Item 1. Business.
GENERAL
Springleaf Finance, Inc. (SLFI or, collectively with its subsidiaries, whether directly or indirectly owned, the Company, we, us, or our) was incorporated in Indiana in 1974 to become the parent holding company of Springleaf Finance Corporation (SLFC). SLFC was incorporated in Indiana in 1927 as successor to a business started in 1920.
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 10, 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). Through an integrated series of transactions pursuant to the terms of the Stock Purchase Agreement and the related transfer agreement, AIG formed and initially capitalized a new holding company, AGF Holding Inc. (AGF Holding), as a subsidiary of ACC. ACC contributed all of the outstanding shares of SLFI to AGF Holding on November 30, 2010 immediately prior to the FCFI Transaction. AIG then caused ACC to sell to FCFI 80% of the outstanding shares of AGF Holding. AIG, through ACC, retained 20% of the outstanding shares of AGF Holding and, indirectly, 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 (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 Annual Report on Form 10-K through the inclusion of a vertical black line between the Successor Company and the Predecessor Company columns.
The financial information for 2010 includes the financial information of the Successor Company for the one month ended December 31, 2010 and of the Predecessor Company for the eleven months ended November 30, 2010. These separate periods are presented to reflect the new accounting basis established for our Company as of November 30, 2010.
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 one month ended December 31, 2010 and for the year ended December 31, 2011 have been the same as those reported if push-down accounting had not been applied. Additionally, key ratios of the Successor Company are not comparable to those of the Predecessor Company, nor are they comparable to other institutions due to the new accounting basis established. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 for further information on the FCFI Transaction.
SLFI is a financial services holding company whose principal subsidiary is SLFC, which is a Securities and Exchange Commission (SEC) registrant. SLFC is a financial services holding company with subsidiaries engaged in the consumer finance and credit insurance businesses. We conduct the credit insurance business to supplement our consumer finance business through Merit Life Insurance Co. (Merit) and Yosemite Insurance Company (Yosemite), which are both wholly-owned subsidiaries of SLFC.
At December 31, 2011, the Company had 1,118 branch offices in 40 states, Puerto Rico, and the U.S. Virgin Islands; foreign operations in the United Kingdom; and approximately 5,800 employees. Our executive offices are located in Evansville, Indiana.
Continued challenging economic conditions and other factors, including high unemployment and the troubled residential real estate market, have negatively affected the markets in which we conduct our business.
· As of January 1, 2012, the Company ceased new originations of real estate loans so that it could focus on its other consumer lending products and its insurance operations.
· On February 1, 2012, we informed affected employees of our plan to close approximately 60 branch offices and immediately cease consumer lending and retail sales financing in 14 states where we do not have a significant presence and in southern Florida. The states affected are: Arizona, Delaware, Iowa, Kansas, Maryland, Michigan, Montana, Nebraska, Nevada, New Jersey, New York, South Dakota, Utah, and Wyoming. Customer accounts in the affected areas will be serviced by our other branches in those states or by other service centers. As a result of the initial branch closings, we expect to incur a pretax charge in the first quarter of 2012 of approximately $5.3 million (revised subsequent to our Form 8-K filing dated February 1, 2012). Also as a result of the branch office closings, our workforce was immediately reduced by approximately 200 employees (revised subsequent to our Form 8-K filing dated February 1, 2012).
· On February 15, 2012, we reduced the workforce at our Evansville, Indiana headquarters by approximately 130 employees due to the cessation of real estate lending, the branch closings, and the cessation of consumer lending and retail sales financing in 14 states and southern Florida. As a result of the headquarters workforce reduction, we expect to incur a pretax charge in the first quarter of 2012 of approximately $2.7 million.
· On March 2, 2012, we informed affected employees of our plan to immediately consolidate certain branch operations and close approximately 150 branch offices in 25 states. The states affected are: Alabama, California, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maryland, Mississippi, New Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington, West Virginia and Wisconsin. Customer accounts in the affected areas will be serviced by our other branches in those states or by other service centers. As a result of these branch closings, we expect to incur a pretax charge in the first quarter of 2012 of approximately $12.5 million. Also as a result of these branch office closings, our workforce was immediately reduced by approximately 360 employees.
· On March 2, 2012, the Company sold approximately 13,100 non-real estate and retail sales finance receivable accounts in Delaware, New Jersey, and Maryland with a carrying value of $45.0 million pursuant to a letter of intent to sell dated January 27, 2012. The receivables were sold at a loss of $0.4 million.
The branch closings and staff reductions described above are the result of our efforts to return to profitability. However, there can be no assurance that these efforts will be effective. In addition, we have retained Alvarez & Marsal North America, LLC and Houlihan Lokey Capital, Inc. to assist us with identifying ways to streamline our operations and reduce costs and to provide financial advisory services.
SEGMENTS
We have three business segments: branch, centralized real estate, and insurance. 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.
We report our segment totals using the historical basis of accounting because management analyzes each business segment on a historical basis. However, in order to reconcile to our 2010 total consolidated financial statement amounts, we are presenting our 2010 segment totals at or for the one month ended December 31, 2010 and for the eleven months ended November 30, 2010. See Note 26 of the Notes to Consolidated Financial Statements in Item 8 for reconciliations of segment totals to consolidated financial statement amounts.
Branch Business Segment
The branch business segment is the core of the Company’s operations. Through its 1,118 branch offices and its centralized support operations, the 4,660 employees of the branch business segment serviced 1.0 million real estate loans, non-real estate loans, and retail sales finance accounts totaling $9.7 billion at December 31, 2011.
Our branch customers encompass a wide range of borrowers. In the consumer finance industry, they are described as prime or near-prime at one extreme and non-prime or sub-prime at the other. These customers’ incomes are generally near the national median but vary, as do their debt-to-income ratios, employment and residency stability, and credit repayment histories. In general, branch customers have lower credit quality than our centralized real estate customers and require significant levels of servicing and, as a result, we charge them interest rates higher than our centralized real estate customers to compensate us for such services and related credit risks.
Structure and Responsibilities. Branch personnel originate non-real estate loans, purchase retail sales finance contracts from retail merchants, offer credit and non-credit insurance and ancillary products to the loan customers, and service these receivables. Branch managers establish retail merchant relationships, identify portfolio acquisition opportunities, manage finance receivable credit quality, and are responsible for branch profitability. Branch managers also hire and train the branch staff and supervise their work. The Company coordinates branch staff training through centrally developed training programs to maintain quality customer service.
Prior to January 1, 2012, our branch personnel also originated real estate loans. Although the Company has ceased its real estate lending as of January 1, 2012, we continue to service these real estate loans and may still be making advances for a period of time for certain existing lines of credit.
We continuously review the performance of our individual branches and the markets they serve, as well as economic conditions. During 2011, we closed 52 branch offices. Customers of closed branch offices are primarily serviced by our other nearby offices.
Products and Services. Non-real estate loans are secured by consumer goods, automobiles, or other personal property or are unsecured, and are generally fixed-rate, fixed-term loans with maximum original terms of 60 months. We also offer unsecured lines of credit to customers that meet the criteria in our credit risk policies.
We purchase retail sales contracts and provide revolving retail sales financing services arising from the retail sale of consumer goods and services by retail merchants. Retail sales contracts are closed-end accounts that represent a single purchase transaction. Revolving retail are open-end accounts that can be used for financing repeated purchases from the same merchant. Retail sales contracts are secured by the real property or personal property designated in the contract and generally have maximum original terms of 60 months. Revolving retail are secured by the goods purchased and generally require minimum monthly payments based on the amount financed calculated after the most recent purchase or outstanding balances. We refer to retail sales contracts and revolving retail collectively as “retail sales finance.”
Real estate loans are secured by first or second mortgages on residential real estate (including manufactured housing), generally have maximum original terms of 360 months, and are usually considered non-conforming. At December 31, 2011, $765.3 million, or 12% of our branch real estate loans, were second mortgages. Real estate loans may be closed-end accounts or open-end home equity lines of credit and are primarily fixed-rate products. At December 31, 2011, $431.5 million, or 7% of our branch real estate loans, were adjustable-rate mortgages. Our real estate loans do not contain any borrower payment options that allow the loan principal balance to increase through negative loan amortization. The home equity lines of credit generally have a predetermined period during which the borrower may take advances. After this draw period, all advances outstanding under the line of credit convert to a fixed-term repayment period, usually over an agreed upon period between 15 and 30 years.
We offer credit life, credit accident and health, credit related property and casualty, credit involuntary unemployment, and non-credit insurance and ancillary products to all eligible branch customers. Insurance companies (including Merit and Yosemite) and/or financial services companies issue these products which we describe under “Insurance Business Segment.”
Customer Development. We solicit finance receivable customers through a variety of channels including mail, E-commerce, and telephone calls.
We solicit new prospects, as well as current and former customers, through a variety of mail offers. Our data warehouse is a central, proprietary source of information regarding current and former customers. We use this information to tailor offers to specific customer segments. In addition to internal data, we purchase prospect lists from major list vendors based on predetermined selection criteria. Mail solicitations include invitations to apply and guaranteed loan offers.
E-commerce provides another source of new customers. Our website includes a brief, user-friendly credit application that, upon completion, is automatically routed to the branch office nearest the consumer. We have established E-commerce relationships with a variety of search engines to bring prospects to our website. Our website also has a branch office locator feature so potential customers can find the branch office nearest to them and can contact branch personnel directly.
New customer relationships also begin through our alliances with approximately 13,500 retail merchants across the United States. After a customer utilizes the merchant’s retail sales financing option, we may purchase that retail sales finance obligation. We then contact the customer using various marketing methods to invite the customer to discuss his or her overall credit needs with our consumer lending specialists. Any resulting loan may pay off the customer’s retail sales finance obligation, along with his or her debts with other creditors, into one consolidated loan with us. During 2011, our retail merchants increased from 8,500 to 13,500, reflecting the enrollment of new dealer operating agreements primarily resulting from our new promotional revolving retail program that we implemented in early 2011.
Our consumer lending specialists, who, where required, are licensed to offer insurance and ancillary products, explain our credit and non-credit insurance and ancillary products to the customer. The customer then determines whether to purchase any of these products.
Account Servicing. Establishing and maintaining customer relationships is very important to us. Branch personnel contact our current customers through solicitation or collection phone calls to assess customers’ current financial situations to determine if they desire additional funds. Centralized support operations personnel contact our retail sales finance customers through solicitation or collection calls. Solicitation and collection efforts are opportunities to help our customers solve their temporary financial problems and to maintain our customer relationships.
Selected Financial Information. Amount, number, and average size of total net finance receivables originated and renewed by portfolio segment for the branch business segment (which are reported on a historical basis of accounting) were as follows:
Amount, number, and average size of net finance receivables by portfolio segment for the branch business segment (which are reported on a historical basis of accounting) were as follows:
Selected financial data for the branch business segment (which are reported on a historical basis of accounting) were as follows:
* Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
Centralized Real Estate Business Segment
The centralized real estate business segment includes generally non-conforming residential real estate loans that were originated or purchased through distribution channels other than our branches. MorEquity, Inc. (MorEquity), a wholly-owned subsidiary of SLFC, is included in this segment. Real estate loans in our centralized real estate business segment have typically had higher credit quality than the real estate loans originated by our branch business segment and are thereby cost-effectively serviced centrally. Our centralized real estate customers are generally described as either prime or near-prime, but for reasons such as elevated debt-to-income ratios, lack of income stability, the level of income disclosure and verification required for a conforming mortgage, as well as credit repayment history or similar measurements, or convenience, they have applied for a non-conforming mortgage. The distribution channels have included direct lending to customers and portfolio acquisitions from third-party lenders. However, with our current limited funding sources, we are not pursuing originations or acquisitions. Since all of the real estate loans in our centralized real estate business segment were either serviced or subserviced externally, the centralized real estate business segment had no employees at December 31, 2011.
Structure and Responsibilities. During 2011, our centralized real estate business segment originated $4.0 million of real estate loans (primarily additional advances on revolving accounts), as we focused on new lending in our branches.
Products and Services. Real estate loans are secured by first or second mortgages on residential real estate and are generally considered non-conforming. At December 31, 2011, $28.5 million or less than 1% of our centralized real estate loans, were second mortgages. Real estate loans generally have maximum original terms of 360 months but we also have offered loans with maximum original terms of 480 months and 600 months, some of which require a balloon payment at the end of 360 months. At December 31, 2011, $199.5 million, or 4% of our centralized real estate loans, were adjustable-rate mortgages. Our real estate loans do not contain any borrower payment options that allow the loan principal balance to increase through negative loan amortization.
At December 31, 2011, MorEquity had $537.1 million of interest only real estate loans. Our underwriting criteria for interest only loans included borrower qualification on a fully amortizing payment basis and excluded investment properties. At December 31, 2011, MorEquity also had $678.7 million of real estate loans that amortize over 480 months or 600 months, some of which require a balloon payment at the end of 360 months.
Account Servicing. From a centralized location, MorEquity serviced approximately 15,000 real estate loans totaling $2.8 billion at December 31, 2011, all of which are subserviced by Nationstar Mortgage LLC (Nationstar), a non-subsidiary affiliate of SLFI. See Note 11 of the Notes to Consolidated Financial Statements in Item 8 for further information on the subservicing agreement. At December 31, 2011, approximately 8,300 of MorEquity’s loans totaling $1.5 billion were serviced by a third party in conjunction with the 2009 securitization of these real estate loans. MorEquity’s real estate loans were generated through:
· portfolio acquisitions from third-party lenders;
· our mortgage origination subsidiaries;
· refinancing existing mortgages;
· advances on home equity lines of credit; or
· correspondent relationships.
Selected Financial Information. Selected financial data for the centralized real estate business segment’s real estate loans (which are reported on a historical basis of accounting) were as follows:
(a) Not meaningful. The amount originated and renewed includes additional advances made on revolving accounts, while the loan count is included only when the original loan is made (not as each advance is made).
(b) Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
Insurance Business Segment
The insurance business segment markets its products to eligible branch customers. We invest cash generated from operations in investment securities, commercial mortgage loans, investment real estate, and policy loans and also use it to pay dividends. The 80 employees of the insurance business segment have numerous underwriting, compliance, and service responsibilities for the insurance companies and also provide services to the branch and centralized real estate business segments.
Structure and Responsibilities. Merit is a life and health insurance company domiciled in Indiana and licensed in 46 states, the District of Columbia, and the U.S. Virgin Islands. Merit writes or reinsures credit life, credit accident and health, and non-credit insurance.
Yosemite is a property and casualty insurance company domiciled in Indiana and licensed in 46 states. Yosemite writes or reinsures credit-related property and casualty and credit involuntary unemployment insurance.
Products and Services. Our credit life insurance policies insure the life of the borrower in an amount typically equal to the unpaid balance of the finance receivable and provide for payment in full to the lender of the finance receivable in the event of the borrower’s death. Our credit accident and health insurance policies provide, to the lender, payment of the installments on the finance receivable coming due during a period of the borrower’s disability due to illness or injury. Our credit-related property and casualty insurance policies are written to protect the lender’s interest in property pledged as collateral for the finance receivable. Our credit involuntary unemployment insurance policies provide, to the lender, payment of the installments on the finance receivable coming due during a period of the borrower’s involuntary unemployment. The borrower’s purchase of credit life, credit accident and health, credit-related property and casualty, or credit involuntary unemployment insurance is voluntary with the exception of lender-placed property damage coverage for property pledged as collateral. In these instances, our branch or centralized real estate business segment personnel obtain property damage coverage through Yosemite either on a direct or reinsured basis under the terms of the lending agreement if the borrower does not provide evidence of coverage with another insurance carrier. Non-credit insurance policies are primarily traditional life level term policies. The purchase of this coverage is also voluntary.
The ancillary products we offer are home security and auto security membership plans and home warranty service contracts of unaffiliated companies. These products are generally not considered to be insurance policies. Our insurance business segment has no risk of loss on these products. The unaffiliated companies providing these membership plans and service contracts are responsible for any required reimbursement to the customer on these products.
Customers usually either pay premiums for insurance products monthly with their finance receivable payment or finance the premiums and contract fees for ancillary products as part of the finance receivable, but they may pay the premiums and contract fees in cash to the insurer or financial services company. We do not offer single premium credit insurance products to our real estate loan customers.
Reinsurance. Merit and Yosemite enter into reinsurance agreements with other insurers, including subsidiaries of AIG, for reinsurance of various non-credit life, group annuity, credit life, credit accident and health, credit-related property and casualty, and credit involuntary unemployment insurance where our insurance subsidiaries reinsure the risk of loss. The reserves for this business fluctuate over time and in some instances are subject to recapture by the insurer. Yosemite also reinsures risks associated with a closed block of excess and surplus lines dating back to the 1970s. At December 31, 2011, reserves on the books of Merit and Yosemite for reinsurance agreements totaled $78.9 million.
Investments. We invest cash generated by our insurance business segment primarily in bonds. We invest in, but are not limited to, the following:
· bonds;
· commercial mortgage loans;
· short-term investments;
· limited partnerships;
· preferred stock;
· investment real estate;
· policy loans; and
· common stock.
Prior to January 1, 2011, other AIG subsidiaries managed substantially all of our insurance business segment’s investments on our behalf, under the supervision and control of our investment committee. Effective January 1, 2011, these investments are managed by a third party on our behalf, under the supervision and control of our investment committee.
Selected Financial Information. Selected financial data for the insurance business segment (which are reported on a historical basis of accounting) were as follows:
* Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
CREDIT RISK MANAGEMENT
A risk in all consumer lending and retail sales financing transactions is the customer’s unwillingness or inability to repay obligations. Unwillingness to repay is usually evidenced in a consumer’s historical credit repayment record. Declines in residential real estate values also may reduce a customer’s willingness to repay his or her mortgage. An inability to repay usually results from lower income due to unemployment or underemployment, major medical expenses, or divorce. The risk of inability to repay intensifies when economic conditions deteriorate. Occasionally, these events can be so economically severe that the customer files for bankruptcy. Because we evaluate credit applications with a view toward ability to repay, our customer’s inability to repay occurs after our initial credit evaluation and funding of an outstanding finance receivable. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary” in Item 7 for significant economic conditions relevant to the Company.
In our branch business segment, we use credit risk scoring models at the time of credit application to assess our risk of the applicant’s unwillingness or inability to repay. We develop these models using numerous factors, including past customer credit repayment experience, and periodically revalidate these models based on recent portfolio performance. We use different credit risk scoring models for different types of non-real estate loan and retail sales finance products as part of the credit underwriting process. In certain retail sales finance cases, the models are the decision factor for extending credit. For our other products, a measure of manual underwriting is also required. Price and size of the loan or retail sales finance transaction are in relation to the estimated credit risk we assume. Prior to January 1, 2012, we also used credit risk scoring models as part of the credit underwriting process for our real estate loans.
In our centralized real estate business segment, MorEquity originated real estate loans according to established underwriting criteria. We performed due diligence investigations on all portfolio acquisitions, including re-underwriting of the individual real estate loans by our own personnel.
See Notes 6 and 8 of the Notes to Consolidated Financial Statements in Item 8 for additional disclosures relating to our credit quality. See Note 16 of the Notes to Consolidated Financial Statements in Item 8 for a discussion of derivative counterparty credit risk management.
OPERATIONAL CONTROLS
We control and monitor our branch and centralized real estate business segments through a variety of methods including the following:
· Our operational policies and procedures standardize various aspects of lending, collections, and business development processes.
· Our branch finance receivable systems control amounts, rates, terms, and fees of our customers’ accounts; create loan documents specific to the state in which the branch operates; and control cash receipts and disbursements.
· Our headquarters accounting personnel reconcile bank accounts, investigate discrepancies, and resolve differences.
· Our credit risk management system reports are used by various personnel to compare branch lending and collection activities with predetermined parameters.
· Our executive information system is available to headquarters and field operations management to review the status of activity through the close of business of the prior day.
· Our branch field operations management structure is designed to control a large, decentralized organization with succeeding levels of supervision staffed with more experienced personnel.
· Our field operations compensation plan aligns the operating activities and goals with corporate strategies by basing the incentive portion of field personnel compensation on profitability and credit quality.
· Our internal audit department audits the Company for adherence to operational policy and procedure and compliance with federal and state law and regulation.
CENTRALIZED SUPPORT
We continually seek to identify functions that could be more effective if centralized to achieve reduced costs or free our branch lending specialists to service our customers and market our products. Our centralized operational functions support the following:
· mail and telephone solicitations;
· payment processing;
· foreclosure and real estate owned processing;
· collateral protection insurance tracking;
· retail sales finance approvals;
· revolving retail processing and collections;
· merchant services; and
· charge-off recovery operations.
SOURCES OF FUNDS
Our primary sources of funds to support operations and repay indebtedness in 2011 were net collections of finance receivables, the refinancing of SLFC’s secured term loan, an on-balance sheet securitization, and cash generated from operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources and Liquidity - Capital Resources” in Item 7 for further information on SLFC’s secured term loan refinancing and Note 7 of the Notes to Consolidated Financial Statements in Item 8 for a detailed description of our 2011 on-balance sheet securitization transaction.
REGULATION
Branch and Centralized Real Estate
Federal Laws. Various federal laws and regulations govern our branch and centralized real estate business segments including:
· the Equal Credit Opportunity Act (prohibits discrimination against creditworthy applicants) and Federal Reserve Board Regulation B, which implements that Act;
· the Fair Credit Reporting Act (governs the accuracy and use of credit bureau reports);
· the Truth in Lending Act (governs disclosure of applicable charges and other finance receivable terms) and Federal Reserve Board Regulation Z, which implements that Act;
· the Fair Debt Collection Practices Act;
· the Fair Housing Act (prohibits discrimination in housing lending);
· the Real Estate Settlement Procedures Act and the Department of Housing and Urban Development’s Regulation X (both of which regulate the making and servicing of certain loans secured by real estate);
· the Home Mortgage Disclosure Act (HMDA) and Federal Reserve Board Regulation C, which implements that Act;
· the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act);
· the Gramm-Leach-Bliley Act (governs the handling of personal financial information) and Federal Reserve Board Regulation P, which implements that Act; and
· the Federal Trade Commission Act.
In many states, federal law preempts state law restrictions on interest rates and points and fees for first lien residential mortgage loans (but not on other types of loans). The federal Alternative Mortgage Transactions Parity Act preempts certain state law restrictions on variable rate loans in many states. Historically, we made residential mortgage loans under this and other federal laws. Federal laws also govern our practices and disclosures when dealing with consumer or customer information.
In third quarter 2009, 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 loans, 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 loans with Nationstar. As a result of the subservicing transfer, the Agreement was terminated on May 26, 2011. Loans subserviced by Nationstar that are eligible for modification pursuant to HAMP guidelines are still subject to HAMP.
On July 21, 2010, the President of the United States signed into law the Dodd-Frank Act. This law, and the regulations to be promulgated under it, are likely to affect our operations in terms of increased oversight of financial services products by the newly-created Bureau of Consumer Financial Protection (the Bureau) and the imposition of restrictions on the terms of certain loans. The Bureau will have significant authority to implement and enforce Federal consumer financial laws, including the new protections established in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive, and abusive acts and practices. In addition, the Bureau will have broad supervisory, examination and enforcement authority over certain consumer products, such as mortgage lending. Under the Dodd-Frank Act, securitizations of loan portfolios are subject to certain restrictions and additional requirements, including requirements that the originator retain a portion of the credit risk of the securities sold and the reporting of buyback requests from investors. The law and accompanying regulations will be phased in over a one to three year period.
It is not possible to estimate the precise effect of the Dodd-Frank Act on our operations at this time because the law requires extensive rule-making, which has not yet been completed.
State Laws. Various state laws and regulations also govern our branch and centralized lending operations. Many states have laws that are similar to the federal laws referred to above. While federal law preempts state law in the event of certain conflicts, compliance with state laws and regulations is still required in the absence of conflicts.
Many states also have laws and regulations that regulate consumer lending. The degree and nature of such regulation vary from state to state. These additional state laws and regulations, under which we conduct a substantial amount of our business, generally:
· provide for state licensing and periodic examination of lenders and loan originators, including state laws adopted or amended to comply with licensing requirements of the federal SAFE Act (which requires licensing of individuals who perform real estate loan originations and, in some states, real estate loan modifications);
· require the filing of reports with regulators;
· impose maximum term, amount, interest rate, and other charge limitations;
· regulate whether and under what circumstances we may offer insurance and other ancillary products in connection with a lending transaction; and
· provide for additional consumer protections.
There is a clear trend of increased regulation, as well as more detailed reporting, more detailed examinations, and coordination of examinations among the states.
Prospective Lending Legislation. The U.S. government and a number of states, counties, and cities have enacted or may be considering, laws, regulations, or rules that restrict the credit terms or other aspects of residential mortgage loans that are typically described as “high cost mortgage loans” or “higher-priced mortgage loans.” These laws or regulations, if adopted, may limit or restrict the terms of covered loan transactions and may also impose specific statutory liabilities in cases of non-compliance. Additionally, some of these laws may restrict other business activities of the Company and its affiliates.
Insurance
State authorities regulate and supervise our insurance business segment. The extent of such regulation varies by product and by state, but relates primarily to the following:
· licensing;
· conduct of business, including marketing and sales practices;
· periodic financial and market conduct examination of the affairs of insurers;
· form and content of required financial reports;
· standards of solvency;
· limitations on the payment of dividends and other affiliate transactions;
· types of products offered;
· approval of policy forms and premium rates;
· permissible investments;
· reserve requirements for unearned premiums, losses, and other purposes; and
· claims processing.
Every state in which we operate regulates credit insurance premium rates and premium refund calculations.
International Regulation
In the United Kingdom, the Financial Services Authority (FSA) regulates first mortgage residential real estate loans and insurance products. The FSA is an independent non-governmental body given statutory powers by the Financial Services and Markets Act 2000. The Consumer Credit Act 2006, which amends the Consumer Credit Act 1974, regulates second mortgage residential real estate loans and consumer loans.
COMPETITION
Branch and Centralized Real Estate
The consumer finance industry is competitive due to the large number of companies offering financial products and services and the sophistication of those products. We compete with other consumer finance companies, as well as other types of financial institutions within our geographic footprint and over the Internet, including credit card companies, local banks, and regional and smaller consumer lenders that offer similar products and services. These companies compete with us in terms of price and speed of service, as well as flexibility of credit underwriting requirements.
Insurance
Our insurance business segment supplements our branch business segment. We believe that our insurance companies’ abilities to market insurance products through our distribution systems provide a competitive advantage.
International Competition
Ocean Finance and Mortgages Limited (Ocean), our United Kingdom subsidiary, competes with other credit intermediaries, many of which are national in scope rather than regional. These credit intermediaries compete on service and quality of products offered. Ocean also competes with various real estate loan lenders which advertise for direct lending to customers.
Item 1A.
Item 1A. Risk Factors.
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 other information regarding our business provided in this Annual Report on Form 10-K and in other documents we file with the SEC. 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.
RISKS RELATED TO OUR INDEBTEDNESS
If current market conditions and our financial performance do not improve or further deteriorate, we may not be able to generate sufficient cash to service all of our indebtedness, and we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business, and other factors beyond our control.
Continued challenging economic conditions have negatively affected our financial condition and results of operations. Current economic conditions have negatively affected the markets in which we conduct our business and the capital markets on which we depend to finance our operation. If current market conditions, as well as our financial performance, do not improve or further deteriorate, we may not be able to generate sufficient cash to service our debt. At December 31, 2011, we had $689.6 million of cash and cash equivalents ($7.0 million of cash and cash equivalents related to our foreign subsidiary, Ocean), and in 2011 we generated a net operating loss of $224.2 million and cash flows from operating and investing activities of $1.7 billion. In 2012, we are required to pay $2.8 billion to service the principal and interest due under the terms of our existing debt (excluding securitizations). Additionally, we have $778.3 million of debt maturities and interest payments (excluding securitizations) due in the first quarter of 2013. In order to meet our debt obligations in 2012 and beyond, we are exploring a number of options, including further operational changes to increase or preserve our available cash; additional debt financings, particularly new securitizations involving real estate and/or non-real estate loans; debt refinancing transactions, or a combination of the foregoing; and we may in the future consider portfolio sales.
We cannot give any assurance that we would be able to take any of these actions, that these actions would be successful even if undertaken, that these actions would permit us to meet our scheduled debt obligations, or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of sufficient cash resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt and other obligations. SLFC’s secured term loan contains certain covenants that may restrict our ability to dispose of assets and use the proceeds from the disposition for certain purposes.
Further, our ability to refinance our debt on attractive terms or at all, as well as the timing of any refinancings, depends upon a number of factors over which we have little or no control, including general economic conditions, such as unemployment levels, housing markets and interest rates, disruptions in the financial markets, the market’s view of the quality, value, and liquidity of our assets, our current and potential future earnings and cash flows, and our credit ratings. In addition, any financing, particularly any securitization, that is reviewed by a rating agency is subject to the rating agency’s view of the quality and value of any assets supporting such financing, the Company’s processes to generate cash flows from, and monitor the status of, such assets, and changes in the methodology used by the rating agencies to review and rate the applicable financing. This process may require significant time and effort to complete and may not result in a favorable rating or any rating at all, which could reduce the effectiveness of such financing or render it unexecutable.
If we cannot make scheduled payments on our debt, we will be in default and, as a result:
· our debt holders could declare all outstanding principal and interest to be due and payable, which could also result in an event of default and declaration of acceleration under certain of our other debt agreements; and
· the lenders under SLFC’s secured term loan could realize related proceeds on the assets securing our borrowings.
Our indebtedness is significant, which could affect our ability to meet our obligations under our debt instruments and could materially and adversely affect our business and our ability to react to changes in the economy or our industry.
We currently have a significant amount of indebtedness. At December 31, 2011, we had $14.3 billion in principal amount of indebtedness outstanding (including securitizations and secured indebtedness). Interest expense on our indebtedness was $1.3 billion in 2011. There can be no assurance that we will be able to repay or refinance our debt in the future.
The amount of indebtedness could have important consequences, including the following:
· it may require us to dedicate a significant portion of our cash flow from operations to the payment of the principal of, and interest on, our indebtedness, which reduces the funds available for other purposes, including finance receivable originations;
· it could limit our ability to withstand competitive pressures and reduce our flexibility in responding to changing regulatory, business and economic conditions;
· it may limit our ability to incur additional borrowings or securitizations for working capital, capital expenditures, business development, debt service requirements, acquisitions or general corporate or other purposes, or to refinance our indebtedness;
· it may require us to seek to change the maturity, interest rate and other terms of our existing debt;
· it may cause a further downgrade of our debt and long-term corporate ratings; and
· it may cause us to be more vulnerable to periods of negative or slow growth in the general economy or in our business.
In addition, meeting our anticipated liquidity requirements is contingent upon our continued compliance with our existing debt agreements. An event of default or declaration of acceleration under one of our existing debt agreements could also result in an event of default and declaration of acceleration under certain of our other existing debt agreements. Such an acceleration of our debt would have a material adverse effect on our liquidity and our ability to continue as a going concern.
Furthermore, our existing debt agreements do not restrict us from incurring significant additional indebtedness. If our debt obligations increase, whether due to the increased cost of existing indebtedness or the incurrence of additional indebtedness, the consequences described above could be magnified.
Our secured term loan and certain of our outstanding notes contain covenants that restrict our operations and may inhibit our ability to grow our business and increase revenues.
Springleaf Financial Funding Company (SFFC), an indirect subsidiary of the Company, is the borrower under the secured term loan. SLFC and most of its consumer finance operating subsidiaries guarantee the secured term loan. The secured term loan contains restrictions, covenants, and representations and warranties that apply to SLFC and certain of its subsidiaries. If SLFC, SFFC or any subsidiary guarantor fails to comply with any of these covenants or breaches these representations or warranties, such noncompliance would constitute a default under the secured term loan (subject to applicable cure periods), and the lenders could elect to declare all amounts outstanding under the agreements related thereto to be immediately due and payable and enforce their respective interests against collateral pledged under such agreements.
The covenants and restrictions in the secured term loan generally restrict certain of SLFC’s subsidiaries’ ability to, among other things:
· incur or guarantee additional debt;
· make certain investments or acquisitions;
· transfer or sell assets;
· make distributions on common stock;
· engage in mergers or consolidations;
· create or incur liens;
· enter into transactions with affiliates; and
· make certain amendments to organizational documents or documents relating to intercompany secured loans.
In certain cases (e.g., the restriction on incurring liens), the restrictions also apply to SLFC. The secured term loan also generally restricts the ability of SLFC and SFFC to engage in mergers or consolidations. Certain of SLFC’s indentures and notes also contain a covenant that limits SLFC’s and its subsidiaries’ ability to create or incur liens.
The restrictions described above may interfere with our ability to obtain new or additional financing or the manner in which we structure such new or additional financing or to engage in other business activities, which may significantly limit or harm our business, financial condition, liquidity, and results of operations. A default and resulting acceleration of obligations could also result in an event of default and declaration of acceleration under certain of our other existing debt agreements. Such an acceleration of our debt would have a material adverse effect on our liquidity and our ability to continue as a going concern. A default could also significantly limit our alternatives to refinance both the debt under which the default occurred and other indebtedness. This limitation may significantly restrict our financing options during times of either market distress or the Company’s financial distress, which are precisely the times when having financing options is most important.
An inability to access adequate sources of liquidity may adversely affect our ability to fund operational requirements and satisfy financial obligations.
Our ability to access capital and credit was significantly affected by the substantial disruption in the U.S. residential mortgage and credit markets and credit rating downgrades on our debt. Historically, we funded our operations and repaid our debt and other obligations using funds collected from our finance receivable portfolio and new debt issuances. Since September 2008, our traditional borrowing sources, including our ability to cost effectively issue large amounts of unsecured debt in the capital markets, have not been available. We currently expect our near-term sources of funding to be more limited than those that had previously been available to us. Management has worked to reduce liquidity risks by pursuing funding sources and limiting our lending activities and operating expenses. For example, we ceased originating real estate loans in January 2012. However, additional work is necessary to be able to fund operation requirements and satisfy financial obligations in the future. Failure to gain access to adequate capital and credit sources could have a material adverse effect on our financial condition, results of operations, and cash flows.
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:
· our ability to generate sufficient cash to service all of our outstanding debt;
· SLFI will pay its note payable to SLFC ($538.0 million at December 31, 2011), if needed by SLFC to meet its liquidity needs;
· our access to debt and securitization markets and other sources of funding on favorable terms;
· 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;
· the potential for further downgrade of our debt by rating agencies, which would have a negative impact on our cost of, and access to, capital;
· our ability to comply with our debt covenants, including the borrowing base for SLFC’s secured term loan;
· 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; and
· additional costs, in excess of amounts accrued, 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 refunds to customers.
Additionally, there are numerous risks to our financial results, liquidity, and capital raising and debt refinancing plans which are not quantified in our current liquidity forecasts. These risks include, but are not limited, to the following:
· 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;
· the potential for it to become increasingly costly and difficult to service our finance receivable 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 the subservicing of our centralized real estate loan portfolio;
· potential liability relating to real estate loans which we have sold or may 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; and
· the potential loss of key personnel.
We intend to support our liquidity position by managing originations (including our decision to cease real estate loan originations) and purchases of finance receivables and maintaining disciplined underwriting standards and pricing on such finance receivables. We intend to support operations and repay indebtedness with one or more of the following activities, among others: finance receivable collections, cash on hand, additional debt financings, particularly new securitizations, debt refinancing transactions, portfolio sales, or a combination of the foregoing. There can be no assurance that we will be successful in undertaking any of these activities to support our operations and repay our obligations.
However, the actual outcome of one or more of our plans could be materially different than expected or one or more of our significant judgments or estimates about the potential effects of these risks and uncertainties could prove to be materially incorrect. In the event of such an occurrence, if third-party financing is not available, our liquidity could be substantially and materially affected, and as a result, substantial doubt could exist about our ability to continue as a going concern.
Our current ratings could adversely affect our ability to raise capital in the debt markets at attractive rates, which could negatively impact our results of operations and financial condition.
Each of Standard & Poor’s Rating Services, Moody’s Investors Service, Inc. and Fitch, Inc. rates our debt. On September 7, 2011, Fitch downgraded SLFC’s ratings, and on February 3, 2012, Standard & Poor’s downgraded SLFC’s ratings. The Fitch rating also applies to SLFI. These rating actions resulted in downward price pressure for SLFC’s outstanding debt. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Analysis of Operating Results - Interest Expense” in Item 7 for further information.
Ratings reflect the rating agencies’ opinions of our financial strength, operating performance, strategic position and ability to meet our obligations. Agency ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating.
If our current ratings continue in effect or our ratings are further downgraded, it will likely increase the interest rate that we would have to pay to raise money in the capital markets, making it more expensive for us to borrow money and adversely impacting our access to capital. As a result, our ratings could negatively impact our business, results of operations, liquidity, and financial condition.
Our securitizations may expose us to financing and other risks, and there can be no assurance that we will be able to access the securitization market in the future, which may require us to seek more costly financing.
We have securitized, and may in the future securitize, certain of our finance receivables to generate cash to originate or purchase new finance receivables or pay our outstanding indebtedness. In each such transaction, we conveyed a pool of finance receivables to a special purpose entity (SPE), which, in turn, conveyed the finance receivables to a trust (the issuing entity). Concurrently, the trust issued non-recourse notes or certificates pursuant to the terms of an indenture or pooling and servicing agreement, respectively, which then were transferred to the SPE in exchange for the finance receivables. The securities issued by the trust were secured by the pool of finance receivables. In exchange for the transfer of finance receivables to the issuing entity, we received the cash proceeds from the sale of the trust securities, all residual interests, if any, in the cash flows from the finance receivables after payment of the trust securities, and a 100% beneficial interest in the issuing entity. As a result of the challenging credit and liquidity conditions, the value of the subordinated securities we retain in our securitizations might be reduced or, in some cases, eliminated.
The more limited securitization markets since 2007 have impaired our ability to complete securitizations. Although we were able to complete a securitization during the third quarter of 2011, the securitization market remains constrained, and we can give no assurances that we will be able to complete additional securitizations.
Rating agencies also can affect our ability to execute a securitization transaction, or increase the costs we expect to incur from executing securitization transactions, not only by deciding not to issue ratings for our securitization transactions, but also by altering the criteria and process they follow in issuing ratings. Rating agencies could alter their ratings processes or criteria after we have accumulated finance receivables for securitization in a manner that effectively reduces the value of those finance receivables by increasing our financing costs or otherwise requires that we incur additional costs to comply with those processes and criteria. We have no ability to control or predict what actions the rating agencies may take.
Further, other matters, such as (i) accounting standards applicable to securitization transactions and (ii) capital and leverage requirements applicable to banks and other regulated financial institutions holding residential mortgage-backed securities or other asset-backed securities, could result in less investor demand for securities issued through our securitization transactions, or increased competition from other institutions that undertake securitization transactions.
