-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RS4xDCeMUzQdOBgOuMMGoaWc6vGQScQrnKB86d2Wb7nkdo0rCqbldeQyl4N0ZFuL L7ZQtIFXO+PxWe2tHyV3Ng== 0000096638-98-000013.txt : 19981118 0000096638-98-000013.hdr.sgml : 19981118 ACCESSION NUMBER: 0000096638-98-000013 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANTA CORP CENTRAL INDEX KEY: 0000096638 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 231462070 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-14120 FILM NUMBER: 98752640 BUSINESS ADDRESS: STREET 1: P.O. BOX 844 STREET 2: WELSH & MCKEAN ROADS CITY: SPRING HOUSE STATE: PA ZIP: 19044 BUSINESS PHONE: 2156574000 MAIL ADDRESS: STREET 1: BRANDYWINE CORPORATE CENTER STREET 2: 650 NAAMANS ROAD CITY: CLAYMONT STATE: DE ZIP: 19703 FORMER COMPANY: FORMER CONFORMED NAME: TSO FINANCIAL CORP DATE OF NAME CHANGE: 19880306 FORMER COMPANY: FORMER CONFORMED NAME: TEACHERS SERVICE ORGANIZATION INC DATE OF NAME CHANGE: 19850812 10-Q 1 SEPTEMBER 30, 1998 10Q FORM 10Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO _______ COMMISSION FILE NUMBER 0-14120 ADVANTA CORP. (Exact name of registrant as specified in its charter) DELAWARE 23-1462070 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) WELSH AND MCKEAN ROADS, P.O. BOX 844, SPRING HOUSE, PA 19477 (Address of Principal Executive Offices) (Zip Code) (215) 657-4000 (Registrant's telephone number, including area code) 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 [ ] * Applicable only to issuers involved in bankruptcy proceedings during the preceding five years: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] * Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class A Outstanding at November 1, 1998 Common Stock, $.01 par value 10,375,494 shares Class B Outstanding at November 1, 1998 Common Stock, $.01 par value 16,300,591 shares TABLE OF CONTENTS Page PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Condensed Balance Sheets 3 Consolidated Condensed Income Statements 4 Consolidated Condensed Statements of Changes in Stockholders' Equity 5-6 Consolidated Statements of Cash Flows 7-8 Notes to Consolidated Condensed Financial Statements 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 PART II Other Information 39 ITEM 1. FINANCIAL STATEMENTS ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS) September 30, December 31, 1998 1997 ASSETS (Unaudited) Cash $ 80,214 $ 57,953 Federal funds sold and interest-bearing deposits with banks 302,800 156,500 Restricted interest-bearing deposits 88,882 543,239 Trading investments 186,923 0 Investments available for sale 791,594 1,392,553 Loan and lease receivables, net: Available for sale 594,591 1,452,560 Other loan and lease receivables, net 315,564 1,923,986 Total loan and lease receivables, net 910,155 3,376,546 Retained interest-only strip 221,116 191,868 Premises and equipment(at cost, less accumulated depreciation of $36,338 in 1998 and $83,746 in 1997) 60,837 152,215 Other assets 744,964 815,258 Total assets $3,387,485 $6,686,132 LIABILITIES Deposits $1,284,929 $3,017,611 Debt and other borrowings 1,187,365 2,300,946 Other liabilities 247,709 340,625 Total liabilities 2,720,003 5,659,182 Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures of the Company 100,000 100,000 STOCKHOLDERS' EQUITY Class A preferred stock, $1,000 par value: authorized, issued and outstanding - 1,010 shares in 1998 and 1997 1,010 1,010 Class B preferred stock, $.01 par value: authorized - 1,000,000 shares in 1998 and 1997; issued and outstanding 14,211 shares in 1998 and 25,000 in 1997 0 0 Class A common stock, $.01 par value: authorized - 214,500,000 shares; issued and outstanding 10,320,489 shares in 1998, and 18,193,885 shares in 1997 103 182 Class B common stock, $.01 par value: authorized - 230,000,000 shares; issued and outstanding 16,227,999 shares in 1998, and 26,564,546 in 1997 162 266 Additional paid-in capital, net 202,204 354,190 Retained earnings, net 381,968 585,709 Less: Treasury stock at cost, 527,168 Class B common shares in 1998, 418,286 Class B common shares in 1997 (17,965) (14,407) Total stockholders' equity 567,482 926,950 Total liabilities and stockholders' equity $3,387,485 $6,686,132 See Notes to Consolidated Condensed Financial Statements. ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED CONDENSED INCOME STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 (Unaudited) (Unaudited) Revenues: Gain on sale of receivables $ 51,275 $ 30,566 $ 115,450 $ 77,419 Interest on receivables 28,080 95,410 99,922 224,994 Interest on investments 22,224 38,231 71,116 107,051 Servicing revenues 30,677 63,406 113,885 185,528 Imputed interest 4,895 5,453 15,683 16,259 Consumer credit card securitization income 0 90,618 84,144 235,755 Gain on transfer of consumer credit card business 0 0 541,288 0 Other revenues, net 10,131 19,037 14 45,586 Total revenues 147,282 342,721 1,041,502 892,592 Expenses: Salaries and employee benefits 41,908 63,964 136,822 178,594 Other operating expenses 38,331 84,940 157,183 277,685 Interest expense 39,165 88,414 142,936 239,673 Provision for credit losses 6,414 48,243 47,220 158,886 Severance and outplacement costs associated with workforce reduction, option exercise and other employee costs associated with Fleet Transaction/ Tender Offer 0 0 62,257 0 Expense associated with exited business/product 0 0 54,115 0 Impairment of facility assets related to restructuring 0 0 8,700 0 Total expenses 125,818 285,561 609,233 854,838 Income before income taxes 21,464 57,160 432,269 37,754 Income taxes (benefit) 6,439 14,748 (11,013) 9,741 Net income $ 15,025 $ 42,412 $ 443,282 $ 28,013 Basic earnings per common share- Combined (See Note 16) $ .58 $ .95 $ 15.80 $ .54 Diluted earnings per share- Combined (See Note 16) $ .58 $ .92 $ 14.88 $ .53 Basic weighted average common shares outstanding - 24,482 42,875 27,880 42,749 Diluted weighted average common shares outstanding - 24,514 46,115 29,776 43,608 Cash dividends declared: Class A $ .063 $ .110 $ .189 $ .330 Class B $ .076 $ .132 $ .227 $ .396 See Notes to Consolidated Condensed Financial Statements. Consolidated Condensed Statements of Changes in Stockholders' Equity (Unaudited) ($ in thousands) Class A Class B Class A Class B Additional Preferred Preferred Common Common Paid-In Stock Stock Stock Stock Capital Balance at Dec. 31,1996 $1,010 $ 0 $ 179 $ 256 $ 350,479 Change in unrealized appreciation of investments Preferred and common cash dividends declared Exercise of stock options 3 6 8,468 Issuance of stock: Dividend reinvestment 857 Benefit plans 4 14,524 Amortization of deferred compensation Termination/tax benefit- benefit plans 5,215 Foreign currency translation adjustment Net Income Balance at Dec. 31, 1997 $1,010 $ 0 $ 182 $ 266 $ 379,543 Tender offer (79) (113) (160,861) Change in unrealized appreciation of investments Preferred and common cash dividends declared Exercise of stock options 1 3 5,156 Issuance of stock: Dividend reinvestment 85 Benefit plans 11 18,772 Stock buyback (1) (1) (1,541) Stock buyback-ESOP Amortization of deferred compensation Termination/tax benefit- benefit plans (4) (12,633) Foreign currency translation adjustment Net Income Balance at September 30, $1,010 $ 0 $ 103 $ 162 $ 228,521 1998 See Notes to Consolidated Condensed Financial Statements. ($ in thousands)
Unrealized Investment Deferred Unearned Holding Retained Treasury Stockholders' Compensation ESOP Gains Earnings Stock Equity (Losses) Net Balance at Dec. 31, 1996 $(41,229) $ 0 $ (618) $542,001 $ (42) $ 852,036 Change in unrealized appreciation of investments 466 466 Preferred and common cash dividends declared (28,301) (28,301) Exercise of stock options 8,477 Issuance of stock: Dividend reinvestment 857 Benefit plans (11,159) 1,297 4,666 Amortization of deferred Compensation 11,343 11,343 Termination/tax benefit benefit plans 15,692 (15,662) 5,245 Foreign currency translation adjustment 536 536 Net Income 71,625 71,625 Balance at Dec. 31, 1997 $(25,353) $ 0 $ (152) $585,861 $(14,407) $ 926,950 Tender offer (640,551) (801,604) Change in unrealized appreciation of investments 2,018 2,018 Preferred and common cash dividends declared (8,231) (8,231) Exercise of stock options 5,160 Issuance of stock: Dividend reinvestment 85 Benefit plans (20,034) 1,251 0 Stock buyback (1,543) Stock buyback-ESOP (4,837) (4,837) Amortization of deferred Compensation 4,687 4,687 Termination/tax benefit- benefit plans 19,220 (4,809) 1,774 Foreign currency translation adjustment (259) (259) Net Income 443,282 443,282 Balance at Sept. 30, 1998 $(21,480) $(4,837) $ 1,866 $ 380,102 $(17,965) $ 567,482
ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) Nine Months Ended September 30, 1998 1997 (Unaudited) OPERATING ACTIVITIES Net income $ 443,282 $ 28,013 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on transfer of consumer credit card business (541,288) 0 Restructure and other unusual charges 99,672 0 Sales/valuation adjustments-equity securities 43,039 10,113 Depreciation and amortization of intangibles 15,797 25,243 Provision for credit losses 47,219 158,886 Change in other assets and amounts due from consumer credit card securitizations (36,782) (37,767) Change in other liabilities (46,308) (36,823) Change in retained I/O strip (29,248) (67,592) Net cash (used in) provided by operating activities (4,617) 80,073 INVESTING ACTIVITIES Purchase of investments available for sale (42,261,460)(33,475,817) Proceeds from sales of investments available for sale 1,226,360 1,057,644 Proceeds from maturing investments available for sale 41,500,657 31,800,974 Change in federal funds sold and interest- bearing deposits (206,538) (557,198) Change in consumer credit card receivables, excluding sales/transfers (1,113,094) 369,906 Proceeds from sales/securitizations of receivables 5,569,946 2,705,381 Purchase of lease portfolios/Advanta Mortgage loans (23,136) (136,887) Principal collected on Advanta Mortgage loans 79,018 85,324 Advanta Mortgage loans made to customers (3,932,942) (2,531,997) Purchases of premises and equipment (41,060) (53,709) Proceeds from sale of premises and equipment 10,558 226 Excess of cash collections over income recognized on direct financing leases 26,998 28,520 Equipment purchased for direct financing leases (230,350) (242,624) Change in business card receivables, excluding sales (119,827) (314,126) Net change in other loans (5,896) (36,178) Net cash provided by (used in) investing activities 479,234 (1,300,561) FINANCING ACTIVITIES Change in demand and savings deposits (379,914) 180,973 Proceeds from sales of time deposits 1,143,128 1,621,209 Payments for maturing time deposits (403,256) (720,125) Change in repurchase agreements and term federal funds - (10,000) Proceeds from issuance of subordinated/ senior debt 18,554 11,784 Payments on redemption of subordinated/ senior debt (51,840) (73,714) Proceeds from issuance of medium-term notes 30 436,333 Payments on maturity of medium-term notes (188,000) (203,235) Change in notes payable 219,913 (69,481) Nine Months Ended September 30, 1998 1997 (Unaudited) Stock tender offer (801,604) 0 Stock buy back (6,380) 0 Proceeds from issuance of stock 5,244 11,903 Cash dividends paid (8,231) (21,247) Net cash (used in) provided by financing activities (452,356) 1,164,400 Net increase (decrease) in cash 22,261 (56,088) Cash at beginning of period 57,953 165,875 Cash at end of period $ 80,214 $ 109,787 See Notes to Consolidated Condensed Financial Statements. ADVANTA CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) SEPTEMBER 30, 1998 (UNAUDITED) Note 1) Basis of Presentation The unaudited consolidated condensed financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the statements include all adjustments (which include only normal recurring adjustments, except for items associated with the disposition of consumer credit card assets described below) required for a fair statement of financial position, results of operations, changes in stockholders' equity and cash flows for the interim periods presented. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's latest annual report on Form 10-K. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations through February 20, 1998 include the results of operations of the Company's consumer credit card business. (See Note 3.) The results of operations for the interim periods are not necessarily indicative of the results for the full year. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates are used when accounting for gain on sale of receivables and the retained interest-only strips, contractual mortgage servicing rights, the allowance for credit losses and income taxes, among others. Actual results could differ from those estimates. The Company has reclassified its consolidated condensed income statements and, accordingly, certain prior period amounts have been reclassified to conform with this presentation and other current year classifications. Note 2) Disposition of Consumer Credit Card Assets Pursuant to the terms of the Contribution Agreement, dated as of October 28, 1997, as amended February 20, 1998, by and between the Company and Fleet Financial Group, Inc. ("Fleet"), the Company and certain of its subsidiaries and Fleet and certain of its subsidiaries each contributed certain assets and liabilities of their respective consumer credit card businesses to Fleet Credit Card LLC (the "LLC") in exchange for an ownership interest in the LLC (the "Fleet Transaction"). As of the consummation of the Fleet Transaction on February 20, 1998, the Company's ownership interest in the LLC was 4.99%, which is accounted for on the cost basis. The Contribution Agreement provides for the parties to make a final determination of the transferred assets and liabilities, and the settlement procedure is currently in process. The Company retained certain immaterial assets of its consumer credit card business which are not required in the operation of such business and certain liabilities related to its consumer credit card business, including, among others, all reserves relating to its credit insurance business and any liability or obligation relating to certain consumer credit card accounts generated in specific programs which comprised a very small portion of the Company's consumer credit card receivables as of February 20, 1998. The assets and liabilities retained have been classified in other assets and other liabilities. Concurrently with the Fleet Transaction the Company purchased 7,882,750 shares of its Class A Common Stock, 12,482,850 of its Class B Common Stock, each at $40 per share net, and 1,078,930 of its depositary shares each representing one one-hundredth interest in a share of 6 3/4% Convertible Class B Preferred Stock, Series 1995 (Stock Appreciated Income Linked Securities (SAILS)) at $32.80 per share net, through an issuer tender offer (the "Tender Offer") which was completed on February 20, 1998. The Office of the Comptroller of the Currency (the "Comptroller") approved the payment of a special dividend from Advanta National Bank to Advanta Corp., its parent company, to effect the purchase of the shares. The contribution was accounted for as a transfer of financial assets (cash, loans, and other receivables) and an extinguishment of financial liabilities (deposits, debt and other borrowings and other liabilities) under Statement of Financial Accounting Standards ("SFAS") No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" and a sale of non financial assets and liabilities (principally property and equipment, prepaid assets, deferred costs and certain contractual obligations). The financial assets and non financial assets and liabilities of the Company's consumer credit card business that were contributed were removed from the balance sheet. The Company was legally released from being the primary obligor under all of the financial liabilities contributed and accordingly, they were removed from the balance sheet. Note 3) Comprehensive Income As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components. The main objective of the statement is to report a measure of all changes in equity that result from transactions and other economic events of the period other than transactions with owners. Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Net income/(loss) $ 15,025 $ 42,412 $ 443,282 $ 28,013 Unrealized holding gain (loss), net of tax 1,448 992 2,018 232 Cumulative translation adjustments 0 (51) (259) 257 Comprehensive income/ (loss) $ 16,473 $ 43,353 $ 445,041 $ 28,502 Note 4) Recent Accounting Pronouncements The American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" in March 1998. SOP 98-1 is effective for fiscal years beginning after December 15, 1998 and specifies that direct costs incurred when developing computer software for internal use should be capitalized once certain capitalization criteria are met. The Company will adopt this SOP during the first quarter of 1999. The adoption of SOP 98-1 is not expected to have a material effect on the Company's financial statements. In June 1998, the Financial Accounting Standards Board ("FASB")issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999 and cannot be applied retroactively. The Company has not yet quantified the impacts of adopting SFAS No. 133 on the financial statements and has not determined the timing of or method of adoption of SFAS No. 133. However, SFAS No. 133 could increase volatility in earnings and other comprehensive income. In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise, an amendment of FASB Statement No. 65." SFAS No. 134 amends SFAS No. 65 to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. SFAS No. 134 also conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a nonmortgage banking enterprise. Prior to the issuance of SFAS No. 134, the Company was required to account for resulting mortgage-backed securities or other retained interests as trading securities. SFAS No. 134 is effective for the first fiscal quarter beginning after December 15, 1998, with early application encouraged. The adoption of SFAS No. 134 is not expected to have a material effect on the Company's financial statements. Note 5) Loan and Lease Receivables Loan and lease receivables on the balance sheet, including those available for sale, consisted of the following: September 30, Dec. 31, 1998 1997 Consumer credit cards $ 0 $ 2,579,890 Advanta Mortgage loans 571,676 478,433 Leases and business cards 282,997 298,789 Other loans 64,605 40,978 Gross loan and lease receivables 919,278 3,398,090 Add: Deferred origination costs, net of deferred fees 10,030 116,229 Less: Reserve for credit losses: Consumer credit cards 0 (118,420) Advanta Mortgage loans (6,235) (5,822) Leases and business cards (9,184) (9,798) Other loans (3,734) (3,733) Total (19,153) (137,773) Net loan and lease receivables $ 910,155 $ 3,376,546 Receivables and accounts serviced for others consisted of the following: September 30, Dec. 31, 1998 1997 Receivables: Consumer credit cards $ 0 $ 8,664,711 Mortgages 6,689,717 4,635,730 Auto loans 193,398 194,673 Leases 492,342 442,312 Business cards 640,468 522,688 Total $ 8,015,925 $14,460,114 Number of Accounts: Consumer credit cards 0 4,529,248 Mortgages 105,249 74,128 Auto loans 20,310 19,189 Leases 87,089 86,261 Business cards 207,945 162,285 Total 420,593 4,871,111 "Advanta Mortgage loans" include mortgage and auto loans and exclude mortgage loans which were never owned by the Company, but which the Company services for a fee ("contract servicing"). Contract servicing receivables were $7.6 billion and $9.2 billion at September 30, 1998 and December 31, 1997, respectively. The related number of accounts serviced at September 30, 1998 and December 31, 1997 were 110,099 and 130,644, respectively. Note 6) Allowance for Credit Losses The following table shows the changes in the allowance for credit losses for the periods presented: Nine Months Year Ended Ended September 30, Dec. 31, 1998 1997 Balance, beginning of period $ 137,773 $ 89,184 Current provision 47,220 210,826 Reserves on receivables (sold)/purchased, net (118,530) (11,015) Net charge-offs (47,310) (151,222) Balance, end of period $ 19,153 $ 137,773 Note 7) Interest-Only Strip The following reflects activity in the interest-only (IO) strip: Nine Months Year Ended Ended September 30, Dec. 31, 1998 1997 Beginning balance $191,868 $ 133,805 Retained IO on sales, net 153,481 165,303 Mark to market adjustments (50,980) (42,371) Additional credit reserve 0 (4,400) Amortization and recourse charge-offs, net (73,253) (60,469) Ending Balance $221,116 $ 191,868 Note 8) Selected Balance Sheet Information September 30, Dec. 31, Other Assets 1998 1997 Receivable from loans sold $348,449 0 Prepaid assets 83,513 $131,305 Investment in affordable housing 62,395 66,187 Due from trustees - Advanta Mortgage loans 56,416 25,383 Escrow advances 49,761 31,236 Contract mortgage servicing rights 45,920 24,546 Accrued interest receivable 26,178 99,167 Current and deferred federal income taxes 15,059 0 Investments in operating leases 9,297 12,432 Due from trustees - leases and business cards 9,268 6,736 Deferred costs 5,807 48,332 Goodwill 3,669 5,134 Other real estate (A) 5,652 689 Amounts due from consumer credit card securitizations 0 222,330 Other 23,580 141,781 Total other assets $744,964 $815,258 (A) Carried at the lower of cost or fair market value less selling costs. September 30, Dec. 31, Other Liabilities 1998 1997 Accounts payable and accrued expenses $ 74,397 $101,493 Accrued interest payable 53,184 73,103 Custodial liability 65,943 30,217 Unearned insurance premium 19,451 17,674 Deferred fees and other reserves 11,217 28,050 Current and deferred federal and state income taxes 0 40,461 Other 23,517 49,627 Total other liabilities $247,709 $340,625 Note 9) Income Taxes Income tax expense is based on the estimated annual effective tax rate of 30% for the three month period ended September 30, 1998, compared to 26% tax rate for the comparable 1997 period. Income tax expense (benefit) consisted of the following: Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Current: Federal $ 24,216 $ (1,079) $ (45,651) $ 14,732 State 1,937 4,232 8,566 3,893 Total current 26,153 3,153 (37,085) 18,625 Deferred: Federal (19,843) 12,742 26,526 (7,115) State 129 (1,147) (454) (1,769) Total deferred (19,714) 11,595 26,072 (8,884) Total tax expense (benefit) $ 6,439 $ 14,748 $ (11,013) $ 9,741 The reconciliation of the statutory federal income tax to the consolidated tax expense is as follows: Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Statutory federal income tax $ 7,484 $ 19,983 $ 151,220 $ 13,142 State income taxes 1,343 2,006 5,273 1,380 Insurance income 755 (2,981) 23,331 (5,177) Tax credits (2,321) (1,346) (6,963) (4,075) 162m limitation 0 0 4,725 0 APB 28 adjustment (742) (3,960) 20,506 3,617 Transfer of consumer credit card business 0 0 (209,110) 0 Other (80) 1,046 5 854 Consolidated tax expense $ 6,439 $ 14,748 $ (11,013) $ 9,741 Note 10) Debt Debt consisted of the following: September 30, Dec. 31, 1998 1997 SENIOR DEBT RediReserve certificates (3.77%) $ 2,806 $ 3,611 6 month senior notes (6.53%-7.00%) 4,581 3,523 12 month senior notes (6.86%-7.33%) 49,486 51,537 18 month senior notes (6.39%-7.42%) 6,074 6,795 24 month senior notes (6.16%-7.48%) 32,437 33,517 30 month senior notes (5.92%-7.56%) 13,111 14,441 48 month senior notes (5.97%-7.79%) 8,053 8,061 60 month senior notes (5.83%-7.93%) 19,677 21,999 Value notes, fixed (6.85%-7.85%) 9,330 30,755 Medium-term notes, fixed (6.40%-8.36%) 728,492 861,462 Medium-term notes, floating (5.69%-6.43%) 183,000 238,000 Short-term bank notes 0 99,986 Short-term bank notes, floating 0 141,974 Medium-term bank notes, fixed (6.45%-7.12%) 7,336 408,651 Medium-term bank notes, floating 0 260,837 Other senior notes (6.53%-11.34%) 6,808 7,491 Total senior debt 1,071,191 2,192,640 SUBORDINATED DEBT Subordinated notes (5.83%-11.34%) 1,614 5,754 7% subordinated bank notes due 2003 0 49,778 Total subordinated debt 1,614 55,532 Other borrowings 114,560 52,774 Total debt and other borrowings 1,187,365 2,300,946 Less short-term debt & certificates (327,780) (809,814) Less other borrowings (114,560) (52,774) Long-term debt $ 745,025 $ 1,438,358 The Company's senior floating rate notes were priced based on a factor of LIBOR. At September 30, 1998, the rates on these notes varied from 5.69% to 6.43%. At September 30, 1998, the Company used derivative financial instruments to effectively convert certain fixed rate debt to a LIBOR based variable rate. Note 11) Capital Stock During the third quarter of 1998, the Board of Directors authorized the repurchase shares of the Company's Class A and Class B common stock and the formation of an Employee Stock Ownership Plan ("ESOP")(see Note 12). Up to 2.5 million shares