ITEM 1. BUSINESS
GENERAL
Onyx Acceptance Corporation, a Delaware Corporation, ("Onyx" or the "Company") is a specialized consumer finance company engaged in the purchase, securitization and servicing of motor vehicle retail installment contracts originated by franchised and select independent automobile dealerships, and to a small extent the origination or purchase of motor vehicle loans on a direct basis through its subsidiaries to consumers throughout the United States (collectively the "Contracts"). The Company focuses its efforts on acquiring Contracts collateralized by late model used and, to a lesser extent, new motor vehicles, entered into with purchasers whom the Company believes have a favorable credit profile. Since commencing the purchase, origination and servicing of Contracts in February 1994, the Company has purchased or originated in excess of $3.8 billion in Contracts and currently has an active dealer base of approximately 7,600 dealerships. The Company has expanded its operations from a single office in Orange County, California to 17 auto finance centers (the "Auto Finance Centers") serving many regions of the United States.
BACKGROUND
The Company was founded in August 1993 by a team of executives with extensive automobile finance experience including responsibility for the major aspects of near-prime auto lending, including underwriting, servicing, information systems implementation, interest rate management, securitizations and auto dealer center management.
The Company was initially capitalized by three venture capital firms in November 1993. In February 1994, the Company began building its portfolio of near-prime quality Contracts collateralized by new and used motor vehicles pursuant to its managed growth strategy. Within its first six years of operations, the Company expanded to 17 Auto Finance Centers, purchased or originated over $3.8 billion in Contracts and completed 18 securitizations.
MARKET AND COMPETITION
The Company operates in a highly competitive market. The automobile finance market has historically been serviced by a variety of financial entities including the captive finance affiliates of major automotive manufacturers, banks, savings associations, independent finance companies, credit unions and leasing companies. A number of these competitors have greater financial resources than the Company. Many of these competitors also have long-standing relationships with automobile dealerships and may offer dealerships or their customers other forms of financing or services not provided by the Company.
The Company competes for the purchase of Contracts which meet its underwriting criteria on the basis of emphasizing strong relationships with its dealership customer base through its local presence. The Company
supports its dealership customer base with an operation that is open seven days a week, and has the ability to finalize purchases of Contracts on weekends. The Company believes that its strong personal relationships with and its level of service to the dealerships in its customer base provide a competitive advantage to the Company.
BUSINESS STRATEGY
The Company's principal objective remains to become one of the leading sources of near-prime auto lending in the United States by leveraging the experience of its senior management team in this industry. The Company seeks to maintain and increase profitability through the implementation of the following strategies:
Targeted Market and Product Focus: The Company targets the near-prime auto lending market because it believes that near-prime lending produces greater origination and operating efficiency than does sub-prime lending. The Company focuses on late model used rather than new vehicles, as management believes the risk of loss on used vehicles is lower due to lower depreciation rates, while interest rates are typically higher. In addition, the Company believes that the late model used motor vehicle finance market is growing at a faster rate than is the finance market for new motor vehicles.
Localized Dealership Service: The Company provides a high level of service to its dealership base by underwriting and purchasing Contracts and marketing to and servicing dealerships on a local level through its Auto Finance Centers. The Company strategically locates its Auto Finance Centers in geographic areas of high dealership concentration to facilitate personal service in the local markets, including consistent buying practices, operations open seven days a week, competitive rates, a dedicated dealer service staff, fast turnaround time and systems designed to expedite the processing of Contract applications. This personal service is provided by a team of experienced account managers (the "Account Managers") with an established reputation for responsiveness and integrity who call on dealerships in a consistent and professional manner. The Company believes that its local presence and service provide the opportunity to build strong and lasting relationships with dealerships.
Expansion of Dealership Customer Base: The Company establishes active relationships with a substantial percentage of franchised dealerships in the regions in which it does business through its 17 existing Auto Finance Centers. The Company intends to establish additional relationships as it expands into other states during 2000.
Maintenance of Underwriting Standards and Portfolio Performance: The Company has developed an underwriting process that is designed to achieve attractive yields while minimizing delinquencies and losses. Based on its belief that a standardized commercially available credit scoring system is a less effective means of assessing credit risk, especially in the near-prime sector, the Company employs experienced credit managers (the "Credit Managers") in the local Auto Finance Centers to purchase Contracts satisfying the underwriting criteria developed by the Company. The Company's Credit Managers and Account Managers are compensated as a team and their compensation relies, in part, upon the quality of underwriting of the Contracts they approve. The Company has developed a credit review process where a post funding audit is performed on most purchases and originations by reviewing Contracts against the Company's underwriting standards shortly after they have been funded. This audit provides feedback to enhance the underwriting process. To further monitor the integrity of the underwriting process, management regularly tracks the delinquency and loss rates of Contracts purchased by each Credit and Account Manager team.
Technology-Supported Operational Controls: The Company has developed and instituted control and review systems that enable it to monitor both the operations of the Company and the performance of the servicing portfolio. These systems allow senior management to monitor Contract production, yields and performance on a real-time basis. The Company believes that its information systems not only enhance its internal controls but also allow it to significantly expand its Servicing Portfolio without a significant corresponding increase in its labor costs.
Liquidity Through Warehousing and Securitizations: The Company's strategy is to complete securitizations on a regular basis and to use warehouse credit facilities to fund Contracts prior to securitization. To fund
dealer participation and finance daily operations the Company relies to a significant extent on credit facilities that are collateralized by the Company's retained interest in securitized assets ("RISA"). The Company also utilizes both securitization and hedging strategies to leverage its capital efficiently and substantially reduce its interest rate risk.
OPERATIONS
Dealership Marketing and Service: As of December 31, 1999, the Company had 17 Auto Finance Centers located throughout the United States and had an active dealer base of approximately 7,600 dealerships. Of these dealerships, approximately 89% are franchised and approximately 11% are independent automobile dealerships. The Company believes that franchised and select independent automobile dealerships are most likely to provide the Company with Contracts that meet the Company's underwriting standards.
The Company has significantly expanded its customer base of automobile dealerships, and has substantially increased both monthly Contract purchases and originations and the size of its servicing portfolio. The following table sets forth information about the Company's Contracts and Auto Finance Centers as of the dates indicated:
The Company's growth objectives over the next 12 months are to open additional Auto Finance Centers in metropolitan areas within the United States and to further develop relationships with existing franchised dealerships in the states where the Company is currently doing business.
The Account Managers work from the Auto Finance Centers to solicit, enroll and educate new dealerships as well as to maintain relationships with the Company's existing dealership customer base. Each Account Manager visits dealership finance managers at each targeted dealership in his or her territory and presents information about the Company's dealership services. The Company's services include service hours seven days a week and the ability to rapidly respond to credit applications. The Account Managers educate the dealership finance managers about the Company's underwriting philosophy, including its preference for near-prime quality Contracts collateralized by late model used motor vehicles and its practice of using experienced Credit Managers (rather than sole reliance upon computerized scoring systems) to review applications.
The Account Managers also advise the dealership finance managers regarding the Company's commitment to serve a broad scope of qualified borrowers through its three near-prime auto lending programs: the "Premier", the "Preferred", and the "Standard" Programs. The Premier Program allows the Company to market lower interest rates in order to capture customers of superior credit quality. The Preferred Program allows the Company to offer Contracts at higher interest rates to borrowers with proven credit quality. The Standard Program allows the Company to assist qualified borrowers, who may have experienced previous credit problems or have not yet established a significant credit history, at interest rates higher than the Company's other programs.
The Company enters into a non-exclusive dealership agreement containing certain representations and warranties by the dealership about the Contracts. After this relationship is established, the Account Managers
continue to actively monitor the relationship to meet the Company's objectives with respect to the volume of applications satisfying the Company's underwriting standards. Due to the non-exclusive nature of the Company's relationships with dealerships, the dealerships retain discretion to determine whether to solicit financing from the Company or from another source or sources for a customer seeking to finance a vehicle purchase. The Account Managers regularly telephone and visit finance managers to reinforce to them the Company's objectives and to answer any questions they may have. To increase the effectiveness of these contacts, the Account Managers can obtain from the Company's management information systems real-time information listing by dealership the number of applications submitted, the Company's response and the reasons why a particular application was rejected. The Company believes that the personal relationships its Account Managers, Credit Managers and Auto Finance Center Managers establish with the finance managers at the dealerships are a significant factor in creating and maintaining productive relationships with its dealership customer base.
UNDERWRITING AND PURCHASING OF CONTRACTS
The Company's underwriting standards are applied by experienced Credit Managers with a personal, hands-on analysis of the creditworthiness of each applicant, rather than sole reliance upon standardized commercially available credit scoring systems used by several of the Company's competitors. The Company believes that credit-scoring systems may approve applicants who are in fact not creditworthy, while denying credit to others whom may have acceptable credit risk for the interest rate being charged. In addition, the Company believes that it can enhance the relationship with its dealership and consumer customer base by having its Credit Managers utilize a rules/exception based credit/audit system to personally review each application and communicate to the submitting dealership the results of the review, including the reasons why a particular application may have been declined. This practice encourages the dealership finance managers to submit Contracts meeting the Company's underwriting standards, thereby increasing the Company's operating efficiency. In order to ensure consistent application of its underwriting standards as its volume of Contract purchases increases, the Company has a formal internal training program for new and existing Account Managers and Credit Managers.
The underwriting process begins when an application is faxed by a dealership to a central toll-free number, at the Company's corporate headquarters, where it is input into the Company's front-end application processing system. Each application is evaluated by a Credit Manager in the local Auto Finance Center or corporate headquarters, using uniform underwriting standards developed by the Company. These underwriting standards are intended to assess the applicant's ability to timely repay all amounts due under the Contract and the adequacy of the financed vehicle as collateral. To evaluate credit applications, the Credit Manager reviews, among other things, on-line information, including reports of credit reporting agencies, nationally recognized vehicle valuation services, and ownership of real estate listed on an application. The Company's wide area network permits a Credit Manager in any Auto Finance Center or the corporate headquarters to access an application on a real-time basis. This computer network enables senior management to efficiently review Contracts requiring approval, and permits the Company to seamlessly shift underwriting work among any of the Auto Finance Centers to increase operating efficiency. Finally, the Company's computer network permits daily review by senior management of operating results sorted by any number of variables, including by Credit Manager, Auto Finance Center or auto dealership.
The funds advanced by the Company to purchase a Contract generally do not exceed: (i) for a new financed vehicle, the dealer's invoice plus taxes, title and license fees, any extended warranty and credit insurance; or (ii) for a used financed vehicle, the wholesale value assigned by a nationally recognized vehicle valuation service value guide, plus taxes, title and license fees, any extended warranty and credit insurance. However, the actual amount advanced for a Contract may be limited by a number of factors, including the length of the Contract term, the make, model and year of the financed vehicle and the creditworthiness of the obligor. These adjustments are made to insure that the financed vehicle constitutes adequate collateral to secure the Contract. Contracts purchased or originated in 1999 had an average loan to value ratio at purchase or origination of 104% which the Company believes is one of the lowest in the industry.
Once the review of an application is completed, the Credit Manager communicates his or her decision to the dealership specifying approval, conditional approval (such as an increase in the downpayment, reduction in the term of the financing, or the addition of a co-signer to the Contract), or denial.
The dealership is required to deliver the necessary documentation for each Contract approved for purchase by the Company to the originating Auto Finance Center. The Company audits such documents for completeness and consistency with the application, providing final approval for purchase of the Contract once these requirements have been satisfied. The completed Contract file is then promptly forwarded to the corporate headquarters.
The Auto Finance Center purchasing the Contract funds the purchase and pays a dealer participation fee, if any. The dealership can receive 100% of the dealer participation, at purchase or at month-end, and the Company is entitled to recover from the dealership over the life of the Contract the unearned portion of the dealer participation in the event of a prepayment of the purchased Contract or charge-off of the Contract. The Company also offers three other participation methods, in which the Company pays less than 100% of the dealer participation, but for which the dealership is under no obligation to refund any unearned participation if the contract defaults or pre-pays after the expiration of a set period of time after the Contract purchase date.
The Company conducts a post-funding credit review of most of its Contracts. In the review, the approved application is re-examined to be certain it complies with the Company's underwriting requirements. The results of these reviews are then reviewed by senior management to ensure consistent application of the Company's underwriting standards.
