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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 NO. 0-14120
ADVANTA CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<Table>
DELAWARE 23-1462070
(STATE OR OTHER JURISDICTION OF ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
WELSH & MCKEAN ROADS, P. O. BOX 844,
SPRING HOUSE, PENNSYLVANIA 19477
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</Table>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (215) 657-4000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<Table>
<Caption>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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NONE N/A
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
CLASS A COMMON STOCK, $.01 PAR VALUE
CLASS B COMMON STOCK, $.01 PAR VALUE
CLASS A RIGHT
CLASS B RIGHT
(TITLE OF EACH CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K Yes [ ].
State the aggregate market value of the voting and nonvoting common equity
held by non-affiliates of the registrant. The aggregate market value shall be
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within 60 days prior
to the date of filing. (See definition of affiliate in Rule 405.)
$264,825,636 as of March 11, 2002 which amount excludes the value of all
shares beneficially owned (as defined in Rule 13d-3 under the Securities
Exchange Act of 1934) by officers and directors of the Company (however, this
does not constitute a representation or acknowledgment that any of such
individuals is an affiliate of the Registrant).
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
As of March 11, 2002 there were 10,041,017 shares of the Registrant's Class
A Common Stock, $.01 par value, outstanding and 18,730,170 shares of the
Registrant's Class B Common Stock, $.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the
Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(e) under the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980).
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<Caption>
DOCUMENT FORM 10-K REFERENCE
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Definitive Proxy Statement relating to the Registrant's 2002 Part III, Items 10-13
Annual Meeting of Stockholders, to be filed pursuant to
Regulation 14A not later than 120 days following the end of
the Registrant's last fiscal year
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PART I
ITEM 1. BUSINESS
In this Form 10-K, "Advanta", "we", "us", "our" and the "Company" refer to
Advanta Corp. and its subsidiaries, unless the context otherwise requires.
OVERVIEW
Advanta is a highly focused financial services company. We have been providing
innovative financial products and solutions since 1951. Currently, our lending
business consists of Advanta Business Cards, one of the nation's largest issuers
of MasterCard(R)* business credit cards to small businesses. In addition to
Advanta Business Cards, we have venture capital investments. We own two
depository institutions, or banks, Advanta Bank Corp. and Advanta National Bank.
We primarily fund and operate our business credit card business through Advanta
Bank Corp. We also own two insurance companies, Advanta Life Insurance Company
and Advanta Insurance Company, through which we offer specialty credit-related
insurance and related products to our existing customers.
At December 31, 2001, we had approximately $2.1 billion in managed
receivables. Managed receivables include both owned and securitized receivables.
Through the first quarter of 2001, we had two additional lending
businesses, Advanta Mortgage and Advanta Leasing Services. During the first
quarter of the year ended December 2001, we exited our mortgage business and
ceased originating new leases in our small ticket equipment leasing business. We
are, however, continuing to service the existing leases in our small ticket
equipment leasing portfolio rather than sell the business or the portfolio.
Pursuant to the terms of the purchase and sale agreement, dated January 8,
2001, as amended, by and between Advanta and Chase Manhattan Mortgage
Corporation, a New Jersey corporation ("Buyer"), Advanta and certain of its
subsidiaries transferred and assigned to Buyer and certain of its affiliates
substantially all of the assets and operating liabilities associated with
Advanta's mortgage business. This transaction is referred to throughout this
Form 10-K as the "Mortgage Transaction." The Mortgage Transaction was
consummated on March 1, 2001, effective as of February 28, 2001 (the "Closing
Date").
The assets acquired by Buyer in the Mortgage Transaction consist of loans
receivable, retained interests in securitizations and other receivables,
contractual mortgage servicing rights and other contractual rights, property and
equipment, and prepaid assets. The liabilities assumed by Buyer in the Mortgage
Transaction consist primarily of certain of our contractual obligations and
other liabilities that appeared on our balance sheet, as well as specified
contingent liabilities arising out of the operation of the mortgage business
before closing that are identified in the purchase and sale agreement.
Following the Mortgage Transaction, we no longer operate a mortgage
business. However, we have retained contingent liabilities, primarily relating
to litigation, arising out of our operation of the mortgage business before the
Closing Date that were not specifically assumed by Buyer in the Mortgage
Transaction.
Advanta Corp. was incorporated in Delaware in 1974 as Teachers Service
Organization, Inc., the successor to a business originally founded in 1951. In
January 1988, we changed our name from TSO Financial Corp. to Advanta Corp. Our
principal executive office is located at Welsh & McKean Roads, P.O. Box 844,
Spring House, Pennsylvania 19477-0844. Our telephone number at our principal
executive office is (215) 657-4000.
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* MasterCard(R) is a federally registered servicemark of MasterCard
International, Inc.
1
CONTINUING OPERATIONS
ADVANTA BUSINESS CARDS
Overview
Advanta Business Cards, a business unit of Advanta, is one of the nation's
leading providers of business credit cards to small businesses. Advanta Business
Cards offers business credit cards to small businesses using targeted direct
mail, the Internet and telemarketing solicitation of potential cardholders. The
"Advanta Business Card" is issued and funded by Advanta Bank Corp.
Our principal objectives are to use our information based strategy to
continue to prudently grow our business while increasing profitability. Based on
our experience and expertise in analyzing the credit behavior and
characteristics of consumers and small businesses, we have developed an
extensive database of customer information and attributes. We use this
information in conjunction with proprietary credit scoring, targeting and other
sophisticated analytical models we have developed to market our products to
prospective customers. We measure the expected behavior of our prospects by
analyzing, among other things, a prospect's responsiveness, creditworthiness,
sensitivity to price and expected transaction volume. We continually validate
our models based on actual results from marketing campaigns, and use this
information to refine and improve our analytical assumptions. The information we
gather and analyze allows us to market directly to specific customer segments,
target prospects effectively, anticipate customer needs, customize our pricing
and products to meet those needs.
Our primary product is a MasterCard business credit card. We also offer a
limited number of Visa(R)** business credit cards. MasterCard and Visa license
banks and other financial institutions, such as Advanta Bank Corp., to issue
credit cards using their servicemarks and to use the interchange network.
Advanta Bank Corp. receives an interchange fee as compensation for the funding
and credit and fraud risks it assumes when its cardholders use the Advanta
Business Card. Our business credit cards provide our customers with access,
through merchants, banks and ATMs, to an instant unsecured revolving business
credit line. Under the terms of our cardholder agreements, our business cards
may be used for business purposes only.
We offer a number of benefits that we believe are important to small
business owners including:
- additional cards for employees at no fee with the ability to set
individual spending limits;
- on-line detailed expense management reports that categorize purchases and
itemize charges for recordkeeping and tax purposes; and
- customized cards and business checks.
Our business credit card also offers free auto rental insurance, free purchase
protection service for a specified time period and several free emergency
assistance and referral services.
We also offer rewards programs on a limited basis, generally for an annual
fee. Under the rewards programs, the cardholder may receive credit toward the
purchase of airline tickets and/or other rewards, such as cash rebates, based on
their card purchases. Additionally, we offer a travel card. Use of the travel
card entitles the cardholder to earn bonus miles toward free air travel and
other travel-related benefits. We expect to continue to expand our business
credit card product offerings and look for innovative ways to tailor products to
the unique needs of small businesses.
The interest rate and credit line size we offer vary and are ultimately
determined based upon the credit history and creditworthiness of the borrower.
At December 31, 2001, the average credit line was approximately $10,000. The
interest rate is generally based on a LIBOR (London Interbank Offered Rate) or
Prime Rate index. In most cases, the interest rate will change with changes in
LIBOR or the Prime Rate, as applicable, and is subject to a minimum below which
the interest rate cannot fall.
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** Visa(R) is a registered servicemark of Visa International, Inc.
2
We generate interest and other income through finance charges assessed on
outstanding loans, interchange income, and cash advance and other credit card
fees. We also generate income through specialty credit-related insurance
products and services we offer to our business credit card customers through our
insurance subsidiaries.
The managed portfolio of Advanta Business Cards grew from $1.66 billion at
December 31, 2000 to $2.04 billion at December 31, 2001. In 2001, approximately
98% of Advanta's total revenues from continuing operations were derived from
Advanta Business Cards. See Note 18 to the consolidated financial statements for
additional segment financial information about Advanta Business Cards.
Originations
We originate substantially all of our business credit card accounts using direct
marketing techniques, including direct mail, telemarketing solicitation and the
Internet. We periodically mail solicitations for an Advanta MasterCard or Visa
business credit card. Similarly, we use inbound and outbound telemarketing to
solicit applicants. We offer applications and instant credit decisions online.
Our marketing program is the result of extensive ongoing testing of various
marketing campaigns that target different segments of the small business market.
The success of each campaign is measured by the profitability of the campaign,
including both the cost of acquisition of new business and the credit
performance of the resulting business. We originated over 224,000 new business
credit card accounts during the year ended December 31, 2001.
Our sources for potential customers include the use of external credit
reporting agencies, the purchase of customer lists from establishments with a
small business customer base, strategic alliances with companies and
associations with a small business customer base and linking with other websites
on the Internet that serve small businesses. In an effort to expand our customer
reach, we are testing new sources for identifying potential customers.
Underwriting
We have developed sophisticated modeling techniques for assessing the
creditworthiness of potential cardholders. Because the owner of the business is
a joint obligor on our business credit card, we may consider credit-related and
other relevant data about both the business and the individual owner of the
business in our assessment of the creditworthiness of potential cardholders.
Through the application process, we verify the applicant's demographic
information and collect current sales and income statistics. This information,
coupled with credit reports received from external credit reporting agencies,
forms the basis for our decision to extend credit. Using a proprietary scoring
system, we rank our prospective cardholders based upon their expected
creditworthiness and profitability potential.
When a cardholder is first approved, our profile of that cardholder is
limited and based solely on historical information generated by third parties
and information provided by the customer at the time of application. As we
compile information regarding each cardholder's behavior over time, we maintain
and continually update our performance database. We use the information we
gather over time regarding actual account performance and cardholder behavior as
a basis for predicting a cardholder's future performance. We use this
information to periodically re-score the cardholder based on all of the
information we accumulate, and to evaluate and potentially adjust the interest
rate and the credit line size that we make available to the cardholder.
Pricing
We continually test different pricing strategies. Our pricing strategies include
a combination of promotional pricing and risk-based pricing. We offer a range of
potential interest rates to potential cardholders. Our offers are subject to
verification of information provided by the potential cardholder through the
application process.
We offer primarily variable rate credit card accounts. The periodic finance
charge assessed on balances in most of these accounts is indexed to LIBOR or the
Prime Rate, plus an add-on percentage or spread. In most cases, the rate will
change with changes in LIBOR or the Prime Rate, as applicable, and is subject to
a
3
minimum below which the rate cannot fall. In addition the rate may vary
depending on the type of transaction. For example, cash advances are generally
subject to a higher periodic finance charge rate than merchandise transactions.
With notice, we may reprice any account at our discretion, based upon a variety
of factors indicating a risk of future nonpayment, such as changes in a
cardholder's credit standing. The credit line size may also be adjusted up or
down based on our continual credit monitoring. To discourage delinquent
payments, we use "penalty pricing" and automatically increase the interest rate
on any account that exceeds the delinquency level set forth in the applicable
cardholder agreement or is otherwise in default. The amount of the automatic
increase may vary, but typically we add 3% to the existing interest rate on an
account.
Servicing and Collections
We perform most of the servicing and collections for our business credit card
accounts in-house. Certain data processing and administrative functions
associated with the servicing of our business credit card portfolio are
outsourced to First Data Resources, Inc. Services performed by First Data
Resources include: authorizing transactions through the MasterCard and Visa
systems; performing billing and settlement processes; generating and monitoring
monthly billing statements; and issuing credit card plastics and new account
agreements.
We have a collections staff that performs the collection activities for our
business credit cards. Accounts are "contractually delinquent" if the minimum
payment is not received by the due date. We discourage delinquent payments by
assessing a late fee and the collections staff pursues late payments
aggressively and immediately.
Efforts to collect contractually delinquent credit cards currently are made
by our collections personnel or their designees. Collection activities include
statement messages, formal collection letters and telephone calls. Collection
personnel initiate telephone contact with delinquent cardholders as early as the
first day the cardholder becomes contractually delinquent. The intensity with
which collection activity is pursued depends on the risk the account presents to
us, which is determined by behavioral scoring and adaptive control techniques.
If initial telephone contact fails to resolve the delinquency, we continue to
contact the cardholder by telephone and by mail.
Delinquency levels are monitored by management of our collections, asset
quality and credit departments and information is reported daily to senior
management. Accounts are charged-off when they become 180 days contractually
delinquent, at which time delinquent accounts of cardholders who have not filed
bankruptcy are generally referred to outside collection agencies. We charge-off
accounts suspected of being fraudulent after a 90-day investigative period
unless our investigation shows no evidence of fraud.
Effective October 1, 2000, the accounts of customers who become debtors in
bankruptcy cases are charged-off when they become 180 days contractually
delinquent or within 60 days of receipt of notification of filing from the
bankruptcy court, whichever is shorter. Prior to October 1, 2000, instead of a
60-day investigation period we used a 90-day investigation period prior to
charge-off to determine whether we should challenge the cardholder's bankruptcy
petition or the discharge of amounts owed to us. Our credit evaluation,
servicing and charge-off policies and collection practices may change from time
to time in accordance with our business judgment and applicable laws and
regulations.
VENTURE CAPITAL INVESTMENTS
We make venture capital investments through our affiliates, including Advanta
Partners LP and Advanta Growth Capital Fund L.P. Advanta Partners LP focuses
primarily on growth capital financings, restructurings and management buyouts in
the financial services, electronic commerce relationship management services and
other consumer and data information management services industries. Advanta
Growth Capital Fund L.P. focuses primarily on earlier stage investment
opportunities in the technology and information services sectors, including the
areas of wireless services, electronic commerce and direct marketing. The
investment objective of our investment affiliates 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. Our investments in
specific companies and industry
4
segments may vary over time. We primarily invest in privately-held companies,
including early stage companies. These investments are inherently risky as the
market for the technologies and products the investees have under development
may never materialize. See Note 18 to the consolidated financial statements for
additional segment financial information about our venture capital investments.
ADVANTA INSURANCE
Our life/health and property/casualty insurance subsidiaries, Advanta Life
Insurance Company and Advanta Insurance Company, respectively, provide insurance
and related products mostly to existing Advanta customers. Together with
unaffiliated insurance carriers, we offer specialty credit-related insurance
products and services to our existing business credit card and leasing
customers. Advanta Insurance uses direct mail marketing and telemarketing to
enroll customers in these programs. The focus of these products is on the
customers' ability to repay their debt. These products include coverage for loss
of life, disability, involuntary unemployment, accidental death, and lost or
damaged equipment. Our insurance subsidiaries generally reinsure all or a
portion of the risks associated with these products or services. Under
reinsurance agreements, our insurance subsidiaries assume a proportional quota
share of the risk from the unaffiliated insurance carriers. In consideration for
assuming these risks, our insurance subsidiaries receive reinsurance premiums
equal to the proportional percentage of the net premiums collected by the
insurance carriers, less a ceding fee as defined by the reinsurance treaties,
and proportional acquisition expenses, premium taxes and loss payments made by
the carriers on these risks.
Through a strategic alliance with Progressive Casualty Insurance Company
formed in 1996 for an initial term of 5 years, Advanta Insurance provided its
direct marketing expertise to market Progressive's automobile insurance policies
nationwide. In the first quarter of 2001, we negotiated an early termination of
the strategic alliance.
DEPOSITORY INSTITUTIONS
We own two depository institutions, Advanta Bank Corp. and Advanta National
Bank. Advanta Bank Corp. is an industrial loan corporation organized under the
laws of the State of Utah with its principal executive offices located in
Draper, Utah. Advanta Bank Corp.'s principal activity consists of the issuance
of the "Advanta Business Card" credit card to small businesses. Prior to first
quarter 2001, Advanta Bank Corp. also was involved in our small ticket equipment
leasing business and our mortgage business. We no longer operate a mortgage
business or originate new equipment leases. However, Advanta Bank Corp.
continues to be involved in the small ticket equipment leasing business because
we are continuing to service our existing lease portfolio. See "-- DISCONTINUED
OPERATIONS."
Advanta National Bank is a national banking association organized under the
laws of the United States of America with its headquarters and sole branch
currently located in Wilmington, Delaware. Prior to February 28, 2001, we
conducted a large portion of our mortgage business through Advanta National
Bank.
DEPOSIT, SAVINGS AND INVESTMENT PRODUCTS
Deposits with each of our bank subsidiaries are insured by the Federal Deposit
Insurance Corporation ("FDIC"). Through our banks we are able to offer a range
of insured deposit products. Advanta Bank Corp.'s deposit products include
retail certificates of deposit and large denomination certificates of deposit of
$99,000 or more. Advanta Bank Corp. generates retail deposits from repeat
deposits from existing customers and from new depositors attracted by direct
mail solicitations, newspaper and other media advertising, and the Internet.
In the past, Advanta National Bank's deposit products have included money
market savings accounts, retail certificates of deposit and large denomination
certificates of deposit of $99,000 or more. Following the Mortgage Transaction,
Advanta National Bank had excess cash liquidity. As a result, Advanta National
Bank suspended originating deposit accounts. To further reduce this excess
liquidity, on June 25, 2001, Advanta
5
National Bank sold substantially all of its deposit liabilities to E*TRADE Bank,
a subsidiary of E*TRADE Group, Inc.
At December 31, 2001, we had total deposits of $636.9 million at our banks,
compared to $1.3 billion as of December 31, 2000. Substantially all of the
deposits as of December 31, 2001 were at Advanta Bank Corp.
Since 1951, Advanta Corp. and its predecessor, Teachers Service
Organization, Inc., have offered unsecured debt securities of the corporation,
in the form of RediReserve Certificates and Investment Notes, to retail
investors through our retail note programs. These debt securities, also referred
to in this Form 10-K as "retail notes," have been sold predominantly on a direct
basis by Advanta in select states. The RediReserve Variable Rate Certificates
are payable on demand and the maturities on the Investment Notes range from 90
days to ten years. The RediReserve Certificates and Investment Notes generally
require an initial minimum investment of $5,000 and are obligations of Advanta
Corp. and are not insured or guaranteed by any public or private entity. We
change the interest rates that we offer frequently, depending on market
conditions and our funding needs. The rates also vary depending on the size of
each investment. At December 31, 2001, $323.4 million of RediReserve
Certificates and Investment Notes were outstanding with interest rates ranging
from 3.00% to 11.56%.
DISCONTINUED OPERATIONS
ADVANTA LEASING SERVICES
Overview
On January 23, 2001, after a thorough review of strategic alternatives available
to our leasing business, we decided to cease originating new equipment leases.
However, we are continuing to service the existing leasing portfolio.
Prior to January 23, 2001, Advanta Leasing Services, a business unit of
Advanta, offered flexible lease financing programs to small businesses. The
primary products that we offered through our leasing business consisted of
leases for small-ticket items such as computers, copiers, fax machines and other
office equipment.
Advanta Leasing Services originated and funded its leases and other
equipment financing arrangements through Advanta Bank Corp. Advanta Business
Services Corp. conducted the marketing, lease originations, customer service and
collections for our leasing business.
Our leases are generally priced on a fixed rate basis. At December 31,
2001, the leases in our portfolio had an average lease size of approximately
$6,700 and an average lease term remaining of approximately 26 months.
Managed lease receivables at December 31, 2001 totaled approximately $421
million, compared to approximately $758 million at December 31, 2000. By the end
of 2002, the managed lease receivables are expected to total approximately $200
million. See Note 2 to the consolidated financial statements for additional
financial information about Advanta Leasing Services.
Originations
Prior to our decision to cease new leasing originations, Advanta Leasing
Services originated leases through marketing programs, vendors, brokers and bulk
or portfolio purchases.
Servicing and Collections
We are continuing to service our existing portfolio of equipment leases. As part
of our servicing we will continue to perform collection activities with respect
to delinquent contracts. Each lease contract has a provision for assessing late
charges in the event that a customer fails to make a payment on the contract on
the
6
related due date. We typically initiate telephone contact when an account is
between one and 16 days past due, depending on certain established criteria.
Telephone contact is continued throughout the delinquency period. If the account
continues to be delinquent, Advanta Leasing Services may exercise any remedies
available to it under the terms of the contract, including termination and
acceleration of the payments due pursuant to the lease contract. We evaluate
each contract on the merits of the individual situation taking into
consideration the equipment value and the current financial strength of the
customer.
If collection activities are unsuccessful, we typically charge-off the
account at 120 days past due. An account may be charged-off prior to 120 days if
we determine that no further payments will be made. In cases where the customer
files for bankruptcy, Advanta Leasing Services' Legal Recovery Department
follows up with the debtor to determine whether the debtor intends to assume or
reject the contract. In many cases, although the customer has filed for
bankruptcy protection from its creditors, it continues to make regular payments
on its contract. At the time a non-bankruptcy account is charged-off, the
account is referred to our in-house litigation department to determine whether
we will pursue the customer or any personal guarantor on the contract through
litigation. If we determine not to pursue an account through litigation it may
be referred to a third party collection agency to enforce the original terms of
the contract.
ADVANTA MORTGAGE
Effective February 28, 2001, we closed the Mortgage Transaction and no longer
operate a mortgage business. In accordance with the terms of the purchase and
sale agreement, Buyer acquired substantially all of the assets and operating
liabilities associated with our mortgage business for a purchase price, net of
operating liabilities assumed by Buyer, exceeding $1 billion. Following the
Mortgage Transaction, we retained contingent liabilities, primarily relating to
litigation arising out of the operation of the mortgage business through the
Closing Date, that were not specifically assumed by Buyer. See "-- OVERVIEW."
Prior to the closing of the Mortgage Transaction, Advanta Mortgage, a
business unit of Advanta, offered a broad range of mortgage products and
services to consumers throughout the country. Advanta Mortgage originated and
serviced non-conforming credit first and second lien mortgage loans, including
home equity lines of credit. In addition to servicing and managing the loans we
originated, Advanta Mortgage serviced the home equity loans of unaffiliated
third parties through our subservicing business. Subserviced loans are not
included in our portfolio of managed receivables and we did not bear the risk of
credit loss on our subserviced portfolio.
Prior to the closing of the Mortgage Transaction, at December 31, 2000,
Advanta Mortgage's portfolio of subserviced loans totaled approximately $7.9
billion and our total serviced portfolio, including the "subserviced" portfolio,
was $15.8 billion. See Note 2 to the consolidated financial statements for
additional financial information about Advanta Mortgage.
GOVERNMENT REGULATION
ADVANTA CORP.
Advanta Corp. is not required to register as a bank holding company under the
Bank Holding Company Act of 1956, as amended (the "BHCA"). We own Advanta
National Bank, which is a "bank" as defined under the BHCA, as amended by the
Competitive Equality Banking Act of 1987 ("CEBA"). However, under grandfathering
provisions of CEBA, we are not required to register as a bank holding company
because Advanta National Bank, which takes demand deposits but does not make
commercial loans, did not come within the BHCA definition of the term "bank"
prior to the enactment of CEBA. Under CEBA, our other banking subsidiary,
Advanta Bank Corp., also is not considered a "bank" for purposes of the BHCA.
Accordingly, our ownership of Advanta Bank Corp. does not impact our exempt
status under the BHCA. Because we are not a bank holding company, we are not
subject to examination by the Federal Reserve Board, other than for purposes of
assuring continued compliance with the CEBA restrictions discussed below.
Under CEBA, Advanta National Bank is subject to certain restrictions, such
as the limitation that it may either take demand deposits or make commercial
loans, but may not do both. In addition, under CEBA Advanta National Bank may
not acquire control of more than 5% of the stock or assets of an additional
"bank" or "savings association," as these terms are defined in the BHCA. The
Gramm-Leach-Bliley Financial
7
Modernization Act of 1999 ("GLB Act") was adopted on November 12, 1999 and
became effective on May 12, 2000. Prior to the enactment of the GLB Act, if
Advanta Corp. or Advanta National Bank had ceased complying with the
restrictions set forth in CEBA, registration as a bank holding company under the
BHCA would have been required. Registration as a bank holding company is not
automatic and, if we were to register, it would subject us and our subsidiaries
to inspection and regulation by the Federal Reserve Board. Under the GLB Act,
should Advanta Corp. or Advanta National Bank fail to comply with any of the
restrictions applicable to them under CEBA, there is a 180-day right to cure
period following receipt of a notice from the Federal Reserve Board. The
opportunity to cure or remediate an activity that is out of compliance
significantly reduces the risk that Advanta Corp. will be required to register
as a bank holding company under the BHCA.
ADVANTA BANK CORP.
Advanta Bank Corp., a Utah-chartered industrial loan corporation, is a
depository institution subject to regulatory oversight and examination by both
the FDIC and the Utah Department of Financial Institutions. See "-- Regulatory
Agreements." Under its banking charter, Advanta Bank Corp. may make consumer and
commercial loans and may accept all FDIC-insured deposits other than demand
deposits such as checking accounts. Advanta Bank Corp. is subject to the same
regulatory and supervisory processes as commercial banks.
Advanta Bank Corp. is subject to provisions of federal law which restrict
and control its ability to extend credit and provide or receive services between
affiliates. In addition, the FDIC has regulatory authority to prohibit Advanta
Bank Corp. from engaging in any unsafe or unsound practice in conducting its
business.
Advanta Bank Corp. is subject to capital adequacy guidelines issued by the
Federal Financial Institutions Examination Council (the "FFIEC"). These
guidelines make regulatory capital requirements more sensitive to differences in
risk profiles among banking organizations and consider off-balance sheet
exposures in determining capital adequacy. Under the rules and regulations of
the FFIEC, at least half of a bank's total capital is required to be "Tier I
capital," comprised of common equity, retained earnings and a limited amount of
non-cumulative perpetual preferred stock. The remaining capital, "Tier II
capital," may consist of other preferred stock, certain hybrid debt/equity
instruments, a limited amount of term subordinated debt or a limited amount of
the reserve for possible credit losses. The FFIEC has also adopted minimum
leverage ratios for banks, which are calculated by dividing Tier I capital by
total average assets. Recognizing that the risk-based capital standards address
only credit risk, and not interest rate, liquidity, operational or other risks,
many banks are expected to maintain capital in excess of the minimum standards.
In addition, pursuant to provisions of the FDIC Improvement Act of 1991
(the "FDICIA") and related regulations with respect to prompt corrective action,
FDIC-insured institutions such as Advanta Bank Corp. may only accept brokered
deposits without FDIC permission if they meet specified capital standards, and
are subject to restrictions with respect to the interest they may pay on
deposits unless they are "well-capitalized." To be "well-capitalized" under the
prompt corrective action provisions, a bank must have a ratio of combined Tier I
and Tier II capital to risk-weighted assets of not less than 10%, Tier I capital
to risk-weighted assets of not less than 6%, and a Tier I leverage ratio of not
less than 5%. In each case, Advanta Bank Corp. met the capital requirements of
the FDICIA and was categorized as well-capitalized under the regulatory
framework for prompt corrective action. See Note 16 to the consolidated
financial statements.
ADVANTA NATIONAL BANK
Advanta National Bank is subject to regulation and periodic examination,
primarily by the Office of the Comptroller of the Currency (the "OCC"). The
OCC's regulations relate to the maintenance of reserves for certain types of
deposits and other products offered by a bank, the maintenance of certain
financial ratios, the terms on which a bank may engage in transactions with its
affiliates and a broad range of other banking practices. As a national bank,
Advanta National Bank is also subject to provisions of federal law which
restrict its ability to extend credit to its affiliates or pay dividends to
Advanta Corp.
8
Advanta National Bank is subject to the FFIEC capital adequacy guidelines
and the FDICIA provisions for accepting brokered deposits described above. See
"-- Advanta Bank Corp." Presently, Advanta National Bank is required to maintain
capital in excess of the minimum regulatory standards. At December 31, 2001,
Advanta National Bank 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 its agreement with the OCC,
even though we have achieved the higher imposed capital ratios required by the
agreement with the OCC. See Note 16 to the consolidated financial statements and
"-- Regulatory Agreements."
REGULATORY AGREEMENTS
In June 2000, we announced that our banking subsidiaries, Advanta National Bank
and Advanta Bank Corp., reached agreements with their respective bank regulatory
agencies, primarily relating to the banks' subprime lending operations. The
agreements outlined a series of steps to modify processes and formalize and
document certain practices and procedures for the banks' subprime lending
operations. The agreements also required us to change our charge-off policy for
delinquent mortgages to 180 days and to modify our accounting processes and
estimate of our allowance for credit losses and valuation of residual assets.
The agreement between Advanta Bank Corp. and the FDIC established temporary
deposit growth limits at Advanta Bank Corp. and provided for prior FDIC approval
of the payment by Advanta Bank Corp. of any future cash dividends. The agreement
between Advanta National Bank and the OCC established temporary asset growth
limits at Advanta National Bank and imposed restrictions on taking brokered
deposits at Advanta National Bank. The June 2000 agreement with the OCC required
that Advanta National Bank maintain certain capital ratios in excess of the
minimum regulatory standards.
In July 2000, we announced that Advanta National Bank signed a second
agreement with the OCC resulting in a significant reduction to the carrying
value of Advanta National Bank's retained interests in mortgage securitizations
and requiring that Advanta National Bank increase its allowance for credit
losses. See Note 15 to the consolidated financial statements.
In 2001, in connection with the Mortgage Transaction, 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 Mortgage Transaction and the resolution of
outstanding Advanta National Bank liabilities. The February 2001 agreement
superseded the capital ratio requirements of the June 2000 agreement and lowered
the capital requirements for Advanta National Bank to 12.7% for Tier 1 capital
and Total capital to risk-weighted assets, and to 5% for Tier 1 capital to
adjusted total assets, as defined in the agreement. The February 2001 agreement
requires that Advanta National Bank obtain prior OCC approval of any future
dividends. Advanta Bank Corp. is unaffected by Advanta National Bank's
agreements with the OCC.
Management believes that Advanta Bank Corp. and Advanta National Bank were
each in compliance with their respective regulatory agreements at December 31,
2001.
LENDING AND LEASING ACTIVITIES
Although our current lending activities are principally directed to small
businesses, certain aspects of various federal and state laws, including the
Equal Credit Opportunity Act, the Community Reinvestment Act, the Electronic
Funds Transfer Act, the Truth-in-Lending Act and the Fair Credit Reporting Act,
apply to us. Provisions of these statutes and related regulations require
disclosure to borrowers of finance charges in terms of an annual percentage
rate, prohibit discriminatory practices in extending credit, require our
FDIC-insured banking institutions to serve the banking needs of their local
communities and regulate the dissemination and use of information relating to a
borrower's creditworthiness.
Additionally, the GLB Act imposes privacy requirements dealing with the use
of nonpublic information about consumer customers. Retail deposit customers of
Advanta National Bank and Advanta Bank Corp. as
9
well as investors who purchase Advanta Corp.'s retail notes are subject to the
GLB Act and its accompanying regulations. This statute is not preemptive and
states may impose additional and more burdensome privacy requirements. To date,
North Dakota has extended these requirements and other states are considering
similar legislative or regulatory initiatives.
DIVIDENDS
There are various legal limitations on the extent to which national banks,
including Advanta National Bank, can supply funds through dividends to their
parent companies or affiliates. The prior approval of the OCC is required if the
total of all dividends declared by the national bank in any calendar year
exceeds its net profits for that year combined with its retained net profits for
the preceding two years, less any required transfers to surplus accounts. In
addition, a national bank may not pay a dividend in an amount greater than its
undivided profits then on hand after deducting its losses and bad debts. The OCC
also has authority under the Financial Institutions Supervisory Act to prohibit
a national bank from engaging in any unsafe or unsound practice in conducting
its business. It is possible, depending upon the financial condition of the bank
in question and other factors, that the OCC, pursuant to its authority under the
Financial Institutions Supervisory Act, could claim that a dividend payment
might under some circumstances be an unsafe or unsound practice.
In February 2001, in connection with the Mortgage Transaction, the OCC
approved the payment of a return of capital in the amount of $261 million from
Advanta National Bank to Advanta Corp. Under Advanta National Bank's current
agreement with the OCC, Advanta National Bank is not eligible to pay any
dividends without the OCC's prior approval. In addition, as a result of Advanta
Bank Corp.'s agreement with the FDIC, Advanta Bank Corp. may not pay cash
dividends without prior FDIC approval. See "-- Regulatory Agreements."
TRANSFERS OF FUNDS
Sections 23A and 23B of the Federal Reserve Act also impose restrictions on
Advanta National Bank and Advanta Bank Corp. These restrictions limit the
transfer of funds by the depository institution to certain of its affiliates,
including Advanta Corp., in the form of loans, extensions of credit, investments
or purchases of assets. These transfers by any one depository institution to us
or any other single affiliate are limited in amount to 10% of the depository
institution's capital and surplus, and transfers to all affiliates are limited
in the aggregate to 20% of the depository institution's capital and surplus.
These loans and extensions of credit are also subject to various collateral
requirements. Sections 23A and 23B of the Federal Reserve Act also require
generally that the depository institution's transactions with its affiliates be
on terms no less favorable to the bank than comparable transactions with
unrelated third parties. In addition, in order for us to maintain our
grandfathered exemption under CEBA, Advanta National Bank is not permitted to
make any loans to us or any of our subsidiaries.
REGULATION OF INSURANCE
Our insurance subsidiaries are subject to the laws and regulations of, and
supervision by, the states in which they are domiciled or have obtained
authority to transact insurance business. These states have adopted laws and
regulations which govern all insurance policy underwriting, rating, licensing,
marketing, administration and financial operations of an insurance company,
including dividend payments and financial solvency. In addition, our insurance
subsidiaries have registered as an Arizona Holding Company which requires an
annual registration and the approval of certain transactions between all
affiliated entities.
