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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the fiscal year ended December 31, 1996
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from _____________ to _________________
COMMISSION FILE NUMBER 000-21673
AUTOBOND ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 75-2487218
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
301 CONGRESS AVENUE
AUSTIN, TEXAS 78701
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code: (512) 435-7000
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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COMMON STOCK, NO PAR VALUE PER SHARE NASDAQ NATIONAL MARKET
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. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant on March 27, 1997 (based on the closing price on such date as
reported on the Nasdaq National Market) was $5,240,625.(1)
As of March 31, 1997, 6,512,500 shares of Common Stock, no par value per
share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
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1 Calculated by excluding all shares that may be deemed to be beneficially
owned by executive officers, directors and five percent, shareholders of the
Registrant, without conceding that all such persons are "affiliates" of the
Registrant for purposes of the Federal securities laws.
Part III -Portions of the Registrant's definitive Proxy Statement
with respect to the Registrant's 1996 Annual Meeting of
Shareholders, to be filed not later than 120 days after the
close of the Registrant's fiscal year.
EXHIBIT INDEX IS LOCATED AT PAGE 43
PAGE 1 OF 45
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AUTOBOND ACCEPTANCE CORPORATION
1996 FORM 10-K ANNUAL REPORT
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TABLE OF CONTENTS
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PAGE
NUMBER
PART I
Item 1. BUSINESS........................................................................1
Item 2. PROPERTIES......................................................................20
Item 3. LEGAL PROCEEDINGS...............................................................20
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................20
PART II
Item 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.............................................................21
Item 6. SELECTED FINANCIAL DATA.........................................................22
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................................23
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................................40
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.............................................40
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..............................40
Item 11. EXECUTIVE COMPENSATION..........................................................41
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT......................................................................41
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................41
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K.....................................................................42
PART I
ITEM 1. BUSINESS
GENERAL
AutoBond Acceptance Corporation (the "Company") is a specialty consumer
finance company engaged in underwriting, acquiring, servicing and securitizing
retail installment contracts ("finance contracts") originated by franchised
automobile dealers in connection with the sale of used and, to a lesser extent,
new vehicles to selected consumers with limited access to traditional sources of
credit ("sub-prime consumers"). Sub-prime consumers generally are borrowers
unable to qualify for traditional financing due to one or more of the following
reasons: negative credit history (which may include late payments, charge-offs,
bankruptcies, repossessions or unpaid judgments); insufficient credit;
employment or residence histories; or high debt-to-income or payment-to-income
ratios (which may indicate payment or economic risk).
The Company acquires finance contracts generally from franchised
automobile dealers, makes credit decisions using its own underwriting guidelines
and credit personnel and performs the collection function for finance contracts
using its own collections department. The Company also acquires finance
contracts from third parties other than dealers, for which the Company
reunderwrites and collects such finance contracts in accordance with the
Company's standard guidelines. The Company securitizes portfolios of these
retail automobile installment contracts to efficiently utilize limited capital
to allow continued growth and to achieve sufficient finance contract volume to
allow profitability. The Company markets a single finance contract acquisition
program to automobile dealers which adheres to consistent underwriting
guidelines involving the purchase of primarily late-model used vehicles. This
has enabled the Company to securitize those contracts into investment grade
securities with similar terms from one issue to another providing consistency to
investors. For the period of inception through December 31, 1996, the Company
acquired 10,073 finance contracts with an aggregate initial principal balance of
$117,699,878, and which had an initial average principal balance, at
acquisition, of $11,685, a weighted average annual percentage rate ("APR") of
19.54%, a weighted average finance contract acquisition discount of 8.3% and a
weighted average maturity of 52 months. During the year ended December 31, 1996,
the Company completed four securitizations pursuant to which it privately placed
$81.7 million in finance contract backed securities.
RECENT DEVELOPMENTS
On February 14, 1997 the Company, through its wholly-owned subsidiary
AutoBond Funding Corporation II, entered into a $50,000,000 warehouse credit
facility with Daiwa Finance Corporation (the "Diawa Facility"), which expires in
March 1998. The proceeds from the borrowings under the Daiwa Facility are to be
used to acquire finance contracts, and to make deposits to a reserve account.
Interest is payable monthly at the 30-day LIBOR plus 1.15% per annum rate. The
Daiwa Facility also requires the Company to pay a monthly fee on the average
unused balance at a per annum rate of 0.25%. Borrowings under the Daiwa Facility
are rated investment-grade by a nationally recognized statistical rating
organization. The Daiwa Facility contains certain conditions and imposes certain
requirements similar to those in the agreements relating to the Company's
existing securitizations including, among
other things, delinquency and repossession triggers.
On March 31, 1997, the Company completed its 1997-A securitization of
$28.0 million in finance contracts. The senior securitization bonds received an
A/A2 rating from Fitch Investors Service and Moody's Investors Services
respectively. Included in the $28.0 million 1997-A securitization were $8.3
million in finance contracts which the Company acquired as part of a $12.9
million pool from Credit Suisse First Boston.
Beginning in the first quarter 1997, the Company elected not to obtain
credit deficiency insurance on every finance contract which it acquires. Of the
$32 million in finance contracts which the Company acquired in the first quarter
of 1997, roughly 40%, or $12.9 million, were covered by an Interstate Fire &
Casualty credit deficiency policy. However, VSI damage policies were and
continue to be purchased for all finance contracts. The completed securitization
structure for 1997-A generated less cash proceeds than prior issuances due to
the lack of credit deficiency insurance on many of the finance contracts
collateralizing the transaction. However, offsetting much of this reduction in
cash proceeds, is the fact that the Company did not pay the up front premiums
associated with the credit deficiency insurance, which resulted in a lower cost
basis in the finance contracts than in the past.
GROWTH AND BUSINESS STRATEGY
The Company's growth strategy anticipates the acquisition of an
increasing number of finance contracts. The key elements of this strategy
include: (i) increasing the number of finance contracts acquired per automobile
dealer; (ii) expanding the Company's presence within existing markets; (iii)
penetrating new markets that meet the Company's economic, demographic and
business criteria and (iv) securitizing portfolios of acquired finance
contracts.
To foster its growth and increase profitability, the Company will
continue to pursue a business strategy based on the following principles:
o TARGETED MARKET AND PRODUCT FOCUS--The Company targets the sub-prime
auto finance market because it believes that sub-prime finance
presents greater opportunities than does prime lending. This greater
opportunity stems from a number of factors, including the relative
newness of sub-prime auto finance, the range of finance contracts
that various sub-prime auto finance companies provide, the relative
lack of competition compared to traditional automotive financing and
the potential returns sustainable from large interest rate spreads.
The Company focuses on late model used rather than new vehicles, as
management believes the risk of loss is lower on used vehicles due to
lower depreciation rates, while interest rates are typically higher
than on new vehicles. For the period from inception through December
31, 1996, new vehicles and used vehicles represented 9.2% and 90.8%,
respectively, of the finance contract portfolio measured by dollar
value of amounts financed and 6.8% and 93.2%, respectively, as a
percentage of units acquired. In addition, the Company concentrates
on acquiring finance contracts from dealerships franchised by major
automobile manufacturers because they typically offer higher quality
vehicles, are better capitalized, and have better service
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facilities than used car dealers.
o EFFICIENT FUNDING STRATEGIES--Through an investment-grade warehouse
facility and a quarterly securitization program, the Company
increases its liquidity, redeploys its capital and reduces its
exposure to interest rate fluctuations. The Company has also
developed the ability to borrow funds on a non-recourse basis,
collateralized by excess spread cash flows from its securitization
trusts. The net effect of the Company's funding and securitization
program is to provide more proceeds than the Company's acquisition
costs, resulting in positive revenue cash flow, lower overall costs
of funding, and permitting loan volume to increase with limited
additional equity capital.
o UNIFORM UNDERWRITING CRITERIA--To manage the risk of delinquency or
defaults associated with sub-prime consumers, the Company has
utilized since inception a single set of underwriting criteria which
are consistently applied in evaluating credit applications. This
evaluation process is conducted on a centralized basis utilizing
experienced personnel. These uniform underwriting criteria create
consistency in the securitized portfolios of finance contracts that
make them more easily analyzed by the rating agencies and more
marketable and permit static pool analysis of loan defaults to
optimally structure securitizations. See "Management's Discussion and
Analysis--Repossession Experience--Static Pool Analysis."
o CENTRALIZED OPERATING STRUCTURE--While the Company establishes and
maintains relationships with dealers through sales representatives
located in the geographic markets served by the Company, all of the
Company's day-to-day operations are centralized at the Company's
offices in Austin, Texas. This centralized structure allows the
Company to closely monitor its marketing, funding, underwriting and
collections operations and eliminates the expenses associated with
full-service branch or regional offices.
o EXPERIENCED MANAGEMENT TEAM--The Company actively recruits and
retains experienced personnel at the executive, supervisory and
managerial levels. The senior operating management of the Company
consists of seasoned automobile finance professionals with
substantial experience in underwriting, collecting and financing
automobile finance contracts.
o INTENSIVE COLLECTION MANAGEMENT--The Company believes that intensive
collection efforts are essential to ensure the performance of
sub-prime finance contracts and to mitigate losses. The Company's
collections managers contact delinquent accounts frequently, working
cooperatively with customers to get full or partial payments, but
will initiate repossession of financed vehicles no later than the
90th day of delinquency. As of December 31, 1996, a total of
$1,826,800 or 1.74%, of the Company's finance contract portfolio were
between 60 and 90 days past due and $1,328,300, or approximately
1.27%, of the Company's finance contracts outstanding were greater
than 90 days past due. From inception through December 31, 1996, the
Company repossessed approximately 6.2% of its financed vehicles. The
Company had completed the disposal of 344 vehicles, resulting in an
average loss per repossession of approximately $1,270 per vehicle.
See
3
"Management's Discussion and Analysis - Net Loss per Repossession."
o LIMITED LOSS EXPOSURE--To reduce its potential losses on defaulted
finance contracts, the Company historically has insured each finance
contract it funds against damage to the financed vehicle through a
vender's comprehensive single interest physical damage insurance
policy (a "VSI Policy"). In addition in connection with the Company's
warehouse financing and securitizations through December 31, 1996,
the Company purchased credit default insurance through a deficiency
balance endorsement (the "Credit Endorsement") to the VSI Policy. The
Credit Endorsement reimburses the Company for the difference between
the unpaid finance contract balance and the net proceeds received in
connection with the sale of the repossessed vehicle. Moreover, the
Company limits loan-to-value ratios and applies a purchase price
discount to the finance contracts it acquires. The Company's
combination of underwriting criteria, intensive collection efforts
and the VSI Policy and Credit Endorsement has resulted in net
charge-offs (after receipt of liquidation and insurance proceeds) of
8.57% (excluding repossession costs) of the principal balance
outstanding on disposed repossessed vehicles for which the
liquidation process has been completed as of December 31, 1996.
Effective April 1997, the insurance company providing the Credit
Endorsement will no longer provide such coverage to the auto finance
industry, including the Company, for finance contracts originated
after, and has asserted rights to increase premiums through, such
date. Although the Company has obtained new VSI Policies, these
policies do not have coverage similar to the Credit Endorsement.
However, management believes that the increased levels of
overcollateralization in its warehouse financing and securitizations
will compensate for the lack of the Credit Endorsement. See
"-Insurance" below and "Management's Discussion and Analysis--Net
Loss per Repossession."
BORROWER CHARACTERISTICS
Borrowers under finance contracts in the Company's finance contract
portfolio are generally sub-prime consumers. Sub-prime consumers are purchasers
of financed vehicles with limited access to traditional sources of credit and
are generally individuals with weak or no credit histories. Based on a sample of
1,533 finance contracts in the finance contract portfolio which the Company
believes are representative of the portfolio as a whole, the Company has
determined the following characteristics with respect to its finance contract
borrowers. The average borrower's monthly income is $2,400, with an average
payment-to-income ratio of 15.7% and an average debt-to-income ratio of 19.2%.
The Company's guidelines permit a maximum payment-to-income ratio and
debt-to-income ratio of 20% and 50%, respectively. The Company's guidelines
require a cash down payment of 10% of the vehicle selling price. Based upon a
sample of its borrowers which the Company believes to be representative, the
average borrower's time spent at current residence is 65.6 months, while the
average time of service at current employer is 46.6 months. The age of the
average borrower is 34.3 years.
4
CONTRACT PROFILE
From inception to December 31, 1996, the Company acquired 10,073 finance
contracts with an aggregate initial principal balance of $117.7 million. Of the
finance contracts acquired, approximately 6.8% have related to the sale of new
automobiles and approximately 93.2% have related to the sale of used
automobiles. The average age of used financed vehicles was approximately two
years at the time of sale. The finance contracts had, upon acquisition, an
average initial principal balance of $11,685; a weighted average APR of 19.54%;
a weighted average finance contract acquisition discount of 8.3%; and a weighted
average contractual maturity of 52 months. As of December 31, 1996, the finance
contracts in the finance contract portfolio had a weighted average remaining
maturity of 45.7 months. Since inception, the Company's cumulative repossessions
have totaled 625 or 6.2% of the total portfolio.
DEALER NETWORK
General. The Company acquires finance contracts originated by automobile
dealers in connection with the sale of late-model used and, to a lesser extent,
new cars to sub-prime borrowers. Accordingly, the Company's business development
strategy depends on enrolling and promoting active participation by automobile
dealers in the Company's financing program. Dealers are selected on the basis of
geographic location, financial strength, experience and integrity of management,
stability of ownership quality of used car inventory, participation in sub-prime
financing programs, and the anticipated quality and quantity of finance
contracts which they originate. The Company principally targets dealers
operating under franchises from major automobile manufacturers, rather than
independent used car dealers. The Company believes that franchised dealers are
generally more stable and offer higher quality vehicles than independent
dealers. This is due, in part, to careful initial screening and ongoing
monitoring by the automobile manufacturers and to the level of financial
commitment necessary to secure and maintain a franchise. As of December 31,
1996, the Company was licensed or qualified to do business in 34 states. Over
the near term, the Company intends to focus its proposed geographic expansion on
states in the midwest and mid-Atlantic regions.
Location of Dealers. Approximately 44.9% of the Company's dealer network
consists of dealers located in Texas, where the Company has operated since 1994.
During the fiscal year ended December 31, 1996, the Company acquired finance
contracts from dealers in 36 states.
A group of six dealerships (including Charlie Thomas Ford) under
substantial common ownership accounted for approximately 26.51% and 17.56% for
the fiscal year ended 1995 and 1996 respectively, of finance contracts acquired
during the same period. One dealership, Charlie Thomas Ford, Inc. of Houston,
Texas, accounted for 8.79% of the finance contracts acquired by the Company for
the period from inception through December 31, 1996 (8.77% and 8.94% for the
fiscal year ended 1995 and 1996 respectively).
DEALER SOLICITATION
Marketing Representatives. As of December 31, 1996, the Company utilized
24
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marketing representatives, twelve of which were individuals employed by the
Company and twelve of which were marketing organizations serving as independent
representatives. These representatives have an average of ten years experience
in the automobile financing industry. Each marketing representative reports to,
and is supervised by, the Company's Senior Vice President--Marketing. The
Company is currently evaluating candidates for additional marketing
representative positions. The marketing representatives reside in the region for
which they are responsible. Marketing representatives are compensated on the
basis of a salary plus commissions based on the number of finance contracts
purchased by the Company in their respective areas. The Company maintains an
exclusive relationship with the independent marketing representatives and
compensates such representatives on a commission basis. All marketing
representatives undergo training and orientation at the Company's Austin
headquarters.
The Company's marketing representatives establish financing
relationships with new dealerships, and maintain existing dealer relationships.
Each marketing representative endeavors to meet with the managers of the finance
and insurance ("F&I") departments at each targeted dealership in his or her
territory to introduce and enroll dealers in the Company's financing program,
educating the F&I managers about the Company's underwriting philosophy, its
practice of using experienced underwriters (rather than computerized credit
scoring) to review applications, and the Company's commitment to a single
lending program that is easy for dealers to master and administer. The marketing
representatives offer training to dealership personnel regarding the Company's
program guidelines, procedures and philosophy.
After each dealer relationship is established, a marketing
representative continues to actively monitor the relationship with the objective
of maximizing the volume of applications received from the dealer that meet the
Company's underwriting standards. Due to the non-exclusive nature of the
Company's relationships with dealers, the dealers retain discretion to determine
whether to seek financing from the Company or another financing source. Each
representative submits a weekly call report describing contacts with prospective
and existing dealers during the preceding week and monthly competitive survey
relating to the competitive situation and possible opportunities in the region.
The Company provides each representative a weekly report detailing applications
received and finance contracts purchased from all dealers in the region. The
marketing representatives regularly telephone and visit F&I managers to remind
them of the Company's objectives and to answer questions. To increase the
effectiveness of these contacts, the marketing representatives can obtain
real-time information from the Company's newly installed management information
systems, listing by dealership the number of applications submitted, the
Company's response to such applications and the reasons why a particular
application was rejected. The Company believes that the personal relationships
its marketing representatives establish with the F&I managers are an important
factor in creating and maintaining productive relationships with its dealership
customer base.
The role of the marketing representatives is generally limited to
marketing the Company's financing program and maintaining relationships with the
Company's dealer network. The marketing representatives do not negotiate, enter
into or modify dealer agreements on behalf of the Company, do not participate in
credit evaluation or loan funding
6
decisions and do not handle funds belonging to the Company or its dealers. The
Company intends to develop notable finance contract volume in each state in
which it initiates coverage. The Company has elected not to establish full
service branch offices, believing that the expenses and administrative burden of
such offices are generally unjustified. The Company has concluded that the
ability to closely monitor the critical functions finance contract approval and
contract administration and collection are best performed and controlled on a
centralized basis from its Austin facility.
Dealer Agreements. Each dealer with which the Company establishes a
financing relationship enters into a non-exclusive written dealer agreement (a
"Dealer Agreement") with the Company, governing the Company's acquisition of
finance contracts from such dealer. A Dealer Agreement generally provides that
the dealer shall indemnify the Company against any damages or liabilities,
including reasonable attorney's fees, arising out of (i) any breach of a
representation or warranty of the dealer set forth in the Dealer Agreement or
(ii) any claim or defense that a borrower may have against a dealer relating to
financing contract. Representations and warranties in a Dealer Agreement
generally relate to matters such as whether (a) the financed automobile is free
of all liens, claims and encumbrances except the Company's lien, (b) the down
payment specified in the finance contract has been paid in full and whether any
part of the down payment was loaned to the borrower by the dealer and (c) the
dealer has complied with applicable law. If the dealer violates the terms of the
Dealer Agreement with respect to any finance contract, the dealer must
repurchase such contract on demand for an amount equal to the unpaid balance and
all other indebtedness due to the Company from the borrower.
FINANCING PROGRAM
Unlike certain competitors who offer numerous marketing programs that
the Company believes serve to confuse dealers and borrowers, the Company markets
a single financing contract acquisition program to its dealers. The Company
believes that by focusing on a single program, it realizes consistency in
achieving its contract acquisition criteria, which aids the funding and
securitization process. The finance contracts purchased by the Company must meet
several criteria, including that each contract: (i) meets the Company's
underwriting guidelines; (ii) is secured by a new or late-model used vehicle of
a type on the Company's approved list; (iii) was originated in a jurisdiction in
the United States in which the Company was licensed or qualified to do business,
as appropriate; (iv) provides for level monthly payments (collectively, the
"Scheduled Payments") that fully amortize the amount financed over the finance
contract's original contractual term; (v) has an original contractual term from
24 to 60 months; (vi) provides for finance charges at an APR of at least 14%;
(vii) provides a verifiable down payment of 10% or more of the cash selling
price; and (viii) is not past due or does not finance a vehicle which is in
repossession at the time the finance contract is presented to Company for
acquisition. Although the Company has in the past acquired a substantial number
of finance contracts for which principal and interest are calculated according
to the Rule of 78s the Company's present policy is to acquire primarily finance
contracts calculated using the simple interest method.
