10-Q 1 0001.txt FORM 10-Q FOR DELTA FINANCIAL CORPORATION SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission File Number: 1-12109 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 registrant's principal executive offices including ZIP Code) (516) 364 - 8500 (Registrant's telephone number, including area code) NO CHANGE (Former name, former address and former fiscal year, if changed since last report) 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 and 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 [ ] As of June 30, 2000, 15,883,749 shares of the Registrant's common stock, par value $.01 per share, were outstanding. INDEX TO FORM 10-Q Page No. PART I - FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Consolidated Balance Sheets as of June 30, 2000 and December 31, 1999................................................... 1 Consolidated Statements of Operations for the three months and six months ended June 30, 2000 and June 30, 1999.................... 2 Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and June 30, 1999..................................... 3 Notes to Consolidated Financial Statements.......................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................... 6 Item 3. Quantitative and Qualitative Disclosures About Market Risk..........22 PART II - OTHER INFORMATION Item 1. Legal Proceedings...................................................23 Item 2. Changes in Securities and Use of Proceeds...........................26 Item 3. Defaults Upon Senior Securities.....................................26 Item 4. Submission of Matters to a Vote of Security Holders.................26 Item 5. Other Information...................................................26 Item 6. Exhibits and Current Reports on Form 8-K........................... 26 Signatures...................................................................27 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS (UNAUDITED)
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) JUNE 30, DECEMBER 31, (DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA) 2000 1999 ---------- ---------- ASSETS Cash and interest-bearing deposits $ 58,228 69,557 Accounts receivable 39,814 32,367 Loans held for sale, net 65,500 89,036 Accrued interest receivable 13,223 63,309 Capitalized mortgage servicing rights 42,872 45,927 Interest-only and residual certificates 238,089 224,659 Equipment, net 19,765 21,721 Prepaid and other assets 19,542 5,428 Goodwill 4,239 4,831 ---------- ---------- Total assets $ 501,272 556,835 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Bank payable $ 617 1,195 Warehouse financing and other borrowings 82,582 109,019 Senior Notes 149,521 149,474 Accounts payable and accrued expenses 30,262 43,607 Investor payable 70,896 82,204 Advance payment by borrowers for taxes and insurance 14,841 13,784 Deferred tax liability 7,113 10,411 ---------- ---------- Total liabilities 355,832 409,694 ---------- ---------- STOCKHOLDERS' EQUITY: Common stock, $.01 par value. Authorized 49,000,000 shares; 16,000,549 shares issued and 15,883,749 shares outstanding at June 30, 2000 and December 31, 1999 160 160 Additional paid-in capital 99,472 99,472 Retained earnings 47,126 48,827 Treasury stock, at cost (116,800 shares) (1,318) (1,318) ---------- ---------- Total stockholders' equity 145,440 147,141 ---------- ---------- Total liabilities and stockholders' equity $ 501,272 556,835 ========== ========== See accompanying notes to consolidated financial statements. 1
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Six Months Ended June 30, June 30, (Dollars in thousands, except per share data) 2000 1999 2000 1999 ------- ------- ------- ------ Revenues Net gain on sale of mortgage loans $ 11,274 $ 22,901 $ 25,928 $ 48,004 Interest 7,567 9,680 18,104 16,113 Servicing fees 3,738 3,743 7,804 7,356 Origination fees 6,365 8,125 13,053 15,489 ------- ------- ------- ------- Total revenues 28,944 44,449 64,889 86,962 ------- ------- ------- ------- Expenses Payroll and related costs 15,699 17,744 31,260 33,586 Interest expense 8,528 6,077 16,331 12,249 General and administrative (1) 10,750 16,937 20,206 27,994 ------- ------- ------- ------- Total expenses 34,977 40,758 67,797 73,829 ------- ------- ------- ------- (Loss) income before income tax (benefit) expense (6,033) 3,691 (2,908) 13,133 Income taxes (benefit) expense (2,506) 1,476 (1,207) 5,174 ------- ------- -------- ------- Net (loss) income $ (3,527) $ 2,215 $ (1,701) $ 7,959 ======= ======= ======== ======= Per share data Net (loss) income per common share - basic and diluted $ (0.22) $ 0.14 $ (0.11) $ 0.52 ======== ======= ======== ======= Weighted-average number of shares outstanding 15,920,869 15,358,749 15,920,869 15,358,749 ----------------- (1) The Company recorded a $6.0 million pre-tax charge in the second quarter of 1999 when it reached a settlement in principle with the NYOAG. (An additional $6.0 million pre-tax charge was recorded in the third quarter of 1999 in connection with the Company's final global settlement with the NYSBD and the NYOAG, which was later joined by the U.S. Department of Justice, the Federal Trade Commission and the U.S. Department of Housing and Urban Development. See "Legal Proceedings" for a more detailed discussion of the settlement. See accompanying notes to consolidated financial statements. 2
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, (Dollars in thousands) 2000 1999 ------- ------- Cash flows from operating activities: Net (loss) income $ (1,701) $ 7,959 Adjustments to reconcile net income to net cash used in operating activities: Provision for loan and recourse losses 542 50 Depreciation and amortization 3,664 2,742 Deferred tax benefit (3,298) (746) Capitalized mortgage servicing rights, net of amortization 3,055 (5,062) Deferred origination costs 499 232 Interest-only and residual certificates received in securitization transactions, net (13,430) (12,450) Changes in operating assets and liabilities: Increase in accounts receivable (7,447) (4,727) Decrease in loans held for sale, net 23,033 1,519 Decrease (increase) in accrued interest receivable 50,086 (7,426) (Increase) decrease in prepaid and other assets (14,640) 659 (Decrease) increase in accounts payable and accrued expenses (13,357) 9,575 (Decrease) increase in investor payable (11,308) 13,038 Increase in advance payments by borrowers for taxes and insurance 1,057 2,249 ------- ------- Net cash provided by operating activities 16,755 7,612 ------- ------- Cash flows from investing activities: Purchase of equipment (1,069) (4,905) ------- ------- Net cash used in investing activities (1,069) (4,905) ------- ------- Cash flows from financing activities: (Repayments) proceeds from warehouse financing and other borrowings (26,437) 12,019 Decrease in bank payable, net (578) (23) ------- ------- Net cash (used in) provided by financing activities (27,015) 11,996 ------- ------- Net (decrease) increase in cash and interest-bearing deposits (11,329) 14,703 Cash and interest-bearing deposits at beginning of period 69,557 59,183 ------- ------- Cash and interest-bearing deposits at end of period $ 58,228 $ 73,886 ======= ======= Supplemental Information: Cash paid during the period for: Interest $ 15,540 $ 11,717 ======= ======= Income taxes $ 2,101 $ 5,921 ======= ======= See accompanying notes to consolidated financial statements. 3
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION Delta Financial Corporation (the "Company" or "Delta") is a Delaware corporation, which was organized in August 1996. The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying unaudited consolidated financial statements and the information included under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the audited consolidated financial statements and related notes of the Company for the year ended December 31, 1999. The results of operations for the three- and six-month periods ended June 30, 2000 are not necessarily indicative of the results that will be expected for the entire year. All adjustments that are, in the opinion of management, considered necessary for a fair presentation of the financial position and results of operations for the interim periods presented have been made. Certain prior period amounts in the financial statements have been reclassified to conform with the current year presentation. (2) SUMMARY OF REGULATORY SETTLEMENTS In September 1999, the Company settled allegations by the New York State Banking Department (the "NYSBD") and a lawsuit by the New York State Office of the Attorney General ("NYSOAG") alleging that Delta had violated various state and federal lending laws. The global settlement was evidenced by that certain (a) Remediation Agreement by and between Delta Funding and the NYSBD, dated as of September 17, 1999 and (b) Stipulated Order on Consent by and among Delta Funding, Delta Financial and the NYOAG, dated as of September 17, 1999. As part of the Settlement, Delta, among other things, implemented agreed upon changes to its lending practices; will provide reduced loan payments aggregating $7.25 million to certain borrowers identified by the NYSBD; and created a fund of approximately $4.75 million financed by the grant of 525,000 shares of Delta