10-Q 1 w52415e10-q.txt ADVANTA CORP. 1 Form 10-Q 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, 2001 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 3, 2001 Common Stock, $.01 par value 10,041,764 shares Class B Outstanding at August 3, 2001 Common Stock, $.01 par value 17,359,944 shares
1 2 TABLE OF CONTENTS
PAGE PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Income Statements 4 Consolidated Statements of Changes in Stockholders' Equity 5-6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 22 Item 3. Quantitative and Qualitative Disclosures About Market Risk 35 PART II - OTHER INFORMATION Item 1. Legal Proceedings 36 Item 4. Submission of Matters to a Vote of Security Holders 37 Item 6. Exhibits and Reports on Form 8-K 38
2 3 ITEM 1. FINANCIAL STATEMENTS ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS) JUNE 30, DECEMBER 31, 2001 2000 ---- ---- (UNAUDITED) ASSETS Cash $ 24,149 $ 1,716 Federal funds sold 443,651 107,584 Restricted interest-bearing deposits 123,621 16,398 Investments available for sale 155,628 758,792 Receivables, net: Held for sale 153,749 154,265 Other 210,231 186,026 ----------- ----------- Receivables, net 363,980 340,291 Retained interests in securitizations 88,658 72,908 Amounts due from securitizations 69,421 61,610 Premises and equipment, net 24,838 26,185 Other assets 275,368 256,658 Net assets of discontinued operations 203,012 1,201,330 ----------- ----------- TOTAL ASSETS $ 1,772,326 $ 2,843,472 ----------- ----------- LIABILITIES Deposits: Noninterest-bearing $ 6,334 $ 4,546 Interest-bearing 647,894 1,342,430 ----------- ----------- Total deposits 654,228 1,346,976 Long-term debt 401,334 755,184 Other borrowings 0 4,289 Other liabilities 205,817 196,121 ----------- ----------- TOTAL LIABILITIES 1,261,379 2,302,570 ----------- ----------- Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures of Advanta Corp. 100,000 100,000 STOCKHOLDERS' EQUITY Class A preferred stock, $1,000 par value: authorized, issued and outstanding - 1,010 shares in 2001 and 2000 1,010 1,010 Class A voting common stock, $.01 par value: authorized - 214,500,000 shares; issued - 10,041,764 shares in 2001 and 10,040,230 shares in 2000 100 100 Class B non-voting common stock, $.01 par value: authorized - 230,000,000 shares; issued - 17,810,229 shares in 2001 and 17,613,166 shares in 2000 178 176 Additional paid-in capital 225,488 220,371 Deferred compensation (4,248) (7,336) Unearned ESOP shares (11,505) (11,714) Accumulated other comprehensive income (loss) 815 (1,302) Retained earnings 217,074 257,562 Less: Treasury stock at cost, 527,168 Class B common shares in 2001 and 2000 (17,965) (17,965) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 410,947 440,902 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,772,326 $ 2,843,472 ----------- -----------
See Notes to Consolidated Financial Statements 3 4 ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 ---- ---- ---- ---- (UNAUDITED) (UNAUDITED) Interest income $ 32,836 $ 34,081 $ 66,840 $ 64,464 Interest expense 26,119 21,559 50,395 41,738 -------- --------- --------- --------- Net interest income 6,717 12,522 16,445 22,726 Provision for credit losses 8,384 5,050 16,324 12,670 -------- --------- --------- --------- NET INTEREST AFTER PROVISION FOR CREDIT LOSSES (1,667) 7,472 121 10,056 NONINTEREST REVENUES: Securitization income 25,609 17,994 47,782 31,238 Servicing revenues 6,909 4,546 13,561 8,386 Interchange income 20,586 15,397 38,208 27,999 Other revenues, net (7,274) 2,651 (23,722) 14,126 -------- --------- --------- --------- TOTAL NONINTEREST REVENUES 45,830 40,588 75,829 81,749 -------- --------- --------- --------- EXPENSES: Operating expenses 44,116 31,401 87,169 64,326 Minority interest in income of consolidated subsidiary 2,220 2,220 4,440 4,440 Unusual charges 1,000 0 41,750 0 -------- --------- --------- --------- TOTAL EXPENSES 47,336 33,621 133,359 68,766 -------- --------- --------- --------- Income (loss) before income taxes (3,173) 14,439 (57,409) 23,039 Income tax benefit 0 (3,310) (16,880) 0 -------- --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS (3,173) 17,749 (40,529) 23,039 Loss from discontinued operations, net of tax 0 (210,444) (8,438) (198,665) Gain (loss), net, on discontinuance of mortgage and leasing businesses, net of tax (4,000) 0 12,361 0 -------- --------- --------- --------- NET LOSS $ (7,173) $(192,695) $ (36,606) $(175,626) -------- --------- --------- --------- Basic income (loss) from continuing operations per common share Class A $ (0.13) $ 0.69 $ (1.61) $ 0.89 Class B (0.12) 0.71 (1.58) 0.93 Combined (0.12) 0.70 (1.59) 0.92 -------- --------- --------- --------- Diluted income (loss) from continuing operations per common share Class A $ (0.13) $ 0.69 $ (1.61) $ 0.88 Class B (0.12) 0.70 (1.58) 0.91 Combined (0.12) 0.70 (1.59) 0.90 -------- --------- --------- --------- Basic net loss per common share Class A $ (0.29) $ (7.65) $ (1.46) $ (7.05) Class B (0.27) (7.63) (1.43) (7.01) Combined (0.28) (7.64) (1.44) (7.03) -------- --------- --------- --------- Diluted net loss per common share Class A $ (0.29) $ (7.60) $ (1.46) $ (6.94) Class B (0.27) (7.58) (1.43) (6.91) Combined (0.28) (7.59) (1.44) (6.92) -------- --------- --------- --------- Basic weighted average common shares outstanding Class A 9,098 9,097 9,082 9,093 Class B 16,744 16,135 16,473 15,916 Combined 25,842 25,232 25,555 25,009 -------- --------- --------- --------- Diluted weighted average common shares outstanding Class A 9,098 9,151 9,082 9,147 Class B 16,744 16,253 16,473 16,247 Combined 25,842 25,404 25,555 25,394 -------- --------- --------- ---------
See Notes to Consolidated Financial Statements 4 5 ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) ($ IN THOUSANDS)
CLASS A CLASS A CLASS B ADDITIONAL COMPREHENSIVE PREFERRED COMMON COMMON PAID-IN INCOME (LOSS) STOCK STOCK STOCK CAPITAL ------------- ----- -------- ----- ------- BALANCE AT DECEMBER 31, 1999 $1,010 $105 $182 $232,585 Net loss $(156,684) Other comprehensive income: Change in unrealized appreciation (depreciation) of investments, net of tax expense of $5,111 9,492 --------- Comprehensive loss $(147,192) ========= Preferred and common cash dividends declared Exercise of stock options 155 Issuance of stock- Benefit plans 2 2,545 Amortization of deferred compensation Termination benefit- Benefit plans (1) (4) (6,455) Retirement of treasury stock (4) (4) (8,496) ESOP shares committed to be released 37 ------ ---- ---- -------- BALANCE AT DECEMBER 31, 2000 $1,010 $100 $176 $220,371 ------ ---- ---- -------- Net loss $ (36,606) Other comprehensive income: Change in unrealized appreciation (depreciation) of investments, net of tax expense of $1,140 2,117 --------- Comprehensive loss $ (34,489) ========= Preferred and common cash dividends declared Exercise of stock options 3 2,429 Modifications of stock options and issuance of restricted stock 4,118 Issuance of stock- Benefit plans 419 Amortization of deferred compensation Termination benefit- Benefit plans (1) (1,877) ESOP shares committed to be released 28 ------ ---- ---- -------- BALANCE AT JUNE 30, 2001 $1,010 $100 $178 $225,488 ------ ---- ---- --------
See Notes to Consolidated Financial Statements 5 6 ($ IN THOUSANDS)
DEFERRED ACCUMULATED COMPENSATION OTHER TOTAL & UNEARNED COMPREHENSIVE RETAINED TREASURY STOCKHOLDERS' ESOP SHARES INCOME (LOSS) EARNINGS STOCK EQUITY ----------- ------------- -------- ----- ------ BALANCE AT DECEMBER 31, 1999 $(28,729) $(10,794) $421,741 $(26,469) $589,631 Net loss (156,684) (156,684) Other comprehensive income: Change in unrealized appreciation (depreciation) of investments, net of tax expense of $5,111 9,492 9,492 Comprehensive loss Preferred and common cash dividends declared (7,495) (7,495) Exercise of stock options 155 Issuance of stock- Benefit plans (2,547) 0 Amortization of deferred compensation 5,348 5,348 Termination benefit- Benefit plans 6,460 0 Retirement of treasury stock 8,504 0 ESOP shares committed to be released 418 455 -------- -------- -------- -------- -------- BALANCE AT DECEMBER 31, 2000 $(19,050) $ (1,302) $257,562 $(17,965) $440,902 -------- -------- -------- -------- -------- Net loss (36,606) (36,606) Other comprehensive income: Change in unrealized appreciation (depreciation) of investments, net of tax expense of $1,140 2,117 2,117 Comprehensive loss Preferred and common cash dividends declared (3,882) (3,882) Exercise of stock options 2,432 Modifications of stock options and issuance of restricted stock 4,118 Issuance of stock- Benefit plans (419) 0 Amortization of deferred compensation 1,629 1,629 Termination benefit- Benefit plans 1,878 0 ESOP shares committed to be released 209 237 -------- -------- -------- -------- -------- BALANCE AT JUNE 30, 2001 $(15,753) $ 815 $217,074 $(17,965) $410,947 -------- -------- -------- -------- --------
See Notes to Consolidated Financial Statements 6 7 ADVANTA CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED ($ IN THOUSANDS) JUNE 30, ---------------- -------- 2001 2000 ---- ---- (UNAUDITED) OPERATING ACTIVITIES Net loss $ (36,606) $ (175,626) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinued operations, net of tax 8,438 198,665 Gain, net, on discontinuance of mortgage and leasing businesses, net of tax (12,361) 0 Investment securities (gains) losses 14,316 (9,866) Loss on sale of deposits 2,835 0 Depreciation and amortization 5,198 5,368 Provision for credit losses 16,324 12,670 Change in receivables held for sale (197,033) (304,213) Proceeds from sale of receivables held for sale 197,549 146,713 Change in other assets and other liabilities (4,344) (27,467) Change in retained interests in securitizations (15,750) (9,422) ----------- ----------- Net cash used in operating activities (21,434) (163,178) ----------- ----------- INVESTING ACTIVITIES - CONTINUING OPERATIONS Change in federal funds sold and interest- bearing deposits (443,290) 37,607 Purchase of investments available for sale (1,001,643) (864,523) Proceeds from sales of investments available for sale 844,566 496,269 Proceeds from maturing investments available for sale 749,182 194,206 Change in receivables not held for sale (40,529) (68,766) Purchases of premises and equipment, net (3,843) (10,400) ----------- ----------- Net cash provided by (used in) investing activities 104,443 (215,607) ----------- ----------- FINANCING ACTIVITIES - CONTINUING OPERATIONS Change in demand and savings deposits (11,311) (21,398) Proceeds from issuance of time deposits 376,747 1,113,062 Payments for maturing time deposits (676,153) (291,332) Payment for sale of deposits and related accrued interest (392,511) 0 Change in repurchase agreements, term fed funds and FHLB advances 0 (324,191) Proceeds from issuance of long-term debt 116,259 130,416 Payments on redemption of long-term debt (470,109) (153,348) Change in other borrowings (4,289) (2,836) Proceeds from issuance of stock 2,432 152 Cash dividends paid (3,882) (3,760) ----------- ----------- Net cash (used in) provided by financing activities (1,062,817) 446,765 ----------- ----------- DISCONTINUED OPERATIONS Proceeds from sale of mortgage business 1,093,975 0 Other cash used in operating activities (91,734) 9,462 ----------- ----------- Net cash provided by operating activities 1,002,241 9,462 Net cash used in investing activities 0 (76,506) Net cash provided by financing activities 0 35,765 ----------- ----------- Net cash provided by (used in) discontinued operations 1,002,241 (31,279) ----------- ----------- Net increase in cash 22,433 36,701 Cash at beginning of period 1,716 5,784 ----------- ----------- Cash at end of period $ 24,149 $ 42,485 ----------- -----------