of the Company's Class A and Class B common stock will be purchased in connection with the stock repurchase program and the ESOP. At September 30, 1998, the Company had purchased approximately 89,000 Class B shares and approximately 427,000 Class A shares at a total cost of $6.4 million. Of the total shares purchased, approximately 372,000 Class A shares were purchased for the Company's newly formed Employee Stock Ownership Plan (see Note 12). Note 12) Employee Stock Ownership Plan On September 10, 1998, the Company's Board of Directors authorized the formation of an Employee Stock Ownership Plan ("ESOP"), covering all employees of the Company who have reached age 21 with one year of service. During September 1998, the ESOP borrowed approximately $4.8 million from the Company (the "ESOP Loan") and used the proceeds to purchase approximately 372,000 shares of the Company's Class A common stock. The ESOP Loan is payable over 30 years. The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends received by the ESOP. All dividends received by the ESOP are used to pay debt service. As the ESOP Loan is repaid, shares are allocated to active employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with AICPA Statement of Position 93-6, "Employer's Accounting for Employee Stock Ownership Plans." Accordingly, unallocated shares are reported as unearned ESOP shares in the balance sheet. As shares of common stock acquired by the ESOP are allocated to each employee based on the repayment of the ESOP Loan, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings-per- share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and interest expense. ESOP compensation expense of the quarter ended September 30, 1998 was not material. Note 13) Restructuring Charges During the first quarter of 1998, the Company implemented a restructuring plan to reduce corporate expenses incurred in the past to support the operations contributed in the Fleet Transaction. In connection with this plan, the Company accrued severance benefits of approximately $35 million during the first quarter, approximately $27 million of which has been classified as severance and outplacement costs associated with workforce reduction, option exercise and other employee costs associated with Fleet Transaction/Tender Offer and the balance has been classified as compensation expense. In connection with this plan approximately 255 employees who ceased to be employed by the Company are entitled to benefits, of which 190 employees were directly associated with the operations contributed to the LLC and approximately 65 employees were associated with the workforce reduction. As of September 30, 1998, the Company paid approximately $28 million of severance benefits to employees which was charged against the associated liability. Also during the first quarter of 1998, the Company implemented a plan to exit business and product offerings not directly associated with its mortgage and business services units. In connection with this plan, contractual commitments associated with development activities to be discontinued were accrued. The contractual commitments and termination benefits are expected to be paid out over the next nine months. The actions to complete the plan are principally the settlement of contractual commitments and distributing the remaining severance benefits. The Company has contractual commitments to certain customers and other nonrelated financial institutions that are providing benefits to these customers under a product that will no longer be offered and for which no future revenues or benefits will be received. A substantial portion of the contractual commitments will be paid out over approximately the next 40 months. The actions required to complete this plan include the settlement of contractual commitments and the payment of customer benefits. During the first quarter of 1998, the Company recorded $29.8 million of charges classified as expense associated with exited business/product in connection with the aforementioned exit plans. As of September 30, 1998, the Company paid approximately $6.9 million of contractual commitments, customer benefits and termination benefits which were charged against the associated liabilities for the aforementioned exit plans. Note 14) Assets Held for Disposal In connection with the Company's restructuring plan to reduce corporate expenses and the Company's efforts to exit business and product development activities previously mentioned, certain assets were identified for disposal and written down to estimated realizable value. These assets principally consisted of facility capital assets, software, intangible and other assets. In the first quarter of 1998, the Company recognized a total of $20 million of losses associated with the write-off of these assets, $11.3 million of which have been classified as expenses associated with exited business/product. The disposal of the assets is expected to be completed within the next six months. Note 15) Net interest income The following presents the components of net interest income: Three Months Nine Months Ended Ended September 30, September 30, 1998 1997 1998 1997 Interest income Loans and leases $ 28,080 $ 95,410 $ 99,922 $ 224,994 Investments 22,224 38,231 71,116 107,051 Total interest income 50,304 133,641 171,038 332,045 Interest expense: Deposits 14,016 44,143 62,747 105,337 Other debt 25,149 44,271 80,189 134,336 Total interest expense 39,165 88,414 142,936 239,673 Net interest income 11,139 45,227 28,102 92,372 Provision for loan losses 6,414 48,243 47,220 158,886 Net interest income after provision for credit losses $ 4,725 $ (3,016) $ (19,118) $ (66,514) Note 16) Earnings Per Share Earnings per share are calculated under the provisions of SFAS No. 128, "Earnings Per Share" ("SFAS 128"). Since the cash dividends declared on the Company's Class B Common Stock were higher than the dividends declared on the Class A Common Stock, Basic and Dilutive Earnings Per Share have been calculated using the "two-class" method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock according to dividends declared and participation rights in undistributed earnings. The Company has also presented "Combined Earnings Per Share," which represents a weighted average of Class A Earnings Per Share and Class B Earnings Per Share. The following table sets forth the calculation of basic earnings per share and diluted earnings per share: Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Net income $ 15,025 $ 42,412 $ 443,282 $ 28,013 less: Preferred "A" dividends 0 0 (141) (141) less: Preferred "B" dividends, net (929) (1,602) (2,733) (4,807) Income available to common Shareholders 14,096 40,810 440,408 23,065 less: Class A dividends declared (653) (2,000) (1,961) (5,996) less: Class B dividends declared (1,147) (3,435) (3,396) (10,302) Undistributed Earnings $ 12,296 $ 35,375 $ 435,051 $ 6,767 Shares: Basic: Combined 24,482 42,875 27,880 42,750 Class A 10,316 18,188 11,780 18,171 Class B 14,166 24,687 16,100 24,579 Options A 4 57 10 78 Options B 28 526 108 611 AMIP B 0 157 156 169 Preferred B 0 2,500 1,622 0 Diluted: Combined 24,514 46,115 29,776 43,608 Class A 10,320 18,245 11,790 18,249 Class B 14,194 27,870 17,986 25,359 Earnings Per Share Basic: Combined(1) $ .58 $ .95 $ 15.80 $ .54 Class A .57 .94 15.77 .49 Class B .58 .96 15.82 .58 Diluted: Combined(1) $ .58 $ .92 $ 14.88 $ .53 Class A .56 .91 14.87 .48 Class B .58 .92 14.89 .56 (1) Combined represents a weighted average of Class A and Class B. For the quarters ended September 30, 1998 and 1997 and the nine months ended September 30, 1997, 14,211 shares, 25,000 shares and 25,000 shares, respectively, of the Company's Convertible Class B Preferred Stock (SAILS) were outstanding but were not included in the computation of diluted earnings per share because they were antidilutive for that period. Options to purchase 3.0 million and 2.2 million shares of Class B common stock, respectively, were outstanding during the three months and nine months ended September 30, 1998 but were not included in the computation of diluted EPS because the options' exercise price was greater than or equal to the average market price of the common shares during the applicable periods. Note 17) Contingencies On June 30, 1997, purported shareholders of the Company who are represented by a group of law firms filed a putative class action complaint against the Company and several of its current and former officers and directors in the United States District Court for the Eastern District of Pennsylvania. A second, similar complaint was filed in the same court a few days later by a different group of law firms. Both complaints allege that the Company made misrepresentations in certain of its public filings and statements in violation of the Securities Exchange Act of 1934. The complaints seek damages of an unspecified amount. On July 10, 1998, the complaints, which had previously been consolidated, were dismissed by the Court for failing to state a claim. The plaintiffs determined not to attempt to amend their Complaints. Rather, they have appealed the District Court's decision to the United States Court of Appeals for the Third Circuit. The Company believes that the District Court's ruling will be affirmed and that the allegations in the complaints are without merit. In the opinion of management, the ultimate resolution of these complaints is not expected to have a material adverse effect on the financial position or future operating results of the Company. Between August 25, 1997 and December 18, 1997, the Company and certain of its subsidiaries were named as defendants in lawsuits by certain consumer credit cardholders claiming to represent consumer credit cardholders in a specific program. The class action complaints allege that consumer credit cardholder accounts in a specific program were improperly repriced to a higher percentage rate of interest. The complaints assert various violations of federal and state law with regard to such repricings, and each seeks damages of an unspecified amount. On June 3, 1998, the Judicial Panel on multidistrict litigation ordered that all of the federal court actions be consolidated into one proceeding for pretrial purposes in the United States District Court for the Eastern District of Pennsylvania. On November 6, 1998, the Company and counsel for plaintiffs in two of the actions pending in the Superior Court of the State of Delaware entered into a Settlement Agreement and Stipulation in the Delaware State Court to settle the claims relating to the specific program referred to above. Pursuant to the Settlement Agreement and Stipulation, which is subject to Court approval, the Company will pay $7.25 million to the plaintiffs. With the exception of persons who opt-out of the settlement, once the Court grants final approval of the settlement and that approval becomes effective, all of the claims in the other lawsuits relating to the specific program referred to above will be released. While management believes the allegations are without merit, the Company recognizes the risk of continued litigation and the additional expenditure of time, energy and resources and that further defense of the actions would be potentially protracted and expensive and that settlement is desirable. The Company and its subsidiaries are involved in legal proceedings, claims and litigation, including those arising in the ordinary course of business. Management believes that the aggregate liabilities, if any, resulting from such actions would not have a material adverse effect on the consolidated financial position of the Company. However, as the ultimate resolution of these proceedings is influenced by factors outside of the Company's control, it is reasonably possible that the Company's estimated liability under these proceedings may change. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview For the quarter ended September 30, 1998, the Company reported net income of $15.0 million or diluted earnings per share of $.58 for Class A and Class B shares combined. The net income for the quarter ended September 30, 1998 includes $10.1 million and $5.1 million for Advanta Mortgage and Advanta Business Services, respectively. This represents an increase of $6.0 million, or 65% from the net income of $9.2 million from Advanta Mortgage and Advanta Business Services that was reported in the second quarter of this year. Last year, the Company reported net income of $42.4 million, or diluted earnings per share of $.92 for Class A and Class B shares combined for the quarter ended September 30, 1997. For the nine months ended September 30, 1998 the Company reported net income of $443.3 million or diluted earnings per share of $14.88 for Class A and Class B shares combined. In the same period of 1997 the Company reported net income of $28.0 million or diluted earnings per share of $.53 for Class A and Class B shares combined. The net income for the nine month period of 1998 reflects the $536.4 million net gain on the Fleet Transaction (See Note 2 to Consolidated Condensed Financial Statements), a $62.3 million pretax charge for severance and outplacement costs associated with workforce reduction, option exercises and other employee costs associated with the Fleet Transaction / Tender Offer, a $54.1 million pretax charge for expenses associated with exited businesses and products, $42.5 million of equity securities losses and an $8.7 million pretax charge for facility impairments. Net income for Advanta Mortgage and Advanta Business Services was $22.4 million and $8.3 million, respectively. Net income for Advanta Mortgage reflects a $51.0 million pretax charge recorded to adjust the retained interest-only (IO) strips in accordance with the Company's practice of regularly reviewing its assumptions to reflect the Company's actual market experience. This report contains forward-looking statements, including, but not limited to, projections of future earnings, that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Significant risks and uncertainties include: the Company's managed net interest margin; the receivables volume; the timing of the Company's securitizations; prepayment rates; the mix of account types and interest rate fluctuations; the level of delinquencies, customer bankruptcies, and charge-offs; and the amount and rate of growth in the Company's expenses. Earnings also may be significantly affected by factors that affect consumer debt, competitive pressures from other providers of financial services, the effects of governmental regulation, the amount and cost of financing available to the Company and its subsidiaries, the difficulty or inability to securitize the Company's receivables and the impact of the ratings of debt of the Company and its subsidiaries. Additional risks that may affect the Company's future performance are set forth elsewhere in this Quarterly Report on Form 10-Q and in the Company's Annual Report on Form 10-K for the year ended December 31, 1997 and other filings with the Securities and Exchange Commission. Gain on Sale of Receivables Advanta Mortgage completed two securitizations with an aggregate principal balance of $1.01 billion for the quarter ended September 30, 1998. In addition, the Company sold $109 million in whole loans and increased its portfolio of loans held in off-balance sheet Commercial Paper conduit facilities by approximately $43 million. Total Advanta Mortgage sales/securitization increased 24.1% and 63.5% over the comparable three month periods ended June 30, 1998 and September 30, 1997, respectively. The increase in sales/securitizations resulted primarily from the increase in mortgages originated during this quarter. Advanta Mortgage originated $1.57 billion in new loans during the third quarter, an increase of 65.3% over the year-ago quarter and 25.8% over the second quarter of 1998. The Company recognized $38.5 million in gains resulting from the securitization and sale of these receivables. This gain, which represents approximately 3.7% of the loans sold in this quarter, is lower than the 4.4% recognized on loans sold last quarter. The decrease in gain as a percentage of loans sold this quarter is primarily due to the mix of loans sold during this quarter. The gain realized varies for each of the Company's products and origination channels. Typically, the gain realized from loans directly originated is higher than the gain from indirect origination channels. In addition, due to the significant drop in interest rates this quarter, the hedge contracts used to manage interest rate risk between origination and sale of the loans for the current quarter generated losses of approximately $29 million. These losses served to offset the higher than normal gains that occur from the sale of loans in a decreasing rate environment. While this type of hedging activity impacts the gains recognized from securitization and sale activity, it does not impact the Company's IO Strip. In this quarter, in accordance with the Company's practice of regularly reviewing and, where appropriate, adjusting the retained IO Strip assumptions for its experience, the Company recognized a pretax charge against third quarter earnings of $17.3 million. In the second quarter of 1998, the Company recorded a $23.9 million pretax charge to adjust the IO Strip. Prepayment rate assumptions used in valuing the Company's IO Strip were revised to 29% for fixed rate loans, 37% for intermediate rate loans and 43% for ARMs. At the end of the second quarter the prepayment assumptions were 27% for fixed rate loans, 33% for intermediate rate loans and 39% for ARMs. The Company announced that beginning in the fourth quarter of this year, it expects to report income for its mortgage business that is essentially equal to that of a portfolio lender, rather than the front- ended income typically reported through gain on sale accounting. Since gain on sale accounting is required under generally accepted accounting principles for securitizations structured as sales, the Company will accomplish this change by increasing its use of on balance sheet funding over time and decreasing its degree of reliance on securitizations structured as sales. Advanta Business Services recognized $12.8 million in securitization income. This includes approximately $3.6 million in gains from the securitization of $77.7 million of leases. The remainder represents gains on the sale of new business card receivables which are sold to the trust on a continuous basis to replenish the investors' interest in trust receivables which have been repaid by the cardholders. The FASB is currently addressing several implementation issues relating to SFAS No. 125. One of these issues relates to an exception SFAS No. 125 currently makes for FDIC-insured institutions. The FDIC, upon reclamation of assets from an FDIC-insured institution, would not be required to pay interest between the date of reclamation and the date of payment, which could indicate that they would not meet the isolation from creditors criterion established in SFAS No. 125. In January 1998, the FASB staff announced that it would study the issue and said that, in the interim, FDIC-insured institutions need not conclude that the FDIC receivership powers preclude sale accounting. An exposure draft of proposed amendments is expected in late 1998, but the timing of such draft is still uncertain, and the effective date would likely not be prior to January, 1999. Originations for Advanta Mortgage were as follows ($ in Thousands): Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Direct $ 483,290 $219,837 $1,148,580 $ 614,404 Broker 162,531 62,096 347,142 192,285 Conduit 584,418 332,460 1,364,374 844,954 Corporate Finance 320,871 292,500 994,770 832,981 Auto 18,593 42,633 98,052 95,883 $1,569,703 $949,526 $3,952,918 $2,580,507 Total third quarter originations for Advanta Mortgage increased 65.3% over the comparable 1997 period. Direct mortgage originations for the third quarter increased 119.8% and indirect mortgage originations increased 48.9% from the comparable period of the prior year. Total year-to-date originations for Advanta Mortgage increased 53.2% from the comparable nine month period of the prior year. Direct mortgage originations increased 86.9% and indirect mortgage originations increased 42.6% from the comparable period of the prior year. The increase in direct originations reflects the Company's focus on capitalizing on its direct marketing experience and centralized telemarketing and processing capabilities. Originations for Advanta Business Services were as follows ($ in Thousands): Three Months Ended Nine Months Ended September. 30, September 30, 1998 1997 1998 1997 Leases $ 95,344 $ 84,567 $ 232,347 $ 247,367 Business card 349,645 294,001 987,267 777,636 $444,989 $378,568 $1,219,614 $1,025,003 Total originations for business cards and leases increased 17.5% in the third quarter of 1998 when compared to the third quarter of 1997. Total year-to-date originations for the business cards and leases increased 19.0% from the comparable period of the prior year. Interest Income and Expense Interest income on receivables and investments decreased $67.0 million and $16.0 million, respectively, for the third quarter of 1998 from the same period of 1997 and interest expense decreased $49.2 million during the same comparative period. For the nine month period ended September 30, 1998 interest income on receivables and investments decreased $124.2 million and $35.9 million, respectively, as compared to the nine months ended September 30, 1997, and interest expense decreased $96.7 million during the same comparative period. The decreases in interest income and interest expense were mainly attributable to the decrease in interest bearing assets and liabilities in connection with the Fleet Transaction and Tender Offer. Also impacting interest income on receivables during the nine months ended September 30, 1998 were consumer credit card securitization transactions prior to the Fleet Transaction as well as the mix of receivables. Both periods reflect suppressed margins as a result of carrying high investment balances as a percent of owned assets. The following tables provide an analysis of both owned and managed interest income and expense data, average balance sheet data, net interest spread (the difference between the yield on interest earning assets and the average rate paid on interest bearing liabilities), and net interest margin (the difference between the yield on interest earning assets and the average rate paid to fund interest earning assets) for the three month and nine month periods ended September 30, 1998 and 1997. Average owned loan and lease receivables and the related interest revenues include certain loan fees. INTEREST RATE ANALYSIS ($ IN THOUSANDS) Three Months Ended September 30, 1998 1997 Average Yield/ Average Yield/ Balance(1) Interest Rate Balance(1) Interest Rate On-balance sheet Consumer credit cards $ 0 $ 0 0.00% $1,711,826 $68,981 15.99% Advanta Mortgage loans 866,759 20,650 9.45 711,034 16,000 8.93 Leases and business cards 263,072 8,149 12.32 345,420 10,378 11.95 Other loans 17,704 574 12.87 37,450 1,003 10.64 Gross receivables (2) 1,147,535 29,373 10.16 2,805,730 96,362 13.63 Trading investments 314,143 4,864 6.19 0 0 0.00 Investments(2) 1,072,933 17,394 6.45 2,697,379 38,256 5.63 Total interest earning assets $2,534,611 $51,631 8.10% $5,503,109 $134,618 9.71% Interest-bearing liabilities $2,475,703 $39,135 6.28% $5,528,703 $ 88,414 6.35% Net interest spread 1.82% 3.36% Net interest margin 1.96% 3.33% Off-balance sheet Consumer credit cards $ 0 $ 9,190,092 Advanta Mortgage loans 6,218,600 3,522,496 Leases and business cards 1,117,123 790,383 Total average securitized receivables $7,335,723 $13,502,971 Total average managed receivables $8,483,258 $16,308,701 (1) Includes assets held and available for sale and nonaccrual loans and leases. (2) Interest and average rate for tax-free securities, loans and leases computed on a tax equivalent basis using a statutory rate of 35%. INTEREST RATE ANALYSIS ($ IN THOUSANDS) Nine Months Ended September 30, 1998 1997 Average Yield/ Average Yield/ Balance(1) Interest Rate Balance(1) Interest Rate On-balance sheet Consumer credit cards $ 514,338 $ 23,457 6.10% $ 1,684,932 $154,490 12.26% Advanta Mortgage loans 715,060 53,268 9.96 567,086 41,300 9.74 Leases and business cards 286,155 25,897 12.09 325,470 30,213 12.40 Other loans 15,002 1,288 11.48 28,700 2,100 9.78 Gross receivables (2) 1,530,555 103,910 9.08 2,606,188 228,103 11.69 Trading investments 120,471 5,556 6.15 0 0 0.00 Investments(2) 1,460,181 65,669 5.99 2,508,087 107,124 5.69 Total interest earning assets $ 3,111,207 $175,135 7.52% $ 5,114,275 $335,227 8.75% Interest-bearing liabilities $ 3,014,661 $142,936 6.30% $ 5,124,867 $239,673 6.23% Net interest spread 1.22% 2.52% Net interest margin 1.41% 2.49% Off-balance sheet Consumer credit cards $ 1,953,903 $ 9,918,540 Advanta Mortgage loans 5,595,171 3,022,539 Leases and business cards 1,042,220 683,030 Total average securitized receivables $ 8,591,294 $13,624,109 Total average managed receivables $10,121,849 $16,230,297 (1) Includes assets held and available for sale and nonaccrual loans and leases. (2) Interest and average rate for tax-free securities, loans and leases computed on a tax equivalent basis using a statutory rate of 35%. Servicing Revenues Servicing revenues decreased to $30.7 million for the three months ended September 30, 1998 as compared to $63.4 million for the three months ended September 30, 1997. For the nine months ended September 30, 1998, servicing revenues were approximately $113.9 million as compared to $185.5 million for the nine months ended September 30, 1997. The 1997 and first quarter 1998 amounts include consumer credit card servicing income, which activities were transferred in connection with the Fleet Transaction. The Company's contract servicing portfolio was $7.6 billion at September 30, 1998 versus $8.3 billion at June 30, 1998 and $8.9 billion at September 30, 1997. The decrease in contract servicing volume since the first quarter resulted from the previously announced withdrawal of business by certain customers who have begun servicing their own portfolios, and from higher prepayments in contract servicing portfolios. Imputed Interest is Comprised of The Following ($ in Thousands): Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Cash received on IO $ 29,720 $ 20,789 $ 88,936 $ 58,145 Amortization and charge-offs (24,825) (15,336) (73,253) (41,886) Imputed interest, net $ 4,895 $ 5,453 $ 15,683 $ 16,259 Gain on Transfer of Consumer Credit Card Business The net gain recognized by the Company in 1998 of approximately $536.4 million represents the excess of liabilities transferred to the LLC over the net basis of the assets transferred and includes the Company's retained minority membership interest in the LLC, which at the closing date of the Fleet Transaction was a 4.99% ownership interest in the LLC valued at $20 million. Other Revenues ($ in Thousands): Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Equity securities (losses)/gains $ (50) $(4,320) $(43,039) $(10,035) Mortgage other revenues 1,291 276 3,836 4,025 Leasing other revenues 5,883 12,644 17,414 30,695 Business card other revenues 2,117 (2,166) 6,761 (3,108) Insurance revenues, net (8) (3,342) 1,623 (8,139) Other 898 15,945 13,419 32,148 Total other revenues,net $ 10,131 $19,037 $ 14 $ 45,586 Other revenues reflect equity securities losses of $42.5 million recognized in the first quarter of 1998. The equity securities losses reflect changes in the fair value of Advanta Partners LP investments. Most of the loss relates to investments not publicly traded for which Advanta Partners LP decided during the first quarter to expedite a disposal plan. Other mortgage, business card, and leasing revenues generally consist of late fees, plus annual fees and interchange income related to the business card. Operating Expenses The Company's operating expenses this quarter totaled $80.2 million, or 3.7% of average managed receivables. The ratio of operating expenses to average managed receivables decreased from 3.9% last quarter due to the continued leveraging of the Company's fixed cost base. As the Company's managed portfolio continues to grow during the remainder of the year, it is expected that the ratio of operating expenses to managed receivables will be within the range of 3.6% to 3.9% Salaries and employee benefits decreased $22.1 million for the three months ended September 30, 1998 as compared to the same period of 1997. This reduction reflects the decrease in the number of employees associated with the Fleet Transaction as well as workforce reductions and exit and disposition plans associated with business and product offerings not directly associated with the Company's mortgage and business services units. Other Operating Expenses ($ in Thousands): Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Marketing $13,569 $14,277 $ 37,931 $ 37,928 Equipment expense 4,511 8,491 18,153 26,759 External processing 3,740 4,126 18,263 29,572 Credit and collection expense 3,381 5,121 11,455 15,155 Occupancy expense 3,243 5,369 11,694 16,765 Telephone expense 2,361 5,450 9,811 15,667 Professional fees 1,606 13,533 8,150 29,638 Postage 1,211 6,489 7,477 21,232 Amortization of credit card deferred origination costs, net 1,175 14,395 21,108 47,916 Credit card fraud losses 100 4,554 3,000 17,730 Other 3,434 3,135 10,141 19,323 Total other operating expenses $38,331 $84,940 $157,183 $277,685 Other operating expenses decreased $46.6 million to $38.3 million for the three months ended September 30, 1998 from $84.9 million for the three months ended September 30 1997. For the nine months ended September 30, 1998, other operating expenses decreased $120.5 million to $157.2 million from $277.7 million for the nine months ended September 30, 1997. The decreases in these expenses reflect the decrease in operating expenses resulting from the Fleet Transaction. Provision for Credit Losses For the third quarter of 1998 the provision for credit losses decreased to $6.4 million from $48.2 million for the same period of 1997 and charge-offs on owned receivables decreased to $5.4 million in the third quarter of 1998 from $40.0 million during the same period of 1997. For the nine months ended September 30, 1998 the provision for credit losses decreased to $47.2 million from the $158.9 million recorded for the same period of 1997. Charge-offs for the same nine month period decreased to $47.3 million in 1998 from the $116.5 million for 1997. These decreases are mainly attributable to the transfer of the consumer credit card receivables in connection with the Fleet Transaction. Asset Quality Managed impaired assets at September 30, 1998 decreased to $343.8 million from the $456.6 million at the comparable period of 1997. The levels of managed loans 30 days or more delinquent also decreased to $616.9 million from the $940.6 million at September 30, 1997. Impaired assets include both nonperforming assets (mortgage, auto and credit cards and leases past due 90 days or more; real estate owned; and bankrupt, decedent and fraudulent credit cards) and accruing loans past due 90 days or more on business cards and leases. The Company charges off expected losses on all nonperforming mortgage loans generally no later than when they have become 12 months delinquent, regardless of anticipated collectibility. Lease receivables are written off no later than when they have become 120 days delinquent. All other loans are generally charged off upon the earlier of approximately 6 months or after an investigative period for bankrupt and fraudulent accounts. The consolidated managed charge-off rate for the third quarter of 1998 was 1.4%, down from 1.5% for the second quarter of 1998 and 5.4% for the third quarter of 1997. The following represents the quarterly results by product: Managed Receivables For the Quarter Ended 9/30/98 9/30/98 6/30/98 9/30/97 (In Millions) Mortgage only 0.56% 0.61% 0.61% $7,216 Auto 7.11 6.54(1) 8.01 239 Business rd 5.79 6.57 3.53 778 Leases 2.29 2.26 2.92 637 (1) Reflects an impact due to the timing of auto loan charge-offs. The second quarter's rate comparable to the current quarter would be approximately 9%. However, the difference had no effect on earnings. The charge-off rates for mortgages and leases are expected to remain relatively consistent with the third quarter 1998.The Company expects the charge-off rate for auto loans to increase moderately by the end of the year. The allowance for credit losses is maintained for on-balance sheet receivables. This allowance is intended to cover anticipated credit losses inherent in the owned loan portfolio. With regard to securitized assets, the fair value of anticipated losses and related recourse liabilities is reflected in the calculations of gain on sale of receivables, business card and lease securitization income, retained interest only strip and other assets. Recourse liabilities are intended to cover all probable credit losses over the life of the securitized receivables. The allowance for credit losses on a consolidated owned basis was $19.2 million or 2.2% of owned receivables at September 30, 1998 compared to $137.8 million or 4.1% of receivables at December 31, 1997 and $126.6 million or 4.8% of receivables at September 30, 1997. The percentage decrease is a result of an increase in the relative percent of secured receivables in the total loan portfolio. The decline in balance is predominately attributable to the transfer of the consumer credit card allowance in conjunction with the Fleet Transaction. On the total managed portfolio, impaired assets were $343.8 million or 3.9% of receivables at September 30, 1998, as compared to $532.0 million or 3.0% of receivables at December 31, 1997 and $456.6 million or 2.8% of receivables at September 30, 1997. On the total owned portfolio, impaired assets were $38.6 million or 4.4% of receivables at September 30, 1998, compared to $100.6 million or 3.0% of receivables at December 31, 1997, and $74.2 million or 2.8% of receivables at September 30, 1997. The following tables provide a summary of impaired assets, delinquencies and charge-offs, as of and for the year-to-date periods indicated. Sept. 30, Dec. 31, Sept. 30, Consolidated-Managed(1) 1998 1997 1997 Nonperforming assets (2) $343,788 $ 328,835 $272,946 Accruing loans past due 90 days or more 36 203,117 183,651 Impaired assets 343,823 531,952 456,597 Total loans 30 days or more delinquent 616,858 1,068,183 940,595 As a percentage of gross receivables: Nonperforming assets (2) 3.9% 1.8% 1.7% Accruing loans past due 90 days or more 0.0 1.1 1.1 Impaired assets 3.9 3.0 2.8 Total loans 30 days or more delinquent 6.9 6.0 5.7 Net charge-offs: Amount $213,287 $ 860,098 $656,920 As a percentage of average gross receivables (annualized) 2.8% 5.3% 5.4% ADVANTA MORTGAGE LOANS - MANAGED Nonperforming assets (2) $315,415 $ 200,600 $152,887 Total loans 30 days or more delinquent 533,695 391,929 322,860 As a percentage of gross receivables: Nonperforming assets (2) 4.2% 3.8% 3.3% Total loans 30 days or more delinquent 7.2 7.4 7.1 Net charge-offs - Mortgage Loans Amount $ 25,273 $ 19,953 $ 14,172 As a percentage of average receivables (annualized) .6% .5% .5% Net charge-offs - Auto Loans $ 13,570 $ 10,212 $ 4,903 As a percentage of average receivables (annualized) 7.9% 7.3% 5.5% LEASES AND BUSINESS CARDS - MANAGED Nonperforming assets (2) $ 28,057 $ 26,782 $ 21,123 Impaired assets 28,063 26,817 21,195 Total loans 30 days or more delinquent 82,550 81,675 68,502 As a percentage of receivables: Nonperforming assets (2) 2.0% 2.1% 1.8% Impaired assets 2.0 2.1 1.8 Total loans 30 days or more delinquent 5.8 6.5 5.7 Net charge-offs - Leases Amount $ 11,532 $ 15,074 $ 10,954 As a percentage of average receivables (annualized) 2.6% 2.7% 2.7% Net Charge-offs - Business Cards Amount $ 32,959 $ 18,928 $ 11,783 As a percentage of average receivables (annualized) 6.0% 3.9% 3.4% (1) Includes consumer credit cards through February 20, 1998. (2) Nonperforming assets include mortgage, auto and credit cards and leases past due 90 days or more; real estate owned; and bankrupt, decedent and fraudulent credit cards. Sept. 30, Dec. 31, Sept. 30, Consolidated-Owned(1) 1998 1997 1997 Allowance for credit losses $ 19,153 $137,773 $126,611 Nonperforming assets (2) 38,561 51,149 37,079 Accruing loans past due 90 days or more 36 49,458 37,116 Impaired assets 38,597 100,607 74,195 Total loans 30 days or more delinquent 60,928 201,891 159,244 As a percentage of gross receivables: Allowance for credit losses 2.2% 4.1% 4.8% Nonperforming assets (2) 4.4 1.5 1.4 Accruing loans past due 90 days or more .0 1.5 1.4 Impaired assets 4.4 3.0 2.8 Total loans 30 days or more delinquent 7.0 5.9 5.9 Net charge-offs: Amount $47,310 $151,222 $116,471 As a percentage of average gross receivables (annualized) 4.1% 5.6% 5.9% ADVANTA MORTGAGE LOANS - OWNED Allowance for credit losses $ 6,235 $ 5,822 $ 5,554 Nonperforming assets (2) 30,858 23,234 11,279 Total