Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period endedJune 30, 2011
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number1-06155
SPRINGLEAF FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
Indiana | 35-0416090 | |
(State of Incorporation) | (I.R.S. Employer Identification No.) | |
601 N.W. Second Street, Evansville, IN | 47708 | |
(Address of principal executive offices) | (Zip Code) |
(812) 424-8031
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
At August 11, 2011, there were 10,160,014 shares of the registrant’s common stock, $.50 par value, outstanding.
Table of Contents
Item | Page | |||||||||
Part I | 1. | Financial Statements | 3 | |||||||
2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 47 | ||||||||
3. | Quantitative and Qualitative Disclosures About Market Risk | 74 | ||||||||
4. | Controls and Procedures | 75 | ||||||||
Part II | 1. | Legal Proceedings | 75 | |||||||
1A. | Risk Factors | 76 | ||||||||
2. | Unregistered Sales of Equity Securities and Use of Proceeds | 78 | ||||||||
3. | Defaults Upon Senior Securities | 78 | ||||||||
4. | Removed and Reserved | — | ||||||||
5. | Other Information | 78 | ||||||||
6. | Exhibits | 79 |
AVAILABLE INFORMATION
Springleaf Finance Corporation (SLFC) files annual, quarterly, and current reports and other information with the Securities and Exchange Commission (the SEC). The SEC’s website,www.sec.gov, contains these reports and other information that registrants (including SLFC) file electronically with the SEC.
The following reports are available free of charge through our website,www.SpringleafFinancial.com (posted on the “About Us – Investor Information – Financial Information” section), as soon as reasonably practicable after we file them with or furnish them to the SEC:
• | Annual Reports on Form 10-K; |
• | Quarterly Reports on Form 10-Q; |
• | Current Reports on Form 8-K; and |
• | any amendments to those reports. |
In addition, our Code of Ethics for Principal Executive and Senior Financial Officers (the Code of Ethics) is posted on the “About Us – Investor Information – Corporate Governance” section of our website atwww.SpringleafFinancial.com. We will post on our website any amendments to the Code of Ethics and any waivers that are required to be described.
The information on our website is not incorporated by reference into this report. The website addresses listed above are provided for the information of the reader and are not intended to be active links.
2
Table of Contents
Part I – FINANCIAL INFORMATION
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(dollars in thousands) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
Assets | ||||||||
Net finance receivables: | ||||||||
Real estate loans (includes loans of consolidated VIEs of $1.9 billion in 2011 and $2.1 billion in 2010) | $ | 10,500,715 | $ | 11,064,444 | ||||
Non-real estate loans | 2,572,018 | 2,615,969 | ||||||
Retail sales finance | 403,651 | 491,185 | ||||||
|
|
|
| |||||
Net finance receivables | 13,476,384 | 14,171,598 | ||||||
Allowance for finance receivable losses (includes allowance of consolidated VIEs of $0.8 million in 2011 and $0.1 million in 2010) | (43,130 | ) | (7,120 | ) | ||||
|
|
|
| |||||
Net finance receivables, less allowance for finance receivable losses | 13,433,254 | 14,164,478 | ||||||
Investment securities | 749,092 | 745,846 | ||||||
Cash and cash equivalents | 1,669,551 | 1,381,534 | ||||||
Notes receivable from parent | 537,989 | 537,989 | ||||||
Restricted cash (includes restricted cash of consolidated VIEs of $23.5 million in 2011 and $30.9 million in 2010) | 49,712 | 320,662 | ||||||
Other assets | 722,706 | 982,451 | ||||||
|
|
|
| |||||
Total assets | $ | 17,162,304 | $ | 18,132,960 | ||||
|
|
|
| |||||
Liabilities and Shareholder’s Equity | ||||||||
Long-term debt (includes debt of consolidated VIEs of $1.1 billion in 2011 and $1.3 billion in 2010) | $ | 14,527,141 | $ | 14,940,989 | ||||
Insurance claims and policyholder liabilities | 318,320 | 340,203 | ||||||
Other liabilities | 347,235 | 607,788 | ||||||
Deferred and accrued taxes | 414,121 | 544,980 | ||||||
|
|
|
| |||||
Total liabilities | 15,606,817 | 16,433,960 | ||||||
|
|
|
| |||||
Shareholder’s equity: | ||||||||
Common stock | 5,080 | 5,080 | ||||||
Additional paid-in capital | 236,067 | 225,566 | ||||||
Accumulated other comprehensive income (loss) | 3,025 | (2,434 | ) | |||||
Retained earnings | 1,311,315 | 1,470,788 | ||||||
|
|
|
| |||||
Total shareholder’s equity | 1,555,487 | 1,699,000 | ||||||
|
|
|
| |||||
Total liabilities and shareholder’s equity | $ | 17,162,304 | $ | 18,132,960 | ||||
|
|
|
|
See Notes to Condensed Consolidated Financial Statements.
3
Table of Contents
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Interest income: | ||||||||||||||||||||
Finance charges | $ | 480,828 | $ | 451,874 | $ | 968,464 | $ | 920,860 | ||||||||||||
Finance receivables held for sale originated as held for investment | — | 9,547 | — | 20,418 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total interest income | 480,828 | 461,421 | 968,464 | 941,278 | ||||||||||||||||
Interest expense | 343,810 | 266,386 | 694,443 | 523,379 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Net interest income | 137,018 | 195,035 | 274,021 | 417,899 | ||||||||||||||||
Provision for finance receivable losses | 102,061 | 54,954 | 175,199 | 239,575 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Net interest income after provision for finance receivable losses | 34,957 | 140,081 | 98,822 | 178,324 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Other revenues: | ||||||||||||||||||||
Insurance | 29,809 | 31,361 | 58,295 | 62,881 | ||||||||||||||||
Investment | 9,978 | 10,616 | 17,757 | 18,266 | ||||||||||||||||
Gain on early extinguishment of secured term loan | 10,664 | — | 10,664 | — | ||||||||||||||||
Other | 14,171 | 3,067 | 7,117 | 83,065 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total other revenues | 64,622 | 45,044 | 93,833 | 164,212 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Other expenses: | ||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||
Salaries and benefits | 92,859 | 97,951 | 186,188 | 197,339 | ||||||||||||||||
Other operating expenses | 105,958 | 85,717 | 180,434 | 166,779 | ||||||||||||||||
Insurance losses and loss adjustment expenses | 137 | 11,246 | 12,732 | 26,830 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total other expenses | 198,954 | 194,914 | 379,354 | 390,948 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Loss before benefit from income taxes | (99,375 | ) | (9,789 | ) | (186,699 | ) | (48,412 | ) | ||||||||||||
Benefit from income taxes | (40,081 | ) | (54,030 | ) | (72,226 | ) | (105,097 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Net (loss) income | $ | (59,294 | ) | $ | 44,241 | $ | (114,473 | ) | $ | 56,685 | ||||||||||
|
|
|
|
|
|
|
|
See Notes to Condensed Consolidated Financial Statements.
4
Table of Contents
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive (Loss) Income
(Unaudited)
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Net (loss) income | $ | (59,294 | ) | $ | 44,241 | $ | (114,473 | ) | $ | 56,685 | ||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Other comprehensive income: | ||||||||||||||||||||
Net unrealized gains (losses) on: | ||||||||||||||||||||
Investment securities on which other-than- temporary impairments were taken | 158 | 2,188 | 158 | 6,924 | ||||||||||||||||
All other investment securities | 9,534 | 11,897 | 13,348 | 20,064 | ||||||||||||||||
Swap agreements | 1,453 | 35,064 | (13,488 | ) | 2,054 | |||||||||||||||
Foreign currency translation adjustments | 255 | (1,928 | ) | 3,813 | (10,472 | ) | ||||||||||||||
Income tax effect: | ||||||||||||||||||||
Net unrealized (gains) losses on: | ||||||||||||||||||||
Investment securities on which other-than- temporary impairments were taken | (55 | ) | (765 | ) | (55 | ) | (2,423 | ) | ||||||||||||
All other investment securities | (3,337 | ) | (4,164 | ) | (4,672 | ) | (7,023 | ) | ||||||||||||
Swap agreements | (509 | ) | (12,273 | ) | 4,720 | (719 | ) | |||||||||||||
Valuation allowance on deferred tax assets for: | ||||||||||||||||||||
Investment securities | — | 8,032 | — | 8,252 | ||||||||||||||||
Swap agreements | — | 12,273 | — | 719 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Other comprehensive income, net of tax, before reclassification adjustments | 7,499 | 50,324 | 3,824 | 17,376 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Reclassification adjustments included in net (loss) income: | ||||||||||||||||||||
Realized losses on investment securities | 345 | 1,859 | 2,515 | 7,103 | ||||||||||||||||
Income tax effect of realized losses on investment securities | (121 | ) | (651 | ) | (880 | ) | (2,486 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Reclassification adjustments included in net (loss) income, net of tax | 224 | 1,208 | 1,635 | 4,617 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Other comprehensive income, net of tax | 7,723 | 51,532 | 5,459 | 21,993 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Comprehensive (loss) income | $ | (51,571 | ) | $ | 95,773 | $ | (109,014 | ) | $ | 78,678 | ||||||||||
|
|
|
|
|
|
|
|
See Notes to Condensed Consolidated Financial Statements.
5
Table of Contents
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholder’s Equity
(Unaudited)
(dollars in thousands) | Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Total Shareholder’s Equity | |||||||||||||||
Predecessor Company | ||||||||||||||||||||
Balance, January 1, 2010 | $ | 5,080 | $ | 2,121,777 | $ | 1,846 | $ | 246,911 | $ | 2,375,614 | ||||||||||
Capital contributions from parent and other | — | 11,426 | — | — | 11,426 | |||||||||||||||
Change in net unrealized gains: | ||||||||||||||||||||
Investment securities | — | — | 30,411 | — | 30,411 | |||||||||||||||
Swap agreements | — | — | 2,054 | — | 2,054 | |||||||||||||||
Foreign currency translation adjustments | — | — | (10,472 | ) | — | (10,472 | ) | |||||||||||||
Net income | — | — | — | 56,685 | 56,685 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Balance, June 30, 2010 | $ | 5,080 | $ | 2,133,203 | $ | 23,839 | $ | 303,596 | $ | 2,465,718 | ||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Successor Company | ||||||||||||||||||||
Balance, January 1, 2011 | $ | 5,080 | $ | 225,566 | $ | (2,434 | ) | $ | 1,470,788 | $ | 1,699,000 | |||||||||
Capital contributions from parent and other | — | 10,501 | — | — | 10,501 | |||||||||||||||
Change in net unrealized gains (losses): | ||||||||||||||||||||
Investment securities | — | — | 10,414 | — | 10,414 | |||||||||||||||
Swap agreements | — | — | (8,768 | ) | — | (8,768 | ) | |||||||||||||
Foreign currency translation adjustments | — | — | 3,813 | — | 3,813 | |||||||||||||||
Net loss | — | — | — | (114,473 | ) | (114,473 | ) | |||||||||||||
Dividends | — | — | — | (45,000 | ) | (45,000 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Balance, June 30, 2011 | $ | 5,080 | $ | 236,067 | $ | 3,025 | $ | 1,311,315 | $ | 1,555,487 | ||||||||||
|
|
|
|
|
|
|
|
|
|
See Notes to Condensed Consolidated Financial Statements.
6
Table of Contents
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(dollars in thousands) | Successor Company | Predecessor Company | ||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||
Cash Flows from Operating Activities | ||||||||||
Net (loss) income | $ | (114,473 | ) | $ | 56,685 | |||||
Reconciling adjustments: | ||||||||||
Provision for finance receivable losses | 175,199 | 239,575 | ||||||||
Depreciation and amortization | 115,893 | 74,413 | ||||||||
Deferral of finance receivable origination costs | (20,629 | ) | (18,046 | ) | ||||||
Deferred income tax benefit | (128,890 | ) | (216 | ) | ||||||
Net realized losses on investment securities | 2,515 | 7,103 | ||||||||
Change in other assets and other liabilities | 63,100 | (135,122 | ) | |||||||
Writedowns and net loss on sales of real estate owned | 31,452 | 20,830 | ||||||||
Gain on early extinguishment of secured term loan | (10,664 | ) | — | |||||||
Change in insurance claims and policyholder liabilities | (21,883 | ) | (18,859 | ) | ||||||
Change in taxes receivable and payable | (7,960 | ) | (110,092 | ) | ||||||
Change in accrued finance charges | 11,250 | 22,478 | ||||||||
Change in restricted cash | 14,652 | (3,365 | ) | |||||||
Other, net | (1,527 | ) | 804 | |||||||
|
|
|
| |||||||
Net cash provided by operating activities | 108,035 | 136,188 | ||||||||
|
|
|
| |||||||
Cash Flows from Investing Activities | ||||||||||
Finance receivables originated or purchased | (835,575 | ) | (712,362 | ) | ||||||
Principal collections on finance receivables | 1,416,437 | 1,682,635 | ||||||||
Affiliates contributed by SLFI to SLFC | — | 466 | ||||||||
Sales and principal collections on finance receivables held for sale originated as held for investment | — | 37,764 | ||||||||
Investment securities purchased | (56,582 | ) | (74,409 | ) | ||||||
Investment securities called, sold, and matured | 62,949 | 36,294 | ||||||||
Change in notes receivable from parent and AIG | — | 735,704 | ||||||||
Change in restricted cash | 256,329 | (155,834 | ) | |||||||
Proceeds from sale of real estate owned | 106,916 | 117,949 | ||||||||
Other, net | (8,596 | ) | (3,700 | ) | ||||||
|
|
|
| |||||||
Net cash provided by investing activities | 941,878 | 1,664,507 | ||||||||
|
|
|
| |||||||
Cash Flows from Financing Activities | ||||||||||
Proceeds from issuance of long-term debt | 2,119,594 | 3,496,468 | ||||||||
Debt commissions on issuance of long-term debt | | (20,076 | ) | | (82,500 | ) | ||||
Repayment of long-term debt | (2,827,437 | ) | (3,595,931 | ) | ||||||
Change in short-term debt | — | (2,342,201 | ) | |||||||
Capital contributions from parent | 10,500 | 11,428 | ||||||||
Dividends paid | (45,000 | ) | — | |||||||
|
|
|
| |||||||
Net cash used for financing activities | (762,419 | ) | (2,512,736 | ) | ||||||
|
|
|
| |||||||
Effect of exchange rate changes | 523 | (339 | ) | |||||||
|
|
|
| |||||||
Increase (decrease) in cash and cash equivalents | 288,017 | (712,380 | ) | |||||||
Cash and cash equivalents at beginning of period | 1,381,534 | 1,292,621 | ||||||||
|
|
|
| |||||||
Cash and cash equivalents at end of period | $ | 1,669,551 | $ | 580,241 | ||||||
|
|
|
|
See Notes to Condensed Consolidated Financial Statements.
7
Table of Contents
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2011
Note 1. Basis of Presentation
Springleaf Finance Corporation (SLFC or, collectively with its subsidiaries, whether directly or indirectly owned, the Company, we, or our) (formerly American General Finance Corporation) is a wholly owned subsidiary of Springleaf Finance, Inc. (SLFI) (formerly American General Finance, Inc.).
Until November 30, 2010, SLFI was a direct wholly owned subsidiary of AIG Capital Corporation (ACC), which is a direct wholly owned subsidiary of American International Group, Inc. (AIG), a Delaware corporation. On August 11, 2010, AIG and FCFI Acquisition LLC (FCFI), an affiliate of Fortress Investment Group LLC (Fortress), announced a definitive agreement (Stock Purchase Agreement) whereby FCFI would indirectly acquire an 80% economic interest in SLFI from ACC (the FCFI Transaction). AIG, through ACC, retained a 20% economic interest in SLFI. On November 30, 2010 and immediately prior to the consummation of the FCFI Transaction, ACC contributed all of its outstanding shares of common stock in SLFI to AGF Holding Inc. (AGF Holding), a wholly owned subsidiary of ACC. In accordance with the Stock Purchase Agreement, it was necessary that this restructuring be completed prior to the closing of the FCFI Transaction. AIG then caused ACC to sell to FCFI 80% of the outstanding shares of AGF Holding.
We prepared our condensed consolidated financial statements using accounting principles generally accepted in the United States of America (U.S. GAAP). These statements are unaudited. The year-end condensed balance sheet data was derived from our audited financial statements, but does not include all disclosures required by U.S. GAAP. The statements include the accounts of SLFC and its subsidiaries, all of which are wholly owned. We eliminated all material intercompany accounts and transactions. We made estimates and assumptions that affect amounts reported in our condensed consolidated financial statements and disclosures of contingent assets and liabilities. In management’s opinion, the condensed consolidated financial statements include the normal, recurring adjustments necessary for a fair statement of results, except for the out of period adjustment recorded in second quarter 2011 discussed below. Ultimate results could differ from our estimates. We evaluated the effects of and the need to disclose events that occurred subsequent to the balance sheet date. In second quarter 2011, we revised the presentation of our condensed consolidated statements of operations to report net interest income. We believe this presentation more clearly shows the key components of our operating income source and use of funds. You should read these statements in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. To conform to the 2011 presentation, we reclassified certain items in the prior period.
Because of the nature of the FCFI Transaction, the significance of the ownership interest acquired, and at the direction of our acquirer, we applied push-down accounting to SLFI and SLFC as the acquired businesses. We revalued our assets and liabilities based on their fair values at the date of the FCFI Transaction in accordance with business combination accounting standards (push-down accounting). Accordingly, a new basis of accounting was established and, for accounting purposes, the old entity (the Predecessor Company) was terminated and a new entity (the Successor Company) was created. This distinction is made throughout this Quarterly Report on Form 10-Q through the inclusion of a vertical black line between the Successor Company and the Predecessor Company columns.
As a result of the application of push-down accounting, the bases of the assets and liabilities of the Successor Company are not comparable to those of the Predecessor Company, nor would the income statement items for the three and six months ended June 30, 2011 have been the same as those reported if push-down accounting had not been applied.
8
Table of Contents
In second quarter 2011, we recorded an out of period adjustment related to prior periods, which decreased insurance losses and loss adjustment expenses by $14.2 million for the three and six months ended June 30, 2011. This adjustment related to the correction of a benefit reserve error related to a closed block of annuities. After evaluating the quantitative and qualitative aspects of this correction, management has determined that the out of period adjustment is immaterial to our estimated full year results and that our previously issued quarterly and annual consolidated financial statements were not materially misstated.
Note 2. Recent Accounting Pronouncements
We adopted the following accounting standard in 2011:
Presentation of Comprehensive Income
In June 2011, the Financial Accounting Standards Board (FASB) issued an accounting standard that requires companies to report total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements, bringing U.S. GAAP and International Financial Reporting Standards (IFRS) into alignment on the required presentation of other comprehensive income. The new standard is effective for interim and annual periods beginning on January 1, 2012. Early application is permitted. The adoption of this new standard did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
We will adopt the following accounting standards in the future:
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the FASB issued an accounting standard update that amends the accounting for costs incurred by insurance companies that can be capitalized in connection with acquiring or renewing insurance contracts. The new standard clarifies how to determine whether the costs incurred in connection with the acquisition of new or renewal insurance contracts qualify as deferred acquisition costs. The new standard is effective for interim and annual periods beginning on January 1, 2012 with early adoption permitted. Prospective or retrospective application is permitted. The adoption of this new standard will not have a material effect on our consolidated financial condition, results of operations, or cash flows.
A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring
In April 2011, the FASB issued an accounting standard that clarifies which loan modifications constitute troubled debt restructurings (TDR). In evaluating whether a restructuring constitutes a TDR, a creditor must separately conclude that both of the following exist: (1) the restructuring constitutes a concession; and (2) the debtor is experiencing financial difficulties. This standard amends the accounting guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. The new standard is effective for the first interim or annual period beginning on or after June 15, 2011. Early application is permitted. The adoption of this new standard will not have a material effect on our consolidated financial condition, results of operations, or cash flows.
9
Table of Contents
Reconsideration of Effective Control for Repurchase Agreements
In April 2011, the FASB issued an amendment to existing criteria for determining whether or not a transferor has retained effective control over securities sold under agreements to repurchase. A secured borrowing is recorded when effective control over the transferred financial assets is maintained while a sale is recorded when effective control over the transferred financial assets has not been maintained. The amendment removes the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially agreed terms, even in the event of default by the transferee. The collateral maintenance implementation guidance related to this criterion also is removed. The collateral maintenance implementation guidance was a requirement of the transferor to demonstrate that it possessed adequate collateral to fund substantially all the cost of purchasing the replacement financial assets. The amendment is effective for us beginning January 1, 2012. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. We are in the process of reviewing the potential impact on our consolidated financial condition, results of operations, and cash flows.
Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs
In May 2011, the FASB and the International Accounting Standards Board jointly issued an accounting standard resulting in a common fair value meaning between U.S. GAAP and IFRS and consistency of disclosures relating to fair value. The new standard is effective for interim and annual periods beginning after December 15, 2011. Early application is not permitted. We are in the process of reviewing the potential impact on our consolidated financial condition, results of operations, and cash flows.
Note 3. Finance Receivables
Components of net finance receivables by type were as follows:
(dollars in thousands) | Real Estate Loans | Non-Real Estate Loans | Retail Sales Finance | Total | ||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Gross receivables | $ | 10,450,091 | $ | 2,826,281 | $ | 445,330 | $ | 13,721,702 | ||||||||
Unearned finance charges and points and fees | (13,382 | ) | (304,638 | ) | (45,075 | ) | (363,095 | ) | ||||||||
Accrued finance charges | 63,634 | 32,872 | 3,409 | 99,915 | ||||||||||||
Deferred origination costs | 390 | 17,503 | — | 17,893 | ||||||||||||
Premiums, net of discounts | (18 | ) | — | (13 | ) | (31 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 10,500,715 | $ | 2,572,018 | $ | 403,651 | $ | 13,476,384 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Gross receivables | $ | 11,010,758 | $ | 2,853,633 | $ | 536,144 | $ | 14,400,535 | ||||||||
Unearned finance charges and points and fees | (15,963 | ) | (274,907 | ) | (48,386 | ) | (339,256 | ) | ||||||||
Accrued finance charges | 69,624 | 33,747 | 3,427 | 106,798 | ||||||||||||
Deferred origination costs | 25 | 3,496 | — | 3,521 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 11,064,444 | $ | 2,615,969 | $ | 491,185 | $ | 14,171,598 | ||||||||
|
|
|
|
|
|
|
|
10
Table of Contents
Included in the table above are real estate finance receivables associated with securitizations that remain on our balance sheet totaling $1.9 billion at June 30, 2011 and $2.1 billion at December 31, 2010. See Note 4 and Note 9 for further discussion regarding our securitization transactions. Also included in the table above are finance receivables that have been pledged as collateral for our secured term loan totaling $5.6 billion at June 30, 2011 and $7.4 billion at December 31, 2010.
Unused credit limits extended to customers by the Company totaled $200.9 million at June 30, 2011 and $162.3 million at December 31, 2010. All unused credit limits, in part or in total, can be cancelled at the discretion of the Company.
There are many different categorizations used in the consumer lending industry to describe the creditworthiness of a borrower, including “prime”, “non-prime”, and “sub-prime”. While there are no industry-wide agreed upon definitions for these categorizations, many market participants utilize third-party credit scores as a means to categorize the creditworthiness of the borrower and his or her finance receivable. Our finance receivable underwriting process does not use third-party credit scores as a primary determinant for credit decisions. However, we do, in part, use such scores to analyze performance of our finance receivable portfolio.
We present below our net finance receivables and delinquency ratios grouped into the following categories based solely on borrower Fair Isaac Corporation (FICO) credit scores at the date of origination or renewal:
• | Prime: Borrower FICO score greater than or equal to 660 |
• | Non-prime: Borrower FICO score greater than 619 and less than 660 |
• | Sub-prime: Borrower FICO score less than or equal to 619 |
Many finance receivables included in the “prime” category in the table below might not meet other market definitions of prime loans due to certain characteristics of the borrowers, such as their elevated debt-to-income ratios, lack of income stability, or level of income disclosure and verification, as well as credit repayment history or similar measurements.