The amount financed with respect to a finance contract will generally
equal the aggregate amount advanced toward the purchase price of the financed
vehicle, which equals the net selling price of the vehicle (cash selling price
less down payment and trade-in), plus
7
the cost of permitted automotive accessories (e.g., air conditioning, standard
transmission, etc.), taxes, title and license fees, credit life, accident and
health insurance policies, service and warranty contracts and other items
customarily included in retail automobile installment contracts and related
costs. Thus, the amount financed may be greater than the Manufacturers Suggested
Retail Price ("MSRP") for new vehicles or the market value quoted for used
vehicles. Down payments must be in cash or real value of traded-in vehicles.
Dealer-assisted or deferred down payments are not permitted.
The Company's current purchase criteria limit acceptable finance
contracts to a maximum (a) net selling price of the lesser of (i) 112% of
wholesale book value (or dealer invoice for new vehicles) or (ii) 95% of retail
book value (or MSRP for new vehicles) and (b) amount financed of 120% of retail
book value in the case of a used vehicle, or 120% of MSRP in the case of a new
vehicle. In assessing the value of a trade-in for purposes of determining the
vehicle's net selling price, the Company uses the published wholesale book value
without regard to the value assigned by the dealer.
The credit characteristics of an application approved by the Company for
acquisition generally consist of the following: (i) stability of applicant's
employment, (ii) stability of applicant's residence history, (iii) sufficient
borrower income, (iv) credit history, and (v) payment of down payment.
The Company applies a loan-to-value ratio in selecting finance contracts
for acquisitions calculated as equaling the quotient of: (a) The cash selling
price less the down payment on the vehicle, divided by (b) the wholesale value
of the vehicle (net of additions or subtractions for mileage and equipment
additions listed in the applicable guide book). For new vehicles, wholesale
value is based on the invoice amount, including destination charges. For used
vehicles, wholesale value is computed using the applicable guide book (Kelley or
NADA) in use within the market in which the vehicle is located.
All of the Company's finance contracts are prepayable at any time.
Finance contracts acquired by the Company must prohibit the sale or transfer of
the financed vehicle without the Company's prior consent and provide for
acceleration of the maturity of the finance contract in the absence of such
consent. For an approved finance contract, the Company will agree to acquire
such finance contract from the originating dealer at a non-refundable contract
acquisition discount of approximately 8.5% to 12% of the amount financed.
CONTRACT ACQUISITION PROCESS
General. Having selected an automobile for purchase, the sub-prime
consumer typically meets with the dealership's F&I manager to discuss options
for financing the purchase of the vehicle. If the sub-prime consumer elects to
finance the vehicle's purchase through the dealer, the dealer will typically
submit the borrower's credit application to a number of potential financing
sources to find the most favorable terms. In general, an F&I department's
potential sources of financing will include banks, thrifts, captive finance
companies and independent finance companies.
For the year ended December 31, 1996, 71,132 credit applications were
submitted to
8
the Company. Of these 71,132 applications, approximately 32.8% were approved and
10.1%, or 7,215 contracts, were acquired by the Company. The difference between
the number of applications approved and the number of finance contracts acquired
is attributable to a common industry practice in which dealers often submit
credit applications to more than one finance company and select on the basis of
the most favorable terms offered. The prospective customer may also decide not
to purchase the vehicle notwithstanding approval of the credit application.
Contract Processing. Dealers send credit applications along with other
information to the Company's Credit Department in Austin via facsimile. Upon
receipt, the credit application and other relevant information is entered into
the Company's computerized contract administration system by the Company's
credit verification personnel and a paper-based file where the original
documents are created. Once logged into the system, the applicant's credit
bureau reports are automatically accessed and retrieved directly into the
system. At this stage, the computer assigns the credit application to the
specific credit manager assigned to the submitting dealer for credit evaluation.
Credit Evaluation. The Company applies uniform underwriting standards.
In evaluating the applicant's creditworthiness and the collateral value of the
vehicle, the credit underwriter reviews each application in accordance with the
Company's guidelines and procedures, which take into account, among other
things, the individual's stability of residence, employment history, credit
history, ability to pay, income, discretionary income and debt ratio. In
addition, the credit underwriter evaluates the applicant's credit bureau report
in order to determine if the applicant's (i) credit quality is deteriorating,
(ii) credit history suggests a high probability of default or (iii) credit
experience is too limited for the Company to assess the probability of
performance. The Company also assesses the value and useful life of the
automobile that will serve as collateral under the finance contract. Moreover,
the credit underwriters consider the suitability of a proposed loan under its
financing program in light of the (a) proposed contract term and (b) conformity
of the proposed collateral coverage to the Company's underwriting guidelines.
Verification of certain applicant-provided information (e.g., employment
and residence history) is required before the Company makes its credit decision.
Such verification typically requires submission of supporting documentation,
such as a paycheck stub or other substantiation of income, or a telephone bill
evidencing a current address. In addition, the Company does not normally approve
any applications from persons who have been the subject of two or more
bankruptcy proceedings or two or more repossessions.
The Company's underwriting standards are applied by experienced credit
underwriters with a personal analysis of each application, utilizing experienced
judgment. These standards have been developed and refined by the Company's
senior credit and collections management who, on average, possess more than 24
years in the automobile finance industry. The Company believes that having its
credit underwriters personally review and communicate to the submitting
dealership the decision with respect to each application, including the reasons
why a particular application may have been declined, enhances the Company's
relationship with such dealers. This practice encourages F&I managers to submit
contracts meeting the Company's underwriting standards, thereby increasing the
Company's operating efficiency by eliminating the need to process applications
unlikely to be approved.
9
The Company's Credit Department personnel undergo ongoing internal
training programs that are scheduled on a weekly basis and are attended by such
personnel depending on their responsibilities. All of these personnel are
located in the Company's offices in Austin where they are under the supervision
of the Vice President--Credit and the credit manager. The credit manager and the
Vice President-- Credit have an aggregate of more than 30 years of experience in
the automobile finance business. In addition, the Company reviews all
repossessions to identify factors that might require refinements in the
Company's credit evaluation procedures.
Approval Process. The time from receipt of application to final credit
approval is a significant competitive factor, and the Company seeks to complete
its funding approval decision in an average of two to three hours. When the
Company approves the purchase of a finance contract, the credit manager notifies
the dealer by facsimile or telephone. Such notice specifies all pertinent
information relating to the terms of approval, including the interest rate, the
term, information about the automobile to be sold and the amount of discount
that the Company will deduct from the amount financed prior to remitting the
funds to the dealer. The discount is not refundable to the dealer.
Contract Purchase and Funding. Upon final confirmation of the terms by
the borrower, the dealer completes the sale of the automobile to the borrower.
After the dealer delivers all required documentation (including an application
for title or a dealer guaranty of title, naming the Company as lienholder) to
the Company, the Company remits funds to the dealer via overnight delivery
service, generally within 48 hours of having received the complete loan funding
package. As a matter of policy, the Company takes such measures as it deems
necessary to obtain a perfected security interest in the related financed
vehicles under the laws of the states in which such vehicles are originated.
This generally involves taking the necessary steps to obtain a certificate of
title which names the Company as lienholder. Each finance contract requires that
the automobile be adequately insured and that the Company be named as loss
payee, and compliance with these requirements is verified prior to the
remittance of funds to the dealer. Upon funding of the finance contract and
payment of the required premium, the financed vehicle is insured under the
Company's VSI Policy, which includes coverage of property damages in the event
that the borrower does not maintain insurance.
From time to time, the Company also acquires bulk portfolios from other
originators. In this event, the Company reunderwrites such contracts to ensure
appropriate credit standards are maintained. The Company acquired approximately
$14 million in finance contracts in 1996 from Greenwich Capital Financial
Products which were originated by First Fidelity Acceptance Corp.
CONTRACT SERVICING AND COLLECTION
Contract servicing includes contract administration and collection.
Because the Company believes that an active collection program is essential to
success in the sub-prime automobile financing market, the Company retains
responsibility for finance contract collection. The Company currently contracts
with CSC Logic/MSA L.L.P. (a Texas limited liability partnership doing business
as "Loan Servicing Enterprises") ("LSE") to provide contract administration. The
Company may in the future assume certain of the servicing functions
10
performed by LSE, but there can be no assurance that this will occur.
Contract Administration. LSE provides certain finance contract
administration functions in connection with warehouse facilities and in
connection with finance contracts sold to securitization trusts, including
payment processing, statement rendering, insurance tracking, data reporting and
customer service for finance contracts. LSE inputs newly originated finance
contracts on the contract system daily. Finance contract documentation is sent
by the Company to LSE as soon as dealer funding occurs. LSE then mails a welcome
letter to the borrower and subsequently mails monthly billing statements to each
borrower approximately ten days prior to each payment due date. Any borrower
remittances are directed to a lock box. Remittances received are then posted to
the proper account on the system. All borrower remittances are reviewed under
LSE's quality control process to assure its proper application to the correct
account in the proper amount. LSE also handles account inquiries from borrowers
and performs insurance tracking services. LSE also sends out notices to
borrowers for instances where proper collateral insurance is not documented.
Contract Collection. As collection agent, the Company is responsible for
pursuing collections from delinquent borrowers. The Company utilizes proactive
collection procedures, which include making early and frequent contact with
delinquent borrowers, educating borrowers as to the importance of maintaining
good credit, and employing a consultative and customer service approach to
assist the borrower in meeting his or her obligations. The Company's ability to
monitor performance and collect payments owed by contract obligors is a function
of its collection approach and support systems. The Company's approach to the
collection of delinquent contracts is to minimize repossessions and charge-offs.
The Company maintains a computerized collection system specifically designed to
service sub-prime automobile finance contracts. The Company believes that if
problems are identified early, it is possible to correct many delinquencies
before they deteriorate further.
The Company currently employs 33 people full-time, including 23
collections specialists and other support personnel, in the Collections
Department. Each employee is devoted exclusively to collection functions. The
Company attempts to maintain a ratio of between 500 and 600 finance contracts
per collections specialist. As of December 31, 1996, there were 400 finance
contracts in the Company's finance contract portfolio for every collections
specialist. The Collections Department is managed by the Vice
President--Collections, who possesses 30 years experience in the automotive and
finance industry. The Company hires additional collections specialists in
advance of need to ensure adequate staffing and training.
The Company's collectors have real-time computer access to LSE's
database. Accounts reaching five days past due are assigned to collectors who
have specific responsibility for those accounts. These collectors contact the
customer frequently, both by phone and in writing. Accounts that reach 60 days
past due are assigned to two senior collectors who handle those accounts until
resolved. To facilitate collections from borrowers, the Company has increased
its utilization of Western Union's "Quick Collect," which allows borrowers to
pay from remote locations, with a check printed at the Company's office.
Consistent with the Company's internal policies and securitization documents,
finance contract provisions, such as term, interest rate, amount, maturity date
or payment schedule will not be amended, modified or otherwise changed, except
when required by applicable law or court order or where permitted under the
applicable insurance Policy.
11
Payment extensions may be granted if, in the opinion of management, such
extension provides a permanent solution to resolve a temporary problem. An
extension fee must be paid by the customer prior to the extension. Normally,
there can be only one extension during the first 18 months of a finance
contract. Additional extensions may be granted if allowed under the applicable
VSI Policy, although the Company's securitization documents restrict permitted
extensions to no longer than one month and not more than once per year. Payment
due dates can be modified once during the term of the contract to facilitate
current payment by the customer.
Repossessions and Recoveries. If a delinquency exists and a default is
deemed inevitable or the collateral is in jeopardy, and in no event later than
the 90th day of delinquency (as required by the applicable VSI Policy), the
Company's Collections Department will initiate the repossession of the financed
vehicle. Bonded, insured outside repossession agencies are used to secure
involuntary repossessions. In most jurisdictions, the Company is required to
give notice to the borrower of the Company's intention to sell the repossessed
vehicle, whereupon the borrower may exercise certain rights to cure his or her
default or redeem the automobile. Following the expiration of the legally
required notice period, the repossessed vehicle is sold at a wholesale auto
auction (or in limited circumstances, through dealers), usually within 60 days
of the repossession. The Company closely monitors the condition of vehicles set
for auction, and procures an appraisal under the applicable VSI Policy prior to
sale. Liquidation proceeds are applied to the borrower's outstanding obligation
under the finance contract and loss deficiency claims under the VSI Policy and,
if applicable, Credit Endorsement, are then filed. See "--Insurance."
INSURANCE
Each finance contract requires the borrower to obtain comprehensive and
collision insurance with respect to the related financed vehicle with the
Company named as a loss payee. The Company relies on a written representation
from the selling dealer and independently verifies that a borrower in fact has
such insurance in effect when it purchases contracts. Each finance contract
acquired by the Company prior to December 31, 1996 is covered from the moment of
its purchase by the Interstate VSI Policy, including the Credit Endorsement. The
Interstate VSI Policy has been issued to the Company by Interstate Fire &
Casualty Company ("Interstate"). Interstate is an indirect wholly-owned
subsidiary of Fireman's Fund Insurance Company. Each finance contract acquired
by the Company after December 31, 1996 will be covered from the moment of its
purchase by either the Interstate VSI Policy, including the Credit Endorsement
or another VSI Policy.
Physical Damage and Loss Coverage. The Company initially relies on the
requirement, set forth in its underwriting criteria, that each borrower maintain
adequate levels of physical damage loss coverage on the respective financed
vehicles. LSE tracks the physical damage insurance of borrowers, and contacts
borrowers in the event of a lapse in coverage or inadequate documentation.
Moreover, LSE is obligated, as servicer, subject to certain conditions and
exclusions, to assist the processing of claims under the VSI Policies. The VSI
policies insure against: (i) all risk of physical loss or damage from any
external cause to financed vehicles which the Company holds as collateral; (ii)
any direct loss which the Company may sustain by unintentionally failing to
record or file the instrument evidencing
12
each contract with the proper public officer or public office, or by failing to
cause the proper public officer or public office to show the Company's
encumbrance thereon, if such instrument is a certificate of title; (iii) any
direct loss sustained during the term of the VSI Policy, by reason of the
inability of the Company to locate the borrower, the related financed vehicle,
or by reason of confiscation of the financed vehicle by a public officer or
public office; and (iv) all risk of physical loss or damage from any external
cause to a repossessed financed vehicle for a period of 60 days while such
financed vehicle is (subject to certain exceptions) held by or being repossessed
by the Company.
The physical damage provisions of a VSI Policy generally provided
coverage for losses sustained on the value of the financed vehicle securing a
contract, but in no event is the coverage to exceed: (i) the cost to repair or
replace the financed vehicle with material of like kind and quality; (ii) the
actual cash value of the financed vehicle at the date of loss, less its salvage
value; (iii) the unpaid balance of the contract; (iv) $40,000 per financed
vehicle (or, in the case of losses or damage sustained on repossessed financed
vehicles, $25,000 per occurrence); or (v) the lesser of the amounts due the
Company under clauses (i) through (iv) above, less any amounts due under all
other valid insurance on the damaged financed vehicle less its salvage value. No
assurance can be given that the insurance will cover the amount financed with
respect to a financed vehicle.
All claim settlements for physical damage and loss coverage under the
Interstate Policy are subject to a $500 deductible per loss. There is no
aggregate limitation or other form of cap on the number of claims under the VSI
Policy. Coverage on a financed vehicle is for the term of the related contract
and is noncancellable. Each VSI Policy requires that, prior to filing a claim, a
reasonable attempt be made to repossess the financed vehicle and, in the case of
claims on skip losses, every professional effort be made to locate the financed
vehicle and the related borrower.
Credit Deficiency Endorsement. In addition to physical damage and loss
coverage, the Interstate VSI Policy contains a Credit Endorsement which provides
that Interstate shall indemnify the Company for certain losses incurred due to a
deficiency balance following the repossession and resale of financed vehicles
securing defaulted finance contracts eligible for coverage. Coverage under the
Credit Endorsement is strictly conditioned upon the Company's maintaining and
adhering to the credit underwriting criteria set forth in the Credit
Endorsement. Losses on each eligible contract are covered in an amount equal to
the deficiency balance resulting from the Net Payoff Balance less the sum of (i)
the Actual Cash Value of the financed vehicle plus (ii) the total amount
recoverable from all other applicable insurance, including refunds from
cancelable add-on products. The maximum coverage under the Credit Endorsement is
$15,000 per contract.
During the first quarter of 1997, the Company elected not to obtain a
credit deficiency endorsement on approximately 60% of the finance contracts
which it acquired, based upon the total principal amount of finance contracts
acquired. However, every contract which the Company acquires is covered by a
Vendors Single Interest policy to insure against damage to the vehicle. The
Company believes that its decision not to insure certain contracts with credit
deficiency coverage will not adversely affect its future results. This is
largely due to the fact that by not obtaining credit deficiency insurance, the
Company can reduce its cost basis in a finance contract by 5 to 6%.
13
"Actual Cash Value" for the purposes of the Credit Endorsement only,
means the greater of (i) the price for which the subject financed vehicle is
sold or (ii) the wholesale market value at the time of the loss as determined by
an automobile guide approved by Interstate applicable to the region in which the
financed vehicle is sold.
"Net Payoff Balance" for the purposes of the Credit Endorsement, means
the outstanding principal balance as of the default date plus late fees and
corresponding interest no more than 90 days after the date of default. In no
event shall Net Payoff Balance include non-approved fees, taxes, penalties or
assessments included in the original instrument, or repossession, disposition,
collection, remarketing expenses and fees or taxes incurred.
MANAGEMENT INFORMATION SYSTEMS
Management believes that a high level of real-time information flow and
analysis is essential to manage the Company's informational and reporting needs
and to maintain the Company's competitive position. As stated above, the Company
has contracted with a third party servicer, LSE, to provide data processing for
the Company's portfolio of finance contracts. LSE provides on-line information
processing services with terminals located in the Company's offices that are
connected to LSE's main computer center in Dallas.
In addition, management uses customized reports, with a download of
information to personal computers, to issue investor reports and to analyze the
Company's finance contract portfolio on a monthly basis. The system's
flexibility allows the Company to achieve productivity improvements with
enhanced data access. Management believes that it has sufficient systems in
place to permit significant growth in the Company's finance contract portfolio
without the need for material additional investment in management information
systems.
FUNDING/SECURITIZATION OF FINANCE CONTRACTS
Warehouse Credit Facilities. The Company obtains a substantial portion
of its working capital for the acquisition of finance contracts through
warehouse credit facilities. Under a warehouse facility, generally the lender
advances amounts requested by the borrower on a periodic basis, up to an
aggregate maximum credit limit for the facility, for the acquisition and
servicing of finance contracts or other similar assets. Until proceeds from a
securitization transaction are used to pay down outstanding advances, as
principal payments are received on the finance contracts, the principal amount
of the advances may be paid down incrementally or reinvested in additional
finance contracts on a revolving basis.
At December 31, 1996, the Company had no balances outstanding under the
$10.0 million Sentry Facility, which expires on December 31, 2000. The proceeds
from borrowings under the Sentry Facility are used to acquire finance contracts,
to pay credit default insurance premiums and to make deposits to a reserve
account with Sentry. The Company pays a utilization fee of up to 0.21% per month
on the average outstanding balance under the Sentry Facility. The Sentry
Facility also requires the Company to pay up to 0.62% per quarter on the average
unused balance. Interest is payable monthly and accrues at a per annum rate of
prime plus 1.75% (which was approximately 10.0% at December 31, 1996).
14
The Sentry Facility contains certain conditions and imposes certain
requirements, including, among other things, minimum net worth and cash and cash
equivalent balances in the reserve account. Under the Sentry Facility, the
Company paid interest of $220,674 for the year ended December 31, 1996. During
1996, the Company also paid $700,000 in commitment fees pursuant to its
agreement with Sentry.
