ITEM 1. BUSINESS.
OVERVIEW
Advanta Corp. (the "Company," the "Registrant" or "Advanta") serves consumers and small businesses through innovative products and services via direct and indirect, cost effective delivery systems. In 1997, the Company primarily originated and serviced credit cards, mortgages, small-ticket equipment leases, auto loans, credit insurance and deposit products. The Company utilizes customer information attributes including credit assessments, usage patterns, and other characteristics enhanced by proprietary information to match customer profiles with appropriate products. At year-end 1997 managed assets totaled $21.1 billion and an additional $9.2 billion in assets were serviced for third parties.
On February 20, 1998, Advanta and certain of its direct and indirect subsidiaries contributed substantially all of the assets of its consumer credit card business to a newly formed Rhode Island limited liability company (the "LLC") controlled by Fleet Financial Group, Inc. ("Fleet"). In the transaction (the "Transaction"), completed under the terms of a Contribution Agreement between Advanta and Fleet (the "Contribution Agreement") dated as of October 28, 1997, each of Advanta and certain of its direct and indirect subsidiaries and Fleet and certain of its direct and indirect subsidiaries contributed substantially all of the assets of their respective consumer credit card businesses, subject to liabilities, to the LLC. Advanta acquired a minority interest of 4.99% in the LLC. Following the Transaction, Advanta continues to operate its mortgage, business services and insurance businesses, including its depository institutions Advanta National Bank ("ANB") and Advanta Financial Corp. ("AFC"). In addition, Advanta retained certain immaterial assets of its consumer credit card business which are not required in the operation of such business and certain liabilities related to its consumer credit card business, including, among others, all reserves relating to its credit insurance business and any liability or obligation relating to certain consumer credit card accounts generated in specific programs which comprise a very small portion of the Company's consumer credit card receivables. Subsequent to the consummation of the Transaction, certain interim services are being provided by each of Advanta and Fleet to the other in accordance with the terms of the Contribution Agreement.
The Company was incorporated in Delaware in 1974 as Teachers Service Organization, Inc., the successor to a business originally founded in 1951. In January 1988, the Company's name was changed from TSO Financial Corp. to Advanta Corp. The Company's principal executive office is located at Welsh & McKean Roads, P. O. Box 844, Spring House, Pennsylvania 19477-0844. The Company's telephone number at its principal executive office is (215) 657-4000. References to the Company in this Report include its consolidated subsidiaries unless the context otherwise requires.
ADVANTA PERSONAL FINANCE SERVICES
Advanta Personal Finance Services, a business unit of Advanta ("Advanta Mortgage" or "personal finance"), capitalizes on numerous niche opportunities primarily in the home equity industry by offering a broad range of services to consumers, brokers and other originators of home equity loans throughout the country. Advanta Mortgage originates, purchases, securitizes, and services non-conforming credit first and second lien home equity loans, and home equity lines of credit, directly through subsidiaries of Advanta, including ANB and Advanta Mortgage Corp. USA. Loan production is generated through multiple distribution channels. Home equity loans and home equity lines of credit are originated directly from consumers using targeted direct mail and direct response television techniques, and through a branch office system ("Advanta Finance") of 56 branches throughout the country. First and second mortgage loans are also originated through a broker network, correspondent relationships and purchases from other financial institutions. In 1997, loans originated and purchased by Advanta Mortgage amounted to $3.7 billion compared to $1.5 billion in 1996.
In November 1996, Advanta Mortgage established its Corporate Finance Services business to capitalize on new opportunities in the growing mortgage industry. Corporate Finance Services solicits third-party originators who believe it is more cost efficient to participate in securitizations sponsored by Advanta Mortgage and such third-party originators receive an interest in the Company sponsored securitizations. The
Corporate Finance Services business has experienced significant growth in 1997. Purchases of loans by this business, which totaled $40 million in 1996, totaled $1.1 billion in 1997.
In addition to servicing and managing the loans it originates, Advanta Mortgage contracts with third parties to service their home equity loans on a sub-servicing basis. Advanta Mortgage's portfolio of third party loans serviced for a fee totaled $9.2 billion at year-end 1997, an increase of $5.5 billion from year-end 1996. The Company has experienced significant growth in this portfolio over the past two years as a result of its favorable reputation in the nonconforming mortgage market and anticipates continued expansion of its market presence. The Company bears no credit risk on this portfolio. Subserviced loans are not included in the Company's managed portfolio.
Advanta Mortgage generally funds the loans it originates and purchases through sales or securitizations which have been structured to qualify as real estate mortgage investment conduits ("REMICs") under the Internal Revenue Code. In a securitization, Advanta Mortgage typically sells receivables to a trust for cash while retaining an interest in the loans securitized. The cash purchase price is generated through an offering of pass-through certificates by the trust. The purchasers of the pass-through certificates are generally entitled to the principal and a portion of the interest collected on the underlying loans while Advanta Mortgage retains the servicing and an interest-only strip. The retained interest-only strip represents the remaining interest collected from the borrowers on the underlying loans after the payment of pass-through interest to the certificate holders and the payment of a servicing fee to the Company in its role as servicer and is partially offset by the estimated fair value of the Company's recourse obligation for anticipated charge-offs. During 1997, Advanta Mortgage securitized $3.4 billion of loans compared to $1.4 billion in 1996.
The cash flows from the interest-only strips are received over the life of the loans. However, in accordance with generally accepted accounting principles ("GAAP"), Advanta Mortgage recognizes a gain at the time of the sale equal to the excess of the fair value of the assets obtained, principally cash, over the allocated cost of the assets sold and transaction costs. Other basic sources of income to Advanta Mortgage are net interest income on loans outstanding pending their sale and loan servicing income, including subservicing of loans which are never owned by the Company. (See Note 1 to Consolidated Financial Statements.)
Advanta Mortgage's managed portfolio of receivables includes owned loans (generally held for sale) and the loans it services in which it retains an interest-only strip. At December 31, 1997, owned personal finance loans receivable totaled $478 million while total managed receivables were $5.3 billion. In contrast to the subserviced loans described above, the performance of the managed portfolio, including loans sold by the Company, can materially impact ongoing income from personal finance activities. See Note 1 to Consolidated Financial Statements. At December 31, 1997, the total serviced portfolio, including the "subserviced" portfolio, was $14.5 billion compared to $6.4 billion at December 31, 1996.
Approximately 92% of the managed portfolio is secured by first lien position loans and the balance is secured by second lien position loans. Approximately 63% of the managed portfolio is comprised of fixed rate loans while the remainder represents adjustable rate loans and intermediate rate loans which bear interest at a fixed rate for a period of two to three years and an adjustable rate thereafter. At December 31, 1997, total
personal finance loans managed, and the nonperforming loans included in these totals, are concentrated in the following five states:
Geographic concentration carries a risk of increased delinquency and/or loss if a specific area suffers an economic downturn. Advanta Mortgage monitors economic conditions in those regions through market and trend analyses. A Credit Policy Committee meets throughout the year to update lending policies based on the results of analyses, which may include abandoning lending activities in economically unstable areas of the country. The Company believes that the concentrations of nonperforming loans reflected in the preceding table are not necessarily reflective of general economic conditions in each region, but rather reflect the credit risk inherent in the different grades of loans originated in each area. The interest rate charged and the maximum loan-to-value ratio permitted with respect to each grade of loans are adjusted to compensate for the credit risk inherent in the loan grade.
Advanta Mortgage also engages in the indirect financing of automotive purchases by consumers in the near-prime market, which are those consumers who have experienced credit problems, are attempting to re-establish credit, may not yet have sufficient credit history or do not wish to deal with traditional sources of financing. Auto finance contracts are purchased from correspondent originators on a flow basis or in bulk purchases. In 1996 and 1997, auto loans purchased amounted to $104 million and $195 million, respectively.
In 1997, approximately 21% of the Company's total revenues net of credit losses were derived from Advanta Mortgage.
ADVANTA BUSINESS SERVICES
Advanta Business Services, a business unit of Advanta ("ABS" or "business loans and leases"), offers flexible lease financing programs on small-ticket equipment and corporate credit cards to small businesses. ABS is one of the nation's leading providers of these products to small businesses.
The commercial equipment leasing business is generated primarily through third party referrals from manufacturers or distributors of equipment as well as independent brokers. Most contact with these referral sources is made from the Company's ABS headquarters in Voorhees, New Jersey, using extensive direct marketing operations. These operations include a staff of telephone sales representatives who are assigned to specific industries, and are backed by the Company's direct mail marketing program. Additional business is also generated from direct contact with customers through these same channels.
The primary markets of the leasing business include office machinery, security systems and computers. ABS has also expanded its presence into additional market segments. The most significant of these are leasing programs for certain industrial and agricultural equipment and programs for leasing equipment to agencies of state and local governments. Additionally, ABS has expanded its National Accounts program which seeks referral business from larger distributors and manufacturers. Managed lease receivables at December 31, 1997 totaled approximately $595 million, an increase of approximately $75 million from year end 1996.
The business-purpose credit card operation grew from approximately 79,000 accounts with balances of $306 million in 1996 to approximately 170,000 accounts with balances of $663 million as of December 31, 1997. Direct marketing techniques, primarily direct mail to prospective customers, are the source of new accounts. This marketing program is the result of extensive and ongoing testing of various campaigns, with success of each campaign measured by both the cost of acquisition of new business, and the credit performance of the resulting business. The "Advanta Business Card" is marketed by ABS and issued by its affiliate, AFC (see "Government Regulation -- Advanta Financial Corp.").
ADVANTA INSURANCE COMPANIES
Advanta's insurance subsidiaries ("Advanta Insurance") make available, through unaffiliated insurance carriers, specialty credit related insurance products and services to Advanta's existing customer base. The focus of these products is on the customers' ability to repay their debt in the event of certain circumstances. These products include a combined credit life, disability and unemployment program, an accidental death program and equipment insurance. Enrollment in these programs is achieved through Advanta's direct mail or telemarketing distribution channels. In consideration, the lending subsidiary of Advanta that extends the loan to Advanta's customers receives as an expense reimbursement, a percentage of insurance premiums collected by the unaffiliated insurance carriers.
In addition, ANB (and its predecessors by merger) makes available to the consumer credit card customers of APPS in certain states the option to purchase debt cancellation products called Credit Protection Plus(R) and Credit Protector(R). ANB (and its predecessors by merger) has purchased from Advanta Insurance insurance protection against excess losses, as defined, incurred from providing these services.
In certain circumstances, Advanta Insurance reinsures all or a portion of certain risks associated with these products or services. Advanta Insurance's reinsurance agreements provide for a proportional quota share of 100% of these risks from the insurance carriers. In consideration for assumption of these risks, the Advanta Insurance receives reinsurance premiums equal to 100% of the net premiums collected by the insurance carriers, less a ceding fee as defined by the reinsurance treaties, and all acquisition expenses, premium taxes and loss payments made by the carriers on these risks. Under the terms of certain reinsurance agreements Advanta Insurance is either obligated to maintain in trust for the benefit of an insurance carrier an amount equal to 100% of the unearned premiums and all statutory reserves for future incurred loss payments. Advanta Insurance has entered into an aggregate excess of loss reinsurance treaty for its accidental death risks with an unaffiliated insurance carrier. Under the terms of the treaty, losses in excess of a specified percentage of earned premium levels will be reimbursed by the insurance carrier. In addition, the treaty provides for certain experience refunds.
In connection with the contribution of Advanta's consumer credit card business to the LLC, all of ANB's credit card customer relationships underlying the insurance risks reinsured by Advanta Insurance were transferred to Fleet or its subsidiaries. Following the closing under the Contribution Agreement on February 20, 1998, Advanta Insurance no longer reinsures these insurance risks and will not recognize any reinsurance revenues as provided under the reinsurance agreements. Advanta Insurance is, however, responsible to reimburse the unaffiliated insurance carriers for losses paid and maintain loss reserves on losses incurred on risks assumed on or prior to February 20, 1998. Additionally, following the Transaction with Fleet, ANB is responsible for customers who request activation of their debt cancellation agreements for events covered under these agreements occurring on or prior to February 20, 1998. ANB is responsible for all reserves for expenses related to these future activations. Following the contribution of Advanta's consumer credit card business to the LLC, Advanta Insurance continues to make its insurance products available to the Company's personal finance and business loan and leasing customers. However, a significant portion of Advanta Insurance's total revenues in 1997 were derived from the sale of its combined insurance product and services to consumer credit card customers of APPS.
Pursuant to a strategic alliance formed in 1996 with Progressive Casualty Insurance Company ("Progressive"), Advanta Insurance is direct marketing Progressive's automobile insurance policies nationwide. Advanta Insurance and Progressive also entered into a quota share reinsurance agreement that provides that
Advanta's insurance subsidiary assumes 50% of all risks on automobile policies written by Progressive under the insurance programs being jointly marketed. Generally, automobile policies underwritten by Progressive provide for automobile liability protection up to $500,000 and automobile physical damage protection up to $100,000 as defined under specific policy and customer requirements.
ADVANTA PARTNERS
Advanta Partners LP ("Advanta Partners") is a private venture capital equity investment firm formed in 1994. The firm focuses primarily on growth capital financings, restructurings and management buyouts in the financial services and information services industries. The investment objective of Advanta Partners is to earn attractive returns by building the long-term values of the businesses in which it invests. Advanta Partners combines transaction expertise, management skills and a broad contact base with strong industry-specific knowledge which is further enhanced by its relationship with the Company.
ADVANTA PERSONAL PAYMENT SERVICES
Prior to the contribution of substantially all of the assets of the Company's consumer credit card business to the LLC, the Company offered consumer credit cards through Advanta Personal Payment Services, a business unit of Advanta ("APPS" or "consumer credit cards"). The Company, which had been in the credit card business since 1983, issued gold (i.e., premium) and standard MasterCard(R)* and VISA(R)* credit cards nationwide. APPS had built a substantial cardholder base which, as of December 31, 1997, totaled 5.9 million accounts and $11.2 billion in managed receivables. The primary method of account acquisition was direct mail solicitation and APPS generally used credit scoring by independent third parties and proprietary market segmentation and targeting models to target its mailings to profitable segments of the market.
In 1982, the Company acquired Colonial National Bank USA, the name of which was changed to Advanta National Bank USA ("AUS") in May 1996. In 1995, the Company chartered Advanta National Bank ("Old ANB") to complement the credit card activities of AUS. Old ANB was a limited purpose national bank known as a "credit card bank" and its lending activities were limited to consumer credit card lending. See "Government Regulation -- Advanta National Bank." Effective June 30, 1997, Old ANB was merged into AUS and AUS was renamed Advanta National Bank (previously defined herein as ANB). As national banks, AUS and Old ANB, and now ANB, have had the ability to make loans to consumers without many of the restrictions found in various state usury and licensing laws, to negotiate variable rate loans, to generate funds economically in the form of deposits insured by the Federal Deposit Insurance Corporation ("FDIC"), and to include in their product mix both MasterCard and VISA credit card programs.
MasterCard and VISA license banks, such as ANB and other financial institutions, to issue credit cards using their trademarks and to utilize their interchange networks. Cardholders may use their cards to make purchases at participating merchants or to obtain cash advances at participating financial institutions. Cardholders may also use special credit line drafts issued by the banks to draw against their Visa or MasterCard credit lines for cash, purchases or balance transfers. Each credit card transaction is submitted to a merchant bank which remits to the merchant the purchase amount less a merchant discount fee, and submits the purchase to the card issuing bank for payment through the appropriate settlement system. The card issuing bank receives an interchange fee as compensation for the funding and credit and fraud risk that it takes when its customers use its credit card. MasterCard or VISA sets the interchange fee as a percentage of each card transaction (averaging approximately 1.4% in 1997).
APPS generated interest and other income from its credit card business through finance charges assessed on outstanding loans, interchange income, cash advance and other credit card fees, and securitization income as described below. Credit card income also included fees paid by credit card customers for product enhancements they selected, and revenues paid to ANB (and its predecessors by merger) by third parties for the right to market their products to the APPS credit card customers.
- --------------- * MasterCard(R) is a federally registered servicemark of MasterCard International, Inc.; VISA(R) is a federally registered servicemark of VISA, U.S.A., Inc.
Most of such MasterCard and VISA credit cards carried no annual fee, and those credit cards which included an annual fee generally had lower fees than those charged by many of APPS' competitors. The interest rates on the majority of APPS' credit card receivables were variable, tied either to the prime rate or the London interbank offered rate ("LIBOR"). This variable rate structure helped APPS maintain net interest margins in both rising and declining interest rate environments.
The following table shows the geographic distribution by state of total managed consumer credit card receivables among the top five states, together with the impaired credit card receivables in those states as of December 31, 1997:
Since 1988, APPS, through ANB (and its predecessors by merger), has been active in the consumer credit card securitization market. Through 1997 and up to the closing of the Transaction with Fleet, the Company recognized income on a monthly basis from the securitized receivables. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Notes 1 and 3 to Consolidated Financial Statements.
On February 20, 1998, in connection with the contribution of the Company's consumer credit card business to the LLC, the assets and liabilities relating to ANB's consumer credit card securitizations and servicing capabilities and obligations were transferred to the LLC.
Prior to the contribution of the consumer credit card business to the LLC, the consumer credit card securitization program provided a number of benefits: diversifying the funding base; providing liquidity; reducing regulatory capital requirements; lowering the cost of funds; and providing a source of variable-rate funding to complement the variable-rate credit card portfolio. Additionally, until September 30, 1996, securitization was important in helping to limit the on-balance sheet growth of AUS to less than 7% per annum. See "Government Regulation -- the Company."
A credit card securitization involves the transfer of the receivables generated by a pool of credit card accounts to a securitization trust. Certificates issued by the trust and sold to investors represent undivided ownership interests in receivables transferred to the trust. Accordingly, the credit card securitizations resulted in removal of the related credit card receivables from the Company's balance sheet for financial and regulatory accounting purposes. For tax purposes, the investor certificates were characterized as a collateralized debt financing of the Company.
In a credit card securitization, the trust receives finance and other charges paid by the credit card customers and pays a rate of return on a monthly or quarterly basis to the certificate holders. While in most cases the rate of return paid to investors in the securitization trusts was variable in order to match the pricing dynamics of the underlying receivables, the Company also used fixed rate securitizations in certain circumstances. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Asset/Liability Management." APPS serviced the accounts for a fee of approximately 2.0% of the securitized receivables. ANB (and its predecessors by merger) retained an interest-only strip representing the remaining interest and fees collected from credit card customers after the payment of pass-through interest to the certificate holders and the payment of a servicing fee to ANB (and its predecessors by merger) in its role
as servicer and is partially offset by the estimated fair value of the ANB's recourse obligation for anticipated charge-offs. Cash flows from the interest-only strip were first retained in the securitization trusts to build up a reserve fund to a certain level, after which amounts were remitted to ANB. APPS' relationship with its credit card customers was not affected by its securitizations.
Investors in the securitization trusts received payments only of interest during the first three to eight and one-half years of the trust. Thereafter, an amortization period (generally between six and ten months) commenced, during which the certificate holders are entitled to payment of principal and interest. Under the terms of ANB's credit card securitizations, the acceleration of the commencement of the amortization period (which could occur in limited circumstances) on a securitization would accelerate ANB's funding requirement. Upon full repayment of principal to the certificate holders, whether as a result of normal or accelerated amortization, the trust's lien on the accounts would terminate and all related receivables and funds held in the trust, including the reserve fund, would be transferred to ANB. On February 20, 1998, in connection with the Transaction with Fleet, Fleet and its subsidiaries assumed ANB's obligations as seller and servicer with respect to each of the credit card securitization trusts.
In 1997, approximately 59% of the Company's total revenues net of credit losses were derived from APPS.