The maximum dividend that any of our insurance subsidiaries can distribute
to Advanta Corp., in any twelve-month period, without prior approval of the
State of Arizona Department of Insurance, is the lesser of:
- 10% of the subsidiary's statutory surplus; or
- for any given twelve-month period, the subsidiary's net income, if it is
a life insurance company; or
- for any given twelve-month period, the subsidiary's net investment
income, if it is a property and casualty insurance company.
10
During 2001, the State of Arizona Department of Insurance approved payments to
Advanta Corp. from its insurance subsidiaries totaling $63.6 million, consisting
of a $57.5 million return of capital and dividends of $6.1 million.
The State of Arizona has adopted minimum risk-based capital standards as
developed by the National Association of Insurance Commissioners. Risk-based
capital is the quantification of an insurer's investment, underwriting, reserve
and business risks in relation to its total adjusted capital and surplus. The
ratio of an insurer's total adjusted capital and surplus is compared to various
levels of risk-based capital to determine what intervention, if any, is required
by either the insurance company or an insurance department. At December 31,
2001, our insurance subsidiaries met all risk-based capital standards and
required no intervention by any party.
Our insurance subsidiaries reinsure risks using underwriting insurance
practices and rates, which are regulated in part or fully by state insurance
departments. State insurance departments continually review and modify these
rates based on prior historical experience. Any modifications may impact the
future profitability of our insurance subsidiaries.
LEGISLATIVE AND REGULATORY DEVELOPMENTS
The banking and finance businesses in general are the subject of the extensive
regulation described above at both the state and federal levels, and numerous
legislative and regulatory proposals are advanced each year which, if adopted,
could affect our profitability or the manner in which we conduct our activities.
It is impossible to determine the extent of the impact of any new laws,
regulations or initiatives, or whether any of the federal or state proposals
will become law and, if so, what impact they will have on us.
In the fourth quarter of 2001, the bank regulatory agencies issued an
interagency policy statement that revised the regulatory capital treatment of
recourse, direct credit substitutes, and residual interests in asset
securitizations. This rule applies to our banking subsidiaries and supercedes
the former low-level recourse rules and requires that banks hold one dollar in
total risk-based capital against every dollar of residual interest, with some
exceptions. It further requires that credit enhancing interest-only strips in
excess of 25% of Tier 1 capital be deducted from Tier 1 capital for purposes of
calculating bank capital ratios. This rule has an effective date of January 1,
2002. Early adoption was permitted for transactions entered into prior to the
effective date that result in a reduced capital requirement. Banks can delay
until December 31, 2002 the application of the final rule to transactions
entered into prior to January 1, 2001 that result in increased capital
requirements. Advanta Bank Corp. elected to adopt the rule effective December
31, 2001 and it resulted in a reduced capital requirement. We do not anticipate
the adoption of this rule will have an effect on the capital requirements of
Advanta National Bank.
Other federal legislative proposals and initiatives that could impact
Advanta and its businesses include financial privacy initiatives that would
restrict the permissible use of customer-specific financial and other credit
information and statutory changes to those aspects of the Truth in Lending Act
that are applicable to our business. In addition, Congress is currently
considering legislation to reform the Bankruptcy Code. The bankruptcy reform
bills would require that debtors pass a means test to determine eligibility for
bankruptcy relief while adding new consumer protections, such as new minimum
payment and introductory rate disclosures for credit cards and exemptions for
retirement savings in bankruptcy. They also would promote education and credit
counseling as alternatives to resolving financial difficulties, allowing more
debtors to avoid a bankruptcy filing. While these provisions are primarily
directed at consumer bankruptcies, they would also impact small businesses that
file for bankruptcy liquidation under Chapter 7 of the Bankruptcy Code.
Our current marketing is based on direct marketing to small businesses
using direct mail, telemarketing and the Internet. There are a number of federal
and state legislative initiatives that would restrict the use of unsolicited
commercial e-mail and telemarketing to wireless telephones and would strengthen
"do not call list" laws. Additionally, the Federal Trade Commission has proposed
a nationwide registry for consumers who wish to block telemarketing calls,
including provisions that would allow the blocking of telephone solicitations
from companies with which they already do business. While this proposal is
intended to apply to individual consumers, the practical application of the
registry may impact our marketing to small businesses as well.
11
Following the attack on the United States on September 11, 2001, a number
of law enforcement-related financial privacy initiatives have also been enacted
or proposed. In addition, there are initiatives under consideration that could
affect the imposition of credit card late fees during periods when mail service
is limited or interrupted.
Additionally, federal and state legislatures are considering legislative
and regulatory initiatives related to credit scoring disclosure, minimum monthly
payments and other legislation relating to credit card lending and marketing has
been proposed. While these initiatives are generally directed at consumer
transactions, it is possible that final legislation could impact small business
lending as well.
COMPETITION
As a marketer of credit products, we face intense competition from numerous
financial services providers. Many of these companies are substantially larger
and have more capital and other resources than we do. Competition among lenders
can take many forms, including convenience in obtaining a loan, the size of
their existing customer base and the ability to cross sell products to that
customer base, customer service, size of loans, interest rates, and other types
of finance or service charges, the nature of the risk the lender is willing to
assume and the type of security, if any, required by the lender. Although we
believe we are generally competitive in most of the geographic areas in which we
offer our products and services, there can be no assurance that our ability to
market our services successfully or to obtain an adequate yield on our loans
will not be impacted by the nature of the competition that now exists or may
develop.
In seeking investment funds from the public, we face competition from
banks, savings institutions, money market funds, mutual funds, credit unions and
a wide variety of private and public entities that sell debt securities, some of
which are publicly traded. Many of our competitors are larger and have more
capital and other resources than we have. Competition relates to matters such
as: rate of return, collateral, insurance or guarantees applicable to the
investment, if any; the amount required to be invested; convenience and the cost
to and conditions imposed upon the investor in investing and liquidating the
investment, including any commissions which must be paid or interest forfeited
on funds withdrawn; customer service; service charges, if any; and the
taxability of interest.
EMPLOYEES
As of December 31, 2001, we had 734 employees. We believe that we have good
relationships with our employees. None of our employees is represented by a
collective bargaining unit.
------------------------
Information or statements provided by the Company from time to time may
contain certain "forward-looking information" including information relating to:
anticipated earnings per share; anticipated returns on equity; realizability of
net deferred tax asset; anticipated growth in loans outstanding and credit card
accounts; anticipated net interest margins; anticipated operations costs and
employment growth; anticipated payment and prepayment rates of outstanding
loans; anticipated marketing expense; estimated values of our retained interests
in securitizations and anticipated cash flows; our ability to replace existing
credit facilities, when they expire, with appropriate levels of funding on
similar terms and conditions; anticipated delinquencies and charge-offs; and
anticipated outcome and effects of litigation. The cautionary statements
provided below are being made pursuant to the provisions of the Private
Securities Litigation Reform Act of 1995 (the "Act") and with the intention of
obtaining the benefits of the "safe harbor" provisions of the Act for any such
forward-looking information.
We caution readers that any forward-looking information provided by us is
not a guarantee of future performance and that actual results may differ
materially from those in the forward-looking information as a result of various
factors, including but not limited to:
- Increased credit losses and collection costs associated with a worsening
of general economic conditions, rising interest rates, shifts in product
mix within our portfolio of loans, rising delinquency levels,
12
increases in the number of customers seeking protection under the
bankruptcy laws resulting in accounts being charged off as uncollectible,
and the effects of fraud by third parties or customers.
- Intense and increasing competition from numerous providers of financial
services who may employ various competitive strategies. We face
competition from originators of business credit cards, some of which have
greater resources than we do.
- The completion of post-closing procedures following the Mortgage
Transaction and revisions to estimated charges associated with the
discontinued operations of our mortgage and leasing businesses.
- The effects of interest rate fluctuations on our net interest margin and
the value of our assets and liabilities; the continued legal or
commercial availability of techniques, including loan pricing and
repricing, hedging and other techniques, that we use to manage the risk
of those fluctuations.
- Difficulties or delays in the securitization of our receivables and the
resulting impact on the cost and availability of such funding.
Difficulties and delays may result from the current economic, legal,
regulatory, accounting and tax environments and adverse changes in the
performance of the securitized assets.
- The amount, type and cost of financing available to us, including secured
financing, and any changes to that financing including any impact from
changes in the current economic, legal, regulatory, accounting and tax
environments, adverse changes in the performance of our loan portfolio,
any impact from changes in our debt ratings and the activities of parties
with which we have agreements or understandings, including any activities
affecting any investment.
- Changes in our aggregate accounts or loan balances, and the growth rate
thereof, including changes resulting from factors such as shifting
product mix, amount of actual marketing investment made by us, the rate
of repayment of loan balances, changes in general economic conditions and
other factors beyond our control.
- The impact of "seasoning" (the average age of a lender's portfolio) on
our level of delinquencies and losses which may require a higher
allowance for loan losses for on-balance sheet assets and may adversely
impact securitization income. The addition of account originations or
balances and the attrition of those accounts or balances could
significantly impact the seasoning of our overall portfolio.
- The amount of, and rate of growth in, our expenses (including employee
and marketing expenses) as our businesses develop or change and we expand
into new market areas; the acquisition or disposition of assets
(interest-earning, fixed or other); and the effects of changes within our
organization or in our compensation and benefit plans.
- Difficulties or delays in the development, production, testing and
marketing of products or services, including, but not limited to, a
failure to implement new product or service programs when anticipated,
the failure of or delay in customers' acceptance of these products or
services, losses associated with the testing and implementation of new
products or services or financial, legal or other difficulties as may
arise in the course of such implementation.
- The effects of, and changes in, tax laws, rates, regulations and
policies.
- The effects of, and changes in, political conditions, social conditions
and general economic conditions, including inflation, recession or other
adverse economic conditions.
- The effects of, and changes in the level of scrutiny, regulatory
requirements and regulatory initiatives resulting from the fact that our
banking and finance businesses are highly regulated and subject to
periodic review and examination by federal and state regulators,
including the OCC and the FDIC.
- The effects of, and changes in, monetary and fiscal policies, federal and
state laws and regulations (financial, consumer, regulatory or
otherwise), and other activities of governments, agencies and other
similar organizations, including the OCC and the FDIC.
13
- The costs and other effects of legal and administrative cases and
proceedings, settlements and investigations, claims and changes in those
items, developments or assertions by or against us or any of our
subsidiaries arising in the ordinary course of business or in connection
with our discontinued operations.
- Adoptions of new, or changes in existing, accounting policies and
practices and the application of such policies and practices.
- Our relationships with customers, significant vendors and business
partners.
- Our ability to attract and retain key personnel.
ITEM 2. PROPERTIES
At December 31, 2001, Advanta owned two buildings in Horsham, Pennsylvania
totaling 198,000 square feet. During January and February 2001, these buildings
were primarily used by Advanta Mortgage and Advanta Business Cards. As of March
1, 2001, these buildings were 100% leased to the buyer of Advanta's mortgage
business. Advanta leased 109,511 square feet in Spring House, Pennsylvania for
its principal executive offices and for use by Advanta Business Cards. Advanta
leased an additional 39,203 square feet in two buildings in the Pennsylvania
suburbs of Philadelphia for certain corporate staff functions, until August 31,
2001 when Advanta vacated one 33,000 square foot building. In the adjoining
state of New Jersey, Advanta owned one building consisting of 56,196 square feet
for its Leasing operations, until December 10, 2001, at which time the building
was sold. Advanta leased back 21,328 square feet on the third floor of the
building in New Jersey for Advanta Leasing Services. Advanta also leased 12,000
square feet of office space and 3,000 square feet of storage space in two
buildings in New Jersey for Advanta Leasing Services and a portion of Advanta
Business Cards operations. In Delaware, Advanta leased 36,589 square feet of
office space for Advanta National Bank. In New York, Advanta leased 6,000 square
feet of office space in two buildings for Advanta Partners LP and Advanta Growth
Capital Fund, LP. Advanta also leased 50,625 square feet of office space in Utah
for Advanta Bank Corp.
In addition to the principal locations in Pennsylvania, New Jersey, New
York, Delaware and Utah, until February 28, 2001 Advanta leased approximately
84,923 square feet of office space in twenty-one states to support the mortgage
loan production offices and an additional 6,213 square feet of office space in
five states to support Advanta Mortgage and Advanta Leasing Services. Since
Advanta ceased origination of new leases and exited the mortgage business in the
first quarter of 2001, Advanta has been buying out, assigning or subleasing this
space. Accordingly, as of December 31, 2001, the remaining leased space totaled
approximately 31,112 square feet.
At December 31, 2001, the total leased and owned office space was
approximately 474,368 square feet.
ITEM 3. LEGAL PROCEEDINGS
On January 22, 1999, Fleet Financial Group, Inc. ("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 Credit Card
LLC in connection with the transfer of our consumer credit card business in 1998
(the "Consumer Credit Card Transaction"). Fleet seeks damages of approximately
$141 million. We 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 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. In October 2001, the court issued a ruling
on summary judgment in favor of Fleet on certain legal issues and positions
advocated by Fleet and against others that Fleet advocated. As a result, for
purposes of trial only, the parties stipulated to a number of issues relating to
the court's orders including certain amounts that would be owed by each party to
the other, while preserving their rights to appeal. Many issues remained to be
determined at trial, including the financial impact of all
14
issues in dispute. The trial took place in November and December 2001. The court
ordered a post-trial briefing schedule, which has the parties submitting briefs
through March 2002, with oral argument scheduled for April 2002. As a result of
related litigation with Fleet, $70.1 million of our reserves in connection with
this litigation were funded in an escrow account in February 2001. Taking into
account amounts that Fleet owes to us and the amount escrowed, including
interest, we have funded our estimated maximum net exposure to Fleet in the
litigation. Management expects that the ultimate resolution of this litigation
will not have a material adverse effect on our financial position or future
operating results given the amount escrowed, our reserves and amounts that Fleet
owes us.
On December 5, 2000, a former executive of Advanta obtained a jury verdict
against Advanta in the amount of $3.9 million in the United States District
Court for the Eastern District of Pennsylvania, in connection with various
claims against Advanta related to the executive's termination of employment. In
September 2001, the District Court Judge issued orders denying both parties'
post-trial motions. A judgment in the amount of approximately $6 million, which
includes the $3.9 million described above, was entered against Advanta. In
September 2001, Advanta filed an appeal to the United States Court of Appeals
for the Third Circuit. Advanta has posted a supersedeas bond in the amount of $8
million and has filed its principal brief in the Court of Appeals. The plaintiff
filed a cross-appeal from the order adverse to him. Advanta is vigorously
pursuing its appeal. The District Court Judge has not yet ruled on the
executive's petition for attorney's fees and costs in the amount of
approximately $1.2 million, which Advanta has contested. 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. An
answer to Banc One's second amended complaint was filed in July 2001 denying
liability, raising affirmative defenses and asserting a counterclaim. Various
motions were filed, including Advanta's motion for partial summary judgment
under one of the two loan servicing agreements, Banc One's motion for summary
judgment on liability under both loan servicing agreements, and Banc One's
motions to strike Advanta's counterclaim and ninth affirmative defense (both
alleging breach of the implied covenant of good faith and fair dealing). In
January 2002, the court entered an opinion and order on the pending motions,
which granted in part and denied in part both parties' motions for summary
judgment. The court treated Banc One's motions to strike as motions for summary
judgment, and although not entirely clear on this point, apparently granted them
in part and denied them in part. Banc One's motions to strike were denied as
moot. The court's ruling is essentially an interlocutory ruling in favor of
Advanta under one of the two agreements and in favor of Banc One under the other
of the two agreements. Advanta's counterclaim survives in part. The court's
order does not constitute a final judgment and no assessment of damages either
on Advanta's counterclaim or Banc One's claim has occurred. Further proceedings
in the trial court on the matter of damages on both the surviving portion of
Advanta's counterclaim and Banc One's surviving claim are to ensue. The amount
of damages which Banc One might ultimately be entitled to recover from Advanta
remains undetermined and dependent upon a number of factors, including the
resolution of various legal issues which remain to be resolved and the amount of
any damages Advanta might be entitled to recover against Banc One, which
likewise remains undetermined. 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 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 Mortgage
Transaction. Chase claims that Advanta misled Chase concerning the value of
certain of the assets sold to Chase. In September 2001, Advanta filed an answer
to the complaint in which Advanta denied all of the substantive allegations of
the complaint and asserted a counterclaim against Chase for breach of contract
relating to funds owed by Chase to Advanta in connection with the transaction.
The matter is in discovery and trial is scheduled for April 2003. We believe
that the lawsuit is without merit and will vigorously defend Advanta. We do not
15
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.
On November 8, 2001 and January 28, 2002, Grant Thornton, LLP ("Grant
Thornton") filed third-party complaints against Advanta Mortgage Corp., USA
("AMCUSA") in two related lawsuits in the United States District Court for the
Southern District of West Virginia. The third-party claims allege negligent
misrepresentation, claiming without specificity or factual support that Grant
Thornton received inaccurate information from AMCUSA concerning the amount of
loans that AMCUSA had been servicing for the First National Bank of Keystone,
West Virginia ("Keystone"). Grant Thornton was the former auditor for Keystone,
which failed. Grant Thornton was sued on November 9, 1999 and January 28, 2000
by shareholders and others with purported ownership interests in Keystone,
alleging that Grant Thornton rendered an unqualified opinion for Keystone's
financial statements, when in fact the financial statements fraudulently
overstated Keystone's assets by approximately $500 million. In December 2001 and
February 2002, AMCUSA filed motions to dismiss the third-party complaints. We
plan to vigorously defend this litigation, and because we believe that the
likelihood of a final judgment of liability against AMCUSA is remote, we do not
expect that the ultimate resolution of this litigation will have a material
adverse effect on our financial position or future operating results.
On December 20, 2001, a purported shareholder of Advanta filed a complaint
in the Court of Common Pleas of Montgomery County, Pennsylvania, that alleges,
among other things that certain members of Advanta's Board of Directors breached
their fiduciary duties in connection with their oversight of Advanta management
relating to certain issues in dispute between Advanta and Fleet. The action is a
derivative lawsuit pursuant to which certain members of Advanta's Board of
Directors are named as defendants and Advanta is merely a nominal defendant. In
essence, the complaint alleges that the directors failed to cause Advanta to
voluntarily pay Fleet the amounts that Fleet claims in the dispute. The
complaint was served in January 2002. We believe that the lawsuit is without
merit both substantively and procedurally and will vigorously defend the claims.
In February 2002 preliminary objections to the allegations were filed with the
court, asserting that the complaint failed to allege any viable claim and that
the plaintiff failed to comply with the procedural requirements to bring his
claim.
In addition to the cases described above, Advanta Corp. and its
subsidiaries are involved in class action lawsuits, other litigation, claims and
legal proceedings arising in the ordinary course of business or discontinued
operations, including litigation arising from our operation of the mortgage
business prior to the Mortgage Transaction in the first quarter of 2001.
Management believes that the aggregate liabilities, if any, resulting from all
litigation, claims and other legal proceedings will not have a material adverse
effect on the consolidated financial position or results of our operations based
on the level of litigation reserves we have established and our expectations
regarding the ultimate resolutions of these actions. However, due to the
inherent uncertainty in litigation and since the ultimate resolutions of our
litigation, claims and other legal proceedings are influenced by factors outside
of our control, it is reasonably possible that our estimated liability under
these proceedings may change or that actual results will differ from our
estimates.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
16
EXECUTIVE OFFICERS OF THE REGISTRANT
Each of the executive officers of Advanta Corp. and its subsidiaries listed
below was elected by the applicable Board of Directors, to serve at the pleasure
of the Board in the capacities indicated.
<Table>
<Caption>
NAME AGE OFFICE DATE ELECTED
- ------------------------------------------------------------------------------------------------------
Dennis Alter 59 Chairman of the Board and Chief Executive 1972
Officer
William A. Rosoff 58 Vice Chairman of the Board and President 1996
Jeffrey D. Beck 53 Vice President and Treasurer of Advanta Corp. 2001
and President and Chief Investment Officer,
Advanta Bank Corp.
Philip M. Browne 42 Senior Vice President and Chief Financial 1998
Officer
Christopher J. Carroll 42 Chief Credit Officer 2001
Rosemary Cauchon 44 Senior Vice President of Advanta Corp. and 2001
President, Advanta Small Business Services
David B. Weinstock 37 Vice President and Chief Accounting Officer 2001
</Table>
Mr. Alter became Executive Vice President and a Director of Advanta Corp.'s
predecessor organization in 1967. He was elected President and Chief Executive
Officer in 1972, and Chairman of the Board of Directors in August 1985. In
February 1986, he relinquished the title of President, and in August 1995 he
relinquished the title of Chief Executive Officer. In October 1997, Mr. Alter
reassumed the title of Chief Executive Officer
Mr. Rosoff joined Advanta Corp. in January 1996 as a Director and Vice
Chairman. In October 1999, Mr. Rosoff became President and Vice Chairman of the
Board of Advanta Corp. Prior to joining Advanta Corp., Mr. Rosoff was a long
time partner of the law firm of Wolf, Block, Schorr and Solis-Cohen LLP, Advanta
Corp.'s outside counsel, where he advised Advanta Corp. for over 20 years. While
at Wolf, Block, Schorr and Solis-Cohen LLP, he served as Chairman of its
Executive Committee and, immediately before joining Advanta Corp., as a member
of its Executive Committee and Chairman of its Tax Department. Mr. Rosoff is a
Trustee of Atlantic Realty Trust, a publicly held real estate investment trust.
Mr. Beck joined Advanta Corp. in 1986 as Senior Vice President of Advanta
National Bank and was elected Vice President and Treasurer of Advanta Corp. in
1992. In June 2000, Mr. Beck was elected Chief Investment Officer of Advanta
Bank Corp. and in May 2001, he was elected President of Advanta Bank Corp.
Mr. Browne joined Advanta Corp. in June 1998 as Senior Vice President and
Chief Financial Officer. Prior to joining Advanta Corp., he was an Audit and
Business Advisory Partner at Arthur Andersen LLP where, for over sixteen years,
he audited public and private companies and provided business advisory and
consulting services to financial services companies. Mr. Browne had served as
the Arthur Andersen engagement partner for Advanta Corp. since 1994. Mr. Browne
is a director of AF&L Insurance Company, a privately held long-term care and
home health care insurance company.
Mr. Carroll joined Advanta Corp. in 2001 as Chief Credit Officer. Prior to
joining Advanta Corp., Mr. Carroll was a consultant with The Secura Group for
two years where he assisted clients, including Advanta, with bank regulatory
issues in areas such as credit risk management, credit policy and process
management, regulatory compliance, due diligence, and consolidation and
conversion projects. Prior to that, he held a variety of positions in credit
management and administration at First Interstate Bancorp. (now Wells Fargo),
where he spent 11 years as a consumer and commercial lender, credit
administrator, regulatory liaison and credit risk manager.
Ms. Cauchon joined Advanta Corp. in 2001 as Senior Vice President of
Advanta Corp. and President, Advanta Small Business Services. Prior to joining
Advanta Corp., she was Executive Vice President, Partnership Marketing and
Business Card Group at First USA Bank where she managed a $30 billion portfolio
and 1,900 partnership relationships. Prior to assuming that position, between
1994 and 2000
17
Ms. Cauchon served First USA Bank in various other capacities including
Executive Vice President, Cobrand Marketing and Business Card Group and Senior
Vice President, Marketing Analysis and Database Marketing.
Mr. Weinstock joined Advanta Corp. in 1998 and became Vice President and
Chief Accounting Officer in March 2001. Mr. Weinstock joined the Company in
December 1998 as Controller and he became Vice President of Investor Relations
in October 1999. Prior to joining Advanta Corp., Mr. Weinstock served as Senior
Manager at Arthur Andersen LLP from 1996 to 1998, where he audited public and
private companies and provided business advisory and consulting services to
financial services companies.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
COMMON STOCK PRICE RANGES AND DIVIDENDS
The Company's common stock is traded on the National Market System of The Nasdaq
Stock Market, Inc. under the symbols ADVNA (Class A voting common stock) and
ADVNB (Class B non-voting common stock).
Following are the high, low and closing sale prices and cash dividends
declared for the last two years as they apply to each class of stock:
<Table>
<Caption>
CASH
DIVIDENDS
QUARTER ENDED: HIGH LOW CLOSE DECLARED
- -------------- ------ ------ ------ ---------
CLASS A:
March 31, 2000 $21.88 $16.88 $20.31 $0.063
June 30, 2000 21.00 10.88 12.19 0.063
September 30, 2000 13.56 10.69 11.25 0.063
December 31, 2000 11.88 5.75 8.81 0.063
March 31, 2001 $16.00 $ 8.75 $15.81 $0.063
June 30, 2001 16.00 12.86 16.00 0.063
September 30, 2001 19.10 8.00 9.40 0.063
December 31, 2001 11.72 8.00 9.94 0.063
CLASS B:
March 31, 2000 $15.50 $11.50 $14.48 $0.076
June 30, 2000 15.13 7.75 8.50 0.076
September 30, 2000 10.19 7.50 8.14 0.076
December 31, 2000 8.38 4.13 7.19 0.076
March 31, 2001 $14.00 $ 7.16 $13.69 $0.076
June 30, 2001 14.00 11.90 13.97 0.076
September 30, 2001 17.10 8.10 8.95 0.076
December 31, 2001 10.79 6.85 9.10 0.076
</Table>
At March 1, 2002, the Company had approximately 260 and 748 holders of
record of Class A and Class B common stock, respectively.
Although we anticipate that comparable cash dividends will continue to be
paid in the future, the payment of future dividends by Advanta will be at the
discretion of the Board of Directors and will depend on numerous factors
including Advanta's cash flow, financial condition, capital requirements and
such other factors as the Board of Directors deems relevant.
18
ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL HIGHLIGHTS
<Table>
<Caption>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------
Summary of Operations(1)
Noninterest revenues $ 188,960 $ 157,081 $ 105,370 $ 140,408 $ 655,605
Interest revenues 117,851 136,100 104,584 111,502 331,021
Interest expense 82,470 86,508 80,800 101,226 266,118
Provision for credit losses 35,976 36,309 22,506 38,329 199,509
Operating expenses 180,186 150,292 95,506 136,835 466,535
Minority interest in income of
consolidated subsidiary 8,880 8,880 8,880 8,880 8,880
Unusual charges(2) 41,750 0 16,713 125,072 0
Gain on transfer of consumer credit card
business 0 0 0 541,288 0
Income (loss) before income taxes (42,451) 11,192 (14,451) 382,856 45,584
Income (loss) from continuing operations (30,456) 11,192 41,334 408,604 25,920
Income (loss) from discontinued
operations, net of tax (8,438) (163,578) 8,484 39,276 45,705
Loss, net, on discontinuance of mortgage
and leasing businesses, net of tax (31,639) (4,298) 0 0 0
Net income (loss) (70,533) (156,684) 49,818 447,880 71,625
- ----------------------------------------------------------------------------------------------------------
Per Common Share Data
Basic income (loss) from continuing
operations
Class A $ (1.23) $ 0.39 $ 1.59 $ 15.14 $ 0.38
Class B (1.17) 0.47 1.66 15.21 0.50
Combined(3) (1.19) 0.44 1.63 15.18 0.45
Diluted income (loss) from continuing
operations
Class A (1.23) 0.39 1.58 14.32 0.38
Class B (1.17) 0.46 1.65 14.35 0.49
Combined(3) (1.19) 0.44 1.62 14.33 0.45
Basic net income (loss)
Class A (2.79) (6.28) 1.95 16.62 1.45
Class B (2.73) (6.21) 2.02 16.68 1.57
Combined(3) (2.75) (6.24) 1.99 16.65 1.52
Diluted net income (loss)
Class A (2.79) (6.23) 1.94 15.69 1.43
Class B (2.73) (6.16) 2.00 15.73 1.54
Combined(3) (2.75) (6.19) 1.98 15.71 1.50
Cash dividends declared
Class A 0.252 0.252 0.252 0.252 0.440
Class B 0.302 0.302 0.302 0.302 0.528
Book value-combined 14.20 17.06 23.14 21.26 19.01
Closing stock price
Class A 9.94 8.81 18.25 13.25 26.25
Class B 9.10 7.19 14.06 11.06 25.38
- ----------------------------------------------------------------------------------------------------------
Financial Condition -- Year End
Investments(4) $ 476,568 $ 866,376 $ 893,819 $1,290,373 $1,378,772
Gross business credit card receivables
Owned 416,265 335,087 275,095 150,022 140,399
Securitized 1,626,709 1,324,137 765,019 664,712 522,688
--------------------------------------------------------------
Managed 2,042,974 1,659,224 1,040,114 814,734 663,087
Total assets 1,636,680 2,843,472 3,538,560 3,662,062 6,637,617
Deposits 636,915 1,346,976 1,512,359 1,749,790 3,017,611
Debt 323,582 755,184 788,508 1,030,147 2,248,172
Capital securities(5) 100,000 100,000 100,000 100,000 100,000
Stockholders' equity 366,299 440,902 589,631 560,304 926,950
- ----------------------------------------------------------------------------------------------------------
</Table>
19
<Table>
<Caption>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------
Selected Financial Ratios
Return on average assets (3.39)% (4.35)% 1.34% 11.95% 1.09%
Return on average common equity (17.50) (31.37) 8.82 82.76 8.47
Return on average total equity(6) (12.82) (25.11) 8.30 64.81 8.12
Equity/owned assets(6) 28.49 19.02 19.49 18.03 15.47
Dividend payout(7) N/M N/M 15.67 1.62 33.34
As a percentage of managed receivables:
Total receivables 30 days or more
delinquent 6.6 5.0 3.7 4.4 5.2
Net charge-offs(8) 7.6 4.6 5.1 6.7 6.8
==========================================================================================================
</Table>
(1) Results through February 1998 include the results of the consumer credit
card unit. The results of the mortgage and leasing businesses are reported
as discontinued operations in all periods presented.
(2) 2001 amounts included severance, outplacement and other compensation costs
associated with restructuring our corporate functions commensurate with the
ongoing businesses as well as expenses associated with exited businesses and
assets impairments. 1999 amounts included charges associated with cost
reduction initiatives in the first quarter and additional costs associated
with products exited in the first quarter of 1998. 1998 amounts included
severance and outplacement costs associated with workforce reduction, option
exercises and other employee costs associated with the disposition of our
consumer credit card business and tender offer, and expense associated with
exited business/products and asset impairment.
(3) Combined represents a weighted average of Class A and Class B (see Note 1 to
the consolidated financial statements).
(4) Includes federal funds sold, investments available for sale and trading
investments.
(5) Represents company-obligated mandatorily redeemable preferred securities of
subsidiary trust holding solely subordinated debentures of Advanta Corp.
(6) Return on average total equity and equity/owned assets include capital
securities as equity. The ratios without capital securities for 2001 were
(17.42%) and 22.38%, respectively, for 2000 were (31.28%) and 15.51%,
respectively, for 1999 were 8.82% and 16.66%, respectively, for 1998 were
74.75% and 15.30%, respectively and for 1997 were 8.33% and 13.97%,
respectively.
(7) The dividend payout ratio for the years ended December 31, 2001 and 2000 is
negative and therefore, not meaningful.
(8) Effective October 1, 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. Managed 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.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
Our primary business segment is Advanta Business Cards, one of the nation's
largest issuers of business credit cards to small businesses. In addition to our
business credit card lending business, we have venture capital investments.
Through the first quarter of 2001, we had two additional lending businesses,
Advanta Mortgage and Advanta Leasing Services. In the first quarter of 2001, we
exited 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 year ended December 31, 2001, we reported net loss from continuing
operations of $30.5 million or $1.19 per combined common share, assuming
dilution, compared to net income of $11.2 million or $0.44 per combined diluted
common share for the year ended December 31, 2000. For the year ended December
31, 1999, we reported net income from continuing operations of $41.3 million or
$1.62 per combined diluted common share. The loss from continuing operations for
the year ended December 31, 2001 includes pretax investment losses on venture
capital investments of $28.9 million and $41.8 million of pretax 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.
In 2000, income from continuing operations includes pretax investment
gains, net, on venture capital investments of $7.7 million, a pretax increase in
the provision for credit losses on business credit cards of $18.4 million, and a
$7.0 million pretax charge for an increase in litigation reserves.
In 1999, income from continuing operations includes a tax benefit of $50.0
million related to the former consumer credit card business. Income from
continuing operations for the year ended December 31, 1999 also includes pretax
unusual charges of $6.7 million for severance and outplacement costs associated
with cost cutting initiatives implemented in the first quarter of 1999 and $10.0
million of additional costs associated with products exited in the first quarter
of 1998. In addition, in 1999 we recognized pretax investment gains on venture
capital investments of $29.2 million, and non-operating charges of $16.9 million
related to our exit from the auto finance business.
Net income (loss) from continuing operations included the following
business segment results:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
- -------------------------------------------------------------------------------------------
ADVANTA BUSINESS CARDS
Pretax income $ 63,515 $45,325 $ 11,997
Income tax (expense) (24,452) 0 (4,727)
- -------------------------------------------------------------------------------------------
Net income $ 39,063 $45,325 $ 7,270
- -------------------------------------------------------------------------------------------
VENTURE CAPITAL
Pretax income (loss) $(33,158) $ 3,382 $ 26,329
Income tax (expense) benefit 12,765 0 (10,068)
- -------------------------------------------------------------------------------------------
Net income (loss) $(20,393) $ 3,382 $ 16,261
===========================================================================================
</Table>
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
Mortgage Transaction. Loss from discontinued operations, net of tax, was $163.6
million for the year ended December 31, 2000 and income from discontinued
operations, net of tax, was $8.5 million for the year ended December 31, 1999.
