While there haven't been many success stories for the small home equity specialty finance lenders of the 1990s, Delta Financial is perhaps the Energizer Bunny of the sector.

The company is planning its next deal within a month, likely with either RBC Greenwich Capital or Wachovia Securities as lead manager, both of which have led Delta deals over the past year. Since its headline debt restructuring in summer 2001, the company has included a triple-A wrap on top of its senior subordinate, natural triple-A notes, via Financial Security Assurance. Delta placed its most recent deal in the wee hours of 2002 - the day after Christmas, in fact.

The New York-based subprime lender, in the business for more than 20 years, was one of the first to be targeted by anti-abuse advocates in late 1998, and subsequently settled with the New York State Banking Department for what amounted to about $12 million in charges. The settlement enraged the state New York Office of the Attorney General, which had initially filed a complaint, though it was not originally part of the $12 million settlement (finder's fee?). The NYOAG later joined with the Banking Department. The $12 million charges, however, were mostly related to Delta lowering interest rates for some of its lower-credit borrowers, and a sizeable stock contribution to fund public service programs that involved consumer education.

Of course, throughout the proceedings, the company maintained that it hadn't violated any laws and, and, despite the impression that predatory lenders are after their borrower's homes, an official was quoted by ASR as saying, "We lose money on virtually every foreclosure."

It was also learned that much of the questionable lending activity was associated with third-party brokers that Delta purchased loans through - not benefiting from the excessive "predatory" fees the brokers might have been charging. The company substantially tightened its loan purchase process through more rigid underwriting standards and also discontinued relationships, Delta's CEO Hugh Miller told ASR at the time.

Nevertheless, the incident prompted uncertainty and subsequent scrutiny on the part of the rating agency (credit watch) on several of Delta's securitizations, and was a factor in the postponement of a third quarter ABS offering that year (1999).

The following year, Delta reached a compliance-related agreement with the Department of Justice (DOJ), the Department of Housing and Urban Development (HUD) and the Federal Trade Commission (FTC).

Later in 2000, Delta announced a debt restructuring agreement with its high yield debt holders (approximately $150 million was outstanding), amending an indenture that was preventing the cash-strapped company from leveraging its residual interests. Around the same time, the company announced that it was shedding a portion of its workforce. In the beginning of 2001, Delta sold its servicing rights to Ocwen Financial Corp., which then became responsible for the servicing advances, collecting excess servicing fees.

While companies in Delta's pier group - such as United Companies Financial Corp., First Plus Corp., or the larger ContiFinancial - began dropping like fumigated flies, Delta kept on ticking. Other companies merely exited the home equity market, such as Providian Financial Corp. and Advanta Corp.

At what might have been the company's rock-bottom moment, Delta began an ambitious effort to extinguish its outstanding high yield debt, or else fail to "continue as a going concern," a company spokesman told ASR as the effort ensued.

After numerous stabs at a feasible structure (and frequent amended filings with the Securities & Exchange Commission), Delta was essentially able to package its existing portfolio of residuals and other mortgage-related assets - from its $6 billion-area in outstanding securitizations - into a newly created entity. This new "corporation" would issue preferred shares based on the residual cash flow. The company's debt holders were given corresponding equity positions in the new entity in exchange for the outstanding $140 million of senior-secured and unsecured notes paying 9.5% and due 2004.

Perhaps remarkable in its own right, this restructuring was an in-house job - e.g., the company and its legal advisors pulled it off without the help of an investment bank.

Quarters of profitability

Talk about a turnaround, Delta is now regularly receiving awards for its contribution to low-income communities by way of charity, borrower awareness programs and other initiatives. In fact, in January Delta scored its second consecutive Martin Luther King Jr. Day Award for Community Services, from the Caribbean Images Television.

For the quarter ending Dec. 31, 2002 Delta reported its first full year-over-year of consecutive profitable quarters and consecutive quarter-over-quarter growth in earnings since its debt restructuring.

"We were not only cash flow positive for the entire year 2002, we were cash flow positive each and every quarter throughout the year," said Richard Blass, chief financial officer and treasurer at Delta. "Not many financial services companies are cash flow positive. Many of these companies must rely on short-term borrowings - i.e., commercial paper or investment notes to fund their business. We organically generate our own working capital to fund our business."

Delta's originations grew significantly in 2002, as the company posted an 84% increase in the 4Q02 versus 4Q01. The company has also successfully lowered its origination costs, improving loan-by-loan profitability - both of which are at least partially associated with an increase in average loan size to $108,000 from $81,000 in 2001. Increasing loan size is advantageous as many of the origination costs are fixed regardless of loan size. Similarly, expenses in the foreclosure process are often independent of loan size, which translates into higher recovery rates on pools of larger loans.

In May 2001, Delta revised and tightened its underwriting criteria, and has seen significant improvement in pool performance, noticeable in the 2001-2 securitization and forward, Blass said. According to statistics from Fitch Ratings, Delta's 2001-2 is showing a 0.20% cumulative loss rate versus 0.79% for the 2001-1 deal, and 1.02% and 2.09% for the 2000-4 and 2000-2 deals, respectively. The four deals Delta has issued under the Renaissance Mortgage Acceptance Corp. brand, which includes all of Delta's deal since the 2001-2 transaction, have yet to show losses.

Like other mortgage lenders, Delta saw a decent increase in business and higher margins associated with historically low interest rates.

"[Low rates] have helped in our securitization execution somewhat," Blass said. "We are anticipating some lower securitization gains in 2003 (factored into our guidance for 2003) as a result of a potential increase in rates."

The company plans to continue increasing loan originations from 2002 levels, by expanding its presence in existing markets, increasing average loan size, and leveraging off of its retail origination centers in various locations across the country, Blass said.

Throughout the years, Delta has used a pre-funding feature in it securitizations, which allows it to lock in current pricing for future delivery of collateral, and mitigate interest rate risk. The company incorporated a pre-funding sale into its last two deals, whereby it promises to deliver within a specified period of time collateral with pre-determined specifications, such as weighted average coupon, loan-to-value ratios and FICO scores.

The company securitizes about 90% of its production, and sells the rest wholesale, generally to buy and hold investors, rather than the Street.

"The competitive advantage we have in securitizing our loans, versus selling off the loans vis-a-vis a whole loan trade, is that we retain the ability to see how our loans perform over time and can, from a risk-management perspective, tweak our underwriting guidelines or make more significant changes," Blass said.

Of course time will ultimately tell the future of Delta Financial. All subprime lenders are facing a somewhat uncertain forecast on consumer credit, as well as the likelihood of rising interest rates this year, which could squeeze securitization margins, plus uncertainty of war and terror risk. For now though, Delta seems like a company that can take a licking.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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