On May 22, 1996 the Company, through its wholly-owned subsidiary
AutoBond Funding Corporation II, entered into the Providian Facility, which
expired December 15, 1996. The proceeds from the borrowings under the Providian
Facility were used to acquire finance contracts, to pay credit default insurance
premiums and to make deposits to a reserve account. Interest was payable monthly
with a delay of 15 days and accrued at a per annum rate of LIBOR plus 2.60%
(which was 8.0375% when initially determined on May 17, 1996). The Providian
Facility also required the Company to pay a monthly fee on the average unused
balance at a per annum rate of 0.25%. Borrowings under the Providian Facility
were rated investment-grade by a nationally recognized statistical rating
organization. As of December 31, 1996, no advances were outstanding with respect
to the Providian Facility.
The Company's wholly-owned subsidiary, AutoBond Funding Corporation I,
entered into the Nomura Facility, pursuant to a credit agreement dated as of
June 16, 1995, with a final maturity date of June 16, 2005. This facility was
terminated at the lender's option, and no new advances were made after February
6, 1996. The Nomura Facility provided for advances to AutoBond Funding up to a
maximum aggregate principal amount of $25 million, for the acquisition of
finance contracts. As of December 31, 1996 no advances were outstanding with
respect to the Nomura Facility.
On February 14, 1997 the Company, though its wholly-owned subsidiary
AutoBond Funding Corporation II, entered into the $50,000,000 Daiwa Facility,
which expires March of 1998. The proceeds from the borrowings under the Daiwa
Facility are to be used to acquire finance contracts, and to make deposits to a
reserve account. Interest is payable monthly at the 30-day LIBOR plus 1.15% per
annum rate. The Daiwa Facility also requires the Company to pay a monthly fee on
the average unused balance at a per annum rate of 0.25%. Borrowings under the
Daiwa Facility are rated investment-grade by a nationally recognized statistical
rating organization. The Daiwa Facility contains certain conditions and imposes
certain requirements similar to those in the agreements relating to the
Company's existing securitizations including, among other things, delinquency
and repossession triggers.
Securitization Program. The periodic securitization of finance contracts
is an integral part of the Company's business. Securitizations enable the
Company to monetize its assets and redeploy its capital resources and warehouse
credit facilities for the purchase of additional finance contracts. To date, the
Company has completed five securitizations involving approximately $108 million
in aggregate principal amount of finance contracts (excluding $3.6 million in
finance contracts sold in securitizations during the revolving period).
In its securitization transactions through December 31, 1996, the
Company sold pools of finance contracts
15
to a special purpose subsidiary, which then assigned the finance contracts to a
trust in exchange for cash and certain retained beneficial interests in the
trust. The trust issued two classes of fixed income investor certificates: Class
A Certificates which were sold to investors, generally at par with a fixed
coupon, and subordinated excess spread certificates (representing a senior
interest in excess spread cash flows from the finance contracts) which were
retained by the Company's securitization subsidiary and which collateralize
borrowings on a non-recourse basis. The Company would also fund a cash reserve
account that provides credit support to the Class A Certificates. The Company's
securitization subsidiaries also retained an interest in the trust that is
subordinate to the interest of the investor certificateholders. The retained
interests entitle the Company to receive the future excess spread cash flows
from the trust after payment to investors, absorption of losses, if any, that
arise from defaults on the transferred finance contracts and payment of the
other expenses and obligations of the trust. In its securitization transactions
planned for 1997, the Company intends to utilize the provisions of the recently
effective SFAS 125. In these securitizations the Company will sell pools of
finance contracts to a special purpose subsidiary, which will then issue notes
under a trust indenture secured by such finance contracts. The special purpose
corporations may issue multiple classes of secured notes, including subordinated
excess spread notes. The Company will also fund a cash reserve account that
provides credit support to the senior notes. The Company's securitization
subsidiaries also will retain an interest in the finance contracts that is
subordinate to the interest of the noteholders. The retained interests entitle
the Company to receive the future excess spread cash flows from the trust estate
after payment to investors, absorption of losses, if any, that arise from
defaults on the transferred finance contracts and payment of the other expenses
and obligations of the trust estate.
Securitization transactions impact the Company's liquidity primarily in
two ways. First, the application of proceeds toward payment of the outstanding
advances on warehouse credit facilities makes additional borrowing available, to
the extent of such proceeds, under those facilities for the acquisition of
additional finance contracts. Second, additional working capital is obtained
through the Company's practice of borrowing, through the issuance of
non-recourse debt, against the value of the senior interest in the retained
excess spread. If the structure of the securitizations was changed, it could
impact the Company's ability to generate liquidity. See "Recent Events".
Upon each securitization, the Company recognizes the sale of finance
contracts and records a gain or loss in an amount which takes into account the
amounts expected to be received as a result of its retained interests. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations --Revenues--Gain on Sale of Finance Contracts." At December 31, 1996,
the Company held excess servicing receivables and Class B Certificates totalling
$14.7 million, a portion of which had been pledged to secure notes payable of
$10.2 million.
If the Company were unable to securitize contracts in a financial
reporting period, the Company would incur a significant decline in total
revenues and net income or report a loss for such period. If the Company were
unable to securitize its contracts and did not have sufficient credit available,
either under its warehouse credit facilities or from other sources, the Company
would have to sell portions of its portfolio directly to investors or curtail
its finance contract acquisition activities. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
16
When the Company securitizes finance contracts, it repays a portion of
its outstanding warehouse indebtedness, making such portion available for future
borrowing. As finance contract volume increases, the Company expects to
securitize its assets at least quarterly, although there can be no assurance
that the Company will be able to do so.
The securitization trust agreements and the servicing agreement contain
certain events of administrator termination, the occurrence of which entitle the
trustee to terminate the Company's right to act as collection agent and
administrator. Events of administrator termination typically include: (i)
defaults in payment obligations under the trust agreements; (ii) unremedied
defaults in the performance of certain terms or covenants under the trust
agreements, the servicing agreements or related documents; (iii) the institution
of certain bankruptcy or liquidation proceedings against the Company; (iv)
material breaches by the Company of representations and warranties made by it
under the servicing agreements and the sale agreements pursuant to which it has
sold the securitized finance contracts; (v) the occurrence of a trigger event
whereby the ratio of delinquent finance contracts to total securitized finance
contracts for each transaction exceeds the percentage set forth in the servicing
agreements; (vi) a material adverse change in the consolidated financial
condition or operations of the Company, or the occurrence of any event which
materially adversely affects the collectibility of a material amount of the
securitized finance contracts or which materially adversely affects the ability
of the Company to collect a material amount of the finance contracts or to
perform in all material respects its obligations under the servicing agreements,
trust agreements and related documents; or (vii) any of the rating agencies
rating the securitization transactions determines that the Company's serving as
collection agent under the servicing agreement would prevent such agency from
maintaining the required ratings on such transactions, or would result in such
transactions' being placed on negative review suspension or downgrade.
The trust agreements contain amortization events, the occurrence of any
of which may affect the Company's rights to receive payments in respect of the
future excess spread cash flows otherwise payable to it until principal and
interest payments due the holders of all investor certificates are paid in full.
Such amortization events include: (i) defaults in certain payments or repurchase
obligations under the trust agreements; (ii) unremedied defaults in the
performance of any covenants or terms of the trust agreements by a
securitization subsidiary; (iii) the occurrence of certain bankruptcy or
insolvency events of a securitization subsidiary; (iv) unremedied material
breaches of representations or warranties of a securitization subsidiary; (v)
occurrence of an event of administrator termination; (vi) failure of a
securitization subsidiary to transfer certain required amounts of unpaid
principal balance of finance contracts to each securitization trust or to retain
the resulting shortfall in the collection accounts; (vii) failure of any
transfer under the trust agreements to create, or failure of any investor
certificates to evidence, a valid and perfected first priority undivided
ownership or security interest in the pool of securitized finance contracts and
related collateral; (viii) failure of the Company to own, directly or
indirectly, 100% of the outstanding shares of common stock of any securitization
subsidiary; (ix) entry of unpaid and unstayed judgments aggregating in excess of
$25,000 are entered against any securitization subsidiary; or (x) occurrence of
a "change in control" with respect to the Company.
17
COMPETITION
The sub-prime credit market is highly fragmented, consisting of many
national, regional and local competitors, and is characterized by relative ease
of entry and the recent arrival of a number of well capitalized publicly-held
competitors. Existing and potential competitors include well-established
financial institutions, such as banks, savings and loans, small loan companies,
industrial thrifts, leasing companies and captive finance companies owned by
automobile manufacturers and others. Many of these financial organizations do
not consistently solicit business in the sub-prime credit market. The Company
believes that captive finance companies generally focus their marketing efforts
on this market only when inventory control and/or production scheduling
requirements of their parent organizations dictate a need to enhance sales
volumes and exit the market once such sales volumes are satisfied. The Company
also believes that increased regulatory oversight and capital requirements
imposed by market conditions and governmental agencies have limited the
activities of many banks and savings and loans in the sub-prime credit market.
In many cases, those organizations electing to remain in the automobile finance
business have migrated toward higher credit quality customers to allow
reductions in their overhead cost structures.
As a result, the sub-prime credit market is primarily serviced by
smaller finance organizations that solicit business when and to the extent their
capital resources permit. The Company believes no one of its competitors or
group of competitors has a dominant presence in the market. The Company's
strategy is designed to capitalize on the market's relative lack of major
national financing sources. Nonetheless, several of these competitors have
greater financial resources than the Company and may have a significantly lower
cost of funds. Many of these competitors also have long-standing relationships
with automobile dealerships and may offer dealerships or their customers other
forms of financing or services not provided by the Company. Furthermore, during
the past two years, a number of automobile finance companies have completed
public offerings of common stock, the proceeds of which are being used, at least
in part, to fund expansion and finance increased purchases of finance contracts.
The Company's ability to compete successfully depends largely upon its
relationships with dealerships and the willingness of dealerships to offer
finance contracts to the Company that meet the Company's underwriting criteria.
There can be no assurance that the Company will be able to continue successfully
in the markets it serves.
Additionally, during the first quarter of 1997 several of the Company's
competitors have experienced serious problems ranging from allegedly fraudulent
misstatements of earnings to increasing losses and inadequate reserves. Although
the Company believes it has made adequate reserves to cover losses, the ability
of the Company to obtain funding in the future and the rates at which such
financings may be obtained could be impaired as the result of the turmoil in the
subprime auto finance industry. Although the Company was able to obtain
financing under the Daiwa Facility and continues to have financing available
under the Sentry Facility there can be no assurance that the turmoil in the
subprime auto finance industry will not have an affect on the Company's ability
to raise funds and may result in an increased cost of funding to the Company.
18
REGULATION
The Company's business is subject to regulation and licensing under
various federal, state and local statutes and regulations. As of December 31,
1996, the Company's business operations were conducted with dealers located in
26 states, and, accordingly, the laws and regulations of such states govern the
Company's operations. Most states where the Company operates (i) limit the
interest rates, fees and other charges that may be imposed by, or prescribe
certain other terms of, the finance contracts that the Company purchases and
(ii) define the Company's rights to repossess and sell collateral. In addition,
the Company is required to be licensed or registered to conduct its finance
operations in certain states in which the Company purchases finance contracts.
As the Company expands its operations into other states, it will be required to
comply with the laws of such states.
Numerous federal and state consumer protection laws and related
regulations impose substantive disclosure requirements upon lenders and
servicers involved in automobile financing. Some of the federal laws and
regulations include the Truth-in-Lending Act, the Equal Credit Opportunity Act,
the Federal Trade Commission Act, the Fair Credit Reporting Act, the Fair Credit
Billing Act, the Fair Debt Collection Practices Act, the Magnuson-Moss Warranty
Act, the Federal Reserve Board's Regulations B and Z and the Soldiers' and
Sailors' Civil Relief Act.
In addition, the Federal Trade Commission ("FTC") has adopted a
holder-in-due-course rule which has the effect of subjecting persons that
finance consumer credit transactions (and certain related lenders and their
assignees) to all claims and defenses which the purchaser could assert against
the seller of the goods and services. With respect to used automobiles
specifically, the FTC's Rule on Sale of Used Vehicles requires that all sellers
of used automobiles prepare, complete and display a Buyer's Guide which explains
the warranty coverage for such automobiles. The Credit Practices Rules of the
FTC impose additional restrictions on sales contract provisions and credit
practices.
The Company believes that it is in substantial compliance with all
applicable material laws and regulations. Adverse changes in the laws or
regulations to which the Company's business is subject, or in the interpretation
thereof, could have a material adverse effect on the Company's business. In
addition, due to the consumer-oriented nature of the industry in which the
Company operates and the unclear application of various truth-in-lending laws
and regulations to certain products offered by companies in the industry,
industry participants are sometimes named as defendants in litigation involving
alleged violations of federal and state consumer lending or other similar laws
and regulation. A significant judgment against the Company or within the
industry in connection with any litigation could have a material adverse effect
on the Company's financial condition and results of operations.
In the event of default by a borrower under a finance contract, the
Company is entitled to exercise the remedies of a secured party under the
Uniform Commercial Code ("UCC"). The UCC remedies of a secured party include the
right to repossession by self-help means, unless such means would constitute a
breach of the peace. Unless the borrower voluntarily surrenders a vehicle,
self-help repossession by an independent repossession agent engaged by the
Company is usually employed by the Company when a borrower defaults. Self-help
19
repossession is accomplished by retaking possession of the vehicle. If a breach
of the peace is likely to occur, or if applicable state law so requires, the
Company must obtain a court order from the appropriate state court and repossess
the vehicle in accordance with that order. None of the states in which the
Company presently does business has any law that would require the Company, in
the absence of a probable breach of the peace, to obtain a court order before it
attempts to repossess a vehicle.
In most jurisdictions, the UCC and other state laws require a secured
party to provide an obligor with reasonable notice of the date, time and place
of any public sale or the date after which any private sale of collateral may be
held. Unless the obligor waives his rights after default, the obligor in most
circumstances has a right to redeem the collateral prior to actual sale (i) by
paying the secured party all unpaid installments on the obligation, plus
reasonable expenses for repossessing, holding and preparing the collateral for
disposition and arranging for its sale, plus in some jurisdictions, reasonable
attorneys' fees or (ii) in some states, by paying the secured party past-due
installments. Repossessed vehicles are generally resold by the Company through
wholesale auctions which are attended principally by dealers.
EMPLOYEES
As of December 31, 1996, the Company employed 116 persons, none of which
was covered by a collective bargaining agreement. The Company believes that its
relationship with its employees is satisfactory.
ITEM 2. PROPERTIES
PROPERTIES AND FACILITIES
The Company's headquarters are located in approximately 18,900 square
feet of leased space at 301 Congress Avenue, Austin, Texas, for a monthly rent
of $18,338. The lease for such facility expires in June 1998. The Company's
headquarters contain the Company's executive offices as well as those related to
automobile finance contract acquisition. In addition, the Company leased
approximately 520 square feet of office space at 1010 Woodman Drive, Suite 240,
Dayton, Ohio, for its midwest regional marketing office at a rent of $550 per
month. The lease for the Ohio facility expired on February 28, 1997. The Company
no longer maintains any regional office facilities
ITEM 3. LEGAL PROCEEDINGS
The Company is currently not a party to any material litigation,
although it is involved from time to time in routine litigation incident to its
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Not Applicable.
20
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS
On November 8, 1996, the Company's Common Stock was listed for quotation
and began trading on Nasdaq National Market under the symbol "ABND." Prior to
such date, the Company's stock was closely held and not traded on any regional
or national exchange. The high and low sale prices for the Common Stock during
the period beginning November 8, 1996, when the Common Stock began trading
publicly, through the end of 1996, as reported by Nasdaq, were $11 and $9 1/4,
respectively.
The transfer agent and registrar for the Common Stock is American Stock
Transfer & Trust Company. As of December 31, 1996, the Company had approximately
41 stockholders of record, exclusive of holders who own their shares in "street"
or nominee names.
The Company has not paid and does not presently intend to pay cash
dividends on its Common Stock. The Company anticipates that its earnings for the
foreseeable future will be retained for use in operation and expansion of
business. Payment of cash dividends, if any, in the future will be at the sole
discretion of the Company's Board of Directors and will depend upon the
Company's financial condition, earnings, current and anticipated capital
requirements, terms of indebtedness and other factors deemed relevant by the
Company's Board of Directors.
21
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data as of and for each of the years in
the three-year period ended December 31, 1996 are derived from the financial
statements of the Company. The selected financial data should be read in
conjunction with the Financial Statements, including the Notes thereto, and
other financial data included elsewhere herein and the following "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
YEAR ENDED DECEMBER 31,
-----------------------
1994(1) 1995 1996
------- ---- ----
(DOLLARS IN THOUSANDS EXCEPT FOR PER
SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA:
Net interest income .......................... $ 19 $ 781 $ 137
Servicing fee income ......................... 0 0 658
Gain on sale of finance contracts ............ 0 4,086 12,821
Unrealized gain on Class B Certificates ...... 0 0 388
------ ------- -------
Total revenues .............................. 19 4,867 14,004
------ ------- -------
Provision for credit losses .................. 45 49 412
Salaries and benefits ........................ 226 1,320 4,529
General and administrative ................... 245 1,463 2,331
Other operating expenses ..................... 48 963 1,120
------ ------- -------
Total expenses .............................. 564 3,795 8,392
------ ------- -------
Net income (loss) before taxes and ........... (545) 1,072 5,611
extraordinary item
Provision for income taxes ................... 0 199 1,927
Extraordinary loss net of tax effect ......... -- -- (100)
------ ------- -------
Net income (loss) ............................ (545) 873 3,585
====== ======= =======
Net income (loss) before extraordinary item ... $(0.11) $0.17 $0.64
Net income (loss) per share ................... $(0.11) $0.17 $0.62
Weighted average shares outstanding ........... 5,118,753 5,190,159 5,811,377
PORTFOLIO DATA:
Number of finance contracts acquired ........... 202 2,656 7,215
Principal balance of finance contacts .......... $2,465 $31,863 $83,372
acquired
Principal balance of finance contracts ......... 0 26,261 85,036
securitized
Average initial finance contract principal ..... $ 12.2 $ 12.0 $ 11.6
balance
Weighted average initial contractual term ...... 54.3 53.3 51.5
(months)
Weighted average APR of finance contracts(2) ... 19.1% 19.3% 19.6%
Weighted average finance contract .............. 8.6% 8.8% 8.2%
acquisition discount(2)
Number of finance contacts outstanding (end .... 197 2,774 9,030
of period)(2)
Principal balance of finance contracts (end ...... $2,450 $31,311 $94,352
of period)(2)
OPERATING DATA:
Number of enrolled dealers (end of period) ..... 50 280 715
Number of active states (end of period) ........ 2 7 26
Total expenses as a percentage of total ........ 23.0% 12.0% 10.07%
principal balance of finance contracts
acquired in period
ASSET QUALITY DATA:
Delinquencies 60+ days past due as a ............. 0.30% 2.30% 3.34%
percentage of principal balance of finance
contract portfolio (end of period)(2)
22
DECEMBER 31,
-------------
1994 1995 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents...................... $ 0 $ 93 4,121
Cash held in escrow............................ 0 1,323 2,663
Finance contracts held for sale, net........... 2,361 3,355 228
Excess servicing receivable.................... 0 847 4,247
Total assets................................ 2,500 11,065 27,277
Notes payable.................................. 0 2,675 10,175
Repurchase agreement........................... 0 1,061 0
Revolving credit agreement..................... 2,055 1,150 0
Subordinated debt.............................. 0 0 0
------ ------- ------
Total debt.................................. 2,055 4,886 10,175
Shareholders' equity........................... (109) 3,026 12,286
- ---------------
(1) The Company was incorporated on June 15, 1993 and commenced operations in
August 1994.
