized into teams, each consisting of loan officers and processors,
which are generally assigned to specific brokers. Because Delta operates in a
highly competitive environment where brokers may submit the same loan
application to several prospective lenders simultaneously, Delta strives to
provide brokers with a rapid and informed response. Loan officers analyze the
application and provide the broker with a preliminary approval, subject to final
underwriting approval, or a denial, typically within one business day. If the
application is approved by the Company's underwriters, a "conditional approval"
will be issued to the broker with a list of specific conditions to be met and
additional documents to be supplied prior to funding the loan. The loan officer
and processor team will then work directly with the submitting broker to collect
the requested information and meet all underwriting conditions. In most cases,
the Company funds loans within 14 to 21 days after preliminary approval of the
loan application. In the case of a denial, Delta will make all reasonable
attempts to ensure that there is no missing information concerning the borrower
or the application that might change the decision on the loan.
The Company compensates its loan officers, who on a loan-by-loan basis are
the primary relationship contacts with the brokers, predominantly on a
commission basis. All of the Company's loan officers must complete an extensive
9 to 12 month training program to attain the level of knowledge and experience
integral to the Company's commitment to providing the highest quality service
for brokers. Management believes that by maintaining an efficient, trained and
experienced staff, it has addressed three central factors which determine where
a broker sends its business: (i) the speed with which a lender closes loans,
(ii) the lender's knowledge concerning the broker and his business and (iii) the
support a lender provides.
CORRESPONDENTS. For the year ended December 31, 1997, Delta's correspondent
network accounted for $632.6 million, or 51%, of Delta's loans purchases and
originations compared to $337.0 million, or 51%, of Delta's loan purchases and
originations for the year ended December 31, 1996 and $112.1 million, or 39%, of
Delta's loan purchases and originations for the year ended December 31, 1995. No
single correspondent contributed more than 6.5%, 6.3% or 6.3% of Delta's total
loan purchases and originations in 1997, 1996 or 1995, respectively.
An approved correspondent is a licensed mortgage banker or savings and loan
who sells loans to Delta which the correspondent has originated, processed,
closed and funded in its own name in conformity with Delta's underwriting
standards. The loans are sold to Delta either on an individual flow basis or in
block sales. When selling on a flow basis, a correspondent will typically seek a
pre-approval from Delta prior to closing the loan, and Delta will approve the
loan based on a partial or full credit package, stipulating for any items needed
to complete the package in adherence to Delta's underwriting guidelines. On a
block sale, a correspondent will offer a group of loans, generally that have not
been pre-approved, to Delta for sale, and Delta will purchase those loans in the
block that meet Delta's underwriting criteria.
RETAIL LOANS. The Company began retail origination of loans in 1997 with its
acquisition of Fidelity Mortgage, and for the year ended December 31, 1997, this
channel accounted for $140.4 million, or 11%, of Delta's loan
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purchases and originations. Fidelity Mortgage is able, through its marketing
efforts, to identify, locate and focus on individuals who, based on its
historic customer profiles, are likely customers for the Company's products.
Fidelity Mortgage's telemarketing representatives identify interested customers
and refer these to loan officers at the retail branch offices who then proceed
to determine the applicant's qualifications for the Company's loan products,
negotiate loan terms with the borrower and process the loan through completion.
LOAN UNDERWRITING
All of Delta's brokers, correspondents and retail offices are provided with
the Company's underwriting guidelines. Loan applications received from brokers
and correspondents or retail customers are classified according to certain
characteristics, including but not limited to: condition and location of the
collateral, credit history of the applicant, ability to pay, loan-to-value ratio
and general stability of the applicant in terms of employment history and time
in residence. Delta has established classifications with respect to the credit
profile of the applicant, and each loan is placed into one of four letter
ratings "A" through "D", with subratings within those categories. Terms of loans
made by Delta, as well as maximum loan-to-value ratios and debt-to-income
ratios, vary depending on the applicant's classification. Loan applicants with
less favorable credit ratings are generally offered loans with higher interest
rates and lower loan-to-value ratios than applicants with more favorable credit
ratings. The general criteria used by Delta's underwriting staff in classifying
loan applicants are set forth in the following table:
7
DELTA'S UNDERWRITING CRITERIA
"A" RISK "B" RISK "C" RISK "D" RISK
EXCELLENT CREDIT
HISTORY GOOD OVERALL CREDIT GOOD TO FAIR CREDIT FAIR TO POOR CREDIT
---------------- ------------------- ------------------- -------------------
Existing mortgage
history................... Current at Current at Up to 30 days 90 days delinquent
application time application time delinquent at or more
and a maximum of and a maximum of application time
two 30-day late four 30-day late and a maximum of
payments in the payments in the four 30-day late
last 12 months last 12 months payments, two
60-day late
payments and
one 90-day late
payment in the
last 12 months
Other credit................ Minor 30 day Some slow pays Slow pays, some Not a factor.
late items allowed allowed but open delinquencies Derogatory
with a letter of majority of credit allowed. Isolated credit must
explanation; no and installment charge-offs, collec- be paid with
open collection debt paid as agreed. tion accounts or proceeds. Must
accounts, charge- Small isolated judgments case- demonstrate
offs, judgments charge-offs, collec- by-case ability to pay
tion accounts or
judgments case-by-
case
Bankruptcy filings.......... Discharged more Discharged more Discharged more May be open at
than three years than two years than one year closing, but must
prior to closing prior to closing prior to closing be paid off with
and excellent and excellent and good proceeds
reestablished reestablished reestablished
credit credit credit
Debt service to
Income ratio.............. Generally 45% Generally 50% Generally 55% Generally 55%
or less or less or less or less
Maximum loan-to-value
ratio:
Owner-occupied............ Generally 80% Generally 80% Generally 75% Generally 65%
(up to 90%*) for (up to 85%*) for (up to 80%*) for (up to 70%*) for
a one- to four- a one- to four- a one- to four- a one- to four-
family residence family residence family residence family residence
Non-owner
occupied................ Generally 70% Generally 70% Generally 65% Generally 55%
(up to 80%*) for (up to 80%*) for (up to 75%*) for (up to 60%*) for
a one- to four- a one- to four a one- to four- a one- to four-
family residence family residence family residence family residence
Employment.................. Minimum 2 years Minimum 2 years No minimum No minimum
employment in the employment in the required required
same field same field
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* On an exception basis
Delta uses the foregoing categories and characteristics as guidelines only.
On a case-by-case basis, the Company may determine that the prospective borrower
warrants an exception, if sufficient compensating factors exist. Examples of
such compensating factors are a low loan-to-value ratio, a low debt ratio,
long-term stability of employment and/or residence, excellent payment history on
past mortgages, or a significant reduction in monthly housing expenses.
The following table sets forth certain information with respect to Delta's
originations and purchases of first and second mortgage loans by borrower
classification, along with weighted average coupons, for the periods shown.
8
PERCENT
YEAR CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
- ---- ------ ----- -------- ------ -------
1997 A $ 617,724 49.2% 10.4% 76.2%
B 349,166 27.8 11.0 72.0
C 222,854 17.8 11.8 67.7
D 64,867 5.2 13.2 56.7
---------- ----- ---- ----
Totals $1,254,611 100.0% 11.0% 72.5%
========== ===== ==== ====
1996 A $ 219,550 33.4% 10.6% 72.1%
B 234,589 35.6 11.2 70.2
C 156,296 23.7 12.2 65.7
D 48,331 7.3 13.8 56.9
---------- ----- ---- ----
Totals $658,766 100.0% 11.4% 68.8%
========== ===== ==== ====
1995 A $ 89,830 31.3% 10.7% 66.8%
B 124,954 43.4 11.6 64.5
C 37,190 12.9 12.8 59.6
D 35,831 12.4 14.5 53.2
---------- ----- ---- ----
Totals $287,805 100.0% 11.8% 63.2%
========== ===== ==== ====
- ---------------
(1) Weighted Average Coupon ("WAC").