The Company employs a compensation system for its Credit Managers, Account Managers and Auto Finance Center Managers designed to reward those employees whose Contract purchases meet the Company's volume and yield objectives while preserving credit quality. Generally, these bonuses, which are payable monthly, may constitute up to 40% of an employee's compensation and are initially calculated based on the volume of Contracts purchased and the yield on such Contracts. This bonus amount is reduced if the Company's post-funding credit review reveals that a portion of the purchased Contracts did not satisfy the Company's underwriting standards. Under this system, 50% of the bonus payment is based on attainment of Account Manager/Credit Manager team objectives and 50% is based on attainment of the Auto Finance Center objectives. The Company believes this incentive compensation system motivates employees to purchase only those near-prime quality Contracts that meet the Company's objectives of increasing volume at targeted yields while preserving credit quality.
The following table sets forth information about the Company's Contracts as of the dates indicated:
Periodically the Company performs an analysis of its servicing portfolio to evaluate the effectiveness of its underwriting guidelines. If external economic factors, credit delinquencies or credit losses change, the Company may adjust its underwriting guidelines to maintain the asset quality deemed acceptable by the Company's management.
SERVICING AND COLLECTION PROCEDURES
The Company services all Contracts in its servicing portfolio. To reduce the costs of its servicing operations, the Company has outsourced certain data processing and billing functions related to its servicing of
Contracts. This includes a three-year contract expiring in 2000 with a service bureau to provide certain loan accounting, reporting, collections and servicing functions; the Company intends to take these processes in-house at the expiration of this contract. Through its service providers, the Company mails to each obligor a monthly billing statement 20 days prior to the due date. The Company believes this method has proven to be more effective in controlling delinquency, and therefore losses, than payment coupon books which are delivered to the obligor at the time the Contract is purchased. The Company charges a late fee, where allowed by law, on any payment received after the expiration of the statutory or contractual grace period. Most payments from obligors are deposited directly into a lockbox account while the remainder of payments are received directly by the Company and promptly deposited by the Company into the lockbox account.
Under the terms of its credit facilities and securitization trusts, the Company acts as servicer with respect to all Contracts purchased or originated in its servicing portfolio. The Company receives servicing fees for servicing securitized Contracts equal to one percent per annum of the outstanding principal balance of such Contracts. The Company services the securitized Contracts by collecting payments due from obligors and remitting such payments to the trustee in accordance with the terms of the servicing agreements. The Company maintains computerized records with respect to each Contract to record receipts and disbursements and to prepare related servicing reports.
COLLECTION PROCEDURES
Collection activities with respect to delinquent Contracts are performed by the Company at its Foothill Ranch, California Collection Center. Collection activities include prompt investigation and evaluation of the causes of any delinquency. An obligor is considered delinquent when he or she has failed to make a scheduled payment under the Contract within 30 days of the related due date (each a "Due Date").
To automate its collection procedures, the Company uses features of the computer system of its third party service bureau to provide tracking and notification of delinquencies. The collection system provides relevant obligor information (for example, current addresses, phone numbers and loan information) and records of all Contracts. The system also records an obligor's promise to pay and affords supervisors the ability to review collection personnel activity and to modify collection priorities with respect to Contracts. The Company utilizes a predictive dialing system located at the Foothill Ranch Collection Center to make phone calls to obligors whose payments are past due by more than eight days but less than 20 days. The predictive dialer is a computer-controlled telephone dialing system which dials phone numbers of obligors from a file of records extracted from the Contract database. By eliminating time wasted on attempting to reach obligors, the system gives a single collector, on average, the ability to speak with and work 200 to 250 accounts per day. Once a live voice responds to the automated dialer's call, the system automatically transfers the call to a collector and the relevant account information to the collector's computer screen. The system also tracks and notifies collections management of phone numbers that the system has been unable to reach within a specified number of days, thereby promptly identifying for management all obligors who cannot be reached by telephone.
Once an obligor is 20 days or more delinquent, these accounts are assigned to specific collectors at the Foothill Ranch Collection Center who have primary responsibility for such delinquent accounts until they are resolved. To expedite collections from late paying obligors, the Company uses Western Union "Quick Collect," which allows an obligor to pay, at numerous locations, any late payments which are in turn wired daily to the Company's lockbox account by Western Union. The Company also uses a Western Union payment system that allows an obligor to authorize the Company to present a draft directly to the obligor's bank for payment to the Company.
Generally, after a scheduled payment under a Contract continues to be past due for between 45 and 60 days, the Company will initiate repossession of the financed vehicle. However, if a Contract is deemed uncollectable, if the financed vehicle is deemed by collection personnel to be in danger of being damaged, destroyed or made unavailable for repossession, or if the obligor voluntarily surrenders the financed vehicle, Onyx may repossess it without regard to the length or existence of payment delinquency. Repossessions are conducted by third parties that are engaged in the business of repossessing vehicles for secured parties. Under
California law and the laws of most other states, after repossession, the obligor generally has an additional period of time to redeem the financed vehicle before the financed vehicle may be resold by the Company in an effort to recover the balance due under the Contract.
If the proceeds from the sale of a repossessed vehicle fall short of the balance due on the Contract, the Company will experience a loss. The current policy of the Company is to recognize losses on repossessed vehicles in the month in which the vehicle is sold or in which the scheduled payment becomes 120 days delinquent, whichever occurs first. Losses may occur in connection with delinquent Contracts for which the vehicle was not repossessed, either because of a discharge of the obligor's indebtedness in a bankruptcy proceeding or due to the Company's inability to locate the financed vehicle or the obligor. In these cases, losses are recognized at the time a Contract is deemed uncollectable or during the month a scheduled payment under the Contract becomes 150 days past due, whichever occurs first.
Upon repossession and sale of the financed vehicle, any deficiency remaining is pursued against the obligor to the extent deemed practical by the Company and to the extent permitted by law. The loss recognition and collection policies and practices of the Company may change over time in accordance with the Company's business judgement.
MODIFICATIONS AND EXTENSIONS
The Company offers certain credit-related extensions to obligors. Generally, these extensions are offered only when (i) the Company believes that the obligor's financial difficulty has been resolved or will no longer impair the obligor's ability to make future payments, (ii) the extension will result in the obligor's payments being brought current, (iii) the total number of credit-related extensions granted on the Contract will not exceed three, and the total credit-related extensions granted on the Contract will not exceed three months in the aggregate, (iv) there has been no more than one credit-related extension granted on the Contract in the immediately preceding twelve months, and (v) Onyx (or its assignee) has held the Contract for at least six months. Any deviation from this policy requires the concurrence of a Collection Supervisor and the Company's Collection Manager and the Executive Vice President, Collections. The total number of extensions was less than 4% of the number of Contracts in the Servicing Portfolio for the years ending December 31, 1999, and December 31, 1998.
INSURANCE
Each Contract requires the obligor to obtain comprehensive and collision insurance with respect to the related financed vehicle with the Company named as a loss payee. In the event that the obligor fails to maintain the required insurance, however, the Company has purchased limited comprehensive and collision insurance, referred to as the "Blanket Insurance Policy" coverage. The Blanket Insurance Policy provides the Company with protection on each uninsured or underinsured financed vehicle against total loss, damage or theft. The Company has obtained its Blanket Insurance Policy from Great American Insurance Companies. For the Blanket Insurance Policy, the Company is assessed a premium based on the size of the Servicing Portfolio. In 1998, the Company opened an insurance tracking department at its corporate headquarters. The Company believes that this function has helped reduce its exposure to uninsured motorists through its prompt follow up on non-compliant obligors.
FINANCING AND SALE OF CONTRACTS
The Company finances the acquisition and origination of Contracts primarily through its warehouse credit facilities as discussed below:
CP Facilities: As of December 31, 1999, the Company was party to two primary auto loan warehousing programs (the "CP Facilities"), one, a $375 million facility with Triple-A One Funding Corporation ("Triple-A"), and the other, a $150 million facility with Park Avenue Receivables Corporation ("Parco"). Two of the Company's special purpose subsidiaries, Onyx Acceptance Financial Corporation ("Finco") for the Triple-A One Facility, and newly created Onyx Acceptance Receivables Corporation ("Recco") for the Parco Facility, are the borrowers under the CP Facilities. The CP Facilities are used to fund the purchase or
origination of Contracts. Triple-A and Parco are both rated commercial paper asset-backed conduits sponsored by MBIA Insurance Corporation ("MBIA") and The Chase Manhattan Bank ("Chase"), respectively. MBIA provides credit enhancement for both facilities by issuing financial guarantee insurance policies covering all principal and interest obligations owed for the borrowings under the facilities. The Company pledges its Contracts held for sale to borrow from Triple-A and from Parco. The Parco Facility was executed in August 1999, and expires in August 2000, but may be renewed at the option of the lenders. The Triple-A Facility is subject to renewal in September 2000 at the option of the lenders, and, if so renewed, will expire in September 2001.
The Merrill Line: A subsidiary of the Company, Onyx Acceptance Funding Corporation ("Fundco"), has a $100 million line of credit (the "Merrill Line"), with Merrill Lynch Mortgage Capital, Inc. ("MLMCI"), which provides warehouse funding for the purchase or origination of Contracts and is used in concert with the CP Facilities the Company currently has in place. The Merrill Line was renewed in February 2000 for a one year term, but can be terminated at the option of the lender at any time.
The Company finances dealer participation payments and daily operations principally through credit facilities collateralized by its retained interest in securitized assets, as well as through proceeds from subordinated debt offerings.
The Residual Lines: The Company, through Fundco, has two residual Facilities: a $10 million committed facility with MLMCI and a $50 million line with Salomon Smith Barney Realty Corporation ("SBRC") (the "SBRC Line" and together with the facility with MLMCI, the "Residual Lines"). The Residual Lines are used by the Company to finance operating requirements. The lines utilize a collateral-based formula that sets borrowing availability to a percentage of the value of excess cash flow to be received from certain securitizations. The facility provided by MLMCI was renewed in February 2000 for a one year term. Each loan under the SBRC Line matures one year after the date of the loan; the Company expects each loan to be renewed at term.
Excess Servicing Facility: The Company is party to a collateralized loan ("Excess Servicing Facility") with a lending group for up to $45 million, which was used for working capital and other expenditures. The Excess Servicing Facility matured in June 1999. This line is now in the amortization period and all cash flows from the underlying securitizations, which are collateral, are being used to repay the outstanding principal balance.
Subordinated Debt: As of December 31, 1999, the Company had outstanding $10 million of subordinated debt with an initial term of two years. In February 2000, the Company exercised its option to extend the term by three years during which the loan will fully amortize. Final maturity is scheduled for February 2003.
The facilities and lines above contain affirmative, negative and financial covenants typical of such credit facilities. The Company was in compliance with these covenants as of December 31, 1999.
Hedging and Interest Rate Risk Management: The Company employs a hedging strategy that is intended to minimize the risk of interest rate fluctuations, and which historically has involved the execution of forward interest rate swaps or use of a pre-funding structure for the Company's securitizations. The Company is not required to maintain collateral on the outstanding hedging program, until the point where the fair value declines below ($1.0) million.
Securitization: Regular securitizations are an integral part of the Company's business plan because they allow the Company to increase its liquidity, provide for redeployment of its capital and reduce risks associated with interest rate fluctuations. The Company has developed a securitization program that involves selling interests in pools of its Contracts to investors through the public issuance of AAA/Aaa rated asset-backed securities. The Company completed four AAA/Aaa rated publicly underwritten asset-backed securitizations in the amount of $1.45 billion in 1999.
The net proceeds of these securitizations are used to pay down outstanding indebtedness incurred under the Company's credit facilities to purchase Contracts, thereby creating availability for the purchase of additional Contracts. Through December 31, 1999, the Company had securitized $3.4 billion of Contracts in 18 separate transactions. In each of its securitizations, the Company sold its Contracts to a newly formed
grantor or owner trust which issued pass-through certificates or notes in an amount equal to the aggregate principal balance of the Contracts.
To improve the level of profitability from the sale of securitized Contracts, the Company arranges for credit enhancement to achieve an improved credit rating on the asset-backed securities issued. This credit enhancement has taken the form of a financial guaranty issued by MBIA, or a predecessor, which issues a financial guaranty insurance policy (the "Financial Guarantee Insurance Policy") insuring the payment of principal and interest due on the asset-backed securities.
The Company receives servicing fees for its duties relating to the accounting for and collection of the Contracts. In addition, the Company is entitled to the future excess cash flows arising from the trusts. Generally, the Company sells the Contracts at face value and without recourse, except that certain representations and warranties with respect to the Contracts are provided by the Company as the servicer and Finco as the seller to the trusts.