If it is not possible or economical for us to securitize our finance receivables in the future, we might seek alternative financing to support our operations and to meet our existing debt obligations, which could be less efficient and have a material adverse effect on our results of operations and liquidity.
RISKS RELATED TO OUR BUSINESS
Our consolidated results of operations and financial condition have been adversely affected by economic conditions and other factors, including high unemployment and the troubled residential real estate market, and we do not expect these conditions to significantly improve in the near future.
Our actual consolidated results of operations or financial condition may differ from the consolidated results of operations or financial condition that we anticipate or that we achieved in the past. We believe that generally the factors affecting our consolidated results of operations or financial condition relate to: general economic conditions, such as unemployment levels, housing markets, and interest rates; our ability to successfully underwrite lending risk; our ability to cost-effectively access the capital markets to support our business; fluctuations in the demand for our products and services and the effectiveness of our distribution channels; and natural or other events and catastrophes that affect our customers, collateral, and branches or other operating facilities.
In 2008 and 2009, the U.S. residential real estate markets 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 many financial institutions (including us). The U.S. residential real estate market remains fragile. High unemployment levels negatively affect the ability and willingness of many borrowers to make the required interest and principal payments on their loans. Decreased real estate values that accompany a market downturn can reduce a borrower’s ability to refinance his or her mortgage, as well as increase the LTV ratios of our real estate loans. In addition, adverse changes in the real estate market increase the probability of default, as the incentive for a borrower to continue making payments declines if the borrower has little or no equity in the property securing the loan. Further, declining real estate values significantly increase the likelihood that we will incur losses on our real estate loans in the event of default because the value of our collateral may be insufficient to recover the amount due on the loan.
Defaults by borrowers on finance receivables could cause losses to us, could lead to increased claims relating to non-prime or sub-prime loan 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 non-real estate loan products that we offer, and could also require us to devote additional resources to comply with the new and changing regulation.
The market developments discussed above have adversely affected our operating results significantly. As a result, we have ceased our real estate lending as of January 1, 2012. The continuation or worsening of these conditions could further adversely affect our business and results of operations. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our revenue from finance receivables in our portfolio and our ability to acquire, sell and securitize finance receivables, which would significantly harm our revenues, financial condition, liquidity, results of operations, and business prospects. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements” in Item 7 for a more detailed list of factors which could cause our consolidated results of operations or financial condition to differ, possibly materially, from the consolidated results of operations or financial condition that we anticipate.
We are exposed to credit risk and the risk of loss in our lending activities.
Our ability to collect on finance receivables depends on our borrowers’ willingness and ability to repay their amounts borrowed. Any material adverse change in the ability or willingness of a significant portion of our borrowers to meet their obligations to us, whether due to changes in economic conditions, the cost of consumer goods, interest rates or home values, or due to natural disasters, acts of war or terrorism, or other causes over which we have no control, could have a material adverse effect on our earnings and financial condition. Further, a substantial majority of our borrowers are subprime or non-prime borrowers, who are more likely to be affected, and more severely affected, by adverse macroeconomic conditions such as those that have persisted over the last few years. In addition, although the vast majority of our real estate loans are fixed-rate loans, rising interest rates may increase the credit risks associated with certain types of residential real estate loans in our portfolio, such as adjustable-rate real estate loans. At December 31, 2011, 5% of our real estate loan portfolio was subject to adjustable rates. Accordingly, when short-term interest rates rise, required monthly payments from homeowners who have adjustable rate loans will rise under the terms of these real estate loans, and this may increase borrower delinquencies and defaults. In addition, we cannot be certain that our policies and procedures will adequately adapt to changes in economic or any other conditions affecting customers and the quality of the finance receivable portfolio.
In the event of default under a finance receivable held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral, if any, and the outstanding principal and accrued but unpaid interest of the finance receivable, which could adversely affect our cash flow from operations. Foreclosure of a real estate loan can be an expensive and lengthy process, which would negatively affect our anticipated return on the foreclosed loan.
We may be required to indemnify, or repurchase finance receivables from, purchasers of finance receivables that we have sold or securitized, or which we will sell or securitize in the future, if our finance receivables fail to meet certain criteria or characteristics or under other circumstances.
The documents governing our finance receivable sales and securitizations contain provisions that require us to indemnify the purchasers of securitized finance receivables, or to repurchase the affected finance receivables, under certain circumstances. While our sale and securitization documents vary, they generally contain provisions that may require us to repurchase finance receivables if:
· our representations and warranties concerning finance receivable quality and circumstances are inaccurate, including representations concerning the licensing of a mortgage broker;
· borrower fraud or if a payment default occurs on a finance receivable shortly after its origination;
· we fail to comply, at the individual finance receivable level or otherwise, with regulatory requirements; and
· in limited instances, an individual finance receivable reaches certain defined finance delinquency limits.
We believe that, as a result of the current market environment, many purchasers of real estate loans (including through securitizations) are particularly aware of the conditions under which originators must indemnify purchasers or repurchase finance receivables, and would benefit from enforcing any repurchase remedies that they may have. Theoretically our exposure to repurchases under our representations and warranties could include the current unpaid balance of all finance receivables that we have sold or securitized and which are not subject to settlement agreements with purchasers.
The risk of loss on the finance receivables that we have securitized is recognized in our allowance for finance receivable losses since all of our securitizations are recorded on-balance sheet. If we are required to indemnify purchasers or repurchase finance receivables that we sell that result in losses that exceed our reserve for sales recourse, or recognize losses on securitized finance receivables that exceed our recorded allowance for finance receivable losses associated with our securitizations, this could adversely affect our business, financial condition, or results of operations.
If our estimates of finance receivable losses are not adequate to absorb actual losses, our provision for finance receivable losses would increase, which would adversely affect our results of operations.
We maintain an allowance for finance receivable losses. To estimate the appropriate level of allowance for finance receivable losses, we consider known and relevant internal and external factors that affect finance receivable collectability, including the total amount of finance receivables outstanding, historical finance receivable charge-offs, our current collection patterns, and economic trends. Our methodology for establishing our allowance for finance receivable losses is based in large part on our historic loss experience. If customer behavior changes as a result of economic conditions and if we are unable to predict how the unemployment rate, housing foreclosures, and general economic uncertainty may affect our allowance for finance receivable losses, our provision may be inadequate. Our allowance for finance receivable losses is an estimate, and if actual finance receivable losses are materially greater than our allowance for finance receivable losses, our financial condition and results of operations could be adversely affected. Neither state regulators nor federal regulators regulate our allowance for finance receivable losses. Additional information regarding our allowance for finance receivable losses is included in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Allowance for Finance Receivable Losses.”
We may be required to take impairment charges for intangible assets related to the FCFI Transaction.
As a result of the application of push-down accounting, we recorded intangible assets related to the FCFI Transaction. We recorded no goodwill associated with the FCFI Transaction. Additionally, we have no remaining goodwill from previous transactions. As a result of our future quarterly reviews and evaluation of our intangible assets for potential impairment, we may be required to take an impairment charge to the extent that the carrying values of our intangible assets exceed their fair value. Also, if we sell a business for less than the book value of the assets sold, including intangible assets attributable to that business, we may be required to take an impairment charge on all or part of the intangible assets attributable to that business.
We have recognized impairments on several of the intangible assets related to the FCFI Transaction. We cannot give assurances that we will not have to recognize additional material impairment charges in the future. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 for further information on the impairments of our intangible assets.
Our risk management efforts may not be effective.
We could incur substantial losses and our business operations could be disrupted if we are unable to effectively identify, manage, monitor, and mitigate financial risks, such as credit risk, interest rate risk, prepayment risk, liquidity risk, and other market-related risks, as well as operational risks related to our business, assets and liabilities. We use a proprietary credit risk management system, which provides decision support to the underwriters. A key component of the system is the credit risk modeling component used to assess the credit risk of potential borrowers. That assessment is derived from the applicant credit profile and evaluated by proprietary credit risk scoring models. To the extent the models do not adequately identify potential risks, the valuations produced would not adequately represent the risk profile of the borrower and could result in a riskier finance receivable profile than originally identified. Our risk management policies, procedures, and techniques, including our scoring technology, may not be sufficient to identify all of the risks we are exposed to, mitigate the risks we have identified or identify additional risks to which we may become subject in the future.
We may be unable to maintain or grow our finance receivable origination volume, which could cause us to implement changes to our business and adversely affect our business prospects, liquidity, financial condition, results of operations, or cash flows.
Our finance receivable origination business consists of non-real estate loans and retail sales finance. Prior to January 1, 2012, our branch and centralized real estate personnel also originated real estate loans. We continually evaluate the type and mix of finance receivables that we believe are prudent to originate. Our ability to originate new finance receivables is dependent on a number of factors, including, but not limited to, consumer demand for finance receivables, economic conditions, interest rates and property values, as well as our access to financing, the terms of such financing, and the amount of capital we have available to originate finance receivables.
Since September 2008, one or more of these factors has contributed to a significant reduction in the number and dollar amount of our real estate loan originations. In particular, our traditional borrowing sources, including our ability to cost effectively issue large amounts of unsecured debt in the capital markets, have not been available. We currently expect our near-term sources of funding to originate finance receivables and for other purposes to be more limited than those that had been available to us prior to September 2008.
Since current conditions have not improved, we have ceased our real estate loan originations as of January 1, 2012. In addition, on February 1, 2012, we announced plans to close branches and cease consumer lending and retail sales financing in certain states, and on March 2, 2012 we announced plans to consolidate branches in certain states. Any or all of these events could adversely affect our business prospects, liquidity, financial condition, results of operations, or cash flows, in particular by reducing the amount of cash generated from operations that is available to service our significant indebtedness. Moreover, the benefit to our liquidity positions from these measures may not be as significant as we anticipate or may not materialize at all.
Any additional decisions to close branches or cease consumer lending and retail sales financing may result in the recording of additional special charges, such as workforce reduction costs. Furthermore, ceasing to originate real estate loans impairs our ability to offer our customers a broad suite of products. Customers may decide to seek out our competitors that have the ability to offer products that address all of our customers’ lending needs. Loss of business due to our inability to provide a full service option to our customers as we have done in the past could adversely affect our business prospects, liquidity, financial condition, results of operations, or cash flows.
Recent market conditions may upset the historical relationship between interest rate changes and prepayment trends, which could adversely affect our liquidity and reduce the value our finance receivable portfolio.
Our liquidity position and the value of our finance receivable portfolio (and in particular, our real estate loan portfolio) will be affected by prepayment rates, which cannot be predicted with certainty. Prepayment rates may be affected by a number of factors, including, but not limited to, the availability of credit, changes in housing prices, changes in interest rates, the relative economic vitality of the area in which the borrowers and the related properties are located, possible changes in tax laws, other opportunities for investment, homeowner mobility, and other economic, social, geographic, demographic, and legal factors beyond our control. Prepayment rates typically increase during periods of declining interest rates, and decrease during periods of increasing interest rates. The current challenging economic conditions and recent significant declines in home values (and the resulting loss of homeowner equity) has limited many homeowners’ ability to refinance mortgage loans, which has reduced the rate of repayment for real estate loans, even in the current low interest rate environment. The slower rate of prepayment for finance receivables could adversely affect our liquidity by reducing our cash flow received from prepayments and lowering the market value of the finance receivables for sale or as collateral for secured funding.
Increases in interest rates could adversely affect the value of our finance receivables and increase our financing cost, which could negatively affect our profitability and liquidity.
The vast majority of our finance receivables are fixed-rate finance receivables that will generally decline in value if interest rates increase. Declines in market value could reduce the proceeds of a sale or secured financing of these finance receivables.
A significant risk associated with these finance receivables is if interest rates increase significantly. If rates increased significantly, the market value of these finance receivables would decline, and the weighted-average life of the finance receivables would increase if prepayments slowed. Moreover, an increase in interest rates could increase the cost to finance our assets.
Apart from interest rate changes, the market values of our finance receivables also may decline for a number of reasons, such as increases or expected increases in defaults, increases or expected increases in voluntary prepayments for those finance receivables that are subject to prepayment risk, or widening of credit spreads.
Our finance receivable approval process is decentralized, which may result in variability of finance receivable structures, and could adversely affect our results of operations.
Our branch finance receivable origination system is decentralized. Subject to approval by District Managers and/or Directors of Operations in certain cases, our branches have the authority to approve and structure finance receivables within broadly written underwriting guidelines rather than having all finance receivable terms approved centrally. As a result, there may be variability in finance receivable structure (e.g., whether or not collateral is taken for the finance receivable) and finance receivable quality among branches or regions, even when underwriting policies are followed. This decentralized approach could adversely affect our operating results.
We are not able to track the default status of the senior lien loan for our second mortgages if we are not the holder of the senior loan.
Second mortgages constituted approximately 6% of our finance receivable portfolio as of December 31, 2011. When we hold the second mortgage, either we or another creditor holds the first mortgage on the property, and our second mortgage is subordinate in right of payment to the first mortgage holder’s right to receive payment. We are not able to track the default status of a first mortgage for our second mortgages if we are not the holder of the related first mortgage. In such instances, the value of our second mortgage may be lower than our records indicate.
We are a party to various lawsuits and proceedings which, if resolved in a manner adverse to us, could materially adversely affect our consolidated results of operations or financial condition.
We are a party to various legal proceedings, including certain purported class action claims, arising in the ordinary course of our business. Some of these proceedings are pending in jurisdictions that permit damage awards disproportionate to the actual economic damages alleged to have been incurred. 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. A large judgment that is adverse to us could have a material adverse effect on our consolidated results of operations or financial condition. See “Legal Proceedings” in Item 3 and Note 23 of the Notes to Consolidated Financial Statements in Item 8 for more information.
If we lose the services of any of our key management personnel, our business could suffer.
Our future success significantly depends on the continued service and performance of our key management personnel. Competition for these employees is intense and our current financial condition could adversely affect our ability to attract and retain key personnel. The loss of the service of members of our senior management or key team members, or the inability to attract additional qualified personnel as needed, could materially harm our business.
Employee misconduct could harm us by subjecting us to significant legal liability, regulatory scrutiny, and reputational harm.
Our reputation is critical to maintaining and developing relationships with our existing and potential customers and third parties with whom we do business. There is a risk that our employees could engage in misconduct that adversely affects our business. For example, if an employee were to engage - or be accused of engaging - in illegal or suspicious activities, we could be subject to regulatory sanctions and suffer serious harm to our reputation, financial condition, customer relationships, and ability to attract future customers. Employee misconduct could prompt regulators to allege or to determine based upon such misconduct that we have not established adequate supervisory systems and procedures to inform employees of applicable rules or to detect and deter violations of such rules. It is not always possible to deter employee misconduct, and the precautions we take to detect and prevent misconduct may not be effective in all cases. Misconduct by our employees, or even unsubstantiated allegations, could result in a material adverse effect on our reputation and our business.
Security breaches in our information systems, in the information systems of third parties or in our branches could adversely affect our reputation and could subject us to significant costs and regulatory penalties.
Our operations rely heavily on the secure processing, storage and transmission of confidential customer and other information in our computer systems and networks. Each branch is part of an electronic information network that is designed to permit us to originate and track finance receivables and collections, and perform several other tasks that are part of our everyday operations. Although we take extensive measures to protect our information systems, which we refer to as cyber security, our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code that could result in disruption to our business, or the loss or theft of confidential information, including customer information. Any failure, interruption, or breach in our cyber security, including any failure of our back-up systems, could result in reputational harm, disruption in the management of our customer relationships, or the inability to originate, process and service our finance receivable products. Further, any of these cyber security and operational risks could result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. In addition, we may be required to incur significant costs to increase our cyber security to address any vulnerabilities that may be discovered or to remediate the harm caused by any security breaches.
As part of our business, we may share confidential customer information and proprietary information with clients, vendors, service providers, and business partners. The information systems of these third parties may be vulnerable to security breaches and we may not be able to ensure that these third parties have appropriate security controls in place to protect the information we share with them. If our confidential information is intercepted, stolen, misused, or mishandled while in possession of a third party, it could result in reputational harm to us, loss of customer business, and additional regulatory scrutiny, and it could expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
Our branches have physical customer records necessary for day-to-day operations that contain extensive confidential information about our customers, including financial and personally identifiable information. We also retain physical records in various storage locations outside of our branches. The loss or theft of customer information and data from our branches or other storage locations could subject us to additional regulatory scrutiny and penalties, and could expose us to civil litigation and possible financial liability, which could have a material adverse effect on our financial condition and results of operations.
The nature of our operations exposes us to security and other risks that could adversely affect our operations.
Many of our account payments occur at our branches, either in person or by mail, and frequently consist of cash payments, which we deposit at local banks throughout the day. This business practice exposes us daily to the potential for employee or other theft of funds. Despite controls and procedures to prevent such losses, we have in the past sustained losses due to employee fraud and theft. In addition, our employees “field call” delinquent accounts by visiting the home or workplace of a delinquent borrower. Such visits may subject our employees to a variety of dangers including violence, vehicle accidents, and other perils. We also have had break-ins at our branches, where money and/or customer records have been taken. A breach in the security of our branches or in the safety of our employees could result in employee injury, loss of funds or records and adverse publicity, and could result in a loss of customer business or expose us to civil litigation and possible financial liability. Although we have insurance that is intended to cover certain losses from such events, there can be no assurance that such insurance will be adequate or available, and in certain circumstances, these events could have a material adverse effect on our financial condition and results of operations.
We could face environmental liability and costs for damage caused by hazardous waste (including the cost of cleaning up contaminated property) if we foreclose upon or otherwise take title to property pledged as collateral.
If a real estate loan goes into default, we will start foreclosure proceedings in appropriate circumstances, which could result in our taking title to the mortgaged real estate. We also will consider alternatives to foreclosure, such as “short sales,” where we take title to mortgaged real estate. There is a risk that toxic or hazardous substances could be found on property after we take title. As the owner of any property where hazardous waste is present, we could be held liable for clean-up and remediation costs, as well as damages for personal injuries or property damage caused by the condition of the property. We can be responsible for these costs if we are in the chain of title for the property, even if we were not responsible for the contamination, and even if the contamination is not discovered until after we have sold the property. Costs related to these activities and damages could be substantial. Although we have policies and procedures in place to investigate properties for potential hazardous substances before taking title to properties, these reviews may not always uncover potential environmental hazards.
Our insurance operations are subject to a number of risks and uncertainties, including claims, catastrophic events, underwriting risks and dependence on a sole distribution channel.
Insurance claims and policyholder liabilities are difficult to predict and may exceed the related reserves for losses and loss adjustment expenses. Additionally, events such as hurricanes, earthquakes, pandemic disease, cyber security breaches, and other catastrophes could adversely affect our insurers’ financial condition or results of operations. Other risk factors for our insurance operations include the regulatory environment, capital/reserve requirements, and our insurers’ dependence on our lending operations for their sole source of business and product distribution.
The financial condition of counterparties, including other financial institutions, could adversely affect our financial condition and results of operations.
We have entered into, and may in the future enter into, derivative transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by the counterparty or client, which can be exacerbated during periods of market illiquidity. During such periods, our credit risk may be further increased when any collateral held by us cannot be realized upon or is liquidated at prices that are not sufficient to recover the full amount of our exposure.
RISKS RELATED TO OUR INDUSTRY AND REGULATION
We operate in a highly competitive market, and we cannot ensure that the competitive pressures we face will not have a material adverse effect on our business, financial condition, liquidity, and results of operations.
The consumer finance industry is highly competitive, and the barriers to entry for new competitors are relatively low in the markets in which we operate. Our profitability depends, in large part, on our ability to originate finance receivables. We compete with other consumer finance companies as well as other types of financial institutions that offer similar products and services in originating finance receivables. Some of these competitors may have considerably greater financial, technical, and marketing resources than we possess. Some competitors may also have a lower cost of funds and access to funding sources that may not be available to us. We cannot assure that the competitive pressures we face will not have a material adverse effect on our business, financial condition, liquidity, and results of operations.
We cannot predict the consequences and market distortions that may stem from anticipated far-ranging governmental intervention in the economic and financial system or from regulatory reform of the oversight of financial markets.
The U.S. Government, the Federal Reserve, the U.S. Treasury Department (the Treasury), the SEC, and other governmental and regulatory bodies have taken or are taking various actions to address the recent financial crisis.
The far-ranging government intervention in the economic and financial system may carry intended and unintended consequences and cause market distortions that may have a negative impact on our business. We are unable to predict the extent and nature of such consequences and market distortions, if any. For example, to the extent that new government programs are designed, in part, to restart the market for origination of finance receivables, the establishment of these programs may result in increased competition and higher prices for origination.
On July 21, 2010, the President of the United States signed into law the Dodd-Frank Act. This law, and the regulations already promulgated and to be promulgated under it, are likely to affect our operations in terms of increased oversight of financial services products by the Consumer Financial Protection Bureau (the Bureau), and the imposition of restrictions on the allowable terms for certain consumer credit finance receivables. The Bureau has significant authority to implement and enforce Federal consumer finance laws, including the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive, or abusive acts and practices. In addition, the Dodd-Frank Act provides the Bureau with broad supervisory, examination, and enforcement authority over various consumer financial products and services. The Dodd-Frank Act and accompanying regulations will be phased in over a one- to three-year period, and we cannot predict the terms of the final regulations, their intended consequences, or how such regulations will affect us or our industry. A Director for the Bureau was appointed as a recess appointment in early January 2012. Although there is a question over whether the appointment was valid, the Bureau and Director are taking the position that the Bureau has the authority to supervise and examine non-depository institutions such as SLFI and its subsidiaries.
The Dodd-Frank Act may adversely affect the securitization market because it requires, among other things, that a securitizer generally retain not less than 5% of the credit risk for certain types of securitized assets that are transferred, sold, or conveyed through issuance of asset-backed securities (ABS). Also, the SEC has proposed significant changes to Regulation AB, which, if adopted in their present form, could result in sweeping changes to the commercial and residential mortgage loan securitization markets, as well as to the market for the re-securitization of mortgage-backed securities. The SEC also has proposed rules that would require issuers and underwriters to make any third-party due diligence reports on ABS publicly available. In addition to the foregoing, the Federal Reserve, the Treasury, and other federal, state, and local governmental and regulatory bodies may continue to enact additional legislation or undertake regulatory actions designed to address the recent economic crisis or for other purposes that could have a material and adverse effect on our ability to execute our business strategies. We cannot predict whether or when such additional actions may occur. However, such actions could have an impact on our business, results of operations, liquidity, and financial condition, and the cost of complying with any additional laws and regulations could have a material adverse effect on our financial condition, liquidity, and results of operations.
The SEC recently solicited public comment on a wide range of issues relating to certain existing provisions of the Investment Company Act, including the nature of the assets that qualify for purposes of certain exemptions. There can be no assurance that the laws and regulations governing our Investment Company Act status, or SEC guidance regarding these exemptions, will not change in a manner that adversely affects our operations.
Real estate loan modification and refinancing programs and future legislative action may adversely affect the value of, and the returns on, our portfolio.
The U.S. Government has implemented a number of federal programs designed to assist homeowners, including the HAMP, which provides homeowners with assistance in avoiding residential real estate loan foreclosures. HAMP involves, among other things, the modification of real estate loans to reduce the principal amount of the loans (through forbearance and/or forgiveness) and/or the rate of interest payable on the loans, or to extend payment terms of the loans. Some of the real estate loans serviced by various third parties for certain of our subsidiaries may be eligible for modification under HAMP. Other existing or future government programs designed to assist homeowners also could affect the servicing of, and our ability to foreclose on, real estate loans.
HAMP (as it applies to those real estate loans serviced by third parties) and other existing or future legislative or regulatory actions, including possible amendments to the bankruptcy laws, which result in the modification of outstanding real estate loans, may adversely affect the value of, and the returns on, our initial portfolio and the assets we acquire in the future.
High-cost and other lending laws could adversely impact our results of operations, liquidity, financial condition, and business.
Various U.S. federal, state and local laws are designed to discourage or prohibit certain lending practices, including by restricting finance receivable terms, amounts, interest rates, and other charges. For example, the federal Home Ownership and Equity Protection Act of 1994, or HOEPA, prohibits inclusion of certain provisions in residential mortgage loans that have mortgage rates or origination costs in excess of prescribed levels and requires that borrowers be given certain disclosures prior to origination. Some states and municipalities have enacted, or may enact, similar laws or regulations, which in some cases impose restrictions and requirements greater than those in the HOEPA. In addition, under the lending laws of some states, the origination of certain residential mortgage loans, including loans that are not classified as “high-cost” loans under applicable law, must satisfy a “tangible net benefits” or similar test with respect to the related borrower. This test may be highly subjective and open to interpretation. As a result, a court may determine that a residential mortgage loan, for example, does not meet the test even if the related originator reasonably believed that the test was satisfied.
Lawsuits have been brought in various states making claims against owners of high-cost finance receivables for violations of federal or state law. If any of our finance receivables are found to have been originated in violation of high-cost or unfair lending laws, we could incur losses, including monetary penalties and finance receivable rescissions, which could adversely affect our results of operations, financial condition, liquidity, and business.
Real estate loan servicing has come under increasing scrutiny from government officials and others, which could make servicing our portfolio more costly and difficult.
Real estate loan servicers have recently come under increasing scrutiny. Certain state Attorneys General, court administrators and governmental agencies, as well as representatives of the federal government, have issued letters of inquiry to real estate loan servicers, including our branch operations and certain of our third party real estate loan servicers, requesting written responses to questions regarding policies and procedures, especially with respect to notarization and affidavit preparation procedures. These requests, and any subsequent administrative, judicial, or legislative actions taken by these regulators, court
administrators, or other governmental entities may subject us or our third party real estate loan servicers to fines and other sanctions, including a moratorium or suspension on foreclosures.
In addition, some states and municipalities have passed laws that impose additional duties on foreclosing lenders and real estate loan servicers, such as mandatory mediation, or extensive requirements for maintenance of vacant properties, which, in some cases, begin even before a lender has taken title to property. These additional requirements can delay foreclosures, make it uneconomical to foreclose on mortgaged real estate, or result in significant additional costs.
These developments could adversely affect our business. For example, our servicing expenses would likely increase if we or the companies servicing our loans were subject to increased costs. Moreover, real estate loan servicing companies may shut down or restrict their servicing operations in response to these developments, which would limit our servicing options. Without effective servicing at a competitive price, the value of our portfolio would be adversely affected. Any of these or other external influences could delay foreclosures on the loans in our portfolio, which could materially affect the value of our portfolio.
Our businesses are subject to extensive regulation in the jurisdictions in which we conduct our business.
Our businesses are subject to various U.S. state and federal laws and regulations, and various U.S. state authorities regulate and supervise our insurance business segment. The laws under which a substantial amount of our branch and centralized real estate businesses are conducted generally: provide for state licensing of lenders and, in many cases, licensing of employees involved in real estate lending; impose limits on the term of a finance receivable, amounts, interest rates and charges on the finance receivables; regulate whether and under what circumstances insurance and other ancillary products may be offered to consumers in connection with a lending transaction; and provide for other consumer protections. The extent of state regulation of our insurance business varies by product and by jurisdiction, but relates primarily to the following: licensing; conduct of business; periodic examination of the affairs of insurers; form and content of required financial reports; standards of solvency; limitations on dividend payments and other related party transactions; types of products offered; approval of policy forms and premium rates; permissible investments; deposits of securities for the benefit of policyholders; reserve requirements for unearned premiums, losses and other purposes; and claims processing. We are also subject to various laws and regulations relating to our subsidiaries in the United Kingdom.
All of our operations are subject to regular examination by state and federal regulators, and as a whole, our entities are subject to several hundred regulatory examinations in a given year. These examinations may result in requirements to change our policies or practices, and in some cases, we are required to pay monetary fines or make reimbursements to customers. Many states have indicated an intention to pool their resources in order to conduct examinations of licensed entities, including us, at the same time (referred to as a “multi-state” examination). This could result in more in-depth examinations, which could be more costly and lead to more significant enforcement actions.
We believe that we maintain all material licenses and permits required for our current operations and are in substantial compliance with all applicable federal, state and local regulations. We may not be able to maintain all requisite licenses and permits, and the failure to satisfy those and other regulatory requirements could have a material adverse effect on our operations. In addition, changes in laws or regulations affecting us could affect our ability to conduct business or the manner in which we conduct business and, accordingly, could have a material adverse effect on our consolidated results of operations or financial condition.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
We generally conduct branch office operations, branch office administration, other operations, and operational support in leased premises. Lease terms generally range from three to five years. Ocean currently leases one facility under a lease that expires in 2018. Ocean also leases land on which it owns an office facility in Tamworth, England under a 999 year land lease that expires in 3001.
Our investment in real estate and tangible property is not significant in relation to our total assets due to the nature of our business. SLFC subsidiaries own two branch offices in Riverside and Barstow, California, two branch offices in Hato Rey and Isabela, Puerto Rico, one branch office in Terre Haute, Indiana, and eight buildings in Evansville, Indiana. The Evansville buildings house our administrative offices, our centralized services and support operations for our branch and centralized real estate business segments, and one of our branch offices.
Item 3.
Item 3. Legal Proceedings.
See Note 23 of the Notes to Consolidated Financial Statements in Item 8.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
No trading market exists for SLFI’s common stock. All of the Company’s common stock is held by AGF Holding. SLFI did not pay any cash dividends on its common stock in 2011 or 2010.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources and Liquidity - Capital Resources” in Item 7 and Note 21 of the Notes to Consolidated Financial Statements in Item 8, regarding limitations on the ability of SLFI and its subsidiaries to pay dividends.
Item 6.
Item 6. Selected Financial Data.
You should read the following selected financial data in conjunction with the consolidated financial statements and related notes in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the consolidated financial statements and related notes in Item 8. With this discussion and analysis, we intend to enhance the reader’s understanding of our consolidated financial statements in general and more specifically our liquidity and capital resources, our asset quality, and the results of our operations.
An index to our management’s discussion and analysis follows:
Topic
Page
Forward-Looking Statements
FCFI Transaction
Executive Summary
Springleaf REIT Inc.
Basis of Reporting
Recent Accounting Pronouncements
Critical Accounting Policies and Estimates
Off-Balance Sheet Arrangements
Capital Resources and Liquidity
Selected Loan Portfolio Segment Information
Analysis of Financial Condition
Analysis of Operating Results
Regulation and Other
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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 eventual 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 substantial indebtedness, which could prevent us from meeting our obligations under our debt instruments and limit our ability to react to changes in the economy or our industry, or our ability to incur additional borrowings;
· our ability to generate sufficient cash to service all of our indebtedness;
· 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;
· our ability to comply with our debt covenants, including the borrowing base for SLFC’s secured term loan;
· 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;
· additional costs, in excess of amounts accrued, 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 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 the subservicing of our centralized mortgage loan portfolio;
· potential liability relating to real estate loans which we have sold or may 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;
· 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;
· the potential for further downgrade of our debt by rating agencies, which would have a negative impact on our cost of, and access to, capital;
· 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 Item 1A in this report and in other documents we file with the SEC. 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, indirectly retained a 20% economic interest in SLFI. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 for further information on the FCFI Transaction.
EXECUTIVE SUMMARY
Segment Overview
We have three business segments: branch, centralized real estate, and insurance. 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. See Note 1 of the Notes to Consolidated Financial Statements in Item 8 for a description of our business segments.
2011 Overview
Following the deepest recession in more than a half-century, the U.S. economy struggled with high unemployment, poor housing markets, retrenching businesses, and reluctant consumers. After spiking to nearly 480,000 early in the year, weekly initial jobless claims declined to below 400,000 in fourth quarter 2011. The unemployment rate hovered around 9% through September 2011 until dropping below the 9% level in fourth quarter 2011. Such jobs figures are now recognized to be understated since those who are no longer looking for work are excluded.
Consumer spending contributes approximately two-thirds of the U.S. economy’s spending and has a significant impact on our core lending operations. U.S. consumer credit increased in all but one month in 2011, with the largest gains late in the year. Consumer confidence is a key determinant of U.S. consumers’ willingness to spend and to borrow money to spend. Measures of consumer confidence were relatively low until October 2011 and improved as 2011 came to a close.
With the positive economic trends in late 2011 combined with a fourth quarter annualized gross domestic product (GDP) growth of 2.8% (the highest since the second quarter of 2010), most economists’ concerns of a double-dip recession abated. Global capital markets improved for most market participants and many took advantage of historically low interest rates. However, the current recovery is weak compared to other post-recession periods. The mix of growth in the fourth quarter 2011 GDP was disappointing and largely attributable to a surge in business inventories, which accounted for two-thirds of the growth.
The housing market has not made a meaningful recovery, yet residential spending grew at 10.9% in fourth quarter 2011, the fastest rate of growth since 2006. Consumers are putting money into their existing homes, since homeowners are reluctant to sell their homes at a loss, and the U.S. has had a particularly mild winter. The Federal Housing Finance Agency’s House Price Index ended December 2011 at 320, up slightly from September 2011, but well off its pre-recession levels of more than 370.
Credit quality improved on our non-real estate and retail sales finance portfolios, which is where we focused our lending efforts during 2011. With our very limited real estate loan originations and the continued adverse housing markets during 2011, we saw our real estate delinquency rates increase while the absolute dollar amount of 60-days plus delinquent real estate loans did not change significantly from year-end 2010.
The continued limited availability of funding for the Company led to additional downgrades of our unsecured credit ratings during 2011. Our capital market activities in 2011 were focused on secured funding. In May 2011, we refinanced our $3.0 billion secured term loan into a $3.75 billion loan with improved advance rates, lower borrowing costs, and a longer maturity (see “Capital Resources and Liquidity - Capital Resources”). In September 2011, we securitized $496.9 million of our real estate loans and sold $242.7 million of senior mortgage backed notes (while retaining subordinated notes for possible future sale, $49.7 million of which we sold in February 2012 at 99.3% of face amount before expenses).
In September 2011, our Board of Directors appointed Jay N. Levine to the positions of President, Chief Executive Officer, and Director of the Company effective October 1, 2011 following the retirement of our prior Chief Executive Officer.
2012 Outlook
The gradual economic improvement observed in 2011 is expected to continue into 2012. The forecasted 2012 GDP growth is expected to be approximately 2.1% in the first half of 2012 and increase to approximately 2.5% in the second half of 2012. Weak labor markets, a stubbornly high but somewhat improving unemployment rate, and a continued weak housing market will likely weigh on 2012 fundamentals. We believe 2012 may be the third year of a cyclical recovery from the recent recession that began in late 2007. We believe that gradual economic improvement may aid the lending environment, and financial markets should continue to improve and provide support to both consumer and business spending.
As we focus on returning the Company to profitability, we are pursuing consumer lending that we believe will provide higher returns and more cost-effective operations during 2012. Starting January 1, 2012, we ceased originating real estate loans nationwide. On February 1, 2012, we announced our plan to close approximately 60 branch offices and to immediately cease lending and retail sales financing in 14 states and southern Florida. On February 15, 2012, we reduced the workforce at our Evansville, Indiana headquarters by approximately 130 employees due to the cessation of real estate lending and the branch closings. On March 2, 2012, we announced our plan to consolidate certain branch operations and close approximately 150 branch offices in 25 states. As a result of these events, our workforce was reduced by approximately 690 employees and we expect to incur a total pretax charge of $20.5 million in first quarter 2012.
Assuming the U.S. economy maintains its recent performance, we expect the 2012 credit quality of our non-real estate and retail sales finance portfolio to correlate with the U.S. economy. With our mortgage portfolio liquidating and the continuing difficulty in the housing markets, we anticipate our 2012 credit quality ratios for real estate loans will likely remain under pressure.
We expect that our funding activities will include further operational changes to increase or preserve our available cash, additional debt financings, particularly new securitizations, debt refinancing transactions, portfolio sales, or a combination of the foregoing. However, there can be no assurance as to the sufficiency or availability of these funds. Should these sources of funding be insufficient or unavailable, there could be a material adverse effect on our financial position, results of operations, and cash flows.
Risks and Uncertainties
See Note 2 of the Notes to Consolidated Financial Statements in Item 8 for a discussion of our risks and uncertainties.
SPRINGLEAF REIT INC.
In May 2011, SLFC caused the formation of Springleaf REIT Inc. (Springleaf REIT), a Delaware corporation. Springleaf REIT, an indirect subsidiary of SLFI, filed with the SEC a registration statement for an initial public offering of its common stock. As a result of revisions to our strategic direction to cease real estate lending as discussed further in “Executive Summary” above, this registration statement has not been declared effective and the offering has been suspended indefinitely.
BASIS OF REPORTING
We prepared our consolidated financial statements using accounting principles generally accepted in the United States of America (U.S. GAAP). The statements include the accounts of SLFI and its subsidiaries, all of which are wholly owned. We eliminated all material intercompany accounts and transactions. We made judgments, estimates, and assumptions that affect amounts reported in our consolidated financial statements and disclosures of contingent assets and liabilities. Ultimate results could differ from our estimates.
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 Annual Report on Form 10-K through the inclusion of a vertical black line between the Successor Company and the Predecessor Company columns.
The financial information for 2010 includes the financial information of the Successor Company for the one month ended December 31, 2010 and of the Predecessor Company for the eleven months ended November 30, 2010. These separate periods are presented to reflect the new accounting basis established for our Company as of November 30, 2010.
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 one month ended December 31, 2010 and for the year ended December 31, 2011 have been the same as those reported if push-down accounting had not been applied. Additionally, key ratios of the Successor Company are not comparable to those of the Predecessor Company, nor are they comparable to other institutions due to the new accounting basis established. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 for further information on the FCFI Transaction.
At December 31, 2011, 85% of our assets were net finance receivables less allowance for finance receivable losses. Finance charge revenue is a function of the amount of average net receivables and the yield on those average net receivables. U.S. GAAP requires that we recognize finance charges as revenue on the accrual basis using the interest method.
At December 31, 2011, 92% of our liabilities were debt issued primarily to support our net finance receivables. Interest expense is a function of the amount of average borrowings and the interest expense rate on those average borrowings. U.S. GAAP requires that we recognize interest on borrowings as expense on the accrual basis using the interest method. Interest expense includes the effect of our swap agreements that qualify for hedge accounting under U.S. GAAP.
Insurance revenues consist primarily of insurance premiums resulting from our branch customers purchasing various credit and non-credit insurance policies. Insurance premium revenue is a function of the premium amounts and policy terms. U.S. GAAP dictates the methods of insurance premium revenue recognition. Our credit life premiums are recognized as revenue using the rule of 78’s method for decreasing credit life and the pro rata method for level credit life. Our credit accident and health premiums are recognized as revenue using the mean of the rule of 78’s method and the pro rata method. Our credit property and casualty and credit involuntary unemployment premiums are recognized as revenue using the pro rata method. Our non-credit premiums are recognized as revenue when collected. Insurance revenues also include commissions received from selling third-party insurers’ products, primarily through the operations of Ocean.
We invest cash in investment securities (mainly bonds), which were 7% of our assets at December 31, 2011, and to lesser extents in commercial mortgage loans, policy loans, and investment real estate, which we include in other assets. We report the resulting revenue in investment revenue. U.S. GAAP requires that we recognize interest on these investments as revenue on the accrual basis.