See Notes to Consolidated Financial Statements 7 8 ADVANTA CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS EXCEPT PER SHARE DATA, UNLESS OTHERWISE NOTED) JUNE 30, 2001 (UNAUDITED) In these notes to consolidated financial statements, "we", "us", and "our" refer to Advanta Corp. and its subsidiaries, unless the context otherwise requires. NOTE 1) BASIS OF PRESENTATION Advanta Corp. (collectively with its subsidiaries, "Advanta") has prepared the consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission. We have 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) 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 our 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, retained interests in securitizations, the fair value of certain financial instruments, the allowance for credit losses, litigation 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) DISCONTINUED OPERATIONS Effective February 28, 2001, we completed the sale of our mortgage business, Advanta Mortgage, to Chase Manhattan Mortgage Corporation as buyer. Following the transaction, we no longer operate a mortgage business. The purchase and sale agreement provided for the sale, transfer and assignment of substantially all of the assets and operating liabilities associated with our mortgage business, as well as specified contingent liabilities arising from our operation of the mortgage business prior to closing that were identified in the purchase and sale agreement. We retained contingent liabilities, primarily relating to litigation, arising from our operation of the mortgage business before closing that were not specifically assumed by the buyer. The proceeds from the sale exceeded $1 billion, subject to closing adjustments, resulting in an estimated gain of approximately $60 million before transaction expenses, severance expenses and other costs. Although the sale of our mortgage business resulted in a gain for financial reporting purposes, due to book/tax differences, we will not pay any material federal income tax as a result of the sale. See Note 13 for a discussion of litigation related to the sale of our mortgage business. On January 23, 2001, we announced that after a thorough review of strategic alternatives available for our leasing business, Advanta Leasing Services, we decided to cease originating leases. We will continue to service the existing portfolio rather than sell the business or the portfolio. In connection with the discontinuance of the leasing business, we recorded a $4.3 million pretax loss effective December 31, 2000, representing the estimated operating results through the remaining term of the leasing 8 9 portfolio. In the six months ended June 30, 2001, we recorded an additional $6.0 million pretax loss due to a change in estimate of those operating results. This change in estimate was needed due to an increase in estimated credit losses expected throughout the remaining term of the leasing portfolio based on recent credit loss experience in 2001. A principal factor contributing to the credit losses is that one of our former leasing vendors recently filed for bankruptcy protection and this vendor's financial problems are impacting its ability to service a segment of our leasing portfolio. The sale of the mortgage business and discontinuance of the leasing business represent the disposal of business segments following Accounting Principles Board ("APB") Opinion No. 30. Accordingly, results of these operations are classified as discontinued in all periods presented. Advanta Leasing Services incurred a net loss of $9.0 million for the three months ended June 30, 2000, including revenues of $6.6 million, interest expense of $3.1 million, other expenses of $9.2 million, and income tax expense of $3.3 million. For the six months ended June 30, 2000, Advanta Leasing Services incurred a net loss of $14.2 million, including revenues of $10.1 million, interest expense of $6.1 million, and other expenses of $18.2 million. Revenues and expenses of Advanta Mortgage were as follows for the period from January 1, 2001 to the disposal date of February 28, 2001 and for the three and six months ended June 30, 2000:
January 1 Three Months Six Months through Ended Ended February 28, June 30, June 30, 2001 2000 2000 ---- ---- ---- Revenues $ 36,631 $(108,460) $ (654) Interest expense (11,160) (27,063) (51,638) Other expenses (37,721) (76,545) (132,146) Income tax benefit 3,812 10,638 0 Income (loss) from discontinued operations $ (8,438) $(201,430) $(184,438) --------- ---------- ----------
The estimated operating results of Advanta Leasing Services through the remaining term of the lease portfolio were estimated at the measurement date of December 31, 2000 in the determination of the loss on discontinuance. As discussed above, the estimate was revised and an additional $6.0 million loss was recorded in the six months ended June 30, 2001 as a loss on discontinuance. In the three months ended June 30, 2001, we increased our estimate of mortgage transaction expenses by $2.0 million. The gain on the sale of the mortgage business does not reflect any impact from the post-closing adjustment process that has been extended by agreement of the parties. The components of the gain (loss) on discontinuance of our mortgage and leasing businesses were as follows:
Three Months Ended Six Months Ended June 30, 2001 June 30, 2001 Advanta Advanta Advanta Leasing Advanta Leasing Mortgage Services Mortgage Services -------- -------- -------- -------- Pretax gain (loss) on discontinuance of mortgage and leasing businesses $(2,000) $ (2,000) $ 25,753 $(6,000) Income tax (expense) benefit 0 0 (8,637) 1,245 Gain (loss) on discontinuance of mortgage and leasing businesses, net of tax $(2,000) $ (2,000) $ 17,116 $(4,755) ------- -------- -------- -------
9 10 Per share data was as follows:
Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- Advanta Advanta Advanta Mortgage Leasing Services Advanta Mortgage Leasing Services ---------------- ---------------- ---------------- ---------------- 2001 2000 2001 2000 2001 2000 2001 2000 ---- ---- ---- ---- ---- ---- ---- ---- Basic loss from discontinued operations per common share Class A $ 0.00 $(7.98) $ 0.00 $(0.36) $(0.33) $(7.37) $ 0.00 $(0.57) Class B 0.00 (7.98) 0.00 (0.36) (0.33) (7.37) 0.00 (0.57) Combined 0.00 (7.98) 0.00 (0.36) (0.33) (7.37) 0.00 (0.57) Diluted loss from discontinued operations per common share Class A $ 0.00 $(7.93) $ 0.00 $(0.35) $(0.33) $(7.26) $ 0.00 $(0.56) Class B 0.00 (7.93) 0.00 (0.35) (0.33) (7.26) 0.00 (0.56) Combined 0.00 (7.93) 0.00 (0.35) (0.33) (7.26) 0.00 (0.56) Basic gain (loss), net, on discontinuance of mortgage and leasing businesses, net of tax, per common share Class A $(0.08) $ 0.00 $(0.08) $ 0.00 $ 0.67 $ 0.00 $(0.19) $ 0.00 Class B (0.08) 0.00 (0.08) 0.00 0.67 0.00 (0.19) 0.00 Combined (0.08) 0.00 (0.08) 0.00 0.67 0.00 (0.19) 0.00 Diluted gain (loss), net, on discontinuance of mortgage and leasing businesses, net of tax, per common share Class A $(0.08) $ 0.00 $(0.08) $ 0.00 $ 0.67 $ 0.00 $(0.19) $ 0.00 Class B (0.08) 0.00 (0.08) 0.00 0.67 0.00 (0.19) 0.00 Combined (0.08) 0.00 (0.08) 0.00 0.67 0.00 (0.19) 0.00
The components of net assets of discontinued operations were as follows:
June 30, December 31, 2001 2000 ---- ---- Loans and leases, net $ 65,339 $ 370,682 Other assets 155,103 887,168 Liabilities 17,430 56,520 -------- ---------- Net assets of discontinued operations $203,012 $1,201,330 ======== ==========
As discussed above, we will continue to service the existing lease portfolio. At June 30, 2001, there were $518 million of securitized leases outstanding, and we had retained interests in leasing securitizations of $65 million. At December 31, 2000, there were $658 million of securitized leases outstanding, and we had retained interests in leasing securitizations of $78 million. The retained interests in leasing securitizations are included in net assets of discontinued operations in the consolidated balance sheets. At June 30, 2001, the fair value of the retained interests in leasing securitizations was estimated using an 8.5% discount rate on future cash flows excluding credit losses, a 5.0% discount rate on future credit losses, a 5.2% loss rate and a weighted average life of 1.2 years. Actual results may vary from our estimates, and the impact of any differences will be recognized in income when determined. 10 11 NOTE 3) RESTRICTED INTEREST-BEARING DEPOSITS AND INVESTMENTS AVAILABLE FOR SALE Restricted interest-bearing deposits at June 30, 2001 include $70.9 million of amounts held in escrow in connection with our litigation with Fleet Financial Group ("Fleet"), and $44.1 million held in escrow in connection with other litigation-related contingencies. Investments available for sale consisted of the following:
JUNE 30, 2001 DECEMBER 31, 2000 AMORTIZED MARKET AMORTIZED MARKET COST VALUE COST VALUE ---- ----- ---- ----- U.S. Treasury & other U.S. Government securities $ 56,650 $ 57,690 $401,168 $401,225 State and municipal securities 4,290 4,333 4,280 4,436 Collateralized mortgage obligations 28,500 28,575 165,689 162,897 Mortgage-backed securities 9,501 9,597 91,520 91,973 Equity securities(1) 36,287 36,287 72,403 72,403 Other(2) 19,146 19,146 25,735 25,858 -------- -------- -------- -------- Total investments available for sale $154,374 $155,628 $760,795 $758,792 ======== ======== ======== ========
(1) Includes venture capital investments of $28.2 million at June 30, 2001 and $45.3 million at December 31, 2000. The amount shown as amortized cost represents fair value for these investments. (2) Other investments at June 30, 2001 include $19.0 million of short-term investments held in a custodial account in connection with Advanta National Bank's February 2001 agreement with the Office of the Comptroller of the Currency. NOTE 4) RECEIVABLES Receivables on the balance sheet, including those held for sale, consisted of the following:
JUNE 30, DECEMBER 31, 2001 2000 ---- ---- Business credit card receivables $ 353,978 $ 335,087 Other receivables 28,252 24,203 --------- --------- Gross receivables 382,230 359,290 --------- --------- Add: Deferred origination costs, net of deferred fees 19,318 14,368 Less: Allowance for credit losses Business credit cards (37,166) (33,165) Other receivables (402) (202) --------- --------- Total allowance (37,568) (33,367) --------- --------- Receivables, net $ 363,980 $ 340,291 ========= =========
Gross managed receivables (owned receivables and securitized receivables) and managed credit quality data were as follows:
JUNE 30, DECEMBER 31, 2001 2000 ---- ---- Owned business credit card receivables $ 353,978 $ 335,087 Owned other receivables 28,252 24,203 Securitized business credit card receivables 1,545,326 1,324,137 Total managed receivables 1,927,556 1,683,427 Nonperforming assets - managed 63,009 45,160 Receivables 30 days or more delinquent - managed 110,867 83,798 Net charge-offs year-to-date - managed 61,852 64,638 ---------- ----------
11 12 NOTE 5) 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, 2001 2000 ---- ---- Beginning balance $ 33,367 $ 14,865 Provision for credit losses 16,324 36,309 Gross charge-offs (14,374) (20,176) Recoveries 2,251 2,369 -------- -------- Net charge-offs (12,123) (17,807) -------- -------- Ending balance $ 37,568 $ 33,367 ======== ========
NOTE 6) SECURITIZATION ACTIVITIES In September 2000, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125." SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions without amendment. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The statement was effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material effect on our financial position or results of operations. The following represents business credit card securitization data for the three and six months ended June 30, 2001 and 2000.
