Item 1. Business.
GENERAL
Springleaf Finance Corporation (SLFC or, collectively with its subsidiaries, whether directly or indirectly owned, the Company, we, us, or our) was incorporated in Indiana in 1927 as successor to a business started in 1920. All of the common stock of SLFC is owned by Springleaf Finance, Inc. (SLFI), which was incorporated in Indiana in 1974.
On November 30, 2010, FCFI Acquisition LLC (FCFI), an affiliate of Fortress Investment Group LLC (Fortress), indirectly acquired an 80% economic interest in SLFI from AIG Capital Corporation (ACC), a direct wholly-owned subsidiary of American International Group, Inc. (AIG) (the FCFI Transaction). AIG, through ACC, indirectly retained a 20% economic interest in SLFI.
SLFC is a financial services holding company with subsidiaries engaged in the consumer finance and credit insurance businesses. We provide secured and unsecured personal loans to customers who generally need timely access to cash and also offer associated insurance products. At December 31, 2012, we had $11.7 billion of net finance receivables due from over 973,000 customer accounts and $3.4 billion of credit and non-credit life insurance policies in force covering over 630,000 customer accounts.
Our headquarters is located in Evansville, Indiana. At December 31, 2012, we had 852 branch offices in the United States, Puerto Rico, and the U.S. Virgin Islands and over 3,600 employees. In December 2012, over 1,000 of our employees were redeployed to a subsidiary of SLFI, which now provides management services to us. See Note 12 of the Notes to Consolidated Financial Statements in Item 8 for further information.
Item 1. Continued
As part of a strategic effort to streamline operations and reduce expenses, we initiated the following restructuring activities during the first half of 2012: (1) ceased originating real estate loans nationwide and in the United Kingdom; (2) ceased personal lending and retail sales financing in 14 states; (3) consolidated certain branch operations in 26 states; and (4) closed 231 branch offices. As a result of these initiatives, we reduced our workforce in our branch operations, at our Evansville, Indiana headquarters, and operations in the United Kingdom by 820 employees and incurred a pretax charge of $23.5 million during the first half of 2012.
SEGMENTS
Prior to our 2012 restructuring initiatives and further refinement of our business strategy, we had three business segments: branch, centralized real estate, and insurance, which were defined by the types of financial service products we offered, the nature of our production processes, and the methods we used to distribute our products and to provide our services, as well as our management reporting structure.
Subsequent to our 2012 strategic review of our operations, we have redefined our segments to coincide with how our businesses are currently managed. At December 31, 2012, our three business segments include: consumer, insurance, and real estate. These business segments evolved primarily from management’s redefined business strategy, including its decision to cease real estate lending effective January 1, 2012 and to shift its focus to consumer loan products which we believe have significant prospects for growth and business development due to the strong demand in our target market of nonprime borrowers. Throughout 2012, management continued to refine our business strategy and operating footprint and the reporting tools necessary to manage the Company under the new segments, which were defined in final form in the fourth quarter of 2012 and led to our revision to 2012 segment reporting.
Due to the nature of the FCFI Transaction, 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). However, we continue to report our segment financial information using the same accounting basis that we employed prior to the FCFI Transaction, which we refer to as “historical accounting basis,” to provide a consistent basis for both management and other interested third parties to better understand our operating results. The historical accounting basis (which is a basis of accounting other than generally accepted accounting principles in the United States of America (U.S. GAAP)) also provides better comparability of our operating results to our competitors and other companies in the financial services industry.
The segment financial information disclosed below and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 is discussed on a historical accounting basis. See Note 24 of the Notes to Consolidated Financial Statements in Item 8 for reconciliations of segment information on a historical accounting basis to consolidated financial statement amounts.
Consumer Business Segment
The consumer business segment is the core of the Company’s operations with over 3,480 employees, 834 branch offices in 26 states, which are our core operating states, and its centralized support operations located in Evansville, Indiana. The consumer business segment serviced over 729,100 personal loan accounts totaling $2.5 billion at December 31, 2012.
Products and Services. We originate and service personal loans, which are typically closed-end accounts with a fixed rate and a fixed, original term of 2 to 4 years. These loans are secured by titled personal property (such as automobiles), consumer goods, or other personal property or are unsecured.
Item 1. Continued
Customer Development. Our branch network helps solicit new prospects for our consumer business segment due to the geographical proximity that typically exists between our branch offices and our current customers. Our employees at these branch offices are typically on a “first name basis” with these customers. Many of these customers develop an affinity with their local office representatives that can lead to additional lending opportunities with our customers’ friends and family members.
We also solicit new prospects for our consumer business segment, as well as current and former customers, through a variety of direct 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 lists of new potential consumer loan borrowers from major list vendors based on predetermined selection criteria. Mail solicitations include invitations to apply for personal loans and pre-qualified offers of guaranteed personal loan credit.
E-commerce provides another significant source of new customers. Search engine marketing is used to drive prospects to our website at www.SpringleafFinancial.com. Our website includes a brief, user-friendly credit application that, upon completion, is automatically routed to the branch office nearest the consumer. 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.
Credit Risk. In our consumer business segment, we use credit risk scoring models at the time of credit application to assess the applicant’s ability and willingness to repay. We develop these models using numerous factors, including past customer credit repayment experience and application data, and periodically revalidate these models based on recent portfolio performance. Our underwriting process also includes the development of a budget (net of taxes and monthly expenses) for the applicant. Finally, we attempt to obtain a security interest in either titled non-real estate property or other household goods.
Our consumer business segment customers are typically considered non-prime or sub-prime (less creditworthy) and require significantly higher levels of servicing than prime or near-prime customers. As a result, we charge these customers higher interest rates to compensate us for the related credit risks and servicing.
Account Servicing. The account servicing and collection processing for our personal loans are generally handled at the branch office where the personal loans were originated. All servicing and collection activity is conducted and documented on the Customer Lending and Solicitation System (CLASS), a proprietary system which logs and maintains, within our centralized information systems, a permanent record of all transactions and notations made with respect to the servicing and/or collection of a personal loan and is also used to assess a personal loan application. CLASS permits all levels of branch management to review on a daily basis the individual and collective performance of all branch offices for which they are responsible.
Insurance Business Segment
We conduct the insurance business segment through Merit Life Insurance Co. (Merit) and Yosemite Insurance Company (Yosemite), which are both wholly-owned subsidiaries of SLFC. Merit is a life and health insurance company that writes or reinsures credit life, credit accident and health, and non-credit insurance and is licensed in 46 states, the District of Columbia, and the U.S. Virgin Islands. Yosemite is a property and casualty insurance company that writes or reinsures credit-related property and casualty and credit involuntary unemployment insurance and is licensed in 46 states.
Item 1. Continued
The insurance business segment markets its products to eligible finance receivable customers. We invest cash generated from operations in investment securities, commercial mortgage loans, and policy loans and also use it to pay dividends. The insurance business segment entails numerous underwriting, compliance, and service responsibilities for the insurance companies and also provides services to the consumer and real estate business segments.
Products and Services. We write and reinsure credit life, credit accident and health, credit related property and casualty, and credit involuntary unemployment insurance policies covering our customers and the property pledged as collateral through products that the consumer and real estate business segments offer to its customers. We also offer non-credit insurance and ancillary products.
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 consumer or 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 level term life policies. The purchase of this coverage is also voluntary.
The ancillary products we offer are home security and auto security membership plans and home appliance 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.
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.
Real Estate Business Segment
As a result of the cessation of real estate lending effective January 1, 2012, our real estate loans are in a liquidating status. At December 31, 2012, our real estate business segment loans totaled $10.4 billion. Our real estate loans are secured by first or second mortgages on residential real estate and are usually considered non-conforming. These loans may be closed-end accounts or open-end home equity lines of credit and are primarily fixed-rate products. Our 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
Item 1. Continued
months, some of which require a balloon payment at the end of 360 months. Our real estate loans do not contain any borrower payment options that allow the loan principal balance to increase through negative loan amortization.
Real estate loans previously originated through our branch offices are either serviced by our branch personnel or centrally serviced at our Evansville, Indiana location or other specialized servicing centers. Real estate loans previously acquired or originated through centralized distribution channels are serviced by MorEquity, Inc. (MorEquity), a wholly-owned subsidiary of SLFC, all of which are subserviced by Nationstar Mortgage LLC (Nationstar), except for certain securitized real estate loans, which are serviced and subserviced by third parties. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar.
CENTRALIZED SUPPORT
We continually seek to identify functions that could be more effective if centralized to achieve reduced costs or free our consumer and real estate business segment lending specialists to service our customers and market our products. Our centralized operational functions support the following:
· mail and telephone solicitations;
· payment processing and collections;
· foreclosure and real estate owned processing;
· real estate escrow accounts;
· collateral protection insurance tracking; and
· charge-off recovery operations.
Item 1. Continued
OPERATIONAL CONTROLS
We control and monitor our 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 compliance department assesses the Company’s compliance with federal and state regulations, as well as its compliance with our internal policies and procedures; manages our regulatory examination process; and maintains our consumer complaint resolution and reporting process.
· Our internal audit department audits the Company for adherence to operational policy and procedure and compliance with federal and state law and regulation.
REGULATION
Consumer and Real Estate Business Segments
Federal Laws. Various federal laws and regulations govern our consumer and real estate business segments including:
· the Equal Credit Opportunity Act (prohibits discrimination against creditworthy applicants) and Consumer Financial Protection Bureau (the Bureau) 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 Bureau 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 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 Bureau Regulation P, which implements that Act; and
· the Federal Trade Commission Act.
Item 1. Continued
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). On February 1, 2011, MorEquity entered into subservicing agreements for the servicing of its real estate loans with Nationstar. Loans subserviced by Nationstar that are eligible for modification pursuant to HAMP guidelines are 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 promulgated under it, is likely to affect our operations in terms of increased oversight of financial services products by the Bureau and the imposition of restrictions on the terms of certain loans. The Bureau has significant authority to implement and enforce Federal consumer finance 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, 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. Many of these regulations will be phased in over the next year.
The Dodd-Frank Act gave the Bureau broad powers to supervise financial services entities and enforce consumer protection laws. Currently, the Bureau only has supervisory authority over us with respect to mortgage servicing and mortgage origination, which allows the Bureau to conduct an examination of our mortgage servicing practices and our prior mortgage origination practices. The Dodd-Frank Act also gives the Bureau supervisory authority over entities that are designated as “larger participants” in certain financial services markets, including consumer installment loans and related products. The Bureau has not yet promulgated regulations which designate “larger participants” for consumer finance companies. If we are designated as a “larger participant” for this market, we also will be subject to supervision and examination by the Bureau with respect to our consumer loan business. We expect to be designated as a “larger participant.” In addition to its supervision and examination authority, the Bureau is authorized to conduct investigations to determine whether any person is engaging in, or has engaged in, conduct that violates Federal consumer financial protection laws, and to initiate enforcement actions for such violations, regardless of its direct supervisory authority. Investigations may be conducted jointly with other regulators. We have not been notified of any planned examinations or enforcement actions by the Bureau.
State Laws. Various state laws and regulations also govern our consumer and real estate business segments. 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.
Item 1. Continued
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 state 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 our other business activities.
Insurance Business Segment
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 jurisdiction in which we operate regulates credit insurance premium rates and premium refund calculations.
Item 1. Continued
COMPETITION
The consumer finance industry is highly competitive, and the barriers to entry for new competitors are relatively low in the market segment in which we operate. We compete with other consumer finance companies, as well as other types of financial institutions within our geographic footprint and over the Internet, including community banks, credit unions, and smaller regional finance companies, 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.
Our insurance business segment supplements our consumer and real estate business segments. We believe that our insurance companies’ abilities to market insurance products through our distribution systems provide a competitive advantage.
Available Information
SLFC files annual, quarterly, and current reports and other information with the Securities and Exchange Commission (the SEC). The SEC’s website, www.sec.gov, contains these reports and other information that registrants (including SLFC) file electronically with the SEC. Readers may also read and copy any document that SLFC files at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room.
The following reports are available free of charge through our website, www.SpringleafFinancial.com (posted on the “About Us - Investor Information - Financial Information” section), as soon as reasonably practicable after we file them with or furnish them to the SEC:
· Annual Reports on Form 10-K;
· Quarterly Reports on Form 10-Q;
· Current Reports on Form 8-K; and
· any amendments to those reports.
In addition, our Code of Ethics for Principal Executive and Senior Financial Officers (the Code of Ethics) is posted on the “About Us - Investor Information - Corporate Governance” section of our website at www.SpringleafFinancial.com. We will post on our website any amendments to the Code of Ethics and any waivers that are required to be described.
The information on our website is not incorporated by reference into this report. The website addresses listed above are provided for the information of the reader and are not intended to be active links.
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.
Item 1. Continued
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 disasters, acts of war, terrorism or catastrophes or high energy costs, major medical expenses, divorce or death 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). 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 loan-to-value (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 personal 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.
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’ ability and willingness to repay the amounts that they have 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, unemployment, high energy costs, major medical expenses, divorce or death or due to natural disasters, acts of war or terrorism, or other
Item 1A. Continued
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, 2012, 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;
· there is 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.
As a result of the current market environment, we believe that 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 or our indemnification obligations 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.
Item 1A. Continued
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 26 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 and is used in automated underwriting as a key control function. 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’s credit profile and application information 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.
Item 1A. Continued
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 personal loans. Through January 15, 2013, we also purchased retail sales contracts and revolving retail accounts arising from the retail sale of consumer goods and services by retail merchants. Prior to January 1, 2012, we 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 were available to us prior to September 2008.
We have ceased our real estate loan originations as of January 1, 2012. In addition, in the first half of 2012, we closed 231 branches and ceased consumer lending and retail sales financing 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 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.
Item 1A. Continued
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 a substantial increase in interest rates. If rates increased substantially, 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.
In addition to interest rate changes, the market values of our finance receivables may also 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 loans for our second mortgages if we are not the holder of the senior loan.
Second mortgages constituted 7% of our real estate loans as of December 31, 2012. 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 Contingencies” in Note 21 of the Notes to Consolidated Financial Statements in Item 8 for further information.
Item 1A. Continued
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
Item 1A. Continued
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. 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 do not 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.
Item 1A. Continued
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 INDEBTEDNESS
If current market conditions deteriorate and our financial performance does not improve, 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 deteriorate and our financial performance does not improve, we may not be able to generate sufficient cash to service our debt. At December 31, 2012, we had $1.4 billion of cash and cash equivalents and in 2012 we generated a net loss of $220.7 million and net cash inflow from operating and investing activities of $1.6 billion. At December 31, 2012, our scheduled principal and interest payments for 2013 on our existing debt (excluding securitizations) totaled $2.1 billion. As of December 31, 2012, we had unpaid principal balances of $2.0 billion of unencumbered personal loans and $609.7 million of unencumbered real estate loans. In addition, SLFC may demand payment of some or all of its note receivable from SLFI ($538.0 million outstanding at December 31, 2012); however, SLFC does not anticipate the need for additional liquidity during 2013 and does not expect to demand payment from SLFI in 2013. In order to meet our debt obligations in 2013 and beyond, we are exploring a number of other options, including additional debt financings (particularly new securitizations involving real estate and personal loans and possible new issuances and/or debt refinancing transactions), or a combination of the foregoing. We are also considering finance receivable 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. Our 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
Item 1A. Continued
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, our 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 our 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, 2012, we had $13.4 billion in principal amount of indebtedness outstanding (including securitizations and secured indebtedness). Interest expense on our indebtedness was $1.1 billion in 2012. 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.
Item 1A. Continued
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), a subsidiary of SLFC, 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 may affect 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 our 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 capital markets funding to be from debt transactions, including securitizations.
Item 1A. Continued
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’s ability to pay some or all of its note payable to SLFC ($538.0 million at December 31, 2012), if needed by SLFC to meet its liquidity needs;
· our continued ability to access debt and securitization markets and other sources of funding on favorable terms;
· our ability to complete on favorable terms, as needed, additional borrowings, securitizations, finance receivable 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 $3.75 billion six-year secured term loan facility (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 finance receivable portfolio sales; and
· the potential for reduced income due to the possible deterioration of the credit quality of our finance receivable portfolios.
