Also included in non-interest income is income associated with securitizing and servicing securitized
loans. When NextBank securitized loans, interchange and other credit card fees associated with
such loans were no longer reported as "Interchange and credit card fees" but instead are reported
as part of "Securitization Income." In addition, interest income generated by these securitized loans
in excess of the interest paid to investors, related credit losses, servicing fees, and other transaction
expenses were also reported as part of "Securitization Income." Average securitized loans
outstanding in 2001 were $1.3 billion, an increase of 330%compared $302.0 million in 2000.
Securitization income in 2001 totaled $84.7 million and included net gains on loan sales of $7.7
million. Changes in economic and performance expectations as well as the changes to NextBank's
business in the third quarter discussed above, which began to impact the yield on the portfolio in the
fourth quarter of 2001, all affected the present value of the estimated excess servicing income during
the period the securitized loans are projected to be outstanding. As a result, NextBank recorded a
mark-to-market charge of $10.3 million related to these interest-only strip receivables for
securitizations completed in prior periods. This charge is included in securitization income for 2001.
Securitization income in 2000 totaled $47.6 million and includes gains of $25.5 million.
Non-interest expenses of the discontinued banking operations includes salaries and employee
benefits, marketing and advertising, credit card activation and servicing costs, occupancy and
equipment, professional fees, amortization of loan structuring fees and deferred compensation
costs, fraud and miscellaneous other expenses. Non-interest expense was $175.1 million in 2001,
an increase of 20% from $146.2 million in 2000. This increase reflects the increase in the cost of
operations to manage the growth in customers, products and the loan portfolio prior to
discontinuance of our banking operations, as well as the classification of certain fraud losses in the
first and second quarters of 2001. The increase in non-interest expense was partially offset by the
decrease in marketing and advertising expenditures, which consist primarily of Internet-based
advertising, promotional expenditures, various branding campaigns and public relations. Marketing
and advertising expenditures were $14.7 million for 2001, a decrease of 53% from $31.4 million in
2000. This decrease in marketing and advertising expenditures was due to no large-scale branding
campaign expenditures in 2001, unlike 2000, as well as our increased marketing efficiencies
resulting from the continued success of our Internet Database Marketing System and our ability to
continually test and optimize our online marketing campaigns. In addition, as one of the largest
advertisers on the Internet, we had more negotiating power, particularly as online advertising rates
softened in 2001.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Loss from discontinued banking operations for the year ended December 31, 2000 was $81.9
million, an increase of 6% over a loss of $77.2 million for the year ended December 31, 1999. As of
December 31, 2000, managed loans, which includes reported and securitized loans, was $1.3
billion, an increase of 215% over the balance of $416.3 million at December 31, 1999. Average
managed credit card loans for 2000 were $856.0 million, an increase of 346% from $191.9 million
for 1999. Total customer accounts were 708,000 at December 31, 2001, an increase of 222% from
220,000 at December 31, 2000. These large increases in balances and accounts were the result of
the continued success of our marketing and account management strategies and the increased
acceptance of credit card usage over the Internet.
The discontinued banking operations' managed net interest margin increased to 6.00% for 2000
compared to 4.25% for 1999. The increase in net interest margin in 2000 was primarily attributable
to our ability to refine our pricing for appropriate customer segments using profile based pricing
technology, the repricings of the credit card loan portfolio due to the expiration of introductory rates
periods, and a lower cost of funds compared to 1999. Risk-adjusted margin for 2000 was 8.38%.
The managed net credit loss rate for 2000 increased to 2.62% from 1.61% in 1999. The more than
30 days delinquency rate at December 31, 2000 increased to 3.92% from 1.48% at December 31,
1999. These increases in credit loss and delinquency rates were primarily due to the ongoing
seasoning of the portfolio, which was expected with a relatively new and growing portfolio. At
December 31, 2000, the majority of the credit card loan portfolio was less than twelve months old.
The provision for loan losses was $57.1 million for 2000, an increase of 373% compared to $12.1
million in 1999. At December 31, 2000, the allowance for loan losses represented 4.8% of reported
loans compared to 2.8% at December 31, 1999. Increases in both the loan loss provision and
allowance for loan losses reflected increased delinquency and loss rates within the seasoning
portfolio as well as the dramatic growth of the portfolio.
As previously discussed, included in non-interest income are interchange and other credit card fees
consisting of income from the Visa system for purchases made with the NextCard Visa and fees
paid by NextBank's cardholders, such as late fees, over-limit fees and program fees. Such reported
non-interest income for 2000 was $29.7 million compared with $4.2 million for 1999. The significant
increase in credit card fee income in 2000 was attributable to the increase in the credit card loan
portfolio, an increase in cardholder purchase volume, the introduction and the increase in marketing
of fee-based products and the July 2000 change in domicile of NextBank's charter from California to
Arizona which, as permitted under Arizona law, brought the credit card fees we could charge our
customers more in line with the rest of the industry.
Average securitized loans outstanding for 2000 were $302.1 million. No loans were securitized in
1999. Securitization income in 2000 totaled $47.6 million and included gains on sale of $25.5 million
related to the sale of $784.2 million of credit card loan receivables.