(2) Includes the Company's entire finance contract portfolio of contracts
held and contracts securitized.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the preceding "Selected
Financial Data" and the Company's Consolidated Financial Statements and Notes
thereto and the other financial data included herein. The financial information
set forth below has been rounded in order to simplify its presentation. However,
the ratios and percentages set forth below are calculated using the detailed
financial information contained in the Financial Statements and the Notes
thereto, and the financial data included elsewhere in this Form 10-K.
The Company is a specialty consumer finance company engaged in acquiring,
securitizing and servicing finance contracts originated by automobile dealers in
connection with the sale of used and new vehicles to subprime consumers. The
Company has experienced significant growth in its finance contract portfolio
since it commenced operations in August 1994.
REVENUES
The Company's primary sources of revenues consist of three components: net
interest income, gain on sale of finance contracts and servicing and collection
fees.
Net Interest Income. Net interest income consists of the sum of two
components: (i)
23
the difference between interest income earned on finance contracts held for sale
and interest expense incurred by the Company pursuant to borrowings under its
warehouse and other credit facilities; and (ii) the accretion of finance
contract acquisition discounts. Other factors influencing net interest income
during a given fiscal period include (a) the annual percentage rate of the
finance contracts acquired, (b) the aggregate principal balance of finance
contracts acquired and funded through the Company's warehouse and other credit
facilities prior to securitization, (c) the length of time such contracts are
funded by the warehouse and other credit facilities. Finance contract
acquisition growth has had a significant impact on the amount of net interest
income earned by the Company.
Gain on Sale of Finance Contracts. Upon completion of a securitization, the
Company recognizes a gain on sale of finance contracts equal to the present
value of future excess spread cash flows from the securitization trust, and the
difference between the net proceeds from the securitization and the net carrying
cost (including the cost of VSI Policy premiums) to the Company of the finance
contracts sold. The Class B Certificates and the excess servicing receivable are
determined based on the estimated present value of excess spread cash flows from
a securitization trust. Excess spread cash flows represent the difference
between the weighted average contract rate earned and the rate paid on Class A
Certificates issued to third party investors in the securitization, less
servicing fees and other costs, over the life of the securitization. Excess
spread cash flows are computed by taking into account certain assumptions
regarding prepayments, defaults, proceeds from disposal of repossessed assets,
and servicing and other costs. The Class B Certificates and excess servicing
receivable are determined by discounting the excess spread cash flows at a rate
based on assumptions that market participants would use for similar financial
instruments subject to prepayment, default, collateral value and interest rate
risks. The Class B Certificates are then formed by carving out 65% to 80% of the
discounted excess spread cash flows. The remaining 20% to 35% of the discounted
excess spread cash flows represent excess servicing receivable. All of the
excess spread cash flows are paid by the securitization Trustee to the Class B
Certificateholders until such time as all accrued interest at 15% together with
principal have been paid in full. Subsequently, all remaining excess spread cash
flows are paid to the Company and are referred to as the "Transferor's
Interest." The discounted Transferor's Interest is reported in the balance
sheets as "Excess Servicing Receivable". In each securitization, all of the
Class B Certificate and Transferor's Interest are retained by the Company. The
Class B Certificates are used by the Company as collateral on its non-recourse
term loans entered into with investors. The Company performs an impairment
review of the excess servicing receivable by calculating the net present value
of the expected future excess spread cash flows to the Company from the
securitization trust utilizing the same discount rate used to record the initial
excess servicing receivable. To the extent that market and economic changes
occur which adversely impact the assumptions utilized in determining the excess
servicing receivable, the Company would record a charge against servicing fee
income and write down the asset accordingly. Impairment is determined on a
disaggregated basis consistent with the risk characteristics of the underlying
finance contracts, consisting principally of origination date and originating
dealership, as well as the performance of the pool to date. There were no
adjustments required as a result of impairment reviews during any of the periods
presented in the
24
financial statements. Should the Company be unable to securitize finance
contracts in the form of a sale in a financial reporting period, the Company
would likely incur a significant decline in total revenues and net income or
report a loss for such period To date, the Company's securitizations have been
characterized as debt for tax purposes. Since the Company records a provision
for income taxes on securitization, alternatively characterizing securitizations
as sales for tax purposes would have no effect on net income, although the
timing of tax payments by the Company would be accelerated.
Gain on sale of finance contracts was $3,951,706, $2,749,612, $2,972,804,
$3,554,745, and $3,543,539 for each of the securitizations occurring in December
1995, March 1996, June 1996, September 1996, and December 1996 respectively.
This represents approximately 15.05%, 16.60%, 16.67%, 15.94% and 14.17% of the
outstanding balances of the finance contracts at each of the respective
securitization dates. Gain on sale can be broken into three major components:
the amount by which the proceeds from the sale of Class A Certificates exceeds
the Company's cost basis in the contracts; costs of sale (primarily placement,
rating agent, and legal and accounting fees); and discounted excess spread cash
flows (the Class B Certificates and Transferor's Interests).
The Company's cost basis in finance contracts sold has varied from
approximately 97.5% to 103% of the value of the Class A Certificates. This
portion of recognized gain on sale will vary based on the Company's cost on
insurance covering the finance contracts and discount obtained upon acquisition
of the finance contracts.
Additionally, costs of sale reduce the total gain recognized. As the
Company's securitization program matures, placement fees and other costs
associated with the sale should shrink as a percentage of the size of the
securitization. For example, costs of sale for the March 1996 transaction were
$280,000 (or 1.7%), while costs for the December 1996 transaction were about
$240,000 (or 1.0%).
Further, the excess spread component of recognized gain is affected by
various factors, including most significantly, the coupon on the Class A
Certificates and the age of the finance contracts in the pool, as the excess
spread cashflow from a pool of aged, as opposed to new, finance contracts is
less. The aging (capture of excess spread prior to securitization) necessarily
results in less available excess spread cash flow from the securitization. The
Company believes that margins in the range of those previously recognized are
sustainable subject to adverse interest rate movements, availability of VSI
insurance at current rates and the Company's ability to continue purchasing
finance contracts from dealers at approximately an 8.5% discount.
The gain on sale of finance contracts is affected by the aggregate
principal balance of contracts securitized and the gross interest spread on
those contracts. The following table illustrates the gross interest spread for
each of the Company's securitizations:
25
REMAINING WEIGHTED
BALANCE AT AVERAGE
ORIGINAL DECEMBER 31, CONTRACT CERTIFICATE GROSS
SECURITIZATION BALANCE(1) 1996 RATE RATE RATINGS(2) SPREAD(3)
-------------- ---------- ---- ---- ---- ---------- ---------
(DOLLARS IN THOUSANDS)
AutoBond Receivables
Trust 1995-A............. $26,261 $21,826 18.9% 7.23% A/A3 11.7%
AutoBond Receivables
Trust 1996-A............. 16,563 14,289 19.7 7.15 A/A3 12.5
AutoBond Receivables
Trust 1996-B............. 17,833 17,833(4) 19.7 7.73 A/A3 12.0
AutoBond Receivables
Trust 1996-C............. 22,297 22,297(4) 19.7 7.45 A/A3 12.3
AutoBond Receivables
Trust 1996-D............. 25,000 25,000(4) 19.5 7.37 A/A3 12.1
-------- --------
Total................ $107,954 $101,245
======== ========
- ------------------
(1) Refers only to balances on Class A investor certificates.
(2) Indicates ratings by Fitch Investors Service, L.P. and Moody's Investors
Service, Inc., respectively.
(3) Difference between weighted average contract rate and senior Class A
Certificate rate.
(4) Before expiration of the revolving period for each trust.
Servicing Fee Income. The Company earns substantially all of its servicing
fee income on the contracts it services on behalf of securitization trusts.
Servicing fee income consists of: (i) contractual servicing fees received
through securitizations, equal to $7.00 per month per contract included in each
trust (excluding amounts paid to third-party servicers by the trust); (ii)
Transferor's Interest, reduced by the amortization of the excess servicing
receivable; and (iii) fee income earned as servicer for such items as late
charges and documentation fees, which are earned whether or not a securitization
has occurred.
Servicing fee income, excess spread cash flows and the value of the excess
servicing receivable may be affected by changes in the levels of prepayments,
defaults, delinquencies, recoveries and interest rates from those assumed by the
Company at the time of securitization. To the extent the assumptions used
materially differ from actual results, the amount of cash received by the
Company over the remaining life of the securitization could be significantly
affected, and the Company would be required to take a charge against earnings,
which could have a material adverse effect on the Company's financial condition
and operating results. To date, no such charge has been required.
EXPENSE ALLOCATIONS
The Company has shared certain general and administrative expenses with
ABI. Historically, each entity's expenses have been allocated based on the
estimated utilization of resources, including employees, office space, equipment
rentals and other miscellaneous expenses. The office, equipment and furniture
leases at the Company's headquarters are in ABI's name, and accordingly,
approximately 75% of ABI's lease expense for the year ended December 31, 1995
was allocated to the Company. As of July 1996, such leases were assigned to the
Company. As of January 1, 1996, the Company has been and will be
26
compensated for services rendered and reimbursed for expenses incurred on behalf
of ABI, pursuant to a management agreement. See "Certain Transactions" and Note
[12] to Notes to Consolidated Financial Statements. ABI has no material current
operations other than to manage its investment in, and its shareholder's
investments in, securitizations unrelated to the Company. It is anticipated that
ABI will wind down as the outstanding principal of such investments is retired.
FINANCE CONTRACT ACQUISITION ACTIVITY
The following table sets forth information about the Company's finance
contract acquisition activity.
PERIOD FROM
INCEPTION THROUGH YEAR ENDED YEAR ENDED
DECEMBER 31, 1994 DECEMBER 31, 1995 DECEMBER 31, 1996
----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
Number of finance contracts acquired 202 2,656 7,215
Principal balance of finance contracts 2,464 $31,863 $83,372
Number of active dealerships(1)..... 50 222 654
Number of enrolled dealerships...... 50 280 715
- ---------
(1) Dealers who have sold at least one finance contract to the Company during
the period.
RESULTS OF OPERATIONS
Period-to-period comparisons of operating results may not be meaningful,
and results of operations from prior periods may not be indicative of future
results. Because results of operations for 1994 are based on a five-month period
from the inception of the Company's operations through December 31, 1994, a
comparison of those results to results of operations for fiscal 1995 may not be
meaningful. The following discussion and analysis should be read in conjunction
with "Selected Consolidated Financial and Operating Data" and the Company's
Consolidated Financial Statements and the Notes thereto.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total Revenues
Total revenues increased $9.1 million to $14.0 million for the year
ended December 31, 1996 from $4.9 million for the year ended December 31, 1995
due to growth in finance contract acquisition and securitization activity.
Net Interest Income. Net interest income decreased $644,300 to $136,794
for the year ended December 31, 1996 from $781,094 for the year ended December
31, 1995. The decrease in net interest income was primarily due to a reduction
in the average daily balance of finance contracts held for sale. This was due to
the fact that the Company securitized its production quarterly in 1996 versus a
single securitization in 1995. Interest income also declined due to an increase
in overall net borrowing costs and fees associated with non-recourse term loans
and Revolving Credit Facilities. Finally, there is no spread between the
interest rate earned on the Class B certificates and the related non recourse
27
loans collateralized by such certificates. The increase in the outstanding
balance of the Class B certificates and the related debt causes net interest
income to narrow. The average APR of outstanding finance contracts was 19.45% at
December 31, 1996, compared with 19.3% at December 31, 1995.
Gain on Sale of Finance Contracts. For the year ended December 31, 1996,
gain on sale of finance contracts amounted to $12.8 million. For the year ended
December 31, 1996, the Company completed four securitizations aggregating
approximately $81.7 million in principal amount of finance contracts and the
gain on sale of finance contracts accounted for 91.6% of total revenues. For the
year ended December 31, 1995, there was one securitization transaction in the
principal amount of $26.3 million. The gain on sale of finance contracts for
this sale transaction accounted for 84.0% of total revenues in 1995.
Servicing Fee Income. The Company reports servicing fee income only with
respect to finance contracts that are securitized. For the year ended December
31, 1996, servicing fee income was $657,950, of which $402,016 was collection
agent fees, $154,029 resulted from discount accretion on the excess servicing
receivable, $50,000 was management fees from an affiliated company, and $51,904
arose from other sources. The Company had completed only one securitization in
1995, which was completed at December 31, 1995, and had no servicing fee income
for such period.
Total Expenses
Total expenses of the Company increased $4.6 million to $8.4 million for
the year ended December 31, 1996 from $3.8 million for the year ended December
31, 1995. Although operating expenses increased during the year ended December
31, 1996, the Company's finance contract portfolio grew at a faster rate than
the rate of increase in operating expenses. Total expenses as a percentage of
total principal balance of finance contracts acquired in the period decreased
slightly to 10.1% during the year ended December 31, 1996 from 12.0% for the
year ended December 31, 1995, reflecting improved efficiency in the Company's
operations.
Salaries and Benefits. Salaries and benefits increased $3.2 million to
$4.5 million for the year ended December 31, 1996 from $1.3 million for the year
ended December 31, 1995. This increase was due primarily to an increase in the
number of the Company's employees necessary to handle the increased contract
acquisition volume and the collection activities on a growing portfolio of
loans, and due to compensation of the Company's Chief Executive Officer, which
the Company began paying in May 1996. See Note 13 to Notes to Consolidated
Financial Statements.
General and Administrative Expenses. General and administrative expenses
increased $868,506 to $2.3 million for the year ended December 31, 1996 from
$1.5 million for the year ended December 31, 1995. This increase was due
primarily to growth in the Company's operations. General and administrative
expenses consist principally of office, furniture and equipment leases,
professional fees, communications and office
28
supplies, and are expected to increase as the Company continues to grow and also
due to the costs of operating as a public company.
Other Operating Expenses. Other operating expenses (consisting
principally of servicing fees, credit bureau reports and insurance) increased
$156,628 to $1.1 million for the year ended December 31, 1996 from $963,017 for
the year ended December 31, 1995. This increase was due to increased finance
contract acquisition volume.
Net Income
In the year ended December 31, 1996, net income increased to $3.6
million from $873,487 for the year ended December 31, 1995. Net income for the
year ended December 31, 1996 includes an extraordinary charge of $100,000, net
of income tax benefits of $50,000, which represents the prepayment penalty
associated with the early redemption of the Class B Certificate Notes from the
1995A securitization. The increase in net income was primarily attributable to
an increase in the number of finance contracts securitized during 1996: $81.7
million, compared to $26.3 million in 1995.
FISCAL YEAR ENDED DECEMBER 31, 1995 COMPARED TO PERIOD FROM AUGUST 1, 1994
(INCEPTION) THROUGH DECEMBER 31, 1994
Total Revenues
Total revenues increased to $4.9 million for the fiscal year ended
December 31, 1995 from $19,001 for the period from inception through December
31, 1994. Although the Company was incorporated in June 1993, it did not
commence operations until August 1994; thus the period from inception through
December 31, 1994 reflects only five months of start-up operations.
Net Interest Income. Net interest income increased $762,093 to $781,094
for the fiscal year ended December 31, 1995 from $19,001 for the period from
inception through December 31, 1994. The increase in net interest income was
primarily due to an increase in average balance of finance contracts held for
sale. The average daily balance of outstanding finance contracts increased $13.8
million to $14.7 million for the fiscal year ended December 31, 1995 from
$855,640 for the period from inception through December 31, 1994. The average
APR of finance contracts outstanding was 19.3% at December 31, 1995 as compared
to 19.1% at December 31, 1994.
Gain on Sale of Finance Contracts. In the fiscal year ended December 31,
1995, the gain on sale of finance contracts was $4.1 million, or 83.9% of total
revenues, from the securitization of approximately $26.3 million in finance
contracts and the sale of finance contracts to a third party. For the period
from inception through December 31, 1994, there were no securitizations.
Servicing Fee Income. The Company completed its first securitization
transaction
29
on December 29, 1995; therefore prior to 1996 there was no servicing fee income
collected by the Company.
Total Expenses
Total expenses of the Company increased $3.2 million to $3.8 million for
the fiscal year ended December 31, 1995 from $563,606 for the five-month period
ended December 31, 1994. Although operating expenses increased during the year
ended December 31, 1995, the Company's finance contract portfolio grew at a
faster rate than the rate of increase in operating expenses. As a result, total
expenses as a percentage of total principal balance of finance contracts
acquired in period decreased to 12.0% in the year ended December 31, 1995 from
23.0% in the five months ended December 31, 1994.
Provision for Credit Losses. Provision for credit losses increased
$3,702 to $48,702 for the fiscal year ended December 31, 1995, from $45,000 for
the period from inception through December 31, 1994. This increase was due
primarily to increased acquisition volume and does not reflect any change in
expected defaults as a percentage of finance contracts purchased.
Salaries and Benefits. Salaries and benefits increased $1.1 million to
$1.3 million for the fiscal year ended December 31, 1995 from $225,351 for the
five-month period ended December 31, 1994. This increase was due primarily to an
increase in the number of the Company's employees.
General and Administrative Expenses. General and administrative expenses
increased $1.2 million to $1.5 million for the fiscal year ended December 31,
1995 from $244,974 for the five-month period ended December 31, 1994. This
increase was due primarily to growth in the Company's operations.
Other Operating Expenses. Other operating expenses increased $914,736 to
$963,017 for the fiscal year ended December 31, 1995, from $48,281 for the
five-month period ended December 31, 1994, due to the increase in finance
contracts acquired.
Net Income
Net income increased to $873,487 for the fiscal year ended December 31,
1995 from a net loss of $544,605 for the period from inception through December
31, 1994. This increase was primarily attributable to the Company's initial
securitization transaction having been completed in December 1995, as well as
growth in finance contract acquisitions.
FINANCIAL CONDITION
Finance Contracts Held for Sale, Net. Finance contracts held for sale,
net of allowance for credit losses, decreased $3.1 million to $228,429 at
December 31, 1996, from $3.4 million at December 31, 1995. The number and
principal balance of contracts held for sale are largely dependent upon the
timing and size of the Company's securitizations. The Company plans to
securitize finance contracts on a regular quarterly
30
basis. See Note 1 to the Notes to Consolidated Financial Statements for a
discussion of finance contracts held for sale and allowance for credit losses.
Trust Receivable. At the time a securitization closes, the Company's
securitization subsidiary is required to fund a cash reserve account within the
trust to provide additional credit support for the senior trust certificates.
Additionally, depending on the structure of the securitization, a portion of the
future excess spread cash flows from the trust is required to be deposited in
the cash reserve account to increase the initial deposit to a specified level.
Amounts on deposit in cash reserve accounts are also reflected as advances to
the relevant trust under the item "Cash flows from investing activities" in the
Company's consolidated statements of cash flows. The initial cash reserve
deposits for the December 1995, March 1996, June 1996, September 1996 and
December 1996 securitizations were $525,220, $331,267, $356,658, $445,934, and
$500,000 respectively, equivalent to 2% of the initial principal amount of the
senior trust certificates. A portion of excess spread cash flows will increase
such reserves until they reach 6%.
Excess Servicing Receivable. The following table provides historical
data regarding the excess servicing receivable:
PERIOD FROM
INCEPTION THROUGH YEAR ENDED YEAR ENDED
DECEMBER 31, 1994 DECEMBER 31, 1995 DECEMBER 31, 1996
----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
Beginning balance.............. $0 $0 $847
Additions...................... 0 847 3,246
Accretion...................... 0 0 154
--- ---- ------
Ending balance................. $0 $847 $4,247
== ==== ======
Delinquency Experience
The following table reflects the delinquency experience of the Company's
finance contract portfolio at December 31, 1995 and at December 31, 1996:
DECEMBER 31,
-------------------------------
1995 1996
---- -----
(DOLLARS IN THOUSANDS)
Principal balance of finance
contracts outstanding ......... $31,311 $ 104,889
Delinquent finance contracts(1):
60-89 days past due ............. 474 1.51 1,827 1.74%
90 days past due and over ....... 246 0.79 1,328 1.27
--- ---- ------- ----
Total ...................... 720 2.30% $ 3,155 3.01%
- ----------
(1) Percentage based on outstanding balance. Excludes finance contracts where
the underlying vehicle is repossessed, the, borrower is in bankruptcy, Or there
are insurance claims filed.