loans 30 days or more delinquent 42,267 42,916 33,862 As a percentage of gross receivables: Allowance for credit losses 1.1% 1.2% .1% Nonperforming assets (2) 5.4 4.9 1.9 Total loans 30 days or more delinquent 7.4 9.0 5.8 Net charge-offs - Mortgage: Amount $ 2,469 $ 2,310 $ 1,750 As a percentage of average gross receivables (annualized) .5% .4% .5% Net charge-offs - Auto: Amount $ 5,697 $ 3,524 $ 1,692 As a percentage of average gross receivables (annualized) 15.8% 5.8% 4.5% LEASES AND BUSINESS CARDS - OWNED Allowance for credit losses $ 9,184 $ 9,798 $ 10,741 Nonperforming assets (2) 7,387 6,705 6,496 Impaired assets 7,393 6,740 6,568 Total loans 30 days or more delinquent 18,048 17,799 17,416 As a percentage of receivables: Allowance for credit losses 3.3% 3.3% 2.8% Nonperforming assets (2) 2.6 2.2 1.7 Impaired assets 2.6 2.3 1.7 Total loans 30 days or more delinquent 6.4 6.0 4.5 Net charge-offs - Leases: Amount $ 3,030 $ 2,170 $ 1,804 As a percentage of average receivables( annualized) 2.9% 1.5% 1.7% Net charge-offs - Business Cards: Amount $ 7,836 $ 6,198 $ 3,990 As a percentage of average gross receivables (annualized) 7.1% 3.3% 3.0% (1) Includes consumer credit cards through February 20, 1998. (2) Nonperforming assets include mortgage, auto and credit cards and leases past due 90 days or more; real estate owned; and bankrupt, decedent and fraudulent credit cards. Costs and Expenses Associated With Fleet Transaction/Tender Offer Pursuant to the Tender Offer, the Company purchased 7,882,750 shares of its Class A Common Stock and 12,482,850 of its Class B Common Stock at $40 per share net, and 1,078,930 of its SAILS Depositary Shares at $32.80 per share, net. Contingent on the Fleet Transaction, the Company accelerated vesting of 43.15% of outstanding options that were not vested at the time of the closing of the Fleet Transaction. In connection with the Tender Offer, present and former directors and employees who held exercisable options to purchase Class A and Class B Common Stock tendered such options in lieu of first exercising such options and tendering the underlying stock. The Company used approximately $850 million (before taking into account the exercise price of options) to repurchase the shares in the Tender Offer. In addition, the Company also amended the terms of options granted to employees who became employees of the LLC or whose employment with the Company was otherwise terminated in connection with the Fleet Transaction (the "Affected Employees") to extend the post-employment exercise period. Although, there was a charge to earnings associated with this amendment, there was no net impact to capital in connection with this amendment. The Company also canceled options issued to certain members of the Board of Directors and replaced the canceled options with stock appreciation rights. In March 1997, the Compensation Committee of the Board of Directors approved the Advanta Senior Management Change of Control Severance Plan (the "Management Severance Plan") which provides benefits to senior management employees in the event of a change of control (as defined) of the Company if, within one year of the date of a change of control, there has been either an actual or constructive termination of the senior management employee. In February 1998, pursuant to the Company's agreement with Fleet, the Compensation Committee approved an amendment to the Management Severance Plan that allows the Office of the Chairman, in its sole discretion, to extend the level of benefits that would otherwise be allowed in the event of a change of control to Affected Employees. The Board of Directors also authorized the Chairman of the Board, in his sole discretion, to pay bonuses to certain key employees in recognition of their efforts on behalf of the Company in the strategic alternatives process. In accordance with the Company's agreement with Fleet, the LLC agreed to assume the Company's Management Severance Plan and 50% of the bonus payments with respect to those Affected Employees who became employees of the LLC in connection with the Fleet Transaction. In May 1997, the Board of Directors adopted the Office of the Chairman Supplemental Compensation Program which entitled the members of the Office of the Chairman to receive benefits in the event of a change of control (as defined) or other similar transaction. In October 1997, the Company announced that the Chief Executive Officer ("CEO") of the Company and the CEO of the consumer credit card business unit were leaving the Company in connection with the Fleet Transaction. These benefits were all contingent upon the consummation of the Fleet Transaction and were recognized upon the closing of the transaction. In connection with the Company's evaluation of strategic alternatives and the Fleet Transaction, the Company adopted special retention programs. Under these programs certain employees are entitled to receive special payments based on their targeted bonuses and contingent upon their continued employment with the Company or a successor entity. The first payments under the special retention programs were made in March 1998. Further, in March 1998, the Company identified employees that would be terminated in connection with the Fleet Transaction as part of the corporate restructuring to reduce corporate expenses. During the first quarter of 1998, the corporate restructuring was approved by the Board of Directors and affected employees were informed of the termination benefits they would receive. Substantially all of these employees ceased employment with the Company prior to April 30, 1998. The Company recorded a $62.3 million pretax charge to earnings in connection with the foregoing plans, plan amendments and workforce reduction activities. Expense Associated With Exited Business/Products In connection with the Company's restructuring efforts to reduce expenses associated with business and product offerings which are not directly associated with its mortgage and business services units, management approved exit and disposition plans during the first quarter of 1998 related to certain businesses and products previously offered. The Company recorded charges in the quarter ended March 31, 1998 related to costs to be incurred by the Company in executing these plans, including contractual obligations to customers for which no future revenue will be received, and contractual vendor obligations for services from which no future benefit will be derived. The charges also include termination benefits to employees associated with the businesses and products identified in the exit plan. Related to the exit plan, certain assets were identified for disposal and written down to estimated realizable value. In addition, the Company recognized investment banking, professional and consulting fees that were contingent upon completion of the Fleet Transaction as well as other professional and consulting fees associated with the Company's corporate restructuring. During the quarter ended March 31, 1998 the Company recorded a $54.1 million pretax charge to earnings in connection with exited businesses and products. Impairment of Facility Assets In connection with the Company's corporate restructuring, certain facility assets were identified for disposal and were written down to their estimated realizable value resulting in an asset impairment charge of $8.7 million. Liquidity and Capital Resources The Company's goal is to maintain an adequate level of liquidity, for both long- and short-term needs, through active management of both assets and liabilities. During the first nine months of 1998, the Company, through its subsidiaries, securitized approximately $3.7 billion of Advanta Mortgage loans and $.4 billion of business card and lease receivables. Cash generated from these transactions was temporarily invested in short-term, high quality investments at money market rates awaiting redeployment to pay down borrowings and to fund future mortgage loan and business card and lease receivable growth. At September 30, 1998, the Company had approximately $.8 billion of loan and lease receivables and $.6 billion of investments available for sale which could be sold to generate additional liquidity. The Company's funding strategy for 1998 relies heavily on the cash, cash equivalents and investments as well as deposit gathering activity at both Advanta National Bank ("ANB") and Advanta Bank Corp. ("ABC", formerly Advanta Financial Corp. ("AFC")). As a result of the Fleet Transaction, approximately $1.3 billion in cash, cash equivalents and investments which had previously been held by the Company in connection with its consumer credit card business was no longer required in such business and became available for general corporate purposes. The Company used approximately $850 million of such amount (before taking into account the exercise price of options) to purchase 7,882,750 shares of its Class A Common Stock, 12,482,850 of its Class B Common Stock, and 1,078,930 of its SAILS Depositary Shares through the Tender Offer which was completed on February 20, 1998. After paying down approximately $170 million in long-term debt, the Company closed the third quarter of 1998 with unrestricted cash, cash equivalents and marketable securities of approximately $400 million at the Parent company level and $485 million at the Company's two banks and equity, including capital securities, was approximately $667 million. Beginning in the fourth quarter of this year, the Company will increase the use of on balance sheet funding over time and decrease its degree of reliance on securitizations structured as sales. This will include greater use of deposit funding through the Company's two banks and the use of other funding sources which are accounted for as debt. Advanta Mortgage Corp. USA and its subsidiaries and ANB are parties to secured credit facilities. These warehouse lines and Commercial Paper conduit facilities had $721 million available at September 30, 1998. In addition, Advanta Business Services and its subsidiaries are parties to Commercial Paper conduit facilities. These facilities had $160 million available at September 30, 1998. As of September 30, 1998 ANB's total deposits were $1.13 billion after a significant portion of its deposits were contributed to the LLC in the first quarter of this year in connection with the Fleet Transaction, and ABC, a Utah state-chartered, FDIC-insured industrial loan corporation had total deposits of $153.1 million. Total deposits increased approximately $400 million and $13 million for ANB and ABC, respectively, from June 30, 1998. ANB's combined Tier I and Tier II capital ratio at September 30, 1998 was 12.29%. At December 31, 1997, the combined Tier I and Tier II capital ratio was 16.39% for ANB. ABC's combined Tier I and Tier II capital ratios were 20.79% and 17.99% at September 30, 1998 and December 31, 1997, respectively. In each case, ANB and ABC met the requirements of the Office of the Comptroller of the Currency and FDIC, respectively, and qualified as well-capitalized. During May of 1998, ANB offered to repurchase its outstanding Bank Notes that were not assumed by the LLC in connection with the acquisition of the Company's consumer credit card business by Fleet and certain of its affiliates. ANB repurchased $93.4 million of Bank Notes; $7.4 million of Bank Notes that were not tendered remain outstanding. In June of 1998, ANB retained $445 million of Advanta Mortgage Loan Trust 1998-2 securities to be held in its trading portfolio. This decision was consistent with ANB's liquidity management objectives and its high levels of liquidity. By holding these securities, ANB receives an attractive yield and maintains flexibility for future funding requirements. In August 1998, ANB sold approximately $257 million of these securities. During the third quarter of 1998, the Board of Directors authorized the repurchase of shares of the Company's Class A and Class B common stock and the formation of an Employee Stock Ownership Plan ("ESOP"). Up to 2.5 million shares of the Company's Class A and Class B common stock will be purchased in connection with the stock repurchase program and the ESOP. Market Risk Sensitivity Market risk is the potential for loss or diminished financial performance arising from adverse changes in market forces such as interest rates and market prices. Market