Item 1A. 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 liquidation and related losses within our real estate portfolio could be substantial and result in reduced cash receipts;
· our inability to grow our consumer loan portfolio with adequate profitability to fund operations, loan losses, and other expenses;
· our inability to monetize assets including, but not limited to, our access to debt and securitization markets and our note receivable from parent;
· the effect of federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Act (which, among other things, established the 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 increasing costs and difficulty in servicing 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 real estate loans that were originated or acquired centrally;
· potential liability relating to real estate and personal 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; and
· the potential effect on us if the capital levels of our regulated and unregulated subsidiaries prove inadequate to support current business plans.
We intend to support our liquidity position by managing originations (including our decision to cease real estate loan originations effective January 1, 2012) and purchases of finance receivables (including our decision to no longer purchase retail sales finance receivables after January 15, 2013) 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 and possible new issuances and/or debt refinancing transactions), finance receivable 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.
Item 1A. Continued
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 (Standard & Poor’s), Moody’s Investors Service, Inc. (Moody’s), and Fitch, Inc. (Fitch) rates our debt. On September 7, 2011, Fitch downgraded SLFC’s ratings, and on February 3, 2012, Standard & Poor’s downgraded SLFC’s ratings. On June 1, 2012, Moody’s downgraded the Company’s debt. These rating actions resulted in downward price pressure for SLFC’s outstanding debt.
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 and three during 2012, 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.
Item 1A. Continued
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 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. There can be no assurance 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 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-
Item 1A. Continued
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 SLFC 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). Moreover, 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 of 1940, as amended (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 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.
Item 1A. Continued
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.
Item 1A. Continued
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.
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.
In addition, the Bureau has extensive authority to enforce consumer protection laws, and likely will have supervisory authority over our consumer lending business once it promulgates “larger participant” regulations for consumer lending. The Bureau’s broad supervisory and enforcement powers could affect our business and operations significantly in terms of increased operating and regulatory compliance costs, and limits on the types of products we offer and the manner in which they are offered, among other things.
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 Finance and Mortgages Limited (Ocean), our United Kingdom subsidiary, 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. Since January 2013, we have leased an additional executive office in Connecticut under a lease that expires in 2015 and an administrative office in Delaware under a lease that expires in 2020.
Our investment in real estate and tangible property is not significant in relation to our total assets due to the nature of our business. At December 31, 2012, SLFC subsidiaries owned two branch offices in Riverside and Barstow, California, one branch office in Isabela, Puerto Rico, one branch office in Terre Haute, Indiana, and seven buildings in Evansville, Indiana. The Evansville buildings house our administrative offices, our centralized services and support operations for our consumer and real estate business segments, and one of our branch offices. On February 28, 2013, the branch office in Evansville, Indiana was sold.
Item 3.
Item 3. Legal Proceedings.
See Note 21 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 SLFC’s common stock. All of SLFC’s common stock is held by SLFI. SLFC did not pay any cash dividends on its common stock in 2012 or 2010. SLFC paid $45.0 million of cash dividends on its common stock in May 2011. See Note 16 of the Notes to Consolidated Financial Statements in Item 8 regarding limitations on the ability of SLFC and its subsidiaries to pay dividends.
On each of January 10, 2012 and July 11, 2012, SLFC issued one share of SLFC common stock to SLFI for $10.5 million each in order to satisfy a non-debt capital funding requirement with respect to SLFC’s hybrid debt. Similarly, on January 11, 2013, SLFC issued one share of SLFC common stock to SLFI for $10.5 million in order to satisfy SLFC’s hybrid debt semi-annual interest payments due in January 2013. Each share of SLFC common stock was issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. See “Capital Resources and Liquidity - Capital Resources” in Item 7 of this Annual Report on Form 10-K for further information on SLFC’s hybrid debt.
Item 6.
Item 6. Selected Financial Data.
As a result of the FCFI Transaction, 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 the years ended December 31, 2011 and 2012 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.
Item 6. Continued
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.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes in Item 8.
An index to our management’s discussion and analysis follows:
Topic
Page
Our Business
2012 Overview
2013 Developments and Outlook
Results of Operations
Segment Overview
Balance Sheet
Credit Quality
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
Critical Accounting Policies and Estimates
Recent Accounting Pronouncements
Glossary of Terms
Our Business
We are a leading national consumer finance company offering responsible consumer lending products and related credit insurance products to “Main Street” America with over $14.7 billion of total assets at December 31, 2012. We continue to service over 973,000 finance receivable customer accounts through our 852 branch offices in the United States, Puerto Rico, and the U.S. Virgin Islands as of December 31, 2012. Although the majority of our consumer lending operations involve decentralized branch-based lending, we also utilize our centralized support operations located in Evansville, Indiana and other specialized servicing centers. Our branch-based and related centralized support personnel total over 3,600 people.
OUR PRODUCTS
Personal Loans
We offer personal loans to customers who generally need timely access to cash. Our personal loans are typically non-revolving with a fixed-rate and a fixed, original term of 2 to 4 years. These personal loans are generally secured by titled personal property (such as automobiles), consumer goods or other personal property, but some are unsecured. At December 31, 2012, $1.4 billion, or 52%, of our personal loan portfolio was secured by “hard” collateral such as automobiles, $865.2 million, or 33%, was secured by consumer goods or other items of personal property, and the remainder was unsecured.
Item 7. Continued
Insurance Products
In addition to personal loans, we offer credit insurance (life, accident and health insurance, and involuntary unemployment insurance), non-credit insurance, and ancillary products, such as warranty protection. We also require credit-related property and casualty insurance, when needed, to protect our interest in the property pledged as collateral for the finance receivable. Credit insurance and non-credit insurance products are provided by Merit and Yosemite, subsidiaries of SLFC. The ancillary products are home security and auto security membership plans and home appliance service contracts of unaffiliated companies. Our consumer lending specialists, who, where required, are licensed to offer insurance and ancillary products.
Legacy Products
Through January 15, 2013, we purchased retail sales contracts and revolving retail accounts 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, generally have maximum original terms of 60 months, and are secured by the personal property designated in the contract. Revolving retail are open-end accounts that can be used for financing repeated purchases from the same merchant, generally require minimum monthly payments based on the amount financed calculated after the most recent purchase or outstanding balances, and are secured by the goods purchased. We continue to service the liquidating retail sales contracts and will provide revolving retail sales financing services on our revolving retail accounts. We refer to retail sales contracts and revolving retail collectively as “retail sales finance.”
Prior to 2012, we also originated real estate loans. These loans may be closed-end accounts or open-end home equity lines of credit, generally have a fixed rate and maximum original terms of 360 months, and are secured by first or second mortgages on residential real estate. Although we ceased our real estate lending as of January 1, 2012, we continue to service the liquidating real estate loans and support any advances on open-end accounts.
OUR INDUSTRY
Based on independently sourced data, the consumer lending industry is a $2.1 trillion market, with 30% - 40% of the current market as non-prime customers. These customers have ongoing need for access to credit, however supply has fallen over the last decade due to macro-economic conditions and banks refocusing on the prime and super-prime segments. Additionally, many of the consumer finance companies that previously served this segment have been acquired or ceased operations. This imbalance of supply and demand has led to a proliferation in recent years of payday, title and other high cost lenders. We believe the Company's strategy of prudent underwriting of fairly priced loans to this customer segment positions it well to capitalize on these current market opportunities and to achieve its goal of growing its personal loan business.
2012 Overview
RESTRUCTURING ACTIVITIES AND CORPORATE REORGANIZATION
As part of our 2012 strategic review of our operations, we initiated the following restructuring activities during the first half of 2012: (1) we ceased originating real estate loans nationwide and in the United Kingdom effective January 1, 2012 to focus on our other lending products, which we believe have greater growth potential; (2) we also ceased personal lending and retail sales financing in 14 states where we do not have a significant presence; (3) we consolidated certain branch operations in 26 states; and (4) we closed 231 branch offices. As a result of these restructuring activities, our workforce was reduced by 820
Item 7. Continued
employees, and we incurred a pretax charge of $23.5 million during the first half of 2012. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for the components of this restructuring charge.
In mid-2012, SLFI took the initial steps to explore additional growth opportunities, including centralized online lending and strategic acquisitions of loan portfolios. SLFI created Springleaf Consumer Loan, Inc. (SCLI) for centralized online lending to customers out of the SLFC branch footprint. In addition to direct lending, SCLI has established certain strategic alliances with our state branch operating entities to provide online loan processing services for customers who are located in the geographic footprint of our branch network, but who prefer the convenience of interacting with us primarily online. Among other things, SCLI provides loan application processing and credit underwriting services on behalf of our branch offices for loan applications submitted through a centralized online or telephone application system that are within the branch footprint. SLFI also created Springleaf Acquisition Corporation (SAC) for potential portfolio and other acquisitions. Subsidiaries of SAC and certain third parties recently entered into an agreement to purchase and service a portfolio of real estate and personal loans. SCLI and SAC are not subsidiaries of SLFC.
In 2012, SLFI and SLFC realigned their internal structure related to the provision of certain administrative services. Historically, the employer for all of our employees has been Springleaf Finance Management Corporation (SFMC), a subsidiary of SLFC. SFMC provided management services for all of our companies, and also provided the employees who work in the branches for our state consumer lending entities. Because employees who work at our headquarters and certain other employees provide services to all of our entities, including subsidiaries of SLFI, in late 2012 we reassigned over 1,000 employees who provide those services from SFMC to a new management corporation (Springleaf General Services Corporation) (SGSC), a subsidiary of SLFI. Employees who work in the branches or primarily provide services to our branch system remain employees of SFMC. Most SLFI subsidiaries, including SFMC and the state consumer lending entities, have entered into a services agreement with SGSC for the provision of various centralized services, such as accounting, human resources, and information technology support. These services previously had been provided by SFMC.
This reassignment of employees and the intercompany agreements related to the structural realignment are not expected to result in a material increase in the costs and expenses that SLFC would have incurred had this reorganization not taken place. We expect to continue to focus on the consumer business segment which is the core of our present operations. SGSC is not a subsidiary of SLFC.
SALE OF FINANCE RECEIVABLES AND MORTGAGE BROKERAGE BUSINESS
On August 29, 2012, Ocean Money Limited (Ocean Money), and Ocean Money (II) Limited (Ocean Money (II)), wholly owned subsidiaries of Ocean and our indirect subsidiaries, sold their entire finance receivable portfolios totaling $103.1 million, which resulted in a gain of $6.3 million. On August 31, 2012, Ocean, Ocean Money, and Ocean Money (II) sold their mortgage brokerage business consisting of various intangible assets including supplier lists, records, sales, marketing and promotional material, the business pipeline, the client database and records, and the Ocean brand name, which resulted in a gain of $0.6 million. As a result of the sales of these assets, as well as our decision to cease loan originations in the United Kingdom, we recorded a loss of $4.6 million in the third quarter of 2012, which represented the full impairment of our United Kingdom customer lists intangible assets and wrote off $1.4 million of related fixed assets.
Item 7. Continued
SECURITIZATIONS
We completed the following securitization transactions during 2012:
2012-1 Securitization
On April 20, 2012, SLFC effected a private securitization transaction in which SLFC caused Eleventh Street Funding LLC (Eleventh Street), a special purpose vehicle wholly owned by SLFC, to sell $371.0 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-1 (the 2012-1 Trust), with a 4.38% weighted average yield, to certain investors. Eleventh Street sold the mortgage-backed notes for $367.8 million, after the price discount but before expenses. Eleventh Street initially retained $42.6 million of the 2012-1 Trust’s subordinate mortgage-backed notes.
2012-2 Securitization
On August 8, 2012, SLFC effected a private securitization transaction in which SLFC caused Twelfth Street Funding LLC (Twelfth Street), a special purpose vehicle wholly owned by SLFC, to sell $750.8 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-2 (the 2012-2 Trust), with a 3.59% weighted average yield, to certain investors. Twelfth Street sold the mortgage-backed notes for $749.7 million, after the price discount but before expenses. SLFC initially retained $107.7 million of the 2012-2 Trust’s subordinate mortgage-backed notes.
2012-3 Securitization
On October 25, 2012, SLFC effected a private securitization transaction in which SLFC caused Fourteenth Street Funding LLC (Fourteenth Street), a special purpose vehicle wholly owned by SLFC, to sell $787.4 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-3 (the 2012-3 Trust), with a 2.80% weighted average yield, to certain investors. Fourteenth Street sold the mortgage-backed notes for $787.2 million, after the price discount but before expenses. Fourteenth Street initially retained $112.3 million of the 2012-3 Trust’s subordinate mortgage-backed notes.
LEGAL SETTLEMENT
A lawsuit filed in 1996 against our South Carolina operating entity was settled on August 27, 2012, and final approval of the settlement was obtained on November 19, 2012. At December 31, 2012, the remaining reserve for this class action lawsuit totaled $3.5 million. Funds were distributed beginning in late December 2012. Aggregate settlement costs paid in 2012 totaled $30.3 million, which included $16.8 million paid to class members who made claims and $13.5 million in attorney fees and costs. In addition, we paid $3.5 million of unclaimed funds to South Carolina charities in February 2013. See Note 21 of the Notes to Consolidated Financial Statements in Item 8 for further information on this legal settlement.
2013 Developments and Outlook
CESSATION OF PURCHASES OF RETAIL SALES FINANCE RECEIVABLES
Effective January 16, 2013, we ceased purchasing retail sales finance receivables so that we could focus our lending efforts on personal loans.
Item 7. Continued
REPAYMENTS OF LONG-TERM DEBT
In January 2013, we repaid $498.9 million of long-term debt consisting of $431.6 million (345.2 million) of Euro denominated notes, $53.6 million of securitizations, and $13.7 million of retail notes.
SECURITIZATION
On February 19, 2013, SLFC effected a private securitization transaction in which SLFC caused Tenth Street Funding LLC (Tenth Street), a special purpose vehicle wholly owned by SLFC, to sell $567.9 million of notes backed by personal loans of Springleaf Funding Trust 2013-A (the 2013-A Trust), at a 2.83% weighted average yield, to certain investors. Tenth Street sold the asset-backed notes for $567.5 million, after the price discount but before expenses and a $6.6 million interest reserve requirement of the transaction. 2013-A Trust subordinate asset-backed notes totaling $36.4 million were initially retained by Tenth Street.
OUTLOOK
Assuming the U.S. economy performs in a relatively positive manner, we expect to maintain the favorable trends in credit quality of our personal loans and liquidating retail sales finance receivables that has been achieved during 2012. The improved credit quality of our consumer loan portfolio is the result of our collection efforts, tighter underwriting guidelines, and response to changing economic conditions as we focus on our personal loans to meet the growing demand for consumer credit. With our real estate loan portfolio liquidating, we anticipate our credit quality ratios for real estate loans will likely remain under pressure.
Item 7. Continued
Results of Operations
CONSOLIDATED RESULTS
See table below for our consolidated operating results. A further discussion of our operating results for each of our business segments is provided under “Segment Results.”
Item 7. Continued
Comparison of Consolidated Results for 2012 and 2011
Finance charges decreased due to the net of the following:
Average net receivables decreased in 2012 when compared to 2011 primarily due to the cessation of new originations of real estate loans as of January 1, 2012 and branch office closings during 2012, partially offset by an increase in personal loans average net receivables as we focus on consumer lending that we believe will provide higher returns and allow us to operate on a more cost-effective basis.
Yield decreased in 2012 when compared to 2011 primarily due to the increase in Troubled Debt Restructuring (TDR) finance receivables (which result in reduced finance charges reflecting the reductions to the interest rates on these TDR finance receivables) and lower accretion of the net discount applied to non-credit impaired personal loan and retail sales finance receivables, partially offset by a higher proportion of personal loans in our finance receivable portfolio, which have higher yields. As a result of the FCFI Transaction, we revalued our finance receivable portfolio based on its fair value on November 30, 2010, which had a greater impact on increasing our personal loan and retail sales finance yields in 2011 due to higher discount accretion. The decrease in yield in 2012 also reflected lower finance charges resulting from the out-of-period adjustment described below.
In the second quarter of 2012, we recorded an out-of-period adjustment, which decreased finance charge revenues by $13.9 million ($11.5 million of which related to 2011). The adjustment related to the correction of capitalized interest on purchased credit impaired finance receivables serviced by a third party. 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.
Interest expense decreased due to the following:
Average borrowings decreased in 2012 when compared to 2011 primarily due to liquidity management efforts, including debt maturities and repurchases in 2012 totaling $3.0 billion. Our interest rate decreased in 2012 when compared to 2011 primarily due to debt repurchases in 2012 resulting in lower accretion of net discount applied to long-term debt and three securitization transactions in 2012, which generally have lower interest rates. As a result of the FCFI Transaction, we revalued our long-term debt based on its fair value on November 30, 2010.