Loan brokerage fees revenues (included in other revenues), through the operations of Ocean, consist of commissions from lenders for loans brokered to them, fees from customers to process their loans, and fees from other credit originators for customer referrals. We recognize these commissions and fees in loan brokerage fees revenues when earned.
Mortgage banking revenues (included in other revenues) consist of net gain or loss on sale of finance receivables held for sale, provision for warranty reserve, and interest income on finance receivables held for sale. U.S. GAAP requires that we recognize the difference between the sales price we receive when we sell a finance receivable held for sale and the carrying value of that loan as a gain or loss at the time of the sale. We carry finance receivables held for sale at the lower of cost or fair value. We recognize net unrealized losses through a valuation allowance and record changes in the valuation allowance in other revenues. We also charge provisions for recourse obligations to provision for warranty reserve to maintain the reserves for recourse obligations at appropriate levels. We recognize interest as revenue on the accrual basis using the interest method during the period we hold a real estate loan held for sale.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for discussion of recently issued accounting pronouncements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We describe our significant accounting policies used in the preparation of our consolidated financial statements in Note 3 of the Notes to Consolidated Financial Statements in Item 8. We consider the policies discussed below to be our most critical accounting policies because they involve critical accounting estimates and a significant degree of management judgment.
Allowance for Finance Receivable Losses
Our Credit Strategy and Policy Committee evaluates our finance receivable portfolio monthly by non-real estate loans, retail sales finance, and real estate loans. Our three portfolio segments consist of a large number of relatively small, homogeneous accounts. We evaluate our three portfolio segments for impairment as groups. None of our accounts are large enough to warrant individual evaluation for impairment. Our Credit Strategy and Policy Committee considers numerous internal and external factors in estimating losses inherent in our finance receivable portfolio, including the following:
· prior finance receivable loss and delinquency experience;
· the composition of our finance receivable portfolio; and
· current economic conditions, including the levels of unemployment and personal bankruptcies.
We use migration analysis and, effective September 30, 2011, a roll rate-based model as the principal tools to determine the appropriate amount of allowance for finance receivable losses. We adopted the roll rate-based model because we believe it captures portfolio trends at a more detailed level. Both techniques are historically-based statistical models that attempt to predict the future amount of losses of finance receivables. The overall results of switching from the migration analysis in second quarter 2011 to the roll rate-based model in third quarter 2011 were not material.
Our migration analysis utilizes a rolling 12 months of historical data that is updated quarterly for our real estate loan and retail sales finance receivable portfolio. The primary inputs for our migration analysis are (1) the related historical finance receivable balances, (2) the historical delinquency, charge-off, recovery and repayment amounts, and (3) the related finance receivable balances in each stage of delinquency (i.e., current, greater than 30 days past due, greater than 60 days past due, etc.). The primary assumptions used in our migration analysis are the weighting of historical data and our estimate of the loss emergence period for the portfolio.
Management considers the performance of our second mortgage portfolio when estimating the allowance for finance receivable losses at the time we evaluate our real estate loan portfolio for impairments. However, we are not able to track the default status of the first lien position for our second mortgages if we are not the holders of the first lien position. We attempt to mitigate the risk resulting from the inability to track this information by utilizing our migration model. Our migration model incorporates the historical performance of our real estate portfolio (including second mortgages) and its output will therefore be impacted by any actual delinquency and charge-offs from second mortgages.
In our roll rate-based model, our non-real estate loan portfolio is stratified by delinquency stages (i.e., current, 1-29 days past due, 30-59 days past due, etc.) and projected forward in one-month increments using historical roll rates. In each month of the simulation, losses on non-real estate loans are captured, and the ending delinquency stratification serves as the beginning point of the next iteration. No new volume is assumed. This process is repeated until the number of iterations equals the loss emergence period for the non-real estate loan portfolio. We believe that this model is more effective in determining the appropriate amount of allowance for our non-real estate loan portfolio.
Prior to the FCFI Transaction, we used the Monte Carlo technique for our non-real estate loans, which utilized historical loan level data from January 2003 through the mid month of the current quarter and was updated quarterly. The primary inputs for Monte Carlo were the number of historical finance receivable accounts, the variability in account migration through the various stages of delinquency (i.e., the probability of a loan moving from 30 days past due to 60 days past due in any given month), and average charge-off amounts. The primary assumptions used in our Monte Carlo analysis were the loss emergence period for the portfolio and average charge-off amounts. The program employed a discrete method of incorporating economic conditions with a set of matrices, each of which represented a historical month of data. Each matrix was therefore representative of certain seasonal and secular economic conditions, and the probability of selecting a given matrix during the simulation increased as the simulated economic conditions approached those represented by the matrix.
We consider the current and historical levels of nonaccrual loans in our analysis of the allowance by factoring the delinquency status of loans into both the migration analysis and the roll rate-based model. We classify loans as nonaccrual based on our accounting policy, which is based on the delinquency status of the loan. As delinquency is a primary input into our quantitative models, we inherently consider nonaccrual loans in our estimate of the allowance for finance receivable losses. See Note 6 of the Notes to Consolidated Financial Statements in Item 8 for further information on our nonaccrual loans and finance receivables more than 90 days past due at December 31, 2011.
We calculate our allowance for finance receivable losses at our estimated “most predictive” outcome of our adjusted migration analysis and roll rate-based model. The “most predictive” outcome is the scenario that the Credit Strategy and Policy Committee has identified to be a better estimate than any other amount considering how the analyses best represent the probable losses inherent in our portfolio at the balance sheet date, taking into account the relevant qualitative factors, observable trends, economic conditions and our historical experience with our portfolio.
The allowance for finance receivable losses related to our purchased 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.
The allowance for finance receivable losses related to our Troubled Debt Restructurings (TDRs) is calculated in homogeneous aggregated pools of individually evaluated 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. See Note 6 of the Notes to Consolidated Financial Statements in Item 8 for further information on our troubled debt restructured finance receivables at December 31, 2011.
The Credit Strategy and Policy Committee exercises its judgment, based on quantitative analyses, qualitative factors, and each committee member’s experience in the consumer finance industry, when determining the amount of the allowance for finance receivable losses. If the committee’s review concludes that an adjustment is necessary, we charge or credit this adjustment to expense through the provision for finance receivable losses. We consider this estimate to be a critical accounting estimate that affects the net income of the Company in total and the pretax operating income of our branch and centralized real estate business segments.
Push-down Accounting
On November 30, 2010, FCFI indirectly acquired an 80% economic interest in SLFI from ACC. AIG, through ACC, indirectly 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.
Purchased Credit Impaired Finance Receivables
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. As a result, we identified a population of finance receivables for which it was determined that it is probable that we will be unable to collect all contractually required payments. In establishing this population, consideration was given to the requirement that each individual finance receivable first be reviewed. However, because of the homogeneity of finance receivables within a particular product group as well as the fact that we do not view our business on a loan by loan basis, emphasis was placed on past due status and accounting classification. As a result, the population of accounts identified principally consists of those finance receivables that are 60 days or more past due or that were classified as TDRs as of the acquisition date.
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 fair value should be based on assumptions that market participants would use, including a consideration of non-performance risk.
In determining fair value, we use various valuation techniques and prioritize the use of observable inputs. The availability of observable inputs varies from instrument to instrument and depends on a variety of factors including the type of instrument; whether the instrument is actively traded and other characteristics particular to the transaction. For many financial instruments, pricing inputs are readily observable in the market, the valuation methodology used is widely accepted by market participants, and the valuation does not require significant management discretion. For other financial instruments, pricing inputs are less observable in the marketplace and may require management judgment.
Valuation Allowance on Deferred Tax Assets
The authoritative guidance for the accounting for income taxes permits a deferred tax asset to be recorded if the asset meets a more likely than not standard (i.e., more than 50 percent likely) that the asset will be realized. Realization of our net deferred tax asset depends on our ability to generate sufficient taxable income of the appropriate character within the carryforward periods of the jurisdictions in which the net operating and capital losses, deductible temporary differences and credits were generated. Because the realization of the deferred tax assets relies on a projection of future income, we view this as a critical accounting estimate.
When making our assessment about the realization of our deferred tax assets, we consider all available evidence, including:
· the nature, frequency, and severity of current and cumulative financial reporting losses;
· the carryforward periods for the net operating and capital loss carryforwards;
· the sources and timing of future taxable income, giving greater weight to discrete sources and to earlier years in the forecast period; and
· tax planning strategies that would be implemented, if necessary, to accelerate taxable amounts.
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 December 31, 2011 or 2010.
CAPITAL RESOURCES AND LIQUIDITY
We currently have a significant amount of indebtedness. Our liquidity position has been, and is likely to continue to be, negatively affected by unfavorable conditions in the consumer finance industry, the residential real estate market and the capital markets. In addition, SLFC’s and SLFI’s credit ratings are all non-investment grade, which have a significant impact on our cost of, and access to, capital. This, in turn, negatively affects our ability to manage our liquidity and our ability to refinance our indebtedness.
If current market conditions, as well as our financial performance, do not improve or further deteriorate, we may not be able to generate sufficient cash to service our debt. At December 31, 2011, we had $689.6 million of cash and cash equivalents ($7.0 million of cash and cash equivalents related to our foreign subsidiary, Ocean), and in 2011 we generated a net operating loss of $224.2 million and cash flows from operating and investing activities of $1.7 billion. In 2012, we are required to pay $2.8 billion to service the principal and interest due under the terms of our existing debt (excluding securitizations). Additionally, we have $778.3 million of debt maturities and interest payments (excluding securitizations) due in the first quarter of 2013. In order to meet our debt obligations in 2012 and beyond, we are exploring a number of options, including further operational changes to increase or preserve our available cash, additional debt financings, particularly new securitizations involving real estate and/or non-real estate loans, debt refinancing transactions, portfolio sales, or a combination of the foregoing. As of December 31, 2011, the Company had $3.5 billion of unencumbered real estate loans and $3.1 billion of unencumbered non-real estate loans. We cannot assure that additional debt financings, particularly new securitizations, debt refinancing transactions, or portfolio sales will be available to us on acceptable terms, or at all. Our ability to support operations and repay indebtedness will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, regulatory, and other factors that are beyond our control and cannot be predicted with certainty. We would be materially adversely affected if we were unable to repay or refinance our debt as it comes due.
We actively manage our liquidity and continually work on initiatives to address our liquidity needs. In connection with our liability management efforts, we or our affiliates from time to time may purchase portions of our outstanding indebtedness. Any such future purchases may be made through open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices, as well as with such consideration, as we or any such affiliates may determine. Our plans are dynamic and we may adjust our plans in response to changes in our expectations and changes in market conditions.
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.
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 and SLFI 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. SLFC used a portion of the proceeds from the secured term loan to repay its $2.125 billion multi-year credit facility in April 2010.
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.
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.
The debt agreements to which SLFC and its subsidiaries are a party include standard terms and conditions, including covenants and representations and warranties. These agreements also contain certain restrictions, including restrictions on the ability to create senior liens on property and assets in connection with any new debt financings and restrictions on the intercompany transfer of funds from certain subsidiaries to SLFC or SLFI, except for those funds needed for debt payments and operating expenses. SLFC subsidiaries that borrow funds through the $3.75 billion secured term loan are also required to pledge eligible finance receivables to support their borrowing under the secured term loan.
None of our debt agreements require SLFC or any subsidiary to meet or maintain any specific financial targets or ratios, except the requirement to maintain a certain level of pledged finance receivables under the secured term loan.
Under our debt agreements, certain events, including non-payment of principal or interest, bankruptcy or insolvency, or a breach of a covenant or a representation or warranty may constitute an event of default and trigger an acceleration of payments. In some cases, an event of default or acceleration of payments under one debt agreement may constitute a cross-default under other debt agreements resulting in an acceleration of payments under the other agreements.
As of December 31, 2011, we were in compliance with all of the covenants under our debt agreements.
Historically, we targeted our leverage to be a ratio of 9.0x of adjusted debt to adjusted tangible equity, where adjusted debt equals total debt less 75% of our trust preferred securities (i.e., 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 the 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.
Under the hybrid debt, SLFC, upon the occurrence of a mandatory trigger event, is required 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. A mandatory trigger event occurs if SLFC’s (1) tangible equity to tangible managed assets is less than 5.5% or (2) average fixed charge ratio is not more than 1.10x for the trailing four quarters (where the fixed charge ratio equals earnings excluding income taxes, interest expense, extraordinary items, goodwill impairment, and any amounts related to discontinued operations, divided by the sum of interest expense and any preferred dividends).
Based upon SLFC’s financial results for the twelve months ended September 30, 2011, a mandatory trigger event occurred under SLFC’s hybrid debt with respect to the hybrid debt’s semi-annual payment due in January 2012 due to the average fixed charge ratio being less than 0.76x (while the equity to assets ratio was 9.17%). During January 2012, SLFC received from SLFI the non-debt capital funding necessary to satisfy, and subsequently paid, the January 2012 interest payments required by SLFC’s hybrid debt.
Due to the Company’s and our former indirect parent’s liquidity positions, our primary capitalization efforts have been focused on improving liquidity, refinancing or retiring our outstanding indebtedness, and otherwise 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 December 31, 2011 was 8.78x compared to 9.07x at December 31, 2010. In calculating December 31, 2011 leverage, management deducted $773.9 million of cash equivalents from adjusted debt, resulting in an effective adjusted tangible leverage of 8.25x. 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 8.38x.
Reconciliations of total debt to adjusted debt were as follows:
Reconciliations of equity to adjusted tangible equity were as follows:
Liquidity
Principal sources and uses of cash were as follows:
During 2011, we continued to manage our liquidity with net collections of finance receivables, the refinancing of SLFC’s secured term loan in May 2011, proceeds of $242.5 million from a real estate loan securitization transaction in September 2011, and cash from operations. On May 10, 2011, SLFC successfully refinanced its $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. SLFC received $45.0 million of dividends during second quarter 2011 from its insurance subsidiaries. Cash and cash equivalents decreased $708.0 million during 2011 primarily due to our debt repayments in 2011.
During 2010, we managed our liquidity with cash from operations, proceeds of $501.2 million from a real estate loan securitization transaction in March 2010, and the execution and full draw down of a $3.0 billion five-year secured term loan in April 2010. During the first three months of 2010, we also received repayment of AIG’s $1.6 billion demand promissory notes. SLFC and SLFI used a portion of the proceeds from these transactions to repay the $2.450 billion one-year term loans in March 2010 ($2.050 billion repaid by SLFC and $400.0 million repaid by SLFI) and the SLFC $2.125 billion multi-year credit facility in April 2010, both prior to their due dates in July 2010. On May 11, 2010, SLFC made a loan of $750.0 million to AIG that was payable on demand at any time. The cash used to fund the AIG loan came from operations and SLFC’s secured term loan. On November 29, 2010, AIG repaid the $750.0 million demand promissory note plus accrued interest of $1.3 million.
At December 31, 2011, material obligations were as follows:
(a) Long-term debt and interest payments on debt maturities by period exclude on-balance sheet securitizations due to their variable monthly payments.
(b) Future interest payments on floating-rate debt are estimated based upon floating rates in effect at December 31, 2011.
(c) Operating leases include annual rental commitments for leased office space, automobiles, and data processing and related equipment.
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. In addition, a prolonged decline in originations would negatively impact our long-term liquidity. We intend to support our liquidity position by utilizing the following strategies:
· managing originations and purchases of finance receivables and maintaining disciplined underwriting standards and pricing for such loans;
· pursuing additional debt financings, particularly new securitizations, debt refinancing transactions, portfolio sales, or a combination of the foregoing; and
· from time to time we or our affiliates may purchase portions of our outstanding indebtedness through open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices, as well as with such consideration, as we or any such affiliates may determine.
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.
SELECTED LOAN PORTFOLIO SEGMENT INFORMATION
Allowance for Finance Receivable Losses
Our Credit Strategy and Policy Committee evaluates our finance receivable portfolio monthly by non-real estate loans, retail sales finance, and real estate loans. Allowance for finance receivable losses is calculated for each of our portfolio segments. We allocated the allowance for finance receivable losses for real estate loans to each segment based upon delinquency. See Note 8 of the Notes to Consolidated Financial Statements in Item 8 for information on our allowance for finance receivable losses.
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 the following scores to analyze performance of our finance receivable portfolio:
· 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
See Note 6 of the Notes to Consolidated Financial Statements in Item 8 for our net finance receivables and delinquency ratios classified into these FICO-delineated categories. Management believes the primary reason that prime real estate loans of our centralized business segment have a significantly higher delinquency percentage as compared to prime, non-prime, and sub-prime real estate loans of our branch business segment is that the centralized business segment loans were made primarily through broker or correspondent channels and thereby established no face-to-face relationship with us, whereas substantially all of the branch business segment real estate loans were originated in the branch by our personnel whose future success is dependent on the future performance of those loans. Secondarily, but no less importantly, the centralized business segment loans are subserviced by third parties not necessarily related to us while branch business segment loans are almost always serviced by the persons who originated them and for whom the loan’s future performance is a measure of their job performance and compensation. Lastly, the LTV ratio for our centralized business segment is higher than the LTV ratio for our branch business segment. Borrowers with relatively minimal equity in their home may be less willing to continue making loan payments than borrowers with a greater proportion of equity.
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 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.
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):
(a) Not applicable because these higher-risk loans were not offered by our branch business segment.
(b) Not available.
We held the first mortgage of borrowers on 4% of our second mortgage portfolio at December 31, 2011 and 2010. Our second mortgages may be closed-end accounts or open-end home equity lines of credit and are primarily fixed-rate products. At December 31, 2011 and 2010, 89% of our second mortgages were fixed-rate mortgages. At December 31, 2011, 65% of our second mortgages were open-end home equity lines of credit, compared to 64% at December 31, 2010. The maximum draw period for cash advances for unused credit lines is 120 months, but all unused credit lines, in part or in total, can be cancelled at our discretion at any time.
Charge-off ratios for these higher-risk real estate loans for our branch and centralized real estate business segments were as follows:
* Not applicable because these higher-risk loans were 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 December 31, 2011 was $2.5 billion, or 25%, of total real estate loans. We update collateral valuations by applying the sequential change in the House Price Index as published quarterly by the Federal Housing Finance Agency at the Metropolitan Statistical Area or state level to update the LTV.
ANALYSIS OF FINANCIAL CONDITION
Finance Receivables
Risk Characteristics. Our customers in all portfolio segments (non-real estate loans, retail sales finance, and real estate loans) encompass a wide range of borrowers. In the consumer finance industry, they are described as prime or near-prime at one extreme and non-prime or sub-prime at the other. Our customers’ incomes are generally near the national median but our customers may vary from national norms as to their debt-to-income ratios, employment and residency stability, and/or credit repayment histories. In general, our customers have lower credit quality and require significant levels of servicing. As a result, we charge them higher interest rates to compensate us for such services and related credit risks.
Despite our efforts to avoid losses on our portfolio segments, personal circumstances and national, regional, and local economic situations affect our customers’ willingness or ability to repay their obligations. The risk characteristics of each portfolio segment include the following:
Non-real estate loan portfolio and retail sales finance portfolio
· elevated unemployment levels;
· high energy costs;
· other borrower indebtedness;
· major medical expenses; and
· divorce or death.
Real estate loan portfolio
· adverse shifts in residential real estate values;
· elevated unemployment levels;
· high energy costs;
· other borrower indebtedness;
· major medical expenses; and
· divorce or death.
Occasionally, these events can be so economically severe that the customer files for bankruptcy.
Amount, number, and average size of net finance receivables originated and renewed by portfolio segment were as follows:
Amount and number of net finance receivables net (transferred/sold) transferred back/purchased by portfolio segment were as follows:
See Note 9 of the Notes to Consolidated Financial Statements in Item 8 for a discussion of net finance receivables transferred to finance receivables held for sale, subsequent sales, and finance receivables held for sale transferred back to finance receivables held for investment during 2010 and 2009.
Amount and number of total net finance receivables originated, renewed, and net (transferred/sold) transferred back/purchased by portfolio segment were as follows:
Amount, number, and average size of net finance receivables by portfolio segment were as follows:
The amount of first mortgage loans was 92% of our real estate loan net receivables at December 31, 2011 and 91% at December 31, 2010.
See Note 6 of the Notes to Consolidated Financial Statements in Item 8 for additional information on our finance receivables, including geographic diversification and contractual maturities of finance receivables.
Real Estate Owned
Changes in the amount of real estate owned were as follows:
(a) The beginning balance of real estate owned for the Successor Company for the one month ended December 31, 2010 includes the push-down accounting adjustments.
(b) Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
The decrease in real estate owned at December 31, 2011 when compared to December 31, 2010 reflected our liquidity management efforts. The increase in real estate owned at December 31, 2010 when compared to December 31, 2009 reflected higher foreclosures as a result of negative economic fundamentals and the downturn in the U.S. residential real estate market. The increase in real estate owned at December 31, 2010 when compared to December 31, 2009 also reflected the impact of push-down accounting adjustments, which increased real estate owned by $16.7 million.
See Note 3 of the Notes to Consolidated Financial Statements in Item 8 for information relating to our accounting policy for real estate owned.
Investments
Investments by type were as follows:
Our investment strategy is to optimize after-tax returns on invested assets, subject to the constraints of liquidity, diversification, and regulation. See Note 10 of the Notes to Consolidated Financial Statements in Item 8 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. Although finance receivable lives may change in response to market interest rates and credit conditions, for the quarter ending December 31, 2011, our finance receivables had the following average lives based upon the levels of principal repayments during the fourth quarter of 2011 and excluding the impact of renewals:
The contractual weighted-average life until maturity for our long-term debt was 4.5 years at December 31, 2011.
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 33% of our borrowings at December 31, 2011, compared to 24% at December 31, 2010. Adjustable-rate net finance receivables represented 5% of our total portfolio at December 31, 2011 and 2010.
Since 2008, 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. See “Capital Resources and Liquidity” for further information.
ANALYSIS OF OPERATING RESULTS
Net (Loss) Income
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
(c) Not applicable. Earnings did not cover total fixed charges by $323.2 million in 2011, $264.7 million during the eleven months ended November 30, 2010, and $909.2 million in 2009.
See the following pages for discussion of factors that affected our operating results.
See Note 26 of the Notes to Consolidated Financial Statements in Item 8 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 I, Item 1A.
Factors that affected the Company’s operating results were as follows:
Finance Charges
Finance charges by portfolio segment were as follows:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Finance charges increased (decreased) due to the net of the following:
(a) Not meaningful
(b) Total change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Total change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
Average net receivables by portfolio segment were as follows:
Decreases in average net receivables by portfolio segment were as follows:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Average net receivables decreased in 2011 when compared to the eleven months ended November 30, 2010 reflecting the impact of push-down accounting adjustments, which decreased average net receivables by $2.1 billion in 2011 and our tighter underwriting guidelines and liquidity management efforts.
Average net receivables for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which decreased average net receivables by $2.4 billion for the one month ended December 31, 2010.
The decrease in average net finance receivables for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 reflected our tighter underwriting guidelines and liquidity management efforts.
See Note 9 of the Notes to Consolidated Financial Statements in Item 8 for a discussion of net finance receivables transferred to finance receivables held for sale, subsequent sales, and finance receivables held for sale transferred back to finance receivables held for investment during 2010 and 2009.
Yield by portfolio segment were as follows:
Changes in yield in basis points (bp) by portfolio segment were as follows:
(a) Not meaningful
(b) Total change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Total change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
Yield increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of valuation discount accretion resulting from the push-down accounting adjustments, which increased yield by 352 basis points in 2011.
Yield for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which increased yield by 467 basis points for the one month ended December 31, 2010.
Yield increased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 primarily due to higher non-real estate loan and retail sales finance yields reflecting the origination of new finance receivables at higher rates based on market conditions and the discontinuation of certain promotional products, partially offset by the increase of real estate loan modifications, including TDRs (which result in reduced finance charges).
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:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
See Note 9 of the Notes to Consolidated Financial Statements in Item 8 for a discussion of net finance receivables transferred to finance receivables held for sale, subsequent sales, and finance receivables held for sale transferred back to finance receivables held for investment during 2010 and 2009.
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:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Interest expense increased (decreased) due to the net of the following:
(a) Not meaningful
(b) Total change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Total change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
Average borrowings by type were as follows:
Decreases in average borrowings by type were as follows:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Average borrowings decreased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to liquidity management efforts and the impact of push-down accounting adjustments, which decreased average borrowings by $1.2 billion in 2011. See Note 14 of the Notes to Consolidated Financial Statements in Item 8 for principal maturities of our long-term debt.
Average borrowings for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which decreased average borrowings by $1.3 billion for the one month ended December 31, 2010.
The decrease in average borrowings for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 reflected our liquidity management efforts.
Interest expense rate by type were as follows:
Changes in interest expense rate in basis points by type were as follows:
(a) Not meaningful
(b) Total change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Total change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
Interest expense rate increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of valuation discount accretion resulting from the push-down accounting adjustments, which increased interest expense rate by 284 basis points in 2011.
Interest expense rate for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which increased our interest expense rate by 285 basis points for the one month ended December 31, 2010.
Our future overall interest expense rates are likely to 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.
SLFC’s and SLFI’s credit ratings were further downgraded in 2011 and are all non-investment grade, which has a significant impact on our cost of, and access to, capital. This, in turn, negatively affects our ability to manage our liquidity and our ability to refinance our indebtedness.
The following table presents the credit ratings of SLFC as of March 19, 2012. On September 7, 2011, Fitch downgraded SLFC’s senior, long-term debt to “CCC” and removed it from “Negative Watch” status. On February 3, 2012, Standard & Poor’s lowered its rating on SLFC’s unsecured senior long-term debt from “B” to “CCC” and maintained its “Negative Outlook” status. The Fitch rating also applies to SLFI. 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. SLFI 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.
Provision for Finance Receivable Losses
(dollars in millions)
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
(c) Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
Provision for finance receivable losses decreased in 2011 when compared to eleven months ended November 30, 2010 primarily due to lower net charge-offs in 2011, partially offset by decreases to the allowance for finance receivable losses in the eleven months ended November 30, 2010 compared to increases to the allowance for finance receivable losses in 2011 and one more month in the 2011 period. As a result of our analysis of the favorable trends in our credit quality during the eleven months ended November 30, 2010, partially offset by the increase in TDR net finance receivables, we decreased our allowance for finance receivable losses during the eleven months ended November 30, 2010. Provision for finance receivable losses in 2011 also reflected the impact of purchased credit impaired finance receivables resulting from the push-down accounting adjustments, which decreased net charge-offs by $175.9 million in 2011.
Provision for finance receivable losses for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which decreased net charge-offs by $23.7 million for the one month ended December 31, 2010.
Provision for finance receivable losses decreased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 as a result of our lower delinquency and net charge-offs in 2010 and one less month in the 2010 period.
Charge-offs, recoveries, net charge-offs, and charge-off ratio by portfolio segment were as follows:
Changes in net charge-offs by portfolio segment were as follows:
(a) Not meaningful
(b) Total change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Total change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
Changes in charge-off ratios in basis points by portfolio segment were as follows:
(a) Not meaningful
(b) Total change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Total change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
Total charge-off ratio decreased in 2011 when compared to the eleven months ended November 30, 2010 reflecting the impact of push-down accounting adjustments, which decreased total charge-off ratio by 84 basis points in 2011 and our tighter underwriting guidelines.
Total charge-off ratio for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which decreased total charge-off ratio by 130 basis points for the one month ended December 31, 2010.
Total charge-off ratio decreased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 primarily due to an improvement in the non-real estate loan charge-off ratio reflecting our tighter underwriting guidelines, partially offset by negative economic fundamentals and the impacts of portfolio sales and liquidations.
Charge-off coverage, which compares the allowance for finance receivable losses to annualized net charge-offs, decreased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of push-down accounting adjustments, which decreased charge-off coverage by 239 basis points in 2011. Charge-off coverage for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which decreased charge-off coverage by 204 basis points for the one month ended December 31, 2010. Charge-off coverage increased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 primarily due to lower annualized net charge-offs.
Delinquency and delinquency ratio by portfolio segment were as follows:
Changes in delinquency by portfolio segment were as follows:
Changes in delinquency ratio in basis points by portfolio segment were as follows:
The total delinquency ratio at December 31, 2011 increased when compared to December 31, 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.
The total delinquency ratio at December 31, 2010 decreased when compared to December 31, 2009 primarily due to 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 increase in the allowance for finance receivable losses at December 31, 2011 when compared to December 31, 2010 was primarily due to the increase in allowance for financial receivable losses for non-real estate loans and the increase in TDR net finance receivables. The allowance for finance receivable losses at December 31, 2011 included $29.4 million related to TDRs, compared to $2.8 million at December 31, 2010. See Note 8 of the Notes to Consolidated Financial Statements in Item 8 for the allowance for finance receivable losses and net finance receivables by portfolio segment.
The decrease in the allowance ratio at December 31, 2011 and at December 31, 2010 when compared to the respective prior year ends was primarily due to the impact of push-down accounting adjustments, which reduced the allowance ratio by 726 basis points at December 31, 2011 and 813 basis points at December 31, 2010.
Insurance Revenues
Insurance revenues were as follows:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Earned premiums increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to one more month in the 2011 period.
The components of earned premiums for the one month period ended December 31, 2010 are included in the table below.
Earned premiums decreased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 primarily due to decreases in credit earned premiums and one less month in the 2010 period.
Premiums earned by type were as follows:
Premiums written by type were as follows:
Investment Revenue
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Investment revenue was affected by the following:
Generally, we invest cash in various investments, primarily bonds.
As a result of the FCFI Transaction, we applied push-down accounting and adjusted the book value of our investment securities to their fair value, which increased average invested assets by $30.0 million in 2011 and $34.5 million for the one month period ended December 31, 2010 and decreased average invested asset yield by 105 basis points in 2011 and 20 basis points for the one month period ended December 31, 2010. The increase in average invested assets in 2011 when compared to the eleven months ended November 30, 2010 also reflected a $300.0 million purchase of higher yielding bonds in fourth quarter 2011 related to our corporate cash investing activities. The decrease in average invested asset yield in 2011 when compared to the eleven months ended November 30, 2010 also reflected the replacement of disposed invested assets with lower yielding invested assets reflecting current market conditions.
Gain on Early Extinguishment of Secured Term Loan
As a result of the refinancing of SLFC’s secured term loan on May 10, 2011, certain creditors involved in the syndicate of lenders of the original loan were not included in the syndicate of lenders of the refinanced loan (extinguished creditors). We recorded a $10.7 million gain on the early extinguishment of the original loan, which represented the pro rata amount of the unamortized balance of the fair value adjustment on the debt no longer payable to the extinguished creditors. See “Capital Resources and Liquidity - Capital Resources” for further information on the refinancing of this loan.
Other Revenues
Other revenues were as follows:
(a) See table below for the components of the derivative adjustments.
(b) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(c) Not meaningful
Writedowns on real estate owned and net losses on sales of real estate owned increased in 2011 when compared to the eleven months ended November 30, 2010 reflecting negative economic fundamentals and the fragile U.S. residential real estate market. Writedowns on real estate owned increased for the eleven months ended November 30, 2010 when compared to 2009 reflecting negative economic fundamentals and the downturn in the U.S. residential real estate market. However, net losses on sales of real estate owned improved during the eleven months ended November 30, 2010.
The components of other revenues for the one month ended December 31, 2010 are included in the table above.
Derivative adjustments included in other revenues consisted of the following:
* The credit valuation adjustment gains or losses on our non-designated cross currency derivative 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:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Salaries and benefits decreased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to lower medical claims and premiums paid by the Company in 2011 and fewer employees, partially offset by one more month in the 2011 period.
Salaries and benefits for the one month ended December 31, 2010 reflected monthly salaries, employee medical costs, and pension expenses.
Salaries and benefits decreased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 primarily due to having fewer employees and one less month in the 2010 period, partially offset by higher pension expenses and higher employee medical costs due to the 2010 medical claims exceeding the premium rates.
In third quarter 2010, we recorded out of period adjustments in salaries and benefits related to prior quarters and years, which increased operating expenses by $19.1 million for the eleven months ended November 30, 2010. These adjustments related to $14.6 million in 2010 of certain pension costs under a non-qualified plan covering certain of our employees for the service period of 2001 to 2010 and $4.5 million of certain medical expenses relating to our self-insured medical plans for 2009 and 2010.
Other operating expenses increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of push-down accounting adjustments (including the amortization of other intangible assets), higher professional services expenses, and higher advertising expenses, partially offset by lower legal settlement expenses and lower administrative expenses allocated from our former indirect parent.
Other operating expenses for the one month ended December 31, 2010 reflected monthly rent, real estate owned, and legal expenses.
Other operating expenses decreased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 reflecting one less month in the 2010 period and reduced operating expenses resulting from branch office closings in 2009, partially offset by increased reserves related to ongoing legal matters and higher advertising expenses primarily due to the preliminary costs associated with the change in the Company’s name from American General Finance, Inc. to Springleaf Finance, Inc. effective March 7, 2011.
The operating expense ratio, which compares the annualized operating expenses to average net receivables, increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of push-down accounting adjustments, which increased the operating expense ratio by 92 basis points in 2011. Operating expense ratio for the one month ended December 31, 2010 reflected the impact of push-down accounting adjustments, which increased operating expense ratio by 88 basis points for the one month ended December 31, 2010. Operating expense ratio for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 increased primarily due to the decline in average net finance receivables, which reflected our liquidity management efforts.
Insurance Losses and Loss Adjustment Expenses
Insurance losses and loss adjustment expenses were as follows:
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Losses incurred by type were as follows:
Insurance losses and loss adjustment expenses decreased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to lower losses incurred under group annuities resulting from the out of period adjustment described below, partially offset by one more month in the 2011 period.
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 nine months ended September 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 our previously issued quarterly and annual consolidated financial statements were not materially misstated and that the out of period adjustment is immaterial.
The components of insurance losses and loss adjustment expenses for the one month ended December 31, 2010 are included in the table above.
Insurance losses and loss adjustment expenses decreased for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 primarily due to lower credit involuntary unemployment claims incurred, lower losses incurred under reinsurance agreements, and one less month in the 2010 period. In second and third quarters of 2010, we recorded out of period adjustments related to prior quarters and years, which decreased change in benefit reserves by $7.7 million in the eleven months ended November 30, 2010. These adjustments related to the correction of a valuation error related to an assumed block of annuities. These adjustments were offset by an unfavorable variance in non-credit branch business primarily due to higher non-credit branch premiums written in the eleven months ended November 30, 2010.
Bargain Purchase Gain
As a result of the FCFI Transaction, we recorded a $1.5 billion gain for the one month ended December 31, 2010 resulting from our election to use push-down accounting. See Note 5 of the Notes to Consolidated Financial Statements in Item 8 for further information on the FCFI Transaction.
Benefit from Income Taxes
(a) Amount change and percent change for year ended December 31, 2011 is compared to eleven months ended November 30, 2010. Amount change and percent change for eleven months ended November 30, 2010 is compared to year ended December 31, 2009.
(b) Not meaningful
Benefit from income taxes in 2011 decreased when compared to the eleven months ended November 30, 2010 primarily due to the establishment of valuation allowances against our deferred tax assets in 2011, compared to a release of valuation allowances for the eleven months ended November 30, 2010.
At December 31, 2011, we had a valuation allowance on our state deferred tax assets of $13.8 million, net of a deferred federal tax benefit, and a valuation allowance of $4.0 million for our foreign United Kingdom operations. At December 31, 2011, we had a net deferred tax liability of $398.8 million.
Benefit from income taxes for the one month ended December 31, 2010 reflects the bargain purchase gain, tax exempt interest, and state income tax. Benefit from income taxes also reflects our tax position on a stand alone basis since we no longer are included in AIG’s consolidated federal income tax return due to the FCFI Transaction.
At December 31, 2010, a valuation allowance was not required on our deferred tax assets. We had a net deferred tax liability of $524.4 million at December 31, 2010. 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 eleven months ended November 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 $243.2 million, the tax effect 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 AIG for the amount of the income tax receivable at the closing of the FCFI Transaction.
In September 2010, we reclassified $58.2 million from deferred tax assets to current tax receivable due to AIG estimating the utilization of our existing net operating losses. The release of the valuation allowance associated with these net operating losses produced a $58.2 million tax benefit. In addition, we recorded a $49.5 million deferred tax asset, along with a full valuation allowance associated with the outside basis balance on our foreign subsidiaries.
The lower effective income tax rate for 2011 reflected the impact of recording a partial valuation allowance on our state and foreign operations.
The effective income tax rate for the one month ended December 31, 2010 differed from the statutory tax rate primarily due to the impact of the bargain purchase gain.
The higher effective income tax rate for the eleven months ended November 30, 2010 when compared to the twelve months ended December 31, 2009 was primarily due to the release of a valuation allowance and tax exempt interest, partially offset by the effect of recording a deferred tax on the outside basis on our foreign entities.
REGULATION AND OTHER
Regulation
We discuss regulation of the branch, centralized real estate, and insurance business segments and international regulation in Item 1.
Taxation
We monitor federal, state, and United Kingdom tax legislation and respond with appropriate tax planning.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The fair values of certain of our assets and liabilities are sensitive to changes in market interest rates. The impact of changes in interest rates would be reduced by the fact that increases (decreases) in fair values of assets would be partially offset by corresponding changes in fair values of liabilities. In aggregate, the estimated impact of an immediate and sustained 100 basis point increase or decrease in interest rates on the fair values of our interest rate-sensitive financial instruments would not be material to our financial position.
The estimated increases (decreases) in fair values of interest rate-sensitive financial instruments were as follows:
We derived the changes in fair values by modeling estimated cash flows of certain of our assets and liabilities. We adjusted the cash flows to reflect changes in prepayments and calls, but did not consider loan originations, debt issuances, or new investment purchases.
We do not enter into interest rate-sensitive financial instruments for trading or speculative purposes.
Readers should exercise care in drawing conclusions based on the above analysis. While these changes in fair values provide a measure of interest rate sensitivity, they do not represent our expectations about the impact of interest rate changes on our financial results. This analysis is also based on our exposure at a particular point in time and incorporates numerous assumptions and estimates. It also assumes an immediate change in interest rates, without regard to the impact of certain business decisions or initiatives that we would likely undertake to mitigate or eliminate some or all of the adverse effects of the modeled scenarios.
Item 8.
Item 8. Financial Statements and Supplementary Data.
An index to our financial statements and supplementary data follows:
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholder
of Springleaf Finance, Inc.
In our opinion, the accompanying consolidated balance sheets as of December 31, 2011 and 2010 and the related consolidated statements of operations, comprehensive income (loss), shareholder’s equity, and cash flows for the year ended December 31, 2011 and the one month ended December 31, 2010 present fairly, in all material respects, the financial position of Springleaf Finance, Inc. and its subsidiaries (Successor Company) at December 31, 2011 and 2010 and the results of their operations and their cash flows for the year ended December 31, 2011 and the one month ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index for the year ended December 31, 2011 and the one month ended December 31, 2010 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
March 19, 2012
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholder
of Springleaf Finance, Inc.