31
CREDIT LOSS EXPERIENCE
An allowance for credit losses is maintained for all contracts held for
sale. See Notes 1 and 3 to Notes to Consolidated Financial Statements. The
Company reports a provision for credit losses on finance contracts held for
sale. Management evaluates the reasonableness of the assumptions employed by
reviewing credit loss experience, delinquencies, repossession trends, the size
of the finance contract portfolio and general economic conditions and trends. If
necessary, assumptions will be changed in the future to reflect historical
experience to the extent it deviates materially from that which was assumed.
Since inception, the Company's assumptions have been consistent and are adequate
based upon actual experience. Accordingly, no additional charges to earnings to
date have been necessary to accommodate more adverse experience than
anticipated.
If a delinquency exists and a default is deemed inevitable or the
collateral is in jeopardy, and in no event later than the 90th day of
delinquency (as required by the VSI Policy), the Company's Collections
Department will initiate the repossession of the financed vehicle. Bonded,
insured outside repossession agencies are used to secure involuntary
repossessions. In most jurisdictions, notice to the borrower of the Company's
intention to sell the repossessed vehicle is required, whereupon the borrower
may exercise certain rights to cure his or her default or redeem the automobile.
Following the expiration of the legally required notice period, the repossessed
vehicle is sold at a wholesale auto auction (or in limited circumstances.
through dealers), usually within 60 days of the repossession. The Company
closely monitors the condition of vehicles set for auction, and procures an
appraisal under the VSI Policy prior to sale. Liquidation proceeds are applied
to the borrower's outstanding obligation under the finance contract and loss
deficiency claims under the VSI Policy and Credit Endorsement are then filed.
The physical damage and loss provisions of the VSI Policy insures each financed
vehicle against losses relating to (i) physical damage to repossessed vehicles,
(ii) failure to file or record necessary instruments or documents, and (iii)
loss or confiscation of the vehicle. Generally the amount of coverage will not
exceed (i) the vehicle's replacement value, (ii) its cash value less salvage
value, (iii) the unpaid Finance Contract balance, (iv) $40,000 per vehicle
($25,000 per occurrence for repossessed vehicles), or (v) the lesser of the
amounts under clauses (i)-(iv) above less other insurance coverage on the
vehicle. The Company also has obtained credit deficiency balance coverage
through the Credit Endorsement of the VSI Policy. See "Business-Insurance."
Because of the Company's limited operating history, its finance contract
portfolio is somewhat unseasoned. This effect on the delinquency statistics can
be observed in the comparison of year end 1995 versus 1996 delinquency
percentages. The portfolio is tangibly more seasoned as of December 31, 1996
versus December 31, 1995. Accordingly, delinquency and charge-off rates in the
portfolio may not fully reflect the rates that may apply when the average
holding period for finance contracts in the Portfolio is
32
longer. Increases in the delinquency and/or charge-off rates in the portfolio
would adversely affect the Company's ability to obtain credit or securitize its
receivables.
REPOSSESSION EXPERIENCE-STATIC POOL ANALYSIS
Because the Company's finance contract portfolio is continuing to grow
rapidly, management does not manage losses on the basis of a percentage of the
Company's finance contract portfolio, because percentages can be favorably
affected by large balances of recently acquired finance contracts. Management
monitors actual dollar levels of delinquencies and charge-offs and analyzes the
data on a "static pool" basis.
The following table provides static pool repossession frequency analysis
in dollars of the Company's portfolio performance from inception through
December 31, 1996. In this table, all finance contracts have been segregated by
quarter of acquisition. All repossessions have been segregated by the quarter in
which the repossessed contract was originally acquired by the Company.
Cumulative repossessions equals the ratio of repossessions as a percentage of
finance contracts acquired for each segregated quarter. Annualized repossessions
equals an annual equivalent of the cumulative repossession ratio for each
segregated quarter. This table provides information regarding the Company's
repossession experience over time. For example, recently acquired finance
contracts demonstrate very few repossessions because properly underwritten
finance contracts to subprime consumers generally do not default during the
initial term of the contract. Between approximately one year and 18 months of
seasoning, frequency of repossessions on an annualized basis appear to reach a
plateau. Based on industry statistics and the performance experience of the
Company's finance contract portfolio, the Company believes that finance
contracts seasoned in excess of approximately 18 months will start to
demonstrate declining repossession frequency. The Company believes this may be
due to the fact that the borrower perceives that he or she has equity in the
vehicle. The Company also believes that since the loans generally amortize more
quickly than the collateral depreciates, losses and/or repossessions will
decline over time.
33
REPOSSESSION FREQUENCY
-------------------------
PRINCIPAL BALANCE OF PRINCIPAL BALANCE
YEAR AND QUARTER OF REPOSSESSIONS BY OF CONTRACTS
ACQUISITION QUARTER ACQUIRED CUMULATIVE(1) ANNUALIZED(2) ACQUIRED
----------- ---------------- ------------ ------------- --------
(DOLLARS IN THOUSANDS)
1994
Q3............................. $ 15.74 16.89% 6.76%$ 93.17
Q4............................. 514.39 21.69 9.64 2,371.60
1995
Q1............................. $1,200.89 19.03% 9.52% $ 6,310.42
Q2............................. 1,015.89 16.50 9.43 6,157.44
Q3............................. 984.66 13.66 9.11 7,205.90
Q4............................. 1,589.46 13.04 10.43 12,188.86
1996
Q1............................. $1,462.62 9.46% 9.46% $15,459.93
Q2............................. 1,183.59 6.41 8.55 18,458.82
Q3............................. 508.57 2.14 4.29 23,735.10
Q4............................. 10.98 0.04 0.17 25,802.89
(footnotes on next page)
(footnotes from previous page)
(1) For each quarter, cumulative repossession frequency equals the principal
balance of repossessions divided by the principal amount. of contracts
acquired.
(2) Annualized repossession frequency converts cumulative repossession frequency
into an annual equivalent (e.g., for Q4 1994, principal balance of $514.39
thousand in repossessions divided by principal balance of $2.371 million in
contracts acquired, divided by 9 quarters outstanding times four equals an
annualized repossession frequency of 9.64%).
34
NET LOSS PER REPOSSESSION
Upon initiation of the repossession process, it is the Company's intent
to complete the liquidation process as quickly as possible. The majority of
repossessed vehicles are sold at wholesale auction. The Company is responsible
for the costs of repossession, transportation and storage. The Company's net
charge-off per repossession equals the unpaid balance less the auction proceeds
(net of associated costs) and less proceeds from insurance claims. The following
table demonstrates the net charge-off per repossessed automobile since
inception.
FROM
AUGUST 1, 1994
(INCEPTION) TO
DECEMBER 31, 1996
-----------------
Number of finance contracts acquired............................. 10,073
Number of finance vehicles repossessed........................... 625
Repossessed units disposed of.................................... 344
Repossessed units awaiting disposition (2)....................... 281
Cumulative gross charge-offs(l).................................. $3,898,719
Costs of repossession(l)......................................... 102,728
Proceeds from auction, physical damage insurance and refunds(l).. (2,672,875)
-----------
Net loss......................................................... 1,328,572
Deficiency insurance settlement received(l) ..................... 891,684
------------
Net charge-offs(l)............................................... $ 436,888
============
Net charge-off per unit disposed................................. $ 1,270
Recoveries as a percentage of cumulative gross charge-offs(3).... 91.43%
- -------------
(1) Amounts are based on actual liquidation and repossession proceeds (including
insurance proceeds) received on units for which the repossession process had
been completed as of December 31, 1996.
(2) The vehicles may have been sold at auction; however AutoBond might not have
received all insurance proceeds as of December 31, 1996.
(3) Not including the costs of repossession which are reimbursed by the
securitization trusts.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has primarily funded its operations and the
growth of its finance contract portfolio through seven principal sources of
capital: (i) cash flows from operating activities; (ii) funds provided from
borrowers' payments received under finance contracts held for sale; (iii)
borrowings under various warehouse and working capital facilities; (iv) proceeds
from securitization transactions; (v) cash flows from servicing fees; and (vi)
proceeds from the issuances of subordinated debt and capital contributions of
principal shareholders, and (vii) an initial public offering of common stock.
Cash Flows. Significant cash flows related to the Company's operating
activities include the use of cash for purchases of finance contracts, and, cash
provided by payments on finance contracts and sales of finance contracts. For
the year ended December 31, 1995 and the year ended December 31, 1996, $31.2
million and $83.7 million, respectively, was
35
used by the Company to purchase finance contracts, $2.7 million and $1.6,
respectively, was received as payments on finance contracts, and $27.4 million
and $85.0 million, respectively, was received from sales of finance contracts,
primarily through securitizations. The Company used $525,220 and $1,633,859 to
fund cash reserve accounts for the securitizations completed in the year ended
December 31, 1995 and the year ended December 31, 1996, respectively.
Significant activities comprising cash flows from financing activities
include net repayments under revolving warehouse credit facilities ($904,355 for
the year ended December 31, 1995 and $1,150,421 for the year ended December 31,
1996) and net proceeds from borrowings against excess spread cash flows ($2.7
million for the year ended December 31, 1995 and $2.7 million for the year ended
December 31, 1996).
Warehouse Credit Facilities. The Company obtains a substantial portion
of its working capital for the acquisition of finance contracts through
warehouse credit facilities. Under a warehouse facility, the lender generally
advances amounts requested by the borrower on a periodic basis, up to an
aggregate maximum credit limit for the facility, for the acquisition and
servicing of finance contracts or other similar assets. Until proceeds from a
securitization transaction are used to pay down outstanding advances, as
principal payments are received on the finance contracts, the principal amount
of the advances may be paid down incrementally or reinvested in additional
finance contracts on a revolving basis.
At December 31, 1996, the Company had no balance outstanding on a $10.0
million revolving credit facility (the "Sentry Facility") with Sentry Financial
Corporation ("Sentry"), which expires on December 31, 2000. The proceeds from
borrowings under the Sentry Facility are used to acquire finance contracts, to
pay credit default insurance premiums and to make deposits to a reserve account
with Sentry. The Company pays a utilization fee of up to 0.21% per month on the
average outstanding balance under the Sentry Facility. The Sentry Facility also
requires the Company to pay up to 0.62% per quarter on the average unused
balance. Interest is payable monthly and accrues at a per annum rate of prime
plus 1.75% (which was approximately 10.0% at December 31, 1996).
The Sentry Facility contains certain conditions and imposes certain
requirements, including, among other things, minimum net worth and cash and cash
equivalent balances in the reserve accounts. Under the Sentry Facility, the
Company paid interest of $412,000 for the year ended December 31, 1996. In April
1996, the Company agreed to pay a one-time commitment fee of $700,000 to Sentry.
On May 22, 1996, the Company, through its wholly-owned subsidiary
AutoBond Funding Corporation II, entered into a $20.0 million warehouse facility
(the "Providian Facility") with Peoples Security Life Insurance Company (an
affiliate of Providian Capital Management), which expires December 15, 1996. The
proceeds from the borrowings under the Providian Facility are to be used to
acquire finance contracts, to pay credit default insurance premiums and to make
deposits to a reserve account. Interest is payable monthly
36
at a per annum rate of LIBOR plus 2.60% with a maximum rate of 11.0% and a
minimum rate of 7.60%. The Providian Facility also requires the Company to pay a
monthly fee on the average unused balance at a per annum rate of 0.25%.
Borrowings under the Providian Facility are rated investment-grade by a
nationally recognized statistical rating organization. The Providian Facility
contains certain covenants and representations similar to those in the
agreements governing the Company's existing securitizations.
The Company's wholly-owned subsidiary, AutoBond Funding Corporation I
("AutoBond Funding"), entered into a warehouse credit facility (the "Nomura
Facility") with Nomura Asset Capital Corporation, pursuant to a credit agreement
dated as of June 16, 1995, with a final maturity date of June 16, 2005. This
facility was terminated at the lender's option, and no new advances were made
after February 6, 1996. The Nomura Facility provided advances to AutoBond
Funding up to a maximum aggregate principal amount of $25.0 million for the
acquisition of finance contracts. On March 29, 1996, the remaining total
outstanding balance of advances of $9 million, and interest of $89,000, were
paid by AutoBond Funding. As of December 31, 1996 no advances were outstanding
with respect to the Nomura Facility.
On February 14, 1997 the Company, through its wholly-owned subsidiary
AutoBond Funding Corporation II, entered into the $50,000,000 Daiwa Facility,
which expires March of 1998. The proceeds from the borrowings under the Daiwa
Facility are to be used to acquire finance contracts, and to make deposits to a
reserve account. Interest is payable monthly at the 30-day LIBOR plus 1.15% per
annum rate. The Daiwa Facility also requires the Company to pay a monthly fee on
the average unused balance at a per annum rate of 0.25%. Borrowings under the
Daiwa Facility are rated investment-grade by a nationally recognized statistical
rating organization. The Daiwa Facility contains certain conditions and imposes
certain requirements similar to those in the agreements relating to the
Company's existing securitizations including, among other things, delinquency
and repossession triggers.
Securitization Program. In its securitization transactions, the Company
sells pools of finance contracts to a special purpose subsidiary, which then
sells or assigns the finance contracts to a trust in exchange for cash and
certain retained beneficial interests in future excess spread cash flows. The
trust issues two classes of fixed income investor certificates: "Class A
Certificates" which are sold to investors, generally at par with a fixed coupon,
and subordinated excess spread certificates ("Class B Certificates"),
representing a senior interest in excess spread cash flows from the finance
contracts, which are typically retained by the Company's securitization
subsidiary and which collateralize borrowings on a nonrecourse basis. The
Company also funds a cash reserve account that provides credit support to the
Class A Certificates. The company's securitization subsidiaries also retain a
"Transferor's Interest" in the contracts that is subordinate to the interest of
the investor certificateholders. The retained interests entitle the Company to
receive the future cash flows from the trust after payment to investors,
absorption of losses, if any, that arise from defaults on the transferred
finance contracts and payment of the other expenses and obligations of the
trust.
Securitization transactions impact the Company's liquidity primarily in
two ways.
37
First, the application of proceeds toward payment of the outstanding advances
under warehouse credit facilities makes additional borrowing available, to the
extent of such proceeds, under those facilities for the acquisition of
additional finance contracts. In December 1995, March 1996, June 1996, September
1996 and December 1996 the Company securitized approximately $26.2 million,
$16.6 million, $17.8 million, $22.3 million and $25.0 million respectively, in
nominal principal amount of finance contracts and used the net proceeds to pay
down borrowings under its warehouse credit facilities.
Second, additional working capital is obtained through the Company's
practice of borrowing funds, on a nonrecourse basis, collateralized by its
interest in future excess spread cash flows from its securitization trusts. At
December 31, 1996, the Company held excess servicing receivables and Class B
Certificates totaling $14.3 million, substantially all of which had been pledged
to secure notes payable of $10.1 million.
Subordinated Debt. The Company issued subordinated debt in the principal
amount of $300,000 to an individual investor pursuant to a subordinated note
dated as of March 12, 1996. The subordinated note has a final maturity date of
March 12, 1997 and provides for payment of interest at a per annum rate of 10.0%
and includes a warrant to purchase 18,811 shares of Common Stock at a price of
$0.53 per share. This Subordinated Note was repaid in full in November 1996 with
proceeds from the Company's initial public offering.
Initial Public Offering. On November 14, 1996, the Company completed the
initial public offering of its Common Stock. The closing comprised 825,000
shares sold by the Company (including 75,000 shares issued pursuant to the
exercise of the underwriters overallotment option) and 250,000 shares sold by
the Selling Shareholders. With a price to public of $10 per share and an
underwriting discount at $.70 per share, the Company received gross proceeds of
$7,725,000 from the offering, from which it paid offering expenses of
approximately $1.7 million. The net proceeds were being utilized for working
capital, repayment of subordinated debt of $300,000 and investment in finance
contracts.
Loans to shareholders. Loans to shareholders totaled $235,071 at
December 31, 1996. All shareholder loans were paid in full as of March 20, 1997.
Continued availability of funding from the Company's securitization
program cannot be guaranteed. However, borrowings under the Company's Daiwa
warehouse facility are rated investment grade by a nationally recognized
statistical rating organization. Although the Company currently has only two
long-term warehouse facilities, management believes that the investment grade
rating should allow the Company successfully to obtain additional warehouse
financing if necessary.
The warehouse facilities provide the short-term cash needed to
accumulate loan pools for securitizations. Under the Company's practice of
borrowing funds, on a non-recourse basis, collateralized by its interest in
future excess-spread cash flows, working capital is thereby provided for the
cashflow needs of the Company. The structure of the
38
excess spread cashflow and related note payable provides for self-amortization
of such debt. The Company's excess spread cashflow projections indicate that the
excess spread cashflows will be sufficient to retire the related debt within
approximately 30 months of its incurrence. Cash from the excess spread retained
by the Company is received monthly, commencing immediately upon completion of
the securitization transaction. interest and principal payments are made first
to the Class A Certificateholders, then Trust operating expenses are paid.
Excess cashflow, comprised of interest and fees from the loans reduced by
interest on Class A Certificates and trust operating expenses, is then
distributed in two manners. If the cash reserve account is less than the
required amount, 35% of the excess cash flow is retained in the trust to build
the cash reserves until required levels are met. The remaining 65% of excess
spread cashflow is utilized to first pay down any non-recourse borrowing in
full, and then distributed to the Company for operating purposes. The final cash
flows for each transaction should be released at the expected maturity of 72
months.
The Company has entered into a commitment with a private investment
management company for financing collateralized by the senior excess spread
interests to be created in the Company's next five proposed securitization
transactions. Timing and amount of payments of interest and principal on the
loans will correspond to distributions from the securitization trusts on the
Class B Certificates. The interest rate on such loans will be 15% per annum.
payable monthly. The commitment also provides that the Class B Certificates
evidencing the interests in such senior excess spread cash flows be rated "BB"
by Fitch.
The proceeds of the initial public Offering of the Company's common
stock, proceeds from finance contracts, securitization proceeds and borrowings
under its warehouse facilities will be sufficient to fund expansion of the
Company's business through the end of 1997. The Company has no specific plans or
arrangements for additional equity financings, due to the liquidity provided by
securitizations and financings of excess spread cash flows. The Company believes
it will be able to obtain additional funding through an increase in the maximum
amount available for borrowings under its warehouse facilities and through
securitizations. There can be no assurance, however, that the Company will be
able to obtain such additional funding. See "Risk Factors--Liquidity and Capital
Resources."
IMPACT OF INFLATION AND CHANGING PRICES
Although the Company does not believe that inflation directly has a
material adverse effect on its financial condition or results of operations,
increases in the inflation rate generally are associated with increased interest
rates. Because the Company borrows funds on a floating rate basis during the
period leading up to a securitization, and in many cases purchases finance
contracts bearing a fixed rate nearly equal but less than the maximum interest
rate permitted by law, increased costs of borrowed funds could have a material
adverse impact on the Company's profitability. Inflation also can adversely
affect the Company's operating expenses.
39
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 123 establishes fair,
value-based financial accounting and reporting standards for all transactions in
which a company acquires goods or services by issuing its equity instruments or
by incurring a liability to suppliers in the amounts based on the price of its
common stock or other equity instruments.
During 1996, the Company adopted the disclosure-only alternative under SFAS No.
123, and will continue to account for stock-based compensation as prescribed by
Accounting Principals Board Opinion No. 25, `Accounting for Stock Issued to
Employees.'