Gains on sale of Contracts arising from securitizations provide a significant portion of the Company's revenues. Several factors affect the Company's ability to complete securitizations of its Contracts, including conditions in the securities markets generally, conditions in the asset-backed securities market specifically, the credit quality of the Company's portfolio of Contracts and the Company's ability to obtain credit enhancement.
GOVERNMENT REGULATION
The Company's operations are subject to regulation, supervision, and licensing under various federal, state and local statutes, ordinances and regulations. The Company is required to comply with the laws of those states in which it conducts operations. Management believes that it is in compliance with these laws and regulations.
Consumer Protection Laws: Numerous federal and state consumer protection laws and related regulations impose substantial requirements upon lenders and servicers involved in consumer finance. These laws include the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Federal Trade Commission Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Magnuson-Moss Warranty Act, the Federal Reserve Board's Regulations B and Z, states' adaptations of the Uniform Consumer Credit Code and of the Uniform Commercial Code (the "UCC") and state motor vehicle retail installment sales acts and other similar laws. These laws, among other things, require the Company to provide certain disclosures to applicants, prohibit misleading advertising and protect against discriminatory financing or unfair credit practices. The Truth in Lending Act and Regulation Z promulgated thereunder require disclosure of, among other things, the payment schedule, the finance charge, the amount financed, the total of payments and the annual percentage rate charged on each retail installment contract. The Equal Credit Opportunity Act prohibits creditors from discriminating against loan applicants (including retail installment contract obligors) on the basis of race, color, sex, age (provided the applicant has the capacity to contract), marital status, religion, national origin, the fact that all or part of the applicant's income derives from a public assistance program, or the fact that the applicant has in good faith exercised any right under the Consumer Credit Protection Act. Under the Equal Credit Opportunity Act, creditors are required to make certain disclosures regarding consumer rights and advise consumers whose credit applications are not approved. The rules of the Federal Trade Commission (the "FTC") limit the types of property a creditor may accept as collateral to secure a consumer loan, and its holder in due course rules provide for the preservation of the consumer's claims and defenses when a consumer obligation is assigned to a subject holder. With respect to used vehicles specifically, the FTC's rule on Sale of Used Vehicles requires that all sellers of used vehicles prepare, complete and display a Buyer's guide which explains any applicable warranty coverage for such vehicles. Also, some state laws impose finance charge ceilings and other restrictions on consumer transactions and require contract disclosures in addition to those required under federal law. These requirements impose specific statutory liabilities upon creditors who fail to comply with their provisions. In some cases these provisions could affect the Company's ability to enforce Contracts it purchases or originates.
EMPLOYEES
The Company employs personnel experienced in all areas of loan originations, documentation, collection and administration. The Company employs and trains specialists in loan processing and servicing with minimal crossover of duties. At December 31, 1999, the Company had 715 full-time employees, none of whom were covered by collective bargaining agreements. The Company believes it has good relationships with its employees.
RISK FACTORS
You should carefully consider the following risks in your evaluation of us and our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties, including, but not limited to, credit, economic, competitive, governmental and financial factors affecting our operations, markets, financial products, and services and other factors discussed in our filings with the Securities and Exchange Commission may also adversely impact and impair our business. If any of these risks actually occur, our business, results of operations, cash flows or financial condition would likely suffer. In such case, the trading price of our common stock could decline, and you may lose all or part of the money you paid to buy our common stock.
WE NEED SUBSTANTIAL LIQUIDITY.
We require a substantial amount of liquidity to operate our business. Among other things, we use such liquidity to:
- acquire Contracts;
- pay dealer participation;
- pay securitization costs and fund related accounts;
- settle hedge transactions;
- satisfy working capital requirements and pay operating expenses; and
- pay interest expense.
A substantial portion of our revenues in any period is represented by gain on sale of Contracts generated by a securitization in such period, but the cash underlying such revenues is received over the life of the Contracts.
We have operated on a negative cash flow basis and expect to do so in the future as long as the volume of Contract purchases continues to grow. We have historically funded these negative operating cash flows principally through borrowings from financial institutions, sales of equity securities and sales of subordinated notes. We cannot assure you, however, that (1) we will have access to the capital markets in the future for equity, debt issuances or securitizations, or (2) financing through borrowings or other means will be available on acceptable terms to satisfy our cash requirements. If we are unable to access the capital markets or obtain acceptable financing, our results of operations, financial condition and cash flows would be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
WE DEPEND ON WAREHOUSE FINANCING.
We depend on warehousing facilities with financial institutions to finance the purchase or origination of Contracts pending securitization. See "Business -- Financing and Sale of Contracts." Our business strategy requires that such financing continue to be available during the warehousing period.
Whether the CP Facilities continue to be available to us depends on, among other things, whether we maintain a target net yield for the Contracts financed under the CP Facilities and comply with certain financial covenants contained in the sale and servicing agreements between us, as seller, and our wholly-owned special purpose finance subsidiaries, Finco or Recco, as applicable, as purchaser. These financial covenants include:
- a minimum ratio of net worth plus subordinated debt to total assets;
- a maximum ratio of credit enhancement assets to tangible net worth;
- earnings before interest, depreciation and taxes coverage ratio; and
- minimum cash on hand.
We also have a warehouse line of credit with Merrill Lynch. Whether the Merrill Line continues to be available to us depends on whether we meet certain debt to equity ratios and minimum equity requirements.
We cannot assure you that our CP Facilities or Merrill Line will be available to us or that they will be available on favorable terms. If we are unable to arrange new warehousing credit facilities or extend our existing credit facilities when they expire, our results of operations, financial condition and cash flows could be materially and adversely affected.
WE DEPEND ON RESIDUAL FINANCING.
When we sell our Contracts in securitizations, we receive cash and a residual interest in the securitized assets ("RISA"). The RISA represents the future cash flows to be generated by the Contracts in excess of the interest paid on the securities issued in the securitization and other costs of servicing the Contracts and completing the securitization. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations"). We typically use the RISA from each securitization as collateral to borrow cash to finance our operations. The amount of cash advanced by our lenders under our Residual Lines depends on a collateral formula that is determined in large part by how well our securitized Contracts perform. If our portfolio of securitized Contracts experienced higher delinquency and loss ratios than expected, then the amount of money we could borrow under the Residual Lines would be reduced. The reduction in availability under these Residual Lines could materially and adversely affect our operations, financial condition and cash flows. Additionally, we are subject, under the documentation governing the Residual Lines, to minimum net worth and subordinated debt plus net worth tests, a limitation on quarterly operating losses and covenants restricting delinquencies, losses, prepayments and net yields of Contracts included in a securitization.
The continued amortization of our Excess Servicing Facility depends on, among other things, whether we meet financial covenants that are substantially similar to those of the CP Facilities. A failure to meet these requirements could result in an acceleration of the amount due.
WE DEPEND ON SECURITIZATIONS TO GENERATE REVENUE.
We rely significantly upon securitizations to generate cash proceeds for repayment of our warehouse credit facilities and to create availability to purchase additional Contracts. Further, gain on sale of Contracts generated by our securitizations represents a significant portion of our revenues. Our ability to complete securitizations of our Contracts is affected by the following factors, among other things:
- conditions in the securities markets generally;
- conditions in the asset-backed securities market specifically;
- the credit quality of our portfolio of Contracts; and
- our ability to obtain credit enhancement.
If we were unable to profitably securitize a sufficient number of our Contracts in a particular financial reporting period, then our revenues for such period could decline and could result in lower net income or a loss
for such period. In addition, unanticipated delays in closing a securitization could also increase our interest rate risk by increasing the warehousing period for our Contracts. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Liquidity and Capital Resources," and "Business Financing and Sale of Contracts."
WE DEPEND ON CREDIT ENHANCEMENT.
From inception through December 31, 1999, each of our securitizations has utilized credit enhancement in the form of a financial guarantee insurance policy issued by MBIA, or its predecessor, in order to achieve "AAA/Aaa" ratings. This form of credit enhancement reduces the cost of the securitizations relative to alternative forms of credit enhancements currently available to us. MBIA is not required to insure future securitizations, and we are not restricted in our ability to obtain credit enhancement from providers other than MBIA or to use other forms of credit enhancement. We cannot assure you that:
- we will be able to continue to obtain credit enhancement in any form from MBIA;
- we will be able to obtain credit enhancement from any other provider of credit enhancement on acceptable terms; or
- future securitizations will be similarly rated.
We also rely on MBIA's financial guarantee insurance policy to reduce our borrowing cost under the CP Facilities. If MBIA's credit rating is downgraded or if it withdraws our credit enhancement, we could be subject to higher interest costs for our future securitizations and financing costs during the warehousing period. Such events could have a material adverse effect on our results of operations, financial condition and cash flows.
WE ARE SUBJECT TO INTEREST RATE FLUCTUATIONS.
Our profitability is largely determined by the difference, or "spread," between the effective rate of interest received by us on the Contracts acquired and the interest rates payable under our credit facilities during the warehousing period and for securities issued in securitizations.
Several factors affect our ability to manage interest rate risk. First, the Contracts are purchased or originated at fixed interest rates, while amounts borrowed under our credit facilities bear interest at variable rates that are subject to frequent adjustment to reflect prevailing rates for short-term borrowings. Our policy is to increase the buy rates we issue to dealerships or to increase rates we make available to consumers for Contracts in response to increases in our cost of funds during the warehousing period. However, there is generally a time lag before such increased borrowing costs can be offset by increases in the buy rates for Contracts and, in certain instances, the rates charged by our competitors may limit our ability to pass through our increased costs of warehouse financing.
Second, the spread can be adversely affected after a Contract is purchased or originated and while it is held during the warehousing period by increases in the prevailing rates in the commercial paper markets. While the CP Facilities permit us to select maturities of up to 270 days for commercial paper, if we selected a shorter maturity or had a delay in completing a securitization, we would face this risk.
Third, the interest rate demanded by investors in securitizations is a function of prevailing market rates for comparable transactions and the general interest rate environment. Because the Contracts purchased or originated by us have fixed rates, we bear the risk of spreads narrowing because of interest-rate increases during the period from the date the Contracts are purchased until the pricing of our securitization of such Contracts. We employ a hedging strategy that is intended to minimize this risk and which historically has involved the execution of forward interest rate swaps or use of a pre-funding structure for our securitizations. However, we cannot assure you that this strategy will consistently or completely offset adverse interest-rate movements during the warehousing period or that we will not sustain losses on hedging transactions. Our hedging strategy requires estimates by management of monthly Contract acquisition volume and timing of our
securitizations. If such estimates are materially inaccurate, then our gains on sales of Contracts, results of operations and cash flows could be materially and adversely affected.
We also have exposure to interest rate fluctuations under the Residual Lines and the Excess Servicing Facility. The interest rates are based on 30 day LIBOR and the Prime Rate. The LIBOR lines reset each month while the Prime Rate line is reset with any change in the Prime rates. In periods of increasing interest rates our cash flows, results of operations and financial condition could be adversely affected.
In addition, we have some interest rate exposure to falling interest rates to the extent that the interest rates charged on Contracts sold in a securitization with a pre-funding structure decline below the rates prevailing at the time that the securitization prices. Such a rate decline would reduce the interest rate spread because the interest rate on the notes and/or the certificates would remain fixed. This would negatively impact the gains on sale of Contracts and our results of operations and cash flows.
WE WILL BE ADVERSELY AFFECTED WHEN CONTRACTS ARE PREPAID OR DEFAULTED.
Our results of operations, financial condition, cash flows, and liquidity depend, to a material extent, on the performance of Contracts purchased, originated, warehoused, and securitized by us. A portion of the Contracts acquired by us may default or prepay during the warehousing period. We bear the risk of losses resulting from payment defaults during the warehousing period. In the event of payment default, the collateral value of the financed vehicle may not cover the outstanding Contract balance and costs of recovery. We maintain an allowance for credit losses on Contracts held during the warehousing period which reflects management's estimates of anticipated credit losses during such period. If the allowance is inadequate, then we would recognize as an expense the losses in excess of such allowance, and our results of operations could be adversely affected. In addition, under the terms of the CP Facilities, we are not able to borrow against defaulted Contracts.
Our servicing income can also be adversely affected by prepayment of or defaults under Contracts in the servicing portfolio. Our contractual servicing revenue is based on a percentage of the outstanding principal balance of such Contracts. Thus, if Contracts are prepaid or charged-off, then our servicing revenue will decline to the extent of such prepaid or charged-off Contracts.