DEPOSIT, SAVINGS AND INVESTMENT PRODUCTS
The Company offers a range of insured deposit products as well as uninsured bank notes through ANB (and previously through its predecessors by merger) and offers uninsured investment products of Advanta through both direct and underwritten sales of debt securities. In December 1996, Advanta Capital Trust I, a statutory business trust established by the Company, issued $100,000,000 of 8.99% Capital Securities, maturing in December 2026 (the "Capital Securities"). The Capital Securities represent a preferred beneficial interest in the assets of the trust. The proceeds of that offering were lent to the Company for general corporate purposes (See Note 7 to Consolidated Financial Statements). In October 1995, the Company ceased selling subordinated retail investment notes, and instead began offering senior retail investment notes which (like the previous subordinated notes) are marketed by print advertising and direct mail solicitations to existing and prospective individual investors. In addition to the senior retail investment note program, in July 1996 the Company filed a senior debt shelf registration with the Securities and Exchange Commission covering $1.6 billion of securities. As of December 31, 1997, $1.0 billion of debt securities had been issued under this shelf. The Company also filed a "universal shelf" registration statement in June 1995 for $500 million of debt and/or equity securities. In July 1995, $92.5 million of 6 3/4% Convertible Class B Preferred Stock was issued under that shelf.
Bank deposit products include demand deposits, money market savings, statement savings accounts, retail certificates of deposit; and large denomination certificates of deposit (certificates of $100,000 or more). Consumer deposit business is generated from repeat sales to existing depositors and from new depositors attracted by newspaper advertising and direct mail solicitations.
In addition to the funding diversity provided by the debt issuance capacity of the Company and the debt and deposit raising capabilities of ANB, AFC has been taking deposits in the form of certificates of deposit since January 1992. AFC is an FDIC-insured industrial loan corporation organized under the laws of the State of Utah. As of December 31, 1997, funding provided by AFC was not material to the Company.
GOVERNMENT REGULATION
THE COMPANY
The Company is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA"). The Company indirectly owns ANB, which is a "bank" as defined under the BHCA as amended by the Competitive Equality Banking Act of 1987 ("CEBA"). However, under certain grandfathering provisions of CEBA, the Company is not required to register as a bank holding company under the BHCA because ANB, which takes demand deposits but does not make commercial loans,
did not come within the BHCA's definition of the term "bank" prior to the enactment of CEBA and it complies with certain restrictions set forth in CEBA, such as limiting its activities to those in which it was engaged prior to March 5, 1987 and, prior to September 30, 1996, limiting its growth rate to not more than 7% per annum.
Prior to June 30, 1997, the Company owned two banks, AUS and Old ANB. The elimination of the growth cap of 7% under CEBA by amendment of the BHCA in September 1996 created substantial new flexibility with respect to asset/liability management for the Company's banks. Effective June 30, 1997, the Company merged Old ANB into AUS. The new bank was then renamed Advanta National Bank (previously defined herein as ANB). See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Asset/Liability Management -- Liquidity and Capital Resources."
Continuing CEBA restrictions also prohibit ANB from cross-marketing products or services of an affiliate that are not permissible for bank holding companies under the BHCA. In addition, the Company complies with certain other restrictions set forth in CEBA, such as not acquiring control of more than 5% of the stock or assets of an additional "bank" or "savings association" as defined for these purposes under the BHCA. Consequently, the Company is not subject to examination by the Federal Reserve Board (other than for purposes of assuring continued compliance with the CEBA restrictions referenced in this section). Should the Company or ANB cease complying with the restrictions set forth in CEBA, registration as a bank holding company under the BHCA would be required.
Registration as a bank holding company is not automatic. The Federal Reserve Board may deny an application if it determines that control of a bank by a particular company will cause undue interference with competition or that such company lacks the financial or managerial resources to serve as a source of strength to its subsidiary bank. While the Company believes that it meets the Federal Reserve Board's managerial standards and that its ownership of ANB has improved the bank's competitiveness, should the Company be required to apply to become a bank holding company the outcome of any such application cannot be certain.
Registration as a bank holding company would subject the Company and its subsidiaries to inspection and regulation by the Federal Reserve Board. Although the Company has no plans to register as a bank holding company at this time, the Company believes that registration would not restrict, curtail, or eliminate any of its activities at current levels, except that some portions of the current business operations of the Company's insurance subsidiaries would have to be discontinued, the effects of which would not be material. However, the Company is actively exploring additional lines of business, some of which the Company would not be able to pursue as a registered bank holding company under the BHCA.
Under CEBA, AFC is not considered a "bank" for purposes of the BHCA, and so the Company's ownership of it does not impact the Company's exempt status under the BHCA.
ADVANTA NATIONAL BANK
The Company acquired AUS in 1982, organized Old ANB in 1995, and merged the two banks effective June 30, 1997. After the merger, the surviving entity ANB is a national banking association organized under the laws of the United States of America. The headquarters and sole branch of ANB are currently located in Wilmington, Delaware. The Company conducts a large portion of its mortgage lending business and it conducted a large portion of its consumer credit card lending business through ANB (and its predecessors by merger). ANB is subject primarily to regulation and periodic examination by the Office of the Comptroller of the Currency (the "Comptroller"). Such regulation relates to the maintenance of reserves for certain types of deposits, the maintenance of certain financial ratios, transactions with affiliates and a broad range of other banking practices. As a national bank, ANB is subject to provisions of federal law which restrict its ability to extend credit to its affiliates or pay dividends to its parent company. See "Dividends and Transfers of Funds."
ANB is subject to capital adequacy guidelines issued by the Comptroller. These guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and consider off-balance sheet exposures in determining capital adequacy. Under the rules and regulations of the Comptroller, at least half of the total capital is to be comprised of common equity, retained earnings and a
limited amount of non-cumulative perpetual preferred stock ("Tier I capital"). The remainder may consist of other preferred stock, certain hybrid debt/equity instruments, a limited amount of term subordinated debt or a limited amount of the reserve for possible credit losses ("Tier II capital"). The Comptroller has also adopted minimum leverage ratios (Tier I capital divided by total average assets) for national banks. Recognizing that the risk-based capital standards address only credit risk (and not interest rate, liquidity, operational or other risks), many national banks are expected to maintain capital in excess of the minimum standards.
In addition, pursuant to certain provisions of the FDIC Improvement Act of 1991 ("FDICIA") and regulations promulgated thereunder with respect to prompt corrective action, FDIC-insured institutions such as ANB may only accept brokered deposits without FDIC permission if they meet certain capital standards, and are subject to restrictions with respect to the interest they may pay on deposits unless they are "well-capitalized." To be "well-capitalized," a bank must have a ratio of total capital (combined Tier I and Tier II capital) to risk-weighted assets of not less than 10%, Tier I capital to risk-weighted assets of not less than 6%, and a Tier I leverage ratio of not less than 5%.
As of December 31, 1997, ANB's Tier I capital ratio was 12.93%, its combined Tier I and Tier II capital ratio was 16.39%, and its leverage ratio was 14.07%, each of which meets the requirements of the Comptroller and makes ANB well-capitalized under the regulatory framework described above.
ADVANTA FINANCIAL CORP.
In January 1992, AFC opened for business and began accepting deposits. AFC is an FDIC-insured industrial loan corporation organized under the laws of the State of Utah and is subject to examination and regulation by both the FDIC and the Utah Department of Financial Institutions. At December 31, 1997, AFC had deposits of $195 million and total assets of $236 million. Currently, AFC's principal activities consist of small ticket equipment lease financing and issuance of the "Advanta Business Card" credit card marketed by ABS. The Company anticipates that AFC's managed receivables base of Advanta Business Card loans will continue to grow in 1998.
LENDING AND LEASING ACTIVITIES
The Company's activities as a lender are also subject to regulation under various federal and state laws including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Community Reinvestment Act, the Electronic Funds Transfer Act, the Real Estate Settlement Practices Act and the Fair Credit Reporting Act. Provisions of those statutes, and related regulations, among other matters, require disclosure to borrowers of finance charges in terms of an annual percentage rate, prohibit certain discriminatory practices in extending credit, require the Company's FDIC-insured depository institutions to serve the banking needs of their local communities and regulate the dissemination and use of information relating to a borrower's creditworthiness. Certain of these statutes and regulations also apply to the Company's leasing activities. In addition, Advanta Mortgage, Advanta Finance and their respective subsidiaries are subject to licensure and regulation in various states as mortgage bankers, mortgage brokers, and originators, sellers and servicers of mortgage loans.
DIVIDENDS AND TRANSFERS OF FUNDS
There are various legal limitations on the extent to which ANB or AFC can finance or otherwise supply funds through dividends, loans or other means to the Company and its affiliates. The prior approval of the Comptroller is required if the total of all dividends declared by ANB in any calendar year exceeds that institution's net profits (as defined) for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus accounts. In addition, ANB is not permitted to pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts. The Comptroller also has authority under the Financial Institutions Supervisory Act to prohibit a national bank from engaging in any unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the Comptroller could claim that a dividend payment might under some circumstances be an unsafe or unsound practice.
ANB and AFC are also subject to restrictions under Sections 23A and 23B of the Federal Reserve Act. These restrictions limit the transfer of funds by the depository institution to the Company and certain other affiliates, as defined in that Act, in the form of loans, extensions of credit, investments or purchases of assets, and they require generally that the depository institution's transactions with its affiliates be on terms no less favorable to the bank than comparable transactions with unrelated third parties. These transfers by any one institution to the Company or any single affiliate are limited in amount to 10% of the depository institution's capital and surplus and transfers to all affiliates are limited in the aggregate to 20% of the depository institution's capital and surplus. Furthermore, such loans and extensions of credit are also subject to various collateral requirements. In addition, in order for the Company to maintain its grandfathered exemption under CEBA, ANB is not permitted to make any loans to the Company or any of its subsidiaries.
REGULATION OF INSURANCE
The Company's insurance subsidiaries are subject to the laws and regulations of, and supervision by, the states in which they are domiciled or have obtained authority to transact insurance business. These states have adopted laws and regulations which govern all marketing, licensing, administration and financial operations of an insurance company, including dividend payments and financial solvency. In addition, the insurance subsidiaries have registered as an Arizona Holding Company which requires an annual registration and the approval of certain transactions between all affiliated entities.
The maximum dividend that any of the insurance subsidiaries can distribute to its parent in any twelve month period without prior approval of the State of Arizona Department of Insurance is the lesser of 10% of the subsidiary's statutory surplus or for any given twelve-month period, its net income (if a life insurance company) or net investment income (if a property and casualty insurance company). In 1997, one of the Company's insurance subsidiaries applied and received approval for an extraordinary dividend in the amount of $40.6 million payable to the Company, mainly consisting of common stock of another insurance subsidiary as part of an ownership restructuring.
The State of Arizona has adopted minimum risk-based capital standards as developed by the National Association of Insurance Commissioners. Risk-based capital is the quantification of an insurer's investment, underwriting, reserve and business risks in relation to its total adjusted capital and surplus. The ratio of an insurer's total adjusted capital and surplus, as defined, is compared to various levels of risk-based capital to determine what intervention, if any, is required by either the insurance company or an insurance department. The Company's insurance subsidiaries meet all risk-based capital standards and require no action by any party.
The Company's insurance subsidiaries reinsure risks pursuant to underwriting insurance practices and rates which are regulated in part or fully by state insurance departments. These rates are continually being reviewed and modified by the state insurance departments based on prior historical experience. Any modifications may impact the future profitability of the Company's insurance subsidiaries.
GENERAL
Because the banking and finance businesses in general are the subject of such extensive regulation at both the state and federal levels, and because numerous legislative and regulatory proposals are advanced each year which, if adopted, could affect the Company's profitability or the manner in which the Company conducts its activities, the Company cannot now predict the extent of the impact of any such new laws or regulations.
Various legislative proposals have been or will be introduced in Congress, including, among others, proposals relating to permitting affiliations between banks and commercial or securities firms and statutory changes to the Real Estate Settlement Practices Act and the Truth in Lending Act. It is impossible to determine whether any of these proposals will become law and, if so, what impact they will have on the Company.
COMPETITION
As a marketer of credit products, the Company faces intense competition from numerous providers of financial services. Many of these companies are substantially larger and have more capital and other resources than the Company. Competition among lenders can take many forms including convenience in obtaining a loan, customer service, size of loans, interest rates and other types of finance or service charges, duration of loans, the nature of the risk which the lender is willing to assume and the type of security, if any, required by the lender. Although the Company believes it is generally competitive in most of the geographic areas in which it offers its services, there can be no assurance that its ability to market its services successfully or to obtain an adequate yield on its loans will not be impacted by the nature of the competition that now exists or may develop.
Prior to the contribution of its consumer credit card business to the LLC, in both domestic and international VISA and MasterCard markets, the Company competed with national, regional, and local issuers. American Express and the Discover Card represented additional competition in the general purpose credit card markets in the United States. In recent years, a large segment of customers have been attracted to credit card issuers largely on the basis of product features, including price and credit limit; as such, customer loyalty may have been limited. As a result, account and balance attrition have been significant factors in the credit card industry.
In seeking investment funds from the public, the Company faces competition from banks, savings institutions, money market funds, credit unions and a wide variety of private and public entities which sell debt securities, some of which are publicly traded. Many of the competitors are larger and have more capital and other resources than the Company. Competition relates to such matters as rate of return, collateral, insurance or guarantees applicable to the investment (if any), the amount required to be invested, convenience and the cost to and conditions imposed upon the investor in investing and liquidating his investment (including any commissions which must be paid or interest forfeited on funds withdrawn), customer service, service charges, if any, and the taxability of interest.
EMPLOYEES
As of December 31, 1997, the Company had 4,498 employees, up from 3,541 employees at the end of 1996. On February 20, 1998, 2,204 employees of the Company were transferred to the LLC in connection with the Transaction with Fleet. The Company believes that it has good relationships with its employees. None of its employees are represented by a collective bargaining unit.
CAUTIONARY STATEMENTS
Information or statements provided by the Company from time to time may contain certain "forward-looking information" including information relating to anticipated earnings per share, anticipated returns on equity, anticipated growth in loans outstanding and credit card accounts, anticipated net interest margins, anticipated operations costs and employment growth, anticipated prepayment rates of outstanding loans, anticipated marketing expense or anticipated delinquencies and charge-offs. The cautionary statements provided below are being made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995 (the "Act") and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act for any such forward-looking information. Many of the following important factors discussed below as well as other factors have also been discussed in the Company's prior public filings.
The Company cautions readers that any forward-looking information provided by the Company is not a guarantee of future performance and that actual results may differ materially from those in the forward-looking information as a result of various factors, including but not limited to:
-- Increased credit losses (including increases due to a worsening of general economic conditions), increased collection costs associated with rising delinquency levels, costs associated with an increase in the number of customers seeking protection under the bankruptcy laws, resulting in accounts being charged off as uncollectible, and costs and other effects of fraud by third parties or customers.
-- Intense and increasing competition from numerous providers of financial services who may employ various competitive strategies. The Company faces competition from national, regional and local originators of non-conforming mortgages and business equipment leases, some of which have greater resources than the Company.
-- The effects of increased competition and changes in economic conditions including interest rate fluctuations resulting in higher than anticipated prepayments of outstanding loans.
-- The effects of interest rate fluctuations on the Company's net interest margin and the value of its assets and liabilities; the continued legal or commercial availability of techniques (including interest rate swaps and similar financial instruments, loan repricing, hedging and other techniques) used by the Company to manage the risk of such fluctuations and the continuing operational viability of those techniques and the accounting and regulatory treatment of such instruments.
-- Difficulties or delays in the securitization of the Company's receivables and the resulting impact on the cost and availability of such funding. Such difficulties and delays may result from changes in the availability of credit enhancement in securitizations, the current legal, regulatory, accounting and tax environment and adverse change in the performance of the securitized assets.
-- Changes in the Company's aggregate accounts or loan balances and the growth rate thereof, including changes resulting from factors such as shifting product mix, amount of actual marketing investment made by the Company, prepayment of loan balances and general economic conditions and other factors beyond the control of the Company.
-- The impact of "seasoning" (the average age of a lender's portfolio) on the Company's level of delinquencies and losses which may require a higher allowance for loan losses for on-balance sheet assets, and may adversely impact personal finance and business loan and lease securitization income. The addition of account originations or balances and the attrition of such accounts or balances could significantly impact the seasoning of the overall portfolio.
-- The amount, and rate of growth in, the Company's expenses (including employee and marketing expenses) as the Company's business develops or changes and the Company expands into new market areas; the acquisition of assets (interest-earning, fixed or other); the effects of changes within the Company's organization or in its compensation and benefit plans; and the impact of unusual items resulting from the Company's ongoing evaluation of its business strategies, asset valuations and organizational structures.
-- The amount, type and cost of financing available to the Company, and any changes to that financing including any impact from changes in the Company's debt ratings; and the activities of parties with which the Company has agreements or understandings, including any activities affecting any investment.
-- Difficulties or delays in the development, production, testing and marketing of products or services, including, but not limited to, a failure to implement new product or service programs when anticipated, the failure of customers to accept these products or services when planned, losses associated with the testing of new products or services or financial, legal or other difficulties as may arise in the course of such implementation.
-- The effects of, and changes in, monetary and fiscal policies, laws and regulations (financial, consumer, regulatory or otherwise), other activities of governments, agencies and similar organizations, and social and economic conditions, such as inflation, and changes in taxation of the Company's earnings.
-- The costs and other effects of legal and administrative cases and proceedings, settlements and investigations, claims and changes in those items, developments or assertions by or against the Company or its subsidiaries; adoptions of new, or changes in existing, accounting policies and practices and the application of such policies and practices.
-- The impact of the Company's costs to comply with requirements of the Year 2000 Issue described herein as well as the effects of the compliance or lack thereof by the Company's customers, suppliers and partners.
ITEM 2.
ITEM 2. PROPERTIES.
In 1997, the Company owned four buildings totaling 308,278 square feet and leased an additional 302,453 square feet in eight buildings in the Pennsylvania suburbs of Philadelphia. This includes the Company's principal executive offices located in Spring House, Pennsylvania. In the adjoining states of New Jersey, Delaware and New York the Company owned two buildings totaling 177,196 square feet and leased 62,352 square feet in three buildings. The Company leased seven offices located in Utah, California and Colorado totaling 374,305 square feet. In summary, the Company occupied 1,224,584 square feet of leased and owned space in 24 buildings located in seven states. In addition, the Company leased office space which averaged approximately 1,100 square feet per branch for each of its 56 Advanta Finance branches.
In connection with the contribution of the Company's consumer credit card business to the LLC, the Company contributed three owned buildings totaling 218,278 square feet and leases on four buildings totaling 129,387 square feet in the Pennsylvania suburbs of Philadelphia. In addition, the Company contributed to the LLC one owned building totaling 121,000 square feet in Delaware and a lease on one building totaling 155,655 square feet in Colorado.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
On June 30, 1997, purported shareholders of the Company who are represented by a group of law firms filed a putative class action complaint against the Company and several of its current and former officers and directors in the United States District Court for the Eastern Division of Pennsylvania. A second, similar complaint was filed in the same court a few days later by a different group of law firms. Both complaints allege that the Company made misrepresentations in certain of its public filings and statements in violation of the Securities Exchange Act of 1934. The complaints seek damages of an unspecified amount. Pursuant to stipulation, the complaints have been consolidated into one action. The Company believes that the complaints are without merit and will vigorously defend itself against the actions.
On August 25, 1997, a purported consumer credit cardholder of the Company instituted a putative class action complaint against the Company and certain of its subsidiaries in Delaware Superior Court for New Castle County. Subsequently, on September 8, 10, and 12, October 2, 1997, November 7 and 12, 1997, and December 2, 10, 15, and 18 (2 cases), similar actions were filed in Orange County California Superior Court, the United States District Court for the Eastern Division of Tennessee, Delaware Superior Court, the Circuit Court of Covington County, Alabama, the United States District Court for the Northern District of California, the United States District Court for the Central District of California, the United States District Court for the Eastern District of Pennsylvania, the District Court of Bexar County, Texas, the United States District Court for the Northern District of Texas, the United States District Court for the District of New Jersey and the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida, respectively. The complaints allege that consumer credit cardholder accounts in a specific program were improperly repriced to a higher percentage rate of interest. The complaints assert various violations of federal and state law with regard to such repricings, and each seeks damages of an unspecified amount. The program at issue comprised a very small portion of the Company's consumer credit card receivables. The Company believes that the complaints are without merit and will vigorously defend itself against the actions.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Each of the executive officers of the Company and its subsidiaries listed below was elected by the applicable Board of Directors, to serve at the pleasure of the Board in the capacities indicated.
Mr. Alter became Executive Vice President and a Director of the Company's predecessor organization in 1967. He was elected President and Chief Executive Officer in 1972, and Chairman of the Board of Directors in August 1985. Mr. Alter has remained as Chairman of the Board since August 1985. In February 1986, he relinquished the title of President, and in August 1995 he relinquished the title of Chief Executive Officer. In October 1997, Mr. Alter resumed the title of Chief Executive Officer.
