10-Q 1 e10-q.txt 10-Q FOR ADVANTA CORP. FOR 06/30/2000 1 Form 10Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2000 or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to _______ Commission File Number 0-14120 Advanta Corp. (Exact name of registrant as specified in its charter) Delaware 23-1462070 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Welsh and McKean Roads, P.O. Box 844, Spring House, PA 19477 (Address of Principal Executive Offices) (Zip Code) (215) 657-4000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Applicable only to issuers involved in bankruptcy proceedings during the preceding five years: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class A Outstanding at August 4, 2000 Common Stock, $.01 par value 10,062,544 shares Class B Outstanding at August 4, 2000 Common Stock, $.01 par value 17,177,540 shares 1 2 TABLE OF CONTENTS
PAGE PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Condensed Balance Sheets 3 Consolidated Condensed Income Statements 4 Consolidated Condensed Statements of Changes in Stockholders' Equity 5-6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 41 PART II - OTHER INFORMATION 42 Item 4. Submission of Matters to a Vote of Security Holders 42 Item 6. Exhibits and Reports on Form 8-K 43
2 3 ITEM 1.FINANCIAL STATEMENTS ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS
($ IN THOUSANDS) JUNE 30, DECEMBER 31, 2000 1999 ----------------------------------------------------------------------------------------- (UNAUDITED) ASSETS Cash $ 82,079 $ 29,301 Federal funds sold 131,623 144,938 Restricted interest-bearing deposits 45,459 93,688 Investments available for sale 932,569 748,881 Loan and lease receivables, net: Held for sale 1,030,044 711,303 Other 632,580 738,321 ----------- ----------- Total loan and lease receivables, net 1,662,624 1,449,624 Retained interests in securitizations 353,099 515,789 Contractual mortgage servicing rights 85,272 92,636 Premises and equipment (at cost, less accumulated depreciation of $64,404 in 2000 and $54,613 in 1999) 96,760 89,869 Other assets 612,997 524,936 ----------------------------------------------------------------------------------------- TOTAL ASSETS $ 4,002,482 $ 3,689,662 ----------------------------------------------------------------------------------------- LIABILITIES Deposits: Noninterest-bearing $ 4,104 $ 5,768 Interest-bearing 2,308,587 1,506,591 ----------- ----------- Total deposits 2,312,691 1,512,359 Long-term debt 765,576 788,508 Other borrowings 118,339 409,601 Other liabilities 294,104 289,563 ----------------------------------------------------------------------------------------- TOTAL LIABILITIES 3,490,710 3,000,031 ----------------------------------------------------------------------------------------- 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 2000 and 1999 1,010 1,010 Class A voting common stock, $.01 par value: Authorized - 214,500,000 shares; Issued - 10,060,883 shares in 2000, and 10,465,883 shares in 1999 101 105 Class B non-voting common stock, $.01 par value: Authorized - 230,000,000 shares; Issued - 17,703,777 shares in 2000, and 18,256,029 in 1999 177 182 Additional paid-in capital 221,391 232,585 Deferred compensation (12,379) (16,597) Unearned ESOP shares (11,923) (12,132) Accumulated other comprehensive loss (10,995) (10,794) Retained earnings 242,355 421,741 Less: Treasury stock at cost, 0 Class A and 527,168 Class B common shares in 2000 and 405,000 Class A and 972,768 Class B common shares in 1999 (17,965) (26,469) ----------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 411,772 589,631 ----------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,002,482 $ 3,689,662 -----------------------------------------------------------------------------------------
See Notes to Consolidated Condensed Financial Statements 3 4 ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED CONDENSED INCOME STATEMENTS ($ IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2000 1999 2000 1999 ---------------------------------------------------------------------------------------------- (UNAUDITED) (UNAUDITED) REVENUES: Interest income $ 86,524 $ 59,201 $ 168,678 $124,515 Securitization income (loss) (180,607) 41,116 (148,352) 75,885 Servicing revenues 42,531 30,049 80,218 57,287 Other revenues, net 24,351 25,184 55,092 57,620 ---------------------------------------------------------------------------------------------- TOTAL REVENUES (27,201) 155,550 155,636 315,307 ---------------------------------------------------------------------------------------------- EXPENSES: Operating expenses 94,769 82,179 188,478 168,612 Interest expense 51,730 43,317 99,485 86,594 Provision for credit losses 27,460 7,407 38,859 17,555 Minority interest in income of consolidated subsidiary 2,220 2,220 4,440 4,440 Unusual charges 0 0 0 6,713 ---------------------------------------------------------------------------------------------- TOTAL EXPENSES 176,179 135,123 331,262 283,914 ---------------------------------------------------------------------------------------------- Income (loss) before income taxes (203,380) 20,427 (175,626) 31,393 Income tax expense (benefit) (10,685) 8,115 0 12,308 ---------------------------------------------------------------------------------------------- NET INCOME (LOSS) $(192,695) $ 12,312 $(175,626) $ 19,085 ---------------------------------------------------------------------------------------------- Basic earnings (loss) per share Class A $ (7.65) $ .48 $ (7.05) $ .72 Class B (7.63) .50 (7.01) .76 Combined (7.64) .49 (7.03) .74 ---------------------------------------------------------------------------------------------- Diluted earnings (loss) per share Class A $ (7.65) $ .48 $ (7.05) $ .72 Class B (7.63) .49 (7.01) .75 Combined (7.64) .49 (7.03) .74 ---------------------------------------------------------------------------------------------- Basic weighted average shares outstanding (000's) Class A 9,097 8,976 9,093 9,127 Class B 16,135 14,187 15,916 13,998 Combined 25,232 23,163 25,009 23,125 ---------------------------------------------------------------------------------------------- Diluted weighted average shares outstanding (000's) Class A 9,097 9,009 9,093 9,151 Class B 16,135 14,364 15,916 14,131 Combined 25,232 23,373 25,009 23,282 ---------------------------------------------------------------------------------------------- Cash dividends declared Class A $ .063 $ .063 $ .126 $ .126 Class B .076 .076 .151 .151 ----------------------------------------------------------------------------------------------
See Notes to Consolidated Condensed Financial Statements 4 5 ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) ($ IN THOUSANDS)
CLASS A CLASS B CLASS A CLASS B ADDITIONAL COMPREHENSIVE PREFERRED PREFERRED COMMON COMMON PAID-IN INCOME (LOSS) STOCK STOCK STOCK STOCK CAPITAL ------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1998 $1,010 $ 0 $ 104 $163 $229,304 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 (loss) $ 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 Amortization of deferred compensation Termination benefit- Benefit plans (4) (7,421) Stock buyback ESOP shares committed to be released 117 ------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1999 $1,010 $ 0 $ 105 $182 $232,585 ------------------------------------------------------------------------------------------------------------------------ Net loss $(175,626) Other comprehensive income (loss): Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of $108 (201) --------- Comprehensive income (loss) $(175,827) ========= Preferred and common cash dividends declared Exercise of stock options 152 Issuance of stock: Benefit plans 2 2,182 Amortization of deferred compensation Termination benefit- Benefit plans (3) (5,108) Retirement of treasury stock (4) (4) (8,496) ESOP shares committed to be released 76 ------------------------------------------------------------------------------------------------------------------------ BALANCE AT JUNE 30, 2000 $1,010 $ 0 $ 101 $177 $221,391 ------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Condensed Financial Statements 5 6 ($ IN THOUSANDS)
DEFERRED ACCUMULATED COMPENSATION OTHER TOTAL & UNEARNED COMPREHENSIVE RETAINED TREASURY STOCKHOLDERS' ESOP SHARES LOSS EARNINGS STOCK EQUITY ---------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1998 $ (29,764) $ (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 (loss) 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 (10,589) 0 Amortization of deferred compensation 3,781 3,781 Termination benefit- Benefit plans 7,425 0 Stock buyback (3,955) (3,955) ESOP shares committed to be released 418 535 ---------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1999 $ (28,729) $ (10,794) $421,741 $(26,469) $ 589,631 ---------------------------------------------------------------------------------------------------------------------- Net loss (175,626) (175,626) Other comprehensive income (loss): Change in unrealized appreciation (depreciation) of investments, net of tax benefit (expense) of $108 (201) (201) Comprehensive income (loss) Preferred and common cash dividends declared (3,760) (3,760) Exercise of stock options 152 Issuance of stock: Benefit plans (2,184) 0 Amortization of deferred compensation 1,292 1,292 Termination benefit- Benefit plans 5,111 0 Retirement of treasury stock 8,504 0 ESOP shares committed to be released 208 284 ---------------------------------------------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2000 $ (24,302) $ (10,995) $242,355 $(17,965) $ 411,772 ----------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Condensed Financial Statements 6 7 ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED ($ IN THOUSANDS) JUNE 30, ----------------------------------------------------------------------------------------------------------- 2000 1999 ----------------------------------------------------------------------------------------------------------- (UNAUDITED) OPERATING ACTIVITIES Net income (loss) $ (175,626) $ 19,085 Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: Investment securities gains (9,866) (27,672) Noncash charges associated with exit of auto finance business 0 16,900 Depreciation and amortization 10,159 9,216 Provision for credit losses, excluding auto 38,859 12,655 Proceeds from sale of trading investments 0 185,042 Origination of loans and leases held for sale (1,428,493) (1,586,481) Proceeds from sales of loans and leases held for sale 1,318,984 1,695,407 Change in other assets and other liabilities (61,710) (6,708) Change in retained interest in securitizations and contractual mortgage servicing rights, excluding auto charge 170,054 (10,220) ----------------------------------------------------------------------------------------------------------- Net cash (used in) provided by operating activities (137,639) 307,224 ----------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Change in federal funds sold and interest- bearing deposits 61,544 119,874 Purchase of investments available for sale (864,523) (953,487) Proceeds from sales of investments available for sale 496,269 478,538 Proceeds from maturing investments available for sale 194,206 51,716 Principal collected on Advanta Mortgage loans and leases not held for sale 74,859 50,773 Origination of Advanta Mortgage loans and leases not held for sale (163,708) (86,411) Change in business credit card receivables and other loans not held for sale (73,864) 18,518 Purchases of premises and equipment, net (16,896) (13,011) ----------------------------------------------------------------------------------------------------------- Net cash used in investing activities (292,113) (333,490) ----------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Change in demand and savings deposits (21,398) 104,271 Proceeds from sales of time deposits 1,113,062 338,073 Payments for maturing time deposits (291,332) (262,006) Change in repurchase agreements and FHLB advances (324,191) 0 Proceeds from issuance of long-term debt 130,416 45,194 Payments on redemption of long-term debt (153,348) (163,385) Change in other borrowings 32,929 (23,857) Stock buyback 0 (3,955) Proceeds from issuance of stock 152 80 Cash dividends paid (3,760) (5,520) ----------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 482,530 28,895 ----------------------------------------------------------------------------------------------------------- Net increase in cash 52,778 2,629 Cash at beginning of period 29,301 16,267 ----------------------------------------------------------------------------------------------------------- Cash at end of period $ 82,079 $ 18,896 -----------------------------------------------------------------------------------------------------------