The gain on sale of Contracts recognized by us in each securitization and the value of the retained interest in securitized assets ("RISA") in each transaction reflects management's estimate of future credit losses and prepayments for the Contracts included in such securitization. If actual rates of credit loss or prepayments, or both, on such Contracts exceed those estimated, the value of the RISA would be impaired. We periodically review our credit loss and prepayment assumptions relative to the performance of the securitized Contracts and to market conditions. In this event, our results of operations and liquidity could be adversely affected if credit loss or prepayment levels on securitized Contracts substantially exceed anticipated levels. If necessary, we would write-down the value of the RISA through a reduction to servicing fee income. Further, any write down of RISA would reduce the amount available to us under our residual lines, thus requiring us to pay down amounts outstanding under the facilities or provide additional collateral to cure the borrowing base deficiency.
WE WILL BE ADVERSELY AFFECTED IF WE LOSE SERVICING RIGHTS.
Our results of operations, financial condition and cash flows would be materially and adversely affected if any of the following were to occur:
- loss of the servicing rights under our sale and servicing agreements for the CP Facilities;
- loss of the servicing rights under the applicable pooling and servicing or sale and servicing agreement of a grantor trust and owner trust, respectively; or
- a trigger event that would block release of future excess cash flows generated from the grantor trusts' or owner trusts' respective spread accounts.
We are entitled to receive servicing income only while we act as servicer under the applicable sales and servicing agreements or pooling and servicing agreements. Under the CP Facilities our right to act as servicer can be terminated by MBIA, upon the occurrence of certain events.
OUR QUARTERLY EARNINGS MAY FLUCTUATE.
Our revenues have fluctuated in the past and are expected to fluctuate in the future principally as a result of the following factors:
- the timing and size of our securitizations;
- variations in the volume of our Contract acquisitions;
- the interest rate spread between our cost of funds and the average interest rate of purchased Contracts;
- the effectiveness of our hedging strategies; and
- the investor rate for securitizations.
Any significant decrease in our quarterly revenues could have a material adverse effect on our results of operations, financial condition and cash flows.
WE DEPEND ON KEY PERSONNEL.
Our future operating results depend in significant part upon the continued service of our key senior management personnel, none of whom is bound by an employment agreement. Our future operating results also depend in part upon our ability to attract and retain qualified management, technical, and sales and support personnel for our operations. Competition for such personnel is intense. We cannot assure you that we will be successful in attracting or retaining such personnel. The loss of any key employee, the failure of any key employee to perform in his or her current position or our inability to attract and retain skilled employees, as needed, could materially and adversely affect our results of operations, financial condition and cash flows.
OUR INDUSTRY IS HIGHLY COMPETITIVE.
Competition in the field of financing retail motor vehicle sales is intense. The automobile finance market is highly fragmented and historically has been serviced by a variety of financial entities including the captive finance affiliates of major automotive manufacturers, banks, savings associations, independent finance companies, credit unions and leasing companies. Several of these competitors have greater financial resources than we do. Many of these competitors also have long-standing relationships with automobile dealerships, and offer dealerships or their customers other forms of financing or services not provided by us. Our ability to compete successfully depends largely upon our relationships with dealerships and the willingness of dealerships to offer those Contracts that meet our underwriting criteria to us for purchase. We cannot assure you that we will be able to continue to compete successfully in the markets we serve.
WE MAY BE HARMED BY ADVERSE ECONOMIC CONDITIONS.
We are a motor vehicle consumer auto finance company whose activities are dependent upon the sale of motor vehicles. Our ability to continue to acquire Contracts in the markets in which we operate and to expand into additional markets is dependent upon the overall level of sales of new and used motor vehicles in those markets. A prolonged downturn in the sale of new and used motor vehicles, whether nationwide or in the California markets, could have an adverse impact upon us, our results of operations and our ability to implement our business strategy.
The automobile industry generally is sensitive to adverse economic conditions both nationwide and in California, where we have our largest single-state exposure. Periods of rising interest rates, reduced economic activity or higher rates of unemployment generally result in a reduction in the rate of sales of motor vehicles and higher default rates on motor vehicle contracts. We cannot assure you that such economic conditions will
not occur, or that such conditions will not result in severe reductions in our revenues or the cash flows available to us to permit us to remain current on our credit facilities.
WE ARE SUBJECT TO MANY REGULATIONS.
Our business is subject to numerous federal and state consumer protection laws and regulations, which, among other things:
- require us to obtain and maintain certain licenses and qualifications;
- limit the interest rates, fees and other charges we are allowed to charge;
- limit or prescribe certain other terms of our Contracts;
- require specific disclosures; and
- define our rights to repossess and sell collateral.
We believe that we are in compliance in all material respects with all such laws and regulations, and that such laws and regulations have had no material adverse effect on our ability to operate our business. However, we will be materially and adversely affected if we fail to comply with:
- applicable laws and regulations;
- changes in existing laws or regulations;
- changes in the interpretation of existing laws or regulations; or
- any additional laws or regulations that may be enacted in the future.
WE ARE SUBJECT TO LITIGATION RISKS.
We are party to various legal proceedings, similar to actions brought against other companies in the motor vehicle finance industry. Companies in the motor vehicle finance industry have been named as defendants in an increasing number of class action lawsuits brought by purchasers of motor vehicles claiming violation of various federal and state consumer credit and similar laws and regulations. We are defendants in three such consumer class action lawsuits, one of which was served on us in 2000. One such proceeding served in 1999, in which we are a defendant, has been brought as a putative class action and is pending in the State of California. A class has yet to be certified in this case in which the plaintiffs allege certain defects in post-repossession notice forms in the State of California. Another proceeding also served in 1999, in which we are a defendant, has been brought as a putative class action and also is pending in the State of California. A class was certified in 2000; in the matter, the plaintiffs raise issues regarding the payment of dealer participation to dealers.
On January 25, 2000, a putative class action complaint was filed against us and certain of our officers and directors alleging violations of Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 arising from our use of the cash-in method of measuring and accounting for credit enhancement assets in the financial statements. We believe that our previous use of the cash-in method of measuring and accounting for credit enhancement assets was consistent with then current generally accepted accounting principles and accounting practices of other finance companies. As required by the Financial Accounting Standards Board's Special Report, "A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, Second Edition," dated December 1998 and related statements made by the staff of the Securities and Exchange Commission, we retroactively changed the method of measuring and accounting for credit enhancement assets to the cash-out method and restated our financial statements for 1996, 1997 and the first three fiscal quarters of 1998. We intend to vigorously defend against the complaint.
While we intend to vigorously defend ourselves against such proceedings there is a chance that our results of operations, financial condition and cash flows could be materially and adversely affected by unfavorable outcomes.
WE MAY HAVE COMPUTER PROBLEMS RELATED TO THE YEAR 2000.
Because of the nature of our consumer finance business and the increasing number of electronic transactions in this industry, we have come to rely heavily on our in-house and third party computer systems, business applications and other information technology systems ("IT systems"). Historically, many IT systems were developed to recognize the year as a two-digit number, with the digit "00" being recognized as the year 1900. The year 2000 presents a number of potential problems for such systems, including potentially significant processing errors or failure. Given our reliance on computer systems, our results of operations and cash flows could be materially adversely affected by any significant errors or failures.
In the event that the Company does not complete any additional phases of its plan, the Company may be unable to perform its key operating activities, such as the purchase of Contracts and the invoicing, collecting and application of obligor payments. The Company could be subject to litigation for computer systems failure, such as improper application of payments and resulting incorrect credit reporting to credit bureaus. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The amount of potential liability and lost revenue cannot reasonably be estimated at this time.
ITEM 2.
ITEM 2. PROPERTIES
The Company did not own any real property at December 31, 1999. In January 1999, the Company moved into it new headquarters in Foothill Ranch, California after signing a 10-year lease for approximately 82,000 square feet of office space. The Company also leases office space for its Auto Finance Centers; the average size of such centers is generally four to five thousand square feet. One Auto Finance Center is located in the corporate headquarters building.
ITEM 3.
ITEM 3. LITIGATION
As a consumer finance company, the Company is subject to various consumer claims and litigation seeking damages and statutory penalties based upon, among other things, disclosure inaccuracies and wrongful repossession, which could take the form of a plaintiff's class action complaint. The Company, as the assignee of finance contracts originated by dealers, may also be named as a co-defendant in lawsuits filed by consumers principally against dealers. The damages and penalties claimed by consumers in these types of matters can be substantial. The relief requested by the plaintiffs varies but includes requests for compensatory, statutory and punitive damages. The Company is a defendant in three consumer class action lawsuits, one of which was served in 2000. One such proceeding served in 1999, in which the Company is a defendant, has been brought as a putative class action and is pending in the State of California. A class has yet to be certified in this case in which the plaintiffs allege certain defects in post-repossession notice forms in the State of California. Another proceeding also served in 1999, in which the Company is a defendant, has been brought as a putative class action and is also pending in the State of California. A class was certified in 2000; in the matter, the plaintiffs raise issues regarding the payment of dealer participation to dealers.
Management believes that the Company has taken prudent steps to address the litigation risks associated with the Company's business activities. However, there can be no assurance that the Company will be able to successfully defend against all such claims or that the determination of any such claim in a manner adverse to the Company would not have a material adverse effect on the Company's automobile finance business.
On January 25, 2000, a putative class action complaint was filed against the Company and certain of the Company's officers and directors alleging violations of Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 arising from the Company's use of the cash-in method of measuring and accounting for credit enhancement assets in the financial statements. The Company believes that its previous use of the cash-in method of measuring and accounting for credit enhancement assets was consistent with then current generally accepted accounting principles and accounting practices of other finance companies. As required by the Financial Accounting Standards Board's Special Report, "A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, Second Edition," dated December 1998 and related statements made by the staff of the Securities and Exchange
Commission, the Company retroactively changed the method of measuring and accounting for credit enhancement assets to the cash-out method and restated the Company's financial statements for 1996, 1997 and the first three fiscal quarters of 1998. The Company intends to vigorously defend against the complaint.
In the opinion of management, the resolution of the proceedings described in this section will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K to a vote of security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS: PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the NASDAQ under the symbol "ONYX". The following table provides quarterly high and low closing prices for the Company's Common Stock for the years ended December 31, 1999 and December 31, 1998.
At March 16, 2000, there were approximately 1,606 beneficial holders of the Company's Common Stock.
DIVIDEND POLICY
The Company has never declared or paid dividends on its Common Stock. The Company currently intends to retain any future earnings for its business and does not anticipate declaring or paying any dividends on the Common Stock in the foreseeable future. In addition, the Company's ability to declare or pay dividends is restricted by the terms of the credit facilities.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the Consolidated Financial Statements of the Company and the notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
- --------------- (1) Averages are based on daily balances.
(2) The weighted averages are based on the serviced portfolio outstanding at the end of the period.
(3) Excludes repossessed inventory.
(4) Contracts held for sale excludes dealer participation and allowance for credit losses. See Note 4 to the Consolidated Financial Statements.
ITEM 7.
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Onyx is a specialized consumer finance company engaged in the purchase, origination, securitization and servicing of Contracts originated by franchised and select independent automobile dealerships in the United States and to a small extent the origination or purchase of motor vehicle loans through a subsidiary of Onyx on a direct basis to consumers. The Company focuses its efforts on acquiring Contracts that are collateralized by late model used and, to a lesser extent, new automobiles, that are entered into with purchasers whom the Company believes have a favorable credit profile. Since commencing the purchase of Contracts in February 1994, the Company has acquired more than $3.8 billion in Contracts and currently has an active dealer base of over 7,600 dealerships. The Company has expanded its operations from a single office in California to 17 Auto Finance Centers serving many regions of the United States.
The Company generates revenues primarily through the purchase, origination, warehousing, subsequent securitization and ongoing servicing of Contracts. The Company earns net interest income on Contracts held during the warehousing period. Upon the securitization and sale of Contracts, the Company recognizes a gain on sale of Contracts, receives future excess cash flows generated by owner and grantor trusts, and earns fees from servicing the securitized Contracts.
The following table illustrates the changes in the Company's Contract acquisition volume, total revenue, securitization activity and servicing portfolio during the past three fiscal years.
SELECTED FINANCIAL INFORMATION
- --------------- (1) Total revenue is comprised of net interest income, servicing fee income and gain on sale of contracts.