Item 7. Continued
Provision for finance receivable losses increased $5.3 million in 2012 when compared to 2011. While our overall net finance receivables declined by 10.1% and our delinquency and charge-off trends improved in 2012 when compared to 2011, we increased our allowance for finance receivable losses (through the provision for finance receivable losses) by $108.1 million. The increase in the allowance for finance receivable losses during 2012 reflected the additional allowance requirements on our finance receivables originated after the FCFI Transaction date and on our real estate loans deemed to be TDR finance receivables subsequent to the FCFI Transaction date. The allowance for finance receivables losses was eliminated as of November 30, 2010 with the application of push-down accounting as the allowance was incorporated in the new fair value basis of the finance receivables as of the FCFI Transaction date.
Other revenues decreased $43.3 million in 2012 when compared to 2011 primarily due to unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments and net loss on repurchases of debt in 2012, partially offset by foreign exchange transaction gains in 2012.
Salaries and benefits decreased $39.8 million in 2012 when compared to 2011 primarily due to having fewer employees in 2012 as a result of the restructuring activities during the first half of 2012.
Other operating expenses decreased $39.5 million in 2012 when compared to 2011 primarily due to fewer branch offices in 2012, lower amortization of other intangible assets resulting from the write off of Ocean trade names and customer relationships intangible assets in fourth quarter 2011 and Ocean customer lists intangible assets in third quarter 2012, lower professional services expenses, lower legal accruals, and lower real estate owned expenses, partially offset by additional expenses recorded in 2012 for refunds to Ocean customers relating to payment protection insurance.
We recorded restructuring expenses of $23.5 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability. However, there can be no assurance that these efforts alone will be effective in restructuring the Company to profitable operations. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for further information on the restructuring expenses.
Comparison of Consolidated Results for 2011 and Eleven Months Ended November 30, 2010
Finance charges increased due to the net of the following:
________________
* Total change for the year ended December 31, 2011 (Successor Company) is compared to eleven months ended November 30, 2010 (Predecessor Company).
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 343 basis points in 2011. 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.
Item 7. Continued
Interest expense increased due to the net of the following:
___________________
* Total change for the year ended December 31, 2011 (Successor Company) is compared to eleven months ended November 30, 2010 (Predecessor Company).
Our interest 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 our interest rate by 290 basis points in 2011. 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.
Provision for finance receivable losses decreased $112.0 million in 2011 when compared to eleven months ended November 30, 2010. The 2011 provision for finance receivable losses reflected the requirements for allowance for finance receivable losses under the application of push-down accounting as of the FCFI Transaction date compared to the historical accounting basis for the eleven months ended November 30, 2010. The two bases of accounting are not comparable. The 2011 provision for finance receivable losses primarily reflected the establishment of new allowance requirements for newly originated finance receivables and for additional allowance requirements for real estate loans deemed to be TDR finance receivables after the FCFI Transaction date. The allowance for finance receivables losses was eliminated as of November 30, 2010 with the application of push-down accounting as the allowance was incorporated in the new fair value basis of the finance receivables as of the FCFI Transaction date. The provision for finance receivable losses for the eleven months ended November 30, 2010 reflected an overall reduction of allowance for finance receivables of 8.7%, compared to a reduction in our net finance receivables of 8.4%, as well as improved delinquency and charge-off trends for the period.
Other revenues decreased $93.1 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to an unfavorable variance in foreign exchange gains on Euro denominated debt and higher writedowns on real estate owned and net losses on sales of real estate owned reflecting the fragile U.S. residential real estate market.
Salaries and benefits decreased $30.5 million 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.
Other operating expenses increased $39.8 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to one more month in the 2011 period, 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 accruals and lower administrative expenses allocated from our former indirect parent.
Item 7. Continued
Reconciliation of Net Income (Loss) on Push-Down Accounting Basis to Historical Accounting Basis
Due to the nature of the FCFI Transaction, we applied push-down accounting to SLFC. The reconciliations of net income (loss) on a push-down accounting basis to our historical accounting basis (which is a basis of accounting other than U.S. GAAP that we believe provides a consistent basis for both management and other interested third parties to better understand our operating results) were as follows:
___________________
(a) Finance charge adjustments consist of: (1) the accretion of the net discount applied to non-credit impaired net finance receivables to revalue the non-credit impaired net finance receivables to their fair value at the date of the FCFI transaction using the interest method over the remaining life of the related net finance receivables; (2) the difference in finance charges earned on our pools of credit impaired net finance receivables under a level rate of return over the expected lives of the underlying pools of credit impaired finance receivables net of the finance charges earned on these finance receivables under historical accounting basis; and (3) the elimination of the accretion or amortization of historical unearned points and fees, deferred origination costs, premiums, and discounts.
Components of finance charge adjustments consisted of:
Item 7. Continued
(b) Interest expense adjustments consist of: (1) the accretion of the net discount applied to long-term debt to revalue the debt securities to their fair value at the date of the FCFI transaction using the interest method over the remaining life of the related debt securities; and (2) the elimination of the accretion or amortization of historical discounts, premiums, commissions, and fees.
Components of interest expense adjustments were as follows:
(c) Provision for finance receivable losses consists of the allowance for finance receivable losses adjustments and net charge-offs quantified in the table below. Allowance for finance receivable losses adjustments reflects the net difference between our allowance adjustment requirements calculated under our historical accounting basis net of adjustments required under push-down accounting basis utilizing our methodologies described in Note 7 of the Notes to Consolidated Financial Statements in Item 8. Net charge-offs reflects the net charge off of loans at a higher carrying value under historical accounting basis versus the discounted basis to their fair value at date of the FCFI Transaction under push-down accounting basis.
Components of provision for finance receivable losses adjustments were as follows:
(d) Repurchases of long-term debt adjustments reflect the net loss on acceleration of the accretion of the net discount applied to long-term debt.
(e) Amortization of other intangible assets reflects the amortization over the remaining estimated life of intangible assets established at the date of the FCFI transaction as a result of the application of push-down accounting.
(f) Benefit from income taxes reflects the net tax impact of the net pretax impact of the other reconciling items between push-down accounting and historical accounting basis.
(g) Bargain purchase gain reflects the gain realized under push-down accounting resulting from the net difference between the fair value of assets acquired and fair value of liabilities assumed less the fair value of consideration transferred that was allocated to SLFC as of the date of the FCFI Transaction.
(h) “Other” items reflects less significant differences between historical accounting basis and push-down accounting basis relating to various items such as the elimination of deferred charges, adjustments to the basis of other real estate assets, fair
Item 7. Continued
value adjustments to fixed assets, adjustments to insurance claims and policyholder liabilities, and various other differences all as of the date of the FCFI Transaction.
Segment Overview
Prior to our 2012 restructuring initiatives and further refinement of our business strategy, we had three business segments: branch, centralized real estate, and insurance, which were defined by the types of financial service products we offered, the nature of our production processes, and the methods we used to distribute our products and to provide our services, as well as our management reporting structure.
At December 31, 2012, our three business segments include: consumer, insurance, and real estate. These business segments evolved primarily from management’s redefined business strategy, including its decision to cease real estate lending effective January 1, 2012 and to shift its focus to consumer loan products which we believe have significant prospects for growth and business development due to the strong demand in our target market of nonprime borrowers. We have redefined our segments to coincide with how our businesses are currently managed. As of December 31, 2012, our revised business segments include the following:
· Consumer Business Segment. We originate and service personal loans (secured and unsecured) in 26 states, which are our core operating states.
· 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 consumer and real estate business segments offer to its customers. We also offer non-credit insurance and ancillary products.
· Real Estate Business Segment. We service and hold real estate loans secured by first or second mortgages on residential real estate. Real estate loans previously originated through our branch offices are either serviced by our branch personnel or centrally serviced at our Evansville, Indiana location or other specialized servicing centers. Real estate loans previously acquired or originated through centralized distribution channels are serviced by MorEquity, a wholly-owned subsidiary of SLFC, all of which are subserviced by Nationstar, except for certain securitized real estate loans, which are serviced and subserviced by third parties. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar. As a result of the cessation of real estate lending effective January 1, 2012, all of our real estate loans are in a liquidating status.
The remaining components (which we refer to as “Other”) consist of our non-core and non-originating legacy operations, which are isolated by geographic market and/or distribution channel from our prospective core operations. These operations include our legacy operations in 14 states where we have also ceased personal lending and retail sales financing as a result of our restructuring activities during the first half of 2012, our liquidating retail sales finance portfolio (including our retail sales finance accounts from our dedicated auto finance operation), our lending operations in Puerto Rico and the U.S. Virgin Islands, and Ocean.
Our revised business segment reporting allows management to better track and understand the Company’s performance, assess prospects for future net cash flows, isolate and evaluate core, growth operations versus non-core liquidating operations, and make more informed judgments about our operations as a whole.
Item 7. Continued
Due to the nature of the FCFI Transaction (as described in Note 5 of the Notes to Consolidated Financial Statements in Item 8), we applied push-down accounting to SLFC. However, we continue to report our segment results using the same accounting basis that we employed prior to the FCFI Transaction, which we refer to as “historical accounting basis,” to provide a consistent basis for both management and other interested third parties to better understand our operating results. The historical accounting basis (which is a basis of accounting other than U.S. GAAP) also provides better comparability of our operating results to our competitors and other companies in the financial services industry. See Note 24 of the Notes to Consolidated Financial Statements in Item 8 for reconciliations of segment totals to consolidated financial statement amounts.
We allocate revenues and expenses (on a historical accounting basis) to each segment using the following methodologies:
Finance charges
Directly correlated with a specific segment.
Interest expense
Disaggregated into three categories based on the underlying debt that the expense pertains to: (1) securitizations, (2) secured term loan, and (3) unsecured debt. Securitizations and the secured term loan are allocated to the segments whose finance receivables serve as the collateral securing each of the respective debt instruments. The unsecured debt is allocated to the segments based on the remaining balance of debt by segment.
Provision for finance
receivable losses
Directly correlated with a specific segment except for allocations to “other,” which are based on the remaining delinquent accounts as a percentage of total delinquent accounts.
Insurance revenues
Directly correlated with a specific segment.
Investment revenues
Directly correlated with a specific segment.
Other revenues
Directly correlated with a specific segment except for gains and losses on foreign currency exchange, debt repurchases, and derivatives. These items are allocated to the segments based on the interest expense allocation of unsecured debt.
Salaries and benefits
Directly correlated with a specific segment. Salaries and benefits not directly correlated with a specific segment are allocated to each of the segments based on services provided.
Other operating
expenses
Directly correlated with a specific segment. Other operating expenses not directly correlated with a specific segment are allocated to each of the segments based on services provided.
Insurance losses and
loss adjustment
expenses
Directly correlated with a specific segment.
Item 7. Continued
SEGMENT RESULTS
We evaluate the performance of each of our business segments based on its pretax operating earnings, which are presented below. Due to the changes in the composition of our previously reported business segments, we have restated the corresponding segment information presented in the following tables for the prior year periods. The pretax operating results for each business segment presented below are also disclosed in Note 24 of the Notes to the Consolidated Financial Statements in Item 8 for each period included on our consolidated statement of operations.
Consumer Business Segment
Pretax operating results of the consumer business segment (which are reported on a historical accounting basis) were as follows:
Item 7. Continued
Selected financial statistics for the consumer business segment’s personal loans (which are reported on a historical accounting basis) were as follows:
Comparison of Pretax Operating Results for 2012 and 2011
Finance charges increased $50.2 million in 2012 when compared to 2011 primarily due to increases in yield and average net receivables. Average net receivables increased in 2012 when compared to 2011 as we focused on consumer lending that we believe will provide higher returns and allow us to operate on a more cost-effective basis.
Interest expense increased $16.2 million in 2012 when compared to 2011 primarily due to higher unsecured debt interest expense allocated to the consumer business segment reflecting the higher proportion of personal loans allocated to SLFC’s unsecured debt. The consumer business segment did not have any interest expense allocations from securitizations since its personal loans were not previously utilized in our securitization transactions.
Provision for finance receivable losses increased $82.0 million in 2012 when compared to 2011 primarily due to increasing the allowance for finance receivables losses in 2012 versus recording an allowance reduction in 2011. While the delinquency and charge-off trends of our personal loans improved in 2012 over 2011, we increased our allowance for finance receivable losses during 2012 due to 5.4% growth in these finance receivables during 2012.
Intersegment insurance commissions represent the commissions allocated from the insurance business segment for insurance products sold. Our consumer lending specialists also offer insurance and ancillary products to our branch customers. Intersegment insurance commissions increased $4.9 million in 2012 when compared to 2011 due to higher insurance premiums written on personal loans reflecting the increase in originations of personal loans in 2012.
Other revenues increased $13.1 million in 2012 when compared to 2011 primarily due to foreign exchange transaction gains in 2012, curtailment gain in 2012 as a result of our pension plan freeze, and net gain on repurchases of debt in 2012, partially offset by unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments.
Item 7. Continued
Salaries and benefits decreased $14.3 million in 2012 when compared to 2011 primarily due to having fewer employees in 2012 as a result of the restructuring activities during the first half of 2012.
Other operating expenses decreased $26.9 million in 2012 when compared to 2011 primarily due to fewer branch offices in 2012, lower professional services expenses, and lower legal accruals.
We recorded restructuring expenses of $15.6 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability.
Comparison of Pretax Operating Results for 2011 and 2010
Finance charges decreased $14.0 million in 2011 when compared to 2010 primarily due to a decrease in average net receivables, partially offset by an increase in yield. Average net receivables decreased in 2011 when compared to 2010 reflecting our tighter underwriting guidelines and liquidity management efforts.
Interest expense decreased $18.8 million in 2011 when compared to 2010 primarily due to lower secured term loan interest expense allocated to the consumer business segment reflecting the lower proportion of personal loans allocated to SLFC’s secured term loan.
Provision for finance receivable losses decreased $105.0 million in 2011 when compared to 2010 primarily due to lower required allowance for finance receivables losses. As discussed under “Critical Accounting Estimates - Allowance for Finance Receivable Losses,” effective September 30, 2011, we switched from a migration analysis to a roll rate-based model for purposes of computing our allowance for finance receivables losses for our personal loans. There was no requirement for further increase to our allowance for finance receivables losses under the new roll rate analysis and after consideration of the improved delinquency and charge-off trends of our personal loans in 2011 when compared to 2010.
Intersegment insurance commissions increased $7.6 million in 2011 when compared to 2010 due to higher insurance premiums written on personal loans reflecting higher originations of personal loans in 2011.
Other revenues decreased $7.9 million in 2011 when compared to 2010 primarily due to unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments.
Salaries and benefits decreased $31.8 million in 2011 when compared to 2010 primarily due to lower medical claims and premiums paid by the Company in 2011 and fewer employees.
Other operating expenses decreased $10.1 million in 2011 when compared to 2010 primarily due to lower legal accruals and lower administrative expenses allocated from our former indirect parent, partially offset by higher professional services expenses and higher advertising expenses.
Item 7. Continued
Insurance Business Segment
Pretax operating results of the insurance business segment (which are reported on a historical accounting basis) were as follows:
Selected financial statistics for the insurance business segment (which are reported on a historical accounting basis) were as follows:
Comparison of Pretax Operating Results for 2012 and 2011
Insurance revenues increased $6.0 million in 2012 when compared to 2011 primarily due to increases in credit earned premiums reflecting higher originations of personal loans in 2012, partially offset by a decrease in premiums assumed under reinsurance agreements.
Item 7. Continued
Investment revenues decreased $5.9 million in 2012 when compared to 2011 primarily due to decreases in average invested assets and average invested asset yield, partially offset by a favorable variance in net realized gains (losses) on investment securities.
Other revenues increased $2.2 million in 2012 when compared to 2011 primarily due to higher agency administrative income reflecting an increase in insurance products sold.
We recorded restructuring expenses of $0.2 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability.
Insurance losses and loss adjustment expenses increased $17.7 million in 2012 when compared to 2011 primarily due to an unfavorable variance in change in benefit reserves. In the second quarter of 2011, we recorded an out-of-period adjustment related to prior periods, which decreased change in benefit reserves by $14.2 million for 2011. This adjustment related to the correction of a benefit reserve error related to a closed block of annuities.