(2) Weighted Average Initial Loan-to-Value Ratio ("WLTV").
Delta employs experienced nonconforming mortgage loan credit underwriters to
scrutinize the applicant's credit profile and to evaluate whether an impaired
credit history is a result of adverse circumstances or a continuing inability or
unwillingness to meet credit obligations in a timely manner. Personal
circumstances including divorce, family illnesses or deaths and temporary job
loss due to layoffs and corporate downsizing will often impair an applicant's
credit record. Assessment of an applicant's ability and willingness to pay is
one of the principal elements that distinguishes Delta's lending practices 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, however, in contrast to Delta, 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.
Delta has a staff of 70 underwriters, and its senior underwriters have an
average of more than nine years of non-conforming underwriting experience. Delta
does not delegate underwriting authority to any broker or correspondent. Delta's
Underwriting Department functions independently of its Business Development and
Mortgage Origination Departments and does not report to any individual directly
involved in the origination process. No underwriter at Delta is compensated on
an incentive or commission basis.
Delta has instituted underwriting checks and balances designed to ensure that
every loan is reviewed and approved by a minimum of two underwriters, with
certain higher loan amounts requiring a third approval. Management believes that
by requiring each file be seen by a minimum of two underwriters, a high degree
of accuracy and quality control is ensured throughout the underwriting process.
Delta's underwriting of every loan submitted consists not only of a thorough
credit review, but also (i) a separate appraisal review conducted by Delta's
Appraisal Review Department and (ii) a full compliance review to ensure that all
documents have been properly prepared, all applicable disclosures have been
given in a timely fashion, proper compliance with all federal and state
regulations, the existence of title insurance insuring Delta's interest as
mortgagee and evidence of adequate homeowner's insurance naming Delta as an
additional insured party. Appraisals are performed by third party, fee-based
appraisers or by the Company's staff appraisers and generally conform to current
FNMA/FHLMC secondary market requirements for residential property appraisals.
Each such appraisal includes, among other things, an inspection of the exterior
of the subject property and, where available, data from sales within the
preceding 12 months of similar properties within the same general location as
the subject
9
property.
Delta performs a thorough appraisal review on each loan prior to closing or
prior to purchasing. While Delta recognizes that the general practice by
conventional mortgage lenders is to perform only drive-by appraisals after
closings, management believes this practice does not provide sufficient
protection. In addition to reviewing each appraisal for accuracy, the Company
accesses other sources to validate sales used in the appraisal to determine
market value. These sources include: interfacing with Multiple Listing Services,
Comps, Inc. and other similar databases to access current sales and listing
information; and other sources for verification, including broker price opinions
and market analyses by local real estate agents.
Post closing, in addition to its normal due diligence, the Company selects
one out of every ten appraisals and performs its own drive-by appraisal. This
additional step helps to give the Company an added degree of comfort with
respect to appraisers with which the Company has had limited experience. Delta
actively tracks all appraisers from which it accepts appraisals for quality
control purposes and does not accept work from appraisers who have not conformed
to its review standards.
The Company performs a post-funding quality control review to monitor and
evaluate the Company's loan origination policies and procedures. At least 10% of
all loan originations and purchases are subjected to a full quality control
re-underwriting and review, the results of which are reported to senior
management. Discrepancies noted by this review are analyzed and corrective
actions are instituted. However, to date, this important quality control process
has not revealed material deficiencies in the Company's loan underwriting
procedures. A typical quality control review currently includes: (a) obtaining a
new drive-by appraisal for each property; (b) obtaining a new credit report from
a different credit report agency; (c) reviewing loan applications for
completeness, signatures, and for consistency with other processing documents;
(d) obtaining new written verifications of income and employment; (e) obtaining
new written verification of mortgage to re-verify any outstanding mortgages; and
(f) analyzing the underwriting and program selection decisions. The quality
control process is updated from time to time as the Company's policies and
procedures change.
LOAN SALES
Delta sells substantially all the loans it originates or purchases through
one of two methods: (i) securitizations, which involve the private placement or
public offering of pass-through mortgage-backed securities, and (ii) whole loan
sales, which include the sale of blocks of individual loans to institutional or
individual investors. Since 1991, the Company has sold more than $2.4 billion of
the loans it originated or purchased through securitization and $54 million
through whole loan sales.
SECURITIZATIONS. During 1997, Delta completed 4 securitizations totaling
$1.24 billion. The following table sets forth certain information with respect
to Delta's securitizations (all of which have been rated AAA/Aaa by S&P and
Moody's, respectively) by offering size, which includes prefunded amounts,
weighted average pass-through rate and type of credit enhancement.
INITIAL
OFFERING SIZE WEIGHTED AVERAGE CREDIT
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE ENHANCEMENT
- -------------- --------- ------------- ----------------- -----------
1997-1............ 03/27/97 $235.0 6.72% Insurance Wrap
1997-2............ 06/26/97 $260.0 6.72% Senior/Sub
1997-3............ 09/23/97 $340.0 6.71% Senior/Sub
1997-4............ 12/08/97 $400.0 6.62% Senior/Sub
When Delta securitizes loans, it sells a portfolio of loans to a trust (the
"Home Equity Loan Trust") and issues classes of certificates representing an
undivided ownership interest in the Home Equity Loan Trust. As servicer for each
securitization, the Company collects and remits principal and interest payments
to the appropriate Home Equity Loan Trust which, in turn, passes through
payments to certificateholders. For each of the 1997 securitizations, Delta
retained 100% of the interests in the residual classes of certificates while
selling an interest-only certificate in each of the last three securitizations
for cash. Management contemplates continuing to retain residual certificates in
the future as long as, in management's opinion, this practice maximizes earnings
while
10
remaining within the Company's liquidity requirements.
Each Home Equity Loan Trust has the benefit of either a financial guaranty
insurance policy from a monoline insurance company or a senior-subordination
securitization structure, which insures the timely payment of interest and the
ultimate payment of principal of the credit-enhanced investor certificate. In
"senior-subordination" structures, the senior certificate holders are protected
from losses by subordinated certificates, which absorb any such losses first. In
addition to such credit enhancement, the Excess Servicing is initially applied
as an additional payment of principal of the investor certificates, thereby
accelerating amortization of the investor certificates relative to the
amortization of the loans and creating overcollateralization. Once the
overcollateralization limit is reached, the use of Excess Servicing to create
overcollateralization stops unless it subsequently becomes necessary to obtain
or maintain required overcollateralization limits. Overcollateralization is
intended to create a source of cash (the "extra" payments on the loans) to
absorb losses prior to making a claim on the financial guaranty insurance policy
or the subordinated certificates.
WHOLE LOAN SALES WITHOUT RECOURSE. The Company has in the past determined
from time to time that some of its "A" loans and higher loan-to-value ratio
loans receive better execution by being sold on a whole loan, non-recourse basis
to third party institutions. In 1997, the Company did not sell any loans on a
whole loan basis as management deemed it to be more profitable to securitize all
of its loans. For the years ended December 31, 1996 and 1995, Delta sold $15.3
million and $17.6 million of loans, respectively, on a whole loan, non-recourse
basis, which represents 2.3% and 6.1%, respectively, of its originations and
purchases.
