-----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, Q0SGzoe82yS8pS6aU2V1Jcwy84cFSIn0MbEONJHiec8AC4rF3toAMv99jS+984jB 7fZJx+KgQ1pZM8OOdTaXqQ== 0000893220-00-000308.txt : 20000323 0000893220-00-000308.hdr.sgml : 20000323 ACCESSION NUMBER: 0000893220-00-000308 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000322 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-K SEC ACT: SEC FILE NUMBER: 000-14120 FILM NUMBER: 575842 BUSINESS ADDRESS: STREET 1: P.O. BOX 844 STREET 2: WELSH & MCKEAN ROADS CITY: SPRING HOUSE STATE: PA ZIP: 19477 BUSINESS PHONE: 2154445051 MAIL ADDRESS: STREET 1: C/O WELSH & MCKEAN ROADS STREET 2: P.O. BOX 844 CITY: SPRING HOUSE STATE: PA ZIP: 19477-0844 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-K 1 10-K DECEMBER 31 1999 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NO. 0-14120 ADVANTA CORP. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 23-1462070 (STATE OR OTHER JURISDICTION OF ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) WELSH & MCKEAN ROADS, P. O. BOX 844, SPRING HOUSE, PENNSYLVANIA 19477 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (215) 657-4000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- NONE N/A
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: CLASS A COMMON STOCK, $.01 PAR VALUE CLASS B COMMON STOCK, $.01 PAR VALUE CLASS A RIGHT CLASS B RIGHT (TITLE OF EACH CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K Yes [ ]. State the aggregate market value of the voting stock held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing. (See definition of affiliate in Rule 405.) $136,254,626 as of March 15, 2000 which amount excludes the value of all shares beneficially owned (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) by officers and directors of the Company (however, this does not constitute a representation or acknowledgment that any of such individuals is an affiliate of the Registrant). (APPLICABLE ONLY TO CORPORATE REGISTRANTS) Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. As of March 15, 2000 there were 10,060,888 shares of the Registrant's Class A Common Stock, $.01 par value, outstanding and 17,178,097 shares of the Registrant's Class B Common Stock, $.01 par value, outstanding. DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (e) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).
DOCUMENT FORM 10-K REFERENCE - -------- ------------------- Definitive Proxy Statement relating to the Registrant's 2000 Part III, Items 10-13 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A not later than 120 days following the end of the Registrant's last fiscal year
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I. ITEM 1. BUSINESS In this form 10-K, "Advanta", "we", "us", "our" and the "Company" refer to Advanta Corp. and its subsidiaries, unless the context otherwise requires. OVERVIEW Advanta is a nationwide provider of financial services. We offer diverse and innovative products to consumers and small businesses. Our primary consumer products are first and second lien non-conforming mortgage loans. Our mortgage loans are "non-conforming" because we underwrite loans with credit characteristics that do not meet the underwriting guidelines of federal mortgage agencies, such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. A loan may be considered non-conforming for a variety of reasons, including the size of the loan in relation to the value of the underlying property, the borrower's debt-to-income ratio and the borrower's prior credit history. We service all of the mortgage loans that we originate. In our contract servicing business, also known as "subservicing", we also service the mortgage loans of third parties for a fee. The primary products we offer to small businesses are business credit cards and equipment leases. Our basic business card product is an unsecured MasterCard(R)* business credit card. The majority of our equipment leases are for small-ticket items such as computers, copiers, fax machines and other office equipment. We own two depository institutions, or banks, Advanta National Bank and Advanta Bank Corp. Our banks offer a variety of deposit products, such as retail and large denomination certificates of deposit, that are insured by the Federal Deposit Insurance Corporation, also referred to as the "FDIC." We fund and operate our mortgage, business credit card and leasing businesses primarily through our banks. In addition to our lending and leasing businesses, our other businesses include Advanta Insurance and Advanta Partners. Advanta Insurance offers a variety of credit related insurance products. Advanta Partners is a private equity investment firm. The following table highlights selected information about our lending and leasing business units. Financial information presented in the table is for the year ended December 31, 1999.
ADVANTA ADVANTA ($ IN MILLIONS) ADVANTA MORTGAGE BUSINESS CARDS LEASING SERVICES - ------------------------------------------------------------------------------------------------ REVENUES $325.7 $120.1 $51.7 PERCENT OF TOTAL REVENUES 57% 21% 9% MANAGED RECEIVABLES $8,384 $1,040 $796 TARGET MARKET Consumer Small Business Small Business PRIMARY PRODUCTS AND Originating and servicing MasterCard(R) Small ticket SERVICES non-conforming first and Business credit card equipment leases second lien closed and open end home equity loans; subservicing of non-conforming mortgage loans for third parties
In addition to the revenues from our lending and leasing businesses described in the table above, 13% of our total revenues for the year ended December 31, 1999 were derived from insurance operations, investment income and venture capital gains. - --------------- * MasterCard(R) is a federally registered servicemark of MasterCard International, Inc. 1 3 Prior to February 20, 1998, we also issued consumer credit cards. Under the terms of a contribution agreement, dated October 27, 1997 and amended on February 20, 1998, we and Fleet Financial Group, Inc. ("Fleet") each contributed substantially all of the assets of our respective consumer credit card businesses, subject to liabilities, to Fleet Credit Card, LLC ("Fleet LLC"), a newly formed Rhode Island limited liability company controlled by Fleet. We acquired a 4.99% minority interest in Fleet LLC at the date of the closing of the transaction. This transaction is referred to throughout this Form 10-K as the "Consumer Credit Card Transaction." Advanta currently has over 2,600 employees. At December 31, 1999 we serviced approximately $24 billion in assets, consisting of approximately $12 billion in managed assets and approximately $12 billion in assets serviced for third parties. Advanta Corp. was incorporated in Delaware in 1974 as Teachers Service Organization, Inc., the successor to a business originally founded in 1951. In January 1988, we changed our name from TSO Financial Corp. to Advanta Corp. Our principal executive office is located at Welsh & McKean Roads, P.O. Box 844, Spring House, Pennsylvania 19477-0844. Our telephone number at our principal executive office is (215) 657-4000. STRATEGY Advanta is a diversified nationwide financial services company that is well-positioned in sizeable and growing markets. Our principal objectives are to use our information based strategy to continue to grow each of our businesses while increasing profitability and improving cash flow. The primary components of our strategy for accomplishing these objectives are: Information based strategy. Based on our experience and expertise in analyzing consumers' credit behavior and characteristics, we have developed an extensive database of customer information and attributes. We use this information in conjunction with proprietary credit scoring, targeting and other sophisticated analytical models we have developed to market our products to the most profitable prospective customers. We measure expected profitability through an integrated analysis of a prospect's responsiveness, creditworthiness and sensitivity to price. We continually validate our models based on actual results from marketing campaigns, and use this information to refine and improve our analytical assumptions. We also leverage the information and models we have developed to market and cross-sell our products to existing customers more effectively. The information we gather and analyze allows us to market directly to specific customer segments, target prospects effectively, anticipate customer needs and customize our products to meet those needs. There is substantial opportunity for us to extend our current market positions by further refining these skills and broadening their application within each of our businesses. We have entered into strategic alliances with third parties in which we use our information management and direct marketing tools to market their products. We believe we can further capitalize on these skills within our own businesses and through other ventures and strategic alliances with third parties. Increase direct originations. We are focused on maximizing profitability by identifying the most profitable origination channels in each of our businesses. We are able to originate our products directly from customers, generally referred to as "direct originations," or indirectly through intermediaries such as brokers, generally referred to as "indirect originations." We analyze the profitability of the loans we originate, and we are focused on increasing originations through the origination channels that produce the most profitable loans. Loans that we originate directly from customers typically yield higher margins, generate higher positive cash flows and create stronger customer relationships than loans that we originate indirectly through third parties. For the year ended December 31, 1999, 61% of the mortgage loan receivables that we originated were direct originations, as compared to 32% for the year ended December 31, 1998. Almost all of our business cards are directly originated. Currently, we acquire the majority of our leases through indirect origination channels. We plan to use our information based strategy to change our strategic focus in our leasing business to increase originations directly from vendors and end users of the equipment based on the higher profitability of the leases originated through these channels. 2 4 Improve and refine credit scoring and risk-based pricing models. We use customized credit scoring and risk-based pricing models to balance risk and profitability. These models also enhance our ability to underwrite loans and leases that better meet our customers' needs. Using our credit scoring and pricing models, we are able to provide our customers with a choice among products and pricing alternatives that are designed to satisfy both the specific needs of the customers and our profitability goals. Improve operating efficiencies. We are developing our infrastructure around technology to make all aspects of our operations more efficient. For example, we recently developed and are implementing the Advanta Intelligent Mortgage System, our proprietary automated sales and underwriting system for nonconforming mortgages. We believe that this and other technology-based initiatives will reduce costs, increase capacity and improve customer service. We are also focused on using the Internet as an extension of our existing infrastructure for direct marketing, customer acquisition, application processing and customer service. In July 1999, we became one of the first business card issuers to offer instant credit approval on-line over the Internet. We plan to capitalize on similar Internet opportunities to strengthen our capabilities in our other businesses. Maintain multiple funding sources. We fund our businesses through diversified sources. We offer a range of retail and institutional FDIC-insured deposit products through Advanta National Bank and Advanta Bank Corp., our two FDIC-insured depository institutions. We also fund our businesses through securitization transactions and at December 31, 1999 we had approximately $1.2 billion in warehouse lines and commercial paper conduit facilities available to fund our lending and leasing business units. We directly offer unsecured debt of Advanta Corp. to retail investors through the Advanta Retail Note Program. The availability of multiple funding sources allows us to use cost-effective funding strategies that increase both long-term earnings and economic value. ADVANTA MORTGAGE OVERVIEW Advanta Mortgage, a business unit of Advanta, offers a broad range of mortgage products and services to consumers throughout the country. Advanta Mortgage originates and services non-conforming credit first and second lien mortgage loans, including home equity lines of credit. We fund and operate our mortgage business primarily through our banks, Advanta National Bank and Advanta Bank Corp. Advanta Mortgage's portfolio of managed receivables includes owned loans and securitized loans which we service and in which we retain an interest. At December 31, 1999, Advanta Mortgage had total owned loans receivables of $1.1 billion and total managed receivables of $8.4 billion. In addition to servicing and managing the loans we originate, Advanta Mortgage services the home equity loans of unaffiliated third parties through our subservicing business. Subserviced loans are not included in our portfolio of managed receivables and we bear no risk of credit loss on the receivables in our subserviced portfolio. Advanta Mortgage's portfolio of subserviced loans totaled approximately $12 billion at December 31, 1999. Our total serviced portfolio, including the "subserviced" portfolio, was $20.3 billion at December 31, 1999 compared to $16.6 billion at December 31, 1998. Approximately 87% of the managed mortgage loan portfolio is secured by first lien position loans and the balance is secured by second lien position loans. Home equity lines of credit represented 10% of the managed mortgage loan portfolio at December 31, 1999. During the year ended December 31, 1999, the United States economy experienced increases in interest rates. As a result we experienced an increased demand for second lien mortgage loans. Second lien mortgage loans represented 34% of the mortgage loan receivables originated by us during the quarter ended December 31, 1999. Substantially all of the second lien mortgage loan originations during the quarter ended December 31, 1999 consisted of home equity lines of credit. At December 31, 1999, the combined loan-to-value ratio for our managed mortgage loan portfolio was approximately 79%. Generally, there is a higher risk of delinquency and/or loss associated with second lien home equity loans that have higher loan-to-value ratios. We manage the increased credit risk associated with these loans through our underwriting and risk-based pricing. 3 5 At December 31, 1999, approximately 62% of the managed portfolio consisted of fixed rate loans. The remainder was comprised of adjustable rate loans and intermediate rate loans which typically bear interest at a fixed rate for a period of two to five years and an adjustable rate thereafter. The following table shows the geographic distribution by state for the top five states of total managed Advanta Mortgage loans at December 31, 1999.
($ IN MILLIONS) TOTAL PERCENT OF MORTGAGE PORTFOLIO LOANS BY STATE - -------------------------------------------------------------------------------------- CALIFORNIA $ 997,298 12% MICHIGAN 654,632 8 PENNSYLVANIA 500,998 6 OHIO 439,359 5 FLORIDA 431,008 5 OTHER 5,360,241 64 ---------- --- Total $8,383,536 100% - --------------------------------------------------------------------------------------
Geographic concentration carries a risk of increased delinquency and/or loss if a specific area suffers an economic downturn. Advanta Mortgage monitors economic conditions in those regions through market and trend analyses. Senior management of Advanta Mortgage meets throughout the year to update lending policies based on the results of these analyses. In 1999, approximately 57% of Advanta's total revenues were derived from Advanta Mortgage. ORIGINATION CHANNELS Currently, Advanta Mortgage generates most of its loans through direct originations and through our network of more than 600 brokers. Our direct origination channels consist of our national call center and our 60 loan production offices located throughout the country. We directly originate mortgage loans from consumers using targeted direct mail and direct response television and radio advertising. Using our information based strategy we identify and market to prospective customers who are most likely to respond and result in a profitable relationship for Advanta. In the past, we also relied on indirect originations through our conduit and corporate finance divisions within Advanta Mortgage to acquire mortgage loans through correspondent relationships and purchases from other financial institutions. We curtailed these indirect origination activities during 1999 to the extent we determined that they were no longer consistent with our strategy and did not meet our profitability and return goals. For similar reasons, during the first quarter of 1999, we exited our auto finance business through which we formerly engaged in the financing of automobile purchases by consumers with non-conforming credit characteristics. Because directly originated loans are more profitable and generally perform better with respect to delinquencies, prepayments and charge-offs than loans we originate through indirect channels, we are focused on increasing direct originations as a percentage of our mortgage loan portfolio. Our portfolio of directly originated mortgage loans increased by 37.1% for the year ended December 31, 1999 as compared to the year ended December 31, 1998, and represented 42.4% of the managed loan portfolio at December 31, 1999 as compared to 31.8% at December 31, 1998. Our broker portfolio increased by 21.2% for the year ended December 31, 1999 as compared to the year ended December 31, 1998, and represented 15.2% of the managed mortgage loan portfolio at December 31, 1999 as compared to 12.9% at December 31, 1998. 4 6 The following table sets forth the volume of originations, broken out by origination channel, for the years ended December 31, 1999 and December 31, 1998.
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS) ---------------------------------------------------- 1999 1998 ------------------------ ------------------------ LOAN NUMBER OF LOAN NUMBER OF ORIGINATION CHANNELS RECEIVABLES LOANS RECEIVABLES LOANS - --------------------------------------------------------------------------------------------------- DIRECT $1,621,037 35,515 $1,655,399 29,846 BROKER 542,115 6,200 475,427 5,856 CONDUIT 449,848 5,843 1,752,968 22,656 CORP. FINANCE 37,939 528 1,325,447 17,430 AUTO 5,103 375 104,350 8,531 ---------- ------ ---------- ------ TOTAL ADVANTA MORTGAGE LOANS $2,656,042 48,461 $5,313,591 84,319 - ---------------------------------------------------------------------------------------------------
UNDERWRITING We have been lending to non-conforming borrowers since 1986. We believe that our knowledge of the non-conforming mortgage industry, together with our expertise in analyzing and predicting consumer behavior, affords us an advantage in our ability to manage risk through the underwriting process. We have an experienced staff of underwriters within Advanta Mortgage. The underwriting guidelines used in our mortgage business are designed to consider the value and adequacy of the mortgaged property as collateral for the proposed mortgage loan as well as the borrower's credit standing and repayment ability. We further tailor these underwriting guidelines to the type of product, for example whether the loan is a first or second lien, or whether it is a closed-end mortgage or a revolving home equity line of credit. There are three major steps in the underwriting process: (1) identify the eligibility and appropriate credit grade of the mortgagor; (2) evaluate the eligibility and lendable equity of the mortgaged property; and (3) ensure the loan terms are acceptable for that credit grade. We have developed standardized underwriting guidelines for our national call center and our network of 60 loan production offices. We have also originated mortgage loans through indirect channels by purchasing mortgage loans or pools of mortgage loans, in whole or in part, from correspondents and other unaffiliated third party originators. The underwriting guidelines used by unaffiliated originators may deviate from our own underwriting guidelines. In these circumstances, we will reunderwrite a representative sample of the mortgage loans. We are implementing the Advanta Intelligent Mortgage System, or AIMS, which is our proprietary automated sales and underwriting system that is designed to enable loan officers to structure multiple loan options for customers quickly. AIMS is designed to rapidly analyze customer-specific information against a set of criteria, including our underwriting guidelines, and generate a number of alternative products and pricing structures that will meet our customers' stated needs, consistent with our profitability objectives. AIMS will automate the underwriting and pricing functions in our mortgage business. We expect this to increase our efficiency by reducing the time it takes to structure a product that is tailored to the needs of a particular customer. We expect AIMS to be fully operational in our national call center by March 31, 2000 and believe that it will further increase our effectiveness in direct originations. We intend to introduce AIMS within our other mortgage origination channels by the end of 2000. Once AIMS has been fully implemented, we expect it will provide us with a single platform for mortgage loan originations across all channels and create operating and system efficiencies in our mortgage business. RISK-BASED PRICING In conjunction with the underwriting process, we manage risk in our mortgage business through risk-based pricing. Using our customized models, we analyze customer-specific data that is housed in our database, including both credit-related and non-credit customer attributes. Based on the results of this analysis, we are able to price the mortgage loans that we offer to a potential borrower to account for that borrower's risk profile. 5 7 This risk-based approach to pricing allows us to offer a variety of products and pricing structures that meet the customer's needs, consistent with our profitability goals. Under applicable federal law, Advanta National Bank and Advanta Bank Corp., our bank subsidiaries, may charge interest and assess prepayment penalties at the levels permitted by the laws of the state where the bank is located and may "apply" those rates and fees related to those rates on loans to borrowers in other states. We believe we have a competitive advantage in pricing our mortgage loan products because we are able to export interest rates and prepayment penalties on any of the loans that we originate through our bank subsidiaries. This provides us with greater flexibility in pricing and structuring mortgage loans. For the year ended December 31, 1999, 82% of our mortgage loan originations were originated and funded through Advanta National Bank and Advanta Bank Corp. SERVICING AND COLLECTIONS Advanta Mortgage performs the servicing for its mortgage loans. Our servicing activities consist principally of: - collecting and posting all payments; - responding to inquiries of customers or federal, state or local government authorities; - investigating delinquencies; - initiating contact with borrowers who are delinquent in payment of a loan installment; - supervising foreclosures and property dispositions in the event of unremedied defaults; - reporting tax information to mortgagors; - accounting for collections; - furnishing monthly and annual statements to the trustee for our securitization trusts; and - with respect to securitization transactions, making payment advances when required. In addition, Advanta Mortgage services the home equity loans of unaffiliated third parties for a fee through its subservicing business. Advanta Mortgage's subservicing portfolio totaled approximately $11.9 billion at December 31, 1999, as compared to $8.3 billion at December 31, 1998. We bear no risk of credit loss on the receivables in this portfolio of subserviced loans, and these loans are not included in our portfolio of managed assets. ADVANTA BUSINESS CARDS OVERVIEW Advanta Business Cards, a business unit of Advanta, is one of the nation's leading providers of business credit cards to small businesses. Advanta Business Cards offers MasterCard(R) business credit cards to small businesses using targeted direct mail and the Internet. The "Advanta Business Card" is issued and funded by Advanta Bank Corp. MasterCard licenses banks and other financial institutions, such as Advanta Bank Corp., to issue business credit cards using its trademark and to use its interchange network. Advanta Bank Corp. receives an interchange fee as compensation for the funding and credit and fraud risk it assumes when its cardholders use the Advanta Business Card. MasterCard sets the interchange fee as a percentage of each credit card transaction (currently averaging approximately 2.17%). Our standard product is a MasterCard business credit card that provides our customers with access, through merchants, banks and ATMs, to an instant unsecured revolving business credit line. Under the terms 6 8 of our cardholder agreements, our business cards may be used for business purposes only. We offer a number of benefits that we believe are important to small business owners including: - personalized company checks, which can be used at the same interest rate as credit card purchases; - additional cards for employees at no fee with the ability to set individual spending limits; - detailed quarterly and annual expense management reports that categorize purchases and itemize charges for record keeping and tax purposes; and - access to cash advances up to the full credit line at the same interest rate as credit card purchases. Our business credit card also offers free auto rental insurance, free purchase protection service for a specified time period and several free emergency assistance and referral services. On a limited basis, we also offer a bonus miles program for an annual fee. Under this program, the cardholder receives credit toward the purchase of airline tickets with each card purchase. Additionally, we offer a travel card. Use of the travel card entitles the cardholder to discounts at various hotels and restaurants along with all of the benefits described above. We expect to continue to expand our business credit card product offerings and look for innovative ways to tailor products to the unique needs of small businesses. The interest rate and credit line size we offer vary, and are ultimately determined based upon the credit history and creditworthiness of the borrower. At December 31, 1999, the average credit line was approximately $10,000. The interest rate, which is based on a LIBOR (London Interbank Offered Rate) index, will typically range from approximately 12% to 20%. In most cases, the rate will change with changes in LIBOR and is subject to a minimum below which the rate cannot fall. Advanta Business Cards generates interest and other income through finance charges assessed on outstanding loans, interchange income, and cash advance and other credit card fees. The managed portfolio of Advanta Business Cards grew from $815 million at December 31, 1998 to $1.04 billion at December 31, 1999. In 1999, approximately 21% of Advanta's total revenues were derived from Advanta Business Cards. ORIGINATIONS Advanta Business Cards originates substantially all of its accounts using direct marketing techniques. The primary sources of new accounts are direct mail advertising to prospective customers and the Internet. The Advanta Business Cards marketing program is the result of extensive ongoing testing of various marketing campaigns that target different segments of the small business market. The success of each campaign is measured by both the cost of acquisition of new business and the credit performance of the resulting business. Advanta Business Cards originated over 140,000 new accounts during the year ended December 31, 1999. During 1999, we successfully applied our information based strategy in this business to expand the universe of potential business card customers. Additionally, in July 1999 Advanta Business Cards became one of the first business card issuers to offer instant credit decisions over the Internet. We believe that many of our business card customers will prefer to receive their statements and other customer service activities over the Internet. Therefore, we plan to strengthen our Internet capabilities in this business during 2000. We believe that developing our Internet capabilities can decrease both the account acquisition and servicing costs for this business. UNDERWRITING AND RISK-BASED PRICING Advanta Business Cards has developed sophisticated modeling techniques for assessing the creditworthiness of potential cardholders. Because the owner or other authorized officer of our small business customer is a co-obligor on our business credit card account, we consider credit-related and other relevant data about both the business and the individual in our assessment of the creditworthiness of potential cardholders. Through the application process, we verify the applicant's demographic information and collect current sales and income statistics. This information, coupled with credit reports received from external credit reporting agencies, forms 7 9 the basis for our decision to extend credit. Using a proprietary scoring system, we rank our prospective cardholders based upon their expected creditworthiness and profitability potential. Upon the completion of credit assessment and identification of potential cardholders that meet our criteria via the initial screening process, we offer a range of potential interest rates for which the cardholder may be eligible. These offers are subject to verification of information provided by the potential cardholder through the application process. If the applicant is approved, the actual interest rate and credit line size assigned reflects the level of risk in the cardholder's creditworthiness. When a cardholder is first approved, our profile of that cardholder is limited and based solely on historical information. As we compile information regarding each cardholder's behavior over time, we maintain and continually update our performance database. We believe that the information we gather over time regarding actual account performance and cardholder behavior becomes a better indicator of future performance than the criteria initially used to score the cardholder. Therefore, we periodically re-score the cardholder based on all of the information we accumulate, and use this information to evaluate and potentially adjust the interest rate and the credit line size that we make available to the cardholder. With 30 days notice, we may reprice any account at our discretion, typically based upon changes in a cardholder's credit standing. The credit line size may also be adjusted up or down based on our continual credit monitoring. To discourage delinquent payments, we use "penalty pricing" and automatically apply a 3% increase to the interest rate on any account that is two payment cycles delinquent. SERVICING AND COLLECTIONS Advanta Business Cards performs most of the servicing for our business credit card accounts. Other data processing and administrative functions associated with the servicing of our business credit card portfolio are outsourced to First Data Resources, Inc., including: authorizing transactions through the MasterCard system; performing billing and settlement processes; generating and monitoring monthly billing statements; and issuing credit card plastics and new account agreements. Advanta Business Cards has a collections staff that performs the collection activities for our business credit cards. Accounts are recognized as delinquent one day after a monthly cycle in which no payment is received for an account that had a balance in the prior billing cycle. Collection activity involves contacting the cardholder and taking other appropriate actions. We continually monitor the effectiveness of our collection efforts and make process improvements as we deem necessary. Advanta Business Cards discourages delinquent payments by assessing a late fee. In addition, the collections staff aggressively pursues late payments. In cases where our collection efforts are unsuccessful, the account balance is "charged-off" 180 days after the payment due date. However, we continue to pursue recovery over a longer time period in cases where we believe full or partial payment is probable. For accounts for which we have received a notice of a bankruptcy of the business, we use a 90-day investigation period to determine whether we should challenge the bankruptcy petition or the discharge of amounts owed to us. Following that 90-day period, we charge off the outstanding balance. ADVANTA LEASING SERVICES OVERVIEW Advanta Leasing Services, a business unit of Advanta, offers flexible lease financing programs to small businesses. The primary products that we offer through our leasing business consist of leases for small-ticket items such as computers, copiers, fax machines and other office equipment. Advanta Leasing Services originates and funds its leases and other equipment financing arrangements through Advanta Bank Corp. Advanta Leasing Services uses direct mail and telemarketing to market its products. Repeat business from existing customers generates additional business. 8 10 Our leases are generally priced on a fixed rate basis. The average lease size is approximately $13,400 and the average lease term is 47 months. Managed lease receivables at December 31, 1999 totaled approximately $796 million, compared to approximately $670 million at December 31, 1998. Advanta Leasing Services originated leases in the amount of approximately $454 million for the year ended December 31, 1999 and approximately $328 million for the year ended December 31, 1998. In 1999, approximately 9% of Advanta's total revenues were derived from Advanta Leasing Services. ORIGINATIONS Advanta Leasing Services originates leases through marketing programs, vendors, brokers and bulk or portfolio purchases. Advanta Leasing Services establishes both formal and informal relationships with equipment vendors. As a result of previous transactions with Advanta Leasing Services, vendors may recommend that prospective customers make a credit application to Advanta Leasing Services for financing. A more formal program between Advanta Leasing Services and a vendor may offer prospective customers financing at pre-arranged rates, based upon the vendor's equipment, and terms and conditions approved by Advanta Leasing Services. Advanta Leasing Services also originates contracts through the use of brokers. In a typical broker transaction, the broker refers potential customers to Advanta Leasing Services and the broker is paid a referral fee. In order to maximize the profitability of our leasing business, we are leveraging our information based strategy to change the strategic focus. We are planning to shift the focus away from those broker sources that do not meet our profitability objectives to more profitable vendor and direct origination channels. UNDERWRITING In connection with the origination or acquisition of leases, Advanta Leasing Services performs a thorough credit review of all prospective customers. The credit review process typically begins when the prospective customer completes a credit application. We enter the completed credit application into our computerized application processing system called the Advanced Credit Entry System, or ACE. We can enter applications into ACE internally, or applications can be entered externally by third parties, such as brokers or vendors. Our credit decision is based on several credit-related attributes using our customized credit scoring model. Credit applications can be automatically approved or rejected based on the dollar amount of the application and a credit score falling within a range in the model. For those credit applications not falling within a specified dollar amount and/or credit score, we base our credit decision on an analysis by our credit staff utilizing underwriting criteria developed by Advanta Leasing Services. In addition, we have personnel in our credit department who are dedicated to performing reviews of potential new vendors and brokers to ensure compliance with our overall credit policies and procedures. In reviewing new relationships with vendors and brokers, Advanta Leasing Services considers, among other things, length of time in business, bank, credit and trade references, Dunn & Bradstreet reports, and credit bureau reports on all of the officers of the vendor being reviewed. SERVICING AND COLLECTIONS Advanta Leasing Services performs collection activities with respect to delinquent contracts. Each lease contract has a provision for assessing late charges in the event that a customer fails to make a payment on the contract on the related due date. We typically initiate telephone contact when an account is between one and 16 days past due, depending on certain established criteria. Telephone contact is continued throughout the delinquency period. If the account continues to be delinquent, Advanta Leasing Services may exercise any remedies available to it under the terms of the contract, including termination and acceleration of the lease contract. We evaluate each contract on the merits of the individual situation taking into consideration the equipment value and the current financial strength of the customer. 9 11 If collection activities are unsuccessful, we typically charge off the account at 121 days past due. An account may be charged off prior to 121 days if we determine that there will be no further payments made. At the time an account is charged-off, the account is referred to Advanta Leasing Services' in-house litigation department to determine whether to pursue the customer or any personal guarantor on the contract through litigation. If we determine not to pursue an account through litigation it may be referred to a third party collection agency to enforce the original terms of the contract. In cases where the customer files for bankruptcy, the Advanta Leasing Services' legal recovery department follows up with the debtor to determine whether the debtor intends to assume or reject the contract. In many cases, although the customer has filed for bankruptcy protection from its creditors, it continues to make regular payments on its contract. OTHER BUSINESSES ADVANTA INSURANCE COMPANIES Our life/health and property/casualty insurance subsidiaries, Advanta Life Insurance Company and Advanta Insurance Company, respectively, provide insurance and related products to two distinct markets, existing Advanta customers and the public at large. Together with unaffiliated insurance carriers, we offer specialty credit-related insurance products and services to our existing mortgage, business credit card and leasing customers. Advanta Insurance uses direct mail marketing and telemarketing to enroll customers in these programs. The focus of these products is on the customers' ability to repay their debt. These products include coverage for loss of life, disability, involuntary unemployment, accidental death, and lost or damaged equipment. Our insurance subsidiaries generally reinsure all or a portion of the risks associated with these products or services. Under reinsurance agreements our insurance subsidiaries assume a proportional quota share of the risk from the unaffiliated insurance carriers. In consideration for assuming these risks, our insurance subsidiaries receive reinsurance premiums equal to the proportional percentage of the net premiums collected by the insurance carriers, less a ceding fee as defined by the reinsurance treaties, and proportional acquisition expenses, premium taxes and loss payments made by the carriers on these risks. Advanta Insurance also markets insurance and related products and services of third parties to the public at large. During 1999 we increased our focus on this market. Through a strategic alliance with Progressive Casualty Insurance Company formed in 1996 for an initial term of 5 years, Advanta Insurance provides its direct marketing expertise to market Progressive's automobile insurance policies nationwide. Generally, Progressive's automobile policies provide for automobile liability protection up to $500,000 and automobile physical damage protection up to $100,000, as defined under specific policy and customer requirements. As part of the alliance, Advanta Insurance Company and Progressive have also entered into a quota share reinsurance agreement that provides that Advanta Insurance Company assumes 50% of all risks and expenses on automobile policies written by Progressive under the insurance programs being marketed. Through other strategic alliances or partnership arrangements, we are developing and testing the market for a number of new products including critical illness, term life with no medical exam, and disability insurance. We are currently testing a product that permits customers to receive discounts on prescriptions, dental services and certain other health related goods and services at the point of sale. Each of these efforts is designed to take advantage of our unique skills in database and information management, analysis and targeted direct marketing. In addition, prior to the closing of the Consumer Credit Card Transaction, we offered credit-related insurance products to our consumer credit card customers. Our insurance subsidiaries no longer reinsure these insurance risks. Our insurance subsidiaries are, however, obligated to reimburse the unaffiliated insurance carriers for losses and loss adjustment expenses paid on losses incurred on risks assumed on or before February 20, 1998; and our insurance subsidiaries maintain loss and loss expense reserves for these losses and expenses. 10 12 ADVANTA PARTNERS Advanta Partners LP, formed in 1994, is our private equity investment affiliate. This entity focuses primarily on growth capital financings, restructurings and management buyouts in the financial services, electronic commerce customer service, and other consumer and data information management services industries. The investment objective of Advanta Partners LP is to earn attractive returns by building the long-term values of the businesses in which it invests. Advanta Partners LP combines transaction expertise, management skills and a broad contact base with strong industry-specific knowledge. DEPOSITORY INSTITUTIONS We own two depository institutions, Advanta National Bank and Advanta Bank Corp. Advanta National Bank is a national banking association organized under the laws of the United States of America with its headquarters and sole branch currently located in Wilmington, Delaware. Advanta currently conducts a large portion of Advanta Mortgage's business and, before to February 20, 1998, conducted a large portion of its consumer credit card business through Advanta National Bank. Advanta Bank Corp. is an industrial loan corporation organized under the laws of the State of Utah with its principal executive offices located in Salt Lake City, Utah. Currently, Advanta Bank Corp.'s principal activities consist of the issuance of the "Advanta Business Card" credit card, small ticket equipment lease financing and originating and servicing a portion of Advanta Mortgage's mortgage loans. DEPOSIT, SAVINGS AND INVESTMENT PRODUCTS Deposits with each of our bank subsidiaries are insured by the FDIC. Our banks offer a range of insured deposit products that are used to fund loan and lease originations at the banks. Advanta National Bank's deposit products include money market savings accounts, retail certificates of deposit and large denomination certificates of deposit of $99,000 or more. Advanta Bank Corp.'s deposit products include retail certificates of deposit and large denomination certificates of deposit of $99,000 or more. At December 31, 1999, we had total deposits of $1.5 billion at our banks, compared to $1.8 billion as of December 31, 1998. The banks generate retail deposits from repeat deposits from existing customers and from new depositors attracted by direct mail solicitations, newspaper and other media advertising and over the Internet. Since 1951, Advanta Corp. and its predecessor Teachers Service Organization, Inc. have offered unsecured debt securities of Advanta Corp., in the form of RediReserve Certificates and Investment Notes to retail investors through Advanta's retail note programs. These debt securities are a secondary funding source for Advanta Corp. and provide funding diversity. These debt securities have been sold predominantly on a direct basis by Advanta Corp. in select states. The RediReserve Variable Rate Certificates are payable on demand and the maturities on the Investment Notes range from 91 days to ten years. The RediReserve Certificates and Investment Notes generally require an initial minimum investment of $5,000 and are obligations of Advanta Corp. that are not insured or guaranteed by any public or private entity. We change the interest rates that we offer frequently, depending on market conditions and our funding needs. The rates also vary depending on the size of each investment. As of December 31, 1999, $235.3 million of RediReserve Certificates and Investment Notes were outstanding with interest rates ranging from 6.02% to 11.34%. GOVERNMENT REGULATION ADVANTA CORP. Advanta Corp. is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA"). We own Advanta National Bank, which is a "bank" as defined under the BHCA as amended by the Competitive Equality Banking Act of 1987 ("CEBA"). However, under grandfathering provisions of CEBA, we are not required to register as a bank holding company because Advanta National Bank, which takes demand deposits but does not make commercial loans, did not come within the BHCA definition of the term "bank" prior to the enactment of CEBA. Under CEBA, our other 11 13 banking subsidiary, Advanta Bank Corp., is not considered a "bank" for purposes of the BHCA. Accordingly, our ownership of it does not impact our exempt status under the BHCA. Under CEBA, Advanta National Bank is subject to certain restrictions, such as limiting its activities to those in which it was engaged prior to March 5, 1987 and not acquiring control of more than 5% of the stock or assets of an additional "bank" or "savings association," as these terms are defined in the BHCA. Before September 30, 1996, CEBA also contained restrictions that limited Advanta National Bank's growth rate to not more than 7% per year. This growth cap of 7% was eliminated in September 1996 by an amendment to the BHCA, creating substantial new flexibility for asset liability management at Advanta National Bank. On November 12, 1999, the Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "Financial Modernization Act") was adopted and it will become effective on May 12, 2000. The Financial Modernization Act will further ease some of the limitations on Advanta National Bank that are imposed by CEBA, including restrictions that prohibit Advanta National Bank from cross-marketing products or services of an affiliate that are not permissible products or services for bank holding companies under the BHCA. The elimination of this restriction will create additional flexibility for us in the marketing of our financial services products. Because we are not a bank holding company, we are not subject to examination by the Federal Reserve Board, other than for purposes of assuring continued compliance with CEBA restrictions, as discussed above. Prior to the enactment of the Financial Modernization Act, if Advanta Corp. or Advanta National Bank had ceased complying with the restrictions set forth in CEBA, registration as a bank holding company under the BHCA would be required. Registration as a bank holding company is not automatic and would subject us and our subsidiaries to inspection and regulation by the Federal Reserve Board. Under the Financial Modernization Act, should Advanta Corp. or Advanta National Bank fail to comply with any of the restrictions applicable to them under CEBA, there will be a 180-day right to cure period following receipt of a notice from the Federal Reserve Board. During the cure period we will be required to either cease or correct the activity that is not in compliance, or submit to the Federal Reserve Board a plan to cease the activity within a timely manner that is not in excess of one year and implement procedures that will avoid a reoccurrence of the activity. The opportunity to cure or remediate an activity that is out of compliance significantly reduces the risk that Advanta Corp. will be required to register as a bank holding company under the BHCA. ADVANTA NATIONAL BANK Advanta National Bank is subject to regulation and periodic examination, primarily by the Office of the Comptroller of the Currency (the "OCC"). The OCC's regulations relate to the maintenance of reserves for certain types of deposits and other products offered by a bank, the maintenance of certain financial ratios, the terms on which a bank may engage in transactions with its affiliates and a broad range of other banking practices. As a national bank, Advanta National Bank is also subject to provisions of federal law which restrict its ability to extend credit to its affiliates or pay dividends to Advanta Corp. Advanta National Bank is subject to capital adequacy guidelines issued by the Federal Financial Institutions Examination Council (the "FFIEC"). These guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and consider off-balance sheet exposures in determining capital adequacy. Under the rules and regulations of the FFIEC, at least half of a bank's total capital is required to be "tier I capital," comprised of common equity, retained earnings and a limited amount of non-cumulative perpetual preferred stock. The remaining capital, "tier II capital," may consist of other preferred stock, certain hybrid debt/equity instruments, a limited amount of term subordinated debt or a limited amount of the reserve for possible credit losses. The FFIEC has also adopted minimum leverage ratios for national banks, which are calculated by dividing tier I capital by total average assets. Recognizing that the risk-based capital standards address only credit risk, and not interest rate, liquidity, operational or other risks, many national banks are expected to maintain capital in excess of the minimum standards. In addition, pursuant to provisions of the FDIC Improvement Act of 1991 (the "FDICIA") and related regulations with respect to prompt corrective action, FDIC-insured institutions such as Advanta National 12 14 Bank may only accept brokered deposits without FDIC permission if they meet specified capital standards, and are subject to restrictions with respect to the interest they may pay on deposits unless they are "well-capitalized." To be "well-capitalized," a bank must have a ratio of combined tier I and tier II capital to risk-weighted assets of not less than 10%, tier I capital to risk-weighted assets of not less than 6%, and a tier I leverage ratio of not less than 5%. Advanta National Bank's ratio of combined tier I and tier II capital to risk-weighted assets was 14.86% as of December 31, 1999, and 12.12% as of December 31, 1998. In each case, Advanta National Bank had capital levels that met the definition of "well-capitalized" under the regulatory framework for prompt corrective action. ADVANTA BANK CORP. Advanta Bank Corp., a Utah-chartered industrial loan corporation, is a depository institution subject to regulatory oversight and examination by both the FDIC and the Utah Department of Financial Institutions. Under its banking charter, Advanta Bank Corp. may make consumer and commercial loans and may accept all FDIC-insured deposits other than demand deposits such as checking accounts. Advanta Bank Corp. is subject to the same regulatory and supervisory processes as commercial banks. Advanta Bank Corp. is subject to provisions of federal law which restrict and control its ability to extend credit and provide or receive services between affiliates. Advanta Bank Corp. is subject to the same FFIEC capital adequacy guidelines as Advanta National Bank. See "Business -- Government Regulation -- Advanta National Bank." In addition, the FDIC has regulatory authority to prohibit Advanta Bank Corp. from engaging in any unsafe or unsound practice in conducting its business. Advanta Bank Corp.'s combined total capital ratio of tier I and tier II capital to risk-weighted assets was 13.28% as of December 31, 1999 and 14.13% as of December 31, 1998. In each case, Advanta Bank Corp. had capital levels that met the definition of "well-capitalized" under the regulatory framework for prompt corrective action. LENDING AND LEASING ACTIVITIES Our lending activities are also subject to regulation under various federal and state laws including the Truth-in-Lending Act, the Home Ownership and Equity Protection Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Community Reinvestment Act, the Electronic Funds Transfer Act, the Real Estate Settlement Procedures Act and the Fair Credit Reporting Act. Provisions of these statutes and related regulations require disclosure to borrowers of finance charges in terms of an annual percentage rate, prohibit discriminatory practices in extending credit, require our FDIC-insured banking institutions to serve the banking needs of their local communities and regulate the dissemination and use of information relating to a borrower's creditworthiness. Certain of these statutes and regulations also apply to our leasing activities. In addition, some of our direct and indirect subsidiaries that are engaged in our mortgage business are subject to licensure and regulation in various states as mortgage bankers, mortgage brokers, and originators, sellers and servicers of mortgage loans. DIVIDENDS There are various legal limitations on the extent to which Advanta National Bank can supply funds through dividends to Advanta Corp. The prior approval of the OCC is required if the total of all dividends declared by Advanta National Bank in any calendar year exceeds its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus accounts. In addition, Advanta National Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts. The OCC also has authority under the Financial Institutions Supervisory Act to prohibit a national bank from engaging in any unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the OCC could claim that a dividend payment might be an unsafe or unsound practice. 13 15 During 1998, in connection with the Consumer Credit Card Transaction, the OCC approved the payment of a special dividend/return of capital of $1.3 billion from Advanta National Bank to Advanta Corp. As a result of this extraordinary dividend and the dividend restrictions described above, Advanta National Bank will not be eligible to declare any dividends to Advanta Corp. without the OCC's prior approval until at least the first quarter of 2001. Although Advanta Bank Corp. is not subject to specific limitations on its ability to pay dividends, it is possible, depending upon the financial condition of Advanta Bank Corp. and other factors, that the FDIC could claim that a dividend payment might be an unsafe or unsound practice. In this event, Advanta Bank Corp. would be limited in its ability to pay dividends to Advanta Corp. TRANSFERS OF FUNDS Sections 23A and 23B of the Federal Reserve Act also impose restrictions on Advanta National Bank and Advanta Bank Corp. These restrictions limit the transfer of funds by the depository institution to certain of its affiliates, including Advanta Corp., in the form of loans, extensions of credit, investments or purchases of assets. These transfers by any one depository institution to us or any other single affiliate are limited in amount to 10% of the depository institution's capital and surplus, and transfers to all affiliates are limited in the aggregate to 20% of the depository institution's capital and surplus. These loans and extensions of credit are also subject to various collateral requirements. Sections 23A and 23B of the Federal Reserve Act also require generally that the depository institution's transactions with its affiliates be on terms no less favorable to the bank than comparable transactions with unrelated third parties. In addition, in order for us to maintain our grandfathered exemption under CEBA, Advanta National Bank is not permitted to make any loans to us or any of our subsidiaries. REGULATION OF INSURANCE Our insurance subsidiaries are subject to the laws and regulations of, and supervision by, the states in which they are domiciled or have obtained authority to transact insurance business. These states have adopted laws and regulations which govern all insurance policy underwriting, rating, licensing, marketing, administration and financial operations of an insurance company, including dividend payments and financial solvency. In addition, our insurance subsidiaries have registered as an Arizona Holding Company which requires an annual registration and the approval of certain transactions between all affiliated entities. The maximum dividend that any of our insurance subsidiaries can distribute to Advanta Corp., in any twelve month period without prior approval of the State of Arizona Department of Insurance is the lesser of: - 10% of the subsidiary's statutory surplus; or - for any given twelve-month period, its net income, if it is a life insurance company; or - for any given twelve-month period, its net investment income, if it is a property and casualty insurance company. In 1999, Advanta Life Insurance Company declared and paid dividends to Advanta Corp. in the amount of $1.2 million. In 1998, Advanta Insurance Company declared and paid dividends in the amount of $37.5 million to Advanta Corp., of which $35.0 million was classified as an extraordinary dividend. Advanta Insurance Company applied for and received approval from The Arizona Department of Insurance to pay this extraordinary dividend. Also in 1998, Advanta Life Insurance Company declared and paid dividends in the amount of $1.2 million to Advanta Corp. The State of Arizona has adopted minimum risk-based capital standards as developed by the National Association of Insurance Commissioners. Risk-based capital is the quantification of an insurer's investment, underwriting, reserve and business risks in relation to its total adjusted capital and surplus. The ratio of an insurer's total adjusted capital and surplus is compared to various levels of risk-based capital to determine what intervention, if any, is required by either the insurance company or an insurance department. As of 14 16 December 31, 1999, our insurance subsidiaries met all risk-based capital standards and required no intervention by any party. Our insurance subsidiaries reinsure risks using underwriting insurance practices and rates which are regulated in part or fully by state insurance departments. State insurance departments continually review and modify these rates based on prior historical experience. Any modifications may impact the future profitability of our insurance subsidiaries. LEGAL DEVELOPMENTS Because the banking and finance businesses in general are the subject of the extensive regulation described above at both the state and federal levels, and because numerous legislative and regulatory proposals are advanced each year which, if adopted, could affect our profitability or the manner in which we conduct our activities, we cannot predict the extent of the impact of any new laws or regulations. Various legislative proposals and initiatives relating to the banking and finance businesses have been or will be introduced in Congress. Recently, an FDIC discussion draft proposal has been made public relating to capital requirements of subprime lenders. Under the proposal, regulatory capital required to be held for certain mortgage or other loans that are considered subprime would be increased. We are primarily in the lending and leasing businesses. At this time we have not yet quantified the amount of our mortgage, business credit card and lease receivables that could be categorized as "subprime" under the FDIC's proposal. If a substantial portion of our loan and lease receivables were to meet the FDIC's proposed definition of "subprime" and the draft proposal were to be adopted, the increased regulatory capital requirements could have a negative impact on our financial results. This is one of several regulatory and legislative initiatives focused on the subprime mortgage business that potentially could impact the manner in which we conduct our business and our financial results. Other federal legislative proposals and initiatives that could impact our businesses include financial privacy initiatives that would restrict the permissible use of customer-specific financial and other credit information, and statutory changes to the Real Estate Settlement Procedures Act, the Truth in Lending Act and the Home Ownership Equity Protection Act. Additionally, a number of states are considering, and others likely will consider, legislative and regulatory initiatives related to subprime mortgage lending and financial privacy. It is impossible to determine whether any of these proposals or initiatives will be adopted or occur and, if so, the magnitude of any impact they will have on the manner in which we conduct our business and our financial results. COMPETITION As a marketer of financial services and credit products, we face intense competition from numerous financial services providers. Many of these companies are substantially larger and have more capital and other resources than we do. Competition among lenders can take many forms, including convenience in obtaining a loan, customer service, size of loans, interest rates, prepayment penalties and other types of finance or service charges, duration of loans, the nature of the risk the lender is willing to assume and the type of security, if any, required by the lender. Although we believe we are generally competitive in most of the geographic areas in which we offer our services, there can be no assurance that our ability to market our services successfully or to obtain an adequate yield on our loans will not be impacted by the nature of the competition that now exists or may develop. In seeking investment funds from the public, we face competition from banks, savings institutions, money market funds, mutual funds, credit unions and a wide variety of private and public entities that sell debt securities, some of which are publicly traded. Many of our competitors are larger and have more capital and other resources than we have. Competition relates to matters such as: rate of return, collateral, insurance or guarantees applicable to the investment, if any; the amount required to be invested; convenience and the cost to and conditions imposed upon the investor in investing and liquidating the investment, including any commissions which must be paid or interest forfeited on funds withdrawn; customer service; service charges, if any; and the taxability of interest. 15 17 EMPLOYEES As of December 31, 1999, we had 2,643 employees. We believe that we have good relationships with our employees. None of our employees are represented by a collective bargaining unit. CAUTIONARY STATEMENTS Information or statements provided by the Company from time to time may contain certain "forward-looking information" including information relating to anticipated earnings per share, anticipated returns on equity, anticipated growth in loans outstanding and credit card accounts, anticipated net interest margins, anticipated operations costs and employment growth, anticipated prepayment rates of outstanding loans, anticipated marketing expense or anticipated delinquencies and charge-offs. The cautionary statements provided below are being made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995 (the "Act") and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act for any such forward-looking information. We caution readers that any forward-looking information provided by us is not a guarantee of future performance and that actual results may differ materially from those in the forward-looking information as a result of various factors, including but not limited to: - Increased credit losses and collection costs associated with a worsening of general economic conditions, rising interest rates, declining real estate values, shifts in product mix within our portfolio of loans, rising delinquency levels, increases in the number of customers seeking protection under the bankruptcy laws, resulting in accounts being charged off as uncollectible, and the effects of fraud by third parties or customers. - Intense and increasing competition from numerous providers of financial services who may employ various competitive strategies. We face competition from national, regional and local originators of non-conforming mortgages, business credit cards and business equipment leases, some of which have greater resources than we do. - The effects of interest rate fluctuations on our net interest margin and the value of our assets and liabilities; the continued legal or commercial availability of techniques (including interest rate swaps and similar financial instruments, loan repricing, hedging and other techniques) that we use to manage the risk of such fluctuations and the continuing operational viability of those techniques and the accounting and regulatory treatment of such instruments. - Difficulties or delays in the securitization of our receivables and the resulting impact on the cost and availability of such funding. Such difficulties and delays may result from changes in the availability of credit enhancement in securitizations, the current economic, legal, regulatory, accounting and tax environments and adverse changes in the performance of the securitized assets. - The amount, type and cost of financing available to us, including secured financing, and any changes to that financing including any impact from changes in the current economic, legal, regulatory, accounting and tax environments, adverse changes in the performance of our owned loan portfolio, any impact from changes in our debt ratings and the activities of parties with which we have agreements or understandings, including any activities affecting any investment. - Changes in our aggregate accounts, loan balances or subserviced receivables volume, and the growth rate thereof, including changes resulting from factors such as shifting product mix, amount of actual marketing investment made by us, prepayment of loan balances, changes in relationships with significant customers and general economic conditions and other factors beyond our control. - The impact of "seasoning" (the average age of a lender's portfolio) on our level of delinquencies and losses which may require a higher allowance for loan losses for on-balance sheet assets and may adversely impact mortgage and business loan and lease securitization income. The addition of account originations or balances and the attrition of such accounts or balances could significantly impact the seasoning of our overall portfolio. 16 18 - The amount of, and rate of growth in, our expenses (including employee and marketing expenses) as our businesses develop or change and we expand into new market areas; the acquisition or disposition of assets (interest-earning, fixed or other); the effects of changes within our organization or in our compensation and benefit plans; and the impact of unusual items resulting from the ongoing evaluation of our business strategies, asset valuations and organizational structures. - Difficulties or delays in the development, production, testing and marketing of products or services, including, but not limited to, a failure to implement new product or service programs when anticipated, the failure of or delay in customers' acceptance of these products or services, losses associated with the testing of new products or services or financial, legal or other difficulties as may arise in the course of such implementation. - The effects of, and changes in, tax laws, rates, regulations and policies. - The effects of, and changes in, social conditions and general economic conditions, including inflation. - The effects of, and changes in, the level of scrutiny, regulatory requirements and regulatory initiatives resulting from the fact that our banking and finance businesses are highly regulated and subject to review and examination by federal and state regulators, including the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. - The effects of, and changes in, monetary and fiscal policies, federal and state laws and regulations (financial, consumer, regulatory or otherwise), and other activities of governments, agencies and other similar organizations, including the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. - The costs and other effects of legal and administrative cases and proceedings, settlements and investigations, claims and changes in those items, developments or assertions by or against us or any of our subsidiaries; adoptions of new, or changes in existing, accounting policies and practices and the application of such policies and practices. ITEM 2. PROPERTIES. At December 31, 1999, Advanta owned two buildings in Horsham, Pennsylvania totaling 198,000 square feet. These buildings are primarily used by Advanta Mortgage and Advanta Business Cards. Advanta leased 109,511 square feet in Spring House, Pennsylvania for its principal executive offices as well as some of its Advanta Mortgage operations. Advanta leased an additional 39,203 square feet in two buildings in the Pennsylvania suburbs of Philadelphia that are used to support certain corporate staff functions. In the adjoining state of New Jersey Advanta owned one building consisting of 56,196 square feet and leased 24,090 square feet of office space in 2 buildings for its Advanta Leasing Services and Advanta Business Cards operations. In Delaware, Advanta leased 36,589 square feet of office space for Advanta National Bank. In New York, Advanta leased 4,873 square feet of office space for Advanta Partners. Advanta also leased an additional 164,650 square feet of office space located in 2 buildings in California for Advanta Mortgage and 50,625 square feet of office space in Utah for Advanta Bank Corp. In addition to these principal locations in Pennsylvania, New Jersey, New York, Delaware California and Utah, Advanta leased 76,843 square feet of office space in twenty-three states to support its Advanta Mortgage loan production offices. Advanta leased an additional 7,151 square feet of office space in seven states to support Advanta Mortgage and Advanta Leasing Services. Advanta leased a total of 5,995 square feet of surplus office space in four states as a result of office relocations related to Advanta Mortgage. Advanta sublets 5,112 square feet of this surplus office space to third parties and 883 square feet remain vacant. At December 31, 1999, the total leased and owned office space was 773,726 square feet. 17 19 ITEM 3. LEGAL PROCEEDINGS. On January 22, 1999, Fleet and certain of its affiliates filed a lawsuit against Advanta Corp. and certain of its subsidiaries in Delaware Chancery Court. Fleet's allegations, which Advanta denies, center around Fleet's assertions that Advanta has failed to complete certain post-closing adjustments to the value of the assets and liabilities Advanta contributed to the Fleet LLC in connection with the Consumer Credit Card. Fleet seeks damages of approximately $141 million. Advanta has filed an answer to the complaint denying the material allegations of the complaint, but acknowledging that Advanta contributed $1.8 million in excess liabilities in the post-closing adjustment process, after taking into account the liabilities Advanta has already assumed. Advanta also has filed a countercomplaint against Fleet for approximately $101 million in damages Advanta believes have been caused by certain actions of Fleet following closing of the Consumer Credit Card Transaction. Formal discovery has begun and is ongoing. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on the financial position or future operating results of Advanta. On or about March 26, 1999, a complaint was filed by John Uphaus, individually and on behalf of a class, against Household Bank (Nevada) N.A. ("Household") and Advanta National Bank in the United States District Court for the Northern District of Illinois. Uphaus alleges that he had a credit card account with Household, which account was purchased by Advanta National Bank. He further alleges that the annual percentage rate on a portion of his account was increased in a manner contrary to the promotional material he received. Advanta's preliminary investigation suggests that if a change in interest rate took place, as alleged by Uphaus, that change occurred after the contribution of Advanta's consumer credit card portfolio, and it was made by Fleet LLC. In any event, Fleet LLC is obligated to defend and indemnify Advanta pursuant to the Contribution Agreement and the Licensing Agreement between the parties. Advanta National Bank's response to this complaint was originally due on June 21, 1999. The court has extended this deadline several times to allow the parties to exchange information; thus, no response has been filed by either defendant. Advanta and its subsidiaries are involved in other legal proceedings, claims and litigation, including those arising in the ordinary course of business. Management believes that the aggregate liabilities, if any, resulting from those actions will not have a material adverse effect on the consolidated financial position or results of operations of Advanta. However, as the ultimate resolution of these proceedings is influenced by factors outside of Advanta's control, it is reasonably possible that Advanta's estimated liability under these proceedings may change. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. 18 20 EXECUTIVE OFFICERS OF THE REGISTRANT Each of the executive officers of Advanta Corp. and its subsidiaries listed below was elected by the applicable Board of Directors, to serve at the pleasure of the Board in the capacities indicated.
NAME AGE OFFICE DATE ELECTED - ------------------------------------------------------------------------------------------------------ Dennis Alter 57 Chairman of the Board and Chief Executive 1972 Officer William A. Rosoff 56 Vice Chairman of the Board and President 1996 Philip M. Browne 40 Senior Vice President and Chief Financial 1998 Officer George O. Deehan 57 Chief Executive Officer, Advanta Leasing 1998 Services James L. Shreero 39 Vice President and Chief Accounting Officer 1999
Mr. Alter became Executive Vice President and a Director of Advanta Corp.'s predecessor organization in 1967. He was elected President and Chief Executive Officer in 1972, and Chairman of the Board of Directors in August 1985. Mr. Alter has remained as Chairman of the Board since August 1985. In February 1986, he relinquished the title of President, and in August 1995 he relinquished the title of Chief Executive Officer. In October 1997, Mr. Alter reassumed the title of Chief Executive Officer. Mr. Alter is a director of Next Left, Inc. a privately held internet service company. Mr. Rosoff joined Advanta Corp. in January 1996 as a Director and Vice Chairman. In October 1999, Mr. Rosoff became President as well as Vice Chairman of the Board of Advanta Corp. Prior to joining Advanta Corp., Mr. Rosoff was a long time partner of the law firm of Wolf, Block, Schorr and Solis-Cohen LLP, Advanta Corp.'s outside counsel, where he advised Advanta Corp. for over 20 years. While at Wolf, Block, Schorr and Solis-Cohen LLP he served as Chairman of its Executive Committee and, immediately before joining Advanta Corp., as a member of its Executive Committee and Chairman of its Tax Department. Mr. Rosoff is a Trustee of Atlantic Realty Trust, a publicly held real estate investment trust. Mr. Browne joined Advanta Corp. in June 1998 as Senior Vice President and Chief Financial Officer. Prior to joining Advanta Corp., he was an Audit and Business Advisory Partner at Arthur Andersen LLP where, for over sixteen years, he audited public and private companies and provided business advisory and consulting services to financial services companies. Mr. Browne had served as the Arthur Andersen engagement partner for Advanta Corp. since 1994. Mr. Deehan was elected President and Chief Executive Officer of Advanta Leasing Services in December 1998. Prior to joining Advanta Leasing Services, Mr. Deehan served AT&T Capital a company. Mr. Deehan served AT&T Capital in various capacities, including serving as President of Information Technology Services for AT&T Capital, President and Chief Operating Officer of NCR Credit Corporation, and Senior Vice President of Marketing and Sales of AT&T Capital, Canada. Prior to joining AT&T Capital, Mr. Deehan held numerous positions with financial services companies. Mr. Shreero was elected Vice President and Chief Accounting Officer of Advanta Corp. in April 1999. Mr. Shreero has served as Senior Vice President of Advanta Corp.'s subsidiary, Advanta Mortgage Corp. USA since 1993. Prior to joining Advanta Corp., Mr. Shreero served as Senior Manager at Deloitte & Touche, a public accounting firm, from 1989 to 1993, where he performed audits of and provided business consulting services to financial services companies. 19 21 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. COMMON STOCK PRICE RANGES AND DIVIDENDS The Company's common stock is traded on the National Market System of The Nasdaq Stock Market, Inc. under the symbols ADVNB (Class B non-voting common stock) and ADVNA (Class A voting common stock). Following are the high, low and closing sale prices and cash dividends declared for the last two years as they apply to each class of stock:
CASH DIVIDENDS QUARTER ENDED: HIGH LOW CLOSE DECLARED - -------------- ------ ------ ------ --------- CLASS B: March 1998 $31.25 $19.69 $21.00 $.0756 June 1998 24.25 17.50 19.88 .0756 September 1998 20.56 8.25 10.50 .0756 December 1998 12.00 5.25 11.06 .0756 March 1999 $12.31 $ 7.75 $ 8.94 $.0756 June 1999 14.75 7.59 13.56 .0756 September 1999 19.13 11.38 11.75 .0756 December 1999 15.88 10.44 14.06 .0756 CLASS A: March 1998 $32.75 $21.00 $22.50 $.0630 June 1998 26.25 19.25 21.94 .0630 September 1998 22.75 9.38 12.88 .0630 December 1998 14.88 7.13 13.25 .0630 March 1999 $15.19 $10.31 $11.06 $.0630 June 1999 18.25 9.63 18.06 .0630 September 1999 23.94 14.63 14.63 .0630 December 1999 20.38 14.63 18.25 .0630
At December 31, 1999, the Company had approximately 805 and 315 holders of record of Class B and Class A common stock, respectively. Although the Company anticipates that comparable cash dividends will continue to be paid in the future, the payment of future dividends by the Company will be at the discretion of the Board of Directors and will depend on numerous factors including the Company's cash flow, financial condition, capital requirements and such other factors as the Board of Directors deems relevant. 20 22 ITEM 6. SELECTED FINANCIAL DATA FINANCIAL HIGHLIGHTS SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31, - ---------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------- Summary of Operations(1) Noninterest revenues $ 326,297 $ 417,392 $ 825,895 $ 799,570 $ 532,380 Interest revenues 246,226 245,340 436,860 354,927 249,566 Interest expense 167,676 184,275 324,558 269,700 166,032 Gain on transfer of consumer credit card business 0 541,288 0 0 0 Provision for credit losses 42,647 67,193 210,826 96,862 53,326 Minority interest in income of consolidated subsidiary 8,880 8,880 8,880 222 0 Operating expenses 337,061 379,764 621,961 522,952 350,685 Unusual charges(2) 16,713 125,072 0 0 0 Net income 49,818 447,880 71,625 175,657 136,677 - ---------------------------------------------------------------------------------------------------------- Per Common Share Data Net Income Basic Combined(3) $ 1.99 $ 16.65 $ 1.52 $ 4.15 $ 3.38 Class A 1.95 16.62 1.45 4.08 3.34 Class B 2.02 16.68 1.57 4.19 3.42 Diluted Combined(3) 1.96 15.71 1.50 3.89 3.20 Class A 1.93 15.69 1.43 3.86 3.18 Class B 1.99 15.73 1.54 3.91 3.22 Cash dividends declared Class A .252 .252 .440 .380 .290 Class B .302 .302 .528 .456 .348 Book value-combined 23.14 21.26 19.01 18.06 14.35 Closing stock price Class A 18.25 13.25 26.25 42.75 38.25 Class B 14.06 11.06 25.38 40.88 36.38 - ---------------------------------------------------------------------------------------------------------- Financial Condition -- Year End Investments and money market instruments(4) $ 1,387,655 $ 1,662,343 $ 2,092,292 $ 1,653,384 $ 1,089,317 Gross receivables Owned 1,480,305 1,120,360 3,352,236 2,618,392 2,732,933 Securitized 8,760,918 8,659,797 14,505,968 13,670,801 9,482,422 ------------------------------------------------------------------- Managed 10,241,223 9,780,157 17,858,204 16,289,193 12,215,355 Total serviced receivables(5) 22,142,890 18,058,485 27,039,669 19,981,285 12,838,272 Total assets Owned 3,689,662 3,721,420 6,655,915 5,583,959 4,524,259 Managed 11,977,045 12,065,183 20,945,748 19,141,467 13,943,506 Deposits 1,512,359 1,749,790 3,017,611 1,860,058 1,906,601 Long-term debt 788,508 1,030,147 2,248,172 2,305,081 1,279,190 Capital securities(6) 100,000 100,000 100,000 100,000 0 Stockholders' equity 589,631 560,304 926,950 852,036 672,964 - ---------------------------------------------------------------------------------------------------------- Selected Financial Ratios Return on average assets 1.34% 11.95% 1.09% 3.16% 4.06% Return on average common equity 8.82 82.76 8.47 25.31 26.15 Return on average total equity(7) 8.30 64.81 8.12 22.07 24.75 Equity/managed assets(7) 5.76 5.47 4.90 4.95 4.81 Equity/owned assets(7) 18.69 17.74 15.43 17.05 14.87 Dividend payout 15.67 1.62 33.34 10.75 9.97 As a percentage of managed receivables: Total loans 30 days or more delinquent(8) 8.2 7.7 6.0 5.4 3.3 Net charge-offs(8) 1.6 2.5 5.3 3.2 2.2 Operating expenses 3.3 3.6 3.4 2.9 2.9 - ----------------------------------------------------------------------------------------------------------
21 23 (1) Results through February 1998 include the results of the consumer credit card unit. (2) 1999 amounts included charges associated with cost reduction initiatives in the first quarter and additional costs associated with products exited in the first quarter of 1998. 1998 amounts included severance and outplacement costs associated with workforce reduction, option exercises and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer; expense associated with exited business/product and asset impairment; and equity losses related to exited business/product. (3) Combined represents a weighted average of Class A and Class B (see Note 1 to Consolidated Financial Statements). (4) Includes federal funds sold, restricted interest-bearing deposits, trading investments, investments available for sale and subordinated trust assets. (5) Represents total managed receivables plus contract servicing receivables. (6) Represents company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures of Advanta. (7) In 1999, 1998, 1997 and 1996, return on average total equity, equity/managed assets and equity/owned assets include capital securities as equity. The ratios without capital securities for 1999 were 8.82%, 4.92%, and 15.98%, respectively, for 1998 were 74.75%, 4.64% and 15.06%, respectively, for 1997 were 8.33%, 4.43% and 13.93%, respectively and for 1996 were 22.31%, 4.45%, and 15.26%, respectively. (8) Beginning in 1996, charge-off rates reflect the adoption of a new consumer credit card charge-off methodology. This new policy related to consumer credit card bankruptcies and provided up to a 90 day investigative period following notification of the bankruptcy petition prior to charge-off. 22 24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS OVERVIEW For the year ended December 31, 1999, we reported net income of $49.8 million or $1.96 per combined common share, assuming dilution, compared to $447.9 million or $15.71 per combined diluted common share for the year ended December 31, 1998. For the year ended December 31, 1997, we reported net income of $71.6 million or $1.50 per combined diluted common share. For the year ended December 31, 1999, net income (loss) was ($11.0) million for Advanta Mortgage, $22.8 million for Advanta Business Cards and $3.0 million for Advanta Leasing Services. The earnings reported for 1999 include unusual charges, after tax, of $4.1 million for severance and outplacement costs associated with cost cutting initiatives implemented in the first quarter of 1999 and $6.1 million of additional costs associated with products exited in the first quarter of 1998. In addition, in 1999 we recognized non-operating gains of $16.5 million, after tax, in connection with an investment held by Advanta Partners LP, our private equity investment affiliate, and other non-operating charges of $10.2 million related to our exit from the auto finance business. The earnings for the year ended December 31, 1999 also include a reduction in our retained interest-only strip of $19.4 million, after tax, reflecting the adoption of more conservative fair value assumptions, a $7.3 million after tax charge for the write-down of assets associated with the curtailment of the corporate finance business, and a tax benefit of $50.0 million related to the former consumer credit card business. Our earnings reported for 1998 reflect the $541.3 million gain on the Consumer Credit Card Transaction (see Note 9 to the Consolidated 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 Consumer Credit Card Transaction/Tender Offer, a $54.1 million pretax charge for expenses associated with exited businesses and products, $41.8 million of equity securities losses and an $8.7 million pretax charge for facility impairments. For the year ended December 31, 1998, net income (loss) was $25.1 million for Advanta Mortgage, $11.6 million for Advanta Business Cards and ($1.2) million for Advanta Leasing Services. In addition, included in the net income for 1998 was $10.2 million contributed by the consumer credit card business unit before the Consumer Credit Card Transaction. Net income for 1997 was $33.3 million for Advanta Mortgage, $3.0 million for Advanta Business Cards, $11.8 for Advanta Leasing Services, and $22.9 million for the consumer credit card business unit. ADVANTA MORTGAGE OVERVIEW Advanta Mortgage makes nonconforming home equity loans directly to consumers and through brokers. This business unit originates and services first and second lien mortgage loans, including home equity lines of credit, directly through subsidiaries of Advanta. In addition to servicing and managing the loans it originates, Advanta Mortgage contracts with third parties to service their nonconforming home equity loans on a subservicing basis. Our decision to grow the on-balance sheet portfolio of mortgage loans and reduce securitization income, as well as $32.0 million of charges associated with more conservative fair value assumptions related to our retained interests, resulted in Advanta Mortgage reporting a net loss of $11.0 million for the year ended December 31, 1999. This compares to net income of $25.1 million for the year ended December 31, 1998. During 1999, the retained interest-only strip and contractual mortgage servicing rights from Advanta Mortgage securitizations decreased by $75.2 million to $208.3 million at December 31, 1999 as compared to $283.5 million at December 31, 1998. On a pro forma portfolio lender basis, the net income of Advanta Mortgage was $30.3 million in 1999 and $15.6 million in 1998. See "Portfolio Lender Analysis." 23 25 Net income for Advanta Mortgage was $25.1 million for the year ended December 31, 1998, compared to $33.3 million for the year ended December 31, 1997. The decrease in net income in 1998 as compared to 1997 was partially a reflection of our decision to report income for Advanta Mortgage that is essentially equal to that of a portfolio lender, rather than the front-ended income typically reported through gain on sale accounting. During 1998, net income for Advanta Mortgage included a $51.0 million pretax charge recorded to adjust the retained interest-only strip to fair value reflecting increases in prepayment speeds experienced during the year. A similar charge of $42.4 million was recorded in 1997. SECURITIZATION INCOME Advanta Mortgage recognized gains of $120.5 million from the securitization and sale of $2.3 billion of loans in the year ended December 31, 1999, and recognized gains of $183.3 million from the securitization and sale of $4.9 billion of loans in the year ended December 31, 1998. Total Advanta Mortgage loan sales/ securitization volume decreased 54% for the year ended December 31, 1999, as compared to the year ended December 31, 1998. The decrease in sales/securitization volume resulted primarily from our decision to grow the portfolio of on-balance sheet loans and our decision to report income that is essentially equal to that of a portfolio lender. Total Advanta Mortgage sales/securitization volume in the year ended December 31, 1998 of $4.9 billion, increased 43% over the volume in the year ended December 31, 1997. The increase in sales/ securitization volume during 1998 resulted primarily from a 45% increase in mortgages originated. Gains on the sale of receivables, which represent 5.4% of the loans sold in the year ended December 31, 1999, are higher as a percentage of loans sold than the $183.3 million or 3.8% recognized in 1998, and the $114.4 million or 3.4% recognized in 1997. The increase in gain as a percentage of loans sold for both periods is primarily due to the higher proportion of loans sold that were directly originated. Typically, the gain realized from loans directly originated is higher than the gain from loans that are indirectly originated due to premiums paid to third parties for indirect loan originations. For the year ended December 31, 1999, direct originations represented 61% of Advanta Mortgage's total originations, as compared to 32% in 1998 and 25% in 1997. During 1999, the shift from indirect to direct originations also resulted in improved operating cash flow. Origination fees received from direct originations are a source of cash, whereas, premiums paid on indirect originations are a use of cash. For the year ended December 31, 1999, securitization income included a $32.0 million pretax charge associated with more conservative fair value assumptions related to retained interests. Securitization income included pretax charges of $51.0 million for the year ended December 31, 1998 and $42.4 million for the year ended December 31, 1997 to adjust the retained interest-only strip to fair value, reflecting increases in prepayment speeds experienced during those periods. The FASB is currently addressing several implementation issues relating to Statement of Financial Accounting Standards ("SFAS") No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." One of these issues relates to an exception SFAS No. 125 currently makes for FDIC-insured institutions. In certain circumstances, the FDIC has the authority to repudiate contracts and reclaim assets transferred. The FDIC, upon reclamation of assets from an FDIC-insured institution, would not be required by law to pay interest between the date of reclamation and the date of payment, which could indicate that the securitized assets would not meet the isolation from creditors criterion established in SFAS No. 125. This has potentially significant implications -- most obviously that many transfers of financial assets by FDIC-insured institutions would not meet the isolation test and would therefore be accounted for as secured borrowings. 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. The FDIC recently issued a proposed regulation addressing this issue. Under the FDIC's proposed regulation, subject to certain conditions, the FDIC will not seek to reclaim, recover, or re-characterize as property of an institution or a receivership estate, the financial assets or undivided interest in a loan transferred by an institution to a special purpose entity in connection with a securitization. The timing and ultimate resolution of this matter is uncertain at this time. 24 26 PORTFOLIO LENDER ANALYSIS Beginning in the fourth quarter of 1998, we began to report income for Advanta Mortgage 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, we intend to accomplish this by increasing our use of on-balance sheet funding and decreasing our degree of reliance on securitizations structured as sales over time. In this regard, we began to analyze and evaluate Advanta Mortgage's financial results from a portfolio lender's perspective as well as under generally accepted accounting principles. The following tables present Advanta Mortgage's reported results adjusted to approximate the results of a portfolio lender for the years ended December 31, 1999 and 1998.
($ IN THOUSANDS) YEAR ENDED DECEMBER 31, 1999 - ---------------- --------------------------------------- ADVANTA PRO FORMA MORTGAGE PRO FORMA PORTFOLIO AS REPORTED ADJUSTMENTS LENDER - ----------------------------------------------------------------------------------------------------- REVENUES: Securitization income $ 88,548 $ (88,548) $ 0 Interest income 133,367 710,969 844,336 Servicing revenues 99,235 (32,177) 67,058 Other revenues, net 4,538 0 4,538 - ----------------------------------------------------------------------------------------------------- Total revenues 325,688 590,244 915,932 - ----------------------------------------------------------------------------------------------------- EXPENSES: Operating expenses 230,088 7,449 237,537 Interest expense 89,619 462,880 552,499 Provision for credit losses 16,731 51,715 68,446 Minority interest in income of consolidated subsidiary 7,482 0 7,482 - ----------------------------------------------------------------------------------------------------- Total expenses 343,920 522,044 865,964 - ----------------------------------------------------------------------------------------------------- Income (loss) before income taxes (18,232) 68,200 49,968 Income tax (benefit) expense (7,238) 26,939 19,701 - ----------------------------------------------------------------------------------------------------- Net (loss) income $(10,994) $ 41,261 $ 30,267 - -----------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998 --------------------------------------- ADVANTA PRO FORMA MORTGAGE PRO FORMA PORTFOLIO AS REPORTED ADJUSTMENTS LENDER - ----------------------------------------------------------------------------------------------------- REVENUES: Securitization income $132,369 $(132,369) $ 0 Interest income 123,550 593,601 717,151 Servicing revenues 86,416 (31,016) 55,400 Other revenues, net 21,581 0 21,581 - ----------------------------------------------------------------------------------------------------- Total revenues 363,916 430,216 794,132 - ----------------------------------------------------------------------------------------------------- EXPENSES: Operating expenses 219,131 8,302 227,433 Interest expense 76,056 389,386 465,442 Provision for credit losses 25,577 46,074 71,651 Minority interest in income of consolidated subsidiary 7,395 0 7,395 - ----------------------------------------------------------------------------------------------------- Total expenses 328,159 443,762 771,921 - ----------------------------------------------------------------------------------------------------- Income before income taxes 35,757 (13,546) 22,211 Income tax expense 10,667 (4,064) 6,603 - ----------------------------------------------------------------------------------------------------- Net income $ 25,090 $ (9,482) $ 15,608 - -----------------------------------------------------------------------------------------------------
25 27 With respect to the pro forma portfolio lender results, individual line items are stated as if the securitized mortgages were still owned by Advanta and remained on the balance sheet. The pro forma adjustments (1) eliminate the gain on sale, including the servicing component, (2) reflect interest income, interest expense and operating expenses as if the sales had not occurred, and (3) eliminate the impact of valuation adjustments reflected in the reported results. The pro forma adjustment to provision for credit losses represents the amount by which the provision would have increased from that reported had the securitized Advanta Mortgage loans remained on the balance sheet and the provision for credit losses on the securitized loans been equal to actual reported charge-offs. The actual provision for credit losses of a portfolio lender could differ from the recorded charge-offs depending upon the age and composition of the portfolio and the timing of charge-offs. The increase in pro forma portfolio lender net income from $15.6 million in 1998 to $30.3 million in 1999 is due to our focus on direct-to-consumer originations and on profitable loan growth over volume. The increase is also a result of an increase in subservicing revenues due to the growth of the subservicing portfolio. LOAN ORIGINATIONS Advanta Mortgage generates loans through multiple origination channels. Home equity loans and lines of credit are originated directly from consumers using targeted direct mail and direct response television and radio techniques, and through our 60 loan production offices throughout the country. Mortgage loans are also originated indirectly through a network of over 600 brokers. In the past, Advanta Mortgage also generated loans indirectly through correspondent relationships and purchases from other financial institutions through its conduit and corporate finance operations. These indirect origination activities were curtailed during 1999. Prior to exiting the auto finance business in the first quarter of 1999, auto finance contracts were purchased from correspondent originators. "Advanta Mortgage loans" include home equity loans, home equity lines of credit and auto loans and exclude loans which were never owned by us, but which we service for a fee ("subservicing" or "contract servicing"). Originations for Advanta Mortgage were as follows:
YEAR ENDED DECEMBER 31, -------------------------------------- ($ IN THOUSANDS) 1999 1998 1997 - ----------------------------------------------------------------------------------------------- Direct $1,621,037 $1,655,399 $ 865,001 Broker 542,115 475,427 266,002 Conduit 449,848 1,752,968 1,238,339 Corporate Finance 37,939 1,325,447 1,103,083 Auto 5,103 104,350 194,807 - ----------------------------------------------------------------------------------------------- Total $2,656,042 $5,313,591 $3,667,232 - ----------------------------------------------------------------------------------------------- Number of accounts: Direct 35,515 29,846 16,172 Broker 6,200 5,856 3,663 Conduit 5,843 22,656 17,279 Corporate Finance 528 17,430 13,272 Auto 375 8,531 16,146 - ----------------------------------------------------------------------------------------------- Total 48,461 84,319 66,532 - -----------------------------------------------------------------------------------------------
The dollar volume of total Advanta Mortgage originations decreased 50% for the year ended December 31, 1999 as compared to the year ended December 31, 1998. The dollar volume of direct originations decreased 2% for the year ended December 31, 1999, as compared to 1998; however, the number of loans directly originated in 1999 increased 19% over the number of loans directly originated in 1998. The dollar volume of indirect mortgage originations decreased 71% for the year ended December 31, 1999 as compared to 1998, and the number of loans indirectly originated decreased by 73%. The increase in the number of loans directly originated reflects our decision to focus on direct-to-consumer originations using our information based strategy to identify accounts with enhanced profitability characteristics. The small decrease in the dollar volume of direct originations in 1999 is due to the decrease in the average loan size and our focus on profitable loan growth over volume. The decrease in indirect originations in 1999 over 1998 resulted from our decision to 26 28 curtail the purchase of pools of loans through the conduit and corporate finance channels. Consistent with the strategy of focusing on profitable loan growth over volume, the decision was based on unfavorable market pricing and management's commitment to purchasing loans only when the loans exceed certain profitability characteristics. The decrease in auto loan originations in 1999 was due to our exit from the auto finance business in the first quarter of 1999. The dollar volume of total 1998 originations for Advanta Mortgage increased 45% as compared to 1997. The dollar volume of direct mortgage originations for 1998 increased 91% from originations for 1997 and the dollar volume of indirect mortgage originations for 1998 increased 36% as compared to 1997. Direct originations increased because of our direct marketing experience and centralized telemarketing and processing capabilities. The increase in indirect originations in 1998 was the result of our strategy to grow the portfolio. Advanta Mortgage originated more second lien home equity loans and home equity lines of credit as a percentage of total originations during the year ended December 31, 1999 than it originated during 1998 or 1997. This was primarily due to rising market interest rates that created increased demand for these types of loans. Second lien home equity loans represented 24% of the dollar value of originations for the year ended December 31, 1999, compared to 9% for the year ended December 31, 1998 and 7% for the year ended December 31, 1997. Home equity lines of credit represented 10% of the managed mortgage loan portfolio at December 31, 1999, as compared to 5% at December 31, 1998. SERVICING REVENUES Advanta Mortgage earns servicing revenues on securitized receivables and on the subservicing portfolio. Servicing revenues were $99.2 million for the year ended December 31, 1999, as compared to $86.4 million for the year ended December 31, 1998 and $61.8 million for the year ended December 31, 1997. The increase in servicing revenues in both periods is due to an increase in average serviced receivables of $3.0 billion in 1999 and $3.8 billion in 1998. Advanta Mortgage's subservicing portfolio was $11.9 billion at December 31, 1999, as compared to $8.3 billion at December 31, 1998 and $9.2 billion at December 31, 1997. The increase in the subservicing portfolio in 1999 resulted primarily from growth in existing clients' portfolios. The decrease in subservicing receivables in 1998 resulted from the withdrawal of business by certain customers who began to service their own portfolios, and from higher prepayments in the subservicing portfolio. Revenues from our subservicing business are subject to volatility related to increases or decreases in the portfolios of existing clients. Additionally, this business is highly competitive and clients may elect to contract with other subservicers or service their own portfolios, or they may seek to renegotiate the pricing or other terms of their agreements with us. At December 31, 1999, two clients represented 66% of the portfolio of subservicing receivables. ADVANTA BUSINESS CARDS OVERVIEW Advanta Business Cards offers MasterCard business credit cards to small businesses using targeted direct mail and the Internet. This product provides approved customers with access, through merchants, banks and ATMs, to an instant unsecured revolving business credit line. Advanta Business Cards generates interest and other income through finance charges assessed on outstanding loans, interchange income, and cash advance and other credit card fees. Net income for Advanta Business Cards was $22.8 million for the year ended December 31, 1999 as compared to $11.6 million for year ended December 31, 1998. Net income for Advanta Business Cards was $3.0 million for the year ended December 31, 1997. The increase in net income in 1999 resulted from increased volume of managed receivables, significant increases in portfolio yields due to changes in pricing, increased interchange income and a decrease in receivable charge-offs. The increase in net income in 1998 resulted from increased volume of managed receivables. 27 29 SECURITIZATION INCOME Advanta Business Cards recognized securitization income of $33.5 million for the year ended December 31, 1999, $18.2 million for the year ended December 31, 1998, and $5.7 million for the year ended December 31, 1997. Advanta Business Cards sells receivables to existing securitization trusts on a continuous basis to replenish the investors' interest in trust receivables that have been repaid by the card holders. The increase in securitization income in 1999 was due to increased yields on the securitized receivables, increased volume of securitized receivables and a decrease in receivable charge-offs. The increase in securitization income in 1998 as compared to 1997 was due primarily to increased volume of receivables. ORIGINATIONS Business card accounts are originated through targeted direct marketing techniques, including direct mail to prospective customers, and the Internet. Originations for Advanta Business Cards were $2.0 billion for the year ended December 31, 1999, $1.4 billion for the year ended December 31, 1998 and $1.1 billion for the year ended December 31, 1997. The number of business card accounts originated were 146 thousand in 1999 and 102 thousand in 1998 and 1997. The increases in business card originations over prior years resulted from the successful application of our information based strategy to expand the universe of potential business card customers. ADVANTA LEASING SERVICES OVERVIEW Advanta Leasing Services offers flexible lease financing programs on small-ticket equipment to small businesses. The primary products financed include office machinery, security systems and computers. The commercial equipment leasing business is generated primarily through third-party referrals from manufacturers or distributors of equipment, as well as independent brokers, direct mail marketing and telemarketing. The equipment is leased under noncancelable leases with initial terms of generally one to five years. Net income for Advanta Leasing Services was $3.0 million for the year ended December 31, 1999 as compared to a net loss of $1.2 million for the year ended December 31, 1998. The increase in net income in 1999 was attributable to a decrease in operating expenses that resulted from cost reduction measures implemented during 1999 as well as increased volume. Net income for Advanta Leasing Services was $11.8 million for the year ended December 31, 1997. The decrease in net income in 1998, as compared to 1997, resulted from increases in costs to originate, service and manage Advanta Leasing Services' products and from a change in the mix of lease receivables originated. SECURITIZATION INCOME Advanta Leasing Services recognized $14.8 million in gains on the sale of $414 million of leases for the year ended December 31, 1999, as compared to $11.7 million in gains on the sale of $299 million of leases for the year ended December 31, 1998. As a percentage of receivables sold, these gains represented 3.6% in 1999 and 3.9% in 1998. The decrease in gain as a percentage of loans sold in 1999 resulted from an increase in receivable charge-off rates and a reduction in net interest income spread on securitized receivables. For the year ended December 31, 1997, Advanta Leasing Services recognized $14.3 million or 5.2% in gains on the sale of $276 million of leases. The gain as a percentage of loans sold of 3.9% in 1998 decreased as compared to the 5.2% gain in 1997 due to a reduction in net interest income spread on securitized receivables. The sales were through a combination of commercial paper conduit programs and a public lease securitization. 28 30 ORIGINATIONS Lease originations are generated primarily through third party referrals from manufacturers, distributors or other vendors of equipment as well as through independent brokers, direct mail marketing and telemarketing. Originations for Advanta Leasing Services were as follows:
YEAR ENDED DECEMBER 31, -------------------------------- ($ IN THOUSANDS) 1999 1998 1997 - --------------------------------------------------------------------------------------------- Vendor $204,128 $171,945 $168,655 Broker 232,433 131,776 95,995 Other 16,951 24,042 57,652 - --------------------------------------------------------------------------------------------- Total $453,512 $327,763 $322,302 - ---------------------------------------------------------------------------------------------
The increase in lease originations over the prior years was due to the growth in the number of vendor and broker relationships, as well as the expansion of existing relationships. ADVANTA CORP. INTEREST INCOME AND EXPENSE Interest income on receivables and investments, excluding the interest component of previously discounted cash flows, increased by $3.2 million for the year ended December 31, 1999 as compared to the year ended December 31, 1998. During the same period, interest expense decreased by $16.6 million. The increase in interest income was due to an increase in yields on receivables, partially offset by a decrease in average interest-earning assets as a result of the transfer of consumer credit card receivables in the Consumer Credit Card Transaction in 1998. The decrease in interest expense was due to a decrease in the cost of funds, as well as a reduction in interest-bearing liabilities in connection with the Consumer Credit Card Transaction in 1998. Interest income on receivables and investments, excluding the interest component of previously discounted cash flows, decreased $195.5 million for the year ended December 31, 1998 as compared to 1997. During the same period, interest expense decreased by $140.3 million. The decreases in interest income and interest expense were mainly attributable to the decrease in our owned interest-bearing assets and liabilities following the Consumer Credit Card Transaction/Tender Offer. Also impacting interest income on receivables during 1998 were consumer credit card securitization transactions prior to the Consumer Credit Card Transaction and the mix of receivables. Our cost of funds decreased to 5.87% in 1999 from 6.26% in 1998. Our cost of funds was 6.31% in 1997. The decrease in the cost of funds in 1999 as compared to 1998 and 1997 was primarily attributable to the increase in the use of deposits as a funding source. Deposits represented 66% of total average interest-bearing liabilities for the year ended December 31, 1999 as compared to 50% in 1998 and 48% in 1997. The following table provides an analysis of owned interest income and expense data, average balance sheet data, net interest spread, and net interest margin. Net interest spread represents the difference between the yield on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin represents the difference between the yield on interest-earning assets and the average rate paid to fund interest-earning assets. Average owned loan and lease receivables and the related interest revenues include certain loan fees and costs. 29 31 INTEREST RATE ANALYSIS
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS) ---------------------------------------------------------------------------------------------------- 1999 1998 1997 ------------------------------- ------------------------------- -------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE - --------------------------------------------------------------------------------------------------------------------------------- ON-BALANCE SHEET - --------------------------- Interest-earning assets: Receivables: Mortgage loans $ 779,373 $ 73,319 9.41% $ 730,798 $ 69,012 9.44% $ 525,452 $ 48,846 9.30% Business cards 212,311 35,265 16.61 146,515 21,549 14.71 186,369 26,328 14.13 Leases 109,848 10,880 9.90 102,192 10,768 10.54 105,515 12,034 11.41 Auto loans 14,604 2,166 14.83 47,459 8,300 17.49 60,776 9,858 16.22 Consumer credit cards(1) 0 0 0.00 384,697 23,457 6.10 1,728,039 179,732 10.40 Other loans 17,450 2,188 12.54 15,724 1,858 11.82 31,810 2,639 8.30 ---------- -------- ------ ---------- -------- ------ ----------- -------- ------ Total receivables(2) 1,133,586 123,818 10.92 1,427,385 134,944 9.45 2,637,961 279,437 10.59 Subordinated trust assets 336,254 27,227 8.10 209,043 14,173 6.78 108,653 8,510 7.83 Federal funds sold 272,330 13,535 4.97 203,485 10,933 5.37 345,404 18,659 5.40 Restricted interest-bearing deposits 166,490 11,102 6.67 265,915 16,075 6.05 883,311 54,399 6.16 Trading investments 110,565 6,752 6.11 172,084 10,374 6.03 0 0 0.00 Tax-free securities(2) 3,857 319 8.27 4,992 407 8.15 3,926 307 7.82 Taxable investments 798,633 44,842 5.61 673,239 37,850 5.62 1,115,706 58,870 5.28 ---------- -------- ------ ---------- -------- ------ ----------- -------- ------ Total interest-earning assets(3) $2,821,715 $227,595 8.06% $2,956,143 $224,756 7.60% $ 5,094,961 $420,182 8.25% ========== ======== ====== ========== ======== ====== =========== ======== ====== Interest-bearing liabilities: Deposits Savings $ 262,501 $ 13,120 5.00% $ 202,943 $ 10,916 5.38% $ 402,893 $ 22,850 5.67% Time deposits under $100,000 1,063,354 60,271 5.67 909,132 54,941 6.04 1,018,163 63,473 6.23 Time deposits of $100,000 or more 500,268 27,995 5.60 329,001 20,078 6.10 1,035,366 63,841 6.17 ---------- -------- ------ ---------- -------- ------ ----------- -------- ------ Total deposits 1,826,123 101,386 5.55 1,441,076 85,935 5.96 2,456,422 150,164 6.11 Debt 893,720 58,441 6.53 1,337,508 87,204 6.52 2,452,166 156,524 6.38 Other borrowings 54,008 3,225 5.92 102,372 7,067 6.90 232,820 17,870 7.68 ---------- -------- ------ ---------- -------- ------ ----------- -------- ------ Total interest-bearing liabilities 2,773,851 163,052 5.87 2,880,956 180,206 6.26 5,141,408 324,558 6.31 Net noninterest-bearing liabilities 47,864 75,187 (46,447) ---------- ---------- ----------- Sources to fund interest-earning assets $2,821,715 $163,052 5.78% $2,956,143 $180,206 6.10% $ 5,094,961 $324,558 6.37% ========== ======== ====== ========== ======== ====== =========== ======== ====== Net interest spread 2.19% 1.34% 1.94% ====== ====== ====== Net interest margin(4) 2.29% 1.51% 1.88% ====== ====== ====== OFF-BALANCE SHEET - --------------------------- Securitized receivables: Mortgage loans $7,451,718 $5,777,929 $ 3,251,902 Business cards 680,551 597,677 321,054 Leases 606,672 507,007 450,118 Auto loans 120,898 180,833 80,110 Consumer credit cards(1) 0 1,461,412 9,628,905 ---------- ---------- ----------- Total average securitized receivables $8,859,839 $8,524,858 $13,732,089 ========== ========== =========== Total average managed receivables $9,993,425 $9,952,243 $16,370,050 - ---------------------------------------------------------------------------------------------------------------------------------
(1) Includes consumer credit cards through February 20, 1998. (2) Interest and average rate for tax-free securities, loans, and leases are computed on a tax equivalent basis using a statutory rate of 35%. (3) Includes assets held and available for sale and nonaccrual loans and leases. (4) Managed net interest margin was 3.75% in 1999 and 3.32% in 1998, representing a combination of owned interest-earning assets/owned interest-bearing liabilities and securitized mortgage and business card assets/liabilities. 30 32 INTEREST VARIANCE ANALYSIS: ON-BALANCE SHEET The following table presents the effects of changes in average volume and interest rates on individual financial statement line items on a tax equivalent basis and including certain loan fees. Changes not solely due to volume or rate have been allocated on a pro rata basis between volume and rate. The effects on individual financial statement line items are not necessarily indicative of the overall effect on net interest income.