Intersegment insurance commissions represent the commissions allocated to the consumer and real estate business segments for insurance products sold. Our consumer lending specialists also offer insurance and ancillary products to our branch customers. Intersegment insurance commissions decreased $3.6 million in 2012 when compared to 2011 due to lower insurance premiums written on real estate loans reflecting the cessation of new originations of real estate loans as of January 1, 2012, partially offset by higher insurance premiums written on personal loans reflecting higher originations of personal loans in 2012. We include intersegment insurance commissions in other revenues of our insurance business segment in Note 24 of the Notes to Consolidated Financial Statements in Item 8 in order to reconcile our segment totals to consolidated financial statement amounts.
Comparison of Pretax Operating Results for 2011 and 2010
Insurance revenues decreased $4.4 million in 2011 when compared to 2010 primarily due to decreases in credit earned premiums reflecting lower finance receivable originations in prior years.
Investment revenues increased $4.5 million in 2011 when compared to 2010 primarily due to lower net realized losses on investment securities, partially offset by a decrease in average invested asset yield.
Insurance losses and loss adjustment expenses decreased $3.9 million in 2011 when compared to 2010 primarily due to lower claims incurred in 2011.
Intersegment insurance commissions increased $7.5 million in 2011 when compared to 2010 primarily due to higher insurance premiums written on personal loans reflecting higher originations of personal loans in 2011.
Item 7. Continued
Real Estate Business Segment
Pretax operating results of the real estate business segment (which are reported on a historical accounting basis) were as follows:
Selected financial statistics for the real estate business segment (which are reported on a historical accounting basis) were as follows:
Item 7. Continued
Comparison of Pretax Operating Results for 2012 and 2011
Finance charges decreased $115.4 million in 2012 when compared to 2011 primarily due to decreases in average net receivables and yield. Average net receivables decreased in 2012 when compared to 2011 primarily due to the cessation of new originations of real estate loans as of January 1, 2012.
Interest expense decreased $80.3 million in 2012 when compared to 2011 primarily due to lower unsecured debt interest expense allocated to the real estate business segment. The lower proportion of real estate loans allocated to SLFC’s unsecured debt reflected the real estate business segment’s utilization of three securitization transactions in 2012.
Provision for finance receivable losses decreased $196.4 million in 2012 when compared to 2011 due to lower required allowance for finance receivable losses in response to the 10.8% decline in our real estate loans during 2012 and the improved delinquency and charge-off trends of these finance receivables. As discussed under “Critical Accounting Estimates - Allowance for Finance Receivable Losses,” effective September 30, 2012, we switched from a migration analysis to a roll rate-based model for purposes of computing our allowance for finance receivables losses for our real estate loans. There was no requirement for further increase to our allowance for finance receivable losses under the new roll rate analysis and after consideration of the improved delinquency and charge-off trends of our real estate loans in 2012 when compared to 2011 and the decline in these finance receivables during 2012.
Intersegment insurance commissions represent the commissions allocated from the insurance business segment for insurance products sold. Previously, our real estate lending specialists offered insurance and ancillary products to our branch customers. Intersegment insurance commissions decreased $4.6 million in 2012 when compared to 2011 due to lower insurance premiums written on real estate loans reflecting the cessation of new originations of real estate loans as of January 1, 2012.
Other revenues increased $4.1 million in 2012 when compared to 2011 primarily due to foreign exchange transaction gains and net gain on repurchases of debt in 2012, partially offset by unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments. Writedowns on real estate owned and net losses on sales of real estate owned in 2012 when compared to 2011 remained relatively flat.
Other operating expenses decreased $23.9 million in 2012 when compared to 2011 primarily due to fewer branch offices in 2012 and lower real estate owned expenses.
We recorded restructuring expenses of $0.8 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability.
Comparison of Pretax Operating Results for 2011 and 2010
Finance charges decreased $112.5 million in 2011 when compared to 2010 primarily due to a decrease in average net receivables, partially offset by a slight increase in yield. Average net receivables decreased in 2011 when compared to 2010 primarily due to our tighter underwriting guidelines and liquidity management efforts.
Interest expense decreased $105.9 million in 2011 when compared to 2010 primarily due to lower unsecured debt interest expense allocated to the real estate business segment reflecting the lower proportion of real estate loans allocated to SLFC’s unsecured debt, partially offset by higher secured term loan interest expense allocated to the real estate business segment reflecting the high proportion of real estate loans allocated to SLFC’s secured term loan.
Item 7. Continued
Provision for finance receivable losses decreased $72.9 million in 2011 when compared to 2010 primarily due to lower required allowance for finance receivable losses in response to the 10.9% decline in our real estate loans during 2011.
Other revenues decreased $110.0 million in 2011 when compared to 2010 primarily due to unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments and higher writedowns on real estate owned and net losses on sales of real estate owned.
Salaries and benefits decreased $19.9 million in 2011 when compared to 2010 primarily due to lower medical claims and premiums paid by the Company in 2011 and fewer employees.
Other operating expenses decreased $14.2 million in 2011 when compared to 2010 primarily due to lower professional services expenses, lower administrative expenses allocated from our former indirect parent, and lower real estate owned expenses.
Other
“Other” consists of our non-core and non-originating legacy operations, which are isolated by geographic market and/or distribution channel from our prospective core operations. These operations include our legacy operations in 14 states where we have also ceased personal lending and retail sales financing as a result of our restructuring activities during the first half of 2012, our liquidating retail sales finance portfolio (including our retail sales finance accounts from our dedicated auto finance operation), our lending operations in Puerto Rico and the U.S. Virgin Islands, and Ocean.
Item 7. Continued
Pretax operating results of the other components (which are reported on a historical accounting basis) were as follows:
Net finance receivables of the other components (which are reported on a historical accounting basis) were as follows:
Item 7. Continued
Balance Sheet
FINANCE RECEIVABLES
Amount of net finance receivables (on a historical accounting basis and on a push-down accounting basis) by type and number of net finance receivables by type were as follows:
*
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. 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 purchased credit impaired finance receivables.
The amount of first mortgage loans was 94% of our real estate loan net receivables at December 31, 2012 and 92% at December 31, 2011 (on a historical accounting basis).
Item 7. Continued
Amount and number of net finance receivables originated and renewed by type were as follows:
We record originations and renewals of net finance receivables at their unpaid principal balance; therefore, finance receivables originated and renewed on a historical accounting basis equals the push-down accounting basis.
See Note 8 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.
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.
Item 7. Continued
REAL ESTATE OWNED
Amount and number of real estate owned were as follows:
Real estate owned on a historical accounting basis equals the push-down accounting basis at December 31, 2011 and 2012 because all of our real estate owned that were previously marked to fair value were sold prior to December 31, 2011. The decrease in real estate owned at December 31, 2012 when compared to December 31, 2011 reflected an increase in real estate loan modifications due to management’s efforts to reduce credit losses, the cessation of real estate lending effective January 1, 2012, and a change in our assumptions with respect to estimating the initial fair value of real estate owned, which better approximates the fair value less the estimated cost to sell.
See Note 2 of the Notes to Consolidated Financial Statements in Item 8 for information relating to our accounting policy for real estate owned.
Item 7. Continued
LONG-TERM DEBT
Long-term debt by type of debt (on a historical accounting basis and on a push-down accounting basis) was as follows:
* As a result of the FCFI Transaction, we applied push-down accounting and adjusted the carrying value of our long-term debt to its fair value on November 30, 2010. Subsequent to the FCFI Transaction, we accrete the amount required to adjust the fair value of our long-term debt using the interest method over the remaining life of the long-term debt.
ASSET/LIABILITY MANAGEMENT
To reduce the risk associated with unfavorable changes in interest rates on our debt not offset by favorable changes in yield of our finance receivables, we monitor the anticipated cash flows of our assets and liabilities, principally our finance receivables and debt. We have funded finance receivables with a combination of fixed-rate and floating-rate debt and equity and 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 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 31% of our borrowings at December 31, 2012 and 2011 (on a historical accounting basis). Adjustable-rate net finance receivables represented 5% of our real estate loans at December 31, 2012 and 2011 (on a historical accounting basis).
Item 7. Continued
Credit Quality
Our 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. 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 finance receivables, personal circumstances and national, regional, and local economic situations affect our customers’ ability or willingness to repay their obligations. The risk characteristics of each finance receivable type include the following:
Personal 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.
CREDIT QUALITY INDICATORS
We consider the delinquency status and nonperforming status of the finance receivable as our credit quality indicators. We monitor delinquency trends to manage our exposure to credit risk. We consider finance receivables 60 days or more past due as delinquent and consider the likelihood of collection to decrease at such time. We also monitor finance receivable performance trends to evaluate the potential risk of future credit losses. At 90 days or more past due, we consider our finance receivables to be nonperforming. Once the finance receivables are considered as nonperforming, we consider them to be at increased risk for credit loss. See Note 6 of the Notes to Consolidated Financial Statements for quantitative information on our credit quality indicators.
CONSUMER CREDIT RISK 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.
Item 7. Continued
We present below our net finance receivables, purchased credit impaired finance receivables, and corresponding delinquency ratios grouped into the following categories based solely on borrower Fair Isaac Corporation (FICO) credit scores at the date of origination or renewal:
· Prime: Borrower FICO score greater than or equal to 660
· Non-prime: Borrower FICO score of 620 through 659
· Sub-prime: Borrower FICO score less than or equal to 619
Finance Receivables
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 type on a historical accounting basis and reconciled to the consolidated financial statement amounts were as follows:
(a) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
(b) “Other” includes net finance receivables of our foreign subsidiary, Ocean, at December 31, 2011. The Ocean finance receivables were sold in the third quarter of 2012.
Item 7. Continued
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios (60 days or more past due) by finance receivable type (historical accounting basis equals the push-down accounting basis) were as follows:
(a) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
(b) “Other” includes net finance receivables of our foreign subsidiary, Ocean, at December 31, 2011. The Ocean finance receivables were sold in the third quarter of 2012.
Item 7. Continued
Purchased Credit Impaired Finance Receivables
FICO-delineated prime, non-prime, and sub-prime categories for purchased credit impaired finance receivables (which equal the consolidated amounts) are presented below on a push-down accounting basis because these real estate loans were not designated as purchased credit impaired finance receivables prior to the FCFI Transaction.
* To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
Item 7. Continued
FICO-delineated prime, non-prime, and sub-prime categories for delinquency ratios for purchased credit impaired finance receivables (which equal the consolidated ratios) are presented below on a push-down accounting basis because these real estate loans were not designated as purchased credit impaired finance receivables prior to the FCFI Transaction.
* To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
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.
Item 7. Continued
Additional information regarding these higher-risk real estate loans is presented below on a historical accounting basis. (Our higher-risk real estate loans can be included in more than one of the types of higher-risk real estate loans.)
(a) Not available.
(b) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
We held the first mortgage of borrowers on 4% of our second mortgage portfolio (on a historical accounting basis) at December 31, 2012 and 2011. 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, 2012 and 2011, 90% of our second mortgages (on a historical accounting basis) were fixed-rate. At December 31, 2012 and 2011, 62% of our second mortgages (on a historical accounting basis) were open-end home equity lines of credit. The maximum draw period for cash advances for unused credit lines is 120 months. Unused home equity lines of credit can be terminated for delinquency. Unused lines of credit can be suspended if the value of the real estate declines significantly below the property’s initial appraised value or if we believe the borrower will be unable to fulfill the repayment obligations because of a material change in the borrower’s financial circumstances, or for any other material default.
Item 7. Continued
Charge-off ratios for these higher-risk real estate loans on a historical accounting basis were as follows:
Year Ended December 31,
Charge-off ratios:
Real estate higher-risk loans*:
Interest only
3.19 %
3.17 %
3.48 %
Sub-prime
1.97 %
3.36 %
3.64 %
Second mortgages
5.68 %
7.37 %
9.72 %
LTV greater than 95.5% at origination
2.56 %
2.43 %
2.65 %
Low documentation
1.70 %
1.80 %
1.87 %
* To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in prior years due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
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 (on a historical accounting basis) for which the estimated LTV ratio exceeds 100% at December 31, 2012 was $2.8 billion, or 27%, of total real estate loans. We update collateral valuations quarterly 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.
Liquidity and Capital Resources
RISKS AND UNCERTAINTIES RELATED TO LIQUIDITY AND CAPITAL RESOURCES
We currently have a significant amount of indebtedness in relation to our equity. SLFC’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 and cost to refinance our indebtedness.
Item 7. Continued
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 liquidation and related losses within our real estate portfolio could be substantial and result in reduced cash receipts;
· our inability to grow our consumer loan portfolio with adequate profitability to fund operations, loan losses, and other expenses;
· our inability to monetize assets including, but not limited to, our access to debt and securitization markets and our note receivable from parent;
· the effect of federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Act (which, among other things, established the 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 increasing costs and difficulty in servicing 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 real estate loans that were originated or acquired centrally;
· potential liability relating to real estate and personal 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; and
· the potential effect on us if the capital levels of our regulated and unregulated subsidiaries prove inadequate to support current business plans.
At December 31, 2012, we had $1.4 billion of cash and cash equivalents and in 2012 we generated a net loss of $220.7 million and net cash inflow from operating and investing activities of $1.6 billion. At December 31, 2012, our scheduled principal and interest payments for 2013 on our existing debt (excluding securitizations) totaled $2.1 billion, of which $445.2 million (excluding securitizations) has been repaid in January 2013. As of December 31, 2012, we had unpaid principal balances of $2.0 billion of unencumbered personal loans and $609.7 million of unencumbered real estate loans. In addition, SLFC may demand payment of some or all of its note receivable from SLFI ($538.0 million outstanding at December 31, 2012); however, SLFC does not anticipate the need for additional liquidity during 2013 and does not expect to demand payment from SLFI in 2013.
Based on our estimates and taking into account the risks and uncertainties of our plans, we believe that we will have adequate liquidity to finance and operate our businesses and repay our obligations as they become due during the next twelve months.
It is possible that the actual outcome of one or more of our plans could be materially different than we expect 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 and such actual results could materially adversely affect us.
Item 7. Continued
LIQUIDITY
Operating Activities
Cash from operations increased $69.8 million in 2012 when compared to 2011 primarily due to lower salaries and benefits and other operating expenses reflecting fewer employees and branch offices in 2012 due to the restructuring activities during the first half of 2012, as well as higher net interest income.
Cash from operations decreased $162.9 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to lower net interest income.
Investing Activities
Cash from investing activities increased $13.2 million in 2012 when compared to 2011 primarily due to an increase in proceeds from sales of finance receivables held for sale and net sales of investment securities combined with restrictions on cash due to three securitization transactions during 2012 and the modification of the secured term loan in 2011.
Cash from investing activities decreased $1.8 billion in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the repayment of a demand promissory note receivable from AIG in the first quarter of 2010.
Financing Activities
Net cash used for financing activities decreased $1.7 billion in 2012 when compared to 2011 primarily due to higher amounts of long-term debt repayments in 2011.
Net cash used for financing activities decreased $828.4 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to less net repayments of short-term and long-term debt in 2011 compared to the eleven months ended November 30, 2010.
Liquidity Strategies
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 and possible new issuances and/or debt refinancing transactions), or a combination of the foregoing, and we are considering finance receivable portfolio sales; and
· purchasing 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.
Item 7. Continued
CAPITAL RESOURCES
The debt agreements to which SLFC and its subsidiaries are a party include customary 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.
With the exception of SLFC's hybrid debt, none of our debt agreements require SLFC or any of its subsidiaries 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, 2012, we were in compliance with all of the covenants under our debt agreements.
Secured Term Loan
Springleaf Financial Funding Company, a wholly-owned subsidiary of SLFC, is party to a $3.75 billion, six-year secured 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.
Hybrid Debt
Following our acquisition of Ocean in January 2007, SLFC issued $350.0 million aggregate principal amount of 60-year junior subordinated debentures. 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.
Under our 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, 2012, a mandatory trigger event occurred under SLFC’s hybrid debt with respect to the hybrid debt’s semi-annual payment due in January 2013 due to the average fixed charge ratio being 0.74x (while the tangible equity to tangible managed assets ratio was 8.72%). During January 2013, SLFC received from SLFI the non-debt
Item 7. Continued
capital funding necessary to satisfy, and subsequently paid, the January 2013 interest payments required by SLFC’s hybrid debt.
Contractual Obligations
At December 31, 2012, material obligations were as follows:
(a) On-balance sheet securitizations are not included in maturities by period 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, 2012.