LOAN SERVICING AND COLLECTIONS
Delta has been servicing loans since its inception in 1982, and Delta has
serviced or is servicing substantially all of the loans that it has originated
or purchased. Servicing involves, among other things, collecting payments when
due, remitting payments of principal and interest and furnishing reports to the
current owners of the loans and enforcing such owners' rights with respect to
the loans, including, recovering delinquent payments, instituting foreclosure
and liquidating the underlying collateral. The Company receives a servicing fee
for servicing residential mortgage loans of 0.50% per annum (0.65% per annum on
all securitizations completed before and including the 1996-1 securitization) on
the declining principal balance of all loans sold through securitization and on
the declining principal balance of the loans sold to investors on a recourse
basis, which servicing fees are collected out of the monthly mortgage payments.
Management believes that servicing the Company's own portfolio enhances certain
operating efficiencies and provides an additional and profitable revenue stream
that is less cyclical than the business of originating and purchasing loans. As
of December 31, 1997, Delta had a loan servicing portfolio of $1.84 billion.
Delta services all loans out of its headquarters in Woodbury, New York,
utilizing a leading in-house loan servicing system ("LSAMS") which it
implemented in 1995. LSAMS has provided Delta with considerably more flexibility
to adapt the system to Delta's specific needs as a nonconforming home equity
lender. As such, Delta has achieved significant cost efficiencies by automating
a substantial number of previously manual servicing procedures and functions
since its conversion to LSAMS on July 1, 1995. Management believes that even
greater cost efficiencies can be realized through further automation provided by
LSAMS.
At the same time that it upgraded its primary servicing system, Delta
purchased a default management sub-servicing system with separate "modules" for
foreclosure, bankruptcy, and REO to provide it with the ability to more
efficiently monitor and service loans in default. These sub-servicing modules
provide detailed tracking of all key events in foreclosure and bankruptcy on a
loan-by-loan and portfolio-wide basis; the ability to track and account for all
pre- and post-petition payments received in bankruptcy from the borrower and/or
trustee; and the ability to monitor, market and account for all aspects
necessary to liquidate an REO property after foreclosure. Additionally, Delta's
Management Information Systems Department has created a market value analysis
program to run with LSAMS, which provides Delta with the ability to monitor its
equity position on a loan-by-loan and/or portfolio-wide basis. These features
have led to cost savings through greater automation and system upgrades and have
helped mitigate loan losses as the Servicing Department has been able to
identify problem loans earlier, thus allowing for earlier corrective action.
Delta's collections policy is designed to identify payment problems
sufficiently early to permit Delta to quickly address delinquency problems and,
when necessary, to act to preserve equity in a pre-foreclosure property. Delta
11
believes that these policies, combined with the experience level of independent
appraisers engaged by Delta, help to reduce the incidence of charge-offs of a
first or second mortgage loan.
Centralized controls and standards have been established by Delta for the
servicing and collection of mortgage loans in its portfolio. Delta revises such
policies and procedures from time to time in connection with changing economic
and market conditions and changing legal and regulatory requirements.
Borrowers are billed on a monthly basis in advance of the due date.
Collection procedures commence upon identification of a past due account by
Delta's automated servicing system. If timely payment is not received, LSAMS
automatically places the loan in the assigned collector's "auto queue" and
collection procedures are generally initiated on the day immediately following
the payment due date for chronic late payers, or the day immediately following
the end of the grace period for those borrowers who usually pay within the grace
period, or shortly thereafter. LSAMS automatically queues up each loan in the
assigned collector's "auto-queue" at one of these two dates based upon a
particular borrower's payment history over the prior 12 months. The account
remains in the queue unless and until a payment is received, at which point
LSAMS automatically removes the loan from that collector's auto queue until the
next month's payment is due and/or becomes delinquent.
When a loan appears in a collector's auto queue, a collector will telephone
to remind the borrower that a payment is due. Follow-up telephone contacts are
attempted until the account is current or other payment arrangements have been
made. Standard form letters are utilized when attempts to reach the borrower by
telephone fail and/or, in some circumstances, to supplement the phone contacts.
During the delinquency period, the collector will continue to contact the
borrower. Company collectors have computer access to telephone numbers, payment
histories, loan information and all past collection notes. All collection
activity, including the date collection letters were sent and detailed notes on
the substance of each collection telephone call, is entered into a permanent
collection history for each account on LSAMS. Additional guidance with the
collection process is derived through frequent communication with Delta's senior
management.
For those loans in which collection and initial loss mitigation efforts have
been exhausted without success, the loss mitigation team recommends the loans be
sent to foreclosure at one of the Foreclosure Committee Meetings held each
month. At each such committee meeting, the loss mitigation administrator and
team leader meet with the Servicing Manager, the Default Management Manager and
a member of the Executive Department, to determine whether foreclosure
proceedings are appropriate, based upon their analysis of all relevant factors,
including a market value analysis, reason for default and efforts by the
borrower to cure the default.
Regulations and practices regarding the liquidation of properties (e.g.,
foreclosure) and the rights of a borrower in default vary greatly from state to
state. As such, all foreclosures are assigned to outside counsel, located in the
same state as the secured property. Bankruptcies filed by borrowers are
similarly assigned to appropriate local counsel. All aspects of foreclosures and
bankruptcies are closely monitored by Delta through its sub-servicing loan
system described above and through monthly status reports from attorneys.
Prior to foreclosure sale, Delta performs an in-depth market value analysis
on all defaulted loans. This analysis includes: (i) a current valuation of the
property obtained through at least two drive-by appraisals or broker price
opinions conducted by an independent appraiser and/or broker from Delta's
network of real estate brokers, complete with a description of the property,
recent list prices of comparable properties, recent closed comparables,
estimated marketing time, estimated required or suggested repairs and an
estimate of the sales price; (ii) an evaluation of the amount owed, if any, for
real estate taxes; (iii) an evaluation of the amount owed, if any, to a senior
mortgagee; and (iv) estimated carrying costs, broker's fee, repair costs and
other related costs associated with REO properties. Delta bases the amount it
will bid at foreclosure sales on this analysis.
If Delta acquires title to a property at a foreclosure sale or otherwise, the
REO Department immediately begins working the file by obtaining an estimate of
the sale price of the property by sending at least two local real estate brokers
to inspect the premises, and then hiring one to begin marketing the property. If
the property is not vacant when acquired, local eviction attorneys are hired to
commence eviction proceedings and/or negotiations are held with occupants in an
attempt to get them to vacate without incurring the additional time and cost of
eviction. Repairs are performed if it is determined that they will increase the
net liquidation proceeds, taking into consideration the cost of repairs, the
carrying costs during the repair period and the marketability of the property
both before and after the repairs.
12
Delta's loan servicing software also tracks and maintains homeowners'
insurance information and tax and insurance escrow information. Expiration
reports are generated bi-weekly listing all policies scheduled to expire within
the next 15 days. When policies lapse, a letter is issued advising the borrower
of such lapse and notifying the borrower that Delta will obtain force-placed
insurance at the borrower's expense. Delta also has an insurance policy in place
that provides coverage automatically for Delta in the event that Delta fails to
obtain force-placed insurance.