FICO-delineated prime, non-prime, and sub-prime categories for net finance receivables by portfolio segment and by class were as follows:
(dollars in thousands) | Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | ||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Prime | $ | 1,007,290 | $ | 3,184,700 | $ | 517,721 | $ | 169,037 | ||||||||
Non-prime | 1,101,624 | 845,645 | 586,837 | 57,102 | ||||||||||||
Sub-prime | 3,906,470 | 335,513 | 1,454,513 | 176,515 | ||||||||||||
Other/FICO unavailable | 984 | 1,075 | 12,947 | 997 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 6,016,368 | $ | 4,366,933 | $ | 2,572,018 | $ | 403,651 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Prime | $ | 1,063,809 | $ | 3,399,329 | $ | 528,435 | $ | 220,677 | ||||||||
Non-prime | 1,159,673 | 885,817 | 592,163 | 72,261 | ||||||||||||
Sub-prime | 4,089,894 | 348,773 | 1,482,975 | 197,484 | ||||||||||||
Other/FICO unavailable | 991 | 417 | 12,396 | 762 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 6,314,367 | $ | 4,634,336 | $ | 2,615,969 | $ | 491,184 | ||||||||
|
|
|
|
|
|
|
|
11
Table of Contents
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios by portfolio segment and by class were as follows:
Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | |||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Prime | 3.53 | % | 7.98 | % | 1.61 | % | 2.81 | % | ||||||||
Non-prime | 5.38 | 13.34 | 2.37 | 5.05 | ||||||||||||
Sub-prime | 6.71 | 13.42 | 3.84 | 3.93 | ||||||||||||
Other/FICO unavailable | 13.79 | 56.14 | 1.21 | 2.89 | ||||||||||||
Total | 5.94 | 9.46 | 3.06 | 3.61 | ||||||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Prime | 3.61 | % | 7.31 | % | 2.04 | % | 3.95 | % | ||||||||
Non-prime | 5.21 | 12.39 | 3.11 | 6.32 | ||||||||||||
Sub-prime | 6.89 | 12.43 | 4.75 | 5.71 | ||||||||||||
Other/FICO unavailable | 3.81 | — | N/M | * | 6.94 | |||||||||||
Total | 6.03 | 8.67 | 3.84 | 5.01 |
* | Not meaningful |
Our net finance receivables by performing and nonperforming (nonaccrual) by portfolio segment and by class were as follows:
(dollars in thousands) | Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | ||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Performing | $ | 5,771,731 | $ | 4,038,452 | $ | 2,536,941 | $ | 398,641 | ||||||||
Nonperforming | 244,637 | 328,481 | 35,077 | 5,010 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 6,016,368 | $ | 4,366,933 | $ | 2,572,018 | $ | 403,651 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Performing | $ | 6,085,476 | $ | 4,323,802 | $ | 2,590,614 | $ | 488,377 | ||||||||
Nonperforming | 228,891 | 310,534 | 25,355 | 2,807 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 6,314,367 | $ | 4,634,336 | $ | 2,615,969 | $ | 491,184 | ||||||||
|
|
|
|
|
|
|
|
12
Table of Contents
Our delinquency by portfolio segment and by class were as follows:
(dollars in thousands) | Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | ||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Unpaid principal balance: | ||||||||||||||||
30-59 days past due | $ | 121,658 | $ | 111,304 | $ | 40,527 | $ | 9,727 | ||||||||
60-89 days past due | 72,054 | 78,318 | 21,381 | 5,324 | ||||||||||||
90 days or more past due | 339,614 | 441,020 | 67,281 | 11,866 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total past due | 533,326 | 630,642 | 129,189 | 26,917 | ||||||||||||
Current | 6,399,737 | 4,860,094 | 2,766,952 | 449,658 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 6,933,063 | $ | 5,490,736 | $ | 2,896,141 | $ | 476,575 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Unpaid principal balance: | ||||||||||||||||
30-59 days past due | $ | 129,188 | $ | 108,971 | $ | 44,748 | $ | 13,279 | ||||||||
60-89 days past due | 77,890 | 83,352 | 27,498 | 8,651 | ||||||||||||
90 days or more past due | 363,928 | 434,797 | 86,816 | 20,779 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total past due | 571,006 | 627,120 | 159,062 | 42,709 | ||||||||||||
Current | 6,743,272 | 5,216,774 | 2,814,633 | 545,159 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 7,314,278 | $ | 5,843,894 | $ | 2,973,695 | $ | 587,868 | ||||||||
|
|
|
|
|
|
|
|
As a result of the FCFI Transaction, we evaluated the credit quality of our finance receivable portfolio in order to identify finance receivables that, as of the acquisition date, had evidence of credit quality deterioration.
We include the carrying amount (which initially was the fair value) of these credit impaired finance receivables in net finance receivables, less allowance for finance receivable losses. Prepayments reduce the outstanding balance, contractual cash flows, and cash flows expected to be collected. Information regarding these credit impaired finance receivables was as follows:
(dollars in thousands) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
Carrying amount, net of allowance | $ | 1,639,566 | $ | 1,833,819 | ||||
Outstanding balance | $ | 2,365,225 | $ | 2,661,367 | ||||
Allowance for credit impaired finance receivable losses | $ | — | $ | — |
We did not create an allowance for credit impaired finance receivable losses in the second quarter of 2011 since the net carrying value of these credit impaired finance receivables was less than the present value of the expected cash flow.
13
Table of Contents
Changes in accretable yield of these finance receivables were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
At or for the Three Months Ended June 30, 2011 | At or for the Three Months Ended June 30, 2010* | At or for the Six Months Ended June 30, 2011 | At or for the Six Months Ended June 30, 2010* | |||||||||||||||||
Balance at beginning of period | $ | 591,458 | $ | — | $ | 640,619 | $ | — | ||||||||||||
Additions | — | — | — | — | ||||||||||||||||
Accretion | (41,766 | ) | — | (77,361 | ) | — | ||||||||||||||
Reclassifications from (to) nonaccretable difference | 15,490 | — | 15,490 | — | ||||||||||||||||
Disposals | (12,721 | ) | — | (26,287 | ) | — | ||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 552,461 | $ | — | $ | 552,461 | $ | — | ||||||||||||
|
|
|
|
|
|
|
|
* | Prior to the FCFI Transaction, the accretable yield of our credit impaired finance receivables was immaterial. |
FICO-delineated prime, non-prime, and sub-prime categories for credit impaired finance receivables by portfolio segment and by class were as follows:
(dollars in thousands) | Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | ||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Prime | $ | 59,133 | $ | 557,461 | $ | — | $ | — | ||||||||
Non-prime | 106,483 | 273,741 | — | — | ||||||||||||
Sub-prime | 527,141 | 115,426 | — | — | ||||||||||||
Other/FICO unavailable | 181 | 1 | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 692,938 | $ | 946,629 | $ | — | $ | — | ||||||||
|
|
|
|
|
|
|
| |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Prime | $ | 67,864 | $ | 619,550 | $ | 2,182 | $ | 566 | ||||||||
Non-prime | 120,370 | 294,814 | 4,317 | 374 | ||||||||||||
Sub-prime | 581,082 | 120,647 | 19,646 | 2,205 | ||||||||||||
Other/FICO unavailable | 179 | — | 9 | 14 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 769,495 | $ | 1,035,011 | $ | 26,154 | $ | 3,159 | ||||||||
|
|
|
|
|
|
|
|
14
Table of Contents
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios for credit impaired finance receivables by portfolio segment and by class were as follows:
Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | |||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Prime | 18.85 | % | 26.49 | % | N/M | * | N/M | |||||||||
Non-prime | 17.78 | 27.41 | N/M | N/M | ||||||||||||
Sub-prime | 17.94 | 25.92 | N/M | N/M | ||||||||||||
Other/FICO unavailable | 62.94 | — | N/M | N/M | ||||||||||||
Total | 18.00 | 26.69 | N/M | N/M | ||||||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Prime | 29.32 | % | 33.56 | % | 94.63 | % | 93.40 | % | ||||||||
Non-prime | 24.90 | 32.53 | 93.69 | 90.28 | ||||||||||||
Sub-prime | 24.42 | 31.15 | 92.44 | 89.50 | ||||||||||||
Other/FICO unavailable | 62.92 | — | 100.00 | 88.37 | ||||||||||||
Total | 24.94 | 32.99 | 92.83 | 90.31 |
* | Not meaningful |
If the timing and/or amounts of expected cash flows on credit impaired finance receivables were determined to not be reasonably estimable, no interest would be accreted and the finance receivables would be reported as nonaccrual finance receivables. However, since the timing and amounts of expected cash flows are reasonably estimable, interest is being accreted and the finance receivables are being reported as performing finance receivables.
Information regarding TDR finance receivables (which are all real estate loans) was as follows:
(dollars in thousands) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
TDR net finance receivables | $ | 160,293 | $ | 28,195 | ||||
TDR net finance receivables that have an allowance | $ | 160,293 | $ | 28,195 | ||||
Allowance for TDR finance receivable losses | $ | 17,990 | $ | 2,835 |
As a result of the FCFI Transaction, all TDR finance receivables that existed as of November 30, 2010 were reclassified to and are accounted for prospectively as credit impaired finance receivables. We have no commitments to lend additional funds on our TDR finance receivables.
15
Table of Contents
TDR average net receivables and finance charges recognized on TDR finance receivables were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
TDR average net receivables | $ | 138,518 | $ | 1,768,164 | $ | 105,029 | $ | 1,648,944 | ||||||||||||
TDR finance charges recognized | $ | 1,402 | $ | 21,938 | $ | 2,124 | $ | 41,674 |
In third quarter 2009, MorEquity, Inc. (MorEquity) entered into a Commitment to Purchase Financial Instrument and Servicer Participation Agreement (the Agreement) with the Federal National Mortgage Association as financial agent for the United States Department of the Treasury, which provides for participation in the Home Affordable Modification Program (HAMP). MorEquity entered into the Agreement as the servicer with respect to our centralized real estate finance receivables, with an effective date of September 1, 2009. On February 1, 2011, MorEquity entered into Subservicing Agreements for the servicing of its centralized real estate finance receivables with Nationstar Mortgage LLC (Nationstar), a non-subsidiary affiliate of SLFC. As a result of the subservicing transfer, the Agreement was terminated on May 26, 2011. “Eligible Loans” subserviced by Nationstar are still subject to HAMP.
Note 4. On-Balance Sheet Securitization Transactions
As part of our overall funding strategy and as part of our efforts to support our liquidity from sources other than our traditional capital market sources, we have transferred certain finance receivables to variable interest entities (VIEs) for securitization transactions. These securitization transactions do not satisfy the requirements for accounting sale treatment because the securitization trusts do not have the right to freely pledge or exchange the transferred assets. We also have significant discretion for working out and disposing of defaulted real estate loans and disposing of any foreclosed real estate held by the VIEs. Since the transactions do not meet all of the criteria for sale accounting treatment, the securitized assets and related liabilities are included in our financial statements and are accounted for as secured borrowings.
Our on-balance sheet securitizations of real estate loans and the related debt were as follows:
(dollars in thousands) | Real Estate Loans | Long-term Debt | ||||||
Successor Company June 30, 2011 | ||||||||
2009 securitization | $ | 1,246,542 | $ | 770,544 | ||||
2010 securitization | 700,828 | 366,064 | ||||||
Successor Company December 31, 2010 | ||||||||
2009 securitization | $ | 1,316,280 | $ | 876,607 | ||||
2010 securitization | 740,794 | 423,119 |
16
Table of Contents
We have limited continued involvement with the finance receivables that have been included in these securitization transactions. Our 2009 securitization transaction utilizes a third-party servicer to service the finance receivables. Although we have servicer responsibilities for the finance receivables for our 2010 securitization transaction, effective February 1, 2011, Nationstar began subservicing these finance receivables. In the case of each existing securitization transaction, the related finance receivables have been legally isolated and are only available for payment of the debt and other obligations issued or arising in the applicable securitization transaction. The cash and cash equivalent balances relating to securitization transactions are used only to support the on-balance sheet securitization transactions and are recorded as restricted cash. We hold the right to the excess cash flows not needed to pay the debt and other obligations issued or arising in our securitization transactions. The asset-backed debt has been issued by consolidated VIEs.
Note 5. Allowance for Finance Receivable Losses
Changes in the allowance for finance receivable losses and net finance receivables by portfolio segment and by class were as follows:
(dollars in thousands) | Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | All Other | Consolidated Total | ||||||||||||||||||
Successor Company Three Months Ended June 30, 2011 | ||||||||||||||||||||||||
Balance at beginning of period | $ | 9,637 | $ | 3,010 | $ | 12,759 | $ | 204 | $ | — | $ | 25,610 | ||||||||||||
Provision for finance receivable losses (a) | 33,103 | 32,121 | 30,958 | 5,879 | — | 102,061 | ||||||||||||||||||
Charge-offs | (31,565 | ) | (30,127 | ) | (28,533 | ) | (8,728 | ) | — | (98,953 | ) | |||||||||||||
Recoveries | 2,334 | (14 | ) | 9,012 | 3,080 | — | 14,412 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 13,509 | $ | 4,990 | $ | 24,196 | $ | 435 | $ | — | $ | 43,130 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Predecessor Company Three Months Ended June 30, 2010 | ||||||||||||||||||||||||
Balance at beginning of period | $ | 573,832 | $ | 598,998 | $ | 294,413 | $ | 61,416 | $ | 3,826 | $ | 1,532,485 | ||||||||||||
Provision for finance receivable losses | 27,891 | 23,871 | (2,099 | ) | 4,916 | 375 | 54,954 | |||||||||||||||||
Charge-offs | (64,329 | ) | (29,222 | ) | (54,960 | ) | (22,792 | ) | (249 | ) | (171,552 | ) | ||||||||||||
Recoveries | 2,849 | 731 | 9,805 | 3,341 | (1 | ) | 16,725 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 540,243 | $ | 594,378 | $ | 247,159 | $ | 46,881 | $ | 3,951 | $ | 1,432,612 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(a) | Provision for finance receivable losses for the Successor Company includes $30.2 million of net charge-offs on credit impaired finance receivables, $53.4 million on non-credit impaired finance receivables, and $0.9 million for new origination activity and TDR activity during the three months ended June 30, 2011. As a result of charging off the non-credit impaired finance receivables, $20.4 million of valuation discount accretion was accelerated and is included as a component of finance charges within revenues. |
17
Table of Contents
(dollars in thousands) | Branch Real Estate | Centralized Real Estate | Branch Non- Real Estate | Branch Retail | All Other | Consolidated Total | ||||||||||||||||||
Successor Company Six Months Ended June 30, 2011 | ||||||||||||||||||||||||
Balance at beginning of period | $ | 2,465 | $ | 488 | $ | 4,111 | $ | 56 | $ | — | $ | 7,120 | ||||||||||||
Provision for finance receivable losses (a) | 52,206 | 59,570 | 52,253 | 11,170 | — | 175,199 | ||||||||||||||||||
Charge-offs | (50,256 | ) | (55,205 | ) | (50,888 | ) | (17,536 | ) | — | (173,885 | ) | |||||||||||||
Recoveries (b) | 9,094 | 137 | 18,720 | 6,745 | — | 34,696 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 13,509 | $ | 4,990 | $ | 24,196 | $ | 435 | $ | — | $ | 43,130 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Net finance receivables | $ | 6,016,368 | $ | 4,366,933 | $ | 2,572,018 | $ | 403,651 | $ | 117,414 | $ | 13,476,384 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Predecessor Company Six Months Ended June 30, 2010 | ||||||||||||||||||||||||
Balance at beginning of period | $ | 624,303 | $ | 536,440 | $ | 288,420 | $ | 63,621 | $ | 3,514 | $ | 1,516,298 | ||||||||||||
Provision for finance receivable losses | 33,603 | 127,547 | 55,369 | 22,439 | 617 | 239,575 | ||||||||||||||||||
Charge-offs | (131,891 | ) | (71,143 | ) | (119,584 | ) | (49,508 | ) | (185 | ) | (372,311 | ) | ||||||||||||
Recoveries | 5,359 | 1,534 | 19,379 | 6,586 | 5 | 32,863 | ||||||||||||||||||
Affiliates contributed by SLFI to SLFC (c) | 8,869 | — | 3,575 | 3,743 | — | 16,187 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 540,243 | $ | 594,378 | $ | 247,159 | $ | 46,881 | $ | 3,951 | $ | 1,432,612 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Net finance receivables | $ | 7,712,238 | $ | 6,249,614 | $ | 2,887,884 | $ | 733,201 | $ | 118,592 | $ | 17,701,529 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(a) | Provision for finance receivable losses for the Successor Company includes $67.5 million of net charge-offs on credit impaired finance receivables, $70.7 million on non-credit impaired finance receivables, and $1.0 million for new origination activity and TDR activity during the six months ended June 30, 2011. As a result of charging off the non-credit impaired finance receivables, $35.7 million of valuation discount accretion was accelerated and is included as a component of finance charges within revenues. |
(b) | Successor Company includes $5.0 million of recoveries ($2.9 million branch real estate loan recoveries, $1.9 million branch non-real estate loan recoveries, and $0.2 million branch retail sales finance recoveries) as a result of a settlement of claims relating to our February 2008 purchase of Equity One, Inc.’s consumer branch finance receivable portfolio. |
(c) | Effective January 1, 2010, SLFI contributed two of its wholly-owned subsidiaries to SLFC. The contribution included $16.2 million of allowance for finance receivable losses. |
Within our three main finance receivable types are sub-portfolios, each consisting of a large number of relatively small, homogenous accounts. We evaluate these sub-portfolios for impairment as groups. None of our accounts are large enough to warrant individual evaluation for impairment.
We estimate our allowance for finance receivable losses primarily using the authoritative guidance for contingencies. We base our allowance for finance receivable losses primarily on historical loss experience using migration analysis applied to sub-portfolios of large numbers of relatively small homogenous accounts. This technique is a historically-based statistical technique that attempts to predict the future amount of losses for existing pools of finance receivables. We adjust the amounts determined by migration for management’s estimate of the effects of model imprecision, any changes to the sub-portfolio’s underwriting criteria, portfolio seasoning, and current economic conditions, including the levels of unemployment and personal bankruptcies.
18
Table of Contents
We use our internal data of net charge-offs and delinquency by sub-portfolio as the basis to determine the historical loss experience component of our allowance for finance receivable losses. We use monthly bankruptcy statistics, monthly unemployment statistics, and various other monthly or periodic economic statistics published by departments of the U.S. government and other economic statistics providers to determine the economic component of our allowance for finance receivable losses.
The allowance for finance receivable losses related to our credit impaired finance receivables is calculated using updated cash flows expected to be collected, incorporating assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that are reflective of current market conditions. Probable decreases in expected finance receivable principal cash flows result in the recognition of impairment. Probable and significant increases (defined as a change in cash flows equal to 10 percent or more) in expected cash flows to be collected would first reverse any previously recorded allowance for finance receivable losses.
We also establish reserves for TDR finance receivables, which are included in our allowance for finance receivable losses. The allowance for finance receivable losses related to our TDRs is calculated in homogeneous aggregated pools of impaired finance receivables that have common risk characteristics. We establish our allowance for finance receivable losses related to our TDRs by calculating the present value (discounted at the loan’s effective interest rate prior to modification) of all expected cash flows less the recorded investment in the aggregated pool. We use certain assumptions to estimate the expected cash flows from our TDRs. The primary assumptions for our model are prepayment speeds, default rates, and severity rates.
19
Table of Contents
Note 6. Investment Securities
Cost/amortized cost, unrealized gains and losses, and fair value of investment securities by type, which are classified as available-for-sale, were as follows:
(dollars in thousands) | Cost/ Amortized Cost | Unrealized Gains | Unrealized Losses | Fair Value | Other- Than- Temporary Impairments in AOCI(L) (a) | |||||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||||||
Fixed maturity investment securities: | ||||||||||||||||||||
Bonds: | ||||||||||||||||||||
U.S. government and government sponsored entities | $ | 38,699 | $ | 198 | $ | (153) | $ | 38,744 | $ | — | ||||||||||
Obligations of states, municipalities, and political subdivisions | 209,636 | 1,589 | (600 | ) | 210,625 | — | ||||||||||||||
Corporate debt | 334,057 | 5,113 | (3,678 | ) | 335,492 | — | ||||||||||||||
Mortgage-backed, asset-backed, and collateralized: | ||||||||||||||||||||
RMBS | 115,471 | 2,408 | (15 | ) | 117,864 | — | ||||||||||||||
CMBS | 16,446 | 2,390 | (240 | ) | 18,596 | — | ||||||||||||||
CDO/ABS | 14,297 | 772 | (52 | ) | 15,017 | — | ||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | 728,606 | 12,470 | (4,738 | ) | 736,338 | — | ||||||||||||||
Preferred stocks | 4,959 | — | (212 | ) | 4,747 | — | ||||||||||||||
Other long-term investments (b) | 3,456 | 1,974 | (42 | ) | 5,388 | — | ||||||||||||||
Common stocks | 840 | — | (3 | ) | 837 | — | ||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 737,861 | $ | 14,444 | $ | (4,995 | ) | $ | 747,310 | $ | — | |||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Successor Company December 31, 2010 | ||||||||||||||||||||
Fixed maturity investment securities: | ||||||||||||||||||||
Bonds: | ||||||||||||||||||||
U.S. government and government sponsored entities | $ | 9,566 | $ | — | $ | (174 | ) | $ | 9,392 | $ | — | |||||||||
Obligations of states, municipalities, and political subdivisions | 226,023 | 201 | (2,257 | ) | 223,967 | — | ||||||||||||||
Corporate debt | 345,735 | 3,098 | (6,084 | ) | 342,749 | — | ||||||||||||||
Mortgage-backed, asset-backed, and collateralized: | ||||||||||||||||||||
RMBS | 129,411 | 201 | (1,486 | ) | 128,126 | — | ||||||||||||||
CMBS | 10,064 | 492 | (90 | ) | 10,466 | — | ||||||||||||||
CDO/ABS | 17,980 | 113 | (158 | ) | 17,935 | — | ||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | 738,779 | 4,105 | (10,249 | ) | 732,635 | — | ||||||||||||||
Preferred stocks | 4,959 | — | (206 | ) | 4,753 | — | ||||||||||||||
Other long-term investments (b) | 6,653 | — | (221 | ) | 6,432 | — | ||||||||||||||
Common stocks | 676 | 1 | — | 677 | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 751,067 | $ | 4,106 | $ | (10,676 | ) | $ | 744,497 | $ | — | |||||||||
|
|
|
|
|
|
|
|
|
|
(a) | In January 2011, we reclassified $0.1 million of previously recorded other-than-temporary impairments in accumulated other comprehensive loss to unrealized gains on investment securities in accumulated other comprehensive loss to reflect the proper classification of these investment securities. |
(b) | Excludes interest in a limited partnership that we account for using the equity method ($1.8 million at June 30, 2011 and $1.4 million at December 31, 2010). |
20
Table of Contents
Fair value and unrealized losses on investment securities by type and length of time in a continuous unrealized loss position were as follows:
(dollars in thousands) | 12 Months or Less | More Than 12 Months | Total | |||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||||||||||
Bonds: | ||||||||||||||||||||||||
U.S. government and government sponsored entities | $ | 3,505 | $ | (153 | ) | $ | — | $ | — | $ | 3,505 | $ | (153 | ) | ||||||||||
Obligations of states, municipalities, and political subdivisions | 65,014 | (600 | ) | — | — | 65,014 | (600 | ) | ||||||||||||||||
Corporate debt | 137,392 | (3,678 | ) | — | — | 137,392 | (3,678 | ) | ||||||||||||||||
RMBS | 6,276 | (15 | ) | — | — | 6,276 | (15 | ) | ||||||||||||||||
CMBS | 5,882 | (240 | ) | — | — | 5,882 | (240 | ) | ||||||||||||||||
CDO/ABS | 4,750 | (52 | ) | — | — | 4,750 | (52 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 222,819 | (4,738 | ) | — | — | 222,819 | (4,738 | ) | ||||||||||||||||
Preferred stocks | 4,747 | (212 | ) | — | — | 4,747 | (212 | ) | ||||||||||||||||
Other long-term investments | 1,329 | (42 | ) | — | — | 1,329 | (42 | ) | ||||||||||||||||
Common stocks | 116 | (3 | ) | — | — | 116 | (3 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 229,011 | $ | (4,995 | ) | $ | — | $ | — | $ | 229,011 | $ | (4,995 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Successor Company December 31, 2010 | ||||||||||||||||||||||||
Bonds: | ||||||||||||||||||||||||
U.S. government and government sponsored entities | $ | 9,392 | $ | (174 | ) | $ | — | $ | — | $ | 9,392 | $ | (174 | ) | ||||||||||
Obligations of states, municipalities, and political subdivisions | 207,378 | (2,257 | ) | — | — | 207,378 | (2,257 | ) | ||||||||||||||||
Corporate debt | 273,766 | (6,084 | ) | — | — | 273,766 | (6,084 | ) | ||||||||||||||||
RMBS | 111,384 | (1,486 | ) | — | — | 111,384 | (1,486 | ) | ||||||||||||||||
CMBS | 7,966 | (90 | ) | — | — | 7,966 | (90 | ) | ||||||||||||||||
CDO/ABS | 10,128 | (158 | ) | — | — | 10,128 | (158 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 620,014 | (10,249 | ) | — | — | 620,014 | (10,249 | ) | ||||||||||||||||
Preferred stocks | 4,753 | (206 | ) | — | — | 4,753 | (206 | ) | ||||||||||||||||
Other long-term investments | 6,403 | (221 | ) | — | — | 6,403 | (221 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 631,170 | $ | (10,676 | ) | $ | — | $ | — | $ | 631,170 | $ | (10,676 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Management reviews all securities in an unrealized loss position on a quarterly basis to determine the ability and intent to hold such securities to recovery, which could be maturity, if necessary, by performing an evaluation of expected cash flows. Management considers factors such as our investment strategy, liquidity requirements, overall business plans, and recovery periods for securities in previous periods of broad market declines. For fixed-maturity securities with significant declines, management performs extended fundamental credit analysis on a security-by-security basis, which includes consideration of credit enhancements, expected defaults on underlying collateral, review of relevant industry analyst reports and forecasts and other market available data.