In June 1996, the Financial Accounting Standards Board issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities." SFAS 125 provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. The statement is effective for the transfers of financial assets and
extinguishments of liabilities occurring after December 31, 1996 and is to be
applied prospectively. SFAS 125 is not expected to have a significant impact on
the Company's securitization activity, although it should allow a simpler
structure.
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings Per Share." SFAS No. 128 specifies the computation, presentation, and
disclosure requirements for earnings per share. The Company believes the
implementation of SFAS No. 128 will not have an effect on earnings per share
calculation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
[Financial statements are set forth in this report beginning at page F-1.]
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is
40
hereby incorporated above reference thereto.
No person who, at any time during the fiscal year ended December 31, 1996,
was a director, officer, beneficial owner of more than ten percent of any class
of equity securities of the Company registered pursuant to Section 12 of the
Exchange Act, or any other person subject to Section 16 of the Exchange Act with
respect to the Company because of the requirements of Section 30 of the
Investment Company Act ("reporting person") has failed to file or is delinquent
in filing the forms and reports required by Section 16(a) of the Exchange Act
during the fiscal year ended December 31, 1996 or prior fiscal years.
ITEM 11. EXECUTIVE COMPENSATION
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual Meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated by reference
thereto.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual Meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated by reference
thereto.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual Meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated by reference
thereto.
41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM
8-K
(a)The following documents are filed as part of this Form 10-K:
1. Financial Statements.
Independent Auditors' Report - Coopers & Lybrand L.L.P.
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Earnings
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
2. Financial Statement Schedule.
Schedule II; Valuation and Qualifying Accounts
42
3. Exhibits.
Exhibit No. Description of Exhibit
- ---------- ----------------------
3.1* -- Restated Articles of Incorporation of the Company
3.2* -- Amended and Restated Bylaws of the Company
4.1* -- Specimen Common Stock Certificate
10.1* -- Amended and Restated Loan Origination, Sale and Contribution
Agreement dated as of December 15, 1995 by and between the
Company and AutoBond Funding Corporation I
10.2* -- Security Agreement dated as of May 21, 1996 among AutoBond
Funding Corporation II, the Company and Norwest Bank Minnesota,
National Association
10.3* -- Credit Agreement and Side Agreement, dated as of May 21, 1996
among AutoBond Funding Corporation II, the Company and Peoples
Life Insurance Company
10.4* -- Servicing Agreement dated as of May 21, 1996 among AutoBond
Funding Corporation II, CSC Logic/MSA L.L.P., doing business as
"Loan Servicing Enterprise", the Company and Norwest Bank
Minnesota, National Association
10.5* -- Loan Acquisition Sale and Contribution Agreement dated as of May
21, 1996 by and between the Company and AutoBond Funding
Corporation II
10.6* -- Second Amended and Restated Secured Revolving Credit Agreement
dated as of July 31, 1995 between Sentry Financial Corporation
and the Company
10.7* -- Management Administration and Services Agreement dated as of
January 1, 1996 between the Company and AutoBond, Inc.
10.8* -- Employment Agreement dated November 15, 1995 between Adrian Katz
and the Company
10.9* -- Employment Agreement dated February 15, 1996 between Charles A.
Pond and the Company
10.10* -- Employment Agreement effective as of May 1, 1996 between William
O. Winsauer and the Company
10.11* -- Vender's Comprehensive Single Interest Insurance Policy and
Endorsements, issued by Interstate Fire & Casualty Company
43
Exhibit No. Description of Exhibit
- ---------- ----------------------
10.12* -- Warrant to Purchase Common Stock of the Company dated March 12,
1996
10.13* -- Employee Stock Option Plan
10.14* -- Dealer Agreement dated November 9, 1994, between the Company and
Charlie Thomas Ford, Inc.
10.15* -- Automobile Loan Sale Agreement, dated as of September 30, 1996,
among the Company, First Fidelity Acceptance Corp., and
Greenwich Capital Financial Products, Inc.
10.16'D' -- Servicing Agreement, dated as of January 29, 1997, between CSC
LOGIC/MSA L.P.P., doing business as "Loan Servicing Enterprise"
and the Company
10.17'D' -- Credit Agreement, dated as of February 1, 1997, among
AutoBond Funding Corporation II, the Company and Daiwa
Finance Corporation
10.18'D' -- Security Agreement, dated as of February 1, 1997, by and among
AutoBond Funding Corporation II, the Company and Norwest Bank
Minnesota, National Association
10.19'D' -- Automobile Loan Sale Agreement, dated as of March 19, 1997, by
and between Credit Suisse First Boston Mortgage Capital L.L.C.,
a Delaware limited liability company, and the Company
21'D' -- Subsidiaries of the Company
27.1'D' -- Financial Data Schedule
- ---------------------------------
* Incorporated by reference from the Company's Registration Statement
on Form S-1 (Registration No. 333-05359).
'D' Filed herewith.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1996.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, hereunto duly authorized.
AUTOBOND ACCEPTANCE CORPORATION
By: /s/ William O. Winsauer
----------------------------------
William O. Winsauer, Chairman
of the Board and Chief Executive
Officer
Date: March 31, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
/s/ William O. Winsauer Chairman of the Board and March 31, 1997
- -------------------------- Chief Executive
William O. Winsauer Officer
/s/ Adrian Katz Vice Chairman of the Board March 31, 1997
- -------------------------- and Chief Operating Officer
Adrian Katz
/s/ William J. Stahl Vice President and March 31, 1997
- -------------------------- Chief Financial Officer
William J. Stahl
/s/ John S. Winsauer Secretary and March 31, 1997
- -------------------------- and Director
John S. Winsauer
/s/ Robert S. Kapito Director March 31, 1997
- --------------------------
Robert S. Kapito
45
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants F-2
Consolidated Balance Sheets, December 31, 1995 and 1996 F-3
Consolidated Statements of Operations for the Period From August 1, 1994
(Inception) through December 31, 1994,
and the Years Ended December 31, 1995 and 1996 F-4
Consolidated Statements of Shareholders' Equity for the
Period From August 1, 1994 (Inception) to December 31, 1994,
and the Years Ended December 31, 1995 and 1996 F-5
Consolidated Statements of Cash Flows for the Period From
August 1, 1994 (Inception) to December 31, 1994, and the
Years Ended December 31, 1995 and 1996 F-6
Notes to Consolidated Financial Statements F-7
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts S-1
All other schedules are omitted as the required information is not applicable or
the information is presented in the consolidated financial statements, related
notes, or other schedules.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
AutoBond Acceptance Corporation
We have audited the consolidated financial statements and the financial
statement schedule of AutoBond Acceptance Corporation and Subsidiaries listed in
the index on page F-1 of this Form 10-K. 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 generally accepted auditing
standards. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of AutoBond
Acceptance Corporation and Subsidiaries as of December 31, 1995 and 1996, and
the consolidated results of their operations and their cash flows for the period
from August 1, 1994 (inception) through December 31, 1994 and for the years
ended December 31, 1995 and 1996 in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
COOPERS & LYBRAND L.L.P.
Austin, Texas
March 26, 1997
F-2
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 1995 1996
------ ----------- -------
Cash and cash equivalents $ 92,660 $ 4,121,342
Restricted cash 360,266 318,515
Cash held in escrow 1,322,571 2,662,934
Finance contracts held for sale, net 3,354,821 228,429
Repossessed assets held for sale, net 673,746 152,580
Class B Certificates 2,834,502 10,465,294
Excess servicing receivable 846,526 4,247,274
Debt issuance cost 700,000 997,338
Trust receivable 525,220 2,230,003
Due from affiliate 168,847
Prepaid expenses and other assets 354,208 383,573
Software development costs 300,382
----------- -----------
Total assets $11,064,520 $26,276,511
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Revolving credit agreements $ 1,150,421
Notes payable 2,674,597 $10,174,633
Repurchase agreement 1,061,392
Accounts payable and accrued liabilities 1,836,082 1,474,586
Bank overdraft 861,063
Payable to affiliate 255,597 265,998
Deferred income taxes 199,000 2,075,553
----------- -----------
Total liabilities 8,038,152 13,990,770
----------- -----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 5,000,000
shares authorized; no shares issued
Common stock, no par value; 25,000,000
shares authorized; 5,118,753 and
6,512,500 shares issued and outstanding 1,000 1,000
Additional paid-in capital 2,912,603 8,617,466
Deferred compensation (62,758) (11,422)
Loans to shareholders (153,359) (235,071)
Retained earnings 328,882 3,913,768
----------- -----------
Total shareholders' equity 3,026,368 12,285,741
----------- -----------
Total liabilities and shareholders'
equity $11,064,520 $26,276,511
=========== ===========
The accompanying notes are an integral part of the
consolidated financial statements.
F-3
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Period From
August 1, 1994
(Inception)
Through Year Ended
December 31, December 31,
1994 1995 1996
-------------- ------------ -------
Revenues:
Interest income $ 38,197 $ 2,880,961 $ 2,519,612
Interest expense (19,196) (2,099,867) (2,382,818)
---------- ----------- -----------
Net interest income 19,001 781,094 136,794
Gain on sale of finance contracts 4,085,952 12,820,700
Servicing fee income 657,950
Unrealized gain on Class B
Certificates 388,278
--------- ----------- -----------
Total revenues 19,001 4,867,046 14,003,722
--------- ----------- -----------
Expenses:
Provision for credit losses 45,000 48,702 412,387
Salaries and benefits 225,351 1,320,100 4,529,006
General and administrative 244,974 1,462,740 2,331,246
Other operating expenses 48,281 963,017 1,119,644
--------- ----------- -----------
Total expenses 563,606 3,794,559 8,392,283
--------- ----------- -----------
Income (loss) before income taxes
and extraordinary item (544,605) 1,072,487 5,611,439
Provision for income taxes 199,000 1,926,553
--------- ----------- -----------
Income (loss) before extraordinary
item (544,605) 873,487 3,684,886
Extraordinary loss, net of tax
benefit of $50,000 (100,000)
--------- ----------- -----------
Net income (loss) $(544,605) $ 873,487 $ 3,584,886
========= =========== ===========
Income (loss) per common share:
Income (loss) before extraordinary
item $ (0.11) $ 0.17 $ 0.64
Extraordinary loss (0.02)
----------- ----------- -----------
Net income (loss) $ (0.11) $ 0.17 $ 0.62
=========== =========== ===========
Weighted average shares outstanding 5,118,753 5,190,159 5,811,377
=========== =========== ===========
The accompanying notes are an integral part of the
consolidated financial statements.
F-4
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Additional
Common Stock Paid-In Deferred Loans To Retained
Shares Amount Capital Compensation Shareholders Earnings Total
---------- ------- ----------- ------------ ------------ ----------- --------
Capital contributions at
inception 5,118,753 $ 1,000 $ 451,000 $ 452,000
Loans to shareholders $ (16,000) (16,000)
Net loss $ (544,605) (544,605)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1994 5,118,753 1,000 451,000 (16,000) (544,605) (108,605)
Capital contributions 2,323,103 2,323,103
Loans to shareholders (137,359) (137,359)
Deferred compensation pursuant
to employee contract 138,500 $ (138,500)
Amortization of deferred
compensation 75,742 75,742
Net income 873,487 873,487
----------- ----------- ----------- ----------- ----------- ----------- ----------
Balance, December 31, 1995 5,118,753 1,000 2,912,603 (62,758) (153,359) 328,882 3,026,368
Stock issued pursuant to
employee contract 568,747
Loans to shareholders (81,712) (81,712)
Amortization of deferred
compensation 51,336 51,336
Issuance of common stock in
public offering 825,000 5,704,863 5,704,863
Net income 3,584,886 3,584,886
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1996 6,512,500 $ 1,000 $ 8,617,466 $ (11,422) $ (235,071) $ 3,913,768 $12,285,741
=========== =========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of the
consolidated financial statements.
F-5
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Period From
August 1, 1994
(Inception)
Through Year Ended
December 31, December 31,
1994 1995 1996
--------------- ------ ------
Cash flows from operating activities:
Net income (loss) $ (544,605) $ 873,487 $ 3,584,886
Adjustments to reconcile net income to net cash
used in operating activities:
Amortization of finance contract acquisition
discount and insurance (4,513) (795,579) (358,949)
Amortization of deferred compensation 75,742 51,336
Amortization of debt issuance costs 497,496
Provision for credit losses 45,000 48,702 412,387
Deferred income taxes 199,000 1,876,553
Accretion of excess servicing receivable (154,029)
Unrealized gain on Class B Certificates (388,278)
Changes in operating assets and liabilities:
Restricted cash (138,176) (222,090) 41,751
Cash held in escrow (1,322,571) (1,340,363)
Prepaid expenses and other assets (354,208) (329,747)
Class B Certificates (2,834,502) (7,242,514)
Excess servicing receivable (846,526) (3,246,719)
Accounts payable and accrued liabilities 25,636 1,110,446 (361,496)
Due to/due from affiliate 504,534 (248,937) (158,446)
Purchases of finance contracts (2,453,604) (31,200,131) (83,672,335)
Sales of finance contracts 27,399,543 85,014,394
Repayments of finance contracts 51,638 2,660,018 1,605,461
------------ ------------ ------------
Net cash used in operating activities (2,514,090) (5,457,606) (4,168,612)
------------ ------------ ------------
Cash flows from investing activities:
Advances to AutoBond Receivables Trusts (525,220) (1,704,783)
Loans to shareholders (16,000) (137,359) (81,712)
Disposal proceeds from repossessions 220,359 646,600
------------ ------------ ------------
Net cash used in investing activities (16,000) (442,220) (1,139,895)
------------ ------------ ------------
Cash flows from financing activities:
Net borrowings (repayments) under revolving credit
agreements 2,054,776 (904,355) (1,150,421)
Debt issuance costs (794,834)
Proceeds (repayments) from borrowings under repurchase
agreement 1,061,392 (1,061,392)
Proceeds from notes payable 2,674,597 12,575,248
Payments on notes payable (5,075,212)
Shareholder contributions 452,000 2,323,103
Increase (decrease) in bank overdraft 23,314 837,749 (861,063)
Proceeds from public offering of common stock, net 5,704,863
------------ ------------ ------------
Net cash provided by financing activities 2,530,090 5,992,486 9,337,189
------------ ------------ ------------
Net increase in cash and cash equivalents -0- 92,660 4,028,682
Cash and cash equivalents at beginning of period -0- -0- 92,660
------------ ------------ ------------
Cash and cash equivalents at end of period $ -0- $ 92,660 $ 4,121,342
============ ============ ============
Non-cash investing and financing activities:
Accrual of debt issuance cost $ $ 700,000 $
=========== ============ ============
Repossession of automobiles $ $ 849,756 $ 291,086
=========== ============ ============
Deferred compensation $ $ 138,500 $
=========== ============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
F-6
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF BUSINESS
AutoBond Acceptance Corporation (AAC) was incorporated in June 1993 and
commenced operations August 1, 1994. AAC and its wholly-owned
subsidiaries, AutoBond Funding Corp I (ABF I), AutoBond Funding Corp II
(ABF II), and AutoBond Funding Corp III (ABF III) (collectively, the
Company), engage primarily in the business of acquiring, securitizing
and servicing automobile installment sale contracts originated by
franchised automobile dealers (the Contracts). The Company specializes
in Contracts to consumers who generally have limited access to
traditional financing, such as that provided by commercial banks or
captive finance companies of automobile manufacturers. The Company
purchases Contracts directly from automobile dealers or from other
originators, with the intent to resell them to institution investors in
securitization structures.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of AAC and
its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. Certain
reclassifications have been made to prior years' financial statements to
conform with the current year's presentation.
PERVASIVENESS OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with original maturities
of three months or less to be cash equivalents.
RESTRICTED CASH
In accordance with the Company's revolving credit facilities, the
Company is required to maintain a cash reserve with its lenders of 1% to
6% of the proceeds received from the lender for the origination of the
Finance Contracts. Access to these funds is restricted by the lender;
however, such funds may be released in part upon the occurrence of
certain events including payoffs of Finance Contracts.
CASH HELD IN ESCROW
Upon closing of a securitization transaction, certain funds due to the
various parties, including the Company and its warehouse lenders,
frequently remain in escrow pending disbursement by the Trustee one to
eleven days subsequent to closing.
F-7
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
Continued:
TRUST RECEIVABLE
At the time a securitization closes, the Company is required to
establish a cash reserve within the trust for future credit losses.
Additionally, depending on each securitization structure, a portion of
the Company's future servicing cash flow is required to be deposited as
additional reserves for credit losses. The December 1995, March 1996,
June 1996, September 1996 and December 1996 securitization transactions
resulted in initial cash reserves of approximately $525,000, $331,000,
$357,000, $446,000, and $500,000, respectively, which approximates 2% of
the Finance Contracts sold to the respective trusts. The trust reserves
are increased monthly from excess cash flows until such time as they
attain a level of 6% of the outstanding principal balance.
FINANCE CONTRACTS HELD FOR SALE
Finance Contracts held for sale are stated at the lower of aggregated
amortized cost, or market value. Market value is determined based on the
estimated value of the Finance Contracts if securitized and sold.
The Company generally acquires Finance Contracts at a discount, and has
purchased loss default and vender single interest physical damage
insurance on the Finance Contracts. The purchase discount and insurance
are amortized as an adjustment to the related Finance Contract's yield
and operating expense, respectively, utilizing the same basis as that
used to record income on the Finance Contracts, over the contractual
life of the related loans. At the time of sale, any remaining
unamortized amounts are netted against the Finance Contract's principal
amounts outstanding to determine the resultant gain or loss on sale.
Allowance for credit losses on the Finance Contracts is based on the
Company's historical default rate, the liquidation value of the
underlying collateral in the existing portfolio, estimates of
repossession costs and probable recoveries from insurance proceeds. The
allowance is increased by provisions for estimated future credit losses
which are charged against income. The allowance account is reduced for
direct charge-offs using the specific identification method, and for
estimated losses upon repossession of automobiles which is netted
against the related Finance Contracts and transferred to Repossessed
assets held for sale.
IMPAIRMENT OF LONG-LIVED ASSETS
In the event that facts and circumstances indicate that the cost of
long-lived assets other than financial instruments, excess servicing
receivables and deferred tax assets may be impaired, an evaluation of
recoverability would be performed. If an evaluation of impairment is
required, the estimated future undiscounted cash flows associated with
the asset would be compared to the asset's carrying amount to determine
if a write-down to market value or discounted cash flow value is
required. No such write-downs were recorded in 1995 or 1996.
REPOSSESSED ASSETS HELD FOR SALE
Automobiles repossessed and held for sale are initially recorded at the
recorded investment in the Finance Contracts on the date of repossession
less an allowance. This value approximates the expected cash proceeds
from the sale of the assets and applicable insurance payments, net of
all disposition costs. Due to the relatively short time period between
acquisition and disposal of the assets, discounting of the expected net
cash proceeds to determine fair value is not utilized.
F-8
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
Continued:
REPOSSESSED ASSETS HELD FOR SALE, Continued
Subsequent impairment reviews are performed quarterly on a disaggregated
basis. A valuation allowance is established if the carrying amount is
greater than the fair value of the assets. Subsequent increases and
decreases in fair value result in adjustment of the valuation allowance
which is recorded in earnings during the period of adjustment.
Adjustments for subsequent increases in fair value are limited to the
existing valuation allowance amount, if any. During each of the periods
presented, no valuation allowance was established. An adjustment of
approximately $300,000 was made in the fourth quarter of 1996 to adjust
for the differences between actual proceeds from sale to the carrying
amounts recorded for repossessed assets, some portion of which may
relate to prior quarters.