The following table sets forth information relating to the delinquency and
loss experience of the mortgage loans serviced by Delta (primarily for the
securitization trusts) for the periods indicated. Delta is not the holder of the
securitization loans, but generally holds residual or interest-only certificates
of the trusts, as well as the servicing rights, each of which may be adversely
affected by defaults. (See "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations Certain Accounting
Considerations"):
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
---- ---- ----
Total Outstanding Principal Balance
(at period end)............................................. $ 1,840,150,403 $ 932,958,188 $ 468,846,079
Average Outstanding(1).......................................... $ 1,376,108,923 $ 686,465,257 $ 373,384,417
DELINQUENCY (at period end)
30-59 Days:
Principal Balance........................................... $ 90,052,724 $ 54,582,550 $ 35,052,951
Percent of Delinquency(2)................................... 4.89% 5.85% 7.48%
60-89 Days:
Principal Balance........................................... $ 28,864,099 $ 14,272,587 $ 8,086,230
Percent of Delinquency(2)................................... 1.57% 1.53% 1.72%
90 Days or More:
Principal Balance........................................... $ 17,695,594 $ 9,224,525 $ 6,748,061
Percent of Delinquency(2)................................... 0.96% 0.99% 1.44%
Total Delinquencies:
Principal Balance........................................... $ 136,612,417 $ 78,079,663 $ 49,887,242
Percent of Delinquency(2)................................... 7.42% 8.37% 10.64%
FORECLOSURES
Principal Balance........................................... $ 85,500,439 $ 34,765,628 $ 23,506,751
Percent of Foreclosures by Dollar(2)........................ 4.65% 3.73% 5.01%
REO (at end of period).......................................... $ 10,292,208 $ 5,672,811 $ 4,020,295
Net Gains/(Losses) on liquidated loans.......................... $ (4,985,539) $ (2,866,204) $ (2,142,099)
Percentage of Net Gains/(Losses) on liquidated
loans (based on Average Outstanding Balance)................ (0.36%) (0.42%) (0.57%)
- ---------------
(1) Calculated by summing the actual outstanding principal balances at the end
of each month and dividing the total by the number of months in the
applicable period.
(2) Percentages are expressed based upon the total outstanding principal balance
at the end of the indicated period.
COMPETITION
As an originator and purchaser of mortgage loans, the Company faces intense
competition, primarily from 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 the Company. Competition can take
many forms, including convenience in obtaining a loan, service, marketing and
distribution channels and interest rates. Furthermore, the current level of
gains realized by the Company and its competitors on the sale of the type of
loans originated and purchased is attracting additional competitors into this
market with the effect of lowering the gains that may be realized by the Company
on future loan sales. In addition, greater investor acceptance of securities
backed by loans comparable to the Company's mortgage loans and greater
availability of information regarding the prepayment and default
13
experience of such loans creates greater efficiencies in the market for
such securities. Such efficiencies may create a desire for even larger
transactions giving companies with greater volumes of originations a competitive
advantage. In addition, a more efficient market for such securities may lead
certain investors to purchase securities backed by other types of assets where
potential returns may be greater. 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 the
Company's borrowers to refinance their loans. During economic slowdowns or
recessions, the Company's borrowers may have new financial difficulties and may
be receptive to offers by the Company's competitors.
Furthermore, certain large national finance companies and conforming mortgage
originators have announced their intention to adapt their conforming origination
programs and allocate resources to the origination of non-conforming loans. In
addition, certain of these larger mortgage companies and commercial banks have
begun to offer products similar to those offered by the Company, targeting
customers similar to those of the Company. The entrance of these competitors
into the Company's market could have a material adverse effect on the Company's
results of operations and financial condition.
REGULATION
Delta's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is subject to
various laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Delta's consumer lending
activities are subject to the Federal Truth-in-Lending Act and Regulation Z
(including the Home Ownership and Equity Protection Act of 1994), the Equal
Credit Opportunity Act of 1974, as amended (ECOA), the Fair Credit Reporting Act
of 1970, as amended, the Real Estate Settlement Procedures Act (RESPA), and
Regulation X, the Home Mortgage Disclosure Act and the Federal Debt Collection
Practices Act, as well as other federal and state statutes and regulations
affecting Delta's activities. Delta is also subject to the rules and regulations
of, and examinations by HUD and state regulatory authorities with respect to
originating, processing, underwriting and servicing loans. These rules and
regulations, among other things, impose licensing obligations on Delta,
establish eligibility criteria for mortgage loans, prohibit discrimination,
provide for inspections and appraisals of properties, require credit reports on
loan applicants, regulate assessment, collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to
comply with these requirements can lead to loss of approved status, termination
or suspension of servicing contracts without compensation to the servicer,
demands for indemnifications or mortgage loans repurchases, certain rights of
rescission for mortgage loans, class action lawsuits and administrative
enforcement actions. Delta believes it is in compliance in all material respects
with applicable federal and state laws and regulations.
ENVIRONMENTAL MATTERS
To date, Delta has not been required to perform any investigation or clean up
activities, nor has it been subject to any environmental claims. There can be no
assurance, however, that this will remain the case in the future. In the
ordinary course of its business, Delta from time to time forecloses on
properties securing loans. Although Delta primarily lends to owners of
residential properties, there is a risk that Delta could be required to
investigate and clean-up hazardous or toxic substances or chemical releases at
such properties after acquisition by Delta, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
EMPLOYEES
As of December 31, 1997 Delta had a total of 987 employees (full-time and
part-time). None of Delta's employees is covered by a collective bargaining
agreement. Delta considers its relations with its employees to be good.
14
ITEM 2. PROPERTIES
Delta's executive and administrative offices are located at 1000 Woodbury
Road, Woodbury, New York 11797, where Delta leases approximately 120,000 square
feet of office space at an aggregate annual rent of approximately $2.4 million.
The lease provides for certain scheduled rent increases and expires in 2007.
Delta also maintains a full service office in Atlanta, Georgia, full
processing offices in Chicago, Illinois and Warwick, Rhode Island, processing
offices in Deerfield Beach, Florida and Cleveland, Ohio, and business
development offices in Delaware, Michigan (2), Missouri, New Jersey, Ohio,
Pennsylvania and Virginia. Fidelity Mortgage maintains fifteen retail mortgage
origination offices in Florida (3), Georgia, Illinois, Indiana, Missouri, North
Carolina, Ohio (4), Pennsylvania (2) and Tennessee; one telemarketing hub in
Ohio; and two corporate offices in Ohio and Florida. The terms of the leases
vary as to duration and escalation provisions, with the latest expiring in 2001.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of the Company's business involves the collection of
numerous accounts, the validity of liens and compliance with state and federal
lending laws, the Company is subject to numerous claims and legal actions in the
ordinary course of its business. While it is impossible to estimate with
certainty the ultimate legal and financial liability with respect to such claims
and actions, the Company believes that the aggregate amount of such liabilities
will not result in monetary damages which would have a material adverse effect
on the financial condition or results of operations of the Company.
Several class-action lawsuits have been filed against a number of consumer
finance companies alleging that the compensation of mortgage brokers through the
payment of yield spread premiums violates various federal and state consumer
protection laws. On March 18, 1997, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the Eastern
District of New York, alleging that the Company's compensation of mortgage
brokers by means of yield spread premiums violates, among other things, RESPA.
The complaint seeks (i) certification of a class of plaintiffs, (ii) an
injunction against payment of yield spread premiums by the Company and (iii)
unspecified compensatory and punitive damages (including attorney's fees). On
July 7, 1997, the Company filed an answer to the plaintiff's amended complaint.
Management believes the Company has meritorious defenses and intends to defend
this suit, but the Company cannot estimate with any certainty its ultimate legal
or financial liability, if any, with respect to the alleged claims.
On or about February 10, 1998, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the Northern
District of Mississippi - Greenville Division, alleging that the Company's
compensation of mortgage brokers by means of yield spread premiums violates
RESPA. The complaint seeks (i) certification of a class of plaintiffs, and (ii)
unspecified compensatory damages (including attorney's fees). Management
believes the Company has meritorious defenses and intends to defend this suit,
but the Company has not yet answered the complaint and cannot estimate with any
certainty its ultimate legal or financial liability, if any, with respect to the
alleged claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders was held on May 29, 1997. At the meeting,
Richard Blass and Arnold B. Pollard were elected as Class I Directors for a term
of three years. Hugh Miller, Sidney A. Miller and Martin D. Payson continue to
serve as members of the Board of Directors.
Votes cast in favor of Mr. Blass' election totaled 14,363,632 while
12,468 votes were withheld.