See Notes to Consolidated Condensed Financial Statements 7 8 ADVANTA CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) JUNE 30, 2000 (UNAUDITED) NOTE 1) BASIS OF PRESENTATION Advanta Corp. (collectively with its subsidiaries, "Advanta") has prepared the consolidated condensed financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission. Advanta has condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles pursuant to such rules and regulations. In the opinion of management, the statements include all adjustments (which include normal recurring adjustments and the valuation adjustments discussed in Note 2) required for a fair statement of financial position, results of operations and cash flows for the interim periods presented. These financial statements should be read in conjunction with the financial statements and notes thereto included in Advanta's latest annual report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results for the full year. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates are used when accounting for securitization income (loss) and the retained interest-only strips, contractual mortgage servicing rights, the allowance for credit losses and income taxes, among others. Actual results could differ from those estimates. Certain prior period balances have been reclassified to conform to the current period presentation. NOTE 2) RECENT REGULATORY DEVELOPMENTS In June 2000, Advanta announced that its banking subsidiaries, Advanta National Bank and Advanta Bank Corp., reached agreements with their respective bank regulatory agencies, primarily relating to the banks' subprime lending operations. The agreements outline a series of steps to modify processes and formalize and document certain practices and procedures for the banks' subprime lending operations. The agreements also establish temporary asset growth limits at Advanta National Bank and deposit growth limits at Advanta Bank Corp., impose restrictions on taking brokered deposits at Advanta National Bank, and require that Advanta National Bank's capital ratios be maintained at approximately the level at March 31, 2000 by September 30, 2000. The agreements also provide that the Company change its charge-off policy for delinquent mortgages to 180 days and modify its accounting processes and methodology for its allowance for loan losses and valuation of residual assets. In July 2000, Advanta announced that Advanta National Bank signed an agreement with the Office of the Comptroller of the Currency regarding the carrying value of Advanta National Bank's retained interests in mortgage securitizations and allowance for mortgage loan losses. For Advanta National Bank's June 30, 2000 Call Report, the agreement provided that the retained interests be calculated based on an 18% discount rate on the interest-only strip and subordinated trust assets, a 15% discount rate on the contractual mortgage servicing rights, a prepayment rate that represents the average prepayment experience for the six months ended February 29, 2000 and cumulative loss rates as a percentage of original principal balance of 6% on closed end mortgage loans and 8% for HELOC (open end) mortgage loans. The agreement provided 8 9 that based on these assumptions, the carrying value of Advanta National Bank's contractual mortgage servicing rights be reduced by $13 million and the carrying value of Advanta National Bank's subordinated trust assets and retained interest-only strip be reduced by a total amount of $201 million. The agreement further provided that Advanta National Bank's allowance for loan losses be increased by $22 million. The agreement contains provisions regarding the use of similar discount rate and credit loss assumptions for the calculation of the carrying value of the residual assets in future periods. NOTE 3) 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 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 and SFAS No. 138, 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. NOTE 4) INVESTMENTS AVAILABLE FOR SALE Investments available for sale consisted of the following:
JUNE 30, 2000 DECEMBER 31, 1999 AMORTIZED MARKET AMORTIZED MARKET COST VALUE COST VALUE --------------------------------------------------------------------------------------- U.S. Treasury & other U.S. Government securities $ 570,684 $ 566,167 $ 145,112 $ 140,444 State and municipal securities 5,001 5,015 3,473 3,388 Collateralized mortgage obligations 178,030 170,766 456,288 448,068 Mortgage-backed securities 97,900 92,747 98,190 94,556 Equity securities(1) 73,637 73,637 60,892 60,892 Other 24,232 24,237 1,531 1,533 --------------------------------------------------------------------------------------- Total investments available for sale $ 949,484 $ 932,569 $ 765,486 $ 748,881 ---------------------------------------------------------------------------------------
(1) Includes investments of the venture capital unit, Advanta Partners. The amount shown as amortized cost represents carrying value for these investments. 9 10 NOTE 5) LOAN AND LEASE RECEIVABLES Loan and lease receivables on the balance sheet, including those held for sale, consisted of the following:
JUNE 30, DECEMBER 31, 2000 1999 -------------------------------------------------------------------------------- Advanta Mortgage loans $ 1,081,838 $ 1,050,478 Business credit cards 503,169 275,095 Leases 95,811 132,802 Other loans 21,689 21,930 -------------------------------------------------------------------------------- Gross loan and lease receivables 1,702,507 1,480,305 -------------------------------------------------------------------------------- Add: Deferred origination costs, net of deferred fees, and unamortized purchase premiums 23,709 11,166 Less: Allowance for credit losses Advanta Mortgage loans (38,035) (21,743) Business credit cards (20,132) (14,663) Leases (3,094) (3,110) Other loans (2,331) (2,331) -------------------------------------------------------------------------------- Total allowance for credit losses (63,592) (41,847) -------------------------------------------------------------------------------- Net loan and lease receivables $ 1,662,624 $ 1,449,624 --------------------------------------------------------------------------------
At June 30, 2000, $127.5 million of on-balance sheet business credit card receivables were pledged as collateral for a warehouse facility borrowing. Securitized receivables consisted of the following:
JUNE 30, DECEMBER 31, 2000 1999 -------------------------------------------------------- Advanta Mortgage loans $7,356,839 $7,333,058 Business credit cards 925,563 765,019 Leases 724,454 662,841 -------------------------------------------------------- Total $9,006,856 $8,760,918 --------------------------------------------------------
Advanta Mortgage loans include home equity loans, home equity lines of credit and auto loans, and exclude mortgage loans which were never owned by Advanta, but which Advanta services for a fee ("subservicing"). Subservicing receivables were $13.6 billion at June 30, 2000, and $11.9 billion at December 31, 1999. NOTE 6) ALLOWANCE FOR CREDIT LOSSES The following table presents activity in the allowance for credit losses for the periods presented:
SIX MONTHS YEAR ENDED ENDED JUNE 30, DECEMBER 31, 2000 1999 ------------------------------------------------------------- Beginning balance $ 41,847 $ 33,437 Provision for credit losses 38,859 42,647 Allowance on receivables sold 0 (6,690) Gross charge-offs: Advanta Mortgage loans (9,350) (15,132) Business credit cards (7,942) (11,341) Leases (4,023) (4,429) Other loans (0) (2,404) ------------------------------------------------------------- Total gross charge-offs (21,315) (33,306) Recoveries: Advanta Mortgage loans 2,134 3,011 Business credit cards 741 1,238 Leases 1,326 1,503 Other loans 0 7 ------------------------------------------------------------- Total recoveries 4,201 5,759 ------------------------------------------------------------- Net charge-offs (17,114) (27,547) ------------------------------------------------------------- Ending Balance $ 63,592 $ 41,847 =============================================================
10 11 The provision for credit losses in the three months ended June 30, 2000 includes an increase in the credit loss assumption made in response to Advanta's current bank regulatory examination process, including the implementation of the agreements with the bank regulators that were signed during the second quarter and in July 2000 (see Note 2), and changes during the quarter in the current market, and the political and regulatory environment for subprime lending. NOTE 7) RETAINED INTERESTS IN SECURITIZATIONS AND CONTRACTUAL MORTGAGE SERVICING RIGHTS Retained interests in securitizations include the retained interest-only ("IO") strip and subordinated trust assets related to Advanta Mortgage loan securitizations. The following table presents activity in the retained IO strip and contractual mortgage servicing rights ("CMSR") related to Advanta Mortgage loan securitizations:
SIX MONTHS YEAR ENDED ENDED JUNE 30, DECEMBER 31, 2000 1999 -------------------------------------------------------------------------------- Beginning balance IO Strip $ 115,641 $ 209,096 Beginning balance CMSR $ 92,636 $ 74,425 IO activity: Retained IO on sales, net 24,589 50,462 Interest income 16,486 19,354 Cash received and used to acquire subordinated trust assets (36,800) (111,600) Cash released to Advanta (3,363) (25,760) Fair value adjustments (217,190) (20,731) Fair value adjustment related to auto exit 0 (7,828) Reclassification of IO valuation reserves to subordinated trust assets 97,171 0 Other 3,466 2,648 CMSR activity: Servicing rights retained 23,063 54,124 Amortization, net (13,416) (39,134) Valuation provision (17,011) 3,221 Ending Balance IO Strip $ 0 $ 115,641 Ending Balance CMSR $ 85,272 $ 92,636 ================================================================================
The following table presents activity in subordinated trust assets related to Advanta Mortgage loan securitizations:
SIX MONTHS YEAR ENDED ENDED JUNE 30, DECEMBER 31, 2000 1999 -------------------------------------------------------------------------------- Beginning balance $ 400,148 $ 291,942 Initial collateral deposits 32,406 45,717 Subordinated trust assets acquired with excess cash flows 53,055 111,600 Interest income 22,980 27,227 Excess cash flows released to Advanta (66,346) (60,481) Valuation adjustment related to mortgage loans 8,172 (11,269) Valuation adjustment related to auto loans 0 (4,172) Reclassification of IO valuation reserves to subordinated trust assets (97,171) 0 Net change associated with off- balance sheet warehouse facilities (145) (416) -------------------------------------------------------------------------------- Ending balance $ 353,099 $ 400,148 ================================================================================
Valuation adjustments recorded to the IO strip, CMSR and subordinated trust assets in the three months ended June 30, 2000 resulted from an increase in discount rate and 11 12 credit loss assumption used in the valuation of these assets. These changes were made in response to Advanta's current bank regulatory examination process, including the implementation of the agreements with the bank regulators that were signed during the second quarter and in July 2000 (see Note 2), and changes during the quarter in the current market, and the political and regulatory environment for subprime lending. As a result of such adjustments, the reserve for anticipated charge-offs for certain securitizations exceeded the IO strip carrying value, and such excess has been reclassified as a reduction of the related subordinated trust asset. NOTE 8) SELECTED BALANCE SHEET INFORMATION
JUNE 30, DECEMBER 31, OTHER ASSETS 2000 1999 -------------------------------------------------------------------------------- Servicing advances $125,069 $105,302 Current and deferred income taxes, net 88,003 89,788 Accrued interest receivable 38,928 32,410 Other real estate (A) 6,722 9,560 Goodwill 3,192 3,323 Other 351,083 284,553 -------------------------------------------------------------------------------- Total other assets $612,997 $524,936 ================================================================================
(A) Carried at the lower of cost or fair market value less selling costs.