21
Table of Contents
We did not recognize in earnings the unrealized losses on fixed-maturity securities at June 30, 2011, because management neither intends to sell the securities nor does it believe that it is more likely than not that it will be required to sell these securities before recovery of their amortized cost basis. Furthermore, management expects to recover the entire amortized cost basis of these securities (that is, they are not credit impaired).
As of June 30, 2011 and December 31, 2010, we had no investment securities which had been in an unrealized loss position of more than 50% for more than 12 months. As part of our credit evaluation procedures applied to investment securities, we consider the nature of both the specific securities and the general market conditions for those securities. Based on management’s analysis, we continue to believe that the expected cash flows from our investment securities will be sufficient to recover the amortized cost of our investment. We continue to monitor these positions for potential credit impairments.
At June 30, 2011, we had no unrealized losses on investment securities for which an other-than-temporary impairment was recognized. In January 2011, we reclassified $0.4 million in unrealized losses on investment securities, previously classified as other-than-temporarily impaired, to unrealized losses on all other investment securities to reflect the proper classification of these investment securities for which no other-than-temporary impairment was recognized.
We recognize credit losses into earnings on securities in an unrealized loss position for which we do not expect to recover the entire amortized cost basis. Non-credit losses are recognized in accumulated other comprehensive income or loss since we do not intend to sell these securities, and we believe it is more likely than not that we will not be required to sell any investment security before the recovery of its amortized cost basis.
Components of the other-than-temporary impairment charges on investment securities were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Total other-than-temporary impairment losses | $ | (298 | ) | $ | (171 | ) | $ | (2,227 | ) | $ | (1,977 | ) | ||||||||
Portion of loss recognized in accumulated other comprehensive loss | — | (1,620 | ) | — | (4,062 | ) | ||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Net impairment losses recognized in net (loss) income | $ | (298 | ) | $ | (1,791 | ) | $ | (2,227 | ) | $ | (6,039 | ) | ||||||||
|
|
|
|
|
|
|
|
22
Table of Contents
Changes in the cumulative amount of credit losses (recognized in earnings) on other-than-temporarily impaired investment securities were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
At or for the Three Months Ended June 30, 2011 | At or for the Three Months Ended June 30, 2010 | At or for the Six Months Ended June 30, 2011 | At or for the Six Months Ended June 30, 2010 | |||||||||||||||||
Balance at beginning of period* | $ | 1,929 | $ | 7,368 | $ | — | $ | 3,150 | ||||||||||||
Additions: | ||||||||||||||||||||
Due to other-than-temporary impairments: | ||||||||||||||||||||
Not previously impaired/impairment not previously recognized | 264 | — | 2,193 | 9 | ||||||||||||||||
Previously impaired/impairment previously recognized | 34 | 1,705 | 34 | 5,940 | ||||||||||||||||
Reductions: | ||||||||||||||||||||
Realized due to sales with no prior intention to sell | — | — | — | — | ||||||||||||||||
Realized due to intention to sell | — | — | — | — | ||||||||||||||||
Accretion of credit impaired securities | (39 | ) | (57 | ) | (39 | ) | (83 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 2,188 | $ | 9,016 | $ | 2,188 | $ | 9,016 | ||||||||||||
|
|
|
|
|
|
|
|
* | In January 2011, we reclassified $31,000 of the balance at the beginning of the six months ended June 30, 2011 period, which was previously recorded as accretion of credit impaired securities, to interest income on all other investment securities to reflect the proper classification of these investment securities for which no other-than-temporary impairment was recognized. |
The fair values of investment securities sold or redeemed and the resulting realized gains, realized losses, and net realized losses were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Fair value | $ | 8,575 | $ | 53,728 | $ | 35,904 | $ | 137,779 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Realized gains | $ | 91 | $ | — | $ | 169 | $ | 37 | ||||||||||||
Realized losses | (138 | ) | (68 | ) | (457 | ) | (133 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Net realized losses | $ | (47 | ) | $ | (68 | ) | $ | (288 | ) | $ | (96 | ) | ||||||||
|
|
|
|
|
|
|
|
Contractual maturities of fixed-maturity investment securities at June 30, 2011 were as follows:
(dollars in thousands) June 30, 2011 | Fair Value | Amortized Cost | ||||||
Fixed maturities, excluding mortgage-backed securities: | ||||||||
Due in 1 year or less | $ | 42,771 | $ | 42,690 | ||||
Due after 1 year through 5 years | 162,259 | 162,010 | ||||||
Due after 5 years through 10 years | 211,081 | 209,507 | ||||||
Due after 10 years | 168,750 | 168,185 | ||||||
Mortgage-backed securities | 151,477 | 146,214 | ||||||
|
|
|
| |||||
Total | $ | 736,338 | $ | 728,606 | ||||
|
|
|
|
23
Table of Contents
Actual maturities may differ from contractual maturities since borrowers may have the right to prepay obligations. The Company may sell investment securities before maturity to achieve corporate requirements and investment strategies.
Note 7. Restricted Cash
Restricted cash at June 30, 2011 and December 31, 2010 included funds to be used for future debt payments relating to our securitization transactions (see Note 4), escrow deposits, and funds related to our secured term loan. The decrease in restricted cash at June 30, 2011 when compared to December 31, 2010 was primarily due to reduced collateral requirements on our secured term loan, which was refinanced in May 2011.
Note 8. Related Party Transactions
AFFILIATE LENDING
Prior to the FCFI Transaction, SLFC made loans to AIG under demand note agreements as a short-term investment source for cash. Interest revenue on notes receivable from AIG for the three and six months ended June 30, 2010 totaled $2.3 million and $4.7 million, respectively.
In April 2010, Springleaf Financial Funding Company, a wholly owned subsidiary of SLFC, entered into and fully drew down a $3.0 billion, five-year term loan pursuant to a Credit Agreement among Springleaf Financial Funding Company, SLFC, and most of the consumer finance operating subsidiaries of SLFC (collectively, the Subsidiary Guarantors), and a syndicate of lenders, various agents, and Bank of America, N.A, as administrative agent. At December 31, 2010, affiliates of Fortress and affiliates of AIG were included in the syndicate of lenders.
In May 2011, the $3.0 billion term loan was refinanced to increase total borrowing to $3.75 billion with a new six-year term, significantly improved advance rates, and lower borrowing costs. Any portion of the term loan that is repaid (whether at or prior to maturity) will permanently reduce the principal amount outstanding and may not be reborrowed. At June 30, 2011, affiliates of Fortress and affiliates of AIG were included in the syndicate of lenders.
Notes receivable from SLFI totaled $538.0 million at June 30, 2011 and December 31, 2010, which included interest receivable of $1.4 million and $1.9 million, respectively. The interest rate for the unpaid principal balance is prime plus 100 basis points. Interest revenue on notes receivable from SLFI totaled $4.3 million and $8.6 million for the three and six months ended June 30, 2011, respectively. Interest revenue on notes receivable from SLFI totaled $5.5 million and $7.1 million for the three and six months ended June 30, 2010, respectively.
COST SHARING AGREEMENTS
Prior to the FCFI Transaction, we were party to cost sharing agreements, including tax sharing arrangements, with AIG. Generally, these agreements provided for the allocation of shared corporate costs based upon a proportional allocation of costs to all AIG subsidiaries. See Note 13 for further information on the tax sharing arrangements.
24
Table of Contents
We also reimburse AIG Federal Savings Bank (AIG Bank), a subsidiary of AIG, for costs associated with a remediation program related to a Supervisory Agreement among AIG Bank, Wilmington Finance, Inc. (WFI), SLFI, and the Office of Thrift Supervision dated June 7, 2007 (the Supervisory Agreement). As of June 30, 2011, we have made reimbursements of $61.9 million for payments made by AIG Bank to refund certain fees to customers pursuant to the terms of the Supervisory Agreement. At June 30, 2011, the remaining reserve, which reflects management’s best estimate of the expected costs of the remediation program, totaled $1.4 million.
REINSURANCE AGREEMENTS
Merit Life Insurance Co. (Merit), a wholly-owned subsidiary of SLFC, enters into reinsurance agreements with subsidiaries of AIG, for reinsurance of various group annuity, credit life, and credit accident and health insurance where Merit reinsures the risk of loss. The reserves for this business fluctuate over time and in some instances are subject to recapture by the insurer. Reserves on the books of Merit for reinsurance agreements with subsidiaries of AIG totaled $50.2 million at June 30, 2011 and $51.2 million at December 31, 2010.
DERIVATIVES
At June 30, 2011 and December 31, 2010, all of our derivative financial instruments were with AIG Financial Products Corp. (AIGFP), a subsidiary of AIG. See Note 11 for further information on our derivatives.
SUBSERVICING AND REFINANCE AGREEMENTS
Effective February 1, 2011, Nationstar began subservicing the centralized real estate loans of MorEquity and two other subsidiaries of SLFC (collectively, the Owners). In addition, Nationstar began subservicing certain real estate loans that MorEquity had been servicing in conjunction with the 2010 securitization of these real estate loans and began refinancing certain first lien mortgage loans. During the three and six months ended June 30, 2011, the Owners paid Nationstar $2.7 million and $4.9 million, respectively, in fees for its subservicing. During the three and six months ended June 30, 2011, the Owners paid Nationstar $2.2 million and $2.8 million, respectively, to facilitate the repayment of our centralized real estate loans through refinancings with other lenders.
Note 9. VIEs
CONSOLIDATED VIES
We use special purpose entities (securitization trusts) to issue asset-backed securities in securitization transactions to investors. We evaluated the securitization trusts, determined that these entities are VIEs of which we are the primary beneficiary, and therefore consolidated such entities. We are deemed to be the primary beneficiaries of these VIEs because we have power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses and the right to receive benefits that are potentially significant to the VIE. We have consent power over sales of defaulted real estate loans, which is a significant loss mitigation procedure, and, therefore, a significant control, and our retained subordinated and residual interest trust certificates expose us to potentially significant losses and potentially significant returns.
25
Table of Contents
The asset-backed securities are backed by the expected cash flows from securitized real estate loans. Payments from these real estate loans are not available to us until the repayment of the debt issued in connection with the securitization transactions has occurred. We recorded these transactions as “on-balance sheet” secured financings because the transfer of these real estate loans to the trusts did not qualify for sale accounting treatment. We retain interests in these securitization transactions, including senior and subordinated securities issued by the VIEs and residual interests. We retain credit risk in the securitizations because our retained interests include the most subordinated interest in the securitized assets, which are the first to absorb credit losses on the securitized assets. At June 30, 2011, these retained interests were primarily comprised of $1.4 billion, or 46%, of the assets transferred in connection with the on-balance sheet securitizations. We expect that any credit losses in the pools of securitized assets would likely be limited to our retained interests. We have no obligation to repurchase or replace qualified securitized assets that subsequently become delinquent or are otherwise in default. See Note 4 for further discussion regarding these securitization transactions.
The total consolidated VIE assets and liabilities associated with our securitization transactions were as follows:
(dollars in thousands) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
Assets: | ||||||||
Finance receivables | $ | 1,947,370 | $ | 2,057,074 | ||||
Allowance for finance receivable losses | 827 | 80 | ||||||
Restricted cash | 23,526 | 30,946 | ||||||
Liabilities | ||||||||
Long-term debt | $ | 1,136,608 | $ | 1,299,726 |
We had no off-balance sheet exposure associated with our variable interests in the consolidated VIEs. No additional support to these VIEs beyond what was previously contractually required has been provided by us. Consolidated interest expense related to these VIEs for the three and six months ended June 30, 2011 totaled $15.0 million and $30.4 million, respectively. Consolidated interest expense related to these VIEs for the three and six months ended June 30, 2010 totaled $37.6 million and $76.6 million, respectively.
UNCONSOLIDATED VIE
We have established a VIE, primarily related to a debt issuance, of which we are not the primary beneficiary, and in which we do not have a variable interest. Therefore, we do not consolidate such entity. We calculate our maximum exposure to loss primarily to be the amount of debt issued to or equity invested in a VIE. Our on-balance sheet maximum exposure to loss associated with this unconsolidated VIE was $171.5 million at June 30, 2011 and December 31, 2010. We had no off-balance sheet exposure to loss associated with this VIE at June 30, 2011 or December 31, 2010.
Note 10. Refinancing of Secured Term Loan
In May 2011, we refinanced our $3.0 billion secured term loan to increase total borrowing to $3.75 billion with a new six-year term, significantly improved advance rates, and lower borrowing costs. The unamortized balance of the fair value mark on the $3.0 billion secured term loan was $30.8 million. We accounted for $20.1 million of the $30.8 million as a modification, which would remain on the balance sheet and amortize over the new term. The remaining $10.7 million was recorded as a gain on the early extinguishment of the secured term loan for the three and six months ended June 30, 2011.
26
Table of Contents
Note 11. Derivative Financial Instruments
SLFC uses derivative financial instruments in managing the cost of its debt by mitigating its exposures (interest rate and currency) in conjunction with specific long-term debt issuances and has used them in managing its return on finance receivables held for sale, but is neither a dealer nor a trader in derivative financial instruments. SLFC’s derivative financial instruments consist of interest rate, cross currency, cross currency interest rate, and equity-indexed swap agreements.
While all of our interest rate, cross currency, cross currency interest rate, and equity-indexed swap agreements mitigate economic exposure of related debt, not all of these swap agreements currently qualify as cash flow or fair value hedges under U.S. GAAP. At June 30, 2011, equity-indexed debt and related swaps were immaterial.
In the first quarter of 2010, we re-examined our accounting for a second quarter 2009 de-designated trade and determined that our method for amortizing the debt basis adjustments related to hedge accounting for this second quarter 2009 de-designated trade contained two errors. The debt basis adjustment to be amortized incorrectly included an accounting adjustment on the hedged debt. Secondly, the amortization method did not take into account all cash flows on the debt when calculating the effective yield amortization. In addition, we did not record the foreign exchange translation on the unamortized debt basis. As a result of these errors, we recorded an out of period adjustment in the first quarter of 2010, which reduced other revenues by $8.2 million during the three months ended March 31, 2010. The impact of this error did not have a material effect on our financial condition or results of operations for previously reported periods.
Fair value of derivative instruments presented on a gross basis by type were as follows:
Successor Company | ||||||||||||||||||||||||
June 30, 2011 | December 31, 2010 | |||||||||||||||||||||||
Notional Amount | Derivative Assets | Derivative Liabilities | Notional Amount | Derivative Assets | Derivative Liabilities | |||||||||||||||||||
Hedging Instruments | ||||||||||||||||||||||||
Cross currency and cross currency interest rate | $ | 625,250 | $ | 71,052 | $ | — | $ | 1,226,250 | $ | 114,001 | $ | — | ||||||||||||
Interest rate | 850,000 | — | 21,237 | 850,000 | — | 40,057 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 1,475,250 | 71,052 | 21,237 | 2,076,250 | 114,001 | 40,057 | ||||||||||||||||||
Non-Designated Hedging Instruments | ||||||||||||||||||||||||
Cross currency and cross currency interest rate | 644,250 | 128,363 | — | 644,250 | 75,159 | — | ||||||||||||||||||
Equity-indexed | 6,886 | 1,735 | 54 | 6,886 | 1,720 | 213 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 651,136 | 130,098 | 54 | 651,136 | 76,879 | 213 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total derivative instruments* | $ | 2,126,386 | $ | 201,150 | $ | 21,291 | $ | 2,727,386 | $ | 190,880 | $ | 40,270 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
* | Master netting arrangements had no effect. |
27
Table of Contents
The amount of gain (loss) for cash flow hedges recognized in accumulated other comprehensive income or loss (effective portion), reclassified from accumulated other comprehensive income or loss into other revenues (effective portion), and recognized in other revenues (ineffective portion) were as follows:
(dollars in thousands) | Effective | Ineffective | ||||||||||
AOCI(L)* | From AOCI(L) to Revenues | Revenues | ||||||||||
Successor Company Three Months Ended June 30, 2011 | ||||||||||||
Interest rate | $ | (715 | ) | $ | (501 | ) | $ | (29 | ) | |||
Cross currency and cross currency interest rate | 29,998 | 28,331 | 371 | |||||||||
|
|
|
|
|
| |||||||
Total | $ | 29,283 | $ | 27,830 | $ | 342 | ||||||
|
|
|
|
|
| |||||||
Predecessor Company Three Months Ended June 30, 2010 | ||||||||||||
Interest rate | $ | 13,133 | $ | 278 | $ | (749 | ) | |||||
Cross currency and cross currency interest rate | 6,982 | (15,227 | ) | (20,006 | ) | |||||||
|
|
|
|
|
| |||||||
Total | $ | 20,115 | $ | (14,949 | ) | $ | (20,755 | ) | ||||
|
|
|
|
|
| |||||||
Successor Company Six Months Ended June 30, 2011 | ||||||||||||
Interest rate | $ | (2,880 | ) | $ | (977 | ) | $ | (2,553 | ) | |||
Cross currency and cross currency interest rate | 95,609 | 107,194 | 831 | |||||||||
|
|
|
|
|
| |||||||
Total | $ | 92,729 | $ | 106,217 | $ | (1,722 | ) | |||||
|
|
|
|
|
| |||||||
Predecessor Company Six Months Ended June 30, 2010 | ||||||||||||
Interest rate | $ | 20,539 | $ | 2,634 | $ | (1,575 | ) | |||||
Cross currency and cross currency interest rate | 41,230 | 57,081 | (26,404 | ) | ||||||||
|
|
|
|
|
| |||||||
Total | $ | 61,769 | $ | 59,715 | $ | (27,979 | ) | |||||
|
|
|
|
|
|
* | accumulated other comprehensive income (loss) |
We immediately recognize the portion of the gain or loss in the fair value of a derivative instrument in a cash flow hedge that represents hedge ineffectiveness in current period earnings in other revenues. We included all components of each derivative’s gain or loss in the assessment of hedge effectiveness.
At June 30, 2011, we expect $6.8 million of the deferred net loss on cash flow hedges to be reclassified from accumulated other comprehensive loss to earnings during the next twelve months.
For the six months ended June 30, 2011, there were no instances in which we reclassified amounts from accumulated other comprehensive income or loss to earnings as a result of a discontinuance of a cash flow hedge due to it becoming probable that the original forecasted transaction would not occur at the end of the originally specified time period.
28
Table of Contents
The amount recognized in other revenues for non-designated hedging instruments were as follows:
(dollars in thousands) | Non-Designated Hedging Instruments | |||
Successor Company Three Months Ended June 30, 2011 | ||||
Cross currency, cross currency interest rate, and interest rate | $ | 40,364 | ||
Equity-indexed | 81 | |||
|
| |||
Total | $ | 40,445 | ||
|
| |||
Predecessor Company Three Months Ended June 30, 2010 | ||||
Cross currency and cross currency interest rate | $ | (56,192 | ) | |
Equity-indexed | 78 | |||
|
| |||
Total | $ | (56,114 | ) | |
|
| |||
Successor Company Six Months Ended June 30, 2011 | ||||
Cross currency, cross currency interest rate, and interest rate | $ | 80,115 | ||
Equity-indexed | 161 | |||
|
| |||
Total | $ | 80,276 | ||
|
| |||
Predecessor Company Six Months Ended June 30, 2010 | ||||
Cross currency and cross currency interest rate | $ | (10,128 | ) | |
Equity-indexed | 160 | |||
|
| |||
Total | $ | (9,968 | ) | |
|
|
During the three months ended June 30, 2011, we recognized a mark to market gain of $20.8 million on our non-designated cross currency derivative. During the six months ended June 30, 2011, we recognized a mark to market gain of $40.3 million on our non-designated cross currency derivative. During the three months ended June 30, 2010, we recognized a mark to market loss of $61.4 million on our non-designated cross currency derivative. During the six months ended June 30, 2010, we recognized a mark to market loss of $95.7 million on our non-designated cross currency derivative, partially offset by gains of $68.8 million on the release of other comprehensive income related to cash flow hedge maturities. We included all components of each derivative’s gain or loss in the assessment of hedge effectiveness.
SLFC is exposed to credit risk if counterparties to swap agreements do not perform. SLFC regularly monitors counterparty credit ratings throughout the term of the agreements. SLFC’s exposure to market risk is limited to changes in the value of swap agreements offset by changes in the value of the hedged debt. In compliance with the authoritative guidance for fair value measurements, our valuation methodology for derivatives incorporates the effect of our non-performance risk and the non-performance risk of our counterparties.
29
Table of Contents
Credit valuation adjustment (losses) gains recorded in other revenues for our non-designated derivative and in accumulated other comprehensive income or loss for our cash flow hedges were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Credit valuation adjustment (losses) gains: | ||||||||||||||||||||
Non-designated derivative | $ | (96 | ) | $ | 3,791 | $ | (2,094 | ) | $ | 12,866 | ||||||||||
Cash flow hedges | $ | 660 | $ | 11,831 | $ | (2,897 | ) | $ | 29,047 |
If we do not exit these derivatives prior to maturity and no counterparty defaults occur, the credit valuation adjustment will result in no impact to earnings over the life of the agreements. We currently do not anticipate exiting these derivatives for the foreseeable future. These derivatives are with AIGFP, a subsidiary of AIG.
See Note 17 for information on how we determine fair value on our derivative financial instruments.
Note 12. Accumulated Other Comprehensive Income (Loss)
Components of accumulated other comprehensive income (loss) were as follows:
(dollars in thousands) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
Net unrealized gains (losses) on: | ||||||||
Investment securities | $ | 6,142 | $ | (4,272 | ) | |||
Swap agreements | (7,741 | ) | 1,027 | |||||
Foreign currency translation adjustments | 4,199 | 386 | ||||||
Retirement plan liabilities adjustment | 425 | 425 | ||||||
|
|
|
| |||||
Accumulated other comprehensive income (loss) | $ | 3,025 | $ | (2,434 | ) | |||
|
|
|
|
Note 13. Income Taxes
Benefit from income taxes decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 as a result of the FCFI Transaction and the resulting changes in the book and tax basis of our assets and liabilities and the benefit in 2010 from the release of the deferred tax valuation allowance. The Company was in a net deferred tax liability position at June 30, 2011, and based on the timing and reversal of the deferred tax liabilities, we have concluded that a valuation allowance was required on our United Kingdom operations of $0.7 million, but no valuation allowance was required on our remaining gross deferred tax assets.
Before the FCFI Transaction, the Company was in a net deferred tax asset position and, excluding the foreign operations, the assets were subject to a full valuation allowance.