risk sensitivity is the degree to which a financial instrument, or a company that owns financial instruments is exposed to market forces. The Company regularly evaluates its market risk profile and attempts to minimize the impact of market risks on net interest income and net income. The Company's exposure to foreign currency exchange rate risk, commodity price risk, and equity price risk is immaterial relative to expected overall financial performance. The Company's financial performance can, however, be affected by fluctuations in interest rates, changes in economic conditions, shifts in customer behavior, and other factors. Changes in economic conditions and shifts in customer behavior are difficult to predict, and the financial performance of the Company generally cannot be insulated from such forces. Financial performance variability as a result of fluctuations in interest rates is commonly called interest rate risk. Interest rate risk generally evolves from mismatches in the timing of asset and liability repricing (gap risk) and from differences between the repricing indices of assets and liabilities (basis risk). The Company attempts to analyze the impact of interest rate risk by regularly evaluating the perceived risks inherent in its asset and liability structure, including securitized instruments and off-balance sheet instruments. Risk exposure levels vary continuously, as changes occur in the Company's asset/liability mix, market interest rates, prepayment trends, and other factors affecting the timing and magnitude of cash flows. Computer simulations are used to generate expected financial performance in a variety of interest rate environments. Those results are analyzed to determine if actions need to be taken to mitigate the Company's interest rate risk. In managing interest rate risk exposure, the Company periodically securitizes receivables, sells and purchases assets, alters the mix and term structure of its funding base, changes its investment portfolio and uses derivative financial instruments. Derivative instruments, by Company policy, are not used for speculative purposes (see discussion under "Derivative Activities"). The Company has measured its interest rate risk using a rising rate scenario and a declining rate scenario. Net interest income is estimated using a third party software model that uses standard income modeling techniques (see Note 15 to Consolidated Condensed Financial Statements). The Company estimates that its net interest income over a twelve month period would approximately increase or decrease by 1.0%, respectively, if interest rates were to rise or fall by 200 basis points. Both increasing and decreasing rate scenarios assume an instantaneous shift in rates and measure the corresponding change in expected net interest income over one year. The above estimates of net interest income sensitivity alone do not provide a comprehensive view of the Company's exposure to interest rate risk. The quantitative risk information is limited by the parameters and assumptions utilized in generating the results. Such analyses are useful only when viewed within the context of the parameters and assumptions used. The above rate scenarios in no way reflect management's expectation regarding the future direction of interest rates, and they depict only two possibilities out of a large set of possible scenarios. In addition to interest rate risk, the Company has other financial instruments, namely capitalized servicing rights and interest-only strips, that are subject to prepayment risk. Prepayments are principal payments received in excess of scheduled principal payments. Prepayments generally result from entire loan payoffs due largely to refinancing a loan or selling a home. Actual or anticipated prepayment rates are expressed in terms of a constant prepayment rate ("CPR"), which represents the annual percentage of beginning loan balances that prepay. To a degree, prepayment rates are related to market interest rates and changes in those interest rates. The precise relationship between them, however, is not known at this time. Accordingly, the Company believes it is more relevant to disclose the fair value sensitivity of these instruments based on changes in prepayment rate assumptions rather than based on changes in interest rates. The Company's capitalized servicing rights and interest only strips derive from both fixed and variable rate loans, the majority of which are fixed. Fixed and variable rate loans are currently prepaying at different rates and are expected to continue this behavior in the future. The Company has estimated the impact on the fair value of these assets assuming a change on prepayments of 2.9% CPR for fixed rate loans and 3.6% CPR for variable rate loans. These changes in prepayment assumptions could result in a $26 million change in fair value. In addition, changes in the interest rate environment generally affect the level of loan originations. Prepayment assumptions are not the only assumptions in the fair value calculation, but they are the most influential. Other key assumptions are not directly impacted by market forces as defined earlier. The above prepayment scenarios do not reflect management's expectation regarding the future direction of prepayments, and they depict only two possibilities out of a large set of possible scenarios. The Company currently has securities in a trading portfolio for liquidity purposes (see Liquidity and Capital Resources). The Company estimates that the value of these securities would not materially change assuming a 10% change in market-based investment yields. Derivatives Activities The Company uses derivative financial instruments for the purpose of managing its exposure to interest rate risk and has used derivatives to manage foreign currency risks. The Company has a number of mechanisms in place that enable it to monitor and control both market and credit risk from these derivatives activities. At the broader level, all derivatives strategies are managed under a hedging policy approved by the Board of Directors that details the use of such derivatives and the individuals authorized to execute derivatives transactions. All derivatives strategies must be approved by the Company's senior management. As part of this approval process, a market risk analysis is completed to determine the potential impact on the Company from severe negative (stressed) movements in market rates. By policy, derivatives transactions may only be used to manage the Company's exposure to interest rate and foreign currency risks or for cost reduction and may not be used for speculative purposes. As such, the impact of any derivatives transaction is calculated using the Company's asset/liability model to determine its suitability. Procedures and processes are in place to provide reasonable assurance that prior to and after the execution of any derivatives strategy, market, credit and liquidity risks are fully analyzed and incorporated into the Company's asset/liability and risk measurement models and the proper accounting treatment for the transaction is identified and executed. As of September 30, 1998 and December 31, 1997, all of the Company's derivatives were designated as hedges or synthetic alterations and were accounted for as such. The following table summarizes by notional amounts the Company's derivatives instruments as of September 30, 1998 and December 31, 1997 ($ in thousands): Estimated Fair Value Sept. 30, Sept. 30, Dec. 31, 1998 Asset/ 1998 1997 (Liability) Interest rate swaps $2,046,971 $2,111,711 $ (208) Interest rate options: Caps written 298,052 1,018,781 (76) Caps purchased 298,052 328,781 76 Forward contracts 1,311,000 400,437 (6,511) $3,954,075 $3,859,710 $(6,719) The notional amounts of derivatives do not represent amounts exchanged by the counterparties and, thus, are not a measure of the Company's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivatives contracts. The fair value of interest rate swaps, options and forward contracts is the estimated amount that the Company would pay or receive to terminate the agreement at the reporting date, taking into account current interest and foreign exchange rates and the current creditworthiness of the counterparty. The Company's credit exposure to derivatives, with the exception of caps written, is represented by contracts with a positive fair value without giving consideration to the value of any collateral exchanged. For caps written, credit exposure does not exist since the counterparty has performed its obligation to pay the Company a premium payment. Year 2000 Readiness Disclosure Many existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results on or after the Year 2000. The "Year 2000 Issue" affects computer and information technology ("IT") systems, as well as non-IT systems which include embedded technology such as micro-processors and micro-controllers (or micro-chips) that have date sensitive programs that may not properly recognize the year 2000 or beyond. If the systems and products used by the Company are not properly equipped to identify and recognize the year 2000, the Company's IT systems and non- IT systems could fail or create erroneous results. This could cause the Company to experience a temporary inability to process transactions, originate loans or leases, service the loans of third parties and engage in other normal business activities. Under these circumstances, the Year 2000 Issue could have a material adverse effect on the Company's products, services, operations and financial results. In connection with the Year 2000 Issue, the Company has organized a separate Year 2000 Project Office (the "Project Office") managed by a team led by a senior information technology manager to assess whether the computer systems and applications used by the Company are Year 2000 compliant and to implement appropriate responses in the event any of such systems and applications are not compliant. The Project Office has developed standards for its work based on work of leading authorities in the field. The Project Office reports to the Company's Year 2000 Steering Committee which consists of the head of each of the Company's business units, the corporate General Counsel, the corporate Senior Vice President of Administration and other key members of corporate senior management. In addition, the Company's internal Audit Department has assigned a senior information technology auditor to monitor all Year 2000 issues and developments for the Audit Committee of the Company's Board of Directors. The Company has also engaged independent consultants to assist in the verification and validation processes to assure the reliability of the Company's risk and cost estimates. The Company is proceeding to implement a Year 2000 compliance program in accordance with applicable guidelines and regulations of the Federal Financial Institutions Examination Council ("FFIEC") as adopted by the Office of the Comptroller of the Currency ("OCC") and the Federal Deposit Insurance Corporation ("FDIC"). The Company's compliance program consists of the following phases: Awareness Define the scope of the Year 2000 problem. Establish a Year 2000 project team. Develop an overall strategy to address the Year 2000 problem. Identify all IT and non-IT systems that may be affected by the Year 2000 Issue. Assessment Assess the size and complexity of the Year 2000 Issue. Evaluate whether IT and non-IT systems are Year 2000 compliant. Identify and prioritize "mission-critical" systems. Renovation Remediate or replace systems that are not Year 2000 compliant. Validation Testing of systems to validate that they are Year 2000 compliant. Contingency Develop options in the event that any or Planning all of the IT and non-IT systems fail or cannot be made Year 2000 compliant. Implementation Certify that systems are Year 2000 compliant. Implement contingency plans for any non- compliant system. The Company has completed the Awareness and Assessment phases, and is currently in the Renovation, Validation and Contingency Planning phases of its Year 2000 compliance program with respect to both IT and non-IT systems. Each of the Company's business units has completed the evaluation of its systems, applications and vendor lists, including identifying and prioritizing "mission-critical" systems, and is implementing project plans to modify