Mr. Rosoff joined the Company in January 1996 as a Director and Vice Chairman. Prior to joining the Company, Mr. Rosoff was a long time partner of the law firm of Wolf, Block, Schorr and Solis-Cohen LLP, the Company's outside counsel, where he advised the Company for over 20 years. While at Wolf, Block, Schorr and Solis-Cohen LLP he served as Chairman of its Executive Committee and, immediately before joining the Company, as a member of its Executive Committee and Chairman of its Tax Department. Mr. Rosoff is a Trustee of Atlantic Realty Trust, a publicly held real estate investment trust, and Chairman of the Board of RMH Teleservices, Inc. a publicly held company that is a leading provider of telemarketing services, on an outsourced basis, to Fortune 500 companies.
Mr. Olafsson joined the Company in September 1996 as Vice Chairman of Advanta Information Services, Inc. ("AIS") and was elected as a Director of AIS in October 1996. In December 1997, Mr. Olafsson became a Director of the Company and in March 1998 he was elected as President of the Company. Prior to joining the Company, he was president and chief executive officer of Sony Interactive Entertainment, Inc., a business unit of Sony Corporation, which he founded in 1991.
Mr. Beck joined the Company in 1986 as Senior Vice President of Advanta National Bank (formerly, Advanta National Bank USA) and was elected Vice President and Treasurer of the Company in 1992. Prior to joining the Company, he was Vice President at Fidelity Bank, N.A., responsible for asset/liability planning, as well as for managing a portfolio of investment securities held at the bank. From 1970 through 1980, he served in various treasury and planning capacities for Wilmington Trust Company.
Mr. Calamari joined the Company as Vice President, Finance in May 1988. From May 1985 through April 1988, Mr. Calamari served in various capacities in the accounting departments of Chase Manhattan Bank, N.A. and its subsidiaries, culminating in the position of Chief Financial Officer of Chase Manhattan of Maryland. From 1976 until May 1985, Mr. Calamari was an accountant with the public accounting firm of Peat, Marwick, Mitchell in New York.
Mr. Podowski was elected President of the Advanta Insurance Companies in April 1995 and Chief Executive Officer and President of Advanta Business Services in September 1997. Prior to joining the Company, Mr. Podowski served CIGNA Corporation in various capacities for seventeen years, most recently as Senior Vice President in their International Division, with responsibility for CIGNA's life insurance subsidiaries in Asia,
Australia and New Zealand. Prior to joining CIGNA, Mr. Podowski worked for The Chase Manhattan Bank, N.A.
Mr. Riseman came to the Company in June 1992 as Senior Vice President, Administration. In February 1994, Mr. Riseman became President and Director of Advanta Mortgage Corp. USA and its subsidiaries. Prior to joining the Company, Mr. Riseman had 27 years of experience with Citicorp, most recently as Director of Training and Development. Prior to that he held Citicorp positions as Business Manager for the Long Island Region, Head of Policy and Administration for New York's Retail Bank, and Chairman of Citicorp Acceptance Co. which was involved in the financing and leasing of autos and financing of mobile homes.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
COMMON STOCK PRICE RANGES AND DIVIDENDS
The Company's common stock is traded on the National Market System of The Nasdaq Stock Market, Inc. under the symbols ADVNB (Class B non-voting common stock) and ADVNA (Class A voting common stock).
Following are the high, low and closing sale prices and cash dividends declared for the last two years as they apply to each class of stock:
At December 31, 1997, the Company had approximately 1,100 and 430 holders of record of Class B and Class A common stock, respectively.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
FINANCIAL HIGHLIGHTS
FINANCIAL HIGHLIGHTS (CONTINUED)
(1) Excludes gains on sales of credit card relationships in 1996 and 1994.
(2) All periods reflect adoption of FASB 128 (see Notes 1 and 22 to Consolidated Financial Statements).
(3) Earnings per share before extraordinary items were the same for all years except 1993. Basic earnings per share before extraordinary items for 1993 were $2.09, $2.07 and $2.11 for Combined, A and B, respectively. Dilutive earnings per share before extraordinary items for 1993 were $1.95, $1.94 and $1.97 for Combined, A and B, respectively. (See Note 1 to Consolidated Financial Statements.)
(4) Combined represents a weighted average of Class A and Class B (see Note 1 to Consolidated Financial Statements)
(5) Includes restricted interest-bearing deposits.
(6) Represents total managed receivables plus mortgage contract servicing receivables.
(7) Represents Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures of the Company.
(8) In 1997 and 1996, return on average total equity, equity/managed assets and equity/owned assets include capital securities as equity. The ratios without capital securities for 1997 were 8.33%, 4.38%, and 13.86%, respectively and for 1996 were 22.31%, 4.43% and 15.26%, respectively.
(9) Combination of owned interest-earning assets/interest-bearing liabilities and securitized credit card assets/liabilities.
(10) The 1997 and 1996 figures reflect the adoption of a new charge-off methodology in August 1996 relating to credit card bankruptcies (see "Management's Discussion and Analysis -- Asset Quality").
* Not meaningful.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
OVERVIEW
For the year ended December 31, 1997, the Company reported net income of $71.6 million or $1.50 per combined common share, assuming dilution, compared to $175.7 million or $3.89 per combined diluted common share for the full year of 1996. (See Note 1 to Consolidated Financial Statements.)
The earnings reported for the full year of 1997 reflect an increase in provision for credit losses of $114 million, primarily as a result of higher credit losses in the consumer credit card portfolio. This portfolio was subsequently transferred to the LLC in connection with the Transaction during the first quarter of 1998 (see Note 11 to Consolidated Financial Statements). In addition, 1996 earnings reflected a $33.8 million gain on the sale of credit card relationships.
During 1997, net interest income and the owned net interest margin increased $14.8 million and 7 basis points, respectively. These increases are primarily a result of the substantial growth in the personal finance and business loan and lease portfolios along with an increase in investments and interest bearing deposits, offset by a reduction in the higher yielding credit card portfolio. The owned personal finance portfolio grew from an average of $242.9 million in 1996 to $586.2 million in 1997, a 141% increase. The business loan and lease portfolio also showed strong growth, rising to an average of $333.1 million during 1997 from $200.1 million during 1996. Noninterest revenues excluding the $33.8 million gain on the sale of credit card relationships in 1996 increased $72.4 million to $845.1 million from $772.7 million in 1996. The increase in other noninterest revenues for 1997 is a result of significant increases in personal finance, business loan and lease noninterest revenues and in other revenues. Personal finance noninterest revenues increased by almost 56% to $170 million primarily as a result of the substantial increase in receivables securitized. In 1997 the Company securitized $3.4 billion of personal finance loans compared to $1.4 billion in 1996. The increase in business loan and lease noninterest revenues also reflects an increase in securitization activity. Business loan and lease receivables securitized in 1997 totalled $563 million compared to $363 million in 1996. "Other" other noninterest revenues increased almost $14.2 million due to an increase in other credit card revenues.
The increases in net interest income and noninterest revenues were offset by increases in the provision for loan losses as previously mentioned, as well as operating expenses. The provision for credit losses rose to $210.8 million in 1997 from $96.9 million in 1996. The increase in the provision for credit losses experienced in 1997 resulted from a higher level of charge-offs and delinquencies primarily in the consumer credit card portfolio, as well as management's decision to increase the ratio of the loan loss allowance to receivables to 4.1% at December 31, 1997 from 3.4% at the end of 1996. The charge-off rate in the owned portfolio rose to 5.6% in 1997 from 2.3% in 1996. The 30-day delinquency rate rose to 5.9% in 1997 from 5.5% in 1996. Operating expenses increased to $630.8 million in 1997 from $523.2 million in 1996. The 1997 operating expense ratio increased to 3.4% from 2.9% in 1996. This increase primarily reflects the addition of employees required to support increased collection efforts related to the credit card portfolio and an increase in the employees needed to support the growth in personal finance activities. Other operating expenses also increased as a result of increased marketing and the resources required to support current and future growth in the portfolios.
Net income for 1996 of $175.7 million was 29% higher than the $136.7 million reported for 1995. On a per combined share basis, assuming dilution, net income was $3.89 compared to $3.20 for 1995. The growth in earnings in 1996 was attributable primarily to a 49% increase in noninterest revenues to $806.5 million from $543.0 in 1995. The growth in noninterest revenues was a result of substantial growth in average managed receivables which increased to $14.9 billion in 1996 from $9.5 billion in 1995. Noninterest revenues for 1996 also reflect a $33.8 million gain on the sale of consumer credit card customer relationships. Credit card securitization activities were affected by the adoption in the third quarter of 1996 of a new charge-off methodology relating to bankruptcies (see "Asset Quality"), the upward repricing of interest rates and fees, increases in charge-offs and the related impact on the allowance for loan losses, all of which had an approximate $50 million impact (earnings increase) in 1996, as well as a 57% increase in average securitized receivables. The increase in noninterest revenues was partially offset by increases in the provision for credit
losses reflecting an increase in the charge-off and delinquency rates in 1996 to 3.2% and 5.4% respectively from the 1995 levels of 2.2% and 3.3%, respectively. The operating expense ratio was flat at 2.9% for both 1996 and 1995.
On February 20, 1998 the Company announced that it had completed the Transaction with Fleet whereby the Company and certain of its subsidiaries and Fleet and certain of its subsidiaries contributed substantially all of their respective consumer credit card businesses, subject to liabilities, to the LLC. Advanta has retained a minority membership interest in the LLC, which at the closing date of the Transaction was valued at $20 million. The Transaction was submitted to a vote of stockholders and was approved on February 20, 1998, the closing date for the Transaction. (See Note 11 to Consolidated Financial Statements). The Company realized an after tax gain of approximately $530 million which was recorded in the first quarter of 1998. Concurrently with the Transaction, the Company purchased 7,882,750 shares of its Class A Common Stock and 12,482,850 of its Class B Common Stock at $40 per share net, and 1,078,930 of its depositary shares each representing one one-hundredth interest in a share of 6 3/4% Convertible Class B Preferred Stock, Series 1995 (Stock Appreciated Income Linked Securities (SAILS)) at $32.80 per share net, through an issuer tender offer. (See Notes 8 and 11 to Consolidated Financial Statements).
Associated with the Transaction, the Company intends to substantially reduce corporate expenses and expenses associated with business and product development which are not directly associated with its mortgage and business services companies.
Going forward, the Company will focus on providing innovative financial products and services to consumers and small businesses through its rapidly growing mortgage and business services companies.
NET INTEREST INCOME
Net interest income represents the excess of income generated from interest-earning assets, including on balance-sheet receivables, investments and money market instruments over the interest paid on interest-bearing liabilities, primarily deposits and debt.
Net interest income of $93.1 million for 1997 increased $14.8 million or 18.9% from 1996 as a result of a $682.2 million or 15.3% increase in average interest-earning assets and an increase in the owned net interest margin, which rose to 1.91% in 1997 from 1.84% in 1996, partially offset by higher levels of interest-bearing liabilities which increased 16.7% in 1997. The higher owned net interest margin resulted from a 33 basis point increase in the yield on average interest-earning assets primarily as a result of the repricing of the consumer credit card portfolio. The increase in the owned net interest margin was negatively impacted by the mix of earning assets reflecting the Company's decision to maintain a conservative position in cash and cash equivalents on the balance sheet. In 1997 the investment portfolio, which earned an average yield of 5.73% represented 47.8% of total interest-earning assets, while the higher yielding receivable balances represented only 52.2% of total owned interest-earning assets. In 1996 investments earned a similar average yield of 5.72% but represented only 31.5% of total owned interest-earning assets; receivable balances with an average yield of 8.90% represented 68.5% of total owned interest-earning assets.
Net interest income of $78.3 million for 1996 increased $5.4 million or 7% from 1995 as a result of a $1.7 billion or 63% increase in average owned interest-earning assets, largely offset by a lower owned net interest margin, which fell to 1.84% in 1996 from 2.80% in 1995. The lower owned net interest margin primarily resulted from a 99 basis point decrease in the yield on average interest-earning assets as a significant portion of consumer credit card receivables on the balance sheet were at introductory rates, partially offset by a 34 basis point decrease in the cost of funds.
Credit card, mortgage and other personal finance and business loan and lease receivable securitization activity shifts revenues from interest income to noninterest revenues. This ongoing securitization activity reduces the level of higher-yielding receivables on the balance sheet while proportionately increasing the balance sheet levels of new lower-yielding receivables and money market assets. Net interest income on securitized credit card balances is reflected in credit card securitization income. Net interest income on securitized mortgage and other personal finance loans is reflected in income from personal finance activities,
and net interest income on securitized business loans and leases is reflected in business loan and lease other revenues. All securitization income is included in noninterest revenues. (See Note 1 to Consolidated Financial Statements).
Average managed credit card receivables of $11.4 billion for 1997 decreased $0.8 billion or 6.7% from 1996. In 1997, average owned credit card receivables were $1.7 billion compared to $2.6 billion in 1996. This decrease is attributable to a number of factors including increased competition in the credit card industry, changes in consumer cardholder behavior and changes in marketing strategy.
Average managed personal finance loans increased 83.7% to $3.9 billion in 1997, from $2.1 billion in 1996. The average balance of owned personal finance loans increased to $586 million in 1997 from $243 million in 1996. Personal finance loan originations of $3.7 billion in 1997 were up $2.2 billion or 144.4% from 1996. Personal finance loans securitized in 1997 totalled $3.4 billion compared to $1.4 billion in 1996. Yields on owned personal finance loans decreased to 10.01% in 1997 from 10.62% in 1996 as a result of a different mix of loans in the owned inventory from which the yield calculation is based.
Average managed business loans and leases of $1.1 billion increased $459 million or 76.1% from 1996. Average owned balances of business loans and leases increased $133 million or 66.5% during 1997 primarily due to the success of the business credit card, as those originations increased 107.1% from $519 million in 1996 to $1.1 billion in 1997. Total business loan and lease originations were $1.4 billion in 1997 compared to $856 million in 1996. Additionally, during 1997, the Company securitized $563 million of business loan and lease receivables. Yields on owned business loans and leases increased to 12.26% in 1997 from 11.97% in 1996.
The owned average cost of funds increased to 6.31% in 1997 from 6.12% in 1996. The Company has utilized derivatives to manage interest rate risk (see discussion under "Derivatives Activities").
The following table provides an analysis of both owned and managed interest income and expense data, average balance sheet data, net interest spread (the difference between the yield on interest-earning assets and the average rate paid on interest-bearing liabilities), and net interest margin (the difference between the yield on interest-earning assets and the average rate paid to fund interest-earning assets) for 1995 through 1997. Average owned loan and lease receivables and the related interest revenues include certain loan fees.
INTEREST RATE ANALYSIS
- -------------------------------------------------------------------------------- (1) Includes mortgages and home equity loans for all years presented and auto loans beginning in 1996. (2) Includes leases for all years presented and business cards beginning in 1996. (3) Interest and average rate computed on a tax equivalent basis using a statutory rate of 35%. (4) Includes assets held and available for sale, and nonaccrual loans and leases. (5) Combination of owned interest-earning assets/owned interest-bearing liabilities and securitized credit card assets/liabilities.
INTEREST VARIANCE ANALYSIS: ON-BALANCE SHEET
The following table presents the effects of changes in average volume and interest rates on individual financial statement line items on a tax equivalent basis and including certain loan fees. Changes not solely due to volume or rate have been allocated on a pro rata basis between volume and rate. The effects on individual financial statement line items are not necessarily indicative of the overall effect on net interest income.
- -------------------------------------------------------------------------------- (1) Includes mortgages and home equity loans for all years presented and auto loans beginning in 1996.
(2) Includes leases for all years presented and business cards beginning in 1996.
(3) Includes income from assets held and available for sale.
MANAGED PORTFOLIO DATA
The Company analyzes its financial results on a managed basis and also analyzes data as reported under generally accepted accounting principles. The following table provides selected information on a managed basis, as well as a Managed Income Statement including the effects of credit card securitizations on selected line items of the Company's Consolidated Income Statements for the past three years.
With respect to the Managed Income Statement, the individual line items are stated as if the securitized credit card assets were still owned by the Company and remained on the balance sheet. Net interest income includes the amount of net interest income which has been reported as noninterest revenues. In addition, the provision for credit losses includes the amount by which the provision for credit losses would have been higher had the securitized receivables remained as owned and the provision for credit losses been equal to actual reported charge-offs (see "Asset Quality"). Noninterest revenues on the managed income statement exclude the net interest income and credit losses associated with the securitized credit card assets.
PROVISION FOR CREDIT LOSSES
The provision for credit losses of $210.8 million in 1997 increased $114.0 million or 117.7% from $96.9 million in 1996. The increase was due to higher charge-offs on owned receivables, which increased 114.3% from $70.6 million in 1996 to $151.2 million in 1997 and higher levels of delinquencies which continued to increase throughout the year. Consistent with this experience, management's estimate of possible losses inherent in the loan portfolio at year end increased, resulting in an increase in the ratio of the loss allowance to receivables to 4.1% at the end of 1997 from 3.4% at year end 1996.
The provision for credit losses of $96.9 million in 1996 increased $43.5 million or 82% from $53.3 million in 1995. The increase was primarily due to an increase in the desired level of the allowance given the increase in charge-offs and impaired assets during 1996.
A description of the credit performance of the loan portfolio is set forth under the section entitled "Credit Risk Management."
NONINTEREST REVENUES
($ IN THOUSANDS) - --------------------------------------------------------------------------------
Noninterest revenues increased in 1997 to $845.1 million from $806.5 million in 1996. The 1996 figure includes a gain on the sale of credit card customer relationships of $33.8 million. Excluding this gain, noninterest revenues increased by $72.4 million or 9.4% in 1997. This increase was primarily the result of income derived from increased securitization activity in the personal finance and business loan and lease portfolios, as described below. There were no new credit card securitization transactions in 1997 due to the decrease in average managed credit card receivables during the period.
Due to prior period securitizations of credit card receivables, activity from securitized account balances, which otherwise would be reported as net interest income and charge-offs, is reported in securitization income and servicing income, both of which are included in noninterest revenues. Credit card securitization income was affected by the adoption in the third quarter of 1996 of a new charge-off methodology relating to bankruptcies (see "Asset Quality"), the upward repricing of interest rates and fees, increases in charge-offs and the related impact on the allowance for loan losses all of which had an approximate $50 million impact (earnings increase) in 1996, as well as a 57% increase in average securitized receivables. See Note 1 to Consolidated Financial Statements for further description of securitization income.
The Company adopted Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125"), effective January 1, 1997. (See Note 1 to Consolidated Financial Statements.) The adoption of SFAS 125 did not have a material effect on the Company's financial statements.
Credit card servicing income, which represents fees paid to the Company for continuing to service accounts which have been securitized, remained unchanged in 1997 at $176.1 million compared to $176.6 million in 1996. Such fees generally approximate 2% of securitized receivables and are consistent with the $9.6 billion of average securitized receivables in both 1997 and 1996.
Interchange income represents fees that are payable by merchants to the credit card issuer for sale transactions. Total interchange income, which represents approximately 1.4% of credit card purchases, decreased to $85.2 million in 1997 from $102.8 million in 1996 reflecting the lower volume of transactions experienced in 1997.
During 1997, the Company securitized $3.4 billion of mortgage and home equity loans compared to $1.4 billion in 1996. As a result, income from personal finance activities of $170.0 million for 1997 increased 55.7% from $109.2 million in 1996. The 1997 income reflects the use of higher prepayment assumptions as well as a change in the mix of the loans securitized. See Note 1 to Consolidated Financial Statements for a description of income from personal finance loans.
Business loan and lease other revenues increased $9.3 million to $70.9 million in 1997 primarily due to an 80.8% growth in average securitized business loans and leases from 1996. Credit card overlimit fees on the managed portfolio increased significantly in 1997 as a result of the Company's risk based pricing strategies. Insurance revenues, net, were $37.8 million in 1997, down slightly from the $38.2 million reported in 1996. The decline is attributable to lower receivable balances in the credit card portfolio.
Equity securities (losses) gains in 1997 reflect a decrease in carrying value of portfolio investments in the Company's venture capital unit. "Other" other noninterest revenues increased by $14.2 million due to an increase in other credit card revenues.