30
Table of Contents
Benefit from income taxes for the three and six months ended June 30, 2010 reflected AIG’s projection that it would have sufficient taxable income in 2010 to utilize our 2010 estimated tax losses. As a result, we had classified $107.1 million of our 2010 losses as a current tax receivable. In connection with the closing of the FCFI Transaction on November 30, 2010, AIG and SLFI amended their tax sharing agreement, which terminated on the closing, (1) to provide that the parties’ payment obligations under the tax sharing agreement were limited to the payments required to be made by AIG to SLFI with respect to the 2009 taxable year, and (2) to include the terms of the promissory note to be issued by AIG in satisfaction of its 2009 taxable year payment obligation to SLFI. At December 31, 2010, SLFI’s note receivable from AIG relating to the 2009 taxable year totaled $470.2 million. On March 24, 2011, SLFI sold its $468.7 million note receivable from AIG at a net price after transaction fees of $469.8 million. Due to the amendment of the tax sharing agreement, SLFI did not receive the payment for the tax period ending November 30, 2010. As a result, we recorded a dividend to SLFI for the amount of the income tax receivable remaining at the closing of the FCFI Transaction.
Note 14. Supplemental Cash Flow Information
Supplemental disclosure of non-cash activities was as follows:
(dollars in thousands) | Successor Company | Predecessor Company | ||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||
Transfer of finance receivables held for sale to finance receivables held for investment | $ | — | $ | 655,565 | ||||||
Transfer of finance receivables to real estate owned | $ | 121,700 | $ | 136,142 |
Note 15. Segment Information
We have three business segments: branch, centralized real estate, and insurance. We report our segment information using the historical basis of accounting because management analyzes each business segment on a historical basis. We define our segments by types of financial service products we offer, nature of our production processes, and methods we use to distribute our products and to provide our services, as well as our management reporting structure.
In our branch business segment, we:
• | originate secured and unsecured non-real estate loans; |
• | originate real estate loans secured by first or second mortgages on residential real estate, which may be closed-end accounts or open-end home equity lines of credit and are generally considered non-conforming; |
• | purchase retail sales contracts and provide revolving retail sales financing services arising from the retail sale of consumer goods and services by retail merchants; and |
• | purchased private label finance receivables originated by AIG Bank under a participation agreement which we terminated on September 30, 2010. |
To supplement our lending and retail sales financing activities, we have historically purchased portfolios of real estate loans, non-real estate loans, and retail sales finance receivables originated by other lenders. We also offer credit and non-credit insurance and ancillary products to all eligible branch customers.
In our centralized real estate business segment, we originated or acquired, as well as serviced, a portfolio of residential real estate loans unrelated to our branch business.
31
Table of Contents
Effective February 1, 2011, Nationstar began subservicing the centralized real estate loans of MorEquity and two other subsidiaries of SLFC. In addition, Nationstar began subservicing certain real estate loans that MorEquity had been servicing in conjunction with the 2010 securitization of these real estate loans.
In our insurance business segment, we write and reinsure credit life, credit accident and health, credit-related property and casualty, and credit involuntary unemployment insurance covering our customers and the property pledged as collateral through products that the branch business segment offers to its customers. We also offer non-credit insurance products.
The following table presents information about our segments as well as reconciliations to our condensed consolidated financial statement amounts.
(dollars in thousands) | Branch Segment | Centralized Real Estate Segment | Insurance Segment | All Other | Adjustments | Push-down Accounting Adjustments | Consolidated Total | |||||||||||||||||||||
Successor Company Three Months Ended June 30, 2011 | ||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||
External: | ||||||||||||||||||||||||||||
Finance charges | $ | 319,400 | $ | 81,353 | $ | — | $ | 180 | $ | — | $ | 79,895 | $ | 480,828 | ||||||||||||||
Insurance | 81 | — | 29,803 | 31 | — | (106 | ) | 29,809 | ||||||||||||||||||||
Other | 1,525 | (9,829 | ) | 13,295 | 963 | (9 | ) | 28,868 | 34,813 | |||||||||||||||||||
Intercompany | 16,012 | — | (11,867 | ) | (4,145 | ) | — | — | — | |||||||||||||||||||
Pretax income (loss) | 244,751 | (235,143 | ) | 22,518 | (58,874 | ) | 6,231 | (78,858 | ) | (99,375 | ) | |||||||||||||||||
Predecessor Company Three Months Ended June 30, 2010 | ||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||
External: | ||||||||||||||||||||||||||||
Finance charges | $ | 360,653 | $ | 91,984 | $ | — | $ | (763 | ) | $ | — | $ | — | $ | 451,874 | |||||||||||||
Insurance | 100 | — | 31,148 | 113 | — | — | 31,361 | |||||||||||||||||||||
Other | (3,037 | ) | 10,983 | 14,760 | 3,561 | (3,037 | ) | — | 23,230 | |||||||||||||||||||
Intercompany | 16,541 | 198 | (12,391 | ) | (4,348 | ) | — | — | — | |||||||||||||||||||
Pretax income (loss) | 30,843 | (17,069 | ) | 16,659 | (39,135 | ) | (1,087 | ) | — | (9,789 | ) | |||||||||||||||||
Successor Company Six Months Ended June 30, 2011 | ||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||
External: | ||||||||||||||||||||||||||||
Finance charges | $ | 645,207 | $ | 170,701 | $ | — | $ | 192 | $ | — | $ | 152,364 | $ | 968,464 | ||||||||||||||
Insurance | 167 | — | 58,309 | 49 | — | (230 | ) | 58,295 | ||||||||||||||||||||
Other | 3,150 | (12,770 | ) | 25,959 | (18,579 | ) | (2,360 | ) | 40,138 | 35,538 | ||||||||||||||||||
Intercompany | 32,065 | (437 | ) | (23,221 | ) | (8,407 | ) | — | — | — | ||||||||||||||||||
Pretax income (loss) | 75,543 | (66,739 | ) | 34,186 | (127,873 | ) | 4,709 | (106,525 | ) | (186,699 | ) | |||||||||||||||||
Predecessor Company Six Months Ended June 30, 2010 | ||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||
External: | ||||||||||||||||||||||||||||
Finance charges | $ | 735,694 | $ | 186,829 | $ | — | $ | (1,663 | ) | $ | — | $ | — | $ | 920,860 | |||||||||||||
Insurance | 206 | — | 62,582 | 93 | — | — | 62,881 | |||||||||||||||||||||
Other | (1,532 | ) | 22,064 | 28,367 | 81,096 | (8,246 | ) | — | 121,749 | |||||||||||||||||||
Intercompany | 32,819 | 594 | (24,915 | ) | (8,498 | ) | — | — | — | |||||||||||||||||||
Pretax income (loss) | 37,984 | (105,680 | ) | 28,065 | (7,904 | ) | (877 | ) | — | (48,412 | ) |
32
Table of Contents
The “All Other” column includes:
• | corporate revenues and expenses such as management and administrative revenues and expenses and derivatives adjustments and foreign exchange gain or loss on foreign currency denominated debt that are not considered pertinent in determining segment performance; and |
• | revenues from our foreign subsidiary, Ocean Finance and Mortgages Limited (Ocean). |
The “Adjustments” column includes:
• | realized gains (losses) on investment securities and commercial mortgage loans; |
• | interest expense related to re-allocations of debt among business segments; and |
• | provision for finance receivable losses due to redistribution of amounts provided for the allowance for finance receivable losses. |
The push down accounting adjustments include the accretion or amortization of the valuation adjustments on the applicable revalued assets and liabilities resulting from the FCFI Transaction.
Note 16. Benefit Plans
Between the closing of the FCFI Transaction and January 1, 2011, we continued to participate in various benefit plans sponsored by AIG in accordance with the terms of the FCFI Transaction. These plans included a noncontributory qualified defined benefit retirement plan, post retirement health and welfare and life insurance plans, various stock option, incentive and purchase plans, and a 401(k) plan.
On January 1, 2011, we established a defined benefit retirement plan (the Retirement Plan) in which most of our employees are eligible to participate. The Retirement Plan is based on substantially the same terms as the AIG plan it replaced. The Company’s employees in Puerto Rico and the U.S. Virgin Islands participate in a defined benefit pension plan sponsored by CommoLoCo, Inc., our Puerto Rican subsidiary. The disclosures related to this plan are immaterial to the financial statements of the Company.
The following table presents the components of net periodic benefit cost with respect to our defined benefit pension plans and other postretirement benefit plans:
(dollars in thousands) | Pension | Postretirement | ||||||
Successor Company Three Months Ended June 30, 2011 | ||||||||
Components of net periodic benefit cost: | ||||||||
Service cost | $ | 3,400 | $ | 66 | ||||
Interest cost | 4,504 | 72 | ||||||
Expected return on assets | (4,239 | ) | — | |||||
|
|
|
| |||||
Net periodic benefit cost | $ | 3,665 | $ | 138 | ||||
|
|
|
| |||||
Successor Company Six Months Ended June 30, 2011 | ||||||||
Components of net periodic benefit cost: | ||||||||
Service cost | $ | 6,801 | $ | 131 | ||||
Interest cost | 9,008 | 144 | ||||||
Expected return on assets | (8,478 | ) | — | |||||
|
|
|
| |||||
Net periodic benefit cost | $ | 7,331 | $ | 275 | ||||
|
|
|
|
33
Table of Contents
For the three and six months ended June 30, 2011, the Company contributed $0.1 million and $4.2 million, respectively, to its pension plans and expects to contribute an additional $0.2 million for the remainder of 2011. These estimates are subject to change, since contribution decisions are affected by various factors including our liquidity, asset dispositions, market performance, and management’s discretion.
Note 17. Fair Value Measurements
The fair value of a financial instrument is the amount that would be received if an asset were to be sold or the amount that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments traded in other-than-active markets or that do not have quoted prices have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. An other-than-active market is one in which there are few transactions, the prices are not current, price quotations vary substantially either over time or among market makers, or little information is released publicly for the asset or liability being valued. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is listed on an exchange or traded over-the-counter or is new to the market and not yet established, the characteristics specific to the transaction, and general market conditions.
Management is responsible for the determination of the value of the financial assets and financial liabilities carried at fair value and the supporting methodologies and assumptions. Third-party valuation service providers are employed to gather, analyze, and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments. When the valuation service providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting brokers who are knowledgeable about these securities to provide a quote, which is generally non-binding, or by employing widely accepted internal valuation models.
Valuation service providers typically obtain data about market transactions and other key valuation model inputs from multiple sources and, through the use of widely accepted internal valuation models, provide a single fair value measurement for individual securities for which a fair value has been requested. The inputs used by the valuation service providers include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, currency rates, and other market-observable information as of the measurement date as well as the specific attributes of the security being valued, including its term, interest rate, credit rating, industry sector, and other issue or issuer-specific information. When market transactions or other market observable data is limited, the extent to which judgment is applied in determining fair value is greatly increased. We assess the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, we may validate the reasonableness of fair values by comparing information obtained from the valuation service providers to other third-party valuation sources for selected securities. We also validate prices for selected securities obtained from brokers through reviews by members of management who have relevant expertise and who are independent of those charged with executing investing transactions.
On November 30, 2010, FCFI indirectly acquired an 80% economic interest in SLFI from ACC. AIG, through ACC, retained a 20% economic interest in SLFI. Because of the nature of the FCFI Transaction, the significance of the ownership interest acquired, and at the direction of our acquirer, we applied push-down accounting to SLFI and SLFC as the acquired businesses. We revalued our assets and liabilities based on their fair values at the date of the FCFI Transaction in accordance with business combination accounting standards.
34
Table of Contents
FAIR VALUE HIERARCHY
We measure and classify assets and liabilities recorded at fair value in the consolidated balance sheets in a hierarchy for disclosure purposes consisting of three “Levels” based on the observability of inputs available in the market place used to measure the fair values. In general, we determine the fair value measurements classified as Level 1 based on inputs utilizing quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. We generally obtain market price data from exchange or dealer markets. We do not adjust the quoted price for such instruments.
We determine the fair value measurements classified as Level 2 based on inputs utilizing other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.
In certain cases, the inputs we use to measure the fair value of an asset may fall into different levels of the fair value hierarchy. In such cases, we determine the level in the fair value hierarchy within which the fair value measurement in its entirety falls based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Fair Value Measurements – Recurring Basis
The following table presents information about our assets and liabilities measured at fair value on a recurring basis and indicates the fair value hierarchy based on the levels of inputs we utilized to determine such fair value:
35
Table of Contents
(dollars in thousands) | Fair Value Measurements Using | Total Carried At Fair Value | ||||||||||||||
Level 1 | Level 2 | Level 3 | ||||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Assets | ||||||||||||||||
Investment securities: | ||||||||||||||||
Bonds: | ||||||||||||||||
U.S. government and government sponsored entities | $ | — | $ | 38,744 | $ | — | $ | 38,744 | ||||||||
Obligations of states, municipalities, and political subdivisions | — | 210,625 | — | 210,625 | ||||||||||||
Corporate debt | — | 332,748 | 2,744 | 335,492 | ||||||||||||
RMBS | — | 116,575 | 1,289 | 117,864 | ||||||||||||
CMBS | — | 9,964 | 8,632 | 18,596 | ||||||||||||
CDO/ABS | — | 4,598 | 10,419 | 15,017 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | — | 713,254 | 23,084 | 736,338 | ||||||||||||
Preferred stocks | — | 4,747 | — | 4,747 | ||||||||||||
Other long-term investments (a) | — | — | 5,388 | 5,388 | ||||||||||||
Common stocks (b) | 115 | — | 3 | 118 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | 115 | 718,001 | 28,475 | 746,591 | ||||||||||||
Cash and cash equivalents in mutual funds | 77,166 | — | — | 77,166 | ||||||||||||
Derivatives: | ||||||||||||||||
Cross currency and cross currency interest rate | — | 199,415 | — | 199,415 | ||||||||||||
Equity-indexed | — | — | 1,735 | 1,735 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | — | 199,415 | 1,735 | 201,150 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 77,281 | $ | 917,416 | $ | 30,210 | $ | 1,024,907 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Liabilities | ||||||||||||||||
Derivatives: | ||||||||||||||||
Cross currency and cross currency interest rate | $ | — | $ | 21,237 | $ | — | $ | 21,237 | ||||||||
Equity-indexed | — | 54 | — | 54 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | — | $ | 21,291 | $ | — | $ | 21,291 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Assets | ||||||||||||||||
Investment securities: | ||||||||||||||||
Bonds: | ||||||||||||||||
U.S. government and government sponsored entities | $ | — | $ | 9,392 | $ | — | $ | 9,392 | ||||||||
Obligations of states, municipalities, and political subdivisions | — | 223,967 | — | 223,967 | ||||||||||||
Corporate debt | — | 339,638 | 3,110 | 342,748 | ||||||||||||
RMBS | — | 127,067 | 1,059 | 128,126 | ||||||||||||
CMBS | — | 1,096 | 9,370 | 10,466 | ||||||||||||
CDO/ABS | — | 7,636 | 10,298 | 17,934 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | — | 708,796 | 23,837 | 732,633 | ||||||||||||
Preferred stocks | — | 4,753 | — | 4,753 | ||||||||||||
Other long-term investments (a) | — | — | 6,432 | 6,432 | ||||||||||||
Common stocks (b) | 117 | — | 5 | 122 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | 117 | 713,549 | 30,274 | 743,940 | ||||||||||||
Cash and cash equivalents in mutual funds | 88,703 | — | — | 88,703 | ||||||||||||
Short-term investments | — | 10 | — | 10 | ||||||||||||
Derivatives: | ||||||||||||||||
Cross currency and cross currency interest rate | — | 189,160 | — | 189,160 | ||||||||||||
Equity-indexed | — | — | 1,720 | 1,720 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | — | 189,160 | 1,720 | 190,880 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 88,820 | $ | 902,719 | $ | 31,994 | $ | 1,023,533 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Liabilities | ||||||||||||||||
Derivatives: | ||||||||||||||||
Cross currency and cross currency interest rate | $ | — | $ | 40,057 | $ | — | $ | 40,057 | ||||||||
Equity-indexed | — | 213 | — | 213 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | — | $ | 40,270 | $ | — | $ | 40,270 | ||||||||
|
|
|
|
|
|
|
|
(a) | Other long-term investments excluded our interest in a limited partnership of $1.8 million at June 30, 2011 and $1.4 million December 31, 2010 that we account for using the equity method. |
(b) | Common stocks excluded stocks not carried at fair value of $0.7 million at June 30, 2011 and $0.6 million at December 31, 2010. |
36
Table of Contents
We had no transfers between Level 1 and Level 2 during the three or six months ended June 30, 2011.
The following table presents changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended June 30, 2011:
(dollars in thousands) | Net (losses) gains included in: | |||||||||||||||||||||||||||
Balance at beginning of period | Other revenues | Other comprehensive income | Purchases, sales, issuances, settlements (b) | Transfers into Level 3 | Transfers out of Level 3 | Balance at end of period | ||||||||||||||||||||||
Successor Company Three Months Ended June 30, 2011 | ||||||||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||||||
Bonds: | ||||||||||||||||||||||||||||
Corporate debt | $ | 2,800 | $ | (9 | ) | $ | (47 | ) | $ | — | $ | — | $ | — | $ | 2,744 | ||||||||||||
RMBS | 1,342 | (2 | ) | — | (51 | ) | — | — | 1,289 | |||||||||||||||||||
CMBS | 9,179 | (23 | ) | (136 | ) | (388 | ) | — | — | 8,632 | ||||||||||||||||||
CDO/ABS | 10,692 | (228 | ) | 84 | (129 | ) | — | — | 10,419 | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total | 24,013 | (262 | ) | (99 | ) | (568 | ) | — | — | $ | 23,084 | |||||||||||||||||
Other long-term investments (a) | 7,488 | — | (1,199 | ) | (901 | ) | — | — | 5,388 | |||||||||||||||||||
Common stocks | 3 | — | — | — | — | — | 3 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total investment securities | 31,504 | (262 | ) | (1,298 | ) | (1,469 | ) | — | — | 28,475 | ||||||||||||||||||
Derivatives | 1,731 | (2 | ) | — | 6 | — | — | 1,735 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total assets | $ | 33,235 | $ | (264 | ) | $ | (1,298 | ) | $ | (1,463 | ) | $ | — | $ | — | $ | 30,210 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) | Other long-term investments excluded our interest in a limited partnership of $1.8 million at June 30, 2011 that we account for using the equity method. |
(b) | The detail of purchases, sales, issuances, and settlements for the three months ended June 30, 2011 is presented in the table below. |
The following table presents the detail of purchases, sales, issuances, and settlements of Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended June 30, 2011:
(dollars in thousands) | Purchases | Sales | Issuances | Settlements | Total | |||||||||||||||
Successor Company Three Months Ended June 30, 2011 | ||||||||||||||||||||
Investment securities: | ||||||||||||||||||||
Bonds: | ||||||||||||||||||||
RMBS | $ | — | $ | — | $ | — | $ | (51 | ) | $ | (51 | ) | ||||||||
CMBS | — | — | — | (388 | ) | (388 | ) | |||||||||||||
CDO/ABS | — | — | — | (129 | ) | (129 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | — | — | — | (568 | ) | (568 | ) | |||||||||||||
Other long-term investments | — | — | — | (901 | ) | (901 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total investment securities | — | — | — | (1,469 | ) | (1,469 | ) | |||||||||||||
Derivatives | — | — | — | 6 | 6 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total assets | $ | — | $ | — | $ | — | $ | (1,463 | ) | $ | (1,463 | ) | ||||||||
|
|
|
|
|
|
|
|
|
|
37
Table of Contents
The following table presents changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended June 30, 2010:
(dollars in thousands) | Net (losses) gains included in: | |||||||||||||||||||||||
Balance at beginning of period | Other revenues | Other comprehensive income | Purchases sales, issuances, settlements | Transfers in (out) of Level 3 | Balance at end of period | |||||||||||||||||||
Predecessor Company Three Months Ended June 30, 2010 | ||||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||
Bonds: | ||||||||||||||||||||||||
Corporate debt | $ | 36,938 | $ | — | $ | 1,022 | $ | (92 | ) | $ | (10,325 | ) | $ | 27,543 | ||||||||||
RMBS | 547 | 1 | 25 | — | — | 573 | ||||||||||||||||||
CMBS | 12,119 | (1,676 | ) | 1,694 | (250 | ) | — | 11,887 | ||||||||||||||||
CDO/ABS | 11,240 | (1 | ) | (170 | ) | (337 | ) | 1,941 | 12,673 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 60,844 | (1,676 | ) | 2,571 | (679 | ) | (8,384 | ) | 52,676 | |||||||||||||||
Other long-term investments* | 7,119 | 672 | 129 | (833 | ) | — | 7,087 | |||||||||||||||||
Common stocks | 261 | — | — | 301 | (556 | ) | 6 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total investment securities | 68,224 | (1,004 | ) | 2,700 | (1,211 | ) | (8,940 | ) | 59,769 | |||||||||||||||
Derivatives | 1,860 | (26 | ) | — | 5 | — | 1,839 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total assets | $ | 70,084 | $ | (1,030 | ) | $ | 2,700 | $ | (1,206 | ) | $ | (8,940 | ) | $ | 61,608 | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
* | Other long-term investments excluded our interest in a limited partnership of $1.3 million at June 30, 2010 that we account for using the equity method. |
During the three months ended June 30, 2010, we transferred into Level 3 approximately $1.9 million of assets, consisting of certain CDO/ABS. Transfers into Level 3 for investments in CDO/ABS are primarily due to a decrease in market transparency and downward credit migration of these securities.
During the three months ended June 30, 2010, we transferred approximately $10.9 million of assets out of Level 3, consisting of certain private placement corporate debt and common stock. Transfers out of Level 3 for private placement corporate debt and common stock are primarily the result of using observable pricing information or a third party pricing quote that appropriately reflects the fair value of those securities, without the need for adjustment based on our own assumptions regarding the characteristics of a specific security or the current liquidity in the market.