In our opinion, the accompanying consolidated statements of operations, comprehensive income (loss), shareholder’s equity, and cash flows for the eleven months ended November 30, 2010 and for the year ended December 31, 2009 present fairly, in all material respects, the results of Springleaf Finance, Inc. and its subsidiaries (formerly American General Finance, Inc., Predecessor Company) in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index for the eleven months ended November 30, 2010 and for the year ended December 31, 2009 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for other-than-temporary impairments of fixed maturity securities as of April 1, 2009.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
March 30, 2011
Springleaf Finance, Inc. and Subsidiaries
Consolidated Balance Sheets
See Notes to Consolidated Financial Statements.
Springleaf Finance, Inc. and Subsidiaries
Consolidated Statements of Operations
See Notes to Consolidated Financial Statements.
Springleaf Finance, Inc. and Subsidiaries
Consolidated Statements of Comprehensive (Loss) Income
* We revised our presentation from the prior period to reflect our cash flow hedges on a gross basis. In the prior years, these cash flow hedges were incorrectly presented on a net basis totaling a $1.6 million net gain for the one month ended December 31, 2010, an $8.0 million net gain for the eleven months ended November 30, 2010, and an $82.0 million net gain for the year ended December 31, 2009. This revision had no impact on our other comprehensive income (loss) for the one month ended December 31, 2010, eleven months ended November 30, 2010, or the year ended December 31, 2009.
See Notes to Consolidated Financial Statements.
Springleaf Finance, Inc. and Subsidiaries
Consolidated Statements of Shareholder’s Equity
See Notes to Consolidated Financial Statements.
Springleaf Finance, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
See Notes to Consolidated Financial Statements.
Springleaf Finance, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2011
Note 1. Nature of Operations
Until November 30, 2010, Springleaf Finance, Inc. (SLFI or, collectively with its subsidiaries, whether directly or indirectly owned, the Company, we, us, or our) (formerly American General Finance, Inc.) 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 10, 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). Through an integrated series of transactions pursuant to the terms of the Stock Purchase Agreement and the related transfer agreement, AIG formed and initially capitalized a new holding company, AGF Holding Inc. (AGF Holding), as a subsidiary of ACC. ACC contributed all of the outstanding shares of SLFI to AGF Holding on November 30, 2010 immediately prior to the FCFI Transaction. AIG then caused ACC to sell to FCFI 80% of the outstanding shares of AGF Holding. AIG, through ACC, retained 20% of the outstanding shares of AGF Holding and, indirectly, a 20% economic interest in SLFI. See Note 5 for further information on the FCFI Transaction.
SLFI is a financial services holding company whose principal subsidiary is Springleaf Finance Corporation (SLFC) (formerly American General Finance Corporation). SLFC is also a financial services holding company with subsidiaries engaged in the consumer finance and credit insurance businesses. At December 31, 2011, the Company had 1,118 branch offices in 40 states, Puerto Rico and the U.S. Virgin Islands; foreign operations in the United Kingdom; and approximately 5,800 employees.
Notes to Consolidated Financial Statements, Continued
Events Subsequent to December 31, 2011
The following events have occurred since December 31, 2011:
· As of January 1, 2012, the Company ceased new originations of real estate loans so that it could focus on its other consumer lending products and its insurance operations.
· On February 1, 2012, we informed affected employees of our plan to close approximately 60 branch offices and immediately cease consumer lending and retail sales financing in 14 states where we do not have a significant presence and in southern Florida. See Note 30 for further information on the branch closings.
· On February 3, 2012, Standard & Poor’s lowered its rating on SLFC’s unsecured senior long-term debt from “B” to “CCC” and maintained its negative outlook.
· On February 10, 2012, we received proceeds of $272.7 million (before taxes and selling expenses and excluding accrued interest) from the sales of retained subordinated interests in previously issued securitization transactions. See Note 30 for further information on the sales of retained subordinated interests.
· On February 15, 2012, we reduced the workforce at our Evansville, Indiana headquarters by approximately 130 employees due to the cessation of real estate lending, the branch closings, and the cessation of consumer lending and retail sales financing in 14 states and southern Florida.
· On March 2, 2012, we informed affected employees of our plan to consolidate certain branch operations and close approximately 150 branch offices in 25 states. See Note 30 for further information on the branch closings.
· On March 2, 2012, the Company sold approximately 13,100 non-real estate and retail sales finance receivable accounts in Delaware, New Jersey, and Maryland with a carrying value of $45.0 million pursuant to a letter of intent to sell dated January 27, 2012. The receivables were sold at a loss of $0.4 million.
· We have retained Alvarez & Marsal North America, LLC and Houlihan Lokey Capital, Inc. to assist us with identifying ways to streamline our operations and reduce costs and to provide financial advisory services.
Segments
We have three business segments: branch, centralized real estate, and insurance. 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;
· 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
· originated real estate loans secured by first or second mortgages on residential real estate (until January 1, 2012), which may be closed-end accounts or open-end home equity lines of credit and are generally considered non-conforming.
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.
Notes to Consolidated Financial Statements, Continued
In our centralized real estate business segment, we originated or acquired a portfolio of residential real estate loans unrelated to our branch business. MorEquity, Inc. (MorEquity), a wholly-owned subsidiary of SLFC, services these real estate loans, all of which are subserviced by Nationstar Mortgage LLC (Nationstar), a non-subsidiary affiliate of SLFI, except for certain securitized real estate loans, which are serviced and subserviced by third parties.
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. See Note 26 for further information on the Company’s business segments.
At December 31, 2011, the Company had $13.2 billion of net finance receivables due from 1.1 million customer accounts and $3.3 billion of credit and non-credit life insurance in force covering approximately 601,000 customer accounts.
Note 2. Risks and Uncertainties
We currently have a significant amount of indebtedness. Our liquidity position has been, and is likely to continue to be, negatively affected by unfavorable conditions in the consumer finance industry, the residential real estate market and the capital markets. In addition, SLFC’s and SLFI’s credit ratings are all non-investment grade, which have a significant impact on our cost of, and access to, capital. This, in turn, negatively affects our ability to manage our liquidity and our ability to refinance our indebtedness.
If current market conditions, as well as our financial performance, do not improve or further deteriorate, we may not be able to generate sufficient cash to service our debt. At December 31, 2011, we had $689.6 million of cash and cash equivalents ($7.0 million of cash and cash equivalents related to our foreign subsidiary, Ocean), and in 2011 we generated a net operating loss of $224.2 million and cash flows from operating and investing activities of $1.7 billion. In 2012, we are required to pay $2.8 billion to service the principal and interest due under the terms of our existing debt (excluding securitizations). Additionally, we have $778.3 million of debt maturities and interest payments (excluding securitizations) due in the first quarter of 2013. In order to meet our debt obligations in 2012 and beyond, we are exploring a number of options, including further operational changes to increase or preserve our available cash, additional debt financings, particularly new securitizations involving real estate and/or non-real estate loans, debt refinancing transactions, portfolio sales, or a combination of the foregoing. As of December 31, 2011, the Company had $3.5 billion of unencumbered real estate loans and $3.1 billion of unencumbered non-real estate loans.
The Company ceased its real estate lending effective January 1, 2012 to focus on its other consumer lending products, which have substantially higher yields. The Company also has the flexibility to manage the volume of finance receivable originations on a timely basis to preserve its liquidity for near-term obligations.
We cannot assure that additional debt financings, particularly new securitizations, debt refinancing transactions, or portfolio sales will be available to us on acceptable terms, or at all. Our ability to support operations and repay indebtedness will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, regulatory, and other factors that are beyond our control and cannot be predicted with certainty. We would be materially adversely affected if we were unable to repay or refinance our debt as it comes due.
Notes to Consolidated Financial Statements, Continued
We actively manage our liquidity and continually work on initiatives to address our liquidity needs. In connection with our liability management efforts, we or our affiliates from time to time may purchase portions of our outstanding indebtedness. Any such future purchases may be made through open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices, as well as with such consideration as we or any such affiliates may determine. Our plans are dynamic and we may adjust our plans in response to changes in our expectations and changes in market conditions.
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 during 2012, provided we are able to execute on capital raising or debt refinancing plans. We are also incorporating into our business plans the need to generate liquidity to meet our debt payments into 2013.
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.
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:
· our ability to generate sufficient cash to service all of our outstanding debt;
· SLFI will pay its note payable to SLFC ($538.0 million at December 31, 2011), if needed by SLFC to meet its liquidity needs;
· our access to debt and securitization markets and other sources of funding on favorable terms;
· 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;
· the potential for further downgrade of our debt by rating agencies, which would have a negative impact on our cost of, and access to, capital;
· our ability to comply with our debt covenants, including the borrowing base for SLFC’s secured term loan;
· 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; and
· additional costs, in excess of amounts accrued, 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 refunds to customers.
Notes to Consolidated Financial Statements, Continued
Additionally, there are numerous risks to our financial results, liquidity, and capital raising and debt refinancing plans which are not quantified in our current liquidity forecasts. These risks include, but are not limited, to the following:
· 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;
· 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 the subservicing of our centralized mortgage loan portfolio;
· potential liability relating to real estate loans which we have sold or may 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; and
· the potential loss of key personnel.
Note 3. Summary of Significant Accounting Policies
BASIS OF PRESENTATION
We prepared our consolidated financial statements using accounting principles generally accepted in the United States of America (U.S. GAAP). The statements include the accounts of SLFI 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 consolidated financial statements and disclosures of contingent assets and liabilities. 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. To conform to the 2011 presentation, we reclassified certain items in prior periods.
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 Annual Report on Form 10-K through the inclusion of a vertical black line between the Successor Company and the Predecessor Company columns.
Notes to Consolidated Financial Statements, Continued
The financial information for 2010 includes the financial information of the Successor Company for the one month ended December 31, 2010 and of the Predecessor Company for the eleven months ended November 30, 2010. These separate periods are presented to reflect the new accounting basis established for our Company as of November 30, 2010.
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 one month ended December 31, 2010 and the year ended December 31, 2011 have been the same as those reported if push-down accounting had not been applied. Additionally, key ratios of the Successor Company are not comparable to those of the Predecessor Company, nor are they comparable to other institutions due to the new accounting basis established. See Note 5 for further information on the FCFI Transaction.
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 in 2011. This adjustment related to the correction of a benefit reserve error related to a closed block of annuities.
In third quarter 2011, we recorded an out of period adjustment related to the first and second quarters of 2011. The adjustment decreased other revenues by $6.7 million and decreased other operating expenses by $0.1 million in 2011. This adjustment related to the correction of the calculation of the carrying value for our branch real estate owned and to the calculation of net loss on sales of our centralized real estate owned that are externally serviced.
In third quarter 2011, we reclassified $28.7 million of the interest expense on derivatives (which reduced other revenues and interest expense) relating to amounts previously recognized through June 30, 2011 for the difference between the hypothetical derivative interest expense and the contractual derivative interest expense.
In third quarter 2011, we revised the presentation of our prior period derivative footnote (see Note 16). This revision corrects the omission of the effective portion of the valuation change of our cross currency interest rate swaps that was recorded in accumulated other comprehensive income or loss and an equal amount that was reclassified to earnings in 2010. In addition, we revised the presentation of our consolidated statements of other comprehensive (loss) income to reflect our cash flow hedges on a gross basis. In the prior year, these swap agreements were incorrectly presented on a net basis totaling a $1.6 million net gain for the one month ended December 31, 2010, an $8.0 million net gain for the eleven months ended November 30, 2010, and an $82.0 million net gain for the year ended December 31, 2009.
Historically, we included the accelerated accretion of the valuation discount on non-credit impaired charged-off accounts as a component of finance charge revenue. After further review of this treatment, we have changed our presentation (beginning in third quarter 2011) to include the accelerated accretion in connection with non-credit impaired charged-off accounts as a component of net charge-offs. Accordingly, in third quarter 2011 we reclassified $29.5 million of the accelerated accretion of the valuation discount on non-credit impaired charged off accounts from finance charge revenue to the provision for finance receivable losses, which related to the amount previously recognized through June 30, 2011. This revised presentation provides an income statement treatment that is more consistent with the balance sheet presentation of the related finance receivables as the finance receivables are presented under push-down accounting net of valuation discount. We will apply this revised presentation in all periods in future filings.
Notes to Consolidated Financial Statements, Continued
In fourth quarter 2011, we recorded an out of period adjustment, which increased deferred state tax expense in 2011 by $6.0 million. The adjustment related to the correction of the amount recorded as a deferred state tax asset for one of our subsidiaries as of December 31, 2010.
In fourth quarter 2011, we recorded an out of period adjustment related to the first and second quarters of 2011. The adjustment increased investment income by $2.3 million, decreased benefit from income taxes by $0.8 million, and increased accumulated other comprehensive loss by $1.5 million. The adjustment related to the correction of recording distributions on limited partnerships.
In fourth quarter 2011, we recorded an out of period adjustment related to a payable to our former parent in the amount of $1.7 million as of December 1, 2010. This adjustment related to any refund of (or credit for) taxes, including any interest received thereon.
After evaluating the quantitative and qualitative aspects of these corrections and reclassifications (individually and in aggregate), management has determined that our previously issued consolidated interim and annual financial statements were not materially misstated.
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.
In third quarter 2011, we obtained new information relative to assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction, which indicated that the deferred liability should have been $7.9 million more than the amounts reflected in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. Under push-down accounting, adjustments can be made to the fair value of assets and liabilities recorded at the date of the FCFI Transaction during the measurement period in response to new information about facts and circumstances that existed as of the transaction date. The measurement period ends when information is obtained or is determined to not be available and is not to exceed one year from the date of the transaction. As a result, we recorded a tax adjustment that increased deferred and accrued taxes and decreased retained earnings by $7.9 million pursuant to purchase accounting as of December 31, 2010 to conform with the new information.
BRANCH AND CENTRALIZED REAL ESTATE BUSINESS SEGMENTS
Finance Receivables
Generally, we classify finance receivables originated in our branch business segment as finance receivables held for investment based on management’s intent at the time of origination. We also classify certain real estate loans originated in our centralized real estate business segment as finance receivables held for investment based on management’s intent at the time of origination. We determine classification on a loan-by-loan basis. We classify finance receivables as held for investment due to our ability and intent to hold them until customer payoff. We carry finance receivables at amortized cost which includes accrued finance charges on interest bearing finance receivables, unamortized deferred origination costs, and unamortized net premiums and discounts on purchased finance receivables. They are net of unamortized finance charges on precomputed receivables and unamortized points and fees. We include the cash flows from finance receivables held for investment in the consolidated statements of cash flows as investing activities.
Notes to Consolidated Financial Statements, Continued
Although a significant portion of insurance claims and policyholder liabilities originate from the finance receivables, our policy is to report them as liabilities and not net them against finance receivables. Finance receivables relate primarily to the financing activities of our branch and centralized real estate business segments. Insurance claims and policyholder liabilities relate to the underwriting activities of our insurance business segment.
As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our finance receivables to their fair value on November 30, 2010. See Note 5 for further information on the FCFI Transaction.
Finance Receivable Revenue Recognition
We recognize finance charges as revenue on the accrual basis using the interest method. We amortize premiums or accrete discounts on finance receivables purchased after the date of the FCFI Transaction as a revenue adjustment using the interest method and contractual cash flows. For finance receivables originated after the date of the FCFI Transaction, we defer the costs to originate certain finance receivables and the revenue from nonrefundable points and fees on loans and amortize them to revenue using the interest method.
In our branch business segment, we stop accruing finance charges when the fourth contractual payment becomes past due for real estate loans, non-real estate loans, and retail sales contracts and when the sixth contractual payment becomes past due for revolving retail. In our centralized real estate business segment, we stop accruing finance charges when the third contractual payment becomes past due for real estate loans. We reverse finance charge amounts previously accrued upon suspension of accrual of finance charges.
We recognize the contractual interest portion of payments received on nonaccrual finance receivables as finance charges at the time of receipt. We resume the accrual of interest on a nonaccrual finance receivable when the past due status on the individual finance receivable improves to the point that the finance receivable no longer meets our policy for nonaccrual.
Subsequent to the FCFI Transaction, we accrete the amount required to adjust the fair value of our finance receivables to their contractual amounts over the life of the related finance receivable for non-credit impaired finance receivables and over the life of a pool of finance receivables for credit impaired finance receivables as described below. See Note 5 for further information on the FCFI Transaction.
Purchased Credit Impaired Finance Receivables
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. As a result, we identified a population of finance receivables for which it was determined that it is probable that we will be unable to collect all contractually required payments. In establishing this population, consideration was given to the requirement that each individual finance receivable first be reviewed. However, because of the homogeneity of finance receivables within a particular product group as well as the fact that we do not view our business on a loan by loan basis, emphasis was placed on past due status and accounting classification. As a result, the population of accounts identified principally consists of those finance receivables that are 60 days or more past due or that were classified as Troubled Debt Restructurings (TDRs) as of the acquisition date.
Notes to Consolidated Financial Statements, Continued
In order to determine the unit(s) of account, we considered the risk characteristics associated with the population of identified finance receivables. Accounting literature related to purchased credit impaired finance receivables permits finance receivables to be aggregated if the identified finance receivables have common risk characteristics. In evaluating the identified population, we determined that these finance receivables could be aggregated into pools consistent with the underlying risks associated with each finance receivable and the related collateral, as applicable.
The balance recorded as of the acquisition date was the fair value of each pool, which was determined by discounting the cash flows expected to be collected at a market observable discount rate adjusted for factors that a market participant would consider in determining fair value. In determining the cash flows expected to be collected, we incorporated assumptions regarding default rates, loss severities and the amounts and timing of prepayments. The excess of the cash flows expected to be collected over the discounted cash flows represents the accretable yield, which is not reported in our consolidated balance sheets, but is accreted into interest income at a level rate of return over the expected lives of the underlying pools of finance receivables.
We have established policies and procedures to periodically (at least once a quarter) update the amount of cash flows we expect to collect, incorporating assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that are reflective of then current market conditions. Probable decreases in expected finance receivable principal cash flows result in the recognition of impairment, which is recognized through the provision for finance receivable losses. Probable and significant increases in expected cash flows to be collected would first reverse any previously recorded allowance for finance receivable losses; any remaining increases are recognized prospectively as adjustments to the respective pool’s yield.
If the timing and/or amounts of expected cash flows on purchased credit impaired finance receivables were determined to be not 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 for our pools are reasonably estimable, interest is being accreted and the finance receivables are being reported as performing finance receivables. Our purchased credit impaired finance receivables as determined as of November 30, 2010 remain in our purchased credit impaired pools until liquidation. No finance receivables have been added to these pools subsequent to November 30, 2010. We do not reclassify modified purchased credit impaired finance receivables as TDRs.
We have additionally established policies and procedures related to maintaining the integrity of these pools. Generally, a finance receivable will not be removed from a pool unless we sell, foreclose, or otherwise receive assets in satisfaction of a particular finance receivable or a finance receivable is charged-off. If the facts and circumstances indicate that a finance receivable should be removed from a pool, that finance receivable will be removed at its carrying amount with the carrying amount being determined using the pro-rata method (the unpaid principal balance of the particular finance receivable divided by the unpaid principal balance of the pool multiplied by the carrying amount of the pool). Removal of the finance receivable from a pool does not affect the yield used to recognize accretable yield of the pool. If a finance receivable is removed from the pool because it is charged-off, it is removed at its carrying amount with a charge to the provision for finance receivable losses. Subsequent collections from our charge-off recovery activities will be a credit to the provision for finance receivable losses.
Notes to Consolidated Financial Statements, Continued
Push-down accounting for the purchased credit impaired portfolio has an impact on the carrying amount of finance receivables, the finance charges earned and related yields, and the net charge-off and charge-off ratio. As a result, these financial statement items and key ratios of the Successor Company are not comparable to those of the Predecessor Company. The delinquency ratios are calculated using the customer balances rather than the carrying amounts, and are, therefore, unaffected by the adjustments to the carrying amount of the purchased credit impaired portfolio.
Troubled Debt Restructured Finance Receivables
We make modifications to our real estate loans in our centralized real estate and branch business segments to assist borrowers in avoiding foreclosure. When we modify a real estate loan’s contractual terms for economic or other reasons related to the borrower’s financial difficulties and grant a concession that we would not otherwise consider, we classify that loan as a TDR. We restructure finance receivables only if we believe the customer has the ability to pay under the restructured terms for the foreseeable future. We establish TDR reserves in accordance with the authoritative guidance for impaired loans.
Finance charges for TDR finance receivables require the application of judgment. We place TDR finance receivables on accrual status or nonaccrual status based on the loans’ status prior to modification. TDR finance receivables that are placed on nonaccrual status remain on nonaccrual status until the finance receivable liquidates.
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. See above for our accounting policy related to credit impaired finance receivables and Note 5 for further information on the FCFI Transaction.
Allowance for Finance Receivable Losses
We establish the allowance for finance receivable losses through the provision for finance receivable losses. Our Credit Strategy and Policy Committee evaluates our finance receivable portfolio monthly by non-real estate loans, retail sales finance, and real estate loans. Our three portfolio segments consist of a large number of relatively small, homogeneous accounts. We evaluate our three portfolio segments for impairment as groups. None of our accounts are large enough to warrant individual evaluation for impairment. Our Credit Strategy and Policy Committee considers numerous internal and external factors in estimating losses inherent in our finance receivable portfolio, including the following:
· prior finance receivable loss and delinquency experience;
· the composition of our finance receivable portfolio; and
· current economic conditions, including the levels of unemployment and personal bankruptcies.
We charge off to the allowance for finance receivable losses non-real estate loans on which payments received in the prior six months have totaled less than 5% of the original loan amount and retail sales finance that are six installments past due. To avoid unnecessary real estate loan foreclosures we may refer borrowers to counseling services, as well as consider a cure agreement, loan modification, voluntary sale (including a short sale), or deed in lieu of foreclosure. When two payments are past due on a real estate loan and it appears that foreclosure may be necessary, we inspect the property as part of assessing the costs, risks, and benefits associated with foreclosure. Generally, we start foreclosure proceedings on real estate loans when four monthly installments are past due. When foreclosure is completed and we have
Notes to Consolidated Financial Statements, Continued
obtained title to the property, we obtain a third-party’s valuation of the property, which is either a full appraisal or a real estate broker’s or appraiser’s estimate of the property sale value without the benefit of a full interior and exterior appraisal and lacking sales comparisons. Such appraisals or real estate brokers’ or appraisers’ estimate of value are one factor considered in establishing an appropriate valuation; however, we are ultimately responsible for the valuation established. We reduce finance receivables by the amount of the real estate loan, establish a real estate owned asset, and charge off any loan amount in excess of that value to the allowance for finance receivable losses. We occasionally extend the charge-off period for individual accounts when, in our opinion, such treatment is warranted and consistent with our credit risk policies. We increase the allowance for finance receivable losses for recoveries on accounts previously charged off.
We may modify the terms of existing accounts in certain circumstances, such as certain bankruptcy or other catastrophic situations or for economic or other reasons related to the borrower’s financial difficulties that justify modification. When we modify an account, we primarily use a combination of the following to reduce the borrower’s monthly payment: reduce interest rate, extend the term, capitalize or forgive past due interest and, to a lesser extent, forgive principal. If the account is delinquent at the time of modification, the account is brought current for delinquency reporting. Account modifications that are deemed to be a TDR are measured for impairment in accordance with the authoritative guidance for the accounting for impaired loans. Account modifications that are not classified as a TDR are measured for impairment in accordance with the authoritative guidance for the accounting for contingencies.
We also may renew a delinquent account if the customer meets current underwriting criteria and it does not appear that the cause of past delinquency will affect the customer’s ability to repay the new loan. We subject all renewals, whether the customer’s account is current or delinquent, to the same credit risk underwriting process as we would a new application for credit.
In our branch business segment, we may offer those customers whose accounts are in good standing the opportunity of a deferment, which extends the term of an account. Prior to granting the deferment, we require a partial payment that is usually the greater of one-half of a regular monthly payment or the interest due on the account. We may extend this offer to customers when they are experiencing higher than normal personal expenses. Generally, this offer is not extended to customers who are delinquent. However, we may offer a deferment to a delinquent customer who is experiencing a temporary financial problem. The account is considered current upon granting the deferment. We limit a customer to two deferments in a rolling twelve month period unless we determine that an exception is warranted and is consistent with our credit risk policies.
In our centralized real estate business segment, we may offer a deferment to a delinquent customer who is experiencing a temporary financial problem, which extends the term of an account. Prior to granting the deferment, we require two contractual payments plus any past due principal and escrow payments due on the account. We forebear the remaining past due interest when the deferment is granted. (Prior to March 1, 2012, we waived the remaining past due interest.) The account is considered current upon granting the deferment. We limit a customer to one deferment in a rolling twelve month period unless we determine that an exception is warranted and is consistent with our credit risk policies.
We do not systemically track deferments granted because we believe the deferments we elect to grant, individually and in the aggregate, do not have a material effect on the amount of contractual cash flows of the finance receivables or the timing of their receipt. Accounts that are granted a deferment are not classified as troubled debt restructurings. We do not consider deferments granted as a troubled debt restructuring because the customer is not experiencing an other than temporary financial difficulty, and we are not granting a concession to the customer or the concession granted is immaterial to the contractual cash flows. We pool accounts that have been granted a deferment together with accounts that
Notes to Consolidated Financial Statements, Continued
have not been granted a deferment for measuring impairment in accordance with the authoritative guidance for the accounting for contingencies.
To accommodate a customer’s preferred monthly payment pattern, we may agree to a customer’s request to change a payment due date on an account. We will not change an account’s due date if the change will affect the thirty day plus delinquency status of the account at month end.
As a result of the FCFI Transaction, we applied push-down accounting and reduced our allowance for finance receivable losses to zero on November 30, 2010 as any uncertainties related to the collectability of the finance receivables have been incorporated into the fair value measurement of our finance receivable portfolio. With respect to the November 30, 2010 finance receivables, an allowance for finance receivables losses will not be established until such time as a required allowance amount exceeds the unaccreted fair value adjustment for non-credit impaired finance receivables. See Note 5 for further information on the FCFI Transaction.
Finance Receivables Held for Sale
Depending on market conditions or certain capital sourcing strategies, which may impact our ability and/or intent to hold our finance receivables until maturity or for the foreseeable future, we may decide to sell finance receivables originally intended for investment. Management’s view of foreseeable future is generally a twelve-month period based on the longest reasonably reliable liquidity forecast period. Our ability to hold finance receivables for the foreseeable future is subject to a number of factors, including economic and liquidity conditions, and therefore may change. As of each reporting period, management determines our ability to hold finance receivables for the foreseeable future based on assumptions for liquidity requirements. When it is probable that management’s intent or ability is to no longer hold finance receivables for the foreseeable future and we subsequently decide to sell specifically identified finance receivables that were originally classified as held for investment, the net finance receivables, less allowance for finance receivable losses are reclassified as finance receivables held for sale and are carried at the lower of cost or fair value. Any amount by which cost exceeds fair value is accounted for as a valuation allowance and is recognized in finance receivables held for sale originated as held for investment revenues. We base the fair value estimates on negotiations with prospective purchasers (if any) or by using projected cash flows discounted at the weighted-average interest rates offered in the market for similar finance receivables. We base cash flows on contractual payment terms adjusted for estimates of prepayments and credit related losses. Cash flows resulting from the sale of the finance receivables that were originally classified as held for investment are recorded as an investing activity in the consolidated statements of cash flows since U.S. GAAP requires the statement of cash flow presentation to be based on the original classification of the finance receivable. When sold, we record the sales price we receive less our carrying value of these finance receivables held for sale in finance receivables held for sale originated as held for investment revenues.
When it is determined that management no longer intends to sell finance receivables which had previously been classified as finance receivables held for sale and we have the ability to hold the finance receivables for the foreseeable future, we reclassify the finance receivables to finance receivables held for investment at the lower of cost or fair value and we accrete any fair value adjustment over the remaining life of the related finance receivables.
Notes to Consolidated Financial Statements, Continued
Real Estate Owned
We acquire real estate owned through foreclosure on real estate loans. As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our real estate owned to the estimated fair value less the estimated cost to sell. For foreclosures that occur subsequent to the FCFI Transaction, we initially record real estate owned in other assets at the estimated fair value less the estimated cost to sell. The estimated fair value used as a basis to determine the carrying value of real estate owned is defined as the price that would be received in selling the property in an orderly transaction between market participants as of the measurement date. See Note 5 for further information on the FCFI Transaction. Prior to the FCFI Transaction, we recorded real estate owned in other assets, at the lower of the loan balance or the estimated fair value less the estimated cost to sell.
We test the balances of real estate owned for impairment on a quarterly basis. If the required impairment testing suggests real estate owned is impaired, we reduce the carrying amount to estimated fair value less the estimated costs to sell. We charge these impairments to other revenues. We record the sale price we receive for a property less the carrying value and any amounts refunded to the customer as a recovery or loss in other revenues. We do not profit from foreclosures in accordance with the American Financial Services Association’s Voluntary Standards for Consumer Mortgage Lending. We only attempt to recover our investment in the property, including expenses incurred.
Net Other Intangible Assets
As a result of the FCFI Transaction, we recorded net other intangible assets on November 30, 2010 consisting of Value of Business Acquired (VOBA), customer relationships, trade names, licenses, customer lists, and leases. See Note 5 for further information on the FCFI Transaction.
We began testing these net other intangible assets for impairment in first quarter 2011. Each of these net intangible assets was determined to have a finite useful life with the exception of the insurance licenses. For those net intangible assets with a finite useful life, we review such intangibles for impairment quarterly and whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Impairment is indicated if the sum of undiscounted estimated future cash flows is less than the carrying value of the respective asset. Impairment is permanently recognized by writing down the asset to the extent that the carrying value exceeds the estimated fair value. For the insurance licenses, which were determined to have indefinite lives, impairment is evaluated annually, or more frequently if events or changes in circumstances between annual tests indicate that the licenses may be impaired. In testing for impairment, the fair value of the licenses is determined in accordance with our fair value measurement policy. If the fair value of the licenses is less than the carrying value, an impairment loss will be recognized in an amount equal to the difference and the indefinite life classification of these licenses will be evaluated to determine whether such classification remains appropriate.
Notes to Consolidated Financial Statements, Continued
Reserve for Sales Recourse Obligations
Reserve for sales recourse obligations represent our (i) estimate of losses to be incurred by us on the repurchase of certain loans that we previously sold and (ii) estimate of losses to be incurred by us for indemnification of losses incurred by purchasers with respect to finance receivables that we sold. Certain sale contracts include provisions requiring us to repurchase a finance receivable or indemnify the purchaser for losses it sustains with respect to a finance receivable if a borrower fails to make initial loan payments to the purchaser or if the accompanying mortgage loan breaches certain customary representations and warranties. These representations and warranties are made to the purchasers with respect to various characteristics of the finance receivable, such as the manner of origination, the nature and extent of underwriting standards applied, the types of documentation being provided, and, in limited instances, reaching certain defined delinquency limits. Although the representations and warranties are typically in place for the life of the finance receivable, we believe that most repurchase requests occur within the first five years of the sale of a finance receivable. In addition, an investor may request that we refund a portion of the premium paid on the sale of mortgage loans if a loan is prepaid within a certain amount of time from the date of sale. At the time of the sale of each finance receivable (exclusive of finance receivables included in our on-balance sheet securitizations), we record a provision for recourse obligations for estimated repurchases, loss indemnification and premium recapture on finance receivables sold, which is charged to other revenues. Any subsequent adjustments resulting from changes in estimated recourse exposure are recorded in other revenues. We include our reserve for sales recourse obligations in other liabilities.
Loan Brokerage Fees Revenues Recognition
We recognize the following as loan brokerage fees in other revenues:
· commissions from lenders for loans brokered to them;
· fees from customers to process their loans; and
· fees from other credit originators for customer referrals.
We recognize these commissions and fees in loan brokerage fees revenues when we provide the services or referrals listed above.
INSURANCE BUSINESS SEGMENT
Revenue Recognition
We recognize credit insurance premiums on closed-end real estate loans and revolving finance receivables as revenue when billed monthly. We defer single premium credit insurance premiums in unearned premium reserves which we include in insurance claims and policyholder liabilities. We recognize unearned premiums on credit life insurance as revenue using the sum-of-the-digits or actuarial methods, except in the case of level-term contracts, for which we recognize unearned premiums as revenue using the straight-line method over the terms of the policies. We recognize unearned premiums on credit accident and health insurance as revenue using an average of the sum-of-the-digits and the straight-line methods. We recognize unearned premiums on credit-related property and casualty and credit involuntary unemployment insurance as revenue using the straight-line method over the terms of the policies. We recognize non-credit life insurance premiums as revenue when collected but not before their due dates. We recognize commissions on ancillary products as other revenue when received.
Notes to Consolidated Financial Statements, Continued
Our insurance business segment revenue recognition accounting policy did not change as a result of the FCFI Transaction.
Policy Reserves
Policy reserves for credit life, credit accident and health, credit-related property and casualty, and credit involuntary unemployment insurance equal related unearned premiums. We base claim reserves on Company experience. We estimate reserves for losses and loss adjustment expenses for credit-related property and casualty insurance based upon claims reported plus estimates of incurred but not reported claims. We accrue liabilities for future life insurance policy benefits associated with non-credit life contracts and base the amounts on assumptions as to investment yields, mortality, and surrenders. We base annuity reserves on assumptions as to investment yields and mortality. We base insurance reserves assumed under reinsurance agreements where we assume the risk of loss on various tabular and unearned premium methods.
As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our policy reserves to their fair value on November 30, 2010. This adjustment is recognized through expenses over the life of the policies in effect at the FCFI Transaction date. The accounting policy for our policy reserves did not change as a result of the FCFI Transaction. See Note 5 for further information on the FCFI Transaction.
Acquisition Costs
We defer insurance policy acquisition costs, primarily commissions, reinsurance fees, and premium taxes. We include them in other assets and charge them to expense over the terms of the related policies, whether directly written or reinsured.
As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our insurance acquisition costs to zero. The accounting policy for our acquisition costs did not change as a result of the FCFI Transaction. See Note 5 for further information on the FCFI Transaction.
INVESTMENT SECURITIES
Valuation
We classify our investment securities as available-for-sale, which we record at fair value. We adjust related balance sheet accounts to reflect the current fair value of investment securities and record the adjustment, net of tax, in accumulated other comprehensive income or loss in shareholder’s equity. We record interest receivable on investment securities in other assets.
We classify our investment securities in the fair value hierarchy framework based on the observability of inputs. Inputs to the valuation techniques are described as being either observable (level 1 or 2) or unobservable (level 3) assumptions that market participants would use in pricing an asset or liability.
Notes to Consolidated Financial Statements, Continued
As a result of the FCFI Transaction, no adjustment was required as our investment securities are carried at fair value. However, we adjusted the book value of our investment securities to their carrying value (which is their fair value) on November 30, 2010. The accounting policy for the valuation of our investment securities did not change as a result of the FCFI Transaction. See Note 5 for further information on the FCFI Transaction.
Impairments
Each quarter, we evaluate our investment securities on an individual basis to identify any instances where the fair value of the investment security is below its amortized cost. For these securities, we then evaluate whether an other-than-temporary impairment exists if any of the following conditions are present:
· we intend to sell the security;
· it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or
· we do not expect to recover the security’s entire amortized cost basis (even if we do not intend to sell the security).
If we intend to sell an impaired investment security or we will likely be required to sell the security before recovery of its amortized cost basis less any current period credit loss, we recognize an other-than-temporary impairment in investment revenues equal to the difference between the investment security’s amortized cost and its fair value at the balance sheet date.
In determining whether a credit loss exists, our policy requires that we compare our best estimate of the present value of the cash flows expected to be collected from the security to the amortized cost basis of the security. Any shortfall in this comparison represents a credit loss. The cash flows expected to be collected is determined by assessing all available information, including length and severity of unrealized loss, issuer default rate, ratings changes and adverse conditions related to the industry sector, financial condition of issuer, and other relevant criteria.
If a credit loss exists with respect to an investment in a security (i.e., we do not expect to recover the entire amortized cost basis of the security), we would be unable to assert that we will recover our amortized cost basis even if we do not intend to sell the security. Therefore, in these situations, an other-than-temporary impairment is considered to have occurred.
If a credit loss exists, but we do not intend to sell the security and we will likely not be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the impairment is classified as: (1) the estimated amount relating to credit loss; and (2) the amount relating to all other factors. We recognize the estimated credit loss in investment revenues, and the non-credit loss amount in accumulated other comprehensive income or loss.
Once a credit loss is recognized, we adjust the investment security to a new amortized cost basis equal to the previous amortized cost basis less the amount recognized in investment revenues. For investment securities for which other-than-temporary impairments were recognized in investment revenues, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted to investment income.
We recognize subsequent increases and decreases in the fair value of our available-for-sale investment securities in accumulated other comprehensive income or loss, unless the decrease is considered other than temporary.
Notes to Consolidated Financial Statements, Continued
Revenue Recognition
We recognize interest on interest bearing fixed-maturity investment securities as revenue on the accrual basis. We amortize any premiums or accrete any discounts as a revenue adjustment using the interest method. We stop accruing interest revenue when the collection of interest becomes uncertain. We record dividends on equity securities as revenue on ex-dividend dates. We recognize income on mortgage-backed securities as revenue using a constant effective yield based on estimated prepayments of the underlying mortgages. If actual prepayments differ from estimated prepayments, we calculate a new effective yield and adjust the net investment in the security accordingly. We record the adjustment, along with all investment securities revenue, in investment revenues.
Our revenue recognition accounting policy did not change as a result of the FCFI Transaction. However, the adjusted book value is used to determine the new amount of amortization or accretion. See Note 5 for further information on the FCFI Transaction.
Realized Gains and Losses on Investment Securities
We specifically identify realized gains and losses on investment securities and include them in investment revenues.
OTHER
Variable Interest Entities
An entity is a variable interest entity (VIE) if the entity does not have sufficient equity at risk for the entity to finance its activities without additional financial support or has equity investors who lack the characteristics of a controlling financial interest. A VIE is consolidated into the financial statements of its primary beneficiary. When we have a variable interest in a VIE, we qualitatively assess whether we have a controlling financial interest in the entity and, if so, whether we are the primary beneficiary. In applying the qualitative assessment to identify the primary beneficiary of a VIE, we are determined to have a controlling financial interest if we have (1) the power to direct the activities that most significantly impact the economic performance of the VIE, and (2) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. We consider the VIE’s purpose and design, including the risks that the entity was designed to create and pass through to its variable interest holders. Determining a VIE’s primary beneficiary is an ongoing assessment.