In addition to the operating results of the discontinued operations, we recorded
a loss on the discontinuance of our leasing business of $4.3 million, net of
tax, effective December 31, 2000. We also recorded an after tax loss on the
discontinuance of our mortgage and leasing businesses of $31.6 million for the
year ended December 31, 2001. The components of the net loss recorded in 2001
include a pretax gain on the Mortgage Transaction of
21
$20.8 million, a pretax loss on the discontinuance of our leasing business of
$45.0 million, and tax expense of $7.4 million. The loss on the discontinuance
of our leasing business in the year ended December 31, 2001 represents a
revision to the estimated valuation of leasing assets and a decrease in the
estimated pretax operating results over the remaining life of the lease
portfolio, due primarily to the impact of a former leasing vendor's bankruptcy.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our significant accounting policies are described in Note 1 to the consolidated
financial statements. The preparation of financial statements in accordance with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses, and disclosure of contingent assets
and liabilities. Actual results could differ from those estimates. We have
identified accounting for securitizations, the allowance for credit losses,
valuation of venture capital investments, valuation allowances on deferred tax
assets and litigation contingencies as our most critical accounting policies and
estimates in that they are important to the portrayal of our financial condition
and results, and they require management's most difficult, subjective or complex
judgments as a result of the need to make estimates about the effect of matters
that are inherently uncertain. These accounting policies, including the nature
of the estimates and types of assumptions used, are described throughout
Management's Discussion and Analysis.
ADVANTA BUSINESS CARDS
OVERVIEW
Advanta Business Cards offers 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 $1.0
billion at December 31, 1999 to $1.7 billion at December 31, 2000 and $2.0
billion at December 31, 2001. Advanta Business Cards originated 224,255 new
accounts during the year ended December 31, 2001, 311,275 new accounts in 2000
and 146,436 new accounts in 1999. The growth in receivables and level of
originations in 2001 reflected our plan to grow our portfolio in a controlled
manner that we believed was prudent given the prevailing economic environment.
Pretax income for Advanta Business Cards was $63.5 million for the year
ended December 31, 2001 as compared to $45.3 million for year ended December 31,
2000 and $12.0 million for the year ended December 31, 1999. The components of
pretax income for Advanta Business Cards for the years ended December 31 were as
follows:
<Table>
<Caption>
2001 2000 1999
- -------------------------------------------------------------------------------------------
Net interest income on owned receivables $ 43,337 $ 47,039 $23,185
Noninterest revenues 225,364 155,500 84,252
Provision for credit losses 35,373 36,307 17,926
Operating expenses 169,813 120,907 77,514
- -------------------------------------------------------------------------------------------
Pretax income $ 63,515 $ 45,325 $11,997
- -------------------------------------------------------------------------------------------
</Table>
The increase in noninterest revenues in both years is due primarily to
growth in securitized receivables and increased interchange income. The
increases in operating expenses in both years resulted from growth in managed
receivables. The provision for credit losses and noninterest revenues in the
year ended December 31, 2001 include the impact of an increase in managed credit
losses due to the seasoning of the business credit card portfolio and the
current economic environment. The provision for credit losses for the year ended
December 31, 2000 includes an $8 million increase attributable to a revision of
our estimate of the allowance for credit losses as a result of the following
factors: (1) discussions with our banking regulators relating to the
22
implementation of the agreement between Advanta Bank Corp. and the Federal
Deposit Insurance Corporation that was disclosed in June 2000; (2) changes in
the economic environment; and (3) the use of more conservative loss estimates
for certain segments of the loan portfolio. See further discussion in the
"Provision and Allowance for Credit Losses" section of Management's Discussion
and Analysis.
The following table provides selected information on a managed loan
portfolio basis.
MANAGED PORTFOLIO DATA
($ IN THOUSANDS)
<Table>
<Caption>
2001 2000 1999
- -------------------------------------------------------------------------------------------------
Average managed business credit card receivables $1,872,314 $1,372,717 $ 892,862
Ending managed business credit card receivables 2,042,974 1,659,224 1,040,114
Ending number of accounts -- managed 682,890 585,836 352,312
As a percentage of average managed receivables:
Net interest margin 15.0% 12.8% 11.5%
Fee revenues 5.6 5.4 4.4
Net charge-offs 7.7 4.7 5.0
Risk-adjusted revenues(1) 12.9 13.5 10.9
Total receivables 30 days or more delinquent at December 31 6.7% 5.0% 3.7%
- -------------------------------------------------------------------------------------------------
</Table>
(1) Risk-adjusted revenues represent net interest margin and fee revenues, less
net charge-offs.
SECURITIZATION INCOME
A significant portion of our funding is through off-balance sheet business
credit card securitizations via a securitization trust. The securitization trust
was created to hold the collateral (the securitized receivables) and issue debt
to investors. The securitization trust is a qualifying special-purpose entity as
defined by 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," and therefore, is
not consolidated as part of Advanta Corp.'s consolidated financial statements.
We do not provide any guarantee of the debt issued by the special-purpose entity
and our recourse in the transactions is limited to the value of our interests in
securitizations that act as credit enhancement to the investors' interests.
We sell business credit card receivables through securitizations with
servicing retained. When we securitize, we surrender control over the
transferred assets and account for the transaction as a sale to the extent that
consideration other than beneficial interests in the transferred assets is
received in exchange. We allocate the previous carrying amount of the
securitized receivables between the assets sold and the retained interests,
based on their relative estimated fair values at the date of sale.
Securitization income is recognized at the time of the sale, equal to the excess
of the fair value of the assets obtained (principally cash) over the allocated
cost of the assets sold and transaction costs. During the revolving period of
each business credit card securitization, securitization income is recorded
representing estimated gains on the sale of new receivables to the
securitization trust on a continuous basis to replenish the investors' interest
in securitized receivables that have been repaid by the business credit card
account holders. Fair value estimates used in the recognition of securitization
income require certain assumptions of payment, default and interest rates. To
the extent actual results are different than those estimates, the impact is
recognized in securitization income.
Retained interests in securitizations include restricted cash reserve
accounts, retained interest-only strips and subordinated trust assets related to
securitizations. Subordinated trust assets represent an ownership interest in
the securitized receivables that is subordinated to the other investors'
interests. Retained interests in securitizations serve as credit enhancement for
the securitization transactions. We account for retained interests in
securitizations as trading securities. These assets are recorded at estimated
fair value and the resulting unrealized gain or loss from the valuation is
included in securitization income.
We estimate the fair value of retained interests in securitizations based
on a discounted cash flow analysis. The cash flows of the retained interest-only
strip are estimated as the excess of the weighted average
23
finance charge yield on each pool of the receivables sold over the sum of the
interest rate paid to the note holder, the servicing fee and an estimate of
future credit losses over the life of the receivables. Cash flows are discounted
from the date the cash is expected to become available to us (the "cash-out"
method). These cash flows are projected over the life of the receivables using
payment, default, and interest rate assumptions that management believes would
be used by market participants for similar financial instruments subject to
prepayment, credit and interest rate risk. The cash flows are discounted using
an interest rate that management believes a purchaser unrelated to the seller of
the financial instrument would demand. As all estimates used are influenced by
factors outside our control, there is uncertainty inherent in these estimates,
making it reasonably possible that they could change in the near term. See Note
6 to the consolidated financial statements for the key assumptions used in the
estimation of fair values of the retained interests in securitizations at
December 31, 2001 and 2000. Interest income is recognized over the life of the
retained interests in securitizations using the discount rate used in the
valuation.
Advanta Business Cards recognized securitization income of $113.5 million
for the year ended December 31, 2001, $70.8 million for the year ended December
31, 2000, and $33.5 million for the year ended December 31, 1999. The increase
in securitization income in 2001 and 2000 was due to increased volume of
securitized receivables and increased yields on securitized receivables,
partially offset by increased credit losses on securitized receivables.
In September 2000, the FASB issued SFAS No. 140 which revised the standards
for accounting for securitizations and other transfers of financial assets and
collateral and required certain disclosures, but carried 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.
We adopted Emerging Issues Task Force Issue 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interest in
Securitized Financial Assets" on April 1, 2001. The implementation of EITF 99-20
did not have a material effect on our financial position or results of
operations.
SERVICING REVENUES
Advanta Business Cards recognized servicing revenue of $29.2 million for the
year ended December 31, 2001, $17.3 million for the year ended December 31,
2000, and $13.8 million for the year ended December 31, 1999. The increase in
servicing revenue in 2001 and 2000 was due to increased volume of securitized
receivables.
INTERCHANGE INCOME
Business credit card interchange income on the managed portfolio was $80.7
million for the year ended December 31, 2001, $61.7 million for the year ended
December 31, 2000, and $33.8 million for the year ended December 31, 1999. The
increase in interchange income in both years 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% for the year
ended December 31, 2001 and 2.1% for the years ended December 31, 2000 and 1999.
VENTURE CAPITAL
Our venture capital segment makes venture capital investments through our
affiliates. Our investment objective is to earn attractive returns by building
the long-term values of the businesses in which we invest. Our investment
affiliates combine transaction expertise, management skills and a broad contact
base with strong industry-specific knowledge. We actively monitor the
performance of our venture capital investments and employees and officers of our
investment affiliates participate on the boards of directors of some investees.
Investments of our venture capital unit are included in investments available
for sale and are carried at estimated fair value following the specialized
industry accounting principles of this unit. Management makes fair value
determinations based on quoted market prices, when available, and considers the
investees' financial
24
results, conditions and prospects when market prices are not available. In
accordance with the specialized industry accounting principles of venture
capital investment companies, the unrealized and realized gains and losses on
these investments are included in other revenues rather than other comprehensive
income and the equity method of accounting for investments is not applied.
The fair value of our venture capital investments was $18.6 million at
December 31, 2001 and $45.3 million at December 31, 2000. The fair values of
these equity investments are subject to significant volatility. Our investments
in specific companies and industry segments may vary over time, and changes in
concentrations may affect price volatility. We primarily invest in
privately-held companies, including early stage companies. These investments are
inherently risky as the market for the technologies or products the investees
have under development may never materialize.
Consistent with market conditions for venture capital investments, pretax
loss for the venture capital segment was $33.2 million for the year ended
December 31, 2001, and included $28.9 million of realized losses and decreases
in valuations of venture capital investments. Pretax income for the venture
capital segment was $3.4 million for the year ended December 31, 2000, and
included $11.4 million in gains on the sale of venture capital investments and
$3.7 million of net decreases in valuations of venture capital investments.
Pretax income for the venture capital segment was $26.3 million for the year
ended December 31, 1999, and included $29.2 million of gains on the sale of
venture capital investments.
DISCONTINUED OPERATIONS
We recorded a loss on the discontinuance of our leasing business of $4.3
million, net of tax, effective December 31, 2000. We also recorded an after tax
loss on the discontinuance of our mortgage and leasing businesses of $31.6
million for the year ended December 31, 2001. The components of the net loss
recorded in 2001 include a pretax gain on the Mortgage Transaction of $20.8
million, a pretax loss on the discontinuance of our leasing business of $45.0
million, and tax expense of $7.4 million.
Effective February 28, 2001, we completed the Mortgage Transaction and exit
of our mortgage business, Advanta Mortgage, through a purchase and sale
agreement with Chase Manhattan Mortgage Corporation as buyer. Prior to the
Mortgage Transaction, Advanta Mortgage made nonconforming home equity loans
directly to consumers and through brokers. This business unit originated and
serviced first and second lien mortgage loans, including home equity lines of
credit, through subsidiaries of Advanta. In addition to servicing and managing
the loans it originated, Advanta Mortgage contracted with third parties to
service their nonconforming home equity loans on a subservicing basis. Following
the Mortgage 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 gross gain of approximately $60 million before transaction
expenses, severance expenses and other costs. The gain on the Mortgage
Transaction does not reflect any impact from the post-closing adjustment
process. Although the Mortgage Transaction 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 11 to the consolidated
financial statements for a discussion of litigation related to the Mortgage
Transaction.
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. Advanta Leasing Services offered flexible
lease financing programs on small-ticket equipment to small businesses. The
primary products financed included office machinery, security systems and
computers. 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. Estimated operating results of the leasing
25
business included estimated valuations of retained interests in leasing
securitizations, estimated cash flows from on-balance sheet lease receivables,
interest expense and operating expenses. As all estimates used are influenced by
factors outside our control, there is uncertainty inherent in these estimates,
making it reasonably possible that they could change in the near term. In the
year ended December 31, 2001, we incurred an additional $45.0 million pretax
loss on the discontinuance of the leasing business due to changes in the
estimate of those operating results. These changes in estimate were needed due
to an increase in estimated credit losses expected throughout the remaining term
of the leasing portfolio based on credit loss experience in 2001. The primary
factor contributing to the increased credit losses is that one of our former
leasing vendors filed for bankruptcy protection and this vendor's financial
problems have impacted its ability to service a segment of our leasing
portfolio. This vendor is unique from our other leasing vendors in that it had a
significant servicing relationship with our customers and the equipment under
lease provided fee revenue to our customers for usage. Also, our contract with
the vendor provided that the vendor would provide a guaranty if the performance
of the leases did not meet certain criteria. This guaranty was considered when
underwriting the leases.
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
Mortgage Transaction. Loss from discontinued operations, net of tax, was $163.6
million for the year ended December 31, 2000. Income from discontinued
operations, net of tax, was $8.5 million for the year ended December 31, 1999.
Loss from discontinued operations for the year ended December 31, 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 included 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, loss from discontinued operations for the year ended December
31, 2000 includes $20.3 million of pretax charges resulting from changes in
valuation assumptions related to retained interests in leasing securitizations,
primarily due to higher credit losses associated with certain unprofitable
segments of broker originations from prior periods. These charges reduced net
income by $20.3 million or $0.80 per combined common diluted share. Loss from
discontinued operations for the year ended December 31, 2000 also includes $25.3
million of revenues related to termination fees received under a mortgage
servicing agreement. See Note 11 to the consolidated financial statements.
Income from discontinued operations for the year ended December 31, 1999
includes $28.8 million of pretax valuation adjustments to the retained interests
in mortgage securitizations and contractual mortgage servicing rights, which
decreased net income by $17.4 million or $0.73 per combined diluted share. Of
the total valuation adjustment, $10 million was recorded in the second quarter
of 1999, which resulted from an increase in credit losses expected in the
off-balance sheet mortgage loan portfolio based on portfolio trends and
experience. The majority of the remaining charge was recorded in the fourth
quarter of 1999 and resulted from an increase in the discount rate on the
retained interest-only strip and an increase in the credit loss assumption. The
discount rate was increased due to an increase in market interest rates and an
observed trend toward higher discount rates in available public disclosures
relating to comparable instruments. The increase in the loss assumption was due
to an additional increase in credit losses expected in the off-balance sheet
mortgage loan portfolio based on trends and experience. The decrease in the
valuation caused by the increased discount rate and credit loss assumption was
slightly offset by a decrease in prepayment speeds experienced.
Additionally, in the first quarter of 1999, we recorded pretax valuation
adjustments to the retained interests in auto loan securitizations of $12
million, which decreased net income by $7.4 million, or $0.31 per combined
diluted share. In the first quarter of 1999, management implemented a plan to
exit the auto finance business and engaged an investment banker to solicit bids
for the business as a whole, including our retained interests in auto
securitizations and certain auto loan receivables. Although management did not
ultimately accept any offers to acquire the retained interests, the informal
bids received were considered as part of our
26
fair value analysis of the retained interests, which resulted in a decrease in
the valuation of the assets as of March 31, 1999.
INTEREST INCOME AND EXPENSE
Interest income decreased by $18.2 million for the year ended December 31, 2001
as compared to the year ended December 31, 2000. During the same period,
interest expense decreased by $4.0 million. The decrease in interest income was
due primarily to a decrease in on-balance sheet business credit card receivables
and investments. Also contributing to the decreased interest income was a
decrease in the average yield earned on our investment portfolio caused by the
interest rate environment and a shift in the composition of the portfolio.
Short-term investments, including federal funds sold and interest-bearing
deposits, represented 71% of the average investment portfolio for the year ended
December 31, 2001 as compared to 27% for the year ended December 31, 2000.
Excess liquid assets were held in short-term, high-quality investments earning
money market rates until they could be deployed. See further discussion in the
"Liquidity and Capital Resources" section of Management's Discussion and
Analysis. The decrease in interest expense was due to a decrease in
interest-bearing liabilities, partially offset by an increase in our average
cost of funds.
Interest income increased by $31.5 million for the year ended December 31,
2000 as compared to the year ended December 31, 1999. During the same period,
interest expense increased by $5.7 million. The increase in interest income was
due to an increase in yields on business credit card receivables as well as an
increase in average on-balance sheet business credit card receivables. The
increase in interest expense was due to an increase in our average cost of
funds.
Our average cost of funds increased to 7.24% in 2001 from 6.89% in 2000.
Our average cost of funds was 5.87% in 1999. The increase in the average cost of
funds in 2001 as compared to 2000 was attributable to the increase in debt as a
percentage of total interest-bearing liabilities and an increase in the average
interest rate on debt funding. Debt represented 35% of total average
interest-bearing liabilities for the year ended December 31, 2001 as compared to
27% for the same period of 2000. The average interest rate on debt funding was
9.47% for the period ended December 31, 2001 as compared to 8.17% for the same
period of 2000. The average interest rate on debt funding increased in 2001 due
to a change in the composition of our debt. We paid off substantially all of our
medium-term notes in 2001 and did not renew or originate senior notes for a
portion of 2001 due to our liquidity position. We expect our average interest
rate on debt funding to decrease in the future as we replace the maturities of
our higher rate notes with notes bearing lower interest rates more in line with
the current market rates. The increase in the average cost of funds in 2000 as
compared to 1999 was primarily attributable to rising market interest rates.
During 2001, 2000 and 1999, we used interest rate swaps to manage the
impact of fluctuating interest rates on our cost of funds. The interest rate
swaps effectively converted fixed rate medium-term notes to a LIBOR-based
variable rate. 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. There were no
interest rate swaps outstanding related to continuing operations at December 31,
2001 because of the substantial reduction in outstanding medium-term notes
during the year.
27
The following table provides an analysis of owned interest income and
expense data, average balance sheet data, net interest spread, and net interest
margin for both continuing and discontinued operations. 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
deferred origination costs, net of deferred fees.
INTEREST RATE ANALYSIS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
($ IN THOUSANDS) ---------------------------------------------------------------------------------------------------
2001 2000 1999
------------------------------- ------------------------------- -------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- ---------------------------------------------------------------------------------------------------------------------------------
ON-BALANCE SHEET
- ----------------------------
Interest-earning assets:
Receivables:
Business credit cards $ 382,262 $ 75,998 19.88% $ 399,692 $ 77,528 19.40% $ 212,311 $ 35,265 16.61%
Other receivables 28,271 1,245 4.40 23,067 979 4.25 17,450 2,188 12.54
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
Total receivables 410,533 77,243 18.82 422,759 78,507 18.57 229,761 37,453 16.30
Federal funds sold 347,569 13,169 3.79 218,387 13,896 6.36 272,330 13,535 4.97
Restricted
interest-bearing
deposits 269,317 10,572 3.93 26,121 1,762 6.75 27,586 1,416 5.13
Trading investments 0 0 0.00 0 0 0.00 110,565 6,752 6.11
Tax-free securities(1) 4,295 392 9.13 3,786 348 9.19 3,857 319 8.27
Taxable investments 251,808 15,741 6.25 656,868 41,964 6.39 798,633 44,842 5.61
Interest earning assets of
discontinued operations 205,605 29,121 14.16 1,457,218 179,957 12.35 1,565,773 142,632 9.11
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
Total interest-earning
assets(2) $1,489,127 $146,238 9.82% $2,785,139 $316,434 11.36% $3,008,505 $246,949 8.21%
========== ======== ====== ========== ======== ====== ========== ======== ======
Interest-bearing
liabilities:
Deposits
Savings $ 29,438 $ 1,472 5.00% $ 182,112 $ 10,206 5.60% $ 262,501 $ 13,120 5.00%
Time deposits under
$100,000 682,088 42,303 6.20 1,227,550 79,810 6.50 1,063,354 60,271 5.67
Time deposits of
$100,000 or more 177,371 10,138 5.72 441,856 28,755 6.51 500,268 27,995 5.60
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
Total deposits 888,897 53,913 6.07 1,851,518 118,771 6.41 1,826,123 101,386 5.55
Debt 482,801 45,700 9.47 747,182 61,030 8.17 893,720 58,441 6.53
Other borrowings 17,730 1,035 5.84 137,024 8,792 6.42 54,008 3,225 5.92
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
Total interest-bearing
liabilities 1,389,428 100,648 7.24 2,735,724 188,593 6.89 2,773,851 163,052 5.87
Net noninterest-bearing
liabilities 99,699 49,415 234,654
---------- ---------- ----------
Sources to fund
interest-earning assets(3) $1,489,127 $100,648 6.76% $2,785,139 $188,593 6.77% $3,008,505 $163,052 5.42%
========== ======== ====== ========== ======== ====== ========== ======== ======
Net interest spread 2.58% 4.47% 2.34%
====== ====== ======
Net interest margin 3.06% 4.59% 2.79%
=================================================================================================================================
</Table>
(1) Interest and average rate for tax-free securities are computed on a tax
equivalent basis using a statutory rate of 35%.
(2) Includes assets held and available for sale and nonaccrual receivables.
(3) Includes funding of assets for both continuing and discontinued operations.
28
INTEREST VARIANCE ANALYSIS: ON-BALANCE SHEET
The following table presents the effects of changes in average volume and
interest rates on individual financial statement line items on a tax equivalent
basis. Changes not solely due to volume or rate have been allocated on a pro
rata basis between volume and rate. The effects on individual financial
statement line items are not necessarily indicative of the overall effect on net
interest income.
<Table>
<Caption>
2001 VS. 2000 2000 VS. 1999
($ IN THOUSANDS) --------------------------------- ------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
--------------------------------- ------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
- ---------------------------------------------------------------------------------------------------------
Interest income from:
Receivables:
Business credit cards $ (3,424) $ 1,894 $ (1,530) $ 35,506 $ 6,757 $42,263
Other receivables 230 36 266 551 (1,760) (1,209)
Federal funds sold 6,238 (6,965) (727) (2,989) 3,350 361
Restricted interest-bearing
deposits 9,842 (1,032) 8,810 (79) 425 346
Trading investments 0 0 0 (6,752) 0 (6,752)
Tax-free securities 46 (2) 44 (6) 35 29
Taxable investments (25,323) (900) (26,223) (8,600) 5,722 (2,878)
Interest earning assets of
discontinued operations (173,912) 23,076 (150,836) (10,463) 47,788 37,325
--------- ------- --------- -------- ------- -------
Total interest income(1) $(186,303) $16,107 $(170,196) $ 7,168 $62,317 $69,485
--------- ------- --------- -------- ------- -------
Interest expense on:
Deposits:
Savings $ (7,744) $ (990) $ (8,734) $ (4,357) $ 1,443 $(2,914)
Time deposits under $100,000 (33,977) (3,530) (37,507) 10,030 9,509 19,539
Time deposits of $100,000 or
more (15,479) (3,138) (18,617) (3,489) 4,249 760
Debt (23,975) 8,645 (15,330) (10,556) 13,145 2,589
Other borrowings (7,028) (729) (7,757) 5,277 290 5,567
--------- ------- --------- -------- ------- -------
Total interest expense (88,203) 258 (87,945) (3,095) 28,636 25,541
--------- ------- --------- -------- ------- -------
Net interest income $ (98,100) $15,849 $ (82,251) $ 10,263 $33,681 $43,944
=========================================================================================================
</Table>
(1) Includes income from assets held and available for sale.
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is established as losses are estimated to have
occurred through a provision for credit losses charged to earnings. The
allowance for credit losses is evaluated on a regular basis by management and is
based upon management's periodic review of the collectibility of receivables in
light of historical experience by loan type, the nature and volume of the loan
portfolio, adverse situations that may affect the borrowers' ability to repay
and prevailing economic conditions. Since our loan portfolio is comprised of
large groups of smaller balance homogeneous loans, we evaluate each group
collectively for impairment. The allowance is determined primarily based on a
migration analysis of delinquent and current accounts and certain qualitative
factors consistent with applicable bank regulatory guidelines. As part of our
evaluation, we compare actual credit loss performance to previously estimated
credit losses, and make modifications to estimates as needed. This allowance for
credit loss evaluation is inherently subjective, as it requires estimates that
are susceptible to significant revision as more information becomes available.
The allowance for credit losses is maintained for on-balance sheet
receivables and is intended to cover all credit losses inherent in the owned
loan portfolio. Anticipated losses on securitized assets are reflected in the
calculations of securitization income and the fair value of retained interests
in securitizations. See Note 1 to the consolidated financial statements. Such
loss estimates are intended to cover all probable credit losses over the life of
the securitized receivables. Management continually evaluates both its
on-balance sheet and off-balance sheet estimates and, as appropriate, effects
changes to these amounts.
29
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. Net charge-offs include the principal amount of losses less current
period recoveries. The accrued interest and fee portion of the charged-off
receivable balance is deducted from current period income.
Receivables are put on nonaccrual status when they become 90 days past due.
Gross interest income that would have been recorded for owned nonperforming
assets, had interest been accrued throughout the year in accordance with the
assets' original terms, was $2.7 million in 2001.
The provision for credit losses for the year ended December 31, 2001 was
$36.0 million as compared to $36.3 million for the year ended December 31, 2000.
The provision for credit losses in 2000 includes a revision in our estimate of
the allowance for credit losses on business credit card receivables. The revised
estimate for the overall portfolio was recorded in September 2000 and was
developed based on discussions with our banking regulators, changes in the
economic environment and the use of more conservative loss estimates for certain
segments of the loan portfolio. Those segments included accounts with lower
credit scores, accounts held by businesses in operation less than twelve months,
and accounts in which cash borrowings comprise a significant portion of the
outstanding balance. As a result of these changes in estimate in 2000, we
increased our allowance for credit losses by approximately $8 million, which
increased the provision for credit losses and decreased net income by
approximately $8 million or $0.32 per diluted combined share for the year ended
December 31, 2000. The provision for credit losses in 2001 reflects the
seasoning of the business credit card portfolio and the current economic
environment. These factors were evident in the delinquency rates and charge-off
rates. Total owned business credit card receivables 30 days or more delinquent
increased from 5.5% at December 31, 2000 to 6.7% at December 31, 2001. The
charge-off rate on owned business credit card receivables for the year ended
December 31, 2001 was 7.2% as compared to 4.5% for the year ended December 31,
2000. We expect the trend of increasing charge-off rates to continue in 2002 due
to the continued seasoning of the portfolio and the current economic
environment. Although charge-off levels are not always predictable since they
are impacted by the economic environment and other factors, we currently expect
the twelve month average charge-off rate for 2002 to be between 8.5% and 9.5% on
managed business credit card receivables. We expect charge-off rates to be
higher in the first half of 2002 than in the second half based on the current
composition of the portfolio.
For the year ended December 31, 2000, the provision for credit losses
increased by $13.8 million as compared to 1999. The increase in the provision
was primarily due to a change in estimate of the allowance for credit losses for
business credit cards as discussed above and the maturing and growth of the
business credit card portfolio in 2000. Average on-balance sheet business credit
card receivables increased 88% in 2000 as compared with 1999.
At December 31, 2001, the allowance for credit losses on a consolidated
basis was $42.0 million, or 9.4% of owned receivables, compared to $33.4
million, or 9.3%, at December 31, 2000. The allowance for credit losses on
business credit card receivables was $41.2 million, or 9.9% of owned
receivables, at December 31, 2001, as compared to $33.2 million, or 9.9%, at
December 31, 2000.
The allowance for credit losses on other receivables was $802 thousand at
December 31, 2001 and $202 thousand at December 31, 2000. The increase in the
allowance for credit losses on other receivables in the year ended December 31,
2001 was due to growth in other receivables from $24.2 million at December 31,
2000 to $28.2 million at December 31, 2001. There were no significant changes or
trends in credit quality statistics of other receivables in 1999 through 2001.
30
CREDIT QUALITY
The following table provides a summary of allowances for credit losses,
nonperforming assets, delinquencies and charge-offs for the past five years.
Consolidated data includes business credit cards, consumer credit cards through
February 1998, and other receivables.
<Table>
<Caption>
DECEMBER 31,
------------------------------------------------------
($ IN THOUSANDS) 2001 2000(A) 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------
CONSOLIDATED -- MANAGED
Nonperforming assets $ 81,666 $45,160 $24,118 $ 25,469 $118,815
Accruing receivables past due 90 days or more 0 0 0 0 203,069
Total receivables 30 days or more delinquent 137,517 83,798 39,681 36,578 623,919
As a percentage of gross receivables:
Nonperforming assets 3.9% 2.7% 2.3% 3.1% 1.0%
Accruing receivables past due 90 days or more 0.0 0.0 0.0 0.0 1.7
Total receivables 30 days or more delinquent 6.6 5.0 3.7 4.4 5.2
Net charge-offs:
Amount $143,593 $64,638 $46,707 $173,687 $814,859
As a percentage of average gross receivables 7.6% 4.6% 5.1% 6.7% 6.8%
- --------------------------------------------------------------------------------------------------------------
CONSOLIDATED -- OWNED
Allowance for credit losses $ 41,971 $33,367 $14,865 $ 10,650 $129,053
Nonperforming assets 20,052 10,700 7,028 7,719 25,906
Accruing receivables past due 90 days or more 0 0 0 0 49,410
Total receivables 30 days or more delinquent 29,520 19,395 11,591 7,885 149,094
As a percentage of gross receivables:
Allowance for credit losses 9.4% 9.3% 4.9% 6.3% 4.7%
Nonperforming assets 4.5 3.0 2.3 4.6 0.9
Accruing receivables past due 90 days or more 0.0 0.0 0.0 0.0 1.8
Total receivables 30 days or more delinquent 6.6 5.4 3.8 4.7 5.4
Net charge-offs:
Amount $ 27,372 $17,807 $12,500 $ 38,312 $143,218
As a percentage of average gross receivables 6.7% 4.2% 5.4% 7.0% 7.4%
- --------------------------------------------------------------------------------------------------------------
BUSINESS CREDIT CARDS -- MANAGED
Nonperforming assets $ 81,083 $44,600 $23,498 $ 25,231 $ 17,362
Total receivables 30 days or more delinquent 136,037 82,915 38,437 35,900 29,340
As a percentage of gross receivables:
Nonperforming assets 4.0% 2.7% 2.3% 3.1% 2.6%
Total receivables 30 days or more delinquent 6.7 5.0 3.7 4.4 4.4
Net charge-offs:
Amount $143,590 $64,636 $44,309 $ 43,732 $ 18,928
As a percentage of average gross receivables 7.7% 4.7% 5.0% 5.9% 3.7%
- --------------------------------------------------------------------------------------------------------------
BUSINESS CREDIT CARDS -- OWNED
Allowance for credit losses $ 41,169 $33,165 $14,663 $ 6,916 $ 6,899
Nonperforming assets 19,469 10,140 6,408 7,481 4,696
Total receivables 30 days or more delinquent 28,040 18,512 10,347 7,207 7,918
As a percentage of gross receivables:
Allowance for credit losses 9.9% 9.9% 5.3% 4.6% 4.9%
Nonperforming assets 4.7 3.0 2.3 5.0 3.3
Total receivables 30 days or more delinquent 6.7 5.5 3.8 4.8 5.6
Net charge-offs:
Amount $ 27,369 $17,805 $10,103 $ 10,033 $ 6,198
As a percentage of average gross receivables 7.2% 4.5% 4.8% 6.9% 3.3%
- --------------------------------------------------------------------------------------------------------------
</Table>
(A) Effective October 1, 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. Managed and owned 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.
31
OTHER REVENUES
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
($ IN THOUSANDS) ------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------------------
Investment securities gains (losses), net $(26,227) $ 5,473 $30,132
Business credit card rewards (8,979) (3,162) (834)
Loss on sale of deposits (2,835) 0 0
Insurance revenues, net and other 3,581 4,995 7,279
- --------------------------------------------------------------------------------------------
Total other revenues, net $(34,460) $ 7,306 $36,577
============================================================================================
</Table>
Investment securities gains (losses) include changes in the fair value and
realized gains (losses) on venture capital investments. Investment securities
losses for the year ended December 31, 2001 include $9.3 million in realized
losses on venture capital investments, $19.6 million in decreases in valuations
of venture capital investments, and $2.7 million of realized gains on other
investments. Investment securities gains (losses) for the year ended December
31, 2000 include $11.4 million in gains on the sale of venture capital
investments, $3.7 million of net decrease in valuations of venture capital
investments, and $2.2 million of realized losses on other investments.
Investment securities gains (losses) for the year ended December 31, 1999
include $29.2 million of gains on the sale of venture capital investments.
Business credit card rewards, which include bonus miles and cash-back
rewards, are earned by eligible cardholders based on net purchases charged to
their accounts. The cost of future reward redemptions are estimated and recorded
at the time bonus mile points or cash-back rewards are earned by the cardholder.
We estimate that 80% to 100% of cardholders will ultimately claim rewards. The
estimate varies depending on the structure of the rewards program. These costs
of future reward redemptions are recorded as a reduction of other revenues.
Increases in business credit card rewards in the years ended December 31, 2001
and 2000 were due to the increase in average managed business credit card
accounts in the rewards programs and the corresponding purchase activity in
those accounts.
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. Insurance revenues, net and other for
the year ended December 31, 2001 includes operating results of insurance
operations, the impact of the termination of the strategic alliance with
Progressive Casualty Insurance Company and $10 million of charges related to the
write-off of insurance-related deferred acquisition costs that were unrealizable
subsequent to the termination of the auto insurance strategic alliance.
Insurance revenues, net and other for the year ended December 31, 2000 includes
a charge of approximately $3 million in the insurance business relating to the
settlement of a large policy claim.