Three Months Ended Six Months Ended June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 ------------- ------------- ------------- ------------- Securitization income $ 25,609 $ 17,994 $ 47,782 $ 31,238 Servicing revenues 6,909 4,546 13,561 8,386 Proceeds from new securitizations 97,549 0 197,549 146,713 Proceeds from collections reinvested in revolving-period securitizations 805,607 514,691 1,523,245 920,037 Cash flows received on retained interests 39,582 24,440 78,332 42,925 ------- ------- --------- -------
There were no purchases of delinquent accounts during the three or six months ended June 30, 2001 or 2000. Retained interests in business credit card securitizations serve as credit enhancements for securitization transactions and include restricted cash reserves, the retained interest-only strip and subordinated trust assets. The following assumptions were used in measuring the fair value of retained interests in business credit card securitizations at June 30, 2001 and December 31, 2000. The assumptions listed represent weighted averages of assumptions used for each securitization. 12 13
June 30, December 31, 2001 2000 ---- ---- Discount rate 12.0% 12.0% Monthly payment rate 17.9 19.0 Loss rate 8.8 7.8 Net interest margin 13.2 10.8
We have prepared sensitivity analyses of the valuations of retained interests in securitizations. The sensitivity analyses show the hypothetical effect on the fair value of those assets of two unfavorable variations from the expected levels for each key assumption, independently from any change in another key assumption. The following are the results of those sensitivity analyses on the valuation at June 30, 2001. Fair value at June 30, 2001 $88,658 Effect on fair value of the following hypothetical changes in key assumptions: Discount rate increased by 2% $ (867) Discount rate increased by 4% (1,725) Monthly payment rate at 110% of base assumption (954) Monthly payment rate at 125% of base assumption (1,913) Loss rate at 110% of base assumption (3,758) Loss rate at 125% of base assumption (9,405) Net interest margin decreased by 1% (4,294) Net interest margin decreased by 2% (8,589)
The objective of these hypothetical analyses is to measure the sensitivity of the fair value of the retained interests to changes in assumptions. The methodology used to calculate the fair value in the analyses is a discounted cash flow analysis, the same methodology used to value the retained interests at each reporting date. These estimates do not factor in the impact of simultaneous changes in other key assumptions. The above scenarios do not reflect management's expectation regarding the future direction of these rates, and they depict only certain possibilities out of a large set of possible scenarios. NOTE 7) SELECTED BALANCE SHEET INFORMATION
JUNE 30, DECEMBER 31, OTHER ASSETS 2001 2000 ------------ ---- ---- Current and deferred income taxes, net $100,455 $ 87,794 Cash surrender value of insurance contracts 21,131 20,432 Other 153,782 148,432 -------- -------- Total other assets $275,368 $256,658 ======== ========
JUNE 30, DECEMBER 31, OTHER LIABILITIES 2001 2000 ----------------- ---- ---- Accounts payable and accrued expenses $ 52,722 $ 70,041 Accrued interest payable 25,683 31,048 Other 127,412 95,032 -------- -------- Total other liabilities $205,817 $196,121 ======== ========
13 14 NOTE 8) 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, 2001 2000 ---- ---- SENIOR DEBT: 12 month senior notes, fixed (10.66%-11.33%) $155,823 $152,553 18 month senior notes, fixed (9.08%-11.38%) 9,278 9,229 24 month senior notes, fixed (8.60%-11.42%) 79,020 86,109 30 month senior notes, fixed (8.85%-11.47%) 15,095 14,684 48 month senior notes, fixed (7.19%-11.51%) 9,493 8,384 60 month senior notes, fixed (6.49%-11.56%) 35,735 34,849 Value notes, fixed 0 3,271 Medium-term notes, fixed (6.92%-7.47%) 23,505 313,100 Medium-term notes, floating 10 30,500 Medium-term bank notes, fixed 0 3,404 Other senior notes, fixed (5.05%-11.33%) 72,739 98,387 -------- -------- Total senior debt 400,698 754,470 Subordinated notes, fixed (9.08%-9.94%) 636 714 -------- -------- Total long-term debt $401,334 $755,184 ======== ========
We used part of the proceeds from the sale of mortgage assets in the first quarter of 2001 to pay off substantially all of our outstanding medium-term notes and to reduce our outstanding senior notes. In addition, in the second quarter of 2001, we sold $389.7 million of deposit liabilities to E*TRADE Bank, a wholly-owned subsidiary of E*TRADE Group, Inc. NOTE 9) CAPITAL STOCK The Board of Directors of Advanta Corp. has authorized management to purchase up to 1.5 million shares of Advanta Corp. common stock or the equivalent dollar amount of our capital securities, or some combination thereof. As of July 31, 2001, we have repurchased approximately 120,000 shares of our Class B Common Stock. Cash dividends per share of common stock declared during the three months ended June 30, 2001 and 2000 were $0.063 for Class A Common Stock and $0.076 for Class B Common Stock. Cash dividends per share of common stock declared during the six months ended June 30, 2001 and 2000 were $0.126 for Class A Common Stock and $0.151 for Class B Common Stock. NOTE 10) SEGMENT INFORMATION Our reportable segments as of January 1, 2001 were Advanta Business Cards and our venture capital segment. During the first quarter of 2001, we made changes to the methods used to allocate centrally incurred interest and operating expenses to the reportable segments. These changes were made in order to better reflect the results of the continuing businesses due to the discontinuance of the mortgage and leasing segments and the restructuring of our corporate functions in the first quarter of 2001. Prior period segment results have been restated to reflect the current allocation methods. Advanta Business Cards offers MasterCard(R)* business credit cards to small businesses using targeted direct mail, the Internet and telemarketing solicitation of potential cardholders. This product provides approved customers with access, through merchants, banks, checks and ATMs, to an instant unsecured revolving business credit line. Advanta Business Cards generates interest and other income through finance charges assessed on outstanding balances, interchange income, and cash advance and other credit card fees. ---------- * MasterCard(R) is a federally registered servicemark of MasterCard International, Inc. 14 15 Our venture capital segment makes venture capital investments through our affiliates. The investment objective is to earn attractive returns by building the long-term values of the businesses in which they invest. Our investment affiliates combine transaction expertise, management skills and a broad contact base with strong industry-specific knowledge.