(c) Operating leases include annual rental commitments for leased office space, automobiles, and data processing and related equipment.
In January 2013, we repaid $498.9 million of long-term debt consisting of $431.6 million (345.2 million) of Euro denominated notes, $53.6 million of securitizations, and $13.7 million of retail notes.
On February 19, 2013, SLFC effected a private securitization transaction in which SLFC caused Tenth Street, a special purpose vehicle wholly owned by SLFC, to sell $567.9 million of notes backed by personal loans of the 2013-A Trust, at a 2.83% weighted average yield, to certain investors. Tenth Street sold the asset-backed notes for $567.5 million, after the price discount but before expenses and a $6.6 million interest reserve requirement of the transaction. 2013-A Trust subordinate asset-backed notes totaling $36.4 million were initially retained by Tenth Street.
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 variable interest entities (VIEs) at December 31, 2012 or 2011.
Item 7. Continued
Critical Accounting Policies and Estimates
We consider the following policies 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;
· purchased credit impaired finance receivables;
· TDR finance receivables;
· push-down accounting; and
· fair value measurements.
See Note 2 of the Notes to Consolidated Financial Statements in Item 8 for a discussion of these accounting policies and Note 5 of the Notes to Consolidated Financial Statements in Item 8 for information on the FCFI transaction.
We believe the amount of the allowance for finance receivable losses is the most significant estimate we make. See “Allowance for Finance Receivable Losses” below for further discussion of the models and assumptions used to assess the adequacy of the allowance for finance receivable losses.
ALLOWANCE FOR FINANCE RECEIVABLE LOSSES
Effective September 30, 2012, we base our allowance for finance receivable losses primarily on historical loss experience using a roll rate-based model applied to our retail sales finance and real estate loan portfolios. (Effective September 30, 2011, we switched from the migration analysis to the roll rate-based model for our personal loans.) In our roll rate-based model, our finance receivable types are 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 our finance receivable types 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 (the interval of time between the event which causes a borrower to default on a finance receivable and our recording of the charge-off) for our finance receivable types. As delinquency is a primary input into our roll rate-based model, we inherently consider nonaccrual loans in our estimate of the allowance for finance receivable losses.
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 roll rate-based model. Our roll rate-based 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.
Management exercises its judgment, based on quantitative analyses, qualitative factors, and experience in the consumer finance industry, when determining the amount of the allowance for finance receivable losses. We adjust the amounts determined by the roll rate-based model 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. We charge or credit this adjustment to expense through the provision for finance receivable losses.
We based our allowance for finance receivable losses primarily on historical loss experience using migration analysis prior to September 30, 2012 for our retail sales finance and real estate loan portfolios
Item 7. Continued
and prior to September 30, 2011 for our personal loans. Our migration analysis utilized a rolling 12 months of historical data that was updated quarterly for our real estate loan and retail sales finance receivable portfolio. The primary inputs for our migration analysis were (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 were the weighting of historical data and our estimate of the loss emergence period for the portfolio.
We adopted the roll rate-based model because we believe it captures portfolio trends at a more detailed level. The overall results of switching from the migration analysis to the roll rate-based model for our real estate loan and retail sales finance receivable portfolios in the third quarter of 2012 and for our personal loans the third quarter of 2011 were not material.
Recent Accounting Pronouncements
See Note 3 of the Notes to Consolidated Financial Statements in Item 8 for discussion of recently issued accounting pronouncements.
Item 7. Continued
Glossary of Terms
Average borrowings
average of debt for each day in the period
Average net receivables
average of net finance receivables at the beginning and end of each month in the period
Charge-off ratio
annualized net charge-offs as a percentage of the average of net finance receivables at the beginning of each month in the period
Delinquency ratio
unpaid principal balance 60 days or more past due (greater than three payments unpaid) as a percentage of unpaid principal balance
Hybrid debt
capital securities classified as debt for accounting purposes but due to their terms are afforded, at least in part, equity capital treatment in the calculation of effective leverage by rating agencies
Interest rate
annualized interest expense as a percentage of average borrowings
Loss ratio
annualized net charge-offs, net writedowns on real estate owned, net loss on sales of real estate owned, and operating expenses related to real estate owned as a percentage of the average of real estate loans at the beginning of each month in the period
Net interest income
total interest income less total interest expense
Tangible equity
total equity less accumulated other comprehensive income or loss
Yield
annualized finance charges as a percentage of average net receivables
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:
* Not meaningful since front end treasury rates were well below 100 basis points at December 31, 2012.
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 Corporation
In our opinion, the accompanying consolidated balance sheets as of December 31, 2012 and 2011 and the related consolidated statements of operations, comprehensive income (loss), shareholder’s equity, and cash flows for the years ended December 31, 2012 and 2011 and the one month ended December 31, 2010 present fairly, in all material respects, the financial position of Springleaf Finance Corporation and its subsidiaries (Successor Company) at December 31, 2012 and 2011 and the results of their operations and their cash flows for the years ended December 31, 2012 and 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 years ended December 31, 2012 and 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 18, 2013
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholder
of Springleaf Finance Corporation
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 present fairly, in all material respects, the results of Springleaf Finance Corporation and its subsidiaries (formerly American General Finance Corporation, 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 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 30, 2011
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
See Notes to Consolidated Financial Statements.
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
See Notes to Consolidated Financial Statements.
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
See Notes to Consolidated Financial Statements.
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholder’s Equity
See Notes to Consolidated Financial Statements.
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Consolidated Statements of Cash Flows (Continued)
See Notes to Consolidated Financial Statements.
SPRINGLEAF FINANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2012
1. Nature of Operations
Springleaf Finance Corporation (SLFC or, collectively with its subsidiaries, whether directly or indirectly owned, the Company, we, us, or our) is a wholly-owned subsidiary of Springleaf Finance, Inc. (SLFI).
On November 30, 2010, FCFI Acquisition LLC (FCFI), an affiliate of Fortress Investment Group LLC (Fortress), indirectly acquired an 80% economic interest in SLFI from AIG Capital Corporation (ACC), a direct wholly-owned subsidiary of American International Group, Inc. (AIG) (the FCFI Transaction). AIG, through ACC, indirectly retained a 20% economic interest in SLFI. See Note 5 for further information on the FCFI Transaction.
SLFC is a financial services holding company with subsidiaries engaged in the consumer finance and credit insurance businesses. At December 31, 2012, we had $11.7 billion of net finance receivables due from over 973,000 customer accounts and $3.4 billion of credit and non-credit life insurance policies in force covering over 630,000 customer accounts. At December 31, 2012, we had 852 branch offices in the United States, Puerto Rico, and the U.S. Virgin Islands and over 3,600 employees. In December 2012, over 1,000 of our employees were redeployed to a subsidiary of SLFI, which now provides management services to us. See Note 12 for further information.
SEGMENTS
Prior to our 2012 restructuring initiatives discussed in Note 4 and further refinement of our business strategy, we had three business segments: branch, centralized real estate, and insurance, which were defined by the types of financial service products we offered, the nature of our production processes, and the methods we used to distribute our products and to provide our services, as well as our management reporting structure.
Subsequent to our 2012 strategic review of our operations, we have redefined our segments to coincide with how our businesses are currently managed. At December 31, 2012, our three business segments include: consumer, insurance, and real estate. These business segments evolved primarily from management’s redefined business strategy, including its decision to cease real estate lending effective January 1, 2012 and to shift its focus to consumer loan products which we believe have significant prospects for growth and business development due to the strong demand in our target market of nonprime borrowers. Throughout 2012, management continued to refine our business strategy and operating footprint and the reporting tools necessary to manage the Company under the new segments, which were defined in final form in the fourth quarter of 2012 and led to our revision to 2012 segment reporting.
Consumer Business Segment
In our consumer business segment, we originate and service personal loans (secured and unsecured) in 26 states, which are our core operating states.
To supplement our lending activities, we have historically purchased 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
Insurance Business Segment
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 consumer and real estate business segments offer to its customers. We also offer non-credit insurance and ancillary products.
Real Estate Business Segment
In our real estate business segment, we service and hold real estate loans secured by first or second mortgages on residential real estate. Real estate loans previously originated through our branch offices are either serviced by our branch personnel or centrally serviced at our Evansville, Indiana location or other specialized servicing centers. Real estate loans previously acquired or originated through centralized distribution channels are serviced by MorEquity, Inc. (MorEquity), a wholly-owned subsidiary of SLFC, all of which are subserviced by Nationstar Mortgage LLC (Nationstar), except for certain securitized real estate loans, which are serviced and subserviced by third parties. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar. As a result of the cessation of real estate lending effective January 1, 2012, all of our real estate loans are in a liquidating status.
Other
The remaining components (which we refer to as “Other”) consist of our non-core and non-originating legacy operations, which are isolated by geographic market and/or distribution channel from our prospective core operations. These operations include our legacy operations in 14 states where we have also ceased personal lending and retail sales financing as a result of our restructuring activities during the first half of 2012, our liquidating retail sales finance portfolio (including our retail sales finance accounts from our dedicated auto finance operation), our lending operations in Puerto Rico and the U.S. Virgin Islands, and Ocean Finance and Mortgages Limited (Ocean).
SALE OF FINANCE RECEIVABLES AND MORTGAGE BROKERAGE BUSINESS
On August 29, 2012, Ocean Money Limited (Ocean Money), and Ocean Money (II) Limited (Ocean Money (II)), wholly owned subsidiaries of Ocean and our indirect subsidiaries, sold their entire finance receivable portfolios totaling $103.1 million, which resulted in a gain of $6.3 million. On August 31, 2012, Ocean, Ocean Money, and Ocean Money (II) sold their mortgage brokerage business consisting of various intangible assets including supplier lists, records, sales, marketing and promotional material, the business pipeline, the client database and records, and the Ocean brand name, which resulted in a gain of $0.6 million. As result of the sales of these assets, as well as our decision to cease loan originations in the United Kingdom, we recorded a loss of $4.6 million in the third quarter of 2012, which represented the full impairment of our United Kingdom customer lists intangible assets and wrote off $1.4 million of related fixed assets.
Notes to Consolidated Financial Statements, Continued
2. Summary of Significant Accounting Policies
BASIS OF PRESENTATION
We prepared our consolidated financial statements using generally accepted accounting principles in the United States of America (U.S. GAAP). The statements include the accounts of SLFC and its subsidiaries, all of which are wholly owned. We eliminated all material intercompany accounts and transactions. We made judgments, estimates, and assumptions that affect amounts reported in our consolidated financial statements and disclosures of contingent assets and liabilities. In management’s opinion, the consolidated financial statements include the normal, recurring adjustments necessary for a fair statement of results, and the out-of-period adjustment recorded in the second quarter of 2012 discussed below. Ultimate results could differ from our estimates. We evaluated the effects of and the need to disclose events that occurred subsequent to the balance sheet date. To conform to the 2012 presentation, we reclassified certain items in prior periods.
In the second quarter of 2012, we recorded an out-of-period adjustment, which decreased finance charge revenues by $13.9 million ($11.5 million of which related to 2011). The adjustment related to the correction of capitalized interest on purchased credit impaired finance receivables serviced by a third party. 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.
Historically, we included the commissions and bonuses paid to our employees related to our insurance production as a component of other operating expenses. After further review, we have changed our presentation (beginning in the fourth quarter of 2012) to include these amounts as a component of salaries and benefits. Accordingly, in the fourth quarter of 2012 we reclassified $2.9 million of these commissions and bonuses to salaries and benefits for the amount previously recognized through September 30, 2012 ($3.5 million reclassified for 2011, $0.3 million reclassified for the one month ended December 31, 2010, and $2.3 million reclassified for the eleven months ended November 30, 2010). We believe that this revised presentation more accurately reflects the total compensation paid by the Company. We will apply this revised presentation in all periods in future filings.
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 SLFC as an acquired business. 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 the years ended December 31, 2011 and 2012 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
Notes to Consolidated Financial Statements, Continued
they comparable to other institutions due to the new accounting basis established. See Note 5 for further information on the FCFI Transaction.
ACCOUNTING POLICIES
Finance Receivables
Generally, we classify finance receivables as 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.
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. 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.
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.
We stop accruing finance charges when the fourth contractual payment becomes past due for personal loans and retail sales contracts and when the sixth contractual payment becomes past due for revolving retail. We stop accruing finance charges when the fourth contractual payment becomes past due for our real estate loans that were originated at our branch offices and when the third contractual payment becomes past due for our real estate loans that were originated or acquired centrally. 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 purchased credit impaired finance receivables as described below.
Notes to Consolidated Financial Statements, Continued
Purchased Credit Impaired Finance Receivables
As a result of the FCFI Transaction, 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. The population of accounts identified principally consisted of those finance receivables that were 60 days or more past due or that were classified as Troubled Debt Restructuring (TDR) finance receivables as of the acquisition date.
We accrete the excess of the cash flows expected to be collected on the purchased credit impaired finance receivables over the discounted cash flows (the accretable yield) into interest income at a level rate of return over the expected lives of the underlying pools of the purchased credit impaired 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. We do not reclassify modified purchased credit impaired finance receivables as TDR finance receivables.
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.
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. 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 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 finance receivable. We restructure finance receivables only if we believe the customer has the
Notes to Consolidated Financial Statements, Continued
ability to pay under the restructured terms for the foreseeable future. We establish reserves on our TDR finance receivables in accordance with the authoritative guidance for impaired loans.
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 a 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 finance receivable 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 finance receivable are measured for impairment in accordance with the authoritative guidance for the accounting for contingencies.
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 purchased credit impaired finance receivables. See above for our accounting policy related to purchased credit impaired finance receivables.
Allowance for Finance Receivable Losses
We establish the allowance for finance receivable losses through the provision for finance receivable losses. Management evaluates our finance receivable portfolio monthly by personal loans, retail sales finance, and real estate loans. Our three finance receivable types (personal loans, retail sales finance, and real estate loans) consist of a large number of relatively small, homogeneous accounts. We evaluate our three finance receivable types for impairment as groups. None of our accounts are large enough to warrant individual evaluation for impairment. Effective December 31, 2012, we no longer break out our finance receivable types by class due to management’s assessment of the risk characteristics of our finance receivable portfolio and a change in management’s method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio, which no longer differentiates if the real estate loan was originated at a branch office or originated or acquired centrally.
Management 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 personal 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 collateral dependent real estate loan and it
Notes to Consolidated Financial Statements, Continued
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 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 infrequently 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 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.
For our personal loans and retail sales finance receivables, 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.
For our real estate loans, 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 a partial payment that is usually the greater of one-half of a regular monthly payment or the interest due on the account and any escrow payments for real estate loans that were originated at our branch offices and require two contractual payments plus any past due principal and escrow payments due on the account for real estate loans that were originated or acquired centrally. We forebear the remaining past due interest when the deferment is granted for real estate loans that were originated or acquired centrally. (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 two deferments in a rolling twelve month period for real estate loans that were originated at our branch offices (one deferment for real estate loans that were originated or acquired centrally) 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 have not been granted a deferment for measuring impairment in accordance with the authoritative guidance for the accounting for contingencies.
Notes to Consolidated Financial Statements, Continued
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 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 TDR finance receivables 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 TDR finance receivables 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 TDR finance receivables. The primary assumptions for our model are prepayment speeds, default rates, and severity rates.
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.
Finance Receivables Held for Sale
Depending on market conditions or certain of management’s 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
Notes to Consolidated Financial Statements, Continued
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.
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. 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. 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, which were determined to have indefinite lives.
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, we first complete a qualitative assessment of the licenses to determine whether it is necessary to perform a quantitative impairment test. If the qualitative assessment indicates that the licenses are more likely than not to have been impaired, we proceed with the fair value calculation of the licenses. 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. Prior to our early adoption of ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, effective December 31, 2012, we did not perform a qualitative assessment of our licenses before calculating the fair value.
Notes to Consolidated Financial Statements, Continued
Reserve for Sales Recourse Obligations
When we sell finance receivables, we establish a reserve for sales recourse in other liabilities, which represents our estimate of losses to be: (a) incurred by us on the repurchase of certain finance receivables that we previously sold; and (b) incurred by us for the indemnification of losses incurred by purchasers. 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.
Insurance Premiums and Commissions 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. Our revenue recognition accounting policy for insurance premiums and commissions 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. Ceded reinsurance recoverables are included in other assets and include estimates of the amounts expected to be recovered from reinsurers on insurance claims and policyholder liabilities.