Votes cast in favor of Mr. Pollard's election totaled 14,363,682
while 12,418 votes were withheld.
The stockholders also voted to ratify the appointment of KPMG Peat Marwick
LLP as the Company's independent public accountants for the fiscal year ending
December 31, 1997. Votes cast in favor of this ratification were 14,371,038,
while votes cast against were 2,914 and abstentions totaled 2,148.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock was listed on the New York Stock Exchange (the
"NYSE") under the symbol "DFC" on November 1, 1996. The following table sets
forth for the periods indicated the range of the high and low closing sales
prices for the Company's Common Stock on the NYSE.
1997 HIGH LOW
- ---- ---- ----
First Quarter ............................ $24.00 $18.13
Second Quarter ........................... $20.50 $13.38
Third Quarter............................. $22.13 $18.81
Fourth Quarter ........................... $20.69 $13.38
1996 HIGH LOW
- ---- ---- ----
Fourth Quarter (from 11/1/96)............. $25.25 $18.00
On March 24, 1998, the Company had approximately 78 stockholders of record.
This number does not include beneficial owners holding shares through nominee or
"street" names. The Company believes the number of beneficial stockholders is in
excess of 2,500.
DIVIDEND POLICY
The Company did not pay any dividends in 1997 and, in accordance with its
present general policy, has no present intention to pay cash dividends.
16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Income Statement Data: (DOLLARS IN THOUSANDS EXCEPT FOR PER SHARE DATA)
Revenues:
Net gain on sale of mortgage loans............. $ 86,307 $ 46,525 $ 15,383 $ 6,661 $ 7,639
Interest....................................... 22,341 16,372 13,588 9,839 9,156
Servicing fees................................. 7,094 5,368 2,855 2,183 2,101
Origination fees (1) .......................... 18,108 5,266 4,309 3,114 3,617
---------- ---------- ---------- ---------- ----------
Total revenues........................... $ 133,850 $ 73,531 $ 36,135 $ 21,797 $ 22,513
---------- ---------- ---------- ---------- ----------
Expenses:
Payroll and related costs (1).................. $ 38,991 $ 16,509 $ 12,876 $ 8,815 $ 9,268
Interest....................................... 19,972 11,298 7,964 3,735 2,915
General & administrative (1)................... 23,737 12,236 10,709 7,238 6,670
---------- ---------- ---------- ---------- ----------
Total expenses........................... $ 82,700 $ 40,043 $ 31,549 $ 19,788 $ 18,853
---------- ---------- ---------- ---------- ----------
Income before income taxes and
extraordinary item............................. 51,150 33,488 4,586 2,009 3,660
Provision for income taxes(1)...................... 20,739 9,466 -- -- --
---------- ---------- ---------- ---------- ----------
Income before extraordinary item................... 30,411 24,022 4,586 2,009 3,660
Extraordinary item:................................
Gain on extinguishment of debt................. -- 3,168 -- -- --
---------- ---------- ---------- ---------- ----------
Net income......................................... $ 30,411 $ 27,190 $ 4,586 $ 2,009 $ 3,660
========== ========== ========== ========== ==========
Pro forma information (2)(3):
Provision for pro forma income taxes
before extraordinary item...................... $ n/a $ 14,400 $ 1,972 $ 864 $ 1,574
---------- ---------- ---------- ---------- ----------
Pro forma income before
extraordinary item............................. $ 30,411 $ 19,088 $ 2,614 $ 1,145 $ 2,086
========== ========== ========== ========== ==========
Per share data(2)(4)
Earnings per common share -
basic and diluted........................ $ 1.98 $ 1.46 $ 0.21 $ 0.09 $ 0.17
Weighted average number of
shares outstanding....................... 15,359,280 13,066,485 12,629,182 12,629,182 12,629,182
Selected Balance Sheet Data:
Loans held for sale................................ $ 79,247 $ 82,411 $ 63,324 $ 48,833 $ 41,703
Interest-only and residual certificates............ 167,809 83,073 25,310 7,514 2,204
Capitalized mortgage servicing rights.............. 22,862 11,412 3,831 2,421 3,491
Total assets....................................... 393,232 231,616 139,293 98,589 81,143
---------- ---------- ---------- ---------- ----------
Senior notes, warehouse financing and
other borrowings............................... $ 177,540 $ 95,482 $ 82,756 $ 52,491 $ 36,780
Investor payable................................... 40,852 20,869 13,444 11,091 8,687
Total liabilities.................................. 266,779 138,098 109,460 70,425 52,793
---------- ---------- ---------- ---------- ----------
Stockholders' equity............................... $ 126,453 $ 93,518 $ 29,833 $ 28,164 $ 28,350
========== ========== ========== ========== ==========
- ---------------
(1) In connection with the February 1997 acquisition of Fidelity Mortgage, the
Company incurred additional expenses normally associated with a retail
operation. Fidelity Mortgage's loan origination points when recognized are
reported as origination fee income.
(2) Figures for December 31, 1997 are actual; pro forma presentation for the
years 1996, 1995, 1994 and 1993.
(3) Prior to October 31, 1996, Delta Funding Corporation (a wholly-owned
subsidiary) was treated as an S corporation for Federal and state income
tax purposes. The pro forma presentation reflects a provision for income
taxes as if the Company had always been a C corporation at an assumed tax
rate of 43%.
(4) Pro forma earnings per common share has been computed by dividing pro
forma net income by the sum of (a) 10,653,000 shares of Delta Financial
Corporation common stock received by the former shareholders in exchange
for their shares of Delta Funding Corporation, and (b) the effect of the
issuance of 1,976,182 shares of common stock of Delta Financial
Corporation issued in the Company's initial public offering to generate
sufficient cash for certain S corporation distributions paid to the former
shareholders, which shares are treated as if they had always been
outstanding.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS OF THE COMPANY AND ACCOMPANYING NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS SET FORTH THEREIN.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, Delta sells the
majority of its loans through securitization and derives a substantial portion
of its income therefrom. In a securitization, the Company sells a pool of loans
it has originated or purchased to a REMIC trust for a cash price. The trust, in
turn, finances the pool of loans it has acquired by issuing "pass-through
certificates," or bonds, which represent undivided ownership interests in the
trust. The holders of the pass-through certificates are entitled to receive
monthly distributions of all principal received on the underlying mortgages and
a specified amount of interest, as determined at the time of the trust offering.
When the Company sells a pool of loans to the securitization trust, it
receives the following economic interests in the trust: (a) the difference
between the interest payments due on the loans sold to the trust and the
interest rate paid to the pass-through certificateholders, less the Company's
contractual servicing fee and other costs and expenses of administering the
trust, represented by interest-only and residual certificates, and (b) the right
to service the loans on behalf of the trust and earn a contractual servicing
fee, as well as other ancillary servicing related fees directly from the
borrowers on the underlying loans.
The Company's net investment in the pool of sold loans at the date of the
securitization represents the amount originally paid to originate or acquire the
loan adjusted for (i) 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 a loan under Statement
of Financial Accounting Standards ("SFAS") No. 91, "Accounting for
Non-Refundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," and (ii) the principal payments received, and
the amortization of the net loan fees or costs, during the period the Company
held the loans prior to their securitization. The Company's investment in the
loans also reflects adjustments for any gains (a decrease in the investment) or
losses (an increase in the investment) the Company has incurred on treasury rate
lock contracts which the Company has used to hedge against the effects of
changes in interest rates during the period it holds the loans prior to their
securitization. (See - "Hedging.")
Upon the securitization of a pool of loans, the Company (i) recognizes in
income, as origination fees, the unamortized origination fees included in the
investment in the loans sold, and (ii) recognizes a gain on sale of loans for
the difference between cash received from the trust and the investment in the
loans remaining after the allocation of portions of that investment to record
interest-only and residual certificates and mortgage servicing rights received
in the securitization. The majority of the net gain on sale of mortgage loans
results from, and is initially realized in the form of, the retention of
interest-only and residual certificates.