Other Invested Assets
Commercial mortgage loans, investment real estate, and insurance policy loans are part of our insurance business segment’s investment portfolio and we include them in other assets at amortized cost. We recognize interest on commercial mortgage loans and insurance policy loans as revenue on the accrual basis using the interest method. We stop accruing revenue when collection of interest becomes uncertain. We recognize pretax operating income from the operation of our investment real estate as revenue monthly. We include other invested asset revenue in investment revenues. We record accrued other invested asset revenue receivable in other assets.
Notes to Consolidated Financial Statements, Continued
As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our commercial mortgage loans to their fair value on November 30, 2010. The adjusted carrying value is used to determine the new amount of amortization or accretion. See Note 5 for further information on the FCFI Transaction.
Cash Equivalents
We consider short-term investments having maturity dates within three months of their date of acquisition to be cash equivalents.
Income Taxes
We recognize income taxes using the asset and liability method. We establish deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of assets and liabilities, using the tax rates expected to be in effect when the temporary differences reverse.
We assess our ability to realize deferred tax assets considering all available evidence, including earnings history; timing, character, and amount of future earnings potential; reversal of taxable temporary differences; and tax planning strategies. We provide a valuation allowance for deferred tax assets if it is more likely than not that we will not realize the deferred tax asset in whole or in part. We include an increase or decrease in a valuation allowance resulting from a change in the realizability of the related deferred tax asset in income.
As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our income tax accounts and recognized additional deferred tax amounts resulting from differences between the recorded tax basis and the basis under U.S. GAAP of assets and liabilities resulting from the application of push-down accounting. See Note 5 for further information on the FCFI Transaction.
Derivative Financial Instruments
All of our derivatives are governed by International Swap and Derivatives Association, Inc. (ISDA) standard Master Agreements. The parties to an ISDA Master Agreement agree to net the amounts payable and receivable under all contracts governed by the ISDA Master Agreement in the event of a contract default by either one of the parties. The ISDA Master Agreement further defines “close-out” netting, or netting upon default, which is the netting of transactions stipulated in the ISDA Master Agreement in case either party is unable to fulfill its obligations going forward. The net exposure by instrument is determined as the sum of the mid-market values, prior to consideration of non-performance risk, of the derivative transactions governed by a Master Agreement. If the net exposure is from the counterparty to us, we record the derivative asset in other assets on our consolidated balance sheet. If the net exposure is from us to the counterparty, we record the derivative liability in other liabilities on our consolidated balance sheet. We record net unrealized gains and losses on derivative transactions as adjustments to cash flows from operating activities on our consolidated statements of cash flows.
We recognize all derivatives on our consolidated balance sheet at their fair value. We estimate the fair value of our derivatives using industry standard valuation models. These models project future cash flows and discount the future amounts to a present value using market-based expectations for interest rates, foreign exchange rates, and the contractual terms of the derivative transactions.
Notes to Consolidated Financial Statements, Continued
We designate each derivative as:
· a hedge of the variability of cash flows that we will receive or pay in connection with a recognized asset or liability (a “cash flow” hedge);
· a hedge of the fair value of a recognized asset or liability (a “fair value” hedge); or
· a derivative that does not qualify as either a cash flow or fair value hedge.
We record the effective portion of the changes in the fair value of a derivative that is highly effective and is qualified and designated as a cash flow hedge in accumulated other comprehensive income or loss, net of tax, until earnings are affected by the variability of cash flows of the hedged transaction. We record the effective portion of the changes in the fair value of a derivative that is highly effective and is qualified and designated as a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, in current period earnings in other revenues. We record changes in the fair value of a derivative that does not qualify as either a cash flow or fair value hedge and changes in the fair value of hedging instruments measured as ineffectiveness in current period earnings in other revenues.
We formally document all relationships between derivative hedging instruments and hedged items, as well as our risk-management objectives and strategies for undertaking various hedge transactions and our method to assess ineffectiveness. We link all derivatives that we designate as cash flow or fair value hedges to specific assets and liabilities on the balance sheet. We perform and document an initial prospective assessment of hedge effectiveness using regression analysis to demonstrate that the hedge is expected to be highly effective in future periods. Subsequently, on at least a quarterly basis or sooner if necessary, we perform a prospective hedge effectiveness assessment to demonstrate the continued expectation that the hedge will be highly effective in future periods and a retrospective hedge effectiveness assessment to demonstrate that the hedge was effective in the most recent period. For fair value hedges, ineffectiveness is the difference between the change in fair value included in the assessment of hedge effectiveness related to the gain or loss on the derivative and the change in the hedged item related to the risks being hedged. For cash flow hedges, ineffectiveness is the amount by which the cumulative change in the fair value of the hedging instrument exceeds the cumulative change in the fair value of the hypothetical derivative.
We discontinue hedge accounting prospectively when:
· the derivative is no longer effective in offsetting changes in the cash flows or fair value of a hedged item;
· we sell, terminate, or exercise the derivative and/or the hedged item or they expire; or
· we change our objectives or strategies and designating the derivative as a hedging instrument is no longer appropriate.
For discontinued asset and liability fair value hedges, we begin amortizing the cumulative basis adjustment on the hedged item into earnings over the remaining life of the hedged item using the level yield method. For cash flow hedges that are discontinued for reasons other than the forecasted transaction is not probable of occurring, we begin reclassifying the accumulated other comprehensive income or loss adjustment to earnings when earnings are affected by the hedged item.
As a result of the FCFI Transaction, we applied push-down accounting which resulted in the de-designation of our qualified cash flow hedges on November 30, 2010. We then re-designated our cash flow hedges on November 30, 2010. We performed and documented a prospective assessment of hedge effectiveness using regression analysis to demonstrate that the hedge is expected to be highly effective in future periods. See Note 5 for further information on the FCFI Transaction.
Notes to Consolidated Financial Statements, Continued
Benefit Plans
The Company has both funded and unfunded noncontributory defined pension and postretirement plans. We recognize the funded status of the benefit plans in other liabilities. We recognize the net actuarial gains or losses and prior service cost or credit that arise during the period in other comprehensive income or loss.
Many of our employees are participants in our 401(k) plan. Our contributions to the plan are charged to operating expenses.
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 fair value should be based on assumptions that market participants would use, including a consideration of non-performance risk.
In determining fair value, we use various valuation techniques and prioritize the use of observable inputs. The availability of observable inputs varies from instrument to instrument and depends on a variety of factors including the type of instrument; whether the instrument is actively traded and other characteristics particular to the transaction. For many financial instruments, pricing inputs are readily observable in the market, the valuation methodology used is widely accepted by market participants, and the valuation does not require significant management discretion. For other financial instruments, pricing inputs are less observable in the marketplace and may require management judgment.
We assess the inputs used to measure fair value using a three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market. Level 1 inputs include quoted prices for identical instruments and are the most observable. Level 2 inputs include quoted prices for similar assets and observable inputs such as interest rates, currency exchange rates and yield curves. Level 3 inputs are not observable in the market and include management’s judgments about the assumptions market participants would use in pricing the asset or liability. The use of observable and unobservable inputs is reflected in our hierarchy assessment disclosed in Note 28.
Our fair value processes include controls that are designed to ensure that fair values are appropriate. Such controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and reviews by senior management.
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.
Notes to Consolidated Financial Statements, Continued
Foreign Currency
The functional currency of our operations in the United Kingdom is the local currency, the British Pound. We translate financial statement amounts expressed in British Pounds into U.S. Dollars using the authoritative guidance for foreign currency translation. We translate functional currency assets and liabilities into U.S. Dollars using exchange rates prevailing at the balance sheet date. We translate revenues and expenses using monthly average exchange rates for the period. We record the translation adjustments, net of tax, as a separate component of other comprehensive income (loss), which we include in stockholder’s equity. We record exchange gains and losses resulting from foreign currency transactions in other revenues.
Related Party Transactions
In the normal course of business, we may enter into transactions with related parties. These transactions occur at prevailing market rates and terms and include affiliate lending, reinsurance agreements, derivative transactions, and subservicing agreements. See Note 11 for further information on our related party transactions.
Note 4. Recent Accounting Pronouncements
ACCOUNTING STANDARDS ADOPTED IN 2011
Fair Value Measurements and Disclosures
In January 2010, the FASB issued ASU 2010-06, which requires fair value disclosures about significant transfers between Level 1 and 2 measurement categories and separate presentation of purchases, sales, issuances, and settlements within the rollforward of Level 3 activity. The standard also clarifies the disclosure requirements about the level of disaggregation and valuation techniques and inputs. The new standard was effective for interim and annual periods beginning on January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements within the rollforward of Level 3 activity, which were effective beginning on January 1, 2011. The adoption of this new standard did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Presentation of Comprehensive Income
In June 2011, the FASB issued ASU 2011-05, which 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. See “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05” in this Note 4. The adoption of this new standard (which excluded the presentation requirements of the accumulated other comprehensive income reclassification adjustments) did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Notes to Consolidated Financial Statements, Continued
A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring
In April 2011, the FASB issued ASU 2011-02, which 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 did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Disclosures about an Employer’s Participation in a Multiemployer Plan
In September 2011, the FASB issued ASU 2011-09, which addresses concerns from various users of financial statements on the lack of transparency about an employer’s participation in a multiemployer pension plan. When subsidiaries issue separate financial statements, each subsidiary should account for its participation in the overall single-employer pension plan as a participation in a multiemployer plan. The amendments will require each of our subsidiaries that issues separate financial statements to disclose the name of the plan in which it participates and the amount of contributions the subsidiary made in each period for which a statement of income is presented. The amendments in this new standard are effective for annual periods for fiscal years ending after December 15, 2011. Early adoption is permitted. The amendments should be applied retrospectively for all prior periods presented. The adoption of this new standard did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
ACCOUNTING STANDARDS TO BE ADOPTED IN THE FUTURE
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the FASB issued ASU 2010-26, which 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.
Notes to Consolidated Financial Statements, Continued
Reconsideration of Effective Control for Repurchase Agreements
In April 2011, the FASB issued ASU 2011-03, which is 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.
Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS
In May 2011, the FASB and the International Accounting Standards Board jointly issued ASU 2011-04, 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.
Disclosures about Offsetting Assets and Liabilities
In December 2011, the FASB issued ASU 2011-11, which requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The amendments in this new standard are effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods. The amendments should be applied retrospectively for all prior periods presented. The adoption of this new standard will not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05
In December 2011, the FASB issued ASU 2011-12, which defers the effective date of the presentation requirements of the accumulated other comprehensive income reclassification adjustments in ASU 2011-05. The amendments in this new standard are being made to allow the FASB time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. The new standard is effective for interim and annual periods beginning on January 1, 2012. The adoption of this new standard will not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Notes to Consolidated Financial Statements, Continued
Note 5. FCFI Transaction
As discussed in Note 1, on November 30, 2010, FCFI indirectly acquired an 80% economic interest in SLFI from ACC. AIG, through ACC, indirectly 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. As a result, our consolidated financial statements have been prepared to reflect the push-down accounting adjustments arising from this transaction. The effects of these adjustments on each of the Company’s major classes of assets, liabilities, and shareholder’s equity accounts as of the date of the FCFI Transaction were as follows:
* In third quarter 2011, we recorded a tax adjustment that increased deferred and accrued taxes and decreased retained earnings by $7.9 million to reflect new information obtained relative to the assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction. See Note 3 for further information on this push-down accounting adjustment.
Notes to Consolidated Financial Statements, Continued
In accordance with the terms of the FCFI Transaction, FCFI effectively capitalized AGF Holding through an integrated planned series of transactions negotiated between Fortress and AIG. AGF Holding utilized the contributed capital plus its own shares equal to 20% of its ownership interest to acquire SLFI and its subsidiaries from ACC. The total fair value of the consideration provided was $148.5 million consisting of $118.8 million in cash plus $29.7 million in shares; there is no non-controlling interest associated with SLFI, and AGF Holding did not previously hold an equity interest in SLFI.
The total purchase consideration given by AGF Holding and the fair value of the AIG retained 20% economic interest was $17.0 billion, including the fair value of liabilities assumed. This resulted in a bargain purchase gain for SLFI of $1.5 billion. The following table summarizes the allocation of the Company’s fair value to the assets acquired and liabilities assumed.
(a) The acquisition-date fair value of the consideration transferred consisted of the following:
(b) Adjusted by a $7.9 million third quarter tax adjustment to reflect new information obtained relative to the assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction. See Note 3 for further information on this push-down accounting adjustment.
We included the $1.5 billion excess of the acquisition date fair value of the identifiable net assets over the total purchase consideration, which is considered a bargain purchase by AGF Holding, as income of the Successor Company in the one month period ended December 31, 2010.
* Adjusted by a $7.9 million third quarter tax adjustment to reflect new information obtained relative to the assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction. See Note 3 for further information on this push-down accounting adjustment.
Notes to Consolidated Financial Statements, Continued
Net Finance Receivables
We determined the fair value of our non-credit impaired net finance receivables on a pooled basis which were aggregated by remaining term, delinquency, and account type (real estate, non-real estate and retail sales finance). The value for the various pools was determined through a discount of the contractual cash flows using the then current rate on recently issued finance receivables prior to the FCFI Transaction date that most closely corresponds to the same characteristics of the pool as it approximates the effect of prepayments, default, and other risks embedded in the contractual cash flows. The amount required to adjust the finance receivables to fair value is being amortized over the estimated remaining life of the finance receivables using the interest method and contractual cash flows.
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. As a result, we identified a population of finance receivables for which it was determined that it was probable that we would be unable to collect all contractually required payments. In establishing this population, consideration was given to the requirement that each individual finance receivable first be reviewed. However, because of the homogeneity of finance receivables within a particular product group as well as the fact that we do not view our business on a loan by loan basis, emphasis was placed on past due status and accounting classification. As a result, the population of accounts identified principally consisted of those finance receivables that were 60 days or more past due or that were classified as TDRs as of the acquisition date.
In order to determine the unit(s) of account, we considered the risk characteristics associated with the population of identified finance receivables. Accounting literature related to purchased credit impaired finance receivables permits finance receivables to be aggregated if the identified finance receivables have common risk characteristics. In evaluating the identified population, we determined that these finance receivables could be aggregated into pools consistent with the underlying risks associated with each finance receivable and the related collateral, as applicable.
The balance recorded as of the acquisition date for pools of purchased credit impaired net finance receivables was the fair value of each pool, which was determined by discounting the cash flows expected to be collected at a market observable discount rate at the time of the FCFI Transaction adjusted for factors that a market participant would consider in determining fair value. In determining the cash flows expected to be collected, we incorporated assumptions regarding default rates, loss severities and the amounts and timing of prepayments. The excess of the cash flows expected to be collected over the discounted cash flows represents the accretable yield, which is not reported in our consolidated balance sheets, but is accreted into interest income at a level rate of return over the expected lives of the underlying pools of finance receivables.
We have established policies and procedures to periodically (at least once a quarter) update the amount of cash flows we expect to collect, incorporating assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that are reflective of then current market conditions. Probable decreases in expected finance receivable principal cash flows result in the recognition of impairment, which is recognized through the provision for finance receivable losses. 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; any remaining increases are recognized prospectively as adjustments to the respective pool’s yield.
Notes to Consolidated Financial Statements, Continued
We have additionally established policies and procedures related to maintaining the integrity of these pools. Generally, a finance receivable will not be removed from a pool unless we sell, foreclose, or otherwise receive assets in satisfaction of a particular finance receivable or a finance receivable is charged-off. However, given the nature of our business, finance receivables will also be removed from a pool if the collateral underlying a particular finance receivable changes as we believe that, if such events occur, that particular finance receivable represents a new finance receivable rather than a continuation.
If the timing and/or amounts of expected cash flows on purchased credit impaired finance receivables were determined to be not 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 for our pools are reasonably estimable, interest is being accreted and the finance receivables are being reported as performing finance receivables. Our purchased credit impaired finance receivables as determined as of November 30, 2010 remain in our purchased credit impaired pools until liquidation. No finance receivables have been added to these pools subsequent to November 30, 2010. We do not reclassify modified purchased credit impaired finance receivables as TDRs.
If the facts and circumstances indicate that a finance receivable should be removed from a pool, that finance receivable will be removed at its carrying amount with the carrying amount being determined using the pro-rata method (the unpaid principal balance of the particular finance receivable divided by the unpaid principal balance of the pool multiplied by the carrying amount of the pool). If a finance receivable is removed from the pool because it is charged-off, it is removed at its carrying amount with a charge to the provision for finance receivable losses. Subsequent collections from our charge-off recovery activities will be a credit to the provision for finance receivable losses.
The fair value of net finance receivables, 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 capital market and, more broadly, economic environments at the time of the FCFI Transaction.
Net Other Intangible Assets
A thorough review of our business was conducted in order to identify any intangible assets. The amount recognized for any identified other intangible assets, net of intangible liabilities was determined by considering a variety of valuation approaches including market, income, and cost approaches. The approach that was most appropriate to determine the value of the net other intangible assets, in management’s judgment, was utilized and is described below.
Notes to Consolidated Financial Statements, Continued
We identified other intangible assets, net of intangible liabilities of $83.7 million as of the date of the FCFI Transaction, which consisted of:
(a) Licenses include $11.6 million of insurance licenses (which have an indefinite useful life) and $0.5 million of branch licenses (which have an estimated useful life of three months).
(b) Leases for our branch offices include the net of $5.9 million of leases that are unfavorable to current market terms (included in other liabilities) and $3.4 million of leases that are favorable to current market terms (included in other assets).
The Company established a VOBA intangible asset related to its insurance subsidiaries which was valued by a third party applying the income approach. Valuation inputs included estimated future earnings streams and future cash flows for claims payments discounted at expected rates of return.
The Company valued its established customer relationships using a multi-period excess earnings approach with income and expense assumptions based on projections that management had prepared prior to the closing of the transaction and historical information to serve as the bases for assumptions related to future business derived from the present customers through renewals or conversions. This methodology included assessing charges related to reasonable returns on contributory assets.
The trade names intangible is primarily related to the Company’s United Kingdom operation, Ocean Finance and Mortgages Limited (Ocean). In general terms, the trade names were valued using the relief from royalty approach. In determining the fair value of this trade name, we considered the nature of the business and market conditions as of the acquisition date. Therefore, management believed that Ocean had suffered little in the case of name recognition, but our approach did incorporate the depressed demand for its services and products.
The licenses intangible assets are primarily related to insurance licenses held by Merit Life Insurance Co. (Merit) and Yosemite Insurance Company (Yosemite) and were valued by a third party applying a market approach, reviewing recent transactions of a similar span of licenses. Merit is a life company with licenses in 46 states, the District of Columbia, and the U.S. Virgin Islands, which are valid and in good standing, plus reinsurance-only authority in New York and Puerto Rico. Yosemite has licenses in 46 states, which are valid and in good standing, plus reinsurance-only authority in New York.
The Company has available listings of former customers which were evaluated using a replacement cost valuation approach. Under this approach, the Company estimated the cost associated with the acquisition of a similar quantity of names, adjusting for the ability to repeatedly solicit the names, as apposed to a single use, then increasing that cost to reflect the benefit of soliciting customers known to borrow from the provider. The fair value assigned to this intangible asset represented the costs that would be incurred to reconstruct a listing of customers and related information that would have provided a similar result from the solicitations as that experienced with our customer listing as of the acquisition date.
Notes to Consolidated Financial Statements, Continued
The Company has leases for its branch locations, certain technology assets and satellite communications systems. We utilized estimates of the current market rents as of the FCFI Transaction date for each of the Company’s branch leases, and assets were estimated for those whose lease terms were less than market, and liabilities were estimated for those whose lease terms were greater than the market estimates.
Technology asset leases were valued in the same manner as the branch leases, with the remaining months on the lease being used to determine the estimated cash flows. Since the technology lease terms generally permit continuing the lease on a month to month basis, returning the asset, or acquiring the asset at fair value, the cash flow estimate assumed acquisition of the asset at the end of the term at a value consistent with prior quotes for the purchase of leased assets. The satellite lease was amended in 2010 and was deemed to be at market, and, therefore, no adjustment to fair value was deemed necessary.
VOBA is being amortized based upon the timing of profits for the in force business as of the FCFI Transaction date. All other identified intangible assets, with the exception of the insurance licenses, are being amortized on a straight-line basis over their estimated useful lives.
Our licenses intangible assets, which have an indefinite useful life and are not subject to amortization, are tested annually for impairment or more frequently if events or changes in circumstances indicate that the assets might be impaired. Our testing conducted in fourth quarter 2011 indicated that the fair value of licenses intangible exceeded its carrying amount, and no impairment loss was required to be recognized. No impairment was required to be recognized in 2010.
We test our intangible assets subject to amortization for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. As a result of accelerated liquidations of our branch network loan portfolio, we recognized $0.6 million of impairment in operating expenses in fourth quarter 2011 related to our customer lists intangible assets. Additionally, as part of our strategic review of operations, we have ceased new loan originations in our Ocean operations effective January 1, 2012. As a result, we determined that our Ocean trade names and customer relationships intangible assets had no continuing fair value and the remaining unamortized carrying amounts of $11.2 million and $1.0 million, respectively, were written off and charged to operating expenses in fourth quarter 2011. No impairment losses were required to be recognized 2010.
Amortization expense in 2011 was $38.6 million, including the impairment losses discussed above, and the accumulated aggregate amortization at December 31, 2011 was $42.0 million. Amortization expense for the one month ended December 31, 2010 and the accumulated aggregate amortization at December 31, 2010 was $3.5 million. The estimated aggregate amortization for each of the next five years is reflected in the table below.
Notes to Consolidated Financial Statements, Continued
Other Assets
Various adjustments, totaling $149.7 million, were made as of the FCFI Transaction date to the historical bases of our other assets to record these accounts at their fair values. The adjustment includes the elimination of $119.7 million of deferred charges primarily related to deferred debt issuance costs and a $3.6 million deferred tax asset. Further, we adjusted our basis in real estate owned to fair value based upon recent appraisals of the properties less 15% for estimated selling costs, escrow advances to fair value based upon the estimated balances collectable in the foreseeable future, commercial mortgage loans to fair value based upon future cash flows of the mortgage loans discounted at the then current risk free interest rates and adjusted for credit default rates of the counter parties, and fixed assets to fair value based upon third party value in-use appraisals for real estate properties and estimated fair value of pools of personal property based upon the net book value of the pools adjusted for change in consumer price index factors since acquisition. The combination of these items resulted in a net write up to fair value on November 30, 2010 of $14.3 million. In addition, we recorded a $258.7 million receivable from the AIG pension plan related to the November 30, 2010 fair value of our portion of the assets. These assets were subsequently contributed to our pension plan on January 1, 2011 (see Note 25).
Long-term Debt
We based the fair value of our long-term debt on market-observable prices, when available, and otherwise used projected cash flows discounted at estimated market rates as of November 30, 2010 for debt issuances with similar terms and attributes. The fair value adjustment was $1.6 billion. The fair value adjustment at November 30, 2010 is being accreted using the interest method and resulted in an increase to interest expense of $387.2 million in 2011 and $34.8 million for the one month ended December 31, 2010.
Insurance Claims and Policyholder Liabilities
We adjusted the carrying value of our policy reserves to their fair value based upon future cash flows discounted at the then current earned yield estimates on November 30, 2010. The fair value adjustment was $20.7 million. This adjustment is recognized through expenses over the life of the policies in effect at the FCFI Transaction date.
Other Liabilities
Various adjustments, totaling $293.0 million, were made as of the FCFI Transaction date to the historical bases of our other liabilities to reflect these accounts at their fair values. The adjustments include $0.6 million of deferred commissions eliminated under push-down accounting and $1.8 million to reflect certain nonqualified benefit plan obligations at fair value provided to us by a third-party provider utilizing our actuarial assumptions. We are ultimately responsible for the valuation. In addition, we recorded a $291.7 million liability for our portion of the fair value of the pension benefit obligations under the AIG pension plan as of November 30, 2010. The fair value provided to us by a third-party provider utilized our actuarial assumptions. We are ultimately responsible for the valuation. This obligation was subsequently assumed by our pension plan on January 1, 2011 in conjunction with the transfer of plan assets as noted above (see Note 25). Upon the transfer to the new plan of pension plan assets and the assumption by the new plan of the pension benefit obligations, the Company began accounting for any pension benefit obligation net of the related pension plan assets.
Notes to Consolidated Financial Statements, Continued
Deferred and Accrued Taxes
AIG and Fortress mutually elected to treat the transaction as a sale of assets pursuant to IRS regulations. As a result of this election, the purchase price was allocated to all assets which changed the tax basis used to derive deferred tax assets and liabilities. After all transaction related adjustments were recorded, including the third quarter 2011 tax adjustment of $7.9 million to reflect new information obtained relative to the assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction, the Company had a net deferred tax liability of $532.7 million compared to a net deferred tax asset of $3.6 million immediately preceding the transaction. The deferred tax asset prior to the transaction was net of a valuation allowance of $222.1 million which was reversed upon application of push-down accounting. Subsequent to the transaction, the Company concluded that a valuation allowance on its federal deferred tax assets was not necessary as they can be realized upon reversal of the deferred tax liabilities recorded through push-down accounting.
Note 6. Finance Receivables
Finance Receivable Portfolio Segments
We have three portfolio segments as defined below:
· Real estate loans are secured by first or second mortgages on residential real estate, generally have maximum original terms of 360 months, and are usually considered non-conforming. Real estate loans may be closed-end accounts or open-end home equity lines of credit and are primarily fixed-rate products.
· Non-real estate loans are secured by consumer goods, automobiles, or other personal property or are unsecured, and are generally fixed-rate, fixed-term loans with maximum original terms of 60 months.
· Retail sales finance includes retail sales contracts and revolving retail. Retail sales contracts are closed-end accounts that represent a single purchase transaction. Revolving retail are open-end accounts that can be used for financing repeated purchases from the same merchant. Retail sales contracts are secured by the real property or personal property designated in the contract and generally have maximum original terms of 60 months. Revolving retail are secured by the goods purchased and generally require minimum monthly payments based on the amount financed calculated after the most recent purchase or outstanding balances.
Notes to Consolidated Financial Statements, Continued
Components of net finance receivables by portfolio segment were as follows:
Included in the table above are real estate finance receivables associated with the securitizations that remain on our balance sheet totaling $2.4 billion at December 31, 2011 and $2.2 billion at December 31, 2010. See Note 7 for further discussion regarding our securitization transactions. Also included in the table above are finance receivables totaling $4.8 billion at December 31, 2011 and $6.4 billion at December 31, 2010, which have been pledged as collateral for SLFC’s $3.75 billion six-year secured term loan facility (secured term loan).
At December 31, 2011 and 2010, 97% of our net finance receivables were secured by the real and/or personal property of the borrower. At December 31, 2011, real estate loans accounted for 77% of the amount and 15% of the number of net finance receivables outstanding, compared to 78% of the amount and 15% of the number of net finance receivables outstanding at December 31, 2010.
Maturities of net finance receivables by portfolio segment at December 31, 2011 were as follows:
Maturities are not a forecast of future cash collections. Company experience has shown that customers typically renew, convert or pay in full a substantial portion of finance receivables prior to maturity.
Notes to Consolidated Financial Statements, Continued
Principal cash collections and such collections as a percentage of average net receivables by portfolio segment were as follows:
Unused credit lines extended to customers by the Company totaled $188.1 million at December 31, 2011 and $162.3 million at December 31, 2010. All unused credit lines, in part or in total, can be cancelled at the discretion of the Company.
Geographic Diversification
Geographic diversification of finance receivables reduces the concentration of credit risk associated with economic stresses in any one region. However, the unemployment and housing market stresses in the U.S. have been national in scope and not limited to a particular region. The largest concentrations of net finance receivables were as follows:
* December 31, 2010 concentrations of net finance receivables are presented in the order of December 31, 2011 state concentrations.
Notes to Consolidated Financial Statements, Continued
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.
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.
FICO-delineated prime, non-prime, and sub-prime categories for net finance receivables by portfolio segment and by class were as follows:
* Primarily includes net finance receivables of our foreign subsidiary, Ocean.
Notes to Consolidated Financial Statements, Continued
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios by portfolio segment and by class were as follows:
(a) Primarily includes delinquency ratios of our foreign subsidiary, Ocean.
(b) Not meaningful
Nonaccrual Finance Receivables
Our net finance receivables by performing and nonperforming (nonaccrual) by portfolio segment and by class were as follows:
* Primarily includes net finance receivables of our foreign subsidiary, Ocean.
If our nonaccrual finance receivables would have been current in accordance with their original terms, we would have recorded finance charges of approximately $56.8 million in 2011 and $43.1 million in 2010.
Notes to Consolidated Financial Statements, Continued
Delinquent Finance Receivables
Our delinquency by portfolio segment and by class were as follows:
* Primarily includes delinquency and current receivables of our foreign subsidiary, Ocean.
In our branch business segment we advance the due date on a customer’s account when the customer makes a partial payment of 90% or more of the scheduled contractual payment. We do not advance the due date on a customer’s account further if the customer makes an additional partial payment of 90% or more of the scheduled contractual payment and has not yet paid the deficiency amount from a prior partial payment. We do not advance the customer’s due date on our centralized real estate business segment accounts until we receive full contractual payment.
We accrue finance charges on revolving retail finance receivables up to the date of charge-off at six months past due. We have accrued finance charges of $0.2 million on $3.8 million of branch retail finance receivables more than 90 days past due at December 31, 2011 and $0.7 million on $10.0 million of these finance receivables that were more than 90 days past due at December 31, 2010. Our other portfolio segments by class (branch real estate, centralized real estate, and branch non-real estate) do not have finance receivables that were more than 90 days past due and still accruing finance charges.
Notes to Consolidated Financial Statements, Continued
Purchased Credit Impaired Finance Receivables
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. As a result, we identified a population of finance receivables for which it was determined that it is probable that we will be unable to collect all contractually required payments (purchased credit impaired finance receivables). We include the carrying amount (which initially was the fair value) of these purchased 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 purchased credit impaired finance receivables was as follows:
We did not create an allowance for purchased credit impaired finance receivable losses in the fourth quarter of 2011 since the net carrying value of these purchased credit impaired finance receivables was less than the present value of the expected cash flows.
Changes in accretable yield for purchased credit impaired finance receivables were as follows:
* Prior to the FCFI Transaction, the accretable yield of our purchased credit impaired finance receivables was immaterial.
Notes to Consolidated Financial Statements, Continued
FICO-delineated prime, non-prime, and sub-prime categories for purchased credit impaired finance receivables by portfolio segment and by class were as follows:
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios for purchased credit impaired finance receivables by portfolio segment and by class were as follows:
* Not meaningful
Notes to Consolidated Financial Statements, Continued
If the timing and/or amounts of expected cash flows on purchased credit impaired finance receivables were determined to be not 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 for our pools are reasonably estimable, interest is being accreted and the finance receivables are being reported as performing finance receivables. Our purchased credit impaired finance receivables as determined as of November 30, 2010 remain in our purchased credit impaired pools until liquidation. No finance receivables have been added to these pools subsequent to November 30, 2010. We do not reclassify modified purchased credit impaired finance receivables as TDRs.
TDR Finance Receivables
Information regarding TDR finance receivables (which are all real estate loans) by portfolio segment and by class was as follows:
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 purchased credit impaired finance receivables. We have no commitments to lend additional funds on our TDR finance receivables.
Notes to Consolidated Financial Statements, Continued
TDR average net receivables and finance charges recognized on TDR finance receivables by portfolio segment and by class were as follows:
Information regarding the financial effects of the TDR finance receivables by portfolio segment and by class was as follows:
Notes to Consolidated Financial Statements, Continued
Net finance receivables that defaulted during the period that were modified as TDRs within the previous 12 months, from the earliest payment default date, by portfolio segment and by class were as follows:
* Represents the corresponding balance of TDR net finance receivables at the end of the month in which they defaulted.
Home Affordable Modification Program (HAMP)
In third quarter 2009, 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 HAMP. MorEquity entered into the Agreement as the servicer with respect to our centralized real estate loans, 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 loans with Nationstar. As a result of the subservicing transfer, the Agreement was terminated on May 26, 2011. Loans subserviced by Nationstar that are eligible for modification pursuant to HAMP guidelines are still subject to HAMP.
Note 7. On-Balance Sheet Securitization Transactions and VIEs
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 VIEs for securitization transactions. Since these transactions involve securitization trusts required to be consolidated, the securitized assets and related liabilities are included in our financial statements and are accounted for as secured borrowings.
Notes to Consolidated Financial Statements, Continued
On-Balance Sheet Securitization Transactions
In September 2011, we completed an on-balance sheet securitization transaction which included the sale of approximately $496.9 million of our real estate loans (64.9% of which constituted branch real estate loans and 35.1% of which constituted centralized real estate loans) to a wholly-owned consolidated special purpose vehicle, Eighth Street Funding LLC (Eighth Street), which concurrently formed a trust that issued notes to Eighth Street in exchange for the loans. In connection with the securitization, Eighth Street sold at a discount $242.7 million of senior notes with a 4.05% coupon to a third party. Eighth Street received cash proceeds, including accrued interest after the sales discount but before expenses, of $242.5 million, and retained senior, subordinated and residual interest notes. On February 10, 2012, we completed the sale at a discount of a previously retained senior note with a face value of $49.7 million and a coupon of 5.45% to a third party.
In March 2010, we completed an on-balance sheet securitization transaction which included the sale of approximately $1.0 billion of our centralized real estate loans to a wholly-owned consolidated special purpose vehicle, Sixth Street Funding LLC (Sixth Street), which concurrently formed a trust that issued trust certificates to Sixth Street in exchange for the loans. In connection with the securitization, Sixth Street sold to a third party $501.3 million of senior certificates with a 5.15% coupon. Sixth Street received cash proceeds, including accrued interest after the sales discount but before expenses, of $503.3 million and retained subordinated and residual interest trust certificates. On February 10, 2012, we completed the sale at a premium of a portion of the previously retained subordinated trust certificates with a face value of $215.6 million and a coupon of 5.65% to a third party.
In July 2009, we completed an on-balance sheet securitization which included the sale of approximately $1.9 billion of our centralized real estate loans to a wholly-owned consolidated special purpose vehicle, Third Street Funding LLC (Third Street), that concurrently formed a trust that issued tranches of certificates to Third Street in exchange for the loans. In connection with the securitization, Third Street sold at a discount $1.2 billion of senior certificates with a 5.75% coupon to a third party. Third Street received cash proceeds, including accrued interest after the sales discount but before expenses, of $967.3 million, and retained subordinated and residual interest trust certificates.
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 other existing securitization transactions, Nationstar subservices the centralized real estate loans for the 2006, 2010, and 2011 securitization transactions. 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 in or arising from the applicable securitization transaction. The cash and cash equivalent balances relating to securitization transactions may be used only to support the on-balance sheet securitization transactions and are recorded as restricted cash. We hold the right to certain excess cash flows not needed to pay the debt and other obligations issued in or arising from our securitization transactions. The asset-backed debt has been issued by consolidated VIEs.
Consolidated VIEs
We evaluated the securitization trusts and determined that these entities are VIEs of which we are the primary beneficiary; therefore, we 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. Our power stems from having prescribed detailed servicing standards and procedures that the third-party servicer and Nationstar must observe (and
Notes to Consolidated Financial Statements, Continued
which cannot be modified without our consent), and from our required involvement in certain loan workouts and disposals of defaulted loans or related collateral. Our retained subordinated and residual interest trust certificates expose us to potentially significant losses and potentially significant returns.
The asset-backed securities are backed by the expected cash flows from securitized real estate loans. Cash inflows from these real estate loans are distributed to investors and service providers in accordance with each transaction’s contractual priority of payments (waterfall) and, as such, most of these inflows must be directed first to service and repay each trust’s senior notes or certificates held principally by third-party investors. After these senior obligations are extinguished, substantially all cash inflows will be directed to the subordinated notes until fully repaid and, thereafter, to the residual interest that we own in each trust. 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. We expect that any credit losses in the pools of securitized assets will likely be limited to our subordinated and residual retained interests. We have no obligation to repurchase or replace qualified securitized assets that subsequently become delinquent or are otherwise in default.
The carrying amounts of consolidated VIE assets and liabilities associated with our securitization trusts were as follows:
Other than our retained subordinate and residual interests in the consolidated securitization trusts, we are under no obligation, either contractually or implicitly, to provide financial support to these entities. Consolidated interest expense related to these VIEs totaled $77.0 million in 2011, $6.6 million during the one month ended December 31, 2010, $154.4 million during the eleven months ended November 30, 2010, and $75.0 million in 2009.
Unconsolidated VIE
We have established a VIE that holds the junior subordinated debt described in Note 14. We are not the primary beneficiary, and we do not have a variable interest in this VIE. Therefore, we do not consolidate such entity. We had no off-balance sheet exposure to loss associated with this VIE at December 31, 2011 or 2010.
Notes to Consolidated Financial Statements, Continued
Note 8. 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:
(a) 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.
(b) The beginning balance of allowance for finance receivable losses for the Successor Company for the one month ended December 31, 2010 includes the push-down accounting adjustments.
Notes to Consolidated Financial Statements, Continued
* During 2009, we decreased the allowance for finance receivable losses as a result of the transfers of $1.9 billion of real estate loans from finance receivables held for investment to finance receivables held for sale due to management’s intent to no longer hold these finance receivables for the foreseeable future.
Included in the tables above are allowance for finance receivable losses associated with securitizations that remain on our balance sheet totaling $2.1 million at December 31, 2011, $0.1 million at December 31, 2010, and $70.3 million at December 31, 2009. See Note 7 for further discussion regarding our securitization transactions.
After the FCFI Transaction, the recorded investment or carrying amount of finance receivables includes the impact of push-down adjustments. For the year ended December 31, 2011, the carrying amount charged off for non-credit impaired loans subject to push-down accounting was $203.8 million. For the year ended December 31, 2011, the carrying amount charged off for purchased credit impaired loans subject to push-down accounting was $110.1 million. This amount represents additional impairment recognized, subsequent to the establishment of the pools of purchased credit impaired loans, related to loans that have been foreclosed and transferred to real estate owned status or, in the case of our non real estate pools, have been deemed unrecoverable after further experience with the borrower. Through December 31, 2011, we have not recognized any additional charges to the provision for finance receivable losses related to decreases in the expected cash flows for the remaining accounts in the credit impaired pools that incorporate pool assumptions, above the charges related to removal of foreclosed or charged-off accounts.
Notes to Consolidated Financial Statements, Continued
The allowance for finance receivable losses and net finance receivables by portfolio segment and by impairment method were as follows:
Our three portfolio segments consist of a large number of relatively small, homogeneous accounts. We evaluate our three portfolio segments 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 for non-credit impaired accounts using the authoritative guidance for contingencies. We base our allowance for finance receivable losses primarily on historical loss experience using migration analysis and, effective September 30, 2011, a roll rate-based model applied to our three portfolio segments. We adopted the roll rate-based model because we believe it captures portfolio trends at a more detailed level. Both techniques are historically-based statistical models that attempt to predict the future amount of finance receivable losses. We adjust the amounts determined by these quantitative models for management’s estimate of the effects of model imprecision, any changes to underwriting criteria, portfolio seasoning, and current economic conditions, including levels of unemployment and personal bankruptcies.