1999 VS. 1998 1998 VS. 1997 ($ IN THOUSANDS) -------------------------------- ---------------------------------- INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO -------------------------------- ---------------------------------- VOLUME RATE TOTAL VOLUME RATE TOTAL - --------------------------------------------------------------------------------------------------------- Interest income from: Loan and lease receivables: Mortgage loans $ 4,529 $ (222) $ 4,307 $ 19,417 $ 749 $ 20,166 Business cards 10,652 3,064 13,716 (5,823) 1,044 (4,779) Leases 784 (672) 112 (370) (896) (1,266) Auto loans (5,029) (1,105) (6,134) (2,285) 727 (1,558) Consumer credit cards(1) (23,457) 0 (23,457) (102,016) (54,259) (156,275) Other loans 212 118 330 (1,642) 861 (781) Subordinated trust assets 9,890 3,164 13,054 6,938 (1,275) 5,663 Federal funds sold 3,467 (865) 2,602 (7,632) (94) (7,726) Restricted interest-bearing deposits (6,491) 1,518 (4,973) (37,369) (955) (38,324) Trading investments (3,758) 136 (3,622) 10,374 0 10,374 Tax-free securities (94) 6 (88) 86 14 100 Taxable investments 7,059 (67) 6,992 (24,610) 3,590 (21,020) -------- -------- -------- --------- -------- --------- Total interest income(2) $ (2,236) $ 5,075 $ 2,839 $(144,932) $(50,494) $(195,426) -------- -------- -------- --------- -------- --------- Interest expense on: Deposits: Savings $ 3,019 $ (815) $ 2,204 $ (10,814) $ (1,120) (11,934) Time deposits under $100,000 8,859 (3,529) 5,330 (6,666) (1,866) (8,532) Time deposits of $100,000 or more 9,682 (1,765) 7,917 (43,074) (689) (43,763) Debt (28,897) 134 (28,763) (72,675) 3,355 (69,320) Other borrowings (2,954) (888) (3,842) (9,150) (1,653) (10,803) -------- -------- -------- --------- -------- --------- Total interest expense $(10,291) $ (6,863) $(17,154) $(142,379) $ (1,973) $(144,352) -------- -------- -------- --------- -------- --------- Net interest income $ 8,055 $ 11,938 $ 19,993 $ (2,553) $(48,521) $ (51,074)
- -------------------------------------------------------------------------------- (1) Includes consumer credit cards through February 20, 1998. (2) Includes income from assets held and available for sale. GAIN ON TRANSFER OF CONSUMER CREDIT CARD BUSINESS In 1998 we recognized a gain of $541.3 million which represented the excess of liabilities transferred to Fleet Credit Card LLC ("Fleet LLC") over the net basis of the assets transferred and our retained minority membership interest in Fleet LLC. At the closing date of the Consumer Credit Card Transaction, the minority interest was a 4.99% ownership interest in Fleet LLC valued at $20 million. See Note 9 to the Consolidated Financial Statements. 31 33 OTHER REVENUES
($ IN THOUSANDS) YEAR ENDED DECEMBER 31, ------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- Equity securities gains (losses) $30,391 $(41,750) $(11,426) Business card interchange income 33,786 20,741 11,617 Consumer credit card interchange income 0 11,881 85,208 Consumer credit card overlimit fees 0 16,233 46,447 Mortgage other (loss) income (9,686) 22,945 4,535 Leasing other revenues 15,399 14,519 25,748 Insurance revenues, net 8,206 14,408 37,816 Other 4,387 1,149 18,021 - --------------------------------------------------------------------------------------------- Total other revenues, net $82,483 $ 60,126 $217,966 - ---------------------------------------------------------------------------------------------
Other revenues for the year ended December 31, 1999 include equity securities gains of $30.4 million, representing changes in the fair value and realized gains on Advanta Partners LP investments. Included in this amount is an $18 million gain on an investment in a company that was merged with another entity in exchange for that entity's stock in the first quarter of 1999. The stock received had a value significantly higher than Advanta Partners' basis in its investment. In the second quarter of 1999, Advanta Partners sold the majority of this stock, realizing an additional gain of approximately $10 million. Partially offsetting this gain in the second quarter was the write-down of another equity investment of approximately $0.8 million. Other revenues for the year ended December 31, 1998 included equity securities losses of $41.8 million representing changes in the fair value and realized losses of Advanta Partners investments. Most of the loss in 1998 relates to investments not publicly traded for which Advanta Partners decided to expedite a disposal plan. In 1999, mortgage other loss included a write-down of assets associated with the corporate finance business of $12 million. In 1998, mortgage other income included an $11.2 million gain on the sale of an investment in affordable housing partnerships and $6 million from the favorable settlement of certain prior year claims. Business card interchange income increased by $13.0 million for the year ended December 31, 1999, as compared to 1998, and increased by $9.1 million in 1998 as compared to 1997. The increase in 1999 was due to an increase in interchange rates, as well as an increase in average managed business card receivables. The increase in 1998 was due to an increase in average managed business card receivables. The decline in consumer credit card interchange income, consumer credit card overlimit fees, insurance revenues and "other" other revenues in 1998 as compared to 1997 was attributable to the transfer of the consumer credit card portfolio in the Consumer Credit Card Transaction. Also, the decline in insurance revenues in 1999 of $6.2 million as compared to 1998 was primarily due to the absence of premiums related to the consumer credit card portfolio. 32 34 OPERATING EXPENSES
YEAR ENDED DECEMBER 31, -------------------------------- ($ IN THOUSANDS) 1999 1998 1997 - ---------------------------------------------------------------------------------------------- Salaries and employee benefits $123,768 $152,706 $219,954 Marketing 58,671 53,109 53,039 Professional/consulting fees 24,244 14,767 38,600 Equipment expense 21,039 23,381 37,712 Credit and collection expense 20,264 15,715 20,017 Occupancy expense 16,347 16,001 23,097 External processing 14,936 21,908 43,256 Telephone expense 11,091 12,428 21,262 Postage 5,958 8,949 29,039 Amortization of credit card deferred origination costs, net 5,863 22,271 69,344 Credit card fraud losses 833 3,194 22,287 Other 34,047 35,335 44,354 - ---------------------------------------------------------------------------------------------- Total operating expenses $337,061 $379,764 $621,961 - ---------------------------------------------------------------------------------------------- At year end: Number of accounts managed (in thousands) 678 565 6,342 Number of employees 2,643 2,568 4,498 For the year: Operating expenses as a percentage of average managed receivables(1) 3.31% 3.59% 3.38% - ----------------------------------------------------------------------------------------------
(1) Excludes amortization of credit card deferred origination costs, net. Operating expenses as a percentage of average managed receivables for the year ended December 31, 1999 decreased as compared to 1998 due to cost reduction measures implemented during 1999. Operating expenses as a percentage of average managed receivables increased during 1998 in comparison to 1997 due to lost economies of scale resulting from the downsizing pursuant to the Consumer Credit Card Transaction, and our plan to expand certain aspects of our infrastructure to better position Advanta for the future. Total operating expenses for the year ended December 31, 1999 decreased by $42.7 million as compared to 1998 and decreased by $242.2 million in 1998 as compared to 1997. The decrease in 1999 was due to cost reduction measures, as well as consumer credit card expenses incurred through February 1998 that are included in 1998 amounts. The decrease in 1998 as compared to 1997 was the result of the Consumer Credit Card Transaction as well as the other business and product dispositions in 1998. Professional fees increased by $9.5 million for the year ended December 31, 1999 as compared to 1998. This increase was due, in part, to increased legal activity, as well as consulting and outsourcing costs associated with Advanta's strategic management of capacity and resources, and costs associated with the Year 2000 issue. Salaries and employee benefits decreased $67.2 million for the year ended December 31, 1998 as compared to 1997. This reduction was due to the decrease in the number of employees as a result of the Consumer Credit Card Transaction as well as workforce reductions and other business and product dispositions in 1998. PROVISION FOR CREDIT LOSSES For the year ended December 31, 1999, the provision for credit losses decreased by $24.5 million as compared to 1998. The 1998 provision included a $28.3 million provision related to the consumer credit card business. The decrease in the consumer credit card provision was partially offset by a $3.8 million net increase in the provision recorded on other products, including a $4.3 million decrease in the provision on Advanta Mortgage loans, a $123 thousand increase in the provision on lease receivables, and a $7.9 million increase in the provision on business cards. The decrease in the provision on Advanta Mortgage loans was due to a decrease in 33 35 levels of delinquencies and nonperforming assets in owned receivables. The increase in the provision on business cards was due to a 45% increase in average on-balance sheet business card receivables in 1999. The provision for credit losses of $67.2 million in 1998 decreased $143.6 million or 68% from the provision of $210.8 million in 1997. The decrease was due to the contribution of the consumer credit card business in the Consumer Credit Card Transaction. This decrease was partially offset by an increase in the allowance for Advanta Mortgage loan losses resulting from our decision to increase the level of loans that will remain on the balance sheet in connection with our change in funding strategy. CREDIT RISK MANAGEMENT Management regularly reviews the loan and lease portfolio in order to evaluate the adequacy of the allowance for credit losses. The evaluation includes such factors as the inherent credit quality of the loan and lease portfolio, past experience including frequency of defaults and loss severity, current economic conditions and changes in the composition of the loan and lease portfolio. The allowance for credit losses is maintained for on-balance sheet receivables and is intended to cover all credit losses inherent in the owned loan portfolio. Anticipated losses on securitized assets are reflected in the calculations of securitization income and retained interests in securitizations. See Notes 1 and 2 to Consolidated Financial Statements. Such loss estimates are intended to cover all probable credit losses over the life of the securitized receivables. Management continually evaluates both its on-balance sheet and off-balance sheet estimates and, as appropriate, effects changes to these amounts. At December 31, 1999, the allowance for credit losses on a consolidated basis was $41.8 million, or 2.8% of owned receivables, compared to $33.4 million, or 3.0%, at December 31, 1998. The Advanta Mortgage allowance for credit losses was 2.1% at December 31, 1999 as a percentage of owned receivables, as compared to 2.4% at December 31, 1998. This decrease in the Advanta Mortgage allowance was due to the improvement in the levels of delinquencies and nonperforming assets in 1999. The allowance for credit losses on business card receivables increased from 4.6% as a percentage of owned receivables at December 31, 1998 to 5.3% at December 31, 1999. The increase was due to the expansion of the business card customer base during 1999. At December 31, 1998, the allowance for credit losses of $33.4 million, or 3.0% of owned receivables, had decreased from the allowance of $137.8 million, or 4.1% of owned receivables, at December 31, 1997. The decrease in the allowance was primarily related to the Consumer Credit Card Transaction. The allowance on consumer credit cards was $118.4 million or 4.6% of owned receivables at December 31, 1997. The allowance as a percentage of receivables on consumer credit cards was higher in relation to the allowance on the other products. Since there were no consumer credit cards at December 31, 1998, the allowance for credit losses decreased in amount and as a percentage of receivables. ASSET QUALITY Nonperforming assets include: Advanta Mortgage loans, credit cards and leases past due 90 days or more; real estate owned; and bankrupt, decedent and fraudulent credit cards. We charge losses on nonperforming Advanta Mortgage loans against the allowance generally at the earlier of foreclosure or when they have become twelve months delinquent. Losses on lease receivables are generally charged against the allowance when 121 days contractually delinquent. Our charge-off policy, as it relates to business credit card accounts, is to charge-off a receivable, if not paid, at 180 days contractually delinquent. Consumer credit card accounts, if not paid, were charged-off at 186 days contractually delinquent. Credit card accounts suspected of being fraudulent are charged-off after a 90-day investigative period, unless the investigation shows no evidence of fraud. The carrying value for real estate owned is based on fair value, net of costs of disposition, and is reflected in other assets. Loans are put on nonaccrual status when they become 90 days past due. Gross interest income that would have been recorded for owned nonperforming assets, had interest been accrued throughout the year in accordance with the assets' original terms, was $4.9 million in 1999. The amount of interest on nonperforming assets included in income was $1.5 million in 1999. 34 36 The consolidated managed charge-off rate for the year ended December 31, 1999 was 1.6%, down from 2.5% for 1998 and 5.3% for 1997. The following represents the annual results by product:
FOR THE YEAR ENDED --------------------- 1999 1998 1997 - ----------------------------------------------------------------------------------- Mortgage 0.78% 0.56% 0.53% Auto 13.92 9.30 7.25 Business Card 4.96 5.88 3.73 Leases 3.57 2.66 2.71 - -----------------------------------------------------------------------------------
Advanta Mortgage began to emphasize profitability enhancement over loan growth, and to emphasize the direct-to-consumer channels over indirect channels for originations in the fourth quarter of 1998. This has resulted in a significant reduction in the rate of portfolio growth relative to prior periods. The decline in the growth rate has reduced the proportion of new, unseasoned loans in the portfolio. This "seasoning" effect results in higher reported delinquencies and charge-offs consistent with an aging portfolio. The increase in reported delinquency and charge-off rates is primarily attributable to seasoning of the managed mortgage loan portfolio. 35 37 CREDIT QUALITY -- MANAGED The following table provides a summary of reserves, impaired assets, delinquencies and charge-offs for the past five years:
DECEMBER 31, ---------------------------------------------------------- ($ IN THOUSANDS) 1999 1998 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------- CONSOLIDATED -- MANAGED(1) Nonperforming assets $511,301 $410,584 $ 328,835 $191,668 $ 82,171 Accruing loans past due 90 days or more 0 30 203,117 228,845 84,892 Total loans 30 days or more delinquent 838,563 753,521 1,068,183 886,717 404,072 As a percentage of gross receivables: Nonperforming assets 5.0% 4.2% 1.8% 1.2% .7% Accruing loans past due 90 days or more .0 .0 1.1 1.4 .7 Total loans 30 days or more delinquent: New methodology(2) 8.2 7.7 6.0 5.4 Prior methodology 5.2(3) 3.3 Net charge-offs: Amount $155,452 $247,287 $ 860,098 $479,992 $212,865 As a percentage of average gross receivables: New methodology(2) 1.6% 2.5% 5.3% 3.2% Prior methodology 3.5(3) 2.2% - --------------------------------------------------------------------------------------------------------------- ADVANTA MORTGAGE LOANS -- MANAGED Nonperforming assets $475,711 $375,520 $ 200,600 $ 93,101 $ 56,743 Total loans 30 days or more delinquent 729,187 656,789 391,929 194,412 106,223 As a percentage of gross receivables: Nonperforming assets 5.7% 4.5% 3.8% 3.4% 3.2% Total loans 30 days or more delinquent 8.7 7.9 7.4 7.1 5.9 Net charge-offs -- Mortgage Loans: Amount 64,303 36,142 19,953 14,970 13,836 As a percentage of average gross receivables 0.8% 0.6% .5% 0.7% 0.9% Net charge-offs -- Auto Loans: Amount $ 18,855 $ 21,238 $ 10,212 $ 11 N/A As a percentage of average gross receivables 13.9% 9.3% 7.3% .1% N/A - --------------------------------------------------------------------------------------------------------------- BUSINESS CARDS -- MANAGED Nonperforming assets $ 23,498 $ 25,231 $ 17,362 $ 2,712 N/A Total loans 30 days or more delinquent 38,437 35,900 29,340 8,952 N/A As a percentage of gross receivables: Nonperforming assets 2.3% 3.1% 2.6% 9.0% N/A Total loans 30 days or more delinquent 3.7 4.4 4.4 3.0 N/A Net charge-offs -- Business Cards: Amount $ 44,309 $ 43,732 $ 18,928 $ 4,210 N/A As a percentage of average gross receivables 5.0% 5.9% 3.7% 2.6% N/A - --------------------------------------------------------------------------------------------------------------- LEASES -- MANAGED Nonperforming assets $ 11,472 $ 9,595 $ 9,420 $ 6,791 $ 4,912 Total loans 30 days or more delinquent 69,695 60,154 52,335 50,928 35,274 As a percentage of gross receivables: Nonperforming assets 1.4% 1.4% 1.6% 1.3% 1.3% Total loans 30 days or more delinquent 8.8 9.0 8.7 9.8 9.3 Net charge-offs -- Leases: Amount $ 25,586 $ 16,220 $ 15,074 $ 9,567 $ 5,846 As a percentage of average gross receivables 3.6% 2.7% 2.7% 2.2% 1.9% - ---------------------------------------------------------------------------------------------------------------
(1) Includes consumer credit cards through February 20, 1998. (2) Beginning in 1996, charge-off rates reflect the adoption of a new consumer credit card charge-off methodology. This new policy related to consumer credit card bankruptcies and provided up to a 90 day investigative period following notification of the bankruptcy petition prior to charge-off. (3) Pro forma calculation reflecting charge-off of all credit card bankruptcies within 30 days of notification. 36 38 CREDIT QUALITY -- OWNED The following table provides a summary of reserves, impaired assets, delinquencies and charge-offs for the past five years:
DECEMBER 31, ---------------------------------------------------- ($ IN THOUSANDS) 1999 1998 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- CONSOLIDATED -- OWNED(1) Allowance for credit losses $41,847 $33,437 $137,773 $89,184 $53,494 Nonperforming assets 45,620 49,568 51,149 29,822 21,856 Accruing loans past due 90 days or more 0 30 49,458 40,597 17,399 Total loans 30 days or more delinquent 62,850 73,755 201,891 145,613 76,859 As a percentage of gross receivables: Allowance for credit losses 2.8% 3.0% 4.1% 3.4% 1.9% Nonperforming assets 3.1 4.4 1.5 1.1 .8 Accruing loans past due 90 days or more .0 .0 1.5 1.5 .6 Total loans 30 days or more delinquent: New methodology(2) 4.3 6.5 5.9 5.5 Prior methodology 5.3(3) 2.8 Net charge-offs: Amount $27,547 $53,109 $151,222 $70,576 $42,549 As a percentage of average gross receivables: New methodology(2) 2.4% 3.7% 5.7% 2.3% Prior methodology 2.5(3) 2.3% - -------------------------------------------------------------------------------------------------------------- ADVANTA MORTGAGE LOANS -- OWNED Allowance for credit losses $21,743 $20,092 $ 5,822 $ 8,785 $ 3,360 Nonperforming assets 36,709 38,734 23,234 13,005 18,676 Total loans 30 days or more delinquent 45,263 56,131 42,916 28,546 20,348 As a percentage of gross receivables: Allowance for credit losses 2.1% 2.4% 1.2% 2.3% 1.0% Nonperforming assets 3.5 4.6 4.9 3.5 5.8 Total loans 30 days or more delinquent 4.3 6.7 9.0 7.6 6.3 Net charge-offs -- Mortgage: Amount $ 8,389 $ 3,658 $ 2,310 $ 3,049 $ 5,962 As a percentage of average gross receivables 1.1% .5% .4% 1.3% 3.2% Net charge-offs -- Auto: Amount $ 3,732 $ 7,648 $ 3,524 $ 10 N/A As a percentage of average gross receivables 25.6% 16.1% 5.8% .1% N/A - -------------------------------------------------------------------------------------------------------------- BUSINESS CARDS -- OWNED Allowance for credit losses $14,663 $ 6,916 $ 6,899 $ 2,643 N/A Nonperforming assets 6,408 7,481 4,696 1,591 N/A Total loans 30 days or more delinquent 10,347 7,207 7,918 1,584 N/A As a percentage of gross receivables: Allowance for credit losses 5.3% 4.6% 4.9% 3.7% N/A Nonperforming assets 2.3 5.0 3.3 2.2 N/A Total loans 30 days or more delinquent 3.8 4.8 5.6 2.2 N/A Net charge-offs -- Business Cards: Amount $10,103 $10,033 $ 6,198 $ 2,169 N/A As a percentage of average gross receivables 4.8% 6.9% 3.3% 2.5% N/A - -------------------------------------------------------------------------------------------------------------- LEASES -- OWNED Allowance for credit losses $ 3,110 $ 2,695 $ 2,899 $ 1,598 $ 1,577 Nonperforming assets 1,883 3,115 2,009 1,336 714 Total loans 30 days or more delinquent 5,996 9,739 9,881 7,878 4,350 As a percentage of gross receivables: Allowance for credit losses 2.3% 2.2% 1.8% 1.1% 1.7% Nonperforming assets 1.4 2.5 1.3 0.9 0.8 Total loans 30 days or more delinquent 4.5 7.9 6.2 5.6 4.6 Net charge-offs -- Leases: Amount $ 2,926 $ 3,491 $ 2,170 $ 833 $ 1,139 As a percentage of average gross receivables 2.7% 3.4% 2.1% .8% 1.4% - --------------------------------------------------------------------------------------------------------------
(1) Includes consumer credit cards through February 20, 1998. (2) Beginning in 1996, charge-off rates reflect the adoption of a new consumer credit card charge-off methodology. This new policy related to consumer credit card bankruptcies and provided up to a 90 day investigative period following notification of the bankruptcy petition prior to charge-off. (3) Pro forma calculation reflecting charge-off of all credit card bankruptcies within 30 days of notification. 37 39 UNUSUAL CHARGES EMPLOYEE COSTS ASSOCIATED WITH STAFF REDUCTIONS In the first quarter of 1999, we recorded a $3.3 million charge for costs associated with staff reductions. These expenses included severance and outplacement costs associated with cost reduction initiatives and the consolidation of support functions. There were 121 employees severed who were entitled to benefits. This staff reduction was substantially complete by June 30, 1999. EMPLOYEE COSTS ASSOCIATED WITH CONSUMER CREDIT CARD TRANSACTION/TENDER OFFER In 1998, we accelerated vesting of 43.15% of outstanding options that were not vested at the time of the closing of the Consumer Credit Card Transaction. In connection with the Tender Offer (see Note 9 to the Consolidated Financial Statements), present and former directors and employees who held exercisable options to purchase Class A and Class B Common Stock tendered these options in lieu of first exercising the options and tendering the underlying stock. We used approximately $850 million, before taking into account the exercise price of options, to repurchase the shares in the Tender Offer. In addition, we also amended the terms of options granted to employees who became employees of Fleet LLC or whose employment with us was otherwise terminated in connection with the Consumer Credit Card 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 as a result of this amendment. We 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 which provides benefits to senior management employees in the event of a change of control of Advanta 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 our 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 Advanta in the strategic alternatives process. In accordance with our agreement with Fleet, Fleet LLC agreed to assume Advanta's management severance plan and 50% of the bonus payments with respect to those Affected Employees who became employees of Fleet LLC in connection with the Consumer Credit Card 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 or other similar transaction. In October 1997, we announced that the Chief Executive Officer of Advanta Corp. and the Chief Executive Officer of the consumer credit card business unit were leaving Advanta in connection with the Consumer Credit Card Transaction. These benefits were all contingent upon the consummation of the Consumer Credit Card Transaction and were recognized upon the closing of the transaction. In connection with our evaluation of strategic alternatives and the Consumer Credit Card Transaction, we adopted special retention programs. Under these programs, certain employees were entitled to receive special payments based on their targeted bonuses and contingent upon their continued employment with Advanta or a successor entity. The first payments under the special retention programs were made in March 1998. Further, in March 1998, we identified employees that would be terminated in connection with the Consumer Credit Card Transaction as part of the corporate restructuring to reduce corporate expenses. During the first quarter of 1998, the Board of Directors approved the corporate restructuring and affected employees were informed of the termination benefits they would receive. Substantially all of these employees ceased employment with Advanta before April 30, 1998. We recorded a $62.3 million pretax charge to earnings in connection with the foregoing plans, plan amendments and workforce reduction activities in 1998. 38 40 EXPENSE ASSOCIATED WITH EXITED BUSINESSES/PRODUCTS In the first quarter of 1999, we implemented a plan to cease the origination of auto loans and recorded a $3.4 million charge for costs associated with exited businesses/products. The charges included severance and outplacement costs for 22 employees in the auto origination group, and professional fees associated with exited businesses/products not directly associated with our mortgage, business card and leasing units. We completed the closing of the auto loan origination center and termination of related employees during the second quarter of 1999. We expect to pay a substantial portion of the remaining costs during the year ended December 31, 2000. In connection with our efforts to reduce expenses associated with business and product offerings which are not directly associated with our mortgage, business card and leasing units, management approved exit and disposition plans during the first quarter of 1998 related to certain businesses and products previously offered. We recorded charges in the quarter ended March 31, 1998 related to costs to be incurred by us 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, we recognized investment banking, professional and consulting fees that were contingent upon completion of the Consumer Credit Card Transaction as well as other professional and consulting fees associated with our corporate restructuring. During the quarter ended March 31, 1998, we recorded a $54.1 million pretax charge to earnings in connection with these exit plans. In 1999, an additional charge of $10.0 million was recorded associated with exited products based on a change in the estimate of total expected costs. We expect to pay a substantial portion of these costs over the next 36 months. The actions required to complete these plans include the settlement of contractual commitments and the payment of customer benefits. ASSET IMPAIRMENT/DISPOSAL In connection with Advanta's plans to reduce corporate expenses and exit certain business and product offerings, certain assets were identified for disposal and their carrying costs were written off or written down to estimated realizable value in 1998 resulting in a charge of $8.7 million. These assets consisted principally of leasehold improvements and various other assets. The disposal of these assets has been completed. INCOME TAXES The gain on the Consumer Credit Card Transaction in 1998 was not subject to income tax and no tax provision was recorded. The Consumer Credit Card Transaction also resulted in additional book/tax differences, which were quantified during 1999 in connection with the filing of the 1998 tax return. These book/tax differences, when combined with certain less significant recurring differences, have resulted in net operating loss carryforwards of approximately $521 million. This amount is net of $96 million carried back to prior years, and includes $500 million that pertains to losses incurred on the consumer credit card portfolio after the date of the Consumer Credit Card Transaction. Of the total net operating loss carryforwards, $502 million expire in 2018 and $19 million expire in 2019. A deferred tax asset of $50 million, net of valuation allowance, resulting from the net operating loss carryforwards was recorded as an income tax benefit in the fourth quarter of 1999. In establishing the valuation allowance of $83 million, management considered (1) the level of expected future taxable income, (2) existing and projected book/tax differences, (3) tax planning strategies available, and (4) the general and industry-specific economic outlook. Based on this analysis, management believes the net deferred tax asset will be realized. In 1998, we recorded a consolidated income tax benefit of approximately $9.0 million, as a result of the federal tax treatment of the contribution of assets associated with the Consumer Credit Card Transaction. Our consolidated income tax expense was $24.9 million in 1997, or an effective tax rate of 26%. 39 41 ASSET/LIABILITY MANAGEMENT We manage our financial condition with a focus on maintaining high credit quality standards, disciplined management of market risks and prudent levels of leverage and liquidity. MARKET RISK SENSITIVITY Market risk is the potential for loss or diminished financial performance arising from adverse changes in market forces including 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. We regularly evaluate our market risk profile and attempt to minimize the impact of market risks on net interest income and net income. Our exposure to equity price risk is immaterial relative to expected overall financial performance. Fluctuations in interest rates, changes in economic conditions, shifts in customer behavior, and other factors can, however, affect our financial performance. Changes in economic conditions and shifts in customer behavior are difficult to predict, and our financial performance generally cannot be insulated from these forces. Financial performance variability as a result of fluctuations in interest rates is commonly called interest rate risk. Interest rate risk generally results 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). We attempt to analyze the impact of interest rate risk by regularly evaluating the perceived risks inherent in our asset and liability structure, including securitized instruments and off-balance sheet instruments. Risk exposure levels vary continuously, as changes occur in our 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 our interest rate risk. In managing interest rate risk exposure, we periodically securitize receivables, sell and purchase assets, alter the mix and term structure of our funding base, change our investment portfolio and use derivative financial instruments. Derivative instruments, by Company policy, are not used for speculative purposes. See discussion in Note 24 to the Consolidated Financial Statements. We measure our 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. We estimate that at December 31, 1999, our net interest income over a twelve month period would increase or decrease by approximately 2.4%, if interest rates were to fall or rise by 200 basis points. This compares to an estimate as of December 31, 1998, of an increase or decrease of 5.0%, if interest rates were to rise or fall by 200 basis points. This change is due to various balance sheet composition changes including the purchase of fixed rate investments, growth in fixed rate on-balance sheet loans, and the use of interest rate swaps to convert fixed rate deposits to a variable rate. 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 our exposure to interest rate risk. The quantitative risk information is limited by the parameters and assumptions utilized in generating the results. These 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, we are also subject to prepayment risk related to other financial instruments, namely servicing rights and retained interest-only strips. 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, 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 40 42 relationship between them, however, is not precisely determinable. Accordingly, we believe 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. Our servicing rights and interest-only strips are derived from both fixed and variable rate loans, the majority of which are fixed. Fixed and variable rate loans are currently prepaying at different rates, which is expected to continue in the future. We have estimated the impact on the fair value of these assets assuming a 2.5% change in constant prepayment rate for fixed rate loans and 3.7% change in constant prepayment rate for variable rate loans. We have estimated that these changes in prepayment assumptions could result in a $30 million change in the combined fair value of these assets as of December 31, 1999. This compares to an estimate of a $32 million change as of December 31, 1998, assuming a 2.9% change in constant prepayment rate for fixed rate loans and 3.8% change in constant prepayment rate for variable rate loans. These estimates do not factor in the impact of changes in the interest rate environment associated with the changes in the prepayment rates. Changes in interest rates generally affect the level of loan originations. Prepayment assumptions are not the only assumptions in the fair value calculation for these assets, 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. DERIVATIVES ACTIVITIES We have a number of mechanisms in place that enable us to monitor and control both market and credit risk from our 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 derivatives and the individuals authorized to execute derivatives transactions. Our senior management must approve all derivatives strategies. As part of this approval process, we complete a market risk analysis to determine the potential impact that would result from severe negative (i.e., stressed) movements in market rates. By policy, derivatives transactions may only be used to manage our exposure to interest rate risk or for cost reduction and may not be used for speculative purposes. The impact of any derivatives transaction is calculated using our asset/liability model to determine its suitability. For each counterparty, the total credit exposure amount is calculated by aggregating credit exposure from all derivatives and other capital market transactions with that counterparty. The amount of exposure that we are willing to accept from any single counterparty is based on that counterparty's credit rating and is determined as a percentage of our equity. To manage counterparty exposure, we also use negotiated agreements that establish threshold exposure amounts for each counterparty above which we have the right to call for and receive collateral for the amount of the excess, thereby limiting our exposure to the threshold amount. The threshold levels can be fixed or may change as the credit rating of the counterparty changes, and in all cases, the threshold levels are well below the maximum allowable exposure amounts described above. Similarly, under the terms of the negotiated agreements, counterparties have the right to call for and receive collateral from us for the amount of the excess of their credit exposure to us over applicable threshold levels. To date, substantially all agreements with counterparties have included bilateral collateral agreements. We have a treasury middle office that is independent of the trading function, which measures, monitors, and reports on credit, market, and liquidity risk exposures from capital markets, hedging and derivative product activities. The department is responsible for ensuring compliance with our hedging policy, including the counterparty transaction limits, transaction terms and trader authorizations. In addition, this department marks each derivatives position to market on a weekly basis using both internal and external models. These models have been benchmarked against a sample of derivatives dealers' valuation models for accuracy. Position and counterparty exposure reports are generated and used to manage collateral requirements of the counterparty and Advanta. All of these procedures and processes are designed to provide reasonable assurance that, before and after the execution of any derivatives strategy, market, credit and liquidity risks are fully analyzed and incorporated into Advanta's asset/liability and risk measurement models. 41 43 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 on 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, as amended by SFAS No. 137, cannot be applied retroactively and will be adopted as required January 1, 2001. We anticipate that the adoption of SFAS No. 133 will not have a material effect on the results of operations; however, we continue to monitor potential changes and implementation guidance to this new accounting standard. LIQUIDITY AND CAPITAL RESOURCES Our goal is to maintain an adequate level of liquidity, for both long-term and short-term needs, through active management of both assets and liabilities. During the year ended December 31, 1999, we securitized or sold approximately $2.3 billion of Advanta Mortgage loans, $414 million of leases and $319 million of business card receivables. We temporarily invested cash generated from these transactions in short-term, high quality investments at money market rates pending redeployment to pay down borrowings and to fund future mortgage loan, business card and lease receivable growth. At December 31, 1999, we had $145 million of federal funds sold, $711 million of loan and lease receivables held for sale, and $354 million of investments which could be sold to generate additional liquidity. Equity, including capital securities, was $690 million at December 31, 1999. Our funding strategy relies on cash, cash equivalents and investments as well as deposit gathering activity at Advanta National Bank and Advanta Bank Corp. (together, the "banks") and securitizations. Advanta and the banks use both retail and institutional on-balance sheet funding sources and have the ability to issue a variety of debt and deposit products. As of December 31, 1999, Advanta National Bank's total deposits were $1.3 billion and Advanta Bank Corp.'s total deposits were $257 million. After paying down $365 million in long-term debt for the year ended December 31, 1999, we had unrestricted cash, cash equivalents and marketable securities in excess of $350 million at the parent company level on December 31, 1999. At December 31, 1999, the parent company's assets include advances to wholly-owned non-bank subsidiaries to fund $224.9 million in loans, $29.9 million in retained interest-only strips and contractual mortgage servicing rights, $209.4 million in subordinated trust assets, and $34.4 million of equity securities accounted for at fair value. Total parent company advances to non-bank subsidiaries to fund these assets of $498.6 million at December 31, 1999 have decreased by $111.6 million in comparison to advances at December 31, 1998. At December 31, 1999, we had a $500 million committed warehouse financing facility and a $250 million committed commercial paper conduit facility both secured by mortgage loans. At December 31, 1999, we had additional uncommitted warehouse financing facilities secured by mortgage loans of $550 million. At December 31, 1999, we had $730 million of committed commercial paper facilities secured by business credit card receivables and a $360 million committed commercial paper facility secured by lease contracts and lease residuals. At December 31, 1999, we had available $1.2 billion in unused warehouse financing facilities and commercial paper conduit facilities. We also offer unsecured debt of Advanta Corp. to retail investors through the Advanta Retail Note Program. In addition, notwithstanding our current liquidity, efforts continue to develop new sources of funding, both through previously untapped customer segments and through development of new financing structures. At December 31, 1999, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 14.86%, and Advanta Bank Corp.'s combined total capital ratio was 13.28%. At December 31, 1998, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 12.12% and Advanta Bank Corp.'s combined total capital ratio was 14.13%. In each case, Advanta National Bank and Advanta Bank Corp. had capital levels that met the definition of "well-capitalized" under the regulatory framework for prompt corrective action. We intend to maintain capital ratios at both institutions in order to be "well-capitalized" under current guidelines. Recently, an FDIC discussion draft proposal has been made 42 44 public regarding capital requirements for subprime lenders. Under the proposal, regulatory capital required to be held for certain loan classes included in the institution's portfolio could be increased. The ultimate resolution of this proposal and its impact on our financial results is uncertain at this time. This is one of several regulatory and legislative initiatives and proposals that could impact the manner in which we conduct our business and our financial results. See "Part I -- Item 1. Business -- Legal Developments." Advanta National Bank and Advanta Bank Corp. are prevented by regulatory restrictions from lending to Advanta Corp. and its affiliates unless these extensions of credit are secured by U.S. Government obligations or other specified collateral. Further, secured extensions of credit are limited in amount: (a) as to Advanta Corp. or any affiliate, to 10 percent of each bank's capital and surplus, and (b) as to Advanta Corp. and all affiliates in the aggregate, to 20 percent of each bank's capital and surplus. Advanta National Bank is also subject to various legal limitations on the amount of dividends that can be paid to its parent, Advanta Corp. Advanta National Bank is eligible to declare a dividend provided that it is not greater than the current year's net profits plus net profits of the preceding two years. As a result of a $1.3 billion special dividend/return of capital in 1998, Advanta National Bank will not be eligible to declare any dividends to Advanta Corp. without prior regulatory approval until at least the first quarter of 2001. Our insurance subsidiaries are also subject to certain capital, deposit and dividend rules and regulations as prescribed by state jurisdictions in which they are authorized to operate. Total stockholders' equity of our banking and insurance affiliates was $584 million at December 31, 1999, of which $524 million was restricted. At January 1, 2000, $60 million of stockholders' equity of our banking and insurance affiliates was available for payment of dividends under applicable regulatory guidelines. In addition to dividend restrictions at banking subsidiaries, certain non-bank subsidiaries are subject to minimum equity requirements as part of securitization agreements or financing facility agreements. The total minimum equity requirement of non-bank subsidiaries was $35 million at December 31, 1999. Management believes that these restrictions, for both bank and non-bank subsidiaries, will not have an adverse effect on the Advanta Corp.'s ability to meet its cash obligations due to the current levels of liquidity and diversity of funding sources. The following tables detail the composition of the deposit base and the composition of debt and other borrowings at year end for each of the past five years. COMPOSITION OF DEPOSIT BASE
($ IN MILLIONS) AS OF DECEMBER 31, ---------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 -------------- -------------- -------------- -------------- -------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % - ---------------------------------------------------------------------------------------------------------------- Demand deposits $ 5.8 0% $ 4.3 0% $ 41.6 1% $ 28.3 1% $ 91.7 5% Money market savings 242.4 16 181.5 10 506.8 17 329.7 18 277.5 14 Time deposits of $100,000 or less 1,046.6 69 1,445.8 83 2,163.0 72 978.6 53 965.5 51 Time deposits of more than $100,000 217.6 15 118.2 7 306.2 10 523.5 28 571.9 30 - ---------------------------------------------------------------------------------------------------------------- Total deposits $1,512.4 100% $1,749.8 100% $3,017.6 100% $1,860.1 100% $1,906.6 100% - ----------------------------------------------------------------------------------------------------------------
43 45 COMPOSITION OF DEBT AND OTHER BORROWINGS
($ IN MILLIONS) AS OF DECEMBER 31, ---------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 -------------- -------------- -------------- -------------- -------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % - ---------------------------------------------------------------------------------------------------------------- Subordinated notes and certificates $ 1.0 0% $ 1.5 0% $ 55.5 2% $ 71.1 3% $ 76.2 4% Senior notes and certificates 234.4 20 145.6 14 151.0 7 208.3 8 200.6 11 Short-term bank notes 0.0 0 0.0 0 242.0 11 309.3 13 25.0 1 Medium-term bank notes 7.3 0 7.3 1 669.5 29 835.6 34 322.7 18 5 1/8% notes, due 1996 0.0 0 0.0 0 0.0 0 0.0 0 150.0 8 Medium-term notes 538.0 45 866.5 81 1,099.5 48 880.8 36 504.7 28 Value notes 7.8 1 9.3 1 30.7 1 0.0 0 0.0 0 Term fed funds, fed funds purchased and FHLB advances 220.0 18 0.0 0 0.0 0 10.0 0 443.0 25 Securities sold under agreements to repurchase 104.2 9 0.0 0 0.0 0 0.0 0 0.0 0 Lines of credit and term funding arrangements 76.4 6 18.5 2 3.9 0 40.0 0 0.0 0 Other borrowings 9.0 1 17.8 1 48.9 2 107.0 6 81.8 5 - ---------------------------------------------------------------------------------------------------------------- Total long-term debt and other borrowings $1,198.1 100% $1,066.5 100% $2,301.0 100% $2,462.1 100% $1,804.0 100% - ----------------------------------------------------------------------------------------------------------------
YEAR 2000 READINESS DISCLOSURE Computer programs that use only two digits to identify a year in the date field could fail or create erroneous results on or after the year 2000. The "Year 2000" issue affects computer and information technology systems, as well as non-information technology 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. In order to address this issue, we implemented a Year 2000 compliance program which consisted of six phases: (1) awareness; (2) assessment; (3) renovation; (4) validation; (5) contingency planning; and (6) implementation. We also identified and evaluated compliance of our significant business relationships, including without limitation vendors, customers and asset management and funding counterparties, to assess the potential impact on our operations if those third parties and/or their products or systems would have failed to become Year 2000 compliant in a timely manner. We completed all six phases of our internal and external mission-critical systems as of September 30, 1999. We have not experienced significant problems or issues relating to the Year 2000 issue as of March 15, 2000. We incurred approximately $7.7 million in operating expenses, exclusive of costs associated with diverted personnel, and approximately $1.3 million in capital expenditures to address the Year 2000 issue. Funding for the project was provided out of operating revenues, and operating expenses were expensed as incurred. These costs did not have a material affect on our financial position or results of operations. We deferred development on selected business systems due to Year 2000 priorities. These deferrals are not expected to have a material effect on our financial condition or results of operations. 44 46 CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ($ IN THOUSANDS) ------------------------ 1999 1998 - -------------------------------------------------------------------------------------- ASSETS Cash $ 29,301 $ 16,267 Federal funds sold 144,938 267,400 Restricted interest-bearing deposits 93,688 80,028 Trading investments 0 501,563 Investments available for sale 748,881 521,410 Loan and lease receivables, net: Held for sale 711,303 527,644 Other 738,321 579,783 ------------------------ Total loan and lease receivables, net 1,449,624 1,107,427 Retained interest-only strip 115,641 209,096 Contractual mortgage servicing rights 92,636 74,425 Subordinated trust assets 400,148 291,942 Premises and equipment (at cost, less accumulated depreciation of $54,613 in 1999 and $38,377 in 1998) 89,869 84,396 Other assets 524,936 567,466 - -------------------------------------------------------------------------------------- TOTAL ASSETS $3,689,662 $3,721,420 - -------------------------------------------------------------------------------------- LIABILITIES Deposits: Noninterest-bearing $ 5,768 $ 4,324 Interest-bearing 1,506,591 1,745,466 ------------------------ Total deposits 1,512,359 1,749,790 Long-term debt 788,508 1,030,147 Other borrowings 409,601 36,301 Other liabilities 289,563 244,878 - -------------------------------------------------------------------------------------- TOTAL LIABILITIES 3,000,031 3,061,116 - -------------------------------------------------------------------------------------- Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures of Advanta 100,000 100,000 STOCKHOLDERS' EQUITY Class A preferred stock, $1,000 par value: Authorized, issued and outstanding -- 1,010 shares in 1999 and 1998 1,010 1,010 Class B preferred stock, $.01 par value: Issued -- 0 in 1999 and 14,211 shares in 1998 0 0 Class A voting common stock, $.01 par value; Authorized -- 214,500,000 shares; Issued -- 10,465,883 shares in 1999 and 10,375,489 shares in 1998 105 104 Class B non-voting common stock, $.01 par value; Authorized -- 230,000,000 shares; Issued -- 18,256,029 shares in 1999 and 16,294,825 shares in 1998 182 163 Additional paid-in capital 232,585 229,304 Deferred compensation (16,597) (17,214) Unearned ESOP shares (12,132) (12,550) Accumulated other comprehensive loss (10,794) (91) Retained earnings 421,741 382,092 Less: Treasury stock at cost, 405,000 Class A and 972,768 Class B common shares in 1999 and 55,000 Class A and 972,768 Class B common shares in 1998 (26,469) (22,514) - -------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 589,631 560,304 - -------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,689,662 $3,721,420 - --------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 45 47 CONSOLIDATED INCOME STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31, ------------------------------------ 1999 1998 1997 - ---------------------------------------------------------------------------------------------- REVENUES: Interest income $246,226 $ 245,340 $ 436,860 Securitization income 124,514 162,358 106,005 Servicing revenues 119,300 130,112 249,293 Consumer credit card securitization income 0 64,796 252,631 Gain on transfer of consumer credit card business 0 541,288 0 Other revenues, net 82,483 60,126 217,966 ------------------------------------ Total revenues 572,523 1,204,020 1,262,755 ------------------------------------ EXPENSES: Operating expenses 337,061 379,764 621,961 Interest expense 167,676 184,275 324,558 Provision for credit losses 42,647 67,193 210,826 Minority interest in income of consolidated subsidiary 8,880 8,880 8,880 Unusual charges 16,713 125,072 0 ------------------------------------ Total expenses 572,977 765,184 1,166,225 ------------------------------------ Income (loss) before income taxes (454) 438,836 96,530 Income tax (benefit) expense (50,272) (9,044) 24,905 ------------------------------------ Net income $ 49,818 $ 447,880 $ 71,625 - ---------------------------------------------------------------------------------------------- Basic earnings per share Class A $ 1.95 $ 16.62 $ 1.45 Class B 2.02 16.68 1.57 Combined 1.99 16.65 1.52 - ---------------------------------------------------------------------------------------------- Diluted earnings per share Class A $ 1.93 $ 15.69 $ 1.43 Class B 1.99 15.73 1.54 Combined 1.96 15.71 1.50 - ---------------------------------------------------------------------------------------------- Basic weighted average shares outstanding Class A 9,057 11,174 18,172 Class B 14,515 15,500 24,635 Combined 23,572 26,674 42,807 - ---------------------------------------------------------------------------------------------- Diluted weighted average shares outstanding Class A 9,094 11,182 18,235 Class B 14,835 17,313 25,266 Combined 23,929 28,495 43,501 - ---------------------------------------------------------------------------------------------- Cash dividends declared Class A $ 0.252 $ 0.252 $ 0.440 Class B 0.302 0.302 0.528 - ----------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 46 48 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY ($ IN THOUSANDS)
------------------------------------------------------------------------------------- DEFERRED CLASS A CLASS B CLASS A CLASS B ADDITIONAL COMPENSATION COMPREHENSIVE PREFERRED PREFERRED COMMON COMMON PAID-IN & UNEARNED INCOME STOCK STOCK STOCK STOCK CAPITAL ESOP SHARES - ------------------------------------------------------------------------------------------------------------------------- Balance at Dec. 31, 1996 $1,010 $0 $179 $ 256 $ 350,479 $(41,229) Net income $ 71,625 Other comprehensive income (loss): Foreign currency translation adjustment net of tax benefit (expense) of ($289) 536 Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of ($251) 466 -------- Comprehensive income $ 72,627 ======== 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 (11,159) Amortization of deferred compensation 11,343 Termination benefit -- Benefit plans 5,215 15,692 - ------------------------------------------------------------------------------------------------------------------------- Balance at Dec. 31, 1997 $1,010 $0 $182 $ 266 $ 379,543 $(25,353) Net income $447,880 Other comprehensive income (loss): Foreign currency translation adjustment net of tax benefit (expense) of $109 (202) Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of ($33) 61 -------- Comprehensive income $447,739 ======== Tender Offer (79) (113) (160,861) Preferred and common cash dividends declared Exercise of stock options 1 2 3,102 Issuance of stock -- Dividend reinvestment 89 Benefit plans 13 22,647 (20,605) Amortization of deferred compensation 8,193 Termination benefit -- Benefit plans (5) (15,214) 20,551 Stock buyback ESOP stock purchase (12,569) ESOP shares committed to be released (2) 19 - ------------------------------------------------------------------------------------------------------------------------- Balance at Dec. 31, 1998 $1,010 $0 $104 $ 163 $ 229,304 $(29,764) Net income $ 49,818 Other comprehensive income (loss): Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of $5,763 (10,703) -------- Comprehensive income $ 39,115 ======== Conversion of Class B Preferred Stock 14 (14) Preferred and common cash dividends declared Exercise of stock options 20 Issuance of stock -- Benefit plans 1 9 10,579 (10,589) Amortization of deferred compensation 3,781 Termination benefit -- Benefit plans (4) (7,421) 7,425 Stock buyback ESOP shares committed to be released 117 418 - ------------------------------------------------------------------------------------------------------------------------- Balance at Dec. 31, 1999 $1,010 $0 $105 $ 182 $ 232,585 $(28,729) - ------------------------------------------------------------------------------------------------------------------------- ---------------------------------------------------- ACCUMULATED OTHER TOTAL COMPREHENSIVE RETAINED TREASURY STOCKHOLDERS' INCOME (LOSS) EARNINGS STOCK EQUITY - ---------------------------------- ---------------------------------------------------- Balance at Dec. 31, 1996 $ (952) $ 542,335 $ (42) $ 852,036 Net income 71,625 71,625 Other comprehensive income (loss): Foreign currency translation adjustment net of tax benefit (expense) of ($289) 536 536 Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of ($251) 466 466 Comprehensive income Preferred and common cash dividends declared (28,301) (28,301) Exercise of stock options 8,477 Issuance of stock -- Dividend reinvestment 857 Benefit plans 1,297 4,666 Amortization of deferred compensation 11,343 Termination benefit -- Benefit plans (15,662) 5,245 - ------------------------------------------------------------------------------------------------------ Balance at Dec. 31, 1997 $ 50 $ 585,659 $(14,407) $ 926,950 Net income 447,880 447,880 Other comprehensive income (loss): Foreign currency translation adjustment net of tax benefit (expense) of $109 (202) (202) Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of ($33) 61 61 Comprehensive income Tender Offer (640,553) (801,606) Preferred and common cash dividends declared (10,894) (10,894) Exercise of stock options 3,105 Issuance of stock -- Dividend reinvestment 89 Benefit plans 2,055 Amortization of deferred compensation 8,193 Termination benefit -- Benefit plans (3,558) 1,774 Stock buyback (4,549) (4,549) ESOP stock purchase (12,569) ESOP shares committed to be released 17 - --------------------------------------------------------------------------------------------------------------------- Balance at Dec. 31, 1998 $ (91) $ 382,092 $(22,514) $ 560,304 Net income 49,818 49,818 Other comprehensive income (loss): Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of $5,763 (10,703) (10,703) Comprehensive income Conversion of Class B Preferred Stock 0 Preferred and common cash dividends declared (10,169) (10,169) Exercise of stock options 20 Issuance of stock -- Benefit plans 0 Amortization of deferred compensation 3,781 Termination benefit -- Benefit plans 0 Stock buyback (3,955) (3,955) ESOP shares committed to be released 535 - ------------------------------------------------------------------------------------------------------------------------- Balance at Dec. 31, 1999 $(10,794) $ 421,741 $(26,469) $ 589,631 - -------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 47 49 CONSOLIDATED STATEMENTS OF CASH FLOWS
($ IN THOUSANDS) YEAR ENDED DECEMBER 31, -------------------------------------------- 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 49,818 $ 447,880 $ 71,625 Adjustments to reconcile net income to net cash provided by operating activities: Equity securities (gains) losses (30,391) 41,750 11,426 Noncash charges associated with exit of auto finance business 16,900 0 0 Depreciation and amortization 18,507 21,480 35,280 Provision for credit losses, excluding auto 37,747 67,193 210,826 Gain on transfer of consumer credit card business 0 (541,288) 0 Noncash expense associated with unusual charges 0 25,539 0 Investment in subordinated trust assets, net (112,378) (113,473) (95,237) Proceeds from sale of trading investments 185,042 293,413 0 Origination of loans and leases held for sale (3,077,544) (5,772,116) (4,285,632) Proceeds from sale of loans and leases held for sale 3,138,290 5,760,090 4,309,218 Change in other assets and other liabilities (55,585) (186,317) 68,371 Change in retained interest-only strip, excluding auto charge 85,627 (25,790) (53,603) - ---------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 256,033 18,361 272,274 - ---------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Change in federal funds sold and interest-bearing deposits 108,802 (25,675) 4,541 Purchase of investments available for sale (12,872,622) (44,610,758) (46,510,251) Proceeds from sales of investments available for sale 812,821 1,707,418 1,736,050 Proceeds from maturing investments available for sale 12,171,704 43,591,658 44,263,776 Purchase of loan and lease portfolios 0 (38,190) (141,687) Principal collected on Advanta Mortgage loans and leases not held for sale 177,530 211,444 116,390 Origination of Advanta Mortgage loans and leases not held for sale (478,805) (498,935) (156,115) Change in business card receivables and other loans not held for sale, excluding sales (18,872) 17,974 (113,099) Change in consumer credit card receivables not held for sale, excluding sales/transfers 0 (121,845) (571,215) Purchases of premises and equipment, net (23,683) (41,795) (79,003) - ---------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (123,125) 191,296 (1,450,613) - ---------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Change in demand and savings deposits 62,329 70,415 190,493 Proceeds from sales of time deposits 600,747 1,762,747 1,934,081 Payments for maturing time deposits (900,507) (500,447) (967,021) Change in repurchase agreements, term fed funds and FHLB advances 324,191 38,195 (10,000) Proceeds from issuance of long-term debt 123,537 29,857 536,004 Payments on redemption of long-term debt (365,176) (781,051) (536,827) Change in other borrowings 49,109 (16,473) (92,229) Tender Offer 0 (801,606) 0 Stock buyback (3,955) (4,549) 0 ESOP stock purchase 0 (12,569) 0 Proceeds from issuance of stock 20 5,249 14,000 Cash dividends paid (10,169) (10,894) (28,301) - ---------------------------------------------------------------------------------------------------------- Net cash (used in) provided by financing activities (119,874) (221,126) 1,040,200 - ---------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash 13,034 (11,469) (138,139) Cash at beginning of period 16,267 27,736 165,875 - ---------------------------------------------------------------------------------------------------------- Cash at end of period $ 29,301 $ 16,267 $ 27,736 - ----------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 48 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ($ IN THOUSANDS EXCEPT PER SHARE DATA, UNLESS OTHERWISE NOTED) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Advanta Corp., a Delaware corporation, (collectively with its subsidiaries, "Advanta") is a financial services company that provides consumers and small businesses throughout the country with a variety of financial products including mortgages, business credit cards, equipment leases, insurance and deposit products. Advanta services approximately 680,000 customers and manages receivables of approximately $10.2 billion. Advanta also services mortgage loans for third parties (referred to as "subservicing" or "contract servicing"). Prior to February 20, 1998, Advanta issued consumer credit cards. BASIS OF PRESENTATION AND CONSOLIDATION The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of Advanta Corp. and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform with the current year's presentation. USE OF ESTIMATES 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 securitization income, retained interest-only strips, contractual mortgage servicing rights, the fair value of certain financial instruments, the allowance for credit losses, and income taxes, among others. Actual results could differ from those estimates. INVESTMENTS Trading investments are securities that are bought and held principally for the purpose of selling them in the near term. Trading investments are reported at fair value, with unrealized gains and losses included in earnings. Investments available for sale include securities that Advanta sells from time to time to provide liquidity and in response to changes in the market. Debt and equity securities classified as available for sale are reported at market value and unrealized gains and losses on these securities are reported in other comprehensive income, net of income taxes. Investments of Advanta's venture capital unit, Advanta Partners, are included in investments available for sale and carried at estimated fair value following the specialized industry accounting principles of this unit. Management makes fair value determinations based on quoted market prices, when available, and considers the investees' financial results, conditions and prospects when market prices are not available. The equity method of accounting for investments is not applied in accordance with venture capital accounting principles. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. LOAN AND LEASE RECEIVABLES HELD FOR SALE Loan and lease receivables held for sale represent receivables currently on the balance sheet that Advanta intends to sell or securitize within the next six months. These assets are reported at the lower of aggregate cost or fair market value by loan type. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. 49 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is established as losses are estimated to have occurred through a provision for credit losses charged to earnings. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility in light of historical experience by loan type, the nature and volume of the loan and lease portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Advanta charges losses on nonperforming Advanta Mortgage loans against the allowance generally at the earlier of foreclosure or when they have become twelve months delinquent. Losses on lease receivables are generally charged against the allowance when 121 days contractually delinquent. Advanta's charge-off policy, as it relates to business credit card accounts, is to charge-off a receivable, if not paid, at 180 days contractually delinquent. Consumer credit card accounts, if not paid, were charged-off at 186 days contractually delinquent. Credit card accounts suspected of being fraudulent are charged-off after a 90-day investigative period, unless the investigation shows no evidence of fraud. The accrual of interest is discontinued when the related receivable becomes 90 days past due. Interest income is subsequently recognized only to the extent cash payments are received. ORIGINATION COSTS AND FEES Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using a method which approximates the level yield method. Upon the sale or securitization of Advanta Mortgage loans or lease receivables, the unamortized portion of net fees or costs is included in the computation of the gain on sale. Deferred origination costs include costs of loan origination associated with transactions with independent third parties and certain costs relating to direct sales and underwriting activities and preparing and processing loan documents. Advanta engages third parties to solicit and originate credit card account relationships. Amounts paid to third parties to acquire credit card accounts are deferred and netted against any related credit card fee, and the net amount is amortized on a straight-line basis over the privilege period of one year. Net deferred costs on business card receivables were $8.1 million at December 31, 1999 and $2.1 million at December 31, 1998. SECURITIZATION ACTIVITIES Advanta, through its subsidiaries, sells mortgage loans, business cards and leases through securitizations, typically with servicing retained. Prior to the Consumer Credit Card Transaction in 1998, Advanta also securitized consumer credit card receivables. The transfer of financial assets in which Advanta surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. Liabilities and derivatives incurred or obtained as part of a transfer of financial assets are initially measured at fair value, if practicable. Advanta allocates the previous carrying amount of the receivables securitized between the assets sold and the retained interests, including the servicing relationship, interests in the receivables, and an interest-only strip, based on their relative estimated fair values at the date of sale. A gain is recognized at the time of the sale, equal to the excess of the fair value of the assets obtained (principally cash) over the allocated cost of the assets sold and transaction costs. The retained interest-only strip represents the fair value of the remaining interest to be collected from the borrowers on the underlying loans after the payment of interest to the certificate holders and the payment of a servicing fee to Advanta in its role as servicer reduced by the estimated fair value of Advanta's obligation for anticipated charge-offs. 50 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) During the revolving period of each credit card securitization trust, securitization income is recorded representing gains on the sale of new receivables to the trusts on a continuous basis to replenish the investors' interest in trust receivables that have been repaid by the credit card holders. RETAINED INTEREST-ONLY STRIP Retained interest-only strips are measured in accordance with the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). Advanta accounts for the retained interest-only strips from mortgage securitizations as trading securities. These assets are recorded at estimated fair value and the resulting unrealized gain or loss from the valuation of the receivable is included in the results of operations for the period. Advanta estimates the fair value of retained interest-only strips based on a discounted cash flow analysis. The cash flows are estimated as the excess of the weighted average yield on each pool of the receivables sold over the sum of the interest rate paid to the certificate holder plus the servicing fee, a trustee fee, credit enhancement costs and an estimate of future credit losses over the life of the receivables. Cash flows are discounted from the date the cash is expected to become available to Advanta (the "cash-out" method). These cash flows are projected over the life of the receivables using prepayment, default, and interest rate assumptions that management believes would be used by market participants for similar financial instruments subject to prepayment, credit and interest rate risk. The cash flows are discounted using an interest rate that management believes a purchaser unrelated to the seller of the financial instrument would demand. See Note 23 for discussion of assumptions used in the estimate of fair value at December 31, 1999 and 1998. As all estimates used are influenced by factors outside Advanta's control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. Interest income is recognized over the life of the retained interest-only strip using the discount rate used in the valuation. SERVICING RIGHTS Advanta allocates a portion of the book value of receivables securitized to the retained servicing rights based on relative fair values. Management has estimated the fair value of servicing rights based on a discounted cash flow analysis. The cash flows are estimated as the excess of the benefits of servicing, principally revenues from contractually specified servicing fees, late charges, prepayment penalties and other ancillary sources, over adequate market-based compensation. Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125") defines adequate compensation to include the profit that would be demanded in the marketplace. Servicing rights are amortized in proportion to, and over the period of, estimated net future servicing fee income. Servicing assets associated with credit card securitization transactions are not material as the benefits of servicing are not expected to be more or less than adequate compensation to Advanta for performing the servicing. Advanta periodically evaluates the potential impairment of servicing rights. Advanta stratifies these rights based on two of the predominant risk characteristics of the underlying loans, the period of origination and the type of loan (i.e., fixed or adjustable rate loan). Impairment is recognized through a valuation allowance for each individual stratum. The amount of impairment recognized is the amount by which the servicing rights for a stratum exceed their estimated fair value. See Note 23 for discussion of assumptions used in the estimate of fair value at December 31, 1999 and 1998. SUBORDINATED TRUST ASSETS Subordinated trust assets represent other retained interests in Advanta Mortgage's securitizations. Ownership of these interests, together with the related retained interest-only strip, is represented by the subordinate certificates issued by the securitization trust. These certificates serve as a form of credit enhancement for the transactions, and excess losses on the collateral would be absorbed by these amounts. Subordinated trust assets 51 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) are allocated a variable rate, risk-adjusted return. These assets are classified as trading securities and are carried at estimated fair value. In estimating fair value, management considers the credit enhancement provided by the retained interest-only strip. PREMISES AND EQUIPMENT Premises, equipment, computers and software are stated at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Repairs and maintenance are charged to expense as incurred. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS Securities sold under agreements to repurchase are accounted for as secured borrowings because Advanta maintains effective control over the transferred assets. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. Advanta may be required to provide additional collateral based on the fair value of the underlying securities. DERIVATIVE FINANCIAL INSTRUMENTS Advanta uses various derivative financial instruments, including interest rate swaps, interest rate caps, options and forward contracts, as part of its risk management strategy to reduce interest rate risk. Derivatives are not used for trading or speculative activities. Derivatives are classified as hedges or synthetic alterations of specific on-balance sheet items, off-balance sheet items or anticipated transactions. In order for derivatives to qualify for hedge accounting treatment, the following conditions must be met: 1) the underlying item being hedged must expose Advanta to interest rate risk; 2) the derivative used serves to reduce Advanta's sensitivity to interest rate risk; and 3) the derivative used is designated and deemed effective in hedging Advanta's exposure to interest rate risk. In addition to meeting these conditions, anticipatory hedges must demonstrate that the anticipated transaction being hedged is probable to occur and the expected terms of the transaction are identifiable. Gains or losses on derivatives designated as hedges of balance sheet items not carried at fair value are deferred and are ultimately recognized in income as part of the carrying amount of the related balance sheet item exposing Advanta to interest rate risk. Accrual accounting is applied for derivatives designated as synthetic alterations with income and expense recorded in the same category as the related underlying on-balance sheet or off-balance sheet item synthetically altered. Gains or losses resulting from early terminations of derivatives are deferred and amortized over the shorter of the remaining term of the underlying balance sheet item or the remaining term of the derivative. If the underlying balance sheet item is sold, matures or is extinguished, or the anticipated transaction is no longer likely to occur, any unrecognized gain or loss on the derivative is recognized currently in earnings. For derivatives designated as hedges of balance sheet items where changes in fair value are recognized currently in earnings, the related derivative is included in the balance sheet at fair value, and changes in the fair value of the derivative are also recognized currently in earnings. Derivatives not qualifying for hedge or synthetic accounting treatment would be carried at market value with realized and unrealized gains and losses included in operating results. During 1999, 1998 and 1997, all of Advanta's derivatives qualified as hedges or synthetic alterations. For purposes of reporting cash flows, cash flows from derivatives accounted for as hedges or synthetic alterations are classified in the same category as the item being hedged. 52 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) INSURANCE Insurance premiums are earned ratably over the period of insurance coverage provided. Reinsurance premiums, net of commissions, on credit life, disability and unemployment policies, are earned monthly based upon the outstanding balance of the underlying receivables. The cost of acquiring new reinsurance is deferred and amortized over the period the related premiums are earned in order to match the expense with the anticipated revenue. Insurance loss reserves are based on estimated settlement amounts for both reported losses and incurred but not reported losses. STOCK-BASED COMPENSATION Advanta has elected to account for stock-based compensation following Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" as permitted by SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). Advanta has adopted the disclosure-only provisions of SFAS 123. INCOME TAXES Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and gives current recognition to changes in tax rates and laws. EARNINGS PER SHARE Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Income available to common stockholders is computed by deducting Class A and Class B Preferred Stock dividends from net income. Diluted earnings per share is computed by dividing income available to common stockholders, increased by dividends on dilutive Class B Preferred Stock for the period, by the sum of average common shares outstanding plus dilutive common shares for the period. Potentially dilutive common shares include stock options, restricted stock issued under incentive plans and Class B Preferred Stock. Since the cash dividends declared on Advanta's Class B Common Stock were higher than the dividends declared on the Class A Common Stock, basic and diluted 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. Advanta has also presented combined earnings per share, which represents a weighted average of Class A and Class B earnings per share. CASH FLOW REPORTING Cash paid for interest was $161.0 million during 1999, $218.3 million during 1998, and $304.0 million during 1997. Cash paid (refunds received) for taxes was $8.9 million during 1999, $28.2 million during 1998, and $(6.1) million during 1997. See Note 9 for discussion of noncash transfer of assets and liabilities in the Consumer Credit Card Transaction. Noncash transactions in 1998 also included the retention of $795 million of trust certificates at the time of receivable securitization. These securities were classified as trading investments. In 1999, $315 million of these securities were reclassified from trading to available-for-sale securities. RECENT ACCOUNTING PRONOUNCEMENTS 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 53 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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, as amended by SFAS No. 137, cannot be applied retroactively and will be adopted as required January 1, 2001. Advanta anticipates that the adoption of SFAS No. 133 will not have a material effect on the results of operations; however, Advanta continues to monitor potential changes and implementation guidance to this new accounting standard. 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. Before the issuance of SFAS No. 134, Advanta 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. Advanta adopted SFAS No. 134 on January 1, 1999, and reclassified approximately $315 million of retained mortgage-backed securities related to mortgage loan securitizations from trading to available-for-sale securities based on Advanta's intent with respect to these securities. Advanta continues to classify its retained interest-only strips and subordinated trust assets from mortgage loan securitizations as trading securities. NOTE 2. INVESTMENTS Investments available for sale consisted of the following:
DECEMBER 31, ----------------------------------------------------------------------------------------------- 1999 1998 ---------------------------------------------- ---------------------------------------------- GROSS GROSS GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE - ----------------------------------------------------------------------------------------------------------------------- U.S. Treasury & other U.S. Government securities $145,112 $0 $ (4,668) $140,444 $435,953 $178 $ (33) $436,098 State and municipal securities 3,473 0 (85) 3,388 4,636 182 0 4,818 Collateralized mortgage obligations 456,288 0 (8,220) 448,068 12,278 0 (18) 12,260 Mortgage-backed securities 98,190 0 (3,634) 94,556 4,265 0 (203) 4,062 Equity securities(1) 60,892 0 0 60,892 61,006 0 (250) 60,756 Other 1,531 2 0 1,533 3,411 5 0 3,416 - ----------------------------------------------------------------------------------------------------------------------- Total investments available for sale $765,486 $2 $(16,607) $748,881 $521,549 $365 $(504) $521,410 - ----------------------------------------------------------------------------------------------------------------------- DECEMBER 31, --------------------------------------------------- 1997 1997 ---------- ------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE - --------------------- ------------ ------------------------------------ U.S. Treasury & other U.S. Government securities $1,083,848 $ 82 $(184) $1,083,746 State and municipal securities 5,195 123 0 5,318 Collateralized mortgage obligations 15,639 0 (151) 15,488 Mortgage-backed securities 47,387 150 0 47,537 Equity securities(1) 69,092 0 (250) 68,842 Other 1,344 0 (3) 1,341 - ----------------------------------------------------------------------------- Total investments available for sale $1,222,505 $355 $(588) $1,222,272 - -----------------------------------------------------------------------------
(1) Includes investments of the venture capital unit, Advanta Partners LP. The amount shown as amortized cost represents carrying value for these investments. See Note 1. 54 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Maturities of investments available for sale at December 31, 1999 were as follows:
AMORTIZED MARKET COST VALUE - ----------------------------------------------------------------------------------- Due in 1 year $ 17,698 $ 17,662 Due after 1 but within 5 years 128,794 124,168 Due after 5 but within 10 years 1,140 1,093 Due after 10 years 953 909 - ----------------------------------------------------------------------------------- Subtotal 148,585 143,832 Mortgage-backed securities 98,190 94,556 Collateralized mortgage obligations 456,288 448,068 Equity and other securities 62,423 62,425 - ----------------------------------------------------------------------------------- Total investments available for sale $765,486 $748,881 - -----------------------------------------------------------------------------------
Net realized gains on the sale of investments are included in other revenues in the Consolidated Income Statements. Realized gains and losses on sales of investments available for sale were as follows for the years ended December 31:
1999 1998 1997 - ----------------------------------------------------------------------------------------- Gross realized gains $30,697 $7,457 $3,867 Gross realized losses (64) (176) (181) - ----------------------------------------------------------------------------------------- Net realized gains $30,633 $7,281 $3,686 - -----------------------------------------------------------------------------------------
Investment securities deposited with insurance regulatory authorities to meet statutory requirements or held by a trustee for the benefit of primary insurance carriers were $7.3 million at December 31, 1999 and $5.8 million at December 31, 1998. At December 31, 1999, the carrying amount of securities pledged to secure repurchase agreements was $111.3 million and the carrying value of securities pledged to secure Federal Home Loan Bank ("FHLB") advances was $276.2 million. At December 31, 1998, no securities were pledged in connection with repurchase agreements or FHLB advances Trading investments at December 31, 1998 consisted of AAA rated classes of Advanta Mortgage Loan Trust 1998-2 and Advanta Mortgage Loan Trust 1998-4 securities. There were no investments classified as trading at December 31, 1999. Net realized and unrealized gains on trading investments were $1,471 thousand in 1998, and were included in other revenues. 55 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. LOAN AND LEASE RECEIVABLES Loan and lease receivables on the balance sheet, including those held for sale, consisted of the following:
DECEMBER 31, - -------------------------------------------------------------------------------------- 1999 1998 - -------------------------------------------------------------------------------------- Advanta Mortgage loans(1) $1,050,478 $ 829,819 Business cards(2) 275,095 150,022 Leases(3) 132,802 122,657 Other loans 21,930 17,862 - -------------------------------------------------------------------------------------- Gross loan and lease receivables 1,480,305 1,120,360 - -------------------------------------------------------------------------------------- Add: Deferred origination costs, net of deferred fees, and unamortized purchase premiums 11,166 20,504 Less Allowance for credit losses: Advanta Mortgage loans (21,743) (20,092) Business cards (14,663) (6,916) Leases (3,110) (2,695) Other loans (2,331) (3,734) - -------------------------------------------------------------------------------------- Total allowance (41,847) (33,437) - -------------------------------------------------------------------------------------- Net loan and lease receivables $1,449,624 $1,107,427 - --------------------------------------------------------------------------------------
(1) Includes Advanta Mortgage loan receivables held for sale of $510.9 million in 1999 and $459.5 million in 1998. (2) Includes business cards held for sale of $152.4 million in 1999 and $28.1 million in 1998. (3) Includes leases held for sale of $43.3 million in 1999 and $40.0 million in 1998, and is net of unearned income of $20.8 million in 1999 and $19.4 million in 1998. Also includes residual interests of $78.7 million in 1999 and $67.1 million in 1998. Securitized receivables consist of the following:
DECEMBER 31, - -------------------------------------------------------------------------------------- 1999 1998 - -------------------------------------------------------------------------------------- Advanta Mortgage loans $7,333,058 $7,447,502 Business cards 765,019 664,712 Leases 662,841 547,583 - -------------------------------------------------------------------------------------- Total $8,760,918 $8,659,797 - --------------------------------------------------------------------------------------
Advanta Mortgage loans include home equity loans, home equity lines of credit and auto loans, and exclude subservicing loans which were never owned by Advanta, but which Advanta services for a fee. Subservicing receivables were $11.9 billion at December 31, 1999 and $8.3 billion at December 31, 1998. Advanta bears no risk of credit loss on the receivables in our subservicing portfolio and subserviced loans are not included in the Company's managed portfolio of receivables. At December 31, 1999, two clients represented 66% of the subservicing receivables portfolio. At December 31, 1999, approximately 87% of Advanta Mortgage managed receivables represented first lien position loans and the balance was second lien position loans. At December 31, 1998, approximately 92% of Advanta Mortgage managed receivables represented first lien position loans. Home equity lines of credit represented 10% of the managed mortgage loan portfolio at December 31, 1999 and 5% at December 31, 1998. Advanta Mortgage managed receivables were comprised of approximately 62% of fixed rate loans at December 31, 1999 and 65% of fixed rate loans at December 31, 1998. Lease receivables are priced on a fixed rate basis. Business card receivables have variable rates based on the LIBOR (London Interbank Offered Rate) index. 56 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The geographic concentration of managed receivables (owned receivables and securitized receivables) was as follows:
DECEMBER 31, - ------------------------------------------------------------------------------------------------- 1999 1998 - ------------------------------------------------------------------------------------------------- California $ 1,246,632 12% $1,246,394 13% Michigan 707,978 7 816,971 8 Pennsylvania 588,386 6 517,369 5 Florida 572,187 6 541,501 6 New York 552,502 5 510,187 5 All other 6,573,538 64 6,147,735 63 - ------------------------------------------------------------------------------------------------- Total managed receivables $10,241,223 100% $9,780,157 100% - -------------------------------------------------------------------------------------------------
In the normal course of business, Advanta makes commitments to extend credit to its business card and home equity line of credit customers. Commitments to extend credit are agreements to lend to a customer subject to certain conditions established in the contract. Advanta does not require collateral to support credit card commitments. Advanta had commitments to extend credit outstanding for which there was potential credit risk of $4.4 billion at December 31, 1999 and $3.3 billion at December 31, 1998. Advanta believes that its customers' utilization of these lines of credit will continue to be substantially less than the amount of the commitments, as has been Advanta's experience to date. Unused commitments were $2.6 billion at December 31, 1999 and $2.1 billion at December 31, 1998. NOTE 4. ALLOWANCE FOR CREDIT LOSSES The following table displays five years of allowance history:
YEAR ENDED DECEMBER 31, - ---------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------- Balance at January 1 $ 33,437 $ 137,773 $ 89,184 $ 53,494 $ 41,617 Provision for credit losses 42,647 67,193 210,826 96,862 53,326 Transfer from recourse reserves 0 0 0 3,000 1,100 Allowances on receivables (sold) purchased (6,690) (118,420) (11,015) 6,404 0 Gross charge-offs: Advanta Mortgage loans (15,132) (14,313) (6,825) (3,473) (6,038) Business cards (11,341) (11,126) (6,403) (2,230) N/A Leases (4,429) (4,992) (3,180) (1,214) (1,413) Consumer credit cards 0 (30,999) (155,528) (73,466) (41,779) Other loans (2,404) 0 (4) (13) (38) - ---------------------------------------------------------------------------------------------- Total gross charge-offs (33,306) (61,430) (171,940) (80,396) (49,268) Recoveries: Advanta Mortgage loans 3,011 3,007 991 414 76 Business cards 1,238 1,093 205 61 N/A Leases 1,503 1,501 1,010 381 274 Consumer credit cards 0 2,719 18,511 8,945 6,354 Other loans 7 1 1 19 15 - ---------------------------------------------------------------------------------------------- Total recoveries 5,759 8,321 20,718 9,820 6,719 - ---------------------------------------------------------------------------------------------- Net charge-offs (27,547) (53,109) (151,222) (70,576) (42,549) Balance at December 31 $ 41,847 $ 33,437 $ 137,773 $ 89,184 $ 53,494 - ----------------------------------------------------------------------------------------------
57 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5. SECURITIZATION ACTIVITIES The following table presents activity in the retained interest-only ("IO") strip and contractual mortgage servicing rights ("CMSR") asset related to Advanta Mortgage loan securitizations:
YEAR ENDED DECEMBER 31, - -------------------------------------------------------------------------------------- 1999 1998(1) - -------------------------------------------------------------------------------------- Beginning balance IO Strip $209,096 $183,306 Beginning balance CMSR $ 74,425 $ 24,546 IO activity: Retained IO on sales, net 50,462 181,425 Interest income 19,354 21,674 Cash received and used to acquire subordinated trust assets (111,600) (96,455) Cash received and released to Advanta (25,760) (29,874) Fair value adjustments (20,731) (50,980) Fair value adjustment related to auto exit (7,828) 0 Other 2,648 0 CMSR activity: Servicing rights retained 54,124 71,131 Amortization (39,134) (12,977) Valuation provision 3,221 (8,275) Ending balance IO Strip $115,641 $209,096 Ending balance CMSR $ 92,636 $ 74,425 - --------------------------------------------------------------------------------------
(1) In 1999, Advanta reclassified $25.3 million from IO strip to CMSR to better reflect the deal structures. In addition, Advanta reclassified from IO strip $7.4 million as subordinated trust assets and $5.6 million as due from trustee, as these amounts had already been collected by the trust. These reclassifications had no impact on earnings. The 1998 balances have been reclassified to conform to this presentation. Securitized Advanta Mortgage loans outstanding were $7.3 billion at December 31, 1999 and $7.4 billion at December 31, 1998. The retained interest-only strip is net of estimated liabilities for anticipated charge-offs of $191.4 million at December 31, 1999 and $149.0 million at December 31, 1998. The balance in the valuation allowance for contractual mortgage servicing rights was $5.1 million at December 31, 1999 and was $8.3 million at December 31, 1998. During 1999, 1998 and 1997, there were no direct write-downs or other reductions to the valuation allowance. The following table presents activity in subordinated trust assets related to Advanta Mortgage loan securitizations:
YEAR ENDED DECEMBER 31, - -------------------------------------------------------------------------------------- 1999 1998 - -------------------------------------------------------------------------------------- Beginning balance $291,942 $178,469 Initial collateral deposits 45,717 38,907 Subordinated trust assets acquired with excess cash flows 111,600 96,455 Interest income 27,227 14,173 Valuation adjustment related to auto loans (4,172) 0 Valuation adjustment related to mortgage loans (11,269) 0 Excess cash flows released to Advanta (60,481) (50,044) Net change associated with off-balance sheet warehouse facilities (416) 13,982 - -------------------------------------------------------------------------------------- Ending balance $400,148 $291,942 - --------------------------------------------------------------------------------------
58 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In addition to subordinated trust assets, there were also restricted interest-bearing deposits of $35.8 million at December 31, 1999 and $25.3 million at December 31, 1998 relating to Advanta Mortgage loan securitizations. These deposits, the subordinated trust assets and the retained interest-only strip serve as credit enhancements for the securitization transactions. Securitized business cards outstanding were $765 million at December 31, 1999 and $665 million at December 31, 1998. Advanta had retained interests from business card securitizations of $39.3 million at December 31, 1999 and $31.2 million at December 31, 1998. These retained interests serve as credit enhancements for the securitization transactions and include the retained interest-only strip, subordinated trust assets and restricted cash reserves. These assets are included in other assets and restricted interest-bearing deposits on the balance sheet. The business card retained interest-only strip is net of estimated liabilities for anticipated charge-offs of $26.5 million at December 31, 1999 and $25.5 million at December 31, 1998. Securitized lease receivables outstanding were $663 million at December 31, 1999 and $548 million at December 31, 1998. Advanta had net retained interests from leasing securitizations of $50.9 million at December 31, 1999 and $29.6 million at December 31, 1998. These retained interests serve as credit enhancements for the securitization transactions and include the retained interest-only strip, servicing assets, subordinated trust assets and restricted interest-bearing deposits. These assets are included in other assets and restricted interest-bearing deposits on the balance sheet. The leasing retained interest-only strip is net of estimated liabilities for anticipated charge-offs of $19.1 million at December 31, 1999 and $15.7 million at December 31, 1998. Total interests in equipment residuals for securitized leases that serve as credit enhancements for the securitization transactions were $46.5 million at December 31, 1999 and $40.6 million at December 31, 1998. Interests in equipment residuals are included in loan and lease receivables. NOTE 6. SELECTED BALANCE SHEET INFORMATION Other assets consisted of the following:
DECEMBER 31, -------------------- - ---------------------------------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------------- Servicing advances $105,302 $141,389 Current and deferred federal and state income taxes, net (see Note 19) 89,788 31,243 Accrued interest receivable 32,410 27,184 Other real estate(A) 9,560 6,622 Goodwill 3,323 3,600 Other 284,553 357,428 - ---------------------------------------------------------------------------------- Total other assets $524,936 $567,466 - ----------------------------------------------------------------------------------
(A) Carried at the lower of cost or fair market value less selling costs. Other liabilities consisted of the following:
DECEMBER 31, - ---------------------------------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------------- Accounts payable and accrued expenses $ 98,423 $ 66,852 Accrued interest payable 36,554 38,035 Current and deferred state income taxes 0 2,445 Other 154,586 137,546 - ---------------------------------------------------------------------------------- Total other liabilities $289,563 $244,878 - ----------------------------------------------------------------------------------
59 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7. LONG-TERM DEBT Long-term debt consists of borrowings having an original maturity of over one year. The composition of long-term debt at December 31, 1999 and 1998, was as follows:
DECEMBER 31, - ------------------------------------------------------------------------------------ 1999 1998 - ------------------------------------------------------------------------------------ SENIOR DEBT 12 month senior notes (8.39%-9.40%) $ 86,647 $ 48,948 18 month senior notes (7.42%-9.21%) 8,344 6,565 24 month senior notes (7.14%-9.71%) 50,571 32,360 30 month senior notes (6.95%-9.44%) 13,852 13,609 48 month senior notes (5.97%-9.49%) 8,427 8,454 60 month senior notes (6.02%-9.67%) 28,863 20,779 Value notes, fixed (7.00%-7.85%) 7,779 9,300 Medium-term notes, fixed (6.54%-7.50%) 490,650 703,460 Medium-term notes, floating 47,400 163,000 Medium-term bank notes, fixed (6.45%-7.12%) 7,347 7,338 Other senior notes (6.77%-11.34%) 37,670 14,844 - ------------------------------------------------------------------------------------ Total senior debt 787,550 1,028,657 Subordinated notes (7.00%-11.34%) 958 1,490 - ------------------------------------------------------------------------------------ Total long-term debt $788,508 $1,030,147 - ------------------------------------------------------------------------------------
Advanta has priced its floating rate medium-term notes based on a spread over LIBOR. At December 31, 1999, the rates on these notes varied from 6.05% to 6.91%. At December 31, 1999 and 1998, Advanta used derivative financial instruments to effectively convert certain fixed rate debt to a LIBOR-based variable rate (see Note 24). The annual maturities of long-term debt at December 31, 1999 for the years ending December 31 are as follows: $353.8 million in 2000; $338.2 million in 2001; $78.6 million in 2002; $7.4 million in 2003; and $10.5 million in 2004. The average interest cost of Advanta's long-term debt was 6.53% during 1999, 6.52% during 1998, and 6.38% during 1997. NOTE 8. OTHER BORROWINGS The composition of other borrowings was as follows:
DECEMBER 31, - --------------------------------------------------------------------------------- 1999 1998 - --------------------------------------------------------------------------------- Securities sold under repurchase agreements $104,191 $ 0 FHLB advances 220,000 0 Warehouse facility 76,435 18,517 Other borrowings 8,975 17,784 - --------------------------------------------------------------------------------- Total $409,601 $36,301 - ---------------------------------------------------------------------------------
Advanta has secured warehouse financing facilities and secured commercial paper conduit facilities totaling $2.4 billion at December 31, 1999. Of the total, $1.8 billion was committed. These commitments can be withdrawn under certain conditions, including the failure of Advanta to make payments under the terms of the agreements. Advanta pays a monthly facility fee on the unused commitments of up to 35 basis points. These facilities provide for on-balance sheet and off-balance sheet funding. At December 31, 1999, Advanta 60 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) had $1.2 billion available under these facilities, as there was $1.2 billion of loans funded through these facilities, $76.4 million of which were accounted for as secured borrowings. These facilities are generally renewable annually. Upon the expiration of these facilities, management expects to obtain the appropriate levels of replacement funding under similar terms and conditions. At December 31, 1998, Advanta had secured warehouse financing facilities and secured commercial paper conduit facilities totaling $1.5 billion. There were $536.1 million of loans funded through these facilities at December 31, 1998; $18.5 million of which were accounted for as secured borrowings. Advanta is subject to loan covenants related to the maintenance of certain equity levels at the borrowing subsidiaries, limitations on mergers and acquisitions, limitations on transactions with affiliates, and maintenance of adequate investment base and interest rate protection agreements. Management believes that at December 31, 1999, Advanta was in compliance with all such loan covenants. The following table displays information related to selected types of short-term borrowings:
1999 1998 1997 - ----------------------------------------------------------------------------------------------- AMOUNT RATE AMOUNT RATE AMOUNT RATE - ----------------------------------------------------------------------------------------------- At year end: Securities sold under repurchase agreements $104,191 5.78% $ 0 0% $ 0 0% FHLB advances 220,000 5.53 0 0 0 0 - ----------------------------------------------------------------------------------------------- Average for the year: Securities sold under repurchase agreements $ 24,647 5.39% $ 69,916 6.05% $ 9,796 5.66% Term fed funds, fed funds purchased and FHLB advances 11,432 5.57 272 5.61 11,925 5.71 - ----------------------------------------------------------------------------------------------- Total $ 36,079 5.43% $ 70,188 6.05% $ 21,721 5.69% - ----------------------------------------------------------------------------------------------- Maximum month-end balance: Securities sold under repurchase agreements $104,191 $259,643 $149,130 Term fed funds, fed funds purchased and FHLB advances 220,000 1,700 65,000 - -----------------------------------------------------------------------------------------------
The weighted average interest rates were calculated by dividing the interest expense for the period by the average amount of short-term borrowings outstanding during the period, calculated as an average of daily amounts. NOTE 9. DISPOSITION OF CONSUMER CREDIT CARD ASSETS In accordance with the terms of the contribution agreement, dated as of October 28, 1997, as amended February 20, 1998, by and between Advanta and Fleet Financial Group, Inc. ("Fleet"), Advanta 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 ("Fleet LLC") in exchange for an ownership interest in Fleet LLC. Subsequent to February 20, 1998, Fleet Credit Card Services LP became the successor in interest to Fleet LLC. References to Fleet LLC include its successor in interest, Fleet Credit Card Services LP. Advanta recognized a gain on the transfer of the consumer credit card business (the "Consumer Credit Card Transaction") representing the excess of liabilities transferred to Fleet LLC over the net basis of the assets transferred. The gain also included Advanta's ownership interest in Fleet LLC. The gain on the transfer was not subject to income tax and no tax provision was recorded. The contribution agreement provides for the parties to make a final determination of the transferred assets and liabilities. As further described in Note 10, Advanta and Fleet are parties to a lawsuit concerning disputes regarding the final determination of the transferred assets and liabilities. It is possible that the outcome of the litigation will result in an increase or decrease to the gain recorded. 61 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Advanta retained certain immaterial assets of its consumer credit card business, which are not required in the operation of that business, and certain liabilities related to its consumer credit card business. These retained assets and liabilities include 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 Advanta's consumer credit card receivables as of February 20, 1998. The assets and liabilities retained have been classified in other assets and other liabilities. The contribution was accounted for as: (1) the transfer of financial assets (cash, loans, and other receivables) and an extinguishment of financial liabilities (deposits, debt and other borrowings and other liabilities) following SFAS 125; and (2) the sale of non-financial assets and liabilities (principally property and equipment, prepaid assets, deferred costs and certain contractual obligations). The financial assets, non-financial assets and liabilities of Advanta's consumer credit card business that were contributed were removed from the balance sheet. Advanta was legally released as primary obligor under all of the financial liabilities contributed and, accordingly, they were removed from the balance sheet. Concurrently with the Consumer Credit Card Transaction, Advanta purchased 7,882,750 shares of its Class A Common Stock and 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 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 approved the payment of a special dividend/return of capital from Advanta National Bank to Advanta Corp., its parent company, to effect the purchase of the shares. NOTE 10. COMMITMENTS AND CONTINGENCIES On January 22, 1999, Fleet and certain of its affiliates filed a lawsuit against Advanta and certain of its subsidiaries in Delaware Chancery Court. Fleet's allegations, which Advanta denies, center around Fleet's assertions that Advanta has failed to complete certain post-closing adjustments to the value of the assets and liabilities Advanta contributed to Fleet LLC in connection with the Consumer Credit Card Transaction. Fleet seeks damages of approximately $141 million. Advanta has filed an answer to the complaint denying the material allegations of the complaint, but acknowledging that Advanta contributed $1.8 million in excess liabilities in the post-closing adjustment process, after taking into account the liabilities Advanta has already assumed. Advanta also has filed a countercomplaint against Fleet for approximately $101 million in damages Advanta believes have been caused by certain actions of Fleet following the closing of the Consumer Credit Card Transaction. Formal discovery has begun and is ongoing. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on the financial position or future operating results of Advanta. On or about March 26, 1999, a complaint was filed by John Uphaus, individually and on behalf of a class, against Household Bank (Nevada) N.A. ("Household") and Advanta National Bank in the United States District Court for the Northern District of Illinois. Uphaus alleges that he had a credit card account with Household, which account was purchased by Advanta National Bank. He further alleges that the annual percentage rate on a portion of his account was increased in a manner contrary to the promotional material he received. Advanta's preliminary investigation suggests that if a change in interest rate took place, as alleged by Uphaus, that change occurred after the contribution of Advanta's consumer credit card portfolio, and it was made by Fleet LLC. In any event, Fleet LLC is obligated to defend and indemnify Advanta pursuant to the contribution agreement and the licensing agreement between the parties. Advanta National Bank's response to this complaint was originally due on June 21, 1999. The court has extended this deadline several times to allow the parties to exchange information; thus, no response has been filed by either defendant. Some formal discovery has begun. Advanta and its subsidiaries are involved in other legal proceedings, claims and litigation, including those arising in the ordinary course of business. Management believes that the aggregate liabilities, if any, resulting 62 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) from those actions will not have a material adverse effect on the consolidated financial position or results of operations of Advanta. However, as the ultimate resolution of these proceedings is influenced by factors outside of Advanta's control, it is reasonably possible that Advanta's estimated liability under these proceedings may change. Advanta leases office space in several states under leases accounted for as operating leases. Total rent expense for all of Advanta's locations was $9.4 million in 1999, $7.9 million in 1998, and $11.3 million in 1997. The future minimum lease payments of all non-cancelable operating leases are as follows: Year Ended December 31, 2000 $ 6,807 2001 6,339 2002 5,446 2003 5,064 2004 5,040 Thereafter 10,126
NOTE 11. MANDATORILY REDEEMABLE PREFERRED SECURITIES In December 1996, Advanta Capital Trust I (the "Trust"), a newly formed statutory business trust established and wholly-owned by Advanta, issued $100 million of capital securities, representing preferred beneficial interests in the assets of the Trust (the "capital securities"). Advanta used the proceeds from the sale for general corporate purposes. The assets of the Trust consist of $100 million of 8.99% junior subordinated debentures issued by Advanta due December 17, 2026. The capital securities will be subject to mandatory redemption under certain circumstances. These circumstances include the optional prepayment by Advanta of the junior subordinated debentures at any time on or after December 17, 2006 at an amount per capital security equal to 104.495% of the principal amount plus accrued and unpaid distributions. This amount declines ratably on each December 17 thereafter to 100% on December 17, 2016. The obligations of Advanta with respect to the junior subordinated debentures, when considered together with the obligations of Advanta under the indenture relating to the junior subordinated debentures, the Amended and Restated Declaration of Trust and the capital securities guarantee issued by Advanta will provide, in the aggregate, a full and unconditional guarantee of payments of distributions and other amounts due on the capital securities. Dividends on the capital securities are cumulative, payable semi-annually in arrears, and are deferrable at Advanta's option for up to ten consecutive semi-annual periods. Advanta cannot pay dividends on its preferred or common stocks during deferments. Dividends on the capital securities have been classified as minority interest in income of consolidated subsidiary in the Consolidated Income Statements. The Trust has no operations or assets separate from its investment in the junior subordinated debentures. Separate financial statements of the Trust are not presented because management has determined that they would not be meaningful to investors. NOTE 12. CAPITAL STOCK Class A Preferred Stock is entitled to 1/2 vote per share and a non-cumulative dividend of $140 per share per year, which must be paid prior to any dividend on the common stock. The redemption price of the Class A Preferred Stock is equivalent to its par value. In 1995, Advanta sold 2,500,000 depositary shares each representing a one-hundredth interest in a share of Stock Appreciation Income Linked Securities ("SAILS"). The SAILS constituted a series of Advanta's Class B Preferred Stock, designated as 6 3/4% Convertible Class B Preferred Stock, Series 1995. On September 15, 1999, all of the 1.4 million outstanding depositary shares, each representing a one-hundredth interest in a share of SAILS, mandatorily converted into 1.4 million shares of Class B Common Stock. 63 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) On February 20, 1998, Advanta 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 depositary shares each representing a one-hundredth interest in a share of SAILS, at $32.80 per share net, through the Tender Offer. In 1998, the Board of Directors authorized the repurchase of up to 2.5 million shares of Advanta's Class A and Class B Common Stock and the formation of an Employee Stock Ownership Plan ("ESOP"). Through December 31, 1999, Advanta had purchased 445,600 shares of Class B Common Stock and 1,405,000 shares of Class A Common Stock at a total cost of $21.1 million. Of the total shares purchased, 1,000,000 shares of Class A Common Stock were purchased for Advanta's ESOP. NOTE 13. BENEFIT PLANS RESTRICTED STOCK PLANS Advanta has adopted several management incentive plans designed to provide incentives to participating employees to remain in the employ of Advanta and devote themselves to its success. Under these plans, eligible employees were given the opportunity to elect to take portions of their anticipated or target bonus payments for future years in the form of restricted shares of common stock (with each plan covering three performance years). To the extent that these elections were made, or were required by the terms of the plans for executive officers, restricted shares were issued to employees. The number of shares granted to employees is determined by dividing the amount of future bonus payments that the employee had elected to receive in stock by the market price as determined under the incentive plans. The restricted shares are subject to forfeiture prior to vesting should the employee terminate employment with Advanta. Restricted shares vest 10 years from the date of grant. Vesting was and may continue to be accelerated annually with respect to up to one-third of the shares granted under the plan covering the particular performance year, based on the extent to which the employee and Advanta met or meet their respective performance goals for that plan performance year. When newly eligible employees elect to participate in a plan, the number of shares issued to them with respect to their target bonus payments for the relevant plan performance years is determined based on the average market price of the stock for the 90 days prior to eligibility. Compensation expense on restricted shares is recognized over the vesting period of the shares. Compensation expense recognized in connection with restricted shares was $3.8 million in 1999, $8.2 million in 1998 and $11.3 million in 1997. The following table summarizes restricted shares outstanding and shares issued.