Financial's common stock valued at a constant assumed priced of $9.10 per share, which approximates book value. The proceeds of the fund will be used, for among other things, payments to borrowers, to pay for a variety of consumer educational and counseling programs. In March 2000, the Company finalized an agreement with the U.S. Department of Justice (the "DOJ"), the Federal Trade Commission (the "FTC") and the Department of Housing and Urban 4 Development ("HUD"), to complete the global settlement it had reached with the NYSBD and NYOAG. The Federal agreement mandates some additional compliance efforts for Delta, but it does not require any additional financial commitment by Delta. (3) IMPACT OF NEW ACCOUNTING STANDARDS In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133." This statement amends and supersedes certain paragraphs of SFAS No. 133. The effective date for SFAS No. 138 is for fiscal years beginning after June 15, 2000. SFAS No. 138 and 133 apply to quarterly and annual financial statements. The Company does not believe that there will be a material impact on its financial condition or results of operations upon the adoption of SFAS No. 138 and 133. (4) EARNINGS PER SHARE The following is a reconciliation of the denominators used in the computations of basic and diluted Earnings Per Share ("EPS"). The numerator for calculating both basic and diluted EPS is net income.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- ----------------- (DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 2000 1999 2000 1999 ------------------------------------------------------------------------------------------- Net (loss) income $(3,527) $2,215 $(1,701) $7,959 Weighted-average shares - basic 15,920,869 15,358,749 15,920,869 15,358,749 Basic EPS $(0.22) $0.14 $(0.11) $0.52 Weighted-average shares - basic 15,920,869 15,358,749 15,920,869 15,358,749 Incremental shares-options --- 36,942 693 24,619 ------------------------------------------------------------------------------------------- Weighted-average shares - diluted 15,920,869 15,395,691 15,921,562 15,383,368 Diluted EPS $(0.22) $0.14 $(0.11) $0.52
(5) SUBSEQUENT EVENTS In July 2000, the Company decided to discontinue its correspondent operations to focus exclusively on its less cash intensive broker and retail channels. In July 2000, the Company also sold a domain name for $2.125 million. In August 2000, the Company announced an agreement to restructure (the "Debt Restructuring") its outstanding $150 million aggregate principal amount of 9 1/2% senior notes due 2004 (the "Senior Notes"). With the consent of more than fifty percent of its Senior Note holders, a negative covenant in the Senior Notes Indenture that prevented the Company from encumbering, or otherwise obtaining financing against, any of its residual assets has been modified. In consideration for the Senior Note holders' consent to modify this restriction, the Company has agreed to offer current Senior Note holders the option of exchanging in an exchange offering (the "Exchange Offer") their existing securities for new senior notes (the 5 "New Notes"), to be secured by at least $165 million of the Company's residual assets. The New Notes will have the same coupon, face amount, and maturity date as the Senior Notes. Note holders of the New Notes will receive ten-year warrants to buy approximately 1.6 million shares, at an initial exercise price of $9.10 per share, subject to upward or downward adjustment in certain circumstances. The Company expects that this Exchange Offer will be completed by October 15, 2000. All of the other terms of the New Notes will be substantially similar to the terms of the Senior Notes. In August 2000, the Company also announced that it was streamlining its operations to improve efficiencies and increase profitability by reducing its workforce, consolidating some of its offices and reducing the compensation of its senior management and some of its general staff. In August 2000, the Company entered into a financing agreement with a lender to finance approximately $17 million of its interest-only and residual certificates in accordance with its Debt Restructuring. ITEM 2. 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. GENERAL Delta Financial Corporation (the "Company" or "Delta"), through its wholly-owned subsidiaries, engages in the consumer finance business by originating, acquiring, selling and servicing non-conforming home equity loans. Throughout its 18 years of operating history, the Company has focused on lending to individuals who generally have impaired or limited credit profiles or higher debt-to-income ratios for such purposes as debt consolidation, home improvement, mortgage refinancing or education. Through its wholly-owned subsidiary, Delta Funding Corporation ("Delta Funding"), 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"). However, in July 2000, the Company decided to discontinue its correspondent operations to focus exclusively on its less cash intensive broker and retail channels. Delta Funding currently originates the majority of its loans in 24 states, through its network of approximately 1,500 brokers. Through its wholly-owned subsidiary, Fidelity Mortgage Inc., the Company develops retail loan leads ("Retail Loans") primarily through its telemarketing system and its network of 14 retail offices located in eight states. In March 2000, the Company closed a loan production center in Georgia. In July 2000, the Company opened a new retail origination call center to expand the Company's existing retail operations at its office in Woodbury, New York. 6 In June 1999, the Company announced a settlement in principle with the NYOAG, which was to provide for retrospective relief to certain borrowers in the form of reduced monthly obligations aggregating $6 million and prospective changes to some of the Company's lending practices. The NYOAG took issue with Delta's lending practices, specifically which loans should and should not be made by Delta. The settlement in principle was later expanded to include the NYSBD and the DOJ, which had raised similar concerns relating to Delta's lending practices. In September 1999, the Company finalized its settlements with the NYSBD and the NYOAG, but only after the NYOAG filed suit against the Company in August 1999, as evidenced by (1) a Remediation Agreement by and between the Company and the NYSBD, and (2) a Stipulated Order on Consent by and among the Company and the NYOAG. As part of the final global settlement (in lieu of the previously announced $6 million settlement with the NYOAG), the Company agreed to, among other things, implement agreed upon changes to its lending practices; provide reduced loan payments aggregating $7.25 million to certain borrowers identified by the NYSBD; and create a reversionary fund ("the Fund"), administered by a trustee named by the NYSBD, financed by the grant by Delta of 525,000 shares of Delta's common stock, valued at an assumed constant price of $9.10 per share, which approximates the book value of the shares. All proceeds raised through the Fund shall be used for restitution and/or to pay for a variety of educational and counseling programs at the discretion of the NYSBD. The Company recorded a $6.0 million pre-tax charge in the second quarter of 1999 when it reached a settlement in principle with the NYOAG. Subsequently, an additional $6.0 million pre-tax charge was recorded in the third quarter of 1999 when the Company reached a global settlement with the NYSBD and the NYOAG. The Company finalized its agreement with the DOJ in March 2000. The DOJ settlement, which parallels the NYSBD and NYOAG settlement agreements, was also signed by the FTC and HUD. See "Legal Proceedings" for a discussion of the settlement. For the three months ended June 30, 2000 the Company originated and purchased $264 million of loans, a decrease of 36% over the $414 million of loans originated and purchased in the comparable period in 1999. Of these amounts, approximately $167 million were originated through its network of brokers, $71 million were originated through its retail network and $26 million were purchased from its network of correspondents during the three months ended June 30, 2000 compared to $257 million, $92 million and $65 million, respectively, for the same period in 1999. In July 2000, the Company decided to discontinue its correspondent operations to focus exclusively on its less cash intensive broker and retail channels. The following table sets forth information relating to the delinquency and loss experience of the mortgage loans serviced by the Company (primarily for the securitization trusts, as described below) for the periods indicated. The Company is not the holder of the securitization loans, but generally retains interest-only or residual certificates issued by the securitization trusts, as well as the servicing rights, the value of each of which may be adversely affected by defaults. 7 THREE MONTHS ENDED -------------------------------- (Dollars in thousands) JUNE 30, MARCH 31, 2000 2000 ----------- ----------- Total Outstanding Principal Balance (at period end)...................... $ 3,816,818 $ 3,732,118 Average Outstanding(1)................. 