ADVANTA BUSINESS VENTURE CARDS CAPITAL OTHER (1) TOTAL ----- ------- --------- ----- THREE MONTHS ENDED JUNE 30, 2001 Interest income $ 19,113 $ 2 $ 13,721 $ 32,836 Interest expense 7,998 421 17,700 26,119 Noninterest revenues (losses), net 53,598 (5,607) (2,161) 45,830 Unusual charges 0 0 1,000 1,000 Pretax income (loss) from continuing operations 14,243 (6,551) (10,865) (3,173) Average managed receivables 1,848,424 0 28,184 1,876,608 Total assets 545,015 30,447 1,196,864 1,772,326 ----------- -------- ----------- ----------- THREE MONTHS ENDED JUNE 30, 2000 Interest income $ 19,136 $ 23 $ 14,922 $ 34,081 Interest expense 8,599 342 12,618 21,559 Noninterest revenues (losses), net 39,261 1,352 (25) 40,588 Pretax income (loss) from continuing operations 15,481 433 (1,475) 14,439 Average managed receivables 1,319,434 0 19,939 1,339,373 Total assets 612,270 48,403 3,206,495 3,867,168 ----------- -------- ----------- ----------- SIX MONTHS ENDED JUNE 30, 2001 Interest income $ 37,606 $ 33 $ 29,201 $ 66,840 Interest expense 15,218 839 34,338 50,395 Noninterest revenues (losses), net 100,774 (16,962) (7,983) 75,829 Unusual charges 0 0 41,750 41,750 Pretax income (loss) from continuing operations 27,691 (19,266) (65,834) (57,409) Average managed receivables 1,770,385 0 28,364 1,798,749 ----------- -------- ----------- ----------- SIX MONTHS ENDED JUNE 30, 2000 Interest income $ 35,020 $ 54 $ 29,390 $ 64,464 Interest expense 13,792 659 27,287 41,738 Noninterest revenues (losses), net 70,383 12,278 (912) 81,749 Pretax income (loss) from continuing operations 24,585 10,462 (12,008) 23,039 Average managed receivables 1,220,035 0 20,346 1,240,381 ----------- -------- ----------- -----------
(1) Other includes insurance operations and assets, investment and other activities not attributable to reportable segments. It also includes net assets of discontinued operations, and corporate overhead previously allocated to the mortgage and leasing business units while they were operating segments. Corporate overhead allocations were removed from the results of the discontinued segments as a result of the restatement for discontinued operations. 15 16 NOTE 11) UNUSUAL CHARGES In the first quarter of 2001, we implemented a plan to restructure our corporate functions to a size commensurate with our ongoing businesses and incurred certain other unusual charges related to employee costs. Costs associated with these restructuring activities and other employee costs are included in unusual charges in the consolidated income statements. Accruals related to these costs are included in other liabilities in the consolidated balance sheets. The details of these costs are as follows:
June 30, Charged 2001 Accrued in to Accrual Accrual 2001 in 2001 Balance ---- ------- ------- Employee costs $26,626 $16,330 $10,296 Expenses associated with exited businesses/products 12,565 10,356 2,209 Asset impairments 2,559 2,559 0 ------- ------- ------- Total $41,750 $29,245 $12,505 ======= ======= =======
Employee costs In the first quarter of 2001, we recorded a $4.1 million charge for severance and outplacement costs associated with the restructuring of corporate functions. There were 69 employees severed who were entitled to benefits. These employees worked in corporate support functions including accounting and finance, human resources, information technology, legal and facilities management. Employees were notified in March 2001, and we expect to pay severance amounts over a 12-month period. Additionally, during the first quarter of 2001, we incurred $21.6 million of other employee costs. This amount includes approximately $10 million attributable to bonuses to certain key employees in recognition of their efforts on behalf of Advanta in the strategic alternatives process. It also includes approximately $4.5 million of bonuses in recognition of the restructuring of the company and other significant transitional efforts. These bonuses will be paid over a 12-month period. In the second quarter of 2001, we recorded a $1.0 million increase in employee costs related to a revision in estimate associated with these bonuses. In 2001, we accelerated vesting of 32% of outstanding options that were not vested at the date of the closing of the sale of our mortgage business. This acceleration resulted in a non-cash charge of $1.3 million. In connection with reviewing our compensation plans after the sale of the mortgage business and restructuring of corporate functions, management identified certain programs that would not be continued, including stock appreciation rights and phantom stock programs. We recorded charges of $3.6 million associated with the settlement of outstanding stock appreciation rights and phantom stock with employees and directors. In addition, due to the restructuring of the company, we implemented a program whereby certain out-of-the money options are exchanged for shares of restricted stock. Non-cash charges associated with the issuance of the restricted stock under this program totaled $2.2 million. Expenses associated with exited businesses/products In 1998, in connection with the sale of our consumer credit card business (the "Consumer Credit Card Transaction"), we made major organizational changes 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 our mortgage, business credit card and leasing units. As of December 31, 2000, the remaining accrual related to charges associated with these organizational changes was $13.0 million. This accrual related to contractual commitments to certain customers, and non-related financial institutions that were providing benefits to those customers, under a product that was no longer offered and for which no future revenues or benefits would be received. A third party assumed the liabilities associated with these commitments in the first 16 17 quarter of 2001, and we recorded an additional charge relating to the settlement of these commitments of $10.3 million. In addition, in the three months ended March 31, 2001, there were charges of $2.2 million recorded related to other products exited in the first quarter of 2001 for which no future revenues or benefits would be received. We expect to pay these costs, which include lease and other commitments, over the next 12 months. Asset impairments In connection with our plan to restructure our corporate functions to a size commensurate with our ongoing businesses during the first quarter of 2001, we identified certain assets that would no longer be used, and the carrying costs of these assets were written off resulting in a charge of $2.6 million. We estimated the realizable value of these assets to be zero due to the nature of the assets, which include leasehold improvements and capitalized software. 17 18 NOTE 12) EARNINGS (LOSS) PER SHARE The following table presents the calculation of basic earnings (loss) per common share and diluted earnings (loss) per common share.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 ---- ---- ---- ---- Income (loss) from continuing operations $ (3,173) $ 17,749 $(40,529) $ 23,039 Less: Preferred A dividends 0 0 (141) (141) -------- --------- -------- --------- Income (loss) from continuing operations available to common shareholders (3,173) 17,749 (40,670) 22,898 Loss from discontinued operations, net of tax 0 (210,444) (8,438) (198,665) Gain (loss), net, on discontinuance of mortgage and leasing businesses, net of tax (4,000) 0 12,361 0 -------- --------- -------- --------- Net loss available to common shareholders (7,173) (192,695) (36,747) (175,767) Less: Class A dividends declared (574) (573) (1,146) (1,092) Less: Class B dividends declared (1,302) (1,296) (2,595) (2,527) -------- --------- -------- --------- Undistributed net loss $ (9,049) $(194,564) $(40,488) $(179,386) -------- --------- -------- --------- Basic income (loss) from continuing operations per common share Class A $ (0.13) $ 0.69 $ (1.61) $ 0.89 Class B (0.12) 0.71 (1.58) 0.93 Combined(1) (0.12) 0.70 (1.59) 0.92 Diluted income (loss) from continuing operations per common share Class A $ (0.13) $ 0.69 $ (1.61) $ 0.88 Class B (0.12) 0.70 (1.58) 0.91 Combined(1) (0.12) 0.70 (1.59) 0.90 Basic net loss per common share Class A $ (0.29) $ (7.65) $ (1.46) $ (7.05) Class B (0.27) (7.63) (1.43) (7.01) Combined(1) (0.28) (7.64) (1.44) (7.03) Diluted net loss per common share Class A $ (0.29) $ (7.60) $ (1.46) $ (6.94) Class B (0.27) (7.58) (1.43) (6.91) Combined(1) (0.28) (7.59) (1.44) (6.92) -------- --------- -------- --------- Basic weighted average common shares outstanding Class A 9,098 9,097 9,082 9,093 Class B 16,744 16,135 16,473 15,916 Combined 25,842 25,232 25,555 25,009 Options Class A 0 1 0 1 Options Class B 0 118 0 183 Restricted shares Class A 0 53 0 53 Restricted shares Class B 0 0 0 148 Diluted weighted average common shares outstanding Class A 9,098 9,151 9,082 9,147 Class B 16,744 16,253 16,473 16,247 Combined 25,842 25,404 25,555 25,394 Antidilutive shares Options Class B 2,663 2,534 2,755 2,527 Restricted shares Class A 24 46 36 46 Restricted shares Class B 513 1,051 712 1,118 -------- --------- -------- ---------
(1) Combined represents a weighted average of Class A and Class B earnings (loss) per common share. 18 19 NOTE 13) CONTINGENCIES On January 22, 1999, Fleet and certain of its affiliates filed a lawsuit against Advanta Corp. and certain of its subsidiaries in Delaware Chancery Court. Fleet's allegations, which we deny, center around Fleet's assertions that we failed to complete certain post-closing adjustments to the value of the assets and liabilities we contributed to Fleet LLC in connection with the Consumer Credit Card Transaction. Fleet seeks damages of approximately $141 million. We have filed an answer to the complaint denying the material allegations of the complaint, but acknowledging that we contributed $1.8 million in excess liabilities in the post-closing adjustment process, after taking into account the liabilities we have already assumed. We also have filed a countercomplaint against Fleet for approximately $101 million in damages we believe 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 October 2001. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results. On December 5, 2000, a former executive of Advanta obtained a jury verdict against Advanta in the amount of $3.9 million, in connection with various claims against Advanta related to the executive's termination of employment. Both parties filed post-trial motions. The former executive has filed a motion for a new trial with respect to his claims that were dismissed. The former executive is seeking, among other things, an award of approximately $6 million based upon the jury verdict and additional amounts, including attorney's fees and costs of $1.2 million. We will vigorously pursue our post-trial motions, and if necessary, an appeal to the United States Court of Appeals for the Third Circuit and will continue to contest the former executive's positions. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results. On December 21, 2000, Banc One Financial Services, Inc. and Bank One, N.A (together "Banc One") filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, that alleges, among other things, that Advanta breached two mortgage loan servicing agreements by wrongfully withholding as termination fees an amount in excess of $23 million, from amounts that we had collected under the loan servicing agreements, and by failing to perform under those agreements in certain respects. We dispute these claims and allegations. An answer to Banc One's second amended complaint was filed July 3, 2001 denying liability, raising affirmative defenses and asserting a counterclaim. The case is in active discovery with a discovery cut-off date of April 2, 2002 and a trial ready date of May 2, 2002. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results. On February 1, 2001, Fleet and certain of its affiliates filed a complaint in Delaware Chancery Court in an attempt to block the sale of our mortgage business to Chase Manhattan Mortgage Corporation. The complaint alleged that the terms of the proposed sale of our mortgage business breach a provision of Fleet's 1998 agreement to acquire our consumer credit card business, as amended (the "Contribution Agreement"), that essentially requires a buyer of "substantially all" of our assets to assume any of our remaining obligations under the Contribution Agreement at the time of the sale of "substantially all" of our assets. In February 2001, we announced that we had reached an agreement with Fleet, with regard to Fleet's attempt to block the sale. As part of the agreement, Fleet dismissed its injunction claim and agreed that it would raise no future issue with respect to the sale of the mortgage business. Under the agreement, $70.1 million of our reserves in connection with our long-standing litigation with Fleet were funded in an escrow account. The court presiding over the claims will order the funds paid to Advanta or to Fleet depending upon the outcome of that litigation. The amount escrowed, $70.9 million including interest, represents our maximum exposure to Fleet in the litigation, assuming a court were to rule in favor of Fleet on every claim involved in the litigation. 