1999 1998 ------------------- ---------------------------- (SHARES IN THOUSANDS) --------- WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER OF PRICE AT DATE OF NUMBER OF PRICE AT DATE OF SHARES ISSUANCE SHARES ISSUANCE - ---------------------------------------------------------------------------------------------------------- Restricted shares outstanding at December 31 1,750 $15 1,592 $20 Restricted shares issued in the year ended December 31 1,002 $11 1,234 $17 - ----------------------------------------------------------------------------------------------------------
Advanta also grants shares of phantom stock to certain officers in lieu of restricted shares. In 1999, there were 27,413 shares of phantom stock granted at a price of $10.625. In 1998, there were 50,632 phantom stock shares granted at a price of $10.625. Shares of phantom stock outstanding totaled 78,045 at December 31, 1999 and 50,632 at December 31, 1998. There were no phantom shares granted before 1998. Compensation expense related to the appreciation on shares of phantom stock was not material during 1999 or 1998. STOCK OPTION PLANS At December 31, 1999 Advanta had two stock option plans and accounts for these plans following Accounting Principles Board Opinion No. 25, under which no compensation expense has been recognized. 64 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Had compensation cost for these plans been determined consistent with SFAS 123, Advanta's net income and earnings per share would have been reduced to the following pro forma amounts:
1999 1998 1997 - -------------------------------------------------------------------------------------------- Net income As reported $49,818 $447,880 $71,625 Pro forma $41,810 436,960 58,576 - -------------------------------------------------------------------------------------------- Basic earnings per share As reported Combined $ 1.99 $ 16.65 $ 1.52 Class A 1.95 16.62 1.45 Class B 2.02 16.68 1.57 Pro forma Combined $ 1.65 $ 16.24 $ 1.22 Class A 1.62 16.21 1.15 Class B 1.68 16.27 1.27 - -------------------------------------------------------------------------------------------- Diluted earnings per share As reported Combined $ 1.96 $ 15.71 $ 1.50 Class A 1.93 15.69 1.43 Class B 1.99 15.73 1.54 Pro forma Combined $ 1.63 $ 15.33 $ 1.20 Class A 1.59 15.31 1.14 Class B 1.65 15.34 1.24 - --------------------------------------------------------------------------------------------
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the years ended December 31:
1999 1998 1997 -------------------- Dividend yield 3% 3% 1% Expected life (in years) 10 10 10 Expected volatility 51% 48% 40% Risk-free interest rate 5.4% 5.7% 6.7%
Because SFAS 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. During 1997 and 1998, Advanta changed the exercise price of certain options granted during 1996 and 1997 to the market price on the date of the modification. These modifications did not result in additional compensation expense under the accounting prescribed by SFAS 123. Also in 1998, Advanta amended the terms of options granted to employees who became employees of Fleet LLC or whose employment was otherwise terminated in connection with the Consumer Credit Card Transaction to extend the post-employment exercise period. In 1998, Advanta accelerated vesting of 43.15% of outstanding options that were not vested at the time of the Consumer Credit Card Transaction. See discussion in Note 20 of charges to earnings relating to these modifications. Advanta's two stock option plans together authorize the grant to employees and directors of options to purchase an aggregate of 10.2 million shares of common stock. Advanta presently intends only to issue options to purchase Class B Common Stock. Substantially all of the options outstanding at December 31, 1999 were options to purchase Class B Common Stock. Options generally vest over a four-year period and expire 10 years 65 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) after the date of grant. Shares available for future grant were approximately 2.7 million at December 31, 1999 and 2.2 million at December 31, 1998. Transactions under the plans for the three years ended December 31, 1999, were as follows:
1999 1998 1997 ---------------------------- ---------------------------- ---------------------------- NUMBER OF WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ------------------------------------------------------------------------------------------ Outstanding at beginning of year 2,988 $22 3,934 $27 4,109 $25 Granted 1,358 10 1,186 18 967 27 Exercised (8) 2 (1,471) 24 (774) 11 Terminated (1,610) 23 (661) 21 (368) 33 - ----------------------------------------------------------------------------------------------------------------- Outstanding at end of year 2,728 15 2,988 22 3,934 27 - ----------------------------------------------------------------------------------------------------------------- Options exercisable at year-end 722 1,353 2,003 - ----------------------------------------------------------------------------------------------------------------- Weighted average fair value of options granted during the year $ 4.60 $ 8.05 $22.90 - -----------------------------------------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at December 31, 1999.
(SHARES IN THOUSANDS) OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ------------------------------ NUMBER WEIGHTED AVERAGE NUMBER RANGE OF OUTSTANDING REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE EXERCISE PRICES AT 12/31/99 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/99 EXERCISE PRICE ------------------------------------------------- ------------------------------ 1 to 10 1,004 9.1 years $ 8 56 $ 9 11 to 20 1,053 8.6 16 192 17 21 to 30 641 6.6 22 445 22 31 to 40 27 5.8 38 27 38 41 to 46 3 6.2 46 2 46 - ----------------------------------------------------------------------------------------------------- Total 2,728 722 - -----------------------------------------------------------------------------------------------------
During 1999 and 1998, Advanta issued stock appreciation rights to certain directors of Advanta in exchange for or in lieu of options. At December 31, 1999, 1,230 rights were outstanding with a strike price of $4.75, 127,000 rights were outstanding with a strike price of $10.75, 163,074 rights were outstanding with a strike price of $12.33 and 233,675 rights were outstanding with a strike price between $19.00 and $22.125. At December 31, 1998, 1,230 rights were outstanding with a strike price of $4.75, 163,074 rights were outstanding with a strike price of $12.33 and 233,675 rights were outstanding with a strike price between $19.00 and $22.125. Total stock appreciation rights outstanding were 524,979 at December 31, 1999 and 397,979 at December 31, 1998. Compensation expense related to stock appreciation rights was not material in 1999 or 1998. EMPLOYEE STOCK PURCHASE PLAN Advanta has an Employee Stock Purchase Plan, which allows employees and directors to purchase Class B Common Stock at a 15% discount from the market price without paying brokerage fees. Advanta reports this 15% discount as compensation expense and incurred expense of $162 thousand in 1999, $200 thousand in 1998, and $339 thousand in 1997. Shares issued under the plan are issued at the average market price on the day of purchase. 66 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) EMPLOYEE SAVINGS PLAN Advanta has a tax-deferred employee savings plan, which provides employees with savings and investment opportunities, including the ability to invest in Advanta's Class B Common Stock. The employee savings plan provides for discretionary employer contributions equal to a portion of the first 5% of an employee's compensation contributed to the plan. For the three years ended December 31, 1999, 1998 and 1997, Advanta contributions equaled 100% of the first 5% of participating employees' compensation contributed to the plan. The expense for this plan totaled $2.7 million in 1999, $2.4 million in 1998, and $3.5 million in 1997. All shares purchased by the plan in the years ended December 31, 1999, 1998 and 1997 were acquired from Advanta at the market price on each purchase date or were purchased on the open market. DEFERRED COMPENSATION PLAN Advanta offers an elective, nonqualified deferred compensation plan to qualified executives and non-employee directors, which allows them to defer a portion of their cash compensation on a pretax basis. The plan contains provisions related to minimum contribution levels and deferral periods with respect to any individual's participation. The plan participant makes irrevocable elections at the date of deferral as to deferral period and date of distribution. Interest is credited to the participant's account at the rate of 125% of the 10-year rolling average interest rate on 10-Year U.S. Treasury Notes. Distribution from the plan may be either at retirement or at an earlier date, and can be either in a lump sum or in installment payments. Advanta has purchased life insurance contracts with a face value of $55 million to fund this plan. EMPLOYEE STOCK OWNERSHIP PLAN On September 10, 1998, Advanta's Board of Directors authorized the formation of an Employee Stock Ownership Plan, covering all employees of Advanta who have reached age 21 with one year of service. During 1998, the ESOP borrowed approximately $12.6 million from Advanta and used the proceeds to purchase approximately 1,000,000 shares of Advanta's Class A Common Stock. The ESOP loan is repayable with an interest rate of 8% over 30 years. Advanta makes annual contributions to the ESOP equal to the ESOP's debt service less dividends received on unallocated shares by the ESOP. As the ESOP loan is repaid, shares are allocated to active employees, based on the proportion of debt service paid in the year. Advanta 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 committed to be released to each employee, Advanta 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 used to fund debt service of the ESOP. ESOP compensation expense was $535 thousand for the year ended December 31, 1999 and $17 thousand for the year ended December 31, 1998. At December 31, 1999 there were 965,229 unearned and unallocated ESOP shares with a fair value of $17.6 million. At December 31, 1998, there were 998,513 unearned and unallocated ESOP shares with a fair value of $13.2 million. NOTE 14. CAPITAL RATIOS Advanta National Bank and Advanta Bank Corp. are wholly-owned subsidiaries of Advanta. Advanta National Bank and Advanta Bank Corp. are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the institutions' and Advanta's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the institutions must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The institutions' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. 67 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Quantitative measures established by regulation to ensure capital adequacy require the institution to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 1999 and 1998, Advanta National Bank and Advanta Bank Corp. met all capital adequacy requirements to which they were subject and were categorized as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized the institutions must maintain minimum total risk-based capital, Tier I risk-based capital and Tier I leverage ratios as set forth in the following table.
TO BE WELL- CAPITALIZED UNDER PROMPT FOR CAPITAL CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS - ------------------------------------------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - ------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1999 - --------------------------- Total Capital (to Risk Weighted Assets) Advanta National Bank $427,409 14.86% $230,061 greater $287,576 greater than or than or equal equal to to 8.0% 10.0% Advanta Bank Corp. 143,151 13.28 86,204 greater 107,755 greater than or than or equal equal to to 8.0% 10.0% Tier I Capital (to Risk Weighted Assets) Advanta National Bank $414,359 14.41% $115,030 greater $172,546 greater than or than or equal equal to to 6.0% 4.0% Advanta Bank Corp. 128,193 11.90 43,102 greater 64,653 greater than or than or equal equal to to 6.0% 4.0% Tier I Capital (to Average Assets) Advanta National Bank $414,359 18.18% $ 91,193 greater $113,991 greater than or than or equal equal to to 5.0% 4.0% Advanta Bank Corp. 128,193 27.86 18,406 greater 23,008 greater than or than or equal equal to to 5.0% 4.0% AS OF DECEMBER 31, 1998 - --------------------------- Total Capital (to Risk Weighted Assets) Advanta National Bank $380,107 12.12% $250,932 greater $313,665 greater than or than or equal equal to to 8.0% 10.0% Advanta Bank Corp. 41,840 14.13 23,683 greater 29,604 greater than or than or equal equal to to 8.0% 10.0% Tier I Capital (to Risk Weighted Assets) Advanta National Bank $370,281 11.80% $125,466 greater $188,199 greater than or than or equal equal to to 6.0% 4.0% Advanta Bank Corp. 38,139 12.88 11,842 greater 17,763 greater than or than or equal equal to to 6.0% 4.0% Tier I Capital (to Average Assets) Advanta National Bank $370,281 17.13% $ 86,458 greater $108,074 greater than or than or equal equal to to 5.0% 4.0% Advanta Bank Corp. 38,139 16.10 9,474 greater 11,842 greater than or than or equal equal to to 5.0% 4.0%
NOTE 15. DIVIDEND AND LOAN RESTRICTIONS In the normal course of business, Advanta and its subsidiaries enter into agreements, or are subject to regulatory requirements, that result in dividend and loan restrictions. FDIC-insured banks are subject to certain provisions of the Federal Reserve Act which impose various legal limitations on the extent to which banks may finance or otherwise supply funds to certain of their affiliates. In particular, Advanta National Bank and Advanta Bank Corp. are subject to certain restrictions on any extensions of credit to, or other covered transactions, such as certain purchases of assets, with Advanta or its affiliates. Advanta National Bank and Advanta Bank Corp. are prevented by these restrictions from lending to Advanta and its affiliates unless these extensions of credit are secured by U.S. Government obligations or other specified collateral. Further, secured extensions of credit are limited in amount: (a) as to Advanta Corp. or any affiliate, to 10 percent of each bank's capital and surplus, and (b) as to Advanta Corp. and all affiliates in the aggregate, to 20 percent of each bank's capital and surplus. 68 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Under certain grandfathering provisions of the Competitive Equality Banking Act of 1987, Advanta is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended, so long as Advanta and Advanta National Bank continue to comply with certain restrictions on their activities. These restrictions include limiting the scope of Advanta National Bank's activities to those in which it was engaged prior to March 5, 1987. Since Advanta National Bank was not making commercial loans at that time, it must continue to refrain from making commercial loans -- which would include any loans to Advanta or any of its subsidiaries -- in order for Advanta to maintain its grandfathered exemption under the Bank Holding Company Act. Advanta has no present plans to register as a bank holding company under the Bank Holding Company Act. Advanta National Bank is also subject to various legal limitations on the amount of dividends that can be paid to its parent, Advanta Corp. Advanta National Bank is eligible to declare a dividend provided that it is not greater than the current year's net profits plus net profits of the preceding two years. In addition, dividends paid by either Advanta National Bank or Advanta Bank Corp. would be prohibited if the effect thereof would cause the bank's capital to be reduced below applicable minimum capital requirements. During 1998, the Office of the Comptroller of the Currency approved the payment of a special dividend/return of capital of $1.3 billion from Advanta National Bank to Advanta Corp. to effect the Tender Offer described in Note 9. As a result of this special dividend/return of capital and the dividend restrictions described above, Advanta National Bank will not be eligible to declare any dividends to Advanta Corp. without prior regulatory approval until at least the first quarter of 2001. Advanta National Bank paid no dividends to Advanta Corp. during 1999 or 1997. There were no dividends from Advanta Bank Corp. to Advanta Corp. during 1999, 1998 or 1997. Advanta's insurance subsidiaries are also subject to certain capital, deposit and dividend rules and regulations as prescribed by state jurisdictions in which they are authorized to operate. At December 31, 1999 and 1998, the insurance subsidiaries were in compliance with these rules and regulations. Insurance subsidiaries paid dividends to Advanta Corp. of $1.2 million in 1999. Dividends paid to Advanta Corp. in 1998 by insurance subsidiaries were $39 million, including an extraordinary dividend of $35 million that was approved in advance by the applicable state regulators. There were no dividends paid to Advanta Corp. by insurance subsidiaries in 1997. Total stockholders' equity of Advanta's banking and insurance affiliates approximated $584 million at December 31, 1999, and $429 million at December 31, 1998. Of Advanta's total equity in these affiliates, $524 million was restricted at December 31, 1999 and $406 million was restricted at December 31, 1998. At January 1, 2000, $60 million of stockholders' equity of Advanta's banking and insurance affiliates was available for payment of dividends under applicable regulatory guidelines. In addition to restrictions at banking subsidiaries, certain non-bank subsidiaries are subject to minimum equity requirements as part of securitization agreements or financing facility agreements. The total minimum equity requirement of non-bank subsidiaries was $35 million at December 31, 1999. NOTE 16. SEGMENT INFORMATION Advanta's reportable segments as of December 31, 1999 were Advanta Mortgage, Advanta Business Cards and Advanta Leasing Services. Each of these business segments has separate management teams and infrastructures that offer different products and services. Through February 20, 1998, Advanta also had an additional reportable segment, Advanta Personal Payment Services. Effective January 1, 1999, Advanta Leasing Services and Advanta Business Cards were considered separate segments due to the development of separate management teams and infrastructures in each unit, whereas at December 31, 1998, they were considered one combined segment, Advanta Business Services. Advanta has restated the corresponding items of segment information for earlier periods. Advanta Mortgage makes nonconforming home equity loans directly to consumers and through brokers. This business unit originates and services first and second lien mortgage loans, including home equity lines of 69 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) credit, directly through subsidiaries of Advanta. In addition to servicing and managing the loans it originates, Advanta Mortgage contracts with third parties to service their nonconforming home equity loans on a subservicing basis. Advanta Business Cards offers MasterCard business credit cards to small businesses using targeted direct mail and the Internet. This product provides approved customers with access, through merchants, banks and ATMs, to an instant unsecured revolving business credit line. Advanta Leasing Services offers flexible lease financing programs on small-ticket equipment to small businesses. The primary products financed include office machinery, security systems and computers. The commercial equipment leasing business is generated primarily through third-party referrals from manufacturers or distributors of equipment, as well as independent brokers, direct mail marketing and telemarketing. The equipment is leased under noncancelable leases with initial terms of generally one to five years. Prior to the Consumer Credit Card Transaction, Advanta offered consumer credit cards through Advanta Personal Payment Services. This business segment issued consumer credit cards nationwide using direct marketing techniques. As of February 20, 1998, this segment had no operations, and the activity below reflects operations through that date. The accounting policies of the segments are the same as those followed by Advanta. Centrally incurred operating expenses are allocated to the segments based on consumption, where practical, or based on average managed assets. Centrally incurred interest expense is charged to the segments using a funds transfer pricing methodology primarily based on average assets, and which also reflects the impact of organization-wide interest rate risk management strategies. Advanta evaluates performance based largely on the net income of the respective business units.
ADVANTA ADVANTA ADVANTA BUSINESS LEASING MORTGAGE CARDS SERVICES OTHER(1) TOTAL - ---------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1999 Noninterest revenues $ 192,321 $ 84,288 $ 40,182 $ 9,506 $ 326,297 Interest revenue 133,367 35,798 11,524 65,537 246,226 Interest expense 89,619 14,541 10,940 52,576 167,676 Unusual charges(2) 0 0 0 16,713 16,713 Income tax (benefit) expense(3) (7,238) 14,830 1,958 (59,822) (50,272) Net (loss) income (10,994) 22,829 3,031 34,952 49,818 Average managed receivables 8,366,593 892,862 716,520 17,450 9,993,425 Total assets 1,841,647 387,440 233,913 1,226,662 3,689,662 Capital expenditures 15,698 1,000 4,212 4,568 25,478 Depreciation and amortization 6,715 923 3,998 6,871 18,507 - ----------------------------------------------------------------------------------------------------------
70 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA PERSONAL ADVANTA ADVANTA PAYMENT ADVANTA BUSINESS LEASING SERVICES MORTGAGE CARDS SERVICES OTHER(1) TOTAL - ---------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1998 Noninterest revenues $ 83,823 $ 240,366 $ 53,334 $ 35,107 $ 4,762 $ 417,392 Interest revenue 23,465 123,550 21,730 12,412 64,183 245,340 Interest expense 33,352 76,056 9,983 10,871 54,013 184,275 Gain on transfer of consumer credit card business 541,288 0 0 0 0 541,288 Unusual charges(4) 125,072 0 0 0 0 125,072 Income tax expense (benefit) (24,141) 10,667 4,952 (522) 0 (9,044) Net income (loss) 412,452 25,090 11,555 (1,217) 0 447,880 Average managed receivables 1,846,109 6,737,019 744,192 609,199 15,724 9,952,243 Total assets 0 1,794,491 340,878 132,573 1,453,478 3,721,420 Capital expenditures 2,469 10,140 620 3,038 29,093 45,360 Depreciation and amortization 5,600 6,160 1,105 3,615 5,000 21,480 - ---------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1997 Noninterest revenues $ 587,818 $ 130,511 $ 25,481 $ 47,231 $ 34,854 $ 825,895 Interest revenue 179,844 94,499 26,372 16,111 120,034 436,860 Interest expense 130,351 51,825 8,687 11,386 122,309 324,558 Income tax expense (benefit) 16,042 1,107 1,577 6,279 (100) 24,905 Net income 22,877 33,316 2,956 11,770 706 71,625 Average managed receivables 11,356,944 3,918,240 507,423 555,633 31,810 16,370,050 Total assets 3,498,212 1,018,244 275,418 236,510 1,627,531 6,655,915 Capital expenditures 33,770 26,027 1,340 3,242 14,851 79,230 Depreciation and amortization 22,339 3,534 882 3,321 5,204 35,280 - ----------------------------------------------------------------------------------------------------------------
(1) Other includes insurance operations and assets/investment activities not attributable to other segments. (2) Unusual charges in 1999 represent charges associated with cost reduction initiatives in the first quarter and additional costs associated with products exited in the first quarter of 1998. (3) Other includes a $50 million tax benefit in 1999 related to the former consumer credit card business. See Note 19. (4) Unusual charges in 1998 represent severance and outplacement costs associated with workforce reduction, option exercise and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer; expense associated with exited business/product; asset impairment; and equity losses related to exited business/product. NOTE 17. SELECTED INCOME STATEMENT INFORMATION
OTHER REVENUES YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- Equity securities gains (losses)(1) $30,391 $(41,750) $(11,426) Business card interchange income 33,786 20,741 11,617 Consumer credit card interchange income 0 11,881 85,208 Consumer credit card overlimit fees 0 16,233 46,447 Mortgage other (loss) income (9,686) 22,945 4,535 Leasing other revenues 15,399 14,519 25,748 Insurance revenues, net 8,206 14,408 37,816 Other 4,387 1,149 18,021 - --------------------------------------------------------------------------------------------- Total other revenues, net $82,483 $ 60,126 $217,966 - ---------------------------------------------------------------------------------------------
(1) Equity securities gains (losses) represent changes in the fair value and realized gains on Advanta Partners investments. 71 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OPERATING EXPENSES YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- Salaries and employee benefits $123,768 $152,706 $219,954 Marketing 58,671 53,109 53,039 Professional/consulting fees 24,244 14,767 38,600 Equipment expense 21,039 23,381 37,712 Credit and collection expense 20,264 15,715 20,017 Occupancy expense 16,347 16,001 23,097 External processing 14,936 21,908 43,256 Telephone expense 11,091 12,428 21,262 Postage 5,958 8,949 29,039 Amortization of credit card deferred origination costs, net 5,863 22,271 69,344 Credit card fraud losses 833 3,194 22,287 Other 34,047 35,335 44,354 - --------------------------------------------------------------------------------------------- Total operating expenses $337,061 $379,764 $621,961 - ---------------------------------------------------------------------------------------------
NOTE 18. NET INTEREST INCOME The following table presents the components of net interest income:
YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- Interest income: Loans and leases $122,861 $133,998 $ 278,568 Trading investments 6,752 10,374 0 Investments available for sale 97,259 79,294 140,636 Interest component of previously discounted cash flows 19,354 21,674 17,656 - --------------------------------------------------------------------------------------------- Total interest income 246,226 245,340 436,860 Interest expense: Deposits 101,386 85,935 150,164 Debt 61,940 87,900 161,295 Other borrowings 4,350 10,440 13,099 - --------------------------------------------------------------------------------------------- Total interest expense 167,676 184,275 324,558 Net interest income 78,550 61,065 112,302 Less: Provision for credit losses (42,647) (67,193) (210,826) - --------------------------------------------------------------------------------------------- Net interest after provision for credit losses $ 35,903 $ (6,128) $ (98,524) - ---------------------------------------------------------------------------------------------
72 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 19. INCOME TAXES Income tax (benefit) expense consisted of the following components:
YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- Current: Federal $ 15,500 $ 20,254 $ 5,953 State (155) 2,470 (651) - --------------------------------------------------------------------------------------------- Total current 15,345 22,724 5,302 - --------------------------------------------------------------------------------------------- Deferred: Federal (65,290) (44,777) 16,950 State (327) 13,009 2,653 - --------------------------------------------------------------------------------------------- Total deferred (65,617) (31,768) 19,603 - --------------------------------------------------------------------------------------------- Total tax (benefit) expense $(50,272) $ (9,044) $24,905 - ---------------------------------------------------------------------------------------------
The reconciliation of the statutory federal income tax to the consolidated tax expense is as follows:
YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- Statutory federal income tax $ (159) $ 153,593 $33,786 State income taxes, net of federal income tax benefit (313) 10,061 1,302 Net operating losses (49,956) 0 0 Insurance program income (expense) 112 30,414 (8,707) Tax credits 0 (7,288) (5,271) Compensation limitation 175 4,725 0 Transfer of consumer credit card business (see Note 9) 0 (200,494) 0 Nontaxable investment income (596) (607) (560) Other 465 552 4,355 - --------------------------------------------------------------------------------------------- Tax (benefit) expense $(50,272) $ (9,044) $24,905 - ---------------------------------------------------------------------------------------------
Deferred taxes are provided to reflect the estimated future tax effects of the differences between the financial statement and tax bases of assets and liabilities and enacted tax laws. The net deferred tax asset (liability) is comprised of the following:
DECEMBER 31, - ----------------------------------------------------------------------------------- 1999 1998 - ----------------------------------------------------------------------------------- Deferred tax liabilities $(102,248) $(80,566) Deferred tax assets 194,593 44,541 - ----------------------------------------------------------------------------------- Net deferred tax asset (liability) $ 92,345 $(36,025) - -----------------------------------------------------------------------------------
73 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of deferred tax assets and liabilities follows:
DECEMBER 31, - ---------------------------------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------------- Deferred loan fees and costs $ (6,149) $ (5,167) Allowance for loan losses 22,273 17,415 Net operating loss carryforwards 182,437 0 Securitization income (41,547) (32,538) Leasing income (19,009) (16,092) Deferred compensation 9,054 13,192 Noncash unusual charges 18,321 0 Other 9,965 (12,835) Valuation allowance (83,000) 0 - ---------------------------------------------------------------------------------- Net deferred tax asset (liability) $ 92,345 $(36,025) - ----------------------------------------------------------------------------------
The gain on the Consumer Credit Card Transaction in 1998 was not subject to income tax and no tax provision was recorded. The Consumer Credit Card Transaction also resulted in additional book/tax differences, which were quantified during 1999 in connection with the filing of the 1998 tax return. Such book/tax differences, when combined with certain less significant recurring differences, have resulted in net operating loss carryforwards of approximately $521 million. This amount is net of $96 million carried back to prior years, and includes $500 million that pertains to losses incurred on the consumer credit card portfolio after the date of the transaction. Of the total net operating loss carryforwards, $502 million expire in 2018 and $19 million expire in 2019. A deferred tax asset of $50 million, net of valuation allowance, resulting from the net operating loss carryforwards was recorded as an income tax benefit in the fourth quarter of 1999. Advanta has established a valuation allowance against these deferred tax assets. In establishing the valuation allowance, management considered (1) the level of expected future taxable income, (2) existing and projected book/tax differences, (3) tax planning strategies available, and (4) the general and industry specific economic outlook. Based on this analysis, management believes the net deferred tax asset will be realized. The net deferred federal tax asset (liability) is presented net with current federal income taxes receivable for financial reporting purposes, and is included in other assets. NOTE 20. UNUSUAL CHARGES In connection with the Consumer Credit Card Transaction more fully discussed in Note 9, Advanta made major organizational changes during the first quarter of 1998 to reduce corporate expenses incurred in the past: (a) to support the business contributed to Fleet LLC in the Consumer Credit Card Transaction, and (b) associated with the business and products no longer being offered or not directly associated with its mortgage, business card and leasing units. In addition, in 1999, Advanta implemented a plan to exit the auto finance business and to implement cost reduction initiatives throughout the organization including the consolidation of support functions. Costs associated with these changes include:
CHARGED TO 12/31/98 CHARGED TO 12/31/99 ACCRUED ACCRUAL ACCRUAL ACCRUED ACCRUAL ACCRUAL IN 1998 IN 1998 BALANCE IN 1999 IN 1999 BALANCE - --------------------------------------------------------------------------------------------------------- Employee costs associated with staff reductions $ 0 $ 0 $ 0 $ 3,350 $ 2,528 $ 822 Employee costs associated with Consumer Credit Card Transaction/Tender Offer 62,257 58,966 3,291 0 283 3,008 Expenses associated with exited businesses/products 54,115 39,349 14,766 13,363 7,481 20,648 Asset impairment/disposal 8,700 8,133 567 0 567 0 - --------------------------------------------------------------------------------------------------------- Total $125,072 $106,448 $18,624 $16,713 $10,859 $24,478 - ---------------------------------------------------------------------------------------------------------
74 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) EMPLOYEE COSTS ASSOCIATED WITH STAFF REDUCTIONS In the first quarter of 1999, Advanta recorded a $3.3 million charge for costs associated with staff reductions. These expenses included severance and outplacement costs associated with cost reduction initiatives and the consolidation of support functions. There were 121 employees severed who were entitled to benefits. This staff reduction was substantially complete by June 30, 1999. EMPLOYEE COSTS ASSOCIATED WITH CONSUMER CREDIT CARD TRANSACTION/TENDER OFFER In connection with the organizational changes in 1998, Advanta incurred approximately $26.8 million of severance and related costs classified as employee costs associated with the Consumer Credit Card Transaction/Tender Offer. These expenses included severance and outplacement costs associated with the workforce reduction, option exercise and re-measurement costs, and other employee costs directly attributable to the Consumer Credit Card Transaction/Tender Offer. In connection with these organizational changes, 255 employees who ceased to be employed by Advanta were entitled to benefits, of which 190 employees were directly associated with the business contributed to Fleet LLC and 65 employees were associated with the workforce reduction. Additionally, during the first quarter of 1998, Advanta incurred approximately $35.5 million of other compensation charges. This amount includes $21.3 million attributable to payments under change of control plans and $14.2 million associated with the execution of the Tender Offer. EXITED BUSINESSES/PRODUCTS In the first quarter of 1999, Advanta implemented a plan to cease the origination of auto loans and recorded a $3.4 million charge for costs associated with exited businesses/products. The charges included severance and outplacement costs for 22 employees in the auto origination group, and professional fees associated with exited businesses/products not directly associated with the mortgage, business card and leasing units. Advanta completed the closing of the auto loan origination center and termination of related employees during the second quarter of 1999. Advanta expects to pay a substantial portion of the remaining costs during the year ended December 31, 2000. During the first quarter of 1998, Advanta implemented a plan to exit certain businesses and product offerings not directly associated with its mortgage, business card and leasing units. In connection with this plan, contractual vendor commitments of approximately $10.0 million associated with discontinued development and other activities were accrued. Advanta has substantially completed the settlement of these contractual commitments. Advanta also has contractual commitments to certain customers, and non-related financial institutions that are providing benefits to those customers, under a product that will no longer be offered and for which no future revenues or benefits will be received. In 1998, Advanta recorded a charge of $22.8 million associated with this commitment, and an $8.3 million charge associated with the write-down of assets associated with this program. In 1999, an additional charge of $10.0 million was recorded based on a change in the estimate of total expected costs for exited businesses. Advanta expects to pay a substantial portion of these costs over the next 36 months. The actions required to complete this plan include the settlement of contractual commitments and the payment of customer benefits. In connection with the Consumer Credit Card Transaction/Tender Offer and the other exited business and product offerings, Advanta also incurred $11.5 million of related professional fees and $1.5 million of other expenses related to these plans. ASSET IMPAIRMENT/DISPOSAL In connection with Advanta's plans to reduce corporate expenses and exit certain business and product offerings, certain assets were identified for disposal and the carrying costs thereof were written off or written down to estimated realizable value in 1998 resulting in a charge of $8.7 million. These assets consisted 75 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) principally of leasehold improvements and various other assets. The disposal of these assets has been completed. NOTE 21. CALCULATION OF EARNINGS PER SHARE The following table shows the calculation of basic earnings per share and diluted earnings per share for the years ended December 31:
1999 1998 1997 - --------------------------------------------------------------------------------------------- Net income $49,818 $447,880 $ 71,625 Less: Preferred A dividends (141) (141) (141) Less: Preferred B dividends (2,661) (3,549) (6,409) - --------------------------------------------------------------------------------------------- Income available to common shareholders $47,016 $444,190 $ 65,075 Less: Class A dividends declared (2,471) (2,615) (7,997) Less: Class B dividends declared (4,896) (4,589) (13,754) - --------------------------------------------------------------------------------------------- Undistributed earnings $39,649 $436,986 $ 43,324 Basic shares Class A 9,057 11,174 18,172 Class B 14,515 15,500 24,635 Combined (1) 23,572 26,674 42,807 Options A 1 8 63 Options B 202 103 532 Restricted shares Class A 36 0 0 Restricted shares Class B 118 138 99 Preferred B 0 1,572 0 - --------------------------------------------------------------------------------------------- Diluted shares Class A 9,094 11,182 18,235 Class B 14,835 17,313 25,266 Combined (1) 23,929 28,495 43,501 Basic earnings per share Class A $ 1.95 $ 16.62 $ 1.45 Class B 2.02 16.68 1.57 Combined (1) 1.99 16.65 1.52 - --------------------------------------------------------------------------------------------- Diluted earnings per share Class A $ 1.93 $ 15.69 $ 1.43 Class B 1.99 15.73 1.54 Combined (1) 1.96 15.71 1.50 - ---------------------------------------------------------------------------------------------
(1) Combined represents a weighted average of Class A and Class B earnings per share. There were 14,211 shares of Advanta's Class B Convertible Preferred Stock outstanding from January 1, 1999 through September 15, 1999 and 25,000 shares outstanding during 1997, which were not included in the computation of diluted earnings per share, because they were antidilutive for those periods. Each share of Class B Convertible Preferred Stock was mandatorily converted into one share of Class B Common Stock effective September 15, 1999. In 1999, there were 1.2 million restricted shares of Class B Common Stock outstanding and 1.6 million options to purchase shares of Class B Common Stock outstanding that were not included in the computation of diluted earnings per share because they were antidilutive for the period. In 1998, there were 1.1 million restricted shares of Class B Common Stock outstanding and 2.7 million options to purchase shares of Class B Common Stock outstanding that were not included in the computation of diluted earnings per share because they were antidilutive for the period. 76 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 22. PARENT COMPANY FINANCIAL STATEMENTS ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED BALANCE SHEETS
DECEMBER 31, - -------------------------------------------------------------------------------------- 1999 1998 - -------------------------------------------------------------------------------------- ASSETS Cash $ 4,292 $ 17,276 Commercial paper equivalent(1) 375,000 440,900 Investments 7,820 20,592 Investments in and advances to bank subsidiaries 543,276 446,533 Investments in and advances to non-bank subsidiaries 479,020 708,667 Other assets 165,019 89,456 - -------------------------------------------------------------------------------------- Total assets $1,574,427 $1,723,424 - -------------------------------------------------------------------------------------- LIABILITIES Accrued expenses and other liabilities $ 100,542 $ 37,218 Long-term debt 884,254 1,125,902 - -------------------------------------------------------------------------------------- Total liabilities 984,796 1,163,120 - -------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY Preferred stock 1,010 1,010 Common stock 287 267 Other stockholders' equity 588,334 559,027 - -------------------------------------------------------------------------------------- Total stockholders' equity 589,631 560,304 - -------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $1,574,427 $1,723,424 - --------------------------------------------------------------------------------------
(1) Commercial paper equivalent refers to unsecured loans made to Advanta National Bank and Advanta Bank Corp. for terms less than 35 days in maturity which are not automatically renewable, consistent with commercial paper issuance. The parent company guarantees certain warehouse financing facilities, commercial paper conduit facilities, and lease agreements of its subsidiaries. At December 31, 1999, there were $22.3 million of lease obligations guaranteed by the parent and $19.1 million of parent guarantees associated with warehouse and commercial paper conduit financing facilities. 77 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- INCOME: Dividends from bank subsidiaries(1) $ 0 $ 553,715 $ 0 Dividends from non-bank subsidiaries(1) 2,225 6,300 12,300 Interest 44,369 78,210 81,656 Gain on transfer of credit card business 0 48,944 0 Other, net 52,510 44,623 33,649 - --------------------------------------------------------------------------------------------- Total income 99,104 731,792 127,605 - --------------------------------------------------------------------------------------------- EXPENSES: General and administrative 45,638 44,289 69,010 Interest 67,102 86,557 97,067 Unusual charges 4,561 59,707 0 - --------------------------------------------------------------------------------------------- Total expense 117,301 190,553 166,077 - --------------------------------------------------------------------------------------------- Income (loss) before income taxes and equity in subsidiaries (18,197) 541,239 (38,472) - --------------------------------------------------------------------------------------------- Income tax benefit 22,327 8,566 20,677 - --------------------------------------------------------------------------------------------- Income (loss) before equity in undistributed net profit (loss) in subsidiaries 4,130 549,805 (17,795) - --------------------------------------------------------------------------------------------- Equity in undistributed net profit (loss)of subsidiaries 45,688 (101,925) 89,420 - --------------------------------------------------------------------------------------------- Net income $ 49,818 $ 447,880 $ 71,625 - ---------------------------------------------------------------------------------------------
(1) Dividends from subsidiaries include only dividends from current year net income of subsidiaries. See Parent Company Only Condensed Statements of Cash Flows for total dividends received from subsidiaries. The Parent Company Only Statements of Changes in Stockholders' Equity is the same as the Consolidated Statements of Changes in Stockholder's Equity. 78 80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, - --------------------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 49,818 $ 447,880 $ 71,625 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Equity in net profit of subsidiaries (47,913) (458,090) (101,719) Dividends received from subsidiaries 2,225 903,831 12,300 Equity securities gains (1,709) 0 0 Depreciation and amortization 2,066 6,880 5,083 Gain on transfer of consumer credit card business 0 (48,944) 0 Noncash unusual charges 0 11,974 0 Change in other assets, interest-bearing deposits, accrued expenses and other liabilities (30,987) (101,208) (59,642) - --------------------------------------------------------------------------------------------- Net cash (used in) provided by operating activities (26,500) 762,323 (72,353) - --------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Net change in premises & equipment (2,199) 4,793 (8,793) Net change in commercial paper equivalents 65,900 (440,900) 0 Investments in subsidiaries (23,540) (124,500) 0 Return of investment from subsidiaries 39,731 470,000 0 Purchase of investments available for sale (851,132) (471,582) (87,324) Proceeds from sales of investments available for sale 2,702 143,770 49,946 Proceeds from maturing investments available for sale 850,000 327,200 25,000 - --------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 81,462 (91,219) (21,171) - --------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Change in lines of credit 0 0 (40,000) Proceeds from issuance of long-term debt 123,529 29,858 536,002 Payments on redemption of long-term debt (365,177) (294,026) (359,482) Decrease (increase) in affiliate borrowings 187,806 339,822 (26,827) Issuance of stock 20 5,249 14,000 Tender Offer 0 (801,606) 0 Stock buyback (3,955) (4,549) 0 ESOP stock purchase 0 (12,569) 0 Cash dividends paid (10,169) (10,894) (28,301) - --------------------------------------------------------------------------------------------- Net cash (used in) provided by financing activities (67,946) (748,715) 95,392 - --------------------------------------------------------------------------------------------- Net (decrease) increase in cash (12,984) (77,611) 1,868 Cash at beginning of period 17,276 94,887 93,019 - --------------------------------------------------------------------------------------------- Cash at end of period $ 4,292 $ 17,276 $ 94,887 - ---------------------------------------------------------------------------------------------
In 1999, noncash transactions of the Parent Company included a $4.5 million assumption of liabilities of subsidiaries and a $43.3 million return of investment by subsidiaries through forgiveness of advances. In 1998, the noncash transaction represented capital contributions to subsidiaries through the forgiveness of advances of $143.5 million. 79 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 23. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of Advanta's financial instruments are as follows at December 31:
1999 1998 - ------------------------------------------------------------------------------------------------ CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE - ------------------------------------------------------------------------------------------------ Financial assets: Cash $ 29,301 $ 29,301 $ 16,267 $ 16,267 Federal funds sold 144,938 144,938 267,400 267,400 Restricted interest-bearing deposits 93,688 93,688 80,028 80,028 Trading investments 0 0 501,563 501,563 Investments available for sale 748,881 748,881 521,410 521,410 Loan and lease receivables, net 1,449,624 1,534,106 1,107,427 1,157,618 Retained interest-only strip 115,641 115,641 209,096 209,096 Contractual mortgage servicing rights 92,636 96,736 74,425 77,932 Subordinated trust assets 400,148 400,148 291,942 291,942 Financial liabilities: Demand and savings deposits $ 248,111 $ 248,111 $ 185,782 $ 185,782 Time deposits 1,264,248 1,260,121 1,564,008 1,570,946 Long-term debt 788,508 771,560 1,030,147 989,088 Other borrowings 409,601 409,601 36,301 36,301 Off-balance sheet financial instruments -- Asset/(liability): Interest rate swaps $ 0 $ 29,511 $ 0 $ 11,589 Interest rate caps purchased 1,040 3,137 45 130 Interest rate caps written (1,040) (3,137) (45) (130) Put options purchased (986) 849 0 0 Forward contracts 0 3,867 0 365 - ------------------------------------------------------------------------------------------------
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for Advanta's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Advanta used the following methods and assumptions in estimating fair value disclosures for financial instruments: CASH, FEDERAL FUNDS SOLD AND RESTRICTED INTEREST-BEARING DEPOSITS For these short-term instruments, the carrying amount is a reasonable estimate of the fair value. INVESTMENTS The fair values of trading investments and investment securities available for sale are based on quoted market prices, dealer quotes or estimates using quoted market prices for similar securities. For investments that are 80 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) not publicly traded, management has made estimates of fair value that consider several factors including the investees' financial results, conditions and prospects, and the values of comparable public companies. LOAN AND LEASE RECEIVABLES, NET The fair values of loan and lease receivables are estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value for these loans includes the estimated value of future discounted cash flows estimated as the excess of the weighted average yield over the aggregate cost of funds plus an estimate of future credit losses over the life of the receivables. RETAINED INTEREST-ONLY STRIPS AND CONTRACTUAL MORTGAGE SERVICING RIGHTS The fair values of retained interest-only strips and contractual mortgage servicing rights are estimated based on discounted cash flow analyses as described in Note 1. Management has used the following assumptions in the estimation of fair values of the retained interest-only strip from Advanta Mortgage loan securitizations for the years ended December 31:
1999 1998 - -------------------------------------------------------------------------- Assumed constant prepayment rates: Fixed rate loans 25% 29% Variable rate loans 37 43 Assumed loss rate (annualized) 1.38 1.00 Assumed discount rate 15 14 - --------------------------------------------------------------------------
For purposes of estimating the fair value of contractual mortgage servicing rights, management has assumed a discount rate of 10% and constant prepayment rates consistent with the retained interest-only strip assumptions. SUBORDINATED TRUST ASSETS Subordinated trust assets earn a variable rate, risk-adjusted return. These assets are classified as trading securities, and are reported at estimated fair value. DEMAND AND SAVINGS DEPOSITS The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date. This fair value does not include any benefit that may result from the low cost of funding provided by these deposits compared to the cost of borrowing funds in the market. TIME DEPOSITS The fair value of fixed-maturity certificates of deposit is estimated using discounted cash flow analyses based on the rates currently offered for deposits of similar remaining maturities. LONG-TERM DEBT The fair value of Advanta's long-term borrowings is estimated using discounted cash flow analyses based on Advanta's current incremental borrowing rates for similar types of borrowing arrangements. OTHER BORROWINGS The carrying amounts of borrowings under repurchase agreements and other short-term borrowings maturing within ninety days approximate their fair values. The other borrowings are all at variable interest rates and therefore the carrying value approximates a reasonable estimate of the fair value. 81 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) INTEREST RATE SWAPS, INTEREST RATE CAPS, OPTIONS AND FORWARD CONTRACTS The fair value of interest rate swaps, interest rate caps, options and forward contracts is the estimated amount that Advanta would pay or receive to terminate the agreement at the reporting date, taking into account current interest rates and the current creditworthiness of the counterparty. COMMITMENTS TO EXTEND CREDIT There is no market value associated with Advanta's unused commitments to extend credit, since any fees charged are consistent with the fees charged by other companies at the reporting date to enter into similar agreements. Unused commitments to extend credit were $2.6 billion at December 31, 1999 and $2.1 billion at December 31, 1998. NOTE 24. DERIVATIVE FINANCIAL INSTRUMENTS In managing its interest rate risk, Advanta may use derivative financial instruments. These instruments are used for the express purpose of managing interest rate exposures and are not used for any trading or speculative activities. The following table summarizes by notional amounts Advanta's derivative instruments as of December 31:
1999 1998 - -------------------------------------------------------------------------------------- Interest rate swaps $2,975,086 $2,997,912 Interest rate caps written 409,278 268,633 Interest rate caps purchased 409,278 268,633 Put options purchased 156,000 0 Forward contracts 565,000 499,000 - -------------------------------------------------------------------------------------- Total $4,514,642 $4,034,178 - --------------------------------------------------------------------------------------
The notional amounts of derivatives do not represent amounts exchanged by the counterparties and, thus, are not a measure of Advanta'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. Credit risk associated with derivatives arises from the potential for a counterparty to default on its obligations. Advanta limits credit risk by only transacting with highly creditworthy counterparties, requiring International Swaps and Derivatives Association agreements for all interest rate swap and interest rate option contracts, and maintaining collateral agreements with substantially all counterparties. All derivative counterparties are associated with organizations having securities rated as investment grade by independent rating agencies. The Investment Committee, a management committee, controls the list of eligible counterparties, setting of counterparty limits, and monitoring of credit exposure. Advanta'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 (see Note 23). For caps written, credit exposure does not exist since the counterparty has performed its obligation to pay Advanta a premium payment. INTEREST RATE SWAPS Interest rate swap agreements generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. Based on its interest rate sensitivity analyses, Advanta uses interest rate swaps to more effectively manage the impact of fluctuating interest rates on its noninterest revenues and cost of funds. In 1999, 1998 and 1997, Advanta used interest rate swaps to effectively convert fixed rate debt and deposits to a LIBOR-based variable rate and to effectively convert certain off-balance sheet variable securitizations to a fixed rate. 82 84 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes by notional amounts Advanta's interest rate swap activity by major category for the periods presented:
RECEIVE PAY FIXED RATE FIXED RATE TOTAL - ----------------------------------------------------------------------------------------------- Balance at 12/31/96 $ 812,835 $ 900,609 $1,713,444 Additions 967,250 472,496 1,439,746 Net amortization 0 (142,894) (142,894) Maturities (136,835) (10,500) (147,335) Swaptions exercised 0 (153,000) (153,000) Terminations (598,250) 0 (598,250) - ----------------------------------------------------------------------------------------------- Balance at 12/31/97 $1,045,000 $1,066,711 $2,111,711 Additions 0 1,948,046 1,948,046 Net amortization (4,000) (380,533) (384,533) Maturities (249,000) 0 (249,000) Terminations (54,790) (211,812) (266,602) Contributed to Fleet Credit Card LLC (161,710) 0 (161,710) - ----------------------------------------------------------------------------------------------- Balance at 12/31/98 $ 575,500 $2,422,412 $2,997,912 Additions 200,000 702,446 902,446 Net amortization 0 (658,666) (658,666) Maturities (141,000) (66,324) (207,324) Terminations (15,000) (44,282) (59,282) - ----------------------------------------------------------------------------------------------- Balance at 12/31/99 $ 619,500 $2,355,586 $2,975,086 - -----------------------------------------------------------------------------------------------
The following table discloses Advanta's interest rate swaps by major category, notional value, weighted average interest rates, and annual maturities for the periods presented. Variable rates in the table represent the current LIBOR-based rates.
BALANCES MATURING IN: BALANCE AT -------------------------------------------------------------------------- 12/31/99 2000 2001 2002 2003 2004 2005 2006 - --------------------------------------------------------------------------------------------------------------------------------- Pay Fixed/Receive Variable: Notional Value $2,355,586 $353,818 $ 86,476 $137,986 $374,530 $324,348 $334,076 $744,352 Weighted Average Pay Rate 5.79% 5.70% 5.30% 5.90% 5.34% 6.23% 5.55% 6.01% Weighted Average Receive Rate 6.47% 6.48% 6.18% 6.40% 6.48% 6.48% 6.48% 6.48% Receive Fixed/Pay Variable: Notional Value $ 619,500 $309,000 $250,500 $ 60,000 $ 0 $ 0 $ 0 $ 0 Weighted Average Receive Rate 6.19% 5.76% 6.63% 6.60% 0% 0% 0% 0% Weighted Average Pay Rate 6.24% 6.28% 6.19% 6.23% 0% 0% 0% 0% Total Notional Value $2,975,086 $662,818 $336,976 $197,986 $374,530 $324,348 $334,076 $744,352 Total Weighted Average Rates on Swaps: Pay Rate 5.88% 5.97% 5.96% 6.00% 5.34% 6.23% 5.55% 6.01% Receive Rate 6.41% 6.14% 6.51% 6.46% 6.48% 6.48% 6.48% 6.48% - ---------------------------------------------------------------------------------------------------------------------------------
INTEREST RATE OPTIONS Interest rate options, which include caps and floors, are contracts that transfer, modify or reduce interest rate risk in exchange for the payment of a premium when the contract is initiated. In exchange for the premium payment, these contracts require the seller (writer) to pay the purchaser at specified future dates the amount by which a specified market interest rate exceeds the cap rate or falls below the floor rate, multiplied against a notional amount. 83 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Advanta purchased interest rate caps as part of certain variable rate receivable securitizations for credit enhancement purposes. In order to achieve its desired interest rate sensitivity structure, Advanta has synthetically altered the interest rate structure on certain off-balance sheet receivable securitizations by writing interest rate caps to offset the purchased rate caps attached to them. The premiums received or paid for writing or purchasing the cap contracts with third parties are included in other assets and are amortized to noninterest revenues over the life of the contract. Any obligations, which may arise under these contracts, are recorded in noninterest revenues on an accrual basis. PUT OPTIONS Put options provide the holder the right, but not the obligation, to sell the underlying financial instrument at a specified exercise or strike price at a specific point in time. Put options, therefore, protect Advanta from losses in a rising interest rate environment, but allow for the full appreciation of underlying assets should interest rates fall. Advanta regularly securitizes and sells receivables. Advanta may choose to hedge the changes in the market value of the index on which the securitization is priced, relating to the warehouse and/or pipeline of receivables anticipated to be securitized, by purchasing put options on the underlying index. The maximum term of hedges of anticipated loan sales is seven months; the average term is four months. Premiums paid and gains and losses on put options are deferred as other liabilities and included in the measurement of the dollar basis of the loans sold. Deferred gains were $849 thousand and deferred premiums were $986 thousand at December 31, 1999. There were no put options outstanding at December 31, 1998. FORWARD CONTRACTS Forward contracts are commitments to either purchase or sell a financial instrument at a future date for a specified price and may be settled in cash or through delivery of the underlying financial instrument. Advanta regularly securitizes and sells receivables. Advanta may choose to hedge the changes in the market value of its fixed rate loans and commitments designated for anticipated securitizations by selling U.S. Treasury securities for forward settlement. The maximum term of hedges of anticipated loan sales is seven months; the average term is four months. Gains and losses from forward sales are deferred as other liabilities and included in the measurement of the dollar basis of the loans sold. Advanta had deferred gains of $5.9 million at December 31, 1999 and deferred losses of $3.8 million at December 31, 1998. Advanta may choose to hedge market value changes on its trading investments with forward contracts. Gains and losses on forward contracts hedging trading investments are recognized currently and reported in other revenues with the gains and losses on trading investments. 84 86 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of Advanta Corp.: We have audited the accompanying consolidated balance sheets of Advanta Corp. (a Delaware corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advanta Corp. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Philadelphia, PA January 21, 2000 REPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING To the Stockholders of Advanta Corp.: The management of Advanta Corp. and its subsidiaries is responsible for the preparation, content, integrity and objectivity of the financial statements. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States and as such must, by necessity, include amounts based upon estimates and judgments made by management. The other financial information was also prepared by management and is consistent with the financial statements. Management maintains a system of internal controls that provides reasonable assurance as to the integrity and reliability of the financial statements. This control system includes: (l) organizational and budgetary arrangements which provide reasonable assurance that errors or irregularities would be detected promptly; (2) careful selection of personnel and communications programs aimed at assuring that policies and standards are understood by employees; (3) a program of internal audits; and (4) continuing review and evaluation of the control program itself. The financial statements have been audited by Arthur Andersen LLP, independent public accountants. Their audits were conducted in accordance with auditing standards generally accepted in the United States and considered Advanta's system of internal controls to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. Their report is printed herewith. /s/ Dennis Alter /s/ Philip M. Browne /s/ James L. Shreero - ---------------------------- ---------------------------- ---------------------------- Chairman of the Board and Senior Vice President and Vice President, Finance and Chief Executive Officer Chief Financial Officer Chief Accounting Officer
85 87 SUPPLEMENTAL SCHEDULES (UNAUDITED) MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
DECEMBER 31, (IN THOUSANDS) 1999 - -------------------------------------------------------------------------- Maturity: 3 months or less $115,171 Over 3 months through 6 months 19,667 Over 6 months through 12 months 175,205 Over 12 months 50,878 - -------------------------------------------------------------------------- Total $360,921 - --------------------------------------------------------------------------
COMMON STOCK PRICE RANGES AND DIVIDENDS Advanta's common stock is traded on the National Market tier of The Nasdaq Stock Market under the symbols ADVNB (Class B non-voting common stock) and ADVNA (Class A voting common stock). Following are the high, low and closing sale prices and cash dividends declared for the last two years as they apply to each class of stock:
CASH DIVIDENDS QUARTER ENDED: HIGH LOW CLOSE DECLARED - ------------------------------------------------------------------------------------------------ Class B: - ------------------------------------------------------------------------------------------------ March 1998 $31.25 $19.69 $21.00 $.076 June 1998 24.25 17.50 19.88 .076 September 1998 20.56 8.25 10.50 .076 December 1998 12.00 5.25 11.06 .076 March 1999 $12.31 $ 7.75 $ 8.94 $.076 June 1999 14.75 7.59 13.56 .076 September 1999 19.13 11.38 11.75 .076 December 1999 15.88 10.44 14.06 .076 - ------------------------------------------------------------------------------------------------ Class A: - ------------------------------------------------------------------------------------------------ March 1998 $32.75 $21.00 $22.50 $.063 June 1998 26.25 19.25 21.94 .063 September 1998 22.75 9.38 12.88 .063 December 1998 14.88 7.13 13.25 .063 March 1999 $15.19 $10.31 $11.06 $.063 June 1999 18.25 9.63 18.06 .063 September 1999 23.94 14.63 14.63 .063 December 1999 20.38 14.63 18.25 .063 - ------------------------------------------------------------------------------------------------
At December 31, 1999, Advanta had approximately 805 holders of record of Class B stock and 315 holders of record of Class A stock. 86 88 SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED QUARTERLY DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 - ---------------------------------------------------------------------------------------------------- DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, - ---------------------------------------------------------------------------------------------------- Interest income $ 60,526 $ 61,185 $ 59,201 $ 65,314 Securitization income (loss) (2,731) 51,360 41,116 34,769 Other revenues 38,678 48,198 55,233 59,674 ------------------------------------------------------ Total revenues 96,473 160,743 155,550 159,757 ------------------------------------------------------ Interest expense 39,147 41,935 43,317 43,277 Provision for credit losses 14,640 10,452 7,407 10,148 Operating expenses 85,747 82,702 82,179 86,433 Minority interest in income of consolidated subsidiary 2,220 2,220 2,220 2,220 Unusual charges(2) 10,000 0 0 6,713 ------------------------------------------------------ Total expenses 151,754 137,309 135,123 148,791 ------------------------------------------------------ Pretax income (loss) (55,281) 23,434 20,427 10,966 - ---------------------------------------------------------------------------------------------------- Net income $ 16,555(3) $ 14,178 $ 12,312 $ 6,773 - ---------------------------------------------------------------------------------------------------- Basic earnings per share Class A $ .67 $ .56 $ .48 $ .24 Class B .68 .57 .50 .26 Combined(1) .67 .57 .49 .25 - ---------------------------------------------------------------------------------------------------- Diluted earnings per share Class A $ .65 $ .54 $ .48 $ .24 Class B .66 .56 .49 .26 Combined(1) .66 .55 .49 .25 - ---------------------------------------------------------------------------------------------------- Weighted average shares outstanding Basic Class A 8,992 8,984 8,976 9,280 Class B 15,619 14,429 14,187 13,807 Combined(1) 24,611 23,413 23,163 23,087 - ---------------------------------------------------------------------------------------------------- Weighted average shares -- assuming dilution Diluted Class A 9,042 9,030 9,009 9,282 Class B 16,097 14,960 14,364 13,896 Combined(1) 25,139 23,990 23,373 23,178 - ----------------------------------------------------------------------------------------------------
87 89 SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED QUARTERLY DATA -- CONTINUED
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 - ---------------------------------------------------------------------------------------------------- DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, - ---------------------------------------------------------------------------------------------------- Interest income $ 55,514 $ 56,539 $ 53,561 $ 79,726 Securitization income 49,659 50,489 41,487 20,723 Gain on transfer of consumer credit card business 0 0 0 541,288 Other revenues 57,345 40,254 35,966 121,469 ------------------------------------------------------ Total revenues 162,518 147,282 131,014 763,206 ------------------------------------------------------ Interest expense 41,340 39,165 36,226 67,544 Provision for credit losses 19,972 6,414 6,846 33,961 Operating expenses 92,419 78,019 72,245 137,081 Minority interest in income of consolidated subsidiary 2,220 2,220 2,220 2,220 Unusual charges(2) 0 0 0 125,072 ------------------------------------------------------ Total expenses 155,951 125,818 117,537 365,878 ------------------------------------------------------ Pretax income 6,567 21,464 13,477 397,328 - ---------------------------------------------------------------------------------------------------- Net income $ 4,597 $ 15,025 $ 9,471 $418,787 - ---------------------------------------------------------------------------------------------------- Basic earnings per share Class A $ .15 $ .57 $ .34 $ 11.84 Class B .17 .58 .35 11.85 Combined(1) .16 .58 .35 11.84 - ---------------------------------------------------------------------------------------------------- Diluted earnings per share Class A $ .15 $ .56 $ .34 $ 11.04 Class B .17 .58 .35 11.04 Combined(1) .16 .58 .35 11.04 - ---------------------------------------------------------------------------------------------------- Weighted average shares outstanding Basic Class A 9,374 10,316 10,362 14,798 Class B 13,811 14,166 14,161 20,480 Combined(1) 23,185 24,482 24,523 35,278 - ---------------------------------------------------------------------------------------------------- Weighted average shares -- assuming dilution Diluted Class A 9,377 10,320 10,372 14,822 Class B 13,817 14,194 14,330 23,093 Combined(1) 23,194 24,514 24,702 37,915 - ----------------------------------------------------------------------------------------------------
(1) See Note 1 to Consolidated Financial Statements. (2) 1999 amounts included charges associated with cost reduction initiatives in the first quarter and additional costs associated with products exited in the first quarter of 1998. 1998 amounts included severance and outplacement costs associated with workforce reduction, option exercises and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer; expense associated with exited business/product and asset impairment; and equity losses related to exited business/product. (3) Net income in the fourth quarter of 1999 included a $50 million tax benefit related to the former consumer credit card business. See Note 19 to the Consolidated Financial Statements. 88 90 SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
($ IN THOUSANDS) DECEMBER 31, - -------------------------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------- ------------- -------------- ------------- ------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % - -------------------------------------------------------------------------------------------------------------------------- Advanta Mortgage loans(1) $21,743 52% $20,092 60% $ 5,822 4% $ 8,785 10% $ 3,360 6% Business cards 14,663 35 6,916 21 6,899 5 2,643 3 977 2 Leases 3,110 7 2,695 8 2,899 2 1,598 2 0 0 Consumer credit cards 0 0 0 0 118,420 86 76,084 85 36,889 69 Other loans 2,331 6 3,734 11 3,733 3 74 0 12,268 23 - -------------------------------------------------------------------------------------------------------------------------- Total $41,847 100% $33,437 100% $137,773 100% $89,184 100% $53,494 100% - --------------------------------------------------------------------------------------------------------------------------
COMPOSITION OF GROSS RECEIVABLES
($ IN THOUSANDS) DECEMBER 31, - ---------------------------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ---------------- ---------------- ---------------- ---------------- ---------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % - ---------------------------------------------------------------------------------------------------------------------------- Advanta Mortgage loans(1) $1,050,478 71% $ 829,819 74% $ 478,433 14% $ 376,260 14% $ 321,711 12% Business cards 275,095 19 150,022 13 140,399 4 72,348 3 0 0 Leases 132,802 9 122,657 11 112,536 4 103,730 4 63,666 2 Consumer credit cards 0 0 0 0 2,579,890 77 2,045,219 78 2,338,280 86 Other loans 21,930 1 17,862 2 40,978 1 20,835 1 9,276 0 - ---------------------------------------------------------------------------------------------------------------------------- Total $1,480,305 100% $1,120,360 100% $3,352,236 100% $2,618,392 100% $2,732,933 100% - ----------------------------------------------------------------------------------------------------------------------------
(1) Includes mortgage loans for all years presented and auto loans beginning in 1996. YIELD AND MATURITY OF INVESTMENTS AT DECEMBER 31, 1999
($ IN THOUSANDS) MATURING - ------------------------------------------------------------------------------------------------------------------------------ AFTER ONE BUT AFTER FIVE BUT WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS AFTER TEN YEARS ----------------------- ----------------------- ----------------------- ----------------------- MARKET VALUE YIELD(3) MARKET VALUE YIELD(3) MARKET VALUE YIELD(3) MARKET VALUE YIELD(3) - ------------------------------------------------------------------------------------------------------------------------------ U.S. Treasury and other U.S. Government securities $17,141 4.68% $123,303 5.56% $ 0 0.00% $ 0 0.00% State and municipal securities(1) 521 4.70 865 5.05 1,093 6.08 909 5.58 Other(2) 0 0.00 0 0.00 612 5.49 542,012 6.66 - ------------------------------------------------------------------------------------------------------------------------------ Total investments available for sale $17,662 4.68% $124,168 5.56% $1,705 5.87% $542,921 6.66% - ------------------------------------------------------------------------------------------------------------------------------
(1) Yield computed on a taxable equivalent basis using a statutory rate of 35%. (2) Equity investments and other securities without a stated maturity are excluded from this table. (3) Yields are computed by dividing annualized interest by the amortized cost of the respective investment securities. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 89 91 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The text of the Proxy Statement under the captions "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" are hereby incorporated by reference, as is the text in Part I of this Report under the caption, "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION. The text of the Proxy Statement under the captions "Executive Compensation," "Compensation Committee Report on Executive Compensation" and "Election of Directors "-- Committees, Meetings and Compensation of the Board of Directors", '-- Compensation Committee Interlocks and Insider Participation in Compensation Decisions" and "-- Other Matters" are hereby incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The text of the Proxy Statement under the captions "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" are hereby incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The text of the Proxy Statement under the captions "Election of Directors -- Compensation Committee Interlocks and Insider Participation in Compensation Decisions" and "-- Other Matters" are hereby incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. The following Financial Statements, Schedules, and Other Information of the Registrant and its subsidiaries are included in this Form 10-K: (a)(1) Financial Statements. 1. Consolidated Balance Sheets at December 31, 1999 and 1998. 2. Consolidated Income Statements for each of the three years in the period ended December 31, 1999. 3. Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended December 31, 1999. 4. Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1999. 5. Notes to Consolidated Financial Statements. (a)(2) Schedules. Other statements and schedules are not being presented either because they are not required or the information required by such statements and schedules is presented elsewhere in the financial statements.
90 92 (a)(3) Exhibits 3-a Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 33-53475), filed June 10, 1994) , as amended by the Certificate of Designations, Preferences, Rights and Limitations of the Registrant's 6 3/4% Convertible Class B Preferred Stock, Series 1995 (Stock Appreciation Income Linked Securities (SAILS)) (incorporated by reference to Exhibit 4.3 to the Registrant's Current Report on Form 8-K dated August 15, 1995, as further amended by the Certificate of Designations, Preferences, Rights and Limitations of the Registrant's Series A Junior Participating Preferred Stock (incorporated by reference to Exhibit 1 to the Registrant's Registration Statement on Form 8-A, dated March 17, 1997. 3-b By-laws of the Registrant, as amended (incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated March 17, 1997). 3-c Rights Agreement, dated as of March 14, 1997, by and between the Registrant and the Rights Agent, which includes as Exhibit B thereto the Form of Rights Certificate (incorporated by reference to Exhibit 1 to the Registrant's Registration Statement on Form 8-A dated March 17, 1997). 4-a* Trust Indenture dated April 22, 1981 between Registrant and Mellon Bank, N.A., (formerly, CoreStates Bank, N.A.), as Trustee, including Form of Debenture. 4-b Specimen of Class A Common Stock Certificate and specimen of Class B Common Stock Certificate (incorporated by reference to Exhibit 1 of the Registrant's Amendment No. 1 to Form 8 and Exhibit 1 to Registrant's Form 8-A, respectively, both dated April 22, 1992). 4-c Trust Indenture dated as of November 15, 1993 between the Registrant and The Chase Manhattan Bank (National Association), as Trustee (incorporated by reference to Exhibit 4 to the Registrant's Registration Statement on Form S-3 (No. 33-50883), filed November 2, 1993). 4-d Senior Trust Indenture, dated as of October 23, 1995, between the Registrant and Mellon Bank, N.A., as Trustee (incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-3 (File No. 33-62601), filed September 13, 1995). 4-e Indenture dated as of December 17, 1996 between Advanta Corp. and The Chase Manhattan Bank, as trustee relating to the Junior Subordinated Debentures. (incorporated by reference to Exhibit 4-g to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996). 4-f Declaration of Trust dated as of December 5, 1996 of Advanta Capital Trust I. (incorporated by reference to Exhibit 4-h to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996). 4-g Amended and Restated Declaration of Trust dated as of December 17, 1996 for Advanta Capital Trust I. (incorporated by reference to Exhibit 4-I to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996). 4-h Series A Capital Securities Guarantee Agreement dated as of December 17, 1996. (incorporated by reference to Exhibit 4-j to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996). 9 Inapplicable. 10-a Registrant's Stock Option Plan, as amended (incorporated by reference to Exhibit 10-b to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989).+ 10-b Amended and Restated Advanta Corp. 1992 Stock Option Plan (incorporated by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996).+
91 93 10-c Advanta Management Incentive Plan, as amended (incorporated by reference to Exhibit 10-c to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996).+ 10-d* Application for membership in VISA(R) U.S.A. Inc. and Membership Agreement executed by Colonial National Bank USA on March 25, 1983. 10-e* Application for membership in MasterCard(R) International, Inc. and Card Member License Agreement executed by Colonial National Bank USA on March 25, 1983. 10-f* Indenture of Trust dated May 11, 1984 between Linda Alter, as settlor, and Dennis Alter, as trustee. 10-f(i) Agreement dated October 20, 1992 among Dennis Alter, as Trustee of the trust established by the Indenture of Trust filed as Exhibit 10-g (the "Indenture"), Dennis Alter in his individual capacity, Linda Alter, and Michael Stolper, which Agreement modifies the Indenture (incorporated by reference to Exhibit 10-g(i) to the Registrant's Registration Statement on Form S-3 (File No. 33-58660), filed February 23, 1993). 10-g Agreement dated as of March 5, 1998 between the Registrant and Olaf Olafsson (incorporated by reference to Exhibit 10-g to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997).+ 10-h Advanta Management Incentive Plan with Stock Election (incorporated by reference to Exhibit 4-c to Amendment No. 1 to the Registrant's Registration Statement on Form S-8 (File No. 33-33350), filed February 21, 1990).+ 10-i Advanta Corp. Executive Deferral Plan (incorporated by reference to the Exhibit 10-j to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995).+ 10-j Advanta Corp. Non-Employee Directors Deferral Plan (incorporated by reference to Exhibit 10-K to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995).+ 10-k Advanta Management Incentive Plan With Stock Election II (incorporated by reference to Exhibit 10-o to the Registrant's Registration Statement on Form S-2 (File No. 33-39343), filed March 8, 1991).+ 10-l Amended and Restated Advanta Management Incentive Plan With Stock Election III, (incorporated by reference to Exhibit 10-l to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998).+ 10-m Life Insurance Benefit for Certain Key Executives and Directors (filed herewith).+ 10-n Amended and Restated Advanta Management Incentive Plan With Stock Election IV (incorporated by reference to Exhibit 10-n to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998).+ 10-o Amended and Restated Agreement of Limited Partnership of Advanta Partners LP, dated as of October 1, 1996 (incorporated by reference to Exhibit 10-o to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996). 10-p Agreement dated as of January 15, 1996 between the Registrant and William A. Rosoff (incorporated by reference to Exhibit 10-u to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995).+ 10-q Pooling and Servicing Agreement, dated as of June 1, 1996, among Advanta Business Receivables Corp., Advanta Financial Corp. and First National Bank of Chicago, as Trustee (incorporated by reference to Exhibit 10-q to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997). 10-r Agreement dated May 11, 1998 between the Registrant and Philip M. Browne (incorporated by reference to Exhibit 10-r to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998).+
92 94 10-s Master Business Receivables Asset-Backed Financing Facility Agreement, dated as of May 1, 1997, by and among Advanta Business Service Corp., Advanta Leasing Receivables Corp. III and The Chase Manhattan Bank (incorporated by reference to Advanta Business Services Corp.'s Registration Statement on Form S-1 (File No. 333-38575). 10-t Contribution Agreement, dated as of October 28, 1997, by and between Advanta Corp. and Fleet Financial Group (incorporated by reference to Exhibit (c)(2) to the Registrant's Schedule 13E-4, dated January 20, 1998), as amended by the First Amendment to the Contribution Agreement, dated as of February 10, 1998, by and among Advanta Corp., Fleet Financial Group and Fleet Credit Card, LLC (incorporated by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K, filed March 6, 1998). 10-u Agreement dated July 27, 1998 between the Registrant and George O. Deehan (incorporated by reference to Exhibit 10-u to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998).+ 10-v Commercial Lease, dated September 28, 1995, by and between Draper Park North, L.C. and Advanta Financial Corp., as amended January 31, 1996 and May 20, 1996 (filed herewith). 10-w Lease Agreement, dated August 27, 1997 between San Diego Development #1, LLC and Advanta Mortgage Corp. USA, as amended October 20, 1998 (filed herewith). 10-x Amended and Restated Sale and Servicing Agreement, dated as of August 31, 1999, among Advanta Home Equity Loan Owner Trust 1998-MS1, as Issuer, Advanta Conduit Receivables Inc., as Depositor, Advanta Mortgage Corp. USA, Advanta National Bank and Advanta Bank Corp., as Loan Originators, Advanta Corp., as Transfer Obligor and Bankers Trust Company of California, N.A., as Indenture Trustee (filed herewith). 11 Inapplicable. 12 Computation of Ratio of Earnings to Fixed Charges (filed herewith). 13 Inapplicable. 16 Inapplicable. 18 Inapplicable. 21 Subsidiaries of the Registrant (filed herewith). 22 Inapplicable. 23 Consent of Independent Public Accountants (filed herewith). 24 Powers of Attorney (included on the signature page hereof). 27 Financial Data Schedule (filed herewith). 28 Inapplicable. 99 Inapplicable.
- --------------- * Incorporated by reference to the Exhibit with corresponding number constituting part of the Registrant's Registration Statement on Form S-2 (No. 33-00071), filed on September 4, 1985. + Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K 1. A Report on Form 8-K was filed by the Company on October 25, 1999 regarding the resignation of one of the Company's executive officers. 2. A Report on Form 8-K was filed by the Company on October 26, 1999 regarding consolidated earnings of the Company and its subsidiaries for the fiscal quarter ended September 30, 1999. Summary earnings and balance sheet information as of that date were filed with such report. 3. A Report on Form 8-K was filed by the Company on November 30, 1999 regarding the Company's earnings guidance for the year 2000. 93 95 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Advanta Corp. By: /s/ WILLIAM A. ROSOFF ----------------------------------- William A. Rosoff, President and Vice Chairman of the Board Dated: March 20, 2000 KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned does hereby constitute and appoint Dennis Alter, William A. Rosoff, Philip M. Browne, James L. Shreero and Elizabeth H. Mai, or any of them (with full power to each of them to act alone), his or her true and lawful attorney in-fact and agent, with full power of substitution, for him or her and on his or her behalf to sign, execute and file an Annual Report on Form 10-K under the Securities Exchange Act of 1934, as amended, for the fiscal year ended December 31, 1999 relating to Advanta Corp. and any or all amendments thereto, with all exhibits and any and all documents required to be filed with respect thereto, with the Securities and Exchange Commission or any regulatory authority, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises in order to effectuate the same as fully to all intents and purposes as he or she might or could do if personally present, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on the 20th day of March, 2000.