OPERATING EXPENSES
<Table>
<Caption>
($ IN THOUSANDS) 2001 2000 1999
- ---------------------------------------------------------------------------------------------
Salaries and employee benefits $ 59,823 $ 42,499 $35,300
Amortization of business credit card deferred origination
costs, net 39,118 23,961 5,863
External processing 17,272 13,236 8,507
Professional/consulting fees 15,320 18,451 12,159
Marketing 10,574 11,492 2,397
Equipment 8,768 8,101 4,717
Occupancy 5,941 5,852 6,710
Credit 5,419 4,772 3,926
Insurance 4,607 4,628 2,622
Postage 3,304 2,947 1,846
Fraud loss 2,568 1,965 833
Telephone 2,404 1,811 1,322
Other 5,068 10,577 9,304
- ---------------------------------------------------------------------------------------------
Total operating expenses $180,186 $150,292 $95,506
=============================================================================================
</Table>
32
Salaries and employee benefits, amortization of business credit card
deferred origination costs, net, external processing and fraud loss expenses
increased for the year ended December 31, 2001 as compared to the year ended
December 31, 2000 due primarily to growth in managed business credit card
receivables. Average managed business credit card receivables increased 36% in
2001 from $1.4 billion at December 31, 2000 to $1.9 billion at December 31,
2001. We expect our total operating expenses to continue to increase in 2002 as
we make additional investments in initiatives to strengthen our position as a
leading issuer of business credit cards to the small business market. These
include initiatives to provide additional value to our existing customers,
customer retention campaigns, development of ancillary non-financial products
and services, development of affinity cards and partnership relationships, and
enhancement of internet capabilities for servicing our customers.
Professional fees decreased by $3.1 million for the year ended December 31,
2001 as compared to the year ended December 31, 2000. The decrease in
professional fees was due to consulting costs incurred in 2000 associated with
the implementation of our bank regulatory agreements, partially offset by
increased legal costs in 2001. The decrease in marketing expenses in the year
ended December 31, 2001 as compared to 2000 reflects our decreased origination
activities related to senior notes as a result of our liquidity position
subsequent to the Mortgage Transaction in the first quarter of 2001. See further
discussion in the "Liquidity and Capital Resources" section of Management's
Discussion and Analysis. Other expenses decreased $5.5 million in the year ended
December 31, 2001 as compared to the year ended December 31, 2000. Other
expenses in the year ended December 31, 2000 included an increase in litigation
reserves of $7.0 million.
Salaries and employee benefits, amortization of business credit card
deferred origination costs, net, external processing, marketing, equipment, and
fraud loss expenses increased for the year ended December 31, 2000 as compared
to the year ended December 31, 1999 due primarily to increased marketing and
account origination activities in Advanta Business Cards as well as the
resulting growth in managed business credit card receivables. Business credit
card new account originations increased by 113% for the year ended December 31,
2000 as compared to 1999, and average managed business credit card receivables
grew by 54% in the same period. The increase in equipment expense for the year
ended December 31, 2000 as compared to 1999 also includes an increase in
depreciation expense associated with information technology upgrades placed in
service during 1999. Professional fees increased by $6.3 million for the year
ended December 31, 2000 as compared to the year ended December 31, 1999. The
increase was due to increased legal activity and consulting costs, including
consulting costs associated with the implementation of our bank regulatory
agreements.
LITIGATION CONTINGENCIES
Advanta Corp. and its subsidiaries are involved in class action lawsuits, other
litigation, claims and legal proceedings arising in the ordinary course of
business or discontinued operations, including litigation arising from our
operation of the mortgage business prior to the Mortgage Transaction in the
first quarter of 2001. See discussion in Note 11 to the consolidated financial
statements. Management believes that the aggregate liabilities, if any,
resulting from these actions will not have a material adverse effect on the
consolidated financial position or results of our operations based on the level
of litigation reserves we have established and our expectations regarding the
ultimate resolutions of these actions. However, due to the inherent uncertainty
in litigation and since the ultimate resolutions of these proceedings are
influenced by factors outside of our control, it is reasonably possible that our
estimated liability under these proceedings may change or that actual results
will differ from our estimates. Our litigation reserves at December 31, 2001 are
included in other liabilities on the consolidated balance sheets.
UNUSUAL CHARGES
Subsequent to the Mortgage Transaction 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. Also, in 1999,
we implemented a plan to exit the auto finance business and to implement cost
reduction initiatives throughout
33
the organization including the consolidation of support functions. Costs
associated with these restructuring activities and other employee costs are
included in unusual charges in the consolidated income statements.
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
support functions in the 12 months following the charges, and expect to realize
lower depreciation and amortization expense over the following 5-7 years. These
decreases were due to the termination of employees and the write-off or
write-down of assets previously deployed in connection with exited businesses.
We also expected and realized the elimination of the costs of the contractual
commitments associated with exited business products from future operating
results over the estimated timeframe of the contracts.
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 2001, we incurred $23.2 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 Mortgage Transaction. This acceleration
resulted in a noncash charge of $1.3 million. In connection with reviewing our
compensation plans after the Mortgage Transaction and restructuring of corporate
functions, we implemented a program whereby all outstanding stock appreciation
rights and shares of phantom stock were terminated in exchange for cash to be
paid through a deferred compensation arrangement. We recorded charges of $2.9
million associated with this exchange. The charge reflects a $0.7 million
reduction recorded in the three months ended September 30, 2001, as actual cash
settlement costs were less than estimated. Due to the restructuring of the
company, we implemented programs whereby certain out-of-the-money options were
exchanged for shares of stock, and whereby certain shares of restricted stock
were exchanged for cash and stock options in a tender offer, subject to certain
performance conditions and vesting requirements. Noncash charges associated with
the issuance of the stock, stock options and the tender offer totaled $3.6
million. This charge reflects a $1.4 million increase recorded in the three
months ended September 30, 2001, as actual noncash charges associated with the
tender offer were more than estimated.
In the first quarter of 1999, in connection with cost reduction initiatives
and the consolidation of support functions, we recorded a $3.3 million charge
for costs associated with staff reductions. These expenses included severance
and outplacement costs. There were 121 employees severed who were entitled to
benefits. This staff reduction was substantially complete by June 30, 1999. The
final payment outstanding related to these employee costs was paid in the three
months ended March 31, 2000.
Expenses Associated with Exited Businesses/Products
In the first quarter of 2001, we recorded charges of $2.2 million related to
other products exited for which no future revenues or benefits would be
received. In the third quarter of 2001, we were able to settle some of these
commitments for less than originally estimated, and reduced the charge by $0.7
million. We expect to pay the remaining costs, which include lease and other
commitments, in 2002.
In the first quarter of 1999, we implemented a plan to cease the
origination of auto loans and recorded a $3.4 million charge for costs
associated with exited businesses/products. The charges included severance and
outplacement costs for 22 employees in the auto origination group, and
professional fees associated with exited businesses/products not directly
associated with our mortgage, business credit card and leasing units. We
34
completed the closing of the auto loan origination center and termination of
related employees during the second quarter of 1999. We completed payment of the
remaining professional fees during the first quarter of 2001.
In 1998, in connection with the transfer of our consumer credit card
business to Fleet Credit Card LLC, we made major organizational changes to
reduce corporate expenses incurred in the past: (a) to support the business
contributed to Fleet Credit Card LLC in the transfer of our consumer credit card
business, 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, 1998, the remaining accrual related to
expenses associated with exited businesses/products was $14.8 million. We had
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. In 1998, we recorded a charge of $22.8 million associated with these
commitments, and an $8.3 million charge associated with the write-off of assets
associated with this program that became unrealizable when the product was
exited. In 1999, an additional charge of $10.0 million was recorded based on a
change in the estimate of total expected costs for the contractual commitments
related to the exited product. Updated information regarding future benefits to
be provided in connection with these contractual commitments indicated a higher
level of benefits than originally estimated. A third party assumed the
liabilities 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.
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
As a result of unusual charges, valuation adjustments on venture capital
investments and the loss on the discontinuance of the leasing business in 2001,
we reported a pretax loss for the year ended December 31, 2001. A valuation
allowance has been provided against a portion of the resulting deferred tax
asset given our pre-existing net operating loss carryforwards and the
uncertainty of the realizability of the incremental deferred tax asset. In the
year ended December 31, 2000, we also reported a pretax loss and a valuation
allowance was provided against the resulting deferred tax asset, resulting in a
0% effective tax rate. In establishing the valuation allowance, management
considered (1) estimates of expected future taxable income, (2) existing and
projected book/tax differences, (3) tax planning strategies available, and (4)
the general and industry specific economic outlook. Based on this analysis,
management believes the net deferred tax asset of $107 million at December 31,
2001 will be realized. This analysis is inherently subjective, as it requires
estimates that are susceptible to significant revision as more information
becomes available.
In 1999, in connection with the filing of the 1998 tax returns, additional
book/tax differences related to the disposition of our consumer credit card
business in 1998 were quantified. These book/tax differences, when combined with
certain less significant recurring differences, resulted in net operating loss
carryforwards of approximately $521 million at December 31, 1999. This amount is
net of $96 million carried back to prior years, and includes $500 million that
pertains to losses incurred on the consumer credit card portfolio after the date
of the disposition of our consumer credit card business. A deferred tax asset of
$50 million, net of valuation allowance, resulting from the net operating loss
carryforwards was recorded as an income tax benefit in the fourth quarter of
1999.
At December 31, 2001, remaining net operating loss carryforwards were $662
million, of which $407 million expire in 2018, $29 million expire in 2019, $15
million expire in 2020 and $211 million expire in 2021. We utilized net
operating loss carryforwards of $85 million in 2000. Additionally in 2000, $29
million was carried back to prior years.
35
ASSET/LIABILITY MANAGEMENT
We manage our financial condition with a focus on maintaining high credit
quality standards, disciplined management of market risks and prudent levels of
growth, leverage and liquidity.
MARKET RISK SENSITIVITY
Market risk is the potential for loss or diminished financial performance
arising from adverse changes in market forces including interest rates and
market prices. Market risk sensitivity is the degree to which a financial
instrument, or a company that owns financial instruments, is exposed to market
forces. Fluctuations in interest rates, changes in economic conditions, shifts
in customer behavior, and other factors can affect our financial performance.
Changes in economic conditions and shifts in customer behavior are difficult to
predict, and our financial performance generally cannot be insulated from these
forces.
We are exposed to equity price risk on the equity securities in our
investments available for sale portfolio. The majority of our equity securities
at December 31, 2001 represented venture capital investments. We typically do
not attempt to reduce or eliminate the market exposure on these investments. A
20% adverse change in equity prices would result in an approximate $5 million
decrease in the fair value of our equity investments as of December 31, 2001. A
20% adverse change would have resulted in an approximate $15 million decrease in
fair value as of December 31, 2000.
Financial performance variability as a result of fluctuations in interest
rates is commonly called interest rate risk. Interest rate risk generally
results from mismatches in the timing of asset and liability repricing (gap
risk) and from differences between the repricing indices of assets and
liabilities (basis risk). We regularly evaluate our market risk profile and
attempt to minimize the impact of interest rate risk on net interest income and
net income. In managing interest rate risk exposure, we periodically securitize
receivables, sell and purchase assets, alter the mix and term structure of our
funding base, change our investment portfolio and use derivative financial
instruments. 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 and No. 138 had no impact on
income from continuing operations and was not material to income from
discontinued operations.
Risk exposure levels vary continuously, as changes occur in our
asset/liability mix, market interest rates and other factors affecting the
timing and magnitude of cash flows. We attempt to analyze the impact of interest
rate risk by regularly evaluating the perceived risks inherent in our asset and
liability structure, including derivative instruments. Computer simulations are
used to generate expected financial performance in a variety of interest rate
environments. Those results are analyzed to determine if actions need to be
taken to mitigate our interest rate risk.
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 also measure
the effect of interest rate risk on our managed net interest income, which
includes net interest income on owned assets and net interest income on
securitized receivables. Both increasing and decreasing rate scenarios assume an
instantaneous shift in rates and measure the corresponding change in expected
net interest income as compared to a base case scenario. As of December 31, 2001
and 2000, we estimated that our net interest income and managed net interest
income would change as follows over a twelve-month period:
<Table>
<Caption>
2001 2000
- --------------------------------------------------------------------------
Estimated percentage increase (decrease) in owned net
interest income:
Assuming 200 basis point increase in interest rates 5% 13%
Assuming 200 basis point decrease in interest rates (3)% (2)%
Estimated percentage increase (decrease) in managed net
interest income:
Assuming 200 basis point increase in interest rates (7)% 4%
Assuming 200 basis point decrease in interest rates 7% 13%
- --------------------------------------------------------------------------
</Table>
Our business credit card receivables include interest rate floors that
cause our managed net interest income to rise in the declining rate scenario. As
of December 31, 2001, the interest rate floors also cause a
36
decrease in managed net interest income in a rising rate scenario. This is
because rates at December 31, 2001 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. Changes in the size and the
composition of our balance sheet from December 31, 2001 to December 31, 2000,
including a significant reduction in debt and deposits, also have impacted the
results of sensitivity analysis in the owned net interest income scenarios.
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.
Since Advanta Corp.'s debt rating is not investment grade, our access to
unsecured, institutional debt is limited. However, we do have access to a
diversity of funding sources as described below, and have a high level of
liquidity at December 31, 2001. At December 31, 2001, we had $230 million of
federal funds sold, $203 million of receivables held for sale, and $162 million
of investments, which could be sold to generate additional liquidity.
Components of funding were as follows at December 31:
<Table>
<Caption>
2001 2000 1999
---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
- ------------------------------------------------------------------------------------------------------------
Off-balance sheet business credit card receivables $1,626,709 53% $1,324,137 33% $ 765,019 19%
Deposits 636,915 21 1,346,976 34 1,512,359 37
Debt and other borrowings 355,899 11 759,473 19 1,121,674 27
Equity, including capital securities 466,299 15 540,902 14 689,631 17
- ------------------------------------------------------------------------------------------------------------
Total $3,085,822 100% $3,971,488 100% $4,088,683 100%
============================================================================================================
</Table>
Off-Balance Sheet Business Credit Card Securitizations
We completed our first two public business credit card securitizations in 2000
and completed an additional public securitization in 2001. These public
securitizations enabled us to grow off-balance sheet business credit card
receivables as a component of our funding in 2000 and 2001. In addition to the
public securitizations, the securitization trust has two non-public series
outstanding. The first series provides off-balance sheet funding through a $280
million committed commercial paper conduit facility, of which $160 million was
unused at December 31, 2001. The commitment can be withdrawn under certain
conditions, similar to the conditions for an early amortization event as
described below for the other series of the securitization trust. Our commercial
paper conduit facility also requires the servicer, Advanta Bank Corp., to be
well-capitalized. Upon the expiration of this commercial paper conduit facility
in June 2002, management expects to obtain the appropriate level of replacement
funding under similar terms and conditions. The second non-public series was a
securitization completed in 2000.
The revolving periods of the series of the securitization trust extend to
the following dates:
<Table>
<Caption>
INVESTOR PRINCIPAL
BALANCE AT SCHEDULED END OF
DECEMBER 31, 2001 REVOLVING PERIOD
- -----------------------------------------------------
Series 1997-A $129,750 June 2002
Series 2000-A 157,068 September 2002
Series 2000-B 600,000 October 2002
Series 2000-C 400,000 January 2005
Series 2001-A 300,000 July 2007
</Table>
When the revolving periods of these series end and the series amortize,
management expects to complete new securitizations under similar terms and
conditions. The securitization agreements contain conditions that
37
would trigger an early amortization event. An early amortization event would
result in the repayment of principal to investors prior to the expected dates
above, which would require us to find an alternate means of funding new
receivables. The conditions include the failure to make payments under the terms
of the agreement, or the insolvency, receivership or other similar event of the
servicer, Advanta Bank Corp. An early amortization event would also be triggered
for each individual series if the three-month average excess spread percentage
was not maintained at a level greater than 0% for that series. Excess spread
represents income-related cash flows on securitized receivables (finance
charges, interchange and fees) net of note holders' interest, servicing fees,
and credit losses. At December 31, 2001, our three-month average excess spread
was 13%. Based on the current levels of excess spread, our financial condition
and other considerations, management believes that it is unlikely that the trust
or individual series will have an early amortization event. The business credit
card securitization agreements do not have any provisions or conditions
involving the debt rating of Advanta Corp.
Deposits, Debt, Other Borrowings and Equity
In the first quarter of 2001, we received in excess of $1 billion in cash
proceeds from the Mortgage Transaction. 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 senior notes. In the year ended December 31, 2001, we reduced
debt and deposits by $1.1 billion. Also, Advanta National Bank has suspended
originations of deposit accounts.
The Mortgage Transaction in the first quarter of 2001 resulted in liquidity
in excess of the needs of our continuing businesses. Excess liquid assets were
held in short-term, high-quality investments earning money market rates until
they could 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 reduced this net
interest expense and excess liquidity. However, we expect to continue to have
interest expense in excess of interest income for the next several quarters due
to the time required for our higher-rate debt to mature. We anticipate replacing
these debt maturities with notes bearing lower interest rates more in line with
the current market rates.
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 and received regulatory approval for a
return of capital from our insurance subsidiary to the parent company, Advanta
Corp. The return of capital from the insurance subsidiary to Advanta Corp.,
along with other payments from the insurance subsidiary in the first quarter of
2001, increased Advanta Corp. liquidity by $62.5 million.
In the first quarter of 2001, after consideration of the liquidity and the
capital requirements for the ongoing business, the Board of Directors of Advanta
Corp. authorized management to purchase up to 1.5 million shares of Advanta
Corp. common stock or the equivalent dollar amount of our capital securities, or
some combination thereof. We intend to make purchases modestly and when we
believe it is prudent to do so. As of December 31, 2001, we have repurchased
693,300 shares of our Class B Common Stock.
The following tables detail the composition of the deposit base and the
composition of debt and other borrowings at year end for each of the past five
years.
COMPOSITION OF DEPOSIT BASE
<Table>
<Caption>
($ IN MILLIONS) AS OF DECEMBER 31,
--------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------ -------------- -------------- -------------- --------------
AMOUNT % AMOUNT % AMOUNT % % AMOUNT %
- ---------------------------------------------------------------------------------------------------------------
Demand deposits $ 6.5 1% $ 4.6 0% $ 5.8 0% $ 4.3 0% $ 41.6 1%
Money market savings 3.5 1 64.0 5 242.4 16 181.5 10 506.8 17
Time deposits of $100,000 or
less 389.9 61 916.9 68 1,046.6 69 1,445.8 83 2,163.0 72
Time deposits of more than
$100,000 237.0 37 361.5 27 217.6 15 118.2 7 306.2 10
- ---------------------------------------------------------------------------------------------------------------
Total deposits $636.9 100% $1,347.0 100% $1,512.4 100% $1,749.8 100% $3,017.6 100%
===============================================================================================================
</Table>
38
COMPOSITION OF DEBT AND OTHER BORROWINGS
<Table>
<Caption>
($ IN MILLIONS) AS OF DECEMBER 31,
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------- ------------ -------------- -------------- --------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ---------------------------------------------------------------------------------------------------------------
Subordinated notes and
certificates $ 0.6 0% $ 0.7 0% $ 1.0 0% $ 1.5 0% $ 55.5 2%
Senior notes and certificates 322.8 91 404.2 53 234.4 21 145.6 14 151.0 7
Short-term bank notes 0.0 0 0.0 0 0.0 0 0.0 0 242.0 11
Medium-term bank notes 0.0 0 3.4 1 7.3 0 7.3 1 669.5 29
Medium-term notes 0.2 0 343.6 45 538.0 48 866.5 83 1,099.5 48
Value notes 0.0 0 3.3 0 7.8 1 9.3 1 30.7 1
Term fed funds, fed funds
purchased and FHLB advances 0.0 0 0.0 0 220.0 20 0.0 0 0.0 0
Securities sold under
agreements to repurchase 32.3 9 0.0 0 104.2 9 0.0 0 0.0 0
Other borrowings 0.0 0 4.3 1 9.0 1 17.8 1 48.9 2
- ---------------------------------------------------------------------------------------------------------------
Total debt and other
borrowings $355.9 100% $759.5 100% $1,121.7 100% $1,048.0 100% $2,297.1 100%
===============================================================================================================
</Table>
Contractual Cash Obligations
The following table summarizes our contractual cash obligations as of December
31, 2001 by period:
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
-----------------------------------------------------
LESS THAN
OR EQUAL TO 2-3 4-5 AFTER 5
TOTAL 1 YEAR YEARS YEARS YEARS
- ---------------------------------------------------------------------------------------------------
Time deposits $626,905 $419,907 $204,614 $ 2,384 $ 0
Debt and other borrowings 355,899 283,535 56,537 15,827 0
Operating leases 17,009 5,119 8,261 3,432 197
- ---------------------------------------------------------------------------------------------------
Total contractual cash obligations $999,813 $708,561 $269,412 $21,643 $197
===================================================================================================
</Table>
Management expects to fund our deposit and debt obligations with
replacement deposits or debt having similar terms and conditions. We expect to
fund commitments related to operating leases with operating cash flows.
In addition to these obligations, we make commitments to extend credit to
our business credit card customers in the normal course of business. We had
unused commitments to extend credit of $4.6 billion at December 31, 2001. We
believe that our customers' utilization of their lines of credit will continue
to be substantially less than the amount of the commitments, as has been our
experience to date. We expect to fund the commitments to extend credit with the
various components of funding described above, similar to the funding of other
new receivables.
Regulatory Agreements and Restrictions at Subsidiaries
In June 2000, we announced that our banking subsidiaries, Advanta National Bank
and Advanta Bank Corp., reached agreements with their respective bank regulatory
agencies, primarily relating to the banks' subprime lending operations. The
agreements outlined a series of steps to modify processes and formalize and
document certain practices and procedures for the banks' subprime lending
operations. The agreements also established temporary asset growth limits at
Advanta National Bank and deposit growth limits at Advanta Bank Corp., imposed
restrictions on taking brokered deposits at Advanta National Bank, and required
that Advanta National Bank maintain certain capital ratios in excess of the
minimum regulatory standards. Our regulatory agreements with the Federal Deposit
Insurance Corporation and the Office of the Comptroller of the Currency (the
"OCC") prohibit the payment of cash dividends by Advanta Bank Corp. or Advanta
National Bank without prior regulatory approval.
Management believes that Advanta Bank Corp. and Advanta National Bank were
each in compliance with their respective regulatory agreements at December 31,
2001.
39
In connection with the Mortgage Transaction 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 Mortgage
Transaction 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 December 31, 2001, Advanta Bank Corp.'s combined total capital ratio
(combined Tier I and Tier II capital) was 18.80%, and Advanta National Bank's
combined total capital ratio was 23.34%. At December 31, 2000, Advanta Bank
Corp.'s combined total capital ratio was 14.60%, and Advanta National Bank's
combined total capital ratio was 15.08%. In each case, Advanta Bank Corp. and
Advanta National Bank 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.
In the fourth quarter of 2001, the bank regulatory agencies issued an
interagency policy statement that revised the regulatory capital treatment of
recourse, direct credit substitutes, and residual interests in asset
securitizations. This rule supercedes the former low-level recourse rules and
requires that banks hold one dollar in total risk-based capital against every
dollar of residual interest, with some exceptions. It further requires that
credit enhancing interest-only strips in excess of 25% of Tier 1 capital be
deducted from Tier 1 capital for purposes of calculating bank capital ratios.
This rule has an effective date of January 1, 2002. Early adoption was permitted
for transactions entered into prior to the effective date that result in a
reduced capital requirement. Banks can delay until December 31, 2002, the
application of the final rule to transactions entered into prior to January 1,
2002 that result in increased capital requirements. Advanta Bank Corp. elected
to adopt the rule effective December 31, 2001 and it resulted in a reduced
risk-based capital requirement. We do not anticipate the adoption of this rule
will have an effect on the capital requirements of Advanta National Bank.
Advanta Bank Corp. and Advanta National Bank are prevented by regulatory
restrictions from lending to Advanta Corp. and its affiliates unless these
extensions of credit are secured by U.S. Government obligations or other
specified collateral. Further, secured extensions of credit are limited in
amount: (a) as to Advanta Corp. or any affiliate, to 10% of each bank's capital
and surplus, and (b) as to Advanta Corp. and all affiliates in the aggregate, to
20% of each bank's capital and surplus. See "Part I -- Government Regulation."
Our insurance subsidiaries are also subject to certain capital and dividend
rules and regulations as prescribed by state jurisdictions in which they are
authorized to operate.
Total stockholders' equity of our banking and insurance affiliates was $220
million at December 31, 2001, of which $218 million was restricted. At January
1, 2002, $2.2 million of stockholders' equity of our insurance affiliates was
available for payment of cash dividends in 2002 under applicable regulatory
guidelines without prior regulatory approval.
In addition to dividend restrictions at banking subsidiaries, certain
non-bank subsidiaries are subject to minimum equity requirements as part of
securitization or other agreements. The total minimum equity requirement of
non-bank subsidiaries was $20 million at December 31, 2001. At December 31,
2001, the non-bank subsidiaries were in compliance with these minimum equity
requirements.
Management believes that the restrictions, for both bank and non-bank
subsidiaries, will not have an adverse effect on Advanta Corp.'s ability to meet
its cash obligations due to the current levels of liquidity and diversity of
funding sources.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Item 7, Management's Discussion and Analysis -- ASSET/LIABILITY
MANAGEMENT."
40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
($ IN THOUSANDS) ------------------------
2001 2000
- --------------------------------------------------------------------------------------
ASSETS
Cash $ 20,952 $ 1,716
Federal funds sold 229,889 107,584
Restricted interest-bearing deposits 113,956 16,398
Investments available for sale 246,679 758,792
Receivables, net:
Held for sale 202,612 154,265
Other 220,795 186,026
------------------------
Total receivables, net 423,407 340,291
Retained interests in securitizations 88,658 72,908
Amounts due from securitizations 80,325 61,610
Premises and equipment (at cost, less accumulated
depreciation of $21,667 in 2001 and $21,983 in 2000) 25,722 26,185
Other assets 264,689 256,658
Net assets of discontinued operations 142,403 1,201,330
- --------------------------------------------------------------------------------------
TOTAL ASSETS $1,636,680 $2,843,472
======================================================================================
LIABILITIES
Deposits:
Noninterest-bearing $ 6,500 $ 4,546
Interest-bearing 630,415 1,342,430
------------------------
Total deposits 636,915 1,346,976
Debt 323,582 755,184
Other borrowings 32,317 4,289
Other liabilities 177,567 196,121
- --------------------------------------------------------------------------------------
TOTAL LIABILITIES 1,170,381 2,302,570
- --------------------------------------------------------------------------------------
Commitments and contingencies
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 -- 200,000,000 shares; Issued -- 10,041,017
shares in 2001 and 10,040,230 shares in 2000 100 100
Class B non-voting common stock, $.01 par value;
Authorized -- 200,000,000 shares; Issued -- 17,939,639
shares in 2001 and 17,613,166 shares in 2000 179 176
Additional paid-in capital 223,362 220,371
Deferred compensation (64) (7,336)
Unearned ESOP shares (11,295) (11,714)
Accumulated other comprehensive income (loss) 1,259 (1,302)
Retained earnings 179,370 257,562
Less: Treasury stock at cost, 1,348,079 Class B common
shares in 2001 and 527,168 Class B common shares in
2000 (27,622) (17,965)
- --------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 366,299 440,902
- --------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,636,680 $2,843,472
======================================================================================
</Table>
See Notes to Consolidated Financial Statements.
41
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) ---------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------
INTEREST INCOME:
Receivables $ 77,799 $ 78,506 $ 37,718
Trading investments 0 0 6,752
Investments available for sale 40,052 57,594 60,114
- ---------------------------------------------------------------------------------------------
Total interest income 117,851 136,100 104,584
INTEREST EXPENSE:
Deposits 43,968 53,201 48,856
Debt 37,658 29,369 29,848
Other borrowings 844 3,938 2,096
- ---------------------------------------------------------------------------------------------
Total interest expense 82,470 86,508 80,800
- ---------------------------------------------------------------------------------------------
Net interest income 35,381 49,592 23,784
Provision for credit losses 35,976 36,309 22,506
- ---------------------------------------------------------------------------------------------
Net interest after provision for credit losses (595) 13,283 1,278
NONINTEREST REVENUES:
Securitization income 113,478 70,797 21,188
Servicing revenues 29,221 17,310 13,819
Interchange income 80,721 61,668 33,786
Other revenues, net (34,460) 7,306 36,577
- ---------------------------------------------------------------------------------------------
Total noninterest revenues 188,960 157,081 105,370
EXPENSES:
Operating expenses 180,186 150,292 95,506
Minority interest in income of consolidated subsidiary 8,880 8,880 8,880
Unusual charges 41,750 0 16,713
- ---------------------------------------------------------------------------------------------
Total expenses 230,816 159,172 121,099
- ---------------------------------------------------------------------------------------------
Income (loss) before income taxes (42,451) 11,192 (14,451)
Income tax (benefit) (11,995) 0 (55,785)
- ---------------------------------------------------------------------------------------------
Income (loss) from continuing operations (30,456) 11,192 41,334
Income (loss) from discontinued operations, net of tax (8,438) (163,578) 8,484
Loss, net, on discontinuance of mortgage and leasing
businesses, net of tax (31,639) (4,298) 0
- ---------------------------------------------------------------------------------------------
NET INCOME (LOSS) $(70,533) $(156,684) $ 49,818
=============================================================================================
Basic income (loss) from continuing operations per common
share
Class A $ (1.23) $ 0.39 $ 1.59
Class B (1.17) 0.47 1.66
Combined (1.19) 0.44 1.63
- ---------------------------------------------------------------------------------------------
Diluted income (loss) from continuing operations per
common share
Class A $ (1.23) $ 0.39 $ 1.58
Class B (1.17) 0.46 1.65
Combined (1.19) 0.44 1.62
- ---------------------------------------------------------------------------------------------
Basic net income (loss) per common share
Class A $ (2.79) $ (6.28) $ 1.95
Class B (2.73) (6.21) 2.02
Combined (2.75) (6.24) 1.99
- ---------------------------------------------------------------------------------------------
Diluted net income (loss) per common share
Class A $ (2.79) $ (6.23) $ 1.94
Class B (2.73) (6.16) 2.00
Combined (2.75) (6.19) 1.98
- ---------------------------------------------------------------------------------------------
Basic weighted average common shares outstanding
Class A 9,101 9,110 9,057
Class B 16,581 16,033 14,515
Combined 25,682 25,143 23,572
- ---------------------------------------------------------------------------------------------
Diluted weighted average common shares outstanding
Class A 9,101 9,149 9,078
Class B 16,581 16,202 14,680
Combined 25,682 25,351 23,758
- ---------------------------------------------------------------------------------------------
</Table>
See Notes to Consolidated Financial Statements.
42
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
($ IN THOUSANDS)
<Table>
<Caption>
----------------------------------------------------------------------
COMPREHENSIVE CLASS A CLASS B CLASS A CLASS B ADDITIONAL
INCOME PREFERRED PREFERRED COMMON COMMON PAID-IN
(LOSS) STOCK STOCK STOCK STOCK CAPITAL
- ----------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 1998 $1,010 $0 $104 $163 $229,304
Net income (loss) $ 49,818
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments,
net of tax benefit (expense) of
$5,763 (10,703)
---------
Comprehensive income (loss) $ 39,115
=========
Conversion of Class B Preferred
Stock 14 (14)
Preferred and common cash
dividends declared
Exercise of stock options 20
Issuance of restricted stock 1 9 10,579
Amortization of deferred
compensation
Retirement of restricted stock (4) (7,421)
Stock buyback
ESOP shares committed to be
released 117
- ----------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 1999 $1,010 $0 $105 $182 $232,585
Net income (loss) $(156,684)
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments,
net of tax benefit (expense) of
$(5,111) 9,492
---------
Comprehensive income (loss) $(147,192)
=========
Preferred and common cash
dividends declared
Exercise of stock options 155
Issuance of restricted stock 2 2,545
Amortization of deferred
compensation
Retirement of restricted stock (1) (4) (6,455)
Retirement of treasury stock (4) (4) (8,496)
ESOP shares committed to be
released 37
- ----------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2000 $1,010 $0 $100 $176 $220,371
Net income (loss) $ (70,533)
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments,
net of tax benefit (expense) of
$1,379 2,561
---------
Comprehensive income (loss) $ (67,972)
=========
Preferred and common cash
dividends declared
Exercise of stock options 4 3,476
Stock option exchange for stock
and restricted stock tender offer 934
Modification of stock options 1,966
Issuance of restricted stock 1 720
Amortization of deferred
compensation
Retirement of restricted stock (2) (4,118)
Stock buyback
ESOP shares committed to be
released 13
- ---------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2001 $1,010 $0 $100 $179 $223,362
=========================================================================================================
<Caption>
---------------------------------------------------------------------
DEFERRED ACCUMULATED
COMPENSATION OTHER TOTAL
& UNEARNED COMPREHENSIVE RETAINED TREASURY STOCKHOLDERS'
ESOP SHARES INCOME (LOSS) EARNINGS STOCK EQUITY
- ---------------------------------- ---------------------------------------------------------------------
Balance at Dec. 31, 1998 $(29,764) $ (91) $382,092 $(22,514) $ 560,304
Net income (loss) 49,818 49,818
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments,
net of tax benefit (expense) of
$5,763 (10,703) (10,703)
Comprehensive income (loss)
Conversion of Class B Preferred
Stock 0
Preferred and common cash
dividends declared (10,169) (10,169)
Exercise of stock options 20
Issuance of restricted stock (10,589) 0
Amortization of deferred
compensation 3,781 3,781
Retirement of restricted stock 7,425 0
Stock buyback (3,955) (3,955)
ESOP shares committed to be
released 418 535
- ---------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 1999 $(28,729) $(10,794) $421,741 $(26,469) $ 589,631
Net income (loss) (156,684) (156,684)
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments,
net of tax benefit (expense) of
$(5,111) 9,492 9,492
Comprehensive income (loss)
Preferred and common cash
dividends declared (7,495) (7,495)
Exercise of stock options 155
Issuance of restricted stock (2,547) 0
Amortization of deferred
compensation 5,348 5,348
Retirement of restricted stock 6,460 0
Retirement of treasury stock 8,504 0
ESOP shares committed to be
released 418 455
- ---------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2000 $(19,050) $ (1,302) $257,562 $(17,965) $ 440,902
Net income (loss) (70,533) (70,533)
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments,
net of tax benefit (expense) of
$1,379 2,561 2,561
Comprehensive income (loss)
Preferred and common cash
dividends declared (7,659) (7,659)
Exercise of stock options 3,480
Stock option exchange for stock
and restricted stock tender offer 618 (2,152) (600)
Modification of stock options 1,966
Issuance of restricted stock (721) 0
Amortization of deferred
compensation 3,256 3,256
Retirement of restricted stock 4,120 0
Stock buyback (7,505) (7,505)
ESOP shares committed to be
released 418 431
- --------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2001 $(11,359) $ 1,259 $179,370 $(27,622) $ 366,299
========================================================================================================
</Table>
See Notes to Consolidated Financial Statements.