Noninterest revenues of $806.5 million in 1996 increased $263.5 million or 49% from $543.0 million in 1995, primarily due to increases in credit card securitization, servicing and interchange income, as well as higher personal finance and business loan and lease revenues. Noninterest revenues for 1996 also included a $33.8 million gain on the sale of credit card customer relationships.
OPERATING EXPENSES
($ IN THOUSANDS)
The amortization of credit card deferred origination costs, net, decreased to $69.3 million in 1997 from $88.5 million in 1996. This decrease reflects the lower level of credit card originations in 1997 (see Note 1 to Consolidated Financial Statements).
Total other operating expenses of $561.5 million for 1997 were up $126.8 million or 29.2% from $434.7 million in 1996. The increase in total other operating expenses is attributable, in part, to a $64.6 million or 35.4% increase in salaries and employee benefits as a result of an increase in the number of employees from 3,541 at year-end 1996 to 4,498 at year-end 1997, including the addition of staff in the consumer credit card collection area and additions to staff to support the growth in loan production and serviced receivables in personal finance. Other factors affecting the increase in other operating expenses were a $21.1 million or 65.9% increase in marketing expenses relating to new business advertising for the personal finance and business loan
products and increased advertising related to account retention initiatives for the consumer credit card portfolio. External processing fees for 1997 reflect a $10 million cash rebate related to prior periods' credit card processing performance. Without the rebate, external processing costs would have increased by $10.4 million or 24.4% over the $42.8 million reported in 1996. This increase is primarily the result of customer retention and relationship management programs in the credit card area. Other operating expenses, including equipment and occupancy expenses reflected increases consistent with the current and projected increase in employees and serviced customer accounts and the addition of space and new technology required to support this growth. "Other" other operating expenses increased by $5.7 million or 28.4% primarily as a result of a full year of expenses associated with the mandatorily redeemable preferred securities.
The amortization of credit card deferred origination costs increased by $16.2 million to $88.5 million in 1996 from $72.3 million in 1995. The increase reflects the growth in credit card originations experienced during the last half of 1995 and in 1996.
Total other operating expenses increased by $156.3 million or 56% to $434.7 million in 1996 from $278.4 million in 1995. Part of the increase in total other operating expenses resulted from a $66 million or 57% increase in salaries and employee benefits. In addition, professional and other consulting fees increased $25.3 million from $14.9 million in 1995 to $40.2 million in 1996.
INCOME TAXES
The Company's consolidated income tax expense was $24.9 million for 1997, or an effective tax rate of 26% compared to tax expense of $89.1 million in 1996, or an effective tax rate of 34%, and tax expense of $75.2 million in 1995, or an effective rate of 36%. The decrease in the effective tax rate from 1996 to 1997 resulted from a higher level of insurance-related activities, and tax credits from investments in combination with a lower level of pretax income.
ASSET/LIABILITY MANAGEMENT
The financial condition of Advanta Corp. is managed with a focus on maintaining high credit quality standards, disciplined management of market risks and prudent levels of leverage and liquidity.
MARKET RISK SENSITIVITY
Market risk is the potential for loss or diminished financial performance arising from adverse changes in market forces such as interest rates and market prices. Market risk sensitivity is the degree to which a financial instrument, or a company that owns financial instruments is exposed to market forces. The Company regularly evaluates its market risk profile and attempts to minimize the impact of market risks on net interest income and net income.
The Company's exposure to foreign currency exchange rate risk, commodity price risk, and equity price risk is immaterial relative to expected overall financial performance. The Company's financial performance can, however, be affected by fluctuations in interest rates, changes in economic conditions, shifts in customer behavior, and other factors. Changes in economic conditions and shifts in customer behavior are difficult to predict, and the financial performance of the Company generally cannot be insulated from such forces.
Financial performance variability as a result of fluctuations in interest rates is commonly called interest rate risk. Interest rate risk generally evolves from mismatches in the timing of asset and liability repricing (gap risk) and from differences between the repricing indices of assets and liabilities (basis risk).
The Company attempts to analyze the impact of interest rate risk by regularly evaluating the perceived risks inherent in its asset and liability structure, including securitized instruments and off-balance sheet instruments. Risk exposure levels vary continuously, as changes occur in the Company's asset/liability mix, market interest rates, prepayment trends, and other factors affecting the timing and magnitude of cash flows. Computer simulations are used to generate expected financial performance in a variety of interest rate environments. Those results are analyzed to determine if actions need to be taken to mitigate the Company's interest rate risk.
In managing interest rate risk exposure, the Company periodically securitizes receivables, sells and purchases assets, alters the mix and term structure of its funding base, changes its investment portfolio and uses derivative financial instruments. Derivative instruments, by policy, are not used for speculative purposes (see discussion under "Derivative Activities").
The Company has measured its interest rate risk using a rising rate scenario and a declining rate scenario. Net interest income is estimated using a third party software model that uses standard income modeling techniques. The Company estimates that its net interest income over a twelve month period would neither materially increase or decrease if interest rates were to rise or fall by 200 basis points or less. Both increasing and decreasing rate scenarios assume an instantaneous shift in rates and measure the corresponding change in expected net interest income over one year. The scenario results reflect the completed Transaction with Fleet (see Note 11 to Consolidated Financial Statements). As a result of the Transaction with Fleet, the Company's interest rate risk profile has changed; however, the sensitivity to changes in interest rate is not material.
The above estimates of net interest income sensitivity alone do not provide a comprehensive view of the Company's exposure to interest rate risk. The quantitative risk information is limited by the parameters and assumptions utilized in generating the results. Such analyses are useful only when viewed within the context of the parameters and assumptions used. The above rate scenarios in no way reflect management's expectation regarding the future direction of interest rates, and they depict only two possibilities out of a large set of possible scenarios.
In addition to interest rate risk, the Company has other financial instruments, namely capitalized servicing rights and interest only strips, that are subject to prepayment risk. Prepayments are principal payments in excess of scheduled principal payments. Prepayments generally result from entire loan payoffs due largely to refinancing a loan or selling a home. Actual or anticipated prepayment rates are expressed in terms of a constant prepayment rate ("CPR"), which represents the annual percentage of beginning loan balances that prepay. To a degree, prepayment rates are related to market interest rates and changes in those interest rates. The precise relationship between them, however, is not known at this time. Accordingly, the Company believes it is prudent to disclose the fair value sensitivity of these instruments based on changes in prepayment rate assumptions rather that based on changes in interest rates.
The Company's capitalized servicing rights and interest only strips derive from both fixed and variable rate loans, the majority of which are fixed. Fixed and variable rate loans are currently prepaying at different rates and are expected to continue this behavior in the future. The Company has estimated the fair value impact of prepayment changes of 2.5% CPR for fixed rate loans and 3% CPR for variable rate loans. These key changes in prepayment assumptions could result in an $18 million change in fair value. In addition, changes in the interest rate environment generally affect the level of loan originations. Prepayment assumptions are not the only assumptions in the fair value calculation, but they are the most influential. Other key assumptions are not directly impacted by market forces as defined earlier. The above prepayment scenarios do not reflect management's expectation regarding the future direction of prepayments, and they depict only two possibilities out of a large set of possible scenarios.
LIQUIDITY AND CAPITAL RESOURCES
The Company's goal is to maintain an adequate level of liquidity, for both long- and short-term needs, through active management of both assets and liabilities. During 1997, the Company, through its subsidiaries, securitized $3.4 billion of personal finance loans and $0.6 billion of business loan and lease receivables. In addition, funds totalling approximately $996 million were raised during this same period through the issuance of unsecured notes, other borrowings and an increase in deposits at ANB (and its predecessors by merger). Cash generated from these transactions was temporarily invested in short-term, high quality investments at money market rates awaiting redeployment to pay down borrowings and to fund future credit card, personal finance and business loan receivable growth. Cash and equivalents exceeded amounts normally held to provide liquidity protection subsequent to the Company's March 17, 1997 announcement relating to a decrease in expected 1997 financial results. At December 31, 1997, the Company had approximately $1.5 billion of loan
and lease receivables and $1.3 billion of investments available for sale which could be sold to generate additional liquidity.
The Company's funding strategy for 1998 relies heavily on the cash, cash equivalents and investments released by the Transaction with Fleet as well as deposit gathering activity at both ANB and AFC. As a result of the Transaction with Fleet, approximately $1.3 billion in cash, cash equivalents and investments which had previously been held by the Company in connection with its consumer credit card business was no longer required in such business and became available for general corporate purposes. The Company used approximately $850 million of such amount (before taking into account the exercise price of options) to purchase 7,882,750 shares of its Class A Common Stock, 12,482,850 of its Class B Common Stock, and 1,078,930 of its SAILS Depositary Shares through an issuer tender offer which was completed on February 20, 1998 (see Notes 8 and 11 to the Consolidated Financial Statements). Following the completion of the Transaction with Fleet and the Company's tender offer, the Company expects to benefit from a substantial cash position. However, the external sources described below will remain in place both for contingency funding and for continued future utilization.
Funding diversification has been an essential component of the Company's liquidity and capital management. The Company and ANB have utilized both retail and institutional on balance sheet funding sources issuing a variety of debt and deposit products. The Company and ANB also have utilized a secured revolving credit facility and off balance sheet securitization funding (described below).
The debt securities of Advanta and ANB (and its predecessors by merger) had investment-grade ratings from all of the nationally recognized statistical rating agencies throughout 1996. Beginning March 1997 through early 1998, the various rating agencies lowered their ratings on the debt securities of each of Advanta and its banking subsidiaries. As of March 1998, senior debt of Advanta was rated investment grade by one agency and below investment grade by the other four agencies; and debt of ANB was rated investment grade by two agencies and below investment grade by the other three agencies.
On May 1, 1997, Advanta Mortgage Corp. USA and its subsidiaries entered into a $500 million secured revolving credit facility, $250 million of which is committed. Also, deposit sources proved readily expandable in 1997 as demonstrated in the growth noted above. In addition, notwithstanding the Company's current liquidity, efforts continue to develop new sources of funding, both through previously untapped customer segments and through development of new financing structures.
In December 1996, Advanta Capital Trust I, a newly formed statutory business trust established by and wholly-owned by the Company (the "Trust"), issued in a private offering $100 million of capital securities, representing preferred beneficial interests in the assets of the Trust (the "Capital Securities"). The Company used the proceeds from the sale for general corporate purposes. The sole assets of the Trust consist of $100 million of 8.99% junior subordinated debentures issued by the Company due December 17, 2026 (the "Junior Subordinated Debentures"). The Capital Securities will be subject to mandatory redemption under certain circumstances, including at any time on or after December 17, 2006 upon the optional prepayment by the Company of the Junior Subordinated Debentures. The obligations of the Company with respect to the Junior Subordinated Debentures, when considered together with the obligations of the Company under the Indenture relating to the Junior Subordinated Debentures, the Amended and Restated Declaration of Trust relating to the Capital Securities and the Capital Securities Guarantee issued by the Company with respect to the Capital Securities will provide, in the aggregate, a full and unconditional guarantee of payments of distributions and other amounts due on the Capital Securities. In July, 1997, the Company and the Trust exchanged the outstanding Capital Securities and Junior Subordinated Debentures for substantially identical securities which were registered under the Securities Act of 1933, as amended (the "Act"). The Company also exchanged the Capital Securities Guarantee for a substantially identical guarantee which was also registered under the Act. The Trust has no operations or assets separate from its investment in the Junior Subordinated Debentures. Separate financial statements of the Trust are not presented because management has determined that they would not be meaningful to investors.
In August 1995, in a public offering, the Company sold 2,500,000 depositary shares each representing a one-hundredth interest in a share of Stock Appreciation Income Linked Securities (SAILS). The SAILS constitute a series of the Company's Class B Preferred Stock, designated as 6 3/4% Convertible Class B Preferred Stock, Series 1995 (SAILS). On September 15, 1999, unless either previously redeemed by the Company or converted at the option of the holder, each share of the SAILS will automatically convert into 100 shares of Class B Common Stock. Proceeds from the offering, net of underwriting discount, were approximately $90 million. The Company used the proceeds of the offering for general corporate purposes, including financing the growth of its subsidiaries. As of February 20, 1998, after giving effect to the purchase of shares through an issuer tender offer made following the Transaction with Fleet, 1,421,070 shares of Class B Preferred Stock remain outstanding.
The Company also filed a shelf registration statement in 1996 with the Securities and Exchange Commission which provides for the Company to sell up to $1.6 billion of debt securities. The Company has issued approximately $1.0 billion of debt securities under this shelf.
In September 1995, ANB (and its predecessors by merger) established a $2.25 billion bank note program. Under this program, ANB may issue an aggregate of $2.0 billion of senior bank notes and $250 million of subordinated bank notes. These notes may have maturities ranging from seven days to fifteen years from the date of issuance. In connection with the Transaction with Fleet, a significant portion of bank notes issued under this program was transferred to the LLC.
As of December 31, 1997, the Company and ANB had a $1 billion unsecured revolving credit facility. Following the closing of the Transaction with Fleet in 1998, the facility was terminated by the Company and ANB.
The following tables detail the composition of the deposit base and the composition of debt and other borrowings at year end for each of the past five years.
COMPOSITION OF DEPOSIT BASE
COMPOSITION OF DEBT AND OTHER BORROWINGS
Previously, as a grandfathered institution under the Competitive Equality Banking Act of 1987 ("CEBA"), the Company had to limit AUS's average on-balance sheet asset growth to 7% per annum. For the fiscal CEBA year ended September 30, 1996, AUS's average assets did not exceed the allowable amount and, accordingly, AUS was in full compliance with CEBA growth limits. The timing and size of securitizations, on-balance sheet liability structure and rapid changes in balance sheet structure had frequently been due to the management of AUS's balance sheet within this growth constraint. However, on September 30, 1996 this growth rate provision of CEBA was repealed which has created substantial new flexibility with respect to asset/liability management for AUS (and now ANB) and ultimately the Company.
As of December 31, 1997 ANB's total deposits were $2.8 billion, and AFC, a Utah state-chartered, FDIC-insured industrial loan corporation had total deposits of $195.4 million. A significant portion of ANB's deposits were contributed to the LLC in connection with the Transaction with Fleet.
ANB's combined Tier I and Tier II capital ratio at December 31, 1997 was 16.39%. At December 31, 1996, the combined Tier I and Tier II capital ratio was 15.84% for AUS and 17.20% for Old ANB. In each case, ANB, AUS and Old ANB met the requirements of the Comptroller and qualified each of ANB, AUS and Old ANB as well-capitalized.
In addition, the Company's insurance subsidiaries are subject to certain capital, deposit and dividend rules and regulations as prescribed by state jurisdictions in which they are authorized to operate. At December 31, 1997 and 1996 the insurance subsidiaries were in compliance with such rules and regulations.
CAPITAL EXPENDITURES
The Company spent $83.4 million for capital expenditures in 1997, primarily for the construction of buildings in Pennsylvania for the mortgage division and a new office building in Delaware, leasehold improvements, additional space in existing buildings, office and voice communication equipment and furniture and fixtures. This compared to $78.4 million for capital expenditures in 1996 and $20.6 million in 1995.
In 1998, the Company anticipates capital expenditures to be lower than in 1997 as a result of the decreased need of capital expenditures to support the consumer credit card business contributed to the LLC.
YEAR 2000 ISSUE
Many existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not
corrected, many computer applications could fail or create erroneous results by or at the Year 2000. In connection with this issue (the "Year 2000 Issue"), the Company has initiated a comprehensive assessment of its computer systems and applications, managed by a team led by two senior information technology managers and organized as a separate Year 2000 Project Office (the "Project Office"). The Project Office has developed standards for its work based on work of leading consultants in the field. The Project Office has developed a review process featuring a "Year 2000 Score Card" that will be used to measure the degree to which each of the Company's computer applications are impacted by the Year 2000 Issue.
The Company has also initiated communications with all of its significant outside service providers and some of its larger clients to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 Issue. There can be no assurance that the systems used by outside service providers or other third parties upon which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company.
The Company expects that its on-going evaluation of its systems and applications and testing for the implementation of any modifications of existing computer programs or conversions to new programs, to the extent necessary to address the Year 2000 Issue, will be substantially completed by the end of 1998, consistent with the Year 2000 guidelines issued by the Comptroller. The Company, therefore, believes that the Year 2000 Issue will not pose significant operational problems for the Company. The Company, however, has not completed its evaluation of the costs of addressing the issue. While management does not expect that the costs of evaluating and reprogramming these systems will be significant, the Company cannot yet estimate the actual costs of the necessary remediation program. Moreover, the Company notes that GAAP requires that the costs of becoming Year 2000 compliant, including without limitation modifying computer software or converting to new programs, be charged to expense as they are incurred. The Company believes that the Year 2000 Issue will not have a material adverse effect on the Company's future financial condition, liquidity or results of operations during 1998 and in future periods.
DERIVATIVES ACTIVITIES
The Company utilizes derivative financial instruments for the purpose of managing its exposure to interest rate and foreign currency risks. The Company has a number of mechanisms in place that enable it to monitor and control both market and credit risk from these derivatives activities. At the broader level, all derivatives strategies are managed under a hedging policy approved by the Board of Directors that details the use of such derivatives and the individuals authorized to execute derivatives transactions. All derivatives strategies must be approved by the Company's senior management.
As part of this approval process, a market risk analysis is completed to determine the potential impact on the Company from severe negative (stressed) movements in market rates. By policy, derivatives transactions may only be used to manage the Company's exposure to interest rate and foreign currency risks or for cost reduction and may not be used for speculative purposes. As such, the impact of any derivatives transaction is calculated using the Company's asset/liability model to determine its suitability.
The Company's Investment Committee (a management committee) has a counterparty credit policy. This policy details the maximum credit exposure, transaction limit and transaction term for counterparties based on an internally assigned Investment Committee credit rating. Internal counterparty credit ratings reflect the credit ratings from nationally recognized rating agencies, as well as other significant credit factors where appropriate. Each counterparty's credit quality is reviewed as new information becomes available, and, in any case, at least quarterly. Activities with counterparties will be suspended if there is reason to believe that their credit quality is below the Company's set standards.
For each counterparty, credit exposure amounts are calculated in a stress environment and represent the maximum aggregate credit exposure from derivatives and other capital market transactions the Company is willing to accept from an individually approved counterparty. To manage counterparty exposure, the Company also uses negotiated agreements that establish threshold exposure amounts for each counterparty above which the Company has the right to call for and receive collateral for the amount of such excess, thereby limiting its
exposure to the threshold amount. The threshold levels can be fixed or may change as the credit rating of the counterparty changes, and in all cases, the threshold levels are well below the maximum allowable exposure amounts described above.
Counterparty master agreements and any collateral agreements, by policy, must be signed prior to the execution of any derivatives transactions with a counterparty. To date, substantially all master agreements with counterparties have included bilateral collateral agreements. As such, the potential exposure from a particular counterparty is limited to the maximum threshold level for that counterparty.
The Company has a treasury middle office that is independent of the trading function, which measures, monitors, and reports on credit, market, and liquidity risk exposures from capital markets, hedging and derivative product activities. It is the responsibility of this department to ensure compliance with respect to the hedging policy, including the counterparty transaction limits, transaction terms and trader authorizations. In addition, this department marks each derivatives position to market on a weekly basis using both internal and external models. These models have been benchmarked against a sample of derivatives dealers' valuation models for accuracy. Position and counterparty exposure reports are generated and used to manage collateral requirements of the counterparty and the Company.
All of these procedures and processes are designed to provide reasonable assurance that prior to and after the execution of any derivatives strategy, market, credit and liquidity risks are fully analyzed and incorporated into the Company's asset/liability and risk measurement models and the proper accounting treatment for the transaction is identified and executed.
During 1996, the FASB issued its exposure draft for accounting for hedging and derivatives. This draft, an attempt to standardize accounting treatment for derivatives and hedging, would alter the accounting treatment for the use of such instruments in the reduction of interest rate risk. The FASB is currently reviewing comments on the exposure draft. The Company is unable to predict the outcome of these deliberations at this time.