NAME TITLE ---- ----- /s/ DENNIS ALTER Chairman of the Board and - ------------------------------------------ Chief Executive Officer Dennis Alter /s/ WILLIAM A. ROSOFF President and Vice Chairman - ------------------------------------------ of the Board William A. Rosoff /s/ PHILIP M. BROWNE Senior Vice President and - ------------------------------------------ Chief Financial Officer Philip M. Browne /s/ JAMES L. SHREERO Vice President and Chief - ------------------------------------------ Accounting Officer James L. Shreero /s/ ARTHUR P. BELLIS Director - ------------------------------------------ Arthur P. Bellis /s/ MAX BOTEL Director - ------------------------------------------ Max Botel /s/ WILLIAM C. DUNKELBERG Director - ------------------------------------------ William C. Dunkelberg /s/ DANA BECKER DUNN Director - ------------------------------------------ Dana Becker Dunn
94 96
NAME TITLE ---- ----- /s/ ROBERT C. HALL Director - ------------------------------------------ Robert C. Hall /s/ JAMES E. KSANSNAK Director - ------------------------------------------ James E. Ksansnak /s/ RONALD LUBNER Director - ------------------------------------------ Ronald Lubner /s/ OLAF OLAFSSON Director - ------------------------------------------ Olaf Olafsson /s/ MICHAEL STOLPER Director - ------------------------------------------ Michael Stolper
95 EX-10.M 2 LIFE INSURANCE BENEFIT KEY EXECUTIVES & DIRECTORS 1 EXHIBIT 10-m As a taxable executive benefit, the Company pays the premiums for life insurance policies on the lives of non-employee Directors and certain key executives. The executive or Board member has the right to designate the beneficiary under the applicable life insurance policy. Messrs. Alter and Rosoff are each covered by a $5,000,000 policy. Mr. Deehan is covered by a $1,000,000 policy. Each non-employee Director is covered by a $500,000 policy. All of the life insurance policies are owned by the Company. Upon termination of employment, each executive is entitled to acquire the insurance policy from the Company upon payment to the Company of an amount equal to the cash value of the policy at that time. The policies insuring the non-employee Directors are term life insurance policies, on which there is no build-up in cash value. EX-10.V 3 COMMERCIAL LEASE 9/28/95 DRAPER PARK NORTH 1 10-V SECOND AMENDMENT TO LEASE THIS SECOND AMENDMENT TO LEASE ("2ND AMENDMENT") dated this 20th DAY OF MAY, 1996, is entered into by and between DRAPER PARK NORTH, L.C., a Utah Limited Liability Company ("Landlord"), and ADVANTA FINANCIAL CORP., a Utah corporation ("Tenant"). WITNESSETH: WHEREAS, Landlord and Tenant entered into a Lease dated September 28, 1995, ("Lease") which is incorporated herein by reference; WHEREAS, Landlord and Tenant entered into a First Amendment to Lease dated January 31, 1996 ("1ST Amendment") which is incorporated herein by reference; and WHEREAS, the parties hereto desire to amend certain terms and conditions of the Lease as specifically indicated in this 2ND Amendment. However, unless specifically amended herein, all terms and conditions of the Lease and 1ST Amendment remain in full force and effect; NOW THEREFORE, in consideration of the mutual promises, representations and covenants contained herein, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows. 1. The recitals contained herein are hereby incorporated by reference. 2. Article 1(a) and 1(b) shall be replaced in its entirety by the following: (a) Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, for the term and subject to the terms and conditions herein, to each and all of which Landlord and Tenant hereby mutually agree, those certain Occupied and Unoccupied premises (collectively "Premises", unless otherwise specifically noted), as identified on Exhibit A attached hereto, which includes 35,822 RENTABLE SQUARE FEET OF OCCUPIED PREMISES (34,090 Useable; approx. 5.08% load factor), as determined by final space plan. The location of the Premises is commonly known as: 11850 Election Dr., Draper, UT 84020. (b) Tenant shall also have the right herein to lease AN ADDITIONAL 14,803 RENTABLE SQUARE FEET OF "UNOCCUPIED PREMISES" (14,088 Useable; 5.08% load factor), as more specifically outlined in Article 4(a)(ii) herein. Finally, Tenant shall have a "Right of First Refusal" to further add to the Premises and Unoccupied Premises identified in this Lease, provided that such Right of First Refusal applies only to vacant and unrented space in the same building as the Premises and further provided that Tenant execute within five (5) business days, of written notice from Landlord, a lease for additional space containing the same terms and conditions which have been agreed to by the prospective tenant other than Tenant (Advanta). 2 3. Article 2(a). Initial Term is replaced in its entirety by the following: (a) Initial Term. The Lease term shall be five (5) years and shall commence MAY 1, 1996 ("Commencement Date"). However, if Landlord fails to deliver possession within thirty (30) days of the Commencement Date, Tenant shall have the right to terminate this Lease without any further liability to Landlord or Tenant, in which event Landlord shall refund to Tenant within sixty (60) days any advanced Rents and Security Deposit paid by Tenant. 4. Article 4(a)(i) and (ii) shall be replace in its entirety by the following: (i) BASE RENT FOR OCCUPIED PREMISES. Base Rent for Occupied Premises shall be $ 2,606,050.50, ($14.55 PER SQ. FT. X 35,822 RENTABLE SQ. FT. X 5 YRS.), payable as follows: $43,434.18 PER MONTH payable in advance each month on or before the 1ST day of each month during the duration of the Lease, with the first such monthly rental payments being due upon the execution of the Lease. Base Rent for Occupied Premises includes $3.30 per sq. ft. for Operating Expenses as more specifically defined in Article 7 herein. (ii) BASE RENT FOR UNOCCUPIED PREMISES. Further, in order to accommodate Tenant's potential need for additional space, Tenant shall have the option to rent an additional 14,803 Rentable sq. ft. upon payment of the Base Rent for Unoccupied Premises. Base Rent for Unoccupied Premises shall be $ 546,230.70 ($7.38 PER SQ. FT. X 14,803 UNOCCUPIED SQ. FT. X 5 YRS.), payable as follows: $ 9,103.85 PER MONTH payable in advance each month on or before the 1ST day of each month during the duration of the Lease, with the FIRST month rental payment being due upon execution of the Lease, subject to the following: 1. Tenant shall receive a discount of fifty (50%) percent of the Base Rent for Unoccupied Premises only for months 2 - 5 of the Lease. 2. Base Rent for Unoccupied Premises includes $1.86 per sq. ft. for Operating Expenses as more specifically defined in Article 7 herein, which amount includes a mutually-agreed reduction to Tenant for anticipated Operating Expenses not applicable to such Unoccupied Premises. 3. Tenant may terminate its option rights for additional Premises herein by providing 120 days written notice to Landlord, following which Tenant's obligation to pay further Base Rent of Unoccupied Premises shall cease herein. 4. Upon exercising Tenant's option herein, Tenant may possess the Unoccupied Premises pursuant to the same terms and conditions of the Lease (i.e.; Tenant Improvements, Moving Allowance, Base Rent for Occupied Premises, 6 non-reserved parking stalls per 1,000 rentable sq. ft. of Occupied Premises, etc.) in proportion to the balance of time remaining on the initial term of the Lease. 2 3 IN WITNESS WHEREOF, the parties have executed this Lease dated the day and year first above written. TENANT, LANDLORD, ADVANTA FINANCIAL CORP. DRAPER PARK NORTH, L.C. By: /s/ John L. Richards By: /s/ Scott M. Waldron -------------------- -------------------- John L. Richards, President Scott M. Waldron, Manager 3 4 FIRST AMENDMENT TO LEASE THIS FIRST AMENDMENT TO LEASE ("AMENDMENT") dated this 31st DAY OF JANUARY, 1996, is entered into by and between DRAPER BUSINESS PARK, L.C., a Utah Limited Liability Company ("Landlord"), and ADVANTA FINANCIAL CORP., a Utah corporation ("Tenant"). WITNESSETH: WHEREAS, Landlord and Tenant entered into a Lease dated September 28th, 1995, ("Lease") which is incorporated herein by reference; and WHEREAS, the parties hereto desire to amend certain terms and conditions of the Lease as specifically indicated in this Amendment. However, unless specifically amended herein, all terms and conditions of the Lease remain in full force and effect; NOW THEREFORE, in consideration of the mutual promises, representations and covenants contained herein, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows. 1. The recitals contained herein are hereby incorporated by reference. 2. Article 2(a). Initial Term is replaced in its entirety by the following: (a) Initial Term. The Lease term shall be five (5) years and shall commence APRIL 15, 1996 ("Commencement Date"). In order to allow Tenant's possession by the Commencement Date, the Premises shall be ready by APRIL 1, 1996, for systems and furniture installation by Tenant. In the event that the Premises is not ready for systems and furniture installation by APRIL 1, 1996, Landlord shall provide one (1) day of free Base Rent for each day the Premises are not ready, provided that Landlord, its agents or employees, is solely or substantially the cause of such delay. However, if Landlord fails to deliver possession within thirty (30) days of the Commencement Date, Tenant shall have the right to terminate this Lease without any further liability to Landlord or Tenant, in which event Landlord shall refund to Tenant within sixty (60) days any advanced Rents and Security Deposit paid by Tenant. IN WITNESS WHEREOF, the parties have executed this Lease dated the day and year first above written. TENANT, LANDLORD, ADVANTA FINANCIAL CORP. DRAPER PARK NORTH, L.C. By: /s/ John L. Richards By: /s/ Scott M. Waldron -------------------- -------------------- John L. Richards, President Scott M. Waldron, Manager 5 COMMERCIAL LEASE THIS LEASE dated this 28th DAY OF SEPTEMBER, 1995, is entered into by and between DRAPER PARK NORTH, L.C., a Utah Limited Liability Company ("Landlord"), and ADVANTA FINANCIAL CORP., a Utah corporation ("Tenant"). 1. PREMISES. (a) Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, for the term and subject to the terms and conditions herein, to each and all of which Landlord and Tenant hereby mutually agree, those certain Occupied and Unoccupied premises (collectively "Premises", unless otherwise specifically noted), highlighted on Exhibit A attached hereto, which include APPROXIMATELY 35,000 RENTABLE SQUARE FEET OF OCCUPIED PREMISES (the exact square footage and load factor shall be determined by final space plan; said square footage shall not be less than 35,000 square feet). The location of the Premises is commonly known as: 11850 Election Dr., Draper, UT 84020. (b) Tenant shall also have the right herein to lease AN ADDITIONAL APPROXIMATE 15,000 SQUARE FEET OF "UNOCCUPIED PREMISES" as more specifically outlined in Article 4(a)(ii) herein. Finally, Tenant shall have a "Right of First Refusal" to further add to the Premises and Unoccupied Premises identified in this Lease, provided that such Right of First Refusal applies only to vacant and unrented space in the same building as the Premises and further provided that Tenant execute within five (5) business days, of written notice from Landlord, a lease for the additional space containing the same terms and conditions which have been agreed to by the prospective tenant other than Tenant (Advanta). (c) For purposes of this Lease, the Premises shall be measured in accordance with the Building Owners and Management Association (BOMA) Method, American National Standard (ANSI Z65.1-1980, reaffirmed 1989) of floor measurement. Landlord shall provide, upon Tenant's request, the calculations which show how the Total Rentable Area of the Building and Rentable and Useable Area of the Premises were derived. (d) In addition, the Premises shall include the appurtenant right to use, in common with others, the site, parking and landscaped areas. Landlord shall provide Tenant 6 NON-RESERVED PARKING STALLS PER 1,000 RENTABLE SQ. FT. OF OCCUPIED PREMISES (approximately 210 non-reserved parking stalls at the Commencement Date of this Lease) in the adjacent parking lots of the Premises; one (1) of the above parking stalls to be reserved stalls per each 4,500 square feet of Occupied Premises designated by Tenant. (e) Acceptance of Premises. Unless otherwise notified by Tenant within thirty (30) days of taking possession, by entry hereunder Tenant accepts the Premises as being in the condition in which Landlord is obligated to deliver the Premises. Tenant shall at the end of the term and any extension herein surrender to Landlord the Premises and all alterations, additions and improvements thereto in the same condition as when received; ordinary wear and tear, damage by fire, earthquake, or act of God excepted. Landlord has no liability and has made no representation to alter, improve, repair, or paint the Premises or any part thereof, except as specified in Article 2(c) & 6 herein. 6 (f) Landlord understands and agrees that Tenant intends to be open for regular business during the hours of 6:00 a.m. to 7:00 p.m. Monday through Saturday. In addition, Tenant shall have 24-hour access to the Premises. 2. TERM, OPTION, TENANT IMPROVEMENTS. (a) Initial Term. The Lease term shall be five (5) years and shall commence FEBRUARY 15, 1996 ("Commencement Date"). In order to allow Tenant's possession by the Commencement Date, the Premises shall be ready by FEBRUARY 1, 1996, for systems and furniture installation by Tenant. In the event that the Premises is not ready for systems and furniture installation by February 1, 1996, Landlord shall provide one (1) day of free Base Rent for each day the Premises are not ready, provided that Landlord, its agents or employees, is solely or substantially the cause of such delay. However, if Landlord fails to deliver possession within thirty (30) days of the Commencement Date, Tenant shall have the right to terminate this Lease without any further liability to Landlord or Tenant, in which event Landlord shall refund to Tenant within sixty (60) days any advanced Rents and Security Deposit paid by Tenant. (b) Option. Provided that Tenant is not in default under this Lease, within one-hundred eighty (180) days of expiration of this Lease or any extension period herein and by written notice to Landlord, Tenant shall have the right to renew this Lease for three (3) additional periods of two (2) years each. Tenant shall possess the Premises during the option period upon the same terms and conditions of this Lease, except that Base Rent under Article 4(a) herein will be adjusted for the option period(s) by the proportionate increase in the Consumer Price Index (CPI), using the Commencement Date of this Lease as the base period. Base Rent during any option period(s) shall never decrease, even if the CPI decreases. (c) Tenant Improvements, Space Planning and Moving Allowance. At execution of this Lease, Landlord shall commence the building design, construction and installation of agreed-upon Tenant Improvements requested by Tenant ("Tenant Improvements"). Landlord shall provide Tenant $21.00 PER RENTABLE SQUARE FOOT OF OCCUPIED PREMISES (approximately $735,000) for Tenant Improvements, regardless of the actual costs thereof. It is understood and agreed that Tenant is solely responsible for any costs of Tenant Improvements above $21.00 per rentable sq. ft. of Occupied Premises. Any unexpended Tenant Improvements allowance shall be refunded to Tenant on a prorata basis over the Lease term. Tenant shall have the right to review and approve the bids for Tenant Improvements. The Tenant Improvements shall include all improvements to the Premises, but exclude, at no cost to Tenant, those items specifically the responsibility of Landlord as identified in the Base Building Improvements, incorporated herein and attached hereto as Exhibit B. LANDLORD SHALL FURTHER PROVIDE TENANT $1.50 PER RENTABLE SQ. FT OF OCCUPIED PREMISES FOR MOVING ALLOWANCE UPON TENANT'S TAKING OCCUPANCY, REGARDLESS OF TENANT'S ACTUAL COST, WHICH SHALL BE PAID TO TENANT WITHIN SIXTY (60) DAYS OF THE COMMENCEMENT DATE. (d) Substantial Completion of Tenant Improvements. The Premises shall be deemed complete upon substantial completion. "Substantial Completion" shall mean when (i) installation of Tenant Improvements has occurred to Tenant's reasonable satisfaction, (ii) building services are accessible to the Premises, (iii) Landlord's Architect/Contractor shall have issued a Certificate of Substantial Completion with respect to Premises or that portion of the Building 2 7 within which they are contained, whether or not Substantial Completion of the building itself shall has occurred, and (iv) issuance of a Certificate of Occupancy. Substantial Completion shall be deemed to have occurred notwithstanding a requirement to complete non-substantial "punchlist" work. Landlord shall use its best efforts to advise Tenant of Substantial Completion at least 30 days prior to such date, but failure to give such notice shall not constitute a default by Landlord. 3. NON-OCCUPANCY OF IMPROVED SPACE. In the event Tenant does not occupy the Premises and fails to pay Rents as required in Article 4 of this Lease, all reasonable and verifiable Tenant Improvements become due and payable upon invoicing by Landlord. Further, such invoicing by Landlord does not waive any other rights or remedies Landlord may have against Tenant for failure to occupy. 4. RENT. (a) Base Rent. (i) BASE RENT FOR OCCUPIED PREMISES. Base Rent for Occupied Premises shall be approximately $2,546,250.00, ($14.55 PER SQ. FT. X 35,000 RENTABLE SQ. FT. AND BASE RENT OF OCCUPIED PREMISES SHALL BE DETERMINED BY THE FINAL SPACE PLAN), payable as follows: $42,437.50 PER MONTH payable in advance each month on or before the 1st day of each month during the duration of the Lease, with the first such monthly rental payments being due upon the execution of the Lease. Base Rent for Occupied Premises includes $3.30 per sq. ft. for Operating Expenses as more specifically defined in Article 7 herein. (ii) BASE RENT FOR UNOCCUPIED PREMISES. Further, in order to accommodate Tenant's potential need for additional space, Tenant shall have the option to rent an additional 15,000 square feet of space upon payment of the Base Rent for Option Premises. Base Rent for Unoccupied Premises shall be APPROXIMATELY $553,500.00, $661,500.00, ($7.38 PER SQ. FT. X 15,000 UNOCCUPIED SQ. FT. APPROXIMATELY; THE EXACT SQ. FT. AND BASE RENT SHALL BE DETERMINED BY THE FINAL SPACE PLAN), payable as follows: $9,225 PER MONTH payable in advance each month on or before the 1st day of each month during the duration of the Lease, with the FIRST month rental payment being due upon execution of the Lease, subject to the following: 1. Tenant shall receive a discount of fifty percent (50%) of the Base Rent for Unoccupied Premises only for months 2 - 5 of the Lease. 2. Base Rent for Unoccupied Premises includes $1.86 per sq. ft. for Operating Expenses as more specifically defined in Article 7 herein, which amount includes a mutually-agreed reduction to Tenant for anticipated Operating Expenses not applicable to such Unoccupied Premises. 3 8 3. Tenant may terminate its option rights for additional Premises herein by providing 120 days written notice to Landlord, following which Tenant's obligation to pay further Base Rent of Unoccupied Premises shall cease herein. 4. Upon exercising Tenant's option herein, Tenant may possess the Unoccupied Premises pursuant to the same terms and conditions of the Lease (i.e.; Tenant Improvements, Moving Allowance, Base Rent for Occupied Premises, 6 non-reserved parking stalls per 1,000 rentable sq. ft. of Occupied Premises, etc.) in proportion to the balance of time remaining on the initial term of the Lease. (iii) Any partial months shall be prorated accordingly. All Base Rent for Occupied Premises, Base Rent for Unoccupied Premises, and Additional Rent (collectively "Rents") shall be paid as follows, unless otherwise directed in writing: Draper Park North, L.C.; Attn: Scott Waldron; 5200 South Main; Murray, UT 84107 (b) Additional Rent. All obligations payable by Tenant under this Lease other than Base Rent are called "Additional Rent". Unless otherwise provided, Additional Rent shall be paid with the next monthly installment of Base Rent upon invoicing from Landlord. (c) Interest, Late Charges, Costs and Attorneys' Fees. If Tenant fails to pay within ten (10) days of the date due any Rents which Tenant is obligated to pay under this Lease, the unpaid amount shall bear interest at ten (10%) percent per annum. Tenant acknowledges that any late payments of Rents shall cause Landlord to lose the use of that money and incur costs and expenses not contemplated under this Lease, including without limitation administrative, collection and accounting costs, the exact amount of which is difficult to ascertain. Therefore, in addition to interest, any payments not received by Landlord within ten (10) days from the date it is due, Tenant shall also pay Landlord a late charge equal to five (5%) percent of the late Rents. Further, as Additional Rent, Tenant shall be liable to Landlord for litigation or other enforcement proceeding costs and attorneys' fees actually and reasonably incurred as a result of late payments or non-payments. Acceptance of any interest, late charge, costs or attorneys' fees shall not constitute a waiver of any default by Tenant nor prevent Landlord from exercising any other rights or remedies under this Lease or at law. 5. USE. (a) The Premises shall be used for banking (including but not limited to retail banking), general office and warehouse, assembly, equipment, testing and development, and distribution purposes and no other, unless consented to in writing by Landlord, which consent will not be unreasonably withheld. Tenant shall not do or permit to be done in or about the Premises anything which is prohibited by or in any way in conflict with (in the case of hazardous materials, Tenant shall notify Landlord of any such materials and shall ensure that any such hazardous material is property controlled, safeguarded, and disposed of) any and all laws, statutes, ordinances, rules and regulations now in force or which may hereafter be enacted or 4 9 promulgated or which is prohibited by the standard form of fire insurance policy, or which will increase the existing rate of or affect any fire or other insurance upon the Building or any of its contents, or cause a cancellation of any insurance policy covering the Building or any part thereof or any of its contents. Tenant shall not do or permit anything to be done in or about the Premises which will in any way violate Rules or Regulations reasonably promulgated by Landlord throughout this Lease, obstruct or interfere with the rights of other tenants, or use or allow the Premises to be used for any improper, immoral, unlawful or objectionable purpose, nor shall Tenant cause, maintain or permit any nuisance, in, on or about the Premises or commit or suffer to be committed any waste in, on or about the Premises. Landlord agrees to disclose to Tenant, or Tenant's agent, any information known by Landlord regarding the condition of the Premises, including but not limited to, relevant soil conditions, presence of hazardous or contaminated substances, PCB transformers, or other toxic substances. (b) Tenant shall not use the name of the Building in which the Premises are located, in connection with any business carried on in said Premises (except as Tenant's address) without written consent of Landlord. (c) Tenant shall not manufacture, assemble or store materials inside the common areas outside of Building. 6. LANDLORD'S SERVICES. Landlord, at its sole expense, is only responsible to maintain the roof and structural elements of the Premises, including the party wall. All other repairs, maintenance, insurance, taxes and property management for the Premises, the building(s) and common areas shall be provided by Landlord and be the responsibility of Landlord, but shall be reimbursed by Tenant through payment of Operating Expenses as more fully outlined in Article 7 herein. 7. OPERATING EXPENSES - REPAIRS, MAINTENANCE, INSURANCE, TAXES AND PROPERTY MANAGEMENT (EXCLUDES ELECTRIC AND GAS). Since the Premises is part of a larger building or group of buildings having common expenses and needs, Tenant agrees to pay for Operating Expenses as part of Base Rent $3.30 per rentable square foot per year for Occupied Premises and $1.86 per rentable square foot per year for Unoccupied Premises. Further, Tenant agrees to pay as Base Rent any allowed Operating Expenses Escalation as more specifically defined herein, subject to the Cap as provided for in Article 7(b)(iv) herein. For purposes of this Lease, the following definitions, terms and conditions apply: (a) Definitions. "Operating Expenses" - Operating Expenses include the expenses for all reasonable and necessary repairs, maintenance, insurance, taxes and property 5 10 *management for the operation and management of the Premises and the building(s) and common areas of Draper Park North, L.C. For purposes of this Lease, Operating Expenses specifically excludes electric and gas expenses which are the sole responsibility and cost of the Tenant. "Operating Expenses Escalation" - Operating Expenses Escalation allows the Landlord to recover increases, subject to the Cap as explained herein, in Operating Expenses (attributable to the Premises, the building(s) and common areas of Draper Park North, L.C.) by increasing prorata the rate (i.e., $3.30 per sq. ft for Occupied Premises and $1,86 per sq. ft. for Unoccupied Premises) for Operating Expenses. Operating Expenses Escalation is the difference between Tenant's prorata share of the Operating Expenses for the Base Year and Tenant's prorata share of Operating Expenses for the calendar year in question. Operating Expenses Escalation does not include Real Estate Taxes. "Real Estate Taxes" means real estate taxes levied or assessed against the Premises, building(s) and common areas as finally determined to be legally payable by legal proceedings or otherwise after taking into account any available discount, excluding any interest or penalty for late payment and any transfer, sales, use, or rent taxes. "Special Assessments" may be included with Real Estate Taxes to the extent that the Special Assessment benefits all tenants of a building(s) equally in proportion to each tenant's rentable sq. ft in the building(s); however, excluding any special assessment incurred or paid by Landlord in lieu of a capital expenditure. "Real Estate Taxes Escalation" - Real Estate Taxes Escalation allows the Landlord to recover increases in Real Estate Taxes (attributable to the Premises, the building(s) and common areas of the Draper Park North, L.C.) by passing through a prorata share of such tax increases. "Prorata Share" - Operating Expenses Escalation and Real Estate Taxes Escalation shall be calculated to establish a Prorata Share for each tenant of Draper Park North, L.C. by dividing the sq. ft. of each tenant's Premises by the total rentable sq. ft. of all tenants' Premises. (b) Operating Expenses Escalation. (i) Operating Expenses Escalation is intended to assure that Tenant pays for Tenant's share of all inflationary-type increases in the costs of operating and maintaining the Premises, building(s) and common areas over the costs of the Base Year (as hereinafter defined). For purposes of Operating Expenses Escalation, "Base Year" means calendar year 1996. In addition to the Base Rent, Tenant shall pay the Operating Expenses Escalation (beginning January 1997 as more fully described herein). In Landlord's and Tenant's mutual and reasonable discretion, Operating Expenses for the Base Year shall be adjusted, as necessary, to a level of 95% occupied 6 11 Landlord's building(s) in Draper Park North at cost levels for an entire year. This adjustment shall include: (a) when building systems are under warranty during the Base Year, an adjustment for the cost of service contracts and other expenses that would have been incurred in the absence of such warranties; (b) an adjustment for all other expenses that are not incurred if the Building is new and start-up discounts or similar savings have been achieved; and (c) adjustments for all other atypical costs that occur or do not occur during the Base Year other than those costs which would occur in the Base Year in the ordinary course of business. The purpose of these adjustments is to include in the Operating Expenses for the Base Year all reasonable cost components that occur or are likely to occur in later years. If at any time during the Lease Term, less than 95% of the rentable sq. ft. of the building(s) is occupied by tenants, the Operating Expenses for such calendar year shall be reasonably determined to be an amount equal to the expenses that would normally be expected to be incurred if such occupancy had been 95% of the total rentable sq. ft. of the building(s). The only expenses which shall be adjusted in this manner shall be variable expenses, otherwise includable as Operating Expenses, where the amount is directly related to the level of occupancy or square foot area receiving a particular service. If a new category of Operating Expenses is incurred after the Base Year, the first full year's expense for such items shall be added to the Operating Costs for the Base Year commencing with the first full calendar year that such expense is incurred, so that Tenant shall only be required to pay subsequent increases in such expense. The expense incurred for such items during the first year shall be subject to the adjustments described in the immediately preceding paragraphs of this sub-section. For the first full calendar year following the Base Year, the Operating Expenses Escalation shall be billed as a one-time charge at the close of the year and shall be paid by Tenant within sixty (60) days after receipt of the bill. For the second full calendar year following the Base Year, and all subsequent full or partial calendar years during the Lease, Tenant shall pay Landlord each month, on account as Base Rent, an amount equal to one twelfth (1/12) of the prior year's Operating Expenses Escalation, less any non-recurring expenses (hereinafter "Operating Expenses Escalation Paid on Account"). Landlord shall provide Tenant with a bill for the Operating Expenses Escalation after the close of each calendar year. Tenant shall, within thirty (30) days of the Tenant's receipt of such bill, pay Landlord the difference between the Operating Expenses Escalation Paid On Account and the final amount due as set forth in such bill. If for any calendar year the Operating Expenses Escalation Paid on Account exceeds the actual Operating Expenses Escalation, the excess shall be treated as a prepayment of the next due installment of Base Rent and Operating Expenses Escalation Paid on Account. (ii) Operating Expenses shall be limited to the following reasonable and 7 12 necessary expenses which are paid or incurred (as permitted pursuant to generally accepted accounting principals, consistently applied) for operating and maintaining the Premises, the building(s) and common areas: (1) Cleaning Expenses - All expenses for routine cleaning, including public areas, atriums, elevators, rest rooms and windows. Cleaning expenses shall include, but not be limited to maintenance of cleaning equipment, supplies, contract service and trash removal. Because of Tenant's banking operations, Tenant shall have the right to select the cleaning agent/personnel required hereunder, which cleaning agent/personnel may need to be bonded. Tenant shall pay as additional rent the additional costs of having a bonded cleaning agent/personnel. (2) General - All expenses for general repair and maintenance, including contracted services, elevator, electrical, roof, plumbing, fire and life safety expenses, and other building maintenance supplies. (3) Roads, Grounds and Security - Expenses related to exterior maintenance (e.g., landscaping, snow removal, parking lot repairs, site signage and lighting) and expenses for security. (4) Heating, Ventilation and Air Conditioning - Heating, ventilation and air conditioning expenses for labor and supplies to operate and maintain air conditioning, heating and ventilating systems, including the cost of contracted services. No replacement costs for major components of the heating, ventilation or air conditioning systems or energy costs are included in this category. (5) Insurance - All expenses for insurance of the Premises, building(s) and common areas. (6) Salaries - All salaries, wages, medical, surgical, union and general welfare benefits (including group life insurance), and pension payments of persons employed by the Landlord, however, not above the level of property manager, to the extent such employees are directly engaged in the repair, operations and maintenance of the Premises, building(s) and common areas, together with payroll taxes, workers' compensation insurance premiums, uniforms and related expenses pertaining to such employees, to the extent such expenses are competitive and commercially reasonable. (7) Management Fee - A management fee which in no event shall exceed three (3.0%) percent of the gross receipts from the building(s), as adjusted below. Management Fees for the Base Year and the Lease Term shall be computed as if the vacant areas of the building(s) were 95% rented at the Tenant's Base Rent, including reasonably anticipated amounts for escalations and other rents, without regard to rent abatements or other concessions, that would 8 13 have been collected had the building(s) been fully occupied. After the Base Year, management fees shall be computed by substituting the actual base rents, including reasonably anticipated amounts for escalations and other rents, without regard to rent abatements or other concessions of tenants, for so long as such other tenants occupy areas which were vacant during the Tenant's Base Year. (8) Utilities - Expenses for utilities servicing the common areas, including electricity, gas fuel oil, stream, water, and storm water/sewer; however, a tenant's overtime use of such utilities shall not be considered part of the Operating Expenses, but rather shall be separately charged to the specific tenant incurring such overtime utilities. Further, for purposes of this Lease, Operating Expenses specifically excludes electric and gas expenses which are the sole responsibility and cost of the Tenant. (9) Landlord Reasonable Diligence - Landlord shall exercise reasonable diligence, no later than twenty-four (24) hours after receiving actual notice of a problem, in providing services (repairs, maintenance, snow removal, etc.) under this Lease. (iii) Exclusions/Deductions. By way of illustration and not limitation, Operating Expenses shall not include, among other expenses or costs, any expenses or costs incurred or paid by Landlord for the following items: (1) Capital expenditures, including any capital replacement, capital repair or capital improvement made to the Premises, building's and common areas and any other expense which would be deemed to be a capital expenditure under generally accepted accounting principles, consistently applied. Replacement of an item or of a major component of an item and major repairs to such items in lieu of replacement shall each be considered a capital expenditure if the original item or a subsequent improvement to such item was, or could have been, capitalized. Capital expenditures of $1,000.00 or less may be included in Operating Expenses. For purposes of this clause, a group of expenditures related to the same capital project shall be considered a single expenditure. (2) Depreciation or amortization of the building(s) or its contents or components; (3) Expenses for the preparation of space or other work which Landlord performs for any tenant or prospective tenant of the building(s); (4) Expenses for repairs or other work which is caused by fire, windstorm, casualty or any other incurable occurrence, including costs subject to Landlord's insurance deductible; 9 14 (5) Expenses incurred in leasing or obtaining new tenants or retaining existing tenants, including leasing commissions, legal expenses, advertising or promotion; (6) Legal expenses incurred in enforcing the terms of any lease; (7) Interest, amortization or other costs, including legal fees, associated with any mortgage, loan or refinancing of the Premises, building(s) and common areas; (8) Expenses incurred for any necessary replacement of any item to the extent that it is covered under warranty, provided warranty is honored and is effective; (9) The cost of any item or service which Tenant separately reimburses Landlord or pays to third parties, or that Landlord provides selectively to one or more tenants of the building(s), other than Tenant, whether or not Landlord is reimbursed by such other tenant(s). This category shall include the actual cost of any special electrical, heating, ventilation or air conditioning required by any tenant that exceeds normal building standards; (10) Accounting and legal fees relating to the ownership, construction, leasing, sale or any litigation relating to the Building, the Common Area Facilities or the Land; (11) Any interest or penalty incurred due to the late payments of any Operating Expenses; (12) Any amount paid to an entity or individual related to Landlord which exceeds the amount which would be paid for similar goods or services on an arm's-length basis between unrelated parties; (13) The cost of correcting defects in the construction of the Premises, building(s) and common areas; repairs resulting from ordinary wear and tear shall not be deemed to be defects; (14) The initial cost or the replacement cost of any permanent landscaping, or the regular landscaping maintenance for any property other than the Land; (15) Costs of complying with any governmental laws, rules, regulations, or other requirements applicable to the Premises, building(s) and common areas; (16) Any ground rent, air space rent or other rent incurred for the real 10 15 property that the Premises, building(s) and common areas sit upon; (17) Any cost incurred to test, survey, cleanup, contain, abate, remove or otherwise remedy Hazardous Materials, or asbestos containing materials from the Premises, building(s) and common areas, including any damages or future claims asserted against Landlord in connection with the same; (18) Any personal property taxes of the Landlord for equipment or items not used directly in the operation or maintenance of the Premises, building(s) or common areas; (19) Except for management fees, all expenditures pertaining to the administration of the Premises, building(s) and common areas, including payroll and payroll-related expenses associated with administrative and clerical personnel; general office expenditures; other administrative expenditures (including expenditures for travel, entertainment, dues, subscriptions, donations, data processing, errors and omissions insurance, automobile allowances, charitable contributions, political donations and professional fees of any kind) unless enumerated as Operating Expenses; (20) Rentals and other related expenses, if any, incurred in leasing capital items; (21) Any costs or expenses for sculpture, paintings, or other works of art, including, costs incurred with respect to the purchase, ownership, leasing, repair, and/or maintenance of such works of art; (22) Contributions to reserves for Operating Expenses; (23) The cost of overtime or other expense to Landlord in performing work expressly provided in this Lease to be borne at Landlord's expense; (24) All expenses directly resulting from the negligence or willful misconduct of the Landlord, its agents, servants or other employees; (25) All bad debt loss, rent loss, or reserve for bad debt or rent loss; (26) Any other cost or expense which, under generally accepted accounting principles consistently applied, would not be considered to be Operating Expenses; and (27) Any additional costs incurred in order to operate or maintain the Premises, building(s) or common areas or costs directly incurred by the Landlord due to the nature of business conducted by any tenant(s) within the Building which would not customarily be incurred in an office building, including, 11 16 however not limited to, retail or food service tenants. (iv) The Cap. Notwithstanding any provision of this Lease to the contrary, Tenant shall not be obligated to pay for any annual increases in Operating Expenses per rentable sq. ft. for the Premises greater than four (4%) percent per year, accumulative, of the Operating Expenses per rentable sq. ft. for the Premises for the immediately preceding calendar year (the "Cap"). Such increase, if any, shall be paid as Operating Expenses Escalation during each calendar year, after the Base Year ('96). As an example, if the Base Year ('96) adjusted Operating Expenses for Occupied rentable sq. ft., as calculated under subsection 7(b)(i) herein, was $3.50 per Occupied rentable sq. ft. (an increase of $.20 per sq. ft. from 1996 contracted rate for Occupied Premises), then the following could apply for the 1997 calendar year Operating Expenses Escalation provision: Contracted Operating Expenses per Occupied Rentable sq. ft. $ 3.30 X 4.% Cap, Accumulative .04 ------ OPERATING EXPENSES ESCALATION ALLOWED FOR 1997 $ .132
As indicated, only $.132 would be allowed per sq. ft. as Operating Expenses Escalation for Occupied Premises for the 1997 calendar year. The difference of $.068 (.20 - .132) per sq. ft. could not be recovered by Landlord in 1997 calendar year, but the Cap described herein is accumulative resulting in the $.068 difference potentially being recovered in later years of the Lease. (c) Real Estate Tax Escalation. (i) This real estate tax escalation provision requires Tenant to pay Tenant's Prorata Share of increases in Real Estate Taxes from that of the Base Tax Year. In addition to the Base Rent, Tenant shall pay the Real Estate Taxes Escalation. (ii) "Tax Year" means the full fiscal period for each levied or assessed Real Estate Tax. (iii) "Base Tax Year" means the later to occur of (i) the first Tax Year which falls entirely within the Lease Term and for which Real Estate Taxes are levied or assessed, or (ii) the first Tax Year of the Lease Term during which the Building is 100% fully assessed and 100% fully taxed as a 100% completed structure. (iv) "Base Real Estate Taxes" means Real Estate Taxes for the Base Tax Year, provided that if the Building is not at least 95% leased and occupied, the Base Real Estate Taxes shall mean a fair and reasonable estimate of the Real Estate Taxes that would have been incurred for the Base Year if the Building had been 95% leased and occupied during the Base Year. 12 17 (iv) For the first Tax Year following the Base Tax Year, the Real Estate Tax Escalation shall be billed as a one-time charge at the close of the year and shall be paid by Tenant within thirty (30) days after receipt of the bill. Commencing with the second Tax Year following the Base Tax Year, and all subsequent Tax Years, no sooner than sixty (60) days prior to the earliest due date of the tax bill to the taxing authority, Tenant shall pay Landlord, on account, within thirty (30) days after receiving an invoice therefore, an amount not to exceed the Real Estate Taxes Escalation for the prior Tax year (the "Real Estate Taxes Escalation Paid on Account"). For all subsequent years of the Lease Term, at the close of each Tax Year, and after the applicable tax bills have been paid by Landlord, Landlord shall provide Tenant with an invoice for the Real Estate Taxes Escalation, including copies of the receipted Real Estate Tax bills. Tenant shall, within thirty (30) days of the Tenant's receipt of such invoice, pay Landlord the difference between the Real Estate Taxes Escalation Paid on Account and the final amount due as set forth in such invoice. If for any Tax Year the Real Estate Taxes Escalation Paid on Account exceeds the Real Estate Taxes Escalation, the excess shall be: (i) applied to reduce the Operating Expenses Escalation due pursuant to this Lease; (ii) treated as a prepayment of the next due installments of Base Rent, and/or Operating Expenses Escalation Paid on Account; or (iii) refunded to Tenant within sixty (60) days, at Tenant's option. (v) This Real Estate Taxes Escalation provision is intended to assure that Tenant pays Tenant's Prorata Share of ordinary increases in Real Estate Taxes due to ordinary jurisdiction-wide increases in tax rates and changes in the Premises, building(s) and common areas' assessments due to changes in local market values. It is understood and agreed that the Base Rent shall include all such Real Estate Taxes applicable to the Premises, building(s) and common areas at normal tax rates and assessment levels as of the Base Tax Year. Accordingly: (1) Tenant shall not be responsible for any increase in Real Estate Taxes which results solely from the creation of additional rentable area on the Land or in the building(s) or from improvements or alterations made by Landlord or other tenants. Tenant shall pay the full amount of any increase in Real Estate Taxes which are solely due to improvements to the Premises made by Tenant which are considered to be above-standard. If Tenant seeks to dispute any increase in Real Estate Taxes on its improvements, the burden of proof with respect thereto shall fall solely upon Tenant and Landlord shall reasonably cooperate with Tenant and give the necessary authority to challenge any such assessment on Landlord's behalf, and Tenant shall bear the full cost and expense of any such challenge. (2) If (i) there is a tax abatement program or other reduction in effect 13 18 at any time during the Lease Term which reduces Real Estate Taxes, or (ii) Real Estate Taxes are "phased in" during the Lease Term, Real Estate Taxes for the Base Tax Year shall be adjusted so that they are computed on the same basis as Real Estate Taxes for the Tax Year(s) during which the tax abatement or phase-in is in effect. If following the termination of this Lease, Landlord receives any Real Estate Tax refund(s) allocable to the Premises covering Tenant's tenancy under this Lease, then Landlord shall within sixty (60) days thereof pay to Tenant an equal amount of such refund(s). For example, if Real Estate Taxes for the Base Tax Year are reduced by 50% as part of a tax abatement program and Real Estate Taxes are reduced by 25% for the next Tax Year (year 2) and are not reduced at all for the following Tax Year (year 3), for purposes of computing the increase for year 2, the Base Year Real Estate Taxes shall be recomputed as if there were a 25% abatement in effect, and for purposes of computing the increase for year 3, the Base Real Estate Taxes shall be computed as if there were no abatement in effect. (3) If Tenant desires, Tenant may bring appropriate proceedings in Landlord's name or Tenant's name or both for contesting any assessment for any Tax Year during the Lease Term. The net amount of taxes recovered as a result of such proceedings (e.g., the amount recovered after payment of all sums necessary to attain such recovery) shall be shared between Landlord and Tenant with Tenant receiving Tenant's Prorata Share thereof. Landlord shall cooperate with Tenant with respect to the proceedings so far as is reasonably necessary. Notwithstanding the above, Landlord may but is not obligated to, in its sole discretion, contest any tax assessment if Landlord so determines. (4) Any increase in Real Estate Taxes for the Premises, building(s) or common areas resulting from a refinancing or sale of the Premises, building(s) or common areas shall be added to the Base Real Estate Taxes. (5) Other adjustments shall be made to the Real Estate Taxes Escalation as necessary in order to preserve the intent of this Subsection. (d) Escalation General Provisions. (i) Landlord shall maintain accurate books and records for the Operating Expenses and Real Estate Taxes in accordance with generally accepted accounting principles consistently applied, and shall keep copies of the actual paid bills, canceled checks and copies of any applicable contracts for each year including the Base Year, for the duration of the Lease Term, as extended, and for three (3) years thereafter. Upon request and at Tenant's sole expense, Landlord shall provide Tenant with copies of such books and records. However, adjustments to Operating Expenses and Real Estate Taxes shall be made as provided in the Lease. The Operating Expenses and Real Estate Taxes, including such books and records, may be audited by Tenant or Tenant's authorized 14 19 representative during normal business hours, upon reasonable prior notice to Landlord and at Tenant's sole expense. If Tenant challenges Landlord's computations of the Base Year's Operating Expenses, Real Estate Taxes, or the amount of the Operating Expenses Escalation or Real Estate Taxes Escalation, Tenant shall give Landlord written notice stating Tenant's objections. If Tenant's audit of the Operating Expenses or Real Estate Taxes for the Base Year or any subsequent year indicates that Tenant was overcharged for the Operating Expenses Escalation or Real Estate Taxes Escalation, Landlord shall promptly repay all such overpayments to Tenant and make any necessary adjustment to the Base Year. If Tenant's audit of the Operating Expenses, or Real Estate Taxes for the Base Year, or any subsequent year, indicates that Tenant was overcharged by an amount which is greater than five (5%) of the amount which should have been paid by Tenant, Landlord shall promptly reimburse Tenant for Tenant's audit fees and audit costs incurred. (ii) The escalation payments for the last year of the Lease shall be based upon the number of actual months Tenant occupied the Premises during that year and shall be prorated accordingly. (iii) If there is a change in ownership of the Premises, building(s) or common areas, Landlord agrees to make available complete copies of all records affecting Operating Expenses and Real Estate Taxes to the subsequent owner. (e) Tenant's Negligence. If damage to the Premises, building(s) or common areas, including Landlord supplied Tenant Improvements, is caused by the Tenant's, including Tenant's agents and employees', negligence or willful misconduct, Tenant shall be responsible for all repairs related thereto. 8. ALTERATIONS. (a) Tenant will not make or suffer to be made any alterations, additions, fixtures or improvements (in excess of $1,000) to or of the Premises or any part thereof, or attach any fixtures or equipment thereto, without first obtaining Landlord's written approval which shall not be unreasonably withheld. Any alterations, additions, fixtures or improvements (except the initial Tenant Improvements) to the Premises consented to by Landlord shall be made by Tenant at Tenant's sole cost and expense, and any contractor selected by Tenant to make the same shall be subject to Landlord's prior written approval. All alterations, additions, fixtures and improvements temporary in character, made in or upon the Premises by Tenant, shall remain the property of Tenant provided that such alterations, additions, fixtures and improvements can be and are removed at the end of the term or any extension hereof without damage to the Premises. However, to the extent that Tenant fails to remove the temporary alterations, additions, fixtures and improvements at the end of the term or any extension hereof, such property shall become Landlord's property and remain on the Premises without compensation to Tenant, unless Landlord requests that Tenant remove any such alterations, additions or improvements, excluding Tenant Improvements outlined in Article 2(c) herein. 15 20 (b) Any alteration, addition, fixture or improvement shall, when completed, be of such a character as not to lessen the value of the Premises or such improvements as may be then located thereon. Any alteration, addition, fixture or improvement shall be made promptly and in a good workmanlike manner and in compliance with all applicable permits and authorizations and building and zoning laws and with all other laws, ordinances, orders, rules, regulations and requirements of all federal, state and municipal governments, departments, commissions, boards and offices. The costs of any such alteration, addition, fixture or improvement, excluding Tenant Improvements outlined in Article 2(c) herein, shall be paid by Tenant, so that the Premises be free of liens for services performed, labor and material supplied or claimed to have been supplied. Before any alternation, addition, fixture or improvement shall be commenced, excluding Tenant Improvements outlined in Article 2(c) herein, Tenant shall pay the amount of any increase in premiums on insurance policies (provided for herein) on account of endorsements to be made thereon covering the risk during the course of such alteration, addition, fixture or improvement and the increase value of the Premises. 9. PERSONAL PROPERTY. Tenant may place suitable trade signs or other personal property of Tenant not permanently affixed on the Premises. Such personal property must be removed at the end of the term and any extensions of this Lease or upon Tenant's failing to have possession of the Premises. Placement of signs on the exterior of the building and on any monument, including the type, size and lighting of the signs, must be approved in writing by Landlord prior to their installation, which approval shall not be unreasonably withheld. To the extent that governmental approval is necessary for signage, Landlord shall reasonably cooperate with Tenant in respect thereto at Tenant's sole expense. 10. LIENS. Tenant shall keep the Premises and the Building free from any mechanics' and/or materialmen's liens or other liens arising out of any work performed, materials furnished or obligations incurred by Tenant. Tenant shall notify Landlord in writing at least seventy-two (72) hours before any work or activity is to commence on the Premises which may give rise to such liens to allow Landlord to post and keep posted on the Premises any notices which Landlord may deem to be proper for the protection of Landlord and the Premises from such liens. 11. DESTRUCTION OR DAMAGE. (a) If the Premises is partially damaged by fire, earthquake, or other Act of God, Landlord shall repair the same at Landlord's expense, subject to the provisions of this Article and provided such repairs can, in Landlord's reasonable opinion, be made within 60 days. During such repairs, this Lease shall remain in full force and effect, except that if there shall be damage to the Premises and such damage is not the result of the negligence or willful misconduct of Tenant or Tenant's employees, an abatement of Rents shall be allowed Tenant for such portion of Premises and period of time as the Premises was unusable by Tenant. 16 21 (b) If in Landlord's reasonable opinion the partially damaged Premises can be repaired, but not within 60 days, the Landlord may elect, upon written notice to Tenant within ten (10) days of such damages, to repair such damages over a longer time period and continue this Lease in full force and effect, but with Rents partially abated as provided in Article 11(a). In the event such repairs cannot be made within sixty (60) days, Tenant shall have the option to terminate this Lease, without any liability to Landlord, provided that notice is given to Landlord within ten (10) days of receipt of Landlord's notice stated in this paragraph. (c) If the partially damaged Premises is to be repaired under this Article, Landlord shall repair such damages to the Premises itself, and to the Tenant Improvements supplied by Landlord herein. Tenant shall be responsible for its equipment, furniture and fixtures, and Tenant Improvements made by Tenant located on the Premises. (d) If in Landlord's reasonable opinion, the Premises is totally or substantially destroyed by fire or other casualty, this Lease shall automatically terminate, unless otherwise mutually agreed in writing by the parties hereto. (e) If the partially or totalling damaged Premises was caused by a negligent act or omission of Tenant, Tenant shall pay Landlord the difference between the actual cost of rebuilding and any insurance proceeds received by Landlord. 12. SUBROGATION. Landlord and Tenant shall each, prior to Tenant's taking possession or immediately after the execution of this Lease, procure from each of the insurers under all policies of fire, theft, public liability, workmen's compensation and other insurance now or hereafter existing during the term and any extension hereof and purchased by either of them insuring or covering the Premises and/or Building or any portion thereof or operations therein, a waiver of all rights of subrogation which the insurer might otherwise, if at all, have against the other. 13. INDEMNIFICATION. (a) Tenant shall indemnify, defend, and hold Landlord harmless from any damage to any property or injury to or death of any person arising from the use of the Premises by Tenant, its agents, employees and invitees, except such as is caused solely by reason of the gross negligence or willful act of Landlord, its agents or employees. The foregoing indemnity obligation of Tenant shall include reasonable attorney's fees, investigation costs and all other reasonable costs and expenses incurred by Landlord from the first notice that any claim or demand is to be made or may be made. The provisions of this Article shall survive this Lease's termination with respect to any damage, injury or death occurring prior to such termination. (b) Landlord shall indemnify, defend, and hold Tenant harmless from any damage to any property or injury to or death of any person arising from the use of the Premises by Landlord, its agents, employees and invitees, except such as is caused solely by reason of the gross negligence or willful act of Tenant, its agents or employees. The foregoing indemnity 17 22 obligation of Landlord shall include reasonable attorney's fees, investigation costs and all other reasonable costs and expenses incurred by Tenant from the first notice that any claim or demand is to be made or may be made. The provisions of this Article shall survive this Lease's termination with respect to any damage, injury or death occurring prior to such termination. 14. COMPLIANCE WITH LEGAL REQUIREMENTS (a) Tenant shall, at no cost or expense to Landlord, promptly comply with all laws, statutes, ordinances and governmental rules, regulations or requirements now in force or which may hereafter be in force, with the requirements of any board of fire underwriters or other similar body now or hereafter constituted, with any direction or occupancy certificate issued pursuant to any law by any public officer or officers, as well as the provisions of all recorded documents affecting the Premises, insofar as any thereof relate to or affect Tenant's obligations under the lease or its use and occupancy of the Premises, excluding requirements related to or affected by construction of the Premises and Tenant Improvements made by or for Tenant, and excluding any matter which is the responsibility of the Landlord pursuant to Article 14(b) herein. (b) Landlord shall, at no cost or expense to Tenant, promptly comply with all laws, statutes, ordinances and governmental rules, regulations or requirements, including but not limited to the Americans With Disabilities Act ("ADA"), now in force or which may hereafter be in force, as well as the provisions of all recorded documents affecting the Premises, insofar as any thereof relate to or affect Landlord's obligations under this Lease, or its ownership of the Premises, building(s) or common areas. Further, Landlord represents that to the best of Landlord's knowledge, information and belief, the Premises is substantially free from environmental contamination by hazardous substances, except as may be noted in the Phase I environmental report prepared by Wasatch Environmental, a copy of which shall be provided to Tenant upon request. 15. INSURANCE. (a) Comprehensive General Liability. Tenant shall maintain a Comprehensive General Liability policy including all coverages normally provided by an "Extended Liability Endorsement." Such policies shall specifically name Landlord as an additional insured and shall include a cross-liability endorsement. Landlord may, at its discretion, request evidence of such insurance and products insurance. The minimum limits of liability acceptable are: (i) $1,000,000 Combined Single Limit for Bodily Injury and Property Damage, or (ii) $1,000,000 Bodily Injury and $1,000,000 Property Damage. (b) Premises Insurance. Landlord shall insure the Premises, including Landlord 18 23 supplied Tenant Improvements as deemed necessary in Landlord's sole discretion. Tenant shall pay for such insurance as outlined in Article 7 herein. (c) Tenant's Additional Insurance. Tenant may, at its sole cost and expense, cause all equipment, machinery, furniture and fixtures, personal property, and Tenant Improvements supplied by Tenant from time to time used or intended to be used in connection with the operation and maintenance of the Premises, to be insured by Tenant against loss or damage by fire and other casualty. Landlord is in no way liable for any uninsured Tenant's property, except as caused by Landlord's negligence or willful misconduct. 16. ASSIGNMENT AND SUBLETTING. In the event Tenant should desire to assign this Lease or sublet the Premises, Tenant shall give Landlord written notice of such desire at least forty-five (45) days in advance of the date on which Tenant desires to make such assignment or sublease. Landlord shall then have a period of fifteen (15) days following receipt of such notice within which to notify Tenant in writing that Landlord elects either (i) to terminate this lease as of the date so specified by Tenant, in which event Tenant will be relieved of all further obligations hereunder, or (ii) to permit Tenant to assign or sublet such space, subject to prior written approval of the proposed assignee by Landlord, such consent not to be unreasonably withheld so long as the use of the Premises by the proposed assignee would be a permitted use and the proposed assignee is of sound financial condition as reasonably determined by Landlord. If Landlord should fail to notify Tenant in writing of such election within said fifteen (15) day period, Landlord shall have deemed to have consented to such assignment or sublease. Failure by Landlord to approve a proposed assignee shall not cause a termination of this Lease. Any rents or other consideration realized by Tenant under any such sublease and assignment in excess of the Rents hereunder, after amortization of the reasonable costs of extra tenant improvements for which Tenant has paid and reasonable subletting and assignment costs, shall be divided and paid ninety percent (90%) to Landlord and ten percent (10%) to Tenant. Upon assignment or subletting by Tenant, approved by Landlord, Tenant shall be relieved of any obligation under this Lease. Any assignment or subletting which conflicts with the provisions hereof shall be void. Notwithstanding the above, to the extent that Tenant has more than fifty (50%) percent direct common ownership with Tenant's proposed assignee or sublessee, Tenant shall be allowed to assign or sublease this Lease subject only, in the case of an assignment, to Tenant's proposed assignee executing, with Landlord, an assumption agreement agreeing to be fully bound to the terms and conditions of this Lease. 17. RULES. Tenant shall faithfully observe and comply with all Rules and Regulations reasonably promulgated by Landlord, in writing and after reasonable notice, during the term or any extensions of this Lease. Landlord shall not be responsible to Tenant for the non-performance by other Building tenants, or adjacent buildings' tenants, of any of said Rules and Regulations. 19 24 However, in the event of such non-performance by other tenants, Landlord shall, upon Tenant's request, make reasonable efforts to require such other tenants to perform. 18. ENTRY BY LANDLORD. Subject to United States Government security requirements if and as applicable, the Landlord may enter the Premises and/or Building at reasonable hours and upon 24 hours written notice to Tenant to (a) inspect the same, (b) show the same to prospective purchasers, lenders or tenants, (c) determine whether Tenant is complying with all of Tenant's obligations hereunder, (d) post notices of non-responsibility or (e) make repairs required of Landlord under this Lease, repairs to adjoining space or utility service, or make repairs, alterations or improvements to the Building, provided that all such work shall be done as promptly as possible and with as little interference to Tenant as reasonably possible. Tenant hereby waives any claim for damages for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises or any other loss occasioned by such entry, unless caused by the reckless or intentional acts of Landlord or its agents. Landlord shall at all times have and retain a key to unlock all doors in, on or about the Premises (excluding Tenant's vaults, safes and similar areas designated in writing by Tenant). In the event of an emergency, Landlord shall have the right to use any and all means which Landlord may deem proper to enter the Premises, without notice, for the limited purpose of abating, as possible, said emergency. Such emergency entrance shall not be deemed to be a forcible or unlawful entry or a detainer of the Premises or an eviction, actual or constructive, of Tenant from the Premises. Notwithstanding Landlord's entering the Premises without notice in the case of an emergency, Landlord shall contact Tenant's Designated Representative (as identified below) regarding such emergency entry as soon as possible following such emergency entry. Tenant's Designated Representative is Duane Thurber, who may be contacted at (801) 254-6879, or such other person as Tenant my designate hereafter in writing. 19. EVENTS OF DEFAULT. The occurrence of any one or more of the following events ("Events of Default") shall constitute a breach of this Lease by Tenant: (a) if Tenant fails to pay Rents when and as the same becomes due and payable and such failure continues for more than ten (10) days, or (b) if Tenant fails to pay any other sum when and as the same becomes due and payable and such failure continues for more than ten (10) days; or (c) if Tenant fails to perform or observe any material term or condition of this Lease, such failure continues for more than thirty (30) days after written notice from Landlord, and Tenant does not within such period begin with due diligence and dispatch the curing of such default, or, having so began, thereafter fails or neglects to complete with due diligence and dispatch the curing of such default; or (d) if Tenant shall make a general assignment for the benefit of creditors, or shall admit in writing its inability to pay its debts as they become due or shall file a petition in bankruptcy, or shall be adjudicated as bankrupt or insolvent, or shall file a petition seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any present or future statute, law or regulation, or shall file any answer admitting or shall fail timely to contest the 20 25 material allegations of a petition filed against it in any such proceeding, or shall seek or consent to or acquiesce in the appointment of any trustee, receiver or liquidator of Tenant or any material part of its properties; or (e) if within 60 days after the commencement of any proceeding against Tenant seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any percent or future statute, law or regulation, such proceeding shall not have been dismissed, or if, within 60 days after the appointment without the consent or acquiescence of Tenant, of any trustee, receiver or liquidator of Tenant or of any material part of its properties, such appointment shall not have been vacated; or (f) vacation or abandonment of the Premises for a continuous period in excess of fifteen (15) days, provided that Tenant is otherwise in default or (g) if this Lease or any estate of Tenant hereunder shall be levied upon under any attachment or execution and such attachment or execution is not vacated within ten (10) days. 20. TERMINATION UPON TENANT'S DEFAULT. If an Event of Default shall occur, Landlord at any time thereafter may give a written termination notice to Tenant, and on the date specified in such notice (which shall not be less than fifteen (15) days for all non-Rents related defaults or five (5) days for Rents related defaults after Notice under Article 36 herein) Tenant's right to possession shall terminate and this Lease shall terminate, unless on or before such date all Rents, arrearages and other sums due by Tenant under this Lease, including reasonable costs and attorneys' fees actually incurred by or on behalf of Landlord, shall have been paid by Tenant and all other Events of Default by Tenant shall have been fully cured to the reasonable satisfaction of Landlord. To the extent that Tenant needs confirmation from Landlord of Tenant's having cured any noticed Event of Default or needs an extension to cure such noticed Event of Default, it is incumbent on Tenant to request and receive from Landlord confirmation that a noticed Event of Default has been cured or that an extension to cure has been granted. Landlord is under no unsolicited duty to notify Tenant that an Event of Default has been cured, nor is Landlord under any duty to grant an extension to cure an Event of Default. Upon such termination, Landlord may recover from Tenant: (a) the worth at the time of award of the unpaid Rents which had been earned at the time of termination; plus (b) the worth at the time of award of the amount by which the unpaid Rents which would have been earned after termination until the time of award exceeds the amount of such Rents loss that Tenant proves could have been reasonably avoided; plus (c) the worth at the time of award of the amount by which the unpaid Rents for the balance of the term of this Lease after the time of award exceeds the amount of such Rents loss that Tenant proves could be reasonably avoided by Landlord through mitigation of its damages; and plus (d) any other amount necessary to compensate Landlord for all damages proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary 21 26 course of things would be likely to result therefrom, or by applicable law. The "worth at the time of award" of the amounts referred to in clauses (a) and (b) above is computed by allowing interest at the rate of 10% per annum from the time amounts were due to the time of award. The "worth at the time of award" of the amount referred to in clause (c) above means the present value of the monthly sum of the unpaid Rents under this Lease. In determining the present value of such unpaid Rents, the parties agree that the discount rate shall be equal to the prime rate of interest as published in the Wall Street Journal as of the time of award. Failure of Landlord to declare any default immediately upon occurrence thereof, or delay in taking any action in connection therewith, shall not waive such default, but Landlord shall have the right to declare any such default at any time thereafter. However, nothing herein limits Landlord's duty to reasonably mitigate Landlord's damages. 21. TERMINATION UPON LANDLORD'S DEFAULT; TENANT'S RIGHT TO CURE LANDLORD'S DEFAULT. (a) Any default by Landlord of any of its obligations under this Lease that remain reasonably uncured, for more than thirty (30) days after having received written notice of default from Tenant shall entitle Tenant to elect to terminate this Lease, without any further liability for Landlord or Tenant. (b) Notwithstanding the above, upon Landlord failing to cure or reasonably object to a noticed default of its obligations under this Lease, Tenant may, but is under no obligation to, reasonably satisfy such noticed default. To the extent that Tenant invokes such self-help, Tenant may withhold from Rents such amount actually and reasonably paid to cure such uncured and unobjected to Landlord default, provided that Tenant provide to Landlord evidence of such actual and reasonable amounts paid. In no event is Tenant allowed attorneys' fees, costs or interest under this provision. 22. CONTINUATION AFTER DEFAULT. Even though Tenant has defaulted this Lease and abandoned the Premises, this Lease shall continue in effect as long as Landlord does not terminate Tenant's right to possession, and Landlord may enforce all of its rights and remedies under this Lease, including the right to recover the Rents as they become due under this Lease, subject to Landlord reasonably mitigating any damages. Acts of maintenance or preservation or efforts to relet the Premises or the appointment of a receiver upon initiative of Landlord to protect Landlord's interest under this Lease shall not constitute a termination of Tenant's right to possession. If any fixture, equipment, improvement, installation or appurtenance shall be required to be removed from the Premises and/or Building by Tenant, then Landlord (in addition to all other rights and remedies) may, at its election by written notice to Tenant, deem that the same has been abandoned by Tenant to Landlord, or Landlord may remove and store the same and restore the Premises to its original condition at the expense of Tenant, as Additional Rent to be paid within ten (10) days after written notice to Tenant of such expense. 22 27 23. LANDLORD'S RIGHT TO CURE DEFAULTS. All terms and provisions to be performed by Tenant under this Lease shall be at its sole cost and expense and without any abatement of Rents. If Tenant falls to pay any sum of money, other than Rents, required hereunder or fails to perform any other act required hereunder and such failure continues for thirty (30) days after notice by Landlord, Landlord may, but shall not be obligated, and without waiving or releasing Tenant from any obligations of Tenant, make any such payment or perform any such act on Tenant's part to be made or performed as provided in this Lease. All sums paid by Landlord and all incidental costs shall be deemed Additional Rent hereunder and shall be payable within ten (10) days of written notice of such sums paid. 24. OTHER RELIEF. The remedies provided for in this Lease are in addition to any other remedies available to Landlord or Tenant at law or in equity by statute or otherwise. 25. ATTORNEYS' FEES. In the event either party places the enforcement of this Lease, or any part thereof, or the collection of any Rents, or recovery of the possession of the Premises, or files suit upon the same, then the prevailing party shall recover its reasonable attorneys' fees and costs. 26. EMINENT DOMAIN. If all or any part of the Premises shall be taken or conveyed as a result of the exercise of the power of eminent domain, this Lease shall terminate as to the part so taken as of the date of taking, and, in the case of a partial taking, either Landlord or Tenant shall have the right to terminate this Lease as to the balance of the Premises by written notice to the other within 30 days after such date; provided, however, that a condition to the exercise by Tenant of such right to terminate shall be that the portion of the Premises taken or conveyed shall be of such extent and nature as substantially to handicap, impede or impair Tenant's use of the balance of the Premises. In the event of any taking, Landlord shall be entitled to any and all compensation, damages, income, rent awards or any interest therein whatsoever which may be paid or made in connection therewith, and Tenant shall have no claim against Landlord for the value of any unexpired term of this Lease or otherwise, provided that Tenant shall be entitled to any and all compensation, damages, income, rent or awards paid for or on account of Tenant's moving expenses, trade fixtures, equipment and any leasehold improvements in the Premises, the cost of which was borne by Tenant, to the extent of the then unamortized value of such improvements for the remaining term of the Lease. In the event of a taking of the Premises which does not result in a termination of this Lease, the monthly rental herein shall be apportioned as of the date of such taking so that thereafter the rent to be paid by Tenant shall be in the ration that the area of the Premises not so taken bears to the total area of the Premises prior to such taking. 23 28 27. SUBORDINATION & NONDISTURBANCE. This Lease, at Landlord's option and subject to Landlord's proposed form, shall be subordinate to any ground lease, mortgage, deed of trust, or any other hypothecation for security now or hereafter placed upon the Building and to any and all advances made on the security thereof and to all renewals, modification, consolidations, replacements and extensions thereof. Notwithstanding such subordination, Tenant's right to quiet possession of the Premises shall not be disturbed if Tenant is not in default and so long as Tenant shall pay the rent and observe and perform all of the provisions of the Lease, unless this Lease is otherwise terminated pursuant to its terms. If any mortgagee, trustee or ground lessor shall elect to have this Lease prior to the lien of its mortgage, deed or trust or ground lease, and shall be deemed prior to such mortgage deed of trust or ground lease, whether this Lease is dated prior or subsequent to the date of said mortgage, deed of trust or ground lease or the date of recording thereof, Tenant agrees to execute any reasonable documents required (in the form substantially similar to the sample documents attached hereto as Exhibits C & D) to effectuate such subordination or to make this Lease prior to the lien of any mortgage, deed of trust or ground lease, so long as Landlord is not in material default and such mortgagee, trustee or ground lessor agrees not to disturb Tenant's quiet enjoyment of the Premises. 28. NO MERGER. The voluntary or other surrender of this Lease by Tenant, or a mutual cancellation thereof, shall not work a merger, and shall, at the option of Landlord terminate all or any existing subleases or subtenancies, or may, at the option of Landlord, operate as an assignment to it of any or all such subleases or subtenancies. 29. SALE. In the event the original Landlord hereunder, or any successor owner of the Premises, building(s) or common areas, shall sell or convey the Premises, building(s) or common areas, all liabilities and obligations on the part of the original Landlord, or such successor owner, under this Lease accruing thereafter shall terminate and Tenant shall attorn to such new owner, provided such new owner expressly agrees to assume all such liabilities and obligations of such original Landlord, or such successor owner, from the date the Premises is sold or conveyed. 30. ESTOPPEL CERTIFICATE. At any time and from time to time but on not less than ten (10) days prior written request by Landlord, Tenant will execute, acknowledge and deliver to Landlord, promptly upon request, a certificate certifying (a) that this Lease is unmodified and in full force and effect (or, if there have been modifications, that this Lease is in full force and effect, as modified, and stating the date and nature of each modification), (b) the date, if any, to which rental and other sums payable hereunder have been paid, (c) that no notice has been received by Tenant of any default which has not been cured, except as to defaults specified in said certificate and (d) such other 24 29 matters as may be reasonably requested by Landlord. Any such certificate may be relied upon by any prospective purchaser, mortgagee or beneficiary under any deed or trust of the Building or any part thereof. So long as the above representations are accurate, the failure of Tenant so to deliver such certificate within the time specified above shall be deemed to be a material breach of this Lease and shall entitle Landlord without notice to terminate this Lease. 31. NO LIGHT, AIR OR VIEW EASEMENT. Any diminution or reduction of light, air or view by any structure erected on lands adjacent to the Building shall in no way affect this Lease or impose any liability on Landlord. 32. HOLDING OVER. If, without objection by Landlord, Tenant holds possession of the Premises after expiration of the term or any extension period of this Lease, Tenant shall become a tenant from month to month upon the terms herein specified, but at a monthly Base Rent equivalent to 110% of the Base Rent at the end of the term or extension period pursuant to Article 4, payable in advance on or before the 1st day of each month. All Additional Rent shall also apply. Each party shall give the other notice at least one month prior to the date of termination of such monthly tenancy of its intention to terminate such tenancy. 33. ABANDONMENT. If Tenant shall abandon or surrender the Premises, or be dispossessed by process of law or otherwise, any personal property belonging to Tenant and left on the Premises shall be deemed to be abandoned, at the option of Landlord, except such property as may be mortgaged to Landlord. 34. SECURITY DEPOSIT. Tenant has deposited with Landlord upon execution of this Lease a security deposit equal to a month's full rental payment ("Security Deposit"). The Deposit shall be held by Landlord as security for the faithful performance by Tenant of all of the provisions of this Lease to be performed or observed by Tenant. In the event Tenant fails to perform or observe any of the provisions of this Lease to be performed or observed by it, then, at the option of the Landlord, Landlord may (but shall not be obligated to do so) apply the Deposit, or so much thereof as may be necessary to remedy such default or to repair damages to the Premises caused by Tenant. In the event Landlord applies any portion of the Deposit to remedy any such default or to repair damages to the Premises caused by Tenant, Tenant shall pay to Landlord, within thirty (30) days after written demand for such payment by Landlord, all monies necessary to restore the Deposit up to the original amount. Any portions of the Deposit remaining upon termination of this Lease shall be returned within thirty (30) days. 25 30 35. WAIVER. All waivers by Landlord must be in writing and signed by Landlord. The waiver by Landlord of any term or conditions herein shall not be deemed to be a waiver of any subsequent breach of the same or any other agreement, condition or provision herein contained, nor shall any custom or practice which may develop between the parties in the administration of the terms hereof be construed to waive or to lessen the right of Landlord to insist upon the performance by Tenant in strict accordance with said terms. The subsequent acceptance of Rents hereunder by Landlord shall not be deemed to be a waiver of any preceding breach by Tenant of any term or conditions of this Lease, other than the failure of Tenant to pay the particular Rents so accepted, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such Rents. 36. NOTICES. All notices and demands which may or are required to be given by either party to the other hereunder shall be in writing and shall be deemed to have been fully given when deposited in the United States mail, certified or registered, postage prepaid, and addressed as follows: to Tenant at ADVANTA FINANCIAL CORP., ATTN: JOHN L. RICHARDS, PRESIDENT, 11850 ELECTION DR., DRAPER UT 84020, or to such other place as Tenant may from time to time designate in a notice to Landlord; to Landlord at DRAPER BUSINESS PARK, L.C., ATTN: SCOTT WALDRON, 5200 SOUTH MAIN STREET, SALT LAKE CITY, UTAH, 84107 or to such other place as Landlord may from time to time designate in a notice to Tenant, or in the case of Tenant, delivered to Tenant at the Premises. Tenant hereby appoints as its agent to receive the service of all dispossessory or distraint proceedings and notices hereunder the person in charge of or occupying the Premises at the time, and if no person shall be in charge of or occupying the same, then service may be made by attaching same on the main entrance of the Premises. 37. COMPLETE AGREEMENT. There are no oral agreements between Landlord and Tenant affecting this Lease, and this Lease supersedes and cancels any and all previous negotiations, arrangements, brochures, agreements and understandings, if any, between Landlord and Tenant with respect to the subject matter of this Lease. This Lease may not be altered, changed or amended, except by an instrument in writing signed by both parties hereto. 38. CORPORATE AUTHORITY. If Tenant signs as a corporation, each of the persons executing this Lease on behalf of Tenant does hereby covenant and warrant that (a) Tenant is a duly authorized and validly existing corporation, (b) Tenant has and is qualified to do business in Utah, (c) the corporation has full right and authority to enter into this Lease, and (d) each person executing this Lease on behalf of the corporation is authorized to do so. 26 31 39. GUARANTEE OF LEASE. Tenant guarantees to occupy the Premises, subject to the terms and conditions of this Lease. Any failure to occupy the Premises does not release the Tenant from the obligation of paying Rents or any other terms set forth herein. 40. MISCELLANEOUS. (a) The words "Landlord" and "Tenant" as used herein shall include the plural as well as the singular. If there be more than one Tenant, the obligations hereunder imposed upon Tenant shall be joint and several. (b) Time is of the essence on this Lease and each and all of its terms and conditions. (c) The terms and conditions herein shall apply to and bind the heirs, executors, administrators, successors and assigns of the parties hereto. (d) The captions of this Lease are solely to assist the parties and are not a part of the terms or conditions of this Lease. (e) This Lease shall be governed by and construed in accordance with the laws of the State of Utah, and is deemed to be executed within the State of Utah. 41. SEVERABILITY. If any term of provision of this Lease, or the application thereof to any person or circumstance, shall to any extent be invalid or unenforceable, the remainder of this Lease, or the application of such provision to persons or circumstances other than those as to which it is invalid or unenforceable, shall not be affected thereby, and each provision of this Lease shall be valid and shall be enforceable to the extent permitted by law. 42. BROKERS. Tenant is represented by CB Commercial. Landlord is represented by Prime Commercial, Inc. Agreed-upon commissions shall be due and payable by Landlord 50% upon execution, and 50% upon Tenant taking possession. 27 32 IN WITNESS WHEREOF, the parties have executed this Lease dated the day and year first above written. TENANT, LANDLORD, ADVANTA FINANCIAL CORP. DRAPER PARK NORTH, L.C. By: /s/ John L. Richards By: /s/ Scott M. Waldron -------------------------------- ---------------------------------- John L. Richards, President Scott M. Waldron, Manager 28 33 EXHIBIT A LOT 2, PROPOSED PLAT OF REYNOLDS INDUSTRIAL PARK: Beginning at a point South 89 deg. 46'37" East along the section line 958.59 feet from the North quarter corner of Section 25, Township 3 South, Range 1 West, Salt Lake Base and Meridian; and running thence South 89 deg. 46' 37" East along the section line 203.93 feet; thence South 09 deg. 21'26" East 178.49 feet; thence South 89 deg., 46'37" East 407.75 feet to the true point of beginning; thence South 00 deg. 04'00" West 487.00 feet to the North right of way line of Election Road; thence South 89 deg. 46' 37" East along the North line of said Election Road 377.32 feet to a point of curvature; thence along the arc of a 41.00 foot radius curve to the left through a central angle of 97 deg. 18'23" a distance of 69.63 feet to a point of tangency; thence North 7 deg. 05'00" West along the West right of way line of said Election Road 444.39 feet; thence North 89 deg. 46' 37" West 362.80 feet to the point of beginning. 34 CONTINUING GUARANTY In consideration of, and as an inducement for the granting, execution and delivery of the foregoing Lease attached hereto and made a part hereof, dated SEPTEMBER 28, 1995 ("Lease"), by and between DRAPER PARK NORTH, L.C. ("Landlord") and ADVANTA FINANCIAL CORPORATION ("Tenant"), and other good and valuable consideration given by Landlord to the undersigned guarantor, ADVANTA CORP. ("Guarantor") hereby guarantees to Landlord (herein including its successors and assigns) the full and prompt payment of all Rents by the Tenant (herein including its successors and assigns); and the Guarantor (herein including its successors and assigns) hereby covenants and agrees to and with the Landlord that if Tenant shall be in default under the Lease, the Guarantor will forthwith pay such Rents to the Landlord, including, without limitation, all costs and reasonable attorneys' fees incurred by the Landlord as a result of Tenant's default and enforcement of this Guaranty. This Guaranty is an absolute and unconditional Guaranty of payment. It is enforceable against the Guarantor, upon ten (10) days written notice of Tenant's default, without the necessity of legal suit or proceedings whatsoever on Landlord's part against the Tenant, or acceptance of this Guaranty. Any other notice or demand to which the Guarantor might otherwise be entitled is hereby expressly waived. The Guarantor hereby expressly agrees that the validity of this Guaranty and the obligations of the Guarantor hereunder shall not be terminated, affected or impaired by reason of the assertion or the failure to assert by the Landlord against Tenant of any of Landlord's rights or remedies under the Lease. This Guaranty shall be a continuing Guaranty, and the liability of the Guarantor shall not be effected or impaired by reason of any assignment or extension of the Lease, or by reason of any modification, waiver or change in any terms and conditions of the Lease, or by reason of any dealings between Landlord and Tenant, whether or not notice is given to the Guarantor. Any written notice or contact with Guarantor shall be addressed to: Advanta Corp. Attn: General Counsel Five Horsham Business Center 300 Welsh Road Horsham, PA 19044-2209 Notwithstanding the preceding paragraphs, at the expiration of the Lease and any extensions or holdovers, and providing that Tenant is in full compliance with all obligations under the Lease, Guarantor's obligations under this Guaranty shall automatically terminate. DATED: March 12, 1996 GUARANTOR: ADVANTA CORP. /s/ John J. Crowe, Jr. - ------------------------ Vice President 35 STATE OF PA ) NOTARIAL SEAL ) BETTY VAN SANT, NOTARY PUBLIC :ss HORSHAM TWP., MONTGOMERY COUNTY ) MY COMMISSION EXPIRES FEB. 22, 1999 COUNTY OF MONTGOMERY ) On this 14 day of March, 1996 before me a Notary Public, personally appeared John J. Crowe, Jr., who represented to me to be the _________________ of Advanta Corp., a _______________, that executed the within and foregoing instrument, and acknowledged said instrument to be the free and voluntary act and deed of said corporation, for the uses and purposes therein mentioned, and on oath stated that he/she had the capacity and was duly authorized to execute said instrument. IN WITNESS WHEREOF, I have hereunder set my hand and official seal on the day first above written. /s/ BETTY VAN SANT ------------------------------- NOTARY PUBLIC 2 EX-10.W 4 LEASE AGREEMENT 9/27/97 SAN DIEGO DEVELOPMENT 1 Exhibit 10-W FIRST AMENDMENT TO LEASE AGREEMENT THIS FIRST AMENDMENT TO LEASE AGREEMENT, dated as of October 20,1998, is entered into by and between SAN DIEGO DEVELOPMENT #1, LLC, a Colorado limited liability company, having an office at 4582 South Ulster Street Parkway, Denver, Suite 403, CO 80237 ("Landlord") and ADVANTA MORTGAGE CORP. USA, a Delaware corporation, having an office at 200 Tournament Drive, Suite 103, Horsham, PA 19044 ("Tenant"). Recitals: i. Landlord and Tenant entered into a written lease agreement, dated August 27, 1997 (the "Lease"). (Initially capitalized terms not otherwise defined herein have the same meaning as in the Lease.) ii. Landlord and Tenant desire to amend the Lease in the manner and form hereinafter set forth. C. Advanta Corp., a Delaware corporation ("Guarantor") is the guarantor of Tenant's obligations under the Lease by the terms of a Corporate Guaranty (the "Guaranty"). NOW, THEREFORE, for good and valuable consideration, Landlord and Tenant hereby agree as follows: a. As provided above, the parties acknowledge that the sole tenant under the Lease is Advanta Mortgage Corp. USA and that the references on page 1 of the Lease to "ADVANTA CORP., a Delaware corporation" and " collectively" are typographical errors and are hereby deleted. b. Landlord has delivered all floors of the Leased Premises Tenant Ready and Substantial Completion has occurred and, notwithstanding anything to the contrary set forth in the Lease, the Rent Commencement Date shall mean October 15, 1998. Upon the execution hereof, Tenant shall pay to Landlord $79,046.19 attributable to the Minimum Rent for the period October 15 through October 31, 1998; no late interest charges shall be applicable to Tenant's payment of such installment of Minimum Rent. Tenant has not exercised any right to 2 terminate the Lease under Section 2(e) and has no further rights to terminate the Lease under Section 2(e); Landlord has no obligation to pay Tenant's Holdover Costs under the provisions of Section 2(e). c. The addresses of Landlord and Tenant under Section 42 are hereby amended by deletion in their entirety and substitution of the following in lieu thereof: if intended for Tenant after occupancy: President Advanta Mortgage Corp. USA Welsh & McKean Roads Springhouse, PA 19477 FAX NO. (215) 323-4844 with a copy to: General Counsel Advanta Mortgage Corp. USA Welsh & McKean Roads Springhouse, PA 19477 FAX NO. (215) 444-5915 with a copy to: Vice President, Advanta Corporate Services 200 Tournament Drive Horsham, PA 19044 FAX NO. (215) 674-1442 if intended for Landlord: San Diego Development #1, LLC c/o Miller Global-Pauls 3950 Lewiston Street Aurora, CO 80011 FAX NO. (303) 371-1465 3 with a copy to: Lawrence J. Donovan, Jr. Isaacson Rosenbaum Woods & Levy, PC 633 Seventeenth Street, Suite 2200 Denver, CO 80202 FAX NO. (303) 292-3152 d. Section 43(b) is hereby amended by deletion of subsections (1) and (2) and substitution of the following in lieu thereof: "(1) (i) Without demand or notice, to reenter and take possession of the Leased Premises or any part thereof and repossess the same as of Landlord's former estate and expel Tenant and those claiming through or under Tenant and remove the effects of both or either, without being deemed guilty of any manner of trespass and without prejudice to any remedies for arrears of rent or preceding breach of covenants or conditions. Should Landlord elect to reenter, as provided in this subparagraph (1), or should Landlord take possession pursuant to legal proceedings or pursuant to any notice provided for by law, Landlord may, from time to time, without terminating this Lease, relet the Leased Premises or any part thereof, either alone or in conjunction with other portions of the Building of which the Leased Premises are a part, in Landlord's or Tenant's name but for the account of Tenant, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the term of this Lease) and on such commercially reasonable conditions and upon such other terms (which may include concessions of free rent and alteration and repair of the Leased Premises) as Landlord, in its discretion, may determine and Landlord may collect and receive the rents therefor, which rights include the rights of Landlord under Section 1951.4 of the California Civil Code. In the event that Landlord elects to avail itself of the remedy provided by this subparagraph (1), Landlord shall not unreasonably withhold its consent to an assignment or subletting of the Leased Premises subject to the reasonable standards for Landlord's consent as are contained in this Lease. In addition, in the event Tenant has entered into a sublease which is valid under the terms of this Lease, Landlord may also, at its option, cause Tenant to assign to Landlord the interest of Tenant under said sublease, including, but not limited to, Tenant's right to payment of rent as it becomes due. Landlord shall in no way be responsible or liable for any failure to relet the Leased Premises, or any part thereof, or for any failure to collect any rent due upon such reletting. No such reentry or taking possession of the Leased Premises by Landlord shall be construed as an election on Landlord's part to terminate this Lease unless a written notice of such intention be given to Tenant. No notice from Landlord hereunder or under a forcible entry and detainer statute or sim- 4 ilar law shall constitute an election by Landlord to terminate this Lease unless such notice specifically so states. Landlord reserves the right following any such reentry and/or reletting to exercise its right to terminate this Lease by giving Tenant such written notice, in which event the Lease will terminate as specified in said notice. (ii) If Landlord elects to take possession of the Leased Premises as provided in this subparagraph (1) without terminating the Lease, Tenant shall pay to Landlord (a) the rent and other sums as herein provided, which would be payable hereunder if such repossession had not occurred, less (b) the net proceeds, if any, of any reletting of the Leased Premises after deducting all of Landlord's commercially reasonable expenses incurred in connection with such reletting, including, but without limitation, all repossession costs, brokerage commissions, legal expenses, attorneys' fees, expenses of employees, alteration, remodeling, and repair costs and expenses of preparation for such reletting. If, in connection with any reletting, the new lease term extends beyond the existing Term or the premises covered thereby include other premises not part of the Leased Premises, a fair apportionment of the rent received from such reletting and the expenses incurred in connection therewith, as provided aforesaid, will be made in determining the net proceeds received from such reletting. In addition, in determining the net proceeds from such reletting, any rent concessions will be apportioned over the term of the new lease. Tenant shall pay such amounts to Landlord monthly on the days on which Minimum Rent and Additional Rent and all other amounts owing hereunder would have been payable if possession had not been retaken and Landlord shall be entitled to receive the same from Tenant on each such day; or (2) To give Tenant written notice of intention to terminate this Lease on the date of such given notice or on any later date specified therein and, on the date specified in such notice, Tenant's right to possession of the Leased Premises shall cease and the Lease shall thereupon be terminated, except as to Tenant's liability hereunder as hereinafter provided, as if the expiration of the term fixed in such notice were the end of the Term herein originally demised. In the event this Lease is terminated pursuant to the provisions of this subparagraph (2), Tenant shall remain liable to Landlord for, and Landlord shall have the right to recover from Tenant, an amount equal to (i) the worth at the time of the award of the unpaid Minimum Rent and Additional Rent which had been earned at the time of termination, (ii) the worth at the time of award of the amount by which the unpaid Minimum Rent and Additional Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; (iii) the worth at the time of the award by which the unpaid Minimum Rent and Additional Rent for the balance of the Term after the time of the award exceeds the amount of such rental loss that Tenant proves could 5 be reasonably avoided; and (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, the cost of recovering possession of the Leased Premises, commissions and other expenses of reletting, including necessary repair, demolition and renovation of the Leased Premises to the condition required to be in at the expiration of the Term, the cost of rectifying any damage to the Leased Premises occasioned by the act or omission of Tenant, reasonable attorneys fees and any other reasonable costs; and (v) at Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted by law. "Worth at the time of award" as used in clauses (i) and (ii) above, shall be computed at the rate provided in Paragraph 4(c) above. As used in clause (iii) above, "worth at the time of award" shall be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of the award plus 1%." e. If there is any conflict between the terms of this Amendment and the terms of the Lease, the terms of this Amendment govern. The Lease as hereby amended is in full force and effect, is hereby ratified and affirmed by the parties, and is binding upon the parties in accordance with its terms. IN WITNESS WHEREOF, Landlord and Tenant have entered into this First Amendment effective as of August 27, 1997, having executed this Lease on the dates set forth in the following notarizations. This First Amendment may be executed in counterparts, each of which (or any combination of which) when signed by all of the parties shall be deemed an original, but all of which when taken together shall constitute but one agreement. Any one or more of such duplicate signature pages may be removed from any one or more of such counterparts and annexed to other counterparts and duplicate signature pages to form a completely executed original Lease. LANDLORD: SAN DIEGO DEVELOPMENT #1, LLC, a Colorado limited liability company By: SD 1, LLC, a Colorado limited liability company, Member By: The Pauls Corporation, LLC, a Colorado 6 limited liability company, Its Manager and Member By: /s/ William B. Pauls William B. Pauls, Manager By: GE Investment Realty Partners III Limited Partnership, a Delaware limited partnership, Member By: /s/ Bradford Barrett By: MGA Real Estate Associates, LLLP, a Colorado limited liability limited partnership, Member By: /s/ Gregory Pohle Authorized Signatory 7 STATE OF COLORADO ) ) SS. CITY AND COUNTY OF DENVER ) The foregoing instrument was acknowledged before me this 25 day of January, 1999, by William B. Pauls, as Manager of The Pauls Corporation, LLC, a Colorado limited liability company, as Manager and Member of SD #1, LLC, a Colorado limited liability company, a Member of San Diego Development #1, LLC, a Colorado limited liability company. Witness my hand and official seal. My commission expires: July 31, 2001 ---------------------- /s/ Virginia H. Lucky ----------------------- Notary Public STATE OF CALIFORNIA ) )SS. COUNTY OF LOS ANGELES ) The foregoing instrument was acknowledged before me this 27th day of January, 1999, by B. Bradford Barrett, as President of GE Investment Realty Partners III Limited Partnership, a Delaware limited partnership, a Member of SD #1, LLC, a Colorado limited liability company, a Member of San Diego Development #1, LLC, a Colorado limited liability company. Witness my hand and official seal. My commission expires: November 6th, 1999 ------------------------ /s/ Laura Haver ------------------------ Notary Public STATE OF COLORADO ) )SS. CITY AND COUNTY OF DENVER ) [seal] LAURA HAVER Commission #1076795 Notary Public - California Los Angeles County My Comm. Expires Nov. 6, 1999 8 The foregoing instrument was acknowledged before me this 5th day of February, 1999, by Greg Poule as authorized signatory of MGA Real Estate Associates, LLLP, a Colorado limited liability limited partnership, a member of San Diego Development #1, LLC, a Colorado limited liability company. Witness my hand and official seal. My commission expires: 6/28/2001 /s/ Barbara A. Stephenson ------------------------------------- Notary Public signatures and notarizations continued on next page [SEAL] 9 TENANT: ADVANTA MORTGAGE CORP. USA, a Delaware corporation By: /s/ John J. Crowe, Jr. ------------------------------------ - ------------ Title: Vice President ---------------------------------- - ------------ [Corporate Seal] Attest: /s/ Michele A. Stevenson ----------------------------------------- Assistant Secretary STATE OF PENNSYLVANIA ) : ss. COUNTY OF MONTGOMERY ) On this the 13th day of January, 1999, before me the subscriber, a notary public in and for the Commonwealth of Pennsylvania, personally appeared John J. Crowe, Jr., who acknowledged himself to be the Vice President of ADVANTA MORTGAGE CORP. USA, a Delaware corporation, and that he as such Vice President, being authorized to do so, executed the foregoing instrument for the purpose therein contained by signing the name of the corporation by himself as Vice President. IN WITNESS WHEREOF, I hereunto set my hand and official seal. [Notary Seal] /s/ Patricia D. Kelly - -------------------- --------------------------------------- Notary Public My Commission Expires: - -------------------- ------------ [NOTARIAL SEAL PATRICIA D. KELLY, Notary Public Lower Gwynedd Twp., Montgomery Co. My Commission Expires Aug. 27, 2001] 10 The undersigned, as "Guarantor" under that "Corporate Guaranty" entered into as of August 27, 1997, hereby consents to the terms of the Guaranty and acknowledges and agrees that Guarantor shall guaranty the Lease as amended by the First Amendment in accordance with the terms of the Guaranty. ADVANTA CORP. By: /s/ Christopher S. Derganc ------------------------------ Title: SVP ----------------------------- [Corporate Seal] Attest: /s/ Susan Giusti ----------------------------- Assistant Secretary STATE OF PENNSYLVANIA ) : ss. COUNTY OF MONTGOMERY ) On this the 13th day of January, 1999, before me the subscriber, a notary public in and for the Commonwealth of Pennsylvania, personally appeared Christopher S. Derganc, who acknowledged himself to be the Sr. V.P. of ADVANTA CORP., a Delaware corporation, and that he as such Sr. V.P., being authorized to do so, executed the foregoing instrument for the purpose therein contained by signing the name of the corporation by himself as Sr. Vice President. IN WITNESS WHEREOF, I hereunto set my hand and official seal. [Notarial Seal] /s/ Patricia D. Kelly ------------------------------ Notary Public My Commission Expires: -------- - -------------- [NOTARIAL SEAL PATRICIA D. KELLY, Notary Public Lower Gwynedd Twp., Montgomery, CO. My Commission Expires Aug. 27, 2001] 11 LEASE between SAN DIEGO DEVELOPMENT #1, LLC, a Colorado limited liability company, Landlord and ADVANTA MORTGAGE CORP. USA, a Delaware corporation, Tenant 12 TABLE OF CONTENTS Paragraph Caption Page 1. Leased Premises ......................................... 1 2. Term; Rent Commencement Date; Conditions Precedent ...... 2 3. Options to Extend ....................................... 4 4. Minimum Rent ............................................ 4 5. Assessments Under Declaration ........................... 6 6. Real Estate Taxes ....................................... 7 7. Plans and Specifications ................................ 9 8. Construction; Landlord's Work; Landlord's Improvements .. 11 9. Timing of Landlord's Work ............................... 11 10. Landlord's .............................................. 12 11. Landlord's Financial Condition .......................... 12 12. Tenant's Work ........................................... 12 13. Landlord's Contribution for Tenant's Work ............... 13 14. Manner of Tenant's Work ................................. 13 15. Construction Cooperation ................................ 14 16. Landlord Delay; Tenant Delay/Governmental Inducements ... 14 17. Use and Occupancy of Leased Premises .................... 14 18. Hazardous Materials ..................................... 14 19. Tenant's Signs .......................................... 15 20. Intentionally Omitted ................................... 15 21. Utilities ............................................... 15 i 13 22. Maintenance and Repair ................................................ 16 23. Alterations ........................................................... 17 24. Tenant's Trade Fixtures ............................................... 20 25. Surrender of Leased Premises .......................................... 20 26. Property in the Leased Premises ....................................... 21 27. Landlord's Access to Leased Premises .................................. 21 28. Zoning, Land Use Regulations, Utilities and Compliance with Laws, Ordinances, and Requirements of Public Authorities .................... 21 29. Assignment and Subletting ............................................. 23 30. Holdover .............................................................. 24 31. Indemnification of Landlord and Tenant ................................ 25 32. Liability Insurance ................................................... 25 33. Fire and All Risk Insurance ........................................... 27 34. Intentionally Omitted ................................................. 30 35. General Insurance Requirements ........................................ 30 36. Damage or Destruction ................................................. 30 37. Eminent Domain ........................................................ 32 38. Subordination, Recognition, Non-Disturbance and Attornment ............ 35 39. Quiet Enjoyment ....................................................... 37 40. Condition of Title .................................................... 38 41. Recording; Delivery of Title Report ................................... 38 42. Notices, Payment of Rent .............................................. 38 43. Tenant's Default ...................................................... 40 44. Intentionally Omitted ................................................. 42 ii 14 45. Landlord's Default ............................................. 42 46. Remedies Cumulative ............................................ 44 47. No Waiver ...................................................... 44 48. Waiver of Jury Trial ........................................... 44 49. Unavoidable Delays ............................................. 44 50. Relationship of Parties ........................................ 45 51. Estoppel Certificates .......................................... 45 52. Broker ......................................................... 46 53. Covenants to Run with the Land; Binding Effect ................. 46 54. Choice of Law .................................................. 46 55. Entire Agreement; Interpretation ............................... 46 56. Invalidity of Certain Provisions. .............................. 46 57. Captions ....................................................... 46 58. Definitions .................................................... 47 59. Arbitration .................................................... 51 60. Limitation on Landlord Liability ............................... 51 61. Guaranty ....................................................... 51 iii 15 EXHIBITS Exhibit "A" - Legal Description of Leased Premises Exhibit "B" - Guaranty Exhibit "C" - Permitted Exceptions Exhibit "D" - Final Plans and Specifications Exhibit "E" - Tenant's Plans and Specifications Exhibit "F" - Landlord's Improvements portion of Tenant's Work Exhibit "G" - Form of Subordination, Nondisturbance and Attornment Agreement iv 16 LEASE THIS LEASE made this 27th day of August, 1997, between SAN DIEGO DEVELOPMENT #1, LLC, a Colorado limited liability company, having an office at 4582 South Ulster Street Parkway, Denver, Suite 403, CO 80237 ("Landlord") and ADVANTA MORTGAGE CORP. USA, a Delaware corporation, and ADVANTA CORP., a Delaware corporation, having offices at 200 Tournament Drive, Suite 103, Horsham, PA 19044 (collectively "Tenant"). WITNESSETH: 1. Leased Premises. Landlord does hereby demise and let unto Tenant and Tenant does hereby lease and take from Landlord for the term and upon the conditions set forth in this Lease: ALL THAT CERTAIN Lot or piece of ground located on Rancho Bernardo Road, in the County of San Diego, State of California, commonly known as lot 63, 4S Ranch and which is more particularly described on EXHIBIT "A", attached hereto (the "Leased Premises"), the same being a subdivided lot within the business park known as "4S Ranch" (the "Park"). TOGETHER WITH the building to be erected thereon, of 3 stories and approximately 130,000 gross square feet, having approximately 127,000 rentable square feet (the "Building") and parking structure; and TOGETHER WITH the rights and easements to use, in common with others, those easements established for the benefit of owners and occupants under the Declaration; and TOGETHER WITH and UNDER AND SUBJECT TO the benefit of all rights, appurtenances, privileges, easements, rights of ingress or egress, licenses or hereditaments, now or hereafter belonging or appertaining to the Leased Premises; TOGETHER WITH and UNDER AND SUBJECT TO the benefit and burden of the easements, covenants and restrictions contained in that certain Declaration of Covenants, Conditions and Restrictions of 4-S Ranch Business Park, as amended, as described in item 12 of EXHIBIT "C" hereto (the "Declaration"); SUBJECT, however, to all restrictions, rights, easements or agreements specifically listed on EXHIBIT "C" hereto. 17 2. Term, Rent Commencement Date; Conditions Precedent. (a) Length of Term. The initial term of this Lease (the "Initial Term") shall commence on the date hereof ("Commencement Date") and shall continue to and include the date ("Expiration Date") which is the last day of the tenth (10th) Lease Year (as defined in subparagraph (c) below). If Tenant shall elect to extend the Initial Term for one or more Renewal Periods pursuant to Paragraph 3 below, the term of this Lease (the "Term") shall mean the Initial Term together with each Renewal Period for which Tenant has exercised a Renewal Option and the Expiration Date shall be the last day of the last Renewal Period for which Tenant has exercised a Renewal Option. (b) Rent Commencement Date Defined. The "Rent Commencement Date" shall mean the date on which Tenant's rental obligation for the entire Leased Premises commences, which shall be the later of (i) the 96th calendar day following the date on which Landlord has delivered all floors of the Leased Premises "Tenant Ready" as hereinafter defined, or (ii) the date on which Substantial Completion, as hereinafter defined, has occurred. (c) Lease Year Defined. The first "Lease Year" shall be the period of twelve (12) consecutive calendar months from the Rent Commencement Date. The first Lease Year shall commence on the Rent Commencement Date if the Rent Commencement Date is the first day of a calendar month or, if not, on the first day of the first calendar month immediately following the Rent Commencement Date (and for purposes of payment of Rent such partial month period from the Rent Commencement Date to the first of the calendar month shall be deemed part of the first Lease Year). Each subsequent Lease Year shall commence on the anniversary of the commencement date of the first Lease Year. (d) No Obligations Prior to Rent Commencement. Tenant shall not be obligated to pay any Additional Rent due hereunder or to perform any of Tenant's obligations hereunder during the period between the Commencement Date and the Rent Commencement Date, with the exception of Tenant's obligations hereunder which this Lease expressly provides shall arise prior to the Rent Commencement Date. (e) Delay in Completion. (A) If Landlord has failed to commence construction of the Building (as evidenced by Landlord obtaining a permit permitting grading and commencing site grading in accordance with the Final Plans and Specifications) by October 15, 1997 (the "Construction Deadline"), then either party shall have the right to deliver notice to the other of its intention to terminate this Lease; provided, however, that Landlord shall have a right to terminate under this Section 2(e)(A) only if Landlord has failed to commence construction as a result of the failure of the governmental authorities to issue a grading permit or as a result of governmental authorities issuance of a direct order preventing such grading for reasons beyond Landlord's control. If the notice of intent to terminate is delivered by Landlord to Tenant, this Lease shall terminate fifteen (15) days after Tenant's receipt of such notice, unless Landlord and Tenant can agree in writing on an extension of the Construction Deadline. If Tenant delivers notice to Landlord that Tenant intends to terminate this Lease 2 18 and, within fifteen (15) days following receipt of such notice Landlord fails to commence construction, then Tenant shall have a right thereafter to immediately terminate this Lease by notice given to Landlord but such termination notice shall only be deemed effective if actually received by Landlord prior to the commencement of construction. (B) Following commencement of construction, if Landlord discontinues construction of Landlord's Work for one-hundred twenty (120) consecutive days for reasons other than Unavoidable Delay (but excluding Tenant Delay), then Tenant shall have the right to deliver notice to Landlord of its intention to terminate this Lease. If Tenant delivers such notice and Landlord fails to recommence construction within fifteen (15) days following receipt of such notice, Tenant shall have a right thereafter to immediately terminate this Lease by notice to Landlord, but such termination notice shall only be deemed effective if actually received by Landlord prior to the recommencement of construction. (C) If the Tenant Ready Date (as hereinafter defined) has not occurred on or before September 1, 1998, which deadline shall be extended by any Tenant Delay ("Completion Deadline"), and Tenant is unable to substantially complete Tenant's Work by November 28, 1998, then: Tenant shall have the right to receive a Rent credit against Rent first due following the Rent Commencement Date, equal the product of: (a) the number of days the Tenant Ready Date is delayed beyond the Completion Deadline, or the number of days beyond November 28, 1998 that Tenant is unable to substantially complete Tenant's Work, whichever is less, multiplied by (b) Tenant's Holdover Costs. "Tenant's Holdover Costs" shall mean an amount, calculated on a daily basis, equal to amount by which the holdover rental payments for the Existing Premises for the period of such delay exceed the Minimum Rent rate applicable during the first Lease Year; to the extent that Tenant is not permitted to holdover in any portion of the Existing Premises and obtains substitute space for temporary occupancy purposes, the commercially reasonable out-of-pocket costs of moving to and renting such temporary space shall be considered "holdover rental payments" under the foregoing calculation. The "Existing Premises" shall mean and refer to office space being leased by Tenant under the leases applicable to such space as of the date hereof: approximately 53,907 rentable square feet at 16875 West Bernardo Drive, approximately 50,868 rentable square feet at 16855 West Bernardo Drive, and approximately 3,200 rentable square feet at 16835 West Bernardo Drive. (D) If none of the Leased Premises has been made available in a Tenant Ready condition to permit Tenant to commence Tenant's Work by September 1, 1999 (which deadline shall be extended by Tenant Delay), Tenant shall have a right to terminate this Lease by notice delivered to Landlord on or before September 10, 1999; if this Lease is terminated in accordance with the foregoing provision, this Lease shall be deemed to have expired in accordance with its terms and Landlord and Tenant shall be relieved of liability for all obligations arising thereafter under this Lease. (E) The remedies provided in this Paragraph 2(e) shall be Tenant's sole remedies for delays in completion of Landlord's Work; in no event shall Landlord be liable for direct, actual, or consequential damages or lost profits arising from such delay and Tenant shall have no right to terminate this Lease as a result of such delay except as provided in this Paragraph 2(e). 3 19 (F) If Landlord is delayed in delivering any portion of the Leased Premises Tenant Ready as a result of Tenant Delay or is delayed in Substantial Completion of Landlord's Work as a result of Tenant Delay, Tenant's obligation to pay Minimum Rent under Paragraph 4(b) shall commence on the date that such obligations would have occurred but for such Tenant Delay. 3. Options to Extend. The Term of this Lease may be extended by Tenant, at Tenant's sole option ("Renewal Option"), for two (2) consecutive periods of five (5) years each (each, a "Renewal Period," and collectively, "Renewal Periods"), from and after the expiration of the Initial Term by giving Landlord prior written notice of the exercise of the Renewal Option elected by Tenant not less than twelve (12) months before the end of the Initial Term or six (6) months before the end of the then current Renewal Period, as the case may be. If Tenant exercises a Renewal Option, all of the terms and provisions of this Lease applicable during the Initial Term (including the Additional Rent payable hereunder) shall be applicable to the Renewal Period in question without execution of an extension or renewal lease but the Minimum Rent shall be determined in accordance with Paragraph 4(b) below and Landlord shall have no obligation to complete additional improvements or provide a tenant finish allowance to Tenant. 4. Minimum Rent. (a) Initial Term. Tenant agrees to pay to Landlord as minimum rent ("Minimum Rent"), commencing on the Rent Commencement Date (except as otherwise provided in Paragraph 2, above or elsewhere in this Lease) and continuing through the remainder of the Initial Term, payable on the first day of each month in advance (except that if the Rent Commencement Date is other than the first of a month, the first monthly installment of Minimum Rent will be pro-rated on a per diem basis, and the last installment of Minimum Rent will be due and payable on the Expiration Date) as follows:
Year Monthly Minimum Rent ---- -------------------- First $153,152.00 Second $157,747.00 Third $162,479.00 Fourth $167,353.00 Fifth $172,374.00 Sixth $177,545.00 Seventh $182,871.00 Eighth $188,358.00 Ninth $194,008.00 Tenth $199,829.00
(b) Renewal Terms. Tenant agrees to pay as monthly Minimum Rent during each of the Renewal Terms, if exercised by Tenant, an amount, payable on the first day of each month in advance, determined in accordance with the following provisions: 4 20 (A) The monthly Minimum Rent for the first Lease year of the applicable Renewal Term shall equal the greater of (x) 103% of the monthly Minimum Rent applicable during the last month of the month preceding the commencement of the respective Renewal Term, and (z) the Fair Market Rental Value for the Leased Premises. (B) The monthly Minimum Rent for each Lease Year of the respective Renewal Term following the first Lease Year shall be an amount equal to 103% of the monthly Minimum Rent applicable to the immediately preceding Lease Year (so that the annual Minimum Rent shall increase by 3% each Lease Year following the first Lease Year). (C) If Tenant exercises its Renewal Option by notice in accordance with Paragraph 3, Landlord shall give Tenant written notice of Landlord's determination of Fair Market Rental Value by the later of (x) the first business day of the eleventh month preceding the Renewal Term for which Minimum Rent is to be determined, and (y) 30 days following receipt of Tenant's notice exercising its Renewal Option under Paragraph 3 above. If Tenant notifies Landlord within thirty (30) days after receipt of Landlord's determination of Fair Market Rental Value that Tenant disputes such determination, Fair Market Rental Value shall be determined according to the procedures set forth in subparagraph E below. If Tenant does not notify Landlord that it disputes Landlord's determination of Fair Market Rental Value within the time period herein provided, Tenant shall be deemed to have accepted such determination. (D) The "Fair Market Rental Value" for the Leased Premises shall mean: the monthly payment based on the annual amount per square foot (exclusive of Additional Rent) that a willing tenant would pay and a willing landlord would accept following arms-length negotiations with respect to an "Assumed Lease" (as defined below) under the circumstances as of the determination. "Assumed Lease" means (i) a lease of a "Comparable Building" for a term equal to the Renewal Term, scheduled to commence at the time such Renewal Term is scheduled to commence; and (ii) taking into consideration and making adjustment to reflect allowances and concessions (provided, however, that such assumption shall not obligate Landlord to pay any allowances or contributions or to complete any Landlord Work). "Comparable Building" shall mean any first class suburban office building in the Rancho Bernardo area which is of a size and quality reasonably comparable to the Leased Premises; provided that, to the extent such comparable buildings are not identical, appropriate adjustments shall be made to adjust for differences in the size, location, age, efficiency of floorplate, quality of buildings, and type and amount of parking between such other buildings and the Leased Premises. (E) Whenever it is necessary to determine Fair Market Rental Value for purposes of this Lease, Landlord and Tenant shall confer and attempt to agree as to such Fair Market Rental Value. If either party concludes after conferring with the other that agreement is unlikely to be reached it shall notify the other of such conclusion and each party shall, within fifteen days after the date of such notice, notify the other party of the name of a qualified appraiser selected by such party to participate in the determination of Fair Market Rental Value, and the two appraisers so selected, within thirty (30) days after their selection, shall select a third qualified appraiser to participate in such determination; if they are unable to agree on a third appraiser, the selection shall be made by the highest 5 21 officer in the San Diego chapter of the American Institute of Real Estate Appraisers, or its successor, who is a qualified appraiser. Within fifteen (15) days of selection of the third appraiser, each of the two appraisers selected by Landlord and Tenant shall state, in writing, the appraiser's determination of the Fair Market Rental Value supported by the reasons therefor and shall make counterpart copies for each of the other appraisers, under an arrangement for simultaneous exchange of the determinations. The role of the third appraiser shall be to select whichever of the two proposed resolutions most closely approximates the third appraiser's own determination of the Fair Market Rental Value. The third appraiser shall have no right to propose a middle ground or any modifications of either of the two proposed resolutions. The resolution the third appraiser chooses as the most closely approximating the third appraiser's determination shall constitute the determination of Fair Market Rental Value and shall be final and binding upon the parties. For purposes of this subparagraph the term "qualified appraiser" means a person who has been designated by the American Institute of Real Estate Appraisers as a M.A.I. (Member Appraisal Institute) (or its equivalent) and who has been for at least the four most recent years a M.A.I. in good standing, who has for at least the four most recent years been regularly engaged in appraising commercial real estate in the San Diego metropolitan area, who has no financial interest in either party to this Lease, is not related by blood or marriage to any officer or director of either party and has not been an officer or director of either party. If either party fails to notify the other of such party's choice of a qualified appraiser, the qualified appraiser selected by the notifying party shall make the determination of Fair Market Rental Value. The Fair Market Rental Value determined in accordance with the procedures described above shall be final and binding on both parties, absent fraud or flagrant disregard of the standards set forth in this Lease by one or more of the appraisers. Each party shall pay the costs of the appraiser selected by it and share the cost of the third appraiser. In the event of a failure, refusal or inability of any appraiser to act, the appraiser shall appoint a successor, but in the case of the third appraiser, a successor shall be appointed in the same manner as provided above with respect to appointment of the original third appraiser. Any decision on procedures and interpretations of the standards set forth herein in which the appraisers for Landlord and Tenant concur shall be binding and conclusive upon the parties, except that such appraisers shall not attempt by themselves to mutually ascertain the Fair Market Rental Value. (c) Late Interest. In any case where: (i) any installment of Minimum Rent or Additional Rent is not paid when the same is due, or (ii) any other sum or charge which is owing from Tenant to Landlord hereunder, is not paid within fifteen (15) days after the same is due and payable or within any cure period applicable thereto, whichever is later, then such amount shall thereafter bear interest at an annual rate (the "Interest Rate") which is equal to three percent (3%) over the "prime rate" then being quoted in the Money Rates section (or similar section if renamed or eliminated) of The Wall Street Journal or, if such publication is not in existence, the prime rate published in a similar national business-oriented newspaper or publication. 5. Assessments - Under Declaration. Tenant will pay when due, to the party or parties entitled thereto, all assessments owing for periods following the Rent Commencement Date through the Expiration Date with respect to the Leased Premises under the Declaration; Tenant shall provide evidence of payment to Landlord for each such 6 22 payment on or prior to the date such payments are due. Such assessments will be pro-rated between Landlord and Tenant on a per diem basis for any period preceding the Rent Commencement Date or following the Expiration Date constituting part of an assessment period. 6. Real Estate Taxes. (a) Real Estate Taxes Defined. The term "Real Estate Taxes" shall mean all ad valorem real estate taxes which may be assessed, levied, or imposed upon the Leased Premises for any period during the Initial Term and the Renewal Period from and after the Rent Commencement Date and all other assessments, fees and other governmental charges and levies, of any kind or nature whatsoever (including, without limitation, assessments, fees, levies and charges imposed for public improvements or benefits, or for public services such as fire protection, street, sidewalk and road maintenance or refuse removal, and interest on unpaid installments) which may be levied, assessed or imposed, or become liens upon or arise out of the use, occupancy, ownership, or possession of the Leased Premises, and which accrue during or are allocable to the Term. "Real Estate Taxes" shall include amounts required to be paid under the Bond issued under the 1915 Act for Improvement of 4S Ranch, District 89-1 ("89-1 Bond"), and supplemental taxes or assessments pursuant to the California Revenue and Taxation Code, but shall not include building permit fees, utility tap fees and similar one time fees incurred in connection with the initial construction of the Building and related improvements. Tenant shall pay to the Escrow Agent monthly, on each date on which a payment of Minimum Rent is due, 1/12 of such amount as the Escrow Agent from time to time estimates will be required to pay all Real Estate Taxes required to be paid. The Escrow Agent's estimates shall be based on the amounts actually payable or, if unknown, on the amounts actually paid for the year preceding that for which such payments are being made. Any deficiencies shall be promptly paid by Tenant to the Escrow Agent on demand. When the Escrow Agent has received from Tenant or on its account funds sufficient to pay the same, the Escrow Agent shall pay such Real Estate Tax bills. If the amount paid by Tenant in any year exceeds the aggregate required, such excess shall be applied to Real Estate Taxes payments for the succeeding year. "Escrow Agent" means (i) the Mortgagee, if such Mortgagee elects to act in such capacity pursuant to tax payment escrow provisions of the applicable loan documents, or otherwise (ii) a title company or other escrow agent selected by Landlord. The Escrow Agent's fees for holding and disbursing such amounts shall be paid by Tenant and Tenant shall have the right to receive any interest earned on amounts held in escrow, if any; such escrow shall be used solely for payment of Real Estate Taxes (including reimbursement of Landlord for Real Estate Taxes advanced by Landlord, if applicable) and such fees (if not otherwise paid by Tenant) and for no other purpose. Tenant shall have a right to prepay the amounts due under the 89-1 Bond in accordance with its terms, but such prepayment shall not be credited against payment of Rent or be pro-rated in the event the Lease terminates or expires prior to the date of which the 89-1 Bond payments would otherwise have been paid. (b) Payments in Lieu of Taxes. If at any time during the Term of this Lease the methods of taxation prevailing on the date hereof shall be altered so that in lieu of or as a substitute for the whole or any part of the ad valorem real estate taxes now levied, assessed or imposed on real estate as such, there shall be levied, assessed or imposed 7 23 a tax ("Alternative Tax") on the rents received from such real estate, or a license fee measured by rents, a so-called "value-added tax" or other tax in lieu or fee resulting from revision of the present real estate tax structure, then the Alternative Tax shall thereafter be included as Real Estate Taxes. (c) Right to Contest Assessments. Landlord and Tenant agree to consult with each other and to keep each other advised concerning the assessment and/or tax rate for any Real Estate Taxes and any controversy or contest pertaining to any Real Estate Tax. Tenant shall have the right, but not the obligation, to protest or appeal any such assessment and/or tax rate and to petition for a refund or rebate of the whole or part of any Real Estate Taxes and to carry on any proper proceedings, legal or otherwise, in connection therewith; provided, however, (i) Tenant shall pay the amounts under protest or appeal to the Escrow Agent and, to the extent that such Real Estate Taxes are due to be paid to the applicable Authorities prior to final resolution of such protest or appeal, the Escrow Agent shall pay the applicable taxes, but with notice of protest if requested by Tenant; (ii) Tenant shall comply with all laws, orders, rules and regulations respecting such contest; and (iii) give Landlord prior written notice of Tenant's intent to contest the amount or validity and provide Landlord will copies of any notices filed or documents submitted with regard to any such proceeding. If required by law, Tenant shall have the right to take such action in the name of Landlord, and Landlord shall cooperate with Tenant to the extent Tenant may reasonably require; provided, however, Tenant shall indemnify and save Landlord harmless from and against all loss, cost, damage and expense as a result thereof. As to Real Estate Taxes attributable to periods prior to the Rent Commencement Date, to the last year of the Term (after Tenant has waived or no longer has any Renewal Option), or upon an Event of Default, Landlord shall have a right to initiate and prosecute such proceedings if Tenant fails to initiate or prosecute such proceedings, or participate in such proceedings if Tenant initiates and prosecutes such proceedings. Landlord will furnish Tenant, on request, with prior tax receipts, bills or other data and execute any instruments, which Tenant may deem necessary or proper for the purpose of said protest or review, and such authorization or allegations as may be necessary therefor. The cost and expense of any such proceeding instituted by Tenant shall be borne by Tenant and in the event Tenant shall obtain an abatement, reduction or refund, Tenant shall be entitled to the entire amount thereof (except to the extent any portion thereof represents Real Estate Taxes paid by Landlord respecting periods before the Rent Commencement Date or after the expiration of the Term), and if any sums to which Tenant is entitled are paid by the taxing authority to Landlord, Landlord will promptly pay the same to Tenant. If any proceedings shall be instituted by Landlord, the entire cost and expense of any such proceeding shall be borne by Landlord, but in the event Landlord shall obtain an abatement, reduction or refund, there shall be first deducted from any abatement, reduction or refund, and prior to any adjustment with Tenant, the entire amount of Landlord's cost including reasonable attorneys' fees, incurred in connection therewith. In any tax period for which an abatement, reduction or refund shall be obtained, whether by Landlord or Tenant, an appropriate adjustment or refund shall be made by Landlord to Tenant in the amount due from or paid by Tenant on account of Real Estate Taxes. (d) Items Excluded. Nothing herein contained shall require Tenant to pay any share of municipal, state, federal income, gross receipts or excess profits taxes assessed against Landlord, or municipal, state or federal capital levy, estate, succession, 8 24 inheritance or transfer taxes of Landlord, or corporation franchise taxes imposed upon any corporate owner of the fee of the Leased Premises, or any tax of any kind whatsoever which may be imposed on Landlord or the rents payable except the ad valorem Real Estate Taxes described in this Paragraph 6, the Alternative Tax described in subparagraph (b) above or amounts to be paid in accordance with Paragraph 21. (e) Personal Property Taxes. Tenant shall pay, before delinquency, all taxes and assessments levied against, or on account of, all fixtures, equipment and personal property located in or upon the Leased Premises, even if such taxes do not becomes a lien against Landlord's interest in the Leased Premises. 7. Plans and Specifications. (a) Building; Preliminary Drawings. The Building will be a first class suburban general purpose office building of approximately 130,000 gross square feet and 3 stories and a parking structure, with a footprint substantially as shown on the final working drawings and specifications for Landlord's Work listed on EXHIBIT "D" attached (the "Final Plans and Specifications"), and otherwise substantially in accordance with the Final Plans and Specifications. The Final Plans and Specifications have been approved by Landlord and Tenant. (b) Architect, Final Plans and Specifications. (1) The Final Plans and Specifications have been prepared by Landlord's architect (the "Landlord's Architect"). To the extent that the Final Plans and Specifications are incomplete or lack details, Landlord shall develop additional plans and specifications, based on the scope of the project as is described in the Final Plans and Specifications (the "Scope"), subject to the approval of Tenant. Landlord shall give prior written notice to Tenant (by notice to Tenant's construction representative, Scott Vogt and Ann McFadden, which shall not be required to be made in accordance with Paragraph 42) of such additional plans and specifications; Tenant shall be deemed to approve such changes unless Tenant delivers to Landlord comments objecting to such additional plans and specifications within 5 business days following receipt by Tenant's construction representatives. Tenant shall have the right to request changes in the additional plans and specifications. If Landlord and Tenant agree that such changes are logically within the Scope, Landlord shall make such changes at Landlord's sole cost and expense. If Landlord and Tenant agree that such changes are logically outside the Scope, Landlord shall make such changes but the costs of such changes shall be borne by Tenant. If Landlord and Tenant dispute whether such changes are logically within the Scope, Landlord shall make and pay for such changes in aggregate up to $60,000.00 and costs in excess of $60,000.00 shall be borne by Tenant (or settled by arbitration in accordance with Paragraph 7(d)). If changes to the additional plans and specifications requested by Tenant (other than changes necessary to make the additional plans and specifications complete) cause delay in completion of Landlord's Work (beyond the time otherwise required for completion of the additional plans and specifications as proposed by Landlord), such delay shall be deemed a Tenant Delay. To the extent that the aggregate cost of all such changes to the additional plans and specifications requested by Tenant are less than $60,000.00, the difference may be used first as a credit 9 25 against the costs of changes in the Final Plans and Specifications requested by Tenant under Paragraph 7(b)(ii) below and, if there is any balance remaining, second to be added to Landlord's Contribution and disbursed to Tenant in accordance with Paragraph 13. (ii) Landlord shall have the right to request or approve changes in the Final Plans and Specifications based on conditions discovered on-site and arising in construction of Landlord's Work and to request or approve changes involving substitution of materials if required as a result of such conditions or the non-availability of materials specified in the Final Plans and Specifications, subject to the approval of Tenant in accordance with the following provisions. Landlord shall give prior written notice (by notice to Tenant's construction representative, Scott Vogt and Ann McFadden, which shall not be required to be made in accordance with Paragraph 42) of such changes to Tenant; to the extent prior written notice is not practicable, Tenant shall be informed of such changes orally (but supplemented or confirmed by fax to both such representatives at (215) 674-1442), and thereafter be provided with written description of such changes within 48 hours. Tenant shall be deemed to approved such changes unless Tenant delivers to Landlord comments objecting to such changes (x) within 16 business hours for changes involving substitution of materials, and (y) within 8 business hours as to all other changes. Tenant shall have the right to approve or reasonably object to such changes in the Final Plans and Specifications for: (1) consistency with Tenant's Plans and Specifications; (2) compliance with applicable laws and with the Declaration; (3) matters which Tenant reasonably believes would increase Tenant's maintenance costs over the Term; (4) consistency with the workmanship and materials specified in Tenant's Plans and Specifications; and (5) quality, appearance and cost of such changes. In all other respects, the Final Plans and Specifications shall be under the control of Landlord and the Landlord's Architect. If Tenant requests changes in the Final Plans and Specifications (other than as provided in Paragraph 7(b)(i) above with respect to the additional plans and specifications, which changes are governed thereby), such changes shall be subject to the approval of Landlord and Tenant shall pay the cost of all such changes (to the extent that the changes increase the cost of completing the portion of Landlord's Work, after taking into account cost savings arising from such changes) and all delays caused by such changes shall be deemed Tenant Delay. (c) Plan Submission. Tenant's architect ("Tenant's Architect") shall prepare plans and specifications for Tenant's Work, which shall be subject to approval by Landlord, which approval shall not be unreasonably withheld or delayed. Landlord's approval of the plans and specifications and changes thereto shall be determined on the basis of three respects only: (i) compliance with applicable laws and with the Declaration; and (ii) matters which Landlord reasonably believes would increase Landlord's structural maintenance costs over the Term and consistency with the mechanical, electrical and other systems in Landlord's Work; and (iii) consistency with the workmanship and materials specified in the Final Plans and Specifications. In all other respects, Tenant's Plans and Specifications shall be under the control of Tenant and Tenant's Architect. Upon approval, the plans and specifications shall be deemed "Tenant's Plans and Specifications" and shall be listed on EXHIBIT "E" , to be attached following such approval, which is anticipated to occur following the execution hereof. Tenant shall have the right to request or approve changes in the Tenant's Plans and Specifications based on conditions discovered on-site and arising in construction of Tenant's Work, changes as are necessary or advisable in order to suit the 10 26 Leased Premises for its intended operation as Tenant's offices, or for any other reasons in Tenant's discretion; such changes shall be subject to approval by Landlord (in accordance with the standards set forth above). Landlord shall be deemed to approved such changes unless Landlord delivers to Tenant comments objecting to such changes (i) within 8 business hours for changes involving substitution of materials, and (ii) within 4 business hours as to all other changes. (d) Dispute Resolution. In the event of any dispute between Landlord and Tenant as to any plan, the issue will be referred initially to the Landlord's Architect, who shall advise the parties as to the issue and attempt to resolve the dispute. If the parties shall not have reached agreement within 2 days after the matter shall have been referred to the Architect, then the dispute shall be resolved by binding arbitration conducted in San Diego, California by and under the Construction Industry Rules of the American Arbitration Association and the conclusion of the arbitrator(s) will be final, conclusive and binding on the parties. (e) Replacement Architect. Landlord may from time to time replace Landlord's Architect with another architect duly licensed in California and qualified to design a building and related improvements comparable to those intended hereunder, provided that the replacement of such Landlord's Architect shall be subject to the prior approval of any Mortgagee, if required under the applicable loan documents. Tenant may from time to time replace Tenant's Architect with another architect duly licensed in California and qualified to design a building and related improvements comparable to those intended hereunder, provided that the replacement of such Tenant's Architect shall be subject to the prior approval of Landlord, which approval shall not be unreasonably withheld or delayed. 8. Construction: Landlord's Work; Landlord's Improvements. Landlord will, at Landlord's expense, diligently and in good faith construct and complete Landlord's Work in compliance with the Final Plans and Specifications, using all new first quality materials, in a good and workerlike manner and in compliance with all laws, orders, rules, regulations and Permits (as defined in subparagraph 28(b)(i), below) of all Authorities (as defined in subparagraph 28(b)(i), below) having jurisdiction thereof, with any direction by any public officer pursuant to law and in accordance with the terms and conditions of this Lease. "Landlord's Work" shall mean the work to be completed in accordance with the Final Plans and Specifications (excluding those items of Tenant's Work that are noted on the Final Plans and Specifications for information purposes only, if any). "Landlord's Improvements" shall mean Landlord's Work and the portion of Tenant's Work as described on EXHIBIT "F". 9. Timing of Landlord's Work. Upon commencement of Landlord's Work on the Leased Premises, Landlord will thereafter pursue such work diligently, continuously and in good faith to completion, subject to Unavoidable Delay and normal construction scheduling delays. "Tenant Ready" with respect to each floor of the Building shall mean that Landlord shall have completed the following portions of Landlord's Work on the Building, as determined by Landlord's Architect, so that Tenant can commence construction of Tenant's Work on the respective floor: structure complete, roofing in place, exterior glazing complete, building core partitions in place, concrete floor complete, electrical panels installed with service available, rooftop HVAC units installed and 11 27 functional, high pressure ductwork installed, and fire protection mains and branch Lines complete with heads at tees. "Tenant Ready Date" shall mean the date on which all floors of the Building are Tenant Ready. "Substantial Completion" of Landlord's Work shall mean there has been substantial completion of all of Landlord's Work in accordance with the Final Plans and Specifications as determined by Landlord's Architect in accordance with normal architectural tolerances and standards, except for Punchlist Items. "Completion Date" shall mean the date on which Substantial Completion occurs. "Punchlist Items" shall mean items the completion of which will not interfere with Tenant's ability to commence occupying the Building for purposes of doing business, including landscaping and cosmetic items; Landlord's Architect in consultation with Landlord and Tenant shall prepare a list of Punchlist Items as of the Completion Date ("Landlord's Punchlist"). Landlord shall complete the items set forth on Landlord's Punchlist as soon as reasonably practicable following the Completion Date. 10. Landlord's Construction Warranties. Landlord shall obtain customary construction warranties under its construction contracts for all Landlord's Work providing for completion in accordance with the Final Plans and Specifications, free of defects in materials and workmanship for a period of one (1) year from the date of occupancy or such longer period as may be covered under such warranties. 11. Landlord's Financial Condition. At the time Landlord obtains a commitment for a construction loan for construction of Landlord's Work and Landlord's Contribution, Landlord shall provide evidence to Tenant (which may be disclosed within a loan commitment that requires the Landlord to maintain such cash equity at the time of loan funding) that Landlord has or will have not less than $12,000,000.00 in equity at the time such loan is initially to be funded. 12. Tenant's Work. Tenant shall enter into the Leased Premises for purposes of commencing Tenant's Work when Tenant has received a notice from Landlord that the respective floor of the Leased Premises is Tenant Ready and, thereafter, Tenant shall pursue such work diligently, continuously and in good faith to completion. Tenant shall have the right to commence work on portions of the Leased Premises in advance of the date that a respective portion is Tenant Ready, provided that such work does not interfere with or delay Landlord's Work. Tenant shall, in a good and workerlike manner, cause the Leased Premises to be improved and completed at Tenant's expense (but with the benefit of Landlord's contribution as provided below) and in accordance with Tenant's Plans and Specifications, which work shall include all permanent improvements necessary (beyond Landlord's Work) for Tenant's use and operation within the Leased Premises (including materials, supplies, components, labor and services therefor) ("Tenant's Work"). Tenant shall contract for completion of Tenant's Work under contracts providing customary retainages to be paid following completion. "Tenant's Improvements" shall mean Tenant's Work exclusive of the items described on EXHIBIT "F". Tenant's Improvements shall be deemed the property of Tenant; Landlord's Improvements shall be deemed the property of Landlord. During the course of construction of Tenant's Work, Tenant may make such changes to Tenant's Plans and Specifications as are ordinary and necessary or advisable in order to suit the Leased Premises for its intended operation as Tenant's offices, provided that copies of any changes shall be delivered to Landlord for Landlord's information and such 12 28 changes shall be subject to the provisions of Paragraph 7(c). If Tenant fails to complete and obtain certificates of occupancy for Tenant's Work within twelve (12) months following the Tenant Ready Date (which 12-month period shall be extended by Landlord Delay and Unavoidable Delay), Landlord shall have the right to elect, by not less than ten (10) days prior notice to Tenant, to complete such portion of Tenant's Work as are necessary to obtain a certificate of occupancy and the costs of completion of such work shall be deducted from the undisbursed portion of Landlord's Contribution. To the extent that such costs exceed the undisbursed portion of Landlord's Contribution, Tenant shall pay such amounts as Additional Rent, together with interest thereon at the rate of twelve percent (12%) per annum from the date such amounts are expended by Landlord within fifteen (15) days of billing by Landlord. 13. Landlord's Contribution for Tenant's Work. Landlord shall pay to Tenant the sum of Two Million Four Hundred Thousand Dollars ($2,400,000) ("Landlord's Contribution"), which amount is intended as consideration for completion of Tenant's Work, as follows: (a) On or before the first day of each month during the course of Tenant's Work, Tenant shall deliver to Landlord a statement setting forth the total costs and expenses incurred by Tenant in connection with the procurement and performance of Tenant's Work for the preceding month along with appropriate lien waivers and such other documentation as Landlord may reasonably require, requested within 7 days after Landlord receives Tenant's request for payment; on the last day of the month (subject to delay caused by Landlord's failure to receive the additional documentation requested), Landlord shall pay to Tenant an amount equal to the costs and expenses specified on the statement, not to exceed in the aggregate the amount of Landlord's Contribution. Such payment shall be by delivery to Tenant of Landlord's checks or wire transfers payable to Tenant or, at Landlord's option, payable to Tenant and the respective contractor. (b) Upon Substantial Completion of Tenant's Work, which substantial completion shall be evidenced by a certification of the Tenant's Architect and copies of all appropriate lien waivers, Landlord shall pay to Tenant a sum equal to the difference, if any, between all payments theretofore paid to Tenant on account of Landlord's Contribution pursuant to subparagraph (a) above, and the entire amount of Landlord's Contribution. (c) If Landlord fails to pay Landlord's Contribution in accordance with the foregoing provisions, Tenant's remedy shall be to offset such unpaid amounts, together with interest thereon at the rate of twelve percent (12%) per annum against the first Rent to be paid by Tenant under this Lease upon not less than ten (10) days prior notice of Tenant's election to withhold to Landlord and Landlord's Mortgagee; provided, however, that if Landlord or the Mortgagee disputes, by notice to Tenant within such ten (10) day period, that such amounts are owed by Landlord, Tenant shall have no right to withhold such amounts until the amounts are found to be due Tenant by arbitration. 14. Manner of Tenant's Work. All of Tenant's Work shall be performed in a good and workerlike manner and in compliance with all laws, orders, rules and regulations of all governmental authorities having jurisdiction thereof and with any direction by any 13 29 public officer pursuant to law, including Zoning and Building Laws (as hereinafter defined), in compliance with the Declaration, and in accordance with the terms and conditions of this Lease. 15. Construction Cooperation. Each party during the course of its Work shall not unreasonably interfere with the other's Work and each party shall reasonably cooperate with the other so that each party may perform and complete its Work in a proper and timely fashion. 16. Landlord Delay; Tenant Delay/Governmental Inducements. "Landlord Delay" means delay caused by Landlord, Landlord's agents and employees, and delay by Landlord's contractors in performance of Landlord's Work. "Tenant Delay" means delay caused by Tenant, Tenant's agents and employees, and delay by Tenant's contractors in performance of Tenant's Work. 17. Use and Occupancy of Leased Premises. Tenant shall not use or occupy, or permit or suffer to be used or occupied, the Leased Premises or any part thereof, other than for the Permitted Use. The term "Permitted Use" shall mean: general office use for administrative, clerical, and professional office purposes (the "Primary Use") and for all activities ancillary thereto, such as (i) kitchens, pantries and dining rooms for the feeding of employees and guests of Tenant, (ii) vending machines and snack bars for the sale of food, (iii) business machines, equipment for printing, reproducing forms, circulars and other materials used in connection with the conduct of Tenant's business, (iv) libraries for employees of Tenant, (v) computer and other electronic data processing equipment, (vi) board rooms and conference rooms, (vii) training rooms for employees and customers of Tenant, (viii) ancillary services such as day care and pickup/dropoff for off-site laundry primarily for the benefit of Tenant's employees (although such services may also be open to the general public) (the uses specified under clauses (i)-(viii) are referred to collectively as the "Ancillary Uses"), provided that Ancillary Uses shall not be the primary use of the Leased Premises; in addition, Tenant shall have the right to use the Leased Premises for such other uses as are permitted by Requirements that are expressly approved by Landlord, which approval shall not be unreasonably withheld if such uses are consistent with first class suburban general office building uses ("Specially Approved Uses"). Tenant shall be responsible for obtaining any approvals or permits required for the Ancillary Uses or Specially Approved Uses under Zoning and Building Laws and the Declaration. 18. Hazardous Materials. (a) Definitions. "Hazardous Materials" shall mean any chemical, material, substance or waste (i) exposure to which is prohibited, limited or regulated by any federal, state, county, regional or local authority, or other governmental authority of any nature, that has jurisdiction over the Leased Premises or (ii) which, even if not so regulated, may or could pose a hazard to the health or safety of the occupants of the Leased Premises (herein collectively "Hazardous Materials"). As herein used Hazardous Materials shall include petroleum, crude oil (any fraction thereof), natural gas, natural gas liquids, and those substances defined as "hazardous substances," "hazardous materials," "hazardous wastes," or other similar designations in the Comprehensive Environmental 14 30 Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601 et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901 et seq., the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801 et seq. and any other governmental statutes, laws, ordinances, rules, regulations, and precautions. (b) Tenant's Warranty and Covenants. Tenant shall strictly comply with all statutes, laws, ordinances, rules, regulations, and precautions now or hereafter mandated or advised by any federal, state, local or other governmental agency with respect to the use, generation, storage, or disposal of Hazardous Materials. Tenant shall not cause, or allow any one else to cause, any Hazardous Materials to be used, generated, stored, or disposed of on or about the Leased Premises (other than de minimis amounts used in construction or normal office building operations consistent with applicable industry standards and applicable laws) without the prior written consent of Landlord, which consent may be withheld in the reasonable discretion of Landlord. Tenant's indemnification of Landlord pursuant to this Lease shall extend to all liability, including all foreseeable and unforeseeable consequential damages, directly or indirectly arising out of the use, generation, storage, or disposal of Hazardous Materials by Tenant or any person claiming under Tenant, including, without limitation, the cost of any required or necessary repair, cleanup, or detoxification and the preparation of any closure or other required plans, whether such action is required or necessary prior to or following the termination of this Lease, to the full extent that such action is attributable, directly or indirectly, to the use, generation, storage, or disposal of Hazardous Materials by Tenant, its agents, employees, contractors, or invitees, or any person claiming under Tenant. Neither the written consent by Landlord to the use, generation, storage, or disposal of Hazardous Materials nor the strict compliance by Tenant with all statutes, laws, ordinances, rules, regulations, and precautions pertaining to Hazardous Materials shall excuse Tenant from Tenant's obligation of indemnification. In addition to Landlord's indemnification rights, in the event Tenant is in breach of the covenants herein, Landlord may, in its sole discretion, (i) declare an Event of Default after notice and opportunity to cure in accordance with Paragraph 43 and/or (ii) cause the Leased Premises to be free from the Hazardous Material and all costs and expenses incurred by Landlord to effect the foregoing shall be deemed Additional Rent hereunder and shall immediately be due and payable from Tenant (together with interest thereon at the Interest Rate from the date costs or expenses are incurred by Landlord). The representations and obligations of Tenant under this Paragraph shall survive, notwithstanding the termination or expiration of this Lease. 19. Tenant's Signs. Tenant shall have the right, at its sole cost and expense, to post, paint, construct, attach and maintain the signage set forth on Tenant's Plans and Specifications, to the extent permitted by law and the Declaration ("Tenant's Signage"). Tenant may remove any or all of its signs at or prior to the Expiration Date or as soon thereafter as is reasonably practical; provided Tenant repairs any damage caused by such removal. Tenant shall have the right to alter Tenant's Signage, subject to applicable law and the Declaration. 20. Intentionally Omitted. 21. Utilities. 15 31 (a) Tenant to Pay Charges for Utilities. From and after the Rent Commencement Date, Tenant agrees to pay, as Additional Rent, all charges and deposits for water, gas, electricity, sanitary sewer, telephone and other utility services (the "Utilities") for the Leased Premises during the Term. (b) Tenant Not Responsible for Assessments for Utility Improvements. In no event shall Tenant pay, and Landlord shall be responsible for, assessments for public improvements relating to the construction, installation or improvement of any utility system in accordance with the Final Plans and Specifications, if such assessment exists on the date hereof or is imposed as a condition for the issuance of the Permits. Tenant shall pay the installments coming due during the Term (prorated on a per diem basis with Landlord for periods overlapping the beginning or end of the Term), of any assessment against the Leased Premises other than those described in the preceding sentence (and for such purpose, Tenant shall be entitled to elect to pay such assessments over the longest permitted period); provided, however, that if such assessments pertain to additional utility improvements requested by Tenant, Tenant shall pay for the full cost of such assessments prior to the expiration of the Term (without proration with Landlord). 22. Maintenance and Repair. (a) Tenant's Obligations. The Minimum Rent set forth in Paragraph 4 is set on the assumption that Landlord will not have to pay any expenses or incur any liabilities of any kind in any way relating to, or in connection with, the Leased Premises during the Term from and after the Rent Commencement Date, except as expressly assumed by Landlord elsewhere in this Lease. Accordingly, Tenant will promptly pay all costs of every kind and description relating to or arising out of the Leased Premises during the Term from and after the Rent Commencement Date, except as expressly assumed by Landlord elsewhere in this Lease. From and after the Rent Commencement Date, Tenant agrees at its sole cost and expense, to provide maintenance and make all repairs and replacements to the Leased Premises necessary to maintain it in good order, condition and repair consistent with the continued operation of a first-class suburban general purpose office building, reasonable wear and tear excepted, and to maintain the Leased Premises in a clean and sanitary condition throughout the Term; except that, (i) repairs or replacements required as a result of fire or other casualty covered by the Tenant's Property Insurance shall be governed by the provisions of Paragraph 36, whether or not caused by the acts or negligence of Tenant, its agents or employees; and (ii) Tenant shall not be obligated to make any Structural Repairs, as defined in subparagraph (b) below, unless the need therefor results from the negligence of Tenant, its agents or employees, or to the extent provided in Paragraph 36. At Tenant's expense, Tenant shall enter into and keep in effect during the Term (by renewing or entering into new contracts) maintenance contracts for repair and maintenance of the systems for HVAC, elevator, electrical, elevator, life safety and sprinklers (both landscaping and fire prevention), which contracts shall include periodic maintenance in accordance 16 32 applicable industry standards consistent with warranty requirements; Tenant shall provide copies of such contract(s) and evidence of payment to Landlord upon request. Tenant's building engineers or other person in charge of maintenance of the building shall maintain a maintenance/complaint log, keeping track of any problems or complaints and service calls for Landlord's Improvements. Landlord shall assign to Tenant all assignable warranties with respect to Landlord's Work, including warranties with respect to the Building Fixtures and Equipment, and, to the extent not assignable, Landlord shall cooperate with Tenant in enforcing the terms and provisions of applicable warranties upon request of Tenant, provided that Landlord shall bear all costs of legal actions if Landlord elects to bring a legal action to enforce any such warranties. (b) Landlord's Obligations. Landlord agrees to make all repairs and replacements which may be necessary to the structural support system of the roof, foundation piers and stem walls, and structural elements of exterior walls (including structural elements of curtain walls) and structural elements of the parking structure (collectively such elements are referred to as "Structure" and such repairs or replacement are "Structural Repairs") unless the need therefore results from the negligence of Tenant, its agents or employees. To the extent any repairs, replacements, renewals and alterations arise out of, or are in any way caused by fire or other casualty, responsibility therefor is governed by Paragraph 36 below. Tenant shall notify Landlord as soon as reasonably practicable following discovery by Tenant or its maintenance contractor of the existence of any condition which is believed to require Structural Repairs. If Tenant is deprived of the use of any portion of the usable space in the Building for more than two (2) consecutive business days following notice to Landlord because of Landlord's making of any Structural Repairs under the provisions of this Lease or because of Landlord's failure to make said Structural Repairs, then, in addition to such other rights and remedies as Tenant is expressly accorded under the terms of Paragraph 45 of this Lease if applicable under such paragraph, the Minimum Rent and any Additional Rent payable hereunder shall abate beginning at the end of such two (2) business day period and ending when the respective portion is made usable. If only a portion of the space in the Leased Premises is made unusable, such abatement shall be based on the percentage that such unusable space constitutes of the total space in the Building. Tenant's notice with respect to such condition shall expressly reference its intention to abate rent and shall include a description of the nature of such deprivation and the space affected; if Landlord disputes Tenant's right to abate rent hereunder, Tenant shall have no right to withhold the payment of Rent until such dispute is settled by agreement of the parties or arbitration in accordance with Paragraph 59. 23. Alterations. (a) Tenant's Right to Make Alterations. Tenant, at its own cost and expense, shall have the right to make such alterations, restorations, replacements, improvements and installations ("Alterations") in, of or to the Leased Premises, interior or exterior, structural or non-structural, as Tenant deems necessary or desirable, but no Alterations shall (i) increase the exterior dimensions of the Building, or (ii) materially reduce the value of the Leased Premises or materially and adversely affect the building systems servicing the Building or Structure. Tenant's Work shall not be deemed Alterations, which shall be governed by the terms of Paragraph 14. In the event that Tenant removes any 17 33 portion of Landlord's Improvements, Tenant shall replace such with improvements or equipment of equal or greater value and quality of materials and construction, and such replacements shall be deemed the property of Landlord. The term "Alterations" shall not include any item which is a Tenant Fixture (as defined in subparagraph 24(a), below). All exterior or Structure alterations to the Building and Alterations that require or result in a change in the capacities with respect to heating, air conditioning and ventilation systems ("HVAC"), plumbing systems or electrical systems shall require Landlord's prior consent, which shall not be unreasonably withheld, conditioned or delayed. All Alterations with respect to installation of Tenant Fixtures on the roof or that require any Alteration to the roof shall be subject to the provisions of Paragraph 23(f). (b) Requirements for Alterations. Tenant, in making any Alterations, shall comply with all applicable laws, orders and regulations of federal, state, county and municipal authorities, and with any direction given by a public officer pursuant to law and with all regulations of any board of fire underwriters having jurisdiction and with the Declaration. Tenant shall obtain or cause to be obtained all building permits, licenses, temporary and permanent certificates of occupancy and other governmental approvals which may be required in connection with the making of Alterations. Landlord shall cooperate with Tenant in the obtaining thereof and shall execute any documents required in furtherance of such purpose. Tenant shall provide copies of proposed plans prepared by an engineer or architect licensed in the State of California, selected by Tenant, who may be an employee of Tenant, for all Alterations requiring Landlord's prior consent and, following completion of such Alterations, shall provide copies of and as-built plans; in addition, not less than annually, Tenant shall provide Landlord with as-built plans reflecting all Alterations completed by Tenant as of such date, except for cosmetic changes (including repainting, recarpeting and signage). No Alteration shall injure the safety of the Structure of the Building or diminish its value and all Alterations shall be done in a good and workerlike manner. All Alterations (other than cosmetic changes as described above or changes costing less than $50,000.00 in the aggregate as to changes being completed as a project) shall be conducted with plans prepared by an architect or engineer licensed in the State of California, selected by Tenant, who may be an employee of Tenant and whose scope of engagement shall be determined by Tenant within its business judgment. The work of all Alterations shall be prosecuted with reasonable dispatch, subject to Unavoidable Delays. Tenant shall procure or shall cause the contractor for the work to procure insurance in accordance with Sections 32 and 33, including worker's compensation insurance, covering all persons employed in connection with the work, before any work is begun. (c) Removal of Alterations. Any Alterations made by Tenant to the Leased Premises, except for replacement of any portion of Landlord's Work or the Building Fixtures and Equipment and except for standard suburban office tenant alterations completed in accordance with Paragraph 23(b) above, shall, at the option of Landlord, either remain as part of the Leased Premises or be removed therefrom at the expense of Tenant prior to the end of the Term; provided, however, that Tenant shall have the right, by notice to Landlord at the time consent is requested for Alterations (if applicable) or prior to commencement of Alterations (as to Alterations for which consent is not required), to request that Landlord acknowledge Landlord's election as to the respective Alterations at such time, in which event such election shall govern. Further, Landlord and Tenant agree that the Tenant Work shall 18 34 remain part of the Leased Premises at the end of the Term or upon earlier termination. In the event of any such removal, Tenant shall repair any damage to the Leased Premises caused by such removal (including the patching of holes in ceilings, floors, floor coverings and walls resulting from the removal of Alterations); however, Tenant shall not be obligated to restore the Leased Premises to its original condition or to remove standard suburban office tenant improvements. (d) Insurance Proceeds for Alterations. Insurance with regard to any Alterations shall be governed by the terms of Paragraph 36. (e) Mechanics Liens. (i) Satisfaction of Claims. In connection with the construction of Tenant's Work and any Alterations, Tenant shall cause the payment of all proper and valid invoices and charges of all contractors, subcontractors, suppliers, materialmen and similar parties who furnish services or materials in connection with the construction process. In the event, in connection with the construction of Tenant's Work and any Alterations, any party ever records a mechanic's lien to enforce any claim for services or materials alleged to have been provided in connection with the Leased Premises, Tenant shall cause the same to be released of record within thirty (30) days after the recordation thereof, and Tenant shall be liable to satisfy and cause a discharge of any such mechanic's lien claim. Notwithstanding the foregoing, Tenant shall have the right to contest any such mechanic's lien claim, provided that Tenant conducts such contest in a timely manner and with due diligence, and that Tenant provides Landlord with such security in connection therewith as Landlord may reasonably require. In the event Tenant loses any such contest, with all further rights of appeal having expired, Tenant shall satisfy the mechanic's lien claim in full prior to any foreclosure sale or other disposition of the Leased Premises in order to satisfy the claim. (ii) Posting. Prior to commencement of construction of the Tenant Work and thereafter prior to commencing any Alterations, if Landlord gives written notice requesting same, Tenant shall deliver notices to all contractors and subcontractors and post notices in accordance with applicable law, in locations that will be visible by parties performing any work, which notices shall state that Landlord is not responsible for the payment of such work and setting forth such other information as may be reasonably required pursuant to such statutory provisions. (f) Rooftop Rights. Tenant shall have the exclusive use of the rooftop of the Building, which Tenant may use for communications or related purposes or for the purpose of providing mechanical or other services to the Building consistent with such services commonly located in rooftop facilities of suburban office Buildings. Tenant's use of the rooftop will be subject to all applicable governmental requirements and the Declaration, and to the provisions of subparagraph 23(b). Tenant shall not make any use of the rooftop which would void or impair any warranty of the roof or of any other component of the Building. Tenant will not damage the roof or any other component of the Buildings in connection with the installation, maintenance or use of the rooftop, and should any such damage occur Tenant will promptly correct such damage at Tenant's sole cost and expense. At the expiration of the Term, Tenant will remove at its expense all facilities installed by 19 35 Tenant on the rooftop and all connecting lines (to the extent such lines are within utility chases constructed by Landlord) and will repair any damage resulting from such removal. Tenant shall receive no abatement of Rent for any period during which Tenant is prevented for any reason from using the rooftop facilities. Tenant shall indemnify, defend and save Landlord, its agents and employees harmless of and from all liability, loss, damage, costs or expenses, including reasonable attorneys' fees, on account of any claims of any nature whatsoever, including work performed, materials or supplies furnished, damage to the property, injury to persons or electronic interference caused by Tenant's use of the rooftop. 24. Tenant's Trade Fixtures. (a) Installation of Trade Fixtures. Tenant shall have the right, from time to time, throughout the Term of the Lease to install within the Leased Premises and to attach thereto any trade fixtures, equipment or other property ("Tenant Fixtures") whether owned by Tenant or by any subtenant, assignee, licensee or concessionaire of Tenant or leased by Tenant from another party ("Equipment Lessor"), deemed necessary by Tenant for the operation of its business within the Leased Premises. All Tenant Fixtures installed in or attached to the Leased Premises by Tenant shall remain the property of Tenant, or of any subtenant, assignee, licensee or concessionaire of Tenant, or of any Equipment Lessor; provided, however, that fixtures or equipment that are in replacement of any Landlord's Improvements shall not be deemed Tenant Fixtures but shall be deemed the property of Landlord and shall not be leased from another party. Tenant shall have the right from time to time during the Term of this Lease or at the expiration thereof either to leave any Tenant Fixtures which it caused to be attached to or located on the Leased Premises or to remove such Tenant Fixtures. In the event of such removal, Tenant agrees at its own cost and expense to repair any damage caused to the Leased Premises by such removal (including the patching of holes in ceilings, floors, floor coverings and walls resulting from such removal and the capping or otherwise sealing utility lines in accordance with applicable codes in such fashion that they can be reconnected to replacement equipment and fixtures, in accordance with industry standards); however, Tenant shall not be obligated to restore the Leased Premises to its original condition. Any Tenant Fixtures so left by Tenant at the end of the Term shall be deemed abandoned and become the property of the Landlord without payment or offset. (b) Waiver of Liens in Fixtures. In no event (including a default under this Lease) shall Landlord have any statutory or express contractual liens or lien rights in the Tenant Fixtures and Landlord agrees to execute and deliver to Tenant and Equipment Lessor, within ten (10) days after request therefor, any document (subject to Landlord's reasonable approval) required by Tenant or Equipment Lessor in order to evidence the foregoing; provided, however, that the foregoing shall not prevent Landlord from obtaining a judgment lien against Tenant's property, including Tenant's interest in Tenant Fixtures, following an Event of Default. 25. Surrender of Leased Premises. Tenant agrees that upon the expiration of the Term, or upon the sooner termination of this Lease, possession of the Leased Premises shall be surrendered to Landlord in the same condition and repair as Tenant is required to maintain the Leased Premises and Landlord's Improvements during the Term of this Lease, 20 36 ordinary wear and tear and damage by fire or other casualty excepted (subject to the provisions of Paragraphs 24 and 33) and shall surrender all keys to the Building, and every part thereof, to Landlord and all fixtures necessary to the operation of the Building as a building, including, without limitation, all heating, ventilation and air conditioning equipment and machinery, pipes, ducts, compressors, hardwood floors, wall-to-wall carpeting, and installed landscaping equipment. At the time of surrender, Tenant shall inform Landlord of all combinations on locks, safes and vaults, if any, in the Building and the Leased Premises. Tenant's obligation to observe or perform this covenant shall survive the expiration or termination of the Term. 26. Property in the Leased Premises. In no event whatsoever shall Landlord be liable to Tenant for any loss or damage to personal property which may at any time be in the Leased Premises. Landlord shall not be responsible or liable to Tenant for any loss or damage resulting to Tenant or its property from water, gas, steam, fire, or the bursting, stoppage or leaking of sewer pipes, or from the heating or plumbing fixtures, or from electric wires, or from gas or odors, or from roof leaks, or caused in any manner whatsoever. 27. Landlord's Access to Leased Premises. Tenant shall permit Landlord, upon at least one (1) business day's prior notice (and with only such notice, if any, as may be reasonable in case of emergency), to enter upon the Leased Premises during business hours or such other times as Tenant shall reasonably determine (or at any time in case of emergency). (a) to make repairs, changes, replacements and restorations to the Leased Premises which are required hereunder to be made by Landlord; (b) during the Lease Year preceding the Expiration Date (after Tenant has waived or no longer has any Renewal Option) or following an Event of Default, to exhibit the Leased Premises to prospective tenants, provided that Landlord shall not unreasonably interfere with the conduct of business therein; and (c) to inspect the Leased Premises or to exhibit the Leased Premises to prospective owners or lenders or their representatives. 28. Zoning, Land Use Regulations, Utilities and Compliance with Laws, Ordinances, and Requirements of Public Authorities. (a) Zoning and Building Laws. Landlord has provided Tenant with a copy of a Final Decision of the Zoning Administrator dated April 18, 1997, evidencing the existing zoning applicable to the Leased Premises. Prior to the execution hereof, Tenant shall have had the right to verify that the applicable building, zoning, subdivision or other land use and planning codes, statutes, ordinances and regulations ("Zoning and Building Laws") and the Declaration permit the use of the Leased Premises for the operation of a general purpose office building, including, without limitation, an office building for the origination, processing and servicing of mortgage loans and the parking of motor vehicles in connection therewith. 21 37 (b) Permits; Compliance with Governmental Requirements. (i) Landlord, at its sole cost and expense, shall obtain or cause to be obtained prior to the commencement of construction hereunder, all permits, licenses, and other approvals ("Permits"), with all applicable appeal periods having expired and in final, irrevocable and uncontestable form, necessary and required by all federal, state, and municipal governments, courts, departments, commissions, boards, any architectural control or similar body whose approval is required pursuant to the Declaration (the "Authorities"), for the lawful construction of Landlord's Work (other than certificates of occupancy or similar permits which may only issue upon completion of construction). To the extent that Permits for construction of Landlord's Work also require simultaneous submission or approval of some or all Permits for Tenant's Work (as referred to in subparagraph (ii) below), Tenant shall cooperate with Landlord in submitting plans and applications for and obtaining such Permits in accordance with Landlord's schedule for completion of Landlord's Work. (ii) To the extent not included in the Permits obtained under Paragraph 28(b)(i), Tenant, at its sole cost and expense, shall obtain or cause to be obtained prior to the commencement of construction of Tenant's Work hereunder, all Permits, with all applicable appeal periods having expired and in final, irrevocable and uncontestable form, necessary and required by all Authorities, for the lawful construction of Tenant's Work (other than certificates of occupancy or similar permits which may only issue upon completion of construction). (iii) Subject to Tenant's right to contest by appropriate proceedings diligently conducted in good faith, throughout the term of this Lease, Tenant, at its sole cost and expense, shall promptly remove any violation and shall promptly comply with all requirements of all Authorities, foreseen or unforeseen, ordinary as well as extraordinary, which may be applicable to the Leased Premises, or any part thereof, or to the use or manner of use of the Leased Premises, or any part thereof (collectively, the "Requirements"); except that Landlord shall be responsible for such removal and compliance to the extent the same are attributable to original construction defects in workmanship or materials in Landlord's Work, relate to or require work constituting structural maintenance or alterations for which Landlord is responsible hereunder, or result from the acts or omissions of Landlord, its agents or employees or from Landlord's failure to perform any of its other obligations under this Lease. (c) Utility Services. Landlord shall complete lines, facilities and services for Utilities (as defined in subparagraph 21(a), above) (including, without limitation, storm sewer), to the extent provided in the Final Plans and Specifications. Landlord shall also grant such easements and licenses on the Leased Premises as Tenant may reasonably request in order to provide additional Utilities to the Leased Premises, which easements and licenses shall be subject to Landlord's prior written approval, which approval shall not be unreasonably withheld or delayed. Tenant shall bear all costs of drafting, preparing and recording the necessary easement instruments (excluding Landlord's costs of review). Landlord shall have no responsibility for the interruption or failure to provide Utilities to the Leased Premises, but Landlord shall reasonably cooperate with Tenant in the event that 22 38 Tenant requests Landlord's assistance in obtaining the resumption of Utilities following an interruption in service. 29. Assignment and Subletting. (a) Assignment. (i) Except as provided in Paragraph 29(c), Tenant shall not assign or transfer this Lease, or any interest in this Lease without, in each case, first obtaining the prior consent of the Landlord, which consent may be granted or withheld in Landlord's sole and absolute discretion. (ii) If Tenant attempts to make any assignment without the requisite consent of the Landlord (to the extent required under paragraph (a)(i) above), such assignment shall be void and such occurrence shall be deemed an Event of Default. Notwithstanding any assignment, Tenant shall remain primarily liable for the full performance of the terms, conditions and obligations under this Lease. (b) Subletting. (i) Tenant shall have the right to sublet all or any portion or portions of the Leased Premises without Landlord's consent subject to the following provisions. Tenant shall give Landlord notice of any subletting in accordance with the following: (A) not less than thirty (30) days prior written notice of any subletting of the entirety or substantially all of the Premises and (B) notice of any other subleases from time to time upon request from Landlord. Notice to Landlord under (A) and (B) shall include the name of the subtenant, the uses to be permitted under the sublease (which uses must be permitted under the terms of Paragraph 17), and the terms of the sublease; in addition, notice under (A) above shall include information on the financial capabilities of the subtenant. (ii) If Tenant breaches its obligation to deliver notice of a subletting in accordance with Paragraph (b)(i) above, there shall be deemed an Event of Default if Tenant thereafter fails to cure such breach by delivery of the required notice within five (5) days of receipt of notice from Landlord. Any consent by Landlord to any assignment of this Lease or the occurrence of any sublease of the Leased Premises without the required notice, if any, shall not constitute a waiver by the Landlord of the provisions of this Paragraph as to subsequent transactions of the same or similar nature. Notwithstanding any sublease authorized under the provisions of this Paragraph 29(b), Tenant shall remain primarily liable for the full performance of the terms, conditions and obligations under this Lease. (c) Permitted Assignment/Subletting. Notwithstanding anything to the contrary contained hereinabove, Tenant shall have the right, without obtaining Landlord's prior written consent, to assign or sublease all or any portion or portions of the Leased Premises to the following parties on the following conditions: 23 39 1. Advanta Corp., a Delaware corporation ("Advanta Corp."), Advanta Mortgage Holding Corp., a Delaware corporation ("Advanta Holding"), or subsidiary or affiliate of Tenant, Advanta Corp. or Advanta Holding, provided Tenant, Advanta Corp. or Advanta Holding owns a controlling interest in such affiliate or subsidiary; 2. Any corporation into which Tenant may be merged or consolidated or which purchases all or substantially all of the assets or stock of Tenant; and provided that: (A) Any such assignee or any subtenant of all or of substantially all of the Leased Premises shall assume and be bound by all obligations of Tenant for payment of all amounts of rental and other sums and the performance of all covenants required by Tenant pursuant to this Agreement; and (B) Any such subtenant and/or assignee intends, and is required by the terms of such assignment or sublease, to operate the Leased Premises in accordance with the usage restrictions of this Lease. Tenant shall give Landlord notice of any assignment or subletting under this Paragraph 29(c) in accordance with the following: (i) Tenant shall give Landlord not less than thirty (30) days prior written notice of any subletting of the entirety or substantially all of the Premises or any assignment of this Lease, and (ii) from time to time upon request from Landlord Tenant shall notify Landlord with respect to all other subleases. Notice to Landlord under (i) and (ii) shall include the name of the assignee/subtenant, the uses to be permitted under the sublease (which uses must be permitted under the terms of Paragraph 17), copies of the documents evidencing such transaction, and such evidence as Landlord may reasonably require to establish that such transaction falls within the terms and provisions of this Paragraph 29(c); in addition, notice under (i) above shall include information on the financial capabilities of the assignee/ subtenant. If Tenant breaches its obligation to deliver notice of a subletting or assignment in accordance with (i) or (ii) above, there shall be deemed an Event of Default if Tenant fails to cure such breach by delivery of the required notice within five (5) days after notice from Landlord. In all events, Tenant shall remain primarily liable for the full performance of the terms, conditions and obligations under this Lease notwithstanding any subletting or assignment permitted under this Paragraph 29(c). 30. Holdover. If Tenant continues to occupy the Leased Premises after the last day of any Renewal Period or after the last day of the Initial Term if this Lease is not extended, and Landlord elects to accept rent thereafter, a tenancy from month to month, terminable by either party on not less than one (1) month's notice, shall be created, which shall be upon the same terms and conditions, including rent (except that the Minimum Rent shall be an amount equal to 150% of the monthly payment of Minimum Rent applicable immediately prior to such holdover period), as those herein specified, except only as to the term of this Lease. 24 40 31. Indemnification of Landlord and Tenant. (a) Tenant's Indemnification of Landlord. Tenant covenants and agrees that it will protect, defend, save and keep Landlord harmless and indemnified against and from any and all claims of third parties (including Tenant's agents and employees but excluding agents and employees of Landlord) with respect to personal injuries, penalties or damages or charges, including reasonable attorneys' fees: (i) imposed for any violations by Tenant of any Requirements applicable to the Leased Premises for which Tenant is responsible under the terms of this Lease, (ii) arising out of or from any accident or other occurrence on the Leased Premises following the Rent Commencement Date causing injury to Tenant, Tenant's property or any other person or property whomsoever or whatsoever, (iii) arising out of any failure of Tenant in any respect to comply with and perform Tenant's covenants and obligations under this Lease, (iv) arising out of any work or thing done in or on the Leased Premises by Tenant, its agents, employees and contractors, or (v) arising out of any work or thing done in or on the Leased Premises following the Rent Commencement Date, except that Tenant will not protect, defend, save and keep Landlord harmless and indemnified against and from any of the above claims of third parties caused by the negligence of Landlord or its agents, contractors, or employees. (b) Landlord's Indemnification of Tenant. Landlord covenants and agrees that, from and after the commencement of the Initial Term until the date on which Substantial Completion occurs, Landlord will protect, defend, save and keep Tenant harmless and indemnified against and from any and all claims of third parties (excluding agents and employees of Tenant) with respect to personal injuries, penalties or damages or charges, including reasonable attorneys' fees: (i) imposed for any violations of any Requirements applicable to the Leased Premises for which Landlord is responsible under the terms of this Lease, (ii) arising out of or from any accident or other occurrence on or about the Leased Premises, causing injury to any person, caused by the negligence of Landlord or its agents, or employees, or (iii) arising out of any work or thing done in, on or about the Leased Premises or any part thereof by Landlord, its agents, employees and contractors; except that Landlord will not protect, defend, save and keep Tenant harmless and indemnified against and from any of the above claims of third parties caused by the negligence of Tenant or its agents, contractors, licensees, invitees, or employees. 32. Liability Insurance. (a) Tenant to Maintain Liability Insurance. (i) Tenant, at all times from and after the date on which Tenant commences Tenant's Work, at its sole cost and expense, shall maintain commercial general public liability insurance ("Tenant's Liability Insurance") written on an occurrence form with coverage at least as broad as ISO CGL form CG 00 01 covering any and all claims for injuries or death to persons or property arising in or upon the Leased Premises with combined single limit of One Million Dollars ($1,000,000.00) per occurrence and Two Million ($2,000,000.00) annual aggregate per location for bodily injury, property damage, personal injury and advertising injury, with Five Million Dollars excess coverage. Such maximum's shall be subject to increase from time to time upon request of Landlord based on 25 41 changed economic conditions and the amount of coverage maintained by owners of similar buildings in San Diego County, California. Certified copies of policies or certificates, in a form approved by Landlord evidencing Tenant's Liability Insurance together with evidence of payment therefor, shall be deposited with Landlord not less than three (3) business days prior to the date of the commencement of Tenant's Work. Upon Landlord's substantial completion of Landlord's Work, Tenant's Liability Insurance shall be deemed primary. (ii) The policy for Tenant's Liability Insurance shall contain the following provisions: (A) Tenant's obligations pursuant to subparagraph 31(a), above are insured as a contractual obligation; and (B) A sixty-day notice of cancellation of insurance to Landlord and Landlord's Mortgagee. (C) Landlord and Landlord's Mortgagee shall be named as additional insureds on Tenant's Liability Insurance contract with respect to occurrences in, on or around the Leased Premises. (D) Coverage for premises and operations, products and completed operations on an "if any" basis, independent contractors and blanket contractual liability for all written and oral contracts. (iii) Tenant, if it so elects, may carry Tenant's Liability Insurance under a primary public liability insurance policy or under a combination public liability and umbrella liability insurance policy. (iv) In addition to the above, Tenant shall provide and keep in force with respect to any of its employees performing work on the Leased Premises, worker's compensation insurance coverage as may be required by the statutes of the State of California, or any applicable federal or municipal laws or regulations in effect at any time during the Term and employers' liability coverage, and Tenant shall not permit any contractor or any subcontractor to perform any work or services on the Leased Premises without furnishing evidence that adequate worker's compensation insurance coverage is in force and effect as required by California law. (v) Tenant's contractors completing Tenant's Work or any Alterations, and all subcontractors shall maintain commercial general liability insurance and worker's compensation insurance as provided above, naming Tenant, Landlord and Landlord's Mortgagee as additional insureds. (b) Landlord to Maintain Liability Insurance. (i) Landlord, at all times during the Initial Term and any Renewal Periods, at its sole cost and expense, shall maintain commercial general public liability insurance ("Landlord's Liability Insurance") written on an occurrence form with coverage at 26 42 least as broad as ISO CGL form CG 00 01 covering any and all claims for injuries or death to persons or property arising in or upon the Leased Premises with combined single limit of One Million Dollars ($1,000,000.00) per occurrence and Two Million ($2,000,000.00) annual aggregate per location for bodily injury, property damage, personal injury and advertising injury, with Five Million Dollars excess coverage. Certificates of insurance evidencing Landlord's Liability Insurance, and including the provisions set forth below, together with evidence of payment therefor, shall be deposited with Tenant prior to the commencement of the Initial Term of this Lease. (ii) The policy for Landlord's Liability Insurance shall contain the following provisions: (A) Landlord's obligations pursuant to subparagraphs 31(b) and (c), above are insured as a contractual obligation; and (B) A sixty-day notice of cancellation of insurance to Tenant. (iii) Landlord, if it so elects, may carry Landlord's Liability Insurance under a primary public liability insurance policy or under a combination public liability and umbrella liability insurance policy. 33. Fire and All Risk Insurance. (a) Landlord to Maintain Builders Risk Insurance. Landlord, at all times until Substantial Completion of Landlord's Work, at its sole cost and expense, shall maintain Completed Value Form "All Physical Loss" Builder's Risk Coverage on Landlord's Work ("Landlord's Fire Insurance") in a nonreporting form, including an Occupancy endorsement, against loss by fire, lightning, flood and earthquake, and the perils of the all risk endorsement covering the Leased Premises, with business income coverage equal to not less than one year's Minimum Rent hereunder and with coinsurance waived. The policies effecting Landlord's Fire Insurance shall contain the following endorsements: (i) An endorsement providing for sixty (60) thirty notice of cancellation of insurance or of decrease in insurance coverage to Tenant; (ii) An endorsement whereby the insurer acknowledges that Landlord has waived any and all rights of recovery against Tenant and any other occupant(s) of the Leased Premises and their agents and employees for damage or destruction to any or all of the buildings and improvements, including, without limitation, the Building, on and in the Leased Premises, whether or not caused by acts or negligence of Tenant or said occupant(s) or any of their agents or employees; and (iii) An endorsement whereby the insurer waives all rights of subrogation against Tenant and any other occupant(s) of the Leased Premises and any of their agents or employees. 27 43 (b) Tenant to Maintain Property Insurance. (i) Tenant, at all times from and after the date on which Tenant commences Tenant's Work (but not later than Landlord's Substantial Completion of Landlord's Work) until such time as Tenant's Work is substantially completed and Tenant has taken occupancy of the Leased Premises, at its sole cost and expense, shall maintain Completed Value Form "All Physical Loss" Builder's Risk Coverage on Tenant's Work ("Tenant's Builder's Risk Insurance") flood and earthquake, and the perils of the all risk endorsement covering the Leased Premises, with business income coverage equal to not less than one year's Minimum Rent hereunder and with coinsurance waived. Alternatively, subject to Landlord's approval, Landlord and Tenant shall jointly require the contractor completing Landlord's Work and Tenant's Work (the "Contractor") to maintain Completed Value Form "All Physical Loss" Builder's Risk Coverage on both Landlord's Work and Tenant's Work, which coverage shall be maintained until Tenant's Work is substantially completed and Tenant's Property Insurance coverage commences; in that event, the cost of such insurance shall be prorated between the parties based on the proportionate value of Landlord's Work and Tenant's Work. (ii) In addition, Tenant, at all times from and after the date on which Substantial Completion of Landlord's Work occurs shall provide property insurance coverage at least as broad as ISO Special Form Coverage against risks of direct physical loss or damage (commonly known as "all risk"), insuring the Building and the Improvements for the Full Replacement Cost thereof, and including business income insurance, including insuring Landlord's loss of rents (including all Minimum Rent, Real Estate Taxes, operating expenses and other charges required to be paid by Tenant for not less than a 12-month period) ("Tenant's Property Insurance"). If the Contractor maintains builders risk insurance jointly for Landlord's Work and Tenant's Work (as referred to in Paragraph 33(b)(i) above), then Tenant shall have the right to delay coverage under Tenant's Property Insurance until Tenant's Work is substantially completed, i.e., during the period that such joint builder's risk insurance covers the Leased Premises. (c) Provisions of Policies. (i) The amount of Tenant's Property Insurance shall be not less than the greater of (A) one hundred percent (100%) of the Full Replacement Cost (as defined in this subparagraph (b)) of the Building, including all Alterations thereof, and all other buildings and improvements on and in the Leased Premises required to be insured hereunder, providing for an Agreed Amount endorsement and no deductible in excess of $10,000.00 (except a customary deductible for earthquake not to exceed that permitted by Landlord's Mortgagee), and (B) an amount sufficient to prevent Tenant from becoming a co-insurer within the terms of the applicable policies of Landlord's Fire Insurance. 28 44 The term "Full Replacement Cost" means the cost of replacing the Building, including all Alterations thereof, and all other buildings and improvements on and in the Leased Premises required to be insured hereunder. Such Full Replacement Cost shall be determined from time to time (but not more frequently than once in any twelve (12) calendar months) at the request of either party by an insurer or by an appraiser, engineer, architect or contractor designated by Landlord and approved in writing by Tenant and paid by Tenant. No omission on the part of a party to request any such determination shall relieve Tenant of any of its obligations under this Paragraph 33. Each policy of Tenant's Property Insurance shall contain a "Replacement Cost Endorsement". (ii) Tenant's Property Insurance shall include: "Ordinance or Law Coverage" or "Enforcement" endorsement if any of the improvements or the use of the Leased Premises shall constitute non-conforming structures or uses; boiler and machinery if reasonably required by Landlord; earthquake and flood coverage; deletion of the exclusion for foundations and other underground property and such other or additional coverages as may be reasonably required by Landlord's Mortgagee. (iii) All policies of Tenant's Property Insurance and Tenant's Builder's Risk Insurance shall provide that Tenant and Landlord are named as insureds, as their interests may appear, and the proceeds of any loss shall be payable to Landlord and Tenant and to Landlord's Mortgagee so long as such Mortgagee is obligated to apply proceeds of insurance to rebuild in the manner provided for in this Lease. Tenant's Builder's Risk Insurance and Tenant's Property Insurance shall identify Landlord's Mortgagee under a mortgagee (non-contributory) endorsement reasonably satisfactory to Landlord's Mortgagee. (d) Waiver of Liability. Each party, on behalf of itself and anyone claiming through or under it by way of subrogation or otherwise, hereby waives all rights to recovery against the other and against any other occupant(s) of the Leased Premises and any of their agents and employees and Landlord's Mortgagee for damage or destruction to any property of such party, including, without limitation, the Building, on and in the Leased Premises arising out of fire or other casualty whether or not caused by acts or negligence of the aforementioned persons, or anyone for whom said persons may be responsible. (e) Evidence of Coverage. Not later than thirty (30) days prior to the date that Tenant's Builder's Risk Insurance and Tenant's Property Insurance is required to be effective under this Paragraph, Tenant shall provide Landlord and Landlord's Mortgagee with Certified copies of policies or certificates, in a form approved by Landlord evidencing Tenant's Builder's Risk Insurance and Tenant's Property Insurance together with evidence of payment therefor, shall be deposited with Landlord and Landlord's Mortgagee. In addition, Landlord shall deliver to Tenant renewal policies or certificates thereof not later than thirty (30) days prior to the expiration of any policies which Landlord is required to, or elects to, carry hereunder. Notwithstanding anything in Paragraph 43 to the contrary, Landlord shall have the following remedies in the event Tenant fails to maintain the insurance required under this Paragraph 33: (i) Tenant's failure shall be deemed an Event of Default under this Lease if, within five (5) days after written notice from Landlord, Tenant fails to provide Landlord with reasonable evidence that Tenant has obtained the requisite insurance policies; 29 45 or (ii) Landlord may immediately purchase the required insurance policies on Tenant's behalf and charge Tenant the premium together with a ten percent (10%) handling charge payable within ten (10) days after invoice. 34. Intentionally Omitted. 35. General Insurance Requirements. All insurance provided for in this Lease shall be effected under valid and enforceable policies issued by insurers of recognized responsibility which are licensed to do business in the State of California and approved by Landlord in the good faith exercise of its discretion. The insurance companies must have a general policy rating of A or better and a financial class of VIII or better by A.M. Best Company, Inc. and a claims paying ability of BBB or better according to Standard & Poors. To the extent that the types of insurance coverages described in Paragraphs 32 or 33 are no longer available, there shall be substituted, at the request of Landlord or Tenant, such equivalent coverage as may then be available consistent with coverages maintained by owners of similar buildings in San Diego County, California and consistent with the reasonable requirements of Landlord's Mortgagee. Any dispute with regard to such coverages shall be subject to arbitration. 36. Damage or Destruction. (a) Destruction. If the Leased Premises and the Building and improvements thereon, or any part thereof, are damaged or destroyed by fire, the elements or other casualty (any such damage or destruction being herein called "Casualty Damage"), Tenant shall diligently proceed to restore the property, including the Building and all Alterations thereto, subject to the Casualty Damage at Tenant's cost to a condition as near as possible to that in which such property was immediately prior to the Casualty Damage. If Tenant for any reason whatsoever fails to commence (or cause the commencement of) such restoration work within nine (9) months from the date when the Casualty Damage occurred or fails thereafter to complete such work (or cause the same to be so completed) within the time periods set forth below, Landlord, in addition to such other rights and remedies as may be accorded Landlord by law, shall have the right and option to terminate this Lease by giving Tenant written notice of Landlord's election to do so any time prior to the completion of such work, provided Tenant shall not then be actively undertaking such restoration work, and upon such notice being given, the Term of this Lease shall automatically terminate and end pursuant to the provisions of subparagraph 45(b), below. If the Casualty Damage is partial, Tenant shall complete such restoration work within eighteen (18) months after the Casualty Damage. If the Casualty Damage is total, Tenant shall complete such restoration work within twenty-four (24) months after the Casualty Damage. If Tenant fails to do so, Landlord shall have the right and option to terminate this Lease by written notice to Tenant, upon said deadline dates for completion of restoration and upon said notice being given, the Term of this Lease shall automatically terminate and end pursuant to the provisions of subparagraph 45(b), below. In addition to Landlord's rights and remedies set forth above in this subparagraph (a), if Tenant fails to commence or complete the restoration work to the Leased Premises within the time periods set forth above in this subparagraph (a), Landlord shall have the right to perform said restoration work to the Leased Premises and bill Tenant for the same. 30 46 (b) Changes in Leased Premises. If Tenant is required to restore the Leased Premises in accordance with subparagraph (a) above, Tenant shall have the right to make changes in the Leased Premises in the course of such restoration, subject to the provisions of Paragraph 23. If the cost of restoration of the Leased Premises is increased by any change or changes made by Tenant, then Tenant shall pay the amount by which the cost of restoration exceeded what the cost of restoration of the Leased Premises would have been, had the Leased Premises been restored to substantially the same condition as existed immediately preceding the Casualty Damage. (c) Damage to Leased Premises; Abatement of Rent. If the Casualty Damage renders the Leased Premises unfit for Tenant's normal business purposes, and Tenant by reason thereof discontinues business on the Leased Premises, the Minimum Rent and Additional Rent payable by Tenant hereunder, shall be suspended for the period during which the same are not fit for such business purposes to the extent, and only to the extent, of Landlord's recovery under the rent loss coverage of the business income insurance maintained for Landlord's benefit; and if the Casualty Damage renders only part of the Leased Premises unfit for Tenant's normal business purposes, and Tenant elects to operate its business upon the remaining part, then the Minimum Rent and Additional Rent payable by Tenant hereunder shall be apportioned on a per square foot basis and the proportion thereof applicable to each part of the Leased Premises upon which Tenant discontinues its business operations shall be abated, but only to the extent of Landlord's recovery under the rent loss coverage of the business income insurance maintained for Landlord's benefit, for the period during which such part is not fit for Tenant's normal business purposes or during which Tenant discontinues business operations. If Tenant has paid Minimum Rent or Additional Rent, in advance, Landlord shall immediately repay to Tenant an amount equal to that portion of such payments which is abated and covered by such loss of rents insurance. (d) Arbitration. In the event that Landlord and Tenant are unable to agree as to the extent of any abatement or as to any other issue under this Paragraph 36, the matter shall be resolved by arbitration pursuant to the provisions of Paragraph 59, below. (e) Application of Insurance Proceeds. In the event that the Leased Premises, or any part thereof, are required to be restored as provided in this Paragraph 36, insurance proceeds from Tenant's Property Insurance (maintained pursuant to Paragraph 33, above), shall be applied in full to such restoration, exclusive of loss of rents coverage to be paid to Landlord and other business income insurance payable to Tenant. Such insurance proceeds shall be deposited in trust with a savings bank, bank or trust company acceptable to Landlord and under control of Landlord and Tenant, as trustee, or, if Landlord's Mortgagee which is the holder of the first mortgage, if any, on the Leased Premises shall be a savings bank, bank, trust company or insurance company, such proceeds shall be deposited in trust with such holder, as trustee, and shall be held and disbursed for restoration as provided in this Lease. The trustee shall disburse the insurance proceeds to Tenant upon certification by Tenant, together with such other evidence as the trustee may reasonably require, that the amounts requested either shall have been paid in connection with the restoration or shall be due to contractors, subcontractors, materialmen, architects or other persons who have rendered services or have furnished materials for restoration, and upon completion of restoration, the remaining balance, if any, of such proceeds shall be paid to Landlord upon 31 47 demand or retained by the first mortgagee. In the event that the insurance proceeds are insufficient to pay the entire cost of restoration pursuant to this Paragraph, Tenant shall pay the deficiency without delay. (f) Damage During Last Year. In the event of any Substantial Casualty Damage to the Leased Premises within the last year prior to the expiration of the Initial Term or any Renewal Period, and upon the failure of Tenant to exercise a Renewal Option for a subsequent Renewal Period, Landlord shall have the right to elect not to restore such Casualty Damage, in which event, Landlord shall raze the damaged portion and put the same in good order by paving or landscaping. The term "Substantial Casualty Damage" means any Casualty Damage which reasonably shall cost more than Five Hundred Thousand Dollars ($500,000.00) to repair or restore. In the event Landlord elects not to restore such Substantial Casualty Damage, Tenant shall have the right to terminate this Lease (by delivering written notice of termination to Landlord within thirty (30) days after the casualty) and with Minimum Rent and Additional Rent, prorated to the date of the Casualty Damage and with the date of termination being no later than thirty (30) days after such notice is given. Upon said termination, Landlord and Tenant shall be released from all further obligations thereafter accruing; but such termination shall, in no event, release either party from any liability to the other which has accrued prior to such termination. Alternatively, in the event Landlord elects not to restore such Substantial Casualty Damage and Tenant elects not to terminate this Lease, Minimum Rent and Additional Rent shall be suspended for the period during which the Leased Premises are not fit for business purposes, but only to the extent of Landlord's recovery under the rent loss coverage of the business income insurance maintained for Landlord's benefit; and if the Casualty Damage renders only part of the Leased Premises unfit for Tenant's normal business purposes and Tenant elects to operate its business in the remaining part, then the Minimum Rent and Additional Rent shall be apportioned on a per square foot basis and the proportion thereof applicable to each part of the Leased Premises upon which Tenant discontinues its business operations shall be abated, but only to the extent of Landlord's recovery under the rent loss coverage of the business income insurance maintained for Landlord's benefit, for the period during which such part is not fit for Tenant's normal business purposes or during which Tenant discontinues business operations. If Tenant has paid Minimum Rent or Additional Rent in advance, Landlord shall immediately repay to Tenant an amount equal to that portion of such payments which is abated and covered by such loss of rents insurance. 37. Eminent Domain. (a) Complete Taking. If the whole of the Leased Premises shall be taken under the power of eminent domain by any public, quasi-public or private authority (the "Taking"), then this Lease shall terminate or expire as of the date of such Taking, and any Minimum Rent and Additional Rent due hereunder, if any, paid in advance, for a period after such date of termination shall be refunded immediately by Landlord to Tenant. Upon said termination, Landlord and Tenant shall be relieved of and released from all further obligations thereafter to accrue hereunder; but such termination shall, in no event, relieve or release either party from any liability to the other which has accrued prior to the termination of this Lease, including, but not limited to, Landlord's obligation to pay to Tenant all or any portion of Landlord's Contribution (as defined in Paragraph 13, above) for costs and 32 48 expenses incurred by Tenant prior to termination to which Tenant may be entitled in accordance with that Paragraph. (b) Partial Taking. In the event of a permanent Taking of ten percent (10%) of the usable area of the Building, or in the event of a Taking resulting in a reduction of twenty percent (20%) or more of the automobile parking spaces (unless Landlord provides within ninety (90) days after the Taking adequate and sufficient additional contiguous parking areas in substitution therefor), Tenant may elect to terminate this Lease by giving notice of termination to Landlord on or before the date which is ninety (90) days after receipt by Tenant of notice that the Taking or denial or diminishing of access shall have occurred. Any notice of termination shall state the date of termination, which date of termination shall be not more than thirty (30) days after the date on which such notice of termination is given to Landlord, and (i) upon the date specified in such notice of termination this Lease and the term hereof shall cease and expire, and (ii) any Minimum Rent or Additional Rent due hereunder, paid in advance, for a period after such date of termination shall be refunded by Landlord to Tenant. Upon said termination, Landlord and Tenant shall be relieved of and released from all further obligations thereafter to accrue hereunder; but such termination shall, in no event, relieve or release either party from any liability to the other which has accrued prior to the termination of this Lease, including, but not limited to, Landlord's obligation to pay to Tenant all or any portion of Landlord's Contribution (as defined in Paragraph 13, above) for costs and expenses incurred by Tenant prior to termination to which Tenant may be entitled in accordance with that Paragraph. (c) Abatement of Rent. In the event that any part of the Leased Premises, shall be so Taken or diminished and Tenant elects not to terminate this Lease, then commencing upon the date of vesting of title or of the event of said Taking, whichever occurs earlier, the Minimum Rent and Additional Rent payable by Tenant hereunder shall abate so that such Rent payable immediately after the Taking shall bear the same ratio to the Rent payable immediately before the Taking as the value of the Leased Premises remaining after the Taking bears to the value of the Leased Premises immediately before the Taking; provided, however, there shall be no abatement of rent unless usable square footage of the Building is Taken or parking spaces are Taken for which adequate and sufficient substitute parking spaces are not provided. If Landlord shall be obligated to perform restoration work under the provisions of this Paragraph 37, and if Tenant is deprived of the use of the Leased Premises during the performance by Landlord of the restoration work the Minimum Rent and Additional Rent payable by Tenant hereunder shall be suspended until such restoration work on the Leased Premises and access thereto shall have been completed, apportioned on a per square foot basis and the proportion thereof applicable to each part of the Leased Premises upon which Tenant discontinues its business operations shall be abated for the period during which such part is not fit for Tenant's normal business purposes. If the parties cannot agree upon the amount by which such Rent is to be abated, the same shall be submitted to and 33 49 determined on the basis above provided by arbitration pursuant to the provisions of Paragraph 59, below. (d) Restoration. In the event that any part of the Leased Premises shall be so taken and Tenant elects not to terminate this Lease, then Landlord shall restore the Building, including Tenant's Alterations and Tenant Fixtures, to a complete unit as similar as is reasonably possible in design, character and quality to the building which existed before such Taking. In the event that any part of the parking area or access thereto, shall be so taken or diminished and Tenant elects not to terminate this Lease, then Landlord shall restore the parking areas and the access thereto, as nearly as reasonably possible, to the condition they were in prior to such Taking. The award or payment for the Taking paid to Landlord shall be used by Landlord for said restoration and Landlord shall promptly commence and with due diligence continue to restore the Leased Premises after the Taking; Landlord shall not be obligated to expend any sums in excess of such award or payment for the purpose of said restoration. In the event that Landlord fails to commence said restoration within two (2) months after the Taking or in the event Landlord fails to complete said restoration within six (6) months after the Taking and is not actively and diligently proceeding with the restoration work, subject to Unavoidable Delays, Tenant shall have the option of terminating this Lease by notifying Landlord of its election to do so after the expiration of said two (2) month or six (6) month period, as the case may be (as such deadlines may be extended by Unavoidable Delay), and upon such notice being given the term of this Lease shall automatically terminate and end pursuant to the provisions of subparagraph 45(c), below. (e) Claims for Awards. In the event of a Taking resulting in the termination of this Lease, the parties hereto agree to cooperate in applying for and in prosecuting any claim for compensation for such Taking and further agree, that the aggregate net award, after deducting all expenses and costs, including attorneys' fees, incurred in connection therewith, shall be paid in the following order: (i) First, Landlord shall receive the entirety of the award for the Leased Premises, including the Building, and the Building Fixtures and Equipment but exclusive of Tenant Fixtures Taken and exclusive of Alterations (other than Alterations or replacements or substitutions for items of Landlord's Improvements). (ii) Second, Tenant shall have the fight to receive any relocation damages separately afforded tenants under California laws as well as the right to receive compensation or damages for Tenant Fixtures and Alterations (in accordance with subparagraph (f) below). Provided, however, that Tenant shall waive all damages which shall diminish Landlord's right to recover for its interests as provided in subparagraph (i) above. If the condemning authority shall refuse to permit separate claims to be made, then and in that event Landlord shall prosecute, with counsel satisfactory to Tenant and Landlord, the claims of both Landlord and Tenant, and the proceeds of the award shall be divided between Landlord and Tenant in accordance with the foregoing provisions. (f) Claims for Costs of Alterations. Tenant may make a claim in the condemnation proceedings on account of a Taking for the value of any Tenant's Improvements and Alterations made to or erected on the Leased Premises by Tenant or of 34 50 any Tenant Fixtures Taken placed upon or installed in the Leased Premises by Tenant (other than Alterations that are replacements or substitutions for items of Landlord's Improvements). The value of such Tenant's Improvements, Alterations and Tenant Fixtures shall be the unamortized value based on the total amount of Tenant's expenditures for such items multiplied by a fraction, the numerator of which shall be the lesser of (x) the number of years between the date of the Taking and the last day of the Term of this Lease, including all Renewal Periods, regardless of whether Tenant shall have exercised Renewal Options therefor, and the denominator of which shall be the number of years between the date(s) of Tenant's Expenditures and the last day of the term of this Lease, including all Renewal Periods, regardless of whether Tenant shall have executed Renewal Options therefor; in no event, however, shall the value of such Tenant's Improvements, Alterations and Tenant Fixtures for which Tenant may be entitled hereunder exceed the positive difference, if any between (i) the total award on account of such Taking and (ii) the then-current actual value of Landlord's Improvements determined based on then-current standard appraisal methods. In the event Landlord's award does not specify the amount attributable separately to the value of Landlord's Improvements and such Tenant's Improvements, Alterations and Tenant Fixtures, and Landlord and Tenant cannot agree on the amount of such values, such amounts shall be determined by arbitration pursuant to the provisions of Paragraph 59, below. Any claims by Tenant for the value of the Tenant's Improvements, Alterations and Tenant Fixtures shall nevertheless be subject and subordinate to the rights of the holder of any first mortgage on the Leased Premises to which this Lease is subject and subordinate and who has entered into the agreement described in subparagraph 38(a), below. (g) Date of Taking. A Taking shall be deemed to have occurred on the date possession is required by the condemning authority. (h) Application of Proceeds of Award. The proceeds of any award or payment belonging to Landlord shall be paid and disbursed in the same manner that the proceeds of property insurance are required to be paid and disbursed pursuant to subparagraph 36(f) above. 38. Subordination, Recognition, Non-Disturbance and Attornment. (a) Tenant to Subordinate. Tenant agrees, at the request of Landlord, to execute an agreement whereby Tenant will subordinate this Lease to the lien of any first mortgage of the entire fee interest in the Leased Premises now or hereafter made to a bank, trust company, savings and loan association, insurance company, or other similar institutional type lender, and any renewals, modifications or extensions thereof, provided that such subordination shall be effective only upon the execution by the holder of such mortgage of an agreement, for the benefit of Tenant, in recordable form, executed, acknowledged and delivered by such mortgagee to Tenant (with the joinder of Landlord), which shall be on the lender's standard form subordination and non-disturbance agreement and contain in substance the following provisions and such other provisions as such holder may reasonably require: (i) So long as Tenant continues to pay the Rent as provided in this Lease and otherwise complies with the terms and provisions hereof, the right of possession 35 51 of Tenant to the Leased Premises, and all of the other rights of Tenant under the terms and provisions of this Lease shall otherwise not be affected, impaired or disturbed, nor shall this Lease or the term hereof be terminated, by the mortgagee in the exercise of any of its rights under the mortgage or the bond or debts secured thereby, or otherwise by law provided. (ii) In the event that the mortgagee comes into possession of or ownership of the title of the Lease Premises by foreclosure of the mortgage, or by proceedings on the bond or otherwise, this Lease and all rights of Tenant hereunder shall continue in effect and shall not be terminated by any of said proceedings. (iii) If the mortgagee shall become the owner of the Leased Premises by reason of foreclosure of the mortgage or otherwise, or if the Leased Premises shall be sold as a result of any action or proceeding to foreclose the mortgage or by a deed given in lieu of foreclosure, the Lease shall continue in full force and effect, without necessity for executing any new lease, as a direct lease between Tenant, as tenant thereunder, and the then owner of the Leased Premises as landlord thereunder, upon all of the same terms, covenants and provisions contained in the Lease, and in such event, Tenant shall be bound to such new owner under all of the terms, covenants and provisions of the Lease and Tenant hereby agrees to attorn to such new owner and to recognize such new owner as Landlord under this Lease, and such new owner shall be bound to Tenant under all of the terms, covenants and provisions of this Lease, including any amendments of the Lease whether made before or after the date of the mortgage, which terms, covenants and provisions such new owner hereby agrees to assume and perform; provided that such attornment shall not relieve Landlord of any and all of its liabilities to Tenant arising under this Lease prior to such attornment and further provided, however, such party shall not be (i) liable for any act or omission of any prior landlord or (ii) subject to any offsets or defenses which Tenant might have against any prior landlord (including Landlord); or (iii) bound by any rental which Tenant might have paid for more than one (1) month in advance to any prior landlord; or (iv) bound by any amendment or modification of the Lease made without its consent. (iv) Tenant shall not be named or joined as a party defendant or otherwise in any suit, action or proceeding for the foreclosure of the mortgage or to enforce any rights under the mortgage or the bond or other obligation secured thereby, unless required by applicable law. (v) Mortgagee acknowledges and agrees that all Tenant Fixtures shall be and remain the property of Tenant, or any subtenant, assignee, licensee or concessionaire of Tenant, or any Equipment Lessor or may be removed by Tenant, or any subtenant, assignee, licensee or concessionaire of Tenant, or any Equipment Lessor at any time, in accordance with Paragraph 24. (vi) If the Leased Premises, or any part thereof, is damaged by fire or other casualty or taken by condemnation, the mortgagee agrees that insurance proceeds and/or condemnation awards payable to it will be made available for the purpose of repairing or rebuilding the Leased Premises, as provided and subject to the provisions in this Lease. 36 52 (vii) The agreement shall be binding upon and inure to the benefit of mortgagee, owner and Tenant, and their respective heirs, executors, administrators, successors and assigns. Tenant acknowledges that the form attached hereto as Exhibit "G" is approved for the purposes of this Paragraph. (b) Mortgagee May Require Lease to be Prior. If the holder of any first mortgage of the entire fee interest of the Mortgaged Property, or any part thereof, including without limitation the Leased Premises, requires that this Lease have priority over such mortgage, Tenant shall, upon request of such holder, execute, acknowledge and deliver to such holder an agreement acknowledging such priority and containing the agreement of such mortgagee to apply insurance proceeds and condemnation awards to restoration as herein provided. (c) Notice of Default to Mortgagee. If the holder of the first mortgage covering the Leased Premises shall have given prior written notice to Tenant that it is the holder of said first mortgage ("Mortgagee") and such notice includes the address at which notices to such Mortgagee are to be sent, then Tenant agrees to give to the Mortgagee notice simultaneously with any notice given to Landlord to correct any default of Landlord as hereinabove provided, and agrees that if Landlord fails to cure such default within the time provided the Mortgagee shall have the right, within an additional 30 days following a second notice from Tenant or, if such default cannot be cured within that time, such additional time as may be necessary provided within such 30 days Mortgagee commences and diligently pursues a cure (including commencement of foreclosure proceedings if necessary to effect such cure) to correct or remedy such default before Tenant may take any action under this Lease by reason of such default, except for Tenant's rights under Paragraph 45(b)(i). (d) Mortgagee's Requirements. Tenant will make such modifications to this Lease as may hereafter be required to conform to any reasonable and/or customary Mortgagee's requirements, so long as such modifications do not increase Tenant's obligations or materially alter its rights. 39. Quiet Enjoyment. Landlord covenants and agrees that if Tenant shall perform all the covenants and agreements herein stipulated to be performed on Tenant's part, Tenant shall peaceably and quietly have, hold and enjoy the Leased Premises and all rights, easements, appurtenances and privileges belonging or in anywise appertaining thereto during the Initial Term and all Renewal Periods, subject to the Permitted Exceptions, without hindrance or interruption by any person or persons lawfully or equitably claiming by, through or under Landlord. Landlord shall in no event be liable in damages or otherwise, nor shall Tenant be released from any obligations hereunder (except as expressly provided in Paragraph 33(d)), because of the interruption of any service, or a termination, interruption or disturbance, attributable to strike, lockout, breakdown, accident, war or other emergency, law, order, rule or regulation of or by any governmental authority, failure of supply, inability to obtain supplies, parts or employees, or any cause due to any act or neglect of Tenant or its servants, agents, employees, licensees, business invitees, or any person claiming by, through or under Tenant. 37 53 40. Condition of Title. Tenant is entering into this Lease in reliance on the a preliminary Title Report issued by First American Title Insurance Company (the "Title Company") containing the commitment of the title insurance company to issue to Tenant an ALTA or CLTA form leasehold owner's title insurance policy upon the payment by Tenant of the standard premium as provided therein, free and clear of all leases, tenancies, easements, agreements, encumbrances, restrictions, liens, or any other defects in title other than those listed on EXHIBIT "C" hereto (the "Permitted Exceptions"). Except for Landlord's warranty of quiet enjoyment as to claims arising by, through or under Landlord (as set forth in Paragraph 39), Landlord makes no warranty of title to Tenant and Tenant shall rely solely upon the title insurance for protection as to matters of title. Landlord and Tenant each represents, warrants and covenants to the other that it has the right and lawful authority to enter into this Lease for the Term hereof, including any Renewal Periods. 41. Recording, Delivery of Title Report. Landlord and Tenant have executed, simultaneously with the execution hereof, the document required by statute for the validity and notice of this Lease (the "Memorandum"). Landlord and Tenant shall deliver the Memorandum to the Title Company with instructions to record and issue Tenant's Title insurance policy in accordance with Paragraph 40. Landlord agrees to pay all recording charges, transfer taxes and other taxes imposed upon the entering into of this Lease and the recording of the Memorandum, and any costs and expenses incurred in connection with Landlord's obtaining the Title Report hereinabove described; Tenant agrees to pay for the leasehold title insurance policy issued in accordance with the Title Report. 42. Notices; Payment of Rent. (a) Each notice, demand, request or other communication required or permitted under the terms of this Lease shall be in writing and, unless and until otherwise specified in a written notice by the party to receive it, shall be sent to the parties at the following respective addresses: if intended for Tenant prior to occupancy: President Advanta Mortgage Corp. USA 500 Office Center Drive Fort Washington, PA 19034 FAX NO. (215) 283-4376 if intended for Tenant after occupancy: President Advanta Mortgage Corp. USA 10796 Rancho Bernardo Road San Diego, CA 92127 FAX NO. (____)____________ 38 54 with a copy to: General Counsel Advanta Mortgage Corp. USA 10796 Rancho Bernardo Road San Diego, CA 92127 FAX NO. ( ) with a copy to: Vice President, Advanta Corporate Services 200 Tournament Drive Horsham, PA 19044 FAX NO. (215) 444-6126 if intended for Landlord: San Diego Development #1, LLC c/o Miller Global-Pauls 4600 South Ulster Street Parkway, Suite 940 Denver, CO 80237 FAX NO. (303) 689-2110 with a copy to: Lawrence J. Donovan, Jr. Isaacson Rosenbaum Woods & Levy, PC 633 Seventeenth Street, Suite 2200 Denver, CO 80202 FAX NO. (303) 292-3152 Notices may be given on behalf of any party by its legal counsel. (b) Each such notice, demand, request or other communication shall be deemed to have been properly given for all purposes if (i) hand delivered or (ii) mailed by registered or certified mail of the United States Postal Service, return receipt requested, postage prepaid or (iii) delivered by a nationally recognized overnight courier service for next business day (or sooner) delivery or (iv) delivered via telecopier or facsimile transmission to the facsimile number listed in this Section, provided, however, that if such communication is given via telecopier or facsimile transmission, an original counterpart of such communication shall concurrently be sent in the manner specified in either clause (iii) of this subparagraph (b) or be hand delivered by the next business day. (c) Each such notice, demand, request or other communication shall be deemed to have been received by its addressee, and to have been effectively given, upon the earliest of (i) actual delivery, (ii) refusal of acceptance of delivery; provided that in the case of delivery by telecopier or facsimile, "actual delivery" shall mean receipt of the telecopier or facsimile transmission between the hours of 9:00 AM and 5:00 PM (at the local time of the 39 55 recipient of the notice) on a business day or if not received within such hours on a business day, the next business day after receipt. (d) All payments of rent and any other charges under this Lease shall be paid to Landlord at the address of Landlord provided in this Paragraph or at such other address as Landlord may specify in written notice given pursuant hereto. 