JUNE 30, DECEMBER 31, OTHER LIABILITIES 2000 1999 -------------------------------------------------------------------------------- Accounts payable and accrued expenses $ 64,176 $ 98,423 Accrued interest payable 63,883 36,554 Other 166,045 154,586 -------------------------------------------------------------------------------- Total other liabilities $294,104 $289,563 ================================================================================
NOTE 9) LONG-TERM DEBT Long-term debt consists of borrowings having an original maturity of over one year. The composition of long-term debt was as follows:
JUNE 30, DECEMBER 31, SENIOR DEBT 2000 1999 -------------------------------------------------------------------------------- 12 month senior notes (8.53%-10.66%) $ 124,218 $ 86,647 18 month senior notes (8.48%-10.75%) 9,039 8,344 24 month senior notes (7.47%-11.11%) 70,018 50,571 30 month senior notes (7.23%-11.15%) 13,287 13,852 48 month senior notes (6.36%-11.20%) 8,398 8,427 60 month senior notes (6.02%-11.24%) 30,375 28,863 Value notes, fixed (7.00%-7.85%) 7,779 7,779 Medium-term notes, fixed (6.81%-7.50%) 385,100 490,650 Medium-term notes, floating 30,500 47,400 Medium-term bank notes, fixed (6.45%-7.12%) 7,351 7,347 Other senior notes (7.70%-11.34%) 78,773 37,670 -------------------------------------------------------------------------------- Total senior debt 764,838 787,550 Subordinated notes (9.08%-11.34%) 738 958 -------------------------------------------------------------------------------- Total long-term debt $ 765,576 $ 788,508 ================================================================================
Advanta has priced its floating rate medium-term notes based on a spread over LIBOR. At June 30, 2000, the rates on these notes varied from 6.63% to 7.09%. At June 30, 2000 and December 31, 1999, Advanta used derivative financial instruments to effectively convert certain fixed rate debt to a LIBOR based variable rate. 12 13 NOTE 10) OTHER BORROWINGS The composition of other borrowings was as follows:
JUNE 30, DECEMBER 31, 2000 1999 -------------------------------------------------------------------------------- Warehouse facility $112,200 $ 76,435 FHLB advances 0 220,000 Securities sold under repurchase agreements 0 104,191 Other borrowings 6,139 8,975 -------------------------------------------------------------------------------- Total $118,339 $409,601 ================================================================================
NOTE 11) CAPITAL STOCK In the three months ended March 31, 2000, Advanta retired 405,000 shares of Class A Treasury stock and 445,600 shares of Class B Treasury stock. NOTE 12) SEGMENT INFORMATION During the first quarter of 2000, Advanta made changes to the methods used to allocate centrally incurred interest and operating expenses to the reportable segments in order to better reflect the use of the related assets or personnel by the segments. These changes included the allocation of certain expenses based on consumption rather than based on average managed assets, and a change in the classification of certain employee groups. Prior period segment results have been restated to reflect the current allocation methods. The results for the Advanta Mortgage segment in the three and six months ended June 30, 2000 include the valuation adjustments related to retained interests in securitizations and contractual mortgage servicing rights, and the increase in on-balance sheet reserves made in response to Advanta's current bank regulatory examination process, including the implementation of the agreements with the bank regulators that were signed during the second quarter and in July 2000 (see Note 2), and changes during the quarter in the current market, and the political and regulatory environment for subprime lending.
ADVANTA ADVANTA THREE MONTHS ENDED ADVANTA BUSINESS LEASING JUNE 30, MORTGAGE CARDS SERVICES OTHER(1) TOTAL ------------------------------------------------------------------------------------------------------------- 2000 Noninterest revenues $ (157,304) $ 39,261 $ 2,991 $ 1,327 $ (113,725) Interest revenue 48,844 19,136 3,599 14,945 86,524 Interest expense 27,063 7,545 3,108 14,014 51,730 Pretax income (loss) (221,300) 24,056 (6,744) 608 (203,380) Average managed receivables $ 8,481,098 $1,319,434 $ 802,661 $19,939 $ 10,623,132 ------------------------------------------------------------------------------------------------------------- 1999 Noninterest revenues $ 54,278 $ 19,808 $ 11,153 $11,110 $ 96,349 Interest revenue 30,534 7,785 2,494 18,388 59,201 Interest expense 20,354 2,904 1,846 18,213 43,317 Pretax income 3,796 8,051 2,532 6,048 20,427 Average managed receivables $ 8,408,275 $ 866,732 $ 692,356 $17,019 $ 9,984,382 -------------------------------------------------------------------------------------------------------------
13 14
ADVANTA ADVANTA SIX MONTHS ENDED ADVANTA BUSINESS LEASING JUNE 30, MORTGAGE CARDS SERVICES OTHER(1) TOTAL ---------------------------------------------------------------------------------------------------------------- 2000 Noninterest revenues $ (97,230) $ 70,383 $ 2,439 $ 11,366 $ (13,042) Interest revenue 96,576 35,020 7,638 29,444 168,678 Interest expense 51,638 13,646 6,109 28,092 99,485 Pretax income (loss) (205,838) 37,995 (16,879) 9,096 (175,626) Average managed receivables $ 8,452,433 $1,220,035 $ 804,033 $ 20,346 $ 10,496,847 ---------------------------------------------------------------------------------------------------------------- 1999 Noninterest revenues $ 114,288 $ 36,326 $ 22,534 $ 17,644 $ 190,792 Interest revenue 71,106 12,963 4,480 35,966 124,515 Interest expense 42,260 5,210 4,166 34,958 86,594 Pretax income (loss) 14,920 13,469 3,764 (760) 31,393 Average managed receivables $ 8,360,634 $ 844,913 $ 678,195 $ 17,418 $ 9,901,160 ----------------------------------------------------------------------------------------------------------------
(1) Other includes insurance operations, investment activities not attributable to the reportable segments, and costs associated with exiting the auto finance business in 1999. NOTE 13) NET INTEREST INCOME The following table presents the components of net interest income:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------------------------------------------------------------------------------- 2000 1999 2000 1999 ------------------------------------------------------------------------------------------------- Interest income: Loans and leases $ 46,966 $ 27,169 $ 96,353 $ 57,228 Investments 29,361 28,235 55,839 52,372 Interest component of previously discounted cash flows 10,197 3,797 16,486 14,915 ------------------------------------------------------------------------------------------------- Total interest income 86,524 59,201 168,678 124,515 ------------------------------------------------------------------------------------------------- Interest expense: Deposits 35,176 27,112 62,333 53,594 Debt and other borrowings 16,554 16,205 37,152 33,000 ------------------------------------------------------------------------------------------------- Total interest expense 51,730 43,317 99,485 86,594 ------------------------------------------------------------------------------------------------- Net interest income 34,794 15,884 69,193 37,921 Less: Provision for credit losses (27,460) (7,407) (38,859) (17,555) ------------------------------------------------------------------------------------------------- Net interest income after provision for credit losses $ 7,334 $ 8,477 $ 30,334 $ 20,366 =================================================================================================
14 15 NOTE 14) INCOME TAX EXPENSE Income tax expense (benefit) is based on the estimated annual effective tax rate of 0% for the six months ended June 30, 2000, compared to a 40% tax rate for the comparable 1999 period. Income tax expense (benefit) consisted of the following:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------------------------------------------------------------------ 2000 1999 2000 1999 ------------------------------------------------------------------------------------ Current: Federal $ 480 $5,000 $ 1,204 $ 10,000 State (939) 529 241 2,295 ------------------------------------------------------------------------------------ Total current (459) 5,529 1,445 12,295 ------------------------------------------------------------------------------------ Deferred: Federal (8,727) 1,949 0 1,013 State (1,499) 637 (1,445) (1,000) ------------------------------------------------------------------------------------ Total deferred (10,226) 2,586 (1,445) 13 ------------------------------------------------------------------------------------ Total tax expense (benefit) $(10,685) $8,115 $ 0 $ 12,308 ====================================================================================
The reconciliation of the statutory federal income tax to the consolidated tax expense (benefit) is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------------------------------------------------------------------- 2000 1999 2000 1999 ---------------------------------------------------------------------------------------- Statutory federal income tax $(71,183) $ 7,149 $(61,469) $ 10,988 Valuation allowance 63,008 0 63,008 0 State income taxes (1,584) 758 (782) 842 Compensation limitation 35 44 70 88 Non taxable investment income (125) (156) (238) (316) Other (836) 320 (589) 706 --------------------------------------------------------------------------------------- Consolidated tax expense (benefit) $(10,685) $ 8,115 $ 0 $ 12,308 =======================================================================================
The net deferred tax asset is comprised of the following:
June 30, December 31, 2000 1999 -------------------------------------------------------------------------------- Gross deferred tax liabilities $ (105,241) $ (102,248) Gross deferred tax assets 345,039 277,593 Valuation allowance (146,008) (83,000) -------------------------------------------------------------------------------- Net deferred tax asset $ 93,790 $ 92,345 ================================================================================
A summary of deferred tax assets and (liabilities) follows:
June 30, December 31, 2000 1999 -------------------------------------------------------------------------------- Deferred loan fees and costs $ (5,451) $ (6,149) Allowance for loan losses 23,169 22,273 Net operating loss carryforwards 182,358 182,437 Securitization income (loss) 25,640 (41,547) Leasing income (loss) (13,339) (19,009) Deferred compensation 6,375 9,054 Noncash unusual charges 12,319 18,321 Other 8,727 9,965 Valuation allowance (146,008) (83,000) -------------------------------------------------------------------------------- Net deferred tax asset $ 93,790 $ 92,345 ================================================================================
15 16 As a result of the carrying value adjustments discussed in Note 2, Advanta reported a pretax loss for the three and six months ended June 30, 2000. A valuation allowance has been provided against the resulting deferred tax asset given Advanta's pre-existing net operating loss carryforwards and the uncertainty of the realizability of the incremental deferred tax asset. 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 is presented with current federal income taxes for financial reporting purposes, and is included in other assets. NOTE 15) UNUSUAL CHARGES 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 (the "Consumer Credit Card Transaction"). 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. In connection with the Consumer Credit Card Transaction, 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 credit card and leasing units. In addition, in the first quarter of 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 were included in unusual charges on the consolidated income statements. The following table presents activity in the accrual related to these costs:
12/31/99 CHARGED TO 6/30/00 ACCRUAL ACCRUAL ACCRUAL BALANCE IN 2000 BALANCE ------------------------------------------------------------------------------------------- Employee costs associated with staff reductions $ 822 $ 822 $ 0 Employee costs associated with Consumer Credit Card Transaction/Tender Offer 3,008 3,008 0 Expenses associated with exited businesses/products 20,648 2,766 17,882 ------------------------------------------------------------------------------------------- Total $24,478 $ 6,596 $17,882 ===========================================================================================