The interest-only and residual certificates received by the Company upon the
securitization of a pool of loans are accounted for as trading securities under
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." In accordance with SFAS No. 115, the amount initially allocated to
the interest-only and residual certificates at the date of a securitization
reflects the fair value of those interests. The amount recorded for the
certificates is reduced for distributions thereon which the Company receives
from the related trust, and is adjusted for subsequent changes in the fair value
of interest-only and residual certificates, which are reflected in the statement
of operations. The Company assesses the fair value of interest-only and residual
certificates based upon updated estimates of prepayment and default rates
relating to loan groups comprised of loans of similar types, terms, credit
quality, interest rates, geographic location and value of loan collateral, which
represent the predominant risk characteristics that would affect prepayments and
default rates.
18
In accounting for the securitization of its loans with the retention of
mortgage servicing rights, the Company adopted the provisions of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" effective January 1, 1997. Previously, the Company followed the
requirements of SFAS No. 122, "Accounting for Mortgage Servicing Rights." The
change from the requirements of SFAS No. 122 to those of SFAS No. 125 did not
have a material impact on the Company's result of operations or financial
position.
In accordance with SFAS No. 125, and previously SFAS No. 122, the amount of
the investment in the loans allocated to the retained servicing rights is
measured at the allocated carrying amount of such servicing rights, based on the
fair value of the rights, which is determined by discounting to a present value
(using a discount rate which management believes reflects the rate market
participants would utilize in purchasing similar loan servicing rights) the
estimated future contractual and ancillary servicing fees the Company will
receive and the estimated costs of servicing the loans. Those estimates are
based on the stated terms of the transferred loans adjusted for estimates of
future prepayment rates made on the basis of interest rate conditions and the
availability of alternative financing, and estimates of future defaults among
those loans, each of which would terminate the servicing of the loan and thus
negatively affect servicing income. This amount, which is classified on the
balance sheet as "capitalized mortgage servicing rights" is then amortized over
the period of the estimated net future cash flows from the servicing income.
SFAS No. 125 also requires that the capitalized mortgage loan servicing rights
be assessed periodically to determine if there has been any impairment of the
asset, based on the fair value of the rights at the date of the assessment. The
Company performs this assessment based on the same prepayment and default
estimates utilized in valuing interest-only and residual certificates. A
valuation allowance is provided for the capitalized servicing rights relating to
any loan group for which the recorded investment exceeds the fair value of the
servicing rights.
In recording and accounting for mortgage servicing rights and interest-only
and residual certificates, the Company makes estimates of rates of prepayments
and defaults, and the value of collateral, which it believes reasonably reflect
economic and other relevant conditions then in effect. The actual rate of
prepayments, defaults and the value of collateral will generally differ from the
estimates used, due to subsequent changes in economic and other relevant
conditions and the implicit imprecision of estimates, and such differences can
be material. Prepayment and default rates which are higher than those estimated
would adversely affect the value of both the mortgage servicing rights (actual
mortgage servicing income will be less, and significant changes could require an
impairment of the capitalized mortgage servicing rights) and the interest-only
and residual certificates, for which changes in fair value are recorded in
operations. Conversely, prepayment and default rates which are lower than those
estimated would increase the servicing income earned over the life of the loans
and positively impact the value of the interest-only and residual certificates.
The Company assumes prepayment rates and defaults based upon the seasoning of
its existing securitization loan portfolio. As of December 31, 1997 and 1996,
the Company's underlying assumptions used in determining the fair value of its
interest-only and residual certificates are as follows:
(a) Estimated annual prepayment rates:
(i) for fixed-rate loan pools of 4.8% beginning in the first month of
seasoning and increasing in equal increments to 24.0% by the twelfth month of
seasoning and thereafter;
(ii) for adjustable-rate loan pools of 5.6% beginning in the first month
of seasoning and increasing in equal increments to 28.0% by the twelfth month of
seasoning and thereafter at December 31, 1997, compared to 5.0% and 25.0%,
respectively, at December 31, 1996;
(b) A default reserve for both fixed- and adjustable-rate loans sold to the
securitizations trusts of 1.90% of the amount initially securitized; and
(c) An annual discount rate of 12.0% in determining the present value of cash
flows from residual certificates, which are the predominant form of retained
interests.
19
The Company uses the same prepayment assumptions in estimating the fair value
of its mortgage servicing rights. To date, actual cash flows from the Company's
securitization trusts have either met or exceeded management's expectations.
The Company has, from time to time, sold its economic interest in the
interest-only certificates for cash proceeds including, most recently, the
interest-only certificates on three of its 1997 securitization transactions. The
Company did not sell any of its interest-only certificates in 1996.
The Company has also, from time to time, sold whole loans on a non-recourse
basis, without retaining servicing rights, generally in private transactions to
individual or institutional investors. Upon the sale of loans on a whole-loan
basis, the Company recognizes a gain or loss for the difference between the cash
proceeds received for the loans and the investment in the loans, including
unamortized loan origination fees and costs.
INTEREST RATE RISK
The Company's primary market risk exposure is interest rate risk.
Profitability may be directly affected by the level of, and fluctuation in,
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its borrowings, which are tied
to various United States Treasury maturities and the London Inter-Bank Offered
Rate ("LIBOR"). The profitability of the Company is likely to be adversely
affected during any period of unexpected or rapid changes in interest rates. A
substantial and sustained increase in interest rates could adversely affect the
Company's ability to purchase and originate loans. A significant decline in
interest rates could increase the level of loan prepayments thereby decreasing
the size of the Company's loan servicing portfolio. To the extent servicing
rights and interest-only and residual classes of certificates have been
capitalized on the books of the Company, higher than anticipated rates of loan
prepayments or losses could require the Company to write down the value of such
servicing rights and interest-only and residual certificates, adversely
impacting earnings. Fluctuating interest rates also may affect the net interest
income earned by the Company resulting from the difference between the yield to
the Company on loans held pending sales and the interest paid by the Company for
funds borrowed under the Company's warehouse facilities, although the Company
undertakes to hedge its exposure to this risk by using treasury rate lock
contracts. (See "Hedging.")
RECENT GROWTH
The Company has experienced significant loan origination and purchase growth
in the last few years, particularly since January 1, 1995. Management believes
that this growth is primarily attributable to the Company's (i) geographic
expansion of its operations, (ii) further penetration into its established
markets, (iii) increased access to capital and additional funding sources
through (a) the capital markets and (b) larger warehouse finance agreements
which have enabled the Company to accumulate larger pools of loans for sales
through securitizations, and (iv) recent expansion of its production channels
through the acquisition of the Fidelity Mortgage, retail operations.
In connection with its geographic expansion, the Company has continued to
focus on developing loan production from brokers and correspondents. In
addition, the Company is also committed to developing and growing the Fidelity
Mortgage retail origination network. There can be no assurance that the Company
will continue to grow significantly in the future. Any future growth will be
limited by, among other things, the Company's need for continued funding
sources, access to capital markets, sensitivity to economic slowdowns, ability
to attract and retain qualified personnel, fluctuations in interest rates and
competition from other consumer finance companies and from new market entrants.
To date, the Company has not experienced any significant seasonal variations in
loan originations and purchases.
The Company's recent and rapid growth may have a somewhat distortive impact
on certain of the Company's ratios and financial statistics and may make
period-to-period comparisons difficult. In light of the Company's growth,
historical performance of the Company's earnings may be of limited relevance in
predicting future performance. Furthermore, the Company's financial statistics
may not be indicative of the Company's results in
20
future periods. Any credit or other problems associated with the large number of
loans originated and purchased in the recent past may not become apparent until
sometime in the future.