CONTRACTS PURCHASED AND SERVICING PORTFOLIO
Since its inception, the Company has experienced significant growth in its purchased volume of Contracts. Acquisition volume for the year ended December 31, 1999, was $1.6 billion compared to $1.0 billion for the year ended December 31, 1998, representing an increase of 60%. This growth in acquisition volume is attributable primarily to (i) the opening of three additional Auto Finance Centers during 1999, and (ii) an increased penetration of existing dealers due to the maturation of existing Auto Finance Centers. For the year ended December 31, 1999, Contract acquisition growth was 41% in Auto Finance Centers opened prior to 1999.
The Company's increase in Contract acquisition volume has resulted in the growth in the Company's servicing portfolio. The servicing portfolio at December 31, 1999, was $2.1 billion compared to $1.3 billion at December 31, 1998, an increase of 62%.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
The Company had net income of $9.8 million for the year ended December 31, 1999, compared to net income of $6.1 million and $1.3 million for the years ended December 31, 1998 and 1997, respectively. The
increase in net income from 1998 to 1999 is attributable to several factors, including (i) a 59% increase in the dollar volume of Contracts securitized, resulting in a 48% increase in gains on sales, (ii) higher servicing fee income due to an increase in the serviced portfolio and (iii) improvements in the cost structure of the Company which resulted in a decline in operating expenses as a percentage of average servicing portfolio to 4.1% for 1999 from 4.7% for 1998. The increase in net income from 1997 to 1998 was primarily attributable to a 73% increase in the dollar volume of Contracts securitized, which resulted in an 86% increase in gain on sales.
Net Interest Income. Net interest income consists primarily of the difference between the finance revenue earned on Contracts held on the balance sheet during the warehousing period and the interest costs associated with the Company's borrowings to purchase such Contracts. The following table illustrates the weighted average yield on Contracts held on balance sheet, the weighted average rate paid on warehouse borrowings to fund these Contracts, and the corresponding net interest income margin realized by the Company.
NET INTEREST INCOME MARGIN
- --------------- (1) The yield on Contracts is net of dealer participation amortized expenses.
To arrive at net interest income, the Company also deducts the interest charges associated with non-warehouse borrowings, including interest expense incurred on subordinated debt, residual and excess servicing lines, capital lease outstandings, and other miscellaneous long term borrowings.
Net interest income declined by 16% to $6.1 million for 1999, from $7.3 million during 1998, but increased from $5.0 million during 1997. The reduction from 1998 to 1999 was principally due to a growing percentage of more expensive non-warehouse borrowings relative to warehouse debt in the Company's capital structure, which offset a 0.07% increase in net interest income margin to 7.31% in 1999 from 7.24% in 1998. The 46% increase in net interest income from 1997 to 1998 was due to a combination of a 0.15% increase in net interest income margins and an increase in the average amount of Contracts held for sale. The average amount of Contracts held for sale increased to $148.6 million in 1998 from $85.7 million in 1997.
Servicing Fee Income. Contractual servicing is earned at a rate of 1.0% per annum on the outstanding principal balance of Contracts securitized, and management believes this is consistent with industry standards. Excess servicing income is dependent upon the average excess spread on the Contracts sold and the performance of those Contracts. Servicing fee income is related to the size of the serviced portfolio and also includes investment interest, late fees, extension fees, document fees and other fees charged to customer accounts.
Servicing fee income increased to $28.9 million for the year ended December 31, 1999, from $16.7 million for the year ended December 31, 1998, and from $9.2 million for the year ended December 31, 1997. The increase was attributable to an increase in the size of the average sold portion of the servicing portfolio. For the year ended December 31, 1999, the size of the average sold servicing portfolio increased to $1.6 billion from $874.6 million and from $477.6 million for the same period in 1998 and 1997, respectively.
Gain on Sale of Contracts. The Company computes a gain on sale with respect to Contracts securitized based on the present value of the estimated future excess cash flows to be received from such Contracts using a market discount rate. Gain on sale is recorded as a credit enhancement asset on the statement of financial condition, and is amortized against servicing income over the life of the contracts. The gain recorded in the
statement of income is adjusted for prepaid dealer participation, issuance costs and the effect of hedging activities.
The Company recorded gains on sales of Contracts of $53.9 million on the sale of $1.45 billion of Contracts in 1999 for its securitizations. The gains on sales of Contracts is affected by the amount of Contracts securitized and the net interest rate spread on those Contracts. The following table illustrates the net interest rate spread for each of the Company's securitizations:
- --------------- (1) As of issue date.
(2) Difference between weighted average contract rate and weighted average investor rate as of the issue date.
(3) Difference between weighted average contract rate and weighted average investor rate, net of underwriting costs, other issuance costs, servicing fees, estimated credit losses, ongoing financial guarantee insurance policy premiums, and the hedging gain or loss.
(4) The Company assumes an average prepayment speed of 1.75% ABS, a discount rate ranging from 3.5% to 4.5% above the weighted average investor rate, and utilizes a lifetime loss rate ranging from 3.5% to 4.0% of the original balance, for all remaining securitizations.
The Company completed four securitizations totaling $1.45 billion during the year ended December 31, 1999, resulting in gains on sale of $53.9 million, compared to four securitizations totaling $911.8 million and a whole loan sale of $15 million during the year ended December 31, 1998, resulting in gains on sale of Contracts totaling $36.4 million, and four securitizations totaling $527.3 million for the year ended December 31, 1997, resulting in gains on sale of Contracts of $19.6 million. The average net spread on the 1999 securitizations was 3.15% compared to 3.36% in 1998 and 3.16% in 1997.
Provision for Credit Losses. The Company maintains an allowance for credit losses to cover anticipated losses on the Contracts held on the statement of financial condition. The allowance for credit losses is increased by charging the provision for credit losses and decreased by actual losses on the Contracts held on the statement of financial condition or by the sale of Contracts held on the statement of financial condition.
The level of the allowance is based principally on the outstanding balance of Contracts held on the statement of financial condition, and historical loss trends. When the Company sells Contracts in a securitization transaction, it reduces its allowance for credit losses and factors potential losses into its calculations of gain on sale. The provision for credit losses was $1.2 million during 1999 compared to $1.6 million during 1998 and $0.8 million during 1997. The reduction in provision for credit losses in 1999 relative to 1998 was due primarily to a reduction in the year over year net change in Contracts held for sale. At year-end 1999, Contracts held for sale had increased $77.5 million over year-end 1998, while at year-end 1998, Contracts held for sale had increased $88.6 million over year-end 1997.
Salaries and Benefits Expense. The Company incurred salary and benefit expenses of $40.0 million during the year ended December 31, 1999, compared to $26.8 million during the year ended December 31, 1998, and $17.4 million for the year ended December 31, 1997. In order to support the growth of its operations and the servicing portfolio, the number of employees increased from 319 at December 31, 1997, to 526 at December 31, 1998, to 715 at December 31, 1999.
Other Operating Expenses. Other operating expenses increased to $30.9 million at December 31, 1999, from $21.7 million at December 31, 1998, and from $13.3 million for the year ended December 31, 1997. The majority of the increases were due to the growth of the average servicing portfolio from $563.3 million to $1.02 billion and $1.7 billion at December 31, 1997, 1998 and 1999, respectively. Additionally, the Company opened additional Auto Finance Centers during the years ended December 31, 1999, December 31, 1998, and December 31, 1997.
Income Taxes. The Company files federal and certain state tax returns as part of a consolidated group. Tax liabilities from the consolidated returns are allocated in accordance with a tax sharing agreement based on the relative income or loss of each entity on a stand-alone basis. The effective tax rate for Onyx was 41.5% in 1999 and 1998 and 43.0% in 1997. The reduction in tax rates between 1998 and 1997 is due to lower tax rates in the states where the Company has opened new Auto Finance Centers.
FINANCIAL CONDITION
CONTRACTS HELD FOR SALE
Contracts held for sale totaled $230.0 million at December 31, 1999, compared to $152.8 million at December 31, 1998. The number and principal balance of Contracts held for sale is largely dependent upon the timing and size of the Company's securitizations. The increase in the Contracts held for sale from year end 1998 to year end 1999 is primarily attributable to the Company's higher contract volume during the respective warehousing periods. The Company believes that the allowance for credit losses is currently adequate to absorb potential losses in the owned portfolio. The allowance for credit losses as of December 31, 1999, was approximately $1.4 million, compared to $1.0 million as of December 31, 1998.
CREDIT ENHANCEMENT ASSETS
Credit enhancement assets consisted of the following:
Trust receivable represent servicer advances and initial deposits in spread accounts.
RISA consists of the estimated present value of future servicing cash flows from related securitizations. Future servicing cash flows are computed by taking into account certain assumptions principally regarding prepayments, losses and servicing costs. These cash flows are then discounted until they are released from the spread account and received by the Company at a market-based rate. The balance is then amortized against actual servicing fee income on a monthly basis. The following table provides historical data regarding the RISA. Included in RISA is restricted cash of $35.8 million and $32.7 million for the years ended December 31, 1999 and 1998, respectively.
RETAINED INTEREST IN SECURITIZED ASSETS
ASSET QUALITY
The Company monitors and attempts to minimize delinquencies and losses through timely collections and the use of a predictive dialing system. At December 31, 1999, delinquencies represented 3.24% of the amount of Contracts in its servicing portfolio compared to 2.83% at December 31, 1998, and 2.51% at December 31, 1997. Net charge-offs as a percentage of the average servicing portfolio were 1.85% for the year ended December 31, 1999, compared to 1.72% and 2.03% for the years ended December 31, 1998, and 1997, respectively. The levels of delinquencies at December 31, 1999, increased over December 31, 1998, primarily due to the difficulties the Company experienced in attracting and retaining qualified collection staff as a result of a tight labor market and aggressive pursuit by local competitors for these skilled positions. The increase in delinquency from 1997 to 1998 was attributable in part to the relocation of the collection and customer service areas in conjunction with the relocation of the corporate headquarters beginning in December 1998. The increase in loan losses from 1998 to 1999 is directly correlated to the rise in delinquencies.
Management has increased its off balance sheet reserves as a percentage of the serviced portfolio sold. Reserves have increased from 3.68% at December 31, 1997, to 4.31% at December 31, 1998, to 4.42% at December 31, 1999. Off balance sheet reserves are those reserves established upon the sale of Contracts to the grantor and owner trusts in connection with securitized Contracts.
DELINQUENCY EXPERIENCE OF THE SERVICING PORTFOLIO
- --------------- (1) Delinquencies include principal amounts only, net of repossessed inventory.
(2) The period of delinquency is based on the number of days payments are contractually past due.
LOAN LOSS EXPERIENCE OF THE SERVICING PORTFOLIO
- --------------- (1) Average is based on daily balances.
(2) Net charge-offs are gross charge-offs minus recoveries on Contracts previously charged off.
The following table illustrates the monthly performance of each of the securitized pools outstanding for the period from the date of securitization through December 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires substantial cash and capital resources to operate its business. Its primary uses of cash include: (i) acquisition of Contracts; (ii) payments of dealer participation; (iii) securitization costs; (iv) settlements of hedging transactions; (v) operating expenses; and (vi) interest expense. The capital
resources available to the Company include: (i) interest income during the warehousing period; (ii) servicing fees; (iii) releases from spread accounts; (iv) settlements of hedging transactions; (v) sales of Contracts in securitizations; and (vi) borrowings under its credit facilities. Management believes that the resources available to the Company provide the needed capital to fund the anticipated expansion of the Company, Contract purchases, and investments in origination and servicing capabilities.
Cash used in operating activities was $80.3 million for the year ended December 31, 1999, compared to $113.6 million used in for the year ended December 31, 1998. The decrease in cash used in operating activities was primarily due to an increase in accounts payable and other liabilities. Cash used in investing activities was $5.4 million for the twelve months ended December 31, 1999, compared to $3.8 million for the twelve months ended December 31, 1998. A reduction in the use of the Company's capital lease lines coupled with the relocation of the Company's corporate headquarters contributed to the increase in investing activities. Cash provided by financing activities was $89.0 million for the twelve months ended December 31, 1999, compared to $118.4 million for the twelve months ended December 31, 1998. Higher spread account cash releases from securitization trusts combined with a lower net change in Contracts held for sale during 1999 versus 1998 reduced the requirement for financing sources. The Company also issued $10.0 million in subordinated debt during the previous year.