CREDIT RISK MANAGEMENT
Management regularly reviews the loan and lease portfolio in order to evaluate the adequacy of the allowance for credit losses. The evaluation includes such factors as the inherent credit quality of the loan portfolio, past experience, current economic conditions and changes in the composition of the loan portfolio. The allowance for credit losses is maintained for on-balance sheet receivables. The on-balance sheet allowance is intended to cover all credit losses inherent in the owned loan portfolio. With regard to securitized assets, anticipated losses and related recourse liabilities are reflected in the calculations of Securitization Income, Amounts due from Credit Card Securitizations and Other Assets. Recourse liabilities are intended to cover all probable credit losses over the life of the securitized receivables. Management evaluates both its on-balance sheet and recourse requirements and, as appropriate, effects additions to these accounts.
The allowance for credit losses on a consolidated basis was $137.8 million, or 4.1% of owned receivables, at December 31, 1997, compared to $89.2 million, or 3.4% of owned receivables, at December 31, 1996. The allowance for credit losses on a consolidated basis was $53.5 million, or 1.9% of owned receivables, in 1995.
ASSET QUALITY
Impaired assets include both nonperforming assets (personal finance loans and business loans and leases past due 90 days or more, real estate owned, bankrupt, decedent and fraudulent credit card accounts, and off-lease equipment) and accruing loans past due 90 days or more on credit cards and leases. The carrying value for real estate owned is based on fair value and costs of disposition and is reflected in other assets.
Gross interest income that would have been recorded in 1997 and 1996 for owned nonperforming assets, had interest been accrued throughout the year in accordance with the assets' original terms, was approximately $2.1 million and $3.7 million, respectively. The amount of interest on nonperforming assets included in income for 1997 and 1996 was $0.4 million and $0.7 million, respectively.
In the third quarter of 1996, the Company adopted a new charge-off methodology related to bankrupt credit card accounts, providing for up to a 90-day (rather than up to a 30-day) investigative period following notification of the bankruptcy petition, prior to charge-off. This new methodology is consistent with others in the credit card industry. The 1997 and 1996 credit statistics set forth in the following tables reflect this change in methodology.
The 1997 asset quality information reflects generally higher charge-off and delinquency rates primarily in the credit card business which was consistent with industry trends.
The total managed charge-off rate for 1997 was 5.3% for 1997 compared to 3.2% in 1996. The charge-off rate on managed credit cards increased from 3.7% in 1996 to 7.0% in 1997. The charge-off rate for managed personal finance loans showed a slight increase, rising to 0.8% in 1997 from 0.7% in 1996. For 1997, the charge-off rate for business loans and leases was 3.2% compared to 2.3% for the prior year.
On the total owned portfolio the charge-off rate was 5.6% in 1997 compared to 2.3% for 1996. The charge-off rate on the owned credit card portfolio rose to 7.9% from 2.5% one year earlier. The charge-off rate on owned personal finance loans decreased from 1.3% in 1996 to 1.0% in 1997. The 1997 charge-off rate on business loans and leases was 2.5% compared to 1.5% in 1996.
Nonperforming assets in the total managed portfolio rose to $328.8 million or 1.8% of receivables in 1997 compared to $191.7 million or 1.2% at the end of 1996. In the managed credit card portfolio, nonperforming assets increased to $101.3 million or 0.9% of receivables from $89.1 million or 0.7% in 1996. The nonperforming assets in the managed personal finance portfolio totalled $200.6 million or 3.8% of receivables at the end of 1997, up from $93.1 million or 3.4% at the end of 1996. In the managed business loan and lease portfolio, nonperforming assets totalled $26.8 million or 2.1% of receivables in 1997 compared to $9.5 million or 1.2% at the end of 1996.
In the owned portfolio, nonperforming assets totalled $51.1 million or 1.5% of receivables at the end of 1997 compared to $29.8 million or 1.1% of receivables at the end of 1996. Nonperforming assets in the owned credit card portfolio rose to $21.1 million or 0.8% of receivables compared to $13.9 million or 0.7% at the end of 1996. In the owned personal finance portfolio, nonperforming assets increased to $23.2 million or 4.9% of loans at year end 1997, up from $13.0 million or 3.5% at the end of 1996. Nonperforming assets totalled $6.7 million or 2.2% of receivables in the business loan and lease portfolio, at the end of 1997, up from $2.9 million or 1.4% at the end of 1996.
Loans delinquent 30 days or more in the total managed portfolio were $1.1 billion or 6.0% of receivables at year end 1997, up from $886.7 million or 5.4% of receivables at December 31, 1996. In the managed credit card portfolio loans delinquent 30 days or more totalled $594.4 million or 5.29% of receivables in 1997, compared to $632.1 million or 5.0% of receivables at year end 1996. In the managed personal finance loan portfolio at year end 1997, loans 30 days or more delinquent totalled $391.9 million or 7.4% of receivables, up from $194.4 million or 7.1% of receivables at December 31, 1996. Loans 30 days or more delinquent in the managed business loan and lease portfolio were $81.7 million or 6.5% of receivables at year end 1997 compared to $59.9 million or 7.3% at year end 1996.
In the owned portfolio, loans delinquent 30 days or more at year end 1997 totalled $201.9 million or 5.9% of receivables, up from $145.6 million or 5.5% at year end 1996. Loans 30 days or more delinquent in the owned credit card portfolio totalled $141 million or 5.5% of loans at year end 1997, up from $107.3 million or 5.2% at the end of 1996. At the end of 1997 loans delinquent 30 days or more in the owned personal finance portfolio totalled $42.9 million or 9.0% of receivables compared to $28.5 million or 7.6% at the end of 1996. Owned business loans and leases delinquent more than 30 days at year end 1997 totalled $17.8 million or 6.0% of receivables compared to $9.5 million or 4.4% at the end of 1996.
Impaired assets in the total managed portfolio were $532 million at December 31, 1997 or 3.0% of receivables compared to $420.5 million or 2.6% at year end 1996. In the managed credit card portfolio, impaired assets totalled $304.4 million or 2.7% of receivables at the end of 1997 compared to the 1996 level of $317.9 million or 2.5% of receivables. In the owned portfolio, total impaired assets were $100.6 million or 3.0% of receivables in 1997, up from $70.4 million or 2.7% at the end of 1996. In the owned credit card portfolio,
impaired assets rose to $70.5 million or 2.7% of receivables in 1997 compared to $54.5 million or 2.7% at the end of 1996.
Past due loans represent accruing loans that are past due 90 days or more as to collection of principal and interest. Credit card receivables, except those on bankrupt, decedent and fraudulent accounts, continue to accrue interest until the time they are charged off at 186 days contractual delinquency. In contrast, all personal finance loans and most business loans and leases are put on nonaccrual status when they become 90 days past due.
During 1994, the Company implemented a new policy for the charge-off of mortgage loans. Under this policy, when a nonperforming mortgage loan becomes twelve months delinquent, the Company writes down the loan to its net realizable value, regardless of anticipated collectibility. Consequently, in 1994, all mortgage loans that had been twelve or more months delinquent, as well as any mortgages that became twelve months delinquent during the year were written down (through a recorded charge-off) to their net realizable value.
The following tables provide a summary of impaired assets, delinquencies and charge-offs for the past five years:
(1) The 1997 and 1996 figures reflect the adoption of a new charge-off methodology in August 1996 relating to credit card bankruptcies (see Asset Quality).
(2) Pro forma calculation reflecting charge-off of all credit card bankruptcies within 30 days of notification.
(3) In 1994, the Company implemented a new mortgage loan charge-off policy (see Asset Quality).
(4) Includes mortgage and home equity loans for all years presented and auto loans beginning in 1996.
(5) Includes leases for all years presented and business cards beginning in 1996.
The following tables provide a summary of allowances, impaired assets, delinquencies and charge-offs for the past five years:
(1) The 1997 and 1996 figures reflect the adoption of a new charge-off methodology in August 1996 relating to credit card bankruptcies (see Asset Quality).
(2) Pro forma calculation reflecting charge-off of all credit card bankruptcies within 30 days of notification.
(3) In 1994, the Company implemented a new mortgage loan charge-off policy (see Asset Quality).
(4) Includes mortgage and home equity loans for all years presented and auto loans beginning in 1996.
(5) Includes leases for all years presented and business cards beginning in 1996.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
CONSOLIDATED INCOME STATEMENTS
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
($ IN THOUSANDS)
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ($ IN THOUSANDS, UNLESS OTHERWISE NOTED, EXCEPT PER SHARE DATA)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Advanta Corp. (the "Company"), a Delaware corporation, is a financial services company which provides a variety of products to consumers and small businesses. The Company services approximately 6.3 million customers and manages receivables in excess of $17.8 billion. The Company issues credit cards primarily through its wholly owned subsidiary Advanta National Bank ("ANB"). References to ANB in these Notes to Consolidated Financial Statements include, to the extent applicable, ANB's predecessors by merger (see Note 18). Substantially all of the Company's credit card processing is performed by a single outside third party processor. Total managed credit card receivables at December 31, 1997 totaled $11.2 billion. The Company also operates through other wholly owned subsidiaries including: Advanta Mortgage Corp. USA ("AMC") which originates mortgage loans secured by first or junior liens and automobile loans, Advanta Business Services Corp. ("ABS") which provides small ticket equipment leases and markets credit cards to businesses, and Advanta Life Insurance Company which reinsures or writes various credit insurance products available to the Company's customers. Managed receivables for AMC and ABS totaled approximately $5.3 billion and $1.3 billion, respectively, at December 31, 1997. On February 20, 1998 the Company completed a transaction with Fleet Financial Group, Inc. ("Fleet") to contribute substantially all of its consumer credit card receivables, subject to liabilities, to a limited liability company controlled by Fleet (see Note 11).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
BASIS OF PRESENTATION
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The ultimate results could differ from those estimates.
Certain prior-period amounts have been reclassified to conform with current-year classifications.
CREDIT CARD ORIGINATION COSTS, SECURITIZATION INCOME AND FEES
Credit Card Origination Costs
The Company accounts for credit card origination costs under Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" ("SFAS 91"). This accounting standard requires certain loan and lease origination fees and costs to be deferred and amortized over the life of a loan or lease. Origination costs are defined under this standard to include costs of loan origination associated with transactions with independent third parties and certain costs relating to underwriting activities and preparing and processing loan documents. The Company engages third parties to solicit and originate credit card account relationships. Amounts deferred under these arrangements approximated $89.2 million in 1997, $54.6 million in 1996 and $71.9 million in 1995.
The Company amortizes deferred credit card origination costs following the consensus reached at the May 20, 1993 meeting of the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board ("FASB") regarding the acquisition of individual credit card accounts from independent third parties (EITF Issue 93-1). Under this consensus amounts paid to third parties are deferred and amortized on a straight-line basis over one year. Costs incurred for originations which were initiated prior to May 20, 1993
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
continue to be amortized over a 60 month period as was the Company's practice prior to the EITF Issue 93-1 consensus.
CREDIT CARD SECURITIZATION INCOME
The Company adopted Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125"), effective January 1, 1997. Under SFAS 125, a transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. SFAS 125 requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value, if practicable. It also requires that servicing assets and other retained interests in the transferred assets be measured by allocating the previous carrying amount between the assets sold, if any, and retained interests, if any, based on their relative fair values at the date of the transfer. The adoption of SFAS 125 did not have a material effect on the Company's financial statements.
Under SFAS 125, the Company allocates the previous carrying amount of the credit card receivables securitized between the assets sold, and the retained interests, principally an interest in the receivables and an interest-only strip net of a recourse obligation, based on their relative estimated fair values at the date of sale. A gain is recognized at the time of the sale equal to the excess of the fair value of the assets obtained, principally cash, over the allocated cost of the assets sold. Servicing assets associated with credit card securitization transactions are immaterial as the benefits of servicing are not expected to be more or less than adequate compensation (as defined below) to the Company for performing the servicing. As all estimates used are influenced by factors outside the Company's control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. During the "revolving period" of each trust, securitization income is recorded representing gains on the sale of new receivables that are sold to the trusts on a continuous basis to replenish the investors' interest in trust receivables that have been repaid by the credit cardholders. As directed by SFAS 125, the retained interests in the receivables are measured in accordance with the provisions of SFAS 115 as available-for-sale securities. At December 31, 1997, the carrying value of the retained interests in the credit card receivables securitized approximated the market value.
Prior to January 1, 1997 the Company recorded excess servicing income on credit card securitizations representing additional cash flow from the receivables initially sold based on estimates of the repayment term, including prepayments. As the estimates used to record excess servicing income were influenced by factors outside the Company's control, there was uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. Excess servicing income recorded at the time of each transaction was substantially offset by the establishment of a recourse liability for anticipated charge-offs. During the "revolving period" of each trust, income was recorded based on additional cash flows from the new receivables which were sold to the trusts on a continual basis to replenish the investors' interest in trust receivables which had been repaid by the credit cardholders. Credit card securitization activities were affected by the adoption in the third quarter of 1996 of a new charge-off methodology relating to bankruptcies (see Credit Losses below), the upward repricing of interest rates and fees, increases in charge-offs and the related impact on allowances, all of which had in the aggregate an approximate $50 million impact (earnings increase) in 1996, as well as a 57% increase in average securitized receivables.
INTEREST INCOME
The Company recognizes interest income using a method which approximates the level yield method. Personal finance loans and business loans discontinue the accrual of interest when the related receivable is 90 days or more past due. Interest income is subsequently recognized only to the extent cash payments are received. Credit card receivables, except bankrupt, decedent and fraudulent accounts, continue to accrue interest until the time they charge-off at 186 days contractually delinquent. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MORTGAGE LOAN ORIGINATION FEES
The Company generally charges origination fees ("points") for mortgage loans where permitted under state law. Origination fees, net of direct origination costs, are deferred and amortized over the contractual life of the loan as an adjustment to yield (interest income). However, upon the sale or securitization of the loans, the unamortized portion of such fees is included in the computation of the gain on sale.
LOAN AND LEASE RECEIVABLES AVAILABLE FOR SALE
Loan and lease receivables available for sale represent receivables currently on the balance sheet that the Company generally intends to sell or securitize within the next six months. These assets are reported at the lower of aggregate cost or fair market value.
INVESTMENTS AVAILABLE FOR SALE
Investments available for sale include securities that the Company sells from time to time to provide liquidity and in response to changes in the market. Debt and equity securities classified as Available for Sale are reported at market value under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). Under SFAS 115, unrealized gains and losses on these securities (except those held by the Company's venture capital unit, Advanta Partners LP) are recorded as adjustments to stockholders' equity, net of income taxes.
Changes in the fair value of Advanta Partners LP investments are reported in noninterest revenues as equity securities gains or losses. The fair value of publicly traded investments takes into account their quoted market prices with adjustments made for liquidity or sale restrictions. For investments that are not publicly traded, estimates of fair value have been made by management that consider several factors including the investees' financial results, conditions and prospects, and the values of comparable public companies. Because of the nature of these investments, the equity method of accounting is not used in situations where the Company has a greater than 20 percent ownership interest.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses various derivative financial instruments ("derivatives") such as interest rate swaps and caps, forward contracts, options on securities, and financial futures as part of its risk management strategy to reduce interest rate and foreign currency exposures, and where appropriate, to synthetically lower its cost of funds. Derivatives are classified as hedges or synthetic alterations of specific on-balance sheet items, off-balance sheet items or anticipated transactions. In order for derivatives to qualify for hedge accounting treatment the following conditions must be met: 1) the underlying item being hedged by derivatives exposes the Company to interest rate or foreign currency risks, 2) the derivative used serves to reduce the Company's sensitivity to interest rate or foreign currency risks, and 3) the derivative used is designated and deemed effective in hedging the Company's exposure to interest rate or foreign currency risks. In addition to meeting these conditions, anticipatory hedges must demonstrate that the anticipated transaction being hedged is probable to occur and the expected terms of the transaction are identifiable.
For derivatives designated as hedges of interest rate exposure, gains or losses are deferred and included in the carrying amounts of the related item exposing the Company to interest rate risk and ultimately recognized in income as part of those carrying amounts. For derivatives designated as hedges of foreign currency exposure, gains or losses are reported in stockholders' equity. Accrual accounting is applied for derivatives designated as synthetic alterations with income and expense recorded in the same category as the related underlying on-balance sheet or off-balance sheet item synthetically altered. Gains or losses resulting from early terminations of derivatives are deferred and amortized over the remaining term of the underlying balance sheet item or the remaining term of the derivative, as appropriate.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Derivatives not qualifying for hedge or synthetic accounting treatment would be carried at market value with realized and unrealized gains and losses included in noninterest revenues. At December 31, 1997, 1996 and 1995, all the Company's derivatives qualified as hedges or synthetic alterations.
INCOME FROM PERSONAL FINANCE LOANS
The Company, through its subsidiaries, sells mortgage, home equity and auto loans through secondary market securitizations, typically with servicing retained. Under SFAS 125, the Company allocates the previous carrying amount of the receivables securitized between the assets sold and the retained interests, principally servicing and an interest-only strip net of a recourse obligation, based on their relative estimated fair values at the date of sale. A gain is recognized at the time of the sale equal to the excess of the fair value of the assets obtained, principally cash, over the allocated cost of the assets sold and transaction costs. The retained interest-only strip represents the remaining interest collected from the borrowers on the underlying loans after the payment of pass-through interest to the certificate holders and the payment of a servicing fee to the Company in its role as servicer and is partially offset by the estimated fair value of the Company's recourse obligation for anticipated charge-offs. SFAS 125 directs that the retained interest-only strips should be subsequently classified and measured in accordance with the provisions of SFAS 115. The Company classifies the retained interest-only strips from the securitization of mortgage and home equity loans as trading securities. These assets are subsequently recorded at estimated fair value and the resulting unrealized gain or loss from the valuation of the receivable is recorded in the results of operations for the period. The Company estimates the fair value based on a discounted cash flow analysis. The cash flows are estimated as the excess of the weighted average coupon on each pool of the loans sold over the sum of the pass-through interest rate plus the servicing fee, a trustee fee, credit enhancement costs and an estimate of future credit losses over the life of the loans. Management believes these cash flows are projected over the life of the loans using prepayment, default, and interest rate assumptions that market participants would use for similar financial instruments subject to prepayment, credit and interest rate risk. Management also believes that the cash flows are discounted using an interest rate that a purchaser unrelated to the seller of such a financial instrument would demand. As all estimates used are influenced by factors outside the Company's control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term.
Prior to January 1, 1997, the Company recorded a gain on the securitization of personal finance loans at the time of sale, approximately equal to the present value, using a risk adjusted discount rate, of the excess of the anticipated future interest and fees paid by borrowers on the underlying loans over the sum of the pass through rate of interest payable to the certificate holders, a loan servicing fee which is paid to the Company in its role as servicer, estimated credit losses and certain transaction related costs. The Company recorded a corresponding excess spread asset at the time of sale equal to the gain recognized. The excess spread asset was amortized, as a charge to servicing fees and other income, in proportion to cash flows received over the estimated lives of the underlying loans. The asset was carried at the lower of amortized cost or net realizable value. The carrying value was evaluated quarterly by the Company on a disaggregated basis to determine whether prepayment and loan loss experience had impaired this carrying value. Reductions in the value of the excess spread that are due to adverse prepayment and loan loss experience were recognized as a charge to earnings, while increases were not recognized. As all estimates used were influenced by factors outside the Company's control, there was uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. In addition to the excess spread, the gain also included premiums on loans sold, nonrefundable fees and gains or losses on hedging transactions structured to minimize the risk of interest rate fluctuations (See Notes 3 and 16).
Income from personal finance loans also includes negotiated loan servicing fees on mortgage loan portfolios which were never owned by the Company ("contract servicing").
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME FROM BUSINESS LOAN AND LEASE SECURITIZATIONS
The Company, through its subsidiaries, sells business loans and leases through secondary market securitizations. Under SFAS 125, the Company allocates the previous carrying amount of the lease receivables securitized between the assets sold and the retained interests, principally an interest in the receivables and an interest-only strip net of a recourse obligation, based on their relative estimated fair values at the date of sale. A gain is recognized at the time of the sale equal to the excess of the fair value of the assets obtained, principally cash, over the allocated cost of the assets sold. The Company estimates the fair value based on a discounted cash flow analysis. The cash flows are estimated as the excess of the weighted average yield on each pool of the leases sold over the sum of the pass-through interest rate plus the servicing fee and an estimate of future credit losses over the life of the leases. Management believes that these cash flows are projected over the life of the leases using prepayment, default, and interest rate assumptions that market participants would use for similar financial instruments subject to prepayment, credit and interest rate risk. Management also believes that the cash flows are discounted using an interest rate that a purchaser unrelated to the seller of such a financial instrument would demand. As all estimates used are influenced by factors outside the Company's control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. As directed by SFAS 125, the retained interests in the receivables are measured in accordance with the provisions of SFAS 115 as available-for-sale securities. At December 31, 1997, unrecognized gains and losses on the retained interests in the credit card receivables securitized was not material.