43
ADVANTA CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------
($ IN THOUSANDS) 2001 2000 1999
- --------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES -- CONTINUING OPERATIONS
Net income (loss) $ (70,533) $ (156,684) $ 49,818
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
(Income) loss from discontinued operations, net of tax 8,438 163,578 (8,484)
Loss, net, on discontinuance of mortgage and leasing
businesses, net of tax 31,639 4,298 0
Investment securities (gains) losses 26,227 (5,473) (30,132)
Loss on sale of deposits 2,835 0 0
Depreciation 9,428 11,471 7,794
Provision for credit losses 35,976 36,309 22,506
Change in deferred origination costs, net of deferred
fees (6,556) (6,252) (6,038)
Proceeds from sale of trading investments 0 0 185,042
Change in receivables held for sale (320,896) (509,989) (450,920)
Proceeds from sale of receivables held for sale 272,549 512,619 318,692
Change in amounts due from securitizations, other assets
and other liabilities (32,072) (17,427) (100,164)
Change in retained interests in securitizations (15,750) (28,116) 854
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (58,715) 4,334 (11,032)
- --------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES -- CONTINUING OPERATIONS
Change in federal funds sold and interest-bearing
deposits (219,863) 50,454 115,953
Purchase of investments available for sale (1,144,064) (1,826,620) (12,872,622)
Proceeds from sales of investments available for sale 896,016 937,617 812,562
Proceeds from maturing investments available for sale 737,874 899,286 12,171,704
Change in receivables not held for sale (64,189) (74,330) (11,124)
Purchases of premises and equipment, net (7,698) (18,273) (8,203)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 198,076 (31,866) 208,270
- --------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES -- CONTINUING OPERATIONS
Change in demand and savings deposits (8,055) (179,542) 62,329
Proceeds from issuance of time deposits 724,665 1,325,125 600,747
Payments for maturing time deposits (1,044,640) (1,310,966) (900,507)
Payments for sale of deposits and related accrued
interest (392,511) 0 0
Change in repurchase agreements, term fed funds and FHLB
advances 32,317 (324,191) 324,191
Proceeds from issuance of debt 182,975 256,098 123,537
Payments on redemption of debt (614,577) (289,422) (365,176)
Change in other borrowings (4,289) (4,686) (8,809)
Proceeds from issuance of stock 3,480 155 20
Stock buyback (7,505) 0 (3,955)
Cash dividends paid (7,659) (7,495) (10,169)
- --------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,135,799) (534,924) (177,792)
- --------------------------------------------------------------------------------------------------------
DISCONTINUED OPERATIONS
Proceeds from Mortgage Transaction 1,093,975 0 0
Other cash used in operating activities (78,301) 312,668 241,938
----------- ----------- ------------
Net cash provided by operating activities 1,015,674 312,668 241,938
Net cash provided by (used in) investing activities 0 322,155 (325,616)
Net cash provided by (used in) financing activities 0 (76,435) 57,918
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) discontinued operations 1,015,674 558,388 (25,760)
- --------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 19,236 (4,068) (6,314)
Cash at beginning of period 1,716 5,784 12,098
========================================================================================================
Cash at end of period $ 20,952 $ 1,716 $ 5,784
========================================================================================================
</Table>
See Notes to Consolidated Financial Statements.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ IN THOUSANDS EXCEPT PER SHARE DATA, UNLESS OTHERWISE NOTED)
In these notes to consolidated financial statements, "Advanta", "we", "us", and
"our" refer to Advanta Corp. and its subsidiaries, unless the context otherwise
requires.
Advanta is a highly focused financial services company. We have been
providing innovative financial solutions since 1951. Our primary business
segment is Advanta Business Cards, one of the nation's largest issuers of
business credit cards to small businesses. In addition to our business credit
card lending business, we have venture capital investments. We own two
depository institutions, Advanta Bank Corp. and Advanta National Bank. Our banks
offer a variety of deposit products, such as retail and large denomination
certificates of deposit, that are insured by the Federal Deposit Insurance
Corporation (the "FDIC"). Advanta Business Cards is primarily funded and
operated through Advanta Bank Corp. At December 31, 2001, we serviced
approximately 680,000 business credit card customers and managed business credit
card receivables of $2.0 billion.
Through the first quarter of 2001, we had two additional lending
businesses, Advanta Mortgage and Advanta Leasing Services. In the first quarter
of 2001, we exited our mortgage business, announced the discontinuance of our
leasing business, and restructured our corporate functions to a size
commensurate with our ongoing businesses. The mortgage and equipment leasing
businesses represented 26% of our customers and 84% of our managed receivables
at December 31, 2000. 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.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States and include the
accounts of Advanta Corp. and its subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation. Certain prior
period amounts have been reclassified to conform to the current year's
presentation.
USE OF ESTIMATES
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States 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 allowance for credit losses, the fair
value of venture capital investments, litigation and income taxes, among others.
Actual results could differ from those estimates.
INVESTMENTS
Investments available for sale include securities that we sell from time to time
to provide liquidity and in response to changes in the market. Debt and equity
securities classified as available for sale are reported at market value and
unrealized gains and losses on these securities are reported in other
comprehensive income, net of income taxes.
Trading investments are securities that are bought and held principally for
the purpose of selling them in the near term. Trading investments are reported
at fair value, with unrealized gains and losses included in earnings. There were
no investments classified as trading at December 31, 2001 or 2000.
Investments of our venture capital unit are included in investments
available for sale and are carried at estimated fair value following the
specialized industry accounting principles of this unit. Management makes
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fair value determinations based on quoted market prices, when available, and
considers the investees' financial results, conditions and prospects when market
prices are not available. In accordance with the specialized industry accounting
principles of venture capital investment companies, the unrealized and realized
gains and losses on these investments are included in other revenues rather than
other comprehensive income and the equity method of accounting for investments
is not applied.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Gains and losses on the sale
of securities are recorded on the trade date and are determined using the
specific identification method.
RECEIVABLES HELD FOR SALE
Receivables held for sale represent loans currently on the balance sheet that we
intend to sell or securitize within the next six months. These assets are
reported at the lower of aggregate cost or fair market value by loan type. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is established as losses are estimated to have
occurred through a provision for credit losses charged to earnings. The
allowance for credit losses is evaluated on a regular basis by management and is
based upon management's periodic review of the collectibility of receivables in
light of historical experience by loan type, the nature and volume of the loan
portfolio, adverse situations that may affect the borrowers' ability to repay
and prevailing economic conditions. This evaluation is inherently subjective, as
it requires estimates that are susceptible to significant revision as more
information becomes available. Since our loan portfolio is comprised of large
groups of smaller balance homogeneous loans, we evaluate each group collectively
for impairment. Accordingly, we do not separately identify individual loans for
impairment disclosures.
Credit losses are charged against the allowance when management believes
the uncollectibility of a receivable balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance. Our charge-off policy for
business credit card accounts is to charge-off an unpaid receivable 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. Net charge-offs include the principal amount of losses less current
period recoveries. The accrued interest and fee portion of the charged-off
receivable balance is deducted from current period income.
INTEREST AND FEE INCOME ON RECEIVABLES
Interest income is accrued on the unpaid principal balance of receivables.
Interest income includes late fees on business credit card receivables. Fee
income is recognized when billed to the cardholder, with the exception of
origination fees as discussed in "Origination Costs and Fees." The accrual of
interest and fees is discontinued when the related receivable becomes 90 days
past due.
ORIGINATION COSTS AND FEES
We engage unrelated third parties to solicit and originate business credit card
account relationships. Amounts paid to third parties to acquire business credit
card accounts and certain other origination costs are deferred and netted
against any related business credit card origination fee, and the net amount is
amortized on a straight-line basis over the privilege period of one year. These
costs represent the cost of acquiring business credit card account
relationships, and the net amortization is included in operating expenses.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SECURITIZATION ACTIVITIES
A significant portion of our funding is through off-balance sheet business
credit card securitizations via a securitization trust. The securitization trust
was created to hold the collateral (the securitized receivables) and issue debt
to investors. The securitization trust is a qualifying special-purpose entity as
defined by 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," and therefore, is
not consolidated as part of Advanta Corp.'s consolidated financial statements.
We do not provide any guarantee of the debt issued by the special-purpose entity
and our recourse in the transactions is limited to the value of our interests in
securitizations that act as credit enhancement to the investors' interests.
We sell business credit card receivables through securitizations with
servicing retained. When we securitize, we surrender control over the
transferred assets and account for the transaction as a sale to the extent that
consideration other than beneficial interests in the transferred assets is
received in exchange. We allocate the previous carrying amount of the
securitized receivables between the assets sold and the retained interests,
based on their relative estimated fair values at the date of sale.
Securitization income is recognized at the time of the sale, equal to the excess
of the fair value of the assets obtained (principally cash) over the allocated
cost of the assets sold and transaction costs. During the revolving period of
each business credit card securitization, securitization income is recorded
representing estimated gains on the sale of new receivables to the
securitization trust on a continuous basis to replenish the investors' interest
in securitized receivables that have been repaid by the business credit card
account holders. Fair value estimates used in the recognition of securitization
income require certain assumptions of payment, default and interest rates. To
the extent actual results are different than those estimates, the impact is
recognized in securitization income.
On a monthly basis, income-related cash flows on securitized receivables
(finance charges, interchange and fees) are used to pay note holders' interest
and servicing fees, and any excess cash flow serves as credit enhancement to
cover credit losses in that month.
In September 2000, the FASB issued SFAS No. 140 which revised the standards
for accounting for securitizations and other transfers of financial assets and
collateral and required certain disclosures, but carried 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.
We adopted Emerging Issues Task Force Issue 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interest in
Securitized Financial Assets" on April 1, 2001. The implementation of EITF 99-20
did not have a material effect on our financial position or results of
operations.
RETAINED INTERESTS IN SECURITIZATIONS
Retained interests in securitizations include restricted cash reserve accounts,
retained interest-only strips and subordinated trust assets related to
securitizations. Subordinated trust assets represent an ownership interest in
the securitized receivables that is subordinated to the other investors'
interests. Retained interests in securitizations serve as credit enhancement for
the securitization transactions. We account for retained interests in
securitizations as trading securities. These assets are recorded at estimated
fair value and the resulting unrealized gain or loss from the valuation is
included in securitization income.
We estimate the fair value of retained interests in securitizations based
on a discounted cash flow analysis. The cash flows of the retained interest-only
strip are estimated as the excess of the weighted average finance charge yield
on each pool of the receivables sold over the sum of the interest rate paid to
the note holder, the servicing fee and an estimate of future credit losses over
the life of the receivables. Cash flows are discounted from the date the cash is
expected to become available to us (the "cash-out" method). These cash
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
flows are projected over the life of the receivables using payment, default, and
interest rate assumptions that management believes would be used by market
participants for similar financial instruments subject to prepayment, credit and
interest rate risk. The cash flows are discounted using an interest rate that
management believes a purchaser unrelated to the seller of the financial
instrument would demand. As all estimates used are influenced by factors outside
our control, there is uncertainty inherent in these estimates, making it
reasonably possible that they could change in the near term. Interest income is
recognized over the life of the retained interests in securitizations using the
discount rate used in the valuation.
SERVICING RIGHTS
Servicing assets associated with business credit card securitization
transactions are not material as the benefits of servicing are not expected to
be more or less than adequate compensation for performing the servicing.
AMOUNTS DUE FROM SECURITIZATIONS
Amounts due from securitizations consists primarily of accrued interest and fees
on securitized receivables, amounts owed from the trust for the purchase of new
loan receivables during the revolving period, and amounts owed from the trust
for one month's servicing fee and one month's income-related cash flows in
excess of that month's note holders' interest, servicing fees and credit losses.
INTERCHANGE INCOME
Interchange income includes interchange revenue on both owned and securitized
business credit cards.
PREMISES AND EQUIPMENT
Premises, equipment, computers and software are stated at cost less accumulated
depreciation and amortization. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets. Repairs and
maintenance are charged to expense as incurred. Estimated useful lives used for
premises and equipment are as follows:
<Table>
Furniture, fixtures and equipment 4 to 7 years
Computers and software 3 to 4 years
</Table>
Leasehold improvements are amortized over the shorter of the lives of the
leases or estimated service lives.
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Securities sold under agreements to repurchase are accounted for as secured
borrowings because we maintain effective control over the transferred assets.
Securities sold under agreements to repurchase are reflected at the amount of
cash received in connection with the transaction. We may be required to provide
additional collateral based on the fair value of the underlying securities.
DERIVATIVE FINANCIAL INSTRUMENTS
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 and No. 138
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 either (1) a hedge of the fair value of a recognized asset or
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
liability or of an unrecognized firm commitment, (2) a hedge of a forecasted
transaction or of the variability of cash flows to be received or paid related
to a recognized asset or liability ("cash flow hedge"), or (3) a hedge of a net
investment in a foreign operation. All derivatives used in continuing operations
in the year ended December 31, 2001 were designated as fair value hedges. There
were no derivatives designated as cash flow hedges or net investment hedges in
the year ended December 31, 2001.
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. Changes in the fair value of a derivative
that is designated as, and meets all the required criteria for, a cash flow
hedge are recorded in accumulated other comprehensive income and reclassified
into earnings as the underlying hedged item affects earnings. Changes in the
fair value of a derivative or non-derivative instrument that is designated as,
and meets all the required criteria for, a hedge of a net investment are
recorded in accumulated other comprehensive income. 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 or cash flow 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 or cash flows 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.
Prior to the adoption of SFAS No. 133 on January 1, 2001, gains or losses
on derivatives designated as hedges of balance sheet items not carried at fair
value were deferred and were ultimately recognized in income as part of the
carrying amount of the related balance sheet item exposing us to interest rate
risk. Accrual accounting was applied for derivatives designated as synthetic
alterations with income and expense recorded in the same category as the related
underlying on-balance sheet or off-balance sheet item synthetically altered. For
derivatives designated as hedges of balance sheet items where changes in fair
value were recognized currently in earnings, the related derivative was included
in the balance sheet at fair value, and changes in the fair value of the
derivative were also recognized currently in earnings.
BUSINESS CREDIT CARD REWARDS PROGRAMS
We offer bonus mile and cash-back reward programs with certain of our business
credit cards. Eligible cardholders earn points for bonus miles or up to 2%
cash-back rewards based on net purchases charged on their business credit card
account. The cost of future reward redemptions are estimated and recorded at the
time bonus mile points or cash-back rewards are earned by the cardholder. We
estimate that 80% to 100% of cardholders will ultimately claim rewards. The
estimate varies depending on the structure of the rewards program. These costs
of future reward redemptions are recorded as a reduction of other revenues.
INSURANCE
Insurance premiums and commission revenues are earned ratably over the period of
insurance coverage provided. Reinsurance premiums, net of commission expenses,
on credit life, disability and unemployment policies, are earned monthly based
upon the outstanding balance of the underlying receivables. Acquisition costs
are deferred and amortized over the period the related premiums or commissions
will be earned in order to match the expense with the anticipated revenue.
Insurance loss reserves are based on estimated settlement amounts for both
reported losses, incurred but not reported losses and loss adjustment expenses.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STOCK-BASED COMPENSATION
We have elected to account for stock-based compensation following Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" as
permitted by SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS
123"). We have adopted the disclosure-only provisions of SFAS 123.
INCOME TAXES
Deferred income tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various assets and liabilities and gives
current recognition to changes in tax rates and laws. We reduce our deferred tax
assets by a valuation allowance, if necessary, by the amount of any tax benefits
that, based on available evidence, are not expected to be realized. In
establishing the valuation allowance, management considers (1) estimates of
expected future taxable income, (2) existing and projected book/tax differences,
(3) tax planning strategies available, and (4) the general and industry specific
economic outlook. This analysis is inherently subjective, as it requires
estimates that are susceptible to significant revision as more information
becomes available.
EARNINGS PER SHARE
Basic earnings per common share is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
during the period. Income available to common stockholders is computed by
deducting Class A and Class B Preferred Stock dividends from net income. Diluted
earnings per common share is computed by dividing income available to common
stockholders, increased by dividends on dilutive Class B Preferred Stock (if
applicable for the period), by the sum of average common shares outstanding plus
dilutive common shares for the period. Potentially dilutive common shares
include stock options, restricted stock issued under incentive plans and,
through September 15, 1999, Class B Preferred Stock. Since the cash dividends
declared on our Class B Common Stock were higher than the dividends declared on
the Class A Common Stock, basic and diluted earnings per common share have been
calculated using the "two-class" method. The two-class method is an earnings
allocation formula that determines earnings per share for each class of common
stock according to dividends declared and participation rights in undistributed
earnings. We have also presented combined earnings per common share, which
represents a weighted average of Class A and Class B earnings per common share.
CASH FLOW REPORTING
Cash paid for interest was $122.4 million during 2001, $182.4 million during
2000, and $161.0 million during 1999. The net cash refund received for taxes was
$1.1 million in 2001. Cash paid for taxes was $4.1 million during 2000 and $8.9
million during 1999.
NOTE 2. DISCONTINUED OPERATIONS
Effective February 28, 2001, we completed the exit of our mortgage business,
Advanta Mortgage, through a purchase and sale agreement with Chase Manhattan
Mortgage Corporation as buyer (the "Mortgage Transaction"). Prior to the
Mortgage Transaction, Advanta Mortgage made nonconforming home equity loans
directly to consumers and through brokers. This business unit originated and
serviced first and second lien mortgage loans, including home equity lines of
credit, through subsidiaries of Advanta. In addition to servicing and managing
the loans it originated, Advanta Mortgage contracted with third parties to
service their nonconforming home equity loans on a subservicing basis. Following
the Mortgage 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
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
gross gain of approximately $60 million before transaction expenses, severance
expenses and other costs. The gain on the Mortgage Transaction does not reflect
any impact from the post-closing adjustment process. Although the Mortgage
Transaction 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 11 for a discussion of litigation related to the Mortgage
Transaction.
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. Advanta Leasing Services offered flexible
lease financing programs on small-ticket equipment to small businesses. The
primary products financed included office machinery, security systems and
computers. 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. Estimated operating results of the leasing business
included estimated valuations of retained interests in leasing securitizations,
estimated cash flows from on-balance sheet lease receivables, interest expense
and operating expenses. As all estimates used are influenced by factors outside
our control, there is uncertainty inherent in these estimates, making it
reasonably possible that they could change in the near term. In the year ended
December 31, 2001, we incurred an additional $45.0 million pretax loss on the
discontinuance of the leasing business due to changes in the estimate of those
operating results. These changes in estimate were needed due to an increase in
estimated credit losses expected throughout the remaining term of the leasing
portfolio based on credit loss experience in 2001. The primary factor
contributing to the increased credit losses is that one of our former leasing
vendors filed for bankruptcy protection and this vendor's financial problems
have impacted its ability to service a segment of our leasing portfolio.
The exit 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.
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 years
ended December 31, 2000 and 1999:
<Table>
<Caption>
JANUARY 1, 2001 YEAR ENDED YEAR ENDED
TO FEBRUARY 28, DECEMBER 31, DECEMBER 31,
2001 2000 1999
- -----------------------------------------------------------------------------------------------------
Interest revenue $ 18,922 $ 164,142 $ 131,496
Noninterest revenues 17,709 37,679 179,957
Interest expense (11,160) (93,845) (78,461)
Other expenses (37,721) (245,004) (228,122)
Income tax (expense) benefit 3,812 0 (1,926)
- -----------------------------------------------------------------------------------------------------
Income (loss) from discontinued operations, net of
tax $ (8,438) $(137,028) $ 2,944
=====================================================================================================
</Table>
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenues and expenses of Advanta Leasing Services were as follows for the
years ended December 31:
<Table>
<Caption>
2000 1999
- ----------------------------------------------------------------------------------
Interest revenue $ 15,632 $ 10,146
Noninterest revenues 9,459 40,970
Interest expense (12,777) (8,415)
Other expenses (38,864) (33,574)
Income tax expense 0 (3,587)
- ----------------------------------------------------------------------------------
Income (loss) from discontinued operations, net of tax $(26,550) $ 5,540
==================================================================================
</Table>
We allocated interest expense to the discontinued operations based on the
ratio of net assets of discontinued operations to the total net assets of the
consolidated company.
The components of the gain (loss) on discontinuance of our mortgage and
leasing businesses for the years ended December 31 were as follows:
<Table>
<Caption>
2001 2000
-------------------- --------------------
ADVANTA ADVANTA
ADVANTA LEASING ADVANTA LEASING
MORTGAGE SERVICES MORTGAGE SERVICES
- ------------------------------------------------------------------------------------------------
Pretax gain (loss) on discontinuance of mortgage
and leasing businesses $20,753 $(45,000) $0 $(4,298)
Income tax (expense) benefit (8,637) 1,245 0 0
- ------------------------------------------------------------------------------------------------
Gain (loss) on discontinuance of mortgage and
leasing businesses, net of tax $12,116 $(43,755) $0 $(4,298)
================================================================================================
</Table>
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 $45.0 million loss
was recorded in the year ended December 31, 2001 as a loss on discontinuance.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Per share data was as follows for the years ended December 31:
<Table>
<Caption>
ADVANTA MORTGAGE ADVANTA LEASING SERVICES
------------------------- -------------------------
2001 2000 1999 2001 2000 1999
- -----------------------------------------------------------------------------------------------
Basic income (loss) from discontinued
operations per common share
Class A $(0.33) $(5.45) $0.12 $ 0.00 $(1.06) $0.24
Class B (0.33) (5.45) 0.12 0.00 (1.06) 0.24
Combined (0.33) (5.45) 0.12 0.00 (1.06) 0.24
Diluted income (loss) from discontinued
operations per common share
Class A $(0.33) $(5.41) $0.12 $ 0.00 $(1.05) $0.23
Class B (0.33) (5.41) 0.12 0.00 (1.05) 0.23
Combined (0.33) (5.41) 0.12 0.00 (1.05) 0.23
Basic gain (loss), net, on
discontinuance of mortgage and
leasing businesses, net of tax, per
common share
Class A $ 0.47 $ 0.00 $0.00 $(1.70) $(0.17) $0.00
Class B 0.47 0.00 0.00 (1.70) (0.17) 0.00
Combined 0.47 0.00 0.00 (1.70) (0.17) 0.00
Diluted gain (loss), net, on
discontinuance of mortgage and
leasing businesses, net of tax, per
common share
Class A $ 0.47 $ 0.00 $0.00 $(1.70) $(0.17) $0.00
Class B 0.47 0.00 0.00 (1.70) (0.17) 0.00
Combined 0.47 0.00 0.00 (1.70) (0.17) 0.00
===============================================================================================
</Table>
The components of net assets of discontinued operations were as follows at
December 31:
<Table>
<Caption>
2001 2000
- ------------------------------------------------------------------------------------
Loans and leases, net $ 52,739 $ 370,682
Other assets 100,061 887,168
Liabilities (10,397) (56,520)
- ------------------------------------------------------------------------------------
Net assets of discontinued operations $142,403 $1,201,330
====================================================================================
</Table>
As discussed above, we will continue to service the existing lease
portfolio. At December 31, 2001, there were $365 million of securitized leases
outstanding, and we had retained interests in leasing securitizations of $44
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
December 31, 2001, the fair value of the retained interests in leasing
securitizations was estimated using a 12.0% discount rate on future cash flows,
loss rates ranging from 9.0% to 9.9% and a weighted average life of 1.1 years.
Actual results may vary from our estimates, and the impact of any differences
will be recognized in income when determined.
We use interest rate swaps to manage the impact of fluctuating interest
rates on the fair value of certain retained interests in leasing
securitizations. The interest rate swaps effectively convert a leasing
off-balance sheet variable securitization to a fixed rate. At December 31, 2001,
the notional amount of interest rate swaps outstanding relating to leasing
securitizations was $113.6 million, and the estimated fair value was a liability
of $3.5 million. At December 31, 2000, the notional amount of interest rate
swaps outstanding relating to leasing securitizations was $216.2 million, and
the estimated fair value was a liability of $1.4 million. The interest rate
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
swaps are recorded at fair value with changes in fair value recorded in Advanta
Leasing Services operating results. As discussed above, the estimated operating
results of Advanta Leasing Services through the remaining term of the lease
portfolio were estimated at the measurement date in the determination of the
loss on discontinuance.
NOTE 3. RESTRICTED INTEREST-BEARING DEPOSITS AND INVESTMENTS AVAILABLE FOR SALE
Restricted interest-bearing deposits at December 31, 2001 include $72.0 million
of amounts held in escrow in connection with our litigation with Fleet Financial
Group ("Fleet"), and $36.1 million held in escrow in connection with other
litigation-related contingencies.
Investments available for sale consisted of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------------------------------------------------------------------------------------
2001 2000
---------------------------------------------- ----------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
=========================================================================================================================
U.S. Treasury and other
U.S. Government
securities $ 85,064 $1,238 $(100) $ 86,202 $401,168 $ 831 $ (774) $401,225
State and municipal
securities 3,889 162 (46) 4,005 4,280 192 (36) 4,436
Collateralized mortgage
obligations 20,909 409 0 21,318 165,689 119 (2,911) 162,897
Mortgage-backed
securities 9,961 274 0 10,235 91,520 764 (311) 91,973
Equity securities(1) 26,621 0 0 26,621 72,403 0 0 72,403
Other(2) 98,299 0 (1) 98,298 25,735 124 (1) 25,858
- -------------------------------------------------------------------------------------------------------------------------
Total investments
available for sale $244,743 $2,083 $(147) $246,679 $760,795 $2,030 $(4,033) $758,792
=========================================================================================================================
<Caption>
DECEMBER 31,
----------------------------------------------
1999
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
========================================================================
U.S. Treasury and other
U.S. Government
securities $145,112 $0 $ (4,668) $140,444
State and municipal
securities 3,473 0 (85) 3,388
Collateralized mortgage
obligations 456,288 0 (8,220) 448,068
Mortgage-backed
securities 98,190 0 (3,634) 94,556
Equity securities(1) 60,892 0 0 60,892
Other(2) 1,531 2 0 1,533
- -------------------------------------------------------------------------
Total investments
available for sale $765,486 $2 $(16,607) $748,881
=========================================================================
</Table>
(1) Includes venture capital investments of $18.6 million at December 31, 2001,
$45.3 million at December 31, 2000 and $36.4 million at December 31, 1999.
The amount shown as amortized cost represents fair value for these
investments. See Note 1.
(2) Other investments at December 31, 2001 include a $97.0 million investment in
the Merrill Lynch Premier Institutional Money Market Fund. Other investments
also include $1.2 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.
Maturities of investments available for sale at December 31, 2001 were as
follows:
<Table>
<Caption>
AMORTIZED MARKET
COST VALUE
- -----------------------------------------------------------------------------------
Due in 1 year $ 33,748 $ 34,343
Due after 1 but within 5 years 19,841 20,506
Due after 5 but within 10 years 34,465 34,481
Due after 10 years 899 877
- -----------------------------------------------------------------------------------
Subtotal 88,953 90,207
Collateralized mortgage obligations 20,909 21,318
Mortgage-backed securities 9,961 10,235
Equity securities 26,621 26,621
Other 98,299 98,298
- -----------------------------------------------------------------------------------
Total investments available for sale $244,743 $246,679
===================================================================================
</Table>
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net realized gains on the sale of investments are included in other
revenues in the consolidated income statements. Realized gains and losses on
sales of investments available for sale were as follows for the years ended
December 31:
<Table>
<Caption>
2001 2000 1999
- --------------------------------------------------------------------------------------------
Gross realized gains $ 3,456 $11,728 $30,697
Gross realized losses (10,100) (2,564) (64)
- --------------------------------------------------------------------------------------------
Net realized gains (losses) $ (6,644) $ 9,164 $30,633
============================================================================================
</Table>
Investment securities deposited with insurance regulatory authorities to
meet statutory requirements or held by a trustee for the benefit of primary
insurance carriers were $6.2 million at December 31, 2001 and $6.5 million at
December 31, 2000. The carrying value of securities pledged to secure repurchase
agreements was $32.4 million at December 31, 2001 and $0 at December 31, 2000.
The carrying amount of other pledged securities was $0 at December 31, 2001 and
$2.7 million at December 31, 2000.
NOTE 4. RECEIVABLES
Receivables on the balance sheet, including those held for sale, consisted of
the following:
<Table>
<Caption>
DECEMBER 31,
- ----------------------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------------------
Business credit card receivables $416,265 $335,087
Other receivables 28,189 24,203
- ----------------------------------------------------------------------------------
Gross receivables 444,454 359,290
- ----------------------------------------------------------------------------------
Add: Deferred origination costs, net of deferred fees 20,924 14,368
Less: Allowance for credit losses
Business credit cards (41,169) (33,165)
Other receivables (802) (202)
- ----------------------------------------------------------------------------------
Total allowance (41,971) (33,367)
- ----------------------------------------------------------------------------------
Receivables, net $423,407 $340,291
==================================================================================
</Table>
Gross managed receivables (owned receivables and securitized receivables)
and managed credit quality data were as follows:
<Table>
<Caption>
DECEMBER 31,
- --------------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------------
Owned business credit card receivables $ 416,265 $ 335,087
Owned other receivables 28,189 24,203
Securitized business credit card receivables 1,626,709 1,324,137
- --------------------------------------------------------------------------------------
Total managed receivables 2,071,163 1,683,427
- --------------------------------------------------------------------------------------
Nonperforming assets -- managed 81,666 45,160
Receivables 30 days or more delinquent -- managed 137,517 83,798
Net charge-offs for the year ended December 31 -- managed 143,593 64,638
======================================================================================
</Table>
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The geographic concentration of managed receivables was as follows:
<Table>
<Caption>
DECEMBER 31,
- ----------------------------------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------------------------------
California $ 269,860 13% $ 215,537 13%
Florida 157,555 8 130,250 8
Texas 147,268 7 115,823 7
New York 131,602 6 108,266 6
Illinois 91,910 4 74,542 4
All other 1,272,968 62 1,039,009 62
- ----------------------------------------------------------------------------------------------
Total managed receivables $2,071,163 100% $1,683,427 100%
==============================================================================================
</Table>
In the normal course of business, we make commitments to extend credit to
our business credit card customers. Commitments to extend credit are agreements
to lend to a customer subject to certain conditions established in the contract.
We do not require collateral to support business credit card commitments. We had
commitments to extend credit for which there was potential credit risk of $6.6
billion at December 31, 2001 and $5.9 billion at December 31, 2000. We believe
that our customers' utilization of these lines of credit will continue to be
substantially less than the amount of the commitments, as has been our
experience to date. Of these total commitments, $4.6 billion were unused at
December 31, 2001 and $4.2 billion were unused at December 31, 2000.
NOTE 5. ALLOWANCE FOR CREDIT LOSSES
The following table displays five years of allowance history:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------
Balance at January 1 $ 33,367 $ 14,865 $ 10,650 $ 129,053 $ 78,801
Provision for credit losses 35,976 36,309 22,506 38,329 199,509
Allowance on receivables sold or
transferred 0 0 (5,791) (118,420) (6,039)
Gross charge-offs:
Business credit cards (30,540) (20,174) (11,341) (11,126) (6,403)
Other receivables (3) (2) (2,404) 0 (4)
Consumer credit cards 0 0 0 (30,999) (155,528)
- ----------------------------------------------------------------------------------------------
Total gross charge-offs (30,543) (20,176) (13,745) (42,125) (161,935)
Recoveries:
Business credit cards 3,171 2,369 1,238 1,093 205
Other receivables 0 0 7 1 1
Consumer credit cards 0 0 0 2,719 18,511
- ----------------------------------------------------------------------------------------------
Total recoveries 3,171 2,369 1,245 3,813 18,717
- ----------------------------------------------------------------------------------------------
Net charge-offs (27,372) (17,807) (12,500) (38,312) (143,218)
Balance at December 31 $ 41,971 $ 33,367 $ 14,865 $ 10,650 $ 129,053
==============================================================================================
</Table>
As of September 30, 2000, we modified our estimate of the allowance for
credit losses on business credit card receivables. The revised estimate for the
overall portfolio was developed based on discussions with our banking
regulators, changes in the economic environment and the use of more conservative
loss estimates for certain segments of the loan portfolio. Those segments
included accounts with lower credit scores, accounts held by businesses in
operation less than twelve months, and accounts in which cash borrowings
comprise a significant portion of the outstanding balance. As a result of these
changes in estimate, we increased our
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
allowance for credit losses by approximately $8 million, which decreased net
income from continuing operations in the year ended December 31, 2000 by
approximately $8 million or $0.32 per diluted combined share.