CP Facilities. As of December 31, 1999, the Company was party to two primary auto loan warehousing programs (the "CP Facilities"), one a $375 million facility with Triple-A One Funding Corporation ("Triple-A"), and the other a $150 million facility with Park Avenue Receivables Corporation ("Parco"). Two of the Company's special purpose subsidiaries, Onyx Acceptance Financial Corporation ("Finco") for the Triple-A One Facility, and newly created Onyx Acceptance Receivables Corporation ("Recco") for the Parco Facility, are the borrowers under the CP Facilities. The CP Facilities are used to fund the purchase or origination of Contracts. Triple-A and Parco are both rated commercial paper asset-backed conduits sponsored by MBIA Insurance Corporation ("MBIA") and The Chase Manhattan Bank ("Chase"), respectively. MBIA provides credit enhancement for both facilities by issuing financial guarantee insurance policies covering all principal and interest obligations owed for the borrowings under the facilities. The Company pledges its Contracts held for sale to borrow from Triple-A and from Parco. The Parco Facility was executed in August 1999 and expires in August 2000, but may be renewed at the option of the lenders. The Triple-A Facility is subject to renewal in September 2000 at the option of the lenders, and, if so renewed, will expire in September 2001.
The Merrill Line. A subsidiary of the Company, Onyx Acceptance Funding Corporation ("Fundco"), has an uncommitted $100 million line of credit (the "Merrill Line"), with Merrill Lynch Mortgage Capital, Inc. ("MLMCI"), which provides warehouse funding for the purchase or origination of Contracts and is used in concert with the CP Facilities the Company currently has in place. The Merrill Line was renewed in February 2000 for a one year term.
The Residual Lines. The Company, through Fundco, has two residual Facilities: a $10.0 million committed facility with MLMCI and a $50.0 million line with Salomon Smith Barney Realty Corporation ("SBRC") (the "SBRC Line" and together with the Facility with MLMCI, the "Residual Lines"). The Residual Lines are used by the Company to finance operating requirements. The lines utilize a collateral-based formula that sets borrowing availability to a percentage of the value of excess cash flow to be received from certain securitizations. The facility provided by MLMCI was renewed in February 2000 for a one year term. Each loan under SBRC Line matures one year after the date of the loan; the Company expects each loan to be renewed at term.
Excess Servicing Facility. The Company is party to a collateralized loan ("Excess Servicing Facility") with a lending group for up to $45 million, which was used for working capital and other expenditures. The Excess Servicing Facility matured in June 1999. This line is now in the amortization period and all cash flows from the underlying securitizations, which are collateral, are being used to repay the outstanding principal balance.
Subordinated Debt. As of December 31, 1999, the Company had outstanding $10.0 million of subordinated debt with an initial term of two years. In February 2000, the Company exercised its option to
extend the term by three years during which the loan will fully amortize. Final maturity is scheduled for February 2003.
The facilities and lines above contain affirmative, negative and financial covenants typical of such credit facilities. The Company was in compliance with these covenants as of December 31, 1999.
Hedging and Interest Rate Risk Management. The Company employs a hedging strategy that is intended to minimize the risk of interest rate fluctuations and which historically has involved the execution of forward interest rate swaps or use of a pre-funding structure for the Company's securitizations. The Company is not required to maintain collateral on the outstanding hedging program.
SECURITIZATIONS
Regular securitizations are an integral part of the Company's business plan because they allow the Company to increase its liquidity, provide for redeployment of its capital and reduce risks associated with interest rate fluctuations. The Company has developed a securitization program that involves selling interests in pools of its Contracts to investors through the public issuance of AAA/Aaa rated asset-backed securities. The Company completed four AAA/Aaa rated publicly underwritten asset-backed securitizations in the amount of $1.45 billion in 1999.
The net proceeds of these securitizations are used to pay down outstanding indebtedness incurred under the Company's credit facilities to purchase Contracts, thereby creating availability for the purchase of additional Contracts. Since 1994, the Company has securitized $3.4 billion of its Contracts in 18 separate transactions. In each of its securitizations, the Company has sold its Contracts to a newly formed grantor or owner trust which issued pass-through certificates or notes in an amount equal to the aggregate principal balance of the Contracts.
To improve the level of profitability from the sale of securitized Contracts, the Company arranges for credit enhancement to achieve an improved credit rating on the asset-backed securities issued. This credit enhancement has taken the form of a financial guaranty issued by MBIA, or a predecessor of MBIA, which issues a financial guaranty insurance policy (the "Financial Guarantee Insurance Policy") insuring the payment of principal and interest due on the asset-backed securities.
The Company receives servicing fees for its duties relating to the accounting for and collection of the Contracts. In addition, the Company is entitled to the future excess cash flows arising from the trusts. Generally, the Company sells the Contracts at face value and without recourse, except that certain representations and warranties with respect to the Contracts are provided by the Company as the servicer and Finco as the seller to the trusts.
Gains on sale of Contracts arising from securitizations provide a significant portion of the Company's revenues. Several factors affect the Company's ability to complete securitizations of its Contracts, including conditions in the securities markets generally, conditions in the asset-backed securities market specifically, the credit quality of the Company's portfolio of Contracts and the Company's ability to obtain credit enhancement.
In the first quarter of 2000, the Company securitized contracts in the amount of $430 million.
During the first quarter of 2000, the Company securitized the cash flows from 15 of its outstanding securitizations and sold $49.0 million of notes. The transaction was rated BBB by Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc.
INTEREST RATE EXPOSURE AND HEDGING
The Company is able through the use of varying maturities on advances from the CP Facilities to lock in rates during the warehousing period, when in management's judgment it is appropriate, to limit interest rate exposure during such warehousing period (See "Risk Factors -- Interest Rate Risk").
The Company has the ability to move rates upward in response to rising borrowing costs because the Company currently does not originate loans near the maximum rates permitted by law. Further, the Company employs a hedging strategy which primarily consists of the execution of forward interest rate swaps. These hedges are entered into by the Company in numbers and amounts which generally correspond to the anticipated principal amount of the related securitization. Gains and losses relative to these hedges are recognized in full at the time of securitization as an adjustment to the gain on sale of the Contracts. The Company has only used counterparties with investment grade debt ratings from national rating agencies for its hedging transactions.
Management monitors the Company's hedging activities on a frequent basis to ensure that the value of hedges, their correlation to the Contracts being hedged and the amounts being hedged continue to provide effective protection against interest rate risk. The Company's hedging strategy requires estimates by management of monthly Contract acquisition volume and timing of its securitizations. If such estimates are materially inaccurate, then the Company's gain on sales of Contracts and results of operations and cash flows could be adversely affected. The amount and timing of hedging transactions are determined by senior management based upon the amount of Contracts purchased and the interest rate environment. Senior management currently expects to hedge substantially all of its Contracts pending securitization.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative contracts, and for hedging activities. The new standard requires that all derivatives be recognized as either assets or liabilities in the consolidated statements of financial condition and that those instruments be measured at fair value. If certain conditions are met, a derivative may be specifically designated as a hedging instrument. The accounting for changes in the fair value of a derivative (that is, unrealized gains and losses) depends on the intended use of the derivative and the resulting designation. The statement is effective in the first quarter of year 2001. The Company is presently assessing the effect of SFAS 133 on the consolidated financial statements of the Company.
YEAR 2000 COMPLIANCE
The Company is substantially dependent on its and third party computer systems, business applications and other information technology systems ("IT systems"), due to the nature of its consumer finance business and the increasing number of electronic transactions in the industry. Historically, many IT systems were developed to recognize the year as a two-digit number, with the digits "00" being recognized as the year 1900. The year 2000 presents a number of potential problems for such systems, including potentially significant processing errors or failure. Given the Company's reliance on its computer systems, the Company's results of operations and cash flows could be materially adversely affected by any significant errors or failures.
The Company developed and executed a comprehensive plan designed to address the "Year 2000" issue for its in-house and third party IT applications. To date, the Company has not experienced any significant year 2000-related disruptions internally or with any other company with which the Company interacts on a regular basis. The Company will continue to monitor its IT and non-IT systems throughout 2000 with respect to year 2000 issues.
The Company incurred costs related to Year 2000 compliance remediation for Company-owned IT systems and applications of $450,000 in 1999. The amount expended during 1999 represented approximately 9% of the Company's IT budget.
FORWARD LOOKING INFORMATION
The preceding Management's Discussion and Analysis of the Company's Financial Condition and Results of Operations contain certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which can be identified by the use of forward-looking terminology such as "may," "will," "expect," "anticipate," "estimate," "should" or "continue" or the negative thereof or
other variations thereon or comparable terminology. The matters set forth in this Annual Report on Form 10-K constitute cautionary statements identifying important factors with respect to such forward-looking statements, including certain risks and uncertainties, that could cause actual results to differ materially from those in such forward-looking statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's earnings are affected by changes in interest rates as a result of its dependence upon the issuance of interest-bearing securities and the incurrence of debt to fund its lending activities. Several factors can influence the Company's ability to manage interest rate risk. First, Contracts are purchased at fixed interest rates, while the amounts borrowed under warehouse credit facilities bear interest at variable rates that are subject to frequent adjustment to reflect prevailing market interest rates. Second, the interest rate demanded by investors in a securitization is a function of prevailing market rates for comparable transactions and the general interest rate environment. Because the Contracts originated by the Company have fixed interest rates, the Company bears the risk of smaller gross interest rate spreads in the event interest rates increase during the period between the date contracts are purchased and the completion and pricing of securitization transactions.
The Company uses several strategies to minimize interest rate risk, including the utilization of derivative financial instruments, the regular sale of contracts and pre-funding of securitization transactions. Pre-funding securitizations is the practice of issuing more asset-backed securities than the amount of contracts initially sold to the Trust. The proceeds from the pre-funded portion are held in an escrow account until additional contracts are sold to the Trust in amounts up to the balance of the pre-funded escrow account. In pre-funded securitizations, borrowing costs are locked in with respect to the contracts subsequently delivered to the Trust. However, the Company incurs an expense in pre-funded securitizations equal to the difference between the money market yields earned on the proceeds held in escrow prior to the subsequent delivery of contracts and the interest rate paid on the asset-backed securities outstanding.
Derivative financial instruments are utilized to manage the gross interest rate spread on the Company's securitization transactions. The Company sells fixed rate contracts to the Trusts that, in turn, sell fixed rate securities to investors. The fixed rates on securities issued by the Trust are indexed to rates on U.S. Treasury Notes with similar average maturities or various London Interbank Offered Rates ("LIBOR"). The Company periodically executes the sale of forward swap agreements to lock in the indexed rate for specific anticipated securitization transactions. The Company utilizes these derivative financial instruments to modify its net interest sensitivity to levels deemed appropriate based on the Company's risk tolerance. All transactions are entered into for purposes other than trading, and are settled quarterly upon pricing of the securitization.
The Company received a cash payment net of expenses of $1.8 million in 1999, and made cash payments net of expenses of $4.8 million and $1.3 million in 1998 and 1997, respectively, to settle forward interest rate swap agreements. These amounts were included in the gain on sale of contracts in securitization transactions. Cash payments are recovered over time through a higher gross interest rate spread on the related securitization transaction, while cash receipts are offset through a lower gross interest rate spread on the related securitization transaction. As of December 31, 1999, the Company had $150.0 million of forward swap agreements outstanding.
The table below provides information about the Company's derivative financial instruments by expected maturity date as of December 31, 1999 (dollars in thousands). Notional amounts, which are used to calculate the contractual payments to be exchanged under the contracts, represent average amounts that will be outstanding for each of the years included in the table. Notional amounts do not represent amounts exchanged by parties and, thus, are not a measure of the Company's exposure to loss through its use of the agreements.
There can be no assurance that the Company's strategies will be effective in minimizing interest rate risk or that increases in interest will not have an adverse effect on the Company's profitability.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements, as listed under Item 14, appear in a separate section of this Annual Report on Form 10-K beginning on page.
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
Information regarding the directors and officers of the Company is incorporated herein by reference to the descriptions set forth under the caption "Election of Directors" and "Management" in the Proxy Statement to be filed with the Securities and Exchange Commission for the Annual Meeting of Stockholders currently expected to be held May 31, 2000 (the "2000 Proxy Statement").
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated herein by reference to the descriptions to be set forth under the caption "Executive Compensation" in the 2000 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management of the Company is incorporated herein by reference to the information to be set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the 2000 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions with the Company is incorporated herein by reference to the information to be set forth under the caption "Certain Transactions and Related Transactions" in the 2000 Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS:
The Company's financial statements appear in a separate section of this Annual Report on Form 10-K beginning on the pages referenced below:
(a) EXHIBITS
The following Exhibits are attached hereto and incorporated herein by reference.
INDEX TO EXHIBITS
- --------------- * Filed herewith
(1) Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No. 333-00680).