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. 16 17 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 Advanta's mortgage, business credit 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 credit 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 the fourth quarter of 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 30 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 in 1998, Advanta also incurred $11.5 million of related professional fees and $1.5 million of other expenses related to these plans. 17 18 NOTE 16) EARNINGS (LOSS) PER SHARE The following table presents the calculation of basic earnings (loss) per share and diluted earnings (loss) per share.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------------------------------------------------------------------------- 2000 1999 2000 1999 ----------------------------------------------------------------------------------------------- Net income (loss) $(192,695) $ 12,312 $(175,626) $ 19,085 Less: Preferred A dividends 0 0 (141) (141) Less: Preferred B dividends (2) N/A (887) N/A (1,774) ----------------------------------------------------------------------------------------------- Income (loss) available to common shareholders $(192,695) $ 11,425 $(175,767) $ 17,170 Less: Class A dividends declared (573) (568) (1,092) (1,222) Less: Class B dividends declared (1,296) (1,126) (2,527) (2,383) ----------------------------------------------------------------------------------------------- Undistributed earnings (loss) $(194,564) $ 9,731 $(179,386) $ 13,565 Basic shares (000's) Class A 9,097 8,976 9,093 9,127 Class B 16,135 14,187 15,916 13,998 Combined (1) 25,232 23,163 25,009 23,125 Options Class A 0 1 0 1 Options Class B 0 177 0 133 Restricted shares Class A 0 32 0 23 Restricted shares Class B 0 0 0 0 Diluted shares (000's) Class A 9,097 9,009 9,093 9,151 Class B 16,135 14,364 15,916 14,131 Combined (1) 25,232 23,373 25,009 23,282 Basic earnings (loss) per share Class A $ (7.65) $ .48 $ (7.05) $ .72 Class B (7.63) .50 (7.01) .76 Combined (1) (7.64) .49 (7.03) .74 Diluted earnings (loss) per share Class A $ (7.65) $ .48 $ (7.05) $ .72 Class B (7.63) .49 (7.01) .75 Combined (1) (7.64) .49 (7.03) .74 Antidilutive shares (000's) Preferred Class B (2) N/A 14 N/A 14 Options Class A 2 1 2 0 Options Class B 2,652 1,597 2,710 1,678 Restricted shares Class A 99 68 99 41 Restricted shares Class B 1,051 1,125 1,266 1,278 -----------------------------------------------------------------------------------------------
(1) Combined represents a weighted average of Class A and Class B shares and earnings (loss) per share. (2) Each share of Class B convertible preferred stock was mandatorily converted into one share of Class B Common Stock effective September 15, 1999. 18 19 NOTE 17) 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. The court has scheduled trial in this matter to begin in September 2001. 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. 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. 19 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this form 10-Q, "Advanta", "we", "us", and "our" refer to Advanta Corp. and its subsidiaries, unless the context otherwise requires. OVERVIEW For the three months ended June 30, 2000, we reported a net loss of $192.7 million or $7.64 per combined diluted common share, compared to net income of $12.3 million or $0.49 per combined diluted common share for the three months ended June 30, 1999. The results for the three months ended June 30, 2000 included charges which were made in response to our regulatory review process, including the implementation of the agreements with our regulators that were signed during the second quarter and in July 2000 discussed below, the current market, and the political and regulatory environment for subprime mortgage lenders. Net loss for the three months ended June 30, 2000 included a reduction in the valuation of Advanta National Bank's retained interests in mortgage securitizations of $214.0 million and an increase in the Advanta National Bank's on-balance sheet allowance for credit losses related to mortgage loans of $22.0 million. Pro forma net income for the three months ended June 30, 2000, reflecting income from Advanta Mortgage that is essentially the same as a portfolio lender, and excluding the reduction in the valuation of the retained interests and the increase in the on-balance sheet reserve, was $16.6 million or $0.65 per combined diluted common share. For the six months ended June 30, 2000, we reported a net loss of $175.6 million or $7.03 per combined diluted common share. In addition to the items discussed above that affected results for the three months ended June 30, 2000, the results for the six months ended June 30, 2000 include a non-operating gain of $6.7 million, after tax, on investments held by Advanta Partners, our private equity investment affiliate, and a $5.8 million charge, after tax, for a reduction in the valuation of retained interests in leasing securitizations. The net income of $12.3 million for the three months ended June 30, 1999 included a reduction in the retained interest-only strip of approximately $6.1 million, after tax, associated with more conservative fair value assumptions, and non-operating gains of approximately $5.6 million, after tax, predominately associated with the sale of an investment held by Advanta Partners. For the six months ended June 30, 1999, we reported net income of $19.1 million or $0.74 per combined diluted common share. In addition to the items discussed above that affected earnings for the three months ended June 30, 1999, the earnings for the six months ended June 30, 1999 include non-recurring charges, after tax, of approximately $14.5 million that were principally related to our exit from the auto finance business and severance and outplacement associated with cost cutting initiatives implemented in the first quarter of 1999. We also recognized non-operating gains of approximately $11.1 million, after tax, in the first quarter of 1999 in connection with an investment held by Advanta Partners. Pretax income (loss) by reportable segment for the three months ended June 30, 2000 was ($221.3) million for Advanta Mortgage, $24.1 million for Advanta Business Cards and ($6.7) million for Advanta Leasing Services. Pretax income by reportable segment for the three months ended June 30, 1999 was $3.8 million for Advanta Mortgage, $8.1 million for Advanta Business Cards, and $2.5 million for Advanta Leasing Services. In June 2000, we announced that our banking subsidiaries, Advanta National Bank and Advanta Bank Corp., reached agreements with their respective bank regulatory agencies, primarily relating to the banks' subprime lending operations. The agreements outline a series of steps to modify processes and formalize and document certain practices and procedures for the banks' subprime lending operations. The agreements also establish temporary asset growth limits at Advanta National Bank and deposit growth limits at Advanta Bank Corp., impose restrictions on taking brokered deposits at Advanta National Bank, and require that Advanta National Bank's capital ratios be maintained at approximately the level at March 31, 2000 by September 30, 2000. The agreements also 20 21 provide that the Company change its charge-off policy for delinquent mortgages to 180 days and modify its accounting processes and methodology for its allowance for loan losses and valuation of residual assets. In July 2000, we announced that Advanta National Bank signed an agreement with the Office of the Comptroller of the Currency regarding the carrying value of Advanta National Bank's retained interests in mortgage securitizations and allowance for mortgage loan losses. For Advanta National Bank's June 30, 2000 Call Report, the agreement provided that the retained interests be calculated based on an 18% discount rate on the interest-only strip and subordinated trust assets, a 15% discount rate on the contractual mortgage servicing rights, a prepayment rate that represents the average prepayment experience for the six months ended February 29, 2000 and cumulative loss rates as a percentage of original principal balance of 6% on closed end mortgage loans and 8% for HELOC (open end) mortgage loans. The agreement provided that based on these assumptions, the carrying value of Advanta National Bank's contractual mortgage servicing rights be reduced by $13 million and the carrying value of Advanta National Bank's subordinated trust assets and retained interest-only strip be reduced by a total amount of $201 million. The agreement further provided that Advanta National Bank's allowance for loan losses be increased by $22 million. The agreement contains provisions regarding the use of similar discount rate and credit loss assumptions for the calculation of the carrying value of the residual assets in future periods. This report contains forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. These forward-looking statements can be identified by the use of forward-looking phrases such as "will likely result," "may," "are expected to," "is anticipated," "estimate," "projected," "intends to" or other similar words. The most significant among these risks and uncertainties are: (1) our managed net interest margin; (2) competitive pressures; (3) factors that affect the level of delinquencies and charge-offs, including a deterioration of general economic conditions; (4) the rate of prepayments; (5) interest rate fluctuations; (6) the level of expenses; (7) managed and subserviced receivables volume; (8) the timing of the securitizations of our receivables; (9) the level of insurance policy renewals; (10) the effects of government regulation, including restrictions and limitations imposed by banking laws, regulators, examinations, and the agreements between our bank subsidiaries and their respective regulators; (11) the level of conservatism and volatility associated with the assumptions underlying the valuation of retained interests in securitizations; (12) relationships with significant vendors, business partners and customers; (13) the amount and cost of financing available to us; (14) the ratings on the debt of Advanta Corp. and its subsidiaries; (15) the ability to attract and retain key personnel and customers; and (16) the results of our previously announced evaluation of strategic alternatives. Additional risks that may affect our future performance are set forth elsewhere in this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for the year ended December 31, 1999 and in our other filings with the Securities and Exchange Commission. CHANGES IN VALUATION ESTIMATES For the three months ended June 30, 2000, Advanta Mortgage securitization income included a $214.0 million charge due to an increase in the discount rate and credit loss assumption used in the valuation of Advanta National Bank's retained interests in mortgage securitizations, including the retained interest-only strip, subordinated trust assets and contractual mortgage servicing rights. In addition, we increased Advanta National Bank's on-balance sheet allowance for credit losses on mortgage loans by $22.0 million. During the three months ended June 30, 2000, the subprime lending industry was going through tremendous change due to regulatory and legislative initiatives, changes in market participants caused by the failure of some participants and new entrants into the market, and publicized concerns regarding the business model of certain subprime lenders. The change in the valuation assumptions was made in response to our current regulatory examination process, including the implementation of the agreements with our regulators that were signed during the second quarter and in July 2000, and changes during the quarter in the current market, and the political and regulatory environment for subprime lending. 21 22 Although the mortgage loan portfolio is currently performing in line with management's expectations, the change in the valuation assumptions was made in light of the more conservative regulatory view and changes during the quarter in the current market and the political and regulatory environment for subprime lending. The following summarizes the fair value assumptions used in the valuation of our retained interests at June 30, 2000 and December 31, 1999.