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 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.
Acquisition Costs
We defer insurance policy acquisition costs (primarily commissions, reinsurance fees, and premium taxes). We include deferred policy acquisition costs in other assets and amortize these costs 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.
Valuation of Investment Securities
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.
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.
Impairments on Investment Securities
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
Notes to Consolidated Financial Statements, Continued
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, credit enhancements, collateral default rates, and other relevant criteria. 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.
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.
Investment 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.
Realized Gains and Losses on Investment Securities
We specifically identify realized gains and losses on investment securities and include them in investment revenues.
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
Notes to Consolidated Financial Statements, Continued
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 and insurance policy loans are part of our 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 include other invested asset revenue in investment revenues. We record accrued other invested asset revenue receivable in other assets.
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.
Cash and Cash Equivalents
We consider unrestricted cash on hand and short-term investments having maturity dates within three months of their date of acquisition to be cash and cash equivalents.
Restricted Cash
We include funds to be used for future debt payments relating to our securitization transactions and escrow deposits in restricted cash.
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.
Realization of our gross 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. When we assess our ability to realize deferred tax assets, we consider all available evidence, including:
· the nature, frequency, and severity of current and cumulative financial reporting losses;
· the timing of the reversal of our gross taxable temporary differences in an amount sufficient to provide benefit for our gross deductible temporary differences;
· 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.
Notes to Consolidated Financial Statements, Continued
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 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.
Derivative Financial Instruments
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 the derivatives on our consolidated balance sheets 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.
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 include all components of each derivative’s gain or loss in the assessment of hedge effectiveness.
We formally document all relationships between each derivative hedging instrument and the hedged item, as well as our risk-management objectives and strategies for undertaking various hedge transactions and our method to assess ineffectiveness. We link each derivative that we designate as a cash flow or fair value hedge to the specific asset or liability on the balance sheet. We perform and document an initial
Notes to Consolidated Financial Statements, Continued
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.
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. Effective January 1, 2012, we made an accounting policy election to continue to measure the credit risk of our derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio in compliance with the new authoritative guidance for fair value measurements.
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.
Benefit Plans
We have 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.
Notes to Consolidated Financial Statements, Continued
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 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. 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 measure and classify assets and liabilities 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. Level 1 inputs include quoted prices in active markets for identical instruments and are the most observable. 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. The use of observable and unobservable inputs is reflected in our hierarchy assessment disclosed in Note 26.
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.
Foreign Currency
The functional currency of our residual 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.
Transactions with Affiliates of Fortress or AIG
We may enter into transactions with affiliates of Fortress or AIG. These transactions occur at prevailing market rates and terms and primarily include subservicing and refinancing agreements, reinsurance
Notes to Consolidated Financial Statements, Continued
agreements, and derivative transactions. See Note 11 for further information on our transactions with affiliates of Fortress and AIG.
Related Party Transactions
In the normal course of business, we may enter into transactions with SLFI or affiliates of SLFI (other than affiliates of Fortress or AIG). These transactions occur at prevailing market rates and terms and primarily include affiliate lending and capital contributions. See Note 12 for further information on our related party transactions.
3. Recent Accounting Pronouncements
ACCOUNTING PRONOUNCEMENTS ADOPTED
Insurance Contracts
In October 2010, the Financial Accounting Standards Board (FASB) issued an accounting standard update (ASU), ASU 2010-26, Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, which amends the accounting for costs incurred by insurance companies that can be capitalized in connection with acquiring or renewing insurance contracts. The ASU 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 ASU became effective for interim and annual periods beginning on January 1, 2012 with early adoption permitted. The adoption of this ASU did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Repurchase Agreements
In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements, 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, and 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 upon 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 became effective for interim and annual periods 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. The adoption of this ASU did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Fair Value Measurement
In May 2011, the FASB and the International Accounting Standards Board jointly issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, resulting in a common fair value meaning between U.S. GAAP and IFRS and consistency of disclosures relating to fair value. The ASU became effective for interim and annual periods beginning after December 15, 2011. The adoption of this ASU did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Notes to Consolidated Financial Statements, Continued
Comprehensive Income
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, 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. The ASU became effective for interim and annual periods beginning on January 1, 2012.
In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05, 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 ASU 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 or loss on the components of net income and other comprehensive income for all periods presented. The ASU became effective for interim and annual periods beginning on January 1, 2012. The adoption of this ASU did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Indefinite-Lived Intangible Assets Impairment Test
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, which will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test for an indefinite-lived intangible asset. Under these amendments, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on qualitative assessment, that it is more likely than not that the indefinite-lived intangible asset is impaired. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments in this ASU became effective for annual and interim impairment tests performed for interim and annual periods beginning on January 1, 2013. Early adoption is permitted. The early adoption of this ASU did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
Financial Instruments
In February 2013, the FASB issued ASU 2013-03, Financial Instruments (Topic 825): Clarifying the Scope and Applicability of a Particular Disclosure to Nonpublic Entities, which clarifies the intended scope of the disclosures required by ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments clarify that the requirement to disclose “the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (Level 1, 2, or 3)” does not apply to nonpublic entities for items that are not measured at fair value in the statement of financial position but for which fair value is disclosed. The ASU became effective upon issuance. The adoption of this ASU did not have a material effect on our consolidated financial condition, results of operations, or cash flows.
ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED
Offsetting Assets and Liabilities
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, which requires an entity to disclose information about offsetting and
Notes to Consolidated Financial Statements, Continued
related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The amendments in this ASU 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 is not expected to have a material effect on our consolidated financial condition, results of operations, or cash flows.
Comprehensive Income
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the reporting of reclassifications out of accumulated other comprehensive income or loss. The amendments require an entity to present (either on the face of the statement where net income is presented or in the notes) the effect of significant reclassifications out of accumulated other comprehensive income or loss on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments in this ASU are effective prospectively for the Company for reporting periods beginning after December 15, 2012. Early adoption is permitted. The adoption of this ASU is not expected to have a material effect on our consolidated financial condition, results of operations, or cash flows.
4. Restructuring
As part of our strategic review of our operations, we initiated the following restructuring activities during the first half of 2012:
· As of January 1, 2012, we ceased originating real estate loans nationwide to focus on our other lending products, which we believe have greater growth potential.
· On February 1, 2012, we informed affected employees of our plan to close 60 branch offices and immediately cease personal lending and retail sales financing in 14 states where we do not have a significant presence.
· On February 15, 2012, we reduced the workforce at our Evansville, Indiana headquarters by 130 employees due to the cessation of real estate lending, the branch office closings, and the cessation of personal lending and retail sales financing in 14 states.
· On March 2, 2012, we informed affected employees of our plan to consolidate certain branch operations and close 150 branch offices in 26 states.
· On March 23, 2012, we informed affected employees of our plan to reduce the workforce of Ocean by 57 employees due to the reduction in its finance broker business activity and the cessation of real estate lending in the United Kingdom.
· In the second quarter of 2012, we closed an additional 18 branch offices as a result of ceasing operations in 14 states during the first quarter of 2012.
As a result of these events, our workforce was reduced by 820 employees in the first half of 2012, and we incurred a pretax charge of $23.5 million for the six months ended June 30, 2012.
Notes to Consolidated Financial Statements, Continued
Restructuring expenses and related asset impairment and other expenses by business segment were as follows:
Changes in the restructuring liability were as follows:
* Primarily includes removal expenses for branch furniture and signs and fees for outplacement services. Also includes the impairment of the market value adjustment on leased branch offices from the FCFI Transaction.
We do not anticipate any additional future restructuring expenses to be incurred that can be reasonably estimated at December 31, 2012.
Notes to Consolidated Financial Statements, Continued
5. FCFI Transaction
As stated 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 SLFC as an acquired business. 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 accordance with the terms of the FCFI Transaction, FCFI effectively capitalized AGF Holding Inc. (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.
Notes to Consolidated Financial Statements, Continued
The total purchase consideration given by AGF Holding for SLFI was $17.0 billion, including the fair value of liabilities assumed. This resulted in a bargain purchase gain for SLFI of $1.5 billion, which was also recognized by the Company in conjunction with the push-down accounting to SLFC.
The purchase consideration ascribed to the Company was $16.8 billion including the fair value of liabilities assumed as reflected in the following table.
* The acquisition-date fair value of the consideration transferred consisted of the following:
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. After determining the fair value of the net assets of SLFI and its subsidiaries, the fair value of SLFC’s net assets exceeded that of SLFI by $71.7 million. This $71.7 million of net liabilities of SLFI, other than its investment in SLFC, arises from intercompany items and the valuation of net assets controlled by SLFI that are not attributable to SLFC. In applying push-down accounting, the fair value of the consideration transferred that was allocated to SLFC is increased by this $71.7 million, and the total, net of the par value of common stock, is reflected as additional paid-in-capital.
NET FINANCE RECEIVABLES
The fair value of net finance receivables, both non-impaired and purchased credit impaired, were determined using discounted cash flow methodologies.
Notes to Consolidated Financial Statements, Continued
Non-credit Impaired 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 (personal loans, retail sales finance, and real estate loans). 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.
Purchased Credit Impaired Finance Receivables
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. The population of accounts identified principally consisted of those finance receivables that were 60 days or more past due or that were classified as TDR finance receivables as of the acquisition date. We accrete the excess of the cash flows expected to be collected on the purchased credit impaired finance receivables over the discounted cash flows (the accretable yield) into interest income at a level rate of return over the expected lives of the underlying pools of the purchased credit impaired finance receivables.
NET OTHER INTANGIBLE ASSETS
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 included $11.6 million of insurance licenses (which had an indefinite useful life) and $0.5 million of branch licenses (which had an estimated useful life of three months).
(b) Leases for our branch offices included the net of $5.9 million of leases that were unfavorable to current market terms as of the FCFI Transaction date (included in other liabilities) and $3.4 million of leases that were favorable to current market terms as of the FCFI Transaction date (included in other assets).
VOBA
We established a VOBA intangible asset related to our 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.
Customer Relationships
We valued our 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
Notes to Consolidated Financial Statements, Continued
business derived from the present customers through renewals or conversions. This methodology included assessing charges related to reasonable returns on contributory assets.
Trade Names
The trade names intangible was primarily related to our United Kingdom operation, 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.
Licenses
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.
Customer Lists
We have available listings of former customers. 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.
Leases - Branch Offices
We have leases for our 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 our 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.
Leases - Data Processing
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. The satellite lease was amended in 2010 and was deemed to be at market, and, therefore, no adjustment to fair value was deemed necessary.
OTHER ASSETS
Various adjustments, totaling $154.1 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 adjustments included the elimination of $115.3 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.
Notes to Consolidated Financial Statements, Continued
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 at November 30, 2010 is being accreted using the interest method.
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 is being 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 included $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. In addition, we recorded a $291.7 million liability for our portion of the fair value of the pension benefit obligations previously 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.
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 a 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, we had a net deferred tax liability of $552.7 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.
Notes to Consolidated Financial Statements, Continued
6. Finance Receivables
We have three finance receivable types as defined below:
· Personal loans are secured by consumer goods, automobiles, or other personal property or are unsecured, generally have maximum original terms of 60 months, and are usually fixed-rate, fixed-term loans.
· 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 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. As of January 15, 2013, we ceased purchasing retail sales contracts and revolving retail accounts.
· 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. As of January 1, 2012, we ceased originating real estate loans.
Components of net finance receivables by type were as follows:
Included in the table above are real estate finance receivables associated with the securitizations that remain on our balance sheet totaling $4.0 billion at December 31, 2012 and $2.2 billion at December 31, 2011. The carrying amount of consolidated long-term debt associated with securitizations totaled $3.0 billion at December 31, 2012 and $1.2 billion at December 31, 2011. See Note 14 for further discussion regarding our securitization transactions. Also included in the table above are finance receivables totaling
Notes to Consolidated Financial Statements, Continued
$5.2 billion at December 31, 2012 and $4.8 billion at December 31, 2011, which have been pledged as collateral for SLFC’s secured term loan.
At December 31, 2012 and 2011, 97% of our net finance receivables were secured by the real and/or personal property of the borrower. At December 31, 2012, real estate loans accounted for 76% of the amount and 14% of the number of net finance receivables outstanding, compared to 77% of the amount and 15% of the number of net finance receivables outstanding at December 31, 2011.
Maturities of net finance receivables by type at December 31, 2012 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.
Principal cash collections and such collections as a percentage of average net receivables by type were as follows:
Unused credit lines extended to customers by the Company totaled $164.5 million at December 31, 2012 and $185.5 million at December 31, 2011. Unused lines of credit on home equity lines of credit can be terminated for delinquency. Unused lines of credit can be suspended if the value of the real estate declines significantly below the property’s initial appraised value or if we believe the borrower will be unable to
Notes to Consolidated Financial Statements, Continued
fulfill the repayment obligations because of a material change in the borrower’s financial circumstances, or for any other material default.
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, 2011 concentrations of net finance receivables are presented in the order of December 31, 2012 state concentrations.
CREDIT QUALITY INDICATORS
We consider the delinquency status and nonperforming status of the finance receivable as our credit quality indicators.
For our personal loans and retail sales finance receivables, 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 further advance the due date on a customer’s account 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 real estate loans 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 $0.1 million on $1.0 million of retail sales finance receivables more than 90 days past due at December 31, 2012 and $0.2 million on $3.8 million of these finance receivables that were more than 90 days past due at December 31, 2011. Our personal and real estate loans do not have finance receivables that were more than 90 days past due and still accruing finance charges.
Delinquent Finance Receivables
We consider the delinquency status of the finance receivable as our primary credit quality indicator. We monitor delinquency trends to manage our exposure to credit risk. We consider finance receivables 60 days or more past due as delinquent and consider the likelihood of collection to decrease at such time.
Notes to Consolidated Financial Statements, Continued
Our delinquency by finance receivable type was as follows:
(a) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
(b) “Other” amounts at December 31, 2011 primarily include net finance receivables of our foreign subsidiary, Ocean, which were sold in the third quarter of 2012.
Nonperforming Finance Receivables
We also monitor finance receivable performance trends to evaluate the potential risk of future credit losses. At 90 days or more past due, we consider our finance receivables to be nonperforming. Once the finance receivables are considered as nonperforming, we consider them to be at increased risk for credit loss.
Notes to Consolidated Financial Statements, Continued
Our net finance receivables by performing and nonperforming by type were as follows:
(a) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
(b) “Other” amounts at December 31, 2011 primarily include net finance receivables of our foreign subsidiary, Ocean, which were sold in the third quarter of 2012.
If our nonperforming finance receivables would have been current in accordance with their original terms, we would have recorded finance charges of $35.5 million in 2012 and $40.7 million in 2011.
PURCHASED CREDIT IMPAIRED FINANCE RECEIVABLES
We include the carrying amount (which initially was the fair value) of our 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:
The allowance for purchased credit impaired finance receivable losses at December 31, 2012 reflected the net carrying value of these purchased credit impaired finance receivables being higher than the present value of the expected cash flows. Prior to a $318.3 million transfer from nonaccretable discount to accretable yield in 2012, the carrying value of the purchased credit impaired finance receivables was less than the present value of the expected cash flows. After this transfer, the net present value of the expected cash flows was reduced to the carrying value; therefore, any subsequent deterioration of the real estate loans during 2012 resulted in the need for an allowance for purchased credit impaired finance receivable losses.
Notes to Consolidated Financial Statements, Continued
Changes in accretable yield for purchased credit impaired finance receivables were as follows:
* Reclassifications from nonaccretable difference in 2012 and 2011 represent the increases in accretion resulting from the higher pool yield.
No finance receivables have been added to these pools subsequent to November 30, 2010.
TDR FINANCE RECEIVABLES
Information regarding TDR finance receivables was as follows:
* To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
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 were as follows:
* To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in prior years due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
Information regarding the financial effects of the TDR finance receivables was as follows:
* To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in prior years due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
Net finance receivables that were modified as TDR finance receivables within the previous 12 months and for which there was a default during the period were as follows:
(a) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in the prior year due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
(b) Represents the corresponding balance of TDR net finance receivables at the end of the month in which they defaulted.
Notes to Consolidated Financial Statements, Continued
7. Allowance for Finance Receivable Losses
Changes in the allowance for finance receivable losses by finance receivable type were as follows:
(a) To conform to our 2012 presentation, we have combined the branch real estate and centralized real estate data previously reported separately in prior years due to a change in method of monitoring and assessing the credit risk of our liquidating real estate loan portfolio.