19 20 On July 26, 2001, Chase Manhattan Mortgage Corporation ("Chase") filed a complaint against Advanta and certain of its subsidiaries in the United States District Court for the District of Delaware alleging, among other things, that Advanta breached its contract with Chase in connection with the sale of Advanta's mortgage business to Chase. Specifically, Chase claims that Advanta misled Chase concerning the value of certain of the assets sold to Chase. We believe that the lawsuit is without merit and will vigorously defend Advanta. We do not expect this lawsuit to have any impact on our continuing business and, based on the complete lack of merit, we do not anticipate that the lawsuit will have a material adverse impact to Advanta or the named subsidiaries. Advanta Corp. 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 our operations. However, as the ultimate resolution of these proceedings is influenced by factors outside of our control, it is reasonably possible that our estimated liability under these proceedings may change. NOTE 14) DERIVATIVES We use derivative financial instruments as part of our risk management strategy to reduce interest rate risk. Derivatives are not used for trading or speculative activities. We adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133," on January 1, 2001. The adoption of SFAS No. 133 had no impact on income from continuing operations and was not material to income from discontinued operations. We recognize all derivatives on the balance sheet at fair value. On the date the derivative instrument is entered into, we may designate the derivative as a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment. Changes in the fair value of a derivative that is designated as, and meets all the required criteria for, a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. The portion of the change in fair value of a derivative associated with hedge ineffectiveness or the component of a derivative instrument excluded from the assessment of hedge effectiveness is recorded currently in earnings. Also, changes in the entire fair value of a derivative that is not designated as a hedge are recorded immediately in earnings. We formally document all relationships between hedging instruments and hedged items, as well as our risk-management objective and strategy for undertaking various hedge transactions. This process includes relating all derivatives that are designated as fair value hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. We also formally assess, both at the inception of the hedge and on an ongoing basis, whether each derivative is highly effective in offsetting changes in fair values of the hedged item. If it is determined that a derivative is not highly effective as a hedge or if a derivative ceases to be a highly effective hedge, we will discontinue hedge accounting prospectively. We have used interest rate swaps to manage the impact of fluctuating interest rates on our cost of funds. Interest rate swap agreements generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. In 2001, we used interest rate swaps to effectively convert fixed rate medium-term notes to a LIBOR-based variable rate. There were no interest rate swaps outstanding at June 30, 2001 because of the substantial reduction in outstanding medium-term notes during the second quarter of 2001. The notional amount of interest rate swaps outstanding was $194.5 million at December 31, 2000, and the estimated fair value was $379 thousand. 20 21 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 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 is represented by swaps with a positive fair value without giving consideration to the value of any collateral exchanged. On January 1, 2001, all interest rate swaps used in continuing operations were designated as fair value hedges. There were no derivatives designated as cash flow hedges. There were no net gains (losses) from hedge ineffectiveness or from excluding a portion of a derivative instrument's gain or loss from the assessment of hedge effectiveness included in other income for the three or six months ended June 30, 2001. There was also no gain or loss recognized in earnings as a result of a hedged firm commitment no longer qualifying as a fair value hedge. 21 22 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 During the year ended December 31, 2000, our lending and leasing business units consisted of Advanta Business Cards, Advanta Mortgage and Advanta Leasing Services. In addition to our lending and leasing businesses, we have an insurance business and venture capital investments. In the first quarter of 2001, we sold our mortgage business, announced the discontinuance of our leasing business, and restructured our corporate functions to a size commensurate with our ongoing businesses. We are continuing to service the existing leasing portfolio rather than sell the business or the portfolio. The results of the mortgage and leasing businesses are reported as discontinued operations in all periods presented. The results of our ongoing businesses are reported as continuing operations for all periods presented. For the three months ended June 30, 2001, we reported a net loss from continuing operations of $3.2 million or $0.12 per combined diluted common share, compared to net income from continuing operations of $17.7 million or $0.70 per combined diluted common share for the same period of 2000. For the six months ended June 30, 2001, we reported a net loss from continuing operations of $40.5 million or $1.59 per combined common share, assuming dilution, compared to net income from continuing operations of $23.0 million or $0.90 per combined diluted common share for the same period of 2000. The losses from continuing operations in 2001 include unusual charges representing costs associated with the restructure of our corporate functions to a size commensurate with our ongoing businesses and certain other unusual charges related to employee costs. These charges totaled $40.8 million in the first quarter of 2001 and $1.0 million in the second quarter of 2001. Net income for Advanta Business Cards was $8.8 million for the three months ended June 30, 2001 and $19.0 million for the same period of 2000. Net income for Advanta Business Cards for the six months ended June 30, 2001 was $17.0 million, compared to $24.6 for the same period of 2000. Our venture capital segment had a net loss of $4.0 million for the three months ended June 30, 2001, and net income of $4.3 million for the same period of 2000. For the six months ended June 30, 2001 our venture capital segment had a net loss of $11.8 million, compared to net income of $10.5 million for the same period of 2000. Loss from discontinued operations, net of tax, was $8.4 million for the six months ended June 30, 2001, compared to $198.7 million for the same period of 2000. In addition to the operating results of discontinued operations, we recorded an after-tax gain on the discontinuance of our mortgage and leasing businesses of $12.4 million for the six months ended June 30, 2001. The components of this net gain include a pretax gain on the sale of our mortgage business of $25.8 million, a pretax loss on the discontinuance of our leasing business of $6.0 million and tax expense of $7.4 million. The gain on the sale of our mortgage business includes a $2.0 million increase in our estimate of transaction expenses recorded in the second quarter of 2001. The loss on the discontinuance of our leasing business includes a $2.0 million revision in estimate recorded in the second quarter of 2001 related to an increase in estimated credit losses expected throughout the remaining term of the leasing portfolio based on recent credit loss experience in 2001. 22 23 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) factors affecting fluctuations in the number of accounts or loan balances; (5) interest rate fluctuations; (6) the level of expenses; (7) the timing of the securitizations of our receivables; (8) factors affecting the value of investments that we hold; (9) the effects of government regulation, including restrictions and limitations imposed by banking laws, regulators, examinations, and the agreements between our bank subsidiaries and their regulators; (10) relationships with significant vendors, business partners and customers; (11) the amount and cost of financing available to us; (12) the ratings on the debt of Advanta Corp. and its subsidiaries; (13) the completion of the post-closing process following the sale of our mortgage business and the ultimate amount of restructuring and other related charges associated with the conclusion of the strategic alternatives process for our mortgage and leasing business; (14) the impact of litigation; and (15) the ability to attract and retain key personnel. 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, 2000 and in our other filings with the Securities and Exchange Commission. ADVANTA BUSINESS CARDS OVERVIEW Advanta Business Cards offers MasterCard(R) business credit cards to small businesses using targeted direct mail, the Internet and telemarketing solicitation of potential cardholders. This product provides approved customers with access, through merchants, banks, checks and ATMs, to an instant unsecured revolving business credit line. Advanta Business Cards generates interest and other income through finance charges assessed on outstanding balances, interchange income, and cash advance and other credit card fees. The managed business credit card receivable portfolio grew from $1.4 billion at June 30, 2000 to $1.7 billion at December 31, 2000 and to $1.9 billion at June 30, 2001. Advanta Business Cards originated 66,546 new accounts in the three months ended June 30, 2001, compared to 95,230 new accounts for the same period of 2000. Originations for the six months ended June 30, 2001 were 135,317 new accounts, compared to 201,641 new accounts in the same period of 2000. The growth in receivables and origination results for 2001 reflect our plan to grow our portfolio in a controlled manner that we believe is prudent in the present economic environment. Pretax income for Advanta Business Cards was $14.2 million for the three months ended June 30, 2001 as compared to $15.5 million for the same period of 2000. The decrease of $1.3 million is comprised of a $0.5 million increase in net interest income and a $14.3 million increase in noninterest revenues, offset by a $3.1 million increase in the provision for credit losses and a $13.0 million increase in operating expenses. Pretax income for the six months ended June 30, 2001 was $27.7 million as compared to $24.6 million for the same period of 2000. The increase of $3.1 million for the six months ended June 30, 2001 as compared to the same period of 2000 includes a $1.2 million 23 24 increase in net interest income and a $30.4 million increase in noninterest revenues, offset by a $3.5 million increase in the provision for credit losses and a $25.0 million increase in operating expenses. The increases in both net interest income and noninterest revenues in both periods are due primarily to growth in managed receivables, increases in portfolio yields and increased interchange income. The increases in operating expenses in both periods resulted from growth in managed receivables and account origination activities. The increases in provision for credit losses in both periods relate to the seasoning of the business credit card portfolio and the current economic environment. SECURITIZATION INCOME Advanta Business Cards recognized securitization income of $25.6 million for the three months ended June 30, 2001 and $47.8 million for the six months ended June 30, 2001. This compares to $18.0 million of securitization income recognized for the three months ended June 30, 2000 and $31.2 million of securitization income recognized for the six months ended June 30, 2000. Advanta Business Cards sells interests in receivables through securitizations. Advanta Business Cards also sells receivables to existing securitization trusts on a continuous basis to replenish the investors' interest in trust receivables that have been repaid by the card holders. The increase in securitization income in 2001 was due to increased yields on the securitized receivables and increased volume of securitized receivables, partially offset by increased credit losses on securitized receivables. The following table provides selected information on a managed loan portfolio basis.