Non-interest expenses increased to $146.2 million in 2000 from $80.8 million in 1999. This increase
reflects the increase in the cost of operations to manage the growth in customers, products and the
loan portfolio prior to discontinuance of our banking operations. Included in non-interest expense is
salaries and employee benefit expense of $54.8 million in 2000 compared to $21.9 million in 1999.
This $32.9 million increase was due to increased staffing needs to support the increase in credit
card accounts and other functions, including employees hired in the Phoenix, Arizona call center in
2000. The number of employees at December 31, 2000 and 1999 was 820 and 287, respectively.
Provision for Income Taxes
We have had a net loss for each period since inception. As of December 31, 2001, we had
approximately $203.0 million and $151.0 million of net operating loss carryforwards for federal and
state income tax purposes, respectively. Of these net operating loss carryforwards $63.0 million
federal and $76.0 million state NOL's are related to NextBank. The federal net operating loss
carryforwards will begin expiring in 2012 and the state net operating loss carryforwards will begin
expiring in 2005. Because of uncertainty regarding realizability, and our possible loss of NextBank's
net operating loss carryforwards upon NextBank's closure, we have provided a full valuation
allowance on our deferred tax assets consisting primarily of net operating loss carryforwards. See
Note 11 of Notes to the Consolidated Financial Statements.
Funding, Liquidity and Capital Resources
Prior to the closure of NextBank on February 7, 2002, we financed the growth of our credit card loan
portfolio and operations through third-party commercial paper conduit facilities, term asset
securitizations, certificates of deposit issued by NextBank, and equity issuances. In March 2002, we
entered into the FDIC Service Agreement in which the FDIC agreed to reimburse us for the majority
of our operating expenses for a minimum of three months. The FDIC has the option to continue the
FDIC Service Agreement on a monthly basis after May 30, 2002 in return for our agreement to
continue providing specific services to it. In addition, pursuant to this agreement, the FDIC agreed to
make a $1.0 million non-recourse loan to us which will be made to us in three equal installments
beginning in March 2002. The loan will not bear interest and will mature on September 12, 2002.
Since this loan is secured by an assignment in favor of the FDIC of all our right, title and interest in
and to the security backing a $1.0 million letter of credit executed in favor of MasterCard
International, our unrestricted cash on hand will not be required to repay this amount in September
2002.
As of December 31, 2001, our unrestricted cash and cash equivalents were $10.2 million and we
had outstanding accounts payable of $3.6 million and accrued liabilities of $18.3 million. Included in
the $18.3 million of accrued liabilities was approximately $7.2 million of accrued operating expenses
for which we had yet to be invoiced from our vendors $4.1 million for our estimated future payments
under our continuing NextCard Visa rewards program. The accrued liabilities will be paid in 2002 as
our vendors present invoices to us and the rewards program liability will be paid out as NextBank
credit card customers redeem their accrued points.
In 1998, we entered into a $1.25 million equipment loan and security agreement with a finance
company. Borrowings under the loan agreement bear interest at 7.55% per year and are secured by
related equipment purchases. As of December 31, 2001, the loan had an outstanding balance of
$338,000. Also, in 1998, we entered into a $1.0 million lease/loan financing arrangement with a
financing company. This lease/loan financing arrangement is secured by a pledge of all equipment
leased under the arrangement and bears interest at 7.5% per year. As of December 31, 2001, the
lease/loan had an outstanding balance of $326,000. Also, in February 1999, we entered into a $5.0
million line of credit with a finance company. Borrowings under this line of credit accrue interest at
12.25% per year, is repayable in monthly installments and final payment is due in April 2002. This
line is secured by a subordinated security interest in all tangible and intangible assets of our
company. This line of credit had an aggregate outstanding balance of $758,000 at December 31,
2001. All of these above described loans mature in 2002.
We lease office space under separate lease agreements and have operating leases for office
equipment. The minimum aggregate, non-cancelable payments, by year, under lease obligations
with initial or remaining terms of one year or more, some of which contain renewal options based on
the then current fair market values, consist of the following at December 31, 2001 (in thousands):
2002.............. $5,258
2003.............. 5,352
2004.............. 5,093
2005.............. 3,288
Thereafter........ 3,249
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$22,240
=======
Given the closure of NextBank and our focus on a new business strategy, much
of the office space to which these leases relate will not be needed after the
FDIC Service Agreement is terminated. We plan on discussing alternatives with
each of our landlords, but there can be no assurances that any of the leases'
contractual requirements can, or will be, favorably renegotiated.
Some, but not all, of the obligations discussed above will be reimbursed to us in 2002 by the FDIC
after we have made payment to our vendors and lessors. Once the FDIC Service Agreement has
been terminated, however, we anticipate that our cash will be insufficient to permit us to continue to
pay all of these obligations. In order to continue operations beyond the termination of the FDIC
Service Agreement, we will require a substantial capital infusion, the alleviation of a significant
portion of our obligations or will need to have developed and implemented a new business model
that generates substantial cash flow, or a combination of any or all three of these.
In addition, at December 31, 2001, we had $4.8 million of restricted cash and cash equivalents
which represents collateral held by a bank that has issued four standby letters of credit on behalf of
certain of our beneficiaries. We do no anticipate that such restricted funds will be available to us in
the future.
RECENT ACCOUNTING PRONOUNCEMENTS
See Notes to the Consolidated Financial Statements included elsewhere in this Annual Report on
Form 10-K.
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