NOTE 6. SECURITIZATION ACTIVITIES
The following represents business credit card securitization data for the years
ended December 31, 2001 and 2000, and the key assumptions used in measuring the
fair value of retained interests at the time of each new securitization or
replenishment during those periods.
<Table>
<Caption>
2001 2000
- --------------------------------------------------------------------------------------------
Securitization income $ 113,478 $ 70,797
Interchange income 61,722 39,684
Servicing revenues 29,221 17,310
Proceeds from new securitizations 272,549 512,619
Proceeds from collections reinvested in revolving-period
securitizations 3,283,737 2,011,733
Cash flows received on retained interests 175,445 91,517
KEY ASSUMPTIONS:
Discount rate 12.0% 12.0%
Monthly payment rate 17.9% - 18.8% 18.8% - 19.7%
Loss rate 7.8% - 10.4% 7.2% - 7.8%
Finance charge yield, net of interest paid to note holders 12.1% - 15.8% 10.4% - 10.8%
- --------------------------------------------------------------------------------------------
</Table>
There were no purchases of delinquent accounts during 2001 or 2000.
The following assumptions were used in measuring the fair value of retained
interests in business credit card securitizations at December 31, 2001 and 2000.
The assumptions listed represent weighted averages of assumptions used for each
securitization.
<Table>
<Caption>
2001 2000
- --------------------------------------------------------------------------
Discount rate 12.0% 12.0%
Monthly payment rate 18.2 19.0
Loss rate 10.4 7.8
Finance charge yield, net of interest paid to note holders 15.8 10.8
==========================================================================
</Table>
In addition to the assumptions identified above, management also considered
qualitative factors such as the impact of the current economic environment on
the performance of the business credit card receivables sold and the potential
volatility of the current market for similar instruments in assessing the fair
value of retained interests in business credit card securitizations.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 December 31, 2001.
<Table>
Fair value at December 31, 2001 $ 88,658
Effect on fair value of the following hypothetical changes
in key assumptions:
Discount rate increased by 2% (741)
Discount rate increased by 4% (1,474)
Monthly payment rate at 110% of base assumption 0
Monthly payment rate at 125% of base assumption (1,635)
Loss rate at 110% of base assumption (4,031)
Loss rate at 125% of base assumption (10,040)
Finance charge yield, net of interest paid to note
holders, decreased by 1% (3,888)
Finance charge yield, net of interest paid to note
holders, decreased by 2% (7,764)
</Table>
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 estimate fair value as
described in Note 1. 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
Other assets consisted of the following:
<Table>
<Caption>
DECEMBER 31,
- ----------------------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------------------
Current and deferred federal and state income taxes, net $ 94,922 $ 87,794
Amounts due from transfer of consumer credit card business 70,545 70,545
Cash surrender value of insurance contracts 26,065 20,432
Investment in Fleet Credit Card LLC 20,000 20,000
Other 53,157 57,887
- ----------------------------------------------------------------------------------
Total other assets $264,689 $256,658
==================================================================================
</Table>
Other liabilities consisted of the following:
<Table>
<Caption>
DECEMBER 31,
- ----------------------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------------------
Accounts payable and accrued expenses $ 43,554 $ 70,041
Business credit card rewards 10,389 3,463
Accrued interest payable 9,095 31,048
Other 114,529 91,569
- ----------------------------------------------------------------------------------
Total other liabilities $177,567 $196,121
==================================================================================
</Table>
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. DEPOSITS
Deposit accounts consist of the following:
<Table>
<Caption>
DECEMBER 31,
- ------------------------------------------------------------------------------------
2001 2000
- ------------------------------------------------------------------------------------
Demand deposits $ 6,500 $ 4,545
Money market savings 3,510 64,023
Time deposits of $100,000 or less 389,888 916,921
Time deposits of more than $100,000 237,017 361,487
- ------------------------------------------------------------------------------------
Total deposits $636,915 $1,346,976
====================================================================================
</Table>
Time deposit maturities are as follows:
<Table>
Year Ended December 31,
2002 $419,907
2003 146,257
2004 58,357
2005 2,384
</Table>
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. DEBT
The composition of debt was as follows:
<Table>
<Caption>
DECEMBER 31,
- ----------------------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------------------
SENIOR DEBT
RediReserve demand certificates, variable (3.00%-4.25%) $ 28,312 $ 50,190
12 month senior notes, fixed (4.64%-11.33%) 125,450 152,553
18 month senior notes, fixed (5.59%-11.38%) 12,097 9,229
24 month senior notes, fixed (6.06%-11.42%) 77,228 86,109
30 month senior notes, fixed (6.16%-11.47%) 15,334 14,684
48 month senior notes, fixed (7.00%-11.51%) 9,670 8,384
60 month senior notes, fixed (6.53%-11.56%) 36,258 34,849
Value notes, fixed 0 3,271
Medium-term notes, fixed (6.92%-6.98%) 199 313,100
Medium-term notes, floating 0 30,500
Medium-term bank notes, fixed 0 3,404
Other senior notes, fixed (3.92%-11.33%) 18,453 48,197
- ----------------------------------------------------------------------------------
Total senior debt 323,001 754,470
Subordinated notes, fixed (9.08%-9.54%) 581 714
- ----------------------------------------------------------------------------------
Total debt $323,582 $755,184
==================================================================================
</Table>
We priced our floating rate medium-term notes based on a spread over LIBOR.
At December 31, 2000, the rates on these notes varied from 7.19% to 7.30%;
however, we used derivative financial instruments to effectively convert certain
fixed rate medium-term notes to a LIBOR-based variable rate. See Note 25. We
used part of the proceeds from the Mortgage Transaction 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 2001.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The annual contractual maturities of debt at December 31, 2001 for the
years ending December 31 are as follows: $251.2 million in 2002; $42.0 million
in 2003; $14.5 million in 2004; $10.8 million in 2005; and $5.1 million in 2006.
The average interest cost of our debt was 9.47% during 2001, 8.17% during 2000
and 6.53% during 1999.
NOTE 10. OTHER BORROWINGS
The composition of other borrowings was as follows:
<Table>
<Caption>
DECEMBER 31,
- -------------------------------------------------------------------------------
2001 2000
- -------------------------------------------------------------------------------
Securities sold under repurchase agreements $32,317 $ 0
Other borrowings 0 4,289
- -------------------------------------------------------------------------------
Total $32,317 $4,289
===============================================================================
</Table>
At December 31, 2001 we had a $280.3 million committed commercial paper
conduit facility. We pay a facility fee on the unused portion of the commitment
at an annual rate of 15 basis points. This facility provides for off-balance
sheet funding. At December 31, 2001, there were $120 million of business credit
card receivables securitized through this facility. The commitment can be
withdrawn under certain conditions, including a failure to make payments under
the terms of the agreement and the failure to maintain a three-month average
excess spread percentage on the securitized receivables at a level greater than
0%. Excess spread represents income-related cash flows on securitized
receivables (finance charges, interchange and fees) net of note holders'
interest, servicing fees, and credit losses. The agreement also requires the
servicer of the receivables, Advanta Bank Corp., to be well-capitalized. Upon
the expiration of this facility in June 2002, management expects to obtain the
appropriate level of replacement funding under similar terms and conditions. At
December 31, 2000, we had $130.3 million of business credit card receivables
securitized through this facility.
The following table displays information related to selected types of
short-term borrowings:
<Table>
<Caption>
2001 2000 1999
- -----------------------------------------------------------------------------------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
- -----------------------------------------------------------------------------------------------
At year end:
Securities sold under repurchase
agreements $ 32,317 2.09% $ 0 0% $104,191 5.78%
FHLB advances 0 0 0 0 220,000 5.53
===============================================================================================
Average for the year:
Securities sold under repurchase
agreements $ 16,705 5.74% $ 36,960 6.14% $ 24,647 5.39%
Term fed funds, fed funds purchased and
FHLB advances 0 0 62,435 6.14 11,432 5.57
- -----------------------------------------------------------------------------------------------
Total $ 16,705 5.74% $ 99,395 6.14% $ 36,079 5.43%
===============================================================================================
Maximum month-end balance:
Securities sold under repurchase
agreements $148,545 $149,628 $104,191
Term fed funds, fed funds purchased and
FHLB advances 0 210,000 220,000
===============================================================================================
</Table>
The weighted average interest rates were calculated by dividing the
interest expense for the period by the average amount of short-term borrowings
outstanding during the period, calculated as an average of daily amounts.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11. COMMITMENTS AND 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 Credit Card LLC in connection with the
transfer of our consumer credit card business in 1998 (the "Consumer Credit Card
Transaction"). Fleet seeks damages of approximately $141 million. We 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 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.
In October 2001, the court issued a ruling on summary judgment in favor of Fleet
on certain legal issues and positions advocated by Fleet and against others that
Fleet advocated. As a result, for purposes of trial only, the parties stipulated
to a number of issues relating to the court's orders including certain amounts
that would be owed by each party to the other, while preserving their rights to
appeal. Many issues remained to be determined at trial, including the financial
impact of all issues in dispute. The trial took place in November and December
2001. The court ordered a post-trial briefing schedule, which has the parties
submitting briefs through March 2002, with oral argument scheduled for April
2002. As a result of related litigation with Fleet, $70.1 million of our
reserves in connection with this litigation were funded in an escrow account in
February 2001. Taking into account amounts that Fleet owes to us and the amount
escrowed, including interest, we have funded our estimated maximum net exposure
to Fleet in the litigation. Management expects that the ultimate resolution of
this litigation will not have a material adverse effect on our financial
position or future operating results given the amount escrowed, our reserves and
amounts that Fleet owes us.
On December 5, 2000, a former executive of Advanta obtained a jury verdict
against Advanta in the amount of $3.9 million in the United States District
Court for the Eastern District of Pennsylvania, in connection with various
claims against Advanta related to the executive's termination of employment. In
September 2001, the District Court Judge issued orders denying both parties'
post-trial motions. A judgment in the amount of approximately $6 million, which
includes the $3.9 million described above, was entered against Advanta. In
September 2001, Advanta filed an appeal to the United States Court of Appeals
for the Third Circuit. Advanta has posted a supersedeas bond in the amount of $8
million and has filed its principal brief in the Court of Appeals. The plaintiff
filed a cross-appeal from the order adverse to him. Advanta is vigorously
pursuing its appeal. The District Court Judge has not yet ruled on the
executive's petition for attorney's fees and costs in the amount of
approximately $1.2 million, which Advanta has contested. 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. An
answer to Banc One's second amended complaint was filed in July 2001 denying
liability, raising affirmative defenses and asserting a counterclaim. Various
motions were filed, including Advanta's motion for partial summary judgment
under one of the two loan servicing agreements, Banc One's motion for summary
judgment on liability under both loan servicing agreements, and Banc One's
motions to strike Advanta's counterclaim and ninth affirmative defense (both
alleging breach of the implied covenant of good faith and fair dealing). In
January 2002, the court entered an opinion and order on the pending motions,
which granted in part and denied in part both parties' motions for summary
judgment. The court treated Banc One's motions to strike as motions for summary
judgment, and although not entirely clear on this point, apparently granted them
in part and denied them in part. Banc One's motions to strike were denied as
moot. The court's ruling is essentially an interlocutory ruling in favor of
Advanta under one of
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the two agreements and in favor of Banc One under the other of the two
agreements. Advanta's counterclaim survives in part. The court's order does not
constitute a final judgment and no assessment of damages either on Advanta's
counterclaim or Banc One's claim has occurred. Further proceedings in the trial
court on the matter of damages on both the surviving portion of Advanta's
counterclaim and Banc One's surviving claim are to ensue. The amount of damages
which Banc One might ultimately be entitled to recover from Advanta remains
undetermined and dependent upon a number of factors, including the resolution of
various legal issues which remain to be resolved and the amount of any damages
Advanta might be entitled to recover against Banc One, which likewise remains
undetermined. 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 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 Mortgage
Transaction. Chase claims that Advanta misled Chase concerning the value of
certain of the assets sold to Chase. In September 2001, Advanta filed an answer
to the complaint in which Advanta denied all of the substantive allegations of
the complaint and asserted a counterclaim against Chase for breach of contract
relating to funds owed by Chase to Advanta in connection with the transaction.
The matter is in discovery and trial is scheduled for April 2003. 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.
In addition to the cases described above, Advanta Corp. and its
subsidiaries are involved in class action lawsuits, other litigation, claims and
legal proceedings arising in the ordinary course of business or discontinued
operations, including litigation arising from our operation of the mortgage
business prior to the Mortgage Transaction in the first quarter of 2001.
Management believes that the aggregate liabilities, if any, resulting from all
litigation, claims and other legal proceedings will not have a material adverse
effect on the consolidated financial position or results of our operations based
on the level of litigation reserves we have established and our expectations
regarding the ultimate resolutions of these actions. However, due to the
inherent uncertainty in litigation and since the ultimate resolutions of our
litigation, claims and other legal proceedings are influenced by factors outside
of our control, it is reasonably possible that our estimated liability under
these proceedings may change or that actual results will differ from our
estimates.
We lease office space in several states under leases accounted for as
operating leases. Total rent expense related to continuing operations was $5.2
million in 2001, $5.6 million in 2000 and $5.3 million in 1999. The future
minimum lease payments of non-cancelable operating leases related to continuing
operations are as follows:
<Table>
Year Ended December 31,
2002 $5,119
2003 4,483
2004 3,778
2005 2,970
2006 462
Thereafter 197
</Table>
In the normal course of business, we make commitments to extend credit to
our business credit card customers. See Note 4 for further discussion.
NOTE 12. MANDATORILY REDEEMABLE PREFERRED SECURITIES
In December 1996, a newly formed statutory business trust established and
wholly-owned by Advanta Corp., issued $100 million of capital securities,
representing preferred beneficial interests in the assets of the trust. We used
the proceeds from the sale for general corporate purposes. The assets of the
trust consist of $100
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
million of 8.99% junior subordinated debentures issued by Advanta Corp. due
December 17, 2026. The capital securities will be subject to mandatory
redemption under certain circumstances. These circumstances include the optional
prepayment by Advanta Corp. of the junior subordinated debentures at any time on
or after December 17, 2006 at an amount per capital security equal to 104.495%
of the principal amount plus accrued and unpaid distributions. This amount
declines ratably on each December 17 thereafter to 100% on December 17, 2016.
Our obligations, in the aggregate, provide a full and unconditional guarantee of
payments of distributions and other amounts due on the capital securities.
Dividends on the capital securities are cumulative, payable semi-annually in
arrears at an annual rate of 8.99%, and are deferrable at our option for up to
ten consecutive semi-annual periods. We cannot pay dividends on our preferred or
common stocks during deferments. Dividends on the capital securities have been
classified as minority interest in income of consolidated subsidiary in the
consolidated income statements. The trust has no operations or assets separate
from its investment in the junior subordinated debentures. Separate financial
statements of the trust are not presented because management has determined that
they would not be meaningful to investors.
NOTE 13. CAPITAL STOCK
Class A Preferred Stock is entitled to 1/2 vote per share and a non-cumulative
dividend of $140 per share per year, which must be paid prior to any dividend on
the common stock. The redemption price of the Class A Preferred Stock is
equivalent to its par value.
On September 15, 1999, all of the 1.4 million outstanding depositary
shares, each representing one one-hundredth interest in a share of Stock
Appreciation Income Linked Securities, mandatorily converted into 1.4 million
shares of Class B Common Stock. The Stock Appreciation Income Linked Securities
constituted a series of our Class B Preferred Stock, designated as 6 3/4%
Convertible Class B Preferred Stock, Series 1995.
In 2000, we retired 405,000 shares of Class A Treasury stock and 445,600
shares of Class B Treasury stock.
In 2001, the Board of Directors authorized the purchase of 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 December 31, 2001, we
have repurchased 693,300 shares of our Class B Common Stock.
Cash dividends per share of common stock declared during the years ended
December 31, 2001, 2000 and 1999 were $0.252 for Class A Common Stock and $0.302
for Class B Common Stock.
NOTE 14. BENEFIT PLANS
We have adopted a stock-based incentive plan designed to provide incentives to
participating employees to remain in our employ and devote themselves to
Advanta's success. Our incentive plan authorizes an aggregate of 20.0 million
shares of Advanta Corp. Class B Common Stock for the grant of options, awards of
shares of stock or awards of stock appreciation rights to employees and
directors. Shares available for future grant were 11.9 million at December 31,
2001 and 11.6 million at December 31, 2000.
RESTRICTED STOCK AWARDS
Under our management incentive programs, eligible employees were given the
opportunity to elect to take portions of their anticipated or target bonus
payments for future years in the form of restricted shares of Advanta Corp.
Common Stock (with each program covering three performance years). To the extent
that these elections were made, or were required by the terms of the programs
for executive officers, restricted shares were issued to employees. The number
of shares granted to employees is determined by dividing the amount of future
target bonus payments that the employee had elected to receive in stock by the
market price as determined under the incentive program. The restricted shares
are subject to forfeiture prior to vesting should the employee terminate
employment with us. Restricted shares vest 10 years from the date of grant.
Vesting was and may continue to be accelerated annually with respect to the
shares granted under the program
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
covering the particular performance year, based on the extent to which the
employee and Advanta met or meet their respective performance goals for that
performance year. When newly eligible employees elect to participate in this
program, the number of shares issued to them with respect to their target bonus
payments for the relevant performance years is determined based on the average
market price of the stock for the 90 days prior to the first day of the month in
which they are eligible to join the program. Compensation expense on restricted
shares is recognized over the vesting period of the shares. Compensation expense
recognized in connection with restricted shares was $3.3 million in 2001, $5.3
million in 2000 and $3.8 million in 1999.
Due to the restructuring of the company in the first quarter of 2001, we
implemented a program whereby certain restricted stock was exchanged for cash
and stock options in a tender offer. The cash and stock options are subject to
the same performance conditions and vesting requirements as the tendered
restricted stock. The stock options expire two years after the vesting date.
There were 117 thousand shares of restricted stock tendered with a weighted
average price at date of issuance of $21.11, and 232 thousand options were
issued in connection with the tender offer with an exercise price of $10.63.
Noncash charges associated with the tender offer and related issuance of stock
options were $1.4 million and were included in unusual charges in the
consolidated income statements.
The following table summarizes restricted shares outstanding and shares
issued. Substantially all restricted shares outstanding and issued during the
three years ended December 31, 2001 were Class B Common Stock.
<Table>
<Caption>
2001 2000 1999
(SHARES IN THOUSANDS) ---------------------------- ---------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
NUMBER OF PRICE AT DATE OF NUMBER OF PRICE AT DATE OF NUMBER OF PRICE AT DATE OF
SHARES ISSUANCE SHARES ISSUANCE SHARES ISSUANCE
- -----------------------------------------------------------------------------------------------------------------
Restricted shares
outstanding at
December 31 187 $9 984 $17 1,750 $15
Restricted shares
issued in the year
ended December 31 82 $9 201 $13 1,002 $11
=================================================================================================================
</Table>
STOCK OPTIONS
Stock option transactions for the years ended December 31 were as follows:
<Table>
<Caption>
2001 2000 1999
(SHARES IN THOUSANDS) ---------------------------- ---------------------------- ----------------------------
NUMBER OF WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
- -----------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of year 3,049 $13 2,728 $15 2,988 $22
Granted 1,770 11 1,128 9 1,358 10
Exercised (424) 8 (20) 8 (8) 2
Terminated (1,498) 16 (787) 14 (1,610) 23
- -----------------------------------------------------------------------------------------------------------------
Outstanding at end of
year 2,897 $11 3,049 $13 2,728 $15
- -----------------------------------------------------------------------------------------------------------------
Options exercisable
at year-end 787 1,156 722
- -----------------------------------------------------------------------------------------------------------------
Weighted average fair
value of options
granted during the
year $ 4.93 $ 3.77 $ 4.23
=================================================================================================================
</Table>
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 2001.
<Table>
<Caption>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ------------------------------
(SHARES IN THOUSANDS)
NUMBER WEIGHTED AVERAGE NUMBER
RANGE OF OUTSTANDING REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
EXERCISE PRICES AT 12/31/01 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/01 EXERCISE PRICE
- ----------------------------------------------------------------------------------------------------
$ 1.00 to $ 5.00 261 8.8 years $ 5 128 $ 5
$ 5.01 to $10.00 1,003 7.0 8 202 8
$10.01 to $15.00 1,335 7.8 13 185 13
$15.01 to $20.00 149 6.4 19 123 19
$20.01 to $40.00 149 4.4 23 149 23
- ----------------------------------------------------------------------------------------------------
Total 2,897 7.4 $11 787 $13
====================================================================================================
</Table>
Options generally vest over a four-year period and expire 10 years after
the date of grant. Substantially all options outstanding and issued during the
three years ended December 31, 2001 were options to purchase Class B Common
Stock.
In 2001, we accelerated vesting of 32% of outstanding options that were not
vested at the date of the closing of the Mortgage Transaction. This acceleration
resulted in a noncash charge of $1.3 million that was included in unusual
charges in the consolidated income statements. We also extended the exercise
period for options held by employees in the discontinued businesses for an
additional six months following the date of the Mortgage Transaction, February
28, 2001. This extension resulted in a noncash charge of $650 thousand that was
included in the loss on discontinuance of mortgage and leasing businesses in the
consolidated income statements.
Due to the restructuring of the company in the first quarter of 2001, we
implemented a program whereby certain out-of-the-money options were exchanged
for shares of stock. There were 510 thousand options terminated in connection
with this program with a weighted average exercise price of $19.42. Noncash
charges associated with the issuance of the stock were $2.2 million and were
included in unusual charges in the consolidated income statements. Shares
granted in exchange for options were immediately vested but their distribution
is deferred. Participants will receive distributions of 25% of their shares on
the first, second, third and fourth anniversary of the program or they may elect
to defer distributions of any installment of shares until the second through
tenth anniversary of the program. If a participant terminates employment with
Advanta, any unpaid installments will be distributed on the tenth anniversary of
the program.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
We account for our stock option plans following Accounting Principles Board
Opinion No. 25, under which no compensation expense has been recognized. Had
compensation cost for these plans been determined consistent with SFAS 123, our
net income (loss) and net income (loss) per common share would have changed to
the following pro forma amounts:
<Table>
<Caption>
2001 2000 1999
- ---------------------------------------------------------------------------------------------
Net income (loss)
As reported $(70,533) $(156,684) $49,818
Pro forma (74,868) (163,228) 41,891
- ---------------------------------------------------------------------------------------------
Basic net income (loss) per common share
As reported
Class A $ (2.79) $ (6.28) $ 1.95
Class B (2.73) (6.21) 2.02
Combined (2.75) (6.24) 1.99
Pro forma
Class A $ (2.96) $ (6.54) $ 1.62
Class B (2.90) (6.47) 1.68
Combined (2.92) (6.50) 1.66
- ---------------------------------------------------------------------------------------------
Diluted net income (loss) per common share
As reported
Class A $ (2.79) $ (6.23) $ 1.94
Class B (2.73) (6.16) 2.00
Combined (2.75) (6.19) 1.98
Pro forma
Class A $ (2.96) $ (6.49) $ 1.61
Class B (2.90) (6.42) 1.67
Combined (2.92) (6.44) 1.65
=============================================================================================
</Table>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions for the years ended December 31:
<Table>
<Caption>
2001 2000 1999
--------------------
Dividend yield 3% 4% 3%
Expected life (in years) 7 7 7
Expected volatility 56% 50% 49%
Risk-free interest rate 4.6% 5.9% 5.4%
</Table>
STOCK APPRECIATION RIGHTS AND PHANTOM STOCK
In connection with reviewing our compensation plans after the Mortgage
Transaction and restructuring of corporate functions, we implemented a program
whereby all outstanding stock appreciation rights and shares of phantom stock
were terminated in exchange for cash to be paid through a deferred compensation
arrangement. We recorded charges of $2.9 million associated with this exchange
as unusual charges in the consolidated income statements. Participants will
receive distributions of 25% of their cash on the first, second, third and
fourth anniversary of the program or they may elect to defer payment of any
installment of cash until the second through tenth anniversary of the program.
If a participant terminates employment with Advanta, any unpaid installments
will be distributed on the tenth anniversary of the program.
In 2000 and 1999, we issued stock appreciation rights to certain directors
in exchange for or in lieu of stock options. In 2001, all outstanding stock
appreciation rights were terminated in exchange for cash to be
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
paid through a deferred compensation arrangement as discussed above. The
following table summarized stock appreciation rights outstanding at December 31,
2000:
<Table>
<Caption>
(RIGHTS IN THOUSANDS)
RIGHTS OUTSTANDING
STRIKE PRICE AT 12/31/00
- -----------------------------------
$ 4.75 1
$ 8.50 100
$10.75 27
$12.33 163
$14.50 100
$19.00 - $22.13 234
- -----------------------------------
Total 625
===================================
</Table>
Compensation expense (benefit) related to stock appreciation rights was ($512)
thousand in 2000 and $502 thousand in 1999. There was no compensation expense
(benefit) related to stock appreciation rights in 2001 prior to the exchange.
In 1999, 27,413 shares of phantom stock were granted at a price of $10.625
to an officer in lieu of restricted shares. There were no shares of phantom
stock granted in 2001 or 2000. In 2001, all outstanding shares of phantom stock
were terminated in exchange for cash to be paid through a deferred compensation
arrangement as discussed above. There were 78,045 shares of phantom stock
outstanding as of December 31, 2000. There was no compensation expense (benefit)
related to the appreciation (depreciation) on shares of phantom stock in 2001
prior to the exchange. Compensation expense (benefit) related to the
appreciation (depreciation) on shares of phantom stock was ($268) thousand in
2000 and $246 thousand in 1999.
EMPLOYEE STOCK PURCHASE PLAN
We have an Employee Stock Purchase Plan, which allows employees and directors to
purchase Advanta Corp. Class B Common Stock at a 15% discount from the market
price without paying brokerage fees. We report this 15% discount as compensation
expense and incurred expense of $83 thousand in 2001, $163 thousand in 2000 and
$162 thousand in 1999. All shares of Advanta Corp. Class B Common Stock
purchased by the plan in the three years ended December 31, 2001 were purchased
on the open market.
EMPLOYEE SAVINGS PLAN
We have an Employee Savings Plan, which is a defined contribution plan that
provides employees with tax-deferred savings and investment opportunities,
including the ability to invest in Advanta Corp. Class B Common Stock. The plan
provides for discretionary employer contributions equal to a portion of the
first 5% of an employee's compensation contributed to the plan. For the three
years ended December 31, 2001, 2000 and 1999, our contributions equaled 100% of
the first 5% of participating employees' compensation contributed to the plan.
The compensation expense for this plan totaled $1.3 million in 2001, $3.1
million in 2000 and $2.7 million in 1999. All shares of Advanta Corp. Class B
Common Stock purchased by the plan in the three years ended December 31, 2001
were purchased on the open market.
EMPLOYEE STOCK OWNERSHIP PLAN
On September 10, 1998, our Board of Directors authorized the formation of an
Employee Stock Ownership Plan (the "ESOP"), covering all of our employees who
have reached age 21 with one year of service. During 1998, the ESOP borrowed
approximately $12.6 million from Advanta Corp. and used the proceeds to purchase
approximately 1,000,000 shares of Class A Common Stock. The ESOP loan is
repayable with an interest rate of 8% over 30 years. We make annual
contributions to the ESOP equal to the ESOP's debt service less dividends
received on ESOP shares. As the ESOP loan is repaid, shares are allocated to
active
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employees, based on the proportion of debt service paid in the year. We account
for the ESOP in accordance with AICPA Statement of Position 93-6, "Employer's
Accounting for Employee Stock Ownership Plans." Accordingly, unallocated shares
are reported as unearned ESOP shares in the balance sheet. As shares of common
stock acquired by the ESOP are committed to be released to each employee, we
report compensation expense equal to the current market price of the shares, and
the shares become outstanding for earnings per share computations. Dividends on
allocated ESOP shares are recorded as a reduction of retained earnings;
dividends on unallocated ESOP shares are used to fund debt service of the ESOP.
ESOP compensation expense was $431 thousand for the year ended December 31,
2001, $455 thousand for the year ended December 31, 2000 and $535 thousand for
the year ended December 31, 1999. At December 31, 2001, there were 896,317
unearned and unallocated ESOP shares with a fair value of $8.9 million. At
December 31, 2000, there were 931,945 unearned and unallocated ESOP shares with
a fair value of $8.2 million.
DEFERRED CASH COMPENSATION PLAN
We offer an elective, nonqualified deferred compensation plan to eligible
executives and non-employee directors, which allows them to defer a portion of
their cash compensation on a pretax basis. The plan contains provisions related
to minimum contribution levels and deferral periods with respect to any
individual's participation. The plan participant makes irrevocable elections at
the date of deferral as to deferral period and date of distribution.
Distribution from the plan may be either at retirement or at an earlier date,
and can be either in a lump sum or in installment payments. Interest is credited
to the participant's account at the rate of 125% of the 10-year rolling average
interest rate on 10-Year U.S. Treasury Notes. To assist in funding the deferred
compensation liability, we have invested in life insurance contracts.
Compensation expense related to this deferred cash compensation plan was $342
thousand in the year ended December 31, 2001, $447 thousand in the year ended
December 31, 2000 and $563 thousand in the year ended December 31, 1999.
NOTE 15. REGULATORY AGREEMENTS
In June 2000, we announced that our banking subsidiaries, Advanta National Bank
and Advanta Bank Corp., reached agreements with their respective bank regulatory
agencies, primarily relating to the banks' subprime lending operations. The
agreements outlined a series of steps to modify processes and formalize and
document certain practices and procedures for the banks' subprime lending
operations. The agreements also established temporary asset growth limits at
Advanta National Bank and deposit growth limits at Advanta Bank Corp., imposed
restrictions on taking brokered deposits at Advanta National Bank, and required
that Advanta National Bank maintain certain capital ratios in excess of the
minimum regulatory standards. The agreements also required us to change our
charge-off policy for delinquent mortgages to 180 days and to modify our
accounting processes and estimate of our allowance for credit losses and
valuation of residual assets.
In July 2000, we announced that Advanta National Bank signed a second
agreement with the Office of the Comptroller of the Currency (the "OCC")
regarding the carrying value of Advanta National Bank's retained interests in
mortgage securitizations and allowance for mortgage credit losses. For Advanta
National Bank's June 30, 2000 Call Report, in accordance with the provisions of
the agreement, we calculated the valuation of the retained interests based on an
18% discount rate on the interest-only strip and subordinated trust assets, a
15% discount rate on the contractual mortgage servicing rights, a prepayment
rate that represents the average prepayment experience for the six months ended
February 29, 2000 and cumulative loss rates as a percentage of original
principal balance of 6% on closed end mortgage loans and 8% for HELOC (open end)
mortgage loans. The agreement required that, based on these assumptions, the
carrying value of Advanta National Bank's contractual mortgage servicing rights
be reduced by $13 million and the carrying value of Advanta National Bank's
subordinated trust assets and retained interest-only strip be reduced by a total
amount of $201 million. The agreement further required that Advanta National
Bank's allowance for credit losses be increased by $22 million. The agreement
contained provisions regarding the use of similar discount rate and credit loss
assumptions for the calculation of the carrying value of the residual assets in
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
future periods. These valuation adjustments and provisions for credit losses are
included in the results of Advanta Mortgage in discontinued operations. See Note
2 for discussion of discontinued operations.
In 2001, in connection with the Mortgage Transaction, 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 Mortgage Transaction and the resolution of
outstanding Advanta National Bank liabilities. The February 2001 agreement also
reduces the existing capital requirements for Advanta National Bank and provides
for prior OCC approval of any future dividends. Advanta Bank Corp. is unaffected
by the agreement with the OCC.
Management believes that Advanta Bank Corp. and Advanta National Bank were
each in compliance with their respective regulatory agreements at December 31,
2001.
NOTE 16. CAPITAL RATIOS
Advanta Bank Corp. and Advanta National Bank are wholly owned subsidiaries of
Advanta Corp. Advanta Bank Corp. and Advanta National Bank are subject to
various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory -- and possibly additional discretionary -- actions by regulators
that, if undertaken, could have a direct material effect on the institutions'
and our financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the institutions must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The institutions' capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the institutions to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined).
As set forth in the table below, as of December 31, 2001 and 2000, Advanta
Bank Corp. and Advanta National Bank 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. Our regulatory agreement with the OCC announced in June 2000
required that Advanta National Bank maintain a ratio of 14% of Tier 1 capital to
risk-weighted assets and a ratio of 17% of Tier 1 capital to adjusted total
assets. On February 28, 2001, Advanta National Bank entered into an agreement
with the OCC after the Mortgage Transaction that superceded the capital ratio
requirements of the June 2000 agreement and lowered 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 the fourth quarter of 2001, the bank regulatory agencies issued an
interagency policy statement that revised the regulatory capital treatment of
recourse, direct credit substitutes, and residual interests in asset
securitizations. This rule supercedes the former low-level recourse rules and
requires that banks hold one dollar in total risk-based capital against every
dollar of residual interest, with some exceptions. It further requires that
credit enhancing interest-only strips in excess of 25% of Tier 1 capital be
deducted from Tier 1 capital for purposes of calculating bank capital ratios.
This rule has an effective date of January 1, 2002. Early adoption was permitted
for transactions entered into prior to the effective date that result in a
reduced capital requirement. Banks can delay until December 31, 2002, the
application of the final rule to transactions entered into prior to January 1,
2002 that result in increased capital requirements. Advanta Bank Corp. elected
to adopt the rule effective December 31, 2001 and it resulted in a reduced
risk-based capital requirement. We do
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
not anticipate the adoption of this rule will have an effect on the capital
requirements of Advanta National Bank.