JUNE 30, DECEMBER 31, 2000 1999 -------- ------------ Assumed constant prepayment rates: Fixed rate loans 22% 25% Variable rate loans 35 39 Lines of credit 29 30 Assumed loss rate (annualized) 1.88% 1.38%
The weighted average discount rate used in the estimation of the fair value of the retained interest-only strip and subordinated trust assets was 18% at June 30, 2000, and was approximately 13% at March 31, 2000 and approximately 12% at December 31, 1999. For the three months ended June 30, 2000, cash collections received by the securitization trusts on retained interests related to securitizations aggregated approximately $21.3 million or approximately 28% (annualized) of the adjusted carrying value of the retained interests on an annualized basis. The annualized loss rate on the managed mortgage loan portfolio experienced in the three months ended June 30, 2000 was 1.28% using a charge-off methodology consistent with the prior quarter. At June 30, 2000, the on-balance sheet allowance for loan losses for Advanta National Bank's mortgage loans represented 8.7% of total outstanding loans held for investment at June 30, 2000 and approximately 85 months of charge-off coverage based on historic charge-offs, compared to 2.6% of loans held for investment and approximately 22 months of coverage based on historic charge-offs at year end 1999. The estimated liabilities for anticipated charge-offs on off-balance sheet loans, netted against the retained interest-only strip and subordinated trust assets, represented 9.2% of Advanta National Bank's outstanding off-balance sheet loans at June 30, 2000 and approximately 70 months of charge-off coverage based on historic charge-offs, compared to 5.2% of loans and approximately 50 months coverage based on historic charge-offs at year end 1999. 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, 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. The pretax loss of $221.3 million for Advanta Mortgage for the three months ended June 30, 2000 was due to the reduction in the valuation of the retained interests in mortgage securitizations and the increase in on-balance sheet reserves discussed previously. Pro forma pretax income for Advanta Mortgage on a portfolio lender basis for the quarter ended June 30, 2000, excluding the reduction in the valuation of the retained interests and the increase in the on-balance sheet reserve, was $9.2 million, as compared to pro forma pretax income on a portfolio lender basis of $13.8 million for the same period of 1999. The decrease in pro forma pretax income is due to lower mortgage origination volumes that resulted primarily from the implementation 22 23 of the regulatory agreements. This was partially offset by an increase in servicing revenues from growth in the subservicing portfolio, and higher yields on direct originations. SECURITIZATION INCOME (LOSS) Before consideration of the valuation items discussed above, Advanta Mortgage recognized gains of $38.2 million from the securitization and sale of $477 million of loans in the three months ended June 30, 2000, and recognized gains of $38.4 million from the securitization and sale of $707 million of loans in the three months ended June 30, 1999. Advanta Mortgage recognized gains of $64.6 million from the securitization and sale of $961 million of loans for the six months ended June 30, 2000 and recognized gains of $75.0 million from the securitization and sale of $1.3 billion of loans in the six months ended June 30, 1999. Gains on the sale of receivables represented 8.0% of the loans sold in the three months ended June 30, 2000, as compared to 5.4% of the loans sold in the same period of 1999. The gains recognized in the six months ended June 30, 2000 represented 6.7% of loans sold, as compared to 5.6% of loans sold in the same period of 1999. The increases in the gains recognized are due to changes in the mix of loans sold. Sales of home equity lines of credit and directly originated mortgage loans, which generally have higher yields relative to other mortgage loans, represented a greater proportion of total loan sales in the periods ended June 30, 2000, as compared to the periods ended June 30, 1999. PORTFOLIO LENDER ANALYSIS In the fourth quarter of 1998, we began to report pro forma income for Advanta Mortgage that is essentially equal to that of a portfolio lender, rather than the front-ended income typically reported through gain on sale accounting. Gain on sale accounting is required under generally accepted accounting principles for securitizations structured as sales. In this regard, we began to analyze and evaluate Advanta Mortgage's financial results from a portfolio lender's perspective as well as under generally accepted accounting principles. The following tables present Advanta Mortgage's reported results, adjusted to approximate the results, excluding valuation adjustments made during the quarter, of a portfolio lender for the three and six months ended June 30, 2000 and 1999 ($ in thousands). 23 24 PORTFOLIO LENDER ANALYSIS
THREE MONTHS ENDED THREE MONTHS ENDED JUNE 30, 2000 JUNE 30, 1999 ------------------------------------------- ----------------------------------------- Advanta Mortgage as Pro a Portfolio Advanta Forma & Lender Pro Mortgage Advanta Other Before Advanta Forma as a Mortgage Adjust- Valuation Mortgage Adjust- Portfolio As Reported ments Adjustments As Reported ments Lender ---------------------------------------------------------------------------------------------------------------------------- REVENUES: Interest income $ 48,844 $ 185,174 $234,018 $30,534 $ 175,799 $206,333 Securitization income (loss) (196,037) 196,037 0 28,416 (28,416) 0 Servicing revenues 36,220 (14,306) 21,914 25,001 (8,846) 16,155 Other revenues, net 2,513 0 2,513 861 0 861 ---------------------------------------------------------------------------------------------------------------------------- Total revenues (108,460) 366,905 258,445 84,812 138,537 223,349 ---------------------------------------------------------------------------------------------------------------------------- EXPENSES: Operating expenses 62,616 1,869 64,485 56,433 1,883 58,316 Interest expense 27,063 131,926 158,989 20,354 114,970 135,324 Provision for credit losses 21,385 2,575 23,960 2,364 11,684 14,048 Minority interest in income of consolidated subsidiary 1,776 0 1,776 1,865 0 1,865 ---------------------------------------------------------------------------------------------------------------------------- Total expenses 112,840 136,370 249,210 81,016 128,537 209,553 ---------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes (221,300) 230,535 9,235 3,796 10,000 13,796 Income tax expense (benefit) (5,953) 9,508 3,555 1,585 3,950 5,535 ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) $(215,347) $ 221,027 $ 5,680 $ 2,211 $ 6,050 $ 8,261 ============================================================================================================================
SIX MONTHS ENDED SIX MONTHS ENDED JUNE 30, 2000 JUNE 30, 1999 ------------------------------------------ ----------------------------------------- Advanta Mortgage as Pro a Portfolio Advanta Forma & Lender Pro Mortgage Advanta Other Before Advanta Forma as a Mortgage Adjust- Valuation Mortgage Adjust Portfolio As Reported ments Adjustments As Reported -ments Lender ---------------------------------------------------------------------------------------------------------------------------- REVENUES: Interest income $ 96,576 $ 363,078 $459,654 $ 71,106 $ 341,448 $412,554 Securitization income (loss) (169,561) 169,561 0 64,976 (64,976) 0 Servicing revenues 68,339 (26,544) 41,795 47,321 (16,328) 30,993 Other revenues, net 3,992 0 3,992 1,991 0 1,991 ---------------------------------------------------------------------------------------------------------------------------- Total revenues (654) 506,095 505,441 185,394 260,144 445,538 ---------------------------------------------------------------------------------------------------------------------------- EXPENSES: Operating expenses 126,464 3,678 130,142 119,395 3,681 123,076 Interest expense 51,638 247,713 299,351 42,260 226,000 268,260 Provision for credit losses 23,508 24,169 47,677 5,067 20,463 25,530 Minority interest in income of consolidated subsidiary 3,574 0 3,574 3,752 0 3,752 ---------------------------------------------------------------------------------------------------------------------------- Total expenses 205,184 275,560 480,744 170,474 250,144 420,618 ---------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes (205,838) 230,535 24,697 14,920 10,000 24,920 Income tax expense (benefit) 0 9,508 9,508 5,839 3,950 9,789 ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) $(205,838) $ 221,027 $ 15,189 $ 9,081 $ 6,050 $ 15,131 ============================================================================================================================
24 25 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, excluding the effect of the change in methodology related to the 180 day charge-off policy. The provision for credit losses is also adjusted to exclude the increase recorded in connection with the regulatory agreements. The actual provision for credit losses of a portfolio lender could differ from the charge-offs depending upon the age and composition of the portfolio and the timing of charge-offs. Carrying value adjustments to retained interests in securitizations, including contractual mortgage servicing rights, and loan loss reserves are excluded from the pro forma results above. Income tax expense amounts for the three and six month periods ended June 30, 2000 are adjusted to a normalized rate of 38.5%. ORIGINATIONS Originations for Advanta Mortgage were as follows ($ in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED PERCENTAGE JUNE 30, PERCENTAGE JUNE 30, INCREASE 2000 1999 DECREASE 2000 1999 (DECREASE) -------- -------- ---------- ---------- ---------- ---------- Direct $301,393 $407,880 (26)% $ 681,433 $ 811,084 (16)% Indirect: Broker 198,277 199,889 (1) 381,531 373,976 2 Other Indirect 3,238 119,920 (97) 4,692 253,979 (98) -------- -------- ---------- ---------- Subtotal Indirect 201,515 319,809 (37) 386,223 627,955 (38) Auto 0 0 0 0 5,103 (100) -------- -------- ---------- ---------- Total $502,908 $727,689 (31) $1,067,656 $1,444,142 (26) ======== ======== ========== ==========
We continue to shift the composition of the managed mortgage portfolio toward a higher proportion of direct and broker originations, which tend to have higher yields and are typically more profitable than loans originated through other indirect channels. The dollar volume of originations from direct to consumer channels represented 60% of total originations for the three months ended June 30, 2000 as compared to 56% for the three months ended June 30, 1999 and 64% for the six months ended June 30, 2000 as compared to 56% for the six months ended June 30, 1999. At June 30, 2000, 47% of the managed mortgage portfolio consisted of loans originated directly from consumers. This compares to 42% at December 31, 1999 and 37% at June 30, 1999. The decrease in the dollar volume of direct originations for the three and six months ended June 30, 2000 as compared to the same periods of 1999 is due to the impact of the implementation of the regulatory agreements in the second quarter of 2000, as well as a decrease in the average loan size and our focus on profitable loan growth over volume. The decrease in indirect originations for the three and six months ended June 30, 2000 as compared to the same periods of 1999 resulted from our decision in 1999 to curtail the purchase of pools of loans through the other indirect 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. There were no auto loans originated in 2000 due to our exit from the auto finance business in the first quarter of 1999. Advanta Mortgage originated more second lien home equity loans and home equity lines of credit as a percentage of total originations during the three and six months ended 25 26 June 30, 2000 than it originated during the same periods of 1999. This was primarily due to rising market interest rates that created increased demand for these types of loans. However, we began to experience a reversal of that trend and had increased first lien originations in the second quarter of 2000 as compared to the first quarter of 2000. Second lien home equity loans and home equity lines of credit represented 34% of the dollar value of originations for the three months ended June 30, 2000, as compared to 38% in the three months ended March 31, 2000 and 21% for the three months ended June 30, 1999. Second lien home equity loans and home equity lines of credit represented 36% of the dollar value of