The comparability of the results of operations for the twelve months ended,
and financial position as of, December 31, 1997 and 1996 may also be affected by
the Company's acquisition of Fidelity Mortgage. Fidelity Mortgage was acquired
on February 11, 1997 for a combination of cash and stock, with the acquisition
accounted for using the purchase method of accounting.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
REVENUES
Total revenues for the twelve months ended December 31, 1997 increased $60.4
million, or 82%, to $133.9 million from $73.5 million for the comparable period
in 1996. The increase in revenue was primarily attributable to the increase in
net gains recognized on the sale of mortgage loans, reflecting the growth in the
Company's level of loan originations and purchases and securitizations. Revenue
also increased in all other categories including origination fees, servicing
fees, and interest income.
For the twelve months ended December 31, 1997, the Company originated and
purchased $1.25 billion of mortgage loans, representing a 90% increase from $659
million of mortgage loans originated and purchased for the twelve months ended
December 31, 1996. The Company issued four quarterly closed-end home equity loan
securitizations in 1997 totaling $1.24 billion, compared to three
securitizations and loan sales of $630 million in 1996. Total loans serviced at
December 31, 1997 increased 97% to $1.84 billion from $933 million at December
31, 1996.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
represents (i) the sum of (a) the fair value of the interest-only and residual
certificates associated with loans securitized in each period, (b) the fair
value of mortgage servicing rights associated with loans securitized in each
period, and (c) premiums earned on the sale of whole loans on a
servicing-released basis, (ii) less the (x) premiums paid to originate or
acquire mortgage loans, (y) costs associated with securitizations and (z) any
hedge loss (gain).
For the twelve months ended December 31, 1997, net gain on sale of mortgage
loans increased $39.8 million, or 86%, to $86.3 million from $46.5 million for
the twelve months ended December 31, 1996. This increase was primarily due to an
increase in loans securitized in 1997 of $1.24 billion, or 97%, compared to $630
million of loans sold or securitized for the same period in 1996. Net gains from
the sale of loans increased less than the overall increase in loan
securitizations primarily because of increases in the pass-through rates
required by REMIC trust investors in the fourth quarter of 1997, which reduced
the value of the interest-only and residual certificates the Company received in
connection with that quarter's securitization. As previously noted above, the
Company changed its prepayment assumptions on adjustable-rate mortgage loans in
the third quarter of 1997. This change, which affects the valuation of the
Company's existing interest-only and residual certificates and capitalized
mortgage servicing rights, as well as the valuation of those assets in all
future securitizations, was made based upon the Company's on-going analysis of
industry and Company prepayment trends. The change in this assumption did not
have a material effect on net gain on sale. The weighted average gain on sale
ratio for the twelve months ended December 31, 1997, and for the comparable
period in 1996, was 7.0% and 7.4%, respectively. The weighted average gain on
sale ratio is calculated using the net gain on sale divided by the total amount
of loans securitized and sold.
INTEREST INCOME. Interest income primarily represents the sum of (i) interest
earned on loans held for sale, (ii) interest earned on cash collection balances,
and (iii) the difference between the distributions the Company receives on its
interest-only and residual certificates and the adjustments recorded to reflect
the change in the fair value in the interest-only and residual certificates.
21
Interest income for the twelve months ended December 31, 1997 increased $5.9
million, or 36%, to $22.3 million from $16.4 million in the comparable period in
1996. The increase in interest income was primarily due to (a) a higher average
balance of mortgage loans held for sale during the twelve months ended December
31, 1997 driven by higher loan originations and purchases as noted above, and
(b) an increase in excess servicing received from the Company's interest-only
and residual certificates, partially offset by the fair value adjustment to the
interest-only and residual certificates, primarily related to distributions
received from the securitization trusts. The Company changed its prepayment
assumptions on adjustable rate mortgages in the third quarter of 1997, which did
not have a material effect on interest income.
SERVICING FEES. Servicing fees represent all contractual and ancillary
servicing revenue received by the Company less (a) the offsetting amortization
of the capitalized mortgage servicing rights, and any adjustments recorded to
provide valuation allowances for the impairment in mortgage servicing rights
(see - "Accounting Considerations"), and (b) prepaid interest shortfalls.
Servicing fees for the twelve months ended December 31, 1997 increased $1.7
million, or 31%, to $7.1 million from $5.4 million in the comparable period in
1996. This increase was primarily due to a higher average loan servicing
portfolio, which resulted in increased contractual and ancillary service fees,
partially offset by a $2.9 million increase in amortization of the Company's
capitalized mortgage servicing rights in 1997, compared to 1996. During the
twelve months ended December 31, 1997, the average balance of mortgage loans
serviced by the Company increased 107% to $1.38 billion from $667 million during
the comparable period in 1996. The amount of mortgage loans serviced by the
Company increased at a faster rate than the amount of servicing fees, primarily
as a result of a reduction in the contractual servicing fee rate from 0.65% to
0.50% per annum beginning with the 1996-2 securitization in September 1996.
ORIGINATION FEES. Origination fees represent fees earned on brokered and
retail originated loans. Origination fees for the twelve months ended December
31, 1997 increased $12.8 million, or 242%, to $18.1 million from $5.3 million in
the comparable period in 1996. The increase is primarily the result of (a) the
1997 acquisition of Fidelity Mortgage and the subsequent expansion of its retail
network which accounted for $11.4 million of origination fees in 1997, and (b) a
50% increase in broker originated loans and commensurate increase in broker loan
origination fees.
EXPENSES
Total expenses increased $42.7 million, or 107%, to $82.7 million for the
twelve months ended December 31, 1997, from $40.0 million for the comparable
period in 1996. The increase in expenses was primarily the result of (i)
increased interest expense due to (a) higher interest costs generated by the
growth in the Company's loan origination and purchase activities, which
increased the level of debt needed throughout 1997 to finance the resulting
higher inventory of loans held for resale, (b) the Company's issuance in July
1997 of $150 million aggregate principal amount of 9.5% Senior Notes due August
1, 2004 (the "Senior Notes") and (c) financing the Company's investment in
interest-only and residual certificates (which was subsequently eliminated using
a portion of the proceeds from the Senior Notes), (ii) an increase in the
Company's personnel related to higher loan origination growth, including the
Company's Fidelity Mortgage retail division and (iii) costs associated with the
expansion of the Company's retail, broker and correspondent divisions.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees. For the twelve months ended
December 31, 1997, payroll and related costs expense increased $22.5 million, or
136%, to $39.0 million from $16.5 million for the comparable period in 1996.
This increase is primarily related to staff increases related to the acquisition
and subsequent expansion of Fidelity Mortgage and the increase in loan
originations and purchases at the Company. As of December 31, 1997, the Company
employed 987 full- and part-time employees, 447 of which are employees of
Fidelity Mortgage, compared to 346 full- and part-time employees as of December
31, 1996.
22
INTEREST EXPENSE. Interest expense includes the borrowing costs to finance
loan originations and purchases under (i) the Company's credit facilities, (ii)
the Senior Notes, and (iii) its investment in interest-only and residual
certificates.
For the twelve months ended December 31, 1997, interest expense increased
$8.7 million, or 77%, to $20.0 million from $11.3 million for the comparable
period in 1996. The increase in interest expense was attributable to (i) growth
in loan activity, which increased the level of debt needed throughout 1997 to
finance the inventory of loans held for sale prior to their securitization, (ii)
the Company's issuance in July 1997 of the Senior Notes, (iii) financing of the
Company's interest-only and residual certificates (which was subsequently
eliminated using a portion of the proceeds from the Senior Notes), and (iv) a
higher cost of funds on the Company's credit facilities which were tied to
one-month LIBOR. The one-month LIBOR index increased to an average interest rate
of 5.7% in 1997, compared to an average interest rate of 5.4% in 1996.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, goodwill
amortization, real estate owned expenses, license fees, legal and accounting
fees, travel and entertainment expenses, advertising and promotional expenses
and the provision for loan losses on the inventory of loans held for sale and
recourse loans.