38
Table of Contents
The following table presents changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the six months ended June 30, 2011:
(dollars in thousands) | Net (losses) gains included in: | |||||||||||||||||||||||||||
Balance at beginning of period | Other revenues | Other comprehensive income | Purchases, sales, issuances, settlements (b) | Transfers into Level 3 | Transfers out of Level 3 | Balance at end of period | ||||||||||||||||||||||
Successor Company Six Months Ended June 30, 2011 | ||||||||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||||||
Bonds: | ||||||||||||||||||||||||||||
Corporate debt | $ | 3,110 | $ | (19 | ) | $ | (247 | ) | $ | (100 | ) | $ | — | $ | — | $ | 2,744 | |||||||||||
RMBS | 1,059 | (546 | ) | 887 | (111 | ) | — | — | 1,289 | |||||||||||||||||||
CMBS | 9,370 | (35 | ) | (53 | ) | (650 | ) | — | — | 8,632 | ||||||||||||||||||
CDO/ABS | 10,298 | (200 | ) | 583 | (262 | ) | — | — | 10,419 | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total | 23,837 | (800 | ) | 1,170 | (1,123 | ) | — | — | $ | 23,084 | ||||||||||||||||||
Other long-term investments (a) | 6,432 | — | 2,154 | (3,198 | ) | — | — | 5,388 | ||||||||||||||||||||
Common stocks | 5 | — | (2 | ) | — | — | — | 3 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total investment securities | 30,274 | (800 | ) | 3,322 | (4,321 | ) | — | — | 28,475 | |||||||||||||||||||
Derivatives | 1,720 | 3 | — | 12 | — | — | 1,735 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total assets | $ | 31,994 | $ | (797 | ) | $ | 3,322 | $ | (4,309 | ) | $ | — | $ | — | $ | 30,210 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) | Other long-term investments excluded our interest in a limited partnership of $1.8 million at June 30, 2011 that we account for using the equity method. |
(b) | The detail of purchases, sales, issuances, and settlements for the six months ended June 30, 2011 is presented in the table below. |
The following table presents the detail of purchases, sales, issuances, and settlements of Level 3 assets and liabilities measured at fair value on a recurring basis for the six months ended June 30, 2011:
(dollars in thousands) | Purchases | Sales | Issuances | Settlements | Total | |||||||||||||||
Successor Company Six Months Ended June 30, 2011 | ||||||||||||||||||||
Investment securities: | ||||||||||||||||||||
Bonds: | ||||||||||||||||||||
Corporate debt | $ | — | $ | — | $ | — | $ | (100 | ) | $ | (100 | ) | ||||||||
RMBS | — | — | — | (111 | ) | (111 | ) | |||||||||||||
CMBS | — | — | — | (650 | ) | (650 | ) | |||||||||||||
CDO/ABS | — | — | — | (262 | ) | (262 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | — | — | — | (1,123 | ) | (1,123 | ) | |||||||||||||
Other long-term investments | — | (2,297 | ) | — | (901 | ) | (3,198 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total investment securities | — | (2,297 | ) | — | (2,024 | ) | (4,321 | ) | ||||||||||||
Derivatives | — | — | — | 12 | 12 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total assets | $ | — | $ | (2,297 | ) | $ | — | $ | (2,012 | ) | $ | (4,309 | ) | |||||||
|
|
|
|
|
|
|
|
|
|
39
Table of Contents
The following table presents changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the six months ended June 30, 2010:
(dollars in thousands) | Net (losses) gains included in: | |||||||||||||||||||||||
Balance at beginning of period | Other revenues | Other comprehensive income | Purchases sales, issuances, settlements | Transfers in (out) of Level 3 | Balance at end of period | |||||||||||||||||||
Predecessor Company Six Months Ended June 30, 2010 | ||||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||
Bonds: | ||||||||||||||||||||||||
Corporate debt | $ | 49,978 | $ | — | $ | 1,927 | $ | (3,571 | ) | $ | (20,791 | ) | $ | 27,543 | ||||||||||
RMBS | 449 | 2 | 122 | — | — | 573 | ||||||||||||||||||
CMBS | 7,841 | (4,745 | ) | 4,985 | (331 | ) | 4,137 | 11,887 | ||||||||||||||||
CDO/ABS | 11,381 | (3 | ) | 532 | (1,178 | ) | 1,941 | 12,673 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 69,649 | (4,746 | ) | 7,566 | (5,080 | ) | (14,713 | ) | 52,676 | |||||||||||||||
Other long-term investments* | 7,758 | (139 | ) | 533 | (1,065 | ) | — | 7,087 | ||||||||||||||||
Common stocks | 261 | (2 | ) | 2 | 301 | (556 | ) | 6 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total investment securities | 77,668 | (4,887 | ) | 8,101 | (5,844 | ) | (15,269 | ) | 59,769 | |||||||||||||||
Derivatives | 1,645 | 184 | — | 10 | — | 1,839 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total assets | $ | 79,313 | $ | (4,703 | ) | $ | 8,101 | $ | (5,834 | ) | $ | (15,269 | ) | $ | 61,608 | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
* | Other long-term investments excluded our interest in a limited partnership of $1.3 million at June 30, 2010 that we account for using the equity method. |
During the six months ended June 30, 2010, we transferred into Level 3 approximately $6.1 million of assets, consisting of certain CMBS and CDO/ABS. Transfers into Level 3 for investments in CMBS and CDO/ABS are primarily due to a decrease in market transparency and downward credit migration of these securities.
During the six months ended June 30, 2010, we transferred approximately $21.3 million of assets out of Level 3, consisting of certain private placement corporate debt and common stock. Transfers out of Level 3 for private placement corporate debt and common stock are primarily the result of using observable pricing information or a third party pricing quote that appropriately reflects the fair value of those securities, without the need for adjustment based on our own assumptions regarding the characteristics of a specific security or the current liquidity in the market.
There were no unrealized gains or losses recognized in earnings on instruments held at June 30, 2011 or 2010.
We used observable and/or unobservable inputs to determine the fair value of positions that we have classified within the Level 3 category. As a result, the unrealized gains and losses for assets and liabilities within the Level 3 category presented in the Level 3 tables above may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.
Fair Value Measurements – Non-recurring Basis
We measure the fair value of certain assets on a non-recurring basis when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.
40
Table of Contents
Impairment charges recorded on assets measured at fair value on a non-recurring basis were as follows:
(dollars in thousands) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Real estate owned | $ | 13,673 | $ | 9,873 | $ | 22,580 | $ | 17,605 |
Assets measured at fair value on a non-recurring basis on which we recorded impairment charges were as follows:
(dollars in thousands) | Fair Value Measurements Using | |||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Real estate owned | $ | — | $ | — | $ | 190,863 | $ | 190,863 | ||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Real estate owned | $ | — | $ | — | $ | 210,473 | $ | 210,473 |
In accordance with the authoritative guidance for the accounting for the impairment of long-lived assets, we wrote down certain real estate owned reported in our branch and centralized real estate business segments to their fair value for the three and six months ended June 30, 2011 and 2010 and recorded the writedowns in other revenues. The fair values disclosed in the table above are unadjusted for transaction costs as required by the authoritative guidance for fair value measurements. The amounts recorded on the balance sheet are net of transaction costs as required by the authoritative guidance for accounting for the impairment of long-lived assets.
41
Table of Contents
Financial Instruments Not Measured at Fair Value
In accordance with the amended authoritative guidance for the fair value disclosures of financial instruments, we present the carrying values and estimated fair values of certain of our financial instruments below. Readers should exercise care in drawing conclusions based on fair value, since the fair values presented below can be misinterpreted since they were estimated at a particular point in time and do not include the value associated with all of our assets and liabilities.
(dollars in thousands) | Successor Company | |||||||||||||||
June 30, 2011 | December 31, 2010 | |||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||
Assets | ||||||||||||||||
Net finance receivables, less allowance for finance receivable losses | $ | 13,433,254 | $ | 13,523,204 | $ | 14,164,478 | $ | 13,976,987 | ||||||||
Cash and cash equivalents (excluding cash and cash equivalents in mutual funds and short-term investments) | 1,592,385 | 1,592,385 | 1,292,821 | 1,292,821 | ||||||||||||
Liabilities | ||||||||||||||||
Long-term debt | 14,527,141 | 15,270,647 | 14,940,989 | 15,045,128 | ||||||||||||
Off-balance sheet financial instruments | ||||||||||||||||
Unused customer credit limits | — | — | — | — |
FAIR VALUE MEASUREMENTS –
VALUATION METHODOLOGIES AND ASSUMPTIONS
We used the following methods and assumptions to estimate fair value.
Finance Receivables
The fair value of net finance receivables, less allowance for finance receivable losses, both non-impaired and credit impaired, were determined using discounted cash flow methodologies. The application of these methodologies required us to make certain judgments and estimates based on our perception of market participant views related to the economic and competitive environment, the characteristics of our finance receivables, and other similar factors. The most significant judgments and estimates made relate to prepayment speeds, default rates, loss severity, and discount rates. The degree of judgment and estimation applied was significant in light of the current capital markets and, more broadly, economic environments. Therefore, the fair value of our finance receivables could not be determined with precision and may not be realized in an actual sale. Additionally, there may be inherent weaknesses in the valuation methodologies we employed, and changes in the underlying assumptions used could significantly affect the results of current or future values.
Real Estate Owned
We initially based our estimate of the fair value on third-party appraisals at the time we took title to real estate owned. Subsequent changes in fair value are based upon management’s judgment of national and local economic conditions to estimate a price that would be received in a then current transaction to sell the asset.
42
Table of Contents
Investment Securities
To measure the fair value of investment securities (which consist primarily of bonds), we maximized the use of observable inputs and minimized the use of unobservable inputs. Whenever available, we obtained quoted prices in active markets for identical assets at the balance sheet date to measure investment securities at fair value. We generally obtained market price data from exchange or dealer markets.
We estimated the fair value of fixed maturity investment securities not traded in active markets by referring to traded securities with similar attributes, using dealer quotations and a matrix pricing methodology, or discounted cash flow analyses. This methodology considers such factors as the issuer’s industry, the security’s rating and tenor, its coupon rate, its position in the capital structure of the issuer, yield curves, credit curves, prepayment rates and other relevant factors. For fixed maturity investment securities that are not traded in active markets or that are subject to transfer restrictions, we adjusted the valuations to reflect illiquidity and/or non-transferability. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
We initially estimated the fair value of equity instruments not traded in active markets by reference to the transaction price. We adjusted this valuation only when changes to inputs and assumptions were corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations, and other transactions across the capital structure, offerings in the equity capital markets, and changes in financial ratios or cash flows. For equity securities that are not traded in active markets or that are subject to transfer restrictions, we adjusted the valuations to reflect illiquidity and/or non-transferability. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
Cash and Cash Equivalents
We estimated the fair value of cash and cash equivalents using quoted prices where available and industry standard valuation models using market-based inputs when quoted prices were unavailable.
Short-term Investments
We estimated the fair value of short-term investments using quoted prices where available and industry standard valuation models using market-based inputs when quoted prices were unavailable.
Derivatives
Our derivatives are not traded on an exchange. The valuation model used to calculate fair value of our derivative instruments includes a variety of observable inputs, including contractual terms, interest rate curves, foreign exchange rates, yield curves, credit curves, measure of volatility, and correlations of such inputs. Valuation adjustments may be made in the determination of fair value. These adjustments include amounts to reflect counterparty credit quality and liquidity risk, as well as credit and market valuation adjustments. The credit valuation adjustment adjusts the valuation of derivatives to account for nonperformance risk of our counter-party with respect to all net derivative assets positions. The credit valuation adjustment also accounts for our own credit risk in the fair value measurement of all net derivative liabilities’ positions, when appropriate. The market valuation adjustment adjusts the valuation of derivatives to reflect the fact that we are an “end-user” of derivative products. As such, the valuation is adjusted to take into account the bid-offer spread (the liquidity risk), as we are not a dealer of derivative products.
43
Table of Contents
Long-term Debt
Where market-observable prices are not available, we estimated the fair values of long-term debt using projected cash flows discounted at each balance sheet date’s market-observable implicit-credit spread rates for our long-term debt and adjusted for foreign currency translations.
Unused Customer Credit Limits
The unused credit limits available to our customers have no fair value. The interest rates charged on our loan and retail revolving lines of credit are adjustable and reprice frequently. These amounts, in part or in total, can be cancelled at our discretion.
Note 18. Risks and Uncertainties
In assessing our current financial position and developing operating plans for the future, management has made significant judgments and estimates with respect to our liquidity, including but not limited to:
• | the amount of cash expected to be received from our finance receivable portfolio through collections (including prepayments) and receipt of finance charges, which could be materially different than our estimates; |
• | the potential for declining financial flexibility and reduced income should we use more of our assets for securitizations and portfolio sales; |
• | reduced income due to the possible deterioration of the credit quality of our finance receivable portfolios; |
• | our ability to complete on favorable terms, as needed, additional borrowings, securitizations, portfolio sales, or other transactions to support liquidity, and the costs associated with these funding sources, including sales at less than carrying value and limits on the types of assets that can be securitized or sold, which would affect profitability; |
• | risks in connection with the formation and operation of Springleaf REIT Inc. (Springleaf REIT), a recently established subsidiary which intends to elect and qualify to be taxed as a real estate investment trust (REIT), which we expect to manage, which we expect will own almost all of our existing real estate finance receivable portfolio, as well as our future real estate loan originations, and which we expect will sell a significant percentage of its common stock to the public; |
• | our ability to comply with our debt covenants; |
• | our access to debt markets and other sources of funding on favorable terms; |
• | potential costs for our United Kingdom subsidiaries resulting from the retroactive imposition of guidelines issued in August 2010 by the United Kingdom Financial Services Authority for sales of payment protection insurance that occurred after January 1, 2005, including possible refunds to customers; |
• | the effect of federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) (which, among other things, established a federal Consumer Financial Protection Bureau with broad authority to regulate and examine financial institutions), on our ability to conduct business or the manner in which we conduct business, such as licensing requirements, pricing limitations or restrictions on the method of offering products, as well as changes that may result from increased regulatory scrutiny of the sub-prime lending industry; |
• | potential liability (including the obligation to repurchase securitized or sold loans) resulting from any non-compliance with laws applicable to the origination and servicing of loans, including laws regulating loans that are classified as “high-cost” and “higher-priced” loans, and any practices that are classified as “unfair” or “predatory”; |
• | the potential for it to become increasingly costly and difficult to service our loan portfolio, especially our real estate loan portfolio (including costs and delays associated with foreclosure on |
44
Table of Contents
real estate collateral), as a result of heightened nationwide regulatory scrutiny of loan servicing and foreclosure practices in the industry generally, and related costs that could be passed on to us in connection with Nationstar’s servicing of our centralized mortgage loan portfolio; |
• | potential liability relating to real estate loans which we have sold or will sell in the future, or relating to securitized loans, if it is determined that there was a non-curable breach of a warranty made in connection with the transaction; |
• | the potential for additional unforeseen cash demands or accelerations of obligations; |
• | reduced income due to loan modifications where the borrower’s interest rate is reduced, principal payments are deferred, or other concessions are made; |
• | the potential for declines in bond and equity markets; |
• | the potential effect on us if the capital levels of our regulated and unregulated subsidiaries prove inadequate to support current business plans; |
• | the potential loss of key personnel; and |
• | the undetermined effects of the FCFI Transaction, including the availability of support from our new owner and the effect of any changes to our operations, capitalization, or business strategies. |
We have assumed that there will be no support required from FCFI and no material change in our recent liquidity sources and capitalization management. We intend to support our liquidity position by managing originations and purchases of finance receivables and maintaining disciplined underwriting standards and pricing on such loans. We intend to support operations and repay obligations with one or more of the following: finance receivable collections from operations, securitizations, additional term loans, potential unsecured debt offerings, potential proceeds from the Springleaf REIT stock offering, and portfolio sales.
Based on our estimates and taking into account the risks and uncertainties of such plans, we believe that we will have adequate liquidity to finance and operate our businesses and repay our obligations as they become due for at least the next twelve months.
It is possible that the actual outcome of one or more of our plans could be materially different than expected or that one or more of our significant judgments or estimates about the potential effects of these risks and uncertainties could prove to be materially incorrect.
Note 19. Legal Settlements and Contingencies
LEGAL SETTLEMENTS
In March 2010, WFI and AIG Bank settled a civil lawsuit brought by the United States Department of Justice (DOJ) for alleged violations of the Fair Housing Act and the Equal Credit Opportunity Act. The DOJ alleged that WFI and AIG Bank allowed independent wholesale mortgage loan brokers to charge certain minority borrowers higher broker fees than were charged to certain other borrowers between 2003 and 2006. WFI and AIG Bank denied any legal violation, and maintained that at all times they conducted their lending and other activities in compliance with fair-lending and other laws. As part of the settlement, WFI and AIG Bank agreed to provide $6.1 million for borrower remediation. In March 2010, we paid $6.1 million into an escrow account pursuant to the terms of the settlement agreement with the DOJ. Upon completion of the remediation, all remaining funds will be distributed for consumer education purposes. In the event that the remaining funds do not total at least $1 million, AIG Bank and WFI have agreed to replenish the fund up to $1 million for distribution for educational purposes. In addition, AIG Bank and WFI will incur certain costs associated with administering the settlement. WFI is obligated to indemnify AIG Bank for all amounts that AIG Bank is required to pay pursuant to the terms of the DOJ settlement.
In June 2010, MorEquity settled certain claims relating to the sale of mortgage loans by MorEquity. The opposing parties alleged that they had a binding contract to purchase such loans in 2008, while MorEquity claimed that no such contract existed. On June 17, 2010, MorEquity paid $12.5 million to resolve the dispute.
45
Table of Contents
LEGAL CONTINGENCIES
SLFC and certain of its subsidiaries are parties to various legal proceedings, including certain purported class action claims such as the one described below, arising in the ordinary course of business. Some of these proceedings are pending in jurisdictions that permit damage awards disproportionate to the actual economic damages alleged to have been incurred. Based upon information presently available, we believe that the total amounts, if any, that will ultimately be paid arising from these legal proceedings will not have a material adverse effect on our consolidated results of operations or financial position. However, the continued occurrences of large damage awards in general in the United States, including, in some jurisdictions, large punitive damage awards that bear little or no relation to actual economic damages incurred by plaintiffs, create the potential for an unpredictable result in any given proceeding.
King v. American General Finance, Inc., Case No. 96-CP-38-595 in the Court of Common Pleas for Orangeburg County, South Carolina. In this lawsuit, filed in 1996, the plaintiffs assert class action claims against our South Carolina operating entity for alleged violations of S.C. Code § 37-10-102(a), which requires, inter alia, a lender making a mortgage loan to ascertain the preference of the borrower as to an attorney who will represent the borrower in closing the loan. On July 29, 2011, the court issued an interim order granting the plaintiffs’ motion for summary judgment and holding that SLFI, formerly American General Finance, Inc., violated the statute. The order states that the class consists of 9,157 members who were involved in 5,497 transactions. The court did not rule on the plaintiffs’ request for penalties, prejudgment interest, attorney fees, or class notice. The order also states that the court will issue a final order on summary judgment, which will include its ruling on the plaintiffs’ request for penalties, prejudgment interest, attorney fees, and class notice, following an additional hearing. The statute provides for a penalty range of $1,500 to $7,500 per class member, to be determined by the judge. SLFI is defending the case vigorously.
46
Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q and our other publicly available documents may include, and the Company’s officers and representatives may from time to time make, statements which may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts but instead represent only our belief regarding future events, many of which are inherently uncertain and outside of our control. These statements may address, among other things, our strategy for growth, product development, regulatory approvals, market position, financial results and reserves. Our actual results and financial condition may differ from the anticipated results and financial condition indicated in these forward-looking statements. The important factors, many of which are outside of our control, that could cause our actual results to differ, possibly materially, include, but are not limited to, the following:
• | our continued ability to access the capital markets or the sufficiency of our current sources of funds to satisfy our cash flow requirements; |
• | changes in the rate at which we can collect or potentially sell our finance receivable portfolio; |
• | the impacts of our securitizations and borrowings; |
• | the formation and operation of Springleaf REIT (which will sell common stock to the public), including: the possibility that the initial public offering for Springleaf REIT may not be completed due to market conditions or other events; additional costs associated with operating a REIT with common stock that is held by the public and listed on a securities exchange; our lack of experience with managing a REIT; the possibility that, under our intended agreement with Springleaf REIT pursuant to which we would be required to offer to sell our newly-originated mortgage loans to Springleaf REIT, we are not able to originate a sufficient volume of loans to allow Springleaf REIT to operate profitably or the possibility that Springleaf REIT will terminate such agreement; the possibility that Springleaf REIT may terminate our intended agreement to service the loans held by Springleaf REIT; and potential liability relating to real estate loans that we intend to sell to Springleaf REIT, if it is determined that there was a breach of a warranty made in connection with the transaction (see “Springleaf REIT Inc.” below); |
• | our ability to comply with our debt covenants; |
• | changes in general economic conditions, including the interest rate environment in which we conduct business and the financial markets through which we can access capital and also invest cash flows from the insurance business segment; |
• | changes in the competitive environment in which we operate, including the demand for our products, customer responsiveness to our distribution channels, and the formation of business combinations among our competitors; |
• | the effectiveness of our credit risk scoring models in assessing the risk of customer unwillingness or inability to repay; |
• | shifts in collateral values, delinquencies, or credit losses; |
• | shifts in residential real estate values; |
• | levels of unemployment and personal bankruptcies; |
• | potential costs for our United Kingdom subsidiaries resulting from the retroactive imposition of guidelines issued in August 2010 by the United Kingdom Financial Services Authority for sales of payment protection insurance that occurred after January 1, 2005, including possible refunds to customers; |
• | the potential for it to become increasingly costly and difficult to service our loan portfolio, especially our real estate loan portfolio (including costs and delays associated with foreclosure on real estate collateral), as a result of heightened nationwide regulatory scrutiny of loan servicing and foreclosure practices in the industry generally, and related costs that could be passed on to us in connection with Nationstar’s servicing of our centralized mortgage loan portfolio; |
47
Table of Contents
• | potential liability relating to real estate loans which we have sold or will sell in the future, or relating to securitized loans, if it is determined that there was a non-curable breach of a warranty made in connection with the transaction; |
• | changes in federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Act (which, among other things, established a federal Consumer Financial Protection Bureau with broad authority to regulate and examine financial institutions), that affect our ability to conduct business or the manner in which we conduct business, such as licensing requirements, pricing limitations or restrictions on the method of offering products, as well as changes that may result from increased regulatory scrutiny of the sub-prime lending industry; |
• | potential liability (including the obligation to repurchase securitized or sold loans) resulting from any non-compliance with laws applicable to the origination and servicing of loans, including laws regulating loans that are classified as “high-cost” and “higher-priced” loans, and any practices that are classified as “unfair” or “predatory”; |
• | the effects of participation in the HAMP by subservicers of our loans; |
• | the costs and effects of any litigation or governmental inquiries or investigations involving us, particularly those that are determined adversely to us; |
• | changes in accounting standards or tax policies and practices and the application of such new policies and practices to the manner in which we conduct business; |
• | the undetermined effects of the FCFI Transaction, including the availability of support from our new owner and the effect of any changes to our operations, capitalization, or business strategies; |
• | our ability to maintain sufficient capital levels in our regulated and unregulated subsidiaries; |
• | changes in our ability to attract and retain employees or key executives to support our businesses; |
• | natural or accidental events such as earthquakes, hurricanes, tornadoes, fires, or floods affecting our customers, collateral, or branches or other operating facilities; and |
• | war, acts of terrorism, riots, civil disruption, pandemics, or other events disrupting business or commerce. |
We also direct readers to other risks and uncertainties discussed in “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and in other documents we file with the SEC (including “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010). We are under no obligation (and expressly disclaim any obligation) to update or alter any forward-looking statement, whether written or oral, that we may make from time to time, whether as a result of new information, future events or otherwise.
FCFI TRANSACTION
On November 30, 2010, FCFI indirectly acquired an 80% economic interest in SLFI from ACC. AIG, through ACC, retained a 20% economic interest in SLFI.
SPRINGLEAF REIT INC.
In May 2011, SLFC caused the formation of Springleaf REIT Inc., a Delaware corporation (Springleaf REIT). Springleaf REIT, an indirect subsidiary of SLFC, has recently filed with the SEC a registration statement for an initial public offering of its common stock. After the registration statement is declared effective and the offering is completed, it is anticipated that Springleaf REIT will continue to be an indirect subsidiary of SLFC, with a majority of its common stock to be owned by Springleaf REIT Holdings LLC, a newly formed direct subsidiary of SLFC, and its affiliates, and the remainder to be owned by public shareholders. Upon completion of the offering, Springleaf REIT will own an estimated portfolio of more than 149,000 loans with an aggregate unpaid principal balance of $9.8 billion as of June 30, 2011, which will consist primarily of seasoned, performing, first-lien residential real estate loans, most of which were originated by subsidiaries of the Company. This portfolio will consist of all of
48
Table of Contents
Springleaf’s unsecuritized residential real estate loans as of a specified date before the offering that are no more than 60 days delinquent and certain portfolios of securitized loans. As of June 30, 2011, this portfolio would have represented 93% of SLFC’s residential real estate loan portfolio and 73% of SLFC’s total loan portfolio. Springleaf REIT will have an exclusive right to acquire new real estate loans that SLFC originates and will be externally managed by an affiliate of SLFC. SLFC will have the exclusive right to service the loans it originates and sells to Springleaf REIT. Springleaf REIT intends to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with its initial taxable year ending December 31, 2011. See “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q.
CAPITAL RESOURCES AND LIQUIDITY
Capital Resources
Our capital has varied primarily with the amount of our net finance receivables. We have historically based our mix of debt and equity, or “leverage”, primarily upon maintaining leverage that supports cost-effective funding.
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||||
Long-term debt | $ | 14,527.1 | 90 | % | $ | 17,141.1 | 87 | % | ||||||||||
Equity | 1,555.5 | 10 | 2,465.7 | 13 | ||||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total capital | $ | 16,082.6 | 100 | % | $ | 19,606.8 | 100 | % | ||||||||||
|
|
|
|
|
|
|
| |||||||||||
Net finance receivables | $ | 13,476.4 | $ | 17,701.5 |
We have historically issued a combination of fixed-rate debt, principally long-term, and floating-rate debt, both long-term and short-term. Until September 2008, SLFC obtained our fixed-rate funding by issuing public or private long-term unsecured debt with maturities primarily ranging from three to ten years, and SLFC obtained most of our floating-rate funding by issuing and refinancing commercial paper and by issuing long-term, floating-rate unsecured debt. Since that time we have sold certain mortgage portfolios, entered into a significant term loan funding arrangement, and completed on-balance sheet securitizations.