(2) Incorporated by reference from Onyx Acceptance Financial Corporation's Registration Statement on Form S-1 (Registration No. 333-22301)
(3) Incorporated by reference from the Company's Current Report on Form 8-K dated July 8, 1997. (File No. 000-28050)
(4) Incorporated by reference from Onyx Acceptance Financial Corporation's Registration Statement on Form S-1 (Registration No. 333-28893).
(5) Incorporated by reference from Onyx Acceptance Financial Corporation's Registration Statement on Form S-1 (Registration No. 333-33471).
(6) Incorporated by reference from Onyx Acceptance Financial Corporation's Registration Statement on Form S-1 (Registration No. 333-40089).
(7) Incorporated by reference from the Company's Form 10-Q for quarterly period ended March 31, 1998. (File No. 000-28050).
(8) Incorporated by reference from the Company's Form 10-Q for quarterly period ended June 30, 1998. (File No. 000-28050).
(9) Incorporated by reference from the Company's Form 10-Q for quarterly period ended September 30, 1998. (File No. 000-28050).
(10) Incorporated by reference from Onyx Acceptance Financial Corporation's Registration Statement on Form S-3 (Registration No. 333-46359).
(11) Incorporated by reference from Onyx Acceptance Financial Corporation's Registration Statement on Form S-3 (Registration No. 333-51239).
(12) Incorporated by reference from the Company's Form 10-K for the year ended December 31, 1998. (File No. 000-28050).
(13) Incorporated by reference from the Company's Form 10-Q for quarterly period ended March 31, 1999. (File No. 000-28050).
(14) Incorporated by reference from the Company's Form 10-Q quarterly period ended June 30, 1999. (File No. 000-28050).
(15) Incorporated by reference from the Company's Form 10-Q quarterly period ended September 30, 1999. (File No. 000-28050).
(16) Incorporated by reference from Onyx Acceptance Financial Corporation's Current Report on Form 8-K dated March 11, 1999. (File No. 333-28893).
(17) Incorporated by reference from Onyx Acceptance Financial Corporation's Current Report on Form 8-K dated May 28, 1999. (File No. 333-28893).
(18) Incorporated by reference from Onyx Acceptance Financial Corporation's Current Report on Form 8-K dated September 14, 1999. (File No. 333-28893).
(19) Incorporated by reference from Onyx Acceptance Financial Corporation's Current Report on Form 8-K dated November 12, 1999. (File No. 333-28893).
(a)(3) FINANCIAL STATEMENT SCHEDULES
None.
(b) EXHIBITS ON FORM 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
ONYX ACCEPTANCE CORPORATION
By: /s/ JOHN W. HALL ------------------------------------ John W. Hall President and Chief Executive Officer (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed by the following persons on behalf of the Registrant in the capacities and on the date indicated.
ONYX ACCEPTANCE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders Onyx Acceptance Corporation
In our opinion, the accompanying consolidated statements of financial condition and the related consolidated statements of income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Onyx Acceptance Corporation and its subsidiaries (the "Company") as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. 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 of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Costa Mesa, California January 26, 2000
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
See accompanying notes to consolidated financial statements.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- NATURE OF OPERATIONS
Onyx Acceptance Corporation ("Onyx") was incorporated on August 17, 1993, and commenced operations in February 1994. Onyx and its wholly owned special purpose finance subsidiaries Onyx Acceptance Financial Corporation ("OAFC"), Onyx Acceptance Funding Corporation ("OFC") and Onyx Acceptance Receivables Corporation ("OARC") (collectively, the "Company") specialize in the purchase, origination, sale and servicing of retail automobile installment loans ("Loans" or "Contracts") originated by automobile dealers. The Company provides an independent source to automobile dealers to finance their customers' purchases of new and used vehicles. The Company attempts to meet the needs of dealers through consistent buying practices, competitive rates, a dedicated customer service staff, fast turnaround time and systems designed to expedite the processing of loan applications.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Onyx, OAFC, OFC and OARC. All significant intercompany accounts and transactions have been eliminated upon consolidation.
Cash and Cash Equivalents: The Company considers all significant investments with maturity at acquisition of three months or less to be cash equivalents.
Contracts Held for Sale: Contracts held for sale are stated at the lower of aggregate amortized cost or net realizable value, net of allowance for credit losses.
The Company defers certain Contract origination fees and participation paid to dealers. The net amount is amortized as an adjustment to the related Contract's yield, on the same basis as that used to record income on the Contracts, over the contractual life of the related Contracts. At the time of sale or securitization, any remaining amounts are included as part of the computation of the gain on sale of Contracts.
The current policy of the Company is to recognize losses on repossessed vehicles in the month in which the vehicle is sold or in which the scheduled payment becomes 120 days delinquent, whichever occurs first. Losses may occur in connection with delinquent Contracts for which the vehicle was not repossessed, either because of a discharge of the obligor's indebtedness in a bankruptcy proceeding or due to the Company's inability to locate the financed vehicle or the obligor. In these cases, losses are recognized at the time a Contract is deemed uncollectable or during the month a scheduled payment under the Contract becomes 150 days past due, whichever occurs first.
Allowance for Credit Losses: The allowance for credit losses is maintained at a level believed adequate by management to absorb potential losses in the Contracts held for sale. The provision rate is established by management using the following criteria: past loss experience, current economic conditions, volume, growth and other relevant factors, and is re-evaluated on a quarterly basis. The allowance is increased by provisions for Contract losses charged against income. All recoveries on finance receivables previously charged off are credited to the allowance, while charge-off's of finance receivables are deducted from the allowance.
Sales of Contracts: The Company purchases Contracts to be sold to investors with servicing rights retained by the Company. The Company sells a majority of its Contracts and does not retain any residual interest in securitized or sold Contracts. Contracts are sold at or near par value with the Company retaining a participation in the future cash flows released by Trusts in Contracts securitized but on cash sales no participation is retained in the future cash flows. As of December 31, 1999 the Company was servicing all the Contracts sold to the Trusts. As of December 31, 1999 and 1998, 39% and 54% respectively, of the sold portfolio was originated in California.
Furniture and Equipment: Furniture and equipment are stated at cost less accumulated depreciation, and are depreciated for financial reporting purposes on a straight-line basis over a three year estimated life.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Capitalized leased assets are amortized over the lease term. Leasehold improvements are amortized over a period not exceeding the term of the lease.
Interest and Fee Income: Interest and fee income on Contracts held for sale is determined on a monthly basis using either the simple interest (level yield) method or the sum-of-the-months digits method, which approximates the effective yield method.
Income Taxes: The Company utilizes Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the year in deferred tax assets and liabilities. The Company files consolidated federal and state tax returns.
Net Income Per Share: Net income per share are presented in a dual format, computed both including and excluding the impact of potential common stock.
Derivative Financial Instruments: The Company employs hedging strategies to manage its gross interest rate risk. The hedging strategies include the use of forward swap agreements to manage the interest rate on securitization of the Contracts held for sale.
The forward swap agreements are entered into by the Company in numbers and amounts which correspond to the anticipated principal amount of future securitization transactions. The market value of these forward agreements responds inversely to the market value change of the underlying Contracts. Because of this inverse relationship, the Company can effectively lock in its gross interest rate spread at the time the hedge transaction is entered into. Unrealized gains and losses relative to these agreements are deferred and recognized in full at the time of securitization as an adjustment to the gain on sale of contracts. The Company is not required to maintain any collateral with respect to its hedging strategies, until the point where the fair value declines below ($1.0) million. The Company only uses highly rated counterparties. Credit exposure is limited to those transactions with a positive fair value.
Pervasiveness of Estimates: The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Stock-based Compensation: Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS No. 123"), encourages, but does not require companies to recognize compensation expense associated with stock based compensation plans over the anticipated service period based on the fair value of the award on the date of grant. As allowed by SFAS 123, however, the Company has elected to continue to measure compensation costs as prescribed by APB Opinion No. 25 "Accounting for Stock Issued to Employees." See footnote 12 for Pro Forma disclosures of net income and net income per share, as if SFAS 123 had been adopted.
Comprehensive Income: The Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), effective January 1, 1998. SFAS 130 establishes standards for reporting comprehensive income and its components in a full set of financial statements. The standard requires that all items that are required to be recognized under accounting standards as components of comprehensive income, including an amount representing total comprehensive income, be reported in a
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
financial statement that is displayed with the same prominence as other financial statements. Pursuant to SFAS 130, the Company has reported comprehensive income in the accompanying Consolidated Statements of Stockholders' Equity.
Reclassification: Certain amounts in the prior year consolidated financial statements have been reclassified to conform to 1999 presentation.
NOTE 3 -- RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative contracts, and for hedging activities. The new standard requires that all derivatives be recognized as either assets or liabilities in the consolidated statements of financial condition and that those instruments be measured at fair value. If certain conditions are met, a derivative may be specifically designated as a hedging instrument. The accounting for changes in the fair value of a derivative (that is, unrealized gains and losses) depends on the intended use of the derivative and the resulting designation. The statement is effective in the first quarter of year 2001. The Company is presently assessing the effect of SFAS 133 on the consolidated financial statements of the Company.
NOTE 4 -- CONTRACTS HELD FOR SALE
Contracts held for sale consist of the following:
As of December 31, 1999 and 1998, 25% and 39% of Contracts held for sale were originated in California, respectively.
At December 31, 1999, contractual maturities of Contracts held for sale were as follows:
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Changes in the allowance for credit losses were as follows:
The fair value of Contracts held for sale was $243.9 million and $163.5 million at December 31, 1999 and 1998, respectively.
At December 31, 1999, the Company had entered into four year amortizing forward swap agreements with a notional face amount outstanding of $150.0 million with maturities matching the average life of the Contracts being hedged. At December 31, 1999, these agreements had a fair value of $618,000. In addition, at December 31, 1999, the Company had offsetting swap agreements of $73.3 million in notional face amount outstanding with a fair value of ($259,600). At December 31, 1998, the Company had similar agreements with a notional face amount outstanding of $81.0 million with deferred losses of $1.0 million.
Included in the Gain on Sale of Contracts for the year ended December 31, 1999, is a gain of $1.8 million related to hedging activities. Gain on sale of Contracts for the years ended December 31, 1998 and 1997 included losses of $4.8 million and $1.3 million respectively, arising from hedging activities.
Contracts serviced by the Company for the benefit of others totaled approximately $1.9 billion at December 31, 1999 and $1.2 billion at December 31, 1998. These amounts are not reflected in the accompanying consolidated financial statements.
NOTE 5 -- CREDIT ENHANCEMENT ASSETS
SFAS 125 requires that following a transfer of financial assets, an entity is to recognize the assets it controls and the liabilities it has incurred, and derecognize assets for which control has been surrendered and liabilities that have been extinguished.
Credit enhancement assets consisted of the following:
Retained interest in securitized assets ("RISA") capitalized upon securitization of Contracts represent the present value of the estimated future earnings to be received by the Company from the excess spread created in securitization transactions. Excess spread is calculated by taking the difference between the coupon rate of the Contracts sold and the weighted average certificate rate paid to the investors less contractually specified servicing and guarantor fees and projected credit losses, after giving effect to estimated prepayments.
Prepayment and credit loss assumptions are utilized to project future earnings and are based on historical experience. Credit losses are estimated using cumulative loss frequency and severity estimates by management. All assumptions are evaluated each quarter and adjusted, if appropriate, to reflect the actual performance of the contracts.
Future earnings are discounted at a rate management believes to be representative of market at the time of securitization. The balance of RISA is amortized against actual excess spread income earned on a monthly
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
basis over the expected repayment life of the underlying contracts. RISA is classified in a manner similar to available for sale securities and as such is marked to market each quarter. Market value changes are calculated by discounting the remaining projected excess spread using a current market discount rate. Any changes in the market value of the RISA is reported as a separate component of shareholders' equity as an unrealized gain or loss, net of deferred taxes. As of December 31, 1999 the market value of RISA was $1.0 million lower than cost. As of December 31, 1998 the market value of RISA approximated cost. The Company retains the rights to service all contracts it securitizes.
The following table presents the balances and activity for RISA:
In initially valuing the RISA, the Company establishes an off balance sheet allowance for expected future credit losses. The allowance is based upon historical experience and management's estimate of future performance regarding credit losses. The amount is reviewed periodically and adjustments are made if actual experience or other factors indicate that future performance may differ from management's prior estimates.