3,792,340 3,698,545 DELINQUENCY (at period end) 30-59 Days: Principal Balance.................... $ 208,674 $ 195,375 Percent of Delinquency(2)............ 5.47% 5.24% 60-89 Days: Principal Balance.................... $ 103,347 $ 81,290 Percent of Delinquency(2)............ 2.71% 2.18% 90 Days or More: Principal Balance................... $ 54,718 $ 48,619 Percent of Delinquency(2)............ 1.43% 1.30% Total Delinquencies: Principal Balance.................... $ 366,739 $ 325,284 Percent of Delinquency(2)............ 9.61% 8.72% FORECLOSURES Principal Balance.................... $ 190,059 $ 192,067 Percent of Foreclosures by Dollar(2). 4.98% 5.15% REO (at period end)................... $ 47,098 $ 44,588 Percent of REO...................... 1.23% 1.19% Net Losses on Liquidated Loans......... $ (6,517) $ (4,544) Percentage of Net Losses on Liquidated Loans (based on Average Outstanding Balance)(3) (0.69%) (0.49%) --------------- (1)Calculated by summing the actual outstanding principal balances at the end of each month and dividing the total principal balance 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. (3)Annualized. Management believes that its loan servicing portfolio may incur higher delinquency and loss experience for the foreseeable future as its portfolio becomes more seasoned (aged) and is not offset as much by newer originated loans (loan originations have been lower as compared to prior periods) which usually carry a lower delinquency and loss experience and due to the overall decline in its servicing portfolio due to the sale of its servicing on loans sold through a securitization in June 2000. FAIR VALUE ADJUSTMENTS The fair values of both interest-only and residual certificates and capitalized mortgage servicing rights are significantly affected by, among other factors, prepayments of loans and estimates of future prepayment rates. The Company continually reviews its prepayment assumptions in light of company and industry experience and makes adjustments to those assumptions when such experience indicates. 8 The Company makes assumptions concerning prepayment rates and defaults based upon the seasoning of its existing securitization loan portfolio. The following table compares the prepayment assumptions used during the first six months of 2000 (the "new" assumptions), with those used during the first six months of 1999 (the "old" assumptions): LOAN TYPE MONTH 1 SPEED PEAK SPEED --------- ------------- ---------- NEW OLD NEW OLD --- --- --- --- Fixed Rate Loans 4.0% 4.8% 31% 31% Six-Mo. LIBOR ARMs 10.0% 10.0% 50% 50% Hybrid ARMs 4.0% 6.0% 50% 50% In the fourth quarter of 1999, the Company lowered its prepayment speed assumption along parts of the prepayment rate vector curve while leaving the peak speeds intact. In addition, the Company increased its loss reserve initially established for both fixed- and adjustable-rate loans sold to the securitizations trusts from 2.20% to approximately 3.10% of the issuance amount securitized. The prepayment rate assumption was revised primarily to reflect the Company's actual loan performance experience over the past several quarters. Management believes that industry consolidation and a higher interest rate environment has and will continue to deter borrowers from refinancing their mortgage loans. The loan loss reserve assumption was revised to reflect management's belief that slower prepayment speeds, coupled with an anticipated flat to slightly moderate rise in home values as compared to the past few years and borrowers who had avoided default through refinancing may be readily unable to do so because of industry consolidation and a higher interest rate environment, may have an adverse effect on the Company's non-performing loans. An annual discount rate of 12.0% was utilized in determining the present value of cash flows from residual certificates, using the "cash-out" method, which are the predominant form of retained interests at both June 30, 2000 and December 31, 1999. In the second quarter of 2000, the Company was required to take a $3.7 million valuation adjustment to its interest only and residual certificates in accordance with SFAS 115, due to the increase in one-month LIBOR. Some of the Company's interest only and residual certificates are backed by floating rate securities, which are susceptible to interest rate risk associated with movement in short-term interest rates. The Company uses the same prepayment assumptions in estimating the fair value of its mortgage servicing rights. 9 RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1999 GENERAL The Company's net loss for the three months ended June 30, 2000 was $3.5 million, or ($0.22) per share, compared to net income of $2.2 million, or $0.14 per share, for the three months ended June 30, 1999. Excluding a one-time charge relating to the Company's original settlement in principle with the NYOAG (which settlement has been replaced by the Company's global settlement with the NYSBD, NYOAG and the DOJ), the Company's net income for the three months ended June 30, 1999 would have been $5.8 million, or $0.38 per share. Comments regarding the components of net income are detailed in the following paragraphs. REVENUES Total revenues decreased $15.5 million, or 35%, to $28.9 million for the three months ended June 30, 2000, from $44.4 million for the comparable period in 1999. The decrease in revenue was primarily attributable to a decrease in the net gain recognized on the sale of mortgage loans and to a lesser extent, decreases in interest income and origination fees. The Company originated and purchased $264 million of mortgage loans for the three months ended June 30, 2000, representing a 36% decrease from $414 million of mortgage loans originated and purchased for the comparable period in 1999. The Company securitized and sold $275 million in loans (and sold the related servicing rights) during the three months ended June 30, 2000 compared to $420 million securitized or sold in the corresponding period in 1999, representing a 35% decrease. Total loans serviced increased 14% to $3.82 billion at June 30, 2000 from $3.36 billion at June 30, 1999. NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans represents (1) the sum of (a) the fair value of the interest-only and residual certificates retained by the Company in a securitization for each period and the market value of the interest-only certificates sold in connection with each securitization, (b) the fair value of capitalized mortgage servicing rights associated with loans securitized in each period and the market value of capitalized mortgage servicing rights sold in connection with each securitization, and (c) premiums earned on the sale of whole loans on a servicing-released basis, (2) less the (x) premiums paid to originate or acquire mortgage loans, (y) costs associated with securitizations and (z) any hedge loss (gain) associated with a particular securitization. Net gain on sale of mortgage loans decreased $11.6 million, or 51%, to $11.3 million for the three months ended June 30, 2000, from $22.9 million for the comparable period in 1999. This decrease was primarily due to a 35% decrease in the amount of loans securitized or sold to $275 million in 2000, compared to $420 million of loans securitized or sold in 1999; and a lower amount of gross excess spread expected to be earned over the life of the loans as calculated by the weighted average coupon on the pool of mortgage loans securitized less the total cost of funds on the securitization. The decrease in the gross excess spread was attributable primarily to wider spreads demanded by asset-backed investors who purchased the pass-through certificates issued by the securitization trust during the three months ended June 30, 2000 compared to the corresponding period in 1999. The decrease was partially offset by lower 10 aggregate premiums paid to acquire loans, resulting from both a decrease in amount of loans purchased through the correspondent channel and lower average premiums paid to correspondents. The weighted average net gain on sale ratio was 4.1% for the three months ended June 30, 2000 compared to 5.5% for the comparable period in 1999. INTEREST INCOME. Interest income primarily represents the sum of (1) the difference between the distributions the Company receives on its interest-only and residual certificates and the adjustments recorded to reflect changes in the fair value of the interest-only and residual certificates, (2) the gross interest earned on loans held for sale (other than for loans sold into the mortgage loan conduit, in which case it is the net interest spread), (3) with respect to loans sold into the mortgage loan conduit, the net interest margin earned (excess servicing) between the weighted average rate on the mortgage loans less the conduit's variable funding rate plus administrative fees, and (4) interest earned on cash collection balances. Interest income decreased $2.1 million, or 22%, to $7.6 million for the three months ended June 30, 2000, from $9.7 million for the comparable period in 1999. The decrease in interest income was primarily due to (1) a higher fair value adjustment during the second quarter of 2000 due to an increase in one month LIBOR (see "Fair Value Adjustment")and (2)a decreased amount of