existing computer programs, convert to new programs or replace systems to the extent necessary to address the Year 2000 Issue. The Company is also providing customer awareness training for customer-centered employees which will equip them to respond to customer inquiries about the Company's Year 2000 readiness. The Company expects that testing of its internal mission-critical systems and the development of contingency plans will be substantially complete by the end of 1998. The Company has identified its significant business relationships, including without limitation vendors, customers and asset management and funding counterparties, to assess the potential impact on the Company's operations if those third parties and/or their products or systems fail to become Year 2000 compliant in a timely manner. The Company is mailing questionnaires to third parties with which it maintains a significant business relationship to help identify which of those third parties and/or their products or systems will not be Year 2000 compliant. In addition, the Company reviews Internet websites to monitor and assess the level of Year 2000 compliance of vendors, suppliers and other third parties. Risk assessments, action steps and contingency plans related to significant third party relationships are expected to be complete within the time frames established by the FFIEC guidelines as adopted by the OCC and FDIC. Non-compliant products are being evaluated for remediation, replacement or retirement. To date, the Company is not aware of any material third party business relationship, product or system with a Year 2000 problem that management believes would have a material adverse effect on the Company. However, there can be no assurance that the systems and products used by outside service providers or other third parties upon which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company's Year 2000 compliance program also includes the development of contingency plans for each of the Company's business units in the event that remediation or replacement plans are not successfully implemented. The contingency plans are designed to protect its business and operations from business interruptions related to the Year 2000 Issue and, by way of example, may include back-up procedures or the identification of alternative suppliers, where practical. Each of the Company's business units is in the process of developing its contingency plans. Many of the functions performed by the products and systems used by the Company, which operate automatically, can be performed manually. Consequently, in the event these products or systems experience isolated failures as a result of the Year 2000 problem, the disruption caused by such isolated failures should not have a material adverse effect on the Company. There can be no assurances, however, that any of the Company's contingency plans will be sufficient to anticipate or address all of the problems or issues that may arise. The Company has established a budget of approximately $9.4 million in 1998, and $11.5 million in 1999, including capital expenditures, to address the Year 2000 Issue. This budget includes approximately $2.8 million and $2.5 million for 1998 and 1999, respectively, to cover the costs associated with diverted personnel. Of the total budget, the Company has allocated approximately $1.0 million in 1998 and $8.5 million in 1999 for contingencies. Based on current information, the Company believes that the budget will be sufficient to cover its expenditures associated with the Year 2000 Issue. As of September 30, 1998, exclusive of costs associated with diverted personnel, the Company has spent approximately $2.5 million in operating expenses and approximately $550,000 in capital expenditures. Funding for the project is being provided out of operating revenues. The Company notes that GAAP generally requires that the costs of becoming Year 2000 compliant, including without limitation modifying computer software or converting to new programs, be charged to expense as they are incurred. Therefore, except for the cost of replacement systems or other items that have a future use, the Company will expense the cost of the Year 2000 project as incurred. The Company has deferred development on selected business systems due to Year 2000 priorities. These deferrals are not expected to have a material effect on the financial condition and results of operations of the Company. The Company believes that the Year 2000 Issue will not pose significant operational problems for it and will not have a material adverse effect on its future financial condition, liquidity or results of operations during 1998 and in future periods. The projected costs and expenditures and project completion dates are based on management's best estimates, are subject to the performance of third parties over which the Company has no control and may be updated from time to time as additional information becomes available. This section discussing Year 2000 issues contains forward-looking statements. See "Overview". PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On June 30, 1997, purported shareholders of the Company who are represented by a group of law firms filed a putative class action complaint against the Company and several of its current and former officers and directors in the United States District Court for the Eastern District of Pennsylvania. A second, similar complaint was filed in the same court a few days later by a different group of law firms. Both complaints allege that the Company made misrepresentations in certain of its public filings and statements in violation of the Securities Exchange Act of 1934. The complaints seek damages of an unspecified amount. On July 10, 1998, the complaints, which had previously been consolidated, were dismissed by the Court for failing to state a claim. The plaintiffs determined not to attempt to amend their Complaints. Rather, they have appealed the District Court's decision to the United States Court of Appeals for the Third Circuit. The Company believes that the District Court's ruling will be affirmed and that the complaints are without merit. On August 25, 1997, a purported consumer credit cardholder of the Company instituted a putative class action complaint against the Company and certain of its subsidiaries in Delaware Superior Court for New Castle County. Subsequently, on September 8, 10, and 12, October 2, November 7 and 12, and December 2, 10, 15 and 18 (2 cases), 1997, similar actions were filed in Orange County California Superior Court, the United States District Court for the Eastern District of Tennessee, Delaware Superior Court, the Circuit Court of Covington County, Alabama, the United States District Court for the Northern District of California, the United States District Court for the Central District of California, the United States District Court for the Eastern District of Pennsylvania, the District Court of Bexar County, Texas, the United States District Court for the Northern District of Texas, the United States District Court for the District of New Jersey and the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida, respectively. The class action complaints allege that consumer credit cardholder accounts in a specific program were improperly repriced to a higher percentage rate of interest. The complaints assert various violations of federal and state law with regard to such repricings, and each seeks damages of an unspecified amount. On June 3, 1998, the Judicial Panel on multidistrict litigation ordered that all of the federal court actions be consolidated into one proceeding for pretrial purposes in the United States District Court for the Eastern District of Pennsylvania. On September 3, 1998, a tag-along action was filed in the United States District Court for the Eastern District of Tennessee. Effective October 30, 1998, the tag-along action was consolidated into the consolidated multidistrict proceeding. On November 5, 1998, the Company and counsel for plaintiffs in two of the actions pending in the Superior Court of the State of Delaware entered into a Settlement Agreement and Stipulation in the Delaware State Court to settle the claims relating to the specific program referred to above. Pursuant to the Settlement Agreement and Stipulation, which is subject to Court approval, the Company will pay $7.25 million to the plaintiffs. With the exception of persons who opt-out of the settlement, once the Court grants final approval of the settlement and that approval becomes effective, all the claims in the other lawsuits relating to the specific program referred to above will be released. While management believes the allegations are without merit, the Company recognizes the risk of continued litigation and the additional expenditure of time, energy and resources and that further defense of the actions would be potentially protracted and expensive and that settlement is desirable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits The following exhibits are being filed with this report on Form 10-Q. Exhibit Number Description of Document 4 Amendment No. 2, dated as of September 10, 1998, to the Rights Agreement dated as of March 14, 1997, as amended, by and between the Company and ChaseMellon Shareholder Services, L.L.C. as Rights Agent (incorporated by reference to Exhibit 1 to the Company's Amended Registration on Form 8-A/A, dated September 23, 1998). 12 Computation of Ratio of Earnings to Fixed Charges. 27 Financial data schedule incorporated by reference to Exhibit 27 to the Company's Current Report on Form 8-K October 27, 1998 filed the same date. (b) Reports on Form 8-K. (b)(1) A Current Report on Form 8-K, dated October 27, 1998 was filed by the Company setting forth the financial highlights of the Company's results of operations for the period ending September 30, 1998. (2) A Current Report on Form 8-K, dated August 27, 1998 was filed by the Company relating to the announcement by the Company of a stock repurchase program. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. Advanta Corp. (Registrant) November 15, 1998 By /s/Philip M. Browne Senior Vice President and Chief Financial Officer November 15, 1998 By /s/John J. Calamari Vice President, Finance and Principal Accounting Officer EXHIBIT INDEX Exhibit Description 2 Inapplicable 3 Inapplicable 4 Amendment No. 2, dated as of September 10, 1998, to the Rights Agreement dated as of March 14, 1997, as amended, by and between the Company and ChaseMellon Shareholder Services, L.L.C. as Rights Agent (incorporated by reference to Exhibit 1 to the Company's Amended Registration on Form 8- A/A, dated September 23, 1998). 10 Inapplicable 11 Inapplicable 12 Computation of Ratio of Earnings to Fixed Charges 15 Inapplicable 18 Inapplicable 19 Inapplicable 22 Inapplicable 23 Inapplicable 24 Inapplicable 27 Financial Data Schedule 99 Inapplicable EX-12 2 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 Exhibit 12 ADVANTA CORP. AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Dollars in Thousands) Three Months Ended Nine Months Ended September 30, 1998 September 30, 1998 1998 1997 1998 1997 Net Earnings $ 15,025 $ 42,412 $443,282 $28,013 Federal and state income taxes 6,439 14,748 (11,013) 9,741 Earnings before income taxes 21,464 57,160 432,269 37,754 Fixed charges: Interest 39,165 88,414 142,936 239,673 One-third of all rentals 583 746 2,006 2,572 Preferred stock dividend of subsidiary trust 2,248 2,248 6,743 6,743 Total fixed charges 41,996 91,408 151,685 248,988 Earnings before income taxes and fixed charges $63,460 $148,568 583,954 286,742 Ratio of earnings to fixed charges (A) 1.51x 1.63x 3.85x 1.15x (A) For purposes of computing these ratios, "earnings" represent income before income taxes plus fixed charges. "Fixed charges" consist of interest expense, one-third (the proportion deemed representative of the interest factor) of rental expense on operating leases, and preferred stock dividends of subsidiary trust. EX-27 3 FINANCIAL DATA SCHEDULE
9 1000 9-MOS DEC-31-1998 SEP-30-1998 80214 88882 302800 186923 791594 0 0 929308 19153 3387485 1284929 1187365 247709 744557 0 1010 265 566207 3387485 99922 71116 0 171038 62747 80189 28102 47220 5411 419077 432269 432269 0 0 443282 15.80 14.88 1.41 38561 36 0 0 137773 53995 6685 19153 15419 0 3734
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