The following table presents the estimated future undiscounted retained interest earnings to be received from securitizations. Estimated future undiscounted RISA earnings are calculated by taking the difference between the coupon rate of the Contracts sold and the weighted average certificate rate paid to the investors, less the contractually specified servicing fee of 1.0% and financial insurance fees, after giving effect to estimated prepayments and assuming no losses. To arrive at the RISA, this amount is reduced by the off balance sheet allowance established for potential future losses and by discounting to present value.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 -- FURNITURE AND EQUIPMENT
Furniture and equipment consisted of the following:
NOTE 7 -- WAREHOUSE BORROWING
The Company has two commercial paper facilities (the "CP Facilities") with financial institutions, one with Triple-A One Funding Corporation ("Triple-A") and the other with The Chase Manhattan Bank ("Chase"). The Chase facility was entered into in August 1999 and provides $150 million of additional borrowing capacity. There were no borrowings outstanding under the Chase facility as of December 31, 1999. The Triple-A facility, which provides borrowing availability of $375 million, had borrowings outstanding at December 31, 1999 of $232,287,908 and at December 31, 1998 of $150,044,464. Under terms of the agreements the Company is able to borrow 98% of the principal amount of Contracts purchased. Borrowings under these facilities become due as the principal payments are received or the related automobile Contracts are sold. The amount of commercial paper outstanding under these facilities at any time is collateralized by the Contracts held for sale. The MBIA facility matures in September 2000 while the Chase facility matures in August 2000. Both are subject to annual renewals on each respective anniversary date. The Company is in compliance with certain ratios and other borrowing covenants under each arrangement. The fair value of commercial paper was $232.3 million and $150.0 million at December 31, 1999 and 1998 respectively. The commercial paper facilities had an average interest rate of 6.18% for the year ended December 31, 1999, and 6.47% for the year ended December 31, 1998.
Additionally, the Company has a repurchase facility with Merrill Lynch (the "Merrill Line") providing $100 million of borrowing capacity for the purchase or origination of Contracts. Outstanding debt is collateralized by Contracts held for sale. As of December 31, 1999 and December 31, 1998, there was no debt outstanding under this line. This facility was renewed in February 2000 for a one year term.
NOTE 8 -- EXCESS SERVICING LINES
The Company has three credit lines collateralized by credit enhancement assets. Total borrowings outstanding under all three lines at December 31, 1999 were $55.9 million and $49.6 million at December 31, 1998.
The Company is party to a collateralized loan ("Excess Servicing Facility") with a lending group for up to $45 million, which was used for working capital and other expenditures. The Excess Servicing Facility matured in June 1999. This line is now in the amortization period and all cash flows from the underlying securitizations, which are collateral, are being used to repay the outstanding principal balance. Total
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
borrowings outstanding under the Excess Servicing Facility were $25.0 million at December 31, 1999 and $38.5 million at December 31, 1998. The Excess Servicing Facility had an average interest rate of 8.66% for the year ended December 31, 1999 and 8.76% for 1998. The fair value of the Excess Servicing Facility was $25.0 million at December 31, 1999 and $38.5 million at December 31, 1998. The Company is in compliance with certain ratios and other borrowing covenants under the Excess Servicing Facility.
The Company, through OFC, has two residual Facilities: a $10.0 million committed facility with MLMCI and a $50.0 million line with Salomon Smith Barney Realty Corporation ("SBRC") (the "SBRC Line" and together with the facility with MLMCI, the "Residual Lines"). The Residual Lines are used by the Company to finance operating requirements. The lines utilize a collateral-based formula that sets borrowing availability to a percentage of the value of excess cash flow to be received from certain securitizations. The facility provided by MLMCI was renewed in February 2000 for a one year term. Each loan under the SBRC Line matures one year after the date of the loan; the Company expects each loan to be renewed at term.
Interest paid under each line is tied to the 30 day Libor Rate. The average interest rates for year ending 1999 were 7.86% for the MLMCI facility and 7.94% for the SBRC facility compared to 8.19% and 8.06% respectively for the year ending December 31, 1998. The Residual Lines had a combined fair value of $30.9 million at December 31, 1999, with debt outstanding under the MLMCI line of $9.2 million and debt outstanding under the SBRC line of $21.7 million.
NOTE 9 -- SUBORDINATED DEBT
The Company has a $10.0 million subordinated debt offering. The term of the subordinated debt is for two years ending February 24, 2000, and bears a fixed interest rate of 9.5%. In February 2000, the Company exercised its option to extend the term by three years during which the loan will fully amortize. The Company also issued to the lender a warrant for Common Stock in the amount of 180,529 shares of the Common Stock of the Company.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
Leases: The Company leases furniture, fixtures and equipment under capital leases with terms in excess of one year. The Company leases its office space under operating leases with options to renew. Certain operating lease agreements provide for escalations based on contractual provisions.
Future minimum lease payments required under capital leases and noncancelable operating leases are as follows as of December 31, 1999:
Rental expenses for premises and equipment amounted to approximately $3.1 million, $1.7 million and $1.4 million for the year ended December 31, 1999, 1998, and 1997 respectively.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 -- LITIGATION
As a consumer finance company, the Company is subject to various consumer claims and litigation seeking damages and statutory penalties based upon, among other things, disclosure inaccuracies and wrongful repossession, which could take the form of a plaintiff's class action complaint. The Company, as the assignee of finance contracts originated by dealers, may also be named as a co-defendant in lawsuits filed by consumers principally against dealers. The damages and penalties claimed by consumers in these types of matters can be substantial. The relief requested by the plaintiff's varies but includes requests for compensatory, statutory and punitive damages. The Company is a defendant in three consumer class actions, one of which was served in 2000. One such proceeding served in 1999, in which the Company is a defendant, has been brought as a putative class action and is pending in the State of California. A class has yet to be certified in this case in which the plaintiffs allege certain defects in post-repossession notice forms in the State of California. Another proceeding also served in 1999, in which the Company is a defendant, has been brought as a putative class action and also is pending in the State of California. A class was certified in 2000; in the matter, the plaintiffs raise issues regarding the payment of dealer participation dealers.
Management believes that the Company has taken prudent steps to address the litigation risks associated with the Company's business activities. However, there can be no assurance that the Company will be able to successfully defend against all such claims or that the determination of any such claim in a manner adverse to the Company would not have a material adverse effect on the Company's automobile finance business.
On January 25, 2000, a putative class action complaint was filed against the Company and certain of the Company's officers and directors alleging violations of Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 arising from the Company's use of the cash-in method of measuring and accounting for credit enhancement assets in the financial statements. The Company believes that its previous use of the cash-in method of measuring and accounting for credit enhancement assets was consistent with then current generally accepted accounting principles and accounting practices of other finance companies. As required by the Financial Accounting Standards Board's Special Report, "A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, Second Edition," dated December 1998 and related statements made by the staff of the Commission, the Company retroactively changed the method of measuring and accounting for credit enhancement assets to the cash-out method and restated the Company's financial statements for 1996, 1997 and the first three fiscal quarters of 1998. The Company intends to vigorously defend against the complaint.
In the opinion of management, the resolution of the proceedings described in this section will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.
NOTE 12 -- STOCK OPTIONS
As of December 31, 1999, the Company has reserved 1,539,624 shares for future issuance to certain employees under its stock option plans. The options may be exercised at prices ranging from $0.51 per share to $11.50 per share at any time, in whole or part, within ten years after the date of grant. Reserved, unoptioned shares totaled 249,488 at December 31, 1999, 240,566 at December 31, 1998, and 185,176 at December 31, 1997.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the status of the Company's stock option plan as of December 31, 1999, 1998 and 1997, and changes during the years ending on those dates is presented below:
The following table summarizes information about stock options outstanding at December 31, 1999:
Substantially all of the options granted by the Company vest over a four year period, 25% after one year and the remaining 75% ratably over the following 36 month period. All of the options are granted at the closing price on the date of the grant.
SFAS 123 provides for companies to recognize compensation expense associated with stock based compensation plans over the anticipated service period based on the fair value of the award on the date of grant. However, SFAS 123 allows companies to continue to measure compensation costs prescribed by APB Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"). Companies electing to continue accounting for stock based compensation plans under APB 25 must make pro forma disclosures of net income and net income per share, as if SFAS 123 had been adopted. The company has continued to account for stock-based compensation plans under APB 25. The fair value of the options was estimated at date of grant using a Black-Scholes single option pricing model using the following assumptions:
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table presents the pro forma disclosures required for SFAS 123 for the years ended December 31:
NOTE 13 -- EMPLOYEE 401K DEFERRED SAVINGS PLAN
The Company has established a salary deferral savings program pursuant to IRS Code Section 401(k) (the "401(k) Plan") for qualified employees. Under this plan, employees may contribute a percentage of their pre-tax earnings to the 401(k) Plan. Effective July 1, 1998, the Company amended the 401(k) Plan to permit matching Company contributions. Employee contributions up to the lesser of $10,000 or 6% of pre-tax earnings made after one year of service are matched by a Company contribution equal to 50% of the employee's contribution. Matching contributions are made in the Company's common stock and begin vesting 20% per year following the completion of three years of service. Company expense related to the 401(k) Plan totaled $176,589 in 1999 and $87,000 in 1998.
NOTE 14 -- SHAREHOLDERS' EQUITY
Preferred Stock: The Company has 3 million shares of preferred stock authorized of which 200,000 shares have been designated Series A participating Preferred Stock.
In July 1997, the Company's Board of Directors adopted a Stockholder Rights Plan ("Plan") in which preferred stock purchase rights were distributed as a dividend at the rate of one preferred share purchase right (a "Right") for each outstanding share of common stock held by stockholders of record on July 21, 1997. The Rights are designed to guard against partial tender offers and other abusive tactics that might be used in an attempt to gain control of the Company or to deprive stockholders of their interest in the long-term value of the Company. The Rights will be exercisable only if a person or group acquires 15% or more of the Company's common stock (subject to certain exceptions stated in the Plan) or announces a tender offer, the consummation of which would result in ownership by a person or group of 15% or more of the Company's common stock. The Rights will expire on July 20, 2007.
Dividends: The Company does not intend to declare dividends in the foreseeable future. The Company's ability to pay or declare dividends is restricted by the terms of its current credit facilities.
NOTE 15 -- INCOME TAXES
The following table presents the current and deferred provision for federal and state income taxes for the years ended December 31, 1999, 1998 and 1997:
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The provision for income taxes differs from the amount that would result from applying the federal statutory rate as follows for the years ended December 31, 1999, 1998 and 1997:
The components of the deferred income tax asset or (liability) as of December 31, 1999 and 1998 are as follows:
NOTE 16 -- WARRANTS
At December 31, 1999, the Company had the following warrants outstanding to purchase shares of common stock:
At December 31, 1999, all the Company's warrants outstanding to purchase shares of common stock were exercisable.
No warrants were exercised during 1999.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 17 -- NET INCOME PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128, the following is an illustration of the dilutive effect of the Company's potential common stock on net income per share.
As of December 31, 1999, 1998 and 1997, 310,384, 473,344, and 645,370 of combined options and warrants, respectively, were not included in the calculation of full dilution, as they were antidilutive.
NOTE 18 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgement is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents: The carrying amount approximates fair value because of the short maturity of those investments.
Warehouse borrowings, residual and excess service lines: The fair value of the Company's debt is estimated based upon the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities and characteristics.
Contracts held for sale: The fair value of Contracts held for sale is based on the estimated proceeds expected on securitization of the Contracts held for sale.
Credit enhancement assets: The carrying amount is accounted for at an estimated fair value which is calculated by discounting the excess spread using a current market discount rate.
Hedging. The fair value of the Company's outstanding forward agreements are estimated based on current rates offered to the Company for forward agreements with similar terms and conditions.
ONYX ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The estimated fair values of the Company's financial instruments are as follows at December 31:
NOTE 19 -- RELATED PARTIES
The Company has a note receivable from a certain shareholder in the amount of $175,000. The note bears interest at 6.66% per annum. Principal and accrued interest are due on December 20, 2000.
NOTE 20 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
NOTE 21 -- SUBSEQUENT EVENTS (UNAUDITED)
In the first quarter of 2000, the Company securitized contracts totaling $430.0 million.
During the first quarter of 2000, the Company securitized the cash flows from 15 of its outstanding securitizations and sold $49.0 million of notes. The transaction was rated BBB by Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc.
INDEX TO EXHIBITS
10.1 through 10.96 Omitted.............................................
- --------------- * Filed herewith.
(1) Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No. 333-00680).
(2) Incorporated by reference from the Company's Current Report on Form 8-K dated July 8, 1997. (File No. 000-28050)