43. Tenant's Default. (a) Event of Default Defined. The term "Event of Default" with respect to Tenant shall mean the occurrence of any one or more of the following events: (i) if default shall be made in the due and punctual payment of any Minimum Rent and Additional Rent payable under this Lease when and as the same shall become due and payable that shall continue for a period of five (5) business days after written notice thereof from Landlord to Tenant; (ii) if Tenant shall make any assignment of substantially all of its assets for the benefit of creditors or shall be adjudged a bankrupt, or if a receiver is appointed for Tenant or its assets or Tenant's interest under this Lease and the appointment of such receiver, if involuntary, is not vacated within sixty (60) days, or if Tenant shall file or have filed against it a petition under or pursuant to any of the provisions of the U.S. Bankruptcy Act, the Federal Bankruptcy Code, or any other federal or state law relating to insolvency, or any amendment thereof or substitute thereof, and such petition, if involuntary, is not vacated within sixty (60) days, or the adjudication that the Tenant is insolvent or bankrupt or the entry of an order for relief under the Federal Bankruptcy Code with respect to Tenant; (iii) there is an Event of Default as defined in Paragraphs 29, 33 or 51; and (iv) if default shall be made by Tenant in performing any other of the terms, covenants or agreements contained in this Lease on Tenant's part to be performed, and such default shall continue for a period of thirty (30) days after written notice thereof from Landlord to Tenant or in the case of such a default which cannot with due diligence and in good faith be cured within thirty (30) days, the Tenant fails to commence within such thirty-day period to cure the same and thereafter to prosecute the curing of such default with due diligence and in good faith; (b) Landlord's Remedies. If any one or more Event of Default shall happen, then Landlord shall have the right at Landlord's election then or at any time thereafter, but provided Landlord has not thereafter accepted Tenant's cure, either: (1) (i) Without demand or notice, to reenter and take possession of the Leased Premises or any part thereof and repossess the same as of Landlord's former estate and expel Tenant and those claiming through or under Tenant and remove the effects of both or either, without being deemed guilty of any manner of trespass and without prejudice to 40 56 any remedies for arrears of rent or preceding breach of covenants or conditions. Should Landlord elect to reenter, as provided in this subparagraph (1), or should Landlord take possession pursuant to legal proceedings or pursuant to any notice provided for by law, Landlord may, from time to time, without terminating this Lease, relet the Leased Premises or any part thereof, either alone or in conjunction with other portions of the Building of which the Leased Premises are a part, in Landlord's or Tenant's name but for the account of Tenant, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the term of this Lease) and on such commercially reasonable conditions and upon such other terms (which may include concessions of free rent and alteration and repair of the Leased Premises) as Landlord, in its discretion, may determine and Landlord may collect and receive the rents therefor. Landlord shall in no way be responsible or liable for any failure to relet the Leased Premises, or any part thereof, or for any failure to collect any rent due upon such reletting. No such reentry or taking possession of the Leased Premises by Landlord shall be construed as an election on Landlord's part to terminate this Lease unless a written notice of such intention be given to Tenant. No notice from Landlord hereunder or under a forcible entry and detainer statute or similar law shall constitute an election by Landlord to terminate this Lease unless such notice specifically so states. Landlord reserves the right following any such reentry and/or reletting to exercise its right to terminate this Lease by giving Tenant such written notice, in which event the Lease will terminate as specified in said notice. (ii) If Landlord elects to take possession of the Leased Premises as provided in this subparagraph (1) without terminating the Lease, Tenant shall pay to Landlord (a) the rent and other sums as herein provided, which would be payable hereunder if such repossession had not occurred, less (b) the net proceeds, if any, of any reletting of the Leased Premises after deducting all of Landlord's commercially reasonable expenses incurred in connection with such reletting, including, but without limitation, all repossession costs, brokerage commissions, legal expenses, attorneys' fees, expenses of employees, alteration, remodeling, and repair costs and expenses of preparation for such reletting. If, in connection with any reletting, the new lease term extends beyond the existing Term or the premises covered thereby include other premises not part of the Leased Premises, a fair apportionment of the rent received from such reletting and the expenses incurred in connection therewith, as provided aforesaid, will be made in determining the net proceeds received from such reletting. In addition, in determining the net proceeds from such reletting, any rent concessions will be apportioned over the term of the new lease. Tenant shall pay such amounts to Landlord monthly on the days on which Minimum Rent and Additional Rent and all other amounts owing hereunder would have been payable if possession had not been retaken and Landlord shall be entitled to receive the same from Tenant on each such day; or (2) To give Tenant written notice of intention to terminate this Lease on the date of such given notice or on any later date specified therein and, on the date specified in such notice, Tenant's right to possession of the Leased Premises shall cease and the Lease shall thereupon be terminated, except as to Tenant's liability hereunder as hereinafter provided, as if the expiration of the term fixed in such notice were the end of the Term herein originally demised. In the event this Lease is terminated pursuant to the provisions of this subparagraph (2), Tenant shall remain liable to Landlord for damages in an amount equal 41 57 to the Minimum Rent and Additional Rent and other sums which would have been owing by Tenant hereunder for the balance of the Term had this Lease not been terminated less the net proceeds, if any, of any reletting of the Leased Premises by Landlord subsequent to such termination, after deducting all Landlord's commercially reasonable expenses in connection with such reletting, including, but without limitation, the expenses enumerated above. Landlord shall be entitled to collect such damages from Tenant monthly on the days on which the Minimum Rent and Additional Rent and other amounts would have been payable hereunder if this Lease had not been terminated and Landlord shall be entitled to receive the same from Tenant on each such day. Alternatively, at the option of Landlord, in the event this Lease is terminated, Landlord shall be entitled to recover forthwith against Tenant as damages for loss of the bargain and not as a penalty an amount equal to the worth at the time of termination of the excess, if any, of the amount of Minimum Rent and Additional Rent reserved in this Lease for the balance of the Term hereof over the then Reasonable Rental Value of the Leased Premises for the same period plus all amounts incurred by Landlord in order to obtain possession of the Leased Premises and relet the same, including reasonable attorneys' fees, reletting expenses, alterations and repair costs, brokerage commissions and all other like amounts, all discounted to present value (calculated on the basis of a discount rate of 6% per annum). It is agreed that the "Reasonable Rental Value" shall be the amount of rental which Landlord can obtain as rent for the remaining balance of the term. (c) Reletting at End of Term. At any time or from time to time after Landlord takes possession of the Leased Premises pursuant to subparagraph (1) or subparagraph (2) above, Landlord may relet the Leased Premises or any part thereof, in the name of Landlord or otherwise, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the term of this Lease) and on such conditions if commercially reasonable (which may include concessions or free rent) as Landlord, in its reasonable discretion, may determine and may collect and receive the rents therefor. Landlord shall in no way be responsible or liable for any failure to relet the Leased Premises or any part thereof, or for any failure to collect any rent due upon any such reletting; but Landlord shall use reasonable efforts to relet the Leased Premises and to collect such rent; provided, that Landlord shall have the right to give preference to other space that Landlord may have in other buildings and not be required to expend monies for tenant concessions and allowances beyond those for leases then being entered into by Landlord for comparable space in other buildings at such time. If Tenant has reason to believe that Landlord is not using reasonable diligence to mitigate Landlord's damages, Tenant shall notify Landlord of such determination as soon as reasonably practicable. 44. Intentionally Omitted. 45. Landlord's Default. (a) Event of Default Defined. The term "Event of Default" with respect to Landlord shall mean if default shall be made by Landlord in performing any of the terms, covenants or agreements contained in this Lease on Landlord's part to be performed, and such default shall continue for a period of thirty (30) days after written notice thereof from Tenant to Landlord or, in the case of such a default which cannot with due diligence and in good faith be cured within thirty (30) days, Landlord fails to commence within such 42 58 thirty-day period to cure the same and thereafter to prosecute the curing of such default with due diligence and in good faith. (b) Tenant's Remedies. (i) Tenant's Right to Perform on Behalf of Landlord. Landlord agrees that if an Event of Default occurs with respect to: (A) Landlord's failure to pay any installment of assessments of any interest, principal, costs or other charges upon any mortgage or mortgages or other liens and encumbrances affecting the Leased Premises and to which this Lease may be subordinate for which Tenant has not received a non-disturbance agreement in accordance with Paragraph 38 when any of the same become due, or (B) Landlord's failure to make any repairs, do any work or pay any monies to Tenant, required of Landlord by the provisions of this Lease, or (C) respect to Landlord's failure to perform any covenant or agreement in this Lease contained on the part of Landlord to be performed; then Tenant may pay, but shall be under no obligation to pay, said taxes, assessments, interest, principal, costs and other charges, and may cure such defaults all on behalf of and at the expense of Landlord, and do all necessary work (provided that Tenant gives prior notice of not less than ten (10) days of its intention to do such and a description of the work to be performed). Notwithstanding the foregoing, if Landlord fails to perform an obligation to repair or replace required under Paragraph 22(b) after reasonable prior notice from Tenant and an emergency exists (threatening imminent harm to persons or property in the Building), Tenant shall have the right upon reasonable prior notice to Landlord to perform such repairs or replacements (notwithstanding that the applicable periods and notice required for an Event of Default by Landlord have not occurred). Except in the case of a matter or thing for which Tenant is obligated to reimburse Landlord hereunder as Additional Rent, Landlord agrees to pay to Tenant forthwith the amount so paid by Tenant, including reasonable attorneys' fees, together with interest thereon at the rate of eight percent (8%) per annum, and agrees that Tenant may withhold any and all payments of Minimum Rent and Additional Rent thereafter becoming due to Landlord pursuant to the provisions of this Lease or any extension thereof, and may apply the same to the payment of such indebtedness of Landlord to Tenant until such indebtedness is fully paid with interest thereon as herein provided that Tenant may not withhold payment of Rent until after ten (10) days' prior notice of Tenant's election to withhold to Landlord and Landlord's Mortgagee and further provided, however, that if Landlord or the Mortgagee disputes by notice to Tenant within such ten (10) day period that such amounts are owed by Landlord, Tenant shall have no right to withhold such amounts until the amounts are found to be due Tenant by arbitration. Nothing herein contained shall preclude Tenant from proceeding to bring an action in accordance with Paragraph (iii) below to collect the amount so paid by it as aforesaid without waiting for such offsets from Minimum Rent or Additional Rent to accrue. Tenant hereby waives the right to terminate this Lease or to offset against Minimum Rent and Additional Rent existing at law or in equity or by statute or otherwise (to the extent such waiver is not prohibited by applicable law) except in accordance with the express terms and provisions of this Lease. (ii) Landlord Not Released. Under no circumstances shall the exercise by Tenant of the rights granted in subparagraph (a) above to take all such action as may be necessary to cure any default by Landlord release Landlord in any manner 43 59 whatsoever from liability for the performance of any obligations of Landlord under the terms of this Lease. (iii) Additional Remedies. Tenant may bring an action for actual direct money damages or for injunctive relief, or both, in any court of competent jurisdiction, provided any damages shall be subject to the limitations and waivers provided in the Lease and in no event will Landlord or any Mortgagee be responsible for any consequential damages incurred by Tenant as a result of any default, including, but not limited to, lost profits, income or interruption of business. 46. Remedies Cumulative. Subject to the limitations and waivers provided in the Lease, each right or remedy of Landlord and Tenant provided for in this Lease shall be cumulative and shall be in addition to every other right or remedy provided for in this Lease or otherwise, and the exercise or the beginning of the exercise by Landlord or Tenant of any of one (1) or more of the rights or remedies provided for in this Lease or now or hereafter existing at law or in equity or by statute or otherwise, unless expressly prohibited, limited or waived hereunder, shall not preclude the simultaneous or later exercise by Landlord or Tenant of any and all other rights or remedies provided for in this Lease or now or hereafter existing at law or in equity or by statute or otherwise, unless expressly prohibited, limited or waived hereunder. In any action brought by either party to enforce or contest any provision of this Lease, or to obtain a declaration of the rights or responsibilities of either party hereunder, the prevailing party shall be entitled to recover all costs and expenses, including attorneys' fees, reasonably incurred by such prevailing party in connection with such action. 47. No Waiver. No failure by Landlord or by Tenant to insist upon the strict performance of any term, covenant or condition of this Lease or to exercise any right or remedy consequent upon a breach thereof, and no acceptance by Landlord of partial Rent during the continuance of any such breach, shall constitute a waiver of any such breach or of such term, covenant or condition. No term, covenant or condition of this Lease to be kept, observed or performed by Landlord or by Tenant, and no breach thereof, shall be waived, altered or modified, except by a written instrument executed by Landlord or by Tenant, as the case may be. No waiver of any breach shall affect or alter this Lease, but each and every term, covenant and condition of this Lease shall continue in full force and effect with respect to any other then existing or subsequent breach thereof. 48. Waiver of Jury Trial. TENANT AND LANDLORD HEREBY WAIVE (TO THE EXTENT ALLOWED BY LAW) ANY AND ALL RIGHTS TO A TRIAL BY JURY IN SUIT OR SUITS BROUGHT TO ENFORCE ANY PROVISION OF THIS LEASE OR ARISING OUT OF OR CONCERNING THE PROVISIONS OF THIS LEASE. 49. Unavoidable Delays. If either party shall be prevented or delayed from punctually performing any obligation or satisfying any condition under this Lease by any strike, lockout, labor dispute, inability to obtain labor or material, Act of God, adverse weather condition, governmental restriction, regulation or control, enemy or hostile governmental action, civil commotion, insurrection, sabotage, fire or other casualty or by any other event similar to the foregoing beyond the reasonable control of such party, and not 44 60 the fault of the party delayed in performing any obligation or satisfying any condition under this Lease (all such events being hereinafter called "Unavoidable Delay"), then the time to perform such obligation or satisfy such condition shall be postponed by the period of time consumed by the delay. If either party shall, as a result of an Unavoidable Delay, be unable to exercise any right or option within any time limit provided therefor in this Lease, the time for exercise thereof shall be postponed for the period of time consumed by such delay. In no event shall the periods specified in subparagraphs 2(e) and 9 above or the time limits for restoration after a destruction or a Taking as set forth in Paragraphs 36 and 37 above be extended by reason of the foregoing events of Unavoidable Delay for a period in excess of ninety (90) days. In no event shall the obligation of either Landlord or Tenant to pay money be extended by reason of the foregoing events of Unavoidable Delay. 50. Relationship of Parties. Nothing contained in this Lease shall be deemed or construed by the parties hereto or by any third party to create the relationship of principal and agent or of partnership or of joint venture or of any association whatsoever between Landlord and Tenant, it being expressly understood and agreed that nothing herein shall be deemed to create any relationship between Landlord and Tenant other than the relationship of landlord and tenant. The obligations imposed by this Lease on Tenant shall be joint and several obligations of the entities collectively constituting Tenant. 51. Estoppel Certificates. Upon the request of either party, at any time or from time to time, Landlord and Tenant agree to execute, acknowledge and deliver to the other, within fifteen (15) days after such request, a written instrument, duly executed and acknowledged, (a) certifying that this Lease has not been modified and is in full force and effect or, if there has been a modification of this Lease, that this Lease is in full force and effect as modified, stating such modifications; (b) specifying the dates to which all sums payable hereunder by either Landlord or Tenant, including without limitation, Minimum Rent, Additional Rent and Landlord's Contribution, have been paid; (c) stating whether or not, to the knowledge of the party executing such instrument, the other party hereto is in default and, if such party is in default, stating the nature of such default; (d) stating the Rent Commencement Date; (e) stating which Renewal Options have been exercised or deemed waived, if any; and (f) such other information as the party requesting the estoppel may reasonably request. It is intended that any such statement delivered pursuant to this Paragraph may be relied upon by any prospective purchaser of all or any portion of Landlord's interest herein or a holder of any mortgage or deed of trust encumbering the Leased Premises. If either party 45 61 fails to provide such statement to the requesting party within such 15 day period, and such failure continues for 5 days following additional notice of such failure from the requesting party, such failure shall be deemed an Event of Default, without further notice or opportunity to cure being required. 52. Broker. Tenant represents and warrants that it has dealt with no broker or brokers in connection with this Lease. Landlord represents and warrants that it has dealt with no broker or brokers in connection with this Lease, except John Burnham & Company (the "Broker") (whose commission shall be paid by Landlord pursuant to separate agreement). Each party will defend, indemnify and hold harmless the other from any loss, cost, damage or expense arising by reason of any actual or alleged breach of the foregoing warranty. Tenant acknowledges that Tenant is not relying on any representations or warranties of Broker. 53. Covenants to Run with the Land; Binding Effect. Subject to the provisions of this Lease, the terms, covenants, agreements, provisions, conditions and limitations herein contained shall be construed as covenants running with the land and shall bind and inure to the benefit of the heirs, executors, administrators, successors and assigns, respectively, of Landlord and Tenant. This Lease is to be construed as though the covenants between Landlord and Tenant are independent and not dependent and Tenant is not entitled to any setoff of the Rent against Landlord if Landlord fails to perform its obligations, except as expressly provided herein. 54. Choice of Law. This Lease and the rights and obligations of the parties hereto, shall be interpreted and construed in accordance with the laws of the State of California. 55. Entire Agreement; Interpretation. This Lease and the Exhibits attached hereto contain the entire agreement between the parties, and no oral statements or representations of prior written matter not contained herein shall have any force or effect. This Lease and the Exhibits attached hereto cannot be changed, modified or amended unless such change, modification or amendment is in writing and executed by the party against which the enforcement of the change, modification or amendment is sought. The parties waive any rule of construction that ambiguities are to be resolved against the drafting party. Any words following the words "include," "including," "such as," "for example," or similar words or phrases shall be illustrative only and are not intended to be exclusive, whether or not language of non-limitation is used. 56. Invalidity of Certain Provisions. If any provision of this Lease shall be invalid or unenforceable, the remainder of the provisions of this Lease shall not be affected thereby and each and every provision of this Lease shall be enforceable to the fullest extent permitted by law. 57. Captions. The captions preceding the paragraphs of this Lease are intended only as a matter of convenience and for reference and in no way define, limit or describe the scope of this Lease or the intent of any provision hereof. Wherever applicable hereunder, the neuter pronoun shall be deemed to include the masculine and feminine pronoun and the singular shall be deemed to include the plural. 46 62 58. Definitions. As used in this Lease, the following Terms shall have the respective meanings indicated opposite each of them. "Additional Rent" Sums for Real Estate Taxes, Utilities, sums owing under the Declaration, Landlord's Fire Insurance, and all other amounts, except Minimum Rent, payable by Tenant pursuant to this Lease, whether to Landlord or to a third party. "Alterations" As defined in subparagraph 23(a). "Alternative Tax" As defined in subparagraph 6(b). "Ancillary Uses" As defined in Paragraph 17. "Assumed Lease" As defined in subparagraph 4(c). "Authorities" As defined in subparagraph 28(b). "Building" As defined in Paragraph 1. "Broker" As defined in Paragraph 52. "Casualty Damage" As defined in subparagraph 36(a). "Commencement Date" As defined in subparagraph 2(a). "Commitment" As defined in subparagraph 16(b) "Comparable Building" As defined in subparagraph 4(c). "Completion Date" As defined in Paragraph 9. "Completion Deadline" As defined in subparagraph 2(g) "Construction Deadline" As defined in subparagraph 2(g). "Declaration" As defined in Paragraph 1. "89-1 Bond" As defined in subparagraph 6(a) "Equipment Lessor" As defined in subparagraph 24(a). "Escrow Agent" As defined in subparagraph 6(a) "Event of Default" As defined in subparagraph 43(a) and 45. 47 63 "Existing Premises" As defined in subparagraph 2(g). "Expiration Date" As defined in subparagraph 2(a). "Fair Market Rental Value" As defined in subparagraph 4(c). "Final Plans and Specifications" As defined in subparagraph 7(a). "Full Replacement Cost" As defined in subparagraph 33(b). "Hazardous Materials" As defined in Paragraph 18. "Initial Term" As defined in subparagraph 2(a). "Interest Rate" As defined in subparagraph 4(c). "Landlord" Landlord named herein and any subsequent owner of any part of Landlord's fee interest in the Leased Premises ("Landlord's Estate"), but any owner of any part of Landlord's Estate shall be relieved of all liability under this Lease after the date that it ceases to be the owner of any part of Landlord's Estate (except for any liability arising prior to such date) provided that the party succeeding to any part of Landlord's Estate shall have executed an agreement, wherein it assumes and agrees to perform all of Landlord's obligations under this Lease from and after the date it acquires any part of Landlord's Estate. Notwithstanding the foregoing, Landlord named herein shall not, in any event, be relieved of its obligations to complete Landlord's Work in accordance with the terms hereof, which obligations shall remain a personal covenant of Landlord named herein. "Landlord's Architect" As defined in subparagraph 7(b) "Landlord's Contribution" As defined in subparagraph 13. "Landlord's Delay" As defined in Paragraph 16. "Landlord's Fire Insurance" As defined in subparagraph 33(a). "Landlord's Improvements" As defined in Paragraph 8 48 64 "Landlord's Liability Insurance" As defined in subparagraph 32(b). "Landlord's Punchlist" As defined in Paragraph 9. "Landlord's Work" As defined in subparagraph 8(a). "Lease Year" As defined in subparagraph 2(c). "Leased Premises" As defined in Paragraph 1. "Memorandum" As defined in Paragraph 41. "Minimum Rent" As defined in Paragraph 4. "Mortgagee" As defined in subparagraph 38(c). "Park" As defined in Paragraph 1. "Permits" As defined in subparagraph 28(b). "Permitted Exceptions" As defined in Paragraph 40. "Permitted Use" As defined in Paragraph 17. "Primary Use" As defined in Paragraph 17 "Punchlist Items" As defined in Paragraph 9 "Qualified Appraiser" As defined in subparagraph 4(c). "Real Estate Taxes" As defined in subparagraph 6(a). "Reasonable Rental Value" As defined in subparagraph 43(b) "Renewal Option" As defined in subparagraph 3(a). "Renewal Period" As defined in subparagraph 3(a). "Rent" Minimum Rent and Additional Rent. "Rent Commencement Date" As defined in subparagraph 2(b). "Requirements" As defined in subparagraph 28(b). "Specially Approved Uses" As defined in Paragraph 17. 49 65 "Structure" As defined in subparagraph 22(b) "Structural Repairs" As defined in subparagraph 22(b). "Substantial Casualty Damage" As defined in subparagraph 36(b). "Substantial Completion" As defined in Paragraph 9. "Taking" As defined in subparagraph 37(a). "Tenant Delay" As defined in Paragraph 16. "Tenant Fixtures" As defined in subparagraph 24(a). "Tenant Ready" As defined in Paragraph 9 "Tenant Ready Date" As defined in Paragraph 9 "Tenant's Architect" As defined in subparagraph 7(c) "Tenant's Builder's Risk Insurance" As defined in subparagraph 33(b) "Tenant's Holdover Costs" As defined in subparagraph 2(e) "Tenant's Improvements" As defined in Paragraph 12 "Tenant's Liability Insurance" As defined in subparagraph 32(a). "Tenant's Plans and Specifications" As defined in subparagraph 7(c). "Tenant's Property Insurance" As defined in subparagraph 33(b) "Tenant's Signage" As defined in Paragraph 19. "Tenant's Work" As defined in subparagraph 12. "Term" As defined in subparagraph 2(a). "Title Company" As defined in Paragraph 40. "Unavoidable Delay" As defined in Paragraph 49. "Utilities" As defined in subparagraph 21(a). 50 66 "Zoning and Building Laws" As defined in subparagraph 28(a). 59. Arbitration. Should any dispute arise with respect to any provision of this Lease and such provision states that the matter in dispute is to be resolved by arbitration hereunder, the matter in dispute shall be referred to arbitration. Within ten (10) days following receipt of a request for arbitration, each party shall choose an arbitrator from a panel of arbitrators, and within ten (10) days thereafter, the two selected shall choose a third arbitrator. In the event that the two arbitrators chosen cannot agree upon a third arbitrator, the American Arbitration Association shall be requested to supply an arbitrator and this request may be made by either arbitrator. The panel of arbitrators shall be supplied by the American Arbitration Association and, except for arbitration under subparagraph 7(d) and Paragraph 45, the panel shall all be qualified appraisers (as defined in Paragraph 4). The arbitration proceedings shall take place in the City of San Diego, California pursuant to the rules then obtaining of the American Arbitration Association. The arbitration shall be completed as soon as possible. The decision of the majority of arbitrators on the matter in dispute shall be final, conclusive and binding upon the parties and the arbitrators shall also have the power to determine allocation of costs of the proceedings between the parties; judgments may be entered thereon in any court of competent jurisdiction and no appeal may be taken therefrom. 60. Limitation on Landlord Liability. NOTWITHSTANDING ANYTHING TO THE CONTRARY CONTAINED IN THIS LEASE, LANDLORD'S LIABILITY IS LIMITED TO LANDLORD'S INTEREST IN THE LEASED PREMISES. 61. Guaranty. Landlord is entering into this Lease in reliance on the guaranty by Advanta Corp., a Delaware corporation of even date herewith, a copy of which is attached hereto as EXHIBIT "B". IN WITNESS WHEREOF, Landlord and Tenant have entered into this Lease effective as of August 27, 1997, having executed this Lease on the dates set forth in the following notarizations. This Lease may be executed in counterparts, each of which (or any combination of which) when signed by all of the parties shall be deemed an original, but all of which when taken together shall constitute but one agreement. Any one or more of such duplicate signature pages may be removed from any one or more of such counterparts and 51 67 annexed to other counterparts and duplicate signature pages to form a completely executed original Lease. LANDLORD: SAN DIEGO DEVELOPMENT #1, LLC, a Colorado limited liability company By: SD #1, LLC, a Colorado limited liability company, Member By: The Pauls Corporation, LLC, a Colorado limited liability company, Its Manager and Member By: /s/ William B. Pauls ---------------------------------------- William B. Pauls, Manager By: GE Investment Realty Partners III Limited Partnership, a Delaware limited partnership, Member By: GE Investment Management Incorporated, general partner By: /s/ Michael J. Strone ---------------------------------------- VP By: MGA Real Estate Associates, LLLP, a Colorado limited liability limited partnership, Member By: /s/ James H. Miller ---------------------------------------- Authorized Signatory STATE OF COLORADO ) ) ss. CITY AND COUNTY OF DENVER ) The foregoing instrument was acknowledged before me this 8th day of Sept., 1997, by William B. Pauls, as Manager of The Pauls Corporation, LLC, a Colorado limited liability company, as Manager and Member of SD #1, LLC, a Colorado limited liability company, a Member of San Diego Development #1, LLC, a Colorado limited liability company. Witness my hand and official seal. My commission expires: 1/03/99 /s/ LORRAINE K. BLAKE ---------------------------------------- Notary Public 52 68 STATE OF CONNECTICUT ) ) ss. COUNTY OF FAIRFIELD ) The foregoing instrument was acknowledged before me this 10th day of September, 1997, by Michael J. Strone, as VP of GE Investment Realty Partners III Limited Partnership, a Delaware limited partnership, a Member of SD #1, LLC, a Colorado limited liability company, a Member of San Diego Development #1, LLC, a Colorado limited liability company. Witness my hand and official seal. My commission expires: 1/31/02 /s/ LaVerne M. Burzynski ---------------------------------------- Notary Public STATE OF COLORADO ) ) ss. CITY AND COUNTY OF DENVER ) The foregoing instrument was acknowledged before me this 8th day of Sept., 1997, by James H. Miller as authorized signatory of MGA Real Estate Associates, LLLP, a Colorado limited liability limited partnership, a member of San Diego Development #1, LLC, a Colorado limited liability company. Witness my hand and official seal. My commission expires: 1/03/99 /s/ Lorraine K. Blake ---------------------------------------- Notary Public signatures and notarizations continued on next page 53 69 TENANT: ADVANTA MORTGAGE CORP. USA, a Delaware corporation By: John J. Crowe Jr. Title: V.P. [Corporate Seal] Attest: Robert Cardwell Asst. Secretary STATE OF PENNSYLVANIA ) : ss. COUNTY OF ) On this the 2nd day of Sept., 1997 before me the subscriber, a notary public in and for the Commonwealth of Pennsylvania, personally appeared John J. Crowe, Jr., who acknowledged himself to be the V.P. of ADVANTA MORTGAGE CORP. USA, a Delaware corporation, and that he as such , being authorized to do so, executed the foregoing instrument for the purpose therein contained by signing the name of the corporation by himself as . IN WITNESS WHEREOF, I hereunto set my hand and official seal. [Notarial Seal] /s/ Betty Van Sant ----------------------------------- Notary Public My Commission Expires: NOTARIAL SEAL BETTY VAN SANT, NOTARY PUBLIC HORSHAM TWP., MONTGOMERY COUNTY MY COMMISSION EXPIRES FEB. 22, 1999 54 70 EXHIBIT "A" [Legal Description of Leased Premises] Lot 63 of County of San Diego Tract No. 4478, according to the Map thereof No. 11984, filed in the Office of the County Recorder of San Diego County, January 7, 1988 as File No. 88-006481 of Official Records, in the County of San Diego, State of California 71 CORPORATE GUARANTY In consideration of and as an inducement for the granting, execution and delivery of that certain Lease, dated August 27, 1997 (hereinafter called "Lease"), by SAN DIEGO DEVELOPMENT #1 LLC, a Colorado limited liability company, the Landlord therein named (hereinafter called "Landlord"), to ADVANTA MORTGAGE CORP. USA, a Delaware corporation, the Tenant therein named (hereinafter called "Tenant") with respect to premises commonly known as lot 63, 4S Ranch and located on Rancho Bernardo Road in the County of San Diego, California, and in further consideration of the sum of One Dollar ($1.00) and other good and valuable consideration paid by Landlord to the undersigned, ADVANTA CORP., a Delaware corporation (hereinafter called "Guarantor"), intending to be legally bound, hereby guarantees to Landlord the full and prompt payment when due of all Minimum Rent and Additional Rent and any and all other sums and charges payable by Tenant under the Lease, and the full, faithful and prompt performance and observance of all the covenants, terms, conditions, and agreements therein provided to be performed and observed by Tenant, to the same extent as though both Guarantor and Tenant had been named in the Lease as tenants therein with joint and several liability, (the "Obligations"); and Guarantor does hereby become surety to Landlord for and with respect to all of the Obligations. Guarantor hereby covenants and agrees to and with Landlord that if default shall at any time be made by Tenant in the payment of any such rent or other sums or charges payable by Tenant under the Lease or in the performance of any of the covenants, terms, conditions or agreements contained in the Lease, Guarantor will forthwith pay such rent or other sums or charges to Landlord, and any arrears thereof, and will forthwith faithfully perform and fulfill all of such covenants, terms, conditions and agreements, and will forthwith pay to Landlord all damages and all costs and expenses that may arise in consequence of any default by Tenant under the Lease (including, without limitation, all reasonable attorneys' fees incurred by Landlord or caused by any such default and/or by the enforcement of this Guaranty). This Guaranty is an absolute and unconditional guaranty of payment (and not of collection) and of performance and is a surety agreement. Guarantor's liability hereunder is direct and may be enforced without Landlord being required to resort to any other right, remedy or security and this Guaranty shall be enforceable against Guarantor, without the necessity for any suit or proceedings on Landlord's part of any kind or nature whatsoever against Tenant, and without the necessity of any notice of non-payment, non-performance or non-observance or the continuance of any such default or of any notice of acceptance of this Guaranty or of Landlord's intention to act in reliance hereon or of any other notice or demand to which Guarantor might otherwise be entitled, all of which Guarantor hereby expressly waives; and Guarantor hereby expressly agrees that the validity of this Guaranty and the Obligations of Guarantor hereunder shall in nowise be terminated, affected or impaired by reason of the assertion or the failure to assert by Landlord against Tenant, of 72 any of the rights or remedies reserved to Landlord pursuant to the provisions of the Lease. Landlord may maintain successive actions for other defaults. Its rights hereunder shall not be exhausted by its exercise of any of its rights or remedies or by any such action or by any number of successive actions, until and unless all Obligations hereby guaranteed have been paid and fully performed. This Guaranty shall be a continuing Guaranty, and (whether or not Guarantor shall have notice or knowledge of any of the following) the liability and obligation of Guarantor hereunder shall be absolute and unconditional and shall remain in full force and effect without regard to, and shall not be released, discharged or in any way impaired by (a) any amendment or modification of, or supplement to, or extension or renewal of, the Lease or any assignment or transfer thereof; (b) any exercise or non-exercise of any right, power, remedy or privilege under or in respect of the Lease or this Guaranty or any waiver, consent or approval by Landlord with respect to any of the covenants, terms, conditions or agreements contained in the Lease or any indulgences, forbearances or extensions of time for performance or observance allowed to Tenant from time to time and for any length of time; (c) any bankruptcy, insolvency, reorganization, arrangement, readjustment, composition, liquidation or similar proceeding relating to Tenant, or its properties; (d) any limitation on the liability or obligation of Tenant under the Lease or its estate in bankruptcy or of any remedy for the enforcement thereof resulting from the operation of any present or future provision of the federal bankruptcy law or any other statute or from the decision of any court; (e) any sublease or transfer by Tenant or any assignment, mortgage or pledge of its interest under the Lease (f) any termination of the Lease prior to the expiration of its Term; or (g) any agreement entered into between the Landlord and a Qualified Assignee or a Qualified Subtenant or any New Lease or other agreement entered into between Landlord and the holder of any Leasehold Mortgage (or between Landlord and the nominee of any such holder of a Leasehold Mortgage). All of Landlord's rights and remedies under the Lease and under this Guaranty are intended to be distinct, separate and cumulative and no such right and remedy therein or herein mentioned is intended to be in exclusion of or a waiver of any of the others. No termination of the Lease or repossession or recovering of the premises demised thereby shall deprive Landlord of any of its rights and remedies against Guarantor under this Guaranty. This Guaranty shall apply to the Obligations pursuant to any extension, renewal, amendment, modification and supplement of or to the Lease as well as to the Obligations thereunder during the original Term thereof in accordance with the original provisions thereof. The Guarantor hereby waives any requirement that the Landlord protect, secure, perfect or insure any security interest or lien or any property subject thereto or exhaust any right to take any action against any person or any collateral (including any rights relating to marshaling of assets). Guarantor expressly waives: (i) any and all rights of subrogation, reimbursement, indemnification and contribution until the Obligations have been paid and fully performed, (ii) any other rights and defenses that are or may become available to the 2 73 Guarantor by reason of Sections 2787 through 2855, inclusive, of the California Civil Code, as such Sections may be amended, recodified, or replaced from time to time; (iii) any rights or defenses that Guarantor may have arising out of an election of remedies by Landlord; and (iv) any other statutory or common law rights (to the extent that waiver is not prohibited by law) that are inconsistent with the provisions of this Guaranty. The Obligations will be paid strictly in accordance with the terms of the Lease, regardless of the value, genuineness, validity, regularity or enforceability of the Obligations, and of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights of the Landlord with respect thereto. The liability of the Guarantor to the extent herein set forth shall be absolute and unconditional, not subject to any reduction, limitation, impairment, termination, defense, offset, counterclaim or recoupment whatsoever (all of which are hereby expressly waived by the Guarantor) whether by reason of any claim of any character whatsoever, including, without limitation, any claim of waiver, release, surrender, alteration or compromise, or by reason of any liability at any time to the Guarantor or otherwise, whether based upon any obligations or any other agreements or otherwise, howsoever arising, whether out of action or inaction or otherwise and whether resulting from default, willful misconduct, negligence or otherwise, and without limiting the foregoing irrespective of: (a) any lack of validity or enforceability of the Lease or of any agreement or instrument relating thereto; (b) any change in the time, manner or place of payment of, or in any other term in respect of, all or any of the Obligations, or any other amendment or waiver of or consent to Obligations, or any other amendment or waiver of or consent to any departure from the Lease or any other agreement relating to any Obligations; (c) any increase in, addition to, exchange or release of, or nonperfection of any lien on or security interest in, any collateral or any release or amendment or waiver of or consent to any departure from or failure to enforce any other guarantee, for all or any of the indebtedness; (d) any other circumstance which might otherwise constitute a defense available to, or a discharge of, the Tenant in respect of the Obligations of the Guarantor in respect hereof; (e) the absence of any action on the part of the Landlord to obtain payment for the Obligations from the Tenant; (f) any insolvency, bankruptcy, reorganization or dissolution, or any proceeding of the Tenant or the Guarantor, including, without limitation, rejection of the guaranteed Obligations in such bankruptcy; or (g) the absence of notice or any delay in any action to enforce any Obligations or to exercise any right or remedy against the Guarantor or the Tenant, whether hereunder, under any Obligations or under any agreement or any indulgence, compromise or extension granted. Guarantor agrees that in the event Tenant shall become insolvent or shall be adjudicated a bankrupt, or shall file a petition for reorganization, arrangement or similar relief under any present or future provisions of the United States Bankruptcy Code, or any similar law or statute of the United States or any State thereof, or if such a petition filed by creditors of Tenant shall be approved by a Court, or if Tenant shall seek a judicial readjustment of the rights of its creditors under any present or future Federal or State law or if a receiver of all or part of its property and assets is appointed by any State or Federal court: 3 74 (a) if the Lease shall be terminated or rejected, or the obligations of Tenant thereunder shall be modified, Landlord shall have the option either (i) to require the undersigned, and the undersigned hereby so agree, to execute and deliver to Landlord a new lease as tenant for the balance of the term then remaining as provided in the Lease and upon the same terms and conditions as set forth therein, or (ii) to recover from the undersigned that which Landlord would be entitled to recover from Tenant under the Lease in the event of a termination of the Lease by Landlord because of a default by Tenant, and such shall be recoverable from the undersigned without regard to whether Landlord is entitled to recover the same from Tenant in any such proceeding; and (b) if Guarantor has any claims against Tenant upon any indebtedness of Tenant to Guarantor in any bankruptcy or other proceeding, Guarantor agrees to subordinate all of Guarantor's rights to any such payments or distributions to the rights of Landlord or pay any amounts recovered to Landlord as a credit against the Obligations until the Obligations are fully paid. Guarantor further agrees that, to the extent that the Tenant or the Guarantor makes a payment or payments to the Landlord, which payment or payments or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside and/or required to be repaid to the Tenant or the Guarantor or their respective estate, trustee, receiver or any other party under any bankruptcy law, state or federal law, common law or equitable cause, then to the extent of such payment or repayment, this Guaranty and the advances or part thereof which have been paid, reduced or satisfied by such amount shall be reinstated and continued in full force and effect as of the date of such initial payment, reduction or satisfaction occurred. Tenant is a wholly owned subsidiary of Guarantor as of the date hereof. If at any time hereafter Tenant is neither (i) a wholly-owned subsidiary of Guarantor or of an Affiliate; or (ii) directly or indirectly controlled by or under common control with Guarantor or an Affiliate, and provided Tenant or Guarantor gives written notice of such fact to Landlord, with reasonable evidence of the basis on which such determination is made then at all times thereafter (notwithstanding any contrary provision hereof): (a) Landlord will furnish Guarantor with a copy of any notice of default given by Landlord to Tenant under the Lease; (b) Guarantor will not be in default of Guarantors Obligations hereunder unless and until Landlord shall have furnished Guarantor written demand for payment hereunder and Guarantor shall have failed to pay sums due hereunder for more than fifteen (15) days following such demand; and (c) Following the expiration of the Initial Term and any Renewal Periods (to the extent the Lease is extended substantially in accordance with Paragraph 3 of the Lease), Guarantor will be released from liability hereunder if Landlord and Tenant further 4 75 extend the term of the Lease (other than Tenant's holding over under Paragraph 30 of the Lease). For purposes of this paragraph, an "Affiliate" shall mean any person or entity that wholly-owns or controls Guarantor or is wholly-owned or controlled by Guarantor or is under common-control with Guarantor. If Landlord and Tenant elect to amend the Lease to materially increase the monetary obligations of Tenant under the Lease without the consent of Guarantor, the amendment shall be binding on them and Guarantor's liability under this Guaranty shall remain in full force and effect, but the amendment shall not be enforceable against Guarantor as guaranteed Obligations if and only to the extent it would result in an increase in Guarantor's Obligations under this Guaranty. This Guaranty shall be legally binding upon Guarantor and its successors and assigns and shall inure to the benefit of Landlord and its successors and assigns; if Landlord disposes of, sells, transfers, assigns, hypothecates or otherwise conveys its interest in the Lease, or any part thereof, "Landlord" as used in this Guaranty, shall include Landlord's successor. Reference here to Tenant shall be deemed to include Tenant and its successors and assigns. The word "successor" is used herein in its most comprehensive sense and includes any assignee, transferee, personal representative, heir or other person or entity succeeding to the respective rights or obligations of either party. The terms and provisions of this Guaranty shall be governed by the laws of the State of California. Guarantor and Landlord (by its acceptance of this guaranty) hereby mutually waive trial by jury in connection with any dispute arising hereunder. Guarantor hereby consents to and submits to the jurisdiction of the federal and state courts located in the State of California and any action or suit under this Guaranty by Guarantor shall only be brought in the federal or state court with appropriate jurisdiction over the subject matter established or sitting in the State of California. Guarantor shall not raise, in connection with any action or suit under the Guaranty, and hereby waives any defenses based on the venue, inconvenience of the forum, lack of personal jurisdiction, the sufficiency of service of process or the like in any such action or suit brought in the State of California. Notices to Guarantor hereunder shall be sent by personal delivery, certified or registered mail with return receipt requested, or nationally recognized overnight courier service with receipt, or by facsimile to the following address (any notice delivered by telecopier in accordance with this paragraph shall be deemed to have been duly given upon 5 76 receipt if concurrently with sending by telecopier receipt is confirmed and a copy is sent by mail on the same day): Advanta Corp. Attention: Vice President, Advanta Corporate Services 200 Tournament Drive Horsham, PA 19044 IN WITNESS WHEREOF, Guarantor, intending to be legally bound hereby, has caused this Guaranty to be executed by its duly authorized officer and its corporate seal to be hereunto duly affixed, effective as of the 27th day of August, 1997. ADVANTA CORP. By: /s/ Christopher S. Derzane Title: SVP [Corporate Seal] Attest: /s/ Carl J. Deagler Asst. Secretary STATE OF PENNSYLVANIA ) : ss. COUNTY OF ) On this the 27th day of August, 1997, before me the subscriber, a notary public in and for the Commonwealth of Pennsylvania, personally appeared Christopher S. Derzane, who acknowledged himself to be the SVP of ADVANTA MORTGAGE CORP. USA, a Delaware corporation, and that he as such SVP, being authorized to do so, executed the foregoing instrument for the purpose therein contained by signing the name of the corporation by himself as Christopher S. Derzane. IN WITNESS WHEREOF I hereunto set my hand and official seal. [Notarial Seal] /s/ Betty Van Sant ----------------------------------- Notary Public My Commission Expires: 2/22/99 NOTARIAL SEAL BETTY VAN SANT, NOTARY PUBLIC HORSHAM TWP., MONTGOMERY COUNTY MY COMMISSION EXPIRES FEB. 22, 1999 6 EX-10.X 5 AMENDED & RESTATED SALE & SERVICING AGREEMENT 1 Exhibit 10-X AMENDED AND RESTATED SALE AND SERVICING AGREEMENT Dated as of August 31, 1999 among ADVANTA HOME EQUITY LOAN OWNER TRUST 1998-MS1 (Issuer) ADVANTA CONDUIT RECEIVABLES INC. (Depositor) ADVANTA MORTGAGE CORP. USA (Servicer) ADVANTA BANK CORP., ADVANTA NATIONAL BANK, and ADVANTA MORTGAGE CORP. USA (Loan Originators) ADVANTA CORP., (Transfer Obligor) and BANKERS TRUST COMPANY OF CALIFORNIA, N.A. (Indenture Trustee) ADVANTA HOME EQUITY LOAN OWNER TRUST 1998-MS1 HOME EQUITY LOAN ASSET-BACKED NOTES ISSUABLE IN SERIES 2 TABLE OF CONTENTS
Page ARTICLE I DEFINITIONS Section 1.01 Definitions ................................................................................ 2 Section 1.02 Other Definitional Provisions .............................................................. 32 ARTICLE II CONVEYANCE OF THE TRUST ESTATE; ADDITIONAL NOTE PRINCIPAL BALANCES Section 2.01 Conveyance of the Trust Estate; Additional Note Principal Balances ......................... 33 Section 2.02 Ownership and Possession of Loan Files ..................................................... 35 Section 2.03 Books and Records; Intention of the Parties ................................................ 35 Section 2.04 Delivery of Loan Documents ................................................................. 36 Section 2.05 Acceptance by the Indenture Trustee of the Loans; Certain Substitutions and Repurchases; Certification by the Custodian ........................................................ 38 Section 2.06 Conditions Precedent to Transfer Dates and Collateral Value Excess Dates ................... 39 Section 2.07 Termination of Revolving Period ............................................................ 42 Section 2.08 Correction of Errors ....................................................................... 42 ARTICLE III REPRESENTATIONS AND WARRANTIES Section 3.01 Representations and Warranties of the Depositor ............................................ 42 Section 3.02 Representations and Warranties of the Loan Originators ..................................... 44 Section 3.03 Representations, Warranties and Covenants of the Servicer .................................. 48 Section 3.04 Representations and Warranties of the Transfer Obligor ..................................... 50 Section 3.05 Representations and Warranties Regarding Loans ............................................. 52 Section 3.06 Repurchase and Substitution ................................................................ 52 Section 3.07 Dispositions ............................................................................... 54 Section 3.08 Loan Originator Put; Servicer Call ......................................................... 58 Section 3.09 Modification of Underwriting Guidelines .................................................... 58
3 ARTICLE IV ADMINISTRATION AND SERVICING OF THE LOANS Section 4.01 Duties of the Servicer ..................................................................... 58 Section 4.02 Collection of Certain Loan Payments ........................................................ 60 Section 4.03 Subservicing Agreements Between Servicer and Subservicers .................................. 61 Section 4.04 Successor Subservicers ..................................................................... 61 Section 4.05 Liability of Servicer ...................................................................... 61 Section 4.06 No Contractual Relationship Between Subservicer and Indenture Trustee or the Securityholders 62 Section 4.07 Assumption or Termination of Subservicing Agreement by Successor Servicer .................. 62 Section 4.08 Servicing Advances ......................................................................... 62 Section 4.09 Reserved ................................................................................... 62 Section 4.10 Maintenance of Insurance ................................................................... 62 Section 4.11 Due-on-Sale Clauses; Assumption and Substitution Agreements ................................ 63 Section 4.12 Realization Upon Defaulted Loans ........................................................... 64 Section 4.13 Release of Files ........................................................................... 65 Section 4.14 Access to Information ...................................................................... 66 Section 4.15 Release of Loan Files ...................................................................... 67 Section 4.16 Servicing Compensation ..................................................................... 67 Section 4.17 Statement as to Compliance and Financial Statements ........................................ 68 Section 4.18 Independent Public Accountants' Servicing Report ........................................... 68 Section 4.19 ARMs ....................................................................................... 69 Section 4.20 Year 2000 Compliance ....................................................................... 69 Section 4.21 Inspections by the Majority Noteholders and the Indenture Trustee .......................... 70 Section 4.22 Errors and Omissions Insurance ............................................................. 70 ARTICLE V ESTABLISHMENT OF TRUST ACCOUNTS; TRANSFER OBLIGATION Section 5.01 Collection Account and Distribution Account; Reserve Account ............................... 70 Section 5.02 Payments to Securityholders ................................................................ 75 Section 5.03 Trust Accounts; Trust Account Property ..................................................... 76 Section 5.04 Advance Account ............................................................................ 78 Section 5.05 Transfer Obligation Account ................................................................ 78 Section 5.06 Transfer Obligation ........................................................................ 80
4 ARTICLE VI STATEMENTS AND REPORTS; SPECIFICATION OF TAX MATTERS Section 6.01 Statements ................................................................................. 81 Section 6.02 Specification of Certain Tax Matters ....................................................... 84 Section 6.03 Valuation of Loans, Hedge Value and Retained Securities Value; Market Value Agent .......... 85 ARTICLE VII HEDGING Section 7.01 Hedging Instruments ........................................................................ 85 ARTICLE VIII THE SERVICER Section 8.01 Indemnification; Third Party Claims......................................................... 86 Section 8.02 Merger or Consolidation of the Servicer..................................................... 89 Section 8.03 Limitation on Liability of the Servicer and Others.......................................... 89 Section 8.04 Servicer Not to Resign; Assignment.......................................................... 89 Section 8.05 Relationship of Servicer to Issuer and the Indenture Trustee................................ 90 Section 8.06 Servicer May Own Securities................................................................. 90 Section 8.07 Indemnification of the Indenture Trustee and Initial Noteholder............................. 90 ARTICLE IX SERVICER EVENTS OF DEFAULT Section 9.01 Servicer Events of Default.................................................................. 91 Section 9.02 Appointment of Successor.................................................................... 92 Section 9.03 Waiver of Defaults.......................................................................... 93 Section 9.04 Accounting Upon Termination of Servicer..................................................... 94 ARTICLE X TERMINATION, PUT OPTION Section 10.01 Termination................................................................................ 94 Section 10.02 Optional Termination....................................................................... 95 Section 10.03 Notice of Termination...................................................................... 95 Section 10.04 Put Option................................................................................. 95
5 ARTICLE XI MISCELLANEOUS PROVISIONS Section 11.01 Acts of Securityholders.................................................................... 96 Section 11.02 Amendment.................................................................................. 96 Section 11.03 Recordation of Agreement................................................................... 97 Section 11.04 Duration of Agreement...................................................................... 97 Section 11.05 Governing Law.............................................................................. 97 Section 11.06 Notices.................................................................................... 97 Section 11.07 Severability of Provisions................................................................. 98 Section 11.08 No Partnership............................................................................. 98 Section 11.09 Counterparts............................................................................... 98 Section 11.10 Successors and Assigns..................................................................... 98 Section 11.11 Headings................................................................................... 99 Section 11.12 Actions of Securityholders................................................................. 99 Section 11.13 Non-Petition Agreement..................................................................... 99 Section 11.14 Holders of the Certificates................................................................ 100 Section 11.15 Due Diligence Fees, Due Diligence.......................................................... 100 Section 11.16 Liability.................................................................................. 101 Section 11.17 Confidential Information................................................................... 101 Section 11.18 Servicer to Provide Information to Loan Originator......................................... 102
EXHIBIT A Form of Notice of Additional Note Principal Balance EXHIBIT B Form of Servicer's Remittance Report to Trustee EXHIBIT C Form of S&SA Assignment EXHIBIT D Form of Reserve Account Release Instructions from Initial Noteholder SCHEDULE A Non-Wet Funded Loan Schedule SCHEDULE B Wet-Funded Loan Schedule ANNEX 1 Representations and Warranties Regarding Loans
6 This Amended and Restated Sale and Servicing Agreement is entered into effective as of August 31, 1999, among ADVANTA HOME EQUITY LOAN OWNER TRUST 1998-MS1, a Delaware business trust (the "Issuer"), ADVANTA CONDUIT RECEIVABLES INC., ("ACRI"), a Nevada corporation, as Depositor (in such capacity, the "Depositor"), ADVANTA MORTGAGE CORP. USA, a Delaware corporation ("AMCUSA"), as Servicer (in such capacity, the "Servicer"), AMCUSA, ADVANTA NATIONAL BANK, a national banking association ("ANB"), and ADVANTA BANK CORP., a Utah industrial loan corporation ("ABC"), as Loan Originators (in such capacity, each a "Loan Originator", or collectively the "Loan Originators"), BANKERS TRUST COMPANY OF CALIFORNIA, N.A., a national banking association, as Indenture Trustee on behalf of the Noteholders (in such capacity, the "Indenture Trustee") and ADVANTA CORP., a Delaware corporation as Transfer Obligor (in such capacity, the "Transfer Obligor"), amending and restating the Sale and Servicing Agreement, dated as of September 25, 1998, among the Issuer, ADVANTA LOAN WAREHOUSE CORPORATION, a Delaware corporation ("ALWC"), as Depositor, the Servicer, the Loan Originators, the Indenture Trustee and ADVANTA CORP. and AMCUSA, as Transfer Obligors (the "Original Sale and Servicing Agreement"). WHEREAS, the parties hereto desire to amend and restate the Original Sale and Servicing Agreement to provide terms and conditions for the sale of HELOC Mortgage Loans (as defined herein); WHEREAS, the parties hereto desire to amend and restate the Original Sale and Servicing Agreement to replace ALWC as depositor with ACRI. In connection with such replacement, ALWC wishes to assign, transfer and set over to ACRI all the rights, title and interest, powers, privileges and remedies of ALWC under the Sale and Servicing Agreement, and ACRI wishes to assume all duties, liabilities and obligations of ALWC under the Sale and Servicing Agreement; WHEREAS, upon execution of this Sale and Servicing Agreement by the parties hereto, ALWC shall be fully released from all of its duties, liabilities and obligations under the Original Sale and Servicing Agreement; NOW, THEREFORE, in consideration of the mutual agreements herein contained, the Issuer, the Depositor, the Loan Originators, the Servicer, Transfer Obligor and the Indenture Trustee hereby agree as follows for the benefit of each of them and for the benefit of the holders of the Notes and the Trust Certificates issued hereunder to amend and restate the Original Sale and Servicing Agreement in its entirety to read as follows: W I T N E S S E T H: In consideration of the mutual agreements herein contained, the Issuer, the Depositor, the Servicer, the Indenture Trustee, the Loan Originators and the Transfer Obligor hereby agree as follows for the benefit of each of them and for the benefit of the holders of Securities: -1- 7 ARTICLE I DEFINITIONS Section 1.01 Definitions. Whenever used in this Agreement, the following words and phrases, unless the context otherwise requires, shall have the meanings specified in this Article. Unless otherwise specified, all calculations of interest described herein shall be made on the basis of a 360-day year and the actual number of days elapsed in each Accrual Period. ABC: Advanta Bank Corp. and any successor thereto. Accepted Servicing Practices: The Servicer's normal servicing practices in servicing and administering mortgage loans for its own account, which in general will conform to the mortgage servicing practices of prudent mortgage lending institutions which service for their own account mortgage loans of the same type as the Loans in the jurisdictions in which the related Mortgaged Properties are located and will give due consideration to the Noteholders' reliance on the Servicer. Accrual Period: With respect to the Notes, the period commencing on and including the preceding Payment Date (or, in the case of the first Payment Date, the period commencing on and including the first Transfer Date) and ending on the day preceding the related Payment Date. Act or Securities Act: The Securities Act of 1933, as amended. Additional Note Principal Balance: (a) With respect to each Transfer Date, the aggregate Sales Prices of all Loans conveyed on such date. (b) With respect to each Collateral Value Excess Date, an amount equal to the increase in the Note Principal Balance that the Issuer sells to the Initial Noteholder pursuant to the Note Purchase Agreement on such Collateral Value Excess Date. Adequately Capitalized: Shall mean the maintenance of capital ratios at or above the required minimum levels for such capital category under regulations promulgated pursuant to Section 1831(o) of Title 12 of the United States Code, as amended from time to time. Administration Agreement: The Administration Agreement, dated as of September 25, 1998, among the Issuer and Advanta Mortgage Corp. USA, as Administrator. Administrator: Advanta Mortgage Corp. USA or any successor in interest thereto, in its capacity as Administrator under the Administration Agreement. -2- 8 Advance Account: The account established and maintained pursuant to Section 5.04. Affiliate: With respect to any specified Person, any "affiliate" of such Person as such term is defined in the United States Bankruptcy Code in effect from time to time, and the terms "controlling" and "controlled" have corresponding meanings. Agreement: This Agreement, as the same may be amended and supplemented from time to time. Allocation Percentage: With respect to ANB, ABC or the Depositor and as of each Reallocation Date, the fraction (expressed as a percentage) for which the numerator shall equal the aggregate Principal Balances (as of the close of business on such date) of all Loans then held by the Issuer which were conveyed to the Issuer by ANB, ABC or the Depositor, as applicable and the denominator of which is the aggregate Principal Balance (as of the close of business on such date) of all Loans then held by the Issuer. ALTA: The American Land Title Association and its successors in interest. Alternate Repurchase Price: With respect to a Loan, the sum of (i) the Collateral Value thereof as of the date of repurchase, (ii) all accrued and unpaid interest on such Loan since the last Payment Date to, but not including the date of repurchase, computed at the applicable Note Interest Rate, (iii) the amount of any unreimbursed Servicing Advances made by the Servicer (after deducting therefrom any amounts received in respect of such repurchased Loan and being held in the Collection Account for future distribution to the extent such amounts represent recoveries of principal not yet applied to reduce the related Principal Balance or interest for the period from and after the date of repurchase). The Alternate Repurchase Price shall be (i) increased by the net negative value or (ii) decreased by the net positive value of all Hedging Instruments terminated with respect to the repurchase of such Loan. To the extent the Servicer does not reimburse itself for amounts, if any, in respect of the Servicing Advance Reimbursement Amount pursuant to Section 5.01(c)(1) hereof, with respect to such Loan, the Alternate Repurchase Price shall be reduced by such amounts. AMCUSA: Advanta Mortgage Corp. USA, and any successor thereto. ANB: Advanta National Bank, and any successor thereto. Appraised Value: The value of the Mortgaged Property as set forth in an appraisal performed in connection with the origination of the related Loan. ARM: Any Loan for which the Loan Interest Rate is subject to adjustment. Assignment: A LPA Assignment or S&SA Assignment. Assignment of Mortgage: With respect to any Loan, an assignment of the related Mortgage in blank or to Bankers Trust Company of California, N.A., as custodian or trustee under the applicable custodial agreement or trust agreement, notice of transfer or -3- 9 equivalent instrument in recordable form, sufficient under the laws of the jurisdiction wherein the related Mortgaged Property is located to reflect the assignment and pledge of such Mortgage. Balloon Loan: Any Loan for which the related monthly payments, other than the monthly payment due on the maturity date thereof, are computed on the basis of a period to full amortization ending on a date that is later than the maturity date stated in the Promissory Note. Basic Documents: This Agreement, the Administration Agreement, the Custodial Agreement, the Indenture, the Loan Purchase Agreement, the Note Purchase Agreement, the Trust Agreement, each Hedging Instrument and, as and when required to be executed and delivered, the Assignments. Borrower: The obligor or obligors on a Promissory Note. Business Day: Any day other than (i) a Saturday or Sunday, or (ii) a day on which banking institutions in Delaware, New York City, California or in the city in which the corporate trust office of the Indenture Trustee is located or the city in which the Servicer's servicing operations are located are authorized or obligated by law or executive order to be closed. Certificateholder: A holder of a Trust Certificate. Clean-up Call Date: The first Payment Date occurring on or after the end of the Revolving Period on which the Note Principal Balance declines to 10% or less of the aggregate Note Principal Balance as of the end of the Revolving Period. Closing Date: September 25, 1998, or with respect to a Series of Notes subsequent to the Series issued on such date, as set forth in the related Indenture Supplement. Code: The Internal Revenue Code of 1986, as amended from time to time, and the regulations promulgated by the United States Treasury thereunder. Collateral Percentage: With respect to each Loan and any Business Day, a percentage determined as follows: (a) with respect to all Loans (other than HELOC Mortgage Loans, Loans that are 30 or more days Delinquent and High LTV Loans), 96%; (b) with respect to all High LTV Loans, 94%; (c) with respect to all Loans (other than HELOC Mortgage Loans) that are 30 or more days Delinquent, 90%; (d) with respect to all HELOC Mortgage Loans that are 0-29 days Delinquent, 93%; -4- 10 (e) with respect to all HELOC Mortgage Loans that are 30 to 59 days Delinquent, 85%; and (f) with respect to all HELOC Mortgage Loans that are 60 or more days Delinquent, 0%. Collateral Value: With respect to each Loan and each Business Day, an amount equal to (a) the lesser of (1) the Collateral Percentage of the Market Value of such Loan, and (2) 100% of the Principal Balance of such Loan as of the most recent Determination Date (or, for Loans sold and conveyed to the Trust after the most recent Determination Date, the Transfer Cutoff Date Principal Balance thereof), less (b) the aggregate unreimbursed Servicing Advances attributable to such Loan as of the most recent Determination Date; provided, however, that the Collateral Value shall be zero with respect to each Loan (1) that a Loan Originator is required to repurchase pursuant to Section 2.05 or Section 3.06 hereof or (2) which is a Loan of the type specified in subparagraphs (i)-(vii) hereof and which is in excess of the limits permitted under subparagraphs (i)-(vii) hereof, or (3) which remains pledged to the Indenture Trustee later than 180 days after its related Transfer Date, or (4) which has been released from the possession of the Custodian to the Servicer or any Loan Originator for a period in excess of 14 days; provided further however: (i) the aggregate Collateral Value of Loans (other than HELOC Mortgage Loans) which are Second Lien Loans may not exceed 25% of the aggregate outstanding Note Principal Balance; (ii) the aggregate Collateral Value of Loans which are Mixed Use Loans may not exceed 1% of the Maximum Note Principal Balance; (iii) the aggregate Collateral Value of Loans which are Balloon Loans may not exceed 25% of the Maximum Note Principal Balance; (iv) the aggregate Collateral Value of Loans that are High LTV Loans may not exceed 10% of the Maximum Note Principal Balance; (v) the aggregate Collateral Value of Loans (other than HELOC Mortgage Loans) which are 30 to 59 days Delinquent as of the related Determination Date, may not exceed 3% of the aggregate Note Principal Balance, provided, however that if the aggregate Collateral Value of all Loans (other than HELOC Mortgage Loans) that are 30 to 59 days Delinquent as of such date exceeds 3% of the aggregate Note Principal Balance as of such day, each Loan (other than HELOC Mortgage Loans) or portion thereof included in the portion of such aggregate Collateral Value in excess of such limit shall be deemed to be 60 to 89 days Delinquent; (vi) the aggregate Collateral Value of Loans which are not HELOC Mortgage Loans which are 60 to 89 days Delinquent as of the related Determination Date, may not exceed 1% of the aggregate Note Principal -5- 11 Balance, provided, however that if the aggregate Collateral Value of all Loans which are not HELOC Mortgage Loans that are 60 to 89 days Delinquent as of such date exceed 1% of the aggregate Note Principal Balance as of such day, each Loan or portion thereof included in the portion of such aggregate Collateral Value in excess of such limit shall be deemed to be 90 or more days Delinquent; (vii) the aggregate Collateral Value of Loans which are 90 or more days Delinquent as of the most recent Determination Date (inclusive of all Loans that are deemed to be 90 or more days Delinquent pursuant to clause (vi) above and each Loan which is a Foreclosed Loan or which is an REO Property), may not exceed 0%; (viii) the aggregate Collateral Value of Loans which are secured by a Manufactured Dwelling may not exceed 5% of the Maximum Note Principal Balance; (ix) the aggregate Collateral Value of Loans which are HELOC Mortgage Loans may not exceed $150,000,000; (x) the Collateral Value of each HELOC Mortgage Loan with a Principal Balance as of the most recent Determination Date in excess of the Credit Limit shall be based on the Credit Limit; and (xi) the aggregate Collateral Value of HELOC Mortgage Loans which are 30 to 59 days Delinquent as of the related Determination Date may not exceed 2% of the aggregate Note Principal Balance. Collateral Value Excess: With respect to any Business Day, an amount equal to the positive difference, if any, between (a) (i) the aggregate Collateral Value of all Loans in the Loan Pool on such Business Day, or (ii) in the event that a Performance Trigger shall have occurred and not been Deemed Cured, the aggregate Collateral Value of all Loans in the Loan Pool on such Business Day multiplied by 0.98 and (b) the Note Principal Balance on such Business Day. Collateral Value Excess Date: Any Business Day on which a Collateral Value Excess exists and on which the Initial Noteholder purchases Additional Note Principal Balance in respect thereof pursuant to Section 2.01 hereof. Collection Account: The account designated as such, established and maintained by the Servicer in accordance with Section 5.01(a)(1) hereof. Combined LTV or CLTV: (i) With respect to any HELOC Mortgage Loan, as of any Determination Date, the percentage equivalent of a fraction, the numerator of which is the sum of (A) the Credit Limit and (B) the outstanding principal balance as of the date of execution of the related Credit -6- 12 Line Agreement of such HELOC Mortgage Loan (or as of any subsequent date, if any, as of which such outstanding principal balance may be determined in connection with an increase in the Credit Limit for such HELOC Mortgage Loan) of any mortgage loan or mortgage loans that are senior in priority to the HELOC Mortgage Loan and which is secured by the same Mortgaged Property and the denominator of which is the lesser of (A) the Appraised Value of the related Mortgaged Property on such date of execution of the related Credit Line Agreement or on such subsequent date, if any, or (B) in the case of a Mortgaged Property purchased within one year prior to such date of execution of the related Credit Line Agreement, the purchase price thereof; and (ii) with respect to any Loan that is not a HELOC Mortgage Loan, the ratio of (a) the outstanding principal balance on the related date of origination of (i) such Loan plus (ii) the loan constituting the first lien (if any) to (b) (i) the Appraised Value of the related Mortgaged Property on such date of origination or on such subsequent date, if any, or (ii) in the case of a Mortgaged Property purchased within one year prior to such date of origination, the purchase price thereof, expressed as a percentage. Commission: The Securities and Exchange Commission. Credit Limit: With respect to each HELOC Mortgage Loan, the maximum amount permitted under the terms of the related Credit Line Agreement. Credit Line Agreement: With respect to any HELOC Mortgage Loan, the related home equity line of credit agreement and promissory note (if any) executed by the related mortgagor and any amendment or modification thereof. Custodial Agreement: The custodial agreement dated as of September 25, 1998, among the Issuer, the Servicer, the Indenture Trustee and the Custodian, providing for the retention of the Custodial Loan Files by the Custodian on behalf of the Indenture Trustee. Custodial Loan File: As defined in Section 2.04. Custodian: The custodian named in the Custodial Agreement, which custodian shall not be affiliated with the Servicer, the Loan Originators, the Depositor or any Subservicer. Bankers Trust Company of California, N.A., a national banking association, shall be the initial Custodian pursuant to the terms of the Custodial Agreement. Custodian Fee: If applicable, the quarterly fee payable to the Custodian, calculated and payable on every third Payment Date. The Servicer shall pay such fee pursuant to Section 6 of the Custodial Agreement. Daily Interest Accrual Amount: With respect to each day, interest accrued at the Note Interest Rate on the Note Principal Balance as of the preceding Business Day after giving effect to all changes to the Note Principal Balance on or prior to such preceding Business Day. -7- 13 Deemed Cured: When the condition that originally gave rise to a Performance Trigger or Rapid Amortization Trigger has not continued for 20 consecutive days or has otherwise been waived with the prior written consent of the Majority Noteholders. Default: Any occurrence that is, or with notice or the lapse of time or both would become, an Event of Default. Defaulted Loan: With respect to any Determination Date, any Loan, including, without limitation, any Liquidated Loan with respect to which any of the following has occurred as of the end of the preceding Remittance Period: (a) foreclosure or similar proceedings have been commenced; or (b) the Servicer or any Subservicer has determined in good faith and in accordance with the servicing standard set forth in Section 4.01 that such Loan is in default or imminent default. Deleted Loan: A Loan replaced or to be replaced by one or more Qualified Substitute Loans. Delinquent: A Loan is "Delinquent" if any Monthly Payment due thereon is not made by the close of business on the day such Monthly Payment is required to be paid. A Loan is "30 days Delinquent" if any Monthly Payment due thereon has not been received by the opening of business on the corresponding day of the month immediately succeeding the month in which such Monthly Payment was required to be paid or, if there is no such corresponding day (e.g., as when a 30-day month follows a 31-day month in which a payment was required to be paid on the 31st day of such month), then on the last day of such immediately succeeding month. The determination of whether a Loan is "60 days Delinquent," "90 days Delinquent", etc., shall be made in like manner. Delivery: When used with respect to Trust Account Property means: (a) with respect to bankers' acceptances, commercial paper, negotiable certificates of deposit and other obligations that constitute "instruments" within the meaning of Section 9-105(1)(i) of the UCC and are susceptible of physical delivery (except with respect to Trust Account Property consisting of certificated securities (as defined in Section 8-102(a)(4) of the UCC)), physical delivery to the Indenture Trustee or its custodian endorsed to the Indenture Trustee or its custodian or endorsed in blank; (b) with respect to a certificated security (i) delivery of such certificated security endorsed to, or registered in the name of, the Indenture Trustee or endorsed in blank to a securities intermediary (as defined in Section 8-102(a)(14) of the UCC) and the making by such securities intermediary of appropriate entries in its records identifying such certificated securities as credited to the securities account (as defined in Section 8-501(a) of the UCC) of the Indenture Trustee, or (ii) by delivery thereof to a "clearing corporation" (as defined in Section 8-102(5) of the UCC) and the making by such clearing corporation of appropriate entries in its records crediting the securities account of a securities intermediary by the amount of such certificated security and the making by such securities intermediary of appropriate entries in its records identifying such certificated securities as credited to the securities account of the Indenture Trustee -8- 14 (all of the Trust Account Property described in Subsections (a) and (b), "Physical Property"); and, in any event, any such Physical Property in registered form shall be in the name of the Indenture Trustee or its nominee or custodian; and such additional or alternative procedures as may hereafter become appropriate to effect the complete transfer of ownership of any such Trust Account Property (as defined herein) to the Indenture Trustee or its nominee or custodian, consistent with changes in applicable law or regulations or the interpretation thereof; (c) with respect to any security issued by the U.S. Treasury, FNMA or FHLMC that is a book-entry security held through the Federal Reserve System pursuant to federal book-entry regulations, the following procedures, all in accordance with applicable law, including applicable federal regulations and Articles 8 and 9 of the UCC: the making by a Federal Reserve Bank of an appropriate entry crediting such Trust Account property to an account of a securities intermediary that is also a "participant" pursuant to applicable federal regulations; the making by such securities intermediary of appropriate entries in its records crediting such book-entry security held through the Federal Reserve System pursuant to federal book-entry regulations and Articles 8 and 9 of the UCC to the securities account of the Indenture Trustee; and such additional or alternative procedures as may hereafter become appropriate to effect complete transfer of ownership of any such Trust Account Property to the Indenture Trustee or its nominee or custodian, consistent with changes in applicable law or regulations or the interpretation thereof; and (d) with respect to any item of Trust Account Property that is an uncertificated security (as defined in Section 8-102(a)(18) of the UCC) and that is not governed by clause (c) above, registration in the records of the Issuer thereof in the name of the securities intermediary, and the making by such securities intermediary of appropriate entries in its records crediting such uncertificated certificates to the Indenture Trustee. Denomination: With respect to a Note, the portion of the Note Principal Balance represented by such Note as specified therein. Depositor: Advanta Conduit Receivables Inc., a Nevada corporation, and any successors thereto. Determination Date: With respect to any Payment Date occurring on the 25th day of a month, the third Business Day immediately preceding such Payment Date, and with respect to any other Payment Date, as mutually agreed by the Servicer and the Noteholders. Disposition: A Securitization, Whole Loan Sale transaction, or other disposition of Loans, in each case by the Issuer. Disposition Agent: Morgan Stanley & Co. Incorporated and its successors and assigns acting at the direction of the Majority Noteholders or such other Person designated by -9- 15 the Issuer with the consent of the Majority Noteholders; provided that with respect to any Disposition in connection with an Event of Default, or during a Termination Period, the Disposition Agent shall be Morgan Stanley & Co. Incorporated. Disposition Participant: With respect to a Disposition, any "depositor" with respect to a Securitization, the Disposition Agent, the Majority Noteholders, the Servicer, the related trustee and the related custodian, any nationally recognized credit rating agency, the related underwriters, the related placement agent, the related credit enhancer, the related whole-loan purchaser, the related purchaser of securities and/or any other party necessary or, in the good faith belief of any of the foregoing, desirable to effect a Disposition. Disposition Proceeds: With respect to a Disposition, (x) the proceeds of the Disposition remitted to the Trust in respect of the Loans transferred on the date of and with respect to such Disposition, including without limitation, any cash and Retained Securities created in any related Securitization less all costs, fees and expenses incurred in connection with such Disposition, including, without limitation, all amounts deposited into any reserve funds upon the closing thereof plus or minus (y) the net positive or net negative value of all Hedging Instruments terminated in connection with such Disposition minus (z) all other amounts agreed upon in writing by the Initial Noteholder, the Trust and the Servicer. Distribution Account: The account established and maintained pursuant to Section 5.01(a)(2) hereof. Draw: With respect to any HELOC Mortgage Loan, an additional borrowing by the Borrower under the terms of the related Credit Line Agreement subsequent to each Transfer Cutoff Date in accordance with the related Credit Line Agreement. Draw Period: With respect to any HELOC Mortgage Loan, the period of time during which the Borrower under the related Credit Line Agreement may make a Draw under the related Credit Line Agreement; such period not to exceed three to five years (as applicable), unless extended at the option of the related Loan Originator pursuant to the terms of the related Credit Line Agreement (provided that such extension shall be in accordance with the provisions set forth herein with respect to Loan modifications). Draw Reimbursement Rights: As to each HELOC Mortgage Loan, the right to be reimbursed for the making of Draws on behalf of the Issuer in the case of ANB, ABC and the Depositor, and on behalf of the Depositor, in the case of AMCUSA, which shall equal an amount equal to the principal for the aggregate Draws thereunder, which rights shall automatically be conveyed to the Issuer pursuant to the terms of this Agreement (and in the case of AMCUSA, to the Depositor pursuant to the terms of the Loan Purchase Agreement) under which the related HELOC Mortgage Loans were conveyed. Due Date: The day of the month on which the Monthly Payment is due from the Borrower with respect to a Loan. Due Diligence Fees: Shall have the meaning provided in Section 11.15 hereof. -10- 16 Eligible Account: At any time, an account which is maintained with an institution whose deposits are insured by the Bank Insurance Fund or the Savings Association Insurance Fund of the FDIC, the long-term deposits of which shall be rated A2 or better by Moody's or A or better by S&P and the short-term deposits of which shall be rated P-1 or better by Moody's and A-1 or better by S&P and which is any of the following: (i) a federal savings and loan association duly organized, validly existing and in good standing under the federal banking laws; (ii) an institution duly organized, validly existing and in good standing under the applicable banking laws of any state; (iii) a national banking association duly organized, validly existing and in good standing under the federal banking laws; (iv) a principal subsidiary of a bank holding company; or (v) approved in writing by the Majority Noteholders; provided, however, that any such institution or association shall have combined capital, surplus and undivided profits of at least $50,000,000. Eligible Servicer: (x) AMCUSA, ANB, ABC or (y) any other Person that (a) (i) has been designated as an approved seller-servicer by FNMA or FHLMC for first and second mortgage loans and (ii) has equity of not less than $15,000,000, as determined in accordance with GAAP or (b) any other Person to which the Majority Noteholders may consent in writing. Escrow Payments: With respect to any Loan, the amounts constituting ground rents, taxes, assessments, water rates, sewer rents, municipal charges, fire, hazard, liability and other insurance premiums, condominium charges, and any other payments required to be escrowed by the related Borrower with the related servicer pursuant to the Mortgage or any other document. Event of Default: Either a Servicer Event of Default or an Event of Default under the Indenture. Exchange Act: The Securities Exchange Act of 1934, as amended. FDIC: The Federal Deposit Insurance Corporation and any successor thereto. FHLMC: The Federal Home Loan Mortgage Corporation and any successor thereto. Fidelity Bond: As described in Section 4.22 hereof. Final Put Date: As defined in Section 10.05 of the Indenture. First Lien Loan: A Loan secured by the lien on the related Mortgaged Property, subject to no prior liens on such Mortgaged Property at the time of origination or the date of execution of the Credit Line Agreement, as applicable. FNMA: The Federal National Mortgage Association and any successor thereto. Foreclosed Loan: As of any Determination Date, any Loan that as of the end of the preceding Remittance Period has been discharged as a result of (i) the completion of -11- 17 foreclosure or comparable proceedings by the Servicer, on behalf of the Issuer; (ii) the acceptance of the deed or other evidence of title to the related Mortgaged Property in lieu of foreclosure or other comparable proceeding; or (iii) the acquisition of title to the related Mortgaged Property by operation of law. Foreclosure Property: Any real property securing a Foreclosed Loan that has been acquired by the Servicer on behalf of the Issuer through foreclosure, deed in lieu of foreclosure or similar proceedings in respect of the related Loan. GAAP: Generally Accepted Accounting Principles as in effect in the United States. Gross Margin: With respect to each ARM and HELOC Mortgage Loan, the fixed percentage amount set forth in the related Promissory Note. Hedge Funding Requirement: With respect to any day, all amounts required to be paid or delivered by the Issuer under any Hedging Instrument, whether in respect of payments thereunder or in order to meet margin, collateral or other requirements thereof. Such amounts shall be calculated by the Market Value Agent and communicated in writing to the Indenture Trustee. Hedge Value: With respect to any Business Day and a specific Hedging Instrument, the positive amount, if any, that is equal to the amount that would be paid to the Issuer in consideration of an agreement between the Issuer and an unaffiliated third party, that would have the effect of preserving for the Issuer the net economic equivalent, as of such Business Day, of all payment and delivery requirements payable to and by the Issuer under such Hedging Instrument until the termination thereof, as determined by the Market Value Agent in accordance with Section 6.03 hereof. Hedging Counterparty: A Person (i) (A) the long-term and commercial paper or short-term deposit ratings of which are acceptable to the Majority Noteholders and (B) which shall agree in writing that, in the event that any of its long-term or commercial paper or short-term deposit ratings cease to be at or above the levels deemed acceptable by the Majority Noteholders, it shall secure its obligations in accordance with the reasonable request of the Majority Noteholders, (ii) that has entered into a Hedging Instrument and (iii) that is acceptable to the Majority Noteholders, which acceptance shall not be unreasonably withheld. Hedging Instrument: Any interest rate cap agreement, interest rate floor agreement, interest rate swap agreement or other interest rate hedging agreement entered into by the Issuer with a Hedging Counterparty, and which requires the Hedging Counterparty to deposit all amounts payable thereby directly to the Collection Account. Each Hedging Instrument shall meet the requirements set forth in Article VII hereof with respect thereto. HELOC Mortgage Loan: A Loan which is an adjustable-rate home equity revolving line of credit secured by a first or second mortgage, deed of trust or other instrument creating a lien on the related Mortgaged Property, which lien secures the related Promissory Note. -12- 18 High LTV Loans: First and second lien Loans other than HELOC Mortgage Loans with an LTV greater than 90% and less than or equal to 100%. Indenture: The Indenture dated as of September 25, 1998, together with the Indenture Supplement, between the Issuer and the Indenture Trustee, and all amendments or supplements thereto. Indenture Supplement: With respect to a Series of Notes, the Indenture Supplement pursuant to which such Series of Notes was issued. Indenture Trustee: Bankers Trust Company of California, N.A., a national banking association, as Indenture Trustee under the Indenture, or any successor indenture trustee under the Indenture. Indenture Trustee Fee: As to any Payment Date, the amount payable to the Indenture Trustee equal to an amount as separately agreed in writing by the Indenture Trustee and the Servicer and with the approval of the Majority Noteholders, which approval shall not be unreasonably withheld. Independent: When used with respect to any specified Person, such Person (i) is in fact independent of the Loan Originators, the Transfer Obligor, the Servicer, the Depositor or any of their respective Affiliates, (ii) does not have any direct financial interest in, or any material indirect financial interest in, any of the Loan Originators, the Transfer Obligor, the Servicer, the Depositor or any of their respective Affiliates and (iii) is not connected with any of the Loan Originators, the Transfer Obligor, the Depositor, the Servicer or any of their respective Affiliates, as an officer, employee, promoter, underwriter, trustee, partner, director or Person performing similar functions; provided, however, that a Person shall not fail to be Independent of the Loan Originators, the Transfer Obligor, the Depositor, the Servicer or any of their respective Affiliates merely because such Person is the beneficial owner of 1% or less of any class of securities issued by the Loan Originators, the Transfer Obligor, the Depositor, the Servicer or any of their respective Affiliates, as the case may be. Independent Accountants: A firm of nationally recognized certified public accountants which is Independent. Index: With respect to each ARM and HELOC Mortgage Loan, the index set forth in the related Promissory Note for the purpose of calculating the Loan Interest Rate thereon. Initial Noteholder: MSSFI. Interest Carry-Forward Amount: With respect to any Payment Date, the excess, if any, of (A) the Interest Payment Amount for such Payment Date plus the Interest Carry-Forward Amount for the prior Payment Date over (B) the amount in respect of interest that is actually paid from the Distribution Account on such Payment Date in respect of the interest for such Payment Date. -13- 19 Interest Payment Amount: With respect to any Payment Date, the sum of the Daily Interest Accrual Amounts for all days in the related Accrual Period. LIBOR: With respect to each day, the rate for United States dollar deposits for one month that appears on the Telerate Screen Page 3750 as of 11:00 a.m., London time, on the related LIBOR Determination Date. If such rate does not appear on such page (or such other page as may replace that page on that service, or if such service is no longer offered, such other service for displaying LIBOR or comparable rates as may be reasonably selected by the Initial Noteholder with the consent of the Issuer, such consent not to be unreasonably withheld), LIBOR for the applicable day will be the Reference Bank Rate. If no such rates can be obtained by the Initial Noteholder and no Reference Bank Rate is available, LIBOR will be LIBOR applicable to the first preceding day on which LIBOR has been determined in accordance with this definition. LIBOR Business Day: Any day on which banks are open for dealing in foreign currency and exchange in London. LIBOR Determination Date: With respect to each day that is a LIBOR Business Day, such LIBOR Business Day, and with respect to any day that is not a LIBOR Business Day, the LIBOR Business Day preceding such day. LIBOR Margin: With respect to each day, the percentage equal to the weighted average of the Non HELOC Rate and the HELOC Rate (each as defined below) based on the relative aggregate Principal Balance of the Loans which are not HELOC Mortgage Loans and the aggregate Principal Balance of the HELOC Mortgage Loans, respectively, each as of such day. NON HELOC RATE
Unfunded Transfer Obligation LIBOR Margin: Percentage: >= 8.00% 0.75%, provided that when the aggregate Principal Balance of all Loans and mortgage loans pledged under the Warehouse Lines is greater than $250,000,000 as of such date, 0.65% >=5.00%, but <8.00% 1.25% <5.00% 2.25%
provided that the Non HELOC Rate shall be equal to 2.25% upon the occurrence of an Event of Default or for the period commencing the day following the Clean-up Call Date. HELOC RATE -14- 20
Unfunded Transfer Obligation LIBOR Margin: Percentage: >= 8.00% 0.95%, provided that when the aggregate Principal Balance of all Loans and mortgage loans pledged under the Warehouse Lines is greater than $250,000,000 as of such date, 0.85% >=5.00%, but <8.00% 1.45% <5.00% 2.45%
provided that the HELOC Rate shall be equal to 2.45% upon the occurrence of an Event of Default or for the period commencing the day following the Clean-up Call Date. Lien: With respect to any asset, (a) any mortgage, lien, pledge, charge, security interest, hypothecation, option or encumbrance of any kind in respect of such asset or (b) the interest of a vendor or lessor under any conditional sale agreement, financing lease or other title retention agreement relating to such asset. Lifetime Cap: The provision in the Promissory Note for each ARM or HELOC Mortgage Loan which limits the maximum Loan Interest Rate over the life of such ARM or HELOC Mortgage Loan. Liquidated Loan: As defined in Section 4.12(b). Liquidated Loan Losses: With respect to any Determination Date, the difference between (i) the aggregate Principal Balances as of such date of all Loans that became Liquidated Loans and (ii) all Liquidation Proceeds allocable to principal received on or prior to such date. Liquidation Proceeds: With respect to a Liquidated Loan, any cash amounts received in connection with the liquidation of such Liquidated Loan, whether through trustee's sale, foreclosure sale or other disposition, any cash amounts received in connection with the management of the Mortgaged Property from Defaulted Loans and any other amounts required to be deposited in the Collection Account pursuant to Section 5.01(b)(1) hereof, in each case other than Mortgage Insurance Proceeds and Released Mortgaged Property Proceeds. Loan: Any loan, including a HELOC Mortgage Loan, sold to the Trust hereunder and pledged to the Indenture Trustee, which loan includes, without limitation, (i) a Promissory Note and the related Mortgage and (ii) all right, title and interest of the related Loan Originator in and to the Mortgaged Property covered by such Mortgage. The term Loan shall be deemed to include the related Promissory Note, related Mortgage and related Foreclosure Property, if any. -15- 21 Loan Documents: With respect to a Loan, the documents comprising the Custodial Loan File for such Loan. Loan File: With respect to each Loan, the Custodial Loan File and the Servicer's Loan File. Loan Interest Rate: With respect to each Loan, the annual rate of interest borne by the related Promissory Note, as shown on the Loan Schedule, and, in the case of an ARM or HELOC Mortgage Loan, as the same may be periodically adjusted in accordance with the terms of such Promissory Note. Loan Originator: Each of ANB, AMCUSA and ABC. "Loan Originators" shall mean all such entities, collectively, and any successors thereto. In the case of AMCUSA, its subsidiary, Advanta Finance Corp., may transfer Loans originated by Advanta Finance Corp. to AMCUSA, which Loans shall be transferred by AMCUSA to the Depositor and in turn to the Issuer. AMCUSA shall be the Loan Originator for all such Loans. Loan Originator Put: The mandatory repurchase by a Loan Originator, at the option of the Majority Noteholders, of a Loan pursuant to Section 3.08(a) hereof. Loan Pool: As of any date of determination, the pool of all Loans conveyed to the Issuer pursuant to this Agreement on all Transfer Dates up to and including such date of determination, which Loans have not been released from the Lien of the Indenture pursuant to the terms of the Basic Documents, together with the rights and obligations of a holder thereof, and the payments thereon and proceeds therefrom received after the applicable Transfer Cutoff Date (other than interest thereon accrued prior to such Transfer Cutoff Date), as identified from time to time on the Loan Schedule. Loan Purchase Agreement: The Loan Purchase Agreement, among AMCUSA, as seller and the Depositor, as purchaser, dated as of September 25, 1998, and all amendments and supplements thereto. Loan Schedule: The schedule of Loans conveyed to the Issuer and delivered to the Initial Noteholder and the Indenture Trustee in the form of a computer-readable transmission specifying the following information (a) with respect to each non-Wet Funded Loan conveyed on such date: (i) the Loan identifying number, (ii) the Borrower's name, (iii) the street address, city, state and zip code of the related Mortgaged Property, (iv) the original Principal Balance (v) the Transfer Cutoff Date Principal Balance, (vi) the Loan Interest Rate as of the Transfer Cutoff Date, (vii) whether such Loan has a fixed Loan Interest Rate, or, if such Loan is an ARM or HELOC Mortgage Loan, the Index thereof, the Gross Margin thereof, the Lifetime Cap, and the adjustment date of the Loan; (viii) the maturity date, (ix) the Lien Position of such Loan (i.e., whether such Loan is a First Lien Loan or a Second Lien Loan), (x) the next Due Date, (xi) whether such Loan is a Balloon Loan, (xii) whether such Loan is a Mixed Use Loan, (xiii) whether or not the loan has been assumed pursuant to an assumption agreement, (xiv) the related Loan Originator, (xv) whether there is any written instrument that modifies the Promissory Note or Mortgage, (xvi) such other information as may be reasonably requested by the Majority Noteholders and the Indenture Trustee, and (xvii) that such Loan is -16- 22 not a Wet Funded Loan, (xviii) a code indicating whether such Loan was previously a Wet Funded Loan, (xix) the applicable Servicing Fee Rate, (xx) the Wet Custodial File Delivery Date, (xxi) whether the Loan is a HELOC Mortgage Loan; (b) with respect to each Wet Funded Loan conveyed on such date: (i) the temporary Loan identifying number or the Borrower's name, (ii) the original Principal Balance, and (iii) a code indicating that such Loan is a Wet Funded Loan, and the Wet Custodial File Delivery Date; and (c) with respect to HELOC Mortgage Loans, the Credit Limit under the related Credit Line Agreement. Loan Schedule and Exceptions Report: The meaning set forth in the Custodial Agreement. Loan-to-Value Ratio or LTV: With respect to any Loan, the ratio of the original outstanding principal amount of the Loan to the lesser of (a) the Appraised Value of the Mortgaged Property at origination or (b) if the Mortgaged Property was purchased within 12 months of the origination of the Loan, the purchase price of the Mortgaged Property. LPA Assignment: The Assignment of Loans from AMCUSA to the Depositor under the Loan Purchase Agreement. Majority Certificateholders: Has the meaning set forth in the Trust Agreement. Majority Noteholders: The holder or holders of in excess of 50% of the Note Principal Balance. In the event of the release of the Lien of the Indenture in accordance with the terms thereof, the Majority Noteholders shall mean the Majority Certificateholders. Manufactured Dwelling: Shall mean a fully attached manufactured home which is considered and treated as "real estate" under applicable state law. Market Value: The market value of such Loan as of any Business Day as determined by the Market Value Agent in accordance with Section 6.03 hereof. Market Value Agent: Morgan Stanley & Co. Incorporated and its successors in interest. Maturity Date: With respect to the Notes of a given Series, the date set forth in the related Indenture Supplement or such later date as may be agreed in writing by the Majority Noteholders. Maximum Note Principal Balance: For any Series of Notes, as set forth in the related Indenture Supplement, less the aggregate principal balance of the loans outstanding under the Warehouse Lines. Mixed Use Loan: A Loan secured by a Mortgaged Property that is used primarily for residential purposes, but which is also used for non-residential purposes. -17- 23 Monthly Payment: The scheduled monthly payment of principal and/or interest required to be made by a Borrower on the related Loan, as set forth in the related Promissory Note. Monthly Remittance Amount: With respect to each Remittance Period, the sum, without duplication, of (i) the aggregate interest portions of the payments collected on the Loans during the immediately preceding Remittance Period, (ii) the aggregate principal payments on the Loans collected by the Servicer during the immediately preceding Remittance Period, (iii) the aggregate of amounts deposited into the Collection Account pursuant to Section 5.01(b)(1)(ii) through 5.01(b)(1)(vi) and Section 5.01(b)(1)(viii) during the immediately preceding Remittance Period and (iv) any Termination Price, cash Disposition Proceeds and payments by Hedging Counterparties received on or prior to the related Determination Date. Moody's: Moody's Investors Service, Inc., or any successor thereto. Mortgage: With respect to any Loan, the mortgage, deed of trust or other instrument securing the related Promissory Note, which creates a first or second lien on the fee in real property and/or a first or second lien on the leasehold estate in real property securing the Promissory Note and the assignment of rents and leases related thereto. Mortgage Insurance Policies: With respect to any Mortgaged Property or Loan, the insurance policies required pursuant to Section 4.10. Mortgage Insurance Proceeds: With respect to any Mortgaged Property, all amounts collected in respect of Mortgage Insurance Policies and not required either pursuant to applicable law or the related Loan Documents to be applied to the restoration of the related Mortgaged Property or paid to the related Borrower. Mortgaged Property: With respect to a Loan, the related Borrower's fee and/or leasehold interest in the real property (and/or all improvements, buildings, fixtures, building equipment and personal property thereon (to the extent applicable) and all additions, alterations and replacements made at any time with respect to the foregoing) and all other collateral securing repayment of the debt evidenced by the related Promissory Note. MSSFI: Morgan Stanley Securitization Funding Inc. Net Liquidation Proceeds: With respect to any Payment Date, Liquidation Proceeds received during the prior Remittance Period, net of any reimbursements to the Servicer made from such amounts for any unreimbursed Servicing Compensation, Servicing Advances (including Nonrecoverable Servicing Advances) made and any other fees and expenses paid in connection with the foreclosure, conservation and liquidation of the related Liquidated Loans or Foreclosure Properties pursuant to Section 4.12 hereof. Net Loan Losses: With respect to any Defaulted Loan that is subject to a modification pursuant to Section 4.02 hereof, an amount equal to the portion of the Principal Balance, if any, released in connection with such modification. -18- 24 Nonrecoverable Servicing Advance: With respect to any Loan or any Foreclosure Property, (a) any Servicing Advance (including Preservation Expenses) previously made and not reimbursed from collections, Liquidation Proceeds, Mortgage Insurance Proceeds or the Released Mortgaged Property Proceeds or (b) a Servicing Advance proposed to be made in respect of a Loan or Foreclosure Property either of which, in the good faith business judgment of the Servicer, as evidenced by certificate of a Servicing Officer delivered to the Initial Noteholder, would not be ultimately recoverable. Note: The meaning assigned thereto in the Indenture. Noteholder: The meaning assigned thereto in the Indenture. Note Interest Rate: Interest will accrue on the Notes on each day at a per annum interest rate equal to LIBOR as of the related LIBOR Determination Date plus the LIBOR Margin for such day. Note Principal Balance: With respect to the Notes, as of any date of determination (a) the sum of the Additional Note Principal Balances of all Notes purchased on or prior to such date pursuant to the Note Purchase Agreement less (b) all amounts previously distributed in respect of principal of the Notes on or prior to such day. Note Purchase Agreement: The Note Purchase Agreement among MSSFI, the Issuer and the Depositor, dated as of September 25, 1998, as amended. Note Redemption Amount: As of any Determination Date, an amount without duplication equal to the sum of (i) then outstanding Note Principal Balance plus all accrued and unpaid interest thereon as of the related Payment Date, (ii) any Trust Fees and Expenses due and unpaid on the related Payment Date, (iii) any Servicing Advance Reimbursement Amount as of such Determination Date, and (iv) all amounts due to Hedging Counterparties in respect of the termination of all related Hedging Instruments. Officer's Certificate: A certificate signed by a Responsible Officer of the Depositor, ANB, ABC, the Servicer or the Issuer, in each case, as required by this Agreement. Opinion of Counsel: A written opinion of counsel who may be employed by the Servicer, the Depositor, ANB, ABC or any of their respective Affiliates. Overcollateralization Shortfall: With respect to any Payment Date, an amount equal to the positive difference, if any, between (a) the Note Principal Balance on such Payment Date and (b) (i) the aggregate Collateral Value of all Loans in the Loan Pool as of the last day of the related Remittance Period, or (ii) in the event that a Performance Trigger shall have occurred and not been Deemed Cured, the aggregate Collateral Value of all Loans in the Loan Pool as of the last day of the related Remittance Period multiplied by 0.98; provided, however, that, in either case, on (A) the Maturity Date, (B) the occurrence of a Rapid Amortization Trigger, (C) the Payment Date on which the Trust is to be terminated pursuant to Section 10.02 hereof, the Overcollateralization Shortfall shall be equal to the Note Principal -19- 25 Balance. Notwithstanding anything to the contrary herein, in no event shall the Overcollateralization Shortfall exceed the Note Principal Balance as of such date. With the written consent of the Majority Noteholders in their sole discretion, if as of such Payment Date, no Rapid Amortization Trigger or Default under this Agreement or the Indenture shall be in effect, the Overcollateralization Shortfall shall be reduced (but in no event to an amount below zero) by all or any portion of the aggregate Hedge Value as of such Payment Date as the Majority Noteholders may, in their sole discretion, designate in writing. Owner Trustee: means Wilmington Trust Company, a Delaware banking corporation, not in its individual capacity but solely as Owner Trustee under this Agreement, and any successor owner trustee under the Trust Agreement. Owner Trustee Fee: The annual fee of $2,500.00 payable in equal monthly installments to the Servicer pursuant to Section 5.01(c)(3)(i) which shall in turn pay, in one lump sum, such $2,500.00 to the Owner Trustee on the Scheduled Payment Date occurring in September each year during the term of this Agreement, commencing in September, 1999. Payment Date: The 25th day of each calendar month commencing on the first such 25th day to occur after the first Transfer Date, or if any such day is not a Business Day, the first Business Day immediately following such day, and any day a Loan is sold pursuant to the terms hereof. From time to time, the Majority Noteholders and the Issuer may agree, upon written notice to the Owner Trustee and the Indenture Trustee, to additional Payment Dates in accordance with Section 5.01(c)(4). Payment Statement: As defined in Section 6.01(b) hereof. Percentage Interest: As defined in the Trust Agreement. Performance Trigger: As of any Determination Date, a Performance Trigger shall mean the existence of one or more of the following conditions: (i) the aggregate Principal Balance of all Loans that are 30 to 59 days Delinquent as of such Determination Date divided by the Pool Principal Balance is greater than 5% provided, however, that a Performance Trigger shall not occur if such percentage is reduced to less than 3% within 15 Business Days of such Determination Date as the result of the exercise of a Servicer Call; (ii) the aggregate Principal Balance of all Loans that are 60 to 89 days Delinquent as of such Determination Date divided by the Pool Principal Balance is greater than 2%; provided, however, that a Performance Trigger shall not occur if such percentage is reduced to less than 1% within 15 Business Days of such Determination Date as the result of the exercise of a Servicer Call; -20- 26 (iii) the aggregate Liquidated Loan Losses for the previous three calendar month period divided by the average Pool Principal Balance during such three calendar month period is greater than 0.10%; and A Performance Trigger shall continue to exist until Deemed Cured. Permitted Investments: Each of the following: (a) Direct general obligations of the United States or the obligations of any agency or instrumentality of the United States fully and unconditionally guaranteed, the timely payment or the guarantee of which constitutes a full faith and credit obligation of the United States. (b) Federal Housing Administration debentures and rated Aa2 or higher by Moody's and AA or better by S&P. (c) FHLMC senior debt obligations and rated Aa2 or higher by Moody's and AA or better by S&P. (d) Federal Home Loan Banks' consolidated senior debt obligations and rated Aa2 or higher by Moody's and AA or better by S&P. (e) FNMA senior debt obligations and rated Aa2 or higher by Moody's. (f) Federal funds, certificates of deposit, time and demand deposits, and bankers' acceptances (having original maturities of not more than 365 days) of any domestic bank, the short-term debt obligations of which have been rated A-1 or better by S&P and P-1 by Moody's. (g) Investment agreements approved by the Majority Noteholders, provided: 1. The agreement is with a bank or insurance company which has an unsecured, uninsured and unguaranteed obligation (or claims-paying ability) rated Aa2 or better by Moody's and AA or better by S&P, and 2. Monies invested thereunder may be withdrawn without any penalty, premium or charge upon not more than one day's notice (provided such notice may be amended or canceled at any time prior to the withdrawal date), and 3. The agreement is not subordinated to any other obligations of such insurance company or bank, and 4. The same guaranteed interest rate will be paid on any future deposits made pursuant to such agreement, and -21- 27 5. The Indenture Trustee and the Majority Noteholders receive an opinion of counsel that such agreement is an enforceable obligation of such insurance company or bank. (h) Commercial paper (having original maturities of not more than 365 days) rated A-1 or better by S&P and P-1 or better by Moody's. (i) Investments in money market funds rated AAAm or AAAM-G by S&P and Aaa or P-1 by Moody's. (j) Investments approved in writing by the Majority Noteholders. provided that no instrument described above is permitted to evidence either the right to receive (a) only interest with respect to obligations underlying such instrument or (b) both principal and interest payments derived from obligations underlying such instrument and the interest and principal payments with respect to such instrument provided a yield to maturity at par greater than 120% of the yield to maturity at par of the underlying obligations; and provided, further, that no instrument described above may be purchased at a price greater than par if such instrument may be prepaid or called at a price less than its purchase price prior to stated maturity. Person: Any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, national banking association, unincorporated organization or government or any agency or political subdivision thereof. Physical Property: As defined in clause (b) of the definition of "Delivery" above. PMI Policy or Primary Insurance Policy: A policy of primary mortgage guaranty insurance issued by a Qualified Insurer. Pool Principal Balance: With respect to any Determination Date, the aggregate Principal Balances of the Loans as of the end of the preceding Remittance Period. Premium: Any amount paid by a Loan Originator to a third party seller of a Loan in excess of the par value of the Loan. Premium Recapture: Any portion of a Premium that a Loan Originator receives back from a third party seller of a Loan. Prepaid Installment: With respect to any Loan, any payment thereon received prior to the scheduled Due Date for such installment, intended by the Borrower as an early payment thereof and not as a Prepayment with respect to such Loan. Prepayment: Any payment of principal of a Loan which is received by the Servicer in advance of the scheduled due date for the payment of such principal (other than the principal portion of any Prepaid Installment), and the proceeds of any Mortgage Insurance -22- 28 Policy which are to be applied as a payment of principal on the related Loan shall be deemed to be Prepayments for all purposes of this Agreement. Preservation Expenses: Expenditures made by the Servicer in