<Table>
<Caption>
TO BE WELL-
CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
- ------------------------------------------------------------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------
PERCENTAGE PERCENTAGE
IS IS GREATER
GREATER THAN OR
THAN OR EQUAL TO
EQUAL TO
AS OF DECEMBER 31, 2001
Total Capital (to Risk Weighted
Assets)
Advanta Bank Corp. $160,520 18.80% $ 92,870 8.0% $105,420 10.0%
Advanta National Bank 50,593 23.34 17,341 8.0 21,676 10.0
Tier I Capital (to Risk Weighted
Assets)
Advanta Bank Corp. $145,633 17.06% $ 59,233 4.0% $ 73,132 6.0%
Advanta National Bank 49,791 22.97 8,670 4.0 13,006 6.0
Tier I Capital (to Average Assets)
Advanta Bank Corp. $145,633 15.07% $ 38,655 4.0% $ 48,319 5.0%
Advanta National Bank 49,791 15.31 13,007 4.0 16,258 5.0
AS OF DECEMBER 31, 2000
Total Capital (to Risk Weighted
Assets)
Advanta Bank Corp. $216,237 14.60% $138,232 8.0% $161,854 10.0%
Advanta National Bank 315,482 15.08 204,482 8.0 235,782 10.0
Tier I Capital (to Risk Weighted
Assets)
Advanta Bank Corp. $194,411 13.13% $ 81,819 4.0% $107,149 6.0%
Advanta National Bank 296,947 14.19 131,947 4.0 165,147 6.0
Tier I Capital (to Average Assets)
Advanta Bank Corp. $194,411 21.08% $ 36,894 4.0% $ 46,117 5.0%
Advanta National Bank 296,947 20.52 57,878 4.0 72,347 5.0
</Table>
NOTE 17. DIVIDEND AND LOAN RESTRICTIONS
In the normal course of business, Advanta Corp. and its subsidiaries enter into
agreements, or are subject to regulatory requirements, that result in dividend
and loan restrictions.
FDIC-insured banks are subject to certain provisions of the Federal Reserve
Act which impose various legal limitations on the extent to which banks may
finance or otherwise supply funds to certain of their affiliates. In particular,
Advanta Bank Corp. and Advanta National Bank are subject to certain restrictions
on any extensions of credit to, or other covered transactions, such as certain
purchases of assets, with Advanta Corp. or its affiliates. Advanta Bank Corp.
and Advanta National Bank are prevented by these restrictions from lending to
Advanta Corp. and its affiliates unless these extensions of credit are secured
by U.S. Government obligations or other specified collateral. Further, secured
extensions of credit are limited in amount: (a) as to Advanta Corp. or any
affiliate, to 10 percent of each bank's capital and surplus, and (b) as to
Advanta Corp. and all affiliates in the aggregate, to 20 percent of each bank's
capital and surplus.
Under grandfathering provisions of the Competitive Equality Banking Act of
1987, we are not required to register as a bank holding company under the Bank
Holding Company Act of 1956, as amended, so long as Advanta Corp. and Advanta
National Bank continue to comply with certain restrictions on their activities.
These restrictions include limiting the scope of Advanta National Bank's
activities to those in which it was engaged prior to March 5, 1987. Since
Advanta National Bank was not making commercial loans at that time, it must
continue to refrain from making commercial loans -- which would include any
loans to Advanta Corp. or any of its subsidiaries -- in order for Advanta Corp.
to maintain its grandfathered exemption under the
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Bank Holding Company Act. We have no present plans to register as a bank holding
company under the Bank Holding Company Act.
Our regulatory agreements with the OCC and the FDIC prohibit the payment of
cash dividends by Advanta National Bank or Advanta Bank Corp. without prior
regulatory approval. In connection with the Mortgage Transaction in the first
quarter of 2001, we sought and received regulatory approval for a return of
capital of $261 million from Advanta National Bank. Advanta National Bank paid
no dividends to Advanta Corp. during 2001, 2000 or 1999. In 2001, Advanta Bank
Corp. transferred certain assets as a dividend to Advanta Corp. The fair value
of the assets at time of the dividend was $91.4 million. There were no dividends
from Advanta Bank Corp. to Advanta Corp. during 2000 and 1999.
Our insurance subsidiaries are also subject to certain capital and dividend
rules and regulations as prescribed by state jurisdictions in which they are
authorized to operate. At December 31, 2001, the insurance subsidiaries were in
compliance with these rules and regulations. For the year ended December 31,
2001, Advanta Corp. received a return of capital from insurance subsidiaries of
$57.5 million. Insurance subsidiaries paid dividends to Advanta Corp. of $6.1
million in 2001. Insurance subsidiaries paid dividends to Advanta Corp. of $1.2
million in 1999. There were no dividends paid to Advanta Corp. by insurance
subsidiaries in 2000.
Total stockholders' equity of our banking and insurance affiliates was $220
million at December 31, 2001 and $572 million at December 31, 2000. Of our total
equity in these affiliates, $218 million was restricted at December 31, 2001 and
$566 million was restricted at December 31, 2000. At January 1, 2002, $2.2
million of stockholders' equity of our insurance affiliates was available for
payment of cash dividends in 2002 under applicable regulatory guidelines without
prior regulatory approval.
In addition to dividend restrictions at banking subsidiaries, certain
non-bank subsidiaries are subject to minimum equity requirements as part of
securitization or other agreements. The total minimum equity requirement of
non-bank subsidiaries was $20 million at December 31, 2001. At December 31,
2001, the non-bank subsidiaries were in compliance with these minimum equity
requirements.
NOTE 18. 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 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 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.
Our venture capital segment makes venture capital investments through our
affiliates. Our investment objective is to earn attractive returns by building
the long-term values of the businesses in which we invest. Our investment
affiliates combine transaction expertise, management skills and a broad contact
base with strong industry-specific knowledge. We actively monitor the
performance of our venture capital investments and employees and officers of our
investment affiliates participate on the boards of directors of some investees.
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
ADVANTA
BUSINESS VENTURE
CARDS CAPITAL OTHER(1) TOTAL
- ---------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001
Interest income $ 76,841 $ 37 $ 40,973 $ 117,851
Interest expense 33,504 1,545 47,421 82,470
Noninterest revenues (losses), net 225,364 (28,852) (7,552) 188,960
Unusual charges(2) 0 0 41,750 41,750
Pretax income (loss) from continuing operations 63,515 (33,158) (72,808) (42,451)
Average managed receivables 1,872,314 0 28,271 1,900,585
Total assets 619,062 20,929 996,689 1,636,680
Capital expenditures 2,924 0 5,691 8,615
Depreciation 2,227 10 7,191 9,428
- ---------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2000
Interest income $ 78,424 $ 60 $ 57,616 $ 136,100
Interest expense 31,385 1,541 53,582 86,508
Noninterest revenues (losses), net 155,500 7,847 (6,266) 157,081
Pretax income (loss) from continuing operations 45,325 3,382 (37,515) 11,192
Average managed receivables 1,372,717 0 23,067 1,395,784
Total assets 462,317 45,677 2,335,478 2,843,472
Capital expenditures 3,949 23 9,522 13,494
Depreciation 1,385 17 10,069 11,471
- ---------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1999
Interest income $ 35,613 $ 173 $ 68,798 $ 104,584
Interest expense 12,428 1,350 67,022 80,800
Noninterest revenues (losses), net 84,252 29,505 (8,387) 105,370
Unusual charges(3) 0 0 16,713 16,713
Pretax income (loss) from continuing operations 11,997 26,329 (52,777) (14,451)
Average managed receivables 892,862 0 17,450 910,312
Total assets 352,028 34,945 3,151,587 3,538,560
Capital expenditures 1,000 9 4,559 5,568
Depreciation 923 35 6,836 7,794
=========================================================================================================
</Table>
(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. Total assets in the "Other" segment include net
assets of discontinued operations.
(2) Unusual charges in 2001 represent severance, outplacement and other
compensation costs associated with restructuring our corporate functions
commensurate with the ongoing businesses as well as expenses associated with
exited businesses and asset impairments.
(3) Unusual charges in 1999 represent charges associated with cost reduction
initiatives in the first quarter and additional costs associated with
products exited in the first quarter of 1998.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19. SELECTED INCOME STATEMENT INFORMATION
<Table>
<Caption>
OTHER REVENUES YEAR ENDED DECEMBER 31,
- --------------------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------------------
Investment securities gains (losses), net(1) $(26,227) $ 5,473 $30,132
Business credit card rewards (8,979) (3,162) (834)
Loss on sale of deposits (2,835) 0 0
Insurance revenues, net and other(2) 3,581 4,995 7,279
- --------------------------------------------------------------------------------------------
Total other revenues, net $(34,460) $ 7,306 $36,577
============================================================================================
</Table>
(1) Investment securities gains (losses), net include changes in the fair value
and realized gains and losses on venture capital investments.
(2) Insurance revenues, net and other for the year ended December 31, 2001
includes operating results of insurance operations, the impact of the
termination of our strategic alliance with Progressive Casualty Insurance
Company to direct market auto insurance and $10 million of charges related
to the write-off of insurance-related deferred acquisition costs that were
unrealizable subsequent to the termination of the auto insurance strategic
alliance.
<Table>
<Caption>
OPERATING EXPENSES YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------
Salaries and employee benefits $ 59,823 $ 42,499 $35,300
Amortization of business credit card deferred origination
costs, net 39,118 23,961 5,863
External processing 17,272 13,236 8,507
Professional/consulting fees 15,320 18,451 12,159
Marketing 10,574 11,492 2,397
Equipment 8,768 8,101 4,717
Occupancy 5,941 5,852 6,710
Credit 5,419 4,772 3,926
Insurance 4,607 4,628 2,622
Postage 3,304 2,947 1,846
Fraud loss 2,568 1,965 833
Telephone 2,404 1,811 1,322
Other 5,068 10,577 9,304
- ---------------------------------------------------------------------------------------------
Total operating expenses $180,186 $150,292 $95,506
=============================================================================================
</Table>
NOTE 20. INCOME TAXES
Income tax (benefit) was as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------------------------
Income tax expense (benefit) attributable to:
Continuing operations $(11,995) $ 0 $(55,785)
Discontinued operations (3,812) 0 5,513
Loss on discontinuance of mortgage and leasing businesses 7,392 0 0
- ------------------------------------------------------------------------------------------
Total income tax (benefit) $ (8,415) $ 0 $(50,272)
==========================================================================================
</Table>
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income tax (benefit) on income from continuing operations consisted of the
following components:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------
Current:
Federal $ 0 $ 6,636 $ 15,500
State 300 4,753 (4,083)
- ---------------------------------------------------------------------------------------------
Total current 300 11,389 11,417
- ---------------------------------------------------------------------------------------------
Deferred:
Federal (12,923) (6,994) (69,509)
State 628 (4,395) 2,307
- ---------------------------------------------------------------------------------------------
Total deferred (12,295) (11,389) (67,202)
- ---------------------------------------------------------------------------------------------
Total income tax (benefit) $(11,995) $ 0 $(55,785)
=============================================================================================
</Table>
The reconciliation of the statutory federal income tax to income tax
(benefit) on income from continuing operations is as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------
Statutory federal income tax $(14,858) $ 3,917 $ (5,058)
State income taxes, net of federal income tax benefit 604 232 (1,090)
Nondeductible expenses 1,112 152 152
Insurance program income 499 242 98
Compensation limitation 350 140 175
Net operating losses 0 (4,755) (49,973)
Other 298 72 (89)
- ---------------------------------------------------------------------------------------------
Income tax (benefit) $(11,995) $ 0 $(55,785)
=============================================================================================
</Table>
Deferred taxes are provided to reflect the estimated future tax effects of
the differences between the financial statement and tax bases of assets and
liabilities and enacted tax laws. The net deferred tax asset is comprised of the
following:
<Table>
<Caption>
DECEMBER 31,
- ----------------------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------------------
Deferred tax liabilities $(72,902) $(95,677)
Deferred tax assets 180,240 194,300
- ----------------------------------------------------------------------------------
Net deferred tax asset $107,338 $ 98,623
==================================================================================
</Table>
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of deferred tax assets and liabilities follows:
<Table>
<Caption>
DECEMBER 31,
- ------------------------------------------------------------------------------------
2001 2000
- ------------------------------------------------------------------------------------
Deferred origination fees and costs $ (4,009) $ (4,331)
Allowance for credit losses 16,940 21,280
Net operating loss carryforwards 231,967 142,248
Securitization income (23,482) 50,368
Deferred compensation 9,259 7,863
Noncash unusual charges 5,068 6,835
Other 20,489 12,268
Valuation allowance (148,894) (137,908)
- ------------------------------------------------------------------------------------
Net deferred tax asset $ 107,338 $ 98,623
====================================================================================
</Table>
As a result of unusual charges, valuation adjustments on venture capital
investments and the loss on the discontinuance of the leasing business in 2001,
we reported a pretax loss for the year ended December 31, 2001. A valuation
allowance has been provided against a portion of the resulting deferred tax
asset given our pre-existing net operating loss carryforwards and the
uncertainty of the realizability of the incremental deferred tax asset. In the
year ended December 31, 2000, we also reported a pretax loss and a valuation
allowance was provided against the resulting deferred tax asset, resulting in a
0% effective tax rate. In establishing the valuation allowance, management
considered (1) estimates of expected future taxable income, (2) existing and
projected book/tax differences, (3) tax planning strategies available, and (4)
the general and industry specific economic outlook. Based on this analysis,
management believes the net deferred tax asset will be realized. This analysis
is inherently subjective, as it requires estimates that are susceptible to
significant revision as more information becomes available.
In 1999, in connection with the filing of the 1998 tax returns, additional
book/tax differences related to the disposition of our consumer credit card
business in 1998 were quantified. These book/tax differences, when combined with
certain less significant recurring differences, resulted in net operating loss
carryforwards of approximately $521 million at December 31, 1999. This amount is
net of $96 million carried back to prior years, and includes $500 million that
pertains to losses incurred on the consumer credit card portfolio after the date
of the disposition of our consumer credit card business. A deferred tax asset of
$50 million, net of valuation allowance, resulting from the net operating loss
carryforwards was recorded as an income tax benefit in the fourth quarter of
1999.
At December 31, 2001, remaining net operating loss carryforwards were $662
million, of which $407 million expire in 2018, $29 million expire in 2019, $15
million expire in 2020 and $211 million expire in 2021. We utilized net
operating loss carryforwards of $85 million in 2000. Additionally in 2000, $29
million was carried back to prior years.
The net deferred tax asset is presented net with current income taxes
receivable (payable) for financial reporting purposes, and is included in other
assets.
NOTE 21. UNUSUAL CHARGES
Subsequent to the Mortgage Transaction 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. Also, in 1999,
we implemented a plan to exit the auto finance business and to implement cost
reduction initiatives throughout the organization including the consolidation of
support functions. Costs associated with these restructuring activities and
other employee costs are included in unusual charges in the consolidated income
statements.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accruals related to these costs are included in other liabilities in the
consolidated balance sheets. The details of these costs are as follows:
<Table>
<Caption>
CHARGED TO 12/31/99 CHARGED TO 12/31/00 CHARGED TO 12/31/01
ACCRUED ACCRUAL ACCRUAL ACCRUAL ACCRUAL ACCRUED ACCRUAL ACCRUAL
IN 1999 IN 1999 BALANCE IN 2000 BALANCE IN 2001 IN 2001 BALANCE
- --------------------------------------------------------------------------------------------------------------------------
Employee costs $ 3,350 $ 2,528 $ 822 $ 822 $ 0 $27,296 $24,768 $2,528
Expenses associated with exited
businesses/products 13,363 7,481 20,648 7,601 13,047 11,895 24,313 629
Asset impairments 0 0 0 0 0 2,559 2,559 0
- --------------------------------------------------------------------------------------------------------------------------
Total $16,713 $10,009 $21,470 $8,423 $13,047 $41,750 $51,640 $3,157
==========================================================================================================================
</Table>
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 2001, we incurred $23.2 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 Mortgage Transaction. This acceleration
resulted in a noncash charge of $1.3 million. In connection with reviewing our
compensation plans after the Mortgage Transaction and restructuring of corporate
functions, we implemented a program whereby all outstanding stock appreciation
rights and shares of phantom stock were terminated in exchange for cash to be
paid through a deferred compensation arrangement. We recorded charges of $2.9
million associated with this exchange. The charge reflects a $0.7 million
reduction recorded in the three months ended September 30, 2001, as actual cash
settlement costs were less than estimated. Due to the restructuring of the
company, we implemented programs whereby certain out-of-the-money options were
exchanged for shares of stock, and whereby certain shares of restricted stock
were exchanged for cash and stock options in a tender offer, subject to certain
performance conditions and vesting requirements. Noncash charges associated with
the issuance of the stock, stock options and the tender offer totaled $3.6
million. This charge reflects a $1.4 million increase recorded in the three
months ended September 30, 2001, as actual noncash charges associated with the
tender offer were more than estimated.
In the first quarter of 1999, in connection with cost reduction initiatives
and the consolidation of support functions, we recorded a $3.3 million charge
for costs associated with staff reductions. These expenses included severance
and outplacement costs. There were 121 employees severed who were entitled to
benefits. This staff reduction was substantially complete by June 30, 1999. The
final payment outstanding related to these employee costs was paid in the three
months ended March 31, 2000.
EXPENSES ASSOCIATED WITH EXITED BUSINESSES/PRODUCTS
In the first quarter of 2001, we recorded charges of $2.2 million related to
other products exited for which no future revenues or benefits would be
received. In the third quarter of 2001, we were able to settle some of these
commitments for less than originally estimated, and reduced the charge by $0.7
million. We expect to pay the remaining costs, which include lease and other
commitments, in 2002.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the first quarter of 1999, we implemented a plan to cease the
origination of auto loans and recorded a $3.4 million charge for costs
associated with exited businesses/products. The charges included severance and
outplacement costs for 22 employees in the auto origination group, and
professional fees associated with exited businesses/products not directly
associated with our mortgage, business credit card and leasing units. We
completed the closing of the auto loan origination center and termination of
related employees during the second quarter of 1999. We completed payment of the
remaining professional fees during the first quarter of 2001.
In 1998, in connection with the transfer of our consumer credit card
business to Fleet Credit Card LLC, we made major organizational changes to
reduce corporate expenses incurred in the past: (a) to support the business
contributed to Fleet Credit Card LLC in the transfer of our consumer credit card
business, 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, 1998, the remaining accrual related to
expenses associated with exited businesses/products was $14.8 million. We had
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. In 1998, we recorded a charge of $22.8 million associated with these
commitments, and an $8.3 million charge associated with the write-off of assets
associated with this program that became unrealizable when the product was
exited. In 1999, an additional charge of $10.0 million was recorded based on a
change in the estimate of total expected costs for the contractual commitments
related to the exited product. Updated information regarding future benefits to
be provided in connection with these contractual commitments indicated a higher
level of benefits than originally estimated. A third party assumed the
liabilities 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.
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.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22. CALCULATION OF EARNINGS PER SHARE
The following table shows the calculation of basic earnings per common share and
diluted earnings per common share for the years ended December 31:
<Table>
<Caption>
2001 2000 1999
- ---------------------------------------------------------------------------------------------
Income (loss) from continuing operations $(30,456) $ 11,192 $41,334
Less: Preferred A dividends (141) (141) (141)
Less: Preferred B dividends(2) 0 0 (2,661)
- ---------------------------------------------------------------------------------------------
Income (loss) from continuing operations available to
common shareholders (30,597) 11,051 38,532
Income (loss) from discontinued operations, net of tax (8,438) (163,578) 8,484
Loss, net, on discontinuance of mortgage and leasing
businesses, net of tax (31,639) (4,298) 0
- ---------------------------------------------------------------------------------------------
Net income (loss) available to common shareholders (70,674) (156,825) 47,016
Less: Class A dividends declared (2,294) (2,236) (2,471)
Less: Class B dividends declared (5,224) (5,118) (4,896)
- ---------------------------------------------------------------------------------------------
Undistributed net income (loss) $(78,192) $(164,179) $39,649
- ---------------------------------------------------------------------------------------------
Basic income (loss) from continuing operations per common
share
Class A $ (1.23) $ 0.39 $ 1.59
Class B (1.17) 0.47 1.66
Combined(1) (1.19) 0.44 1.63
Diluted income (loss) from continuing operations per common
share
Class A $ (1.23) $ 0.39 $ 1.58
Class B (1.17) 0.46 1.65
Combined(1) (1.19) 0.44 1.62
Basic net income (loss) per common share
Class A $ (2.79) $ (6.28) $ 1.95
Class B (2.73) (6.21) 2.02
Combined(1) (2.75) (6.24) 1.99
Diluted net income (loss) per common share
Class A $ (2.79) $ (6.23) $ 1.94
Class B (2.73) (6.16) 2.00
Combined(1) (2.75) (6.19) 1.98
- ---------------------------------------------------------------------------------------------
Basic shares
Class A 9,101 9,110 9,057
Class B 16,581 16,033 14,515
Combined 25,682 25,143 23,572
Options A 0 0 1
Options B 0 95 107
Restricted shares Class A 0 39 20
Restricted shares Class B 0 74 58
Diluted shares
Class A 9,101 9,149 9,078
Class B 16,581 16,202 14,680
Combined 25,682 25,351 23,758
Antidilutive shares
Preferred Class B(2) 0 0 14
Options Class B 2,629 2,097 1,550
Restricted shares Class A 25 46 47
Restricted shares Class B 516 1,059 1,222
=============================================================================================
</Table>
(1) Combined represents a weighted average of Class A and Class B earnings per
common share.
(2) Each share of Class B convertible preferred stock was mandatorily converted
into one share of Class B Common Stock effective September 15, 1999.
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 23. PARENT COMPANY FINANCIAL STATEMENTS
ADVANTA CORP. (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
- ------------------------------------------------------------------------------------
2001 2000
- ------------------------------------------------------------------------------------
ASSETS
Cash $ 80,160 $ 135,374
Commercial paper equivalent (1) 0 24,629
Investments 80,042 19,491
Investments in and advances to bank and insurance
subsidiaries 239,440 584,901
Investments in and advances to other subsidiaries 353,460 425,030
Premises and equipment 1,153 11,963
Other assets 135,708 129,457
- ------------------------------------------------------------------------------------
Total assets $889,963 $1,330,845
- ------------------------------------------------------------------------------------
LIABILITIES
Other borrowings $ 32,317 $ 0
Accrued expenses and other liabilities 64,673 35,070
Debt 426,674 854,873
- ------------------------------------------------------------------------------------
Total liabilities 523,664 889,943
- ------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 1,010 1,010
Common stock 279 276
Other stockholders' equity 365,010 439,616
- ------------------------------------------------------------------------------------
Total stockholders' equity 366,299 440,902
- ------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $889,963 $1,330,845
====================================================================================
</Table>
(1) Commercial paper equivalent refers to unsecured loans made to Advanta
National Bank and Advanta Bank Corp. for terms less than 35 days in maturity
which are not automatically renewable, consistent with commercial paper
issuance.
The parent company guarantees certain lease agreements of its subsidiaries.
At December 31, 2001, there were $4.4 million of lease obligations guaranteed by
the parent.
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------
INCOME:
Dividends from bank and insurance subsidiaries(1) $ 97,534 $ 0 $ 1,215
Dividends from other subsidiaries 278 278 1,010
Interest 22,470 40,481 44,369
Other, net 22,476 37,912 52,510
- ---------------------------------------------------------------------------------------------
Total income 142,758 78,671 99,104
- ---------------------------------------------------------------------------------------------
EXPENSES:
General and administrative 64,676 73,099 45,638
Interest 54,810 69,482 67,102
Unusual charges 30,142 0 4,561
- ---------------------------------------------------------------------------------------------
Total expenses 149,628 142,581 117,301
- ---------------------------------------------------------------------------------------------
Loss from continuing operations before income taxes and
equity in undistributed net profit (loss) of
subsidiaries (6,870) (63,910) (18,197)
Income tax (benefit) (15,017) (30,317) (22,327)
- ---------------------------------------------------------------------------------------------
Income (loss) from continuing operations before equity in
undistributed net profit (loss) of subsidiaries 8,147 (33,593) 4,130
Loss on discontinuance of mortgage business, net of tax (5,962) 0 0
- ---------------------------------------------------------------------------------------------
Income (loss) before equity in undistributed net profit
(loss) of subsidiaries 2,185 (33,593) 4,130
Equity in undistributed net profit (loss) of subsidiaries (72,718) (123,091) 45,688
- ---------------------------------------------------------------------------------------------
NET INCOME (LOSS) $(70,533) $(156,684) $ 49,818
=============================================================================================
</Table>
(1) Dividends from bank and insurance subsidiaries in the year ended December
31, 2001 include a noncash dividend from Advanta Bank Corp. of $91.4
million.
The Parent Company Only Statements of Changes in Stockholders' Equity are
the same as the Consolidated Statements of Changes in Stockholder's Equity.
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ (70,533) $(156,684) $ 49,818
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Equity in net loss (profit) of subsidiaries (25,094) 122,813 (47,913)
Dividends received from subsidiaries 6,378 278 2,225
Depreciation 2,241 2,523 2,066
Change in other assets, interest-bearing deposits,
accrued expenses and other liabilities 970 (39,225) (32,696)
- ---------------------------------------------------------------------------------------------
Net cash used in operating activities (86,038) (70,295) (26,500)
- ---------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net change in premises and equipment 6,010 (6,941) (2,199)
Net change in commercial paper equivalents 24,629 350,371 65,900
Investments in subsidiaries (3,991) (119,226) (23,540)
Return of investment from subsidiaries 267,648 22,453 39,731
Purchase of investments available for sale (744,610) (156,661) (851,132)
Proceeds from sales of investments available for sale 262,301 72 2,702
Proceeds from maturing investments available for sale 503,369 152,482 850,000
- ---------------------------------------------------------------------------------------------
Net cash provided by investing activities 315,356 242,550 81,462
- ---------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from issuance of debt 182,973 256,091 123,529
Payments on redemption of debt (611,172) (285,472) (365,177)
(Increase) decrease in affiliate borrowings 123,034 (4,452) 187,806
Increase in other borrowings 32,317 0 0
Issuance of stock 3,480 155 20
Stock buyback (7,505) 0 (3,955)
Cash dividends paid (7,659) (7,495) (10,169)
- ---------------------------------------------------------------------------------------------
Net cash used in financing activities (284,532) (41,173) (67,946)
- ---------------------------------------------------------------------------------------------
Net increase (decrease) in cash (55,214) 131,082 (12,984)
Cash at beginning of period 135,374 4,292 17,276
- ---------------------------------------------------------------------------------------------
Cash at end of period $ 80,160 $ 135,374 $ 4,292
=============================================================================================
</Table>
In 2001, noncash transactions of the Parent Company included noncash
dividends of $91.4 million from subsidiaries, noncash investment in subsidiaries
of $22.3 million, noncash return of investments from subsidiaries of $50.9
million and noncash affiliate borrowings of $69.1 million. There were no
significant noncash transactions of the Parent Company in 2000. In 1999, noncash
transactions of the Parent Company included a $4.5 million assumption of
liabilities of subsidiaries and a $43.3 million return of investment by
subsidiaries through forgiveness of advances.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 24. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of our financial instruments are as follows at
December 31:
<Table>
<Caption>
2001 2000
- -----------------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
- -----------------------------------------------------------------------------------------------
Financial assets:
Cash $ 20,952 $ 20,952 $ 1,716 $ 1,716
Federal funds sold 229,889 229,889 107,584 107,584
Restricted interest-bearing deposits 113,956 113,956 16,398 16,398
Investments available for sale 246,679 246,679 758,792 758,792
Receivables, net 423,407 451,966 340,291 366,595
Retained interests in securitizations 88,658 88,658 72,908 72,908
Amounts due from securitizations 80,325 80,325 61,610 61,610
Financial liabilities:
Demand and savings deposits $ 10,010 $ 10,010 $ 68,568 $ 68,568
Time deposits 626,905 633,506 1,278,408 1,288,742
Debt 323,582 332,522 755,184 752,112
Other borrowings 32,317 32,317 4,289 4,289
Off-balance sheet financial instruments:
Interest rate swaps $ 0 $ 0 $ 0 $ 379
Commitments to extend credit 0 0 0 0
- -----------------------------------------------------------------------------------------------
</Table>
The fair value of a financial instrument is the current amount that would
be exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for our various financial
instruments. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument.
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments," excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements.
We used the following methods and assumptions in estimating fair value
disclosures for financial instruments:
CASH, FEDERAL FUNDS SOLD AND RESTRICTED INTEREST-BEARING DEPOSITS
For these short-term instruments, the carrying amount is a reasonable estimate
of the fair value.
INVESTMENTS AVAILABLE FOR SALE
Investments available for sale are carried at fair value. The fair values of
investments available for sale are based on quoted market prices, dealer quotes
or estimates using quoted market prices for similar securities. For investments
that are not publicly traded, management has made estimates of fair value that
consider several factors including the investees' financial results, conditions
and prospects, and the values of comparable public companies.
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RECEIVABLES, NET
The fair values of receivables are estimated using a discounted cash flow
analysis that incorporates estimates of the excess of the weighted average
finance charge and fee yield over the aggregate cost of funds, servicing costs
and an estimate of future credit losses over the life of the receivables.
RETAINED INTERESTS IN SECURITIZATIONS
Retained interests in securitizations are carried at fair value. The fair values
of retained interests in securitizations are estimated based on discounted cash
flow analyses as described in Note 1. See Note 6 for the assumptions used in the
estimation of fair values of the retained interests in securitizations.
AMOUNTS DUE FROM SECURITIZATIONS
The carrying amount is a reasonable estimate of the fair value of amounts due
from securitizations based on the short-term nature of the assets.
DEMAND AND SAVINGS DEPOSITS
The fair value of demand deposits, savings accounts, and money market deposits
is the amount payable on demand at the reporting date. This fair value does not
include any benefit that may result from the low cost of funding provided by
these deposits compared to the cost of borrowing funds in the market.
TIME DEPOSITS
The fair value of fixed-maturity certificates of deposit is estimated using
discounted cash flow analyses based on the rates currently offered for deposits
of similar remaining maturities.
DEBT
The fair value of our long-term borrowings is estimated using discounted cash
flow analyses based on our current incremental borrowing rates for similar types
of borrowing arrangements.
OTHER BORROWINGS
The carrying amounts of borrowings under repurchase agreements and other
short-term borrowings maturing within ninety days approximate their fair values.
The other borrowings are all at variable interest rates and therefore the
carrying value approximates a reasonable estimate of the fair value.
INTEREST RATE SWAPS
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.
There were no interest rate swaps outstanding related to continuing operations
at December 31, 2001.
COMMITMENTS TO EXTEND CREDIT
There is no market value associated with our unused commitments to extend credit
to our business credit card customers, since any fees charged are consistent
with the fees charged by other companies at the reporting date to enter into
similar agreements. Unused commitments to extend credit were $4.6 billion at
December 31, 2001 and $4.2 billion at December 31, 2000.
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 25. DERIVATIVE FINANCIAL INSTRUMENTS
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.
During 2001, 2000 and 1999, 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 related to continuing operations at December 31,
2001 because of the substantial reduction in outstanding medium-term notes
during the year. The notional amount of interest rate swaps outstanding related
to continuing operations was $194.5 million at December 31, 2000, and the
estimated fair value was $379 thousand. See Note 2 for a discussion of
derivatives used in discontinued operations.
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.
The following table summarizes by notional amounts our interest rate swap
activity in continuing operations for the periods presented:
<Table>
<Caption>
TOTAL
- -----------------------------------------------------------------------
Balance at 12/31/98 $ 575,500
Additions 200,000
Maturities (141,000)
Terminations (15,000)
- -----------------------------------------------------------------------
Balance at 12/31/99 $ 619,500
Maturities (425,000)
- -----------------------------------------------------------------------
Balance at 12/31/00 $ 194,500
Maturities (102,000)
Terminations (92,500)
- -----------------------------------------------------------------------
Balance at 12/31/01 $ 0
=======================================================================
</Table>
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 year ended
December 31, 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.
84
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Advanta Corp.:
We have audited the accompanying consolidated balance sheets of Advanta
Corp. (a Delaware corporation) and subsidiaries as of December 31, 2001 and
2000, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Advanta
Corp. and subsidiaries as of December 31, 2001 and 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Philadelphia, PA
March 15, 2002
REPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING
To the Stockholders of Advanta Corp.:
The management of Advanta Corp. and its subsidiaries ("Advanta") is
responsible for the preparation, content, integrity and objectivity of the
consolidated financial statements. These consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States and as such must, by necessity, include amounts based upon
estimates and judgments made by management. The other financial information was
also prepared by management and is consistent with the financial statements.
Management is also responsible for establishing and maintaining an
effective internal control structure over financial reporting. These systems and
controls are designed to provide reasonable, but not absolute, assurance that
assets are safeguarded, that transactions are properly recorded and executed in
accordance with management's authorization and that financial statements are
reliable. Advanta's control structure includes: (l) organizational and budgetary
arrangements which provide reasonable assurance that errors or irregularities
would be detected promptly; (2) careful selection of personnel and
communications programs aimed at assuring that policies and standards are
understood by employees; (3) continuing management review and evaluation of
systems and controls; and (4) a program of independent internal audit and risk
management reviews to ensure compliance.
The consolidated financial statements have been audited by Arthur Andersen
LLP, independent public accountants. Their audits were conducted in accordance
with auditing standards generally accepted in the United States and considered
Advanta's system of internal controls to the extent they deemed necessary to
determine the nature, timing and extent of their audit tests. Their report is
printed herewith.