In April 2010, Springleaf Financial Funding Company, a wholly owned subsidiary of SLFC, entered into and fully drew down a $3.0 billion, five-year term loan pursuant to a Credit Agreement among Springleaf Financial Funding Company, SLFC, and most of the consumer finance operating subsidiaries of SLFC (collectively, the Subsidiary Guarantors), and a syndicate of lenders, various agents, and Bank of America, N.A, as administrative agent.
In May 2011, the $3.0 billion term loan was refinanced to increase total borrowing to $3.75 billion with a new six-year term, significantly improved advance rates, and lower borrowing costs. Any portion of the term loan that is repaid (whether at or prior to maturity) will permanently reduce the principal amount outstanding and may not be reborrowed.
The term loan is guaranteed by SLFC and by the Subsidiary Guarantors. In addition, other SLFC operating subsidiaries that from time to time meet certain criteria will be required to become Subsidiary Guarantors. The term loan is secured by a first priority pledge of the stock of Springleaf Financial Funding Company that was limited at the transaction date, in accordance with existing SLFC debt agreements, to approximately 10% of SLFC’s consolidated net worth.
49
Table of Contents
Springleaf Financial Funding Company used the proceeds from the term loan to make intercompany loans to the Subsidiary Guarantors. The intercompany loans are secured by a first priority security interest in eligible loan receivables, according to pre-determined eligibility requirements and in accordance with a borrowing base formula. The Subsidiary Guarantors used proceeds of the loans to pay down their intercompany loans from SLFC. SLFC used the payments from Subsidiary Guarantors to, among other things, repay debt and fund operations.
Certain debt agreements of the Company contain terms that could result in acceleration of payments. Under certain circumstances, an event of default or declaration of acceleration under the borrowing agreements of the Company could also result in an event of default and declaration of acceleration under other borrowing agreements of the Company.
Based upon SLFC’s financial results for the twelve months ended March 31, 2011, a mandatory trigger event occurred under SLFC’s hybrid debt with respect to the hybrid debt’s semi-annual payment due in July 2011. The mandatory trigger event requires SLFC to defer interest payments to the junior subordinated debt holders (and not make dividend payments to SLFI) unless SLFC obtains non-debt capital funding in an amount equal to all accrued and unpaid interest on the hybrid debt otherwise payable on the next interest payment date and pays such amount to the junior subordinated debt holders. During June 2011, SLFC received from SLFI the non-debt capital funding necessary to satisfy (and did pay) the July 2011 interest payments required by SLFC’s hybrid debt. See Part II, Item 2 of this Quarterly Report on Form 10-Q.
Historically, we targeted our leverage to be a ratio of 7.5x of adjusted debt to adjusted tangible equity, where adjusted debt equals total debt less 75% of our junior subordinated debentures (hybrid debt) and where adjusted tangible equity equals total shareholder’s equity plus 75% of hybrid debt and less goodwill, other intangible assets, and accumulated other comprehensive income or loss. Our method of measuring target leverage reflects SLFC’s issuance of $350.0 million aggregate principal amount of 60-year junior subordinated debentures following our acquisition of Ocean in January 2007. The debentures underlie a series of trust preferred securities sold by a trust sponsored by SLFC in a Rule 144A/Regulation S offering. SLFC can redeem the debentures at par beginning in January 2017. Based upon the “equity-like” terms of these junior subordinated debentures, our leverage calculation treated the hybrid debt as 75% equity and 25% debt.
Due to the Company’s and our former indirect parent’s liquidity positions, our primary capitalization efforts have been focused on improving liquidity and maintaining compliance with our debt agreements, and not on achieving a targeted leverage. Additionally, the application of push-down accounting significantly altered the presentation of many leverage calculation components and has thereby made our historical methods of leverage calculation less meaningful, particularly when compared to leverage measurements of the Predecessor Company. Our adjusted tangible leverage at June 30, 2011 was 8.91x compared to 8.48x at December 31, 2010, and 6.24x at June 30, 2010. In calculating June 30, 2011 leverage, management deducted $1.5 billion of cash equivalents from adjusted debt, resulting in an effective adjusted tangible leverage of 8.00x. In calculating December 31, 2010 leverage, management deducted $1.2 billion of cash equivalents from adjusted debt, resulting in an effective adjusted tangible leverage of 7.82x. In calculating June 30, 2010 leverage, management deducted $331.5 million of cash equivalents from adjusted debt, resulting in an effective adjusted tangible leverage of 6.12x.
Reconciliations of total debt to adjusted debt were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||
June 30, 2011 | December 31, 2010 | June 30, 2010 | ||||||||||||
Total debt | $ | 14,527.1 | $ | 14,941.0 | $ | 17,141.1 | ||||||||
75% of hybrid debt | (128.6 | ) | (128.6 | ) | (262.0 | ) | ||||||||
|
|
|
|
|
| |||||||||
Adjusted debt | $ | 14,398.5 | $ | 14,812.4 | $ | 16,879.1 | ||||||||
|
|
|
|
|
|
50
Table of Contents
Reconciliations of equity to adjusted tangible equity were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||
June 30, 2011 | December 31, 2010 | June 30, 2010 | ||||||||||||
Equity | $ | 1,555.5 | $ | 1,699.0 | $ | 2,465.7 | ||||||||
75% of hybrid debt | 128.6 | 128.6 | 262.0 | |||||||||||
Net other intangible assets | (65.4 | ) | (83.7 | ) | — | |||||||||
Accumulated other comprehensive (income) loss | (3.0 | ) | 2.5 | (23.8 | ) | |||||||||
|
|
|
|
|
| |||||||||
Adjusted tangible equity | $ | 1,615.7 | $ | 1,746.4 | $ | 2,703.9 | ||||||||
|
|
|
|
|
|
Liquidity Facilities
We historically maintained credit facilities to support the issuance of commercial paper and to provide an additional source of funds for operating requirements. Due to the extraordinary events in the credit markets since 2008, AIG’s liquidity issues, and our reduced liquidity, we borrowed all available commitments under our primary credit facilities during September 2008, including our 364-day facility ($2.050 billion drawn by SLFC and $400.0 million drawn by SLFI) and the SLFC $2.125 billion multi-year facility. On July 9, 2009, we converted the outstanding amounts under our expiring 364-day facility into one-year term loans that would mature on July 9, 2010. On March 25, 2010, SLFC and SLFI each repaid all of their respective outstanding obligations under their one-year term loans ($2.050 billion repaid by SLFC and $400.0 million repaid by SLFI). With these repayments, the related contractual support agreement between SLFC and AIG was terminated. On April 26, 2010, SLFC repaid its outstanding borrowings under the multi-year facility. With this repayment, the borrowing commitments under the multi-year facility were terminated.
SLFC does not guarantee any borrowings of SLFI.
Liquidity
Our sources of funds have included cash flows from operations, issuances of long-term debt, borrowings from banks under credit facilities, sales of finance receivables, and securitizations. On May 10, 2011, we successfully refinanced our $3.0 billion secured term loan with an additional $750.0 million of borrowings, a two-year maturity extension to May 2017, lower borrowing costs, and reduced collateral requirements. Subject to insurance regulations, we also have received dividends from our insurance subsidiaries. On May 12, 2011, we received $45.0 million of dividends from our insurance subsidiaries.
We anticipate that our near-term primary sources of funds to support operations and repay obligations will be finance receivable collections from operations, cash on hand, and, as needed and available, additional borrowings, securitizations, potential proceeds from the Springleaf REIT stock offering, or portfolio sales.
The principal factors that could decrease our liquidity are customer non-payment, a decline in customer prepayments, and a prolonged inability to adequately access capital market funding. We intend to support our liquidity position by operating the Company utilizing the following strategies:
• | managing originations and purchases of finance receivables and maintaining disciplined underwriting standards and pricing for such loans; |
• | as needed, pursuing additional borrowings, securitizations, or portfolio sales; and |
• | potential proceeds from the Springleaf REIT stock offering. |
51
Table of Contents
However, it is possible that the actual outcome of one or more of our plans could be materially different than expected or that one or more of our significant judgments or estimates could prove to be materially incorrect.
Principal sources and uses of cash were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||
Principal sources of cash: | ||||||||||
Net collections/originations and purchases of finance receivables | $ | 580.9 | $ | 970.3 | ||||||
Operations | 108.0 | 136.2 | ||||||||
Capital contributions | 10.5 | 11.4 | ||||||||
Repayment of note receivable from AIG | — | 800.9 | ||||||||
Sales and principal collections of finance receivables held for sale originated as held for investment | — | 37.8 | ||||||||
|
|
|
| |||||||
Total | $ | 699.4 | $ | 1,956.6 | ||||||
|
|
|
| |||||||
Principal uses of cash: | ||||||||||
Net repayment/issuances of debt | $ | 727.9 | $ | 2,524.2 | ||||||
Dividends paid | 45.0 | — | ||||||||
|
|
|
| |||||||
Total | $ | 772.9 | $ | 2,524.2 | ||||||
|
|
|
|
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 of the Notes to Condensed Consolidated Financial Statements for discussion of recently issued accounting pronouncements.
CRITICAL ACCOUNTING ESTIMATES
For a discussion of the critical accounting estimates relating to our businesses, see “Critical Accounting Estimates” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. There have been no significant changes to our critical accounting estimates during the six months ended June 30, 2011.
OFF-BALANCE SHEET ARRANGEMENTS
We have no material off-balance sheet arrangements as defined by SEC rules. We had no off-balance sheet exposure to losses associated with unconsolidated VIEs at June 30, 2011 or December 31, 2010.
52
Table of Contents
SELECTED SEGMENT INFORMATION
See Note 15 of the Notes to Condensed Consolidated Financial Statements for a description of our business segments.
The following statistics are derived from the Company’s segment reporting. We report our segment statistics using the historical basis of accounting. We believe the following segment statistics are relevant to the reader because they are used by management to analyze and evaluate the performance of our business segments. “All Other” includes push-down accounting adjustments and other items that are not identified as part of our business segments and are excluded from our segment reporting. Selected statistics for the business segments (which are reported on a historical basis of accounting) were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | At or for the Six Months Ended June 30, 2011 | At or for the Six Months Ended June 30, 2010 | |||||||||||||||||
Net finance receivables: | ||||||||||||||||||||
Branch real estate loans | $ | 6,910.6 | $ | 7,733.4 | ||||||||||||||||
Centralized real estate | 5,671.0 | 6,513.1 | ||||||||||||||||||
Branch non-real estate loans | 2,638.5 | 2,887.9 | ||||||||||||||||||
Branch retail sales finance | 434.2 | 734.1 | ||||||||||||||||||
|
|
|
| |||||||||||||||||
Total segment net finance receivables | 15,654.3 | 17,868.5 | ||||||||||||||||||
All other | (2,177.9 | ) | (167.0 | ) | ||||||||||||||||
|
|
|
| |||||||||||||||||
Net finance receivables | $ | 13,476.4 | $ | 17,701.5 | ||||||||||||||||
|
|
|
| |||||||||||||||||
Yield: | ||||||||||||||||||||
Branch real estate loans | 8.89 | % | 9.07 | % | 8.92 | % | 9.08 | % | ||||||||||||
Centralized real estate | 5.65 | 5.80 | 5.87 | 5.90 | ||||||||||||||||
Branch non-real estate loans | 22.77 | 21.57 | 22.73 | 21.47 | ||||||||||||||||
Branch retail sales finance | 14.15 | 14.70 | 14.27 | 14.89 | ||||||||||||||||
Total segment yield | 10.15 | 10.21 | 10.22 | 10.30 | ||||||||||||||||
All other effect on yield | 4.03 | 0.09 | 3.94 | 0.08 | ||||||||||||||||
Total yield | 14.18 | 10.30 | 14.16 | 10.38 | ||||||||||||||||
Charge-off ratio: | ||||||||||||||||||||
Branch real estate loans | 2.95 | % | 3.20 | % | 2.65 | % | 3.26 | % | ||||||||||||
Centralized real estate | 2.11 | 1.80 | 1.87 | 2.18 | ||||||||||||||||
Branch non-real estate loans | 3.72 | 6.16 | 3.96 | 6.66 | ||||||||||||||||
Branch retail sales finance | 5.97 | 9.30 | 6.25 | 9.15 | ||||||||||||||||
Total segment charge-off ratio | 2.86 | 3.48 | 2.69 | 3.75 | ||||||||||||||||
All other effect on charge-off ratio | (0.38 | ) | 0.04 | (0.68 | ) | 0.04 | ||||||||||||||
Total charge-off ratio | 2.48 | 3.52 | 2.01 | 3.79 | ||||||||||||||||
Delinquency ratio: | ||||||||||||||||||||
Branch real estate loans | 5.93 | % | 6.10 | % | ||||||||||||||||
Centralized real estate | 9.23 | 7.97 | ||||||||||||||||||
Branch non-real estate loans | 3.06 | 4.09 | ||||||||||||||||||
Branch retail sales finance | 3.61 | 5.79 | ||||||||||||||||||
Total segment delinquency ratio | 6.51 | 6.41 | ||||||||||||||||||
All other effect on delinquency ratio | 0.05 | 0.07 | ||||||||||||||||||
Total delinquency ratio | 6.56 | 6.48 |
53
Table of Contents
ANALYSIS OF FINANCIAL CONDITION
Finance Receivables
Fair Isaac Corporation (FICO) Credit Scores.There are many different categorizations used in the consumer lending industry to describe the creditworthiness of a borrower, including “prime”, “non-prime”, and “sub-prime”. While there are no industry-wide agreed upon definitions for these categorizations, many market participants utilize third-party credit scores as a means to categorize the creditworthiness of the borrower and his or her finance receivable. Our finance receivable underwriting process does not use third-party credit scores as a primary determinant for credit decisions. However, we do, in part, use such scores to analyze performance of our finance receivable portfolio and for informational purposes we present below our net finance receivables and delinquency ratios grouped into the following categories based solely on borrower FICO credit scores at the date of origination or renewal:
• | Prime: Borrower FICO score greater than or equal to 660 |
• | Non-prime: Borrower FICO score greater than 619 and less than 660 |
• | Sub-prime: Borrower FICO score less than or equal to 619 |
Many finance receivables included in the “prime” category in the table below might not meet other market definitions of prime loans due to certain characteristics of the borrowers, such as their elevated debt-to-income ratios, lack of income stability, or level of income disclosure and verification, as well as credit repayment history or similar measurements.
54
Table of Contents
FICO-delineated prime, non-prime, and sub-prime categories for net finance receivables by portfolio segment and by class were as follows:
(dollars in millions) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
Net finance receivables: | ||||||||
Branch real estate loans: | ||||||||
Prime | $ | 1,007.3 | $ | 1,063.8 | ||||
Non-prime | 1,101.6 | 1,159.7 | ||||||
Sub-prime | 3,906.5 | 4,089.9 | ||||||
Other/FICO unavailable | 1.0 | 1.0 | ||||||
|
|
|
| |||||
Total | $ | 6,016.4 | $ | 6,314.4 | ||||
|
|
|
| |||||
Centralized real estate loans: | ||||||||
Prime | $ | 3,184.7 | $ | 3,399.3 | ||||
Non-prime | 845.6 | 885.8 | ||||||
Sub-prime | 335.5 | 348.8 | ||||||
Other/FICO unavailable | 1.1 | 0.4 | ||||||
|
|
|
| |||||
Total | $ | 4,366.9 | $ | 4,634.3 | ||||
|
|
|
| |||||
Branch non-real estate loans: | ||||||||
Prime | $ | 517.7 | $ | 528.4 | ||||
Non-prime | 586.8 | 592.2 | ||||||
Sub-prime | 1,454.5 | 1,483.0 | ||||||
Other/FICO unavailable | 13.0 | 12.4 | ||||||
|
|
|
| |||||
Total | $ | 2,572.0 | $ | 2,616.0 | ||||
|
|
|
| |||||
Branch retail sales finance: | ||||||||
Prime | $ | 169.0 | $ | 220.7 | ||||
Non-prime | 57.1 | 72.3 | ||||||
Sub-prime | 176.5 | 197.5 | ||||||
Other/FICO unavailable | 1.1 | 0.7 | ||||||
|
|
|
| |||||
Total | $ | 403.7 | $ | 491.2 | ||||
|
|
|
|
55
Table of Contents
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios by portfolio segment and by class were as follows:
Successor Company | ||||||||
June 30, 2011 | December 31, 2010 | |||||||
Delinquency ratio: | ||||||||
Branch real estate loans: | ||||||||
Prime | 3.53 | % | 3.61 | % | ||||
Non-prime | 5.38 | 5.21 | ||||||
Sub-prime | 6.71 | 6.89 | ||||||
Other/FICO unavailable | 13.79 | 3.81 | ||||||
Total | 5.94 | 6.03 | ||||||
Centralized real estate loans: | ||||||||
Prime | 7.98 | % | 7.31 | % | ||||
Non-prime | 13.34 | 12.39 | ||||||
Sub-prime | 13.42 | 12.43 | ||||||
Other/FICO unavailable | 56.14 | — | ||||||
Total | 9.46 | 8.67 | ||||||
Branch non-real estate loans: | ||||||||
Prime | 1.61 | % | 2.04 | % | ||||
Non-prime | 2.37 | 3.11 | ||||||
Sub-prime | 3.84 | 4.75 | ||||||
Other/FICO unavailable | 1.21 | N/M | * | |||||
Total | 3.06 | 3.84 | ||||||
Branch retail sales finance: | ||||||||
Prime | 2.81 | % | 3.95 | % | ||||
Non-prime | 5.05 | 6.32 | ||||||
Sub-prime | 3.93 | 5.71 | ||||||
Other/FICO unavailable | 2.89 | 6.94 | ||||||
Total | 3.61 | 5.01 |
* | Not meaningful |
Higher-risk Real Estate Loans.Certain types of our real estate loans, such as interest only real estate loans, sub-prime real estate loans, second mortgages, high loan-to-value (LTV) ratio mortgages, and low documentation real estate loans, can have a greater risk of non-collection than our other real estate loans. Interest only real estate loans contain an initial period where the scheduled monthly payment amount is equal to the interest charged on the loan. The payment amount resets upon the expiration of this period to an amount sufficient to amortize the balance over the remaining term of the loan. Sub-prime real estate loans are loans originated to a borrower with a FICO score at the date of origination or renewal of less than or equal to 619. Second mortgages are secured by a mortgage the rights of which are subordinate to those of a first mortgage. High LTV ratio mortgages have an original amount equal to or greater than 95.5% of the value of the collateral property at the time the loan was originated. Low documentation real estate loans are loans to a borrower that meets certain criteria which gives the borrower the option to supply less than the normal amount of supporting documentation for income.
56
Table of Contents
Additional information regarding these higher-risk real estate loans for our branch and centralized real estate business segments follows (our higher-risk real estate loans can be included in more than one of the types of higher-risk real estate loans):
(dollars in millions) | Amount | Delinquency Ratio | Average LTV | Average FICO | ||||||||||||
Successor Company June 30, 2011 | ||||||||||||||||
Branch higher-risk real estate loans: | ||||||||||||||||
Interest only (a) | ||||||||||||||||
Sub-prime | $ | 3,906.5 | 6.71 | % | 74.7 | % | 557 | |||||||||
Second mortgages | $ | 769.8 | 7.81 | % | N/A | (b) | 602 | |||||||||
LTV greater than 95.5% at origination | $ | 222.8 | 5.04 | % | 97.8 | % | 611 | |||||||||
Low documentation (a) | ||||||||||||||||
Centralized real estate higher-risk loans: | ||||||||||||||||
Interest only | $ | 712.5 | 10.90 | % | 88.7 | % | 707 | |||||||||
Sub-prime | $ | 335.5 | 13.42 | % | 77.4 | % | 586 | |||||||||
Second mortgages | $ | 29.9 | 5.13 | % | N/A | 704 | ||||||||||
LTV greater than 95.5% at origination | $ | 1,509.9 | 8.04 | % | 99.4 | % | 709 | |||||||||
Low documentation | $ | 256.4 | 15.26 | % | 76.5 | % | 663 | |||||||||
Successor Company December 31, 2010 | ||||||||||||||||
Branch higher-risk real estate loans: | ||||||||||||||||
Interest only (a) | ||||||||||||||||
Sub-prime | $ | 4,089.9 | 6.89 | % | 74.8 | % | 557 | |||||||||
Second mortgages | $ | 835.9 | 7.43 | % | N/A | 602 | ||||||||||
LTV greater than 95.5% at origination | $ | 147.2 | 5.50 | % | 97.8 | % | 611 | |||||||||
Low documentation (a) | ||||||||||||||||
Centralized real estate higher-risk loans: | ||||||||||||||||
Interest only | $ | 764.9 | 11.08 | % | 88.6 | % | 707 | |||||||||
Sub-prime | $ | 348.8 | 12.43 | % | 77.4 | % | 586 | |||||||||
Second mortgages | $ | 32.9 | 2.61 | % | N/A | 703 | ||||||||||
LTV greater than 95.5% at origination | $ | 1,600.2 | 7.82 | % | 99.4 | % | 709 | |||||||||
Low documentation | $ | 269.7 | 13.32 | % | 76.4 | % | 664 |
(a) | Not applicable because these higher-risk loans are not offered by our branch business segment. |
(b) | Not available. |
57
Table of Contents
Charge-off ratios for these higher-risk real estate loans for our branch and centralized real estate business segments were as follows:
Successor Company | Predecessor Company | Successor Company | Predecessor Company | |||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Charge-off ratios: | ||||||||||||||||||||
Branch higher-risk real estate loans: | ||||||||||||||||||||
Interest only* | ||||||||||||||||||||
Sub-prime | 2.46 | % | 3.74 | % | 2.23 | % | 3.63 | % | ||||||||||||
Second mortgages | 6.88 | % | 9.30 | % | 6.14 | % | 9.68 | % | ||||||||||||
LTV greater than 95.5% at origination | 3.96 | % | 3.27 | % | 3.28 | % | 4.05 | % | ||||||||||||
Low documentation* | ||||||||||||||||||||
Centralized real estate higher-risk loans: | ||||||||||||||||||||
Interest only | 3.18 | % | 3.34 | % | 3.05 | % | 3.39 | % | ||||||||||||
Sub-prime | 1.79 | % | 2.02 | % | 1.67 | % | 2.77 | % | ||||||||||||
Second mortgages | 0.14 | % | (0.35 | )% | 0.87 | % | 2.39 | % | ||||||||||||
LTV greater than 95.5% at origination | 2.12 | % | 2.04 | % | 2.16 | % | 2.39 | % | ||||||||||||
Low documentation | 3.01 | % | 1.87 | % | 2.20 | % | 2.14 | % |
* | Not applicable because these higher-risk loans are not offered by our branch business segment. |
A decline in the value of assets serving as collateral for our real estate loans may impact our ability to collect on these real estate loans. The total amount of all real estate loans for which the estimated LTV ratio exceeds 100% at June 30, 2011 was $2.4 billion, or 23%, of total real estate loans.