connection with a foreclosed Loan prior to the liquidation thereof, including, without limitation, expenditures for real estate property taxes, hazard insurance premiums, property restoration or preservation. Principal Balance: With respect to any Loan or related Foreclosure Property, (i) at the Transfer Cutoff Date, the Transfer Cutoff Date Principal Balance and (ii) with respect to any other Determination Date, the outstanding unpaid principal balance of the Loan as of the end of the preceding Remittance Period (after giving effect to (1) the allocation of any Net Loan Losses with respect thereto for a Defaulted Loan, (2) Draws and (3) all payments received thereon prior to such day); provided, however, that any Liquidated Loan shall be deemed to have a Principal Balance of zero. With respect to HELOC Mortgage Loans, the Principal Balance as of any date shall take into account all Draws on or prior to such date. Proceeding: Means any suit in equity, action at law or other judicial or administrative proceeding. Promissory Note: With respect to a Loan, the original executed promissory note, Credit Line Agreement or other evidence of the indebtedness of the related Borrower or Borrowers. Put/Call Loan: Any (i) Loan that has become 30 or more days Delinquent, (ii) Defaulted Loan, (iii) Loan that has been in default for a period of 30 days or more (other than a Loan referred to in clause (i) hereof), (iv) Loan that does not meet criteria established by independent rating agencies or surety agency conditions for Dispositions which criteria have been established at the related Transfer Date and may be modified only to match changed criteria of independent rating agencies or surety agents, or (v) Loan that is inconsistent with the intended tax status of the Securitization. Put Date: The date on which the Notes are to be purchased by the Issuer as a result of the exercise of the Put Option. Put Option: The right of the Majority Noteholders to require the Issuer to repurchase the Notes in accordance with Section 10.04 of the Indenture. Qualified Insurer: An insurance company duly qualified as such under the laws of the states in which the Mortgaged Property is located, duly authorized and licensed in such states to transact the applicable insurance business and to write the insurance provided. Qualified Substitute Loan: A Loan or Loans substituted for a Deleted Loan pursuant to Section 3.06 hereof, which (i) has or have been approved in writing by the Majority Noteholders and (ii) complies or comply as of the date of substitution with each representation and warranty set forth in Section 3.05 hereof and is or are not 30 or more days Delinquent as of the date of substitution for such Deleted Loan or Loans. -23- 29 Rapid Amortization Trigger: As of any Determination Date, a Rapid Amortization Trigger shall mean the existence of one or more of the following conditions: (i) the aggregate Principal Balance of all Loans that are 30 to 59 days Delinquent as of such Determination Date divided by the Pool Principal Balance is greater than 6%; provided, however, that a Rapid Amortization Trigger shall not occur if such percentage is reduced to less than 3% within 15 Business Days of such Determination Date as the result of the exercise of a Servicer Call; (ii) the aggregate Principal Balance of all Loans that are 60 to 89 days Delinquent as of such Determination Date divided by the Pool Principal Balance is greater than 3%; provided, however, that a Rapid Amortization Trigger shall not occur if such percentage is reduced to less than 1% within 15 Business Days of such Determination Date as the result of the exercise of a Servicer Call; (iii) (x) the aggregate Liquidated Loan Losses for the previous three calendar month period divided by the average Pool Principal Balance during such three calendar month period is greater than 0.25%; A Rapid Amortization Trigger shall continue to exist until it is Deemed Cured. Rate Change Date: The date on which the Loan Interest Rate of each ARM or HELOC Mortgage Loan is subject to adjustment. Rating Agencies: S&P and Moody's or such other nationally recognized credit rating agencies as may from time to time be designated in writing by the Majority Noteholders in their sole discretion, with the approval of the Issuer, which approval shall not be unreasonably withheld. Reallocation Date: Any date on which Loans are conveyed into the Trust, any date on which any Loans are resold pursuant to a Disposition or otherwise repurchased or substituted from the Trust and, in the case of HELOC Mortgage Loans, any date the related Loan Originator automatically conveys the related Draw Reimbursements Rights to the Depositor or the Issuer and any other date on which the Allocation Percentage shall change for any reason, as applicable. Record Date: With respect to each Payment Date, the close of business on the last day of the preceding Remittance Period. Reference Bank Rate: With respect to any day, the arithmetic mean (rounded upwards, if necessary, to the nearest one sixteenth of a percent) of the offered rates for United States dollar deposits for one month that are offered by the Reference Banks not affiliated with Morgan Stanley & Co. Incorporated as of 11:00 a.m., New York City time, on the related LIBOR Determination Date to prime banks in the London interbank market for a period of one month in amounts approximately equal to the Note Principal Balance, provided that at least two -24- 30 such Reference Banks provide such rate. If fewer than two offered rates appear, the Reference Bank Rate will be the arithmetic mean of the rates quoted by one or more major banks in New York City, selected by the Majority Noteholders, as of 11:00 a.m., New York City time, on such day for loans in U.S. Dollars to leading European Banks for a period of one month in amounts approximately equal to the outstanding Note Principal Balance. If no such quotation can be obtained, the Reference Bank Rate will be the Reference Bank Rate applicable to the preceding day. Reference Banks: Three money center banks selected by the Initial Noteholder with the approval of the Issuer, which approval shall not be unreasonably withheld. Released Mortgaged Property Proceeds: With respect to any Loan, proceeds received by the Servicer in connection with (i) a taking of an entire Mortgaged Property by exercise of the power of eminent domain or condemnation or (ii) any release of part of the Mortgaged Property from the lien of the related Mortgage, whether by partial condemnation, sale or otherwise; which proceeds in either case are not released to the Borrower in accordance with applicable law and the servicing standard set forth in Section 4.01 of this Agreement. Remittance Date: The 18th calendar day of each month, if such date is not a Business Day, the first Business Day immediately following such day. Remittance Period: With respect to any Determination Date or Payment Date, the calendar month immediately preceding such Determination Date or Payment Date, as the case may be. REO Property: Real property (including all improvements and fixtures on the Mortgaged Property) acquired through foreclosure sale or by deed in lieu of foreclosure or otherwise. Repurchase Price: With respect to a Loan, the sum of (i) the Principal Balance thereof as of the date of repurchase, (ii) all accrued and unpaid interest on such Loan to, but not including the date of repurchase, computed at the applicable Loan Interest Rate and (iii) the amount of any unreimbursed Servicing Advances made by the Servicer (after deducting therefrom any amounts received in respect of such repurchased Loan and being held in the Collection Account for future distribution to the extent such amounts represent recoveries of principal not yet applied to reduce the related Principal Balance or interest for the period from and after the date of repurchase). The Repurchase Price shall be (i) increased by the net negative value or (ii) decreased by the net positive value of all Hedging Instruments terminated with respect to the repurchase of such Loan. To the extent the Servicer does not reimburse itself for amounts, if any, in respect of the Servicing Advance Reimbursement Amount pursuant to Section 5.01(c)(1) hereof, with respect to such Loan, the Repurchase Price shall be reduced by such amounts. Reserve Account: The account established and maintained pursuant to Section 5.01(a)(3) hereof. -25- 31 Reserve Account Right: The rights of the Depositor, ANB or ABC, respectively, to receive releases from the Reserve Account in accordance with the terms hereof. Responsible Officer: When used with respect to the Indenture Trustee or Custodian, any officer within the corporate trust office of such Person, including any Vice President, Assistant Vice President, Secretary, Assistant Secretary or any other officer of such Person customarily performing functions similar to those performed by any of the above designated officers and also, with respect to a particular matter, any other officer to whom such matter is referred because of such officer's knowledge of and familiarity with the particular subject. When used with respect to the Issuer, Depositor, ANB, ABC or any officer of the Owner Trustee who is authorized to act for the Owner Trustee in matters relating to the Issuer or Depositor and who is identified on the list of Authorized Officers delivered by the Administrator to the Owner Trustee on the date hereof (as such list may be modified or supplemented from time to time thereafter) and, so long as the Administration Agreement is in effect, any Vice President or more senior officer of the Administrator who is authorized to act for the Administrator in matters relating to the Issuer, Depositor, ANB or ABC and to be acted upon by the Administrator pursuant to the Administration Agreement and who is identified on the list of Responsible Officers delivered by the Administrator to the Owner Trustee on the date hereof (as such list may be modified or supplemented from time to time thereafter). When used with respect to the Depositor, the Loan Originators, the Transfer Obligor or the Servicer, the President, any Vice President, or the Treasurer. Retained Securities: With respect to a Securitization, any subordinated securities issued or expected to be issued, or excess collateral value retained or expected to be retained, in connection therewith to the extent the Depositor, ANB or ABC or an Affiliate thereof decides in its sole discretion to retain, instead of sell, such securities. Retained Securities Value: With respect to any Business Day and a Retained Security, the market value thereof as determined by the Market Value Agent in accordance with Section 6.03(d) hereof. Revolving Period: With respect to a Note of a given Series, the period commencing on the Closing Date and ending on the earlier of (i) the date on which the Revolving Period is terminated pursuant to Section 2.07 and (ii) the date set forth in the related Indenture Supplement. Sales Price: The sum of the Collateral Value with respect to each Loan conveyed on any Transfer Date, minus any Overcollateralization Shortfall as of such date, after giving effect to all payments of principal received thereon prior to the Transfer Cutoff Date. SAS 70: Relevant Statement on Auditing Standards issued by the Auditing Standards Board providing guidance on the factors an Independent Accountant should consider when auditing the financial reports of an entity that uses a service organization to process certain transactions. -26- 32 S&SA Assignment: An Assignment, in the form of Exhibit C hereto, of Loans and other property from the Depositor, ANB and ABC, respectively, to the Issuer pursuant to this Agreement. Second Lien Loan: A Loan secured by the lien on the Mortgaged Property, subject to one Senior Lien on such Mortgaged Property. Securities: The Notes or Trust Certificates. Securitization: A sale or transfer of loans, including Loans, to the Depositor or an Affiliate of the Depositor or any other Person in order to effect one or a series of structured-finance securitization transactions, including but not limited to transactions involving the issuance of securities which may be treated for federal income tax purposes as indebtedness of Advanta Corp. or one or more of its wholly-owned subsidiaries. Securityholder: Any Noteholder or Certificateholder. Senior Lien: With respect to any Second Lien Loan, the mortgage loan(s) having a senior priority lien on the related Mortgaged Property. Series: With respect to a Note, the related series of which such Note is a part, as specified in the Indenture Supplement. There shall be only one Series of Notes at any given time. Servicer: Advanta Mortgage Corp. USA, in its capacity as the master servicer hereunder, or any successor appointed as herein provided. Servicer Call: The optional repurchase by the Servicer of a Loan pursuant to Section 3.08(b) hereof. Servicer Event of Default: As described in Section 9.01 hereof. Servicer's Fiscal Year: January 1st through December 31st of each year. Servicer's Loan File: With respect to each Loan, the file held by the Servicer, consisting of all documents (or electronic images thereof) relating to such Loan, including, without limitation, copies of all of the Loan Documents included in the related Custodial Loan File as well as the original attorney's opinion of title and abstract of title or the original mortgagee title insurance policy, or if the original mortgagee title insurance policy has not been issued, the original irrevocable commitment to issue the same, or with respect to a HELOC Mortgage Loan with a Credit Limit less than $50,000, the title report. Servicer's Remittance Report: A report prepared and computed by the Servicer in substantially the form of Exhibit B attached hereto. -27- 33 Servicing Advance Reimbursement Amount: With respect to any Determination Date, the amount of any Servicing Advances that have not been reimbursed as of such date, including Nonrecoverable Servicing Advances. Servicing Advances: As defined in Section 4.08 hereof. Servicing Compensation: The Servicing Fee and other amounts to which the Servicer is entitled pursuant to Section 4.16 hereof. Servicing Fee: As to each Loan (including any Loan that has been foreclosed and has become a Foreclosure Property, but excluding any Liquidated Loan), the fee payable monthly to the Servicer on each Payment Date, which shall be the product of the applicable Servicing Fee Rate and the Principal Balance of such Loan as of the beginning of the immediately preceding Remittance Period, divided by 12. The Servicing Fee includes any servicing fees owed or payable to any Subservicer, which fees shall be paid from the Servicing Fee. Servicing Fee Rate: Unless the Servicer informs the Issuer and the Initial Noteholder in writing otherwise, 0.50%. The Servicer may inform Issuer and the Initial Noteholder in writing that the Servicing Fee Rate shall be a rate other than 0.50%, but not to exceed 0.75%. The Servicing Fee Rate may exceed 0.75% only with the consent of the Initial Noteholder. Servicing Officer: Any officer of the Servicer or Subservicer involved in, or responsible for, the administration and servicing of the Loans whose name and specimen signature appears on a list of servicing officers annexed to an Officer's Certificate furnished by the Servicer or the Subservicer, respectively, on the date hereof to the Issuer and the Indenture Trustee, on behalf of the Noteholders, as such list may from time to time be amended. S&P: Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. State: Means any one of the states of the United States of America or the District of Columbia. Subservicer: Any Person with which the Servicer has entered into a Subservicing Agreement and which is an Eligible Servicer and satisfies any requirements set forth in Section 4.03 hereof in respect of the qualifications of a Subservicer. Subservicing Account: An account established by a Subservicer pursuant to a Subservicing Agreement, which account must be an Eligible Account. Subservicing Agreement: Any agreement between the Servicer and any Subservicer relating to subservicing and/or administration of any or all Loans as provided in Section 4.03 hereof. Copies of any Subservicing Agreement between the Servicer and a Subservicer which is not an Affiliate of the Servicer shall be made available, along with any modifications thereto, to the Initial Noteholder. -28- 34 Substitution Adjustment: As to any date on which a substitution occurs pursuant to Section 2.05 or Section 3.06 hereof, the amount, if any, by which (a) the sum of the aggregate principal balance (after application of principal payments received on or before the date of substitution) of any Qualified Substitute Loans as of the date of substitution, plus any accrued and unpaid interest thereon to the date of substitution, is less than (b) the sum of the aggregate of the Principal Balances, together with accrued and unpaid interest thereon to the date of substitution, of the related Deleted Loans. Termination Event: Shall have the meaning set forth in Section 5.17 of the Indenture. Termination Period: Shall be the 30 day period commencing with the occurrence of a Termination Event or such other longer period as the Majority Noteholders may approve. Termination Price: As of any Determination Date, an amount without duplication equal to the greater of (A) the Note Redemption Amount and (B) the sum of (i) the Principal Balance of each Loan included in the Trust as of the end of the preceding Remittance Period; and (ii) all unpaid interest accrued on the Principal Balance of each such Loan (net of the Servicing Fee) to the end of the preceding Remittance Period. Transfer Cutoff Date: With respect to each Loan, the later of the first day of the month in which the Transfer Date occurs or the date of origination (or, with respect to a HELOC Mortgage Loan, origination shall mean the date of the first draw). Transfer Cutoff Date Principal Balance: As to each Loan, its Principal Balance as of the opening of business on the Transfer Cutoff Date (after giving effect to any payments received on the Loan before the Transfer Cutoff Date). Transfer Date: With respect to each Loan, the day such Loan is sold and conveyed to the Depositor by AMCUSA pursuant to the Loan Purchase Agreement and to the Issuer by the Depositor, ANB and ABC, as applicable, pursuant to Section 2.01 hereof. Transfer Obligation: The obligation of the Transfer Obligor under Section 5.06 hereof to make certain payments in connection with Dispositions and other related matters. Transfer Obligation Account: The account designated as such, established and maintained pursuant to Section 5.05 hereof. Transfer Obligation Target Amount: With respect to any Payment Date or Collateral Value Excess Date, as applicable, the cumulative total of all withdrawals pursuant to Section 5.05(e), 5.05(f), 5.05(g), and 5.05(h) hereof from the Transfer Obligation Account to but not including such Payment Date minus any amount withdrawn from the Transfer Obligation Account to return to the Transfer Obligor pursuant to Section 5.05(k)(i). Transfer Obligor: Advanta Corp., a Delaware corporation. -29- 35 Treasury Regulations: The regulations, or temporary regulations, promulgated under the Code. References herein to specific provisions of temporary regulations shall include analogous provisions of final Treasury Regulations or other successor Treasury Regulations. Trust: Advanta Home Equity Loan Owner Trust 1998-MS1, the Delaware business trust created pursuant to the Trust Agreement. Trust Agreement: The Trust Agreement dated as of September 25, 1998 among the Depositor and the Owner Trustee. Trust Account Property: The Trust Accounts, all amounts and investments held from time to time in the Trust Accounts and all proceeds of the foregoing. Trust Accounts: The Distribution Account, the Collection Account, the Transfer Obligation Account and the Reserve Account. Trust Certificate: The meaning assigned thereto in the Trust Agreement. Trust Estate: Shall mean the assets subject to this Agreement, the Trust Agreement and the Indenture and assigned to the Trust, which assets consist of: (i) such Loans as from time to time are subject to this Agreement as listed in the Loan Schedule, as the same may be amended or supplemented on each Transfer Date, by the removal of Deleted Loans and by the addition of Qualified Substitute Loans, together with the Servicer's Loan Files and the Custodial Loan Files relating thereto and all proceeds thereof, and including, with respect to all HELOC Mortgage Loans, all Draws which arise after the related Transfer Cutoff Date on HELOC Mortgage Loans then held by the Trust, the Credit Line Agreements and all rights and obligations of the Loan Originator under the related Credit Line Agreements, including the rights to fund Draws thereunder, (ii) the Mortgages and security interests in the Mortgaged Property, (iii) all payments in respect of principal and interest collected or received with respect to each Loan on or after the related Transfer Cutoff Date, (iv) such assets as from time to time are identified as Foreclosure Property, (v) such assets and funds as are from time to time deposited in the Distribution Account, Collection Account, the Transfer Obligation Account and the Reserve Account, including, without limitation, amounts on deposit in such accounts that are invested in Permitted Investments (except any Premium Recapture and net investment earnings), (vi) lenders' rights under all Mortgage Insurance Policies and to any Mortgage Insurance Proceeds, (vii) Net Liquidation Proceeds and Released Mortgaged Property Proceeds, (viii) all right, title and interest of the Trust (but none of the obligations) in and to the obligations of Hedging Counterparties under Hedging Instruments and (ix) all right, title and interest of each of the Depositor and ANB and ABC and the Trust in and under the Basic Documents including, without limitation, the obligations of the Loan Originators (other than ANB and ABC) under the Loan Purchase Agreement pursuant to which the Depositor acquired the Loans from the Loan Originators (other than ANB and ABC), and all proceeds of any of the foregoing. -30- 36 Trust Fees and Expenses: As of each Payment Date, an amount equal to the Servicing Compensation, the Owner Trustee Fee, the Indenture Trustee Fee and the Custodian Fee, if any. UCC: The Uniform Commercial Code as in effect in the State of New York. UCC Assignment: A form "UCC-2" or "UCC-3" statement meeting the requirements of the Uniform Commercial Code of the relevant jurisdiction to reflect an assignment of a secured party's interest in collateral. UCC-1 Financing Statement: A financing statement meeting the requirements of the Uniform Commercial Code of the relevant jurisdiction. Underwriting Guidelines: The underwriting guidelines (including the loan origination guidelines) provided to the Initial Noteholder on or prior to the date hereof by the Loan Originators or Affiliates thereof, as amended and updated from time to time. Unfunded Draw Reimbursement Amount: As of any date of determination, the positive difference, if any, of (x) the aggregate of all Draws made on HELOC Mortgage Loans on or prior to such date for which the related Loan Originator has automatically conveyed the related Draw Reimbursement Rights less (y) the aggregate of all Principal Balances of each Draw for which Collateral Value Excesses were eliminated. Unfunded Transfer Obligation: With respect to any date of determination, an amount equal to (x) the sum of (A) 10% of the aggregate Collateral Value (as of the related Transfer Date, inclusive, in the case of HELOC Mortgage Loans, of the Collateral Value attributable to the Principal Balance of each Draw for which the Collateral Value Excesses have been eliminated) of all Loans sold hereunder, plus (B) any amounts withdrawn or deemed withdrawn from the Transfer Obligation Account for return to the Transfer Obligor pursuant to Section 5.05(k)(i) hereof prior to such Payment Date, less (y) the sum of (i) the aggregate amount of payments actually made by the Transfer Obligor in respect of the Transfer Obligation pursuant to Section 5.06 plus (ii) the aggregate amount of the Repurchase Prices paid by the Loan Originators in respect of any Loan Originator Puts plus (iii) any Unfunded Draw Reimbursement Rights as of such date. Unfunded Transfer Obligation Percentage: As of any date of determination, an amount equal to (x) the Unfunded Transfer Obligation as of such date, divided by (y) 100% of the aggregate Collateral Value as of the related Transfer Date of all Loans sold hereunder. Unqualified Loan: As defined in Section 3.06(a) hereof. USAP: The Uniform Single Attestation Program for Mortgage Bankers. Warehouse Lines: Any facility or arrangement between Advanta Corp. or any of its affiliates, on the one hand, and Morgan Stanley Mortgage Capital, Inc. or any of its affiliates, on the other hand, which has been designated in writing by the Depositor, the Loan -31- 37 Originators and Morgan Stanley Mortgage Capital, Inc. to be deemed a "Warehouse Line" for purposes of this Agreement. Wet Custodial File Delivery Date: With respect to a Wet Funded Loan, the twenty-first day after the related Transfer Date, provided that if a Default or Event of Default shall have occurred, the Wet Custodial File Delivery Date shall be the fifth day after the occurrence of such event. Wet Funded Loan: A Loan for which the related Custodial Loan File shall not have been delivered to the Custodian as of the related Transfer Date. Whole Loan Sale: A Disposition of Loans pursuant to a whole-loan sale. Section 1.02 Other Definitional Provisions. (a) Any agreement, instrument or statute defined or referred to herein or in any instrument or certificate delivered in connection herewith means such agreement, instrument or statute as from time to time amended, modified or supplemented and includes (in the case of agreements or instruments) references to all attachments thereto and instruments incorporated therein; references to a Person are also to its permitted successors and assigns. (b) All terms defined in this Agreement shall have the defined meanings when used in any certificate or other document made or delivered pursuant hereto unless otherwise defined therein. (c) As used in this Agreement and in any certificate or other document made or delivered pursuant hereto or thereto, accounting terms not defined in this Agreement or in any such certificate or other document, and accounting terms partly defined in this Agreement or in any such certificate or other document to the extent not defined, shall have the respective meanings given to them under GAAP. To the extent that the definitions of accounting terms in this Agreement or in any such certificate or other document are inconsistent with the meanings of such terms under GAAP, the definitions contained in this Agreement or in any such certificate or other document shall control. (d) The words "hereof," "herein," "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement; Article, Section, Schedule and Exhibit references contained in this Agreement are references to Articles, Sections, Schedules and Exhibits in or to this Agreement unless otherwise specified; and the term "including" shall mean "including without limitation." (e) The definitions contained in this Agreement are applicable to the singular as well as the plural forms of such terms and to the masculine as well as to the feminine and neuter genders of such terms. -32- 38 ARTICLE II CONVEYANCE OF THE TRUST ESTATE; ADDITIONAL NOTE PRINCIPAL BALANCES Section 2.01 Conveyance of the Trust Estate; Additional Note Principal Balances. (a)(i) On the terms and conditions of this Agreement, on each Transfer Date, each of the Depositor, ANB and ABC, as applicable, agree to offer for sale and to sell Loans and deliver related Loan Documents to or at the direction of the Issuer. To the extent the Issuer has or is able to obtain sufficient funds for the purchase thereof, the Issuer agrees to purchase such Loans offered for sale by the Depositor, ANB and ABC, as applicable. (ii) In consideration of the payment of the Additional Note Principal Balance pursuant to Section 2.06 hereof, the Depositor, ANB and ABC, as applicable, as of the initial Closing Date and concurrently with the execution and delivery hereof, hereby sell, transfer, assign, set over and otherwise convey to the Issuer, without recourse, but subject to the other terms and provisions of this Agreement, all of the right, title and interest of the Depositor, ANB and ABC, as applicable, in and to the Trust Estate. (iii) During the Revolving Period, on each Transfer Date, subject to the conditions precedent set forth in Section 2.06(a) and in accordance with the procedures set forth in Section 2.01(c), the Depositor, ANB and ABC, as applicable, pursuant to an S&SA Assignment, will assign to the Issuer without recourse all their right, title and interest in and to the Loans and all proceeds thereof listed on the Loan Schedule attached to such S&SA Assignment, including all interest and principal received by the Loan Originators, the Depositor or the Servicer on or with respect to the Loans on or after the related Transfer Cutoff Date (and including Monthly Payments due on or after the related Transfer Cutoff Date but received by the Loan Originators on or before the related Transfer Cutoff Date and held for application on the related scheduled Due Dates and excluding any Premium Recapture), together with all right, title and interest in and to the proceeds of any related Mortgage Insurance Policies and all of the Depositor's rights, title and interest in and to (but none of its obligations under) the Loan Purchase Agreement and all proceeds of the foregoing. (iv) The foregoing sales, transfers, assignments, set overs and conveyances do not, and are not intended to, result in a creation or an assumption by the Issuer of any of the obligations of the Depositor, the Loan Originators or any other Person in connection with the Trust Estate or under any agreement or instrument relating thereto except as specifically set forth in the Basic Documents. (v) With respect to ANB, ABC and the Depositor, as applicable, and with respect to a HELOC Mortgage Loan sold on a Transfer Date, ANB, ABC and the Depositor, as applicable, hereby assigns to the Issuer and the Issuer hereby assumes with respect to each such HELOC Mortgage Loan, the duty to fund Draws under the related Credit Line Agreement. The Issuer hereby delegates to ANB, ABC and the Depositor, and each of ANB, ABC and the Depositor hereby assumes with respect to each HELOC Mortgage Loan -33- 39 originated by ANB, ABC and AMCUSA, respectively and sold hereunder, the duty to fund Draws under the related Credit Line Agreement. In consideration of the foregoing, the Issuer hereby assigns, transfers and conveys to ANB, ABC and the Depositor, as applicable, all the right, title and interest in and to the Draw Reimbursement Rights relating to such HELOC Mortgage Loan. (vi) With respect to a HELOC Mortgage Loan, upon the funding of Draws under the related Credit Line Agreement, ANB, ABC and the Depositor, as applicable, agrees to and hereby assigns, automatically, and without any further action, to the Issuer without recourse all the right, title and interest of ANB, ABC and the Depositor, as applicable, in and to the Draw Reimbursement Rights and all proceeds thereof. In consideration of the foregoing, the Trust Certificates attributable to ANB, ABC and the Depositor shall automatically be adjusted ratably to reflect the conveyance of the related Draw Reimbursement Rights. (b) As of the Closing Date and as of each Transfer Date, the Issuer acknowledges (or will acknowledge pursuant to the S&SA Assignment) the conveyance to it of the Trust Estate, including all rights, title and interest of the Depositor, ANB and ABC, as applicable, in and to the Trust Estate, receipt of which is hereby acknowledged by the Issuer. Concurrently with such delivery, as of the initial Closing Date and as of each Transfer Date, pursuant to the Indenture the Issuer pledges the Trust Estate to the Indenture Trustee. In addition, concurrently with such delivery and in exchange therefor, the Owner Trustee, pursuant to the instructions of the Depositor, has executed (not in its individual capacity, but solely as Owner Trustee on behalf of the Issuer) and caused the Trust Certificates to be authenticated and delivered to or at the direction of the Depositor, ANB and ABC, respectively. (c)(i) Pursuant to and subject to the Note Purchase Agreement, the Trust may, at its sole option, from time to time request that the Initial Noteholder advance on any Transfer Date and on any Collateral Value Excess Date, Additional Note Principal Balances and the Initial Noteholder shall remit on such Transfer Date or Collateral Value Excess Date, as the case may be, to the Advance Account an amount equal to the Additional Note Principal Balance. (ii) Notwithstanding anything to the contrary herein, in no event shall the Initial Noteholder be required to advance Additional Note Principal Balances on a Transfer Date if the conditions precedent to a transfer of the Loans under Section 2.06(a) and the conditions precedent to the purchase of Additional Note Principal Balances set forth in Section 3.01 of the Note Purchase Agreement have not been fulfilled. (iii) Notwithstanding anything to the contrary herein, in no event shall the Initial Noteholder be required to advance Additional Note Principal Balance on a Collateral Value Excess Date if the conditions precedent thereto set forth in Section 2.06(b) and the conditions precedent to the purchase of Additional Note Principal Balances set forth in Section 3.01 of the Note Purchase Agreement have not been fulfilled. -34- 40 (iv) The Servicer shall appropriately note such Additional Note Principal Balance (and the increased Note Principal Balance) in the next succeeding Payment Statement; provided, however, that failure to make any such notation in such Payment Statement or any error in such notation shall not adversely affect any Noteholder's rights with respect to its Note Principal Balance and its right to receive interest and principal payments in respect of the Note Principal Balance held by such Noteholder. The Initial Noteholder shall record on the schedule attached to such Noteholder's Note, the date and amount of any Additional Note Principal Balance advanced by it; provided, that failure to make such recordation on such schedule or any error in such schedule shall not adversely affect any Noteholder's rights with respect to its Note Principal Balance and its right to receive interest and principal payments in respect of the Note Principal Balance held by such Noteholder. (v) Absent manifest error, the Note Principal Balance of each Note as set forth in the Initial Noteholder's records shall be binding upon the Noteholders and the Trust, notwithstanding any notation made by the Servicer in its Payment Statement pursuant to the preceding paragraph. Section 2.02 Ownership and Possession of Loan Files. With respect to each Loan, as of the related Transfer Date the ownership of the related Promissory Note, the related Mortgage and the contents of the related Servicer's Loan File and Custodial Loan File shall be vested in the Trust for the benefit of the Securityholders, although possession of the Servicer's Loan File (other than items required to be maintained in the Custodial Loan Files) on behalf of and for the benefit of the Securityholders shall remain with the Servicer, and the Custodian shall take possession of the Custodial Loan Files as contemplated in Section 2.05 hereof. Section 2.03 Books and Records; Intention of the Parties. (a) As of each Transfer Date, the sale of each of the Loans conveyed on such Transfer Date shall be reflected on the balance sheets and other financial statements of the Depositor and the Loan Originators, as the case may be, as a sale of assets by the Depositor and the Loan Originators, as the case may be, under GAAP. Each of the Servicer and the Custodian shall be responsible for maintaining, and shall maintain, a complete set of books and records for each Loan which shall be clearly marked to reflect the ownership of each Loan, as of the related Transfer Date, by the Issuer and for the benefit of the Securityholders. (b) It is the intention of the parties hereto that, other than for federal, state and local income or franchise tax purposes, the transfers and assignments of the Trust Estate on the initial Closing Date, on each Transfer Date and as otherwise contemplated by the Basic Documents and the Assignments shall constitute a sale of the Trust Estate including, without limitation, the Loans and all other property comprising the Trust Estate specified in Section 2.01(a) hereof, from the Depositor, ANB, ABC, as applicable, to the Issuer and such property shall not be property of the Depositor, ANB or ABC. The parties hereto shall treat the Notes as indebtedness for federal, state and local income and franchise tax purposes. -35- 41 (c) If any of the assignments and transfers of the Loans and the other property of the Trust Estate specified in Section 2.01(a) hereof to the Issuer pursuant to this Agreement or the conveyance of the Loans or any of such other property of the Trust Estate to the Issuer, other than for federal, state and local income or franchise tax purposes, is held or deemed not to be a sale or is held or deemed to be a pledge of security for a loan, the Depositor, ANB and ABC intend that the rights and obligations of the parties shall be established pursuant to the terms of this Agreement and that, in such event, with respect to such property, (i) consisting of Loans and related property, the Depositor, ANB and ABC, as applicable, shall be deemed to have granted, as of the related Transfer Date, to the Issuer a first priority security interest in the entire right, title and interest of the Depositor, ANB and ABC, as applicable, in and to such Loans and proceeds and all other property conveyed to the Issuer as of such Transfer Date, (ii) consisting of any other property specified in Section 2.01(a), the Depositor, ANB and ABC, as applicable, shall be deemed to have granted, as of the initial Closing Date, to the Issuer a first priority security interest in the entire right, title and interest of the Depositor, ANB and ABC, as applicable, in and to such property and the proceeds thereof. In such event, with respect to such property, this Agreement shall constitute a security agreement under applicable law. (d) Within ten (10) days of the initial Transfer Date, the Depositor, ANB and ABC shall, at each party's sole expense, cause to be filed UCC-1 Financing Statements naming the Issuer as "secured party" and describing the Trust Estate being sold by the Depositor, ANB and ABC, respectively, to the Issuer with the office of the Secretary of State of the state in which the Depositor, ANB and ABC are located. Section 2.04 Delivery of Loan Documents. (a) The related Loan Originator shall, no less than four (4) Business Days prior to the related Transfer Date, or such other time as mutually agreed upon between the related Loan Originator and the Custodian (or in the case of a Wet Funded Loan, on or before the related Wet Custodial File Delivery Date), deliver or cause to be delivered to the Custodian, as the designated agent of the Indenture Trustee, a Loan Schedule and each of the following documents (collectively, the "Custodial Loan File"): (i) the original Promissory Note bearing all intervening endorsements, endorsed either (i) "Pay to the order of Bankers Trust Company of California, N.A., as custodian or trustee under the applicable custody or trust agreement, without recourse" or (ii) "Pay to the order of Bankers Trust Company of California, N.A., as custodian or trustee under the applicable custody or trust agreement, without recourse, Advanta as Servicer," or (iii) "Pay to the order of Bankers Trust Company of California, N.A., as custodian or trustee" by [Seller, signature, name, title] and signed in the name of the previous owner by an authorized officer (in the event that the Loan was acquired by the previous owner in a merger the signature must be in the following form: "[the previous owner], successor by merger to [name of predecessor]", in the event that the Loan was acquired or originated while doing business under another -36- 42 name, the signature must be in the following form: "[the previous owner], formerly known as [previous name]" or (iv) "Pay to the order of Bankers Trust Company of California, N.A., without recourse" or (v) "Pay to the order of __________________, without recourse". The original Promissory Note should be accompanied by any rider made in connection with the origination of the related Loan; (ii) the original of any guarantee executed in connection with the Promissory Note (if any); (iii) the original Mortgage with evidence of recording thereon or copies certified by the related recording office or, if the original Mortgage has not yet been returned from the recording office, a certified copy of the Mortgage; (iv) the originals of any assumption, modification, consolidation or extension agreements; (v) the original or a certified copy of the Assignment of Mortgage of each Loan to "Bankers Trust Company of California, N.A., as custodian or trustee", "Bankers Trust Company of California, N.A. as trustee or custodian on behalf of Advanta Conduit Receivables Inc.", "Bankers Trust Company of California, N.A., as trustee" or "Pay to the Order of _____________." In the event that the Loan was acquired by the previous owner in a merger, the Assignment of Mortgage must be by the "(previous owner), successor by merger to (names of predecessor)"; and in the event that the Loan was acquired or originated by the previous owner while doing business under another name, the Assignment of Mortgage must be by the "(previous owner), formerly known as (previous name)"; (vi) the originals of all intervening Assignments of Mortgage, showing a complete chain of assignment from origination to the related Loan Originator, including warehousing assignments, with evidence of recording thereon (or, if an original intervening assignment has not been returned from the recording office, a certified copy thereof); (b) The Loan Originator shall, on the related Transfer Date (or in the case of a Wet Funded Loan, on or before the related Wet Custodial File Delivery Date), deliver or cause to be delivered to the Servicer for the benefit of the Indenture Trustee, as secured party on behalf of the Noteholders, the related Servicer's Loan File. (c) The Indenture Trustee shall cause the Custodian to take and maintain continuous physical possession of the Custodial Loan Files in the State of California and, in connection therewith, shall act solely as agent for the Noteholders in accordance with the terms hereof and not as agent for the Loan Originators, the Servicer or any other party. -37- 43 Section 2.05 Acceptance by the Indenture Trustee of the Loans; Certain Substitutions and Repurchases; Certification by the Custodian. (a) The Indenture Trustee declares that it will cause the Custodian to hold the Custodial Loan Files and any additions, amendments, replacements or supplements to the documents contained therein, as well as any other assets included in the Trust Estate and delivered to the Custodian, in trust, upon and subject to the conditions set forth herein. The Indenture Trustee further agrees to cause the Custodian to execute and deliver such certifications as are required under the Custodial Agreement and to otherwise direct the Custodian to perform all of its obligations with respect to the Custodial Loan Files in strict accordance with the terms of the Custodial Agreement. (b)(i) With respect to any Loans which are set forth as exceptions in the Exceptions Report (after giving effect to the specific provisions relating to Wet Funded Loans in Section 2.04(a)), the related Loan Originator shall cure such exception by delivering such missing documents to the Custodian or otherwise curing the defect no later than (A) other than Loan Documents specified in clause (B) below, in the case of (x) a non-Wet Funded Loan, 5 Business Days, or (y) in the case of a Wet Funded Loan one Business Day, in each case, following the receipt of the first Loan Schedule and Exceptions Report listing such exception with respect to such Loan or (B) in the case of Loan Documents referenced in Section 2.04(a) (iii), (iv) and (vi) 30 days after the related Transfer Date or with respect to Wet Funded Loans, from the related Wet Custodial File Delivery Date. (ii) In the event that, with respect to any Loan, the related Loan Originator does not comply with the document delivery requirements of this Section 2.05, the related Loan Originator shall repurchase such Loan within one Business Day of notice thereof from the Indenture Trustee or the Initial Noteholder at the Repurchase Price with respect to such Loan by depositing such Repurchase Price in the Collection Account; provided, however, that if there is not an Overcollateralization Shortfall on the date of such repurchase (after giving effect to such repurchase) the Loan Originator shall remit the Alternate Repurchase Price in accordance with Section 5.01(c)(4)(i). In lieu of such a repurchase, the Depositor and related Loan Originator may comply with the substitution provisions of Section 3.06 hereof. The related Loan Originator shall provide the Servicer, the Indenture Trustee, the Issuer and the Initial Noteholder with a certification of a Responsible Officer on or prior to such repurchase or substitution indicating that the related Loan Originator intends to repurchase or substitute such Loan. (iii) It is understood and agreed that the obligation of the related Loan Originator to repurchase or substitute any such Loan pursuant to this Section 2.05(b) shall constitute the sole remedy against it with respect to such failure to comply with the foregoing delivery requirements. (c) In performing its reviews of the Custodial Loan Files pursuant to the Custodial Agreement, the Custodian shall have no responsibility to determine the genuineness of any document contained therein and any signature thereon. The Custodian shall not have any responsibility for determining whether any document is valid and binding, whether the text -38- 44 of any assignment or endorsement is in proper or recordable form, whether any document has been recorded in accordance with the requirements of any applicable jurisdiction or whether a blanket assignment is permitted in any applicable jurisdiction. (d) The Servicer's Loan File shall be held in the custody of the Servicer (i) for the benefit of, and as agent for, the Noteholders and (ii) for the benefit of the Indenture Trustee, on behalf of the Noteholders, for so long as the Notes are outstanding; after the Notes are not outstanding, the Servicer's Loan File shall be held in the custody of the Servicer for the benefit of, and as agent for, the Certificateholders. It is intended that, by the Servicer's agreement pursuant to this Section 2.05(d), the Indenture Trustee shall be deemed to have possession of the Servicer's Loan Files for purposes of Section 9-305 of the UCC of the state in which such documents or instruments are located. The Servicer shall promptly report to the Indenture Trustee any failure by it to hold the Servicer's Loan File as herein provided and shall promptly take appropriate action to remedy any such failure. In acting as custodian of such documents and instruments, the Servicer agrees not to assert any legal or beneficial ownership interest in the Loans or such documents or instruments. Subject to Section 8.01(d), the Servicer agrees to indemnify the Securityholders and the Indenture Trustee, its officers, directors, employees, agents and "control persons" as such term is used under the Act and under the Securities Exchange Act of 1934, as amended for any and all liabilities, obligations, losses, damages, payments, costs or expenses of any kind whatsoever which may be imposed on, incurred by or asserted against the Securityholders or the Indenture Trustee as the result of the negligence or willful misfeasance by the Servicer relating to the maintenance and custody of such documents or instruments which have been delivered to the Servicer provided, however, that the Servicer will not be liable for any portion of any such amount resulting from the negligence or willful misconduct of any Securityholders or the Indenture Trustee; and provided, further, that the Servicer will not be liable for any portion of any such amount resulting from the Servicer's compliance with any instructions or directions consistent with this Agreement issued to the Servicer by the Indenture Trustee or the Majority Noteholders. The Indenture Trustee shall have no duty to monitor or otherwise oversee the Servicer's performance as custodian hereunder. Section 2.06 Conditions Precedent to Transfer Dates and Collateral Value Excess Dates. (a) On each Transfer Date, the Depositor, ANB and ABC, as applicable, shall convey to the Issuer, the Loans and the other property and rights related thereto described in the related S&SA Assignment, and the Issuer shall cause the Initial Noteholder, pursuant to and subject to the Note Purchase Agreement, only upon the satisfaction of each of the conditions set forth below on or prior to such Transfer Date, to deposit or cause to be deposited cash in the amount of the Additional Note Principal Balance in the Advance Account (or in the case of Wet Funded Loans, in the Reserve Account to the extent of the Sales Prices therefor) in respect thereof, and the Servicer shall, promptly after such deposit, withdraw the amount deposited in respect of applicable Additional Note Principal Balance from the Advance Account, and distribute such amount to or at the direction of the Depositor, ANB and ABC. As of each Transfer Date: -39- 45 (i) the Depositor, ANB and ABC, as applicable, shall have delivered to the Issuer and the Initial Noteholder duly executed Assignments, which shall have attached thereto a Loan Schedule setting forth the appropriate information with respect to all Loans conveyed on such date, expressed in an amount, and shall have delivered to the Initial Noteholder a computer readable transmission of such Loan Schedule; (ii) the Depositor, ANB and ABC or the Servicer, as applicable, shall have deposited in the Collection Account all collections received with respect to each of the Loans on and after the applicable Transfer Cutoff Date; (iii) neither the Loan Originators, nor the Depositor shall (A) be insolvent, (B) be made insolvent by its respective sale of Loans or (C) have reason to believe that its insolvency is imminent; (iv) the Revolving Period shall not have terminated; (v) there shall be no Overcollateralization Shortfall; (vi) in the case of non-Wet Funded Loans, the Issuer shall have delivered the Custodial Loan File to the Custodian in accordance with the Custodial Agreement and the Initial Noteholder shall have received a copy of the Loan Schedule and Exceptions Report reflecting such delivery with evidence that the Promissory Note and Assignment of Mortgage with respect to such Loan shall be present therein; (vii) each of the representations and warranties made by the Loan Originators pursuant to Section 3.05 with respect to the Loans shall be true and correct in all material respects as of the related Transfer Date with the same effect as if then made, and the Depositor, ANB and ABC shall have performed all obligations to be performed by it under the Basic Documents on or prior to such Transfer Date; (viii) the Depositor, ANB and ABC shall each, at its own expense, within one Business Day following the Transfer Date, indicate in its computer files that the Loans, expressed in an amount, identified in the LPA Assignment (with respect to Loans sold by the Depositor) and S&SA Assignment have been sold to the Issuer pursuant to this Agreement and the S&SA Assignment; (ix) the Depositor, ANB and ABC shall have taken any action requested by the Indenture Trustee, the Issuer or the Noteholders -40- 46 required to maintain the ownership interest of the Issuer in the Trust Estate; (x) no selection procedures believed by the Depositor, ANB or ABC to be adverse to the interests of the Noteholders shall have been utilized in selecting the Loans conveyed on such Transfer Date; (xi) the Depositor, ANB or ABC, as applicable, shall have provided the Issuer, the Indenture Trustee and the Initial Noteholder no later than one Business Day prior to such date a Notice of Additional Note Principal Balance in the form of Exhibit A hereto; (xii) after giving effect to the Additional Note Principal Balance associated therewith, the Note Principal Balance will not exceed the Maximum Note Principal Balance; (xiii) all conditions precedent to the Depositor's purchase of Loans pursuant to the Loan Purchase Agreement shall have been fulfilled as of such Transfer Date; (xiv) all conditions precedent to the Noteholders' purchase of Additional Note Principal Balance pursuant to the Note Purchase Agreement shall have been fulfilled; and (xv) on or prior to any Transfer Date the Unfunded Draw Reimbursement Amount shall have been reduced to zero. (b) On each Collateral Value Excess Date, upon the satisfaction of conditions set forth in subclauses (iii), (iv), (ix), (xi), (xii), (xiii) and (xiv) of Section 2.06(a) on such Collateral Value Excess Date, the Issuer shall deposit, cause the Initial Noteholder to deposit, or otherwise cause to be deposited into (i) the Transfer Obligation Account, cash in the amount equal to the lesser of (A) the Additional Note Principal Balance and (B) the Transfer Obligation Target Amount and (ii) the Advance Account the excess (if any) of the Additional Note Principal Balance over the amount deposited into the Transfer Obligation Account pursuant to clause (i) above; provided that, in the case of Wet Funded Loans, the Additional Note Principal Balance shall be deposited in the Reserve Account to the extent of the Sales Prices therefor. The Issuer agrees that on each Collateral Value Excess Date on which there exists an Unfunded Draw Reimbursement Amount, the Issuer shall issue Additional Note Principal Balances in the maximum amount permitted by the related Collateral Value Excess. The Servicer shall withdraw the amount deposited in respect of Additional Note Principal Balance from the Advance Account in respect of such deposit and distribute such amount to or at the direction of the Depositor, ANB and ABC in accordance with the Allocation Percentage or as such parties may otherwise direct. -41- 47 Section 2.07 Termination of Revolving Period . Upon the occurrence of (i) an Event of Default or Default or (ii) a Rapid Amortization Trigger, the Initial Noteholder (if still a Noteholder) may, in its sole discretion, terminate the Revolving Period. Section 2.08 Correction of Errors . The parties hereto shall cooperate to reconcile any errors in calculating the Sales Price from and after the Closing Date. In the event that an error in the Sales Price is discovered by any party, including without limitation, any error due to miscalculations of Market Value where insufficient information has been provided with respect to a Loan to make an accurate determination of Market Value as of any applicable Transfer Date, any miscalculations of Principal Balance, accrued interest, Overcollateralization Shortfall or aggregate unreimbursed Servicing Advances attributable to the applicable Loan, or any prepayments not properly credited, such party shall give prompt notice to the other parties hereto, and the party that shall have benefited from such error shall promptly remit to the other, by wire transfer of immediately available funds, the amount of such error with no interest thereon. ARTICLE III REPRESENTATIONS AND WARRANTIES Section 3.01 Representations and Warranties of the Depositor. The Depositor hereby represents, warrants and covenants to the other parties hereto and the Securityholders that as of each Closing Date, as of each Transfer Date and as of each Collateral Value Excess Date: (a) The Depositor is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and has, and had at all relevant times, full power to own its property, to carry on its business as currently conducted, to enter into and perform its obligations under each Basic Document to which it is a party; (b) The execution and delivery by the Depositor of each Basic Document to which the Depositor is a party and its performance of and compliance with all of the terms thereof will not violate the Depositor's organizational documents or constitute a default (or an event which, with notice or lapse of time, or both, would constitute a default) under, or result in the breach or acceleration of, any material contract, agreement or other instrument to which the Depositor is a party or which are applicable to the Depositor or any of its assets; -42- 48 (c) The Depositor has the full power and authority to enter into and consummate the transactions contemplated by each Basic Document to which the Depositor is a party, has duly authorized the execution, delivery and performance of each Basic Document to which it is a party and has duly executed and delivered each Basic Document to which it is a party. Each Basic Document to which it is a party, assuming due authorization, execution and delivery by the other party or parties thereto, constitutes a valid, legal and binding obligation of the Depositor, enforceable against it in accordance with the terms thereof, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); (d) The Depositor is not in violation of, and the execution and delivery by the Depositor of each Basic Document to which the Depositor is a party and its performance and compliance with the terms of each Basic Document to which the Depositor is a party will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction, which violation would materially and adversely affect the condition (financial or otherwise) or operations of the Depositor or any of its properties or materially and adversely affect the performance of any of its duties hereunder; (e) There are no actions or proceedings against, or investigations of, the Depositor currently pending with regard to which the Depositor has received service of process and no action or proceeding against, or investigation of, the Depositor is, to the knowledge of the Depositor, threatened or otherwise pending before any court, administrative agency or other tribunal that (A) if determined adversely to the Depositor, would prohibit its entering into any of the Basic Documents to which it is a party or render the Securities invalid, (B) seek to prevent the issuance of the Securities or the consummation of any of the transactions contemplated by any of the Basic Documents to which it is a party or (C) if determined adversely to the Depositor, would prohibit or materially and adversely affect the performance by the Depositor of its obligations under, or the validity or enforceability of, any of the Basic Documents to which it is a party or the Securities; (f) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Depositor of, or compliance by the Depositor with, any of the Basic Documents to which the Depositor is a party or the Securities, or for the consummation of the transactions contemplated by any of the Basic Documents to which the Depositor is a party, except for such consents, approvals, authorizations and orders, if any, that have been obtained prior to such date; (g) The Depositor is solvent, is able to pay its debts as they become due and has capital sufficient to carry on its business and its obligations hereunder; it will not be rendered insolvent by the execution and delivery of any of the Basic Documents to -43- 49 which it is a party or the assumption of any of its obligations thereunder; no petition of bankruptcy (or similar insolvency proceeding) has been filed by or against the Depositor; (h) The Depositor did not sell the Loans sold thereon to the Trust with any intent to hinder, delay or defraud any of its creditors; nor will the Depositor be rendered insolvent as a result of such sale; (i) The Depositor had good title to, and was the sole owner of, each Loan sold thereon free and clear of any lien other than any such lien released simultaneously with the sale contemplated herein, and, immediately upon each transfer and assignment herein contemplated, the Depositor will have delivered to the Trust good title to, and the Trust will be the sole owner of, each Loan transferred thereon free and clear of any lien; (j) The Depositor acquired title to each of the Loans sold thereon in good faith, without notice of any adverse claim; (k) None of the Basic Documents to which the Depositor is a party, nor any Officer's Certificate, statement, report or other document prepared by the Depositor and furnished or to be furnished by it pursuant to any of the Basic Documents to which it is a party or in connection with the transactions contemplated thereby contains any untrue statement of material fact or omits to state a material fact necessary to make the statements contained herein or therein not misleading; (l) The Depositor is not required to be registered as an "investment company" under the Investment Company Act of 1940, as amended; (m) The transfer, assignment and conveyance of the Loans by the Depositor thereon pursuant to this Agreement is not subject to the bulk transfer laws or any similar statutory provisions in effect in any applicable jurisdiction; (n) The Depositor's principal place of business and chief executive offices are located at 10790 Rancho Bernardo Rd., San Diego, CA 92127; and (o) The Depositor covenants that during the continuance of this Agreement it will comply in all respects with the provisions of its organizational documents in effect from time to time. Section 3.02 Representations and Warranties of the Loan Originators. Each Loan Originator hereby represents and warrants to the other parties hereto and the Securityholders that as of the Closing Date, as of each Transfer Date and as of each Collateral Value Excess Date: -44- 50 (a) The Loan Originator is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and the Loan Originator or other Person who originated a Loan on behalf of such Loan Originator (i) is duly qualified, in good standing and licensed to carry on its business in each state where any Mortgaged Property relating to a Loan that it originated is located and (ii) is in compliance with the laws of any such jurisdiction, in both cases, to the extent necessary to ensure the enforceability of the Loans in accordance with the terms thereof and had at all relevant times, full corporate power to originate the Loans, to own its property, to carry on its business as currently conducted and to enter into and perform its obligations under each Basic Document to which it is a party; (b) The execution and delivery by the Loan Originator of each Basic Document to which it is a party and its performance of and compliance with the terms thereof will not violate the Loan Originator's articles of organization or by-laws or constitute a default (or an event which, with notice or lapse of time, or both, would constitute a default) under, or result in the breach or acceleration of, any contract, agreement or other instrument to which the Loan Originator is a party or which may be applicable to the Loan Originator or any of its assets; (c) The Loan Originator has the full power and authority to enter into and consummate all transactions contemplated by the Basic Documents to be consummated by it, has duly authorized the execution, delivery and performance of each Basic Document to which it is a party and has duly executed and delivered each Basic Document to which it is a party. Each Basic Document to which it is a party, assuming due authorization, execution and delivery by each of the other parties thereto, constitutes a valid, legal and binding obligation of the Loan Originator, enforceable against it in accordance with the terms hereof, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); (d) The Loan Originator is not in violation of, and the execution and delivery of each Basic Document to which it is a party by the Loan Originator and its performance and compliance with the terms of each Basic Document to which it is a party will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction, which violation would materially and adversely affect the condition (financial or otherwise) or operations of the Loan Originator or its properties or materially and adversely affect the performance of its duties under any Basic Document to which it is a party; (e) There are no actions or proceedings against, or investigations of, the Loan Originator currently pending with regard to which the Loan Originator has received service of process and no action or proceeding against, or investigation of, the Loan Originator is, to the knowledge of the Loan Originator, threatened or otherwise -45- 51 pending before any court, administrative agency or other tribunal that (A) if determined adversely to the Loan Originator, would prohibit its entering into any Basic Document to which it is a party or render the Securities invalid, (B) seek to prevent the issuance of the Securities or the consummation of any of the transactions contemplated by any Basic Document to which it is a party or (C) if determined adversely to the Loan Originator, would prohibit or materially and adversely affect the sale of the Loans to the Depositor, the performance by the Loan Originator of its obligations under, or the validity or enforceability of, any Basic Document to which it is a party or the Securities; (f) No consent, approval, authorization or order of any court or governmental agency or body is required for: (1) the execution, delivery and performance by the Loan Originator of, or compliance by the Loan Originator with, any Basic Document to which it is a party, (2) the issuance of the Securities, (3) the sale of the Loans under the Loan Purchase Agreement (to the extent such Loan Originator is a party thereto), (4) the sale by ANB and ABC, respectively, of the Loans under this Agreement, or (5) the consummation of the transactions required of it by any Basic Document to which it is a party, except such as shall have been obtained before such date; (g) Immediately prior to the Transfer Date related thereto, the Loan Originator had good title to the Loans sold on such Transfer Date without notice of any adverse claim; (h) The information, reports, financial statements, exhibits and schedules furnished in writing by or on behalf of the Loan Originator to the Initial Noteholder in connection with the negotiation, preparation or delivery of the Basic Documents to which it is a party or delivered pursuant thereto, when taken as a whole, do not contain any untrue statement of material fact or omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. All written information furnished after the date hereof by or on behalf of the Loan Originator to the Initial Noteholder in connection with the Basic Documents to which it is a party and the transactions contemplated thereby will be true, complete and accurate in every material respect, or (in the case of projections) based on reasonable estimates, on the date as of which such information is stated or certified; (i) The Loan Originator is solvent, is able to pay its debts as they become due and has capital sufficient to carry on its business and its obligations under each Basic Document to which it is a party; it will not be rendered insolvent by the execution and delivery of this Agreement or by the performance of its obligations under each Basic Document to which it is a party; no petition of bankruptcy (or similar insolvency proceeding) has been filed by or against the Loan Originator prior to the date hereof; (j) Each Loan Originator has transferred the Loans transferred on or prior to such Transfer Date without any intent to hinder, delay or defraud any of its creditors; -46- 52 (k) Each Loan Originator has received fair consideration and reasonably equivalent value in exchange for the Loans they sold on such Transfer Date; (l) (i) Advanta National Bank's principal place of business and chief executive offices are located at One Righter Parkway, Wilmington, Delaware 19803; (ii) Advanta Mortgage Corp. USA's principal place of business and chief executive offices are located at Welsh & McKean Roads, P.O. Box 844, Spring House, Pennsylvania 19477; and (iii) Advanta Bank Corp.'s principal place of business and chief executive offices are located at 11850 South Election Drive, Draper, Utah, 84020; (m) With respect to ANB and ABC only, such party is an "insured depository institution" (within the meaning of Section 1813(c)(2) of Title 12 of the United States Code) and accordingly, makes the following additional representations and warranties: (1) the Basic Documents do not violate any statutory or regulatory requirements applicable to such party; (2) the Basic Documents have been (i) executed contemporaneously with the definitive agreement reached by such party and the parties to the Basic Documents, (ii) approved by a specific resolution by such party's board of directors, which approval shall be reflected in the minutes of said board, and (iii) entered into the official records of such party, a copy of which approvals, certified by a Secretary, Assistant Secretary, vice president or higher officer of such party, has been provided to the Issuer; (3) the aggregate amount of the Sales Price of all Loans conveyed on each Transfer Date by such party to the Issuer does not exceed any restrictions or limitations imposed by the board of directors of such party; (4) ANB and ABC are each at least Adequately Capitalized. It is understood and agreed that the representations and warranties set forth in this Section 3.02 shall survive delivery of the respective Custodial Loan Files to the Custodian (as the agent of the Indenture Trustee) and shall inure to the benefit of the Securityholders, the Depositor, the Servicer, the Indenture Trustee, the Owner Trustee and the Issuer. Upon discovery by any Loan Originator, the Depositor, the Servicer, the Indenture Trustee or the Trust of a breach of any of the foregoing representations and warranties that materially and adversely affects the value of any Loan or the interests of the Securityholders therein, the party discovering such breach shall give prompt written notice (but in no event later than two Business Days following such discovery) to the other parties. The obligations of the Loan Originator set forth in Sections 2.05 and 3.06 hereof to cure any breach or to substitute for or repurchase an affected Loan shall constitute the sole remedies available hereunder to the Securityholders, the Depositor, the Servicer, the Indenture Trustee or the Trust respecting a breach of the representations and warranties contained in this Section 3.02. The fact that the Initial Noteholder has conducted or has failed to conduct any partial or complete due diligence -47- 53 investigation of the Loan Files shall not affect the Securityholders' rights to demand repurchase or substitution as provided under this Agreement. Section 3.03 Representations, Warranties and Covenants of the Servicer. The Servicer hereby represents and warrants to and covenants with the other parties hereto and the Securityholders that as of each Closing Date, as of each Transfer Date and as of each Collateral Value Excess Date: (a) The Servicer is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware and (i) is duly qualified, in good standing and licensed to carry on its business in each state where any Mortgaged Property is located, and (ii) is in compliance with the laws of any such state, in both cases, to the extent necessary to ensure the enforceability of the Loans in accordance with the terms thereof and to perform its duties under each Basic Document to which it is a party and had at all relevant times, full corporate power to own its property, to carry on its business as currently conducted, to service the Loans and to enter into and perform its obligations under each Basic Document to which it is a party; (b) The execution and delivery by the Servicer of each Basic Document to which it is a party and its performance of and compliance with the terms thereof will not violate the Servicer's articles of incorporation or by-laws or constitute a default (or an event which, with notice or lapse of time, or both, would constitute a default) under, or result in the breach or acceleration of, any material contract, agreement or other instrument to which the Servicer is a party or which are applicable to the Servicer or any of its assets; (c) The Servicer has the full power and authority to enter into and consummate all transactions contemplated by each Basic Document to which it is a party, has duly authorized the execution, delivery and performance of each Basic Document to which it is a party and has duly executed and delivered each Basic Document to which it is a party. Each Basic Document to which it is a party, assuming due authorization, execution and delivery by each of the other parties thereto, constitutes a valid, legal and binding obligation of the Servicer, enforceable against it in accordance with the terms hereof, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); (d) The Servicer is not in violation of, and the execution and delivery of each Basic Document to which it is a party by the Servicer and its performance and compliance with the terms of each Basic Document to which it is a party will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction, which violation would materially and adversely affect the condition (financial or -48- 54 otherwise) or operations of the Servicer or materially and adversely affect the performance of its duties under any Basic Document to which it is a party; (e) There are no actions or proceedings against, or investigations of, the Servicer currently pending with regard to which the Servicer has received service of process and no action or proceeding against, or investigation of, the Servicer is, to the knowledge of the Servicer, threatened or otherwise pending before any court, administrative agency or other tribunal that (A) if determined adversely to the Servicer, would prohibit its entering into any Basic Document to which it is a party, (B) seek to prevent the consummation of any of the transactions contemplated by any Basic Document to which it is a party or (C) if determined adversely to the Servicer, would prohibit or materially and adversely affect the performance by the Servicer of its obligations under, or the validity or enforceability of, any Basic Document to which it is a party or the Securities; (f) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Servicer of, or compliance by the Servicer with, any Basic Document to which it is a party or the Securities, or for the consummation of the transactions contemplated by any Basic Document to which it is a party, except for such consents, approvals, authorizations and orders, if any, that have been obtained prior to such date; (g) The information, reports, financial statements, exhibits and schedules furnished in writing by or on behalf of the Servicer to the Initial Noteholder in connection with the negotiation, preparation or delivery of the Basic Documents to which it is a party or delivered pursuant thereto, when taken as a whole, do not contain any untrue statement of material fact or omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. All written information furnished after the date hereof by or on behalf of the Servicer to the Initial Noteholder in connection with the Basic Documents to which it is a party and the transactions contemplated thereby will be true, complete and accurate in every material respect, or (in the case of projections) based on reasonable estimates, on the date as of which such information is stated or certified; (h) The Servicer is solvent and will not be rendered insolvent as a result of the performance of its obligations pursuant to under the Basic Documents to which it is a party; (i) The Servicer acknowledges and agrees that the Servicing Fee represents reasonable compensation for the performance of its services hereunder and that the entire Servicing Fee shall be treated by the Servicer, for accounting purposes, as compensation for the servicing and administration of the Loans pursuant to this Agreement; and -49- 55 (j) The Servicer is an Eligible Servicer and covenants to remain an Eligible Servicer or, if not an Eligible Servicer, each Subservicer is an Eligible Servicer and the Servicer covenants to cause each Subservicer to be an Eligible Servicer. It is understood and agreed that the representations, warranties and covenants set forth in this Section 3.03 shall survive delivery of the respective Custodial Loan Files to the Indenture Trustee or the Custodian on its behalf and shall inure to the benefit of the Depositor, the Securityholders, the Indenture Trustee and the Issuer. Upon discovery by any of the Loan Originators, the Depositor, the Servicer, the Indenture Trustee, the Owner Trustee or the Issuer of a breach of any of the foregoing representations, warranties and covenants that materially and adversely affects the value of any Loans or the interests of the Securityholders therein, the party discovering such breach shall give prompt written notice (but in no event later than two Business Days following such discovery) to the other parties. The fact that the Initial Noteholder has conducted or has failed to conduct any partial or complete due diligence investigation shall not affect the Securityholders' rights to exercise their remedies as provided under this Agreement. Section 3.04 Representations and Warranties of the Transfer Obligor. The Transfer Obligor hereby represents, warrants and covenants to the other parties hereto and the Securityholders that as of each Closing Date, as of each Transfer Date and as of each Collateral Value Excess Date: (a) The Transfer Obligor is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and has, and had at all relevant times, full power to own its property, to carry on its business as currently conducted, to enter into and perform its obligations under each Basic Document to which it is a party; (b) The execution and delivery of each Basic Document to which it is a party and its performance of and compliance with all of the terms thereof will not violate the Transfer Obligor's articles of incorporation or by-laws or constitute a default (or an event which, with notice or lapse of time, or both, would constitute a default) under, or result in the breach or acceleration of, any material contract, agreement or other instrument to which the Transfer Obligor is a party or which is applicable to the Transfer Obligor or any of its material assets; (c) The Transfer Obligor has the full power and authority to enter into and consummate the transactions contemplated by each Basic Document to which it is a party, has duly authorized the execution, delivery and performance of each Basic Document to which it is a party and has duly executed and delivered each Basic Document to which it is a party. Each Basic Document to which it is a party, assuming due authorization, execution and delivery by the other party or parties thereto, constitutes a valid, legal and binding obligation of the Transfer Obligor, enforceable against it in accordance with the terms thereof, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other -50- 56 similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); (d) The Transfer Obligor is not in violation of, and the execution and delivery of each Basic Document to which it is a party by the Transfer Obligor and its performance and compliance with the terms of each Basic Document to which it is a party will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction, which violation would materially and adversely affect the condition (financial or otherwise) or operations of the Transfer Obligor or its properties or materially and adversely affect the performance of its duties hereunder; (e) There are no actions or proceedings against, or investigations of, the Transfer Obligor currently pending with regard to which the Transfer Obligor has received service of process and no action or proceeding against, or investigation of, the Transfer Obligor is, to the knowledge of the Transfer Obligor, threatened or otherwise pending before any court, administrative agency or other tribunal that (A) if determined adversely to the Transfer Obligor, would prohibit its entering into any of the Basic Documents to which it is a party or render the Securities invalid, (B) seek to prevent the issuance of the Securities or the consummation of any of the transactions contemplated by any of the Basic Documents to which it is a party or (C) if determined adversely to the Transfer Obligor, would prohibit or materially and adversely affect the performance by the Transfer Obligor of its obligations under, or the validity or enforceability of, any of the Basic Documents to which it is a party or the Securities; (f) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Transfer Obligor of, or compliance by the Transfer Obligor with, any of the Basic Documents to which it is a party or the Securities, or for the consummation of the transactions contemplated by any of the Basic Documents to which it is a party, except for such consents, approvals, authorizations and orders, if any, that have been obtained prior to the such date; (g) The Transfer Obligor is solvent, is able to pay its debts as they become due and has capital sufficient to carry on its business and its obligations hereunder; it will not be rendered insolvent by the execution and delivery of any of the Basic Documents to which it is a party or the assumption of any of its obligations thereunder; no petition of bankruptcy (or similar insolvency proceeding) has been filed by or against the Transfer Obligor; and (h) None of the Basic Documents to which it is a party, nor any Officer's Certificate, statement, report or other document prepared by the Transfer Obligor and furnished or to be furnished by it pursuant to any of the Basic Documents to which it is a party or in connection with the transactions contemplated thereby contains any untrue -51- 57 statement of material fact or omits to state a material fact necessary to make the statements contained herein or therein not misleading. Section 3.05 Representations and Warranties Regarding Loans. The Loan Originator which sold the related Loan hereby makes the representations and warranties set forth in Annex 1 hereto to the other parties hereto and the Securityholders, with respect to each such Loan as of the related Transfer Date (except as otherwise expressly agreed in writing by the Majority Noteholders). Section 3.06 Repurchase and Substitution. (a) It is understood and agreed that the representations and warranties referenced in Annex 1 hereto shall survive the conveyance of the Loans to the Indenture Trustee on behalf of the Issuer, and the delivery of the Securities to the Securityholders. Upon discovery by the Depositor, the Servicer, the Loan Originators, the Custodian, the Issuer, the Indenture Trustee or any Securityholder of a breach of any of such representations and warranties or the representations and warranties of the Loan Originators set forth in Section 3.02 which materially and adversely affects the value of the Loans or the interests of the Securityholders in the related Loan (notwithstanding that such representation and warranty was made to the related Loan Originator's best knowledge) or which, as a result of the attributes of the aggregate Loan Pool, constitutes a breach of the representations and warranties set forth in Annex 1, the party discovering such breach shall give prompt written notice to the others. The related Loan Originator shall within 5 Business Days of any breach of a representation or warranty, promptly cure such breach in all material respects. If within 5 Business Days after the earlier of the related Loan Originator's discovery of such breach or the related Loan Originator's receiving notice thereof such breach has not been remedied by the related Loan Originator and such breach materially and adversely affects the interests of the Securityholders or in the related Loan (the "Unqualified Loan"), the related Loan Originator shall promptly either (i) remove such Unqualified Loan from the Trust (in which case it shall become a Deleted Loan) and substitute one or more Qualified Substitute Loans in the manner and subject to the conditions set forth in this Section 3.06 or (ii) repurchase such Unqualified Loan at a purchase price equal to the Repurchase Price with respect to such Unqualified Loan by depositing such Repurchase Price in the Collection Account; provided, however, that if there is not an Overcollateralization Shortfall on the date of such repurchase (after giving effect to such repurchase) the Loan Originator shall remit the Alternate Repurchase Price in accordance with Section 5.01(c)(4)(i). The related Loan Originator shall provide the Servicer, the Indenture Trustee, the Initial Noteholder and the Issuer with a certification of a Responsible Officer on the Determination Date next succeeding the end of such 5 Business Days period indicating whether the related Loan Originator is purchasing the Unqualified Loan or substituting in lieu of such Unqualified Loan a Qualified Substitute Loan. To the extent that a Wet Funded Loan is repurchased by the related Loan Originator by means of a withdrawal of the Sales Price therefor from the Reserve Account and distribution of such amount to the Noteholders, the related Loan Originator shall pay an additional amount equal to the Note Interest Rate on the Principal Balance of such Wet Loan, computed for the period of time that the Wet Funded -52- 58 Loan was included in the Trust Estate; and the amount so withdrawn and such additional amount shall constitute the Repurchase Price of such Wet Funded Loan. Any substitution of Loans pursuant to this Section 3.06(a) shall be accompanied by payment by the related Loan Originator of the Substitution Adjustment, if any, to be deposited in the Collection Account pursuant to Section 5.01(b)(1) hereof. It is understood and agreed that the obligation of the Loan Originator to repurchase or substitute any such Loan pursuant to this Section 3.06 shall constitute the sole remedy against it with respect to such breach of the foregoing representations or warranties or the existence of the foregoing conditions. (b) As to any Deleted Loan for which the related Loan Originator substitutes a Qualified Substitute Loan or Loans, the related Loan Originator shall effect such substitution by delivering (i) to the Indenture Trustee and Initial Noteholder a certification executed by a Responsible Officer of the related Loan Originator to the effect that the Substitution Adjustment, if any, has been remitted to the Noteholders or, if an Overcollateralization Shortfall exists on the date of substitution (after giving effect to such substitution), credited to the Collection Account and (ii) to the Custodian the documents constituting the Custodial Loan File for such Qualified Substitute Loan or Loans. The Servicer shall deposit in the Collection Account all payments received in connection with such Qualified Substitute Loan or Loans after the date of such substitution. Monthly Payments received with respect to Qualified Substitute Loans on or before the date of substitution will be retained by the related Loan Originator. The Issuer will be entitled to all payments received on the Deleted Loan on or before the date of substitution and the related Loan Originator shall thereafter be entitled to retain all amounts subsequently received in respect of such Deleted Loan. The Servicer shall give written notice to the Issuer, the Indenture Trustee and Initial Noteholder that such substitution has taken place and the Servicer shall amend the Loan Schedule to reflect (i) the removal of such Deleted Loan from the terms of this Agreement and (ii) the substitution of the Qualified Substitute Loan. The related Loan Originator shall promptly deliver to the Issuer, the Servicer, the Indenture Trustee and Initial Noteholder, a copy of the amended Loan Schedule. Upon such substitution, such Qualified Substitute Loan or Loans shall be subject to the terms of this Agreement in all respects, and the related Loan Originator shall be deemed to have made, as of the date of substitution, the covenants, representations and warranties set forth in Section 3.05 hereof with respect to such Qualified Substitute Loan or Loans. On the date of such substitution, the Servicer shall cause the Indenture Trustee to release the Deleted Loan from the lien of the Indenture and the Servicer will cause such Qualified Substitute Loan to be pledged to the Indenture Trustee under the Indenture as part of the Trust Estate. (c) With respect to all Unqualified Loans or other Loans repurchased by the related Loan Originator pursuant to this Agreement, upon the deposit of the Repurchase Price therefor into the Collection Account or, if there is not an Overcollateralization Shortfall on the date of such repurchase (after giving effect to such repurchase) upon the remittance of the Alternate Repurchase Price by the Loan Originator in accordance with Section 5.01(c)(4)(i), -53- 59 the Indenture Trustee shall assign to the related Loan Originator, without recourse, representation or warranty, all the Indenture Trustee's right, title and interest in and to such Unqualified Loans or Loans, which right, title and interest were conveyed to the Indenture Trustee pursuant to Section 2.01 hereof. The Indenture Trustee shall, at the expense of the related Loan Originator, take any actions as shall be reasonably requested by the related Loan Originator to effect the repurchase of any such Loans. (d) It is understood and agreed that the obligations of the related Loan Originator set forth in this Section 3.06 to cure, repurchase or substitute for an Unqualified Loan constitute the sole remedies hereunder of the Depositor, the Issuer, the Indenture Trustee, the Owner Trustee and the Securityholders respecting a breach of the representations and warranties contained in Section 3.05 hereof. Any cause of action against the related Loan Originator relating to or arising out of a defect in a Custodial Loan File as contemplated by Section 2.05 hereof or against the related Loan Originator relating to or arising out of a breach of any representations and warranties made in Section 3.05 hereof shall accrue as to any Loan upon (i) discovery of such defect or breach by any party and notice thereof to the related Loan Originator, (ii) failure by the related Loan Originator to cure such defect or breach or purchase or substitute such Loan as specified above, and (iii) demand upon the related Loan Originator, as applicable, by the Issuer or the Majority Noteholders for all amounts payable in respect of such Loan. (e) Neither the Issuer nor the Indenture Trustee shall have any duty to conduct any affirmative investigation other than as specifically set forth in this Agreement as to the occurrence of any condition requiring the repurchase or substitution of any Loan pursuant to this Section or the eligibility of any Loan for purposes of this Agreement. Section 3.07 Dispositions. (a) (i) In consideration of the consideration received from the Depositor under the Loan Purchase Agreement, and, with respect to ANB and ABC, from the Issuer hereunder, each Loan Originator hereby agrees and covenants that in connection with each Disposition it shall effect the following at the direction of the Disposition Agent with respect to the Loans it sold to the Issuer: (A) make such representations and warranties concerning the Loans as of the "cutoff date" of the related Disposition to the Disposition Participants as may be necessary to effect the Disposition and such additional representations and warranties as may be necessary, in the reasonable opinion of any of the Disposition Participants, to effect such Disposition; provided, that no Loan Originator shall be required to make any representation or warranty beyond the scope or substance of the representations and warranties delineated herein; and provided further that, to the extent that a Loan Originator has at the time of the Disposition actual knowledge of any facts or circumstances that would render any of such representations and warranties materially false, such Loan Originator may notify the Disposition Participants of such facts or circumstances and, in such event, shall have no obligation to make such materially false representation and warranty; -54- 60 (B) supply such information, opinions of counsel, letters from law and/or accounting firms and other documentation and certificates regarding the origination of the Loans as any Disposition Participant shall reasonably request to effect a Disposition and enter into such indemnification agreements customary for such transaction relating to or in connection with the Disposition as the Disposition Agent may reasonably require; (C) make itself available for and engage in good faith consultation with the Disposition Participants concerning information to be contained in any document, agreement, private placement memorandum, or filing with the Securities and Exchange Commission relating to the Loan Originator or the Loans in connection with a Disposition and shall use reasonable efforts to compile any information and prepare any reports and certificates, into a form, whether written or electronic, suitable for inclusion in such documentation; (D) to implement the foregoing and to otherwise effect a Disposition, enter into, or cause its Affiliates to enter into insurance and indemnity agreements, underwriting or placement agreements, servicing agreements, purchase agreements and any other documentation which may be required of or deemed appropriate by the Disposition Participants in order to effect a Disposition; and (E) take such further actions as may be reasonably necessary to effect the foregoing. provided, that notwithstanding anything to the contrary, (a) the Loan Originators shall have no liability for the Loans arising from or relating to the ongoing ability of the related Borrowers to pay under the Loans; (b) none of the indemnities hereunder shall constitute an unconditional guarantee by the Loan Originators of collectibility of the Loans; (c) the Loan Originators shall have no obligation with respect to the financial inability of any Borrower to pay principal, interest or other amount owing by such Borrower under a Loan; and (d) the Loan Originators shall only be required to enter into documentation in connection with Dispositions that is consistent with the prior public securitizations of affiliates of the Loan Originators, provided that to the extent an Affiliate of the Initial Noteholder acts as "depositor" or performs a similar function in a Securitization, additional indemnities and informational representations and warranties are provided which are consistent with those in the Basic Documents and may upon request of the Loan Originators be set forth in a separate agreement between an Affiliate of the Initial Noteholder and the Loan Originators. (ii) In connection with Dispositions the Loan Originators (A) may participate as a concurrent bidder for the Loans subject to such Whole Loan Sale, but may not pay a price higher than the fair market value thereof (as determined by the Market Value Agent), and (B) shall retain such underwriters or sales agents as shall be agreed in writing between the Servicer and the Initial Noteholder. (iii) Conditions to Dispositions. The following conditions shall apply to all Dispositions: -55- 61 (A) As long as no Event of Default or Default shall have occurred and be continuing under the Sale and Servicing Agreement or the Indenture, the Servicer shall continue to service the Loans included in any Disposition. (B) During a Termination Period, the Loan Originators, the Issuer and the Depositor shall use commercially reasonable efforts to effect a Disposition at the direction of the Disposition Agent prior to the expiration of the Termination Period. (b) In accordance with the terms of Section 3.07(a), Section 2.01(a)(vi) or upon the exercise of the Put Option, the Issuer shall effect Dispositions at the direction of the Disposition Agent. In connection therewith, the Trust agrees to assist the Loan Originators in such Dispositions and accordingly it shall, at the request and direction of the Disposition Agent: (i) transfer, deliver and sell all or a portion of the Loans, as of the "cutoff dates" of the related Dispositions, to such Disposition Participants as may be necessary to effect the Dispositions; provided, that any such sale shall be for "fair market value," as determined by the Disposition Agent in its reasonable discretion; (ii) deposit the cash Disposition Proceeds into the Collection Account pursuant to Section 5.01(b)(1) or otherwise remit the Disposition Proceeds in accordance with Section 5.01(c)(4)(ii) and retain any Retained Securities created in any Securitizations in accordance with the terms of this Agreement or as otherwise directed in writing by the Noteholders of 100% of the outstanding Notes; (iii) to the extent that a Securitization creates any Retained Securities, to accept such Retained Securities as a part of the Disposition Proceeds; and (iv) take such further actions as may be reasonably necessary to effect such Dispositions. (c) The Servicer hereby covenants that it will take such actions as may be reasonably necessary to effect Dispositions as the Disposition Agent may request and direct, including without limitation providing the Loan Originators and Disposition Participants such information as may be required to make representations and warranties required of them hereunder. (d) The right of the Disposition Agent to require the Issuer and the Loan Originators to effect Dispositions is subject to the conditions set forth in Section 3.07(a). (e) The Disposition Agent may effect Whole Loan Sales upon written notice to the Servicer of its intent to cause the Issuer to effect a Whole Loan Sale at least 5 Business Days in advance thereof. The Disposition Agent shall serve as agent for Whole Loan Sales and will receive a reasonable fee for such services provided that no such fee shall be payable if -56- 62 the Loan Originator or its Affiliates purchase such Loans, and no Event of Default or Default shall have occurred. The Loan Originator or its Affiliates may concurrently bid to purchase Loans in a Whole Loan Sale; however, it shall not pay a price in excess of the fair market value thereof as reasonably determined by the Market Value Agent. (f) The parties' obligations under this Section 3.07 shall continue notwithstanding the occurrence of an Event of Default. (g) The Disposition Agent (and the Majority Noteholders to the extent directing the Disposition Agent) shall be an independent contractor to the Issuer and shall have no fiduciary obligations to the Issuer or any of its affiliates. In that connection, the Disposition Agent shall not be liable for any error of judgment made in good faith and shall not be liable with respect to any action it takes or omits to take in good faith in the performance of its duties. (h) In the event there is a Disposition with respect to some but not all of the Loans then subject to this Agreement, the Disposition Agent may select the Loans to be included in such Disposition using the following criteria selection: (i) aggregate Loan Balance; (ii) type of loan (fixed, ARM, intermediate or HELOC Mortgage Loan); (iii) LTV; (iv) average Loan Balance; (v) production channel; (vi) lien position; or (vii) loan originator; provided that in the event that the Disposition Agent shall select Loans using any criteria listed above such that fewer than all Loans meeting any selection criteria are selected, such selection shall be based upon the Transfer Date of each Loan, commencing with the earliest Transfer Date, and progressing to the most recent Transfer Date (commonly referred to as the "first in/first out method"). -57- 63 Section 3.08 Loan Originator Put; Servicer Call. (a) Loan Originator Put. The related Loan Originator shall promptly repurchase, upon the written demand of the Majority Noteholders, any Put/Call Loan originated by such Loan Originator; provided, however, that such Loan Originator shall only be required to repurchase such Put/Call Loan whenever the limits set forth in the definition of Performance Trigger shall have been exceeded. (b) Servicer Call. The Servicer may repurchase any Put/Call Loan at any time. Such Servicer Calls shall be solely at the option of the Servicer. Prior to exercising a Servicer Call, the Servicer shall deliver written notice to the Majority Noteholders and the Indenture Trustee which notice shall identify each Loan to be repurchased and the Repurchase Price or Alternate Repurchase Price therefor, as applicable. (c) In connection with each Loan Originator Put, the related Loan Originator shall deposit such Repurchase Price for the Loans to be repurchased in the Collection Account; provided, however, that if there is not an Overcollateralization Shortfall on the date of such repurchase (after giving effect to such repurchase) the Loan Originator shall remit the Alternate Repurchase Price in accordance with Section 5.01(c)(4)(i). In connection with each Servicer Call, the Servicer shall deposit such Repurchase Price for the Loans to be repurchased in the Collection Account; provided, however, that if there is not an Overcollateralization Shortfall on the date of such repurchase (after giving effect to such repurchase) the Loan Originator shall remit the Alternate Repurchase Price in accordance with Section 5.01(c)(4)(i). The aggregate Repurchase Price of all Loans transferred pursuant to Section 3.08(a) shall in no event exceed the Unfunded Transfer Obligation at the time of such Loan Originator Put. Section 3.09 Modification of Underwriting Guidelines. The Servicer shall give the Initial Noteholder prompt written notification of any material modification or change to the Underwriting Guidelines. ARTICLE IV ADMINISTRATION AND SERVICING OF THE LOANS Section 4.01 Duties of the Servicer. (a) Acting directly or through one or more Subservicers as provided in Section 4.03, the Servicer, as master servicer, shall service and administer the Loans in accordance with this Agreement and on behalf of the Indenture Trustee and the Initial Noteholder and with reasonable care, and using that degree of skill and attention that the Servicer exercises with respect to comparable mortgage loans that it services for itself or others, and shall have full power and authority, acting alone, to do or cause to be done any and all things in connection with such servicing and administration which it may deem necessary or desirable. -58- 64 (b) The duties of the Servicer shall include collecting and posting of all payments, responding to inquiries of Borrowers or by federal, state or local government authorities with respect to the Loans, investigating delinquencies, reporting tax information to Borrowers in accordance with its customary practices and accounting for collections and furnishing monthly and annual statements to the Indenture Trustee and the Initial Noteholder, with respect to distributions, making Servicing Advances pursuant hereto. The Servicer shall follow its customary standards, policies and procedures in performing its duties as Servicer. The Servicer shall cooperate with the Indenture Trustee and furnish to the Indenture Trustee with reasonable promptness information in its possession as may be necessary or appropriate to enable the Indenture Trustee to perform its tax reporting duties hereunder. The Indenture Trustee shall furnish the Servicer or any Subservicer with any powers of attorney and other documents necessary or appropriate to enable the Servicer or any Subservicer to carry out its servicing and administrative duties hereunder. (c) Without limiting the generality of the foregoing, the Servicer (i) shall continue, and is hereby authorized and empowered by the Indenture Trustee, to execute and deliver, on behalf of itself, the Noteholders, the Issuer and the Indenture Trustee or any of them, any and all instruments of satisfaction or cancellation, or of full release or discharge and all other comparable instruments, with respect to the Loans and with respect to the related Mortgaged Properties; (ii) may consent to any modification of the terms of any Promissory Note not expressly prohibited hereby if the effect of any such modification will not be to affect materially and adversely the security afforded by the related Mortgaged Property, the timing of receipt of any payments required hereby or the interests of the Indenture Trustee or Noteholders. (d) The Servicer shall have the right using that degree of skill and attention that the Servicer exercises with respect to comparable mortgage loans that it services for itself or others, to approve applications of Borrowers for consent to (i) partial releases of Mortgages, (ii) alterations to Mortgaged Properties and (iii) removal, demolition or division of Mortgaged Properties. No application for approval shall be considered by the Servicer unless: (x) the provisions of the related Promissory Note and Mortgage have been complied with; (y) the Combined Loan-to-Value Ratio (which may, for this purpose, be determined at the time of any such action in a manner reasonably acceptable to the Majority Noteholders) and the Borrower's debt-to-income ratio after any release does not exceed the Combined Loan-to-Value Ratio and debt-to-income ratio applicable to such Loan at origination and (z) the lien priority of the related Mortgage is not adversely affected; provided, however, that the foregoing requirements (x), (y) and (z) shall not apply to any such situation described in this paragraph if such situation results from any condemnation or easement activity by a governmental entity. (e) The Servicer may, and is hereby authorized to, perform any of its servicing responsibilities with respect to all or certain of the Loans through a Subservicer as it may from time to time designate, but no such designation of a Subservicer shall serve to release the Servicer from any of its obligations under this Agreement. Such Subservicer shall have all the rights and powers of the Servicer with respect to such Loans under this Agreement. -59- 65 (f) Without limiting the generality of the foregoing, but subject to Sections 4.12 and 4.13, the Servicer in its own name or in the name of a Subservicer may be authorized and empowered pursuant to a power of attorney executed and delivered by the Indenture Trustee to execute and deliver, and may be authorized and empowered by the Indenture Trustee to execute and deliver, on behalf of itself, the Noteholders, the Issuer and the Indenture Trustee or any of them, (i) any and all instruments of satisfaction or cancellation or of partial or full release or discharge and all other comparable instruments with respect to the Loans and with respect to the Mortgaged Properties, (ii) to institute foreclosure proceedings or obtain a deed in lieu of foreclosure so as to effect ownership of any Mortgaged Property on behalf of the Indenture Trustee, and (iii) to hold title to any Mortgaged Property upon such foreclosure or deed in lieu of foreclosure on behalf of the Indenture Trustee; provided, however, that Section 4.13 shall constitute a power of attorney from the Indenture Trustee to the Servicer or any Subservicer to execute an instrument of satisfaction (or assignment of mortgage without recourse) with respect to any Loan paid in full (or with respect to which payment in full has been escrowed). Subject to Sections 4.12 and 4.13, the Indenture Trustee shall furnish the Servicer and any Subservicer with any powers of attorney and other documents as the Servicer or such Subservicer shall reasonably request to enable the Servicer and such Subservicer to carry out their respective servicing and administrative duties hereunder. (g) The Servicer shall give prompt notice to the Indenture Trustee and the Initial Noteholder of any action, of which the Servicer has actual knowledge, to (i) assert a claim against the Trust or (ii) assert jurisdiction over the Trust. (h) Servicing Advances incurred by the Servicer or any Subservicer in connection with the servicing of the Loans (including any penalties in connection with the payment of any taxes and assessments or other charges) on any Mortgaged Property shall be recoverable by the Servicer or such Subservicer to the extent described in Section 4.08. (i) In the event of a Disposition or other removal of a Loan from the Trust Estate, the Servicer shall be terminated hereunder with respect to such Loan. (j) The Servicer agrees that in the event that any Notes are outstanding after the applicable Maturity Date, the Servicer will resign and the Majority Noteholders shall appoint a successor in accordance with provisions of Section 9.02. The Majority Noteholders may, by written notice to the Servicer and the Indenture Trustee, elect to have the Servicer continue its duties hereunder. Section 4.02 Collection of Certain Loan Payments. (a) The Servicer shall, to the extent such procedures shall be consistent with this Agreement and the terms and provisions of any applicable Mortgage Insurance Policies, follow Accepted Servicing Practices. Consistent with the foregoing, the Servicer may in its discretion (i) waive any assumption fees, late payment charges, charges for checks returned for insufficient funds, prepayment fees, if any, or other fees which may be collected in the ordinary course of servicing the Loans, (ii) if a Borrower is in default or about to be in default -60- 66 because of a Borrower's financial condition, arrange with the Borrower a schedule for the payment of delinquent payments due on the related Loan; provided, however, the Servicer shall not reschedule the payment of delinquent payments more than one time in any twelve consecutive months with respect to any Borrower. (b) The Servicer shall hold in escrow on behalf of the related Borrower all Prepaid Installments received by it, and shall apply such Prepaid Installments as directed by such Borrower and as set forth in the related Promissory Note. Section 4.03 Subservicing Agreements Between Servicer and Subservicers. The Servicer may enter into Subservicing Agreements for any servicing and administration of Loans with any institution which is in compliance with the laws of each state necessary to enable it to perform its obligations under such Subservicing Agreement and is an Eligible Servicer. The Servicer shall give notice to the Indenture Trustee and the Initial Noteholder of the appointment of any Subservicer and shall furnish to the Indenture Trustee and the Initial Noteholder a copy of the Subservicing Agreement between the Servicer and such unaffiliated Subservicer. For purposes of this Agreement, the Servicer shall be deemed to have received payments on Loans when any Subservicer has received such payments. Any such Subservicing Agreement shall be consistent with and not violate the provisions of this Agreement. Section 4.04 Successor Subservicers. Upon notice to the Indenture Trustee and the Initial Noteholder, the Servicer shall be entitled to terminate any Subservicing Agreement in accordance with the terms and conditions of such Subservicing Agreement and to either itself directly service the related Loans or enter into a Subservicing Agreement with a successor Subservicer which qualifies under Section 4.03. Section 4.05 Liability of Servicer. The Servicer shall not be relieved of its obligations under this Agreement notwithstanding any Subservicing Agreement or any of the provisions of this Agreement relating to agreements or arrangements between the Servicer and a Subservicer or otherwise, and the Servicer shall be obligated to the same extent and under the same terms and conditions as if it alone were servicing and administering the Loans. The Servicer shall be entitled to enter into any agreement with a Subservicer for indemnification of the Servicer by such Subservicer and nothing contained in such Subservicing Agreement shall be deemed to limit or modify this Agreement. The Trust shall not indemnify the Servicer for any losses due to the Servicer's negligence. -61- 67 Section 4.06 No Contractual Relationship Between Subservicer and Indenture Trustee or the Securityholders. Any Subservicing Agreement and any other transactions or services relating to the Loans involving a Subservicer shall be deemed to be between the Subservicer and the Servicer alone and no party hereto nor the Securityholders shall be deemed parties thereto and shall have no claims, rights, obligations, duties or liabilities with respect to any Subservicer except as set forth in Section 4.07. Section 4.07 Assumption or Termination of Subservicing Agreement by Successor Servicer. In connection with the assumption of the responsibilities, duties and liabilities and of the authority, power and rights of the Servicer hereunder by a successor Servicer pursuant to Section 9.02, it is understood and agreed that the Servicer's rights and obligations under any Subservicing Agreement then in force between the Servicer and a Subservicer may be assumed or terminated by the successor Servicer at its option without the payment of any fee (notwithstanding any contrary provision in any Subservicing Agreement). The Servicer shall, upon request of the successor Servicer, but at the expense of the Servicer, deliver to the assuming party documents and records relating to each Subservicing Agreement and an accounting of amounts collected and held by it and otherwise use its best reasonable efforts to effect the orderly and efficient transfer of the Subservicing Agreements to the assuming party, without the payment of any fee by the successor Servicer, notwithstanding any contrary provision in any Subservicing Agreement. Section 4.08 Servicing Advances. The Servicer will pay all "out-of-pocket" costs and expenses incurred in the performance of its servicing obligations including, but not limited to, the cost of (i) Preservation Expenses, (ii) any enforcement or judicial proceedings, including foreclosures, and (iii) the management and liquidation of Foreclosure Property but is only required to pay such costs and expenses to the extent the Servicer reasonably believes such costs and expenses will increase Net Liquidation Proceeds on the related Loan. Each such amount so paid will constitute a "Servicing Advance". The Servicer may recover Servicing Advances (x) from the Borrowers to the extent permitted by the Loans, from Liquidation Proceeds realized upon the liquidation of the related Loan and (y) as provided in Sections 5.01(c)(1)(ii) or 5.01(c)(3)(i) hereof. In no case may the Servicer recover Servicing Advances from principal and interest payments on any Loan or from any amounts relating to any other Loan except as provided pursuant to Sections 5.01(c)(1)(ii) or 5.01(c)(3)(i) hereof. Section 4.09 Reserved. Section 4.10 Maintenance of Insurance. (a) The Servicer shall cause to be maintained with respect to each Loan a hazard insurance policy with a generally acceptable carrier that provides for fire and extended -62- 68 coverage, and which provides for a recovery by the Servicer on behalf of the Trust of insurance proceeds relating to such Loan in an amount not less than the least of (i) the outstanding principal balance of the Loan, (ii) the minimum amount required to compensate for loss or damage on a replacement cost basis and (iii) the full insurable value of the premises. (b) If the Loan at the time of origination relates to a Mortgaged Property in an area identified in the Federal Register by the Federal Emergency Management Agency as having special flood hazards, the Servicer will cause to be maintained with respect thereto a flood insurance policy in a form meeting the requirements of the current guidelines of the Federal Insurance Administration with a generally acceptable carrier in an amount representing coverage, and which provides for a recovery by the Servicer on behalf of the Trust of insurance proceeds relating to such Loan of not less than the least of (i) the outstanding principal balance of the Loan, (ii) the minimum amount required to compensate for damage or loss on a replacement cost basis and (iii) the maximum amount of insurance that is available under the Flood Disaster Protection Act of 1973. The Servicer shall indemnify the Indenture Trustee out of the Servicer's own funds for any loss to the Trust and the Majority Noteholders resulting from the Servicer's failure to maintain the insurance required by this Section. (c) In the event that the Servicer shall obtain and maintain a blanket policy insuring against fire and hazards of extended coverage on all of the Loans, then, to the extent such policy names the Servicer as loss payee and provides coverage in an amount equal to the aggregate unpaid principal balance on the Loans with co-insurance, and otherwise complies with the requirements of this Section 4.10, the Servicer shall be deemed conclusively to have satisfied its obligations with respect to fire and hazard insurance coverage under this Section 4.10, it being understood and agreed that such blanket policy may contain a deductible clause, in which case the Servicer shall, in the event that there shall not have been maintained on the related Mortgaged Property a policy complying with the preceding paragraphs of this Section 4.10, and there shall have been a loss which would have been covered by such policy, deposit in the Collection Account from the Servicer's own funds the difference, if any, between the amount that would have been payable under a policy complying with the preceding paragraph of this Section 4.10 and the amount paid under such blanket policy. Upon the request of the Indenture Trustee, the Issuer or the Initial Noteholder, the Servicer shall cause to be delivered to the Indenture Trustee, the Issuer or the Initial Noteholder, a certified true copy of such policy. Section 4.11 Due-on-Sale Clauses; Assumption and Substitution Agreements. When a Mortgaged Property has been or is about to be conveyed by the Borrower, the Servicer shall, to the extent it has knowledge of such conveyance or prospective conveyance, exercise its rights to accelerate the maturity of the related Loan under any "due on sale" clause contained in the related Mortgage and, in the case of a HELOC Mortgage Loan, the related Credit Line Agreement or Promissory Note; provided, however, that the Servicer shall not exercise any such right if (i) the "due on sale" clause, in the reasonable belief of the Servicer, is not enforceable under applicable law; or (ii) the Servicer reasonably believes that to permit an assumption of the Loan would not materially and adversely affect the interest of the Majority Noteholders or of the Issuer. In such event, the Servicer shall enter into an -63- 69 assumption and modification agreement with the person to whom such property has been or is about to be conveyed, pursuant to which such person becomes liable under the Promissory Note and, unless prohibited by applicable law or the Loan Documents, the Borrower remains liable thereon. If the foregoing is not permitted under applicable law, the Servicer is authorized to enter into a substitution of liability agreement with such person, pursuant to which the original Borrower is released from liability and such person is substituted as Borrower and becomes liable under the Promissory Note; provided, however, that to the extent any such substitution of liability agreement would be delivered by the Servicer outside of its usual procedures for mortgage loans held in its own portfolio the Servicer shall, prior to executing and delivering such agreement, obtain the prior written consent of the Majority Noteholders. The Loan, as assumed, shall conform in all respects to the requirements, representations and warranties of this Agreement. The Servicer shall notify the Indenture Trustee that any such assumption or substitution