loans held prior to securitization, reflecting lower overall loan production in the three months ended June 30, 2000. This was partially offset by (a) a higher mortgage coupon rate of 11.2% from 10.0% reflecting a higher economic interest rate environment and (b) the accounting for loans sold through a mortgage loan conduit (special purpose vehicle) prior to securitization in the second quarter of 1999, in which the Company earns and records the net interest margin between the interest rate earned on the pool of mortgage loans sold to the mortgage loan conduit and the conduit financing rate, less administrative expenses. SERVICING FEES. Servicing fees represent all contractual and ancillary servicing revenue received by the Company less (1) the offsetting amortization of the capitalized mortgage servicing rights, and any adjustments recorded to reflect valuation allowances for the impairment in mortgage servicing rights and (2) prepaid interest shortfalls. Servicing fees remained flat at $3.7 million for both the three months ended June 30, 2000, and June 30, 1999. Contractual servicing income increased due to the increase in the aggregate size of the Company's servicing portfolio, but was offset by a decrease in ancillary service fees collected. The average balance of the mortgage loans serviced by the Company increased 15% to $3.79 billion for the three months ended June 30, 2000 from $3.29 billion during the comparable period in 1999. ORIGINATION FEES. Origination fees represent fees earned on brokered and retail originated loans. Origination fees decreased $1.7 million, or 21%, to $6.4 million for the three months ended June 30, 2000, from $8.1 million for the comparable period in 1999. The decrease was primarily the result of (a) a 35% decrease in broker originated loans and (b) a 23% decrease in retail originated loans. 11 EXPENSES Total expenses decreased by $5.8 million, or 14%, to $35.0 million for the three months ended June 30, 2000, from $40.8 million for the comparable period in 1999. The decrease was primarily the result of a decrease in general and administrative costs related to the Company's original settlement in principle with the NYOAG in June 1999 (which settlement has been replaced by the Company's global settlement with the NYSBD, NYOAG and the DOJ) and a decrease in personnel costs, partially offset by an increase in interest expense. PAYROLL AND RELATED COSTS. Payroll and related costs include salaries, benefits and payroll taxes for all employees. Payroll and related costs decreased by $2.0 million, or 11%, to $15.7 million for the three months ended June 30, 2000, from $17.7 million for the comparable period in 1999. The decrease was primarily due to a decline in staffing in the Company's broker and retail divisions and in commissions paid to these employees, related to a decrease in loans originated. In addition, there was a decrease in bonuses related to executive employees. This was partially offset by an increase in staffing related to growth in the Company's servicing portfolio, coupled with an increase in employee fringe benefits. As of June 30, 2000, the Company employed 1,063 full- and part-time employees, compared to 1,278 full- and part-time employees as of June 30, 1999. INTEREST EXPENSE. Interest expense includes the borrowing costs to finance loan originations and purchases, equipment financing and the Company's overall operations under the Senior Notes and the Company's credit facilities. Interest expense increased by $2.4 million, or 39%, to $8.5 million for the three months ended June 30, 2000 from $6.1 million for the comparable period in 1999. The increase was primarily attributable to the accounting for loans sold through a mortgage loan conduit prior to their securitization during the second quarter of 1999, in which the Company earns and records the net interest margin between the interest rate earned on the pool of mortgage loans sold to the mortgage loan conduit and the conduit financing rate, less administrative expenses. Typically, interest expense related to the Company's other warehouse financing and borrowings are recorded directly to interest expense. The Company did not utilize its mortgage loan conduit during the second quarter of 2000. In addition, there was an increase in the 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 6.5% in the three months ended June 30, 2000, compared to an average interest rate of 5.0% for the comparable period in 1999. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of office rent, insurance, telephone, depreciation, goodwill amortization, legal reserves and fees, license fees, 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. General and administrative expenses decreased $6.2 million, or 37%, to $10.7 million for the three months ended June 30, 2000, from $16.9 million for the comparable period in 1999. This decrease was primarily attributable to the Company's original settlement in principle with the 12 NYOAG (which settlement has been replaced by the Company's global settlement with the NYSBD, NYOAG and the DOJ). 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. The Company recorded a tax benefit of $2.5 million and a tax provision of $1.5 million for the three months ended June 30, 2000 and 1999, respectively. SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1999 GENERAL The Company's net loss for the six months ended June 30, 2000 was $1.7 million, or ($0.11) per share, compared to net income of $8.0 million, or $0.52 per share, for the six months ended June 30, 1999. Excluding a one-time charge relating to the Company's original settlement in principle with the NYOAG (which settlement has been replaced by the Company's global settlement with the NYSBD, NYOAG and the DOJ), the Company's net income for the six months ended June 30, 1999 would have been $11.6 million, or $0.76 per share. Comments regarding the components of net income are detailed in the following paragraphs. REVENUES Total revenues decreased $22.1 million, or 25%, to $64.9 million for the six months ended June 30, 2000, from $87.0 million for the comparable period in 1999. The decrease in revenue was primarily attributable to a decrease in the net gain recognized on the sale of mortgage loans and origination fees, partially offset by an increase in interest income and servicing fees. The Company originated and purchased $551 million of mortgage loans for the six months ended June 30, 2000, representing a 33% decrease from $819 million of mortgage loans originated and purchased for the comparable period in 1999. The Company securitized and sold $565 million in loans (and sold the related servicing rights on its second quarter $275 million securitization) during the six months ended June 30, 2000 compared to $795 million securitized or sold in the corresponding period in 1999, representing a 29% decrease. Total loans serviced increased 14% to $3.82 billion at June 30, 2000 from $3.36 billion at June 30, 1999. NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans decreased $22.1 million, or 46%, to $25.9 million for the six months ended June 30, 2000, from $48.0 million for the comparable period in 1999. This decrease was primarily due to a 29% decrease in the amount of loans securitized or sold; a revision to the Company's loan loss reserve assumption in 1999 (see "-Fair Value Adjustments"); a change in the securitization structure which reduced the Company's profitability (but provided better cash flow dynamics, such as selling of the senior interest-only certificate), coupled with wider spreads demanded by asset-backed investors who purchase the pass-through certificates issued by securitization trusts during the six months ended June 30, 2000 compared to the corresponding period in 1999. The decrease was partially offset by lower aggregate premiums paid to acquire loans, resulting from both a decrease in amount of 13 loans purchased through the correspondent channel and lower average premiums paid to correspondents. The weighted average net gain on sale ratio was 4.6% for the six months ended June 30, 2000 compared to 6.0% for the comparable period in 1999. INTEREST INCOME. Interest income increased $2.0 million, or 12%, to $18.1 million for the six months ended June 30, 2000, from $16.1 million for the comparable period in 1999. The increase in interest income was primarily due to (1) the accounting of loans sold through a mortgage loan conduit prior to securitization in the first six months of 1999, in which the Company earns and records the net interest margin between the interest rate earned on the pool of mortgage loans sold to the mortgage loan conduit and the conduit financing rate, less administrative expenses and (2) a higher mortgage coupon rate of 11.1% from 10.1% reflecting a higher economic interest rate environment. SERVICING FEES. Servicing fees increased $0.4 million, or 5%, to $7.8 million for the six months ended June 30, 2000, from $7.4 million for the comparable period in 1999. This increase was primarily due to an increase in the aggregate size of the Company's servicing portfolio, but was offset by a decrease in ancillary service fees collected. The average balance of the mortgage loans serviced by the Company increased 18% to $3.75 billion