Notes to Consolidated Financial Statements, Continued
(b) During the first quarter of 2012, we decreased the allowance for finance receivable losses as a result of the transfers of $77.8 million of finance receivables 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.
(c) Recoveries during 2011 included $5.0 million ($1.9 million consumer personal loan recoveries, $0.2 million consumer retail sales finance recoveries, and $2.9 million real estate loan 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.
(d) 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.
(e) Effective January 1, 2010, SLFI contributed two of its wholly-owned subsidiaries to SLFC. The contribution included $16.2 million of allowance for finance receivable losses.
Included in the table above is allowance for finance receivable losses associated with securitizations totaling $10.0 million at December 31, 2012 and $2.1 million at December 31, 2011. See Note 14 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. The carrying amount charged off for non-credit impaired loans totaled $166.7 million in 2012 and $203.8 million in 2011.
The carrying amount charged off for purchased credit impaired loans totaled $38.3 million in 2012 and $109.5 million in 2011. These amounts represent 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.
Notes to Consolidated Financial Statements, Continued
The allowance for finance receivable losses and net finance receivables by type and by impairment method were as follows:
In 2012, we recognized $17.0 million of additional charges to the provision for finance receivable losses related to decreases in the expected cash flows for the remaining accounts in the purchased credit impaired pools under Accounting Standards Codification 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality.
See Note 2 for additional information on the determination of the allowance for finance receivable losses.
Notes to Consolidated Financial Statements, Continued
8. Finance Receivables Held for Sale
During 2012, we transferred $180.9 million of finance receivables from held for investment to held for sale due to management’s intent to no longer hold these finance receivables for the foreseeable future. We marked these loans to the lower of cost or fair value at the time of transfer and subsequently recorded additional gains in other revenues at the time of sale resulting in net gains of $4.5 million in 2012. In 2012, we sold finance receivables held for sale totaling $171.0 million. During 2012, we transferred $1.4 million of finance receivables from held for sale back to held for investment due to management’s intent to hold these finance receivables for the foreseeable future.
In February 2010, we transferred $170.7 million of finance receivables from held for sale back to 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 finance receivables from held for sale back to held for investment due to management’s intent to hold these finance receivables for the foreseeable future.
We repurchased 20 loans for $2.8 million during 2012, compared to 12 loans repurchased for $2.1 million during 2011, and 4 loans repurchased for $0.5 million during 2010. In each period, we repurchased the loans because such loans were reaching the defined delinquency limits or had breached the contractual representations and warranties under the loan sale agreements. At December 31, 2012, 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
9. 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:
* Excludes interest in a limited partnership that we account for using the equity method ($0.6 million at December 31, 2012 and $1.4 million at December 31, 2011).
As of December 31, 2012 and 2011, we had no investment securities with other-than-temporary impairments recognized in accumulated other comprehensive income or loss.
Notes to Consolidated Financial Statements, Continued
Fair value and unrealized losses on investment securities by type and length of time in a continuous unrealized loss position were as follows:
We continue to monitor unrealized loss positions for potential credit impairments. During 2012, we recognized other-than-temporary impairment credit loss write-downs to investment revenues on corporate debt, RMBS, and CMBS totaling $0.9 million.
Notes to Consolidated Financial Statements, Continued
Components of the other-than-temporary impairment charges on investment securities were as follows:
Changes in the cumulative amount of credit losses (recognized in earnings) on other-than-temporarily impaired investment securities were as follows:
* The beginning balance for the Successor Company for the one month ended December 31, 2010 includes the push-down accounting adjustments.
Notes to Consolidated Financial Statements, Continued
The fair values of investment securities sold or redeemed and the resulting realized gains, realized losses, and net realized gains (losses) were as follows:
Contractual maturities of fixed-maturity investment securities at December 31, 2012 were as follows:
Actual maturities may differ from contractual maturities since borrowers may have the right to prepay obligations. We may sell investment securities before maturity to achieve corporate requirements and investment strategies.
Notes to Consolidated Financial Statements, Continued
10. Other Assets
Components of other assets were as follows:
(a) Other invested assets primarily include commercial mortgage loans and accrued investment income.
(b) Fixed assets were net of accumulated depreciation of $148.7 million at December 31, 2012 and $164.6 million at December 31, 2011.
(c) Other intangible assets exclude branch office leases of $0.8 million at December 31, 2012 and $2.8 million at December 31, 2011 that are unfavorable to the current market terms and are included in other liabilities and branch office leases of $0.6 million at December 31, 2012 and $1.8 million at December 31, 2011 that are included in fixed assets, net.
(d) Income tax assets include current federal, foreign, and state tax assets.
The gross carrying amount and accumulated amortization, in total and by major intangible asset class were as follows:
Notes to Consolidated Financial Statements, Continued
Amortization expense totaled $13.6 million in 2012, $41.1 million in 2011, and $3.8 million for the one month ended December 31, 2010. Amortization expense for 2012 and 2011 included impairment charges totaling $4.6 million and $12.8 million, respectively. The estimated aggregate amortization of other intangible assets for each of the next five years is reflected in the table below.
11. Transactions with Affiliates of Fortress or AIG
SECURED TERM LOAN
Springleaf Financial Funding Company, a wholly-owned subsidiary of SLFC, is party to a $3.75 billion, six-year secured 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. Affiliates of Fortress and affiliates of AIG owned or managed lending positions in the syndicate of lenders totaling $85.0 million at December 31, 2012 and $105.5 million at December 31, 2011.
SUBSERVICING AND REFINANCE AGREEMENTS
Effective February 1, 2011, Nationstar began subservicing the real estate loans of MorEquity and two other subsidiaries of SLFC (collectively, the Owners), including certain securitized real estate loans. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar.
The Owners paid Nationstar fees for its subservicing and to facilitate the repayment of our real estate loans through refinancings with other lenders as follows:
INVESTMENT MANAGEMENT AGREEMENT
Logan Circle Partners, L.P. (Logan Circle) provides investment management services for our investments. Logan Circle is a wholly-owned subsidiary of Fortress. Costs and fees incurred for these investment management services totaled $0.8 million in 2012.
Notes to Consolidated Financial Statements, Continued
PENSION PLAN
At December 31, 2012, we had no plan assets included in the AIG Retirement Plan, compared to $59.9 million at December 31, 2011. The transfer due from the AIG Retirement Plan to our tax-qualified defined benefit retirement plan, the Springleaf Financial Services Retirement Plan (the Retirement Plan), was completed in April 2012.
REINSURANCE AGREEMENTS
Merit 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 recorded by Merit for reinsurance agreements with subsidiaries of AIG totaled $46.8 million at December 31, 2012 and $49.7 million at December 31, 2011.
DERIVATIVES
At December 31, 2012 and 2011, all of our derivative financial instruments were with AIG Financial Products Corp. (AIGFP), a subsidiary of AIG. In July 2012, SLFI posted $60.0 million of cash collateral with AIGFP as security for SLFC’s two remaining Euro swap positions with AIGFP and agreed to act as guarantor for the swap positions. In August 2012, one of the swap positions was terminated and the cash collateral was reduced by $20.0 million. At December 31, 2012, cash collateral with AIGFP totaled $40.0 million.
12. Related Party Transactions
AFFILIATE LENDING
Note Receivable from Parent
SLFC’s note receivable from SLFI is payable in full on May 31, 2022, and SLFC may demand payment at any time prior to May 31, 2022; however, SLFC does not anticipate the need for additional liquidity during 2013 and does not expect to demand payment from SLFI in 2013. The note receivable from SLFI totaled $538.0 million at December 31, 2012 and 2011. Interest receivable on this note totaled $1.5 million at December 31, 2012 and $11.8 million at December 31, 2011. The interest rate for the unpaid principal balance is the prime rate. Interest revenue on the note receivable from SLFI totaled $17.3 million during 2012, $17.4 million during 2011, $1.9 million during the one month ended December 31, 2010, and $16.4 million during the eleven months ended November 30, 2010.
Receivables from Parent and Affiliates
At December 31, 2012 and 2011, receivables from our parent and affiliates totaled $16.2 million and $24.8 million, respectively, primarily due to a receivable from Second Street Funding Corporation, a subsidiary of SLFI, for income taxes payable under current and prior tax sharing agreements, which were paid by SLFC. The receivables from our parent and affiliates also include interest receivable on SLFC’s note receivable from SLFI discussed above.
Notes to Consolidated Financial Statements, Continued
Intercompany Demand Note
Pursuant to a prepayable, intercompany demand note (the Note) dated October 1, 2012, between SLFI and Springleaf Asset Holding, Inc. (SLAH), a subsidiary of SLFC, SLFI advanced $20.0 million to SLAH. Under the terms of the Note, SLFI may elect to make advances to SLAH from time to time in an aggregate amount not to exceed $50.0 million. The annual interest rate for the principal balance is 6%. SLAH used the advance to pay a cash dividend to SLFC on October 1, 2012, which SLFC plans to use for general corporate purposes. On October 26, 2012, SLAH repaid the $20.0 million advance, plus accrued interest.
CASH COLLATERAL
In August 2012, Springleaf Financial Services of South Carolina, Inc. (SLFSSC), a subsidiary of SLFC, and SLFI entered into a Reimbursement Agreement (the Reimbursement Agreement) and a related Fee Agreement whereby SLFI agreed to post $25.0 million of cash collateral on behalf of SLFSSC in connection with a judgment entered against SLFSSC, subject to SLFSSC’s agreement to repay the collateral in full in the event it was applied to the judgment and to pay a fee equal to an annual rate of 8.00% of the average monthly amount of unreimbursed collateral until fully repaid. SLFSSC agreed to settle the litigation in late August 2012.
In December 2012, SLFSSC and SLFI amended the Reimbursement Agreement and the Fee Agreement to provide that the collateral could be applied toward the settlement and that SLFI would pay up to an additional $11.0 million toward the settlement on behalf of SLFSSC, subject to SLFSSC’s agreement to repay such amounts in full and to pay a fee equal to an annual rate of 8.00% of the average monthly amount paid by SLFI toward the settlement until fully repaid. During 2012, SLFSSC paid SLFI $0.6 million of fees under the Fee Agreement and the amended Fee Agreement.
Subsequently, SLFI paid an additional $5.8 million in December 2012, on SLFSSC’s behalf, to satisfy the remaining portion of the settlement. At December 31, 2012, the resulting payable to SLFI totaled $30.8 million and interest payable to SLFI totaled $0.1 million.
See Note 21 for further information on this legal settlement.
CAPITAL CONTRIBUTIONS
On each of January 10, 2012 and July 11, 2012, SLFC received capital contributions from SLFI of $10.5 million to satisfy SLFC’s hybrid debt semi-annual interest payments due in January and July 2012, respectively.
DERIVATIVES
As discussed in Note 11, SLFI posted $60.0 million of cash collateral with AIGFP as security for SLFC’s two remaining Euro swap positions with AIGFP in July 2012, and in August 2012, one of the swap positions was terminated and the cash collateral was reduced by $20.0 million. Fees payable to SLFI totaled $0.3 million at December 31, 2012. In 2012, SLFC paid SLFI $6.9 million of collateral and guarantee fees.
INTERCOMPANY AGREEMENTS
In mid-2012, SLFI took the initial steps to explore additional growth opportunities, including centralized online lending and strategic acquisitions of loan portfolios. SLFI created Springleaf Consumer Loan, Inc. (SCLI) for centralized online lending to customers out of the SLFC branch footprint. In addition to direct
Notes to Consolidated Financial Statements, Continued
lending, SCLI has established certain strategic alliances with our state branch operating entities to provide online loan processing services for customers who are located in the geographic footprint of our branch network, but who prefer the convenience of interacting with us primarily online. Among other things, SCLI provides loan application processing and credit underwriting services on behalf of our branch offices for loan applications submitted through a centralized online or telephone application system that are within the branch footprint. SLFI also created Springleaf Acquisition Corporation (SAC) for potential portfolio and other acquisitions. Subsidiaries of SAC and certain third parties recently entered into an agreement to purchase and service a portfolio of real estate and personal loans. SCLI and SAC are not subsidiaries of SLFC.
In 2012, SLFI and SLFC realigned their internal structure related to the provision of certain administrative services. Historically, the employer for all of our employees has been Springleaf Finance Management Corporation (SFMC), a subsidiary of SLFC. SFMC provided management services for all of our companies, and also provided the employees who work in the branches for our state consumer lending entities. Because employees who work at our headquarters and certain other employees provide services to all of our entities, including subsidiaries of SLFI, in late 2012 we reassigned over 1,000 employees who provide those services from SFMC to a new management corporation, Springleaf General Services Corporation (SGSC), a subsidiary of SLFI. Employees who work in the branches or primarily provide services to our branch system remain employees of SFMC. Most SLFI subsidiaries, including SFMC and the state consumer lending entities, have entered into a services agreement with SGSC for the provision of various centralized services, such as accounting, human resources, and information technology support. These services previously had been provided by SFMC.
This reassignment of employees and the intercompany agreements related to the structural realignment are not expected to result in a material increase in the costs and expenses that SLFC would have incurred had this reorganization not taken place. We expect to continue to focus on the consumer business segment which is the core of our present operations. SGSC is not a subsidiary of SLFC.
On December 24, 2012, SGSC entered into the following intercompany agreements with SFMC and with certain other subsidiaries of SLFI (collectively, the “Recipients”):
Services Agreement
SGSC provides the following services to the Recipients: management and administrative services; financial, accounting, treasury, tax, and audit services; facilities support services; capital funding services; legal services; human resources services (including payroll); centralized collections and lending support services; insurance, risk management, and marketing services; and information technology services. The fees payable by each Recipient to SGSC is equal to 100% of the allocated cost of providing the services to such Recipient. SGSC allocates its cost of providing these services among the Recipients and any of the companies to which it provides similar services based on an allocation method defined in the agreement. SFMC recorded $1.9 million of service fee expenses during this eight-day period in 2012, which are included in other operating expenses. At December 31, 2012, services fees payable to SGSC totaled $1.9 million. The agreement has a term of 5 years provided that each of SGSC and SFMC may terminate the agreement upon one year’s prior written notice. The agreement will terminate automatically with respect to a Recipient if such Recipient ceases to be an affiliate of SGSC. In addition, each party has the right to terminate the agreement upon the occurrence of certain events, including the filing of a petition of bankruptcy, if the other party becomes or is declared insolvent, makes an assignment on behalf of its creditors or takes any corporate action for its winding up or dissolution.
Notes to Consolidated Financial Statements, Continued
License Agreement
The agreement provides for use by SGSC of SFMC’s information technology systems and software and other related equipment. The monthly license fee payable by SGSC for its use of the information technology systems and software is 100% of the actual costs incurred by SFMC plus a 7% margin. The fee payable by SGSC for its use of the related equipment is 100% of the actual costs incurred by SFMC. The agreement has a term of 5 years provided that each of SGSC and SFMC may terminate the agreement upon one year’s prior written notice. The agreement will terminate automatically with respect to a Recipient if such Recipient ceases to be an affiliate of SGSC. In addition, each party has the right to terminate the agreement upon the occurrence of certain events, including the filing of a petition of bankruptcy, if the other party becomes or is declared insolvent, makes an assignment on behalf of its creditors or takes any corporate action for its winding up or dissolution.
Building Lease
The agreement provides that SFMC will lease six of its buildings to SGSC for an annual rental amount of $3.7 million, plus additional rental amounts to cover other sums and charges, including real estate taxes, water charges, and sewer rents. SGSC is permitted to assign the lease to its affiliates or sub-let up to 50% of the rentable square footage (in aggregate) of each leased building. The agreement has a term of 10 years, which SGSC may renew for an additional 5 years by giving one year’s prior written notice and provided no event of default has occurred. SFMC has the option to cancel the lease at any time by delivering a cancellation notice to SGSC at least 9 months prior to the specified lease cancellation date, provided that no such notice can be delivered prior to January 1, 2018. SFMC may also terminate the lease by written notice and exercise its right of re-entry upon the occurrence of certain events, including failure by SGSC to pay rent for 10 days after notice thereof from SFMC, abandonment by SGSC of the property, if SGSC becomes or is declared insolvent, or if SGSC makes an assignment on behalf of its creditors or takes any corporate action for its winding up or dissolution.