originations for the six months ended June 30, 2000, as compared to 20% for the six months ended June 30, 1999. Home equity lines of credit represented 13% of the managed mortgage loan portfolio at June 30, 2000, as compared to 10% at December 31, 1999, and 7% at June 30, 1999. SERVICING REVENUES Servicing revenues were $36.2 million for the three months ended June 30, 2000, as compared to $25.0 million for the same period in 1999. For the six months ended June 30, 2000, servicing revenues were $68.3 million, as compared to $47.3 million for the six months ended June 30, 1999. The increase in servicing revenues is due to an increase in average serviced receivables of $4.0 billion and $3.9 billion for the three and six months ended June 30, 2000, respectively, as compared to the same periods of 1999. Advanta Mortgage's subservicing portfolio was $13.6 billion at June 30, 2000, as compared to $11.9 billion at December 31, 1999 and $9.4 billion at June 30, 1999. The increase in the subservicing portfolio resulted primarily from growth in existing clients' portfolios. ADVANTA BUSINESS CARDS OVERVIEW Advanta Business Cards offers MasterCard business credit cards to small businesses using targeted direct mail and the Internet. Pretax income for Advanta Business Cards was $24.1 million for the three months ended June 30, 2000 as compared to $8.1 million for the same period in 1999. Pretax income for the six months ended June 30, 2000 was $38.0 million as compared to $13.5 million for the same period in 1999. The increase in pretax income in both periods resulted from increased volume of managed receivables, increases in portfolio yields and increased interchange income. These increased revenues were partially offset by an increase in operating expenses due to increased marketing and account origination activities. SECURITIZATION INCOME Advanta Business Cards recognized securitization income of $18.0 million in the three months ended June 30, 2000 and $31.2 million in the six months ended June 30, 2000. This compares to $7.8 million of securitization income recognized in the three months ended June 30, 1999 and $13.9 million of securitization income recognized in the six months ended June 30, 1999. Advanta Business Cards sells receivables to existing securitization trusts on a continuous basis to replenish the investors' interests in trust receivables that have been repaid by the card holders. The increase in securitization income in both periods was due to increased yields on the securitized receivables and increased volume of securitized receivables. 26 27 ORIGINATIONS Originations for Advanta Business Cards were as follows ($ in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, PERCENTAGE JUNE 30, PERCENTAGE 2000 1999 INCREASE 2000 1999 INCREASE -------------------------------------------------------------------------------------------------- Dollar volume $900,381 $471,239 91% $1,647,968 $871,667 89% Number of accounts 95,230 30,728 210 201,641 52,128 287
The increase in business credit card originations over the comparable periods in 1999 resulted from the successful application of our information based strategy to expand the universe of potential business credit card customers. ADVANTA LEASING SERVICES OVERVIEW Advanta Leasing Services offers flexible lease financing programs on small-ticket equipment to small businesses. Pretax loss for Advanta Leasing Services was $6.7 million for the three months ended June 30, 2000 as compared to pretax income of $2.5 million for the three months ended June 30, 1999. The pretax loss in the three months ended June 30, 2000 as compared to the income from the same period of 1999 was primarily attributable to lower margins and higher losses associated with some unprofitable segments of broker originations from prior periods. Pretax loss for the six months ended June 30, 2000 was $16.9 million as compared to pretax income of $3.8 million for the comparable period in 1999. In addition to the variances discussed above relating to the three months ended June 30, 2000 and 1999, the decrease in pretax income in the six months ended June 30, 2000 was attributable to a $9.5 million pretax reduction in the valuation of retained interests in leasing securitizations in the three months ended March 31, 2000. SECURITIZATION INCOME Advanta Leasing Services recognized $2.8 million in gains on the sale of $127 million of leases for the three months ended June 30, 2000, as compared to $4.9 million in gains on the sale of $106 million of leases for the three months ended June 30, 1999. As a percentage of receivables sold, the gains during the three months ended June 30, 2000 represented 2.2%, while the gains during the three months ended June 30, 1999 represented 4.6%. In the six months ended June 30, 2000, Advanta Leasing Services recognized $4.8 million in gains on the sale of $234 million of leases, as compared to $9.3 million in gains on the sale of $201 million of leases in the same period of 1999. As a percentage of receivables sold, these gains represented 2.1% in 2000 and 4.6% in 1999. The decrease in gain as a percentage of loans sold in both periods resulted from 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. Securitization income also included a $3.8 million charge in the three months ended June 30, 2000 and a $9.5 million pretax charge in the three months ended March 31, 2000, associated with the changes in valuation assumptions related to retained interests in leasing securitizations. There were no similar charges in the six months ended June 30, 1999. 27 28 ORIGINATIONS Originations for Advanta Leasing Services were as follows ($ in thousands):
PERCENTAGE PERCENTAGE THREE MONTHS ENDED INCREASE SIX MONTHS ENDED INCREASE JUNE 30, (DECREASE) JUNE 30, (DECREASE) 2000 1999 2000 1999 ----------------------------------------------------------------------------------------------------- Vendor $ 44,141 $ 54,625 (19)% $ 87,929 $100,119 (12)% Broker 17,397 54,812 (68) 47,996 115,328 (58) Other 26,899 3,947 582 61,594 7,773 692 ----------------------------------------------------------------------------------------------------- Total $ 88,437 $113,384 (22) $197,519 $223,220 (12) =====================================================================================================
The decreases in vendor and broker originations were consistent with our focus on profitable loan growth over volume. The increases in other originations result from a private label service agreement with a national direct marketer of leases. ADVANTA CORP. INTEREST INCOME AND EXPENSE Interest income on receivables and investments, excluding the interest component of previously discounted cash flows on the retained interest only strip, increased by $20.9 million for the three months ended June 30, 2000 as compared to the same period in 1999, and increased $42.6 million for the six months ended June 30, 2000 as compared to the same period in 1999. During the three months ended June 30, 2000, interest expense increased by $8.4 million as compared to the same period in 1999, and increased $12.9 million for the six months ended June 30, 2000 as compared to the same period in 1999. The increase in interest income in both periods was due to an increase in yields on receivables as well as an increase in average on-balance sheet receivables. The increase in interest expense in both periods was due to an increase in the cost of funds. Our cost of funds increased to 6.75% for the three months ended June 30, 2000 from 5.75% in the same period in 1999, and increased to 6.58% in the six months ended June 30, 2000 from 5.78% in the same period in 1999. The increase in the cost of funds in 2000 was primarily attributable to rising market interest rates. The following table provides an analysis of owned interest income and expense data, average balance sheet data, net interest spread, and net interest margin. Net interest spread represents the difference between the yield on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin represents the difference between the yield on interest-earning assets and the average rate paid to fund interest-earning assets. Average owned loan and lease receivables and the related interest revenues include certain loan fees and costs. 28 29 INTEREST RATE ANALYSIS ($ IN THOUSANDS)
THREE MONTHS ENDED JUNE 30, 2000 1999 ------------------------------------- --------------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE(1) INTEREST RATE BALANCE(1) INTEREST RATE ---------- -------- ----- ---------- -------- ------ ON-BALANCE SHEET Mortgage loans $ 997,294 $ 24,195 9.76% $ 729,335 $ 16,238 8.93% Business credit cards 401,630 18,894 18.92 181,510 7,735 17.09 Leases 102,692 3,585 13.96 109,608 2,618 9.55 Auto loans 8,036 315 15.75 9,938 283 11.44 Other loans 19,939 153 3.09 17,019 544 12.83 ----------- ---------- ---------- ---------- Total receivables(2) 1,529,591 47,142 12.39 1,047,410 27,418 10.50 Subordinated trust assets 429,949 11,760 10.94 312,497 6,537 8.37 Investments(2) 1,074,411 17,631 6.55 1,573,299 21,633 5.49 ----------- ---------- ---------- ---------- Total interest-earning assets $ 3,033,951 $ 76,533 10.12% $2,933,206 $ 55,588 7.58% Interest-bearing liabilities $ 3,009,002 $ 50,590 6.75% $2,929,081 $ 42,024 5.75% Net interest spread 3.37% 1.83% Net interest margin 3.44% 1.85% OFF-BALANCE SHEET Mortgage loans securitized $ 7,416,699 $7,538,380 Business credit cards securitized 917,804 685,222 Leases securitized 699,969 582,748 Auto loans securitized 59,069 130,622 ----------- ---------- Total average securitized receivables $ 9,093,541 $8,936,972 =========== ========== Total average managed receivables $10,623,132 $9,984,382 =========== ========== Managed net interest margin (3) 4.23% 3.51%
(1) Includes assets held and available for sale and nonaccrual loans and leases. (2) Interest and average rate for tax-exempt securities, loans and leases are computed on a tax equivalent basis using a statutory rate of 35%. (3) Managed net interest margin represents a combination of owned interest-earning assets/owned interest-bearing liabilities and securitized mortgage and business credit card assets/liabilities. 29 30 INTEREST RATE ANALYSIS ($ IN THOUSANDS)
SIX MONTHS ENDED JUNE 30, 2000 1999 ----------------------------------------- ------------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE(1) INTEREST RATE BALANCE(1) INTEREST RATE ----------- ---------- ------ ----------- -------- ------- ON-BALANCE SHEET Mortgage loans $ 1,053,476 $ 53,478 10.21% $ 824,781 $ 37,072 9.06% Business credit cards 373,931 34,580 18.60 163,178 12,851 15.88 Leases 120,148 7,710 12.83 107,477 4,720 8.78 Auto loans 5,710 558 19.66 27,025 1,995 14.89 Other loans 20,346 396 3.92 17,418 1,092 12.64 ----------- ---------- ---------- -------- Total receivables(2) 1,573,611 96,722 12.36 1,139,879 57,730 10.21 Subordinated trust assets 419,705 22,980 10.95 302,871 12,069 7.97 Investments(2) 1,017,774 32,910 6.46 1,484,575 40,022 5.38 ----------- ---------- ---------- -------- Total interest-earning assets $ 3,011,090 $ 152,612 10.17% $2,927,325 $109,821 7.53% Interest-bearing liabilities $ 2,964,843 $ 97,239 6.58% $2,928,829 $ 84,055 5.78% Net interest spread 3.59% 1.75% Net interest margin 3.70% 1.78% OFF-BALANCE SHEET Mortgage loans securitized $ 7,326,682 $7,366,572 Business credit cards securitized 846,104 681,735 Leases securitized 683,885 570,718 Auto loans securitized 66,565 142,256 ----------- ---------- Total average securitized receivables $ 8,923,236 $8,761,281 =========== ========== Total average managed receivables $10,496,847 $9,901,160 =========== ========== Managed net interest margin (3) 4.36% 3.57%
(1) Includes assets held and available for sale and nonaccrual loans and leases. (2) Interest and average rate for tax-exempt securities, loans and leases are computed on a tax equivalent basis using a statutory rate of 35%. (3) Managed net interest margin represents a combination of owned interest-earning assets/owned interest-bearing liabilities and securitized mortgage and business credit card assets/liabilities. 30 31 OTHER REVENUES
($ in thousands) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------------------------------------------------------------------- 2000 1999 2000 1999 ---------------------------------------------------------------------------------------- Investment securities gains (losses) $ (1,048) $ 9,298 $ 9,866 $27,672 Business credit card interchange income 15,397 8,134 27,999 14,364 Leasing other revenues 2,801 4,082 6,864 8,752 Insurance revenues, net and other 7,201 3,670 10,363 6,832 ---------------------------------------------------------------------------------------- Total other revenues, net $ 24,351 $25,184 $55,092 $57,620 ========================================================================================