58
Table of Contents
Allowance for Finance Receivable Losses
Our Credit Strategy and Policy Committee evaluates our finance receivable portfolio monthly by real estate loans, non-real estate loans, and retail sales finance. Allowance for finance receivable losses is calculated for each product and then allocated to each segment based upon its delinquency. Changes in the allowance for finance receivable losses by portfolio segment and by class were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Balance at beginning of period: | ||||||||||||||||||||
Branch real estate loans | $ | 9.6 | $ | 573.9 | $ | 2.5 | $ | 624.3 | ||||||||||||
Centralized real estate | 3.0 | 599.0 | 0.5 | 536.4 | ||||||||||||||||
Branch non-real estate loans | 12.8 | 294.4 | 4.1 | 288.5 | ||||||||||||||||
Branch retail sales finance | 0.2 | 61.4 | — | 63.6 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total segment | 25.6 | 1,528.7 | 7.1 | 1,512.8 | ||||||||||||||||
All other | — | 3.8 | — | 3.5 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 25.6 | $ | 1,532.5 | $ | 7.1 | $ | 1,516.3 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Provision for finance receivable losses (a): | ||||||||||||||||||||
Branch real estate loans | $ | 33.1 | $ | 27.9 | $ | 52.2 | $ | 33.6 | ||||||||||||
Centralized real estate | 32.1 | 23.9 | 59.6 | 127.6 | ||||||||||||||||
Branch non-real estate loans | 31.0 | (2.1 | ) | 52.3 | 55.4 | |||||||||||||||
Branch retail sales finance | 5.9 | 4.9 | 11.1 | 22.4 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total segment | 102.1 | 54.6 | 175.2 | 239.0 | ||||||||||||||||
All other | — | 0.4 | — | 0.6 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 102.1 | $ | 55.0 | $ | 175.2 | $ | 239.6 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Charge-offs: | ||||||||||||||||||||
Branch real estate loans | $ | (31.5 | ) | $ | (64.4 | ) | $ | (50.3 | ) | $ | (131.9 | ) | ||||||||
Centralized real estate | (30.1 | ) | (29.2 | ) | (55.2 | ) | (71.1 | ) | ||||||||||||
Branch non-real estate loans | (28.6 | ) | (54.9 | ) | (50.9 | ) | (119.6 | ) | ||||||||||||
Branch retail sales finance | (8.8 | ) | (22.8 | ) | (17.5 | ) | (49.5 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total segment | (99.0 | ) | (171.3 | ) | (173.9 | ) | (372.1 | ) | ||||||||||||
All other | — | (0.3 | ) | — | (0.2 | ) | ||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | (99.0 | ) | $ | (171.6 | ) | $ | (173.9 | ) | $ | (372.3 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||||||
Recoveries (b): | ||||||||||||||||||||
Branch real estate loans | $ | 2.3 | $ | 2.8 | $ | 9.1 | $ | 5.3 | ||||||||||||
Centralized real estate | — | 0.7 | 0.1 | 1.5 | ||||||||||||||||
Branch non-real estate loans | 9.0 | 9.8 | 18.7 | 19.4 | ||||||||||||||||
Branch retail sales finance | 3.1 | 3.4 | 6.8 | 6.6 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total segment | 14.4 | 16.7 | 34.7 | 32.8 | ||||||||||||||||
All other | — | — | — | — | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 14.4 | $ | 16.7 | $ | 34.7 | $ | 32.8 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Affiliates contributed by SLFI to SLFC (c): | ||||||||||||||||||||
Branch real estate loans | $ | — | $ | — | $ | — | $ | 8.9 | ||||||||||||
Branch non-real estate loans | — | — | — | 3.5 | ||||||||||||||||
Branch retail sales finance | — | — | — | 3.8 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total segment | $ | — | $ | — | $ | — | $ | 16.2 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period: | ||||||||||||||||||||
Branch real estate loans | $ | 13.5 | $ | 540.2 | $ | 13.5 | $ | 540.2 | ||||||||||||
Centralized real estate | 5.0 | 594.4 | 5.0 | 594.4 | ||||||||||||||||
Branch non-real estate loans | 24.2 | 247.2 | 24.2 | 247.2 | ||||||||||||||||
Branch retail sales finance | 0.4 | 46.9 | 0.4 | 46.9 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total segment | 43.1 | 1,428.7 | 43.1 | 1,428.7 | ||||||||||||||||
All other | — | 3.9 | — | 3.9 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 43.1 | $ | 1,432.6 | $ | 43.1 | $ | 1,432.6 | ||||||||||||
|
|
|
|
|
|
|
|
59
Table of Contents
(a) | Provision for finance receivable losses for the Successor Company for the three months ended June 30, 2011 includes $30.2 million of net charge-offs on credit impaired finance receivables, $53.4 million on non-credit impaired finance receivables, and $0.9 million for new origination activity and TDR activity. As a result of charging off the non-credit impaired finance receivables, $20.4 million of valuation discount accretion was accelerated and is included as a component of finance charges within revenues during the three months ended June 30, 2011. Provision for finance receivable losses for the Successor Company for the six months ended June 30, 2011 includes $67.5 million of net charge-offs on credit impaired finance receivables, $70.7 million on non-credit impaired finance receivables, and $1.0 million for new origination activity and TDR activity. As a result of charging off the non-credit impaired finance receivables, $35.7 million of valuation discount accretion was accelerated and is included as a component of finance charges within revenues during the six months ended June 30, 2011. |
(b) | Successor Company includes $5.0 million of recoveries for the six months ended June 30, 2011 ($2.9 million branch real estate loan recoveries, $1.9 million branch non-real estate loan recoveries, and $0.2 million branch retail sales finance recoveries) as a result of a settlement of claims relating to our February 2008 purchase of Equity One, Inc.’s consumer branch finance receivable portfolio. |
(c) | Effective January 1, 2010, SLFI contributed two of its wholly-owned subsidiaries to SLFC. The contribution included $16.2 million of allowance for finance receivable losses. |
Real Estate Owned
Changes in the amount of real estate owned were as follows.
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Balance at beginning of period | $ | 174.7 | $ | 147.2 | $ | 178.9 | $ | 138.5 | ||||||||||||
Properties acquired | 64.0 | 66.0 | 121.7 | 138.3 | ||||||||||||||||
Properties sold or disposed of | (62.8 | ) | (61.5 | ) | (115.8 | ) | (122.0 | ) | ||||||||||||
Writedowns | (13.7 | ) | (9.9 | ) | (22.6 | ) | (17.6 | ) | ||||||||||||
Affiliates contributed by SLFI to SLFC* | — | — | — | 4.6 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Balance at end of period | $ | 162.2 | $ | 141.8 | $ | 162.2 | $ | 141.8 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Real estate owned as a percentage of real estate loans | 1.55 | % | 1.01 | % |
* | Effective January 1, 2010, SLFI contributed two of its wholly-owned subsidiaries to SLFC. The contribution included $4.6 million of real estate owned. |
Investments
Insurance investments by type were as follows:
(dollars in millions) | Successor Company | |||||||
June 30, 2011 | December 31, 2010 | |||||||
Investment securities | $ | 749.1 | $ | 745.8 | ||||
Commercial mortgage loans | 126.1 | 128.4 | ||||||
Policy loans | 1.5 | 1.5 | ||||||
|
|
|
| |||||
Total | $ | 876.7 | $ | 875.7 | ||||
|
|
|
|
60
Table of Contents
Investment securities are the majority of our insurance business segment’s investment portfolio. Our investment strategy is to optimize after-tax returns on invested assets, subject to the constraints of liquidity, diversification, and regulation. See Note 6 of the Notes to Condensed Consolidated Financial Statements for further information on investment securities.
Asset/Liability Management
To reduce the risk associated with unfavorable changes in interest rates on our debt not offset by favorable changes in yield of our finance receivables, we monitor the anticipated cash flows of our assets and liabilities, principally our finance receivables and debt. We have funded finance receivables with a combination of fixed-rate and floating-rate debt and equity. We have based the mix of fixed-rate and floating-rate debt issuances, in part, on the nature of the finance receivables being supported.
We have historically issued fixed-rate, long-term unsecured debt as the primary source of fixed-rate debt and have also employed interest rate swap agreements to adjust our fixed/floating mix of total debt. Including the impact of interest rate swap agreements that effectively fix floating-rate debt or float fixed-rate debt, our floating-rate debt represented 30% of our borrowings at June 30, 2011, compared to 21% at June 30, 2010. Adjustable-rate net finance receivables represented 5% of our total portfolio at June 30, 2011 and 2010.
For the past several quarters, we have had limited direct control of our asset/liability mix as a result of our limited access to capital markets, our restricted origination of finance receivables, and our sale or securitization of finance receivables.
ANALYSIS OF OPERATING RESULTS
Net (Loss) Income
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Net (loss) income | $ | (59.3 | ) | $ | 44.2 | $ | (114.5 | ) | $ | 56.7 | ||||||||||
Amount change | $ | (103.5 | ) | $ | 271.4 | $ | (171.2 | ) | $ | 524.5 | ||||||||||
Percent change | (234 | )% | 119 | % | (302 | )% | 112 | % | ||||||||||||
Return on average assets | (1.35 | )% | 0.86 | % | (1.29 | )% | 0.53 | % | ||||||||||||
Return on average equity | (14.73 | )% | 7.45 | % | (13.93 | )% | 4.77 | % | ||||||||||||
Ratio of earnings to fixed charges* | N/A | N/A | N/A | N/A |
* | Not applicable. Earnings did not cover total fixed charges by $99.4 million for the three months ended June 30, 2011 and $186.7 million for the six months ended June 30, 2011. Earnings did not cover total fixed charges by $9.8 million for the three months ended June 30, 2010 and $48.4 million for the six months ended June 30, 2010. |
During 2009, the U.S. residential real estate and credit markets experienced significant disruption as housing prices generally declined, unemployment increased, consumer delinquencies increased, and credit availability contracted and became more expensive for consumers and financial institutions. Many of these 2009 trends carried over into 2010 and 2011. These market disruptions negatively impacted our results for the three and six months ended June 30, 2011 and 2010.
61
Table of Contents
Decreased property values that accompany a market downturn can reduce a borrower’s willingness to repay and ability to refinance his or her mortgage. In addition, interest rate resets on adjustable-rate loans could negatively impact a borrower’s ability to repay. Defaults by borrowers on real estate loans could cause losses to us, could lead to increased claims relating to non-prime or sub-prime mortgage origination practices, and could encourage increased or changing regulation. Any increased or changing regulation could limit the availability of, or require changes in, the terms of certain real estate loan products and could also require us to devote additional resources to comply with that regulation.
Net loss for the three months ended June 30, 2011 when compared to net income for the three months ended June 30, 2010 reflected higher interest expense, higher provision for finance receivable losses, higher operating expenses, and lower benefit from income taxes, partially offset by higher finance charges and higher other revenues. See Interest Expense, Provision for Finance Receivable Losses, Operating Expenses, Benefit from Income Taxes, Finance Charges, and Other Revenues for further information.
Net loss for the six months ended June 30, 2011 when compared to net income for the six months ended June 30, 2010 reflected higher interest expense, lower other revenues, and lower benefit from income taxes, partially offset by lower provision for finance receivable losses and higher finance charges. See Interest Expense, Other Revenues, Benefit from Income Taxes, Provision for Finance Receivable Losses, and Finance Charges for further information.
Net loss for the three and six months ended June 30, 2011 also reflects the net cost of maintaining high balances of cash and cash equivalents to support our liquidity position.
See Note 15 of the Notes to Condensed Consolidated Financial Statements for information on the results of the Company’s business segments.
For a discussion of risk factors relating to our businesses, see “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
Factors that affected the Company’s operating results were as follows:
Finance Charges
Finance charges by type were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Real estate loans | $ | 298.4 | $ | 264.1 | $ | 598.5 | $ | 533.4 | ||||||||||||
Non-real estate loans | 161.5 | 158.1 | 323.3 | 320.3 | ||||||||||||||||
Retail sales finance | 20.9 | 29.7 | 46.7 | 67.2 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 480.8 | $ | 451.9 | $ | 968.5 | $ | 920.9 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Amount change | $ | 28.9 | $ | (101.9 | ) | $ | 47.6 | $ | (220.3 | ) | ||||||||||
Percent change | 6 | % | (18 | )% | 5 | % | (19 | )% | ||||||||||||
Average net receivables | $ | 13,599.0 | $ | 17,593.9 | $ | 13,776.1 | $ | 17,863.1 | ||||||||||||
Yield | 14.18 | % | 10.30 | % | 14.16 | % | 10.38 | % |
62
Table of Contents
Finance charges increased (decreased) due to the following:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Increase in yield | $ | 125.6 | $ | 6.3 | $ | 248.3 | $ | 18.1 | ||||||||||||
Decrease in average net receivables | (96.7 | ) | (108.2 | ) | (200.7 | ) | (238.4 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 28.9 | $ | (101.9 | ) | $ | 47.6 | $ | (220.3 | ) | ||||||||||
|
|
|
|
|
|
|
|
Average net receivables and changes in average net receivables by type were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Real estate loans | $ | 10,651.0 | $ | (3,210.1 | ) | $ | 13,861.1 | $ | (2,573.2 | ) | ||||||||
Non-real estate loans | 2,532.9 | (391.2 | ) | 2,924.1 | (689.3 | ) | ||||||||||||
Retail sales finance | 415.1 | (393.6 | ) | 808.7 | (980.6 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 13,599.0 | $ | (3,994.9 | ) | $ | 17,593.9 | $ | (4,243.1 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||||
Percent change | (23 | )% | (19 | )% |
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Real estate loans | $ | 10,794.0 | $ | (3,169.4 | ) | $ | 13,963.4 | $ | (2,975.7 | ) | ||||||||
Non-real estate loans | 2,543.6 | (448.6 | ) | 2,992.2 | (729.9 | ) | ||||||||||||
Retail sales finance | 438.5 | (469.0 | ) | 907.5 | (1,003.0 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 13,776.1 | $ | (4,087.0 | ) | $ | 17,863.1 | $ | (4,708.6 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||||
Percent change | (23 | )% | (21 | )% |
Average net receivables decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of push-down accounting adjustments, which decreased average net receivables by $2.1 billion for the three months ended June 30, 2011 and $2.2 billion for the six months ended June 30, 2011. The decrease in average net finance receivables for the three and six months ended June 30, 2011 when compared to the same periods in 2010 also reflected our tighter underwriting guidelines and liquidity management efforts.
Yield and changes in yield in basis points (bp) by type were as follows:
Successor Company | Predecessor Company | |||||||||||||||||
Three Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Yield | Change | Yield | Change | |||||||||||||||
Real estate loans | 11.24 | % | 360 | bp | 7.64 | % | (11 | ) bp | ||||||||||
Non-real estate loans | 25.55 | 389 | 21.66 | 136 | ||||||||||||||
Retail sales finance | 20.23 | 551 | 14.72 | 282 | ||||||||||||||
Total | 14.18 | 388 | 10.30 | 13 |
63
Table of Contents
Successor Company | Predecessor Company | |||||||||||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Yield | Change | Yield | Change | |||||||||||||||
Real estate loans | 11.18 | % | 348 | bp | 7.70 | % | (12 | ) bp | ||||||||||
Non-real estate loans | 25.56 | 404 | 21.52 | 126 | ||||||||||||||
Retail sales finance | 21.45 | 655 | 14.90 | 342 | ||||||||||||||
Total | 14.16 | 378 | 10.38 | 20 |
Yield increased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of valuation discount accretion resulting from the push-down accounting adjustments, which increased yield by 395 basis points for the three months ended June 30, 2011 and 386 basis points for the six months ended June 30, 2011. The increase in yield for the three and six months ended June 30, 2011 when compared to the same periods in 2010 was partially offset by promotional product mix.
Finance Receivables Held for Sale Originated as Held for Investment Revenues
Finance receivables held for sale originated as held for investment revenues were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Finance receivables held for sale originated as held for investment revenues | $ | — | $ | 9.5 | $ | — | $ | 20.4 | ||||||||||||
Amount change | $ | (9.5 | ) | $ | 77.7 | $ | (20.4 | ) | $ | 103.3 | ||||||||||
Percent change | (100 | )% | 114 | % | (100 | )% | 125 | % |
In June 2010, we transferred $484.9 million of real estate loans at the lower of cost or fair value from finance receivables held for sale back to finance receivables held for investment due to management’s intent to hold these finance receivables for the foreseeable future.
64
Table of Contents
Interest Expense
The impact of using the swap agreements that qualify for hedge accounting under U.S. GAAP is included in interest expense and the related borrowing statistics below. Interest expense by type was as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Long-term debt | $ | 343.8 | $ | 265.9 | $ | 694.4 | $ | 495.8 | ||||||||||||
Short-term debt | — | 0.5 | — | 27.6 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 343.8 | $ | 266.4 | $ | 694.4 | $ | 523.4 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Amount change | $ | 77.4 | $ | 17.3 | $ | 171.0 | $ | 5.9 | ||||||||||||
Percent change | 29 | % | 7 | % | 33 | % | 1 | % | ||||||||||||
�� | ||||||||||||||||||||
Average borrowings | $ | 14,623.2 | $ | 17,332.2 | $ | 14,690.5 | $ | 18,153.7 | ||||||||||||
Interest expense rate | 9.38 | % | 6.13 | % | 9.44 | % | 5.76 | % |
Interest expense increased due to the following:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Increase in interest expense rate | $ | 119.8 | $ | 63.7 | $ | 270.8 | $ | 91.1 | ||||||||||||
Decrease in average borrowings | (42.4 | ) | (46.4 | ) | (99.8 | ) | (85.2 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 77.4 | $ | 17.3 | $ | 171.0 | $ | 5.9 | ||||||||||||
|
|
|
|
|
|
|
|
Average borrowings and changes in average borrowings by type were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Long-term debt | $ | 14,623.2 | $ | (2,709.0 | ) | $ | 17,332.2 | $ | (1,867.4 | ) | ||||||||
Short-term debt | — | — | — | (2,084.8 | ) | |||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 14,623.2 | $ | (2,709.0 | ) | $ | 17,332.2 | $ | (3,952.2 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||||
Percent change | (16 | )% | (19 | )% |
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Long-term debt | $ | 14,690.5 | $ | (2,523.1 | ) | $ | 17,213.6 | $ | (2,181.7 | ) | ||||||||
Short-term debt | — | (940.1 | ) | 940.1 | (1,397.7 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 14,690.5 | $ | (3,463.2 | ) | $ | 18,153.7 | $ | (3,579.4 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||||
Percent change | (19 | )% | (16 | )% |
65
Table of Contents
Average borrowings decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to liquidity management efforts. The decrease in average borrowings for the three and six months ended June 30, 2011 when compared to the same periods in 2010 also reflected the impact of push-down accounting adjustments, which decreased average borrowings by $1.2 billion for the three months ended June 30, 2011 and $1.3 billion for the six months ended June 30, 2011.
Principal maturities of long-term debt (excluding projected securitization repayments by period) by type of debt at June 30, 2011 were as follows:
(dollars in millions) | Retail Notes | Medium Term Notes | Euro Denominated Notes | Secured Term Loan | Securitizations | Junior Subordinated Debt | Total | |||||||||||||||||||||
Interest rates (a) | 4.00% - 9.00 | % | 0.50% - 6.90 | % | 3.25% - 4.13 | % | 5.50 | % | 5.15% - 5.75 | % | 6.00 | % | ||||||||||||||||
Remainder of 2011 | $ | 97.3 | $ | 1,631.9 | $ | — | $ | — | $ | — | $ | — | $ | 1,729.2 | ||||||||||||||
2012 | 83.3 | 2,000.0 | — | — | — | — | 2,083.3 | |||||||||||||||||||||
2013 | 157.6 | 500.0 | 1,269.5 | — | — | — | 1,927.1 | |||||||||||||||||||||
2014 | 365.6 | — | — | — | — | — | 365.6 | |||||||||||||||||||||
2015 | 48.5 | 750.0 | — | — | — | — | 798.5 | |||||||||||||||||||||
2016-2067 | — | 3,675.0 | — | 3,750.0 | — | 350.0 | 7,775.0 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total excluding securitizations (b) | 752.3 | 8,556.9 | 1,269.5 | 3,750.0 | — | 350.0 | 14,678.7 | |||||||||||||||||||||
Securitizations | — | — | — | — | 1,114.8 | — | 1,114.8 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total | $ | 752.3 | $ | 8,556.9 | $ | 1,269.5 | $ | 3,750.0 | $ | 1,114.8 | $ | 350.0 | $ | 15,793.5 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) | The interest rates shown are the range of contractual rates in effect at June 30, 2011, including non U.S. dollar fixed and variable rate issuances, which excludes the effects of the associated derivative instruments used in hedge accounting relationships, if applicable. |
(b) | Securitizations are not included in above maturities by period due to their variable monthly repayments. |
Interest expense rate and changes in interest expense rate in basis points by type were as follows:
Successor Company | Predecessor Company | |||||||||||||||||
Three Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Rate | Change | Rate | Change | |||||||||||||||
Long-term debt | 9.38 | % | 325 | bp | 6.13 | % | 141 | bp | ||||||||||
Short-term debt | — | — | — | N/M | * | |||||||||||||
Total | 9.38 | 325 | 6.13 | 145 |
* | Not meaningful |
Successor Company | Predecessor Company | |||||||||||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Rate | Change | Rate | Change | |||||||||||||||
Long-term debt | 9.44 | % | 368 | bp | 5.76 | % | 97 | bp | ||||||||||
Short-term debt | — | N/M | * | 5.75 | 118 | |||||||||||||
Total | 9.44 | 368 | 5.76 | 100 |
* | Not meaningful |
66
Table of Contents
Interest expense rate increased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of valuation discount accretion resulting from the push-down accounting adjustments, which increased interest expense rate by 306 basis points for the three months ended June 30, 2011 and 312 basis points for the six months ended June 30, 2011.
Our future overall interest expense rates could be materially higher, but actual future interest expense rates will depend on our funding sources utilized, general interest rate levels and market credit spreads, which are influenced by our asset credit quality, our credit ratings, and the market perception of credit risk for the Company.
The credit ratings of SLFI and SLFC are all non-investment grade and therefore have a significant impact on our cost of and access to borrowed funds. This, in turn, affects our liquidity management.
The following table presents the credit ratings of SLFC as of August 11, 2011. These credit ratings may be changed, suspended, or withdrawn at any time by the rating agencies as a result of changes in, or unavailability of, information or based on other circumstances. Ratings may also be withdrawn at our request. SLFC does not intend to disclose any future changes to, or suspensions or withdrawals of, these ratings except in its Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K.
Senior Long-term Debt | ||||
Rating | Status | |||
Moody’s | B3 | Developing Outlook | ||
Standard & Poor’s (S&P) | B | Negative Outlook | ||
Fitch | B- | Negative Watch |
Provision for Finance Receivable Losses
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Provision for finance receivable losses | $ | 102.1 | $ | 55.0 | $ | 175.2 | $ | 239.6 | ||||||||||||
Amount change | $ | 47.1 | $ | (201.5 | ) | $ | (64.4 | ) | $ | (367.8 | ) | |||||||||
Percent change | 86 | % | (79 | )% | (27 | )% | (61 | )% | ||||||||||||
Net charge-offs | $ | 84.5 | $ | 154.8 | $ | 139.2 | $ | 339.4 | ||||||||||||
Charge-off ratio | 2.48 | % | 3.52 | % | 2.01 | % | 3.79 | % | ||||||||||||
Charge-off coverage | 0.13 | x | 2.31 | x | 0.15 | x | 2.11 | x | ||||||||||||
60 day+ delinquency | $ | 1,043.7 | $ | 1,173.2 | ||||||||||||||||
Delinquency ratio | 6.56 | % | 6.48 | % | ||||||||||||||||
Allowance for finance receivable losses | $ | 43.1 | $ | 1,432.6 | ||||||||||||||||
Allowance ratio | 0.32 | % | 8.09 | % |
Provision for finance receivable losses increased for the three months ended June 30, 2011 when compared to the same period in 2010 primarily due to decreases to the allowance for finance receivable losses in the three months ended June 30, 2010, partially offset by lower net charge-offs and delinquency in 2011. Provision for finance receivable losses decreased for the six months ended June 30, 2011 when compared to the same period in 2010 primarily due to our lower net charge-offs and delinquency in 2011, partially offset by decreases to the allowance for finance receivable losses in the six months ended June 30, 2010. As a result of our analysis of the favorable trends in credit quality during the first half of 2010, we decreased our allowance for finance receivable losses during second quarter 2010. Provision for
67
Table of Contents
finance receivable losses for the three and six months ended June 30, 2011 also reflected the impact of credit impaired finance receivables resulting from the push-down accounting adjustments, which decreased net charge-offs by $27.8 million for the three months ended June 30, 2011 and $75.8 million for the six months ended June 30, 2011.