Prior to January 1, 1997, the Company recorded excess servicing income on lease securitizations approximately equal to the present value of the anticipated future cash flows, assuming an estimated prepayment rate, net of anticipated charge-offs, partially offset by deferred initial direct costs, transaction expenses, servicing fees, pass-through interest rate and estimated credit losses under certain recourse requirements of the transactions. As these estimates were influenced by factors outside the Company's control, there was uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. Also included in income was the difference between the net sales proceeds and the carrying amount of the receivables sold. Subsequent to the initial sale, securitization income was recorded in proportion to the actual cash flows received from the trusts.
At December 31, 1997 and 1996, the Company's accounting for the securitization of business card receivables was substantially the same as the accounting for the securitization of credit card receivables discussed above. (See Notes 3 and 16).
Servicing assets associated with business loan and lease securitization transactions are immaterial as the benefits of servicing are not expected to be more or less than adequate compensation (as defined below) to the Company for performing the servicing.
INSURANCE
Reinsurance premiums, net of commissions on credit life, disability and unemployment policies on credit cards, are earned monthly based upon the outstanding balance of the underlying receivables. Insurance premiums are earned ratably over the period of insurance coverage provided. The cost of acquiring new reinsurance is deferred and amortized over the respective periods in order to match the expense with the anticipated revenue. Insurance loss reserves are based on estimated settlement amounts for both reported losses and incurred but not reported losses.
CREDIT LOSSES
The Company's charge-off policy, as it relates to consumer and business credit card accounts, is to charge-off a receivable, if not paid, at 186 days contractually delinquent. Accounts suspected of being fraudulent are written off after a 90 day investigation period, unless the investigation shows no evidence of fraud.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the third quarter of 1996, the Company adopted a new charge-off methodology related to bankrupt credit card accounts, providing for up to a 90-day (rather than up to a 30-day) investigative period following notification of the bankruptcy petition, prior to charge-off. This new methodology is consistent with others in the credit card industry.
The Company charges-off expected losses on all non-performing personal finance loans generally no later than when they have become twelve months delinquent. Lease receivables are generally written-off when at 120 days contractually delinquent.
PREMISES AND EQUIPMENT
Premises, equipment, computers and software are stated at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Repairs and maintenance are charged to expense as incurred.
CONTRACTUAL MORTGAGE SERVICING RIGHTS
Effective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" ("SFAS 122") which requires the Company to recognize rights to service mortgage loans for others based on their relative fair value as separate assets. Effective January 1, 1997, SFAS 125 superceded SFAS 122. Under SFAS 125, the Company capitalizes the right to service mortgage loans based on the relative fair value of the receivables that are sold. Management has estimated the fair value of contractual mortgage servicing rights based on a discounted cash flow analysis. The cash flows are estimated as the excess of the benefits of servicing, principally revenues from contractually specified servicing fees, late charges, and other ancillary sources, over adequate compensation. SFAS 125 defines adequate compensation as the amount of benefits of servicing that would fairly compensate a substitute servicer should one be required, which includes the profit that would be demanded in the marketplace. The cost allocated to the contractual mortgage servicing rights is amortized in proportion to, and over the period of estimated net future servicing fee income.
JOINT VENTURE
In 1995, the Company formed a joint venture with The Royal Bank of Scotland, RBS Advanta, to market, issue and service bankcards in the United Kingdom. As of December 31, 1997 the Company owned 49% of the RBS Advanta joint venture, the investment in which is accounted for under the equity method. In connection with the Transaction described in Note 11, the Company contributed its economic interest in the RBS Advanta joint venture to the Fleet LLC.
GOODWILL
Goodwill, representing the cost of investments in subsidiaries and affiliated companies in excess of net assets acquired at acquisition, is amortized on a straight-line basis for a period of up to 25 years.
STOCK-BASED COMPENSATION
The Company has elected to account for stock-based compensation following Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") as permitted by SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). The Company has adopted the disclosure only provision of SFAS 123.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 utilizes the liability method
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws.
EARNINGS PER SHARE
Earnings per share are calculated under the provisions of SFAS No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 requires the presentation and disclosure of Basic Earnings Per Share and Diluted Earnings Per Share. Basic Earnings Per Share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Income available to common stockholders is computed by deducting Class A and Class B preferred stock dividends from net income. Diluted Earnings Per Share is computed by dividing income available to common stockholders, increased by dividends on dilutive Class B preferred stock for the period, divided by the sum of average common shares outstanding plus dilutive common shares for the period. Potentially dilutive common shares include stock options, restricted stock issued under incentive plans and Class B preferred stock. Since the cash dividends declared on the Company's Class B Common Stock were higher than the dividends declared on the Class A Common Stock, Basic and Dilutive Earnings Per Share have been calculated using the "two-class" method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock according to dividends declared and participation rights in undistributed earnings. The Company has also presented "Combined Earnings Per Share," which represents a weighted average of Class A Earnings Per Share and Class B Earnings Per Share. As required by SFAS 128, all prior period earnings per share data presented have been restated.
CASH FLOW REPORTING
For purposes of reporting cash flows, cash includes cash on hand and amounts due from banks. Cash paid during 1997, 1996 and 1995 for interest was $304.0 million, $241.1 million and $147.2 million, respectively. Cash paid or (refunds received) for taxes during these periods was $(6.1) million, $45.1 million and $43.9 million, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued the following Statements of Financial Accounting Standards:
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" was issued in July 1997. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components. The main objective of the statement is to report a measure of all changes in equity that result from transactions and other economic events of the period other than transactions with owners. The Company adopted SFAS No. 130 on January 1, 1998.
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" was issued in June 1997, and is effective for periods beginning after December 15, 1997. SFAS No. 131 introduces a new model for segment reporting, called the "management approach." The management approach is based on the way the chief operating decision maker organizes segments within a company for making operating decisions and assessing performance. Reportable segments are based on product and services, geography, legal structure, management structure -- any manner in which management desegregates a company. The management approach replaces the notion of industry and geographic segments in current FASB standards. The Company intends to report information on two segments as a result of the adoption of SFAS No. 131, Advanta Personal Finance Services and Advanta Business Services.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. LOAN AND LEASE RECEIVABLES
Loan and lease receivables consisted of the following:
(A) Includes credit card receivables available for sale of $1.0 billion and $1.1 billion in 1997 and 1996, respectively.
(B) Includes personal finance loan receivables available for sale of $394.1 million and $337.3 million in 1997 and 1996, respectively and is net of unearned income of $3.1 million in 1997.
(C) Includes business loans and leases available for sale of $43.8 million and $71.9 million in 1997 and 1996, respectively, and is net of unearned income of $20.7 million and $20.9 million in 1997 and 1996, respectively. Also includes residual interest for both years.
(D) Includes approximately $7.0 million and $4.0 million in 1997 and 1996, respectively, related to loan and lease receivables available for sale.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Receivables serviced for others consisted of the following items:
(A) Excludes mortgage loans which were not originated by the Company, but which the Company services for a fee ("contract servicing"). Contract servicing receivables were $9.2 billion and $3.7 billion at December 31, 1997 and 1996, respectively.
The geographic concentration of managed receivables was as follows:
In the normal course of business, the Company makes commitments to extend credit to its credit card customers. Commitments to extend credit are agreements to lend to a customer subject to certain conditions established in the contract. The Company does not require collateral to support this financial commitment. At December 31, 1997 and 1996, the Company had $54.2 billion and $41.2 billion, respectively, of commitments to extend credit outstanding for which there is potential credit risk. The Company believes that its customers' utilization of these lines of credit will continue to be substantially less than the amount of the commitments, as has been the Company's experience to date. At December 31, 1997 and 1996, outstanding managed consumer and business credit card receivables represented 22% and 32%, respectively, of outstanding commitments.
NOTE 3. CREDIT CARD, PERSONAL FINANCE AND BUSINESS LOAN AND LEASE SECURITIZATIONS
ANB had securitized credit card receivables outstanding of $8.7 billion at December 31, 1997. In each securitization transaction, credit card receivables were transferred to a trust which issued certificates representing ownership interests in the trust primarily to institutional investors. ANB retained a participation interest in the trusts, reflecting the excess of the total amount of receivables transferred to the trust over the portion represented by certificates sold to investors. The retained participation interests in the credit card trusts were $1.6 billion and $0.9 billion at December 31, 1997 and 1996, respectively. Although ANB continues to service the underlying credit card accounts and maintain the customer relationships, these transactions are treated as sales for financial reporting purposes to the extent of the investors' interests in the trusts. Accordingly, the associated receivables are not reflected on the balance sheet.
ANB is subject to certain recourse obligations in connection with these securitizations. At December 31, 1997 and 1996, ANB had liabilities of $338.3 million and $334.6 million, respectively, related to these recourse obligations. These liabilities are netted against the amounts due from credit card securitizations.
At December 31, 1997, ANB had amounts receivable from credit card securitizations, including related interest-bearing deposits, of $647.2 million, $438.8 million of which constitutes amounts which are subject to liens by the providers of the credit enhancement facilities for the individual securitizations and is inclusive of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amounts awaiting distributions to investors. At December 31, 1996, the amounts receivable were $733.3 million and amounts subject to lien (inclusive of amounts due to investors) were $333.9 million.
At December 31, 1997, the Company had $4.8 billion of securitized personal finance loan receivables outstanding which are subject to certain recourse obligations. The Company had liabilities of $120.0 million and $64.4 million at year end 1997 and 1996, respectively, related to these recourse obligations which are netted against the retained interest-only strips (see Note 16). At December 31, 1997, the Company had amounts receivable from mortgage loan sales and securitizations of $402.6 million, $146.8 million of which was subject to liens. At December 31, 1996, the amounts receivable and amounts subject to lien were $260.2 million and $96.5 million, respectively.
At December 31, 1997, the Company had $965 million of securitized business loans and leases outstanding which are subject to certain recourse obligations. There were liabilities of $28.2 million and $22.2 million at year end 1997 and 1996, respectively, related to these recourse obligations which are netted against the retained interest-only strips from business loan and lease securitizations (see Note 16). The Company had amounts receivable from business loan and lease securitizations of $6.3 million at year end 1997, none of which was subject to liens and $27.6 million at year end 1996, of which $8.1 million was subject to liens by providers of the credit enhancement facilities (see Note 16). Total interest in equipment residuals for lease assets sold was $42.7 million and $32.1 million at December 31, 1997 and 1996, respectively, and is also subject to recourse obligations.
As indicated in Note 1, recourse liabilities are established at the time of the securitization transactions based on anticipated future cash flows, prepayment rates and charge-offs. As these estimates are influenced by factors outside of the Company's control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term.
NOTE 4. ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses for lending and leasing transactions is established to reflect losses anticipated from delinquencies that have already occurred. In estimating the allowance, management relies on historical experience by loan type adjusted for any known trends in the portfolio. As these estimates are influenced by factors outside of the Company's control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term.
Any adjustments to the allowance (net of transfers between on-and off-balance sheet recourse liabilities) are reported in the Consolidated Income Statements in the periods they become known.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table displays five years of allowance history:
NOTE 5. INVESTMENTS AVAILABLE FOR SALE
Investments available for sale consisted of the following:
(1) Includes investments of Advanta Partners LP.
At December 31, 1997 and 1996, investment securities with a book value of $2,016 and $2,916, respectively, were pledged at the Federal Reserve Bank. At December 31, 1997, 1996 and 1995, investment securities with a book value of $5,370, $6,395 and $6,281, respectively, were deposited with insurance regulatory authorities to meet statutory requirements or held by a trustee for the benefit of primary insurance carriers. At December 31, 1997, $233 of net unrealized losses on securities was included in investments available for sale. During 1997, the net change in unrealized gains/losses on available for sale securities included as a separate component of stockholders' equity was an increase of $466.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturity of investments available for sale at December 31, 1997 was as follows:
During 1997, proceeds from sales of available for sale securities were $1,736,050. Gross gains of $3,867 and losses of $181 were realized on these sales. Of the gross gains, $3,471 relates to investments held by the Company's venture capital unit. Proceeds during 1996 were $1,121,679. Gross gains of $2,492 and losses of $110 were realized on these sales. Of the gross gains, $2,448 related to an investment held by the Company's venture capital unit. Proceeds during 1995 were $1,692,544. Gross gains of $8,666 and losses of $320 were realized on these sales. Of the gross gains, $8,610 related to investments held by the Company's venture capital unit. The specific identification method was the basis used to determine the amortized cost in computing realized gains and losses.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. DEBT
Debt consisted of the following:
The Company's senior floating rate notes were priced based on a factor of LIBOR. At December 31, 1997 the rates on these notes varied from 5.89% to 6.46%. At December 31, 1997 and 1996, the Company used derivative financial instruments to effectively convert certain fixed rate debt to a LIBOR based variable rate. See Note 23.
The annual maturities of long-term debt at December 31, 1997 for the years ending December 31 are as follows: $407.8 million in 1999; $425.0 million in 2000; $448.0 million in 2001; $91.6 million in 2002; and $66.0 million thereafter. The average interest cost of the Company's debt during 1997, 1996 and 1995 was 6.42%, 6.39%, and 6.92%, respectively.
NOTE 7. MANDATORILY REDEEMABLE PREFERRED SECURITIES
In December 1996, Advanta Capital Trust I, a newly formed statutory business trust established by and wholly-owned by the Company (the "Trust"), issued in a private offering $100 million of capital securities, representing preferred beneficial interests in the assets of the Trust (the "Capital Securities"). The Company used the proceeds from the sale for general corporate purposes. The sole assets of the Trust consist of $100 million of 8.99% junior subordinated debentures issued by the Company due December 17, 2026 (the "Junior Subordinated Debentures"). The Capital Securities will be subject to mandatory redemption under certain
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
circumstances, including at any time on or after December 17, 2006 upon the optional prepayment by the Company of the Junior Subordinated Debentures at an amount per Capital Security equal to 104.495% of the principal amount (declining ratably on each December 17 thereafter to 100% on December 17, 2016), plus accrued and unpaid distributions thereon. The obligations of the Company with respect to the Junior Subordinated Debentures, when considered together with the obligations of the Company under the Indenture relating to the Junior Subordinated Debentures, the Amended and Restated Declaration of Trust relating to the Capital Securities and the Capital Securities Guarantee issued by the Company with respect to the Capital Securities will provide, in the aggregate, a full and unconditional guarantee of payments of distributions and other amounts due on the Capital Securities. In July, 1997, the Company and the Trust exchanged the outstanding Capital Securities and Junior Subordinated Debentures for substantially identical securities which were registered under the Securities Act of 1933, as amended (the "Act"). The Company also exchanged the Capital Securities Guarantee for a substantially identical guarantee which was also registered under the Act. Dividends on the Capital Securities are cumulative, payable semi-annually in arrears, and are deferrable at the Company's option for up to ten consecutive semi-annual periods. The Company cannot pay dividends on its preferred or common stocks during such deferments. Dividends on the Capital Securities have been classified as a component of noninterest expense in the Consolidated Income Statements. The Trust has no operations or assets separate from its investment in the Junior Subordinated Debentures. Separate financial statements of the Trust are not presented because management has determined that they would not be meaningful to investors.
NOTE 8. CAPITAL STOCK
The number of shares of capital stock was as follows:
The Class A Preferred Stock is entitled to 1/2 vote per share and a non-cumulative dividend of $140 per share per year, which must be paid prior to any dividend on the common stock. Dividends were declared on the Class A Preferred Stock for the first time in 1989 and have continued through 1997 as the Company paid dividends on its common stock. The redemption price of the Class A Preferred Stock is equivalent to the par value.
In 1995, the Company sold 2,500,000 depositary shares each representing a one-hundredth interest in a share of Stock Appreciation Income Linked Securities ("SAILS"). The SAILS constitute a series of the Company's Class B Preferred Stock, designated as 6 3/4% Convertible Class B Preferred Stock, Series 1995 (SAILS). The SAILS (and thereby the related depositary shares) are not redeemable by the Company before September 15, 1998. The call price of each of the depositary shares will be $37.6244 declining periodically to $37.00 at September 15, 1999 (the mandatory conversion date). On September 15, 1999, unless either previously redeemed by the Company or converted at the option of the holder, each share of the SAILS will automatically convert into 100 shares of Class B Common Stock. The SAILS pay an annual dividend of $249.75 per share and must be paid prior to any dividend on the common stock. Proceeds from the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
offering, net of underwriting discount, were approximately $90 million. The Company used the proceeds of the offering for general corporate purposes, including financing the growth of its subsidiaries.
On February 20, 1998, the Company purchased 7,882,750 shares of its Class A Common Stock, 12,482,850 of its Class B Common Stock at $40 per share net, and 1,078,930 of its depositary shares each representing one one-hundredth interest in a share of SAILS at $32.80 per share net through an issuer tender offer.
NOTE 9. INCOME TAXES
Income tax expense (benefit) consisted of the following components:
The reconciliation of the statutory federal income tax to the consolidated tax expense is as follows:
Deferred taxes are determined based on the estimated future tax effects of the differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. The net deferred tax asset/(liability) is comprised of the following:
The Company concluded that a valuation allowance against deferred tax assets at December 31, 1997 and 1996 was not necessary. Realization of the deferred tax asset is dependent on generating sufficient future taxable income. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effect of significant temporary differences representing deferred tax assets and liabilities is as follows:
NOTE 10. BENEFIT PLANS
The Company has adopted several management incentive plans designed to provide incentives to participating employees to remain in the employ of the Company and devote themselves to its success. Under these plans, eligible employees were given the opportunity to elect to take portions of their anticipated or "target" bonus payments for future years in the form of restricted shares of common stock (with each plan covering three performance years). To the extent that such elections were made (or, for executive officers, were required by the terms of such plans), restricted shares were issued to employees, with the number of shares granted to employees determined by dividing the amount of future bonus payments the employee had elected to receive in stock by the market price as determined under the incentive plans. The restricted shares are subject to forfeiture should the employee terminate employment with the Company prior to vesting. Restricted shares vest 10 years from the date of grant, but with respect to the restricted shares issued under each plan, vesting was and will be accelerated annually with respect to one-third of the shares, to the extent that the employee and the Company met or meet their respective performance goals for a given plan performance year. When newly eligible employees elect to participate in a plan, the number of shares issued to them with respect to their "target" bonus payments for the relevant plan performance years is determined based on the average market price of the stock for the 90 days prior to eligibility.
The following table summarizes the Company's incentive plans:
The weighted average fair value of shares issued on or after January 1, 1995 are: $35 for 77,517 AMIPWISE III shares and $26 for 450,321 AMIPWISE IV shares issued in 1995, $42 for both 277,219 AMIPWISE III shares and 281,931 AMIPWISE IV shares issued in 1996, and $39 for 99,494 AMIPWISE III shares and $38 for 158,958 AMIPWISE IV shares in 1997.
At December 31, 1997, a total of 1,334,434 shares issued under these and the predecessor plans to AMIPWISE III were subject to restrictions and were included in the number of shares outstanding.
At December 31, 1997 the Company had two stock option plans and accounts for these plans under APB 25, under which no compensation expense has been recognized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Had compensation cost for these plans been determined consistent with SFAS 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
Because SFAS 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. During 1997, the Company changed the exercise price of certain options granted during 1996 and 1997 to the current market price on the date of the modification. No other modifications were made to these awards, and this modification would not have resulted in additional compensation expense under the accounting prescribed by SFAS 123.
The Company's two stock option plans together authorize the grant to employees and directors of options to purchase an aggregate of 10.2 million shares of common stock. The Company presently intends only to issue options to purchase Class B common stock. Options generally vest over a four-year period and expire 10 years after the date of grant.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Shares available for future grant were approximately 2.8 million at December 31, 1997, and 3.2 million at December 31, 1996. Transactions under the plans for the three years ended December 31, 1997, were as follows:
The following table summarizes information about stock options outstanding at December 31,1997:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used: risk-free interest rates of 6.7%, 6.0% and 6.7% for 1997, 1996 and 1995, respectively; expected dividend yields of 1 percent; expected lives of 10 years; expected volatility of 40% for 1997 and 41% for 1996 and 1995.