Notes to Consolidated Financial Statements, Continued
Prior to the FCFI Transaction, we used migration analysis and the Monte Carlo technique as the principal tools to determine the appropriate amount of allowance for finance receivable losses.
We use our internal data of net charge-offs and delinquency by portfolio segment 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 statistic providers to determine the economic component of our allowance for finance receivable losses.
The allowance for finance receivable losses related to our purchased 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 individually evaluated 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. See Note 6 for information on TDR reserves.
See Note 3 for additional information on the determination of the allowance for finance receivable losses.
Note 9. Finance Receivables Held for Sale
We repurchased 12 loans for $2.1 million during 2011 primarily due to loans reaching defined delinquency limits under certain loan sale agreements, compared to 4 loans repurchased for $0.5 million during 2010. We did not repurchase any loans during 2009. At December 31, 2011, there were no material unresolved recourse requests.
The activity in our reserve for sales recourse obligations was as follows:
Notes to Consolidated Financial Statements, Continued
Our reserve for sales recourse obligations has declined due to substantial reductions in loan sales in recent years and reductions in loss exposure estimates resulting from improving estimated losses on projected loan repurchases.
In February 2010, we transferred $170.7 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 in preparation for an on-balance sheet securitization that was completed in March 2010. 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.
During 2009, we transferred $1.9 billion of real estate loans from finance receivables held for investment to finance receivables held for sale due to management’s intent to no longer hold these finance receivables for the foreseeable future. In 2009, we sold $1.9 billion of finance receivables held for sale.
Notes to Consolidated Financial Statements, Continued
Note 10. 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:
(a) In January 2011, we reclassified $0.1 million of previously recorded other-than-temporary impairments in accumulated other comprehensive income or loss to unrealized gains on all other investment securities in accumulated other comprehensive income or loss to reflect the proper classification of these investment securities.
Notes to Consolidated Financial Statements, Continued
(b) Excludes interest in a limited partnership that we account for using the equity method ($1.4 million at December 31, 2011 and 2010).
Fair value and unrealized losses on investment securities by type and length of time in a continuous unrealized loss position were as follows:
Notes to Consolidated Financial Statements, Continued
Management reviews all securities in an unrealized loss position on a quarterly basis. We determine if it is probable that the security will recover and if we will collect all amounts due according to the contractual terms of the debt, which could be at maturity. We utilize the evaluation criteria supplied by our third-party valuation providers, which includes changes in the issuer’s credit status and the issuer’s ability to fulfill contractual obligations. For structured securities, this evaluation also includes analyses of the estimated net present value of expected future 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 evaluates vendor-supplied credit analyses 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.
During 2011, we recognized a $3.7 million other-than-temporary impairment credit loss write-down to investment revenues on corporate debt, RMBS, and CMBS. For these securities, we had no intent to sell them nor were we required to sell them; however, management was unable to assert that the security would recover the amortized cost prior to or at maturity. In addition, the loss criterion discussed with third-party valuation professionals, supported by analyst, industry, and cash flow reports indicated that there was a high risk that the interest and principal payments were likely to be uncollectible or substantially reduced. Considering the data, we determined that it was reasonable to record a fair value write-down to investment revenues. In these instances, which have been confirmed by deal specifics, economic, market and credit events, tranche and cash flow information, underlying collateral, credit enhancement information, and default rates, management does not expect to recover a substantial portion of the contractual principal and interest payments sufficient to cover the entire amortized cost basis of these securities (that is, they are credit impaired).
As of December 31, 2011 and 2010, we had no investment securities which had been in an unrealized loss position of more than 25% 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.
In January 2011, we reclassified $0.4 million of 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.
Components of the other-than-temporary impairment charges on investment securities were as follows:
Notes to Consolidated Financial Statements, Continued
Changes in the cumulative amount of credit losses (recognized in earnings) on other-than-temporarily impaired investment securities were as follows:
(a) On April 1, 2009, we adopted the accounting standard that requires us to recognize the credit component of an other-than-temporary impairment in earnings.
(b) The beginning balance for the Successor Company for the one month ended December 31, 2010 includes the push-down accounting adjustments. In January 2011, we reclassified $31,000 of the balance at the beginning of the year ended December 31, 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) gains were as follows:
Notes to Consolidated Financial Statements, Continued
Contractual maturities of fixed-maturity investment securities at December 31, 2011 were as follows:
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 11. 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 these notes receivable from AIG totaled $11.2 million for the eleven months ended November 30, 2010 and $6.6 million in 2009.
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. Affiliates of Fortress and affiliates of AIG owned or managed lending positions in the syndicate of lenders and had contributed approximately $105.5 million and $93.0 million, respectively, at December 31, 2011 and 2010.
Pension Plan
In January 2011, $216.0 million of plan assets were transferred from the AIG Retirement Plan to our tax-qualified defined benefit retirement plan (Retirement Plan). At December 31, 2011, $59.9 million of plan assets had not been transferred, but were included in our total plan assets. The remaining $59.9 million of plan assets will be transferred no later than May 1, 2012.
Notes to Consolidated Financial Statements, Continued
Reinsurance Agreements
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 $49.7 million at December 31, 2011 and $51.2 million at December 31, 2010.
Derivatives
At December 31, 2011, all of our derivative financial instruments were with AIG Financial Products Corp. (AIGFP), a subsidiary of AIG. At December 31, 2010, all but one of our derivative financial instruments were with AIGFP. The derivative financial instrument that was not with AIGFP was terminated in March 2011 due to the sale of the related note receivable from AIG. See Note 16 for further information on our derivatives.
Subservicing and Refinance Agreements
Nationstar subservices the centralized real estate loans of MorEquity and two other subsidiaries of SLFC (collectively, the Owners), including certain securitized real estate loans. During 2011, the Owners paid Nationstar $9.9 million in fees for its subservicing and $6.6 million to facilitate the repayment of our centralized real estate loans through refinancings with other lenders.
Investment Management Agreement
Logan Circle Partners, L.P. (Logan Circle), a non-subsidiary affiliate of SLFI, provides investment management services for $300.0 million of higher yielding bonds purchased in fourth quarter 2011. At December 31, 2011, fees of $0.1 million were due for these investment management services.
Contribution of Subsidiaries to SLFC
Effective January 1, 2010, SLFI contributed two of its wholly-owned subsidiaries to SLFC. The contribution included $300.3 million of finance receivables. At December 31, 2009, these subsidiaries owed an aggregate total of $278.9 million to SLFI under intercompany notes. As part of the January 1, 2010 transaction, SLFC established direct notes to the subsidiaries in the same amount and as a result, SLFI then reduced its intercompany borrowings from SLFC. Because the transaction was between entities under common control, we recorded the transaction by transferring the assets, liability, and equity from SLFI to SLFC at the carrying value that existed as of January 1, 2010.
Note 12. Restricted Cash
Restricted cash at December 31, 2011 and 2010 included funds to be used for future debt payments relating to our securitization transactions (see Note 7) and escrow deposits. Restricted cash at December 31, 2010 also included funds related to SLFC’s secured term loan. The decrease in restricted cash at December 31, 2011 when compared to December 31, 2010 was primarily due to reduced collateral requirements on SLFC’s secured term loan, which was refinanced in May 2011.
Notes to Consolidated Financial Statements, Continued
Note 13. Other Assets
Components of other assets were as follows:
(a) Other investments primarily include commercial mortgage loans and accrued investment income.
(b) Other intangible assets at December 31, 2011 include VOBA, customer relationships, licenses, customer lists, and branch office leases, net of accumulated amortization, resulting from the FCFI Transaction. Other intangible assets at December 31, 2010 also included trade names, which were written off in 2011. See Note 5 for additional information on the impairments of our intangible assets. (Other intangible assets exclude branch office leases of $2.8 million at December 31, 2011 and $5.9 million at December 31, 2010 and data processing equipment leases of $1.3 million at December 31, 2010 that are unfavorable to the current market terms and are included in other liabilities.)
(c) Income tax assets include both current and deferred amounts. The components of net deferred tax assets are detailed in Note 22.
(d) Note receivable from AIG represents payments to be made by AIG to SLFI with respect to the 2009 taxable year in accordance with our tax sharing agreement.
(e) Upon the establishment of the Retirement Plan on January 1, 2011, plan assets were transferred from the AIG Retirement Plan to our Retirement Plan. We began accounting for our Retirement Plan effective January 1, 2011 and netted the related pension plan assets with the pension benefit obligation in other liabilities.
Notes to Consolidated Financial Statements, Continued
Note 14. Long-term Debt
Carrying value and fair value of long-term debt by type were as follows:
Weighted average interest expense rates on long-term debt by type were as follows:
Notes to Consolidated Financial Statements, Continued
Principal maturities of long-term debt (excluding projected securitization repayments by period) by type of debt at December 31, 2011 were as follows:
(a) Euro denominated notes include two Euro 500 million note issuances, shown here at the U.S. dollar equivalent at time of issuance.
(b) Issued by wholly-owned Company subsidiaries.
(c) Guaranteed by SLFC and by the Subsidiary Guarantors (defined below).
(d) The interest rates shown are the range of contractual rates in effect at December 31, 2011, which exclude the effects of the associated derivative instruments used in hedge accounting relationships, if applicable.
(e) Securitizations are not included in above maturities by period due to their variable monthly repayments.
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.
Notes to Consolidated Financial Statements, Continued
As a result of the refinancing of SLFC’s secured term loan on May 10, 2011, certain creditors involved in the syndicate of lenders of the original loan remained in the syndicate of lenders of the refinanced loan (remaining creditors), while certain creditors involved in the original syndicate of lenders were no longer included in the syndicate of lenders of the refinanced loan (extinguished creditors). Since none of the remaining creditors’ balances exceeded the 10 percent cash flow test, we accounted for this refinancing transaction as a modification of the secured term loan.
We recorded a $10.7 million gain on the early extinguishment of the original loan, which represented the pro rata amount of the unamortized balance of the fair value adjustment on the debt no longer payable to the extinguished creditors. We deferred the remaining $20.1 million of the fair value adjustment on the debt for the remaining creditors, which was recognized on our balance sheet and is amortized over the new term using the interest rate method.
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.
The debt agreements to which SLFC and its subsidiaries are a party include standard terms and conditions, including covenants and representations and warranties. These agreements also contain certain restrictions, including restrictions on the ability to create senior liens on property and assets in connection with any new debt financings and restrictions on the intercompany transfer of funds from certain subsidiaries to SLFC or SLFI, except for those funds needed for debt payments and operating expenses. SLFC subsidiaries that borrow funds through the $3.75 billion secured term loan are also required to pledge eligible finance receivables to support their borrowing under the secured term loan.
None of our debt agreements require SLFC or any subsidiary to meet or maintain any specific financial targets or ratios, except the requirement to maintain a certain level of pledged finance receivables under the secured term loan.
Under our debt agreements, certain events, including non-payment of principal or interest, bankruptcy or insolvency, or a breach of a covenant or a representation or warranty may constitute an event of default and trigger an acceleration of payments. In some cases, an event of default or acceleration of payments under one debt agreement may constitute a cross-default under other debt agreements resulting in an acceleration of payments under the other agreements.
As of December 31, 2011, we were in compliance with all of the covenants under our debt agreements.
Under the hybrid debt, SLFC, upon the occurrence of a mandatory trigger event, is required 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. A mandatory trigger event occurs if SLFC’s (1) tangible equity to tangible managed assets is less than 5.5% or (2) average fixed charge ratio is not more than 1.10x for the trailing four quarters (where the fixed charge ratio equals earnings excluding income taxes, interest expense, extraordinary items, goodwill impairment, and any amounts related to discontinued operations, divided by the sum of interest expense and any preferred dividends).
Notes to Consolidated Financial Statements, Continued
Based upon SLFC’s financial results for the twelve months ended September 30, 2011, a mandatory trigger event occurred under SLFC’s hybrid debt with respect to the hybrid debt’s semi-annual payment due in January 2012 due to the average fixed charge ratio being less than 0.76x (while the equity to assets ratio was 9.17%). During January 2012, SLFC received from SLFI the non-debt capital funding necessary to satisfy, and subsequently paid, the January 2012 interest payments required by SLFC’s hybrid debt.
Note 15. Short-term Debt
Information concerning short-term debt was as follows:
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 capital support agreement was terminated in accordance with its terms. See Note 21 for further information on the terms of the capital support agreement.
Note 16. Derivative Financial Instruments
Our principal borrowing subsidiary is SLFC. 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. At December 31, 2011, SLFC’s derivative financial instruments consisted of cross currency interest rate swap agreements. SLFC’s interest rate and equity-indexed swap agreements matured in 2011.
While all of SLFC’s cross currency interest rate 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.
We formally document all relationships between derivative hedging instruments and hedged items, as well as our risk-management objectives and strategies for undertaking various hedge transactions and our method to assess ineffectiveness. We link all derivatives that we designate as cash flow or fair value hedges to specific assets and liabilities on the balance sheet. We perform and document an initial prospective assessment of hedge effectiveness using regression analysis to demonstrate that the hedge is expected to be highly effective in future periods. Subsequently, on at least a quarterly basis or sooner if necessary, we perform a prospective hedge effectiveness assessment to demonstrate the continued expectation that the hedge will be highly effective in future periods and a retrospective hedge effectiveness assessment to demonstrate that the hedge was effective in the most recent period. For fair value hedges, ineffectiveness is the difference between the change in fair value included in the assessment of hedge effectiveness related to the gain or loss on the derivative and the change in the hedged item related to the risks being hedged. For cash flow hedges, ineffectiveness is the amount by which the
Notes to Consolidated Financial Statements, Continued
cumulative change in the fair value of the hedging instrument exceeds the cumulative change in the fair value of the hypothetical derivative.
Notional amounts of our swap agreements and weighted average receive and pay rates were as follows:
Notional amount maturities of our cross currency interest rate swap agreements at December 31, 2011 were as follows:
Changes in the notional amounts of our swap agreements and foreign currency forward agreement were as follows:
New contracts in 2010 included notional amount for a note receivable from AIG ($468.0 million). This contract was terminated on March 24, 2011 as a result of the sale of the related note receivable from AIG.
Notes to Consolidated Financial Statements, Continued
Fair value of derivative instruments presented on a gross basis by type were as follows:
Notes to Consolidated Financial Statements, Continued
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 and interest expense (effective portion), and recognized in other revenues (ineffective portion) were as follows:
(a) In third quarter 2011, we corrected the omission of the effective portion of the valuation change of our interest rate and cross currency interest rate swaps that was recorded in accumulated other comprehensive income or loss and an equal amount that was reclassified to earnings for the one month ended December 31, 2010 and the eleven months ended November 30, 2010. This revision had no impact on the amount of AOCI(L) at December 31, 2010 and November 30, 2010.
(b) Accumulated other comprehensive income (loss)
(c) Represents the total amounts reclassified from AOCI(L) to other revenues and to interest expense for cash flow hedges as disclosed on our consolidated statement of comprehensive (loss) income.
Notes to Consolidated Financial Statements, Continued
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 December 31, 2011, we expect $7.0 million of the deferred net gain on cash flow hedges to be reclassified from accumulated other comprehensive income or loss to earnings during the next twelve months.
For the year ended December 31, 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.
The amounts recognized in other revenues for non-designated hedging instruments were as follows:
Notes to Consolidated Financial Statements, Continued
Derivative adjustments included in other revenues consisted of the following:
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.
See Note 28 for information on how we determine fair value on our derivative financial instruments.
Note 17. Insurance
Components of insurance claims and policyholder liabilities were as follows:
Notes to Consolidated Financial Statements, Continued
Our insurance subsidiaries enter into reinsurance agreements with other insurers (including subsidiaries of AIG). Insurance claims and policyholder liabilities included the following amounts assumed from other insurers:
Our insurance subsidiaries’ business reinsured to others was not significant during any of the last three years.
Our insurance subsidiaries file financial statements prepared using statutory accounting practices prescribed or permitted by the Indiana Department of Insurance, which is a comprehensive basis of accounting other than U.S. GAAP.
Reconciliations of statutory net income to U.S. GAAP net income were as follows*:
* We report our statutory financial information on a historical basis of accounting. We are not required and did not apply push-down accounting to the insurance subsidiaries on a statutory basis.
Notes to Consolidated Financial Statements, Continued
Reconciliations of statutory equity to U.S. GAAP equity were as follows*:
* We report our statutory financial information on a historical basis of accounting. We are not required and did not apply push-down accounting to the insurance subsidiaries on a statutory basis.
Note 18. Other Liabilities
Components of other liabilities were as follows:
(a) As a result of the FCFI Transaction, we applied push-down accounting and recognized a $285.6 million liability at December 31, 2010 for our proportionate share of the projected benefit obligation.
(b) Escrow liabilities at December 31, 2011 and 2010 reflected liabilities for mortgagors’ funds placed in escrow for future payments of insurance, tax, and other charges for real estate loans.
Note 19. Capital Stock
SLFI has two classes of authorized capital stock: special shares and common shares. SLFI may issue special shares in series. The board of directors determines the dividend, liquidation, redemption, conversion, voting and other rights prior to issuance.
Notes to Consolidated Financial Statements, Continued
Par value and shares authorized at December 31, 2011 were as follows:
Shares issued and outstanding at December 31, 2011 and 2010 were as follows:
Note 20. Accumulated Other Comprehensive Loss
Components of accumulated other comprehensive loss were as follows:
Note 21. Retained Earnings
Under our debt agreements, certain events, including non-payment of principal or interest, bankruptcy or insolvency, or a breach of a covenant or a representation or warranty may constitute an event of default and trigger an acceleration of payments. In some cases, an event of default or acceleration of payments under one debt agreement may constitute a cross-default under other debt agreements resulting in an acceleration of payments under the other agreements.
Based upon SLFC’s financial results for the twelve months ended September 30, 2011, a mandatory trigger event occurred under SLFC’s hybrid debt with respect to the hybrid debt’s semi-annual payment due in January 2012 due to the average fixed charge ratio being less than 0.76x (while the equity to assets ratio was 9.17%). During January 2012, SLFC received from SLFI the non-debt capital funding necessary to satisfy, and subsequently paid, the January 2012 interest payments required by SLFC’s hybrid debt.
Notes to Consolidated Financial Statements, Continued
State law restricts the amounts our insurance subsidiaries may pay as dividends without prior notice to, or in some cases prior approval from, the Indiana Department of Insurance. Our insurance subsidiaries paid $45 million of dividends in second quarter 2011 that did not require prior approval and paid $200 million of dividends in first quarter 2009 upon receiving prior approval. At December 31, 2011, our insurance subsidiaries had combined statutory capital and surplus of $622.7 million.
Note 22. Income Taxes
SLFI and all of its domestic U.S. subsidiaries file a consolidated life/nonlife federal tax return with the Internal Revenue Service (IRS). Our foreign subsidiaries file tax returns in Puerto Rico, the U.S. Virgin Islands, and the United Kingdom. Prior to the FCFI Transaction, including the eleven months ended November 30, 2010, SLFI and all of its domestic U.S. subsidiaries were included in AIG’s consolidated federal income tax return. Prior to the FCFI Transaction, we provided federal income taxes as if SLFI and the domestic U.S. subsidiaries of SLFI filed separate tax returns and paid taxes to or received tax benefits from AIG accordingly under a tax sharing agreement.
AIG and Fortress mutually elected to treat the FCFI Transaction as a sale of assets pursuant to IRS regulations. As a result of this election, the purchase price was allocated to all assets which changed the tax basis used to derive deferred tax assets and liabilities. After all transaction related adjustments were recorded, including the third quarter 2011 tax adjustment of $7.9 million to reflect new information obtained relative to the assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction, the Company had a net deferred tax liability of $532.7 million compared to a net deferred tax asset of $3.6 million immediately preceding the transaction. The deferred tax asset prior to the transaction was net of a valuation allowance of $220.5 million which was reversed upon application of push-down accounting. Subsequent to the transaction, the Company concluded that a valuation allowance on its federal deferred tax assets was not necessary as they can be realized upon reversal of the deferred tax liabilities recorded through push-down accounting.
As of December 31, 2011, the Company made the determination that it could no longer assert that it intended to permanently reinvest the earnings of its foreign subsidiaries, and deferred taxes were recorded on the basis difference in its foreign subsidiaries as of December 31, 2011, which resulted in no material impact on tax expense.
Notes to Consolidated Financial Statements, Continued
Components of (benefit from) provision for income taxes were as follows:
Benefit from income taxes of $99.0 million in 2011 decreased when compared to the eleven months ended November 30, 2010 primarily due to the establishment of valuation allowances against our deferred tax assets in 2011, compared to a release of valuation allowances for the eleven months ended November 30, 2010.
Benefit from income taxes for the one month ended December 31, 2010 reflected the bargain purchase gain, tax exempt interest, and state income tax. Benefit from income taxes also reflected our tax position on a stand alone basis since we no longer are included in AIG’s consolidated federal income tax return due to the FCFI Transaction.
Benefit from income taxes of $250.7 million for the eleven months ended November 30, 2010 principally relates to $252.9 million income tax receivable from AIG and a $114.1 million change in net deferred tax assets offset by an equal release of the valuation allowance. 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 AIG for the amount of the income tax receivable at the closing of the FCFI Transaction.
(Benefit from) provision for foreign income taxes includes our foreign subsidiaries that operate in Puerto Rico, the U.S. Virgin Islands, and the United Kingdom. In 2011, we recorded a full valuation allowance on the deferred tax assets related to our United Kingdom operations. Previously, a valuation allowance was not required on the deferred tax assets related to our foreign operations.
Notes to Consolidated Financial Statements, Continued
We recorded a current state income tax provision in 2011 attributable to profitable operations in certain states in which we do business that could not be offset against losses incurred in other states. We recorded a valuation allowance against the majority of our state deferred tax assets including all state deferred tax assets related to net operating losses.
We recorded a current state income tax provision for the one month ended December 31, 2010 based on the operations of the Company for the one month period.
We recorded a current state tax provision for the eleven months ended November 30, 2010 attributable to profitable operations in certain states in which we do business that could not be offset against losses incurred in other states. A full valuation allowance was required on our deferred state tax assets.
Reconciliations of the statutory federal income tax rate to the effective tax rate were as follows:
The effective income tax rate for 2011 differed from the statutory tax rate primarily due to the impact of recording a partial valuation allowance on the deferred tax assets related to our state and foreign operations.
The effective income tax rate for the one month ended December 31, 2010 differed from the statutory tax rate primarily due to the impact of the bargain purchase gain.
The effective income tax rate for the eleven months ended November 30, 2010 reflected the release of the valuation allowance and tax exempt interest, partially offset by the effect of recording a deferred tax on the outside basis on our foreign entities.
Our unrecognized tax benefit (all of which would affect the effective tax rate if recognized), excluding interest and penalties, was zero at December 31, 2011 and 2010. We recognize interest and penalties related to unrecognized tax benefits in income tax expense. At December 31, 2011 and 2010, we had accrued zero for the payment of interest (net of the federal benefit) and penalties.
Under the terms of the sale of SLFI, AIG and FCFI have made certain customary representations, warranties and covenants in the stock purchase agreement and AIG agreed to provide the purchaser with certain indemnities, including prior tax positions. Accordingly, any liability for prior tax positions would be offset by this indemnity.
We continually evaluate proposed adjustments by taxing authorities. At December 31, 2011, such proposed adjustments would not result in a material change to our consolidated financial condition.
Notes to Consolidated Financial Statements, Continued
The IRS has completed examinations of AIG’s tax returns through 1999. The IRS has also completed examinations of our former direct parent company’s tax returns through 2000. Although a Revenue Agent’s Report has not yet been issued for the years ended December 31, 2001 or 2002, AIG has received a notice of proposed adjustments for certain items during that period from the IRS. The portion of proposed adjustments attributable to SLFI was immaterial. Under the indemnity arising from the FCFI Transaction, it is not expected that SLFI would have any liability for historical tax positions for periods through and including November 30, 2010.
Components of deferred tax assets and liabilities were as follows:
* The deferred tax balances at December 31, 2010 have been adjusted by $7.9 million to reflect new information obtained relative to the assumptions applied in our determination of the deferred and accrued taxes recorded as of the date of the FCFI Transaction.
At December 31, 2011, we had a net deferred tax liability of $398.8 million. This deferred tax liability is expected to reverse in timing and amount sufficient to create positive taxable income which will allow for the realization of all of our gross federal deferred tax assets. Included in our gross deferred tax assets are a foreign net operating loss carryforward of $3.5 million from our United Kingdom operations, a foreign tax credit benefit of $2.7 million, and a domestic federal net operating loss carryforward of $2.3 million. A full valuation allowance was recorded for the net deferred tax assets of our United Kingdom operations including the benefit of the foreign net operating loss carryforward. At December 31, 2011, we had a valuation allowance on our state deferred tax assets of $13.8 million, net of a deferred federal tax benefit.
Notes to Consolidated Financial Statements, Continued
At December 31, 2010, we did not have a federal net operating loss carryforward due to the FCFI Transaction. At December 31, 2010, we had a capital loss carryforward of $0.4 million, which may be carried forward for five years.
At December 31, 2010, no valuation allowance was required on our deferred state tax assets.
We released $114.1 million of the valuation allowance as an additional income tax benefit during the eleven months ended November 30, 2010 as a result of the change in the deferred tax asset during the period. The remaining balance of the valuation allowance was reversed as a result of the FCFI Transaction. At December 31, 2010, a valuation allowance was not required on our deferred tax assets.
Our foreign United Kingdom subsidiary has a three year accumulated loss. Previously, this company was included in a unitary return with AIG foreign affiliates and its losses were being utilized. Therefore, in previous years no valuation allowance on related deferred tax assets was required. As of December 31, 2011, our United Kingdom subsidiary remains in a loss position and will be filing a separate tax return. A full valuation allowance was recorded against Ocean’s deferred tax assets of $4.0 million as of December 31, 2011.
At December 31, 2011, other assets included $34.6 million of net current federal income tax receivable and $404.7 million of net deferred tax liabilities, compared to $5.4 million of net current federal income tax payable and $524.4 million of net deferred tax liabilities, respectively, at December 31, 2010. At December 31, 2011 and 2010, deferred and accrued taxes consisted of $6.3 million of non-income based taxes.
Note 23. Lease Commitments, Rent Expense, and Contingent Liabilities
Lease Commitments and Rent Expense
Annual rental commitments for leased office space, automobiles and data processing equipment accounted for as operating leases, excluding leases on a month-to-month basis and the amortization of the lease intangibles recorded as a result of the FCFI Transaction, were as follows:
* Includes $1.9 million of rental commitments for leased office space at closed locations (included in other liabilities at December 31, 2011).
Notes to Consolidated Financial Statements, Continued
In addition to rent, the Company pays taxes, insurance, and maintenance expenses under certain leases. In the normal course of business, we will renew leases that expire or replace them with leases on other properties. Rental expense totaled $37.9 million in 2011, $3.6 million for the one month ended December 31, 2010, $41.3 million for the eleven months ended November 30, 2010, and $59.2 million in 2009. We anticipate minimum annual rental commitments in 2012 to be less than the amount of rental expense incurred in 2011 primarily due to the closing of 52 branch offices in 2011 and additional branch office closings in 2012.
Legal Contingencies
In the normal course of business, the Company has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation arising in connection with its activities. Some of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. While the Company has identified below certain legal actions where the Company believes a material loss to be reasonably possible and reasonably estimable, there can be no assurance that material losses will not be incurred from claims that have not yet been notified to the Company or are not yet determined to be probable or reasonably possible.
The Company contests liability and/or the amount of damages, as appropriate, in each pending matter. Where available information indicates that it is probable that a liability had been incurred at the date of the consolidated financial statements and the Company can reasonably estimate the amount of that loss, the Company accrues the estimated loss by a charge to income. In many actions, however, it is inherently difficult to determine whether any loss is probable or even reasonably possible or to estimate the amount of any loss. In addition, even where loss is reasonably possible or an exposure to loss exists in excess of the liability already accrued with respect to a previously recognized loss contingency, it is not always possible to reasonably estimate the size of the possible loss or range of loss.
For certain legal actions, the Company cannot reasonably estimate such losses, particularly for actions that are in their early stages of development or where plaintiffs seek substantial or indeterminate damages. Numerous issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, and by addressing novel or unsettled legal questions relevant to the actions in question, before a loss or additional loss or range of loss or additional loss can be reasonably estimated for any given action.
For certain other legal actions, other than the action referred to in the following paragraphs, the Company can estimate reasonably possible losses, additional losses, ranges of loss or ranges of additional loss in excess of amounts accrued but does not believe, based on current knowledge and after consultation with counsel, that such losses will have a material adverse effect on the Company’s consolidated financial statements as a whole.
Discussed below is a description of each legal action in which it is reasonably possible that the Company may incur, on an individual basis, a material loss that can be reasonably estimated. Based on currently available information, the Company believes the estimate of the aggregate range of reasonably possible losses for such actions, in excess of amounts accrued, is from $0 to $57.0 million at December 31, 2011.
Notes to Consolidated Financial Statements, Continued
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 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 Springleaf Financial Services of South Carolina, Inc. (SLFSSC), 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 statute provides for a penalty range of $1,500 to $7,500 per class member, to be determined by the judge. SLFSSC timely submitted a motion to alter, amend or reconsider the Court’s interim order on summary judgment. The Court denied that motion on February 22, 2012. On October 14, 2011, the Court conducted a hearing on the issues of attorney fees and penalties. Plaintiffs requested approximately $68.7 million in penalties and approximately $24.5 million in attorney fees, plus interest. At the conclusion of the hearing, the Court ordered the parties to submit written arguments and proposed orders on all outstanding issues, including penalties, attorney fees, prejudgment interest, and class notice, by November 14, 2011. The parties timely submitted their proposed orders and written argument, but the Court has not yet ruled. The Company continues to defend the case vigorously.
Payment Protection Insurance
Ocean provides payments of compensation to its customers who have made claims concerning Payment Protection Insurance (PPI) policies sold in the normal course of business by insurance intermediaries. On April 20, 2011, the High Court in the United Kingdom handed down judgment supporting the Financial Services Authority (FSA) guidelines on the treatment of PPI complaints. In addition, the FSA issued a guidance consultation paper in March 2012 on the payment protection insurance customer contact letters. As a result, the Company has concluded that there are certain circumstances where customer contact and/or redress is appropriate. The total reserves related to the estimated PPI claims, net of professional indemnity insurance receivable, was $13.5 million at December 31, 2011 and $6.3 million at December 31, 2010.
Note 24. Supplemental Cash Flow Information
Supplemental disclosure of certain cash flow information was as follows:
Notes to Consolidated Financial Statements, Continued
Supplemental disclosure of non-cash activities was as follows:
Note 25. 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 the Retirement Plan and a 401(k) 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. In addition, we sponsor unfunded defined benefit plans for certain employees. We also provide postretirement health and welfare and life insurance plans. The Company’s employees in Puerto Rico participate in a defined benefit pension plan sponsored by CommoLoCo, Inc., our Puerto Rican subsidiary.
PENSION PLANS
The Company and its subsidiaries offer various defined benefit plans to eligible employees based on completion of a specified period of continuous service, subject to age limitations.
The Company’s Retirement Plan is a noncontributory defined benefit plan which is subject to the provisions of ERISA. U.S. salaried employees who are employed by a participating company, have attained age 21, and completed twelve months of continuous service are eligible to participate in the plan. Employees generally vest after 5 years of service. Unreduced benefits are paid to retirees at normal retirement (age 65) and are based upon a percentage of final average compensation multiplied by years of credited service, up to 44 years. The CommoLoCo Retirement Plan is a noncontributory defined benefit plan which is subject to the provisions of the Puerto Rico tax code. Puerto Rican residents employed by CommoLoCo, Inc. who have attained age 21 and completed one year of service participate in the plan.
Notes to Consolidated Financial Statements, Continued
We also sponsor unfunded defined benefit plans for certain employees, including key executives, designed to supplement pension benefits provided by our other retirement plans. These include: (1) the Excess Retirement Income Plan, which provides a benefit equal to the reduction in benefits payable to certain employees under our qualified retirement plan as a result of federal tax limitations on compensation and benefits payable; and (2) the Supplemental Executive Retirement Plan (SERP), which provides additional retirement benefits to designated executives. Benefits under the SERP were frozen at the end of August 2004.
POSTRETIREMENT PLANS
The Company and its subsidiaries also provide postretirement medical care and life insurance benefits. Eligibility is based upon completion of 10 years of credited service and attainment of age 55. Life and dental benefits are closed to new participants.
Postretirement medical and life insurance benefits are based upon the employee electing immediate retirement and having a minimum of ten years of service. Medical benefits are contributory, while the life insurance benefits are non-contributory. Retiree medical contributions are based on the actual premium payments reduced by Company-provided credits. These retiree contributions are subject to adjustment annually. Other cost sharing features of the medical plan include deductibles, coinsurance, and Medicare coordination.
Notes to Consolidated Financial Statements, Continued
The following table presents the funded status of the plans, reconciled to the net amount included in other liabilities:
(a) Includes non-qualified unfunded plans, for which the aggregate projected benefit obligation was $10.0 million at December 31, 2011.
(b) The Company does not currently fund postretirement benefits.
The accumulated benefit obligation for U.S. pension benefit plans at December 31, 2011 was $367.1 million.
Notes to Consolidated Financial Statements, Continued
Defined benefit pension plan obligations in which the projected benefit obligation was in excess of the related plan assets and the accumulated benefit obligation was in excess of the related plan assets were as follows:
The following table presents the components of net periodic benefit cost recognized in income and other amounts recognized in accumulated other comprehensive income or loss with respect to the defined benefit pension plans and other postretirement benefit plans:
The estimated net loss that will be amortized from accumulated other comprehensive income or loss into net periodic benefit cost over the next fiscal year is $1.1 million for our combined defined benefit pension plans. We estimate that the prior service credit that will be amortized from accumulated other comprehensive income or loss into net periodic benefit cost over the next fiscal year will be zero for our combined defined benefit pension plans. We estimate that the estimated amortization from accumulated other comprehensive income or loss for net loss and prior service credit that will be amortized into net periodic benefit cost over the next fiscal year will be zero for our defined benefit postretirement plans.
Notes to Consolidated Financial Statements, Continued
Assumptions
The following table summarizes the weighted average assumptions used to determine the projected benefit obligations and the net periodic benefit costs:
* Not applicable
Discount Rate Methodology
The projected benefit cash flows were discounted using the spot rates derived from the unadjusted Citigroup Pension Discount Curve at December 31, 2011 and an equivalent single discount rate was derived that resulted in the same liability. This single discount rate for each plan was used.
Plan Assets
The investment strategy with respect to assets relating to our pension plans is designed to achieve investment returns that will (a) provide for the benefit obligations of the plans over the long term; (b) limit the risk of short-term funding shortfalls; and (c) maintain liquidity sufficient to address cash needs. Accordingly, the asset allocation strategy is designed to maximize the investment rate of return while managing various risk factors, including but not limited to, volatility relative to the benefit obligations, diversification and concentration, and the risk and rewards profile indigenous to each asset class.
Pension Plans
The long-term strategic asset allocation is reviewed and revised annually. The plans’ assets are monitored by the Company’s Retirement Plans Committee and the investment managers, which can entail allocating the plans assets among approved asset classes within pre-approved ranges permitted by the strategic allocation.
At December 31, 2011, the actual asset allocation for the primary asset classes was 77% in fixed income securities, 17% representing the transfer due from the AIG Retirement Plan, and 6% in equity securities. The 2012 target asset allocation for the primary asset classes is 94% in fixed income securities and 6% in equity securities. The actual allocation may differ from the target allocation at any particular point in time.
Notes to Consolidated Financial Statements, Continued
The expected long-term rate of return for the plans was 6.0% for the Retirement Plan and 7% for the CommoLoCo Retirement Plan for 2011. The expected rate of return is an aggregation of expected returns within each asset class category. The expected asset return and any contributions made by the Company together are expected to maintain the plans’ ability to meet all required benefit obligations. The expected asset return with respect to each asset class was developed based on a building block approach that considers historical returns, current market conditions, asset volatility and the expectations for future market returns. While the assessment of the expected rate of return is long-term and thus not expected to change annually, significant changes in investment strategy or economic conditions may warrant such a change.
Assets Measured at Fair Value
The inputs and methodology used in determining the fair value of the plan assets are consistent with those used to measure our assets.
The following table presents information about our plan assets measured at fair value and indicates the fair value hierarchy based on the levels of inputs we utilized to determine such fair value:
(a) Includes index funds that primarily track several indices including S&P 500 and S&P 600 in addition to other actively managed accounts, comprised of investments in large cap companies.
(b) Includes investment funds in companies in emerging and developed markets.
(c) Includes investment funds in U.S. and non-U.S. government issued bonds, U.S. government agency or sponsored agency bonds, and investment grade corporate bonds.
(d) Includes investment funds in securities or debt obligations that have a rating below investment grade.
(e) Represents the final settlement from the AIG Retirement Plan to the Retirement Plan to complete the transfer of plan assets, which will be complete by May 2012.
The inputs or methodologies used for valuing securities are not necessarily an indication of the risk associated with investing in these securities. Based on our investment strategy, we have no significant concentrations of risks.
Notes to Consolidated Financial Statements, Continued
Changes in Level 3 Fair Value Measurements
The following table presents changes in our Level 3 plan assets measured at fair value:
Expected Cash Flows
Funding for the U.S. pension plan ranges from the minimum amount required by ERISA to the maximum amount that would be deductible for U.S. tax purposes. This range is generally not determined until the fourth quarter. Contributed amounts in excess of the minimum amounts are deemed voluntary. Amounts in excess of the maximum amount would be subject to an excise tax and may not be deductible under the Internal Revenue Code. Supplemental and excess plans’ payments and postretirement plan payments are deductible when paid.
The annual pension contribution in 2012 is expected to be approximately $0.6 million for certain U.S. plans. 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.
The expected future benefit payments, net of participants’ contributions, of our defined benefit pension plans and other postretirement benefit plans, at December 31, 2011 are as follows:
Defined Contribution Plans
The Company sponsors a voluntary savings plan for U.S. employees, which provided for salary reduction contributions by employees and matching U.S. contributions by the Company of up to 6% of annual salary depending on the employees’ years of service. The salaries and benefit expense associated with this plan was $8.4 million in 2011. Effective January 1, 2012, the employees’ contribution of up to 6% will be matched by the Company by a percentage of the employees’ contribution of up to 6%, depending on the employees’ years of service.
Notes to Consolidated Financial Statements, Continued
SHARE-BASED COMPENSATION PLAN
We did not record any share-based compensation expense in 2011. We recorded share-based compensation expense of $15.3 million in 2010.
Note 26. Segment Information
See Note 1 for a description of our business segments.