for the six months ended June 30, 2000 from $3.19 billion during the comparable period in 1999. ORIGINATION FEES. Origination fees decreased $2.4 million, or 15%, to $13.1 million for the six months ended June 30, 2000, from $15.5 million for the comparable period in 1999. The decrease was primarily the result of (a) a 31% decrease in broker originated loans and (b) a 16% decrease in retail originated loans. EXPENSES Total expenses decreased by $6.0 million, or 8%, to $67.8 million for the six months ended June 30, 2000, from $73.8 million for the comparable period in 1999. The decrease was primarily the result of a decrease in general and administrative costs related to the Company's original settlement in principle with the NYOAG in June 1999 (which settlement has been replaced by the Company's global settlement with the NYSBD, NYOAG and the DOJ) and a decrease in personnel costs, partially offset by an increase in interest expense. PAYROLL AND RELATED COSTS. Payroll and related costs decreased by $2.3 million, or 7%, to $31.3 million for the six months ended June 30, 2000, from $33.6 million for the comparable period in 1999. The decrease was due primarily to a decline in staffing in the Company's broker and retail divisions and in commissions paid to these employees, related to a decrease in loans originated. In addition, there was a decrease in bonuses related to executive employees. This was partially offset by an increase in staffing related to growth in the Company's servicing portfolio, coupled with an increase in employee fringe benefits. As of June 30, 2000, the Company employed 1,063 full- and part-time employees, compared to 1,278 full- and part-time employees as of June 30, 1999. INTEREST EXPENSE. Interest expense increased by $4.1 million, or 34%, to $16.3 million for the six months ended June 30, 2000 from $12.2 million for the comparable period in 1999. The increase was primarily attributable to the accounting for loans sold through a mortgage loan 14 conduit prior to their securitization during the six months ended June 30, 1999, in which the Company earns and records the net interest margin between the interest rate earned on the pool of mortgage loans sold to the mortgage loan conduit and the conduit financing rate, less administrative expenses. Typically, interest expense related to the Company's other warehouse financing and borrowings are recorded directly to interest expense. The Company did not utilize its mortgage loan conduit during the six months ended June 30, 2000. In addition, there was a increase in the 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 6.2% in the six months ended June 30, 2000, compared to an average interest rate of 5.0% for the comparable period in 1999. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses decreased $7.8 million, or 28%, to $20.2 million for the six months ended June 30, 2000, from $28.0 million for the comparable period in 1999. This decrease was primarily attributable to the Company's original settlement with the NYOAG (which settlement has been replaced by the Company's global settlement with the NYSBD, NYOAG and the DOJ) and higher legal-related costs and reserves during the six months ended June 30, 1999. INCOME TAXES. The Company recorded a tax benefit of $1.2 million and a tax provision of $5.2 million for the six months ended June 30, 2000 and 1999, respectively. FINANCIAL CONDITION JUNE 30, 2000 COMPARED TO DECEMBER 31, 1999 Cash and interest-bearing deposits decreased $11.4 million, or 16%, to $58.2 million at June 30, 2000, from $69.6 million at December 31, 1999. The decrease was primarily the result of lower prepayments which caused a decrease in monies held in securitization trust accounts by the Company, acting as servicer for its ongoing securitization program. Accounts receivable increased $7.4 million, or 23%, to $39.8 million at June 30, 2000, from $32.4 million at December 31, 1999. The increase was primarily attributable to an increase in reimbursable servicing advances made by the Company, acting as servicer on its securitizations, related to a higher average servicing portfolio, coupled with a $2.7 million receivable related to the sale of servicing rights in conjunction with the Company's second quarter loan securitization. Loans held for sale, net decreased $23.5 million, or 26%, to $65.5 million at June 30, 2000, from $89.0 million at December 31, 1999. This decrease was primarily due to the net difference between loan originations and loans sold or securitized during the six months ended June 30, 2000. Accrued interest receivable decreased $50.1 million, or 79%, to $13.2 million at June 30, 2000, from $63.3 million at December 31, 1999. This decrease was primarily due to the sale of interest receivable assets, partially offset by an increase in reimbursable interest advances made by the Company, acting as servicer on its securitizations. Capitalized mortgage servicing rights decreased $3.0 million, or 7%, to $42.9 million at June 30, 2000, from $45.9 million at December 31, 1999. This decrease was primarily due to the 15 amortization of the capitalized mortgage servicing rights which was not offset in the second quarter 2000, with a new recorded capitalized mortgage servicing rights usually associated with a securitization. The Company sold its contractual right to service the loans on its second quarter 2000 securitization for a cash premium. Interest-only and residual certificates increased $13.4 million, or 6%, to $238.1 million at June 30, 2000, from $224.7 million at December 31, 1999. This increase is primarily attributable to the Company's receipt of residual certificates valued and recorded at $17.8 million from loans securitized during the six months ended June 30, 2000, partially offset by normal amortization due to cash distributions and fair value adjustments. Prepaid and other assets increased $14.1 million, or 261%, to $19.5 million at June 30, 2000, from $5.4 million at December 31, 1999. This increase was primarily attributable to the Company's investment in new affiliate companies (qualified special purpose entities used for securitizations). Warehouse financing and other borrowings decreased $26.4 million, or 24%, to $82.6 million at June 30, 2000, from $109.0 at December 31, 1999. This decrease was primarily attributable to the repayment in full of the Company's bank syndicate working capital line in June 2000. The aggregate principal balance of the Senior Notes totaled $149.5 million at June 30, 2000 and December 31, 1999, net of unamortized bond discount. The Senior Notes accrue interest at a rate of 9.5% per annum, payable semi-annually on February 1 and August 1 (See Subsequent Events, Note 5). Accounts payable and accrued expenses decreased $13.3 million, or 31%, to $30.3 million at June 30, 2000, from $43.6 million at December 31, 1999. The decrease was primarily the result of timing of various operating accruals and payables. Investor payable decreased $11.3 million, or 14%, to $70.9 million at June 30, 2000, from $82.2 million at December 31, 1999. The decrease was primarily the result of lower prepayments, which caused a decrease in the amount payable to investors. Investor payable is comprised of all principal collected on mortgage loans and accrued interest. Variability in this account is primarily due to the principal payments collected within a given collection period. Deferred tax liability decreased $3.3 million, or 32%, to $7.1 million as June 30, 2000, from $10.4 million as December 31, 1999. This decrease is primarily due to a tax benefit of $1.2 million and tax payments of $2.1 million. LIQUIDITY AND CAPITAL RESOURCES The Company has primarily operated on a negative cash flow basis in the past and anticipates that it will continue to have a negative operating cash flow for the foreseeable future due primarily to lower projected aggregate cash inflows from the Company's retained interest-only and residual certificates. The lower projected inflows are due to expected timing differences between older deals cash flowing less per month per deal as the mortgage pool pays down and newer deals not yet cash flowing until initial reserve requirements are satisfied. As initial reserve requirements on some newer deals are reached, the Company 16 will begin to receive additional cash inflows from its retained interest-only and residual certificates which, coupled with (a) the Company's continued concentration on its less cash-intensive broker and retail originations, and (b) its recent history of utilizing favorable securitization structures that have allowed the Company to sell senior interest-only certificates and/or mortgage servicing rights for an up front cash purchase price, may help offset the operating cash deficit in future quarters. However, market conditions and various other possibilities identified below under "Risk Factors" could impact the Company's cash flows potentially resulting in a more significant negative cash flow. For the six months ended June 30, 2000, the Company had an operating cash flow of $16.8 million compared to an operating cash flow of $7.6 million for the comparable period in 1999. The increase in operating cash flow was primarily due to the Company's sale of interest receivable assets