The Company also has outstanding options to purchase 25 thousand shares of common stock at a price of $4.75 per share, which were not issued pursuant to either of the stock option plans. All of these shares were issued prior to January 1, 1995 and were vested at December 31, 1997.
The Company has an Employee Stock Purchase Plan which allows employees and directors to purchase Class B common stock at a 15% discount from the market price without paying brokerage fees. The Company reports this 15% discount as compensation expense and incurred expense of $339, $248 and $145 in 1997, 1996 and 1995, respectively. During 1996, shares were issued under the plan from unissued stock or from treasury stock at the average market price on the day of purchase.
The Company has a tax-deferred employee savings plan which provides employees savings and investment opportunities, including the ability to invest in the Company's Class B common stock. The employee savings plan provides for discretionary Company contributions equal to a portion of the first 5% of an employee's compensation contributed to the plan. For the three years ended December 31, 1997, 1996 and 1995, the Company contributions equaled 100% of the first 5% of participating employees' compensation contributed to the plan. The expense for this plan totaled $3,494, $2,546 and $2,027 in 1997, 1996, and 1995, respectively. All shares purchased by the plan for the three years ended December 31, 1997, 1996 and 1995
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
were acquired from the Company at the market price on each purchase date or were purchased on the open market.
The Company offers an elective, nonqualified deferred compensation plan to qualified executives and nonemployee directors, which allows them to defer a portion of their cash compensation on a pretax basis. The plan contains provisions related to minimum contribution levels and deferral periods with respect to any individual's participation. The plan participant makes irrevocable elections at the date of deferral as to deferral period and date of distribution. Interest is credited to the participant's account at the rate of 125% of the 10 Year Rolling Average Interest Rate on 10-Year U.S. Treasury Notes. Distribution from the plan may be either at retirement or at an earlier date, and can be either in a lump sum or in installment payments. The Company has purchased life insurance contracts with a face value of $53.4 million to fund this plan.
NOTE 11. DISPOSITION OF CREDIT CARD ASSETS (UNAUDITED)
Pursuant to the terms of a contribution agreement, dated as of October 28, 1997, as amended February 20, 1998, by and between the Company and Fleet Financial Group, Inc. ("Fleet"), the Company and certain of its subsidiaries and Fleet and certain of its subsidiaries each contributed certain assets and liabilities of their respective consumer credit card businesses in exchange for an ownership interest in the LLC (the "Transaction"). The Transaction was consummated on February 20, 1998. Concurrent with the Transaction the Company purchased 7,882,750 shares of its Class A Common Stock, 12,482,850 of its Class B Common Stock at $40 per share net, and 1,078,930 of its depositary shares each representing one one-hundredth interest in a share of SAILS at $32.80 per share net through an issuer tender offer (the "Offer") which was completed on February 20, 1998.
The following pro forma unaudited consolidated financial information is based on historical information which has been adjusted to reflect the Transaction and the purchase pursuant to the Offer. The pro forma consolidated income statements were prepared assuming that the Transaction and purchase pursuant to the Offer had occurred January 1, 1997 and January 1, 1996 for the years ended December 31, 1997 and 1996 respectively. The pro forma consolidated balance sheets were prepared assuming that the Transaction and purchase pursuant to the Offer had occurred on December 31, 1997 and 1996.
The pro forma unaudited consolidated financial information presented below does not purport to represent what the results of operations or financial position would actually have been if the Transaction and purchase pursuant to the Offer had occurred on the dates referred to above. Also, the pro forma unaudited consolidated financial information is not indicative of the future results of operations or financial position of Advanta to be expected in future periods. A substantial portion of corporate expenses incurred in the past have been to support the operations contributed. Also, Advanta has incurred expenditures in the past for new businesses and product development. Associated with the Transaction, Advanta intends to substantially reduce corporate expenses and expenses associated with business and product development not directly associated with its mortgage and business service companies. No pro forma adjustments have been reflected associated with Advanta's plans to reduce these expenses. Further, the Pro Forma Adjustments do not reflect a restructuring charge or similar charges related to the planned reduction in corporate expenses or transaction expenses associated with the Transaction and purchase pursuant to the Offer. The restructuring charge or similar charges and transaction expenses will be incurred during the first quarter of 1998. The Pro Forma Adjustments are based upon available information and certain assumptions that the Company believes are reasonable.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. AND SUBSIDIARIES
PRO FORMA UNAUDITED CONSOLIDATED INCOME STATEMENT YEAR ENDED DECEMBER 31, 1997
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED INCOME STATEMENT
[A] The pro forma consolidated income statement reflects the elimination of income and expense related to the results of operations of the Advanta consumer credit card business (the "Business") as if the Transaction had occurred for the periods presented.
[B] The pro forma consolidated income statement reflects (1) interest expense of the Business, and (2) an adjustment of approximately $75.7 million to reflect approximately $1.3 billion of additional interest bearing liabilities to be transferred in the Transaction above the amount of interest bearing liabilities of the Business. The $1.3 billion of additional interest bearing liabilities will be transferred from Advanta National Bank (ANB), where a large portion of the credit card operations are conducted and were incurred in the ordinary course of ANB's business.
[C] The pro forma consolidated income statement reflects the reduction in other operating expenses related to (1) the results of operations of the Business had the Transaction occurred for the periods presented (2) $532 thousand of additional depreciation expense for fixed assets to be transferred to Fleet LLC that were not dedicated to the Business and (3) $4.6 million of operating expenses for an Advanta Corp. support group whose operations will be transferred to Fleet LLC.
[D] The pro forma consolidated income statement reflects the net effects of the Pro Forma Adjustments at the statutory federal tax rate of 35% for the period presented.
[E] The pro forma consolidated income statement reflects the purchase of approximately $850 million of shares of Advanta's outstanding capital stock through the Offer as if the purchase had occurred for the periods presented. The pro forma consolidated income statement reflects (1) the reduction of interest income by approximately $50.6 million to reflect the sale of $820 million of investments to purchase shares of Advanta Class A Common Stock, Class B Common Stock (together with the Class A Common Stock, the "Common Shares") and depositary shares each representing one one-hundredth interest in a share of SAILS (the "SAILS Depositary Shares") and (2) the increase in compensation expense related to the tender of Common Shares underlying options granted under the Advanta's stock option plans. The $820 million of investments sold reflects $850 million of shares at the applicable purchase price per share primarily net of the difference between $40 per share and the option exercise price of options anticipated to be exercised in connection with the Offer.
[F] Pro forma earnings per share (1) includes a $3.1 million increase to net income for the excess of the carrying value of the SAILS Depositary Shares redeemed over the amount paid upon redemption and (2) reflects $6.4 million of preferred stock dividends.
[G] For the year ended December 31, 1997, pro forma earnings were inadequate to cover pro forma fixed charges. The deficiency was approximately $77.5 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. AND SUBSIDIARIES
PRO FORMA UNAUDITED CONSOLIDATED INCOME STATEMENT YEAR ENDED DECEMBER 31, 1996
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED INCOME STATEMENT
[A] The pro forma consolidated income statement reflects the elimination of income and expense related to the results of operations of the Advanta consumer credit card business (the "Business") as if the Transaction had occurred for the periods presented.
[B] The pro forma consolidated income statement reflects (1) interest expense of the Business, and (2) an adjustment of approximately $67.4 million to reflect approximately $1.3 billion of additional interest bearing liabilities to be transferred in the Transaction above the amount of interest bearing liabilities of the Business. The $1.3 billion of additional interest bearing liabilities will be transferred from Advanta National Bank (ANB), where a large portion of the credit card operations are conducted and were incurred in the ordinary course of ANB's business.
[C] The pro forma consolidated income statement reflects the reduction in other operating expenses related to (1) the results of operations of the Business had the Transaction occurred for the periods presented (2) $302 thousand of additional depreciation expense for fixed assets to be transferred to Fleet LLC that were not dedicated to the Business and (3) $3.9 million of operating expenses for an Advanta Corp. support group whose operations will be transferred to Fleet LLC.
[D] The pro forma consolidated income statement reflects the net effects of the Pro Forma Adjustments at the statutory federal tax rate of 35% for the period presented.
[E] The pro forma consolidated income statement reflects the purchase of approximately $850 million of shares of Advanta's outstanding capital stock through the Offer as if the purchase had occurred for the periods presented. The pro forma consolidated income statement reflects (1) the reduction of interest income by approximately $46.6 million to reflect the sale of $813 million of federal funds sold, interest-bearing deposits and investments to purchase shares of Advanta Class A Common Stock, Class B Common Stock (together with the Class A Common Stock, the "Common Shares") and depositary shares each representing one one-hundredth interest in a share of SAILS (the "SAILS Depositary Shares") and (2) the increase in compensation expense related to the tender of Common Shares underlying options granted under the Advanta's stock option plans. The $813 million of federal funds sold, interest-bearing deposits and investments sold reflects $850 million of shares at the applicable purchase price per share primarily net of the difference between $40 per share and the option exercise price of options anticipated to be exercised in connection with the Offer.
[F] Pro forma earnings per share (1) includes a $3.9 million increase to net income for the excess of the carrying value of the SAILS Depositary Shares redeemed over the amount paid upon redemption and (2) reflects $3.8 million of preferred stock dividends.
[G] For the year ended December 31, 1996, pro forma earnings were inadequate to cover pro forma fixed charges. The deficiency was approximately $16.4 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. AND SUBSIDIARIES
PRO FORMA UNAUDITED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. AND SUBSIDIARIES
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED BALANCE SHEET
[A] Represents the contribution to Fleet LLC of assets and liabilities of Advanta consumer credit card business (the "Business") had the Transaction occurred at the balance sheet date.
[B] Represents (1) the contribution to Fleet LLC of cash, federal funds sold and interest bearing deposits dedicated to the Business and (2) a $10 million redemption of federal funds sold that were not dedicated to the Business.
[C] Represents the contribution to Fleet LLC of loans available for sale dedicated to the Business except for a very small portion of consumer credit card receivables generated in a specific program that will not initially be contributed to Fleet LLC.
[D] Represents (1) the contribution to Fleet LLC of property and equipment dedicated to the Business and (2) approximately $8 million of fixed assets to be contributed to Fleet LLC that were not dedicated to the Business.
[E] Represents (1) the contribution to Fleet LLC of other assets dedicated to the Business except for $8.8 million of Credit Insurance Business related assets that will not be contributed to Fleet LLC and (2) Advanta's membership interest in Fleet LLC valued at $20 million.
[F] Represents the contribution to Fleet LLC of deposits, debt and other borrowings by an amount equaling total assets of the Business plus, approximately, an additional $510 million of liabilities representing a portion of the premium received by Advanta, less other liabilities contributed to Fleet LLC in accordance with the Contribution Agreement.
[G] Represents the contribution to Fleet LLC of (1) other liabilities related to the Business had the Transaction occurred at the balance sheet date and (2) $29.1 million of accrued interest payable on the deposits, debt and other borrowings discussed in [E] above, net of (3) $16.4 million of Credit Insurance Business related liabilities that will not be contributed to Fleet LLC.
[H] Represents the increase in retained earnings resulting from the gain on the Transaction of approximately $530 million, consisting of liabilities in excess of assets contributed of approximately $510 million and Advanta's membership interest in Fleet LLC valued at $20 million.
[I] Represents the sale of $820 million of investments to purchase the Common Shares, the SAILS Depositary Shares and options to purchase Common Shares, and the tax benefit related to the tender of Common Shares underlying options granted under the Advanta's stock option plans. The $820 million of investments sold reflects $850 million of shares at the applicable purchase price per share primarily net of the difference between $40 per share and the option exercise price of options anticipated to be exercised in connection with the Offer.
[J] Represents (1) the purchase of approximately 7.9 million Class A Common Stock and approximately 11.3 million Class B Common Stock at $40 per share; (2) the purchase of approximately 1.1 million SAILS Depositary Shares at $32.80 per share and (3) the tender of approximately 1.2 million of Common Shares underlying options at a cost to the Company of the amount by which $40 per share exceeds the option exercise price.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. AND SUBSIDIARIES
PRO FORMA UNAUDITED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1996
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. AND SUBSIDIARIES
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED BALANCE SHEET
[A] Represents the contribution to Fleet LLC of assets and liabilities of Advanta consumer credit card business (the "Business") had the Transaction occurred at the balance sheet date.
[B] Represents (1) the contribution to Fleet LLC of cash, federal funds sold and interest bearing deposits dedicated to the Business and (2) a $5 million redemption of federal funds sold that were not dedicated to the Business.
[C] Represents (1) the contribution to Fleet LLC of property and equipment dedicated to the Business and (2) approximately $8 million of fixed assets to be contributed to Fleet LLC that were not dedicated to the Business.
[D] Represents (1) the contribution to Fleet LLC of other assets dedicated to the Business except for $10.2 million of Credit Insurance Business related assets that will not be contributed to Fleet LLC and (2) Advanta's membership interest in Fleet LLC valued at $20 million.
[E] Represents the contribution to Fleet LLC of deposits, debt and other borrowings by an amount equaling total assets of the Business plus, approximately, an additional $510 million of liabilities representing a portion of the premium received by Advanta, less other liabilities contributed to Fleet LLC in accordance with the Contribution Agreement.
[F] Represents the contribution to Fleet LLC of (1) other liabilities related to the Business had the Transaction occurred at the balance sheet date and (2) $34.7 million of accrued interest payable on the deposits, debt and other borrowings discussed in [E] above, net of (3) $11.1 million of Credit Insurance Business related liabilities that will not be contributed to Fleet LLC.
[G] Represents the increase in retained earnings resulting from the gain on the Transaction of approximately $530 million, consisting of liabilities in excess of assets contributed of approximately $510 million and Advanta's membership interest in Fleet LLC valued at $20 million.
[H] Represents the sale of $813 million of federal funds sold, interest-bearing deposits and investments to purchase the Common Shares, the SAILS Depositary Shares and options to purchase Common Shares, and the tax benefit related to the tender of Common Shares underlying options granted under the Advanta's stock option plans. The $813 million of investments sold reflects $850 million of shares at the applicable purchase price per share primarily net of the difference between $40 per share and the option exercise price of options anticipated to be exercised in connection with the Offer.
[I] Represents: (1) the purchase of approximately 7.7 million Class A Common Stock and approximately 11.0 million Class B Common Stock at $40 per share; (2) the purchase of approximately 1.1 million SAILS Depositary Shares at $32.80 per share and (3) the tender of approximately 1.4 million of Common Shares underlying options at a cost to the Company of the amount by which $40 per share exceeds the option exercise price.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12. CREDIT CARD SALES
In June 1996, the Company, through its subsidiary ANB (and its predecessors by merger), sold certain consumer credit card customer relationships and the related receivables balance to a domestic bank. The receivables associated with these relationships represented less than 2% of the Company's managed credit card portfolio as of June 30, 1996. The Company recorded a $33.8 million net gain related to this transaction.
NOTE 13. COMMITMENTS AND CONTINGENCIES
In May 1997, the Company's Board of Directors approved the Office of the Chairman Supplemental Compensation Program. Under the program, each of the Chairman and Vice Chairman received $5 million as a result of the Transaction described in Note 11. In addition, the restrictions on 50,000 shares of Class B Common Stock previously granted to the Vice Chairman under his employment agreement were removed and certain previously agreed to benefits related to these shares were accelerated as a result of the Transaction described in Note 11. These amounts were recognized in connection with the Transaction in the first quarter of 1998.
On June 30, 1997 and July 8, 1997 the Company and several of its current and former officers and directors were named as defendants in lawsuits brought by shareholders claiming to represent shareholders that purchased shares of the Company's common stock during the periods between August 13, 1996 and March 17, 1997, and October 17, 1996 and March 17, 1997, respectively. In December 1997, these lawsuits were consolidated in an action styled In Re Advanta Corp. Securities Litigation pending in federal court in Pennsylvania. The class action complaints allege that the Company made misrepresentations in certain of its public filings and statements in violation of the Securities Exchange Act of 1934 and seek damages of an unspecified amount although management believes that the allegations are without merit. In the opinion of management, the ultimate resolution of these complaints is not expected to have a material adverse effect on the financial position or future operating results of the Company.
Between August 25, 1997 and December 18, 1997, the Company and certain other subsidiaries were named as defendants in lawsuits by cardholders claiming to represent cardholders in a specific program. The class action complaints allege that cardholder accounts in the specific program were improperly repriced to a higher percentage rate of interest. The complaints assert various violations of federal and state law with regard to such repricings, and each seeks damages of an unspecified amount although management believes that the allegations are without merit. In the opinion of management, the ultimate resolution of these complaints is not expected to have a material adverse effect on the financial position or future operating results of the Company.
Prior to the closing of the Transaction described in Note 11, certain holders of the Company's Medium Term Notes (the "Holders") questioned whether the Transaction would require their consent. At the request of such Holders, the trustee under the indenture and under the indenture for the Company's Junior Subordinated Debentures and the related declaration of trust for the Capital Securities called a meeting of holders of the Company's Medium Term Notes, Value Notes, and Capital Securities for January 15, 1998, and formally notified all holders of the Company's Senior Investment Notes and RediReserve Certificates of the Transaction and the question raised by such Holders. No action was taken at the meeting and, to date, no holders of such instruments have commenced any legal action. While there is no assurance that the holders of such instruments will not pursue legal remedies, including seeking a determination that the maturity of such instruments should be accelerated upon consummation of the Transaction, Advanta believes that the Transaction did not require the consent of the holders of such instruments, and further believes that the holders would not be successful in the pursuit of such remedies.
The Company leases office space in several states under leases accounted for as operating leases. Total rent expense for all of the Company's locations for the years ended December 31, 1997, 1996 and 1995 was
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$11.3 million, $8.5 million and $4.9 million, respectively. The future minimum lease payments of all non-cancelable operating leases are as follows:
NOTE 14. OTHER BORROWINGS
Certain of the Company's personal finance subsidiaries had a line of credit of $500 million at December 31, 1997. There is no facility fee related to this line of credit. At December 31, 1997, there was $3.9 million of outstanding borrowing on this line of credit. The Company is subject to various loan covenants, including the maintenance of certain profit levels at the borrowing subsidiaries, limitations on mergers and acquisitions, and limitations on liens on property and other assets. This line of credit expires on May 1, 1998. Management expects to obtain a new line of credit under substantially similar terms and conditions. Through May 1997, the Company had money market bid lines of $265 million under which the Company had borrowed $40 million at December 31, 1996. Through February 20, 1998, the Company had a revolving credit facility of $1.0 billion. There was a quarterly facility fee of up to 35 basis points on the total amount of the revolving credit facility. There were no borrowings outstanding under this facility at December 31, 1997 and 1996. Following the closing of the Transaction described in Note 11, the Company terminated this facility.
The composition of other borrowings was as follows:
The following table displays information related to selected types of short-term borrowings:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average interest rates were calculated by dividing the interest expense for the period for such borrowings by the average amount of short-term borrowings outstanding during the period.
NOTE 15. SELECTED INCOME STATEMENT INFORMATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 16. SELECTED BALANCE SHEET INFORMATION
(A) Represents initial deposits and subsequent excess collections up to the required amount on each of the credit card, mortgage and business loan and lease securitizations. Also includes amounts to be distributed to investors.
(A) Carried at the lower of cost or fair market value less selling costs.
At December 31, 1997 and 1996, the Company had $208.3 million and $399.4 million, respectively, of amounts due from credit card securitizations. These amounts include retained interest-only strips, net of recourse liabilities, accrued interest receivable and other amounts related to these securitizations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17. CONTRACTUAL MORTGAGE SERVICING RIGHTS
The activity in the contractual mortgage servicing rights asset is as follows:
The Company periodically evaluates the potential impairment of contractual mortgage servicing rights. The Company stratifies these rights based on two of the predominant risk characteristics of the underlying loans, such as the year of origination and the type of loan (i.e., fixed or adjustable rate loan). Impairment is recognized through a valuation allowance for each individual stratum. The amount of impairment recognized is the amount by which the contractual mortgage servicing rights for a stratum exceed their estimated fair value.