June 30, -------- Managed Portfolio Data ($ in thousands) 2001 2000 --------------------------------------- ---- ---- Average managed business credit card receivables: Three months ended June 30 $ 1,848,424 $ 1,319,434 Six months ended June 30 1,770,385 1,220,035 Ending managed business credit card receivables 1,899,304 1,428,732 Ending number of accounts managed 656,324 516,904 Managed net interest margin: Three months ended June 30 14.3% 12.3% Six months ended June 30 14.1 12.6 As a percentage of gross managed receivables Receivables 30 days or more delinquent 5.8% 3.7% Net charge-offs: Three months ended June 30 7.4% 3.8% Six months ended June 30 7.0 4.1
In September 2000, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125." SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions without amendment. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The statement was effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material effect on our financial position or results of operations. SERVICING REVENUES Advanta Business Cards recognized servicing revenue of $6.9 million for the three months ended June 30, 2001 and $13.6 million for the six months ended June 30, 2001. This compares to servicing revenue of $4.5 million for the three months ended June 30, 2000 and $8.4 million for the six months ended June 30, 2000. The increase in servicing revenue was due to increased volume of securitized receivables. 24 25 INTERCHANGE INCOME Business credit card interchange income was $20.6 million for the three months ended June 30, 2001 and $38.2 million for the six months ended June 30, 2001. This compares to business credit card interchange income of $15.4 million for the three months ended June 30, 2000 and $28.0 million for the six months ended June 30, 2000. The increase in interchange income was primarily due to higher purchase volume related to the increase in average managed business credit card accounts and receivables. The average interchange rate was 2.2% in the three months ended June 30, 2001, compared to 2.1% in the same period of 2000. The average interchange rate was 2.1% for the six months ended June 30, 2001 and 2000. VENTURE CAPITAL Our venture capital segment makes venture capital investments through our affiliates. The investment objective is to earn attractive returns by building the long-term values of the businesses in which they invest. Our investment affiliates combine transaction expertise, management skills and a broad contact base with strong industry-specific knowledge. Consistent with market conditions, pretax loss for the venture capital segment was $6.6 million for the three months ended June 30, 2001, and included $5.6 million of decreases in valuations of venture capital investments. Pretax income for the venture capital segment was $0.4 million for the three months ended June 30, 2000, and included $1.4 million in gains on venture capital investments. For the six months ended June 30, 2001, pretax loss for the venture capital segment was $19.3 million as compared to pretax income of $10.5 million for the same period of 2000. The pretax loss for the six months ended June 30, 2001 included $17.0 million of decreases in valuations and losses on venture capital investments as compared to $12.3 million in gains realized on venture capital investments in the same period of 2000. DISCONTINUED OPERATIONS Loss from discontinued operations, net of tax, was $8.4 million for the period from January 1, 2001 through February 28, 2001, the effective date of the sale of our mortgage business. Loss from discontinued operations, net of tax, was $210.4 million for the three months ended June 30, 2000 and $198.7 million for the six months ended June 30, 2000. Loss from discontinued operations for the three and six months ended June 30, 2000 includes charges which were made in response to our regulatory review process, including the implementation of the agreements with the bank regulators that were signed during the second and third quarters of 2000, and changes during the second quarter in the market and the political and regulatory environment for subprime lending. These charges include a pretax reduction in the valuation of Advanta National Bank's retained interests in mortgage securitizations of $214.0 million and an increase in Advanta National Bank's on-balance sheet allowance for credit losses related to mortgage loans of $22.0 million. These Advanta National Bank charges reduced net income by $236.0 million or $9.31 per combined common diluted share. In addition to the operating results through February 28, 2001 of discontinued operations, we recorded an after-tax gain on the discontinuance of our mortgage and leasing businesses of $12.4 million for the six months ended June 30, 2001. This net gain includes a pretax gain on the sale of our mortgage business of $25.8 million, a pretax loss on the discontinuance of our leasing business of $6.0 million and tax expense of $7.4 million. Effective February 28, 2001, we completed the sale of our mortgage business, Advanta Mortgage, to Chase Manhattan Mortgage Corporation as buyer. Following the transaction, we no longer operate a mortgage business. The purchase and sale agreement provided for the sale, transfer and assignment of substantially all of the assets and operating liabilities associated with our mortgage business, as well as specified contingent liabilities arising from our operation of the mortgage business prior to closing that 25 26 were identified in the purchase and sale agreement. We retained contingent liabilities, primarily relating to litigation, arising from our operation of the mortgage business before closing that were not specifically assumed by the buyer. The proceeds from the sale exceeded $1 billion, subject to closing adjustments, resulting in an estimated gain of approximately $60 million before transaction expenses, severance expenses and other costs. The gain on the sale of the mortgage business does not reflect any impact from the post-closing adjustment process that has been extended by agreement of the parties. Although the sale of our mortgage business resulted in a gain for financial reporting purposes, due to book/tax differences, we will not pay any material federal income tax as a result of the sale. See Note 13 to the consolidated financial statements for a discussion of litigation related to the sale of our mortgage business. On January 23, 2001, we announced that after a thorough review of strategic alternatives available for our leasing business, Advanta Leasing Services, we decided to cease originating leases. We will continue to service the existing portfolio rather than sell the business or the portfolio. In connection with the discontinuance of the leasing business, we recorded a $4.3 million pretax loss effective December 31, 2000, representing the estimated operating results through the remaining term of the leasing portfolio. In the six months ended June 30, 2001, we recorded an additional $6.0 million pretax loss due to a change in estimate of those operating results. This change in estimate was needed due to an increase in estimated credit losses expected throughout the remaining term of the leasing portfolio based on recent credit loss experience in 2001. A principal factor contributing to the credit losses is that one of our former leasing vendors recently filed for bankruptcy protection and this vendor's financial problems are impacting its ability to service a segment of our leasing portfolio. INTEREST INCOME AND EXPENSE Interest income on receivables and investments decreased $1.2 million for the three months ended June 30, 2001 as compared to the same period of 2000, and increased $2.4 million for the six months ended June 30, 2001 as compared to the same period of 2000. During the three months ended June 30, 2001, interest expense increased by $4.6 million as compared to the same period of 2000, and increased $8.7 million for the six months ended June 30, 2001 as compared to the same period of 2000. The decrease in interest income for the three months ended June 30, 2001 was due to a decrease in on-balance sheet business credit card receivables, offset by an increase in yields on business credit card receivables. The increase in interest income for the six months ended June 30, 2001 was due to an increase in yields on business credit card receivables. The increase in interest expense in both periods was due to an increase in our cost of funds. Our cost of funds increased to 7.41% for the three months ended June 30, 2001 from 6.75% during the same period of 2000, and increased to 7.33% for the six months ended June 30, 2001 from 6.58% for the same period of 2000. The increase in the cost of funds in 2001 was attributable to the increase in debt as a percentage of total interest-bearing liabilities and an increase in the interest rate on debt funding. Debt represented 32% of total average interest-bearing liabilities for the three months ended June 30, 2001 as compared to 25% for the same period of 2000, and represented 35% for the six months ended June 30, 2001 as compared to 25% for the same period of 2000. The average interest rate on debt funding was 9.77% for the three months ended June 30, 2001 as compared to 7.94% for the same period of 2000, and was 9.05% for the six months ended June 30, 2001 as compared to 7.74% for the same period of 2000. 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. Interest income includes late fees on business credit card receivables. Average owned receivables include certain loan fees and costs. 26 27 INTEREST RATE ANALYSIS ($ IN THOUSANDS)
THREE MONTHS ENDED JUNE 30, --------------------------- 2001 2000 ---- ---- AVERAGE YIELD/ AVERAGE YIELD/ NET INTEREST INCOME BALANCE(1) INTEREST RATE BALANCE(1) INTEREST RATE ---------- -------- ---- ---------- -------- ------ ON-BALANCE SHEET Receivables: Business credit cards $371,764 $18,841 20.33% $401,630 $18,894 18.92% Other receivables 28,184 348 4.95 19,939 153 3.09 ---------- ------- ---------- ------- Total owned receivables 399,948 19,189 19.24 421,569 19,047 18.17 Investments(2) 1,156,111 13,340 4.58 931,140 15,076 6.46 Interest-earning assets of discontinued operations 95,565 2,917 12.21 1,790,644 52,607 11.78 ---------- ------- ---------- ------- ----- Total interest-earning assets $1,651,624 $35,446 8.57% $3,143,353 $86,730 11.06% Interest-bearing liabilities(3) $1,503,172 $27,759 7.41% $3,009,002 $50,590 6.75% Net interest spread 1.16% 4.31% Net interest margin 1.87% 4.62%
SIX MONTHS ENDED JUNE 30, ------------------------- 2001 2000 ---- ---- AVERAGE YIELD/ AVERAGE YIELD/ NET INTEREST INCOME BALANCE(1) INTEREST RATE BALANCE(1) INTEREST RATE ------------------- ---------- -------- ---- ---------- -------- ---- ON-BALANCE SHEET Receivables: Business credit cards $371,118 $37,027 20.12% $373,931 $ 34,580 18.60% Other receivables 28,364 558 3.97 20,346 396 3.92 ---------- ------- ---------- -------- Total owned receivables 399,482 37,585 18.97 394,277 34,976 17.84 Investments(2) 1,137,745 29,058 5.10 924,371 29,547 6.38 Interest-earning assets of discontinued operations 339,011 25,720 15.20 1,804,193 104,576 11.63 ---------- ------- ---------- -------- Total interest-earning assets $1,876,238 $92,363 9.88% $3,122,841 $169,099 10.86% Interest-bearing liabilities(3) $1,794,907 $65,279 7.33% $2,964,843 $97,239 6.58% Net interest spread 2.55% 4.28% Net interest margin 2.91% 4.63%
(1) Includes assets held and available for sale and nonaccrual receivables. (2) Interest and average rate for tax-free securities are computed on a tax equivalent basis using a statutory rate of 35%. (3) Includes funding of assets for both continuing and discontinued operations. 27 28 OTHER REVENUES
($ in thousands) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 2001 2000 2001 2000 ---- ---- ---- ---- Investment securities gains (losses), net $(6,119) $(1,048) $(14,316) $ 9,866 Loss on sale of deposits (2,835) 0 (2,835) 0 Insurance revenues (losses), net and other 1,680 3,699 (6,571) 4,260 ------- ------- -------- ------- Total other revenues, net $(7,274) $ 2,651 $(23,722) $14,126 ======= ======= ======== =======
Investment securities gains (losses) include changes in the fair value and realized gains (losses) on venture capital investments. Investment securities losses for the three months ended June 30, 2001 include $5.6 million of decreases in valuations of venture capital investments and $0.5 million of realized losses on other investments. Investment securities losses for the six months ended June 30, 2001 also include a $4.9 million loss on the sale of a venture capital investment, $6.5 million of decreases in valuations of venture capital investments, and $3.2 million of realized gains on other investments. Investment securities gains for the six months ended June 30, 2000 include $1.4 million in gains on venture capital investments in the second quarter of 2000, $10.9 million in gains on venture capital investments in the first quarter of 2000, and $2.4 million of realized losses on other investments. In the second quarter of 2001, we sold $389.7 million of deposit liabilities to E*TRADE Bank, a wholly-owned subsidiary of E*TRADE Group, Inc., resulting in a $2.8 million loss. In the first quarter of 2001, we successfully negotiated an early termination of our strategic alliance with Progressive Casualty Insurance Company to direct market auto insurance. The loss in insurance revenues (losses), net and other for the six months ended June 30, 2001 includes operating results of insurance operations, the impact of the termination of the strategic alliance with Progressive Casualty Insurance Company and charges related to the write-off of certain assets previously associated with the auto insurance strategic alliance. 28 29 OPERATING EXPENSES
($ in thousands) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 2001 2000 2001 2000 ---- ---- ---- ---- Salaries and employee benefits $14,882 $ 7,877 $29,877 $20,433 Amortization of business credit card deferred origination costs, net 9,315 5,288 17,109 9,559 External processing 4,391 3,397 8,254 6,398 Professional/consulting fees 3,158 3,786 6,222 7,275 Marketing expense 2,150 3,511 6,974 5,296 Equipment expense 1,635 2,195 3,659 4,037 Occupancy expense 1,652 2,103 3,235 4,429 Telephone expense 757 1,184 2,230 2,242 Other 6,176 2,060 9,609 4,657 ------- ------- ------- ------- Total operating expenses $44,116 $31,401 $87,169 $64,326 ======= ======= ======= =======
Salaries and employee benefits, amortization of business credit card deferred origination costs, net, and external processing expense have increased for the three and six months ended June 30, 2001 as compared to the same periods of 2000, due primarily to increased account origination activities in Advanta Business Cards as well as the resulting growth in managed business credit card receivables. Average managed business credit card receivables increased to $1.8 billion for the three months ended June 30, 2001 from $1.3 billion for the same period of 2000, and increased to $1.8 billion for the six months ended June 30, 2001 from $1.2 billion for the same period of 2000. PROVISION AND ALLOWANCE FOR CREDIT LOSSES The provision for credit losses of $8.4 million for the three months ended June 30, 2001 increased by $3.3 million as compared to the provision for credit losses of $5.1 million for the same period of 2000. The provision for credit losses of $16.3 million for the six months ended June 30, 2001 increased by $3.6 million in comparison to the provision for credit losses of $12.7 million for the same period of 2000. The increases in provision for credit losses in both periods relate to the seasoning of the business credit card portfolio and the current economic environment. At June 30, 2001, the allowance for credit losses on a consolidated basis was $37.6 million, or 9.8% of owned receivables, as compared to $33.4 million, or 9.3% of owned receivables, at December 31, 2000. The allowance for credit losses on business credit card receivables was $37.2 million at June 30, 2001 as compared to $33.2 million at December 31, 2000. The allowance for credit losses on business credit card receivables represented 10.5% of owned receivables at June 30, 2001 and 9.9% of owned receivables at December 31, 2000. Total owned business credit card receivables 30 days or more delinquent at June 30, 2001 were 6.1% of gross receivables as compared to 5.5% at December 31, 2000. We have experienced a trend of increasing charge-off rates, consistent with our expectations of the seasoning portfolio and the current economic environment, which has been factored into our estimate of the allowance for credit losses.