For the twelve months ended December 31, 1997, general and administrative
expenses increased $11.5 million, or 94%, to $23.7 million from $12.2 million
for the comparable period in 1996. This increase was primarily attributable to
(i) the amortization of acquisition costs (goodwill) associated with the
Company's purchase of Fidelity Mortgage; (ii) the expansion costs associated
with the Company's increasing the number of Fidelity Mortgage retail branch
offices from five to thirteen during 1997, and (iii) an increase in expenses
associated with the Company's increase in loan origination and purchases in
1997.
INCOME TAXES. Income taxes are accounted for under SFAS No. 109, "Accounting
for Income Taxes." Deferred tax assets and liabilities are recognized on the
income reported in the financial statements regardless of when such taxes are
paid. These deferred taxes are measured by applying current enacted tax rates.
Prior to October 31, 1996, the Company was an S corporation pursuant to the
Internal Revenue Code of 1986, as amended, and, as such, did not incur any
Federal income tax expense. On October 31, 1996 the Company became a C
corporation for Federal and state income tax purposes and, as such, is subject
to Federal and state income tax on its taxable income for the period beginning
on November 1, 1996.
The Company recorded a tax provision of $20.7 million and $9.5 million (which
included a $3.9 million deferred tax charge in connection with its change in
status from an S corporation to a C corporation in 1996) for the years ended
December 31, 1997 and 1996, respectively.
Income taxes provided a 40.5% effective tax rate for the year ended December
31, 1997, compared to a 42.5% assumed effective tax rate for the year ended
December 31, 1996 if the Company would have been a C corporation for the entire
period. The reduction in the effective tax rate is primarily attributable to the
Company's expansion into lower taxing state and local jurisdictions.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
REVENUES
Total revenues increased $37.4 million, or 104%, to $73.5 million in 1996
from $36.1 million in 1995. The increase in revenues was primarily due to the
increase in loan originations and purchases and a corresponding increase in the
amount of loans sold through securitizations.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
increased $31.1 million, or 202%, to $46.5 million in 1996 from $15.4 million in
1995. This increase was the result of higher loan originations and purchases,
resulting in an increased amount of loans sold through securitizations. Total
loan originations and
23
purchases increased $371.0 million, or 129%, to $658.8 million in 1996
from $287.8 million in 1995. The Company sold or securitized $630.4 million of
loans in 1996 compared to $247.6 million in 1995, with a weighted average net
gain on sale ratio of 7.4% and 6.2%, respectively.
INTEREST INCOME. Interest income increased $2.8 million, or 21%, to $16.4
million in 1996 from $13.6 million in 1995. The increase in interest income was
primarily due to a higher average balance of loans held for sale during 1996
resulting from the increases in loan originations and purchases, but was
partially offset by the shorter holding period in which the mortgage loans
remained in inventory during 1996. The Company completed three securitizations
during 1996 compared to two securitizations in 1995.
SERVICING FEES. Servicing fees increased $2.5 million, or 86%, to $5.4
million in 1996 from $2.9 million in 1995. This increase was primarily due to
higher loan servicing volume, which resulted in increased contractual and
ancillary service fees. During 1996, the average balance of mortgage loans
serviced by the Company increased 79% to $667.4 million from $373.4 million
during 1995.
ORIGINATION FEES. Origination fees increased $1.0 million, or 23%, to $5.3
million in 1996 from $4.3 million in 1995. This increase was primarily due to an
83% increase in broker loan originations to $321.7 million in the year ended
1996 from $175.7 million in comparable period of 1995. Loan origination fees
increased at a slower rate than broker loan originations primarily because the
Company earned lower average origination fees per loan.
EXPENSES
Total expenses increased $8.5 million, or 27%, to $40.0 million for 1996 from
$31.5 million in 1995. The increase in expenses was primarily the result of
increased interest expense on loans held for sale and higher operating expenses
associated with the additional personnel required to process the greater number
of loan originations and purchases. Total expenses increased at a slower rate
than total revenues, primarily due to efficiencies realized from the Company's
investment in technology, experienced staff and economies of scale.
PAYROLL AND RELATED COSTS. Payroll and related costs increased $3.6 million,
or 28%, to $16.5 million for 1996 from $12.9 million for 1995. The increase was
primarily due to increased staffing in the Company's originations area
associated with the increase in loan originations and purchases, as well as the
Company's expansion into new and existing markets. As of December 31, 1996, the
Company employed 346 full- and part-time persons as compared to 255 full- and
part-time persons as of December 31, 1995.
INTEREST EXPENSE. Interest expense increased $3.3 million, or 41%, to $11.3
million in 1996 from $8.0 million in 1995. The increase in interest expense was
attributable to the interest costs associated with both a higher balance of
loans pending sale during 1996, resulting from increases in loan originations
and purchases during the period, and an increase in the excess servicing
receivable financing during 1996. The Company had financings against its
interest-only and residual certificates of $47.0 million as of December 31, 1996
compared to $16.2 million as of December 31, 1995. Interest expense was
partially offset by lower cost of funds on the Company's floating-rate
borrowings which are based on one-month LIBOR. The average one-month LIBOR
decreased to an average rate of 5.4% in 1996, compared to an average rate of
5.9% in 1995.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses,
which consist primarily of office and administration, rent, and health care and
insurance, increased $1.5 million, or 14%, to $12.2 million in 1996 from $10.7
million in 1995. The increase in general and administrative expenses was
primarily due to expenses incurred in connection with the increases in loan
originations and purchases, and increased employee benefit expenses.
EXTRAORDINARY GAIN. In May 1996, the Company closed out its long-term $31.7
million warehouse facility with a European financial institution at a 10%
discount. As a result, the Company realized an extraordinary gain of $3.17
million for the year ended December 31, 1996.
INCOME TAXES. Prior to October 31, 1996, Delta Funding Corporation was
treated as an S corporation for
24
Federal and state income tax purposes. As a result, the Company's historical
earnings prior to such date had been taxed directly to the former shareholders
of Delta Funding and not to the Company.
On October 31, 1996, Delta Funding Corporation's status as an S corporation
was terminated and the Company became a C corporation for Federal and state
income tax purposes and as such was subject to Federal and state income tax on
its taxable income for the months of November and December 1996. During 1996,
the Company recorded a tax provision of $9.5 million. This includes a $4.2
million provision for November and December earnings at the statutory rate of
42% and a deferred tax expense of $3.9 million in connection with the change in
tax status from an S corporation to a C corporation.
FINANCIAL CONDITION
DECEMBER 31, 1997 COMPARED TO DECEMBER 31, 1996
Cash and interest-bearing deposits increased $14.2 million, or 76%, to $32.9
million at December 31, 1997 from $18.7 million at December 31, 1996. The
increase was primarily the result of additional monies held in securitization
trust accounts by the Company, acting as servicer for its ongoing securitization
program.
Accounts receivable increased $20.7 million, or 197%, to $31.2 million at
December 31, 1997 from $10.5 million at December 31, 1996. The increase was
attributable to (i) a higher average loan servicing portfolio, which resulted in
increased reimbursable servicing advances made by the Company, acting as
servicer on its securitizations, and (ii) a $14.8 million income tax receivable
related to current tax assets.
Loans held for sale decreased $3.2 million, or 3.9%, to $79.2 million at
December 31, 1997 from $82.4 milli