Investment securities gains (losses) include changes in the fair value and realized gains on venture capital investments. Investment securities gains for the six months ended June 30, 2000 include a $9.4 million gain on the sale of an investment. Included in investment securities gains in the six months ended June 30, 1999, 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 of 1999 was the write-down of another equity investment of approximately $0.8 million. Business credit card interchange income increased by $7.3 million for the three months ended June 30, 2000 and $13.6 million for the six months ended June 30, 2000, as compared to the same periods of 1999. The increase in both periods was due to higher purchase volume related to the increase in average managed business credit card accounts and receivables. OPERATING EXPENSES
($ in thousands) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------------------------------------------------------------- 2000 1999 2000 1999 -------------------------------------------------------------------------------- Salaries and employee benefits $30,936 $29,101 $60,504 $62,937 Marketing expense 20,925 14,016 43,649 28,141 Equipment expense 6,267 5,362 11,950 10,515 External processing expense 5,353 3,554 9,866 6,889 Amortization of business credit card deferred origination costs, net 5,288 1,200 9,559 2,356 Professional fees 5,161 8,857 10,415 15,416 Occupancy expense 4,399 4,054 8,572 8,165 Credit and collection expense 4,177 3,756 9,585 8,909 Telephone expense 3,285 2,697 6,321 5,536 Postage expense 1,709 1,488 3,238 2,994 Credit card fraud losses 416 182 693 434 Other 6,853 7,912 14,126 16,320 -------------------------------------------------------------------------------- Total operating expenses $94,769 $82,179 $188,478 $168,612 ================================================================================ At quarter end (in thousands): Number of accounts managed 862 613 N/A N/A Number of employees 2,900 2,417 N/A N/A For the quarter: Operating expenses as a percentage of average managed receivables(1) 3.37% 3.25% 3.41% 3.36% --------------------------------------------------------------------------------
(1) Excludes amortization of business credit card deferred origination costs, net. 31 32 Operating expenses as a percentage of average managed receivables for the three months and six months ended June 30, 2000 were slightly higher than the same periods of 1999. Marketing expenses have increased by $6.9 million for the three months ended June 30, 2000 as compared to the same period of 1999, and increased by $15.5 million for the six months ended June 30, 2000 as compared to the same period of 1999. These increases are primarily due to increased marketing and account origination activities in Advanta Business Cards. In addition, there was an increase in marketing expenses associated with the Advanta Retail Note Program, through which we offer unsecured debt of Advanta Corp. to retail investors. In the three months ended June 30, 2000, there was a $4.1 million increase in the amortization of business credit card deferred origination costs, net, and a $1.8 million increase in external processing expense compared to the same periods of 1999. In the six months ended June 30, 2000 there was a $7.2 million increase in the amortization of business credit card deferred origination costs, net, and a $3.0 million increase in external processing expense compared to the same periods of 1999. These increases in deferred origination cost amortization and external processing expenses are due to the growth in managed business credit card receivables. For the three months ended June 30, 2000 there was a $3.7 million decrease in professional fees, as compared to the same period of 1999. In the six months ended June 30, 2000 there was a $5.0 million decrease in professional fees, as compared to the same period of 1999. These decreases were due to a decrease in consulting and outsourcing costs, including consulting costs associated with the year 2000 computer issue. PROVISION FOR CREDIT LOSSES For the three months ended June 30, 2000, the provision for credit losses was $27.5 million compared to $7.4 million for the same period in 1999. For the six months ended June 30, 2000, the provision for credit losses increased to $38.9 million from $17.6 million for the same period in 1999. The provision for the six months ended June 30, 1999 included a $4.6 million provision related to our exit from the auto finance business. Excluding the provision related to the auto exit in 1999, the increase in the provision in the six months ended June 30, 2000 was $25.9 million. The majority of the increases in both the three and six month periods were in the provision for credit losses relating to Advanta Mortgage, which increased by $19.0 million in the three months ended June 30, 2000 and $18.4 million for the six months ended June 30, 2000, as compared to the same periods of 1999. The increase in the provision relating to Advanta Mortgage loans represents an increase in the credit loss assumption made in response to our current regulatory examination process, including the implementation of the agreements with our regulators that were signed during the second quarter and in July 2000, and changes during the quarter in the current market, and the political and regulatory environment for subprime lending. The provision relating to Advanta Business Cards increased by $6.4 million for the six months ended June 30, 2000 as compared to the same period of 1999. The increase in Advanta Business Cards' provision relates to a $211 million increase in average on-balance sheet business credit card receivables. ASSET QUALITY Nonperforming assets include: Advanta Mortgage loans; business credit cards and leases past due 90 days or more; real estate owned; and bankrupt, decedent and fraudulent business credit cards. We charge losses on nonperforming Advanta Mortgage loans against the allowance generally at the earlier of foreclosure or when they have become 180 days delinquent. This policy was implemented in the three months ended June 30, 2000. The previous policy was the earlier of foreclosure or 12 months delinquent. Losses on lease receivables are generally charged against the allowance when 121 days contractually delinquent. During the three months ended June 30, 2000 the timing of the delinquency measurement of lease receivables was changed from mid-month to month end. See the following tables for charge-off rates using the new and prior methodologies for both mortgage loans and leases. Our charge-off policy, as it relates to business credit card accounts, is to charge-off a receivable, if not paid, 32 33 at 180 days contractually delinquent. Business 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. Advanta Mortgage continues to emphasize profitability enhancement over loan growth, and to emphasize the direct to consumer channels over indirect channels for originations. We had lower mortgage originations during the three months ended June 30, 2000 due to the implementation of the regulatory agreements, as well as our focus on profitable loan growth over volume. These factors have 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 mortgage loan portfolio. Delinquency and charge-off rates on business credit cards have improved in the six months ended June 30, 2000 as compared to the same period of the prior year. Charge-off rates on leases have increased in the six months ended June 30, 2000 as compared to the same period in the prior year. This increase is due to the performance of a certain segment of the leasing portfolio. We expect the impact of this segment of the lease portfolio to moderate by the end of the year. The following tables provide a summary of nonperforming assets, delinquencies and charge-offs, under the new and prior methodologies, as of and for the year-to-date periods indicated ($ in thousands). 33 34
JUNE 30, DEC. 31, JUNE 30, CONSOLIDATED - MANAGED 2000 1999 1999 ------------------------------------------------------------------------------------------------------------------------------------ Nonperforming assets $ 473,948 $ 511,301 $ 486,124 Total loans 30 days or more delinquent 801,120 838,563 814,103 As a percentage of gross receivables: Nonperforming assets New methodology (A) 4.4% Prior methodology 4.7 5.0% 4.8% Total loans 30 days or more delinquent New methodology (A) 7.5 Prior methodology 7.8 8.2 8.1 Net charge-offs: Amount $ 130,466 $ 155,452 $ 69,931 As a percentage of average gross receivables (annualized) New methodology (A) 2.5% Prior methodology 1.9 1.6% 1.4% ADVANTA MORTGAGE LOANS - MANAGED Nonperforming assets $ 431,153 $ 475,711 $ 450,359 Total loans 30 days or more delinquent 679,359 729,187 725,596 As a percentage of gross receivables: Nonperforming assets New methodology (A) 5.1% Prior methodology 5.5 5.7% 5.4% Total loans 30 days or more delinquent New methodology (A) 8.1 Prior methodology 8.4 8.7 8.6 Net charge-offs - Mortgage Loans: Amount $ 81,218 $ 64,303 $ 24,206 As a percentage of average gross receivables (annualized) New methodology (A) 1.9% Prior methodology 1.2 0.8% 0.6% Net charge-offs - Auto Loans: Amount $ 3,862 $ 18,855 $ 12,325 As a percentage of average gross receivables (annualized) 10.7% 13.9% 14.6% BUSINESS CREDIT CARDS - MANAGED Nonperforming assets $ 31,199 $ 23,498 $ 23,437 Total loans 30 days or more delinquent 52,828 38,437 33,126 As a percentage of gross receivables: Nonperforming assets 2.2% 2.3% 2.6% Total loans 30 days or more delinquent 3.7 3.7 3.7 Net charge-offs - Business Credit Cards: Amount $ 25,043 $ 44,309 $ 22,844 As a percentage of average gross receivables (annualized) 4.1% 5.0% 5.4% LEASES - MANAGED Nonperforming assets $ 11,069 $ 11,472 $ 12,006 Total loans 30 days or more delinquent 68,168 69,695 54,568 As a percentage of gross receivables: Nonperforming assets New methodology (A) 1.4% Prior methodology 1.7 1.4% 1.6% Total loans 30 days or more delinquent New methodology (A) 8.3 Prior methodology 8.7 8.8 7.3 Net charge-offs - Leases: Amount $ 20,343 $ 25,586 $ 10,525 As a percentage of average gross receivables (annualized) New methodology (A) 4.8% Prior methodology 4.4 3.6% 3.1%
(A) Beginning in the second quarter of 2000, charge-off and delinquency statistics reflect the adoption of new charge-off policies for mortgage loans and leases. Under the new policy, mortgage loans are generally charged-off at the earlier of foreclosure or 180 days delinquent. The previous policy was the earlier of foreclosure or 12 months delinquent. Leases are generally charged-off at 121 days delinquent, however, under the new policy, the timing of the delinquency measurement was changed from mid-month to month end in the second quarter of 2000. Cumulative catch-up adjustments included in second quarter charge-off amounts are not annualized when calculating the annualized charge-off rate under the new methodology. 34 35
JUNE 30, DEC. 31, JUNE 30, CONSOLIDATED - OWNED 2000 1999 1999 ------------------------------------------------------------------------------------------------------------------------------------ Allowance for credit losses $ 63,592 $ 41,847 $ 31,963 Nonperforming assets 51,465 45,620 53,611 Total loans 30 days or more delinquent 85,306 62,850 68,867 As a percentage of gross receivables: Allowance for credit losses 3.7% 2.8% 2.8% Nonperforming assets New methodology (A) 3.0 Prior methodology 3.2 3.1 4.7 Total loans 30 days or more delinquent New methodology (A) 5.0 Prior methodology 5.2 4.3 6.0 Net charge-offs: Amount $ 17,114 $ 27,547 $ 12,339 As a percentage of average gross receivables (annualized) New methodology (A) 2.1% Prior methodology 1.7 2.4% 2.2% ADVANTA MORTGAGE LOANS - OWNED Allowance for credit losses $ 38,035 $ 21,743 $ 14,955 Nonperforming assets 38,456 36,709 44,842 Total loans 30 days or more delinquent 59,518 45,263 54,114 As a percentage of gross receivables: Allowance for credit losses 3.5% 2.1% 1.8% Nonperforming assets New methodology (A) 3.6 Prior methodology 3.8 3.5 5.4 Total loans 30 days or more delinquent New methodology (A) 5.5 Prior methodology 5.8 4.3 6.5 Net charge-offs - Mortgage Loans: Amount $ 7,360 $ 8,389 $ 3,744 As a percentage of average gross receivables (annualized) New methodology (A) 1.3% Prior methodology 0.8 1.1% 0.9% Net charge-offs - Auto Loans: Amount $ (144) $ 3,732 $ 3,503 As a percentage of average gross receivables (annualized) (5.0%) 25.6% 25.9% BUSINESS CREDIT CARDS - OWNED Allowance for credit losses $ 20,132 $ 14,663 $ 9,002 Nonperforming assets 11,041 6,408 5,625 Total loans 30 days or more delinquent 18,837 10,347 7,691 As a percentage of gross receivables: Allowance for credit losses 4.0% 5.3% 5.2% Nonperforming assets 2.2 2.3 3.2 Total loans 30 days or more delinquent 3.7 3.8 4.4 Net charge-offs - Business Credit Cards: Amount $ 7,201 $ 10,103 $ 4,155 As a percentage of average gross receivables (annualized) 3.9% 4.8% 5.1% LEASES - OWNED Allowance for credit losses $ 3,094 $ 3,110 $ 3,310 Nonperforming assets 1,441 1,883 2,822 Total loans 30 days or more delinquent 6,186 5,996 6,249 As a percentage of gross receivables: Allowance for credit losses 3.2% 2.3% 2.6% Nonperforming assets New methodology (A) 1.5 Prior methodology 2.1 1.4 2.2 Total loans 30 days or more delinquent New methodology(A) 6.5 Prior methodology 7.1 4.5 4.8 Net charge-offs - Leases: Amount $ 2,697 $ 2,926 $ 906 As a percentage of average gross receivables (annualized) New methodology (A) 4.2% Prior methodology 3.5 2.7% 1.7%