<Table>
/s/ DENNIS ALTER /s/ PHILIP M. BROWNE /s/ DAVID B. WEINSTOCK
- ----------------------------- ----------------------------- -----------------------------
Chairman of the Board and Senior Vice President and Vice President and
Chief Executive Officer Chief Financial Officer Chief Accounting Officer
</Table>
85
SUPPLEMENTAL SCHEDULES (UNAUDITED)
QUARTERLY DATA
<Table>
<Caption>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2001
- -----------------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
- -----------------------------------------------------------------------------------------------------
Interest income $24,623 $ 26,388 $32,836 $ 34,004
Interest expense 15,156 16,919 26,119 24,276
- -----------------------------------------------------------------------------------------------------
Net interest income 9,467 9,469 6,717 9,728
Provision for credit losses 10,124 9,528 8,384 7,940
- -----------------------------------------------------------------------------------------------------
Net interest after provision for credit
losses (657) (59) (1,667) 1,788
- -----------------------------------------------------------------------------------------------------
Noninterest revenues 63,840 49,291 45,830 29,999
Operating expenses 48,275 44,742 44,116 43,053
Minority interest in income of consolidated
subsidiary 2,220 2,220 2,220 2,220
Unusual charges 0 0 1,000 40,750
- -----------------------------------------------------------------------------------------------------
Total expenses 50,495 46,962 47,336 86,023
- -----------------------------------------------------------------------------------------------------
Income (loss) before income taxes 12,688 2,270 (3,173) (54,236)
Income (loss) from continuing operations 7,803 2,270 (3,173) (37,356)
Loss from discontinued operations, net of tax 0 0 0 (8,438)
Gain (loss), net, on discontinuance of
mortgage and leasing businesses, net of tax 0 (44,000) (4,000) 16,361
- -----------------------------------------------------------------------------------------------------
Net income (loss) $ 7,803 $(41,730) $(7,173) $(29,433)
- -----------------------------------------------------------------------------------------------------
Basic income (loss) from continuing
operations per common share
Class A $ 0.29 $ 0.08 $ (0.13) $ (1.49)
Class B 0.31 0.09 (0.12) (1.48)
Combined(1) 0.30 0.09 (0.12) (1.48)
- -----------------------------------------------------------------------------------------------------
Diluted income (loss) from continuing
operations per common share
Class A $ 0.29 $ 0.08 $ (0.13) $ (1.49)
Class B 0.31 0.09 (0.12) (1.48)
Combined(1) 0.30 0.09 (0.12) (1.48)
- -----------------------------------------------------------------------------------------------------
Basic net income (loss) per common share
Class A $ 0.29 $ (1.62) $ (0.29) $ (1.18)
Class B 0.31 (1.60) (0.27) (1.16)
Combined(1) 0.30 (1.61) (0.28) (1.17)
- -----------------------------------------------------------------------------------------------------
Diluted net income (loss) per common share
Class A $ 0.29 $ (1.60) $ (0.29) $ (1.18)
Class B 0.31 (1.59) (0.27) (1.16)
Combined(1) 0.30 (1.59) (0.28) (1.17)
- -----------------------------------------------------------------------------------------------------
Basic weighted average common shares
outstanding
Class A 9,125 9,116 9,098 9,103
Class B 16,552 16,820 16,744 16,200
Combined(1) 25,677 25,936 25,842 25,303
- -----------------------------------------------------------------------------------------------------
Diluted weighted average common shares
outstanding
Class A 9,128 9,120 9,098 9,103
Class B 16,716 17,121 16,744 16,200
Combined(1) 25,844 26,241 25,842 25,303
- -----------------------------------------------------------------------------------------------------
</Table>
(1) Combined represents a weighted average of Class A and Class B (see Note 1 to
the consolidated financial statements).
86
SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED
QUARTERLY DATA -- CONTINUED
(In thousands, except per share amounts)
<Table>
<Caption>
2000
- ----------------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
- ----------------------------------------------------------------------------------------------------
Interest income $ 32,187 $39,449 $ 34,081 $30,383
Interest expense 20,313 24,457 21,559 20,179
- ----------------------------------------------------------------------------------------------------
Net interest income 11,874 14,992 12,522 10,204
Provision for credit losses 6,833 16,806 5,050 7,620
- ----------------------------------------------------------------------------------------------------
Net interest after provision for credit losses 5,041 (1,814) 7,472 2,584
- ----------------------------------------------------------------------------------------------------
Noninterest revenues 36,116 39,216 40,588 41,161
Operating expenses 51,473 34,493 31,401 32,925
Minority interest in income of consolidated
subsidiary 2,220 2,220 2,220 2,220
- ----------------------------------------------------------------------------------------------------
Total expenses 53,693 36,713 33,621 35,145
- ----------------------------------------------------------------------------------------------------
Income (loss) before income taxes (12,536) 689 14,439 8,600
Income (loss) from continuing operations (12,536) 689 17,749 5,290
Income (loss) from discontinued operations,
net of tax 20,032 15,055 (210,444) 11,779
Loss on discontinuance of leasing business,
net of tax (4,298) 0 0 0
- ----------------------------------------------------------------------------------------------------
Net income (loss) $ 3,198 $15,744 $(192,695) $17,069
- ----------------------------------------------------------------------------------------------------
Basic income (loss) from continuing operations
per common share
Class A $ (0.51) $ 0.02 $ 0.69 $ 0.19
Class B (0.49) 0.03 0.71 0.22
Combined(1) (0.50) 0.03 0.70 0.21
- ----------------------------------------------------------------------------------------------------
Diluted income (loss) from continuing
operations per common share
Class A $ (0.51) $ 0.02 $ 0.69 $ 0.19
Class B (0.49) 0.03 0.70 0.21
Combined(1) (0.50) 0.03 0.70 0.20
- ----------------------------------------------------------------------------------------------------
Basic net income (loss) per common share
Class A $ 0.12 $ 0.61 $ (7.65) $ 0.67
Class B 0.13 0.63 (7.63) 0.69
Combined(1) 0.13 0.62 (7.64) 0.68
- ----------------------------------------------------------------------------------------------------
Diluted net income (loss) per common share
Class A $ 0.12 $ 0.61 $ (7.60) $ 0.65
Class B 0.13 0.63 (7.58) 0.67
Combined(1) 0.13 0.62 (7.59) 0.67
- ----------------------------------------------------------------------------------------------------
Basic weighted average common shares
outstanding
Class A 9,143 9,109 9,097 9,088
Class B 16,150 16,150 16,135 15,697
Combined(1) 25,293 25,259 25,232 24,785
- ----------------------------------------------------------------------------------------------------
Diluted weighted average common shares
outstanding
Class A 9,143 9,158 9,151 9,143
Class B 16,150 16,168 16,253 16,241
Combined(1) 25,293 25,326 25,404 25,384
- ----------------------------------------------------------------------------------------------------
</Table>
(1) Combined represents a weighted average of Class A and Class B (see Note 1 to
the consolidated financial statements).
87
SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
<Table>
<Caption>
($ IN THOUSANDS) DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------- ------------- ------------- ------------- -------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ---------------------------------------------------------------------------------------------------------------------------
Business credit cards $41,169 98% $33,165 99% $14,663 99% $ 6,916 65% $ 6,899 5%
Consumer credit cards 0 0 0 0 0 0 0 0 118,420 92
Other receivables 802 2 202 1 202 1 3,734 35 3,734 3
- ---------------------------------------------------------------------------------------------------------------------------
Total $41,971 100% $33,367 100% $14,865 100% $10,650 100% $129,053 100%
===========================================================================================================================
</Table>
COMPOSITION OF GROSS RECEIVABLES
<Table>
<Caption>
($ IN THOUSANDS) DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------- -------------- -------------- -------------- ---------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------------------------------------------
Business credit cards $416,265 94% $335,087 93% $275,095 90% $150,022 89% $ 140,399 5%
Consumer credit cards 0 0 0 0 0 0 0 0 2,579,890 94
Other receivables 28,189 6 24,203 7 30,302 10 17,862 11 40,978 1
- ----------------------------------------------------------------------------------------------------------------------------
Total $444,454 100% $359,290 100% $305,397 100% $167,884 100% $2,761,267 100%
============================================================================================================================
</Table>
YIELD AND MATURITY OF INVESTMENTS AT DECEMBER 31, 2001
<Table>
<Caption>
($ IN THOUSANDS) MATURING
- ------------------------------------------------------------------------------------------------------------------------------
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS AFTER TEN YEARS
----------------------- ----------------------- ----------------------- -----------------------
MARKET VALUE YIELD(3) MARKET VALUE YIELD(3) MARKET VALUE YIELD(3) MARKET VALUE YIELD(3)
- ------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury and other
U.S. Government
securities $34,227 4.09% $19,829 5.87% $32,146 6.19% $ 0 0.00%
State and municipal
securities(1) 116 3.31 677 3.91 2,335 5.82 877 5.37
Other(2) 0 0.00 0 0.00 5,527 6.19 26,026 6.33
- ------------------------------------------------------------------------------------------------------------------------------
Total investments
available for sale $34,343 4.09% $20,506 5.81% $40,008 6.17% $26,903 6.30%
==============================================================================================================================
</Table>
(1) Yield computed on a taxable equivalent basis using a statutory rate of 35%.
(2) Equity investments and other securities without a stated maturity are
excluded from this table.
(3) Yields are computed by dividing interest by the amortized cost of the
respective investment securities.
88
SUPPLEMENTAL SCHEDULES (UNAUDITED) -- CONTINUED
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
<Table>
<Caption>
DECEMBER 31,
($ IN THOUSANDS) 2001
- --------------------------------------------------------------------------
Maturity:
3 months or less $ 71,368
Over 3 months through 6 months 37,725
Over 6 months through 12 months 56,238
Over 12 months 145,686
- --------------------------------------------------------------------------
Total $311,017
==========================================================================
</Table>
COMMON STOCK PRICE RANGES AND DIVIDENDS
Advanta's common stock is traded on the National Market tier of The Nasdaq Stock
Market under the symbols ADVNA (Class A voting common stock) and ADVNB (Class B
non-voting common stock). Following are the high, low and closing sale prices
and cash dividends declared for the last two years as they apply to each class
of stock:
<Table>
<Caption>
CASH
DIVIDENDS
QUARTER ENDED: HIGH LOW CLOSE DECLARED
- ------------------------------------------------------------------------------------------------
Class A:
- ------------------------------------------------------------------------------------------------
March 31, 2000 $21.88 $16.88 $20.31 $0.063
June 30, 2000 21.00 10.88 12.19 0.063
September 30, 2000 13.56 10.69 11.25 0.063
December 31, 2000 11.88 5.75 8.81 0.063
March 31, 2001 $16.00 $ 8.75 $15.81 $0.063
June 30, 2001 16.00 12.86 16.00 0.063
September 30, 2001 19.10 8.00 9.40 0.063
December 31, 2001 11.72 8.00 9.94 0.063
- ------------------------------------------------------------------------------------------------
Class B:
- ------------------------------------------------------------------------------------------------
March 31, 2000 $15.50 $11.50 $14.48 $0.076
June 30, 2000 15.13 7.75 8.50 0.076
September 30, 2000 10.19 7.50 8.14 0.076
December 31, 2000 8.38 4.13 7.19 0.076
March 31, 2001 $14.00 $ 7.16 $13.69 $0.076
June 30, 2001 14.00 11.90 13.97 0.076
September 30, 2001 17.10 8.10 8.95 0.076
December 31, 2001 10.79 6.85 9.10 0.076
================================================================================================
</Table>
At December 31, 2001, Advanta had approximately 262 holders of record of
Class A stock and 677 holders of record of Class B stock.
89
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The text of the Proxy Statement under the captions "Election of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance" are hereby
incorporated by reference, as is the text in Part I of this Report under the
caption, "Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The text of the Proxy Statement under the captions "Executive Compensation,"
"Report on Executive Compensation" and "Election of Directors -- Committees,
Meetings and Compensation of the Board of Directors, -- Compensation Committee
Interlocks and Insider Participation and -- Other Matters" are hereby
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The text of the Proxy Statement under the captions "Security Ownership of
Certain Beneficial Owners" and "Security Ownership of Management" are hereby
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The text of the Proxy Statement under the captions "Election of Directors
- -- Compensation Committee Interlocks and Insider Participation and -- Other
Matters" are hereby incorporated herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following Financial Statements, Schedules, and Other Information of the
Registrant and its subsidiaries are included in this Form 10-K:
<Table>
(a)(1) Financial Statements.
1. Consolidated Balance Sheets at December 31, 2001 and 2000.
2. Consolidated Income Statements for each of the three years
in the period ended December 31, 2001.
3. Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended December 31,
2001.
4. Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2001.
5. Notes to Consolidated Financial Statements.
(a)(2) Schedules.
Other statements and schedules are not being presented
either because they are not required or the information
required by such statements and schedules is presented
elsewhere in the financial statements.
(a)(3) Exhibits
2-a Purchase and Sale Agreement, dated January 8, 2001, by and
between Advanta Corp. and Chase Manhattan Mortgage
Corporation (incorporated by reference to Annex I to the
Registrant's Definitive Proxy Statement filed January 25,
2001).
2-b Mortgage Loan Purchase and Sale Agreement, dated February
23, 2001, by and among Advanta Corp., Chase Manhattan
Mortgage Corporation, and Chase Manhattan Bank USA, National
Association (incorporated by reference to Exhibit 2.2 to the
Registrant's Current Report on Form 8-K filed March 14,
2000).
</Table>
90
<Table>
2-c Mortgage Loan Purchase and Sale Agreement, dated February
28, 2001, by and among Advanta Corp., Chase Manhattan
Mortgage Corporation, and Chase Manhattan Bank USA, National
Association (incorporated by reference to Exhibit 2.3 to the
Registrant's Current Report on Form 8-K filed March 14,
2000).
3-a Restated Certificate of Incorporation of Registrant
(incorporated by reference to Exhibit 4.1 to Pre-Effective
Amendment No. 1 to the Registrant's Registration Statement
on Form S-3 (File No. 33-53475), filed June 10, 1994), as
amended by the Certificate of Designations, Preferences,
Rights and Limitations of the Registrant's 6 3/4%
Convertible Class B Preferred Stock, Series 1995 (Stock
Appreciation Income Linked Securities (SAILS))(incorporated
by reference to Exhibit 4.3 to the Registrant's Current
Report on Form 8-K dated August 15, 1995), as further
amended by the Certificate of Designations, Preferences,
Rights and Limitations of the Registrant's Series A Junior
Participating Preferred Stock (incorporated by reference to
Exhibit 1 to the Registrant's Registration Statement on Form
8-A, dated March 17, 1997).
3-b By-laws of the Registrant, as amended (incorporated by
reference to Exhibit 3.1 the Registrant's Current Report on
Form 8-K dated March 17, 1997).
3-c Rights Agreement, dated as of March 14, 1997, by and between
the Registrant and the Rights Agent, which includes as
Exhibit B thereto the Form of Rights Certificate
(incorporated by reference to Exhibit 1 to the Registrant's
Registration Statement on Form 8-A dated March 17, 1997).
4-a* Trust Indenture dated April 22, 1981 between Registrant and
Mellon Bank, N.A., (formerly, CoreStates Bank, N.A.), as
Trustee, including Form of Debenture.
4-b Specimen of Class A Common Stock Certificate and specimen of
Class B Common Stock Certificate (incorporated by reference
to Exhibit 1 of the Registrant's Amendment No. 1 to Form 8
and Exhibit 1 to Registrant's Form 8-A, respectively, both
dated April 22, 1992).
4-c Trust Indenture dated as of November 15, 1993 between the
Registrant and The Chase Manhattan Bank (National
Association), as Trustee (incorporated by reference to
Exhibit 4 to the Registrant's Registration Statement on Form
S-3 (No. 33-50883), filed November 2, 1993).
4-d Senior Trust Indenture, dated as of October 23, 1995,
between the Registrant and Mellon Bank, N.A., as Trustee
(incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on Form S-3 (File No.
33-62601), filed September 13, 1995).
4-e Indenture dated as of December 17, 1996 between Advanta
Corp. and The Chase Manhattan Bank, as trustee relating to
the Junior Subordinated Debentures (incorporated by
reference to Exhibit 4-g to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1996).
4-f Declaration of Trust dated as of December 5, 1996 of Advanta
Capital Trust I (incorporated by reference to Exhibit 4-h to
the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1996).
4-g Amended and Restated Declaration of Trust dated as of
December 17, 1996 for Advanta Capital Trust I (incorporated
by reference to Exhibit 4-i to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1996).
4-h Series A Capital Securities Guarantee Agreement dated as of
December 17, 1996. (incorporated by reference to Exhibit 4-j
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1996).
10-a Advanta Corp. 2000 Omnibus Stock Incentive Plan
(incorporated by reference to 4(f) to Post-Effective
Amendment No. 1 to the Registrant's Registration Statement
on Form S-8 (File No. 333-04469).+
</Table>
91
<Table>
10-b Card Member License Agreement between Colonial National
Financial Corp. (now known as Advanta Bank Corp.) and
MasterCard International Incorporated dated April 19, 1994
(filed herewith).
10-c VISA U.S.A. Inc. Membership Agreement and Principal Member
Addendum executed by Advanta Corp. on February 27, 1997
(filed herewith).
10-d VISA U.S.A. Inc. Membership Agreement executed by Advanta
Bank Corp. on March 31, 2000 (filed herewith).
10-e* Application for membership in VISA(R) U.S.A. Inc. and
Membership Agreement executed by Colonial National Bank USA
on March 25, 1983.
10-f* Application for membership in MasterCard(R) International,
Inc. and Card Member License Agreement executed by Colonial
National Bank USA on March 25, 1983.
10-g* Indenture of Trust dated May 11, 1984 between Linda Alter,
as settlor, and Dennis Alter, as trustee.
10-g(i) Agreement dated October 20, 1992 among Dennis Alter, as
Trustee of the trust established by the Indenture of Trust
filed as Exhibit 10-g (the "Indenture"), Dennis Alter in his
individual capacity, Linda Alter, and Michael Stolper, which
Agreement modifies the Indenture (incorporated by reference
to Exhibit 10-g(i) to the Registrant's Registration
Statement on Form S-3 (File No. 33-58660), filed February
23, 1993).
10-h Advanta Corp. Executive Deferral Plan (incorporated by
reference to the Exhibit 10-j to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1995).+
10-i Advanta Corp. Non-Employee Directors Deferral Plan
(incorporated by reference to Exhibit 10-K to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995).+
10-j Life Insurance Benefit for Certain Key Executives and
Directors (incorporated by reference to Exhibit 10-g to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000).+
10-k Amended and Restated Agreement of Limited Partnership of
Advanta Partners LP, dated as of October 1, 1996
(incorporated by reference to Exhibit 10-o to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996).
10-l Agreement of Limited Partnership of Advanta Growth Capital
Fund L.P., dated as of July 28, 2000 (incorporated by
reference to Exhibit 10-i to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 2000).
10-m Agreement dated as of January 15, 1996 between the
Registrant and William A. Rosoff (incorporated by reference
to Exhibit 10-u to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1995).+
10-n Agreement dated May 11, 1998 between the Registrant and
Philip M. Browne (incorporated by reference to Exhibit 10-r
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998).+
10-o Contribution Agreement, dated as of October 28, 1997, by and
between Advanta Corp. and Fleet Financial Group
(incorporated by reference to Exhibit (c)(2) to the
Registrant's Schedule 13E-4, dated January 20, 1998), as
amended by the First Amendment to the Contribution
Agreement, dated as of February 10, 1998, by and among
Advanta Corp., Fleet Financial Group and Fleet Credit Card,
LLC (incorporated by reference to Exhibit 2.2 to the
Registrant's Current Report on Form 8-K, filed March 6,
1998).
10-p Commercial Lease, dated September 28, 1995, by and between
Draper Park North, L.C. and Advanta Financial Corp., as
amended January 31, 1996 and May 20, 1996 (incorporated by
reference to Exhibit 10-v to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1999).
</Table>
92
<Table>
10-q Master Indenture, dated as of August 1, 2000, between Wilmington Trust Company, as Owner Trustee
of the Advanta Business Card Master Trust and Bankers Trust Company, as Indenture Trustee
(incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K, filed August 20,
2000 by Advanta Business Receivables Corp.).
10-r Series 2000-B Indenture Supplement, dated August 1, 2000, between Advanta Business Card Master
Trust and Bankers Trust Company (incorporated by reference to Exhibit 4.2 to the Current Report
on Form 8-K, filed August 20, 2000 by Advanta Business Receivables Corp.).
10-s Transfer and Servicing Agreement, dated as of August 1, 2000, among Advanta Business Receivables
Corp., Advanta Bank Corp., as Servicer, and Advanta Business Card Master Trust (incorporated by
reference to Exhibit 4.3 to the Current Report on Form 8-K, filed August 20, 2000 by Advanta
Business Receivables Corp.).
10-t Series 2000-C Indenture Supplement, dated as of November 1, 2000, between Advanta Business Card
Master Trust and Bankers Trust Company, as indenture trustee (incorporated by reference to
Exhibit 4.1 to the Current Report on Form 8-K, filed November 21, 2000 by Advanta Business
Receivables Corp.).
10-u Service Agreement between First Data Resources Inc. and Advanta Bank Corp., dated as of January
1, 2002 (filed herewith).
12 Computation of Ratio Earnings to Fixed Charges (filed herewith).
21 Subsidiaries of the Registrant (filed herewith).
23 Consent of Independent Public Accountants (filed herewith).
24 Powers of Attorney (included on the signature page hereof).
99 Letter to the Commission pursuant to Temporary Note 3T to Article 3 of Regulation S-X (filed
herewith).
</Table>
- ---------------
* Incorporated by reference to the Exhibit with corresponding number
constituting part of the Registrant's Registration Statement on Form S-2 (No.
33-00071), filed on September 4, 1985.
+ Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
1. A Report on Form 8-K was filed by the Company on October 24, 2001
announcing results for the third quarter and the addition of two new members to
the Company's management team.
2. A Report on Form 8-K was filed by the Company on December 4, 2001,
announcing earnings guidance for the fiscal year 2002.
93
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Advanta Corp.
By: /s/ WILLIAM A. ROSOFF
-----------------------------------
William A. Rosoff, President and
Vice Chairman of the Board
Dated: March 15, 2002
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned does hereby
constitute and appoint Dennis Alter, William A. Rosoff, Philip M. Browne, David
B. Weinstock and Elizabeth H. Mai, or any of them (with full power to each of
them to act alone), his or her true and lawful attorney in-fact and agent, with
full power of substitution, for him or her and on his or her behalf to sign,
execute and file an Annual Report on Form 10-K under the Securities Exchange Act
of 1934, as amended, for the fiscal year ended December 31, 2001 relating to
Advanta Corp. and any or all amendments thereto, with all exhibits and any and
all documents required to be filed with respect thereto, with the Securities and
Exchange Commission or any regulatory authority, granting unto such
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises in order to effectuate the same as fully to all intents
and purposes as he or she might or could do if personally present, hereby
ratifying and confirming all that such attorneys-in-fact and agents, or any of
them, or their substitute or substitutes, may lawfully do or cause to be done.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated on the 15th day of March, 2002.
<Table>
<Caption>
NAME TITLE
---- -----
/s/ DENNIS ALTER Chairman of the Board and
- ------------------------------------------ Chief Executive Officer
Dennis Alter
/s/ WILLIAM A. ROSOFF President and Vice Chairman
- ------------------------------------------ of the Board
William A. Rosoff
/s/ PHILIP M. BROWNE Senior Vice President and
- ------------------------------------------ Chief Financial Officer
Philip M. Browne
/s/ DAVID B. WEINSTOCK Vice President and Chief
- ------------------------------------------ Accounting Officer
David B. Weinstock
/s/ ARTHUR P. BELLIS Director
- ------------------------------------------
Arthur P. Bellis
/s/ ROBERT S. BLANK Director
- ------------------------------------------
Robert S. Blank
/s/ MAX BOTEL Director
- ------------------------------------------
Max Botel
/s/ DANA BECKER DUNN Director
- ------------------------------------------
Dana Becker Dunn
</Table>
94
<Table>
<Caption>
NAME TITLE
---- -----
/s/ JAMES E. KSANSNAK Director
- ------------------------------------------
James E. Ksansnak
Director
- ------------------------------------------
Ronald Lubner
/s/ OLAF OLAFSSON Director
- ------------------------------------------
Olaf Olafsson
/s/ ROBERT H. ROCK Director
- ------------------------------------------
Robert H. Rock
Director
- ------------------------------------------
Michael Stolper
</Table>
95
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT AND MANNER OF FILING
------- ----------------------------
(a)(1) Financial Statements.
1. Consolidated Balance Sheets at December 31, 2001 and 2000.
2. Consolidated Income Statements for each of the three years
in the period ended December 31, 2001.
3. Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended December 31,
2001.
4. Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2001.
5. Notes to Consolidated Financial Statements.
(a)(2) Schedules.
Other statements and schedules are not being presented
either because they are not required or the information
required by such statements and schedules is presented
elsewhere in the financial statements.
(a)(3) Exhibits
2-a Purchase and Sale Agreement, dated January 8, 2001, by and
between Advanta Corp. and Chase Manhattan Mortgage
Corporation (incorporated by reference to Annex I to the
Registrant's Definitive Proxy Statement filed January 25,
2001).
2-b Mortgage Loan Purchase and Sale Agreement, dated February
23, 2001, by and among Advanta Corp., Chase Manhattan
Mortgage Corporation, and Chase Manhattan Bank USA, National
Association (incorporated by reference to Exhibit 2.2 to the
Registrant's Current Report on Form 8-K filed March 14,
2000).
2-c Mortgage Loan Purchase and Sale Agreement, dated February
28, 2001, by and among Advanta Corp., Chase Manhattan
Mortgage Corporation, and Chase Manhattan Bank USA, National
Association (incorporated by reference to Exhibit 2.3 to the
Registrant's Current Report on Form 8-K filed March 14,
2000).
3-a Restated Certificate of Incorporation of Registrant
(incorporated by reference to Exhibit 4.1 to Pre-Effective
Amendment No. 1 to the Registrant's Registration Statement
on Form S-3 (File No. 33-53475), filed June 10, 1994), as
amended by the Certificate of Designations, Preferences,
Rights and Limitations of the Registrant's 6 3/4%
Convertible Class B Preferred Stock, Series 1995 (Stock
Appreciation Income Linked Securities (SAILS))(incorporated
by reference to Exhibit 4.3 to the Registrant's Current
Report on Form 8-K dated August 15, 1995), as further
amended by the Certificate of Designations, Preferences,
Rights and Limitations of the Registrant's Series A Junior
Participating Preferred Stock (incorporated by reference to
Exhibit 1 to the Registrant's Registration Statement on Form
8-A, dated March 17, 1997).
3-b By-laws of the Registrant, as amended (incorporated by
reference to Exhibit 3.1 the Registrant's Current Report on
Form 8-K dated March 17, 1997).
3-c Rights Agreement, dated as of March 14, 1997, by and between
the Registrant and the Rights Agent, which includes as
Exhibit B thereto the Form of Rights Certificate
(incorporated by reference to Exhibit 1 to the Registrant's
Registration Statement on Form 8-A dated March 17, 1997).
4-a* Trust Indenture dated April 22, 1981 between Registrant and
Mellon Bank, N.A., (formerly, CoreStates Bank, N.A.), as
Trustee, including Form of Debenture.
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT AND MANNER OF FILING
------- ----------------------------
4-b Specimen of Class A Common Stock Certificate and specimen of
Class B Common Stock Certificate (incorporated by reference
to Exhibit 1 of the Registrant's Amendment No. 1 to Form 8
and Exhibit 1 to Registrant's Form 8-A, respectively, both
dated April 22, 1992).
4-c Trust Indenture dated as of November 15, 1993 between the
Registrant and The Chase Manhattan Bank (National
Association), as Trustee (incorporated by reference to
Exhibit 4 to the Registrant's Registration Statement on Form
S-3 (No. 33-50883), filed November 2, 1993).
4-d Senior Trust Indenture, dated as of October 23, 1995,
between the Registrant and Mellon Bank, N.A., as Trustee
(incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on Form S-3 (File No.
33-62601), filed September 13, 1995).
4-e Indenture dated as of December 17, 1996 between Advanta
Corp. and The Chase Manhattan Bank, as trustee relating to
the Junior Subordinated Debentures (incorporated by
reference to Exhibit 4-g to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1996).
4-f Declaration of Trust dated as of December 5, 1996 of Advanta
Capital Trust I (incorporated by reference to Exhibit 4-h to
the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1996).
4-g Amended and Restated Declaration of Trust dated as of
December 17, 1996 for Advanta Capital Trust I (incorporated
by reference to Exhibit 4-i to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1996).
4-h Series A Capital Securities Guarantee Agreement dated as of
December 17, 1996. (incorporated by reference to Exhibit 4-j
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1996).
10-a Advanta Corp. 2000 Omnibus Stock Incentive Plan
(incorporated by reference to 4(f) to Post-Effective
Amendment No. 1 to the Registrant's Registration Statement
on Form S-8 (File No. 333-04469).+
10-b Card Member License Agreement between Colonial National
Financial Corp. (now known as Advanta Bank Corp.) and
MasterCard International Incorporated dated April 19, 1994
(filed herewith).
10-c VISA U.S.A. Inc. Membership Agreement and Principal Member
Addendum executed by Advanta Corp. on February 27, 1997
(filed herewith).
10-d VISA U.S.A. Inc. Membership Agreement executed by Advanta
Bank Corp. on March 31, 2000 (filed herewith).
10-e* Application for membership in VISA(R) U.S.A. Inc. and
Membership Agreement executed by Colonial National Bank USA
on March 25, 1983.
10-f* Application for membership in MasterCard(R) International,
Inc. and Card Member License Agreement executed by Colonial
National Bank USA on March 25, 1983.
10-g* Indenture of Trust dated May 11, 1984 between Linda Alter,
as settlor, and Dennis Alter, as trustee.
10-g(i) Agreement dated October 20, 1992 among Dennis Alter, as
Trustee of the trust established by the Indenture of Trust
filed as Exhibit 10-g (the "Indenture"), Dennis Alter in his
individual capacity, Linda Alter, and Michael Stolper, which
Agreement modifies the Indenture (incorporated by reference
to Exhibit 10-g(i) to the Registrant's Registration
Statement on Form S-3 (File No. 33-58660), filed February
23, 1993).
10-h Advanta Corp. Executive Deferral Plan (incorporated by
reference to the Exhibit 10-j to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1995).+
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT AND MANNER OF FILING
------- ----------------------------
10-i Advanta Corp. Non-Employee Directors Deferral Plan
(incorporated by reference to Exhibit 10-K to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995).+
10-j Life Insurance Benefit for Certain Key Executives and
Directors (incorporated by reference to Exhibit 10-g to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000).+
10-k Amended and Restated Agreement of Limited Partnership of
Advanta Partners LP, dated as of October 1, 1996
(incorporated by reference to Exhibit 10-o to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996).
10-l Agreement of Limited Partnership of Advanta Growth Capital
Fund L.P., dated as of July 28, 2000 (incorporated by
reference to Exhibit 10-i to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 2000).
10-m Agreement dated as of January 15, 1996 between the
Registrant and William A. Rosoff (incorporated by reference
to Exhibit 10-u to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1995).+
10-n Agreement dated May 11, 1998 between the Registrant and
Philip M. Browne (incorporated by reference to Exhibit 10-r
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998).+
10-o Contribution Agreement, dated as of October 28, 1997, by and
between Advanta Corp. and Fleet Financial Group
(incorporated by reference to Exhibit (c)(2) to the
Registrant's Schedule 13E-4, dated January 20, 1998), as
amended by the First Amendment to the Contribution
Agreement, dated as of February 10, 1998, by and among
Advanta Corp., Fleet Financial Group and Fleet Credit Card,
LLC (incorporated by reference to Exhibit 2.2 to the
Registrant's Current Report on Form 8-K, filed March 6,
1998).
10-p Commercial Lease, dated September 28, 1995, by and between
Draper Park North, L.C. and Advanta Financial Corp., as
amended January 31, 1996 and May 20, 1996 (incorporated by
reference to Exhibit 10-v to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1999).
10-q Master Indenture, dated as of August 1, 2000, between
Wilmington Trust Company, as Owner Trustee of the Advanta
Business Card Master Trust and Bankers Trust Company, as
Indenture Trustee (incorporated by reference to Exhibit 4.1
to the Current Report on Form 8-K, filed August 20, 2000 by
Advanta Business Receivables Corp.).
10-r Series 2000-B Indenture Supplement, dated August 1, 2000,
between Advanta Business Card Master Trust and Bankers Trust
Company (incorporated by reference to Exhibit 4.2 to the
Current Report on Form 8-K, filed August 20, 2000 by Advanta
Business Receivables Corp.).
10-s Transfer and Servicing Agreement, dated as of August 1,
2000, among Advanta Business Receivables Corp., Advanta Bank
Corp., as Servicer, and Advanta Business Card Master Trust
(incorporated by reference to Exhibit 4.3 to the Current
Report on Form 8-K, filed August 20, 2000 by Advanta
Business Receivables Corp.).
10-t Series 2000-C Indenture Supplement, dated as of November 1,
2000, between Advanta Business Card Master Trust and Bankers
Trust Company, as indenture trustee (incorporated by
reference to Exhibit 4.1 to the Current Report on Form 8-K,
filed November 21, 2000 by Advanta Business Receivables
Corp.).
10-u Service Agreement between First Data Resources Inc. and
Advanta Bank Corp., dated as of January 1, 2002 (filed
herewith).
12 Computation of Ratio Earnings to Fixed Charges (filed
herewith).
21 Subsidiaries of the Registrant (filed herewith).
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT AND MANNER OF FILING
------- ----------------------------
23 Consent of Independent Public Accountants (filed herewith).
24 Powers of Attorney (included on the signature page hereof).
99 Letter to the Commission pursuant to Temporary Note 3T to
Article 3 of Regulation S-X (filed herewith).
</Table>
- ---------------
* Incorporated by reference to the Exhibit with corresponding number
constituting part of the Registrant's Registration Statement on Form S-2 (No.
33-00071), filed on September 4, 1985.
+ Management contract or compensatory plan or arrangement.