Net charge-offs and changes in net charge-offs by type were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Real estate loans | $ | 59.4 | $ | (30.7 | ) | $ | 90.1 | $ | (20.8 | ) | ||||||||
Non-real estate loans | 19.5 | (25.7 | ) | 45.2 | (30.0 | ) | ||||||||||||
Retail sales finance | 5.6 | (13.9 | ) | 19.5 | (4.1 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 84.5 | $ | (70.3 | ) | $ | 154.8 | $ | (54.9 | ) | ||||||||
|
|
|
|
|
|
|
|
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Real estate loans | $ | 96.2 | $ | (100.0 | ) | $ | 196.2 | $ | (7.0 | ) | ||||||||
Non-real estate loans | 32.2 | (68.1 | ) | 100.3 | (52.1 | ) | ||||||||||||
Retail sales finance | 10.8 | (32.1 | ) | 42.9 | (4.1 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 139.2 | $ | (200.2 | ) | $ | 339.4 | $ | (63.2 | ) | ||||||||
|
|
|
|
|
|
|
|
Charge-off ratios and changes in charge-off ratios in basis points by type were as follows:
Successor Company | Predecessor Company | |||||||||||||||||
Three Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Ratio | Change | Ratio | Change | |||||||||||||||
Real estate loans | 2.22 | % | (38 | ) bp | 2.60 | % | (7 | ) bp | ||||||||||
Non-real estate loans | 3.10 | (306 | ) | 6.16 | (210 | ) | ||||||||||||
Retail sales finance | 5.38 | (393 | ) | 9.31 | 415 | |||||||||||||
Total | 2.48 | (104 | ) | 3.52 | (27 | ) |
Successor Company | Predecessor Company | |||||||||||||||||
Six Months Ended June 30, | 2011 | 2010 | ||||||||||||||||
Ratio | Change | Ratio | Change | |||||||||||||||
Real estate loans | 1.78 | % | (103 | ) bp | 2.81 | % | 44 | bp | ||||||||||
Non-real estate loans | 2.53 | (413 | ) | 6.66 | (145 | ) | ||||||||||||
Retail sales finance | 4.84 | (433 | ) | 9.17 | 435 | |||||||||||||
Total | 2.01 | (178 | ) | 3.79 | 26 |
Total charge-off ratio decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 reflecting our tighter underwriting guidelines. The decrease in our charge-off ratios for the three and six months ended June 30, 2011 when compared to the same periods in 2010 also reflected the impact of push-down accounting adjustments, which decreased total charge-off ratio by 37 basis points for the three months ended June 30, 2011 and 67 basis points for the six months ended June 30, 2011.
68
Table of Contents
Charge-off coverage, which compares the allowance for finance receivable losses to net charge-offs (annualized), decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of push-down accounting adjustments, which decreased charge-off coverage by 261 basis points for the three months ended June 30, 2011 and 271 basis points for the six months ended June 30, 2011.
Delinquency and changes in delinquency by type were as follows:
(dollars in millions) | Successor Company | Predecessor Company | ||||||||||||||||
June 30, | 2011 | 2010 | ||||||||||||||||
Amount | Change | Amount | Change | |||||||||||||||
Real estate loans | $ | 937.6 | $ | (60.7 | ) | $ | 998.3 | $ | 25.0 | |||||||||
Non-real estate loans | 88.9 | (39.5 | ) | 128.4 | (56.5 | ) | ||||||||||||
Retail sales finance | 17.2 | (29.3 | ) | 46.5 | (19.7 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 1,043.7 | $ | (129.5 | ) | $ | 1,173.2 | $ | (51.2 | ) | ||||||||
|
|
|
|
|
|
|
|
Delinquency ratios and changes in delinquency ratios in basis points by type were as follows:
Successor Company | Predecessor Company | |||||||||||||||||
June 30, | 2011 | 2010 | ||||||||||||||||
Ratio | Change | Ratio | Change | |||||||||||||||
Real estate loans | 7.48 | % | 43 | bp | 7.05 | % | 78 | bp | ||||||||||
Non-real estate loans | 3.07 | (103 | ) | 4.10 | (78 | ) | ||||||||||||
Retail sales finance | 3.61 | (218 | ) | 5.79 | 222 | |||||||||||||
Total | 6.56 | 8 | 6.48 | 70 |
The total delinquency ratio at June 30, 2011 increased when compared to June 30, 2010 primarily due to an increase in real estate loan delinquency reflecting real estate loan liquidations, partially offset by decreases in non-real estate loan and retail sales finance delinquency ratios reflecting our tighter underwriting guidelines.
Our Credit Strategy and Policy Committee evaluates our finance receivable portfolio monthly to determine the appropriate level of the allowance for finance receivable losses. We believe the amount of the allowance for finance receivable losses is the most significant estimate we make. In our opinion, the allowance is adequate to absorb losses inherent in our existing portfolio. The decrease in the allowance for finance receivable losses at June 30, 2011 when compared to June 30, 2010 was primarily due to the impact of push-down accounting adjustments, which resulted in reducing the allowance for finance receivables losses to zero at November 30, 2010. We also decreased our allowance for finance receivable losses through the provision for finance receivable losses during the third and fourth quarters of 2010 in response to our lower delinquency and net charge-offs in 2010. The allowance for finance receivable losses at June 30, 2011 also included $18.0 million related to TDRs, compared to $413.3 million at June 30, 2010. See Note 3 of the Notes to Consolidated Financial Statements in Item 8 for further information on our TDRs.
The decrease in the allowance ratio at June 30, 2011 when compared to June 30, 2010 was primarily due to the impact of push-down accounting adjustments, which reduced the allowance ratio by 760 basis points at June 30, 2011.
69
Table of Contents
Insurance Revenues
Insurance revenues were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Earned premiums | $ | 29.8 | $ | 31.1 | $ | 58.2 | $ | 62.5 | ||||||||||||
Commissions | — | 0.3 | 0.1 | 0.4 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 29.8 | $ | 31.4 | $ | 58.3 | $ | 62.9 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Amount change | $ | (1.6 | ) | $ | (2.6 | ) | $ | (4.6 | ) | $ | (6.1 | ) | ||||||||
Percent change | (5 | )% | (8 | )% | (7 | )% | (9 | )% |
Earned premiums decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to a decrease in credit earned premiums.
Investment Revenue
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Investment revenue | $ | 10.0 | $ | 10.6 | $ | 17.8 | $ | 18.3 | ||||||||||||
Amount change | $ | (0.6 | ) | $ | (4.1 | ) | $ | (0.5 | ) | $ | (5.1 | ) | ||||||||
Percent change | (6 | )% | (28 | )% | (3 | )% | (22 | )% |
Investment revenue was affected by the following:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Average invested assets | $ | 984.1 | $ | 937.7 | $ | 988.3 | $ | 941.9 | ||||||||||||
Average invested asset yield | 4.08 | % | 5.85 | % | 4.00 | % | 5.65 | % | ||||||||||||
Net realized losses on investment securities | $ | (0.3 | ) | $ | (1.9 | ) | $ | (2.5 | ) | $ | (7.1 | ) |
Average invested assets increased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of push-down accounting adjustments, which increased average invested assets by $45.2 million for three months ended June 30, 2011 and $41.6 million for the six months ended June 30, 2011. Average invested asset yield decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of push-down accounting adjustments, which decreased average invested asset yield by 104 basis points for the three months ended June 30, 2011 and 108 basis points for the six months ended June 30, 2011.
70
Table of Contents
Gain on Early Extinguishment of Secured Term Loan
As a result of the refinancing of our secured term loan on May 10, 2011, we recorded a $10.7 million gain on its early extinguishment for the three and six months ended June 30, 2011. See Capital Resources and Liquidity – Capital Resources for further information.
Other Revenues
Other revenues were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Derivative adjustments | $ | 40.8 | $ | (76.9 | ) | $ | 78.5 | $ | (37.9 | ) | ||||||||||
Foreign exchange (losses) gains on foreign currency denominated debt | (16.9 | ) | 73.8 | (55.9 | ) | 116.1 | ||||||||||||||
Writedowns on real estate owned | (13.7 | ) | (9.9 | ) | (22.6 | ) | (17.6 | ) | ||||||||||||
Net (loss) gain on sales of real estate owned | (4.3 | ) | 0.2 | (8.9 | ) | (3.2 | ) | |||||||||||||
Interest revenue – notes receivable from SLFI | 4.3 | 5.5 | 8.6 | 7.1 | ||||||||||||||||
Loan brokerage fees | 1.4 | 1.5 | 2.6 | 3.0 | ||||||||||||||||
Mortgage banking revenues | 0.5 | 3.0 | 1.2 | 5.2 | ||||||||||||||||
Net service fees | — | 1.3 | — | 1.7 | ||||||||||||||||
Other | 2.1 | 4.6 | 3.6 | 8.7 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 14.2 | $ | 3.1 | $ | 7.1 | $ | 83.1 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Amount change | $ | 11.1 | $ | 46.0 | $ | (76.0 | ) | $ | 157.2 | |||||||||||
Percent change | 362 | % | 107 | % | (91 | )% | 212 | % |
Other revenues for the three and six months ended June 30, 2011 reflected gains arising from derivative adjustments, partially offset by foreign exchange losses on foreign currency denominated debt and writedowns on real estate owned.
Derivative adjustments for the three months ended June 30, 2011 included a mark to market gain of $20.8 million on our non-designated cross currency derivative and a net gain of $20.0 million reflecting derivative gains and net interest income. Derivative adjustments for the six months ended June 30, 2011 included a mark to market gain of $40.3 million on our non-designated cross currency derivative and a net gain of $38.3 million reflecting derivative gains and net interest income, partially offset by a credit valuation adjustment loss on our non-designated cross currency derivative and ineffectiveness losses on our cash flow derivatives.
The loss in other revenues for the three months ended June 30, 2010 reflected losses arising from derivative adjustments that were not fully offset by foreign exchange gains on foreign currency denominated debt. Derivative adjustments for the three months ended June 30, 2010 included a mark to market loss of $61.4 million on our non-designated cross currency derivative and an ineffectiveness loss of $20.8 million on our cash flow derivatives. These losses were partially offset by a credit valuation adjustment gain of $3.8 million on our non-designated cross currency derivative.
71
Table of Contents
Other revenues for the six months ended June 30, 2010 reflected foreign exchange gains on foreign currency denominated debt that were not fully offset by losses arising from derivative adjustments. Derivative adjustments for the six months ended June 30, 2010 included a mark to market loss of $95.7 million on our non-designated cross currency derivative and an ineffectiveness loss of $28.0 million on our cash flow derivatives. These losses were partially offset by an other comprehensive income release gain of $68.8 million on cash flow hedge maturities and a credit valuation adjustment gain of $12.9 million on our non-designated cross currency derivative.
The credit valuation adjustment on our non-designated cross currency derivative for the three and six months ended June 30, 2011 and 2010 resulted from the measurement of credit risk using credit default swap valuation modeling. If we do not exit these derivatives prior to maturity, the credit valuation adjustment will result in no impact to earnings over the life of the agreements. We currently do not anticipate exiting these derivatives for the foreseeable future.
Operating Expenses
Operating expenses were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Salaries and benefits | $ | 92.9 | $ | 98.0 | $ | 186.2 | $ | 197.3 | ||||||||||||
Other operating expenses | 105.9 | 85.7 | 180.4 | 166.8 | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 198.8 | $ | 183.7 | $ | 366.6 | $ | 364.1 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Amount change | $ | 15.1 | $ | (17.4 | ) | $ | 2.5 | $ | (23.2 | ) | ||||||||||
Percent change | 8 | % | (9 | )% | 1 | % | (6 | )% | ||||||||||||
Operating expenses as a percentage of average net receivables | 5.85 | % | 4.18 | % | 5.32 | % | 4.08 | % |
Salaries and benefits decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to fewer employees.
Other operating expenses increased for the three months ended June 30, 2011 when compared to the same period in 2010 primarily due to higher professional services expenses and the impact of push-down accounting adjustments, including the amortization of other intangible assets.
Other operating expenses increased for the six months ended June 30, 2011 when compared to the same period in 2010 primarily due to higher professional services expenses and the impact of push-down accounting adjustments, including the amortization of other intangible assets, partially offset by lower administrative expenses allocated from our former indirect parent, lower occupancy expenses, and lower legal settlement expenses.
Operating expenses as a percentage of average net receivables increased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 primarily due to the impact of push-down accounting adjustments, which increased the operating expense ratio by 95 basis points for the three months ended June 30, 2011 and 91 basis points for the six months ended June 30, 2011.
72
Table of Contents
Insurance Losses and Loss Adjustment Expenses
Insurance losses and loss adjustment expenses were as follows:
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Claims incurred | $ | 15.1 | $ | 15.6 | $ | 30.2 | $ | 33.6 | ||||||||||||
Change in benefit reserves | (15.0 | ) | (4.4 | ) | (17.5 | ) | (6.8 | ) | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 0.1 | $ | 11.2 | $ | 12.7 | $ | 26.8 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Amount change | $ | (11.1 | ) | $ | (5.3 | ) | $ | (14.1 | ) | $ | (6.5 | ) | ||||||||
Percent change | (99 | )% | (32 | )% | (53 | )% | (19 | )% |
In second quarter 2011, we recorded an out of period adjustment related to prior periods, which decreased change in benefit reserves by $14.2 million for the three and six months ended June 30, 2011. This adjustment related to the correction of a benefit reserve error related to a closed block of annuities. After evaluating the quantitative and qualitative aspects of this correction, management has determined that the out of period adjustment is immaterial to our estimated full year results and that our previously issued quarterly and annual consolidated financial statements were not materially misstated.
Benefit from Income Taxes
(dollars in millions) | Successor Company | Predecessor Company | Successor Company | Predecessor Company | ||||||||||||||||
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||
Benefit from income taxes | $ | (40.1 | ) | $ | (54.0 | ) | $ | (72.2 | ) | $ | (105.1 | ) | ||||||||
Amount change | $ | 13.9 | $ | (49.5 | ) | $ | 32.9 | $ | (104.1 | ) | ||||||||||
Percent change | 26 | % | N/M | * | 31 | % | N/M | |||||||||||||
Pretax loss | $ | (99.4 | ) | $ | (9.8 | ) | $ | (186.7 | ) | $ | (48.4 | ) | ||||||||
Effective income tax rate | 40.33 | % | N/M | 38.69 | % | N/M |
* | Not meaningful |
Pretax loss for the three months ended June 30, 2011 increased when compared to the same period in 2010 primarily due to higher interest expense, higher provision for finance receivable losses, and higher operating expenses, partially offset by higher finance charges and higher other revenues.
Pretax loss for the six months ended June 30, 2011 increased when compared to the same period in 2010 primarily due to higher interest expense and lower other revenues, partially offset by lower provision for finance receivable losses and higher finance charges.
Benefit from income taxes decreased for the three and six months ended June 30, 2011 when compared to the same periods in 2010 as a result of the FCFI Transaction and the resulting changes in the book and tax basis of our assets and liabilities and the benefit in 2010 from the release of the deferred tax valuation allowance.
73
Table of Contents
At June 30, 2011, we recorded a valuation allowance of $0.7 million for our foreign United Kingdom operations to reduce net deferred tax assets to amounts we considered more likely than not (a likelihood of more than 50 percent) to be realized. No valuation allowance was required on our remaining gross deferred tax assets. At June 30, 2011, we had a net deferred tax liability of $408.7 million.
Before the FCFI Transaction, the Company was in a net deferred tax asset position and, excluding the foreign operations, the assets were subject to a full valuation allowance.
Benefit from income taxes for the three and six months ended June 30, 2010 reflected AIG’s projection that it would have sufficient taxable income in 2010 to utilize our 2010 estimated tax losses. As a result, we had classified $107.1 million of our 2010 losses as a current tax receivable. In connection with the closing of the FCFI Transaction, AIG and SLFI amended their tax sharing agreement, which terminated on the closing, (1) to provide that the parties’ payment obligations under the tax sharing agreement were limited to the payments required to be made by AIG to SLFI with respect to the 2009 taxable year, and (2) to include the terms of the promissory note to be issued by AIG in satisfaction of its 2009 taxable year payment obligation to SLFI. Due to the amendment of the tax sharing agreement, SLFI did not receive the payment for the tax period ending November 30, 2010. As a result, we recorded a dividend to SLFI for the amount of the income tax receivable remaining at the closing of the FCFI Transaction.
The lower effective income tax rate for the three and six months ended June 30, 2011 when compared to the same periods in 2010 reflected the release of the deferred tax valuation allowance in the prior periods.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
There have been no significant changes to our market risk since December 31, 2010.
74
Table of Contents
Item 4. Controls and Procedures.
(a) | Evaluation of Disclosure Controls and Procedures |
The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms. The Company’s disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
The Company’s management, including its Chief Executive Officer and its Chief Financial Officer, evaluates the effectiveness of our disclosure controls and procedures as of the end of each quarter and year using the framework and criteria established in “Internal Control – Integrated Framework”, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on an evaluation of the disclosure controls and procedures as of June 30, 2011, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective and that the condensed consolidated financial statements fairly present our consolidated financial position and the results of our operations for the periods presented.
(b) | Changes in Internal Control over Financial Reporting |
There have been no changes in the Company’s internal control over financial reporting during the three months ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
See Note 19 of the Notes to Condensed Consolidated Financial Statements in Part I of this Quarterly Report on Form 10-Q.
75
Table of Contents
We face a variety of risks that are inherent in our business. Accordingly, you should carefully consider the following discussion of risks in addition to the risk factors and other information regarding our business provided in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (our “2010 Annual Report”), including “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I of this Quarterly Report on Form 10-Q and “Item 1. Business” and “Item 1A. Risk Factors” in Part I and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our 2010 Annual Report. These risks are subject to contingencies which may or may not occur, and we are not able to express a view on the likelihood of any such contingency occurring. New risks may emerge at any time, and we cannot predict those risks or estimate the extent to which they may affect our business or financial performance.
The assessment of our liquidity is based upon significant judgments or estimates that could prove to be materially incorrect.
In assessing our current financial position and developing operating plans for the future, management has made significant judgments and estimates with respect to our liquidity, including but not limited to:
• | the amount of cash expected to be received from our finance receivable portfolio through collections (including prepayments) and receipt of finance charges, which could be materially different than our estimates; |
• | the potential for declining financial flexibility and reduced income should we use more of our assets for securitizations and portfolio sales; |
• | reduced income due to the possible deterioration of the credit quality of our finance receivable portfolios; |
• | our ability to complete on favorable terms, as needed, additional borrowings, securitizations, portfolio sales, or other transactions to support liquidity, and the costs associated with these funding sources, including sales at less than carrying value and limits on the types of assets that can be securitized or sold, which would affect profitability; |
• | risks in connection with the formation and operation of Springleaf REIT, a recently established subsidiary which intends to elect and qualify to be taxed as a REIT, which we expect to manage, which we expect will own almost all of our existing real estate finance receivable portfolio, as well as our future real estate loan originations, and which we expect will sell a significant percentage of its common stock to the public; |
• | our ability to comply with our debt covenants; |
• | our access to debt markets and other sources of funding on favorable terms; |
• | potential costs for our United Kingdom subsidiaries resulting from the retroactive imposition of guidelines issued in August 2010 by the United Kingdom Financial Services Authority for sales of payment protection insurance that occurred after January 1, 2005, including possible refunds to customers; |
• | the effect of federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Act (which, among other things, established a federal Consumer Financial Protection Bureau with broad authority to regulate and examine financial institutions), on our ability to conduct business or the manner in which we conduct business, such as licensing requirements, pricing limitations or restrictions on the method of offering products, as well as changes that may result from increased regulatory scrutiny of the sub-prime lending industry; |
• | potential liability (including the obligation to repurchase securitized or sold loans) resulting from any non-compliance with laws applicable to the origination and servicing of loans, including laws regulating loans that are classified as “high-cost” and “higher-priced” loans, and any practices that are classified as “unfair” or “predatory”; |
76
Table of Contents
• | the potential for it to become increasingly costly and difficult to service our loan portfolio, especially our real estate loan portfolio (including costs and delays associated with foreclosure on real estate collateral), as a result of heightened nationwide regulatory scrutiny of loan servicing and foreclosure practices in the industry generally, and related costs that could be passed on to us in connection with Nationstar’s servicing of our centralized mortgage loan portfolio; |
• | potential liability relating to real estate loans which we have sold or will sell in the future, or relating to securitized loans, if it is determined that there was a non-curable breach of a warranty made in connection with the transaction; |
• | the potential for additional unforeseen cash demands or accelerations of obligations; |
• | reduced income due to loan modifications where the borrower’s interest rate is reduced, principal payments are deferred, or other concessions are made; |
• | the potential for declines in bond and equity markets; |
• | the potential effect on us if the capital levels of our regulated and unregulated subsidiaries prove inadequate to support current business plans; |
• | the potential loss of key personnel; and |
• | the undetermined effects of the FCFI Transaction, including the availability of support from our new owner and the effect of any changes to our operations, capitalization, or business strategies. |
We have assumed that there will be no support required from FCFI and no material change in our recent liquidity sources and capitalization management. We intend to support our liquidity position by managing originations and purchases of finance receivables and maintaining disciplined underwriting standards and pricing on such loans. We intend to support operations and repay obligations with one or more of the following: finance receivable collections from operations, securitizations, additional term loans, potential unsecured debt offerings, potential proceeds from the Springleaf REIT stock offering, and portfolio sales.
Based on our estimates and taking into account the risks and uncertainties of such plans, we believe that we will have adequate liquidity to finance and operate our businesses and repay our obligations as they become due for at least the next twelve months.
It is possible that the actual outcome of one or more of our plans could be materially different than expected or that one or more of our significant judgments or estimates about the potential effects of these risks and uncertainties could prove to be materially incorrect.
77
Table of Contents
Our business is subject to risks in connection with the formation and operation of Springleaf REIT, which could have a material adverse effect on our consolidated results of operations or financial condition.
Our business is subject to risks in connection with the formation and operation of Springleaf REIT, including:
• | the possibility that the initial public offering of Springleaf REIT common stock may not be completed due to market conditions or other events, which would reduce our proposed sources of liquidity; |
• | additional costs associated with operating a REIT with common stock that is held by the public and listed on a securities exchange, which could reduce our financial flexibility; |
• | our lack of experience with managing a REIT, which could hinder the ability of Springleaf REIT to achieve its investment objectives; |
• | the possibility that, under our intended agreement with Springleaf REIT pursuant to which we would be required to offer to sell our newly-originated mortgage loans to Springleaf REIT, we are not able to originate a sufficient volume of loans to allow Springleaf REIT to operate profitably or the possibility that Springleaf REIT will terminate such agreement; |
• | the possibility that Springleaf REIT may terminate our intended agreement to service the loans held by Springleaf REIT; and |
• | potential liability relating to real estate loans that we intend to sell to Springleaf REIT, if it is determined that there was a breach of a warranty made in connection with the transaction. |
The realization of one or more of the aforementioned risks could have a material adverse effect on our consolidated results of operations or financial condition.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On June 20, 2011, in order to satisfy a non-debt capital funding requirement with respect to SLFC’s hybrid debt, SLFC issued one share of SLFC common stock to SLFI for $10.5 million. The share of SLFC common stock was issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. See “Capital Resources and Liquidity – Capital Resources” in Part I, Item 2 of this Quarterly Report on Form 10-Q.
Item 3. Defaults Upon Senior Securities.
None.
None.
78
Table of Contents
Exhibits are listed in the Exhibit Index beginning on page 81 herein.
79
Table of Contents
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SPRINGLEAF FINANCE CORPORATION | ||||||||
(Registrant) | ||||||||
Date: | August 11, 2011 | By | /s/ Donald R. Breivogel, Jr. | |||||
Donald R. Breivogel, Jr. | ||||||||
Senior Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) |
80
Table of Contents
Exhibit Index
Exhibit
3.1 | Amended and Restated Articles of Incorporation of Springleaf Finance Corporation (formerly American General Finance Corporation), as amended to date. Incorporated by reference to Exhibit (3a.) to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010. |
3.2 | Amended and Restated By-laws of Springleaf Finance Corporation, as amended to date. Incorporated by reference to Exhibit (3b.) to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010. |
10.1 | Amended and Restated Credit Agreement, dated as of May 10, 2011, among Springleaf Financial Funding Company; Springleaf Finance Corporation; the Subsidiary Guarantors party thereto; Bank of America, N.A.; Other Lenders party thereto; Merrill Lynch, Pierce, Fenner & Smith Incorporated; JPMorgan Chase Bank, N.A.; and J.P. Morgan Securities LLC. Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated May 6, 2011. |
12 | Computation of Ratio of Earnings to Fixed Charges |
31.1 | Rule 13a-14(a)/15d-14(a) Certifications of the President and Chief Executive Officer of Springleaf Finance Corporation |
31.2 | Rule 13a-14(a)/15d-14(a) Certifications of the Senior Vice President and Chief Financial Officer of Springleaf Finance Corporation |
32 | Section 1350 Certifications |
101* | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive (Loss) Income, (iv) Condensed Consolidated Statements of Shareholder’s Equity, (v) Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text. |
* | As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Section 11 and 12 of the Securities and Exchange Act of 1933 and Section 18 of the Securities and Exchange Act of 1934. |
81