NOTE 18. CASH, DIVIDEND AND LOAN RESTRICTIONS
In the normal course of business, the Company and its subsidiaries enter into agreements, or are subject to regulatory requirements, that result in cash, debt and dividend restrictions.
Effective June 30, 1997 the Company's credit card bank, Advanta National Bank ("Old ANB"), was merged with Advanta National Bank USA ("AUS") and AUS was renamed Advanta National Bank ("ANB"). The combined bank is subject to the following restrictions. FDIC-insured banks are subject to certain provisions of the Federal Reserve Act which impose various legal limitations on the extent to which such banks can finance or otherwise supply funds to certain of their affiliates. In particular, ANB is subject to certain restrictions on any extensions of credit to, or other covered transactions, such as certain purchases of assets, with the Company or its affiliates. Such restrictions prevent ANB from lending to the Company and its affiliates unless such extensions of credit are secured by U.S. Government obligations or other specified collateral. Further, such secured extensions of credit by ANB are limited in amount: (a) as to the Company or any such affiliate, to 10 percent of the bank's capital and surplus, and (b) as to the Company and all such affiliates in the aggregate, to 20 percent of the bank's capital and surplus.
Under certain grandfathering provisions of the Competitive Equality Banking Act of 1987, the Company is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA"), so long as the Company and ANB continue to comply with certain restrictions on their activities. These restrictions include limiting the scope of its activities to those in which it was engaged prior to March 5, 1987. Since ANB was not making commercial loans at that time, it must continue to refrain from making commercial loans -- which would include any loans to the Company or any of its subsidiaries -- in order for the Company to maintain its grandfathered exemption under the BHCA. The Company has no present plans to register as a bank holding company under the BHCA. ANB is also subject to various legal limitations on the amount of dividends that can be paid to its parent, the Company. ANB is eligible to declare a dividend provided that it is not greater than the current year's net profits plus net profits of the preceding two years, as defined. During 1997, ANB did not pay dividends to the Company, while $107 million of dividends were paid during 1996. At December 31, 1997, total stockholders' equity of the Company's banking and insurance affiliates approximated $828.5 million, of which $59.5 million was available for payment of dividends under applicable regulatory guidelines.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19. PARENT COMPANY FINANCIAL STATEMENTS
ADVANTA CORP. (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF OPERATIONS
The Parent Company Only Statements of Changes in Stockholders' Equity is the same as the Consolidated Statements of Changes in Stockholders' Equity (see page 42).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVANTA CORP. (PARENT COMPANY ONLY) STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20. CAPITAL RATIOS
ANB is, and the former Advanta National Bank ("Old ANB") and Advanta National Bank USA ("AUS") were subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the institutions' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the institution must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The institution's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the institution to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes that as of December 31, 1997, ANB meets all capital adequacy requirements to which it is subject.
As of December 31, 1997 the Office of the Comptroller of the Currency categorized ANB and as of December 31, 1996 categorized Old ANB and AUS, as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized an institution must maintain minimum total risk-based and Tier I risk-based capital and Tier I leverage ratios as set forth in the following table. There are no conditions or events since those notifications that management believes have changed such categorizations.
- -------------------------------------------------------------------------------- (1) In connection with the formation of Old ANB, supplementary agreement with the OCC required Old ANB to maintain a Tier I capital ratio of at least 8% during its first three years of operation as well as a minimum Tier I capital level of $50 million. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are as follows:
The above values do not necessarily reflect the premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular instrument. In addition, these values, derived from the methods and assumptions described below, do not consider the potential income taxes or other expenses that would be incurred on an actual sale of an asset or settlement of a liability. With respect to the fair value of liabilities, the above table is prepared on the basis that the amounts necessary to discharge such liabilities represent fair value. The Company's off-balance sheet financial instruments relate to managing the interest rate sensitivity position as described in Note 23.
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, FEDERAL FUNDS SOLD AND INTEREST-BEARING DEPOSITS
For these short-term instruments, the carrying amount is a reasonable estimate of the fair value.
INVESTMENTS
For investment securities held to maturity and those available for sale, the fair values are based on quoted market prices, dealer quotes or estimated using quoted market prices for similar securities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LOANS, NET OF ALLOWANCE FOR CREDIT LOSSES
For consumer credit card receivables, business card receivables and mortgage loans, the fair value is estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value for these loans also includes the estimated value of the portion of the retained interest-only strip and, for mortgage loans, servicing, which are not sold with the securities backed by these types of loans. The value of the retained interest-only strips and, for mortgage loans, servicing is estimated based on a discounted cash flow analysis. The cash flows are estimated as the excess of the weighted average yield on each pool of the loans sold over the sum of the pass-through interest rate plus the servicing fee and an estimate of future credit losses over the life of the loans and other amounts as described in Note 1. The value of direct finance lease receivables and other loans is estimated based on the market prices of similar receivables with similar characteristics.
AMOUNTS DUE FROM CREDIT CARD SECURITIZATIONS AND RETAINED INTEREST-ONLY STRIPS-PERSONAL FINANCE LOANS
The fair values of the retained interest-only strips component of amounts due from credit card securitizations and retained interest-only strips from personal finance loan securitizations are estimated based on discounted flow analyses as described in Note 1. For the other components of amounts due from credit card securitizations, the carrying amount is a reasonable estimate of the fair value. For purposes of estimating the fair value of the retained interest-only strip from credit card securitizations, management has assumed a discount rate of 12%, a principal payment rate of 10% and a loss rate of 7.8% for December 31, 1997 and assumed a discount rate of 12%, a principal payment rate of 10% and a loss rate of 6.5% for December 31, 1996. For purposes of estimating the fair value of the retained interest-only strip from personal finance loan securitizations, management has assumed a discount rate of 14%, a prepayment rate of 24% CPR for fixed rate loans and 29% for adjustable rate loans and a loss rate of 80 basis points for December 31, 1997 and assumed a discount rate of 14%, a prepayment rate of 21% CPR for fixed rate loans and 25% CPR for adjustable rate loans and a loss rate of 80 basis points for December 31, 1996.
CONTRACT MORTGAGE SERVICING RIGHTS
The fair value of these rights is estimated by discounting future cash flows, adjusted for prepayments, using rates available for instruments with similar terms and remaining maturities.
DEMAND AND SAVINGS DEPOSITS
The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date. This fair value does not include any benefit that may result from the low cost of funding provided by these deposits compared to the cost of borrowing funds in the market.
TIME DEPOSITS AND DEBT
The fair value of fixed-maturity certificates of deposit and notes is estimated using the rates currently offered for deposits and notes of similar remaining maturities.
OTHER BORROWINGS
The other borrowings are all at variable interest rates and therefore the carrying value approximates a reasonable estimate of the fair value.
INTEREST RATE SWAPS, OPTIONS AND FORWARD CONTRACTS
The fair value of interest rate swaps, options and forward contracts (used for managing interest rate and foreign currency risks) is the estimated amount that the Company would pay or receive to terminate the agreement at the reporting date, taking into account current interest and foreign exchange rates and the current creditworthiness of the counterparty.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMMITMENTS TO EXTEND CREDIT
Although the Company had $42.1 billion of unused commitments to extend credit, there is no market value associated with these commitments, as any fees charged are consistent with the fees charged by other companies at the reporting date to enter into similar agreements.
NOTE 22. CALCULATION OF EARNINGS PER COMMON SHARE
The following table shows the calculation of basic earnings per share and diluted earnings per share for the years ended December 31, 1997, 1996 and 1995.
(1) 25,000 shares of the Company's Class B convertible preferred stock were outstanding during 1997 but were not included in the computation of diluted earnings per share for the year ended December 31, 1997 because they were antidilutive for that period.
(2) Combined represents a weighted average of Class A and Class B. (See Note 1.)
NOTE 23. DERIVATIVE FINANCIAL INSTRUMENTS
In managing its interest rate sensitivity and foreign currency positions, the Company may use derivative financial instruments. These instruments are used for the express purpose of managing its interest rate and foreign currency exposures and are not used for any trading or speculative activities. As of December 31,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and 1996, all of the Company's derivatives were designated as hedges or synthetic alterations and were accounted for as such.
The following table summarizes by notional amounts the Company's derivatives instruments as of December 31, 1997 and 1996:
The notional amounts of derivatives do not represent amounts exchanged by the counterparties and, thus, are not a measure of the Company's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivatives contracts.
Credit risk associated with derivatives arises from the potential for a counterparty to default on its obligations. The Company attempts to limit credit risk by only transacting with highly creditworthy counterparties and requiring master netting and collateral agreements for all interest rate swap and interest rate option contracts. All derivative counterparties are associated with organizations having securities rated as investment grade by independent rating agencies. The list of eligible counterparties, setting of counterparty limits, and monitoring of credit exposure is controlled by the Investment Committee, a management committee. The Company's credit exposure to derivatives, with the exception of caps written, is represented by contracts with a positive fair value without giving consideration to the value of any collateral exchanged (see Note 21). For caps written, credit exposure does not exist since the counterparty has performed its obligation to pay the Company a premium payment.
Interest rate swap agreements generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. Based on its interest rate sensitivity analyses, the Company enters into interest rate swaps to more effectively manage the impact of fluctuating interest rates on its net interest income and noninterest revenues. The Company has used interest rate swaps to synthetically alter the cash flows on certain deposit, debt, and off-balance sheet credit card and leasing securitizations.
As of December 31, 1997, the Company used interest rate swaps for the following purposes: $1.0 billion to effectively convert fixed rate debt to a LIBOR based variable rate, and $1.1 billion to effectively convert certain off-balance sheet variable pass-through rate home equity and leasing securitizations to a fixed rate. In 1997, as part of its asset/liability risk management process, the Company chose to effectively convert $598 million of fixed rate off-balance sheet credit card securitizations to a LIBOR based variable rate through the use of interest rate swaps. The Company elected to terminate all of these interest rate swap positions after a 7 month period and realized a gain of $16.3 million. Gains or losses resulting from these interest rate swap terminations are deferred and amortized to other noninterest revenues over the remaining life of the underlying fixed rate credit card securitization. As of December 31, 1997, the unamortized gain amounted to $15.6 million with the remaining amortization period of 4.2 years. As of December 31, 1996, the Company used interest rate swaps and swaptions for the following purposes; $976.3 million to effectively convert fixed rate debt to a LIBOR based variable rate, and $737.1 million to effectively convert certain off-balance sheet variable pass-through rate home equity and leasing securitizations to a fixed rate.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes by notional amounts the Company's interest rate swap and swaption activity by major category for the periods presented:
Interest rate options are contracts that grant the purchaser, for a premium payment, the right to either purchase or sell a financial instrument at a future date for a specified price from the writer of the option. Interest rate caps and floors are option-like contracts that require the seller (writer) to pay the purchaser at specified future dates the amount by which a specified market interest rate exceeds the cap rate or falls below the floor rate, multiplied against a notional amount. A corridor is also an option-like contract which is the simultaneous purchase and sale of separate interest rate caps where each cap is referenced to a different interest rate index. A collar is an option-like contract which is the simultaneous purchase of an interest rate cap and the sale of an interest rate floor using the same reference interest rate index.
As part of managing its balance sheet and liquidity position, the Company periodically securitizes and sells credit cards, business loans and leases. For credit enhancement purposes, certain variable pass-through rate credit card and business loan and lease securitizations were issued with embedded or purchased interest rate caps. These rate caps, however, were not needed to satisfy asset/liability management strategies. In order to achieve its desired interest rate sensitivity structure and further reduce the effective pass-through rate of the securitization, the Company has synthetically altered the interest rate structure on certain off-balance sheet credit card, business loan and lease securitizations by writing interest rate caps to offset the embedded and purchased rate caps attached to them.
The premiums received or paid for writing or purchasing such cap contracts with third parties are included in other assets and are amortized to noninterest revenues over the life of the contract. Any obligations which may arise under these contracts are recorded in noninterest revenues on an accrual basis. As of December 31, 1997, unamortized premiums for caps written and purchased amounted to $1.3 million and $360 thousand, respectively. The weighted average maturities for caps written and purchased were 3.3 years and 4.6 years, respectively. As of December 31, 1996, unamortized premiums for caps written and purchased amounted to $2.1 million and $273 thousand, respectively. The weighted average maturities for caps written and purchased were 2.7 years and 4.3 years, respectively.
When the Company periodically securitized and sold credit card receivables, the receivables sold to the securitization trust carried rates which were indexed to the prime rate, whereas the securitization certificates issued from the trust may have been priced at a spread over LIBOR. The Company is exposed to interest rate
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
risk to the extent that these two rate indices react differently to changes in market interest rates. The Company may have chosen to hedge its credit card interest-only strips from the risk of spread compression between the prime rate and LIBOR by entering into corridor transactions which effectively fixed a prime/ LIBOR spread. In addition, variable rate receivables sold to a variable pass-through rate securitization trust may have contained introductory fixed rates which expose the Company to interest rate risk during the receivables' introductory period. The Company may have chosen to hedge the risk of interest rate spread compression by entering into collar transactions which effectively locked in a minimum interest rate spread in a changing interest rate environment.
Premiums paid or received for entering into corridor and collar transactions are included in other assets or other liabilities and are amortized to noninterest revenues over the life of the contract. Any obligations which may arise under these contracts are recorded to noninterest revenues on an accrual basis. As of December 31, 1997, the Company had no corridor or collar transactions outstanding. During 1997, substantially all of the Company's credit cards were indexed to LIBOR eliminating the need to hedge credit card interest-only strips from the risk of spread compression between the prime rate and LIBOR. Accordingly, the Company chose to terminate $500 million of corridor transactions and recorded a net gain of $429 thousand to income. As of December 31, 1996, unamortized premiums received for corridor and collar transactions amounted to $831 thousand. As of December 31, 1996, the weighted average maturities of corridor and collar transactions were 2.2 years.
Forward contracts are commitments to either purchase or sell a financial instrument at a future date for a specified price and may be settled in cash or through delivery of the underlying financial instrument. The Company regularly securitizes and sells fixed rate mortgage, business loan and lease receivables. The Company may choose to hedge the changes in the market value of its fixed rate loans and commitments designated for anticipated securitizations by selling U.S. Treasury securities for forward settlement. The maximum and average terms of hedges of anticipated mortgage loan sales is four and two months, respectively. Gains and losses from forward sales are deferred and included in the measurement of the dollar basis of the loans sold. Realized gains of $4.2 million and $3.4 million were deferred as of December 31, 1997 and 1996, respectively.
In addition, the Company periodically issues fixed pass-through rate credit card securitizations, fixed rate bank notes and capital securities. The Company is exposed to interest rate risk to the extent that rates rise before the issuance of the anticipated fixed rate obligations. The Company may choose to hedge the interest costs associated with anticipated obligations by selling securities for forward settlement. Gains or losses resulting from these hedges are deferred and amortized to interest expense over the life of the underlying obligation. The maximum and average terms of these types of anticipatory hedges is two months. As of December 31, 1997 and 1996, unamortized losses on hedges of anticipated fixed interest rate obligations amounted to $1.2 million and $1.7 million, respectively and the remaining weighted average amortization period was 2.4 years and 3.3 years, respectively.
The Company also had foreign currency risk to the extent that its net investment in the joint venture with the Royal Bank of Scotland is not funded with local currency. The Company hedged its foreign exchange risk by selling foreign currency for forward settlement. The maximum and average terms of hedges of foreign currency exposure is thirty days. Gains/(losses) from foreign currency forward contracts are included in stockholders' equity and amounted to $1.2 million and $(2.3) million as of December 31, 1997 and December 31, 1996, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table discloses the Company's interest rate swaps by major category, notional value, weighted average interest rates, and annual maturities for the periods presented.
(A) A portion of the Company's interest rate swaps were contributed to the Fleet LLC in connection with the Transaction described Note 11.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Advanta Corp.:
We have audited the accompanying consolidated balance sheets of Advanta Corp. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advanta Corp. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP Philadelphia, PA February 27, 1998
REPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING
To the Stockholders of Advanta Corp.:
The management of Advanta Corp. and its subsidiaries is responsible for the preparation, content, integrity and objectivity of the financial statements contained in this Annual Report. These financial statements have been prepared in accordance with generally accepted accounting principles and as such must, by necessity, include amounts based upon estimates and judgments made by management. The other financial information in the Annual Report was also prepared by management and is consistent with the financial statements.
Management maintains a system of internal controls that provides reasonable assurance as to the integrity and reliability of the financial statements. This control system includes: (l) organizational and budgetary arrangements which provide reasonable assurance that errors or irregularities would be detected promptly, (2) careful selection of personnel and communications programs aimed at assuring that policies and standards are understood by employees, (3) a program of internal audits, and (4) continuing review and evaluation of the control program itself.
The financial statements in this Annual Report have been audited by Arthur Andersen LLP, independent public accountants. Their audits were conducted in accordance with generally accepted auditing standards and considered the Company's system of internal controls to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. Their report is printed herewith.
SUPPLEMENTAL SCHEDULES
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
COMMON STOCK PRICE RANGES AND DIVIDENDS
The Company's common stock is traded on the National Market tier of The Nasdaq Stock Market under the symbols ADVNB (Class B non-voting common stock) and ADVNA (Class A voting common stock). Following are the high, low and closing sale prices and cash dividends declared for the last two years as they apply to each class of stock:
At December 31, 1997, the Company had approximately 1,100 and 430 holders of record of Class B and Class A common stock, respectively.
QUARTERLY DATA
QUARTERLY DATA (CONTINUED)
(1) See Note 1 to Consolidated Financial Statements.
SUPPLEMENTAL SCHEDULES
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
COMPOSITION OF GROSS RECEIVABLES
(1) Includes mortgage and home equity loans for all years presented and auto loans beginning in 1996. (2) Includes leases for all years presented and business cards beginning in 1996.
YIELD AND MATURITY OF INVESTMENTS AVAILABLE FOR SALE AT DECEMBER 31, 1997
(A) Yield computed on a taxable equivalent basis using a statutory rate of 35%.
(B) Equity investments and other securities without a stated maturity are excluded from this table.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The text of the Proxy Statement under the captions "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" are hereby incorporated by reference, as is the text in Part I of this Report under the caption, "Executive Officers of the Registrant."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The text of the Proxy Statement under the captions "Executive Compensation," "Compensation Committee Report on Executive Compensation" and "Election of Directors -- Committees, Meetings and Compensation of the Board of Directors", "-- Compensation Committee Interlocks and Insider Participation in Compensation Decisions" and "-- Other Matters" are hereby incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The text of the Proxy Statement under the captions "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" are hereby incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The text of the Proxy Statement under the captions "Election of Directors -- Compensation Committee Interlocks and Insider Participation in Compensation Decisions" and "-- Other Matters" are hereby incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
The following Financial Statements, Schedules, and Other Information of the Registrant and its subsidiaries are included in this Form 10-K:
- --------------- * Incorporated by reference to the Exhibit with corresponding number constituting part of the Registrant's Registration Statement on Form S-2 (No. 33-00071), filed on September 4, 1985.
+ Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
1. A Report on Form 8-K was filed by the Company on October 15, 1997 regarding consolidated earnings of the Company and its subsidiaries for the fiscal quarter ended September 30, 1997. Summary earnings and balance sheet information as of that date were filed with such report.
2. A Report on Form 8-K was filed by the Company on October 28, 1997 reporting certain announcements made by the Company that day.
3. A Report on Form 8-K was filed by the Company on December 3, 1997 regarding earnings guidance for the Company and its subsidiaries for the 1998 fiscal year.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ADVANTA CORP.
Dated: March 30, 1998 By: /s/ OLAF OLAFSSON ------------------------------------ Olaf Olafsson, President and Director
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned does hereby constitute and appoint Dennis Alter, William A. Rosoff, Olaf Olafsson, John J. Calamari, Jeffrey D. Beck and Elizabeth H. Mai, or any of them (with full power to each of them to act alone), his or her true and lawful attorney in-fact and agent, with full power of substitution, for him or her and on his or her behalf to sign, execute and file an Annual Report on Form 10-K under the Securities Exchange Act of 1934, as amended, for the fiscal year ended December 31, 1997 relating to Advanta Corp. and any or all amendments thereto, with all exhibits and any and all documents required to be filed with respect thereto, with the Securities and Exchange Commission or any regulatory authority, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises in order to effectuate the same as fully to all intents and purposes as he or she might or could do if personally present, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on the 30th day of March, 1998.