CLASS B CERTIFICATES
Pursuant to the securitization transactions, the related Trusts have
issued Class B Certificates to the Company which are subordinate to the
Class A Certificates and senior to the excess servicing receivable with
respect to cash distributions from the Trust. The Company accounts for
the Class B Certificates as trading securities in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." SFAS
No. 115 requires fair value accounting for these certificates with the
resultant unrealized gain or loss recorded in the statements of
operations in the period of the change in fair value. The company
determines fair value on a disaggregated basis utilizing quotes from
outside dealers who utilize discounted cash flow analyses similar to
that described below for determining market value of the excess
servicing receivable, as well as other unique characteristics such as
the remaining principal balance in relation to estimated future cash
flows and the expected remaining terms of the certificates. Estimated
transaction costs associated with a sale of the Class B Certificates are
not deducted from the fair value determination. During 1996, an
unrealized gain of $388,278 was recognized on the Class B Certificates.
During 1996, the Company's Class B Certificate from their 1995
securitization was upgraded by Fitch Investors Service from BB to BB+.
The Class B Certificates accrue interest at 15%.
EXCESS SERVICING RECEIVABLE
Excess servicing receivable includes the estimated present value of
future net cash flows from securitized receivables over the amounts due
to the Class A and Class B Certificate holders in the securitization and
certain expenses paid by the entity established in connection with the
securitization transaction. The Finance Contracts sold in conjunction
with the securitization transactions are treated as sale transactions in
accordance with SFAS No. 77, 'Reporting by Transferors for Transfers of
Receivables with Recourse.' Gain or loss is recognized on the date the
Company surrenders its control of the future economic benefits relating
to the receivables and the investor has placed its cash in the
securitization trust. Accordingly, all outstanding debt related to the
Finance Contracts sold to the securitization trust is deemed to be
simultaneously extinguished. The Company sells 100% of the Finance
Contracts and retains a participation in the future cash flows released
by the securitization Trustee. The Company also retains the servicing
rights, and contracts with third parties to perform certain aspects of
the servicing function.
F-9
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
Continued
EXCESS SERVICING RECEIVABLE, Continued
The discount rate utilized to determine the excess servicing receivable
is based on assumptions that market participants would use for similar
financial instruments subject to prepayment, default, collateral value
and interest rate risks. The future net cash flows are estimated based
on many factors including contractual principal and interest to be
received, as adjusted for expected prepayments, defaults, collateral
sales proceeds, insurance proceeds, payments to investors on the
pass-through securities, servicing fees and other costs associated with
the securitization transaction and related loans. The gain from
securitization transactions include the excess servicing receivable and
Class B Certificates plus the difference between net proceeds received
on the transaction date and the net carrying value of Finance Contracts
held for sale.
The carrying value of the excess servicing receivable is amortized in
proportion to and over the period of estimated net future excess
servicing fee income, for which the amortization is recorded as a charge
against servicing fee income. The excess servicing receivable is
reviewed to determine if the present value of the estimated remaining
future excess servicing fee income is less than the carrying amount
using the discount factor applied in the original determination of the
excess servicing receivable. The Company does not increase the carrying
value of the excess servicing receivable for favorable variances from
original estimates, but to the extent that actual results exceed the
Company's prepayment or loss estimates, any required decrease adjustment
is reflected as a write down of the receivable and a related charge
against current period earnings. Write downs of excess servicing
receivables due to modification of future estimates as a result of the
impairment review are determined on a disaggregated basis consistent
with the risk characteristics of the underlying loans consisting
principally of origination date and originating dealership. There were
no adjustments for impairment to the carrying value of the excess
servicing receivable during 1995 or 1996.
The receipt of the servicing fee income related to the excess servicing
asset is subordinate to the Class A and Class B Certificates. As a
result, the Company recognizes income for the accretion of the discount
associated with the present value effect on the carrying value of the
excess servicing asset. Such accretion amounted to approximately
$154,000 in 1996.
The value of the excess servicing reflects management's estimate of the
net future servicing income on the finance contracts held in each
securitization trust. Such estimate is affected by assumptions such as
repossession rates, uninsured loss amounts, delinquencies, prepayment
rates and timing of cash receipts. If actual results are significantly
different than those assumptions presumed by management in such a manner
as to reduce the amount of excess spread cash flows available than
originally estimated, the excess servicing asset will be impaired. Given
the valuation of the excess servicing asset is affected by a significant
number of assumptions and that changes in such assumptions affect the
amount of cash flows available to the Company, it is at least reasonably
possible that decreases to the value of the excess servicing receivable
will occur in the near term and that the decreases could materially
affect the amounts reported in the income statement.
F-10
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
Continued
SOFTWARE DEVELOPMENT COSTS
Software development costs recorded include external costs incurred to
modify the related software from a state of technical feasibility to its
operational form and will be amortized over 5 years, which is its
estimated useful life. No amortization was recorded in 1996, as the
software was not available for use during 1996.
DEBT ISSUANCE COSTS
The costs related to the issuance of debt are capitalized and amortized
in interest expense over the lives of the related debt.
Debt issuance costs related to the issuance of notes payable
collateralized by Class B Certificates, are amortized on a
dissaggregated basis over the term of the related note using the
interest method. Debt issuance costs related to warehouse credit
facilities are amortized using the straight-line method.
INCOME TAXES
The Company uses the liability method in accounting for income taxes.
Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized. The provision for income taxes represents the tax payable for
the period and the change during the year in deferred tax assets and
liabilities. The Company files a consolidated federal income tax return.
EXTRAORDINARY ITEM
The extraordinary loss recorded in 1996 relates to a $150,000 prepayment
fee on a $2,684,000 term loan that was repaid during 1996. The term loan
carried a stated interest rate of 20% (see Note 6).
EARNINGS PER SHARE
Earnings per share is calculated using the weighted average number of
common shares and common share equivalents outstanding during the year.
Common share equivalents of 71,406 and 19,489 were used in the
calculation of earnings per share in 1995 and 1996, respectively. Fully
diluted earnings per share are not presented because the relevant stock
options and warrants are not significant. There were no common share
equivalents in 1994. Effective May 30, 1996, the Board of Directors of
the Company voted to effect a 767.8125-for-1 stock split. All share
information and earnings per share calculations for the periods
presented in the financial statements herein, and the notes hereto, have
been retroactively restated for such stock split.
F-11
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
Continued
INTEREST INCOME
Generally, interest income on Finance Contracts acquired prior to
December 31, 1995 is determined on a monthly basis using the Rule of 78s
method which approximates the simple interest method. Subsequent to
December 31, 1995, the Company generally uses the simple interest method
to determine interest income on Finance Contracts acquired. The Company
discontinues accrual of interest on loans past due for more than 90
days. The Company accrues interest income on the Class B Certificates
monthly at 15% using the interest method.
CONCENTRATION OF CREDIT RISK
The Company generally acquires Finance Contracts from a network of
automobile dealers located in thirty-six states, including among others
Texas, Arizona, Oklahoma, New Mexico, Connecticut, Georgia and Utah. For
the years ended December 31, 1995 and 1996, the Company had a
significant concentration of Finance Contracts with borrowers in Texas,
which approximated 91% and 63.7% of total Finance Contracts,
respectively. For the years ended December 31, 1995 and 1996, one dealer
accounted for 8.8% and 8.9%, respectively, of the Finance Contracts
purchased by the Company. No other dealer accounted for more than 10% of
the Finance Contracts purchased.
2. RECENT ACCOUNTING PRONOUNCEMENTS:
In June 1996, the Financial Accounting Standards Board issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." SFAS No. 125 provides consistent
standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings. The statement is
effective for transfers of financial assets and extinguishments of
liabilities occurring after December 31, 1996 and is to be applied
prospectively.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per
Share." SFAS No. 128 specifies the computation, presentation, and
disclosure requirements for earnings per share. The Company believes the
implementation of SFAS No. 128 will not have an effect on earnings per
share calculation.
3. FINANCE CONTRACTS HELD FOR SALE:
The following amounts are included in Finance Contracts held for sale as
of:
December 31,
1995 1996
---- ----
Principal balance of Finance Contracts
held for sale $3,539,195 $ 266,450
Prepaid insurance 260,155 18,733
Contract acquisition discounts (350,827) (31,554)
Allowance for credit losses (93,702) (25,200)
---------- ----------
$3,354,821 $ 228,429
========== ==========
F-12
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
4. EXCESS SERVICING RECEIVABLE AND SECURITIZATIONS:
The Company has completed the following securitization transactions
(rounded to thousands):
December March June September December
1995 1996 1996 1996 1996
----------- ----------- ----------- ----------- -----------
Principal of loans sold $26,200,000 $16,500,000 $17,800,000 $22,300,000 $25,000,000
A Certificate 26,200,000 16,500,000 17,800,000 22,300,000 25,000,000
A Certificate rate 7.23% 7.15% 7.73% 7.45% 7.37%
B Certificate $ 2,800,000 $ 2,000,000 $ 2,000,000 $ 2,400,000 $ 2,800,000
B Certificate rate 15% 15% 15% 15% 15%
Excess servicing asset $ 846,000 $ 597,000 $ 650,000 $ 1,000,000 $ 1,000,000
Gain on sale 4,100,000 2,800,000 2,900,000 3,320,000 3,800,000
The changes in the excess servicing asset are as follows:
Balance, January 1, 1996 $ 846,526
Additions from securitization transactions 3,246,719
Accretion of discount 154,029
-----------
Balance, December 31, 1996 $ 4,247,274
===========
The Company is required to represent and warrant certain matters with
respect to the Finance Contracts sold to the Trusts, which generally
duplicate the substance of the representations and warranties made by
the dealers in connection with the Company's purchase of the Finance
Contracts. In the event of a breach by the Company of any representation
or warranty, the Company is obligated to repurchase the Finance
Contracts from the Trust at a price equal to the remaining principal
plus accrued interest. The Company has not recorded any liability and
has not been obligated to purchase Finance Contracts under the recourse
provisions during any of the reporting periods, however, the Company
repurchased loans with principal balances of $420,000 in total from a
Trust in February 1997. The Company expects that it will recover, under
dealer representations and warranty provisions, the amounts due on the
repurchased loans from the dealership who sold the Company the loans.
F-13
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
5. REVOLVING CREDIT AGREEMENTS:
Effective August 1, 1994, the Company entered into a Secured Revolving
Credit Agreement with Sentry Financial Corporation ('Sentry') which was
amended and restated on July 31, 1995. The amended agreement ('Revolving
Credit Agreement') provides for a $10,000,000 warehouse line of credit
which terminates December 31, 2000, unless terminated earlier by the
Company or Sentry upon meeting certain defined conditions. The proceeds
of the Revolving Credit Agreement are to be used to originate and
acquire Finance Contracts, to pay for loss default insurance premiums,
to make deposits to a reserve account with Sentry, and to pay for fees
associated with the origination of Finance Contracts. The Revolving
Credit Agreement is collateralized by the Finance Contracts acquired
with the outstanding borrowings. Interest is payable monthly and accrues
at a rate of prime plus 1.75% (10.25% and 10% at December 31, 1995 and
1996, respectively). The Revolving Credit Agreement contains certain
restrictive covenants, including requirements to maintain a certain
minimum net worth, and cash and cash equivalent balances. Under the
Revolving Credit Agreement, the Company paid interest of $411,915 and
$220,674 for the years ended December 31, 1995 and 1996, respectively.
Pursuant to the Revolving Credit Agreement, the Company is required to
pay a $700,000 warehouse facility fee payable upon the successful
securitization of Finance Contracts. The $700,000 was payable in varying
amounts after each of the first three securitizations. The Company
accrued the $700,000 debt issuance cost upon the first securitization in
December 1995, the date the Company determined the liability to be
probable in accordance with SFAS No. 5. The $700,000 debt issuance cost
is being amortized as interest expense on a straight line basis through
December 31, 2000, the termination date of the Revolving Credit
Agreement. The Company pays a utilization fee of up to 0.21% per month
on the average outstanding balance of the Revolving Credit Agreement.
The Revolving Credit Agreement also requires the Company to pay up to
0.62% per quarter on the average unused balance. At December 31, 1996,
$10,000,000 was available for borrowings under the credit line as there
were no amounts outstanding at that date.
Effective June 16, 1995, the Company entered into a $25,000,000 Credit
Agreement with Nomura Asset Capital Corporation ('Nomura') which allowed
for advances to the Company through June 2000 with all outstanding
amounts to mature June 2005. Advances outstanding under the facility
accrued interest at the three month LIBOR rate plus 6.75% which
approximated 12.59% at December 31, 1995. The warehouse facility allowed
Nomura to terminate the agreement upon 120 days notice. On October 6,
1995, the Company received notice of Nomura's intent to terminate, and
all outstanding advance amounts together with accrued interest were paid
by the Company prior to March 31, 1996. No advances under the Nomura
credit facility were outstanding at December 31, 1996.
F-14
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
5. REVOLVING CREDIT AGREEMENTS, Continued:
Effective May 21, 1996 the Company, through its wholly-owned subsidiary
AutoBond Funding Corporation II, entered into a $20 million revolving
warehouse facility (the 'Revolving Warehouse Facility'), with Peoples
Security Life Insurance Company (an affiliate of Providian Capital
Management), which expired December 15, 1996. The proceeds from the
borrowings under the Revolving Warehouse Facility were used to acquire
Finance Contracts, to pay credit default insurance premiums and to make
deposits to a reserve account. Interest was payable monthly at a per
annum rate of LIBOR plus 2.60%. The Revolving Warehouse Facility also
required the Company to pay a monthly fee on the average unused balance
of 0.25% per annum. The Revolving Warehouse Facility was collateralized
by the Finance Contracts acquired with the outstanding borrowings. The
Revolving Warehouse Facility contains certain covenants and
representations similar to those in the agreements governing the
Company's existing securitizations. No advances under the Revolving
Warehouse Facility were outstanding at December 31, 1996.
The interest rate on borrowings under revolving credit agreements ranged
from 8% to 10% for the year ended December 31, 1996.
6. NOTES PAYABLE:
Pursuant to the securitization completed in December 1995, the Company
entered into a term loan agreement with a finance company to borrow
approximately $2,684,000. The loan was collateralized by the Company's
Class B Certificates from its 1995 securitization as well as the excess
servicing receivable from the cash flows of the related Trust (see Note
4). The loan accrued interest at 20% per annum payable monthly and
principal payments were made based on principal payments received on the
Class B Certificates.
Effective April 8, 1996, the outstanding balance of $2,585,757 was
refinanced through a non-recourse term loan entered into with a new
finance company. The term loan is collateralized by the Company's Class
B Certificates, and matures April 8, 2002. The term loan bears interest
at 15% per annum payable monthly. Principal and interest payments on the
term loan are paid directly by the Trustee to the finance company and
are based on payments required to be made to the Class B Certificate
holders pursuant to the Trust. The Company can prepay the term loan in
whole or part at any time if the holder seeks to transfer such loan to a
third party.
Effective March 28, 1996, the Company obtained another non-recourse term
loan in the amount of $2,059,214 from an institutional investor under
similar terms as described in the preceding paragraph. The loan is
collateralized by the Class B Certificates issued to the Company
pursuant to the March 29, 1996 securitization transaction. The Company
may prepay the loan in whole or in part at any time subsequent to March
28, 1997, or any time after receiving notice by the investor of its
intent to transfer the loan to a third party. The maturity date of the
loan is the earlier of March 28, 2002 or the date that all outstanding
principal and accrued interest has been paid by the Trustee or the
Company.
F-15
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. NOTES PAYABLE, Continued:
Effective June 27, 1996, the Company obtained a third non-recourse term
loan in the amount of $2,066,410 from an institutional investor under
similar terms as described in the preceding two paragraphs. The loan is
collateralized by the Class B Certificates issued to the Company
pursuant to the June 27, 1996 securitization transaction. The Company
may prepay the loan in whole or in part at any time subsequent to June
27, 1997, or any time after receiving notice by the investor of its
intent to transfer the loan to a third party. The maturity date of the
loan is the earlier of June 26, 2002 or the date that all outstanding
principal and accrued interest has been paid by the Trustee or the
Company.
Effective September 30, 1996 and December 27, 1996, the Company obtained
non-recourse term loans for $2,403,027 and $2,802,891, respectively,
from institutional investors under similar terms as described above. The
loans are collateralized by the Class B Certificates issued to the
Company pursuant to the September 30, 1996 and December 27, 1996
securitization transactions. The Company may prepay the loans in whole
or in part at any time subsequent to September 30, 1997, or any time
after receiving notice by the investor of its intent to transfer the
loan to a third party. The maturity date for the loans is September 30,
2002 and December 31, 2002, respectively.
During July 1996, a private investment management company entered into a
commitment agreement to provide the Company financing collateralized by
the senior excess spread interests to be created in the Company's next
five proposed securitization transactions. Timing and amount of payments
of interest and principal on the loans will correspond to distributions
from the securitization trusts on the Class B Certificates. The interest
rate on such loans will be 15% per annum, payable monthly and the
borrowings will include a 3% origination fee. The commitment is subject
to the Company's ability to continue meeting several provisions,
including: (1) similarly structured securitization transactions; (2) the
absence of rating downgrades and defaults from previous securitization;
and (3) satisfactory performance reports.
7. REPURCHASE AGREEMENT:
On December 20, 1995, the Company entered into an agreement to sell
certain Finance Contracts totaling $1,061,392 to a finance company, and
repurchase such Finance Contracts in January 1996 for an amount equal to
the remaining unpaid principal balance plus interest accruing at an
annual rate of 19%.
The Company repurchased such Finance Contracts during January 1996 in
accordance with the terms of the agreement.
8. INITIAL PUBLIC OFFERING:
On November 14, 1996, the Company and Selling Shareholders sold 750,000
and 250,000, respectively, of shares of common stock in an initial
public offering at a price of $10 per share. The net proceeds from the
issuance and sale of common stock amounted to approximately $5,000,000
after deducting underwriter discounts and issuer expenses. Portions of
the net proceeds were used (i) to prepay outstanding subordinated debt
of approximately $300,000 plus accrued interest, (ii) to repay advances
under Revolving Credit Facilities, and (iii) for general corporate and
working capital purposes.
F-16
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
8. INITIAL PUBLIC OFFERING, Continued:
The underwriters of the Company's initial public offering purchased an
additional 75,000 shares of the Company's common stock at $10 per share
by exercising half of their over-allotment option. The net proceeds from
the issuance and sale of these shares amounted to approximately $700,000
after deducting underwriter's discounts.
9. INCOME TAXES:
The provision for income taxes for 1996 consists of a deferred tax
provision of $1,926,553 and no current liability. The provision for
income taxes for 1995 consists of a deferred tax provision of $199,000
and no current liability. Due to net losses incurred from inception
through December 31, 1994, the Company has no provision in 1994. The
reconciliation between the provision for income taxes and the amounts
that would result from applying the Federal statutory rate is as
follows:
Period From
August 1, 1994
(Inception) Year Ended
December 31, December 31,
1994 1995 1996
-------------- ------------ --------
Federal tax at statutory rate
of 34% $ (185,166) $ 364,646 $ 1,907,889
Nondeductible expenses 2,166 17,354 18,664
Change in valuation allowance 183,000 (183,000) --
----------- ----------- -----------
Provision for income taxes $ -- $ 199,000 $ 1,926,553
=========== =========== ===========
Deferred income tax assets and liabilities reflect the tax effect of
temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and income tax purposes
Significant components of the Company's net deferred tax liability are
as follows:
December 31,
1995 1996
----------- -----------
Deferred Tax Assets:
Allowance for credit losses $ 31,859 $ 16,728
Costs related to securitizations 19,664 491,935
Other 106,424 3,883
Net operating loss carryforwards 1,032,396 2,792,067
----------- -----------
Gross deferred tax assets 1,190,343 3,304,613
----------- -----------
Deferred Tax Liabilities:
Gain on securitization 1,389,343 5,242,372
Other -- 137,794
----------- -----------
Gross deferred tax liabilities 1,389,343 5,380,166
----------- -----------
Net deferred tax liabilities $ 199,000 $ 2,075,553
=========== ===========
At December 31, 1996, the Company had tax net operating loss
carryforwards of approximately $8,212,000 which will expire in fiscal
years 2009 through 2011.