during the six months ended June 30, 2000, which, due to the "off-balance sheet" nature of the transactions are classified as "operating activities." However, the majority of the proceeds - approximately $25 million - from these interest receivable asset sales was used to repay the Company's bank syndicate working capital line, which is classified as a "financing activity." Excluding those proceeds that were used to repay the working capital line from operating cash flows results in a pro forma net operating deficit of $[8.2] million. To a lesser extent, the increase in operating cash flow also was due to a reduction in tax payments and the Company's de-emphasis of the correspondent loan production channel (thereby decreasing the amount of premiums paid to correspondents) during the six months ended June 30, 2000. This was partially offset by a decrease in cash flows from the Company's retained interest-only and residual certificates, a reduction in cash received on the sale of interest only assets at the time of securitization and the Company's use of operating cash to fund interest (delinquency) and servicing advance obligations required as servicer for its securitization program. These interest and servicing advances are reimbursable to the Company as the borrowers repay their obligations over time. As such, the exact timing of these reimbursements cannot be predicted with certainty. Currently, the Company's primary cash requirements include the funding of (1) loan originations pending their pooling and sale, (2) interest expense on its Senior Notes and warehouse and other financings, (3) fees, expenses, interest (delinquency) advances, servicing-related advances and tax payments incurred in connection with its securitization program, and (4) ongoing administrative and other operating expenses. The Company must be able to sell loans and obtain adequate credit facilities and other sources of funding in order to continue to originate and service loans. Historically, the Company has utilized various financing facilities and an equity financing to offset negative operating cash flows and support the continued growth of its loan originations, securitizations and general operating expenses. In July 1997, the Company completed an offering of the Senior Notes. A portion of the Senior Notes proceeds were used to pay down various financing facilities with the remainder used to fund the Company's growth in loan originations and its ongoing securitization program. The Company's primary sources of liquidity continue to be warehouse and other financing facilities, securitizations (of mortgage loans, interest (delinquency) advances and servicing advances) and, subject to market conditions, sales of whole loans, and debt and equity securities. The Company also anticipates, subject to market conditions, utilizing net interest 17 margin securitizations ("NIMS") and/or other financing against its residual assets, following its Debt Restructuring, which was announced subsequent to June 30, 2000 and which permits the Company to now sell and/or obtain financing against a portion of its residual and interest-only certificates. To accumulate loans for securitization, the Company borrows money on a short-term basis through warehouse lines of credit. The Company has relied upon a few lenders to provide the primary credit facilities for its loan originations and purchases. The Company had three warehouse facilities as of June 30, 2000 for this purpose. One of the Company's facilities is a $200 million credit line with a variable rate of interest. This credit line was renewed in June 2000. However, the Company and the lender have not finalized all terms and as such are still operating under the existing agreement. The Company's second warehouse facility is a renewal of a $200 million mortgage loan conduit with a variable rate of interest and a final maturity date of September 2000. The Company's third warehouse facility is a $200 million credit facility that has a variable rate of interest and a final maturity date of September 2000. There can be no assurance that the Company will be able to renew any of these warehouse facilities at their respective maturities. The Company is required to comply with various operating and financial covenants as provided in the agreements described above which are customary for agreements of their type. The continued availability of funds provided to the Company under these agreements is subject to, among other conditions, the Company's continued compliance with these covenants. Management believes that the Company is in compliance with all such covenants under these agreements as of June 30, 2000. The Company purchased a total of 116,800 shares of its common stock during the year ended December 31, 1998, under the Company's stock repurchase program, at a total cost of $1.3 million. All of the repurchased shares were purchased in open market transactions at then prevailing market prices. During the first six months of 2000, no additional shares were repurchased. 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, commercial paper rates 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. In an effort to mitigate the effect of 18 interest rate risk, the Company periodically reviews its various mortgage products and identifies and modifies those that have proven historically more susceptible to prepayments. However, there can be no assurance that such modifications to its product line will effectively mitigate interest rate risk in the future. Periods of unexpected or rapid changes in interest rates, and/or other volatility or uncertainty regarding interest rates, can also adversely affect the Company by increasing the likelihood that asset-backed investors will demand higher spreads than normal to offset the volatility and/or uncertainty, which decreases the value of the residual assets received by the Company through securitization. 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"). Fluctuating interest rates may also affect net interest income as certain of the Company's asset-backed securities are priced off of one-month LIBOR, but the collateral underlying such securities are comprised of mortgage loans with either fixed interest rates or "hybrid" interest rates - fixed for the initial 2 or 3 years, and then adjusts thereafter every six months - which creates basis risk (See "--Fair Value Adjustments"). HEDGING The Company originates and purchases mortgage loans and then sells them primarily through securitizations. At the time of securitization and delivery of the loans, the Company recognizes gain on sale based on a number of factors including the difference, or "spread," between the interest rate on the loans and the interest rate paid to asset-backed investors who purchase pass-through certificates issued by securitization trusts. Historically, the rate paid on the pass-through certificates generally was related to the interest rate on treasury securities with maturities corresponding to the anticipated life of the loans. If interest rates rise between the time the Company originates or purchases the loans and the time the loans are sold at securitization, the excess spread narrows, resulting in a loss in value of the loans. The Company has implemented a strategy to protect against such losses and to reduce interest rate risk on loans originated and purchased that have not yet been securitized through the use of treasury rate lock contracts with various durations (which are similar to selling a combination of United States Treasury securities), which equate to a duration similar to the duration of the underlying loans. The nature and quantity of hedging transactions are determined by the Company based upon various factors including, without limitation, market conditions and the expected volume of mortgage originations and purchases. The Company will enter into treasury rate lock contracts through one of its warehouse lenders and/or one of the investment bankers, which underwrite the Company's securitizations. These contracts are designated as hedges in the Company's records and are closed out when the associated loans are sold through securitization. If the value of the hedges decrease, offsetting an increase in the value of the loans, the Company, upon settlement with its hedge counterparty, will pay the hedge loss in cash and then realize the corresponding increase in the value of the loans as part of its net gain on sale of 19 mortgage loans and its corresponding interest-only and residual certificates. Conversely, if the value of the hedges increase, offsetting a decrease in the value of the loans, the Company, upon settlement with its hedge counterparty, will receive the hedge gain in cash and realize the corresponding decrease in the value of the loans through a reduction in the value of the corresponding interest-only and residual certificates. The Company has continued to review its hedging strategy in order to best mitigate risk pending securitization. As the asset-backed securitization market improved in the first quarter of 1999, and spreads over treasuries became largely more predictable, the Company resumed its hedging strategy of selling treasury rate-lock contracts to mitigate its interest rate risk pending