agreement has been completed by forwarding to the Indenture Trustee the original copy of such assumption or substitution agreement, which copy shall be added by the Indenture Trustee to the related Loan File and which shall, for all purposes, be considered a part of such Loan File to the same extent as all other documents and instruments constituting a part thereof. The Servicer shall be responsible for recording or causing the recordation any such assumption or substitution agreements. In connection with any such assumption or substitution agreement, the required monthly payment on the related Loan shall not be changed but shall remain as in effect immediately prior to the assumption or substitution, the stated maturity or outstanding principal amount of such Loan shall not be changed nor shall any required monthly payments of principal or interest be deferred or forgiven. Any fee collected by the Servicer or the Subservicer for consenting to any such conveyance or entering into an assumption or substitution agreement shall be retained by or paid to the Servicer as additional servicing compensation. Notwithstanding the foregoing paragraph or any other provision of this Agreement, the Servicer shall not be deemed to be in default, breach or any other violation of its obligations hereunder by reason of any assumption of a Loan by operation of law or any assumption which the Servicer may be restricted by law from preventing, for any reason whatsoever. Section 4.12 Realization Upon Defaulted Loans. (a) The Servicer shall foreclose upon or otherwise comparably effect the ownership on behalf of the Trust of Mortgaged Properties relating to defaulted Loans as to which no satisfactory arrangements can be made for collection of Delinquent payments and which the Servicer has not purchased pursuant to a Servicer Call. In connection with such foreclosure or other conversion, the Servicer shall exercise such of the rights and powers vested in it hereunder, and use the same degree of care and skill in their exercise or use, as prudent mortgage lenders would exercise or use under the circumstances in the conduct of their own affairs, including, but not limited to, advancing funds for the payment of taxes, amounts due with respect to senior liens, and insurance premiums. Any amounts so advanced shall constitute "Servicing Advances" within the meaning of Section 4.08 hereof. The Servicer shall sell any Foreclosure Property as soon as practicable in accordance with the servicing standard set forth herein. Notwithstanding the generality of the foregoing provisions, the -64- 70 Servicer shall manage, conserve, protect and operate each Foreclosure Property for the Issuer and the Majority Noteholders solely for the purpose of its prompt disposition and sale. Pursuant to its efforts to sell such Foreclosure Property, the Servicer shall either itself or through an agent selected by the Servicer protect and conserve such Foreclosure Property in the same manner and to such extent as is customary in the locality where such Foreclosure Property is located and may, incident to its conservation and protection of the interests of the Securityholders, rent the same, or any part thereof, as the Servicer deems to be in the best interest of the Securityholders for the period prior to the sale of such Foreclosure Property. The Servicer shall take into account the existence of any hazardous substances, hazardous wastes or solid wastes, as such terms are defined in the Comprehensive Environmental Response Compensation and Liability Act, the Resource Conservation and Recovery Act of 1976, or other federal, state or local environmental legislation, on a Foreclosure Property in determining whether to foreclose upon or otherwise comparably convert the ownership of such Foreclosure Property. With respect to any Loan secured by a mixed use Foreclosure Property, the Servicer shall, prior to foreclosing upon or otherwise comparably effecting the ownership in the name of the Servicer on behalf of the Trust, either (x) perform a "phase one environmental study" of such Foreclosure Property or (y) repurchase such Foreclosure Property at the Alternate Repurchase Price, unless an Overcollateralization Shortfall exists, in which case it shall be at the Repurchase Price. Pursuant to its efforts to sell such Foreclosure Property, the Servicer shall either itself or through an agent selected by the Servicer protect and conserve such Foreclosure Property in the same manner and to such extent as is customary in the locality where such Foreclosure Property is located and may, incident to its conservation and protection of the interests of the Securityholders, rent the same, or any part thereof, as the Servicer deems to be in the best interest of the Securityholders for the period prior to the sale of such Foreclosure Property. The Servicer shall take into account the existence of any hazardous substances, hazardous wastes or solid wastes, as such terms are defined in the Comprehensive Environmental Response Compensation and Liability Act, the Resource Conservation and Recovery Act of 1976, or other federal, state or local environmental legislation, on a Mortgaged Property in determining whether to foreclose upon or otherwise comparably convert the ownership of such Mortgaged Property. (b) The Servicer shall determine, with respect to each Defaulted Loan, when it has recovered, whether through trustee's sale, foreclosure sale or otherwise, all amounts it expects to recover from or on account of such defaulted Loan, whereupon such Loan shall become a "Liquidated Loan" and shall promptly deliver to the Initial Noteholder a related liquidation report with respect to such Liquidated Loan. Section 4.13 Release of Files. Upon the payment in full of any Loan (including the repurchase of any Loan or any liquidation of such Loan through foreclosure or otherwise), or the receipt by the Servicer or any Subservicer of a notification that payment in full will be escrowed in a manner customary for such purposes, the Servicer shall deliver to the Custodian a Request for Release and Receipt in accordance with the terms of the Custodial Agreement. The Servicer shall -65- 71 either hold such Custodial File in trust or deliver it to (i) an escrow agent or (ii) any employee, agent or attorney of the Indenture Trustee, in each case pending its release by the Servicer, such escrow agent or such employee, agent or attorney of the Indenture Trustee, as the case may be. Upon any such payment in full, or the receipt of such notification that such funds have been placed in escrow, the Servicer or any Subservicer is authorized to give, as attorney-in-fact for the Issuer and the Indenture Trustee and the mortgagee under the Mortgage which secured the Promissory Note, an instrument of satisfaction (or assignment of Mortgage without recourse) regarding the Mortgaged Property relating to such Mortgage, which instrument of satisfaction or assignment, as the case may be, shall be delivered to the Person or Persons entitled thereto against receipt therefor of payment in full, it being understood and agreed that no expense incurred in connection with such instrument of satisfaction or assignment, as the case may be, shall be chargeable to the Collection Account. In lieu of executing any such satisfaction or assignment, as the case may be, the Servicer may prepare and submit to the Indenture Trustee, a satisfaction (or assignment without recourse, if requested by the Person or Persons entitled thereto) in form for execution by the Indenture Trustee with all requisite information completed by the Servicer or any Subservicer; in such event, the Indenture Trustee shall execute and acknowledge such satisfaction or assignment, as the case may be, and deliver the same with the related Custodial File, as aforesaid. Section 4.14 Access to Information. (a) The Servicer understands that, in connection with the transfer of the Notes, Noteholders may request that the Servicer make available to the Noteholders and to prospective Noteholders annual audited financial statements of Advanta Corp. if AMCUSA or any Affiliate thereof is the Servicer, or if not, the Servicer for any or all of the most recently completed five fiscal years for which such statements are available, which request shall not be unreasonably denied. (b) So long as any Notes remain outstanding, each of the Issuer and any Noteholder shall, at any time and from time to time during regular business hours, or at such other times upon reasonable notice to the Servicer and the Servicer shall permit the Issuer and any Noteholder, or its agents or representatives to: (i) examine all books, records and documents (including computer tapes and disks) in the possession or under the control of the Servicer relating to the Loans, the servicing of the Loans and the compliance of the terms of the Basic Documents, as may be reasonably requested; (ii) visit the offices and property of the Servicer for the purpose of examining such materials described in clause (b)(i) above; (iii) consult with such professionals as may reasonably be aware of the operations or condition of the Servicer, including, without limitation, accountants and auditors, and the Servicer shall cause such professionals to cooperate with any examination conducted in accordance with the terms of this Section 4.14 and to provide access to those materials listed in subclause (b)(i) above in the possession or under the control of such professionals. -66- 72 Section 4.15 Release of Loan Files. If with respect to any Loan: (i) such Loan has become an Unqualified Loan and has been repurchased or a Qualified Substitute Loan has been conveyed to the Trust pursuant to Section 3.06 hereof; (ii) such Loan or the related Foreclosure Property has been sold in connection with the termination of the Trust pursuant to Section 10.01 hereof; (iii) such Loan has been repurchased by the related Loan Originator in accordance with the terms of Section 3.08; or (iv) such Loan has been included in a Disposition and concurrently with such release the cash Disposition Proceeds associated therewith will be deposited into the Collection Account, then, in each such case, the Servicer shall deliver a certificate to the effect that the Servicer has complied with all of its obligations under this Agreement with respect to such Loan and requesting that the Indenture Trustee release to the Servicer the related Custodial Loan File, and the Indenture Trustee shall, within five Business Days or such shorter period as may be required by applicable law, release, or cause the Custodian to release (unless such Custodial Loan File has previously been released), the related Custodial Loan File to the Servicer and execute and deliver such instruments of transfer or assignment prepared and delivered to it by the Servicer, in each case without recourse, representation or warranty as shall be necessary to vest ownership of such Loan in the Servicer or such other Person as may be specified in such certificate, the forms of any such instrument to be appended to such certificate. Section 4.16 Servicing Compensation. As compensation for its services hereunder, the Servicer shall be entitled to retain from collections on the Loans or otherwise withdraw from the Collection Account the Servicing Fee, out of which the Servicer shall pay any servicing fees owed or payable to any Subservicer. Additional servicing compensation in the form of investment income on the Collection Account, Distribution Account and Transfer Obligation Account, assumption fees, modification fees, and other administrative fees, and any prepayment premiums, insufficient funds charges, amounts remitted pursuant to Section 5.01 hereof and late payment charges shall be part of the Servicing Compensation payable to the Servicer hereunder and shall be paid either by the Servicer's retaining such additional servicing compensation prior to deposit into the Collection Account pursuant to Section 5.01(b)(1) hereof or, if deposited into the Collection Account, as part of the Servicing Compensation withdrawn therefrom pursuant to Section 5.01 hereof. The Servicer shall be required to pay all expenses incurred by it in connection with its servicing activities hereunder and shall not be entitled to reimbursement therefor -67- 73 except as specifically provided for herein. The Servicer also agrees to pay all reasonable costs and expenses incurred by any successor Servicer or the Indenture Trustee in replacing the Servicer in the event of a default by the Servicer in the performance of its duties under the terms and conditions of this Agreement. Section 4.17 Statement as to Compliance and Financial Statements. The Servicer will deliver to the Initial Noteholder: (a) not later than 105 days following the end of each calendar year (beginning in March, 2000), an Officer's Certificate stating that (i) a review of the activities of the Servicer during the preceding year and of performance under this Agreement has been made under such officer's supervision and (ii) to the best of such officer's knowledge, based on such review, the Servicer has fulfilled all of its obligations under this Agreement throughout such year, or, if there has been a default in the fulfillment of any such obligation, specifying each such default known to such officer and the nature and status thereof and what action the Servicer proposes to take with respect thereto. (b) As soon as available and in no event later than 5 Business Days after the filing thereof with the Commission each of the first three quarterly fiscal periods of Advanta Corp., a Quarterly Report on "Form 10-Q" filed by Advanta Corp. with the Commission. (c) As soon as available and in no event later than 5 Business Days after the filing thereof with the Commission, an Annual Report on "Form 10-K" filed by Advanta Corp. with the Commission. (d) As soon as available and in any event within 5 Business Days after the delivery thereof to its shareholders, the annual report that is delivered to its shareholders. (e) Within 10 days after service of process on any of the following, notice of all legal or arbitrable proceedings affecting the Servicer or any of its subsidiaries that questions or challenges the validity or enforceability of any of the Basic Documents or as to which there is a reasonable likelihood of adverse determination which would result in a material adverse effect with respect to the value of the Loans or the interests of any of the Securityholders therein. The Servicer shall also furnish and certify to the requesting party such other information as to (i) its organization, activities and personnel relating to the performance of the obligations of the Servicer hereunder, (ii) its financial condition, (iii) the Loans and (iv) the performance of the obligations of any Subservicer under the related Subservicing Agreement, in each case as the Indenture Trustee or the Issuer may reasonably request from time to time. Section 4.18 Independent Public Accountants' Servicing Report. Not later than 105 days following the end of each calendar year (beginning in March, 2000), the Servicer at its expense shall cause a nationally recognized firm of Independent Certified Public Accountants (which may also render other services to the Servicer) to furnish a statement to the Indenture Trustee, the Depositor and the Initial Noteholder to the effect that such firm has examined certain documents and records relating to -68- 74 the servicing of the Loans under this Agreement or of loans under pooling and servicing agreements (including the Loans and this Agreement) substantially similar to one another (such statement to have attached thereto a schedule setting forth the pooling and servicing agreements covered thereby) and that, on the basis of such examination conducted substantially in compliance with USAP or SAS 70, such firm confirms that such servicing has been conducted in compliance with such pooling and servicing agreements except for such significant exceptions or errors in records that, in the opinion of such firm, USAP or SAS 70 requires it to report, each of which errors and omissions shall be specified in such statement. In rendering such statement, such firm may rely, as to matters relating to direct servicing of loans by Subservicers, upon comparable statements for examinations conducted substantially in compliance with USAP or SAS 70 (rendered within one year of such statement) of Independent certified public accountants with respect to the related Subservicer. Notwithstanding the foregoing, in the event that the Independent Certified Public Accountants conduct reviews of the Servicer pursuant to SAS 70, then SAS 70 rather than USAP shall govern such reviews. Section 4.19 ARMs. The Servicer shall enforce each ARM in accordance with its terms and shall timely calculate, record, report and apply all interest rate adjustments in accordance with the related Promissory Note. The Servicer's records shall, at all times, reflect the then Loan Interest Rate and monthly payment and the Servicer shall timely notify the Borrower of any changes to the Loan Interest Rate or the Borrower's monthly payment. If the Servicer fails to make either a timely or accurate adjustment to the Loan Interest Rate or monthly payment or to notify the Borrower of such adjustments, the Servicer shall pay from its own funds any shortage. If the Servicer's failure to make a scheduled change affects the Trust's rights to make future adjustments under the terms of the ARM, the Servicer shall purchase the ARM, in accordance with the provisions of the last sentence of Section 3.08(b). Any amounts paid by the Servicer pursuant to this Section shall not be an advance and shall not be reimbursable from the proceeds of any Loan. Section 4.20 Year 2000 Compliance. By December 31, 1999, the Servicer will maintain all hardware, firmware or software, or any system consisting of one or more thereof, including, without limitation, any and all enhancements, upgrades, customizations, modifications, maintenance and the like (collectively, the "System"), used by or for the benefit of the Servicer in order for the Servicer to perform its obligations under the Basic Documents to which it is a party in a manner that permits the Servicer to record, store, process, provide and where appropriate, insert, true and accurate dates and calculations for dates and spans, including and following January 1, 2000 (herein referred to as "Year 2000 Compliant"). In addition, "Year 2000 Compliant" shall mean that the System will support the ability for its continued normal usage such that neither the performance nor the correct functioning of the System will be affected by the approach, and passing into, the year 2000. -69- 75 Section 4.21 Inspections by the Majority Noteholders and the Indenture Trustee. At any reasonable time and from time to time upon reasonable notice, the Majority Noteholders, the Indenture Trustee, or any agents or representatives thereof may inspect the Servicer's servicing operations and discuss the servicing operations of the Servicer with any of its officers or directors. The costs and expenses incurred by the Servicer or its agents or representatives in connection with any such examinations or discussions shall be paid by the Servicer. Section 4.22 Errors and Omissions Insurance. The Servicer agrees to maintain errors and omissions coverage and a fidelity bond, each at least to the extent generally maintained by prudent mortgage loan servicers having servicing portfolios of similar size. ARTICLE V ESTABLISHMENT OF TRUST ACCOUNTS; TRANSFER OBLIGATION Section 5.01 Collection Account and Distribution Account; Reserve Account. (a) (1) Establishment of Collection Account. The Servicer, for the benefit of the Noteholders, shall cause to be established and maintained one or more Collection Accounts (collectively, the "Collection Account"), which shall be separate Eligible Accounts entitled "Collection Account, Bankers Trust Company of California, N.A., as Indenture Trustee, for the benefit of the Advanta Home Equity Loan Owner Trust 1998-MS1". The Collection Account shall be maintained with the Indenture Trustee or any other depository institution which satisfies the requirements set forth in the definition of Eligible Account. Funds in the Collection Account shall be invested in accordance with Section 5.03 hereof. The Collection Account shall be established, as of the date hereof, as an Eligible Account pursuant to the definition thereof. (2) Establishment of Distribution Account. No later than the date hereof, the Servicer, for the benefit of the Noteholders, shall cause to be established and maintained with Bankers Trust Company of California, N.A., one or more Distribution Accounts (collectively, the "Distribution Account"), which shall be separate Eligible Accounts, entitled "Distribution Account, Bankers Trust Company of California, N.A., as Indenture Trustee, for the benefit of the Advanta Home Equity Loan Owner Trust 1998-MS1." (3) Establishment of Reserve Account. No later than the date hereof, the Servicer, for the benefit of the Noteholders, shall cause to be established and maintained with Bankers Trust Company of California, N.A. a Reserve Account (the "Reserve Account"), which shall be an Eligible Account, entitled "Reserve Account, Bankers Trust Company of California, N.A., as Indenture Trustee, for the benefit of the Advanta Home Equity Loan -70- 76 Owner Trust 1998-MS1." Funds in the Reserve Account shall be invested in accordance with Section 5.03 hereof. (b)(1) Deposits to Collection Account. The Servicer shall deposit or cause to be deposited to the Collection Account (without duplication): (i) all payments on or in respect of each Loan collected on or after the related Transfer Cutoff Date net of any Servicing Compensation retained therefrom and excluding any Premium Recapture within two (2) Business Days after receipt thereof; (ii) all Net Liquidation Proceeds pursuant to Section 4.12 hereof within two (2) Business Days after receipt thereof; (iii) all Mortgage Insurance Proceeds not required to be applied to restoration or repair of Mortgaged Property pursuant to Section 4.10 within two (2) Business Days after receipt thereof; (iv) all Released Mortgaged Property Proceeds within two (2) Business Days after receipt thereof; (v) any amounts payable in connection with the repurchase of any Loan and the amount of any Substitution Adjustment pursuant to Sections 2.05 and 3.06 hereof concurrently with payment thereof; (vi) any Repurchase Price payable in connection with a Servicer Call pursuant to Section 3.08(b) hereof concurrently with payment thereof; (vii) the deposit of the Termination Price under Section 10.02 hereof concurrently with payment thereof; (viii) any Repurchase Price payable in connection with a Loan Originator Put remitted by the related Loan Originator pursuant to Section 3.08 hereof in accordance with the last sentence of this Section 5.01(b)(1); (ix) any cash Disposition Proceeds pursuant to Section 3.07 in accordance with the last sentence of this Section 5.01(b)(1); and (x) any payments received under Hedging Instruments or the return of amounts by the Hedging Counterparty pledged pursuant to prior Hedge Funding Requirements in accordance with the last sentence of this Section 5.01(b)(1). Except as provided in Section 5.01(c)(4), the Servicer agrees that it will cause the Loan Originator, Borrower or other appropriate Person paying such amounts, as the case may be, to remit directly to the Indenture Trustee for deposit into the Collection Account all amounts referenced in clauses (vii), (viii), (ix) and (x) to the extent such amounts are in excess -71- 77 of a Monthly Payment on the related Loan. To the extent the Servicer receives any such amounts, it will deposit them into the Collection Account on the same Business Day as receipt thereof. (2) Deposits to the Reserve Account. On any Transfer Date on which Wet Funded Loans are purchased by the Issuer and pledged to the Noteholders, the Initial Noteholder shall deposit into the Reserve Account the Sales Prices for each such Wet Funded Loan. (c) Withdrawals From Collection Account; Deposits to Distribution Account. (1) Withdrawals From Collection Account -- Reimbursement Items. The Indenture Trustee, at the written direction of the Servicer, shall periodically but in any event on each Determination Date, make the following withdrawals from the Collection Account prior to any other withdrawals, in no particular order of priority: (i) to withdraw any amount not required to be deposited in the Collection Account or deposited therein in error; (ii) to withdraw the Servicing Advance Reimbursement Amount; and (iii) to withdraw net investment earnings and remit such amounts to the Servicer, as provided in Section 5.03(b)(1); and (iv) to clear and terminate the Collection Account in connection with the termination of this Agreement. (2) Indenture Trustee Deposits to Distribution Account - Payment Dates. (A) On the Business Day prior to each Payment Date, the Indenture Trustee shall deposit into the Distribution Account such amounts as are required from the Transfer Obligation Account pursuant to Sections 5.05(e), 5.05(f), 5.05(g) and 5.05(h). (B) After making all withdrawals specified in Section 5.01(c)(1) above, on each Remittance Date, the Indenture Trustee (based on information provided by the Servicer for such Payment Date), shall withdraw the Monthly Remittance Amount from the Collection Account not later than 5:00 P.M. Noon, New York City time and deposit such amount into the Distribution Account. (C) The Indenture Trustee shall make such deposits into the Distribution Account from the Reserve Account as required by Section 5.01(d)(2). (3) Withdrawals From Distribution Account -- Payment Dates. On each Payment Date, to the extent funds are available in the Distribution Account, the Indenture Trustee (based on the information provided by the Servicer contained in the Servicer's -72- 78 Remittance Report for such Payment Date) shall make withdrawals therefrom for application in the following order of priority: (i) to distribute on such Payment Date the following amounts in the following order: (a) to the Servicer, (x) an amount equal to the Servicing Compensation and all unpaid Servicing Compensation from prior Payment Dates (to the extent not retained from collections), including net investment earnings on the Distribution Account and (y) all Nonrecoverable Servicing Advances not previously reimbursed, (b) to the Servicer, in trust for the Owner Trustee, an amount equal to the Owner Trustee Fee and all unpaid Owner Trustee Fees from prior Payment Dates; (ii) to distribute on such Payment Date, the Hedge Funding Requirement to the appropriate Hedging Counterparties; provided, that only cash on or in respect of fixed rate Loans (including cash Disposition Proceeds received therefrom) shall be distributed for such purpose and; provided, further, that amounts distributed pursuant to clause (i) above to the extent not attributable to a specific Loan shall be deemed paid from fixed rate Loans, pro rata based on their aggregate Principal Balances relative to the Pool Principal Balance on such Payment Date; (iii) to the holders of the Notes pro rata, the sum of the Interest Payment Amount for such Payment Date and the Interest Carry-Forward Amount for such Payment Date; (iv) to the holders of the Notes pro rata, the sum of the Overcollateralization Shortfall for such Payment Date for such Payment Date; provided, however, that if (a) a Rapid Amortization Trigger shall have occurred and not been Deemed Cured or (b) an Event of Default under the Indenture or Default shall have occurred, the holders of the Notes shall receive, in respect of principal, all remaining amounts on deposit in the Distribution Account; (v) to the appropriate Person, amounts in respect of Issuer/Depositor Indemnities (as defined in the Trust Agreement) and Due Diligence Fees until such amounts are paid in full; (vi) to the Transfer Obligation Account, all remaining amounts until the balance therein equals the Transfer Obligation Target Amount; and (vii) to the holders of the Trust Certificates of record on the next preceding Record Date, pro rata, all amounts remaining therein. (4) (i) If a Loan Originator or the Servicer, as applicable, repurchases a Loan pursuant to Section 2.05, 3.06(a), 3.06(c), 3.08 (b) or 3.08(c), as applicable, and on the date of such repurchase there is not an Overcollateralization Shortfall (after giving effect to -73- 79 such repurchase), then the Majority Noteholders and the Issuer shall deem such date to be an additional Payment Date and will provide written notice to the Indenture Trustee of such additional Payment Date. On such additional Payment Date, the Loan Originator or Servicer, in satisfaction of its obligations under 2.05, 3.06(a), 3.06(c), 3.08 (b) or 3.08(c) and in satisfaction of the obligations of the Issuer, to distribute such amounts to the Noteholders pursuant to Section 5.01(c), shall remit to the Noteholders, on behalf of the Issuer, an amount equal to the Alternate Repurchase Price, and the Note Principal Balance will be reduced accordingly. Such amounts shall be deemed deposited into the Collection Account and the Distribution Account, as applicable, and such amounts will be deemed distributed pursuant to the terms of Section 5.01(c). (ii) To the extent that there is deposited in the Collection Account any amounts referenced in Section 5.01(b)(1)(v), (vi), (vii), (viii) and (ix) and the Majority Noteholders and the Issuer may agree, upon reasonable written notice to the Indenture Trustee, to additional Payment Dates, provided that such notice may provide that the Servicer shall, instead of depositing into the Collection Account the amounts referenced in Section 5.01(b)(1)(v), (vi), (vii), (viii) and (ix), the Servicer shall distribute such amounts to the Persons specified in such written notice. The Issuer and the Majority Noteholder shall give the Indenture Trustee at least one (1) Business Day's written notice prior to such additional Payment Date and such notice shall specify each amount (if any) in Section 5.01(c) to be withdrawn from the Collection Account and Distribution Account on such day. Notwithstanding that the Notes have been paid in full, the Indenture Trustee and the Servicer shall continue to maintain the Distribution Account hereunder until this Agreement has been terminated. (d) Withdrawals from the Reserve Account. (1) On each day on which (A) the Indenture Trustee shall have been directed by the Initial Noteholder pursuant to instructions substantially in the form of Exhibit D hereto, which instructions shall be delivered by the Initial Noteholder by no later than 12:00 p.m. Noon New York City time on the Business Day following any day on which the Indenture Trustee and the Initial Noteholder shall have received, by 6:00 p.m. New York City time, a Loan Schedule and Exceptions Report, complete and in form and substance satisfactory to the Initial Noteholder, confirming that the Custodial Loan File has been received by the Custodian for the related Wet Funded Loan in accordance with Section 2.04 (provided, that if such Loan Schedule and Exceptions Report shall be received after 6:00 p.m. New York City time it shall be deemed to have been received by 6:00 p.m. New York City time on the following Business Day) or on which (B) the Indenture Trustee and the Initial Noteholder shall have confirmed receipt of the Repurchase Price on account of such Wet Funded Loan in the Collection Account paid pursuant to Section 2.05(b), the Indenture Trustee shall distribute an amount equal to the Sales Price for such Wet Funded Loan to the applicable Loan Originator that conveyed such Wet Funded Loan, as the assignee of the Reserve Account Right. (2) For each Wet Funded Loan for which the Custodian shall not have received a Custodial Loan File in accordance with Section 2.04, on or before the related Wet -74- 80 Custodial File Delivery Date the related Loan Originator, upon demand of the Initial Noteholder or Issuer, shall repurchase such Wet Funded Loan pursuant to Section 2.05(b)(ii), provided that if the related Repurchase Price is not received prior to 1:00 P.M., New York City time on such date, the Indenture Trustee, at the direction of the Initial Noteholder, shall withdraw from the Reserve Account and deposit into the Distribution Account for payment to the Noteholders, an amount equal to the Sales Price for such Loan. (3) The Indenture Trustee shall withdraw from the Reserve Account any net investment earnings then on deposit therein, and remit such amounts to the Loan Originators, as provided in Section 5.03(b)(1) hereof. (4) Notwithstanding anything set forth in the Basic Documents, the Reserve Account shall be applied in accordance with this Section 5.01(d) regardless of the occurrence of a Default or Event of Default. Section 5.02 Payments to Securityholders. (a) All distributions made on the Notes on each Payment Date will be made on a pro rata basis among the Noteholders of record of the Notes on the next preceding Record Date based on the Percentage Interest represented by their respective Notes, without preference or priority of any kind, and, except as otherwise provided in the next succeeding sentence, shall be made by wire transfer of immediately available funds to the account of such Noteholder, if such Noteholder shall own of record Notes having a Percentage Interest (as defined in the Indenture) of at least 20% and shall have so notified the Indenture Trustee, 5 Business Days prior to the related Record Date and otherwise by check mailed to the address of such Noteholder appearing in the Notes Register. The final distribution on each Note will be made in like manner, but only upon presentment and surrender of such Note at the location specified in the notice to Noteholders of such final distribution. (b) All distributions made on the Trust Certificates on each Payment Date will be made pro rata among the holders of the Trust Certificates of record on the next preceding Record Date based on their Percentage Interests (as defined in the Trust Agreement), without preference or priority of any kind, and, except as otherwise provided in the next succeeding sentence, shall be made by wire transfer of immediately available funds to the account of each such holder, if such holder shall be the Depositor, ANB or ABC or an Affiliate thereof or shall own of record a Trust Certificate in an original denomination aggregating at least 25% of the Percentage Interests (as defined in the Trust Agreement) and shall have so notified the Indenture Trustee 5 Business Days prior to the related Record Date, and otherwise by check mailed to the address of such Certificateholder appearing in the Certificate Register. The final distribution on each Trust Certificate will be made in like manner, but only upon presentment and surrender of such Trust Certificate at the location specified in the notice to holders of the Trust Certificates of such final distribution. Any amount distributed to the holders of the Trust Certificates on any Payment Date shall not be subject to any claim or interest of the Noteholders. In the event that at any time there shall be more than one Certificateholder, the Indenture Trustee shall be entitled to reasonable additional -75- 81 compensation from the Servicer for its obligations hereunder, including, without limitation, its obligations to distribute funds and produce and deliver statements. (c) For purposes of this Section 5.02, the sole holders of the Trust Certificates shall be deemed to be the Depositor, ANB and ABC until such time as the Depositor, ANB or ABC provides written notice to the contrary to the Indenture Trustee and the Initial Noteholder. Section 5.03 Trust Accounts; Trust Account Property. (a) Control of Trust Accounts. Each of the Trust Accounts established hereunder has been pledged by the Issuer to the Indenture Trustee under the Indenture and shall be subject to the lien of the Indenture. Amounts distributed from each Trust Account in accordance with the terms of this Agreement shall be released for the benefit of the Securityholders from the Trust Estate upon such distribution thereunder or hereunder. The Indenture Trustee shall possess all right, title and interest in and to all funds on deposit from time to time in the Trust Accounts and in all proceeds thereof (excluding all investment earnings thereon) and all such funds, investments, proceeds and income shall be part of the Trust Account Property and the Trust Estate. If, at any time, any Trust Account ceases to be an Eligible Account, the Indenture Trustee shall, within ten Business Days (or such longer period, not to exceed 30 calendar days, with the prior written consent of the Majority Noteholders) (i) establish a new Trust Account as an Eligible Account, (ii) terminate the ineligible Trust Account, and (iii) transfer any cash and investments from such ineligible Trust Account to such new Trust Account. With respect to the Trust Accounts, the Issuer and the Indenture Trustee agree, that each such Trust Account shall be subject to the sole and exclusive dominion, custody and control of the Indenture Trustee for the benefit of the Noteholders, and, except as may be consented to in writing by the Majority Noteholders, the Indenture Trustee shall have sole signature and withdrawal authority with respect thereto. The Servicer shall have the power, revocable by the Majority Noteholder or by the Indenture Trustee, to instruct the Indenture Trustee to make withdrawals and payments from the Trust Accounts for the purpose of permitting the Servicer to carry out its duties hereunder or permitting the Indenture Trustee or Owner Trustee to carry out their respective duties herein or under the Indenture or the Trust Agreement, as applicable. (b)(1) Investment of Funds. Funds held in the Distribution Account, the Collection Account, Reserve Account and the Transfer Obligation Account may be invested (to the extent practicable and consistent with any requirements of the Code) in Permitted Investments, as directed by the Servicer prior to the occurrence of an Event of Default and by the Majority Noteholders thereafter, in writing or facsimile transmission confirmed in writing by the Servicer or Majority Noteholders, as applicable. In the event the Indenture Trustee has not received such written direction, such Funds shall be invested in any investment described in clause (i) of the definition of Permitted Investments. Funds held in the Reserve Account may be invested at the direction of the Majority Noteholders in the same method. In any case, -76- 82 funds in the Collection Account, Reserve Account and the Transfer Obligation Account must be available for withdrawal without penalty, and any Permitted Investments must mature or otherwise be available for withdrawal, one Business Day prior to the next Payment Date and shall not be sold or disposed of prior to its maturity subject to Subsection (b)(2) of this Section. All interest and any other investment earnings on amounts or investments held in the Trust Accounts (other than the Reserve Account) shall be paid to the Servicer immediately upon receipt by the Indenture Trustee. All investment income on the Reserve Account shall be distributed to the Loan Originators as assignees of the Reserve Account Right in accordance with the applicable Allocation Percentage or as such parties may otherwise direct by the Indenture Trustee upon receipt. All Permitted Investments in which funds in the Collection Account, Reserve Account or the Transfer Obligation Account are invested must be held by or registered in the name of "Bankers Trust Company of California, N.A., as Indenture Trustee, in trust for the Advanta Home Equity Loan Owner Trust 1998-1." (2) Insufficiency and Losses in Trust Accounts. If any amounts are needed for disbursement from the Collection Account, Reserve Account or the Transfer Obligation Account held by or on behalf of the Indenture Trustee and sufficient uninvested funds are not available to make such disbursement, the Indenture Trustee shall cause to be sold or otherwise converted to cash a sufficient amount of the investments in the Collection Account, Reserve Account or the Transfer Obligation Account, as the case may be. The Indenture Trustee shall not be liable for any investment loss or other charge resulting therefrom, unless such loss or charge is caused by the failure of the Indenture Trustee to perform in accordance with written directions provided pursuant to this Section 5.03. If any losses are realized in connection with any investment in the Collection Account or the Transfer Obligation Account pursuant to this Agreement, then the Servicer shall deposit the amount of such losses (to the extent not offset by income from other investments in the Collection Account or the Transfer Obligation Account, as the case may be) into the Collection Account, or the Transfer Obligation Account, as the case may be, immediately upon the realization of such loss, provided that all such losses incurred with respect to Permitted Investments in the Reserve Account specified in clause (j) of the definition thereof shall be reimbursed by the Initial Noteholder. All interest and any other investment earnings on amounts held in the Collection Account, Reserve Account and the Transfer Obligation Account shall be taxed to the Issuer and for federal and state income tax purposes the Issuer shall be deemed to be the owner of the Collection Account, Reserve Account and/or the Transfer Obligation Account, as the case may be. (c) Subject to Section 6.01 of the Indenture, the Indenture Trustee shall not in any way be held liable by reason of any insufficiency in any Trust Account held by the Indenture Trustee resulting from any investment loss on any Permitted Investment included therein. (d) With respect to the Trust Account Property, the Indenture Trustee acknowledges and agrees that: -77- 83 (1) any Trust Account Property that is held in deposit accounts shall be held solely in the Eligible Accounts, subject to the last sentence of Subsection (a) of this Section 5.03; and each such Eligible Account shall be subject to the sole and exclusive dominion, custody and control of the Indenture Trustee; and, without limitation on the foregoing, the Indenture Trustee shall have sole signature authority with respect thereto; (2) any Trust Account Property that constitutes Physical Property shall be delivered to the Indenture Trustee in accordance with paragraph (a) of the definition of "Delivery" in Section 1.01 hereof and shall be held, pending maturity or disposition, solely by the Indenture Trustee or a financial intermediary (as such term is defined in Section 8-102(a)(14) of the UCC) acting solely for the Indenture Trustee; (3) any Trust Account Property that is a book-entry security held through the Federal Reserve System pursuant to federal book-entry regulations shall be delivered in accordance with paragraph (b) of the definition of "Delivery" in Section 1.01 hereof and shall be maintained by the Indenture Trustee, pending maturity or disposition, through continued book-entry registration of such Trust Account Property as described in such paragraph; and (4) any Trust Account Property that is an "uncertificated security" under Article 8 of the UCC and that is not governed by clause (3) above shall be delivered to the Indenture Trustee in accordance with paragraph (c) of the definition of "Delivery" in Section 1.01 hereof and shall be maintained by the Indenture Trustee, pending maturity or disposition, through continued registration of the Indenture Trustee's (or its nominee's) ownership of such security. Funds in the Collection Account shall be invested in accordance with Section 5.03 hereof. Section 5.04 Advance Account. (a) The Servicer shall cause to be established and maintained in its name, an Advance Account (the "Advance Account"), which need not be a segregated account. The Advance Account shall be maintained with any financial institution the Servicer elects. (b) Deposits and Withdrawals. Amounts in respect of the transfer of Additional Note Principal Balances and Loans shall be deposited in and withdrawn from the Advance Account as provided in Sections 2.01(c) and 2.06 hereof, Section 3.01 of the Note Purchase Agreement. Section 5.05 Transfer Obligation Account. (a) The Servicer, for the benefit of the Noteholders, shall cause to be established and maintained in the name of the Indenture Trustee a Transfer Obligation Account (the "Transfer Obligation Account"), which shall be a separate Eligible Account and may be interest-bearing, entitled "Transfer Obligation Account, Bankers Trust Company of California, N.A., as Indenture Trustee, in trust for the Advanta Home Equity Loan Owner Trust 1998-MS1." The Transfer Obligation Account shall be maintained with the Indenture Trustee. The Indenture Trustee shall have no monitoring or calculation obligation with respect to -78- 84 withdrawals from the Transfer Obligation Account. Amounts in the Transfer Obligation Account shall be invested in accordance with Section 5.03. (b) In accordance with Section 5.06, the Transfer Obligor shall deposit into the Transfer Obligation Account such amounts as may be required thereby. (c) (i) On each Payment Date, the Indenture Trustee will deposit in the Transfer Obligation Account any amounts required to be deposited therein pursuant to Section 5.01(c)(3)(v). (ii) On each Collateral Value Excess Date, the Issuer shall deposit in the Transfer Obligation Account any amounts required to be deposited therein pursuant to Section 2.06(b). (d) On the date of each Disposition, the Indenture Trustee shall withdraw from the Transfer Obligation Account such amount on deposit therein as may be requested by the Disposition Agent in writing to effect such Disposition. (e) On each Payment Date, the Indenture Trustee, upon the written direction of the Servicer shall withdraw from the Transfer Obligation Account and deposit into the Distribution Account on such Payment Date the lesser of (x) the amount then on deposit in the Transfer Obligation Account and (y) the Interest Carry-Forward Amount as of such date. (f) If with respect to any Business Day the Overcollateralization Shortfall exceeds the lesser of (x) 1% of the aggregate Principal Balance of all Loans as of the prior Business Day and (y) $500,000, the Indenture Trustee, upon the written direction of the Servicer shall withdraw from the Transfer Obligation Account and deposit into the Distribution Account on the related Payment Date the lesser of the amount then on deposit in the Transfer Obligation Account and the amount of such Overcollateralization Shortfall as of such date. (g) If with respect to any Payment Date there shall exist a Hedge Funding Requirement, the Indenture Trustee, upon the written direction of the Servicer shall withdraw from the Transfer Obligation Account and deposit into the Distribution Account on the Business Day prior to such Payment Date the lesser of (x) the amount then on deposit in the Transfer Obligation Account (after making all other required withdrawals therefrom with respect to such Payment Date) and (y) the amount of such Hedge Funding Requirement as of such date. (h) In the event of the occurrence of an Event of Default under the Indenture, the Indenture Trustee shall withdraw all remaining funds from the Transfer Obligation Account and apply such funds in satisfaction of the Notes as provided in Section 5.04(b) of the Indenture. (i) The Indenture Trustee shall withdraw from the Transfer Obligation Account any net investment earnings on deposit therein, and remit such amounts to the Servicer, as provided in Section 5.03(b)(1) hereof. -79- 85 (j) To the extent this Agreement requires the deposit of any amounts into the Transfer Obligation Account, if the Majority Noteholders and the Transfer Obligor agree in writing to distribute such amounts to persons specified in such written notice, then upon reasonable notice to the Indenture Trustee such amounts may be distributed in accordance with such written notice. All such amounts shall be deemed deposited and withdrawn from the Transfer Obligation Account for purposes of making calculations hereunder. (k) (i) The Indenture Trustee shall return to the Transfer Obligor (as the Transfer Obligor shall agree) all amounts on deposit in the Transfer Obligation Account (after making all other withdrawals pursuant to this Section 5.05) until the Majority Noteholders provide written notice to the Indenture Trustee (with a copy to the Transfer Obligor) of the occurrence of a default or event of default (however defined) under any Basic Document with respect to the Issuer, Transfer Obligor, the Depositor, ANB or ABC or any of their Affiliates and (ii) upon the date of the termination of this Agreement pursuant to Article X, the Indenture Trustee, at the written direction of the Loan Originator, shall withdraw any remaining amounts from the Transfer Obligation Account and remit all such amounts to the Transfer Obligor. Section 5.06 Transfer Obligation. (a) In consideration of the transactions contemplated by the Basic Documents, the Transfer Obligor agrees and covenants with the Depositor that: (i) In connection with each Disposition it shall fund, or cause to be funded, reserve funds, pay credit enhancer fees, pay, or cause to be paid, underwriting fees, fund any difference between the cash Disposition Proceeds and the aggregate Note Principal Balance at the time of such Disposition, and make, or cause to be made, such other payments as may be, in the reasonable opinion of the Disposition Agent, commercially reasonably necessary to effect Dispositions, in each case to the extent that Disposition Proceeds are insufficient to pay such amounts; (ii) In connection with Hedging Instruments, on the Business Day prior to each Payment Date, it shall deliver to the Indenture Trustee for deposit into the Transfer Obligation Account any Hedge Funding Requirement (to the extent amounts available on the related Payment Date pursuant to Section 5.01 are insufficient to make such payment), when as and if due to any Hedging Counterparty; (iii) If any Interest Carry-Forward Amount shall occur, it shall deposit into the Transfer Obligation Account any such Interest Carry-Forward Amount on or before the Business Day preceding such related Payment Date; (iv) If on any Business Day, the Overcollateralization Shortfall exceeds the lesser of (x) 1% of the aggregate Principal Balance of all Loans in the Loan Pool as of the prior Business Day and (y) $500,000, it shall, on the following Business Day deposit into the Transfer Obligation Account the full amount of the Overcollateralization Shortfall as of such date; and -80- 86 (v) Notwithstanding anything to the contrary herein, in the event of the occurrence of an Event of Default under the Indenture, the Transfer Obligor shall promptly deposit into the Transfer Obligation Account the entire amount of the Unfunded Transfer Obligation; provided, that notwithstanding anything to the contrary contained herein, the Transfer Obligor' cumulative payments under or in respect of the Transfer Obligation (after subtracting therefrom any amounts returned to the Transfer Obligor pursuant to Section 5.05(k)(i)) together with the related Loan Originator's payments in respect of any Loan Originator Puts shall not in the aggregate exceed the Unfunded Transfer Obligation. (b) The Transfer Obligor shall pay such amounts upon one Business Day's notice from either the Servicer or the Majority Noteholders. (c) The Transfer Obligor agree that the Noteholders, as ultimate assignee of the rights of the Depositor, ANB and ABC, respectively under this Agreement and the other Basic Documents, may enforce the rights of the Depositor, ANB and ABC, respectively, directly against the Transfer Obligor. ARTICLE VI STATEMENTS AND REPORTS; SPECIFICATION OF TAX MATTERS Section 6.01 Statements. (a) No later than 12 noon (California time) on each Remittance Date, the Servicer shall deliver to the Indenture Trustee and the Initial Noteholder by facsimile, the receipt and legibility of which shall be confirmed by telephone, and with hard copy thereof to be delivered no later than one (1) Business Day after such Remittance Date, the Servicer's Remittance Report, setting forth the date of such Report (day, month and year), the name of the Issuer (i.e., "Advanta Home Equity Loan Owner Trust 1998-MS1"), the Series designation of the Notes (i.e., "Series 1998-MS1") and the date of this Agreement, all in substantially the form set out in Exhibit B hereto. Furthermore, on each Remittance Date, the Servicer shall deliver to the Indenture Trustee and the Initial Noteholder a magnetic tape or computer disk providing, with respect to each Loan in the Loan Pool as of the last day of the related Remittance Period (i) the related Loan Originator's internal loan identifying number; (ii) if such Loan is an ARM, the current Loan Interest Rate; (iii) the Principal Balance with respect to such Loan; (iv) the date of the last Monthly Payment paid in full; and (v) such other information as may be reasonably requested by the Initial Noteholder and the Indenture Trustee. (b)(i) No later than 12 noon (California time) on each Remittance Date, the Servicer shall prepare and provide to the Indenture Trustee via fax, receipt confirmed by telephone, the Initial Noteholder and each Noteholder, a statement (the "Payment Statement"), -81- 87 stating each date and amount of a purchase of Additional Note Principal Balance (day, month and year), the name of the Issuer (i.e., "Advanta Home Equity Loan Owner Trust 1998-MS1"), the Series designation of the Notes (i.e., "Series 1998-MS1"), the date of this Agreement and the following information: (1) the aggregate amount of collections in respect of principal of the Loans received by the Servicer during the preceding Remittance Period; (2) the aggregate amount of collections in respect of interest on the Loans received by the Servicer during the preceding Remittance Period; (3) all Mortgage Insurance Proceeds received by the Servicer and not required to be applied to restoration or repair of the related Mortgaged Property during the preceding Remittance Period; (4) all Net Liquidation Proceeds deposited by the Servicer into the Collection Account during the preceding Remittance Period; (5) all Released Mortgaged Property Proceeds deposited by the Servicer into the Collection Account during the preceding Remittance Period; (6) the aggregate amount of all Servicing Advances, set forth separately, made by the Servicer during the preceding Remittance Period; (7) the aggregate of all amounts deposited into the Collection Account in respect of the repurchase of Unqualified Loans and the repurchase of Loans pursuant to Section 2.05 hereof during the preceding Remittance Period; (8) the aggregate Principal Balance of all Loans for which a Servicer Call was exercised during the preceding Remittance Period; (9) the aggregate Principal Balance of all Loans for which a Loan Originator Put was exercised during the preceding Remittance Period; (10) the aggregate amount of all payments received under Hedging Instruments during the preceding Remittance Period; (11) the aggregate amount of all withdrawals from the Collection Account pursuant to Section 5.01(c)(1)(i) hereof during the preceding Remittance Period; (12) the aggregate amount of cash Disposition Proceeds received during the preceding Remittance Period; (13) withdrawals from the Collection Account in respect of the Servicing Advance Reimbursement Amount with respect to the Payment Date; -82- 88 (14) [Reserved]; (15) [Reserved]; (16) the aggregate amount of Liquidated Loan Losses incurred (i) during the preceding Remittance Period, and (ii) during the preceding three Remittance Periods; (17) the aggregate of the Principal Balances of all Loans in the Loan Pool as of the end of the related Remittance Period; (18) the aggregate amount of all deposits into the Distribution Account from the Transfer Obligation Account pursuant to Sections 5.05(e), 5.05(f), 5.05(g), and 5.05(h) on the preceding Payment Date; (19) if the Servicer is not Advanta Corp. or an Affiliate thereof, the aggregate amount of distributions in respect of Servicing Compensation to the Servicer, and unpaid Servicing Compensation from prior Payment Dates for the related Payment Date; (20) the aggregate amount of distributions in respect of Indenture Trustee Fees and unpaid Indenture Trustee Fees from prior Payment Dates for the related Payment Date; (21) the aggregate amount of distributions in respect of the Custodian Fee and unpaid Custodian Fees from prior Payment Dates for the related Payment Date; (22) the Unfunded Transfer Obligation and Overcollateralization Shortfall on such Payment Date for the related Payment Date; (23) the aggregate amount of distributions in respect of Servicing Compensation and unpaid Servicing Compensation from prior Payment Dates, to the Servicer, if Advanta Corp. or an Affiliate thereof is the Servicer, for the related Payment Date; (24) the aggregate amount of distributions to the Transfer Obligation Account for the related Payment Date; (25) the aggregate amount of distributions in respect of Trust/Depositor Indemnities for the related Payment Date; (26) the aggregate amount of distributions to the holders of the Trust Certificates for the related Payment Date; (27) the Note Principal Balance of the Notes as of the last day of the related Remittance Period (without taking into account any additional Note -83- 89 Principal Balance between the last day of the related Remittance Period and the Payment Date) before and after giving effect to distributions made to the holders of the Notes for the related Payment Date; (28) the Pool Principal Balance as of the end of the preceding Remittance Period; (29) whether a Rapid Amortization Trigger shall exist with respect to such Payment Date; (30) the aggregate Principal Balance of all HELOC Mortgage Loans as of the end of the related Remittance Period; (31) the aggregate Principal Balance of all Draw Amounts during the preceding Remittance Period; (32) the aggregate Principal Balance of Credit Limits on the HELOC Mortgage Loans as of the end of the related Remittance Period; and (33) the Unfunded Draw Reimbursement Amounts as of the end of the related Remittance Period. Such Payment Statement shall also be provided on the Remittance Date to the Initial Noteholder and Indenture Trustee in the form of a magnetic tape or computer disk in a form mutually agreed to by and between the Initial Noteholder, the Indenture Trustee and the Servicer. The Indenture Trustee shall have no duty to monitor the occurrence of a Performance Trigger, Rapid Amortization Trigger, Collateral Value Excess or any events resulting in withdrawals from the Transfer Obligation Account. (c) On each Payment Date, the Indenture Trustee shall forward to the holders of the Securities a copy of the Payment Statement in respect of such Payment Date, together with such other information as the Indenture Trustee deems necessary or appropriate. Section 6.02 Specification of Certain Tax Matters. The Indenture Trustee shall comply with all requirements of the Code and applicable state and local law with respect to the withholding from any distributions made to any Securityholder of any applicable withholding taxes imposed thereon and with respect to any applicable reporting requirements in connection therewith, giving due effect to any applicable exemptions from such withholding and effective certifications or forms provided by the recipient. Any amounts withheld pursuant to this Section 6.02 shall be deemed to have been distributed to the Securityholders, as the case may be, for all purposes of this Agreement. -84- 90 Section 6.03 Valuation of Loans, Hedge Value and Retained Securities Value; Market Value Agent. (a) The Issuer hereby irrevocably appoints the Market Value Agent to determine the Market Value of each Loan, the Hedge Value of each Hedging Instrument and the Retained Securities Value of all Retained Securities. (b) The Market Value Agent shall determine the Market Value of each Loan in its sole judgment. In determining the Market Value of each Loan, the Market Value Agent may consider any information that it may deem relevant and shall base such determination primarily on the lesser of its estimate of the projected proceeds from such Loan's inclusion in (i) a Securitization (inclusive of the projected Retained Securities Value of any Retained Securities to be issued in connection with such Securitization) and (ii) a Whole Loan Sale, in each case net of such Loan's ratable share of all costs and fees associated with such Disposition, including, without limitation, any costs of issuance, sale, underwriting and funding reserve accounts. The Market Value Agent's determination, in its sole judgment, of Market Value shall be conclusive and binding upon the parties hereto, absent manifest error (including without limitation, any error contemplated in Section 2.08). (c) On each Business Day the Market Value Agent shall determine in its sole judgment the Hedge Value of each Hedging Instrument as of such Business Day. In making such determination the Market Value Agent may rely exclusively on quotations provided by the Hedging Counterparty, by leading dealers in instruments similar to such Hedging Instrument, which leading dealers may include the Market Value Agent and its Affiliates and such other sources of information as the Market Value Agent may deem appropriate. (d) On each Business Day, the Market Value Agent shall determine in its sole judgment the Retained Securities Value of the Retained Securities, if any, expected to be issued pursuant to such Securitization as of the closing date of such Securitization. In making such determination the Market Value Agent may rely exclusively on quotations provided by leading dealers in instruments similar to such Retained Securities, which leading dealers may include the Market Value Agent and its Affiliates and such other sources of information as the Market Value Agent may deem appropriate. ARTICLE VII HEDGING Section 7.01 Hedging Instruments. (a) If the Unfunded Transfer Obligation Percentage is less than 7%, the Trust, upon request of the Majority Noteholders, shall enter into such Hedging Instruments as the Market Value Agent, on behalf of the Majority Noteholders shall determine are necessary, in order to hedge the interest rate risk with respect to at least 80% of the Collateral Value of fixed rate Loans acquired by the Trust on or after the date of such request relative to the expected Disposition Proceeds therefrom. The Market Value Agent shall determine, in its sole -85- 91 discretion, whether any Hedging Instrument conforms to the requirements of Section 7.01(b), (c) and (d). (b) Each Hedging Instrument shall expressly provide that in the event of a Disposition or other removal of the Loan from the Trust, such portion of the Hedging Instrument shall terminate as the Disposition Agent deems appropriate to facilitate the hedging of the risks specified in Section 7.01(a). In the event that the Hedging Instrument is not otherwise terminated, it shall contain provisions that allow the position of the Trust to be assumed by an Affiliate of the Trust upon the liquidation of the Trust. The terms of the assignment documentation and the credit quality of the successor to the Trust shall be subject to the Hedging Counterparty's approval. (c) Any Hedging Instrument that provides for any payment obligation on the part of the Issuer must (i) be without recourse to the assets of the Issuer, (ii) contain a non-petition covenant provision in the form of Section 11.l3, (iii) limit payment dates thereunder to Payment Dates and (iv) contain a provision limiting any cash payments due on any day under such Hedging Instrument solely to funds available therefor in the Collection Account on such day pursuant to Section 5.01(c)(3)(ii) hereof and funds available therefor in the Transfer Obligation Account. (d) Each Hedging Instrument must (i) provide for the direct payment of any amounts thereunder to the Collection Account pursuant to Section 5.01(b)(1)(x), (ii) contain an assignment of all of the Issuer's rights (but none of its obligations) under such Hedging Instrument to the Indenture Trustee and shall include an express consent to the Hedging Counterparty to such assignment, (iii) provide that in the event of the occurrence of an Event of Default, such Hedging Instrument shall terminate upon the direction of the Majority Noteholders, (iv) prohibit the Hedging Counterparty from "setting-off" or "netting" other obligations of the Issuer or its Affiliates against such Hedging Counterparty's payment obligations thereunder, (v) provide that the appropriate portion of the Hedging Instrument will terminate upon the removal of the related Loans from the Trust Estate and (vi) have economic terms that are fixed and not subject to alteration after the date of assumption or execution. (e) If agreed to by the Majority Noteholders, the Issuer may pledge its assets in order to secure its obligations in respect of Hedge Funding Requirements, provided that such right shall be limited solely to Hedging Instruments for which an Affiliate of the Initial Noteholder is a Hedging Counterparty. ARTICLE VIII THE SERVICER Section 8.01 Indemnification; Third Party Claims. (a) The Servicer shall indemnify the Loan Originators, the Owner Trustee, the Trust, the Depositor, the Indenture Trustee and the Noteholders, their respective officers, directors, employees, agents and "control persons," as such term is used under the Act and -86- 92 under the Securities Exchange Act of 1934 as amended (each a "Servicer Indemnified Party") and hold harmless each of them against any and all claims, losses, damages, penalties, fines, forfeitures, reasonable legal fees and related costs, judgments, and other costs and expenses resulting from any claim, demand, defense or assertion based on or grounded upon, or resulting from, a breach of any of the Servicer's representations and warranties and covenants contained in this Agreement or in any way relating to the failure of the Servicer to perform its duties and service the Loans in compliance with the terms of this Agreement except to the extent such loss arises out of such Servicer Indemnified Party's gross negligence or willful misconduct; provided, however, that if the Servicer is not liable pursuant to the provisions of Section 8.01(d) hereof for its failure to perform its duties and service the Loans in compliance with the terms of this Agreement, then the provisions of this Section 8.01 shall have no force and effect with respect to such failure. (b) None of the Loan Originators, the Depositor or the Servicer or any of their respective Affiliates, directors, officers, employees or agents shall be under any liability to the Owner Trustee, the Issuer, the Indenture Trustee or the Securityholders for any action taken, or for refraining from the taking of any action, in good faith pursuant to this Agreement, or for errors in judgment; provided, however, that this provision shall not protect the Loan Originators, the Depositor, the Servicer or any of their respective Affiliates, directors, officers, employees, agents against the remedies provided herein for the breach of any warranties, representations or covenants made herein, or against any expense or liability specifically required to be borne by such party without right of reimbursement pursuant to the terms hereof, or against any expense or liability which would otherwise be imposed by reason of misfeasance, bad faith or negligence in the performance of the respective duties of the Servicer, the Depositor or the Loan Originators, as the case may be. The Loan Originators, the Depositor, the Servicer and any of their respective Affiliates, directors, officers, employees, agents may rely in good faith on any document of any kind which, prima facie, is properly executed and submitted by any Person respecting any matters arising hereunder. (c) Each Loan Originator agrees to indemnify and hold harmless the Depositor and the Noteholders, as the ultimate assignees from the Depositor (each an "Originator Indemnified Party," together with the Servicer Indemnified Parties, the "Indemnified Parties"), from and against any loss, liability, expense, damage, claim or injury arising out of or based on (i) any breach of any representation, warranty or covenant of the Loan Originators, the Servicer or their Affiliates, in any Basic Document, including, without limitation, the origination or prior servicing of the Loans by reason of any acts, omissions, or alleged acts or omissions arising out of activities of the Loan Originators, the Servicer or their Affiliates, and (ii) any untrue statement by the Loan Originators, the Servicer or its Affiliates of any material fact or any such Person's failure to state a material fact necessary to make such statements not misleading with respect to any such Person's statements contained in any Basic Document, including, without limitation, any Officer's Certificate, statement, report or other document or information prepared by any such Person and furnished or to be furnished by it pursuant to or in connection with the transactions contemplated thereby including, without limitation, such written information as may have been and may be furnished in connection with any due diligence investigation with respect to the Loans or any such Person's business, operations or financial condition, including reasonable attorneys' fees and other costs or -87- 93 expenses incurred in connection with the defense of any actual or threatened action, proceeding or claim; provided that the Loan Originators shall not indemnify an Originator Indemnified Party to the extent such loss, liability, expense, damage or injury is due to either an Originator Indemnified Party's willful misfeasance, bad faith or negligence or by reason of an Originator Indemnified Party's reckless disregard of its obligations hereunder; provided, further, that the Loan Originators shall not be so required to indemnify an Originator Indemnified Party or to otherwise be liable to an Originator Indemnified Party for any losses in respect of the performance of the Loans, the creditworthiness of the Borrowers under the Loans, changes in the market value of the Loans or other, similar investment risks associated with the Loans arising from a breach of any representation or warranty set forth in Section 3.05(a) or (b) hereof, a remedy for the breach of which is provided in Section 3.06 hereof. The provisions of this indemnity shall run directly to and be enforceable by an Originator Indemnified Party subject to the limitations hereof. (d) With respect to a claim subject to indemnity hereunder made by any Person against an Indemnified Party (a "Third Party Claim"), such Indemnified Party shall notify the related indemnifying parties (each an "Indemnifying Party") in writing of the Third Party Claim within a reasonable time after receipt by such Indemnified Party of written notice of the Third Party Claim unless the Indemnifying Parties shall have previously obtained actual knowledge thereof. Thereafter, the Indemnified Party shall deliver to the Indemnifying Parties, within a reasonable time after the Indemnified Party's receipt thereof, copies of all notices and documents (including court papers) received by the Indemnified Party relating to the Third Party Claim. No failure to give such notice or deliver such documents shall effect the rights to indemnity hereunder. Each Indemnifying Party shall promptly notify the Indenture Trustee and the Indemnified Party (if other than the Indenture Trustee) of any claim of which it has been notified and shall promptly notify the Indenture Trustee and the Indemnified Party (if applicable) of its intended course of action with respect to any claim. (e) If a Third Party Claim is made against an Indemnified Party, (a) the related Indemnifying Party will be entitled to participate in the defense thereof and, (b) if it so chooses, to assume the defense thereof with counsel selected by the Indemnifying Party, provided that in connection with such assumption (i) such counsel is not reasonably objected to by the Indemnified Party and (ii) the Indemnifying Party first admits in writing its liability to indemnify the Indemnified Party with respect to all elements of such claim in full. Should the related Indemnifying Party so elect to assume the defense of a Third Party Claim, the Indemnifying Party will not be liable to the Indemnified Party for any legal expenses subsequently incurred by the Indemnified Party in connection with the defense thereof. If the Indemnifying Party elects to assume the defense of a Third Party Claim, the Indemnified Party will (i) cooperate in all reasonable respects with the Indemnifying Party in connection with such defense and (ii) not admit any liability with respect to, or settle, compromise or discharge, such Third Party Claim without the Indemnifying Party' prior written consent, as the case may be. If the Indemnifying Party shall assume the defense of any Third Party Claim, the Indemnified Party shall be entitled to participate in (but not control) such defense with its own counsel at its own expense. If the Indemnifying Party does not assume the defense of any such Third Party Claim, the Indemnified Party may defend the same in such manner as it may deem appropriate, including settling such claim or litigation after giving notice to the -88- 94 Indemnifying Party of such terms and the Indemnifying Party will promptly reimburse the Indemnified Party upon written request. Anything contained in this Agreement to the contrary notwithstanding, the Indemnifying Party shall not be entitled to assume the defense of any part of a Third Party Claim that seeks an order, injunction or other equitable relief or relief for other than money damages against an Indemnified Party unless the Indemnifying Party has demonstrated to such Indemnified Party reasonable financial capacity to meet its obligations with respect to such Third Party Claim. Section 8.02 Merger or Consolidation of the Servicer. The Servicer shall keep in full effect its existence, rights and franchises as a corporation, and will obtain and preserve its qualification to do business as a foreign corporation and maintain such other licenses and permits in each jurisdiction necessary to protect the validity and enforceability of each Basic Document to which it is a party and each of the Loans and to perform its duties under each Basic Document to which it is a party; provided, however, that the Servicer may merge or consolidate with any other corporation upon the satisfaction of the conditions set forth in the following paragraph. Any Person into which the Servicer may be merged or consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Servicer shall be a party, or any Person succeeding to the business of the Servicer, shall be an Eligible Servicer and shall be the successor of the Servicer, as applicable hereunder, without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding. The Servicer shall send notice of any such merger, conversion, consolidation or succession to the Indenture Trustee and the Issuer. Section 8.03 Limitation on Liability of the Servicer and Others. The Servicer and any director, officer, employee or agent of the Servicer may rely on any document of any kind which it in good faith reasonably believes to be genuine and to have been adopted or signed by the proper authorities respecting any matters arising hereunder. Subject to the terms of Section 8.01 hereof, the Servicer shall have no obligation to appear with respect to, prosecute or defend any legal action which is not incidental to the Servicer's duty to service the Loans in accordance with this Agreement. Section 8.04 Servicer Not to Resign; Assignment. The Servicer shall not resign from the obligations and duties hereby imposed on it except (a) with the consent of the Majority Noteholders or (b) upon determination that its duties hereunder are no longer permissible under applicable law. Any such determination pursuant to clause (b) of the preceding sentence permitting the resignation of the Servicer shall be evidenced by an Independent opinion of counsel to such effect delivered (at the expense of the Servicer) to the Indenture Trustee and Majority Noteholders. No resignation of the Servicer shall become effective until a successor servicer, appointed pursuant to the provisions of Section 9.02 hereof shall have assumed the Servicer's responsibilities, duties, liabilities (other than those liabilities arising prior to the appointment of such successor) and obligations under this Agreement. -89- 95 Except as expressly provided herein, the Servicer shall not assign or transfer any of its rights, benefits or privileges hereunder to any other Person, or delegate to or subcontract with, or authorize or appoint any other Person to perform any of the duties, covenants or obligations to be performed by the Servicer hereunder and any agreement, instrument or act purporting to effect any such assignment, transfer, delegation or appointment shall be void. The Servicer agrees to cooperate with any successor Servicer in effecting the transfer of the Servicer's servicing responsibilities and rights hereunder pursuant to the first paragraph of this Section 8.04, including, without limitation, the transfer to such successor of all relevant records and documents (including any Loan Files in the possession of the Servicer) and all amounts received with respect to the Loans and not otherwise permitted to be retained by the Servicer pursuant to this Agreement. In addition, the Servicer, at its sole cost and expense, shall prepare, execute and deliver any and all documents and instruments to the successor Servicer including all Loan Files in its possession and do or accomplish all other acts necessary or appropriate to effect such termination and transfer of servicing responsibilities. Section 8.05 Relationship of Servicer to Issuer and the Indenture Trustee. The relationship of the Servicer (and of any successor to the Servicer as servicer under this Agreement) to the Issuer, the Owner Trustee and the Indenture Trustee under this Agreement is intended by the parties hereto to be that of an independent contractor and not of a joint venturer, agent or partner of the Issuer, the Owner Trustee or the Indenture Trustee. Section 8.06 Servicer May Own Securities. Each of the Servicer and any Affiliate of the Servicer may in its individual or any other capacity become the owner or pledgee of Securities with the same rights as it would have if it were not the Servicer or an Affiliate thereof except as otherwise specifically provided herein; provided, however, that at any time that AMCUSA or any of its Affiliates is the Servicer, neither the Servicer nor any of its Affiliates (other than an Affiliate which is a corporation whose purpose is limited to holding securities and related activities and which cannot incur recourse debt) may be a Noteholder. Securities so owned by or pledged to the Servicer or such Affiliate shall have an equal and proportionate benefit under the provisions of this Agreement, without preference, priority, or distinction as among all of the Securities; provided, however, that any Securities owned by the Servicer or any Affiliate thereof, during the time such Securities are owned by them, shall be without voting rights for any purpose set forth in this Agreement unless the Servicer or such Affiliate owns all outstanding Securities of the related class. The Servicer shall notify the Indenture Trustee promptly after it or any of its Affiliates becomes the owner or pledgee of a Security. Section 8.07 Indemnification of the Indenture Trustee and Initial Noteholder. The Servicer agrees to indemnify the Indenture Trustee and its employees, officers, directors and agents, and reimburse its reasonable out-of-pocket expenses in accordance with Section 6.07 of the Indenture as if it was a signatory thereto. The Servicer -90- 96 agrees to indemnify the Initial Noteholder in accordance with Section 9.01 of the Note Purchase Agreement as if it were signatory thereto. ARTICLE IX SERVICER EVENTS OF DEFAULT Section 9.01 Servicer Events of Default. (a) In case one or more of the following Servicer Events of Default by the Servicer shall occur and be continuing, that is to say: (i) any failure by Servicer to deposit (A) into the Collection Account in accordance with Section 5.01(b) any amount required to be deposited by it under any Basic Document to which it is a party, which failure continues unremedied for two Business Days following the date on which such deposit was first requested to be made, which failure continues unremedied until 12:00 p.m. New York City time on the Business Day following such day; or (ii) any failure on the part of the Servicer duly to observe or perform in any material respect any other of the material covenants or agreements on the part of the Servicer, contained in any Basic Document to which it is a party, which continues unremedied for a period of 30 days (or, in the case of payment of insurance premiums, for a period of 15 days) after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Servicer by any other party hereto or to the Servicer (with copy to each other party hereto), by Holders of 25% of the Percentage Interests of the Notes or the Trust Certificates; or (iii) any breach on the part of the Servicer of any representation or warranty contained in any Basic Document to which it is a party that materially and adversely affects the interests of any of the parties hereto or any Securityholder and which continues unremedied for a period of 30 days after the date on which notice of such breach, requiring the same to be remedied, shall have been given to the Servicer by any other party hereto or to the Servicer (with copy to each other party hereto), by the Initial Noteholder or Holders of 25% of the Percentage Interests (as defined in the Indenture) of the Notes; or (iv) there shall have been commenced before a court or agency or supervisory authority having jurisdiction in the premises an involuntary proceeding against the Servicer under any present or future federal or state bankruptcy, insolvency or similar law for the appointment of a conservator, receiver, liquidator, trustee or similar official in any bankruptcy, insolvency, readjustment of debt, marshaling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs, which action shall not have been dismissed for a period of 60 days; or -91- 97 (v) the Servicer shall consent to the appointment of a conservator, receiver, liquidator, trustee or similar official in any bankruptcy, insolvency, readjustment of debt, marshaling of assets and liabilities or similar proceedings of or relating to it or of or relating to all or substantially all of its property; or (vi) the Servicer shall admit in writing its inability to pay its debts generally as they become due, file a petition to take advantage of any applicable bankruptcy, insolvency or reorganization statute, make an assignment for the benefit of its creditors, voluntarily suspend payment of its obligations, or take any corporate action in furtherance of the foregoing. (b) Then, and in each and every such case, so long as an Servicer Event of Default shall not have been remedied, the Indenture Trustee or the Majority Noteholders, by notice in writing to the Servicer may, in addition to whatever rights such Person may have at law or in equity to damages, including injunctive relief and specific performance, may terminate all the rights and obligations of the Servicer under this Agreement and in and to the Loans and the proceeds thereof, as servicer under this Agreement. Upon receipt by the Servicer of such written notice, all authority and power of the Servicer under this Agreement, whether with respect to the Loans or otherwise, shall, subject to Section 9.02 hereof, pass to and be vested in a successor servicer, and the successor servicer is hereby authorized and empowered to execute and deliver, on behalf of the Servicer, as attorney-in-fact or otherwise, any and all documents and other instruments and do or cause to be done all other acts or things necessary or appropriate to effect the purposes of such notice of termination, including, but not limited to, the transfer and endorsement or assignment of the Loans and related documents. The Servicer agrees to cooperate with the successor servicer in effecting the termination of the Servicer's responsibilities and rights hereunder, including, without limitation, the transfer to the successor servicer for administration by it of all amounts which shall at the time be credited by the Servicer to each Collection Account or thereafter received with respect to the Loans. Section 9.02 Appointment of Successor. On and after the date the Servicer receives a notice of termination pursuant to Section 9.01 hereof, or the Owner Trustee receives the resignation of the Servicer evidenced by an Opinion of Counsel or accompanied by the consents required by Section 8.04 hereof, or the Servicer is removed as servicer pursuant to this Article IX or Section 4.01(i), then, the Majority Noteholders shall appoint a successor servicer to be the successor in all respects to the Servicer in its capacity as Servicer under this Agreement and the transactions set forth or provided for herein and shall be subject to all the responsibilities, duties and liabilities relating thereto placed on the Servicer by the terms and provisions hereof; provided, however, that the successor servicer shall not be liable for any actions of any servicer prior to it. The successor servicer shall be obligated to make Servicing Advances hereunder. As compensation therefor, the successor servicer appointed pursuant to the following paragraph, shall be entitled to all funds relating to the Loans which the Servicer would have been entitled to receive from the Collection Account pursuant to Section 5.01(c) hereof as if the Servicer had continued to act as servicer hereunder, together with other -92- 98 Servicing Compensation in the form of assumption fees, late payment charges or otherwise as provided in Section 4.16 hereof. The Servicer shall not be entitled to any termination fee if it is terminated pursuant to Section 9.01 hereof but shall be entitled to any accrued and unpaid Servicing Compensation to the date of termination. Any collections received by the Servicer after removal or resignation shall be endorsed by it to the Indenture Trustee and remitted directly to the successor servicer. The compensation of any successor servicer appointed shall be the Servicing Fee, together with other Servicing Compensation provided for herein. The Indenture Trustee, the Issuer, any Custodian, the Servicer and any such successor servicer shall take such action, consistent with this Agreement, as shall be reasonably necessary to effect any such succession. Any costs or expenses incurred by the Indenture Trustee in connection with the termination of the Servicer and the succession of a successor servicer shall be an expense of the outgoing Servicer and, to the extent not paid thereby, an expense of such successor servicer. The Servicer agrees to cooperate with the Indenture Trustee and any successor servicer in effecting the termination of the Servicer's servicing responsibilities and rights hereunder and shall promptly provide the successor servicer all documents and records reasonably requested by it to enable it to assume the Servicer's functions hereunder and shall promptly also transfer to the successor servicer all amounts which then have been or should have been deposited in any Trust Account maintained by the Servicer or which are thereafter received with respect to the Loans. Upon the occurrence of an Event of Default, the Majority Noteholders shall have the right to order the Servicer's Loan Files and all other files of the Servicer relating to the Loans and all other records of the Servicer and all documents relating to the Loans which are then or may thereafter come into the possession of the Servicer or any third party acting for the Servicer to be delivered to such custodian or servicer as it selects and the Servicer shall deliver to such custodian or servicer such assignments as the Majority Noteholders shall request. No successor servicer shall be held liable by reason of any failure to make, or any delay in making, any distribution hereunder or any portion thereof caused by (i) the failure of the Servicer to deliver, or any delay in delivering, cash, documents or records to it or (ii) restrictions imposed by any regulatory authority having jurisdiction over the Servicer hereunder. No appointment of a successor to the Servicer hereunder shall be effective until written notice of such proposed appointment shall have been provided by the Indenture Trustee to the Initial Noteholder, the Issuer and the Depositor, ANB, ABC, the Majority Noteholders and the Issuer shall have consented in writing thereto. In connection with such appointment and assumption, the Majority Noteholder may make such arrangements for the compensation of such successor servicer out of payments on the Loans as they and such successor servicer shall agree. Section 9.03 Waiver of Defaults. The Majority Noteholders may waive any events permitting removal of the Servicer as servicer pursuant to this Article IX. Upon any waiver of a past default, such default shall cease to exist and any Servicer Event of Default arising therefrom shall be deemed to have been remedied for every purpose of this Agreement. No such waiver shall extend to -93- 99 any subsequent or other default or impair any right consequent thereto except to the extent expressly so waived. Section 9.04 Accounting Upon Termination of Servicer. Upon termination of the Servicer under this Article IX, the Servicer shall, at its own expense: (a) deliver to its successor or, if none shall yet have been appointed, to the Indenture Trustee the funds in any Trust Account maintained by the Servicer; (b) deliver to its successor or, if none shall yet have been appointed, to the Indenture Trustee all Loan Files and related documents and statements held by it hereunder and a Loan portfolio computer tape; (c) deliver to its successor or, if none shall yet have been appointed, to the Indenture Trustee and to the Issuer and the Securityholders a full accounting of all funds, including a statement showing the Monthly Payments collected by it and a statement of monies held in trust by it for payments or charges with respect to the Loans; and (d) execute and deliver such instruments and perform all acts reasonably requested in order to effect the orderly and efficient transfer of servicing of the Loans to its successor and to more fully and definitively vest in such successor all rights, powers, duties, responsibilities, obligations and liabilities of the Servicer under this Agreement. ARTICLE X TERMINATION; PUT OPTION Section 10.01 Termination. (a) This Agreement shall terminate upon either: (a) the later of (i) the satisfaction and discharge of the Indenture and the provisions thereof, to the Noteholders of all amounts due and owing in accordance with the provisions hereof or (ii) the disposition of all funds with respect to the last Loan and the remittance of all funds due hereunder and the payment of all amounts due and payable, including, in both cases, without limitation, indemnification payments payable pursuant to any Basic Document to the Indenture Trustee, the Owner Trustee, the Issuer and the Custodian, written notice of the occurrence of either of which shall be provided to the Indenture Trustee by the Servicer; or (b) the mutual consent of the Servicer, the Depositor, ANB, ABC and all Securityholders in writing and delivered to the Indenture Trustee by the Servicer. (b) The Securities shall be subject to an early redemption or termination at the option of the Majority Noteholders in the manner and subject to the provisions of Section 10.02 of this Agreement. -94- 100 (c) Except as provided in Sections 10.01 and 10.02, none of the Depositor, the Servicer nor any Noteholder shall be entitled to revoke or terminate the Trust. Section 10.02 Optional Termination (a) The Majority Certificateholders may, at their option, effect an early termination of the Trust on any Payment Date on or after the Clean-up Call Date. The Majority Certificateholders shall effect such early termination by providing notice thereof to the Indenture Trustee and Owner Trustee and by purchasing all of the Loans at a purchase price, payable in cash, equal to or greater than the Termination Price. The expense of any Independent appraiser required under this Section 10.02 shall be a nonreimbursable expense of the Majority Certificateholders. Any such early termination by the Majority Certificateholders shall be accomplished by depositing into the Collection Account on the third Business Day prior to the Payment Date on which the purchase is to occur the amount of the Termination Price to be paid. The Termination Price and any amounts then on deposit in the Collection Account (other than any amounts withdrawable pursuant to Section 5.01(c)(1) hereof) shall be distributed by the Indenture Trustee pursuant to Section 5.01(c)(3) of this Agreement and Section 9.1 of the Trust Agreement on the next succeeding Payment Date; and any amounts received with respect to the Loans and Foreclosure Properties subsequent to the final Payment Date shall belong to the purchaser thereof. Section 10.03 Notice of Termination. Notice of termination of this Agreement or of early redemption and termination of the Issuer pursuant to Section 10.01 shall be sent by the Indenture Trustee to the Noteholders in accordance with Section 10.02 of the Indenture. Section 10.04 Put Option. The Majority Noteholders may, at their option, effect a put of the entire outstanding Note Principal Balance, or any portion thereof, to the Trust on any Payment Date by exercise of the Put Option. The Majority Noteholders shall effect such put by providing notice thereof in accordance with Section 10.05 of the Indenture. On the third Business Day prior to the Payment Date on which the exercise of the Put Option is to occur the Issuer shall deposit the Note Redemption Amount into the Collection Account and any amounts then on deposit in the Collection Account (other than any amounts withdrawable pursuant to Section 5.01(c)(1) hereof) shall be distributed by the Indenture Trustee pursuant to Section 5.01(c)(3) of this Agreement on the next succeeding Payment Date; and any amounts received with respect to the Loans and Foreclosure Properties subsequent to the final Payment Date shall belong to the Issuer. -95- 101 ARTICLE XI MISCELLANEOUS PROVISIONS Section 11.01 Acts of Securityholders. Except as otherwise specifically provided herein, whenever action, consent or approval of the Securityholders is required under this Agreement, such action, consent or approval shall be deemed to have been taken or given on behalf of, and shall be binding upon, all Securityholders if the Majority Noteholders agree to take such action or give such consent or approval. Section 11.02 Amendment. (a) This Agreement may be amended from time to time by the Depositor, the Servicer, the Loan Originators, the Indenture Trustee and the Issuer by written agreement with notice thereof to the Securityholders, without the consent of any of the Securityholders, to cure any error or ambiguity, to correct or supplement any provisions hereof which may be defective or inconsistent with any other provisions hereof or to add any other provisions with respect to matters or questions arising under this Agreement; provided, however, that such action will not adversely affect in any material respect the interests of the Securityholders. An amendment described above shall be deemed not to adversely affect in any material respect the interests of the Securityholders if an Opinion of Counsel is obtained to such effect. (b) This Agreement may also be amended from time to time by the Depositor, the Servicer, the Loan Originators, the Indenture Trustee and the Issuer by written agreement, with the prior written consent of the Majority Noteholders, for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Agreement, or of modifying in any manner the rights of the Securityholders; provided, however, that no such amendment shall (i) reduce in any manner the amount of, or delay the timing of, collections of payments on Loans or distributions which are required to be made on any Security, without the consent of the holders of 100% of the Securities, (ii) adversely affect in any material respect the interests of any of the holders of the Securities in any manner other than as described in clause (i), without the consent of the holders of 100% of the Securities, or (iii) reduce the percentage of the Securities, the consent of which is required for any such amendment, without the consent of the holders of 100% of the Securities. (c) It shall not be necessary for the consent of Securityholders under this Section to approve the particular form of any proposed amendment, but it shall be sufficient if such consent shall approve the substance thereof. Prior to the execution of any amendment to this Agreement, the Issuer and the Indenture Trustee shall be entitled to receive and rely upon an Opinion of Counsel stating that the execution of such amendment is authorized or permitted by this Agreement. The Issuer and the Indenture Trustee may, but shall not be obligated to, enter into any such amendment which affects the Issuer's own rights, duties or immunities of the Issuer or the Indenture Trustee, as the case may be, under this Agreement. -96- 102 Section 11.03 Recordation of Agreement. To the extent permitted by applicable law, this Agreement, or a memorandum thereof if permitted under applicable law, is subject to recordation in all appropriate public offices for real property records in all of the counties or other comparable jurisdictions in which any or all of the Mortgaged Property is situated, and in any other appropriate public recording office or elsewhere, such recordation to be effected by the Servicer at the Securityholders' expense on direction of the Majority Noteholders but only when accompanied by an Opinion of Counsel to the effect that such recordation materially and beneficially affects the interests of the Securityholders or is necessary for the administration or servicing of the Loans. Section 11.04 Duration of Agreement. This Agreement shall continue in existence and effect until terminated as herein provided. Section 11.05 Governing Law. THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK AND THE OBLIGATIONS, RIGHTS AND REMEDIES OF THE PARTIES HEREUNDER SHALL BE DETERMINED IN ACCORDANCE WITH SUCH LAWS, WITHOUT GIVING EFFECT TO PRINCIPLES OF CONFLICTS OF LAW. Section 11.06 Notices. All demands, notices and communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered personally, mailed by overnight mail, certified mail or registered mail, postage prepaid, or (ii) transmitted by telecopy, upon telephone confirmation of receipt thereof (with a copy delivered by overnight courier), as follows: (I) in the case of the Depositor, to Advanta Conduit Receivables Inc., Welsh & McKean Roads, Spring Hill, Pennsylvania 19477, Attention: Susan McVeigh, telecopy number: (215) 444-5051, telephone number: (215) 323-4586, or such other addresses or telecopy or telephone numbers as may hereafter be furnished to the Securityholders and the other parties hereto in writing by the Depositor; (II) in the case of the Trust, to Advanta Home Equity Loan Owner Trust 1998-MS1, c/o Wilmington Trust Company, One Rodney Square North, 1100 North Market Street, Wilmington, Delaware 19890, Attention: Corporate Trust Administration, telecopy number: (302) 651-8882, telephone number: (302) 651-1000, or such other address or telecopy or telephone numbers as may hereafter be furnished to the Noteholders and the other parties hereto in writing by the Trust; (III) in the case of the Transfer Obligor, to Advanta Corp., Welsh & McKean Roads, Spring House, Pennsylvania 19477, Attention: Philip M. Browne, telecopy number: (215) 444-5915, telephone number: (215) 444-5060 or such other addresses or telecopy or telephone numbers as may hereafter be furnished to the Securityholders and the other parties hereto in writing by the Transfer Obligor, (IV) in the case of the Loan Originators, to Advanta Mortgage Corp. USA, Welsh & McKean Roads, Spring House, Pennsylvania 19477, Attention: Attention: Susan McVeigh, telecopy number: (215) 444-5051, telephone number: (215) 323-4586, and/or to Advanta National Bank, One Righter Parkway, Wilmington, DE 19803, Attention: Attention: Susan McVeigh, -97- 103 telecopy number: (215) 444-5051, telephone number: (215) 323-4586, and/or to Advanta Bank Corp., Welsh & McKean Roads, Spring House, Pennsylvania 19477, Attention: Attention: Susan McVeigh, telecopy number: (215) 444-5051, telephone number: (215) 323-4586, or such other addresses or telecopy or telephone numbers as may hereafter be furnished to the Securityholders and the other parties hereto in writing by the Loan Originators, (V) in the case of the Servicer, to Advanta Mortgage Corp. USA, Welsh & McKean Roads, Spring House, Pennsylvania 19477, Attention: Attention: Susan McVeigh, telecopy number: (215) 444-5051, telephone number: (215) 323-4586, or such other addresses or telecopy or telephone numbers as may hereafter be furnished to the Securityholders and the other parties hereto in writing by the Servicer; and, (VI) in the case of the Indenture Trustee, at the Corporate Trust Office, as defined in the Indenture, any such notices shall be deemed to be effective with respect to any party hereto upon the receipt of such notice or telephone confirmation thereof by such party, except; provided, that notices to the Securityholders shall be effective upon mailing or personal delivery. Section 11.07 Severability of Provisions. If any one or more of the covenants, agreements, provisions or terms of this Agreement shall be held invalid for any reason whatsoever, then such covenants, agreements, provisions or terms shall be deemed severable from the remaining covenants, agreements, provisions or terms of this Agreement and shall in no way affect the validity or enforceability of the other covenants, agreements, provisions or terms of this Agreement. Section 11.08 No Partnership. Nothing herein contained shall be deemed or construed to create any partnership or joint venture between the parties hereto and the services of the Servicer shall be rendered as an independent contractor. Section 11.09 Counterparts. This Agreement may be executed in one or more counterparts and by the different parties hereto on separate counterparts, each of which, when so executed, shall be deemed to be an original; such counterparts, together, shall constitute one and the same Agreement. Section 11.10 Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Servicer, the Loan Originators, the Depositor, the Indenture Trustee, the Issuer and the Securityholders and their respective successors and permitted assigns. -98- 104 Section 11.11 Headings. The headings of the various Sections of this Agreement have been inserted for convenience of reference only and shall not be deemed to be part of this Agreement. Section 11.12 Actions of Securityholders. (a) Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Agreement to be given or taken by Securityholders may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Securityholders in person or by agent duly appointed in writing; and except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments are delivered to the Depositor, ANB, ABC, the Servicer or the Issuer. Proof of execution of any such instrument or of a writing appointing any such agent shall be sufficient for any purpose of this Agreement and conclusive in favor of the Depositor, ANB, ABC, the Servicer and the Issuer if made in the manner provided in this Section 11.12. (b) The fact and date of the execution by any Securityholder of any such instrument or writing may be proved in any reasonable manner which the Depositor, ABC, ANB the Servicer or the Issuer may deem sufficient. (c) Any request, demand, authorization, direction, notice, consent, waiver or other act by a Securityholder shall bind every holder of every Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof, in respect of anything done, or omitted to be done, by the Depositor, ANB, ABC, the Servicer or the Issuer in reliance thereon, whether or not notation of such action is made upon such Security. (d) The Depositor, ANB, ABC, the Servicer or the Issuer may require additional proof of any matter referred to in this Section 11.12 as it shall deem necessary. Section 11.13 Non-Petition Agreement. Notwithstanding any prior termination of any Basic Document, the Loan Originators, the Transfer Obligor, the Servicer, the Depositor and the Indenture Trustee each severally and not jointly covenants that it shall not, prior to the date which is one year and one day after the payment in full of the all of the Notes, acquiesce, petition or otherwise, directly or indirectly, invoke or cause the Trust or the Depositor to invoke the process of any governmental authority for the purpose of commencing or sustaining a case against the Issuer or Depositor under any Federal or state bankruptcy, insolvency or similar law or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator or other similar official of the Issuer or Depositor or any substantial part of their respective property or ordering the winding up or liquidation of the affairs of the Issuer or the Depositor. -99- 105 Section 11.14 Holders of the Certificates. (a) Any sums to be distributed or otherwise paid hereunder or under this Agreement to the holders of the Securities shall be paid to such holders pro rata based on their Percentage Interests; (b) Where any act or event hereunder is expressed to be subject to the consent or approval of the holders of the Securities, such consent or approval shall be capable of being given by the holder or holders evidencing in the aggregate not less than 51% of the Percentage Interests. Section 11.15 Due Diligence Fees, Due Diligence. Each Loan Originator acknowledges that the Initial Noteholder has the right to perform continuing due diligence reviews with respect to the Loans, for purposes of verifying compliance with the representations, warranties and specifications made hereunder, or otherwise, and each Loan Originator agrees that upon reasonable (but no less than 10 Business Days') prior notice (with no notice being required upon the occurrence of an Event of Default) to any Loan Originator, the Initial Noteholder, the Indenture Trustee and Custodian or its authorized representatives will be permitted during normal business hours to examine, inspect, and make copies and extracts of, the Loan Files and any and all documents, records, agreements, instruments or information relating to such Loans in the possession or under the control of the Servicer and the Indenture Trustee. The Loan Originators also shall make available to the Initial Noteholder a knowledgeable financial or accounting officer for the purpose of answering questions respecting the Loan Files and the Loans. Without limiting the generality of the foregoing, each Loan Originator acknowledges that the Initial Noteholder may purchase Notes based solely upon the information provided by the Loan Originators to the Initial Noteholder in the Loan Schedule and the representations, warranties and covenants contained herein, and that the Initial Noteholder, at its option, has the right at any time to conduct a partial or complete due diligence review on some or all of the Loans securing such purchase, including without limitation ordering new credit reports and new appraisals on the related Mortgaged Properties and otherwise re-generating the information used to originate such Loan. The Initial Noteholder may underwrite such Loans itself or engage a mutually agreed upon third party underwriter to perform such underwriting. Each Loan Originator agrees to cooperate with the Initial Noteholder and any third party underwriter in connection with such underwriting, including, but not limited to, providing the Initial Noteholder and any third party underwriter with access to any and all documents, records, agreements, instruments or information relating to such Loans in the possession, or under the control, of the Servicer. Each Loan Originator further agrees that the Loan Originators shall reimburse the Initial Noteholder for any and all reasonable out-of-pocket costs and expenses incurred by the Initial Noteholder in connection with the Initial Noteholder's activities pursuant to this Section 11.15 hereof (the "Due Diligence Fees"), provided that, unless an Event of Default shall occur, the sum of (i) the aggregate reimbursement obligation of the Loan Originators under this Agreement, and (ii) the reimbursement obligation of Morgan Stanley Mortgage Capital Inc. pursuant to the Warehouse Lines, shall be limited to $25,000 per annum. The Initial Noteholder agrees (on behalf of itself and its Affiliates, directors, officers, employees and -100- 106 representatives) to use reasonable precaution to keep confidential, in accordance with its customary procedures for handling confidential information and in accordance with safe and sound practices, and not to disclose to any third party, any non-public information supplied to it or otherwise obtained by it hereunder with respect to any of the Loan Originators, Advanta Corp. or any of its Affiliates; provided, however, that nothing herein shall prohibit the disclosure of any such information to the extent required by statute, rule, regulation or judicial process; provided, further that, unless specifically prohibited by applicable law or court order, the Initial Noteholder shall, prior to disclosure thereof, notify Loan Originators of any request for disclosure of any such non-public information. The Initial Noteholder further agrees not to use any such non-public information for any purpose unrelated to this Agreement. Section 11.16 Liability. AMCUSA shall be liable for all obligations of the Loan Originators set forth in this Agreement. Section 11.17 Confidential Information. All Confidential Information (as defined below) will be held and treated by each Noteholder in confidence and will not, without the prior written consent of the Servicer be disclosed or used by such Noteholder or its directors, officers, employees, agents or controlling persons ("Information Recipients") other than in connection with the Basic Documents. Each Noteholder agrees to disclose Confidential Information only to its Information Recipients who need to know it for purposes of the Basic Documents and who are informed by such Noteholder of its confidential nature and who agree to be bound by the terms of this Section 11.17. Disclosure that is not in violation of the Right to Financial Privacy Act or other applicable law by such Noteholder of any Confidential Information at the request of any of its auditors, governmental regulatory authorities or self-regulatory authorities in connection with an examination of a Noteholder by any such authority shall not constitute a breach of its obligations under this Section 11.17 and shall not require the prior consent of the Servicer. Each Noteholder shall be responsible for any breach of this Section 11.17 by its Information Recipients. The Initial Noteholder may use Confidential Information for internal due diligence purposes in connection with its analysis of the transactions contemplated by the Basic Documents. The Disposition Agent may disclose Confidential Information to Disposition Participants as required to effect Dispositions. This Section 11.17 shall terminate upon the occurrence of an Event of Default. As used herein, "Confidential Information" means all information, whether in electronic or written form concerning the Servicer or any Loan Originator, any client or customer list of the Servicer or any Loan Originator, including, but not limited to, all information relating to the Loans, individual Borrowers, the Loans and the Promissory Notes, in each case which the Servicer or any Loan Originator made available to such Noteholder, together with analyses, statistics or compilations or other documents, which contain or otherwise reflect such information. Confidential Information shall not include information which (i) is or becomes generally available to the public other than as a result of a disclosure by such Noteholder or any Information Recipients; (ii) was available to such Noteholder on a non-confidential basis prior to its disclosure to such Noteholder by the Servicer or such Loan Originator; (iii) required to be disclosed by a governmental authority or related governmental agencies, auditors, accountants or as otherwise required by law; or (iv) becomes available to such Noteholder on a non-confidential basis from a person other than the Servicer or any Loan Originator who, to the best knowledge of such Noteholder, is not otherwise bound by a confidentiality agreement -101- 107 with the Servicer or any Loan Originator or is not otherwise prohibited from transmitting the information to such Noteholder. Section 11.18 Servicer to Provide Information to Loan Originator. The Servicer, as appropriate, will provide the Loan Originator such information as may be required to make representations and warranties required of them. The Servicer hereby agrees to indemnify and hold harmless the Loan Originator from and against any loss, liability, expense, damage, claim or injury arising out of or based on any breach of any representation or warranty relating to information provided by the Servicer, or out of the failure of the Servicer to provide such required information. [SIGNATURE PAGE FOLLOWS] -102- 108 IN WITNESS WHEREOF, the Issuer, the Depositor, the Servicer, the Indenture Trustee, the Loan Originators and the Transfer Obligor have caused their names to be signed by their respective officers thereunto duly authorized, as of the day and year first above written, to this Amended and Restated Sale And Servicing Agreement. ADVANTA HOME EQUITY LOAN OWNER TRUST 1998-MS1, By: Wilmington Trust Company not in its individual capacity but solely as Owner Trustee By:* /s/ ------------------------------- Name: Title: ADVANTA CONDUIT RECEIVABLES INC., as Depositor By: /s/ ------------------------------- Name: Title: ADVANTA MORTGAGE CORP. USA, as Servicer By: /s/ ------------------------------- Name: Title: BANKERS TRUST COMPANY OF CALIFORNIA, N.A., as Indenture Trustee By: /s/ ------------------------------- Name: Title: 109 ADVANTA CORP., as Transfer Obligor By: /s/ ------------------------------- Name: Title: ADVANTA MORTGAGE CORP. USA, as Loan Originator By: /s/ ------------------------------- Name: Title: ADVANTA NATIONAL BANK, as Loan Originator By: /s/ ------------------------------- Name: Title: ADVANTA BANK CORP., as Loan Originator By: /s/ ------------------------------- Name: Title: EX-12 6 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 Exhibit 12 ADVANTA CORP. AND SUBSIDIARIES Statement setting forth details of computation of ratio of earnings to fixed charges COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
($ in thousands) For The Years Ended December 31, ------------------------------------------------------------------------------------ 1999 1998 1997 1996 1995 --------- --------- -------- -------- -------- Net earnings $ 49,818 $ 447,880 $ 71,625 $175,657 $136,677 Federal and state income taxes (50,272) (9,044) 24,905 89,104 75,226 --------- --------- -------- -------- -------- Earnings before income taxes (454) 438,836 (A) 96,530 264,761 211,903 --------- --------- -------- -------- -------- Fixed charges: Interest 167,676 184,275 324,558 269,700 166,032 One-third of all rentals 3,124 2,627 3,492 2,834 1,641 Preferred stock dividend of subsidiary trust 8,990 8,990 8,990 350 0 --------- --------- -------- -------- -------- Total fixed charges 179,790 195,892 337,040 272,884 167,673 --------- --------- -------- -------- -------- Earnings before income taxes and fixed charges $179,336 $ 634,728 $433,570 $537,645 $379,576 --------- --------- -------- -------- -------- Ratio of earnings to fixed charges (B) 1.00x 3.24x 1.29x 1.97x 2.26x
(A) Earnings before income taxes in 1998 included a $541.3 million gain on the transfer of the consumer credit card business and $125.1 million of unusual charges including severance and outplacement costs associated with workforce reduction, option exercise and other employee costs associated with the Consumer Credit Card Transaction/Tender Offer; expense associated with exited businesses/products; and asset impairment. (B) For purposes of computing these ratios, "earnings" represent income before income taxes plus fixed charges. "Fixed charges" consist of interest expense, one-third (the portion deemed representative of the interest factor) of rental expense on operating leases, and preferred stock dividends of subsidiary trust. EX-21 7 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21 CURRENT LIST OF SUBSIDIARIES OF REGISTRANT Advanta Corp. (DE) Advanta Residual Holding Corp. (DE) Advanta National Corp. (DE) Advanta National Bank Advanta Bank Corp. (UT) Advanta Leasing Receivables Corp. VI (NV) Advanta Leasing Receivables Corp. VII (NV) Advanta Business Receivables Corp. (NV) Advanta GP Corp. (DE) Advanta 101 GP Corp. (DE) Advanta Investment Corp. (DE) Advanta Investment Corp. II (DE) Advanta Information Services, Inc. (DE) Advanta International Corporation I (DE) Advanta International Corporation II (DE) Advanta Leasing Holding Corp. (DE) Advanta Business Services Corp. (DE) Advanta Leasing Receivables Corp. (DE) Advanta Leasing Receivables Corp. II (DE) Advanta Leasing Receivables Corp. III (NV) Advanta Business Receivables LLC (NV) Advanta Leasing Receivables Corp. IV (NV) Advanta Leasing Receivables Corp. V (NV) Advanta Leasing Receivables Corp. VIII (NV) Advanta Leasing Receivables Corp. IX (NV) Advanta Commercial Credit Corp. (NV) Mt. Vernon Leasing, Inc. (NJ) Service Partners I Corp. (NV) Service Partners II Corp. (NV) Advanta Service Corp. (DE) Coltex Leverage Lease Corporation I (DE) TSLL Jedobert Cal, Inc. (DE) Advanta Properties I Corp. (PA) Advanta Properties II Corp. (PA) Advanta Life Insurance Company (AZ) Advanta Insurance Company (AZ) Advanta Insurance Agency Inc. (DE) First Advanta Insurance Agency Inc. (PA) AICM, Inc. (AZ) Advanta Name Corp. (DE) Advanta Advertising, Inc. (DE) ADVANTENNIS Corp. (DE) Advanta Mortgage Holding Company (DE) Advanta Auto Finance Corporation (NV) Advanta Auto Receivables Corp. I (NV) Advanta Mortgage Corp. USA (DE) Advanta Finance Corp. (NV) Advanta Finance Residential Mortgage Corp. (NV) Advanta Finance Residual Corporation (DE) Advanta Mortgage Corp. Midatlantic (PA) Advanta Mortgage Corp. Midatlantic II (PA) Advanta Mortgage Corp. New Jersey (NJ) Advanta Mortgage Corp. Northeast (NY) Advanta Mortgage Corp. Midwest (PA) Advanta Nominee Services, Inc. (DE) Advanta Mortgage Conduit Services, Inc. (DE) Advanta Conduit Receivables, Inc. (NV) Advanta Mortgage Receivables Inc. (DE) Advanta Mortgage Funding Corp. (DE) EX-23 8 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS 1 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this form 10-K, into the Company's previously filed Registration Statements; File No. 33-12510, No. 33-19290, No. 33-31456, No. 33-32969, No. 33-33350, No. 33-39331, No. 33-47308, No. 33-47305, No. 33-50256, No. 33-50254, No. 33-50258, No. 33-57516, No. 33-53205, No. 33-53475, No. 33-54991, No. 33-58029, No. 33-59219, No. 33-61555, No. 33-60419, No. 333-01681, No. 333-01833, No. 333-04471, No. 333-04465, No. 333-04469, No. 333-04471, No. 333-05701, No. 333-18993, No. 333-74575, No. 333-71995, No. 333-89665, and No. 333-92151. /s/ ARTHUR ANDERSEN LLP Philadelphia, PA March 20, 2000 EX-27 9 FINANCIAL DATA SCHEDULE
9 1,000 12-MOS DEC-31-1999 DEC-31-1999 29,301 93,688 144,938 0 748,881 0 0 1,449,624 41,847 3,689,662 1,512,359 763,364 289,563 434,745 0 1,010 287 588,334 3,689,662 122,861 104,011 19,354 246,226 101,386 167,676 78,550 42,647 30,633 362,654 (454) 49,818 0 0 49,818 1.99 1.96 2.29 45,620 0 0 0 33,437 33,306 5,759 41,847 41,847 0 0
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