Three Months Ended ------------------ Mar. Jun. Sept. Dec. Mar. Jun. 2000 2000 2000 2000 2001 2001 ---- ---- ---- ---- ---- ---- Net charge-offs as a % of owned business credit card receivables 4.1% 3.7% 4.9% 5.1% * 6.4% 6.7%
* The charge-off rate for the fourth quarter of 2000 includes a 0.5% acceleration of charge-offs to adopt a 60-day charge-off policy for bankrupt accounts. 29 30 Nonperforming assets include receivables past due 90 days or more, and bankrupt, decedent and fraudulent business credit card accounts. We charge losses on business credit card accounts against the allowance at 180 days contractually delinquent. Business credit card accounts suspected of being fraudulent are charged-off after a 90-day investigative period, unless our investigation shows no evidence of fraud. Effective October 1, 2000, bankrupt business credit cards are charged off within a 60-day investigative period after receipt of notification. The previous policy provided a 90-day investigative period. The following table provides a summary of nonperforming assets, delinquencies and charge-offs as of and for the year-to-date periods indicated ($ in thousands).
JUNE 30, DEC. 31, JUNE 30, CREDIT QUALITY 2001 2000 (A) 2000 -------------- ---- -------- ---- CONSOLIDATED - MANAGED Nonperforming assets $ 63,009 $45,160 $31,726 Receivables 30 days or more delinquent 110,867 83,798 53,593 As a percentage of gross receivables: Nonperforming assets 3.3% 2.7% 2.2% Receivables 30 days or more delinquent 5.8 5.0 3.7 Net charge-offs: Amount $ 61,852 $64,638 $25,043 As a percentage of average gross receivables (annualized) 6.9% 4.6% 4.0% CONSOLIDATED - OWNED Allowance for credit losses $ 37,568 $33,367 $20,334 Nonperforming assets 12,669 10,700 11,568 Receivables 30 days or more delinquent 22,482 19,395 19,602 As a percentage of gross receivables: Allowance for credit losses 9.8% 9.3% 3.9% Nonperforming assets 3.3 3.0 2.2 Receivables 30 days or more delinquent 5.9 5.4 3.7 Net charge-offs: Amount $ 12,123 $17,807 $ 7,201 As a percentage of average gross receivables (annualized) 6.1% 4.2% 3.7% BUSINESS CREDIT CARDS - MANAGED Nonperforming assets $ 62,606 $44,600 $31,199 Receivables 30 days or more delinquent 109,877 82,915 52,828 As a percentage of gross receivables: Nonperforming assets 3.3% 2.7% 2.2% Receivables 30 days or more delinquent 5.8 5.0 3.7 Net charge-offs: Amount $ 61,852 $64,636 $25,043 As a percentage of average gross receivables (annualized) 7.0% 4.7% 4.1% BUSINESS CREDIT CARDS - OWNED Allowance for credit losses $ 37,166 $33,165 $20,132 Nonperforming assets 12,266 10,140 11,041 Receivables 30 days or more delinquent 21,492 18,512 18,837 As a percentage of gross receivables: Allowance for credit losses 10.5% 9.9% 4.0% Nonperforming assets 3.5 3.0 2.2 Receivables 30 days or more delinquent 6.1 5.5 3.7 Net charge-offs: Amount $ 12,123 $17,805 $ 7,201 As a percentage of average gross receivables (annualized) 6.5% 4.5% 3.9%
(A) Beginning in the fourth quarter of 2000, business credit card charge-off statistics reflect the adoption of a new charge-off policy for bankruptcies. Bankrupt business credit cards are charged off within a 60-day investigative period after receipt of notification. The previous policy provided a 90-day investigative period. Business credit card charge-offs for the year ended December 31, 2000 include a 0.2% acceleration of charge-offs in connection with the adoption of this policy. 30 31 UNUSUAL CHARGES Subsequent to the sale of the mortgage business and discontinuance of our leasing business in the first quarter of 2001, we implemented a plan to restructure our corporate functions to a size commensurate with our ongoing businesses and incurred certain other unusual charges related to employee costs. The restructuring activities had no significant impact on operations while they were ongoing. Due to the termination of employees and the write-off of certain assets no longer used, we expect to realize lower personnel expenses in the 12 months following the charges, and expect to realize lower depreciation and amortization expense over the next 5-7 years. EMPLOYEE COSTS In the first quarter of 2001, we recorded a $4.1 million charge for severance and outplacement costs associated with the restructuring of corporate functions. There were 69 employees severed who were entitled to benefits. These employees worked in corporate support functions including accounting and finance, human resources, information technology, legal and facilities management. Employees were notified in March 2001, and we expect to pay severance amounts over a 12-month period. Additionally, during the first quarter of 2001, we incurred $21.6 million of other employee costs. This amount includes approximately $10 million attributable to bonuses to certain key employees in recognition of their efforts on behalf of Advanta in the strategic alternatives process. It also includes approximately $4.5 million of bonuses in recognition of the restructuring of the company and other significant transitional efforts. These bonuses will be paid over a 12-month period. In the second quarter of 2001, we recorded a $1.0 million increase in employee costs related to a revision in estimate associated with these bonuses. In 2001, we accelerated vesting of 32% of outstanding options that were not vested at the date of the closing of the sale of our mortgage business. This acceleration resulted in a non-cash charge of $1.3 million. In connection with reviewing our compensation plans after the sale of the mortgage business and restructuring of corporate functions, management identified certain programs that would not be continued, including stock appreciation rights and phantom stock programs. We recorded charges of $3.6 million associated with the settlement of outstanding stock appreciation rights and phantom stock with employees and directors. In addition, due to the restructuring of the company, we implemented a program whereby certain out-of-the money options are exchanged for shares of restricted stock. Non-cash charges associated with the issuance of the restricted stock under this program totaled $2.2 million. EXPENSES ASSOCIATED WITH EXITED BUSINESSES/PRODUCTS In 1998, in connection with the Consumer Credit Card Transaction, we made major organizational changes 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 our mortgage, business credit card and leasing units. As of December 31, 2000, the remaining accrual related to charges associated with these organizational changes was $13.0 million. This accrual related to contractual commitments to certain customers, and non-related financial institutions that were providing benefits to those customers, under a product that was no longer offered and for which no future revenues or benefits would be received. A third party assumed the liabilities 31 32 associated with these commitments in the first quarter of 2001, and we recorded an additional charge relating to the settlement of these commitments of $10.3 million. In addition, in the three months ended March 31, 2001, there were charges of $2.2 million recorded related to other products exited in the first quarter of 2001 for which no future revenues or benefits would be received. We expect to pay these costs, which include lease and other commitments, over the next 12 months. ASSET IMPAIRMENTS In connection with our plan to restructure our corporate functions to a size commensurate with our ongoing businesses during the first quarter of 2001, we identified certain assets that would no longer be used, and the carrying costs of these assets were written off resulting in a charge of $2.6 million. We estimated the realizable value of these assets to be zero due to the nature of the assets, which include leasehold improvements and capitalized software. INCOME TAXES Income tax expense (benefit) is based on the estimated annual effective tax rate of 29% for the six months ended June 30, 2001, compared to a 0% tax rate for the comparable 2000 period. The income tax benefit for the six months ended June 30, 2001 represents the benefit we expect to realize over the remaining six months of fiscal year 2001. 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, 2001, our net interest income over a 12-month period would increase by approximately 3% if interest rates were to rise by 200 basis points, and that our net interest income over a 12-month period would decrease by approximately 1% if interest rates were to fall by 200 basis points. We also measure the effect of interest rate risk on our managed interest income, which includes net interest income on owned assets and net interest income on securitized receivables. We estimate that at June 30, 2001, our managed net interest income over a 12-month period would decrease by approximately 8 to 10% if interest rates were to rise by 200 basis points, and that our managed net interest income over a 12-month period would increase by approximately 10 to 12% if interest rates were to fall by 200 basis points. Our business credit card receivables include interest rate floors that cause our managed net interest income to rise in the declining rate scenario. The interest rate floors also cause a decrease in managed net interest income in a rising rate scenario. Current rates are well below certain of the interest rate floors, and a 200 basis point increase in rates would not impact the contractual rate on a substantial portion of the receivables. 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. 32 33 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. 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, 2001, we securitized approximately $215 million of business credit card receivables. At June 30, 2001, we had $444 million of federal funds sold, $154 million of receivables held for sale, and $98.7 million of investments, which could be sold to generate additional liquidity. Components of funding were as follows:
June 30, 2001 December 31, 2000 ------------- ----------------- Amount % Amount % ------ - ------ - Off-balance sheet business credit card receivables $1,545,326 50% $1,324,137 33% Deposits 654,228 21 1,346,976 34 Debt and other borrowings 401,334 13 759,473 19 Equity, including capital securities 510,947 16 540,902 14 ---------- --- ---------- --- Total $3,111,835 100% $3,971,488 100% ---------- --- ---------- ---