securitization. For the six months ended June 30, 2000 and 1999, the Company recorded a hedge loss of $0.1 million and a hedge gain of $4.1 million respectively, which largely offset a change in the value of mortgage loans being hedged, as part of its gain on sale of loans. INFLATION Inflation affects the Company most significantly in the area of loan originations and can have a substantial effect on interest rates. Interest rates normally increase during periods of high inflation and decrease during periods of low inflation. (See "--Interest Rate Risk.") IMPACT OF NEW ACCOUNTING STANDARDS For discussion regarding the impact of new accounting standards, refer to Note 3 of Notes to the Consolidated Financial Statements. RISK FACTORS Except for historical information contained herein, certain matters discussed in this Form 10-Q are "forward-looking statements" as defined in the Private Securities Litigation Reform Act ("PSLRA") of 1995, which involve risk and uncertainties that exist in the Company's operations and business environment, and are subject to change on various important factors. The Company wishes to take advantage of the "safe harbor" provisions of the PSLRA by cautioning readers that numerous important factors discussed below, among others, in some cases have caused, and in the future could cause the Company's actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. The following include some, but not all, of the factors or uncertainties that could cause actual results to differ from projections: o Costs associated with litigation, compliance with the NYSBD Remediation Agreement and NYOAG Stipulated Order on Consent, and rapid or unforeseen escalation of the cost of regulatory compliance, generally including but not limited to, adoption of new, or changes in state or federal lending laws and regulations and the application of such laws and regulations, licenses, environmental compliance, adoption of new, or changes in accounting policies and practices and the application of such polices and practices. Failure to comply with various federal, state and local regulations, accounting policies, environmental compliance, and compliance with the Remediation Agreement and Stipulated Order on Consent can lead to 20 loss of approved status, certain rights of rescission for mortgage loans, class action lawsuits and administrative enforcement action against the Company. o The Company's ability or inability to continue to access lines of credit at favorable terms and conditions, including without limitation, warehouse and other credit facilities used to finance newly originated mortgage loans held for sale and interest and delinquency advances. o The Company's ability or inability to continue its practice of securitization of mortgage loans held for sale, as well as its ability to utilize optimal securitization structures at favorable terms to the Company. o A general economic slowdown. Periods of economic slowdown or recession may be accompanied by decreased demand for consumer credit and declining real estate values. Because of the Company's focus on credit-impaired borrowers, the actual rate of delinquencies, foreclosures and losses on loans affected by the borrowers reduced ability to use home equity to support borrowings could be higher than those generally experienced in the mortgage lending industry. Any sustained period of increased delinquencies, foreclosure, losses or increased costs could adversely affect the Company's ability to securitize or sell loans in the secondary market. o The effects of interest rate fluctuations and the Company's ability or inability to hedge effectively against such fluctuations in interest rates; the effect of changes in monetary and fiscal policies, laws and regulations, other activities of governments, agencies, and similar organizations, social and economic conditions, unforeseen inflationary pressures and monetary fluctuation. o Increased competition within the Company's markets has taken on many forms, such as convenience in obtaining a loan, customer service, marketing and distribution channels, loan origination fees and interest rates. The Company is currently competing with large finance companies and conforming mortgage originators many of whom have greater financial, technological and marketing resources. 21 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The primary market risk to which the Company is exposed is interest rate risk, which is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the control of the Company. Changes in the general level of interest rates between the time when the Company originates or purchases mortgage loans and the time when the Company sells such mortgage loans at securitization can affect the value of the Company's mortgage loans held for sale and, consequently, the Company's net gain on sale revenue by affecting the "excess spread" between the interest rate on the mortgage loans and the interest rate paid to asset-backed investors who purchase pass-through certificates issued by the securitization trusts. If interest rates rise between the time the Company originates or purchases the loans and the time the loans are sold at securitization, the excess spread generally narrows, resulting in a loss in value of the loans and a lower net gain on sale reported by the Company. A hypothetical 10 basis point increase in interest rates, which historically has resulted in approximately a 10 basis point decrease in the excess spread, would be expected to reduce the Company's net gain on sale by approximately 25 basis points. Many factors, however, can affect the sensitivity analysis described above including, without limitation, the structure and credit enhancement used in a particular securitization, the Company's prepayment, loss and discount rate assumptions, and the spread over treasuries demanded by asset-backed investors who purchase the Companies asset-backed securities. To reduce its financial exposure to changes in interest rates, the Company generally hedges its mortgage loans held for sale by entering into treasury rate lock contracts (see "-Hedging"). The Company's hedging strategy has been for the most part an effective tool to manage the Company's interest rate risk on loans prior to securitization, by providing the Company with a cash gain (or loss) to largely offset the reduced (increase) excess spread (and resultant lower (or higher) net gain on sale) from an increase (decrease) in interest rates. A hedge may not, however, perform its intended purpose of offsetting changes in net gain on sale. Changes in interest rates also could adversely affect the Company's ability to purchase and originate loans and/or could affect the level of loan prepayments thereby impacting the size of the Company's loan servicing portfolio and the value of the Company's interest only and residual certificates and capitalized mortgage servicing rights. (See "-Interest Rate Risk"). 22 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Because the nature of the Company's business involves the collection of numerous accounts, the validity of liens and compliance with various state and federal lending laws, the Company is subject, in the normal course of business, to numerous claims and legal proceedings. The Company's lending practices have been the subject of several lawsuits styled as class actions and of investigations by various regulatory agencies including the New York State Banking Department (the "NYSBD"), the Office of the Attorney General of the State of New York (the "NYOAG") and the United States Department of Justice (the "DOJ"). The current status of these actions are summarized below. o In or about November 1998, 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. In December 1998, plaintiffs filed an amended complaint alleging that the Company had violated the Home Equity and Ownership Protection Act ("HOEPA"), the Truth in Lending Act ("TILA") and New York State General Business Lawss.349. The complaint seeks (a) certification of a class of plaintiffs, (b) declaratory judgment permitting rescission, (c) unspecified actual, statutory, treble and punitive damages (including attorneys' fees), (d) certain injunctive relief, and (e) declaratory judgment declaring the loan transactions as void and unconscionable. On December 7, 1998, plaintiff filed a motion seeking a temporary restraining order and preliminary injunction, enjoining Delta from conducting foreclosure sales on 11 properties. The District Court Judge ruled that in order to consider such a motion, plaintiff must move to intervene on behalf of these 11 borrowers. Thereafter, plaintiff moved to intervene on behalf of 3 of these 11 borrowers and sought the injunctive relief on their behalf. The Company opposed the motions. On December 14, 1998, the District Court Judge granted the motion to intervene and on December 23, 1998, the District Court Judge issued a preliminary injunction enjoining the Company from proceeding with the foreclosure sales of the three intervenors' properties. The Company has filed a motion for reconsideration of the December 23, 1998 order. In January 1999, the Company filed an answer to plaintiffs' first amended complaint. In July 1999, plaintiffs were granted leave, on consent, to