We evaluate the performance of the segments based on pretax operating earnings. The accounting policies of the segments are the same as those disclosed in Note 3, except we exclude realized gains and losses from segment investment revenues.
We report our segment totals using the historical basis of accounting because management analyzes each business segment on a historical basis. However, in order to reconcile to total consolidated financial statement amounts we are presenting our segment totals at or for the one month ended December 31, 2010 and for the eleven months ended November 30, 2010.
Notes to Consolidated Financial Statements, Continued
The following tables display information about the Company’s segments as well as reconciliations to the consolidated financial statement amounts.
* Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
Notes to Consolidated Financial Statements, Continued
The “All Other” column includes:
· corporate revenues and expenses such as management and administrative revenues and expenses, interest expense on debt not allocated to the business segments, and derivatives adjustments and foreign exchange gain or loss on foreign currency denominated debt that are not considered pertinent in determining segment performance;
· revenues, expenses, and assets from our foreign subsidiary, Ocean; and
· corporate assets which include cash, derivatives, prepaid expenses, deferred charges, and fixed assets.
The “Adjustments” column includes:
· realized gains (losses) on investment securities and commercial mortgage loans; and
· other assets that are not considered pertinent to determining performance.
The push-down accounting adjustments column includes the accretion or amortization of the valuation adjustments on the applicable revalued assets and liabilities resulting from the FCFI Transaction.
Notes to Consolidated Financial Statements, Continued
Note 27. Interim Financial Information (Unaudited)
Our quarterly statements of operations for 2011 were as follows:
* See reconciliation below of amounts previously reported in our March 31, 2011 and June 30, 2011 Quarterly Reports on Form 10-Q to revised amounts presented above and Note 3 for further information on these reclassification adjustments.
Notes to Consolidated Financial Statements, Continued
Our quarterly statements of operations for 2010 were as follows:
Notes to Consolidated Financial Statements, Continued
Note 28. 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.
Notes to Consolidated Financial Statements, Continued
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:
Notes to Consolidated Financial Statements, Continued
(a) Other long-term investments excludes our interest in a limited partnership of $1.4 million at December 31, 2011 and 2010 that we account for using the equity method.
(b) Common stocks excludes stocks not carried at fair value of $0.7 million at December 31, 2011 and $0.6 million at December 31, 2010.
Notes to Consolidated Financial Statements, Continued
We had no transfers between Level 1 and Level 2 during 2011.
The following table presents changes during 2011 in Level 3 assets and liabilities measured at fair value on a recurring basis:
(a) The detail of purchases, sales, issuances, and settlements during 2011 is presented in the table below.
(b) Balance at beginning of period was adjusted to reflect a reclassification between CMBS and CDO/ABS.
(c) Other long-term investments excludes our interest in a limited partnership of $1.4 million at December 31, 2011 that we account for using the equity method.
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 during 2011:
Notes to Consolidated Financial Statements, Continued
The following table presents changes during 2010 in Level 3 assets and liabilities measured at fair value on a recurring basis:
* Other long-term investments excluded our interest in a limited partnership that we account for using the equity method of $1.4 million at November 30, 2010 and December 31, 2010.
Notes to Consolidated Financial Statements, Continued
During the eleven months ended November 30, 2010, we transferred into Level 3 approximately $24.1 million of assets, consisting of certain private placement corporate debt, CMBS, CDO/ABS, and RMBS. Transfers into Level 3 for private placement corporate debt are primarily the result of our over-riding third-party matrix pricing information downward to better reflect the additional risk premium associated with those securities that we believe were not captured in the matrix. Transfers into Level 3 for investments in CMBS, CDO/ABS, and RMBS are primarily due to a decrease in market transparency and downward credit migration of these securities.
Assets are transferred out of Level 3 when circumstances change such that significant inputs can be corroborated with market observable data. This may be due to a significant increase in market activity for the asset, a specific event, one or more significant input(s) becoming observable, or when a long-term interest rate significant to a valuation becomes short-term and thus observable. During the eleven months ended November 30, 2010, we transferred approximately $52.6 million of assets out of Level 3, consisting of certain private placement corporate debt, CDO/ABS, 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. Transfers out of Level 3 for CDO/ABS investments are primarily due to increased usage of pricing from valuation service providers that are reflective of market activity, where previously an internally adjusted price had been used.
There were no unrealized gains or losses recognized in earnings on instruments held at December 31, 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 - Nonrecurring 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.
Notes to Consolidated Financial Statements, Continued
The following table presents information about our assets measured at fair value on a non-recurring basis and indicates the fair value hierarchy based on the levels of inputs we utilize to determine such fair value:
* Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2011 and 2010; therefore, balance sheet information at November 30, 2010 is not applicable.
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 during 2011, the one month ended December 31, 2010, and the eleven months ended November 30, 2010 and recorded the writedowns in other revenues. The fair values disclosed in the tables 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.
In accordance with the authoritative guidance for the accounting for the impairment of other intangible assets, we recognized $0.6 million of impairment in operating expenses in fourth quarter 2011 related to our customer lists intangible assets as a result of accelerated liquidations of our branch network loan portfolio. Additionally, as part of our strategic review of operations, we have ceased new loan originations in our Ocean operations effective January 1, 2012. As a result, we determined that our Ocean trade names and customer relationships intangible assets had no continuing fair value and the remaining unamortized carrying amounts of $11.2 million and $1.0 million, respectively, were written off and charged to operating expenses in fourth quarter 2011.
Notes to Consolidated Financial Statements, Continued
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.
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.
Notes to Consolidated Financial Statements, Continued
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.
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.
Commercial Mortgage Loans
We estimated the fair value of commercial mortgage loans using projected cash flows discounted at an appropriate rate based upon market conditions.
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.
Notes to Consolidated Financial Statements, Continued
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 counterparty 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.
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 Lines
The unused credit lines 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 29. Legal Settlements
In March 2010, WFI and AIG Federal Savings Bank (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. All remediation claims have been paid. Following completion of the remediation and pursuant to the terms of the settlement agreement, in July 2011 all remaining funds, totaling $1.3 million, were distributed to charities for use in consumer education programs. The Company has no further monetary obligations under the settlement agreement.
Notes to Consolidated Financial Statements, Continued
Note 30. Subsequent Events
Cessation of Real Estate Lending
As of January 1, 2012, the Company ceased new originations of real estate loans so that it could focus on its other consumer lending products and its insurance operations.
Branch Office Closings - February 1, 2012
As part of a strategic review of our operations, on February 1, 2012, we informed affected employees of our plan to close approximately 60 branch offices and immediately cease consumer lending and retail sales financing in 14 states where we do not have a significant presence and in southern Florida. The states affected are: Arizona, Delaware, Iowa, Kansas, Maryland, Michigan, Montana, Nebraska, Nevada, New Jersey, New York, South Dakota, Utah, and Wyoming. Customer accounts in the affected areas will be serviced by our other branches in those states or by other service centers. As a result of the initial branch closings, we expect to incur a pretax charge in the first quarter of 2012 of approximately $5.3 million.
Also as a result of these branch office closings, our workforce was immediately reduced by approximately 200 employees. The branch closings and workforce reductions are the result of our efforts to return to profitability. However, there can be no assurance that these efforts will be effective.
Sales of Retained Senior and Subordinated Interests
On February 10, 2012, we sold certain previously retained subordinated trust certificates from our March 2010 securitization. The certificates had a face value of $215.6 million and were sold at 103.6% (before taxes and selling expenses and excluding accrued interest). Also on February 10, 2012, we sold a previously retained senior note from our September 2011 securitization. The note had a face value of $49.7 million and was sold at 99.3% (before taxes and selling expenses and excluding accrued interest).
Headquarters Workforce Reduction
On February 15, 2012, we reduced the workforce at our Evansville, Indiana headquarters by approximately 130 employees due to the cessation of real estate lending, the branch closings, and the cessation of consumer lending and retail sales financing in 14 states and southern Florida, and as part of our efforts to return to profitability. However, there can be no assurance that these efforts will be effective.
Notes to Consolidated Financial Statements, Continued
Branch Office Closings - March 2, 2012
As part of a strategic review of our operations, on March 2, 2012, we informed affected employees of our plan to immediately consolidate certain branch operations and close approximately 150 branch offices in 25 states. The states affected are: Alabama, California, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maryland, Mississippi, New Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington, West Virginia and Wisconsin. Customer accounts in the affected areas will be serviced by our other branches in those states or by other service centers. As a result of these branch closings, we expect to incur a pretax charge in the first quarter of 2012 of approximately $12.5 million.
Also as a result of these branch office closings, our workforce was immediately reduced by approximately 360 employees. The branch closings and workforce reductions are the result of our efforts to return to profitability. However, there can be no assurance that these efforts will be effective.
Sale of Finance Receivables
On March 2, 2012, the Company sold approximately 13,100 non-real estate and retail sales finance receivable accounts in Delaware, New Jersey, and Maryland with a carrying value of $45.0 million pursuant to a letter of intent to sell dated January 27, 2012. The receivables were sold at a loss of $0.4 million.
Item 9A.
Item 9A. 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 December 31, 2011, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective and that the consolidated financial statements fairly present our consolidated financial position and the results of our operations for the periods presented.
(b) Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management is responsible for the integrity and fair presentation of our consolidated financial statements and all other financial information presented in this report. We prepared our consolidated financial statements using U.S. GAAP, and they reflect all material correcting adjustments. We made estimates and assumptions that affect amounts recorded in the financial statements and disclosures of contingent assets and liabilities.
The Company’s management is responsible for establishing and maintaining an effective system of internal control over financial reporting. We established this system to provide reasonable assurance that assets are safeguarded from loss or unauthorized use, that transactions are recorded in accordance with U.S. GAAP under management’s direction and that financial records are reliable to prepare financial statements. We support the internal control structure with careful selection, training and development of qualified personnel. The Company’s employees are subject to a Code of Conduct designed to assure that all employees perform their duties with honesty and integrity. In addition, a Code of Ethics was adopted for Principal Executive and Senior Financial Officers that is applicable to the Company’s Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer and Controller. We do not allow loans to executive officers. The Company’s system of internal control over financial reporting includes a documented organizational structure and policies and procedures that we communicate throughout the Company. The internal audit department continually monitors the operation of our internal controls and reports their findings to the Company’s management. We take prompt action to correct control deficiencies and improve the system.
All internal control structures and procedures for financial reporting, no matter how well designed, have inherent limitations. Even internal controls and procedures determined to be effective may not prevent or detect all misstatements. Changes in conditions or the complexity of compliance with policies and procedures creates a risk that the effectiveness of our internal control structure and procedures for financial reporting may vary over time.
The Company’s management, including its Chief Executive Officer and its Chief Financial Officer, evaluates the effectiveness of our internal control over financial reporting as of the end of each 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 internal control over financial reporting as of December 31, 2011, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, has concluded that the internal control over financial reporting was effective and that the consolidated financial statements fairly present our consolidated financial position and the results of our operations for the periods presented.
(c) 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 December 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
Resignation of Officer
On March 15, 2012, Raymond S. Brown, Senior Vice President, advised the Company of his intent to resign as an officer of the Company and its subsidiaries on March 31, 2012.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
DIRECTORS
The Company’s directors are elected for one year terms at the annual meeting of the shareholder. Information regarding the directors of the Company is presented below:
Bradford D. Borchers, age 48
Executive Vice President and Director
Mr. Borchers has been Executive Vice President of Branch Operations and a director since April 2008. He is also a director of SLFC. Mr. Borchers started as a management trainee with the Company in 1983 and has held positions of increasing responsibility over the intervening 29 years. Before being promoted to Executive Vice President, Mr. Borchers was a Senior Director of Operations for the Company from 2004 to 2008.
Mr. Borchers holds an Associates Degree in Accounting from Kankakee Community College. His extensive experience with all facets of the Company’s branch operations allows Mr. Borchers to provide the Company’s Board with an important perspective of the Company’s operations.
Donald R. Breivogel, Jr., age 51
Senior Vice President, Chief Financial Officer, and Director
Mr. Breivogel has been a director of the Company and of SLFC since March 2001. He joined the Company in 1988 as Accounting Manager, and held various positions in the Accounting and Finance area until he was named Vice President and Treasurer in 2000. He was promoted to Vice President, Chief Financial Officer and Treasurer in February 2001. He was promoted to Senior Vice President in February 2002, retaining the title of Chief Financial Officer, but relinquishing the duties of Treasurer. Mr. Breivogel also oversees the Human Resources function.
Mr. Breivogel received his BS from the University of Southern Indiana and holds a CPA license. His extensive experience with finance and detailed knowledge of the Company’s financial operations is an invaluable tool for the Board.
Robert A. Cole, age 60
Senior Vice President and Director
Mr. Cole has been a director since December 1997. He is also a director of SLFC. In his position as Senior Vice President for Marketing and Insurance Operations for the Company, a role he assumed in 2001, Mr. Cole oversees two key functions for the Company. He also assumed responsibility for the Company’s facilities and general services operations in 2008 and the legal and information technology functions in 2011. Prior to taking over the Company’s marketing and insurance operations, Mr. Cole had been Senior Vice President, Risk Management, and Chief Financial Officer. He joined the Company in 1989.
Mr. Cole has a BS in Industrial Management from Purdue University and an MBA from DePaul University. Mr. Cole’s lengthy tenure with the Company in various high-level positions gives the Board the benefit of a broad view of the Company’s operations, as well as historical context.
Wesley R. Edens, age 50
Chairman of the Board and Director
Mr. Edens was elected to the Board on November 30, 2010 and elected as Chairman of the Board on September 13, 2011. He also serves as the Chairman of the Compensation Committee. He is also a director of SLFC. He is the founding principal and Co-Chairman of the board of directors of Fortress (our indirect parent and an alternative assets investment company) and has been a principal and the Chairman of the Management Committee of Fortress since co-founding Fortress in May 1998. Previously, Mr. Edens served as Chief Executive Officer of Fortress from inception to August 2009. Mr. Edens has primary investment oversight of Fortress, private equity and publicly traded alternative businesses. He is the Chairman of the board of directors of each of Aircastle Limited (a commercial aircraft sales and leasing company), Brookdale Senior Living Inc. (an operator of senior living communities), Eurocastle Investment Limited (a closed-end investment company), GateHouse Media, Inc. (a publisher of print and online media), Mapeley Limited (a real estate investor and asset manager), Nationstar Mortgage Holdings, Inc. (a residential mortgage loan originator and servicer), and Newcastle Investment Corp. (a real estate investment and finance company). He is a director of GAGFAH S.A. (a residential property owner and manager) and Penn National Gaming Inc. (an owner and operator in the gaming and racing industry). Mr. Edens was Chief Executive Officer of Global Signal Inc. from February 2004 to April 2006 and Chairman of the board of directors of that company from October 2002 to January 2007. Mr. Edens serves as Chairman, Chief Executive Officer and Trustee of Fortress Investment Trust II (a registered investment company that de-registered with the SEC in January 2011). Mr. Edens previously served on the boards of the following publicly traded company and registered investment companies: Crown Castle Investment Corp. (merged with Global Signal Inc.) from January 2007 to July 2007; Fortress Brookdale Investment Fund LLC, from August 13, 2000 (deregistered with the SEC in March 2009); Fortress Pinnacle Investment Fund, from July 24, 2002 (deregistered with the SEC in March 2008); and RIC Coinvestment Fund LP, from May 10, 2006 (deregistered with the SEC in June 2009).
Prior to forming Fortress, Mr. Edens was a partner and managing director of BlackRock Financial Management Inc. (an investment management firm), where he headed BlackRock Asset Investors, a private equity fund. In addition, Mr. Edens was formerly a partner and managing director of Lehman Brothers (a financial services firm). He received a B.S. in Finance from Oregon State University.
Mr. Edens brings strong leadership, extensive business and managerial experience, and a tremendous knowledge of the financial services industry to the Board. In addition, Mr. Edens brings his broad strategic vision to the Company and the Board. Further, his experience on the boards of other public companies, including serving as chairman of the board of certain of such companies, provides the Board with insights into how boards at other companies address issues similar to those faced by the Company.
Susan Givens, age 35
Director
Ms. Givens was elected to the Board on November 30, 2010. She is also a director of SLFC. She joined Fortress, our indirect parent and an alternative assets investments company, in July 2006, and is a Vice President in the acquisitions area. Ms. Givens was an associate at Seaport Capital, a middle market private equity firm, from November 2002 to August 2004, where she handled acquisitions and managed
portfolio companies. Prior to that, she was an associate and an analyst in investment banking at Deutsche Bank (a national banking organization), from June 1999 to November 2002, where she worked on acquisitions and financing matters. Ms. Givens was pursuing an MBA degree from August 2004 to June 2006.
Ms. Givens received a BA in political science from Middlebury College and an MBA from Harvard Business School. She brings extensive management, financial analysis and acquisitions experience to the Company’s Board, which will assist the Company as it explores financing alternatives and growth strategies.
Douglas L. Jacobs, age 64
Director
Mr. Jacobs was elected to the Board on November 30, 2010. Mr. Jacobs is also a director of SLFC; Fortress (our indirect parent and an alternative assets investment company), where he chairs the Audit Committee and is a member of the Compensation Committee; Clear Channel Outdoor (an international outdoor advertising company), where he chairs the Audit Committee and is a member of the Compensation Committee; and Doral Financial Corporation (a financial services company), where he is Chairman of the Risk Policy Committee and a member of the Dividend Committee. From November 2004 to mid-2008, Mr. Jacobs was also a director of ACA Capital Holdings, Inc. (a financial guaranty company), where he was Chairman of the Audit Committee and a member of the Compensation and Risk Management Committees. Mr. Jacobs was a director and Chairman of the Audit Committee for Global Signal Inc. from February 2004 until January 2007, and also was a director of Hanover Capital Mortgage Holdings, Inc. (a mortgage REIT) from 2003 until 2007. From 1988 to 2003, Mr. Jacobs was an Executive Vice President and Treasurer at FleetBoston Financial Group (a financial services firm), managing the company’s funding, securitization, capital, and asset and liability management activities in addition to its securities, derivatives, and mortgage loan portfolios. Prior to joining FleetBoston, Mr. Jacobs was active in a variety of positions at Citicorp (a global banking institution) for over 17 years, culminating in his role as Division Executive of the Mortgage Finance Group.
Mr. Jacobs holds a BA from Amherst College and an MBA from the Wharton School of Business at the University of Pennsylvania. As a result of his past experiences, Mr. Jacobs has finance and management expertise and experience serving on public company boards and committees, which provide him with the qualifications and skills to serve as a director.
Alpheus E. Keller II, age 63
Director
Mr. Keller was elected to the Board on November 30, 2010. He is also a director of SLFC. He is a real estate professional who is the principal and sole proprietor of AEK Financial Services (a real estate services company), a position he has held since December 2001. He is also a realtor with Gateway Realty in Bluffton, SC. (a real estate brokerage firm), and he holds uncompensated positions with Basis Point LLC (a real estate investment company) and Basis Point Capital LLC (an investment company involved in alternative green energy projects).
From 1977 to 1984 Mr. Keller held several positions, including Senior Vice President, at Greater Jersey Bancorp (a banking corporation), working in fixed income portfolio management, funding, and asset liability management. Mr. Keller held a similar position with UJB Financial (a banking corporation) from 1984 to 1986. After that, Mr. Keller was a Senior Vice President in the fixed income sales and trading
divisions for both Smith Barney (a brokerage, investment banking and asset management firm) (1984 to 1986) and Lehman Brothers (a financial services firm) (1987 to 1996).
Mr. Keller holds a BA from The College of William and Mary and an MBA from Seton Hall University. His extensive experience at several financial institutions will be of benefit to the Company as it explores financing options going forward, which makes him qualified to be a director.
Jay N. Levine, age 50
President, Chief Executive Officer, and Director
Mr. Levine has served as President, Chief Executive Officer, and Director of the Company since October 1, 2011. Mr. Levine served as President and Chief Executive Officer and as a director of Capmark Financial Group Inc. (Capmark), a commercial real estate finance company, from December 2008 until February 2011. On October 25, 2009, Capmark and certain of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Capmark and certain of its debtor subsidiaries emerged from bankruptcy on September 30, 2011.
From 2000 to 2008, Mr. Levine served as President, Chief Executive Officer (Co-CEO from March 2000 until January 2007), and a member of the board of directors of RBS Global Banking & Markets, North America, a banking and financial services company, and Chief Executive Officer of RBS Greenwich Capital, a financial services company, with responsibility for the company’s institutional business in the United States. Previously, Mr. Levine was co-head of the Mortgage and Asset Backed Departments at RBS Greenwich Capital.
Mr. Levine earned a BA in economics from the University of California at Davis. Mr. Levine’s extensive experience in the financial industry and his previous experience as an executive officer and director of financial services companies allow him to provide the Board with a broad perspective of the Company’s industry.
Randal A. Nardone, age 56
Director
Mr. Nardone was elected to the Board on November 30, 2010 and serves on the Compensation Committee. He is also a director of SLFC. Mr. Nardone is a principal and has been a member of the board of directors of Fortress (our indirect parent and an alternative assets investment company) since November 2006, and a member of the Management Committee of Fortress since 1998. Mr. Nardone has served as interim Chief Executive Officer of Fortress since December 21, 2011.
Prior to co-founding Fortress in 1998, Mr. Nardone was a managing director of UBS (a financial services firm) from May 1997 to May 1998. Before joining UBS in 1997, Mr. Nardone was a principal of BlackRock Financial Management, Inc. (an investment management firm), and prior to joining BlackRock, Mr. Nardone was a partner and a member of the executive committee at the law firm of Thacher Proffitt & Wood.
Mr. Nardone is also a director of Alea Group Holdings (Bermuda) Ltd. (an insurance company), GAGFAH S.A. (a residential property owner and manager) and Eurocastle Investment Limited (a closed-end investment company).
Mr. Nardone received a BA in English and Biology from the University of Connecticut and a JD from Boston University School of Law. His legal background and expertise in finance provides the Company with an additional perspective on key legal and financial matters, which makes him well qualified to be a director.
Peter M. Smith, age 44
Director
Mr. Smith was elected to the Board on November 30, 2010. He is also a director of SLFC. Mr. Smith is a managing director in the Private Equity business at Fortress (our indirect parent and an alternative assets investment company) and is also a member of its Management Committee. At Fortress, Mr. Smith has been a senior team member focused on acquisitions and ongoing management of various finance company investments. Prior to joining Fortress in May 1998, Mr. Smith worked at UBS (a financial services firm) and, before that, at BlackRock Financial Management Inc. (an investment management firm) from 1996 to 1998. Mr. Smith worked at CRIIMI MAE Inc. (a commercial mortgage company) during 1996.
Mr. Smith received a BBA in Finance from Radford University and an MBA in Finance from George Washington University. He brings extensive acquisition, management and financing experience in the financial services sector, which makes him qualified to be a director.
EXECUTIVE OFFICERS
Information regarding the executive officers of the Company is presented below:
Jay N. Levine, age 50
President and Chief Executive Officer
See Mr. Levine’s biography in “- Directors”.
Bradford D. Borchers, age 48
Executive Vice President
See Mr. Borchers’s biography in “- Directors”.
Donald R. Breivogel, Jr., age 51
Senior Vice President and Chief Financial Officer
See Mr. Breivogel’s biography in “- Directors”.
Raymond S. Brown, age 63
Senior Vice President
Mr. Brown was appointed Vice President of the Company’s Risk Management function in 1999, and was promoted to Senior Vice President in August 2005. He served as Chief Compliance Officer from September 2010 until October 2011. He started employment with the Company in 1987, left the Company in 1997, and rejoined the Company in 1999.
Robert A. Cole, age 60
Senior Vice President - Marketing and Insurance Operations
See Mr. Cole’s biography in “- Directors”.
Lenis McClain, age 59
Vice President - Auditing
Mr. McClain has been head of the Company’s Auditing function since 1990, and was appointed Vice President in April 1999. He started employment with the Company in 1975, and was employed by AIG, the Company’s former indirect parent, from July 2006 to September 2009, at which point he became an employee of the Company again. During the period he was employed by AIG, he continued as an officer and head of the Company’s Auditing function.
Leonard J. Winiger, age 62
Vice President, Chief Accounting Officer and Controller
Mr. Winiger has been Vice President and Chief Accounting Officer since April 2007. He was Director of Corporate Accounting and Assistant Controller of the Company from June 1992 to April 2007. He started employment with the Company in 1972.
AUDIT COMMITTEE
The Board does not have a separately-designated Audit Committee and, therefore, the entire Board acts as the Audit Committee. The Board has not determined whether any of its members is an “audit committee financial expert” within the meaning of SEC rules, but the Board believes that each director has sufficient knowledge of financial and auditing matters to serve on the Board. The Board of Directors of SLFC, a direct subsidiary, has made a determination that Mr. Jacobs qualifies as an “audit committee financial expert” within the meaning of SEC rules.
CODE OF ETHICS
The Company has adopted a Code of Ethics for Principal Executive and Senior Financial Officers (the Code of Ethics) that is applicable to the Company’s Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer and Controller. The Code of Ethics is posted on “About Us - Investor Information - Corporate Governance” of our website at www.SpringleafFinancial.com. We will post any amendments to the Code of Ethics and any waivers that are required to be disclosed on our website.
Item 11.
Item 11. Executive Compensation.
COMPENSATION DISCUSSION AND ANALYSIS
Executive Summary
The Company is committed to compensation practices that allow us to attract and retain capable and experienced professionals and motivate them to achieve short-term and long-term business results. This section discusses the compensation awarded to, earned by, or paid to the Company’s named executive officers for 2011. Under applicable SEC rules, the Company’s named executive officers include its Chief Executive Officer, Chief Financial Officer, the three other most highly compensated executive officers who were serving as executive officers of the Company as of December 31, 2011, and up to two additional individuals who would have been included but for the fact that they were not serving as executive officers at year end. The Company’s named executive officers for 2011 are Jay N. Levine, Donald R. Breivogel, Jr., Bradford D. Borchers, Raymond S. Brown, Vincent J. Ciuffetelli, and Robert A. Cole. Frederick W. Geissinger, who resigned as President and Chief Executive Officer of the Company effective as of October 1, 2011, is also considered a named executive officer under the SEC’s rules because he served as Chief Executive Officer during part of 2011. These six executive officers are referred to as the “named executives.”
Organizational Overview. Until November 30, 2010, SLFI was an indirect wholly-owned subsidiary of AIG. As a result, many of the decisions affecting the Company’s 2010 executive compensation program were made prior to it being sold by AIG and those decisions were determined in the context of SLFI being an indirect wholly-owned subsidiary and not a stand alone entity. In addition, in 2009, AIG became subject to strict, legally mandated limits on the structure and amounts of compensation it could pay to its executive officers and other highly compensated employees (the TARP Standards), which affected the compensation decisions in 2009 and 2010 with respect to Mr. Geissinger, our Chief Executive Officer at the time. The compensation decisions for Mr. Geissinger under the TARP Standards were effectively confined to approving compensation awards up to the amounts allowed by the TARP Special Master. While our other named executives were not subject to the TARP Standards, the compensation awarded to these individuals prior to November 30, 2010 was nonetheless determined by the general compensation policies in place at AIG.
Executive compensation decisions made since November 30, 2010, the effective date of the sale of SLFI, were not subject to the TARP Standards. Since November 30, 2010, executive compensation decisions have been made in the context of the results achieved by the Company’s executive team during 2010 and 2011 in maintaining the underlying operating performance of our business in light of the decline in worldwide economic conditions and the constraints on our liquidity.
Objectives and Design of Compensation Framework
In 2011, our compensation philosophy focused on the following strategies, which are designed to advance the short- and long-term goals of the Company:
· achieving goals relating to maintaining and developing origination volume;
· monetizing assets;
· minimizing charge-offs;
· controlling credit quality in a strong risk return culture; and
· sustaining a substantial capital and liquidity base.
Compensation decisions are based upon evaluation as to how the executive’s performance contributed to the Company’s attainment of the established strategies.
Executive Compensation Program Elements
Compensation for Mr. Levine. On September 13, 2011, the Board of Directors of the Company appointed Mr. Levine to the positions of President, Chief Executive Officer, and Director of the Company, effective October 1, 2011. As of December 31, 2011, the Company’s Compensation Committee had not determined Mr. Levine’s compensation package, and Mr. Levine received no base salary or bonus compensation from the Company for 2011.
Compensation for Mr. Geissinger and the Other Named Executives. The following chart sets forth various compensation elements under the executive compensation program for 2011, each of which is described in detail in this Compensation Discussion and Analysis, and the purpose of each element.
Executive Compensation Elements -Named Executives
Compensation Elements for Mr. Geissinger
Cash Salary. Cash salary provides a constant stream of pay that is intended to be competitive with market practices in order to attract, motivate and retain executive talent. From 2009 through his retirement on October 1, 2011, Mr. Geissinger received an annual base salary of $500,000.
Annual Bonus. In March 2011, the Company’s Board of Directors established a Compensation Committee (the Compensation Committee). The Compensation Committee decides whether to award an annual bonus to the Company’s Chief Executive Officer and also determines the amount of such bonus. Bonuses generally are based on performance against established goals for the year. Mr. Geissinger did not receive any bonus for 2011 because he retired prior to the end of 2011.
Stock Salary. In 2009, AIG implemented a program allowing for a portion of Mr. Geissinger’s total salary to be paid in regular grants of immediately vested stock units (Stock Salary). The Stock Salary was based on the value of AIG’s common stock (AIG Common Stock) and AIG long-term debt securities (Long-Term Performance Units, or LTPUs). While grants awarded in previous years continue to be paid according to the award’s schedule, no Stock Salary grants were awarded following the Company’s sale on November 30, 2010.
Other Compensation. Mr. Geissinger did not receive any other forms of compensation in 2011.
Compensation Elements for Other Named Executives
In 2011, the Chief Executive Officer at the time the decision was made determined each compensation element for the other named executives based on the executive’s level of responsibility, historical compensation and contribution to our performance, and for incentive compensation, a subjective assessment of performance. Below is a description of each element of compensation awarded to the other named executives, as well as the amounts earned by or paid to them in 2011.
Cash Salary. Cash salary provides a constant stream of pay that is intended to be competitive with market practices in order to attract, motivate and retain executive talent. The cash salary levels for Messrs. Breivogel, Borchers, and Brown were increased between 3% and 9% for 2011. Messrs. Ciuffetelli and Cole did not receive a base salary increase in 2011. We reviewed market data on key management positions from professional published compensation surveys. This information was used to determine an acceptable range of total cash compensation and provide general guidance to the compensation decision process. For 2011, multiple published salary surveys were used for comparison of key positions at the Company. Generally, the Company compared the cash salary of its named executives to the 25th and the 75th percentile of such salary surveys.
Annual Bonuses. In the first quarter of each fiscal year, the Chief Executive Officer will make a recommendation to the Compensation Committee regarding bonus awards for the other named executives for their performance in the prior fiscal year. The Compensation Committee will evaluate the recommendation of the Chief Executive Officer, approve bonus awards, if any, with any modifications it deems appropriate, and make a recommendation to the Company’s Board of Directors regarding the bonus awards. The Company’s Board of Directors makes the final determination regarding bonus awards to the other named executives. The decision regarding bonuses generally is based on performance against established goals for the year and ranking among peers within the Company, and weighed against guidelines provided by the Company’s Human Resources Department. In early 2012, Messrs. Breivogel, Borchers, Brown, Ciuffetelli, and Cole were awarded discretionary annual bonuses for 2011 performance based on the Chief Executive Officer’s subjective assessment of their performance relative to both individual and the Company’s performance objectives. A portion of these bonuses was paid in February 2012. In order to incentivize continued service, the remainder of these bonuses will be paid in August 2012, provided the applicable executive is employed with the Company on the payment date, or otherwise is eligible for the bonus.
Long-Term Incentive Compensation. No long term incentive program was in place for 2011.
Other Compensation Elements Available to Named Executives
Termination Benefits and Policies. During 2011, Messrs. Geissinger, Breivogel, Brown, and Cole were participants in the Springleaf Finance, Inc. Executive Severance Plan (ESP), which was adopted by SLFI on behalf of itself and its subsidiaries on March 11, 2011, effective as of November 30, 2010. Mr. Geissinger was no longer a plan participant following his retirement on October 1, 2011.
For the participating named executives, the ESP provides for severance payments and benefits if a participating executive is terminated other than by reason of death, disability, resignation by the executive without “Good Reason” (as defined in the ESP), or termination by the Company for “Cause” (as defined in the ESP).
In the event that the named executive is terminated without Cause by the Company or resigns for Good Reason, a participant at the named executive’s level will be eligible to receive an amount ranging from one-twelfth to 100% of the sum of his annual base salary and three-year-average of annual cash bonuses, which is based on the executive’s seniority or length of service. Messrs. Breivogel, Brown, and Cole are entitled to receive 100% of the sum of their respective annual base salaries and three-year average of annual cash bonuses due to their length of service. Unvested long-term awards continue to vest during the severance period and are forfeited if not vested or settled as of the end of the severance period. Each participant is also eligible to receive continued health and group life insurance benefits on the same terms as active employees during the severance period. Any severance payments that would otherwise be payable under the ESP will be offset by any amounts resulting from the participant’s subsequent employment by another employer. The executive is required to sign a severance and release agreement in order to be eligible for severance benefits and must comply with the terms of such agreement in order to continue receiving benefits.
Welfare and Other Indirect Benefits. Each of the named executives participates in the same health and welfare benefit plans and fringe benefit programs generally available to all other employees.
Retirement Benefits. The Company provides retirement benefits to eligible employees, including both defined contribution plans (such as 401(k) plans) and traditional pension plans (called defined benefit plans).
We currently have one active defined contribution plan for eligible employees at the named executives’ level, a 401(k) plan which is tax-qualified. We match a percentage of participants’ contributions to the 401(k) plan depending on the participant’s length of service. The match for each of the named executives in 2011 was $17,149.
Our defined benefit plans include a tax-qualified pension plan and an Excess Retirement Income Plan (a “restoration” plan). Each of these plans provides for a yearly benefit based on years of service and average final salary. These plans and their benefits are described in greater detail in “- Pension Benefits.”
Mr. Geissinger was grandfathered in the Supplemental Executive Retirement Agreement (SERA), which is a plan implemented between American General Corporation (AGC) (a predecessor holding company of the Company) and Mr. Geissinger on May 1, 2000 to provide supplemental retirement benefits in the year prior to AIG acquiring AGC. The plan was frozen following the acquisition of AGC by AIG as of August 29, 2001. It was assumed by the Company on December 23, 2010 and remains a frozen plan. As a result of Mr. Geissinger’s retirement, benefits under this plan were paid to him. There are no additional plan participants.
Process for Compensation Decisions
Role of the Compensation Committee. In March 2011, the Company’s Board of Directors established the Compensation Committee. In accordance with its charter, the Committee’s role is to evaluate annually the performance of the Chief Executive Officer in light of the goals and objectives of the Company’s executive compensation plans, and determine and approve the Chief Executive Officer’s compensation level based on this evaluation. The Committee also makes recommendations to the Company’s Board of Directors regarding the compensation of the other executive officers of the Company based on the recommendation of the Chief Executive Officer.
Role of the Company’s Chief Executive Officer. The compensation of the other executive officers is recommended by the Chief Executive Officer, which is approved by the Compensation Committee, with such modifications as the Committee deems appropriate, and recommended to the Company’s Board of Directors.
COMPENSATION COMMITTEE REPORT
The Compensation Committee of the Board of Directors of the Company has reviewed and discussed with management the Compensation Discussion and Analysis contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the 2011 Form 10-K). Based on such review and discussions, the Compensation Committee of the Company has recommended to the Board of Directors of the Company that the Compensation Discussion and Analysis be included in the 2011 Form 10-K filed with the United States Securities and Exchange Commission.
Respectfully submitted,
The Compensation Committee of the Board of Directors
Wesley R. Edens
Randal A. Nardone
2011 EXECUTIVE COMPENSATION
The following tables contain compensation information with respect to the Company’s named executives for 2011. Each of the named executives of the Company is also a named executive of SLFC. SLFC does not allocate the compensation that such individuals receive between the two companies. SLFC pays the compensation presented below to such individuals for services they provide to SLFI, SLFC, and all subsidiaries of both companies. Under applicable SEC rules, the Company’s named executives include its Chief Executive Officer, Chief Financial Officer, the three other most highly compensated executive officers who were serving as executive officers of the Company on December 31, 2011, Mr. Geissinger, who served as the Company’s Chief Executive Officer until his retirement in October 2011, and Mr. Ciuffetelli, who would have been one of the three most highly compensated executive officers of the Company in 2011 but for the fact that he was no longer serving as an executive officer as of December 31, 2011.
2011 Summary Compensation Table
(1) Mr. Levine received no compensation from the Company in 2011.
(2) The amounts reported in this column for 2011 represent a discretionary cash award. As described above in “- Annual Bonuses,” a second payment (Mr. Breivogel ($82,500), Mr. Borchers ($120,000), Mr. Brown ($57,500), Mr. Cole ($82,500), and Mr. Ciuffetelli ($70,000)) will be made in August 2012 to those executives who remain actively employed at the time of payment or otherwise meet the eligibility requirements.
The amounts reported in this column for 2010 represent (i) special discretionary bonuses (Mr. Breivogel ($7,521), Mr. Borchers ($4,658), Mr. Brown ($6,016) and Mr. Cole ($6,016)), and (ii) 2010 year-end cash bonuses (Mr. Breivogel ($150,000), Mr. Borchers ($150,000), Mr. Brown ($125,000) and Mr. Cole ($125,000)). The special discretionary bonuses were paid to replace restricted stock units (RSUs) that were forfeited upon the consummation of the sale of the Company.
The amounts reported in this column for 2009 represent (i) retention bonuses (Mr. Breivogel ($184,202), Mr. Borchers ($180,000), Mr. Brown ($180,000) and Mr. Cole ($245,600)), and (ii) year-end cash bonuses (Mr. Breivogel ($60,000), Mr. Borchers ($60,000), Mr. Brown ($50,000) and Mr. Cole ($30,000)). Retention awards were paid to key executives in 2009 to retain their expertise and support the integrity of the Company essential to long-term success in light of the economic downturn.
(3) No stock awards were made in 2011.
The amounts reported in this column for Mr. Geissinger in 2010 consist of the following: (i) one year Stock Salary grant ($130,000), (ii) three year Stock Salary grant ($640,000), (iii) variable stock award ($415,000), (iv) RSU grant ($475,000), and (v) LTPUs representing 50% of a sale completion bonus ($75,000). The RSUs and a portion of the Stock Salary grant were subsequently forfeited as a result of the sale of the Company. In 2011, Mr. Geissinger was paid $143,015 for the Stock Salary grants awarded in 2009 and 2010. He also received the second part of his 2010 variable cash award totaling $207,500 in November 2010.