At June 30, 2001, we had a $280 million committed commercial paper conduit facility secured by business credit card receivables, of which $235 million was unused at June 30, 2001. In the first quarter of 2001, we received in excess of $1 billion in cash proceeds from the sale of our mortgage business. We have strategically used the proceeds to strengthen Advanta for the future, including a significant reduction in our leverage. In the second quarter of 2001, we sold $389.7 million of our deposit liabilities to E*TRADE Bank, a wholly-owned subsidiary of E*TRADE Group, Inc. We also paid off substantially all of our outstanding medium-term notes and reduced our outstanding retail notes. In the three months ended June 30, 2001, we reduced debt and deposits by $902 million. Also, because of our current liquidity position, Advanta Corp. is temporarily not originating or renewing retail notes and Advanta National Bank has suspended originations of deposit accounts. The sale of the mortgage business in the first quarter of 2001 resulted in liquidity in excess of the needs of our continuing businesses. Excess liquid assets are being held in short-term, high-quality investments earning money market rates until they can be deployed. As a result we had interest expense in excess of interest income on this excess liquidity in 2001. The deposit sale and significant debt reduction in the second quarter of 2001 will reduce this net interest expense and excess liquidity. However, we expect to continue to have interest expense in excess of interest income on excess liquidity for the next several quarters due to the time required to reduce interest-bearing liabilities. In the first quarter of 2001, we successfully negotiated an early termination of our strategic alliance with Progressive Casualty Insurance Company to 33 34 direct market auto insurance and received regulatory approval for a dividend from our insurance subsidiary to the parent company. The insurance dividend, along with other payments from the insurance subsidiary in the first quarter of 2001, increased parent liquidity by $62.5 million. In the second quarter of 2001, there was an additional dividend from an insurance subsidiary of $5.6 million. In the first quarter of 2001, after consideration of the parent liquidity and the capital requirements for the ongoing business, the Board of Directors of Advanta Corp. authorized management to purchase up to 1.5 million shares of Advanta Corp. common stock or the equivalent dollar amount of our capital securities, or some combination thereof. We intend to make purchases modestly and when we believe it is prudent to do so while we analyze evolving capital requirements. As of July 31, 2001, we have repurchased approximately 120,000 shares of our Class B Common Stock. Our regulatory agreements with the Office of the Comptroller of the Currency (the "OCC") and the Federal Deposit Insurance Corporation prohibit the payment of dividends by Advanta National Bank or Advanta Bank Corp. without prior regulatory approval. In connection with the sale of our mortgage business in the first quarter of 2001, Advanta National Bank sought approval of the OCC for a return of capital to Advanta Corp. in the amount of $261 million. On February 28, 2001, the OCC approved the amount requested and, at the same time, Advanta National Bank entered into an agreement with the OCC regarding restrictions on new business activities and product lines at Advanta National Bank after the sale of the mortgage business and the resolution of outstanding Advanta National Bank liabilities. The agreement also reduced the capital requirements for Advanta National Bank to 12.7% for Tier 1 and Total capital to risk-weighted assets, and to 5% for Tier 1 capital to adjusted total assets as defined in the agreement. In addition, the agreement provides for prior OCC approval of any future dividends. Advanta Bank Corp. is unaffected by the agreement with the OCC. At June 30, 2001, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 20.30%, and Advanta Bank Corp.'s combined total capital ratio was 15.36%. At December 31, 2000, Advanta National Bank's combined total capital ratio (combined Tier I and Tier II capital) was 15.08% and Advanta Bank Corp.'s combined total capital ratio was 14.60%. 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 our agreement with the OCC, even though we have achieved the higher imposed capital ratios required by the agreement. Recently, guidelines were issued jointly by the federal bank regulatory agencies regarding additional requirements for subprime lenders, including additional capital requirements. Under the guidelines, regulatory capital required to be held for certain loan classes included in Advanta Bank Corp.'s portfolio could be increased. In addition, in a draft proposal recently issued jointly by the federal bank regulatory agencies, capital requirements associated with certain residual interests would be amended to require capital equal to the residual retained, regardless of retained recourse levels. Further, the proposal requires residuals in excess of 25% of Tier 1 capital to be treated as a deduction of 34 35 Tier 1 capital for purposes of risk-based and leverage capital calculations. In another draft proposal recently issued jointly by the federal bank regulatory agencies, the agencies would use credit ratings and certain alternative approaches to match the risk-based capital requirement more closely to a banking organization's relative risk of loss in asset securitizations. The proposal also requires the sponsor of a revolving credit securitization that involves an early amortization feature to hold capital against the amount of assets under management (the off-balance sheet securitized receivables). The proposal treats recourse obligations and direct credit substitutes more consistently than under the agencies' current risk-based capital standards. The ultimate resolution of these proposals and their 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." 35 36 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On January 22, 1999, Fleet and certain of its affiliates filed a lawsuit against Advanta Corp. and certain of its subsidiaries in Delaware Chancery Court. Fleet's allegations, which we deny, center around Fleet's assertions that we failed to complete certain post-closing adjustments to the value of the assets and liabilities we contributed to Fleet LLC in connection with the Consumer Credit Card Transaction. Fleet seeks damages of approximately $141 million. We have filed an answer to the complaint denying the material allegations of the complaint, but acknowledging that we contributed $1.8 million in excess liabilities in the post-closing adjustment process, after taking into account the liabilities we have already assumed. We also have filed a countercomplaint against Fleet for approximately $101 million in damages we believe 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 October 2001. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results. On December 5, 2000, a former executive of Advanta obtained a jury verdict against Advanta in the amount of $3.9 million, in connection with various claims against Advanta related to the executive's termination of employment. Both parties filed post-trial motions. The former executive has filed a motion for a new trial with respect to his claims that were dismissed. The former executive is seeking, among other things, an award of approximately $6 million based upon the jury verdict and additional amounts, including attorney's fees and costs of $1.2 million. We will vigorously pursue our post-trial motions, and if necessary, an appeal to the United States Court of Appeals for the Third Circuit and will continue to contest the former executive's positions. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results. On December 21, 2000, Banc One Financial Services, Inc. and Bank One, N.A (together "Banc One") filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, that alleges, among other things, that Advanta breached two mortgage loan servicing agreements by wrongfully withholding as termination fees an amount in excess of $23 million, from amounts that we had collected under the loan servicing agreements, and by failing to perform under those agreements in certain respects. We dispute these claims and allegations. An answer to Banc One's second amended complaint was filed July 3, 2001 denying liability, raising affirmative defenses and asserting a counterclaim. The case is in active discovery with a discovery cut-off date of April 2, 2002 and a trial ready date of May 2, 2002. Management expects that the ultimate resolution of this litigation will not have a material adverse effect on our financial position or future operating results. On February 1, 2001, Fleet and certain of its affiliates filed a complaint in Delaware Chancery Court in an attempt to block the sale of our mortgage business to Chase Manhattan Mortgage Corporation. The complaint alleged that the terms of the proposed sale of our mortgage business breach a provision of Fleet's 1998 agreement to acquire our consumer credit card business, as amended (the "Contribution Agreement"), that essentially requires a buyer of 36 37 "substantially all" of our assets to assume any of our remaining obligations under the Contribution Agreement at the time of the sale of "substantially all" of our assets. In February 2001, we announced that we had reached an agreement with Fleet, with regard to Fleet's attempt to block the sale. As part of the agreement, Fleet dismissed its injunction claim and agreed that it would raise no future issue with respect to the sale of the mortgage business. Under the agreement, $70.1 million of our reserves in connection with our long-standing litigation with Fleet were funded in an escrow account. The court presiding over the claims will order the funds paid to Advanta or to Fleet depending upon the outcome of that litigation. The amount escrowed, $70.9 million including interest, represents our maximum exposure to Fleet in the litigation, assuming a court were to rule in favor of Fleet on every claim involved in the litigation. On July 26, 2001, Chase Manhattan Mortgage Corporation ("Chase") filed a complaint against Advanta and certain of its subsidiaries in the United States District Court for the District of Delaware alleging, among other things, that Advanta breached its contract with Chase in connection with the sale of Advanta's mortgage business to Chase. Specifically, Chase claims that Advanta misled Chase concerning the value of certain of the assets sold to Chase. We believe that the lawsuit is without merit and will vigorously defend Advanta. We do not expect this lawsuit to have any impact on our continuing business and, based on the complete lack of merit, we do not anticipate that the lawsuit will have a material adverse impact to Advanta or the named subsidiaries. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) Advanta Corp. held its Annual Meeting of Stockholders on June 21, 2001. (b) Not required. (c) The following proposal was submitted to a vote of stockholders. (i) The election of three directors to hold office until the 2004 Annual Meeting of Stockholders.
NOMINEES VOTES FOR VOTES WITHHELD -------- --------- -------------- Dennis Alter 8,242,839 1,458,805 Dana Becker Dunn 9,438,058 263,606 Arthur Bellis 9,397,402 304,262
37 38 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 ------ ----------------------- 2.1 Purchase and Assumption Agreement, dated as of May 7, 2001, by and between Advanta Corp. and E*TRADE Bank. 12 Consolidated Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K (b)(1) A Current Report on Form 8-K, dated April 9, 2001, was filed by Advanta announcing that $237.7 million of medium-term notes had been tendered in response to the tender offer which was announced March 7, 2001. (b)(2) A Current Report on Form 8-K, dated April 24, 2001, was filed by Advanta setting forth the financial highlights of Advanta's results of operations for the three months ended March 31, 2001. (b)(3) A Current Report on Form 8-K, dated June 28, 2001, was filed by Advanta announcing its sale of $389.7 million of deposit liabilities to E*TRADE Bank, a wholly-owned subsidiary of E*TRADE Group, Inc. 38 39 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, 2001 By /s/Philip M. Browne -------------------------- Senior Vice President and Chief Financial Officer August 14, 2001 By /s/David B. Weinstock -------------------------- Vice President and Chief Accounting Officer 39 40 EXHIBIT INDEX
EXHIBIT DESCRIPTION ------- ----------- 2.1 Purchase and Assumption Agreement, dated as of May 7, 2001, by and between Advanta Corp. and E*TRADE Bank. 12 Consolidated Computation of Ratio of Earnings to Fixed Charges
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