file a second amended complaint. In August 1999, plaintiffs filed a second amended complaint that, among other things, added additional parties but contained the same causes of action alleged in the first amended complaint. In September 1999, the Company filed a motion to dismiss the complaint, which was opposed by plaintiffs and, in June 2000, was denied in part and granted in part by the Court. Also in September 1999, plaintiffs filed a motion for class certification, which was opposed by Delta in February 2000, and is now fully briefed and filed pending hearing. In or about October 1999, plaintiffs filed a motion seeking an order preventing the Company, its attorneys and/or the NYSBD from issuing notices to certain of Delta's borrowers, in accordance with a settlement agreement entered into by and between the Company and the NYSBD. In or about October 1999 and November 1999, respectively, Delta and the NYSBD submitted opposition to plaintiffs' motion. In March 2000, the Court issued an order that permits Delta to issue an approved 23 form of the notice. The Company believes that it has meritorious defenses and intends to defend this suit, but cannot estimate with a ny certainty its ultimate legal or financial liability, if any, with respect to the alleged claims. o In or about March 1999, the Company received notice that it had been named in a lawsuit filed in the Supreme Court of the State of New York, New York County, alleging that Delta had improperly charged certain borrowers processing fees. The complaint seeks (a) certification of a class of plaintiffs, (b) an accounting, and (c) unspecified compensatory and punitive damages (including attorneys' fees), based upon alleged (i) unjust enrichment, (ii) fraud, and (iii) deceptive trade practices. In April 1999, the Company filed an answer to the complaint. In August 1999, plaintiffs filed a motion for class certification, which the Company opposed in July 2000 and the motion is now submitted. In September 1999, the Company filed a motion to dismiss the complaint, which was opposed by plaintiffs, and in February 2000, the Court denied the motion to dismiss. In April 1999, the Company filed a motion to change venue and Plaintiff's opposed the motion. In July 1999, the Court denied the motion to change venue. The Company appealed and in March 2000, the Appellate Court granted Delta's appeal to change venue from New York County to Nassau County. The Company believes that it has meritorious defenses and intends to defend this suit, but cannot estimate with any certainty its ultimate legal or financial liability, if any, with respect to the alleged claims. o In or about July 1999, the Company received notice that it had been named in a lawsuit filed in the United States District Court for the Western District of New York, alleging that amounts collected and maintained by it in certain borrowers' tax and insurance escrow accounts exceeded certain statutory (RESPA) and/or contractual (the respective borrowers' mortgage agreements) ceilings. The complaint seeks (a) certification of a class of plaintiffs, (b) declaratory relief finding that the Company's practices violate applicable statutes and/or the mortgage agreements, (c) injunctive relief, and (d) unspecified compensatory and punitive damages (including attorneys' fees). In October 1999, the Company filed a motion to dismiss the complaint. In or about November 1999, the case was transferred to the United States District Court for the Northern District of Illinois. In February 2000, the plaintiff opposed the Company's motion to dismiss. In March 2000, the Court granted the Company's motion to dismiss in part, and denied it in part. The Company believes that it has meritorious defenses and intends to defend this suit, but cannot estimate with any certainty its ultimate legal or financial liability, if any, with respect to the alleged claims. o In or about August 1999, the NYOAG filed a lawsuit against the Company alleging violations of (a) RESPA (by paying yield spread premiums), (b) HOEPA and TILA, (c) ECOA, (d) New York Executive Lawss.296-a, and (e) New York Executive Lawss. 63(12). In September 1999, Delta and the NYOAG settled the lawsuit, as part of a global settlement by and among Delta, the NYOAG and the NYSBD, evidenced by that certain (a) Remediation Agreement by and between Delta and the NYSBD, dated as of September 17, 1999 and (b) Stipulated Order on Consent by and among Delta, Delta 24 Financial and the NYOAG, dated as of September 17, 1999. As part of the Settlement, Delta will, among other things, implement agreed upon changes to its lending practices; provide reduced loan payments aggregating $7.25 million to certain borrowers identified by the NYSBD; and create a fund of approximately $4.75 million to be financed by the grant of 525,000 shares of Delta Financial's common stock valued at a constant assumed priced of $9.10 per share, which approximates book value. The proceeds of the fund will be used, for among other things, to pay borrowers and for a variety of consumer educational and counseling programs. As a result, the NYOAG lawsuit has been dismissed as against the Company. The Remediation Agreement and Stipulated Order on Consent supersede the Company's previously announced settlements with the NYSBD and NYOAG. In March 2000, the Company finalized a settlement agreement with the United States Department of Justice, the Federal Trade Commission and the Department of Housing and Urban Renewal, to complete the global settlementit had reached with the NYSBD and NYOAG. The Federal agreement mandates some additional compliance efforts for Delta, but it does not require any additional financial commitment. o In November 1999, 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, seeking certification as a class action and alleging violations of the federal securities laws in connection with the Company's initial public offering in 1996 and its reports subsequently filed with the Securities and Exchange Commission. The complaint alleges that the scope of the violations alleged recently in the consumer lawsuits and regulatory actions indicate a pervasive pattern of action and risk that should have been more thoroughly disclosed to investors in the Company's common stock. In May 2000, the Court consolidated this case and several other lawsuits that purportedly contain the same or similar allegations. The Company believes that it has meritorious defenses and intends to defend these suits, but has not answered yet and cannot estimate with any certainty its ultimate legal or financial liability, if any, with respect to the alleged claims. o In or about April 2000, the Company received notice that it had been named in a lawsuit filed in the Supreme Court of the State of New York, Nassau County, alleging that the Company has improperly charged and collected from borrowers certain fees when they paid off their mortgage loans with Delta. The complaint seeks (a) certification of a class of plaintiffs, (b) declaratory relief finding that the payoff statements used include unauthorized charges and are deceptive and unfair, (c) injunctive relief, and (d) unspecified compensatory, statutory and punitive damages (including legal fees), based upon alleged violations of Real Property Law 274-a, unfair and deceptive practices, money had and received and unjust enrichment, and conversion. The Company answered the complaint in June 2000. The Company believes that it has meritorious defenses and intends to defend this suit, but cannot estimate with any certainty its ultimate legal or financial liability, if any, with respect to the alleged claims. 25 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS. The annual meeting of stockholders was held on May 16, 2000. At the meeting, Richard Blass and Arnold B. Pollard were elected as a Class I Directors for a term of three years. Sidney A. Miller, Hugh Miller, Martin D. Payson and Margaret Williams continue to serve as members of the Board of Directors. Votes cast in favor of Mr. Blass' selection totaled 14,598,596, while 30,340 votes were withheld. Votes cast in favor of Mr. Pollard's selection totaled 14,598,596, while 30,340 votes were withheld. The stockholders also voted to ratify the appointment of KPMG LLP as the Company's independent auditors for the fiscal year ending December 31, 2000. Votes cast in favor of this ratification were 14,620,621, while votes cast against were 7,365 and abstentions totaled 950. ITEM 5. OTHER INFORMATION. None ITEM 6. EXHIBITS AND CURRENT REPORTS ON FORM 8-K. (a) Exhibits: 11.1 Statement re: Computation of Per Share Earnings 27.1 Financial Data Schedule - Six Months Ended June 30, 2000 (b) Reports on Form 8-K: None. 26 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, as amended, the Registrant has duly caused this Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized. DELTA FINANCIAL CORPORATION (Registrant) Date: August 11, 2000 By: /S/ HUGH MILLER --------------- Hugh Miller PRESIDENT & CHIEF EXECUTIVE OFFICER By: /S/ RICHARD BLASS ----------------- Richard Blass SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 27 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------ ----------- 27.1 Financial Data Schedule - Six Months Ended June 30, 2000