F-17
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
10. STOCKHOLDERS' EQUITY:
Effective May 30, 1996, the Board of Directors adopted Restated Articles
of Incorporation which authorized 25,000,000 shares of no par value
common stock and 5,000,000 shares of no par value preferred stock.
STOCK BASED COMPENSATION PLAN
The Company grants stock options under a stock-based incentive
compensation plan (the "Plan"). The Company applies Accounting
Principles Board Opinion 25 and related Interpretations in accounting
for the Plan. In 1995, SFAS No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123") was issued, which, if fully adopted by the
Company, would change the methods the Company applies in recognizing the
cost of the Plan. Adoption of the cost recognition provisions of SFAS
123 is optional and the Company has decided not to elect these
provisions of SFAS 123. However, pro forma disclosures as if the Company
adopted the expense recognition provisions of SFAS 123 for 1996 are
required by SFAS 123 and are presented below.
Under the Plan, the Company is authorized to issue shares of Common
Stock pursuant to "Awards" granted in various forms, including incentive
stock options (intended to qualify under Section 422 of the Internal
Revenue Code of 1986, as amended), non-qualified stock options, and
other similar stock- based Awards. The Company granted stock options in
1996 under the Plan in the form of non-qualified stock options.
STOCK OPTIONS
The Company granted stock options in 1996 to employees and directors.
The stock options granted in 1996 have contractual terms of 10 years.
All options granted to the employees and directors have an exercise
price no less than the fair market value of the stock at grant date. The
options granted in 1996 vest, 33.33% per year, beginning on the first
anniversary of the date of grant. The Company granted 274,500 options in
1996 and 1 warrant for 100,000 shares of stock (collectively, "stock
options"). The warrant is fully exercisable after 1 year.
In accordance with APB 25, the Company has not recognized any
compensation cost for these stock options granted in 1996.
A summary of the status of the Company's stock options as of December
31, 1996 and the changes during the year ended is presented below:
STOCK OPTIONS
1996
-------------------------
Weighted
# Shares of Average
Underlying Exercise
Options Prices
----------- ---------
Outstanding at beginning of the year 0 n/a
Granted at-the-money 274,500 $10.06
Granted at a premium 100,000 $12.00
-------
Total granted 374,500 $10.58
======= ======
Outstanding at end of year 374,500 $10.58
======= ======
Exercisable at end of year 0 n/a
Weighted-average FV of options granted at-the-money $ 4.88
Weighted-average FV of warrants granted at a premium $ 4.65
Weighted-average FV of options granted during the year $ 4.82
F-18
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
10. STOCKHOLDERS' EQUITY, Continued:
STOCK OPTIONS, Continued
The fair value of each stock option and warrant granted is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions for grants in 1996: dividend
yield of 0.00% for both years; risk-free interest rates are different
for each grant and range from 5.89% to 6.06%; the expected lives of
options are estimated to be 5 years; and a volatility of 46.46% for all
grants.
As of December 31, 1996, 374,500 options are outstanding with none
bearing exercisable and a weighted-average contractual life of all stock
options being 9.93 years.
PRO FORMA NET INCOME AND NET INCOME PER COMMON SHARE
Had the compensation cost for the Company's stock-based compensation
plan been determined consistent with SFAS 123, the Company's net income
and net income per common share for 1996 would approximate the pro forma
amounts below:
As Reported Pro Forma
December 31, December 31,
1996 1996
------------ --------
SFAS 123 Charge, pre-tax - $1,804,560
APB 25 Charge - -
Net income $3,584,886 $2,393,876
Net income per common share $ .62 $ .41
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to awards prior to
1995.
WARRANTS
The Company issued to its underwriters of their initial public offering
a warrant to purchase up to 100,000 common shares of the Company's
common stock at a price per share equal to $12.00. The warrant is
exercisable after one year from November 14, 1996, or earlier if the
Company effects certain registrations of its common stock.
In addition to subordinated debt issued March 12, 1996, which was not
outstanding at December 31, 1996, a detachable warrant was issued to an
individual for the purchase of 18,811 shares of common stock at an
exercise price equal to the fair market value as of March 12, 1996, the
date of grant. The warrant is exercisable in full or in part during the
period commencing six months after the effective date of the Company's
initial public offering and ending 1.5 years thereafter. Management has
determined that the fair value of the warrant at its issuance date was
de minimus.
F-19
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
10. STOCKHOLDERS' EQUITY, Continued:
PREFERRED STOCK
Pursuant to the Company's Amended Articles of Incorporation, the Company
is authorized to issue from time to time up to 5,000,000 shares of
Preferred Stock, in one or more series. The Board of Directors is
authorized to fix the dividend rights, dividend rates, any conversion
rights or right of exchange, any voting right, any rights and terms of
redemption (including sinking fund provisions), the redemption rights or
prices, the liquidation preferences and any other rights, preferences,
privileges and restrictions of any series of Preferred Stock and the
number of shares constituting such series and the designation thereof.
There were no shares of Preferred Stock issued or outstanding during
1995 or 1996.
11. RELATED PARTY TRANSACTIONS:
Prior to January 1, 1996 the Company shared certain general and
administrative expenses with AutoBond, Inc. ('ABI'), which was founded
and is 100% owned by the Chief Executive Officer ('CEO') of the Company.
The CEO owns 56.59% of the Company. Each entity was allocated expenses
based on a proportional cost method, whereby payroll costs were
allocated based on management's review of each individual's
responsibilities, and costs related to office space and equipment
rentals were based on management's best estimate of usage during the
year. Miscellaneous expenses were allocated based on the specific
purposes for which each expense related. Management believes the methods
used to allocate the general and administrative expenses shared with ABI
were reasonable, and that the expenses reported in the financial
statements after the ABI allocations approximate the expenses that would
have been incurred on a stand-alone entity basis. Total expenses
allocated to the Company from ABI amounted to approximately $441,000 for
the period from August 1, 1994 (inception) to December 31, 1994 and
$2,163,000 for the year ended December 31, 1995. Additionally, neither
the Company nor any of its affiliates had paid any compensation to its
CEO during 1994 or 1995; however, management of the Company commenced
compensation payments to the CEO during the latter half of 1996 (see
Note 12). The Company estimated that a reasonable amount of compensation
to pay the CEO on a stand-alone entity basis would approximate $40,000
and $100,000 for the five months ended December 31, 1994 and the year
ended December 31, 1995.
The Company advanced approximately $132,000 and $201,000 as of December
31, 1995 and December 31, 1996, respectively, to William Winsauer, CEO
and majority shareholder of the Company, and approximately $21,000 and
$34,000 as of December 31, 1995 and December 31, 1996, respectively, to
John Winsauer, a significant shareholder of the Company. The advances
are non-interest bearing amounts that have no repayment terms and are
shown as a reduction of shareholders' equity. As of March 20, 1997,
these loans were repaid in full.
F-20
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
11. RELATED PARTY TRANSACTIONS, Continued:
The Company and ABI entered into a management agreement dated as of
January 1, 1996 (the 'ABI Management Agreement') which requires ABI to
pay an annual fee of $50,000 to the Company for services rendered by it
or the Company's employees on behalf of ABI as follows: (i) monitoring
the performance of certain partnership interests owned by ABI and its
sole shareholder, (ii) certain cash management services, including the
advancing of funds to pay ABI's ordinary business expenses and (iii)
providing advice as to regulatory compliance. The ABI Management
Agreement also provides that the Company will perform certain accounting
functions on behalf of ABI including (i) maintenance of financial books
and records, (ii) monitoring of cash management functions, (iii)
preparation of financial statements and tax returns and (iv) providing
advice in connection with retention of independent accountants. The ABI
Management Agreement further provides for the reimbursement of advances
made by the Company for out-of-pocket costs and expenses incurred on
behalf of ABI. Amounts due to the Company under the ABI Management
Agreement amounted to $143,547 at December 31, 1996.
12. EMPLOYMENT AGREEMENTS:
During 1995 and 1996, the Company entered into three-year employment
agreements with two officers of the Company. One employment agreement is
dated November 15, 1995 and is effective from such date through November
15, 1998. This agreement is automatically extended unless the Company
gives six months notice of its intent not to extend the terms of the
agreement. This agreement provides for a minimum monthly salary of
$12,500, together with shares of the Company's common stock, issued
January 1, 1996, equal to 10% of the outstanding shares after giving
effect to the shares issued to the employee. Half of such issued shares
are not subject to forfeiture whereas the remaining 50% are subject to
forfeiture. Equal amounts of the forfeitable shares bear no risk of
forfeiture upon the officer remaining employed as of November 15, 1996
and November 15, 1997, respectively.
The Company valued the shares issued January 1, 1996 based on an
independent appraisal of the Company as of November 15, 1995, the
measurement date, and recorded an increase to additional paid-in capital
and deferred compensation of $138,500. Deferred compensation is
amortized on a straight-line basis over the two forfeiture periods
ending November 15, 1997 resulting in compensation expense of $75,742
and $51,336 for the years ended December 31, 1995 and 1996,
respectively.
The second employment agreement is dated May 31, 1996, and is effective
from such date for five years. The agreement provides for compensation
at a base salary of $240,000 per annum, which may be increased and may
be decreased to an amount of not less than $240,000, at the discretion
of the Board of Directors. The agreement entitles the chief executive
officer to receive the benefits of any cash incentive compensation as
may be granted by the Board to employees, and to participate in any
executive bonus or incentive plan established by the Board of Directors.
The agreement also provides the officer with certain additional
benefits.
F-21
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
12. EMPLOYMENT AGREEMENTS, Continued:
The agreement automatically terminates upon (i) the death of the
officer, (ii) disability of the officer for six continuous months
together with the likelihood that the officer will be unable to perform
his duties for the following continuous six months, as determined by the
Board of Directors, (iii) termination of the officer 'for cause' (which
termination requires the vote of a majority of the Board) or (iv) the
occurrence of the five-year expiration date provided, however, the
agreement may be extended for successive one-year intervals unless
either party elects to terminate the agreement in a prior written
notice. The officer may terminate his employment for 'good reason' as
defined in the agreement. In the event of the officer's termination for
cause, the agreement provides that the Company shall pay the officer his
base salary through the date of termination and the vested portion of
any incentive compensation plan to which the officer may be entitled.
Other than following a change in control, if the Company terminates the
officer in breach of the agreement, or if the officer terminates his
employment for good reason, the Company must pay the officer: (i) his
base salary through the date of termination; (ii) a severance payment
equal to the base salary multiplied by the number of years remaining
under the agreement; and (iii) in the case of breach by the Company of
the agreement, all other damages to which the officer may be entitled as
a result of such breach, including lost benefits under retirement and
incentive plans.
In the event of the officer's termination following a change in control,
the Company is required to pay the officer an amount equal to three
times the sum of (i) his base salary, (ii) his annual management
incentive compensation and (iii) his planned level of annual
perquisites. The agreement also provides for indemnification of the
officer for any costs or liabilities incurred by the officer in
connection with his employment.
13. COMMITMENTS AND CONTINGENCIES:
An affiliate of the Company leases office space, furniture, fixtures and
equipment under operating leases and during 1995 allocated a significant
portion of such costs to the Company based on estimated usage (see Note
11).
Future minimum lease payments (which reflect leases having noncancelable
lease terms in excess of one year) are as follows for the year ended
December 31:
Operating
Leases
--------
1997 $542,580
1998 305,697
1999 91,847
2000 16,567
2001 --
Thereafter --
--------
956,691
========
Rental expense under operating leases for the years ended December 31,
1996, 1995 and 1994 were approximately $524,000, $351,000, and $61,000,
respectively.
F-22
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
13. COMMITMENTS AND CONTINGENCIES, Continued:
The Company guaranteed a working capital line entered into by the
Company's majority shareholder. Total borrowings of $2,250,000 under
such line of credit were contributed to the Company as additional
paid-in capital during the year ended December 31, 1995. The
indebtedness of the majority shareholder is repaid from and
collateralized by a portion of cash flows from Finance Contracts
underlying certain securitization transactions completed by the majority
shareholder and affiliates owned by the majority shareholder. The
outstanding balance guaranteed by the Company at December 31, 1995 was
approximately $2,000,000. All amounts outstanding under the working
capital line, if any, are expected to be repaid from the sale of a
portion of the majority shareholder's common stock upon successful
completion by the Company of an initial public offering. In April 1996,
the Company made a payment of $89,000 as a principal reduction in the
working capital line to bring the outstanding balance to the maximum
permitted outstanding amount as of March 31, 1996. Effective September
26, 1996 the Company was released from its guarantee of the
shareholder's debt for a release fee of $125,000.
The Company is the plaintiff or the defendant in several legal
proceedings that its management considers to be the normal kinds of
actions to which an enterprise of its size and nature might be subject,
and not to be material to the Company's overall business or financial
condition, results of operations or cash flows.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The estimated fair value amounts have been determined by the Company,
using available market information and appropriate valuation
methodologies. However, considerable judgment is necessarily required in
interpreting market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily
indicative of the amounts that the Company would realize in a current
market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated
fair value amounts. The following methods and assumptions were used to
estimate the fair value of each class of financial instruments for which
it is practicable to estimate that value.
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short
maturity of those investments.
NOTE PAYABLE, REVOLVING CREDIT BORROWINGS AND REPURCHASE AGREEMENT
The fair value of the Company's debt is estimated based upon the quoted
market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities and
characteristics. The revolving credit lines are variable rate loans,
resulting in a fair value that approximates carrying cost at December
31, 1996. Additionally, due to the December borrowing date, the note
payable and repurchase agreement fair values approximated cost at
December 31, 1995.
FINANCE CONTRACTS HELD FOR SALE
The fair value of Finance Contracts held for sale is based on the
estimated proceeds expected on securitization of the Finance Contracts
held for sale.
F-23
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
14. FAIR VALUE OF FINANCIAL INSTRUMENTS, Continued:
EXCESS SERVICING RECEIVABLE
The fair value is determined based on discounted future net cash flows
utilizing a discount rate that market participants would use for
financial instruments with similar risks. Due to the nature of this
financial instrument and the relative recency of the securitization
transaction date, the carrying amount approximates fair value.
The estimated fair values of the Company's financial instruments at
December 31, 1995 and 1996 are as follows:
1995 1996
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
Cash and cash equivalents $ 92,660 $ 92,660 $ 4,121,342 $ 4,121,342
Finance Contracts held for sale, net 3,354,821 3,854,821 228,428 228,428
Class B Certificates 2,834,502 2,834,502 10,465,294 10,465,294
Excess servicing receivable 846,526 846,526 4,247,274 4,247,274
Note payable 2,674,597 2,674,597 10,174,633 10,174,633
Revolving credit borrowings 1,150,421 1,150,421 -- --
Repurchase agreement 1,061,392 1,061,392 -- --
15. SUPPLEMENTAL CASH FLOW DISCLOSURES:
Supplemental cash flow information with respect to payments of interest
is as follows:
Year Ended December 31,
--------------------------------------
1994 1995 1996
---- ---- ----
Interest paid $ 19,196 $2,099,867 $1,885,322
No income taxes were paid during fiscal 1994, 1995 or 1996.
16. SUBSEQUENT EVENTS:
Effective February 5, 1997, the Company through its wholly owned
subsidiary AutoBond Funding II, obtained a warehouse line of credit of
$50,000,000 with Daiwa Finance Corporation for a fourteen month period.
This line of credit does not require that the loans funded be covered by
default deficiency insurance. The interest rate applied to this line of
credit is the lesser of (x) 30 day LIBOR plus 1.15% or (y) 11% per
annum. The agreement requires the Company pay a non-utilization fee of
.25% per annum on the amount of the line unused. Pursuant to this line
of credit, the Company paid a $243,750 commitment fee. The Debt issuance
costs will be amortized as interest expense through April 1998,
utilizing the effective interest method.
In January 1997, the Company granted 40,000 options to officers and
employees.
F-24
SCHEDULE II
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance Charged Balance
at Beginning Cost and at End
Description of Period Expenses Deductions (A) of Period
----------- ------------ --------- -------------- ----------
Allowance for Credit Losses:
Period from August 1, 1994
(Inception) to December 31, 1994 $ -- $ 45,000 $ -- $ 45,000
Year ended December 31, 1995 $ 45,000 $ 48,702 $ -- $ 93,702
Year ended December 31, 1996 $ 93,702 $412,387 $(480,889) $ 25,200
(A) Deductions in 1996 were write-offs of uncollectible finance contracts.
S-1
EXHIBIT INDEX
Exhibit No. Description of Exhibit Page No.
---------- ---------------------- --------
3.1* -- Restated Articles of Incorporation of the Company
3.2* -- Amended and Restated Bylaws of the Company
4.1* -- Specimen Common Stock Certificate
10.1* -- Amended and Restated Loan Origination, Sale and
Contribution Agreement dated as of December 15, 1995
by and between the Company and AutoBond Funding
Corporation I
10.2* -- Security Agreement dated as of May 21, 1996 among
AutoBond Funding Corporation II, the Company and Norwest
Bank Minnesota, National Association
10.3* -- Credit Agreement and Side Agreement, dated as of May 21,
1996 among AutoBond Funding Corporation II, the Company and
Peoples Life Insurance Company
10.4* -- Servicing Agreement dated as of May 21, 1996 among
AutoBond Funding Corporation II, CSC Logic/MSA L.L.P., doing
business as "Loan Servicing Enterprise", the Company and
Norwest Bank Minnesota, National Association
10.5* -- Loan Acquisition Sale and Contribution Agreement dated as
of May 21, 1996 by and between the Company and AutoBond
Funding Corporation II
10.6* -- Second Amended and Restated Secured Revolving Credit
Agreement dated as of July 31, 1995 between Sentry
Financial Corporation and the Company
10.7* -- Management Administration and Services Agreement dated as
of January 1, 1996 between the Company and AutoBond, Inc.
10.8* -- Employment Agreement dated November 15, 1995 between
Adrian Katz and the Company
10.9* -- Employment Agreement dated February 15, 1996 between
Charles A. Pond and the Company
10.10* -- Employment Agreement effective as of May 1, 1996 between
William O. Winsauer and the Company
10.11* -- Vender's Comprehensive Single Interest Insurance Policy and
Endorsements, issued by Interstate Fire & Casualty Company
i
10.12* -- Warrant to Purchase Common Stock of the Company dated
March 12, 1996
10.13* -- Employee Stock Option Plan
10.14* -- Dealer Agreement dated November 9, 1994, between the
Company and Charlie Thomas Ford, Inc.
10.15* -- Automobile Loan Sale Agreement, dated as of September 30,
1996, among the Company, First Fidelity Acceptance Corp.,
and Greenwich Capital Financial Products, Inc.
10.16 -- Servicing Agreement, dated as of January 29, 1997,
between CSC LOGIC/MSA L.P.P., doing business as "Loan
Servicing Enterprise" and the Company
10.17 -- Credit Agreement, dated as of February 1, 1997, among
AutoBond Funding Corporation II, the Company and Daiwa
Finance Corporation
10.18 -- Security Agreement, dated as of February 1, 1997, by and
among AutoBond Funding Corporation II, the Company and
Norwest Bank Minnesota, National Association
10.19 -- Automobile Loan Sale Agreement, dated as of March 19,
1997, by and between Credit Suisse First Boston
Mortgage Capital L.L.C., a Delaware limited liability
company, and the Company
16.1* -- Change in certifying accountant's letter
21'D' -- Subsidiaries of the Company
27.1'D' -- Financial Data Schedule
ii
* Incorporated by reference from the Company's Registration Statement on
Form S-1
(Registration No. 333-05359).
'D' Filed herewith.
iii
STATEMENT OF DIFFERENCES
The dagger symbol shall be expressed as .................'D'