35 36 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. The final payment outstanding related to these severance costs was paid in the three months ended March 31, 2000. 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 15 to the Consolidated Condensed 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. 36 37 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. The final payment outstanding related to these employee costs was paid in the three months ended March 31, 2000. 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 credit 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 credit 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 30 months. The actions required to complete these plans include the settlement of contractual commitments and the payment of customer benefits. 37 38 INCOME TAXES As a result of the carrying value adjustments described previously, we reported a pretax loss for the three and six months ended June 30, 2000. A valuation allowance has been provided against the resulting deferred tax asset given our pre-existing net operating loss carryforwards and the uncertainty of the realizability of the incremental deferred tax asset. 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 as of June 30, 2000 will be realized. ASSET/LIABILITY MANAGEMENT We manage our financial condition with a focus on maintaining disciplined management of market risks and prudent levels of leverage and liquidity. MARKET RISK SENSITIVITY 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 June 30, 2000, our net interest income over a twelve-month period would increase or decrease by approximately 6% if interest rates were to rise or fall by 200 basis points. Both increasing and decreasing rate scenarios assume an instantaneous shift in rates and measure the corresponding change in expected net interest income over one year. The above estimates of net interest income sensitivity alone do not provide a comprehensive view of 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 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. 38 39 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 2.2% change in constant prepayment rate for fixed rate loans and 3.3% change in constant prepayment rate for variable rate loans. We have estimated that these changes in prepayment assumptions could result in a $27 million change in the combined fair value of these assets as of June 30, 2000. These estimates do not factor in the impact of changes in the interest rate environment associated with the changes in the prepayment rates. Changes in interest rates generally affect the level of loan originations. Prepayment assumptions are not the only assumptions in the fair value calculation for these assets. Other key assumptions are not directly impacted by market forces, as defined earlier. The above prepayment scenarios do not reflect management's expectation regarding the future direction of prepayments, and they depict only two possibilities out of a large set of possible scenarios. DERIVATIVES ACTIVITIES The following table summarizes by notional amounts our derivative instruments as of June 30, 2000 and December 31, 1999 ($ in thousands):
ESTIMATED FAIR VALUE JUNE 30, JUNE 30, DECEMBER 31, 2000 ASSET/ 2000 1999 (LIABILITY) -------------------------------------------------------------------------------- Interest rate swaps $ 2,412,439 $ 2,975,086 $ 29,134 Interest rate caps written 391,266 409,278 (3,453) Interest rate caps purchased 391,266 409,278 3,453 Put options purchased 407,000 156,000 (880) Forward contracts 398,000 565,000 (2,293) -------------------------------------------------------------------------------- Total $ 3,999,971 $ 4,514,642 $ 25,961 ================================================================================
The notional amounts of derivatives do not represent amounts exchanged by the counterparties and, thus, are not a measure of our exposure through our use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivative contracts. The fair value of interest rate swaps, options and forward contracts is the estimated amount that we 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. Our credit exposure to derivatives, with the exception of caps written, is represented by contracts with a positive fair value without giving consideration to the value of any collateral exchanged. For caps written, credit exposure does not exist since the counterparty has performed its obligation to pay us a premium payment. 39 40 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 six months ended June 30, 2000, we securitized or sold approximately $961 million of Advanta Mortgage loans, $157 million of business credit card receivables and $234 million of leases. 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 credit card and lease receivable growth. At June 30, 2000, we had $132 million of federal funds sold, $1.0 billion of loan and lease receivables held for sale, and $799 million of investments that could be sold to generate additional liquidity. Equity, including capital securities, was $512 million at June 30, 2000. 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"), unsecured debt of Advanta Corp., and securitizations. Advanta and the banks use both retail and institutional on-balance sheet funding sources. We have the ability to issue a variety of debt securities and, through the banks, deposit products. As of June 30, 2000, Advanta National Bank's total deposits were $1.7 billion and Advanta Bank Corp.'s total deposits were $650 million. Our regulatory agreements establish temporary deposit growth limits at Advanta Bank Corp. and impose restrictions on taking brokered deposits at Advanta National Bank. After paying down $122 million in medium term notes in the six months ended June 30, 2000, we had approximately $325 million of unrestricted cash, cash equivalents and marketable securities at the parent company level at June 30, 2000. At June 30, 2000, the parent company's assets include advances to wholly-owned non-bank subsidiaries to fund $82 million in loans, $195 million in retained interest-only strips, subordinated trust assets and contractual mortgage servicing rights, and $48 million of equity securities accounted for at fair value. At June 30, 2000, we had a $500 million committed warehouse financing facility for mortgage loans. At June 30, 2000, we had additional uncommitted warehouse financing facilities for mortgage loans of $550 million. At June 30, 2000, we had $730 million of committed commercial paper facilities for business credit card receivables and a $200 million uncommitted repurchase agreement facility for business card receivables. At June 30, 2000, we had a $360 million committed commercial paper facility for lease contracts and lease residuals. At June 30, 2000, we had available $1.4 billion in unused warehouse financing facilities and commercial paper conduit facilities. During the quarter ended June 30, 2000, we maintained all of our receivable funding facilities, with the exception of one, which we terminated at our discretion due to infrequent use. In addition, the $200 million repurchase agreement facility for business card receivables was added during the second quarter of 2000. We also offer unsecured debt of Advanta Corp. to retail investors through the Advanta Retail Note Program. In July 2000, we added significant funding capacity for our business card business as our $2 billion shelf registration statement to issue publicly registered business card asset-backed securities became effective. 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. 40 41 At June 30, 2000, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 10.40% and Advanta Bank Corp.'s combined total capital ratio was 11.52%. 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%. In each case, Advanta National Bank and Advanta Bank Corp. had capital at levels a bank is required to maintain to be classified as "well-capitalized" under the regulatory framework for prompt corrective action. However, Advanta National Bank does not meet the definition of "well-capitalized" because of the existence of the agreement with the Office of the Comptroller of the Currency. Our regulatory agreement with the Office of the Comptroller of the Currency requires that Advanta National Bank achieve by September 30, 2000 and thereafter maintain a ratio of 14% of Tier 1 capital to risk-weighted assets and a ratio of 17% of Tier 1 capital to adjusted total assets. We intend to meet this requirement through a combination of a reduction of Advanta National Bank's assets, thereby reducing the total amount of required capital, and a parent capital contribution of approximately $60 million. Recently an FDIC discussion draft proposal has been made 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 financial results is uncertain at this time. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information required by this item is set forth in "Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report on Form 10-Q. See "Asset/Liability Management-Market Risk Sensitivity." 41 42 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) Advanta Corp.'s 2000 Annual Meeting of Stockholders was held on June 7, 2000. (b) Not required. (c) The following proposals were submitted to a vote of stockholders. (i) The election of three directors to hold office until the 2002 Annual Meeting of Stockholders. NOMINEES VOTES FOR VOTES WITHHELD Olaf Olafsson 8,422,620 758,372 William A. Rosoff 8,422,459 758,533 Michael Stolper 8,424,418 756,574 (ii) The approval of the Advanta Corp. 2000 Omnibus Stock Incentive Plan. BROKER FOR AGAINST ABSTENTIONS NON-VOTES 5,692,986 2,314,854 38,012 1,135,140 42 43 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits - The following exhibits are being filed with this report on Form 10-Q. EXHIBIT NUMBER DESCRIPTION OF DOCUMENT 12 Consolidated Computation of Ratio of Earnings to Fixed Charges. 27 Financial data schedule. (b) Reports on Form 8-K (b)(1) A Current Report on Form 8-K, dated April 6, 2000, was filed by Advanta incorporating by reference a Unanimous Consent of the Executive Committee of the Board of Directors dated April 6, 2000 as an exhibit to the Registration Statement (No. 333-33136) on Form S-3. (b)(2) A Current Report on Form 8-K, dated April 25, 2000, was filed by Advanta setting forth the financial highlights of Advanta's results of operations for the three months ended March 31, 2000. (b)(3) A Current Report on Form 8-K, dated May 17, 2000, was filed announcing Advanta's intent to explore strategic alternatives to unlock the unrecognized value of its mortgage and leasing businesses. (b)(4) A Current Report on Form 8-K, dated June 5, 2000, was filed by Advanta announcing that its banking subsidiaries, Advanta National Bank and Advanta Bank Corp., have each reached agreements with their respective bank regulatory agencies, primarily relating to the banks' subprime lending operations. (b)(5) A Current Report on Form 8-K, dated June 21, 2000, was filed by Advanta stating that following an action by Thomson Financial BankWatch on June 9, 2000, Advanta's long-term debt securities have been rated non-investment grade by all five of the nationally recognized statistical rating organizations. Also, Advanta's annual meeting of shareholders was held June 7, 2000 and the shareholders approved the adoption of an omnibus stock incentive plan and re-elected three directors. 43 44 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Advanta Corp. (Registrant) August 14, 2000 By /s/Philip M. Browne -------------------------------- Senior Vice President and Chief Financial Officer August 14, 2000 By /s/James L. Shreero -------------------------------- Vice President and Chief Accounting Officer 44 45 EXHIBIT INDEX EXHIBIT DESCRIPTION Exhibit 12 Consolidated Computation of Ratio of Earnings to Fixed Charges Exhibit 27 Financial Data Schedule 45