The amounts reported in this column are valued based on the aggregate grant date fair value computed in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation-Stock Compensation. In calculating the 2010 variable stock award value, we used the closing stock price on the grant date ($34.45) as the assumed price. Each 2010 LTPU represented a mix of AIG’s 8.175% Series A-6 Junior Subordinated Debentures (Hybrid Securities) and AIG Common Stock, par value $2.50 per share. The assigned value of an LTPU on the grant date equaled $1,000, and the underlying securities for the LTPU consisted of AIG Common Stock and Hybrid Securities with assigned values on the grant date of $200 and $800, respectively.
(4) No option awards were made in 2011.
In 2010, all the named executives except Mr. Geissinger were granted stock appreciation rights (SARs) under the AIG long-term Incentive Plan (AIG LTIP). The 2010 SAR awards were intended to be multi-year awards for the 2009-2010 and 2010-2011 performance periods. The aggregate grant date fair value reported in this column for SARs is calculated based on the probable satisfaction of the performance conditions for such awards. If the highest level of performance is achieved for these SARs, the maximum value of these awards at the grant date would be as follows: Mr. Breivogel - $328,284; Mr. Borchers - $257,920; Mr. Brown - $252,924; and Mr. Cole - $289,004. In connection with the sale of the Company, all SARs were paid out in December 2010, after the sale was consummated. The 2009-2010 SARs were paid out at 191.75% of target, reflecting the Company’s performance against established goals pursuant to the terms of the AIG LTIP, and the 2010-2011 SARs were paid out at 100% pursuant to the terms of the AIG LTIP. In connection with the vesting of these awards, Mr. Breivogel, Mr. Borchers, Mr. Brown, and Mr. Cole received $306,923, $203,125, $227,083 and $270,681, respectively.
Assumptions used in determining the aggregate grant date fair value included expected dividend yield, risk-free interest rate, expected term, and expected volatility, which resulted in a grant date fair value of $8.41 for 2009 and $8.09 for 2010. A “monte carlo” simulation was used to incorporate a range of assumptions for inputs. The risk free interest rate for periods within the contractual life of the SARs was based on the swap yield curve in effect at the grant date (2009-1.67%, 2010-2.23%). Expected volatilities were based on implied volatilities with the nearest maturity and exercise prices as of grant date from traded stock options with respect to AIG Common Stock (51.75% for both 2009 and 2010). The expected term used was based on the period of time the SARs were expected to be outstanding, with the expected terms of 2.76 and 3.76 years for 2009 and 2010, respectively. Dividend yield was estimated at zero percent given AIG’s recent dividend history. The estimates of fair value from these models are theoretical values for stock options, and changes in the assumptions used in the models could result in materially different fair value estimates. The actual value of the SARs will depend on the market value of AIG Common Stock when the grants are exercised.
(5) No Non-Equity Incentive Plan awards were made in 2011.
The amounts reported in 2010 in the Non-Equity Incentive Plan column represent the (i) sale completion bonus payable to Mr. Geissinger ($75,000 representing the cash portion of his award), Mr. Breivogel ($316,200), Mr. Borchers ($275,000), Mr. Brown ($231,750) and Mr. Cole ($316,200), and (ii) the cash awards earned in 2010 under the AIG LTIP by Mr. Breivogel ($924,013), Mr. Borchers ($701,850), Mr. Brown ($683,661) and Mr. Cole ($814,933). Mr. Geissinger forfeited $37,500 of the sale completion award due to his retirement in October 2011. In connection with the sale of the Company, the 2009-2010 cash awards were paid out at 191.75% of target, reflecting the Company’s performance against established goals pursuant to the AIG LTIP, and the 2010-2011 cash awards were paid out at 100% of target pursuant to the terms of the AIG LTIP. In 2010, Mr. Geissinger received payouts under the AIG Sr. Partners Plan in an aggregate of $1,027,741, representing compensation earned in years prior to the years reported in the 2011 Summary Compensation Table.
(6) The amounts in the Change in Pension Value and Nonqualified Deferred Compensation Earnings column reflect the actuarial increase in the present value of each individual’s pension benefits under all defined benefit pension plans of the Company, determined using the same interest rate and mortality assumptions as those used for financial statement reporting purposes. There were no above-market earnings on deferred
compensation under the Company’s non-qualified deferred compensation programs. Pursuant to the TARP Standards, during 2010, there was a freeze on Mr. Geissinger’s benefit accruals with regard to the benefits provided under the excess plan (Excess Retirement Income Plan). This restriction was removed for 2011.
(7) “All Other Compensation” for 2011 consists of the 401(k) employer matching contribution of $17,149 for each named executive.
(8) Mr. Ciuffetelli was an executive officer of the Company until October 2011.
2011 Grants of Plan-Based Awards
No plan-based awards were granted in 2011.
Exercises and Holdings of Previously Awarded Equity
Outstanding Equity Awards at December 31, 2011. Equity-based awards held at the end of 2011 by each named executive, including awards under the AIG Partners Plan and the AIG Deferred Compensation Profit Participation Plan (AIG - DCPPP), were issued under various AIG stock incentive plans and vested in January 2012.
The following table sets forth outstanding equity-based awards held by each named executive as of December 31, 2011. All of these outstanding equity-based awards relate to shares of AIG Common Stock.
(1) Represents RSUs granted under the AIG Partners Plan for the January 1, 2006 - December 31, 2007 performance period. The RSUs vested in January 2012.
(2) Under the AIG - DCPPP, in 2007 participants were awarded time-vested RSUs based upon the number of plan units they had been granted. The remaining time-vested RSUs vested in January 2012.
(3) Amounts reported in this column are calculated based on the closing sale price for AIG Common Stock, as reported on the New York Stock Exchange (NYSE) on December 30, 2011, of $23.20 per share.
Vesting of Stock-Based Awards During 2011
The following table sets forth the amounts notionally realized in accordance with SEC rules by each named executive as a result of the exercise, settlement or vesting of stock-based awards in 2011.
(1) No option awards were settled in 2011.
(2) The following stock-based awards held by Mr. Geissinger vested in 2011: (i) RSUs granted under the 2006 Partners Plan (162), (ii) RSUs granted under the AIG - DCPPP in 2009 (160), and (iii) Remaining shares (540) from Starr International Company, Inc.’s Deferred Compensation Profit Participation Plan.
Pension Benefits
Eligible employees of the Company participate in tax-qualified and nonqualified defined benefit retirement plans maintained by the Company. These retirement plans provide retirement benefits for eligible employees whose length of service allows them to vest in and receive these benefits. Eligible employees who are citizens of the United States or non-citizens working in the United States had been covered under the American International Group, Inc. Retirement Plan (the AIG Retirement Plan), a U.S. tax-qualified defined benefit retirement plan, through December 31, 2010. On January 1, 2011, SLFI created the Retirement Plan and assumed the obligations under the AIG Retirement Plan with respect to the Company’s employees and retirees. Participants whose formula benefit is restricted from being fully paid from the tax-qualified retirement plan due to IRS limits on compensation are eligible to participate in the Excess Retirement Income Plan.
The Retirement Plan and Excess Retirement Income Plan formulas range from 0.925 percent to 1.425 percent times average final compensation for each year of credited service accrued since April 1, 1985, up to 44 years, and 1.25 percent to 1.75 percent times average final compensation of a participant for each year of credited service accrued prior to April 1, 1985, up to 40 years. For participants who retire after the normal retirement age of 65, the retirement benefit is actuarially increased to reflect the later benefit commencement date. Because of applicable TARP Standards, there was a freeze on Mr. Geissinger’s future benefit accruals with regard to his benefits under the Excess Retirement Income Plan. Once he was no longer subject to TARP Standards, Mr. Geissinger was permitted to accrue additional benefits.
For purposes of both the Retirement Plan and the Excess Retirement Income Plan, average final compensation is the average annual pensionable salary of a participant during those three consecutive years in the last ten years of credited service that afford the highest such average. Final average compensation does not include amounts attributable to overtime pay, supplemental cash incentive payments, annual cash bonuses or long-term incentive awards, except for the branch operations incentive plan.
Early retirement benefits. The Retirement Plan and the Excess Retirement Income Plan provide for reduced early retirement benefits. These benefits are available to participants who have reached age 55 and have ten or more years of credited service. The Excess Retirement Income Plan provides reduced early retirement benefits to participants who have reached age 60 with five or more years of service, or who have reached age 55 with ten or more years of credited service, unless otherwise determined.
In the case of early retirement, participants in the Retirement Plan and the Excess Retirement Income Plan will receive the plan formula benefit projected to normal retirement at age 65 (using average final salary as of the date of early retirement), but prorated based on years of actual service, then reduced by three, four or five percent (depending on age and years of service at retirement) for each year that retirement precedes age 65. Participants in the Retirement Plan with at least ten years of continuous service have a vested reduced retirement allowance pursuant to which, in the case of termination of employment prior to reaching age 55, such participants may elect to receive a reduced early retirement benefit commencing at any date between age 55 and age 65. Participants in the Retirement Plan and the Excess Retirement Income Plan can not choose to receive a lump sum payment upon normal or early retirement. At December 31, 2011, Messrs. Cole and Brown were eligible for early retirement.
Death and disability benefits. Each of the Retirement Plan and the Excess Retirement Income Plan also provides for death and disability benefits. The Retirement Plan and the Excess Retirement Income Plan generally provide a death benefit to active participants who die before age 65 equal to 50 percent of the benefit the participant would have received if he or she had terminated employment on the date of death, survived until his or her earliest retirement date and elected a 50 percent joint and survivor annuity.
Under the Retirement Plan and the Excess Retirement Income Plan, participants continue to accrue credited service while receiving payments under SLFI’s sponsored long-term disability plan or during periods of unpaid medical leave before reaching age 65 if they have at least ten years of service when they become disabled. Participants who have less than ten years of credited service when they become disabled continue to accrue credited service for a maximum of three additional years.
As with other retirement benefits, in the case of death and disability benefits, the formula benefit under the Excess Retirement Income Plan is reduced by amounts payable under the Retirement Plan.
SERA. The SERA is a plan implemented between American General Corporation (the Company’s predecessor parent) and Mr. Geissinger on May 1, 2000 and adopted by the Company on December 23, 2010. The Plan provided supplemental retirement benefits for Mr. Geissinger for the years prior to AIG’s acquisition of AGC. For purposes of SERA, final average compensation is the sum (divided by three) of base salary and certain incentive payments received with respect to the three calendar years (whether or not consecutive) ending within the last 60 months of August 29, 2004 which produce the highest total of such base salary and incentive payments, not including certain deferred payments.
With respect to retirement upon or after age 62, the SERA provides a benefit equal to 67.2 percent of Mr. Geissinger’s final average compensation multiplied by a fraction equal to his years of service, not in excess of 28 years, divided by 28, and reduced in total by the monthly benefits payable to him from the Retirement Plan, the Excess Retirement Income Plan, social security, and any predecessor plan.
2011 pension benefits. The following table details the accumulated benefits for the named executives under the Retirement Plan, the Excess Retirement Income Plan, and, in the case of Mr. Geissinger, the SERA. In accordance with SEC rules, the accumulated benefits are presented as if they were payable upon the named executive’s normal retirement at age 65. None of the named executives has been granted extra years of credited service under the defined benefit plans described above.
(1) The actuarial present values of the accumulated benefits are based on service and earnings as of December 31, 2011 (the pension plan measurement date for purposes of our financial statement reporting). Benefit accruals in the Excess Retirement Income Plan ceased from December 11, 2009 through December 31, 2010 for Mr. Geissinger due to the implementation of the TARP Standards.
Assumptions used in the calculation of the present value of accumulated benefits were discount rates of 4.44% for the Company’s Retirement Plan and 4.0% for the Excess Retirement Income Plan; 2011 Pension Protection Act static annuitant mortality tables, post retirement only; and normal retirement age (age 65 for the Company’s Retirement and Excess Retirement Income Plans; age 62 for the SERA) or current age if older.
(2) Mr. Geissinger retired on October 1, 2011. His Excess Retirement Income Plan benefit will commence April 1, 2012.
Nonqualified Deferred Compensation
In addition to being eligible to participate in a U.S. tax qualified (401(k)) defined contribution plan, designated named executives were eligible to receive deferred incentive awards under the AG Supplemental Thrift Plan (AG Plan).
The AG Plan is a non-qualified savings plan established by American General Corporation (the Company’s predecessor parent) to credit employer matching contributions for amounts that could not be contributed to the tax-qualified 401(k) plan due to IRS limitations. Contributions to the AG Plan ceased after American General Corporation was acquired by AIG, but the amount accrued in this plan and earnings thereon have continued. Only Mr. Geissinger and Mr. Cole participate in this plan. The following table provides for the information regarding the AG Plan.
(1) The AG Plan is a legacy grandfathered plan and has no registrant contributions.
(2) Represents the earnings or loss since December 31, 2010.
(3) The AG Plan account balances were distributed in the first quarter of 2011 upon the rollover of the tax-qualified AIG 401(k) accounts to the Company’s 401(k) plan.
(4) Except for any increases or decreases in plan balances attributable to changes in the value of AIG Common Stock, the AG Plan balances would have been reported as compensation in prior years if the Company had been subject to the same executive compensation disclosure rules in prior years.
Potential Payments and Benefits on Termination
ESP. Messrs. Breivogel, Brown, and Cole were participants in AIG’s Executive Severance Plan (AIG-ESP) on December 31, 2010. When SLFI adopted its own ESP following its separation from AIG, it carried forward the prior plan’s participants. Mr. Geissinger was a plan participant until his retirement in October 2011. Mr. Borchers and Mr. Ciuffetelli were not participants because they were not eligible under the AIG-ESP. They would be entitled to receive severance under the Company’s employee severance plan, which is available generally to all employees and which does not discriminate in favor of executive officers.
Under the ESP, eligible participants at the named executive’s level will receive payments or benefits if their employment is terminated by the Company without “Cause,” or if the named executive resigns with “Good Reason,” as defined in the ESP. “Cause” generally means the participant’s failure to perform his or her duties, misconduct, material violation of applicable codes of conduct, or conviction of or plea of guilty or no contest to a felony or lesser crime involving fraud or dishonesty. “Good Reason” generally means material reduction in duties, responsibilities, titles, offices, base pay, or annual target bonus opportunity.
In the event of a termination without “Cause,” or resignation for “Good Reason,” Messrs. Breivogel, Brown, and Cole would each be entitled to the following severance benefits based upon a December 31, 2011 termination of employment: the sum of his annual base salary and three-year-average of annual cash bonuses. The cash severance would be paid over the severance period in accordance with normal payroll practices. Mr. Geissinger was a grandfathered participant in the ESP and, as a result, would have been eligible for 13 months of severance had he not retired in October 2011. Unvested long-term awards continue to vest during the severance period and are forfeited if not vested or settled as of the end of the severance period. Each participant is also eligible to receive continued health and group life insurance benefits on the same terms as active employees during the severance period. Any severance payments that would otherwise be payable under the ESP will be offset by any amounts resulting from the participant’s subsequent employment by another employer. In order to receive the severance benefits provided under the ESP, the participant must generally execute a release of claims in favor of the Company and comply with the terms of such agreement in order to continue receiving benefits.
The following table shows the payments and benefits that the named executives would have been eligible to receive if their employment had been terminated as of December 31, 2011. These payments and benefits would be provided by the Company. This table does not include benefits generally available to all salaried employees, such as life insurance benefits. Additional information about benefits upon termination is provided in “- Pension Benefits” above.
(1) The amounts reported in this column represent the cash severance payments that would have been provided under the ESP if the individual had terminated employment as of December 31, 2011.
(2) The amounts reported represent the cost to the Company of continued health and group life insurance benefits provided for under the ESP or the Company’s employee severance plan, as applicable. If eligible for retiree medical and life insurance benefits, these named executives are covered under the Company’s retiree medical plan provisions under the same terms as any other employee with similar seniority.
(3) The amounts in this column for termination due to permanent disability represent the increase in the present value, if any, of the named executive’s accumulated pension benefits, representing additional years of credited service that would accrue during participation in SLFI’s long-term disability plan. The amount shown for all of the termination events is the increase above the accumulated value of pension benefits shown in the 2011 Pension Benefits Table, calculated using the same assumptions.
The present value, if any, for involuntarily termination by the Company reflects additional service under the qualified pension plan equal to the severance period under the ESP. For an involuntary termination by the Company without cause where the executive is entitled to a benefit reflecting service during the severance period, the pension plan credit assumes that the qualified plan benefit will be payable at the end of the severance period or when first eligible to retire, if later.
Death benefits under SLFI’s pension plans generally are no more than half of normal retirement benefits and would result in a loss of value on a present value basis for all of the named executives who participate in AIG’s pension plans. All termination benefits, except disability benefits, are assumed to commence at the earliest permissible retirement date. Disability benefits are assumed to commence at age 65.
For information on pension benefits generally, see “- Pension Benefits.”
(4) The amounts in this column represent the total market value (based on the closing sale price on the NYSE of $23.20 on December 30, 2011) of shares of AIG Common Stock underlying unvested equity-based awards under the AIG - DCPPP and the Partners Plan. Stock-based award holdings at the end of 2011 are detailed in the Outstanding Equity Awards at December 31, 2011 Table.
Compensation of Directors
The total 2011 compensation of our directors is shown in the following table. Messrs. Jacobs and Keller each receive an annual fee of $75,000. Messrs. Jacobs and Keller are also directors of SLFC. We do not allocate the compensation of directors between SLFI and SLFC.
We do not separately compensate our directors who also are employees or who are otherwise affiliated with us. Other than Messrs. Jacobs and Keller, none of the directors who served on the Board during the fiscal year ended December 31, 2011 were separately compensated, as the other directors were either employees or were otherwise affiliated with us.
Compensation Committee Interlocks and Insider Participation
Prior to the FCFI Transaction, we did not have a separately-designated standing Compensation Committee; therefore, compensation decisions regarding our Chief Executive Officer were made by AIG (since 2009, AIG’s Compensation and Management Resources Committee and the Special Master for TARP Executive Compensation) and compensation decisions regarding other executive officers and directors were made by our Chief Executive Officer, with input from managers. Subsequent to the FCFI Transaction and prior to the establishment of a Compensation Committee of the Board of Directors, compensation decisions regarding our Chief Executive Officer and directors were made by principals of Fortress Investment Group LLC, including by our director Wesley R. Edens, and compensation decisions regarding our other executive officers were made by our Chief Executive Officer. All of the compensation decisions regarding our executive officers and directors for 2011, except for our Chief Executive Officer, were approved by the Compensation Committee and the Board of Directors. Our Chief Executive Officer received no compensation from the Company for 2011.
For the reasons described in Item 13. “Certain Relationships and Related Transactions, and Director Independence” of this report, Messrs. Edens and Nardone may be deemed to own the shares listed as beneficially owned by FIF HE Holdings LLC (FIF HE Holdings), which owns 100% of Nationstar. Nationstar subservices the centralized real estate loans of MorEquity and two other subsidiaries of SLFC (collectively, the Owners), including certain securitized real estate loans. Nationstar is a non-subsidiary affiliate of SLFI and the Owners.
Nationstar subservices loans on behalf of the Owners consistent with its normal servicing practices and, as applicable, the terms of the loans and securitization documents. Nationstar receives certain fees for its subservicing services, including the right to retain certain income incidental to servicing. Nationstar started subservicing on February 1, 2011. During 2011, the Owners paid $9.9 million in fees to Nationstar.
The Owners also entered into a marketing agreement on September 24, 2010 with Nationstar, permitting Nationstar to refinance certain first lien mortgage loans of existing customers of the Owners. On February 16, 2011, the Owners, by an amendment to the marketing agreement, further agreed to pay closing costs and reduce the principal amount of any such refinancing in an amount not to exceed six percent of the unpaid balance of the loan. Approximately $135.6 million in first mortgages were modified under the refinancing program during 2011, and Nationstar has received $6.6 million from the Owners to pay closing costs and reduce the principal amount of refinancings under the marketing agreement during 2011.
All of the executive officers of the Company are also executive officers of SLFC and all of the directors of the Company also are directors of SLFC. Prior to the FCFI Transaction, neither the Company nor SLFC had a separately-designated standing compensation committee and, therefore, the Board of Directors of each such entity performed compensation committee functions for that entity. Executive officers of the Company who also are directors of the Company serve on the Board of Directors of SLFC, and executive officers of SLFC who also are directors of SLFC serve on the Board of Directors of the Company. Neither Mr. Edens nor Mr. Nardone, members of the Company’s Compensation Committee established in March 2011, has served as one of our or SLFC’s officers or employees at any time. None of our executive officers currently serves as a member of the board of directors or as a member of a compensation committee of any other company that has an executive officer serving as a member of the Board or the Compensation Committee.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth, as of February 29, 2012, information regarding the only persons that the Company knows of that beneficially own more than 5% of the Company’s common stock. The Company is wholly owned by AGF Holding. AGF Holding is 80% owned by FCFI and 20% owned by ACC. FCFI holds 800 shares of voting Class A common stock of AGF Holding. ACC holds 150 shares of voting Class A common stock and 50 shares of non-voting Class B common stock of AGF Holding.
(1) AGF Holding is 80% directly owned by FCFI. Fortress Investment Fund V (Fund A) L.P., Fortress Investment Fund V (Fund B) L.P., Fortress Investment Fund V (Fund C) L.P., Fortress Investment Fund V (Fund D), L.P., Fortress Investment Fund V (Fund E) L.P., Fortress Investment Fund V (Fund F) L.P. and Fortress Investment Fund V (Fund G) L.P. (collectively the Fund V Funds) collectively own 100% of FCFI. FIG LLC is the investment manager of each of the Fund V Funds. Fortress Operating Entity I LP (FOE I) is the 100% owner of FIG LLC. FIG Corp. is the general partner of FOE I. FIG Corp. is a wholly-owned subsidiary of Fortress. As of December 31, 2011, Mr. Edens owns approximately 14.14% of Fortress (Class A and B shares), and Mr. Nardone owns approximately 10.30% of Fortress (Class A and B shares). By virtue of their ownership interest in Fortress and certain of is affiliates, Mr. Edens and Mr. Nardone may be deemed to own the shares listed as beneficially owned by FCFI. Mr. Edens and Mr. Nardone each disclaim beneficial ownership of such shares except to the extent of his pecuniary interest therein.
(2) FCFI holds 800 shares of voting Class A common stock of AGF Holding. ACC holds 150 shares of voting Class A common stock and 50 shares of non-voting Class B common stock of AGF Holding.
(3) AGF Holding is 20% directly owned by ACC. ACC is wholly owned by AIG.
SECURITY OWNERSHIP OF MANAGEMENT
The Company is wholly owned by AGF Holding.
The Company is 80% indirectly owned by certain investment funds managed by affiliates of Fortress. The number and percentage of Class A and Class B shares of Fortress common stock beneficially owned as of December 31, 2011 by the Company’s directors, executive officers named in the Summary Compensation Table (as set forth in Item 11) and directors and executive officers as a group were as follows:
* Less than 1%
(1) The percentage of beneficial ownership of Class A shares is based on 189,887,822 Class A shares outstanding as of December 31, 2011.
(2) The percentage of beneficial ownership of Class B shares is based on 305,857,751 Class B shares outstanding as of December 31, 2011.
(3) The total percentage of voting power is based on 189,887,822 Class A shares and 305,857,751 Class B shares outstanding as of December 31, 2011.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
CERTAIN TRANSACTIONS
Affiliates
Affiliate Lending. 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. Affiliates of Fortress and affiliates of AIG owned or managed lending positions in the syndicate of lenders and had contributed approximately $105.5 million and $93.0 million, respectively, at December 31, 2011 and 2010.
Pension Plan. In January 2011, $216.0 million of plan assets were transferred from the AIG Retirement Plan to the Retirement Plan. At December 31, 2011, $59.9 million of plan assets had not been transferred, but were included in our total plan assets. The remaining $59.9 million of plan assets will be transferred no later than May 1, 2012.
Reinsurance Agreements. 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 $49.7 million at December 31, 2011 and $51.2 million at December 31, 2010.
Derivatives. At December 31, 2011, all of our derivative financial instruments were with AIGFP, a subsidiary of AIG. At December 31, 2010, all but one of our derivative financial instruments were with AIGFP. The derivative financial instrument that was not with AIGFP was terminated in March 2011 due to the sale of the related note receivable from AIG. We did not execute any new derivative contracts with AIGFP during 2011. See Note 16 for further information on our derivatives.
Fortress and its Affiliates
Subservicing and Refinance Agreements. Nationstar subservices the centralized real estate loans of the Owners, including certain securitized real estate loans. Nationstar is a non-subsidiary affiliate of SLFI and the Owners.
Nationstar subservices loans on behalf of the Owners consistent with its normal servicing practices and, as applicable, the terms of the loans and securitization documents. Nationstar receives certain fees for its subservicing services, including the right to retain certain income incidental to servicing. Nationstar started subservicing on February 1, 2011. During 2011, the Owners paid $9.9 million in fees to Nationstar.
The Owners also entered into a marketing agreement on September 24, 2010 with Nationstar, permitting Nationstar to refinance certain first lien mortgage loans of existing customers of the Owners. On February 16, 2011, the Owners, by an amendment to the marketing agreement, further agreed to pay closing costs and reduce the principal amount of any such refinancing in an amount not to exceed six percent of the unpaid balance of the loan. Approximately $135.6 million in first mortgages were modified under the refinancing program during 2011, and Nationstar has received $6.6 million from the Owners to pay closing costs and reduce the principal amount of refinancings under the marketing agreement during 2011.
FIF HE Holdings owns 100% of Nationstar. Fortress Investment Fund III LP, Fortress Investment Fund III (Fund B) LP, Fortress Investment Fund III (Fund C) L.P., Fortress Investment Fund III (Fund D) L.P., Fortress Investment Fund III (Fund E) L.P., Fortress Investment Fund IV (Fund A) L.P., Fortress Investment Fund IV (Fund B) L.P., Fortress Investment Fund IV (Fund C) L.P., Fortress Investment Fund IV (Fund D) L.P., Fortress Investment Fund IV (Fund E) L.P., Fortress Investment Fund IV (Fund F) L.P., and Fortress Investment Fund IV (Fund G) L.P. (collectively the Fortress Funds) beneficially own approximately 98% of FIF HE Holdings. FIG LLC is the investment manager of the Fortress Funds. FOE I wholly owns FIG LLC. FIG Corp. is the general partner of FOE I and is a wholly-owned subsidiary of Fortress. As of December 31, 2011, Mr. Edens owns approximately 14.14% of Fortress and Mr. Nardone owns approximately 10.30% of Fortress. By virtue of their respective ownership interests in Fortress and certain of its affiliates, Mr. Edens or Mr. Nardone may be deemed to own the shares listed as beneficially owned by FIF HE Holdings. Mr. Edens and Mr. Nardone each disclaim beneficial ownership of such shares except to the extent of his pecuniary interest therein.
Investment Management Agreement. Logan Circle, a non-subsidiary affiliate of SLFI, provides investment management services for $300.0 million of higher yielding bonds purchased in fourth quarter 2011. At December 31, 2011, fees of $0.1 million were due for these investment management services.
Review, Approval or Ratification of Transactions with Related Persons
We have not adopted a formal policy for reviewing related party transactions that are required to be disclosed under the SEC rules. The Board reviews related party transactions as required by our Code of Ethics and when otherwise desired by management or members of the Board. The Board did not approve the Fortress related party agreements. The Board approved certain AIG related party agreements.
DIRECTOR INDEPENDENCE
Prior to the FCFI Transaction on November 30, 2010, the Company was an indirect, wholly-owned consolidated subsidiary of AIG (which has its common stock listed on the New York Stock Exchange, Inc.) and the Company did not have any independent directors. Effective March 2011, a Compensation Committee of the Board was established. Messrs. Edens and Nardone serve as members of the Compensation Committee, with Mr. Edens serving as Chairman. The Company does not have a separately designated audit committee or nominating committee.
The Board has not determined whether any of the Company’s current directors (including the members of the Compensation Committee) are “independent.”
Our securities are not listed on a national securities exchange or in an inter-dealer quotation system which has requirements that a majority of the board of directors be independent. If our common stock were listed on the NYSE, we would be considered a “controlled company” under the NYSE rules because 50% of the voting power for the election of our directors is held by an individual, a group or another company. As a result, we would not be required to have a majority of our board of directors consist of independent directors. Similarly, we would not be required to have an independent nominating or compensation committee.
Item 14.
Item 14. Principal Accountant Fees and Services.
The Board pre-approves all audit and non-audit services provided by our independent accountants, PricewaterhouseCoopers LLP. Prior to November 30, 2010, AIG’s Audit Committee pre-approved all of the Predecessor Company’s audit-related fees.
Independent accountant fees charged to SLFI and the related services were as follows:
Audit fees in 2011 and 2010 were primarily for the audit of SLFI’s and SLFC’s Annual Reports on Form 10-K, quarterly review procedures in relation to SLFI’s and SLFC’s Quarterly Reports on Form 10-Q, statutory audits of insurance subsidiaries of SLFC, and audits of other subsidiaries of SLFC. SLFC is a separate SEC registrant and its fees are part of the total SLFI fee, representing 98% of the total audit fees for SLFI. Audit-related fees in 2011 were primarily due to the filing of a registration statement with the SEC for Springleaf REIT. Audit-related fees in 2010 were primarily for securitization procedures.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) (1) and (2) The following consolidated financial statements of Springleaf Finance, Inc. and subsidiaries are included in Item 8:
Consolidated Balance Sheets, December 31, 2011 and 2010
Consolidated Statements of Operations, year ended December 31, 2011, one month ended December 31, 2010, eleven months ended November 30, 2010, and year ended December 31, 2009
Consolidated Statements of Comprehensive (Loss) Income, year ended December 31, 2011, one month ended December 31, 2010, eleven months ended November 30, 2010, and year ended December 31, 2009
Consolidated Statements of Shareholder’s Equity, year ended December 31, 2011, one month ended December 31, 2010, eleven months ended November 30, 2010, and year ended December 31, 2009
Consolidated Statements of Cash Flows, year ended December 31, 2011, one month ended December 31, 2010, eleven months ended November 30, 2010, and year ended December 31, 2009
Notes to Consolidated Financial Statements
Schedule I-Condensed Financial Information of Registrant is included in Item 15(c).
All other financial statement schedules have been omitted because they are inapplicable.
(3) Exhibits:
Exhibits are listed in the Exhibit Index beginning on page 232 herein.
(b) Exhibits
The exhibits required to be included in this portion of Item 15 are submitted as a separate section of this report.
Item 15(c).
Schedule I - Condensed Financial Information of Registrant
Springleaf Finance, Inc.
Condensed Balance Sheets
See Notes to Condensed Financial Statements.
Springleaf Finance, Inc.
Condensed Statements of Operations
See Notes to Condensed Financial Statements.
Springleaf Finance, Inc.
Condensed Statements of Cash Flows
See Notes to Condensed Financial Statements.
Springleaf Finance, Inc.
Notes to Condensed Financial Statements
December 31, 2011
Note 1. Accounting Policies
SLFI records its investments in subsidiaries at cost plus the equity in (overdistributed) undistributed net income of subsidiaries since the date of incorporation or, if purchased, the date of the acquisition. You should read the condensed financial statements of the registrant in conjunction with SLFI’s consolidated financial statements.
Note 2. Short-term Debt
Short-term debt at December 31, 2011 and 2010 included an intercompany master note payable totaling $538.1 million.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 19, 2012.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 19, 2012.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE SECURITIES EXCHANGE ACT OF 1934.
No annual report to security-holders or proxy material has been sent to security-holders.
Exhibit Index
Exhibit
Number
(3)
a.
Amended and Restated Articles of Incorporation of Springleaf Finance, Inc. (formerly American General Finance, Inc.), as amended to date. Incorporated by reference to Exhibit (3)a. to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
b.
Amended and Restated By-laws of Springleaf Finance, Inc., as amended to date. Incorporated by reference to Exhibit (3)b. to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
(4)
a.
The following instruments are filed pursuant to Item 601(b)(4)(ii) of Regulation S-K, which requires with certain exceptions that all instruments be filed which define the rights of holders of the Company’s long-term debt and of our consolidated subsidiaries. In the aggregate, the outstanding issuances of debt at December 31, 2010 under the following Indenture exceeds 10% of the Company’s total assets on a consolidated basis:
Indenture dated as of May 1, 1999 from Springleaf Finance Corporation (formerly American General Finance Corporation) to Wilmington Trust Company (successor trustee to Citibank, N.A.). Incorporated by reference to Exhibit (4)a.(1) filed as a part of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 (File No. 2-82985).
b.
In accordance with Item 601(b)(4)(iii) of Regulation S-K, certain other instruments defining the rights of holders of the Company’s long-term debt and of our consolidated subsidiaries have not been filed as exhibits to this Annual Report on Form 10-K because the total amount of securities authorized and outstanding under each instrument does not exceed 10% of the total assets of the Company on a consolidated basis. We hereby agree to furnish a copy of each instrument to the Securities and Exchange Commission upon request.
(10)
Supervisory Agreement, dated June 7, 2007, among AIG Federal Savings Bank, Wilmington Finance, Inc., Springleaf Finance, Inc. (formerly American General Finance, Inc.), and the Office of Thrift Supervision. Incorporated by reference to Exhibit (10) filed as part of the Company’s Current Report on Form 8-K dated June 7, 2007.
(10.1)
Letter Agreement dated July 8, 2009 between PennyMac Loan Services, LLC; Credit Suisse; and Springleaf Finance Corporation (formerly American General Finance Corporation). Incorporated by reference to Exhibit (10.6) to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2009.
(10.2)
Commitment to Purchase Financial Instrument and Service Participation Agreement dated July 17, 2009 between MorEquity, Inc. and the Federal National Mortgage Association. Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated July 17, 2009.
Exhibit Index (Continued)
Exhibit
Number
(10.3)
Mortgage Loan Purchase Agreement dated July 30, 2009 between MorEquity, Inc., Springleaf Financial Services of Arkansas, Inc. (formerly American General Financial Services of Arkansas, Inc.), Springleaf Home Equity, Inc. (formerly American General Home Equity, Inc.), Springleaf Finance Corporation (formerly American General Finance Corporation), and Third Street Funding LLC. Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated July 30, 2009.
(10.4)
Purchase Agreement dated July 30, 2009 between Third Street Funding LLC and Credit Suisse Securities (USA) LLC. Incorporated by reference to Exhibit (10.2) to the Company’s Current Report on Form 8-K dated July 30, 2009.
(10.5)
Pooling and Servicing Agreement dated July 30, 2009 between Third Street Funding LLC; Wells Fargo Bank, N.A.; PennyMac Loan Services, LLC; MorEquity, Inc.; Select Portfolio Servicing, Inc.; U.S. Bank National Association; and The Bank of New York Mellon Trust Company, N.A. Incorporated by reference to Exhibit (10.8) to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009.
(10.6)
Mortgage Loan Purchase Agreement dated January 31, 2010 between MorEquity, Inc., Springleaf Financial Services of Arkansas, Inc. (formerly American General Financial Services of Arkansas, Inc.), Springleaf Home Equity, Inc. (formerly American General Home Equity, Inc.), Springleaf Finance Corporation (formerly American General Finance Corporation), and Sixth Street Funding LLC. Incorporated by reference to Exhibit (10.1) to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010.
(10.7)
Pooling and Servicing Agreement dated January 31, 2010 between Sixth Street Funding LLC; Wells Fargo Bank, N.A.; MorEquity, Inc.; Green Tree Servicing LLC; and U.S. Bank National Association. Incorporated by reference to Exhibit (10.2) to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010.
(10.8)
Purchase Agreement dated March 29, 2010 between Sixth Street Funding LLC, RBS Securities Inc., and Springleaf Finance Corporation (formerly American General Finance Corporation). Incorporated by reference to Exhibit (10.3) to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010.
(10.9)
Credit Agreement dated April 21, 2010 between Springleaf Financial Funding Company (formerly AGFS Funding Company), Springleaf Finance Corporation (formerly American General Finance Corporation), Bank of America, N.A., Deutsche Bank Securities Inc., various Co-Documentation Agents, and Other Lenders Party Thereto. Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated April 21, 2010.
(10.10)*
Form of Indemnification Agreement between Springleaf Finance, Inc. and each of its directors dated as of November 30, 2010. Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated December 2, 2010.
Exhibit Index (Continued)
Exhibit
Number
(10.11)*
Springleaf Finance, Inc. Excess Retirement Income Plan dated as of January 1, 2011. Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated December 3, 2010.
(10.12)*
Supplemental Executive Retirement Agreement dated as of November 30, 2010 between Springleaf Finance, Inc. and Frederick W. Geissinger. Incorporated by reference to Exhibit (10.2) to the Company’s Current Report on Form 8-K dated December 3, 2010.
(10.13)*
Springleaf Finance, Inc. Executive Severance Plan dated as of November 30, 2010. Incorporated by reference to Exhibit (10.15) to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
(10.14)
Subservicing Agreement, dated as of February 1, 2011, among MorEquity, Inc., Springleaf Financial Services of Arkansas, Inc. (formerly American General Financial Services of Arkansas, Inc.), and Springleaf Home Equity, Inc. (formerly American General Home Equity, Inc.), as owners and as servicers, and Nationstar Mortgage LLC, as subservicer (portions of this Exhibit have been omitted pursuant to a request for confidential treatment under Rule 24b-2 under the Securities Exchange Act of 1934). Incorporated by reference to Exhibit (10.1) to the Company’s Current Report on Form 8-K dated February 4, 2011.
(10.15)
Subservicing Agreement (American General Mortgage Loan Trust 2006-1), dated as of February 1, 2011, between MorEquity, Inc., as servicer, and Nationstar Mortgage LLC, as subservicer (portions of this Exhibit have been omitted pursuant to a request for confidential treatment under Rule 24b-2 under the Securities Exchange Act of 1934). Incorporated by reference to Exhibit (10.2) to the Company’s Current Report on Form 8-K dated February 4, 2011.
(10.16)
Subservicing Agreement (American General Mortgage Loan Trust 2010-1), dated as of February 1, 2011, between MorEquity, Inc., as servicer, and Nationstar Mortgage LLC, as subservicer (portions of this Exhibit have been omitted pursuant to a request for confidential treatment under Rule 24b-2 under the Securities Exchange Act of 1934). Incorporated by reference to Exhibit (10.3) to the Company’s Current Report on Form 8-K dated February 4, 2011.
(10.17)
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
(21)
Subsidiaries of Springleaf Finance, Inc.
(31.1)
Rule 13a-14(a)/15d-14(a) Certifications of the President and Chief Executive Officer of Springleaf Finance, Inc.
Exhibit Index (Continued)
Exhibit
Number
(31.2)
Rule 13a-14(a)/15d-14(a) Certifications of the Senior Vice President and Chief Financial Officer of Springleaf Finance, Inc.
(32)
Section 1350 Certifications
(101)**
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive (Loss) Income, (iv) Consolidated Statements of Shareholder’s Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements, tagged as blocks of text, and (vii) Schedule I - Condensed Financial Information of Registrant, tagged as a block of text.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 15(b).
** 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.