SALE OF SUBSIDIARY TO SLFI
On December 19, 2012, SLFC sold 100% of the common stock of its wholly-owned subsidiary, Spingleaf Mortgage Holding Company (SMHC), to SLFI. The sale of SMHC’s common stock to SLFI was recorded at the carrying value of $0.6 million as of December 19, 2012, which approximated the fair value because the purchased assets and liabilities assumed consisted of cash and short-term duration assets and liabilities.
13. Long-term Debt
Carrying value and fair value of long-term debt by type were as follows:
Notes to Consolidated Financial Statements, Continued
Weighted average interest rates on long-term debt by type were as follows:
Junior
Senior
Subordinated
Debt
Debt
Total
Successor Company
Year Ended December 31, 2012
8.09 %
12.26 %
8.25 %
Year Ended December 31, 2011
8.68 %
12.26 %
8.83 %
One Month Ended December 31, 2010
9.27 %
12.26 %
9.41 %
Predecessor Company
Eleven Months Ended November 30, 2010
5.97 %
6.17 %
6.10 %
Successor Company
At December 31, 2012
5.52 %
12.26 %
7.54 %
At December 31, 2011
8.33 %
12.26 %
8.49 %
Principal maturities of long-term debt (excluding projected securitization repayments by period) by type of debt at December 31, 2012 were as follows:
_________________
(a) Euro denominated notes include 345.2 million notes and 323.4 million notes, 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.
(d) The interest rates shown are the range of contractual rates in effect at December 31, 2012, 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.
Notes to Consolidated Financial Statements, Continued
Springleaf Financial Funding Company, a subsidiary of SLFC, is the borrower of the secured term loan that 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 secured 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 $167.9 million.
Springleaf Financial Funding Company used the proceeds from the secured 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 customary 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.
With the exception of SLFC's hybrid debt, none of our debt agreements require SLFC or any of its subsidiaries 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, 2012, we were in compliance with all of the covenants under our debt agreements.
Under our 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, 2012, a mandatory trigger event occurred under SLFC’s hybrid debt with respect to the hybrid debt’s semi-annual payment due in January 2013 due to the average fixed charge ratio being 0.74x (while the tangible equity to tangible managed assets ratio was 8.72%). During January 2013, SLFC received from SLFI the non-debt capital funding necessary to satisfy, and subsequently paid, the January 2013 interest payments required by SLFC’s hybrid debt.
Notes to Consolidated Financial Statements, Continued
In connection with our liability management efforts, we or our affiliates from time to time have purchased, and may in the future purchase, portions of our outstanding indebtedness. Any such 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.
14. Variable Interest Entities
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.
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 control stems from having prescribed detailed servicing standards and procedures that the third-party servicer and Nationstar must observe (and 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.
Notes to Consolidated Financial Statements, Continued
The carrying amounts of consolidated VIE assets and liabilities associated with our securitization trusts were as follows:
Securitization Transactions
2012-1 Securitization. On April 20, 2012, SLFC effected a private securitization transaction in which SLFC caused Eleventh Street Funding LLC (Eleventh Street), a special purpose vehicle wholly owned by SLFC, to sell $371.0 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-1 (the 2012-1 Trust), with a 4.38% weighted average yield, to certain investors. Eleventh Street sold the mortgage-backed notes for $367.8 million, after the price discount but before expenses. Eleventh Street initially retained $42.6 million of the 2012-1 Trust’s subordinate mortgage-backed notes.
2012-2 Securitization. On August 8, 2012, SLFC effected a private securitization transaction in which SLFC caused Twelfth Street Funding LLC (Twelfth Street), a special purpose vehicle wholly owned by SLFC, to sell $750.8 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-2 (the 2012-2 Trust), with a 3.59% weighted average yield, to certain investors. Twelfth Street sold the mortgage-backed notes for $749.7 million, after the price discount but before expenses. SLFC initially retained $107.7 million of the 2012-2 Trust’s subordinate mortgage-backed notes.
2012-3 Securitization. On October 25, 2012, SLFC effected a private securitization transaction in which SLFC caused Fourteenth Street Funding LLC (Fourteenth Street), a special purpose vehicle wholly owned by SLFC, to sell $787.4 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-3 (the 2012-3 Trust), with a 2.80% weighted average yield, to certain investors. Fourteenth Street sold the mortgage-backed notes for $787.2 million, after the price discount but before expenses. Fourteenth Street initially retained $112.3 million of the 2012-3 Trust’s subordinate mortgage-backed notes.
2011 Securitization. In September 2011, we completed an on-balance sheet securitization transaction which included the sale of $496.9 million of our 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.
2010 Securitization. In March 2010, we completed an on-balance sheet securitization transaction which included the sale of $1.0 billion of our 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
Notes to Consolidated Financial Statements, Continued
proceeds, including accrued interest after the sales discount but before expenses, of $503.3 million and retained subordinated and residual interest trust certificates.
Sales of Previously Retained Notes
During 2012, we sold the following previously retained mortgage-backed notes/trust certificates:
· $215.6 million trust certificates from our March 2010 securitization and subsequently recorded $223.4 million of additional debt;
· $122.7 million mortgage-backed notes from our September 2011 securitization and subsequently recorded $124.4 million of additional debt; and
· $23.7 million mortgage-backed notes from our 2012-1 securitization and subsequently recorded $23.2 million of additional debt.
VIE Interest Expense
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 $110.7 million in 2012, $67.2 million in 2011, $5.6 million during the one month ended December 31, 2010, and $141.4 million during the eleven months ended November 30, 2010.
UNCONSOLIDATED VIE
We have established a VIE that holds the junior subordinated debt described in Note 13. 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, 2012 or 2011.
15. Derivative Financial Instruments
SLFC uses derivative financial instruments in managing the cost of its debt by mitigating its exposures to interest rate and currency risks 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. During the third quarter of 2012, we terminated a cross currency interest rate swap agreement with a remaining notional amount of 183.0 million. At December 31, 2012, SLFC’s remaining derivative financial instrument (included in other assets) consisted of a cross currency interest rate swap agreement that matures in 2013.
While SLFC’s cross currency interest rate swap agreement mitigates economic exposure of related debt, it does not currently qualify as a cash flow or fair value hedge under U.S. GAAP.
Weighted average receive and pay rates of our cross currency interest rate swap agreements were as follows:
Notes to Consolidated Financial Statements, Continued
Changes in the notional amounts of our cross currency interest rate swap agreements and foreign currency forward agreement were as follows:
During 2012, we decreased the notional amounts of our Euro cross currency interest rate swap agreements by 676.7 million. We elected to discontinue hedge accounting prospectively on one of our cash flow hedges as of May 2012 and terminated this cross currency interest rate swap agreement in August 2012. We continue to report the gain related to the discontinued and terminated cash flow hedge in accumulated other comprehensive income, which is being reclassified into earnings during the remaining contractual term of the debt agreement (January 2013) as the hedged transaction impacts earnings. As a result of our decision to repurchase Euro denominated debt, we elected to discontinue hedge accounting and subsequently accelerated the reclassification of amounts in accumulated other comprehensive income to other revenues resulting in gains of $0.7 million in 2012.
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, reclassified from accumulated other comprehensive income or loss into other revenues (effective and ineffective portion) and interest expense (effective portion), and recognized in other revenues (ineffective portion) were as follows:
(a) Accumulated other comprehensive income (loss).
(b) See table below for the effective and ineffective components of other revenues reclassified from accumulated other comprehensive income or loss.
(c) Represents the total amounts reclassified from accumulated other comprehensive income or loss to other revenues and to interest expense for cash flow hedges as disclosed on our consolidated statement of comprehensive income (loss).
Notes to Consolidated Financial Statements, Continued
Other revenues reclassified from accumulated other comprehensive income or loss consisted of the following:
* Ineffective portion for 2012 consisted of gains related to our election to discontinue hedge accounting.
At December 31, 2012, we expect the remaining $0.2 million deferred net gain on cash flow hedges to be reclassified from accumulated other comprehensive income or loss to earnings during the next twelve months.
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.
16. Insurance
Components of insurance claims and policyholder liabilities were as follows:
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:
Notes to Consolidated Financial Statements, Continued
At December 31, 2012 and 2011, reserves related to insurance claims and policyholder liabilities ceded to nonaffiliated insurance companies totaled $27.3 million and $27.0 million, respectively.
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. We report our statutory financial information on a historical accounting basis. We are not required and did not apply push-down accounting to the insurance subsidiaries on a statutory basis.
Reconciliations of statutory net income to U.S. GAAP net income were as follows:
Reconciliations of statutory equity to U.S. GAAP equity were as follows:
* “Other, net” at December 31, 2012 includes a receivable for securities due from broker of $5.7 million that was non-admitted for statutory accounting.
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 $150.0 million of dividends in second quarter 2012 upon receiving prior approval and paid $45.0 million of dividends in second quarter 2011 that did not require prior approval.
Notes to Consolidated Financial Statements, Continued
17. Other Liabilities
Components of other liabilities were as follows:
* Payable to affiliate consists of a payable to SLFI for payments made by SLFI, on SLFSSC’s behalf, to satisfy a legal settlement against SLFSSC. See Note 12 for further information on the payable to SLFI.
18. Capital Stock
SLFC has two classes of authorized capital stock: special shares and common shares. SLFC may issue special shares in series. The board of directors determines the dividend, liquidation, redemption, conversion, voting and other rights prior to issuance.
Par value and shares authorized at December 31, 2012 were as follows:
Shares issued and outstanding at December 31, 2012 and 2011 were as follows:
On each of January 10, 2012 and July 11, 2012, SLFC issued one share of SLFC common stock to SLFI for $10.5 million in order to satisfy SLFC’s hybrid debt semi-annual interest payments due in January and July 2012, respectively.
Similarly, on January 11, 2013, SLFC issued one share of SLFC common stock to SLFI for $10.5 million in order to satisfy SLFC’s hybrid debt semi-annual interest payments due in January 2013.
Notes to Consolidated Financial Statements, Continued
19. Accumulated Other Comprehensive Income (Loss)
Components of accumulated other comprehensive income (loss) were as follows:
20. Income Taxes
AGF Holding and all of its domestic U.S. subsidiaries, including SLFC, file a consolidated life/nonlife federal tax return with the Internal Revenue Service (IRS). Federal income taxes are allocated to these subsidiaries under a tax sharing agreement with AGF Holding. Our foreign subsidiaries file tax returns in Puerto Rico, the U.S. Virgin Islands, and the United Kingdom.
As of December 31, 2011, we made the determination that we could no longer assert that we intended to permanently reinvest the earnings of our foreign subsidiaries, and deferred taxes were recorded on the unremitted earnings in our foreign subsidiaries as of December 31, 2011, which resulted in no material impact on tax expense.
Components of benefit from income taxes were as follows:
Notes to Consolidated Financial Statements, Continued
Benefit from 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.
We recorded a current state income tax provision in 2012 and 2011 attributable to profitable operations in certain states in which we do business that could not be offset against losses incurred. 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.
Reconciliations of the statutory federal income tax rate to the effective tax rate were as follows:
The effective income tax rate for 2012 and 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 foreign and state operations.
A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax obligation (all of which would affect the effective tax rate if recognized) is as follows:
Our gross unrecognized tax obligation includes interest and penalties. We recognize interest and penalties related to gross unrecognized tax obligations in income tax expense. At December 31, 2012, we had accrued $0.2 million for the payment of interest (net of the federal benefit) and penalties, compared to zero at December 31, 2011; however, the amount or the uncertainty of this tax obligation may change in the next twelve months.
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 SLFI’s 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. Under the indemnity arising from the FCFI Transaction, it is not expected that SLFC 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:
At December 31, 2012, we had a net deferred tax liability of $298.9 million. The gross deferred tax liabilities are 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 is the benefit of a foreign net operating loss carryforward of $19.6 million from our United Kingdom operations and a foreign tax credit benefit of $3.1 million. At December 31, 2012, we had a valuation allowance on our state deferred tax assets of $19.7 million, net of a deferred federal tax benefit. At December 31, 2012, we also had a $19.6 million valuation allowance against our United Kingdom operations.
At December 31, 2011, we had a net deferred tax liability of $415.9 million. Included in our gross deferred tax assets was 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
Notes to Consolidated Financial Statements, Continued
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. At December 31, 2011 we also had a $4.0 million valuation allowance against our United Kingdom operations.
At December 31, 2012, we had $4.3 million of net current federal and foreign income tax receivable, compared to $37.8 million at December 31, 2011. At December 31, 2012, we had state net operating loss carryforwards of $228.1 million, compared to $333.2 million at December 31, 2011. The state net operating loss carryforwards expire between 2016 and 2033. At December 31, 2012, we had deferred and accrued taxes consisting of $5.0 million of non-income based taxes compared to $6.3 million at December 31, 2011.
21. 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 $2.4 million of rental commitments for leased office space at closed locations (included in other liabilities at December 31, 2012).
In addition to rent, we pay 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 $36.3 million in 2012, $37.9 million in 2011, $3.6 million for the one month ended December 31, 2010, and $41.3 million for the eleven months ended November 30, 2010. We anticipate minimum annual rental commitments in 2013 to be less than the amount of rental expense incurred in 2012 primarily due to 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 we will continue to identify certain legal actions where we believe 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 we have not yet been notified of or are not yet determined to be probable or reasonably possible.
Notes to Consolidated Financial Statements, Continued
We contest 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 we can reasonably estimate the amount of that loss, we accrue 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, we 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, we can estimate reasonably possible losses, additional losses, ranges of loss or ranges of additional loss in excess of amounts accrued, but do not believe, based on current knowledge and after consultation with counsel, that such losses will have a material adverse effect on our consolidated financial statements as a whole.
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 asserted class claims against our South Carolina operating entity for alleged violations of S.C. Code § 37-10-102(a), which requires, among other things, 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. After almost 17 years of litigation, on August 27, 2012, the parties settled the case on a claims made basis. Preliminary approval of the settlement was obtained on September 6, 2012 and final approval was obtained on November 19, 2012. At December 31, 2012, the remaining reserve for this class action lawsuit totaled $3.5 million. Funds were distributed beginning in late December 2012. Class members who made a claim and had one loan in the class period received $5,000; those with two loans, $5,750; those with three loans, $6,500; those with four loans, $7,250; and those with five or more loans, $8,000. Aggregate payments to these class members totaled $16.8 million in 2012. In addition, we paid $13.5 million in attorney fees and costs in December 2012 and $3.5 million of unclaimed funds to South Carolina charities in February 2013.
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, we have concluded that there are certain circumstances where customer contact and/or redress is appropriate. The total reserves related to the estimated PPI claims were $62.7 million at December 31, 2012 and $13.5 million (net of professional indemnity insurance receivable) at December 31, 2011. In 2012, our professional indemnity insurance claim was disputed, and in the fourth quarter of 2012, we reversed this claim based upon our assessment that the probability of the recovery of the claim no longer met the probability standard for recognition.
Notes to Consolidated Financial Statements, Continued
22. Risks and Uncertainties Related to Liquidity and Capital Resources
We currently have a significant amount of indebtedness in relation to our equity. SLFC’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 and cost to refinance our indebtedness.
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 liquidation and related losses within our real estate portfolio could be substantial and result in reduced cash receipts;
· our inability to grow our consumer loan portfolio with adequate profitability to fund operations, loan losses, and other expenses;
· our inability to monetize assets including, but not limited to, our access to debt and securitization markets and our note receivable from parent;
· 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 (which, among other things, established the 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 increasing costs and difficulty in servicing 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 real estate loans that were originated or acquired centrally;
· potential liability relating to real estate and personal 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; and
· the potential effect on us if the capital levels of our regulated and unregulated subsidiaries prove inadequate to support current business plans.
At December 31, 2012, we had $1.4 billion of cash and cash equivalents and in 2012 we generated a net loss of $220.7 million and net cash inflow from operating and investing activities of $1.6 billion. At December 31, 2012, our scheduled principal and interest payments for 2013 on our existing debt (excluding securitizations) totaled $2.1 billion, of which $445.2 million (excluding securitizations) has been repaid in January 2013. As of December 31, 2012, we had unpaid principal balances of $2.0 billion of unencumbered personal loans and $609.7 million of unencumbered real estate loans. In addition, SLFC may demand payment of some or all of its note receivable from SLFI ($538.0 million outstanding at December 31, 2012); however, SLFC does not anticipate the need for additional liquidity during 2013 and does not expect to demand payment from SLFI in 2013.
Notes to Consolidated Financial Statements, Continued
Based on our estimates and taking into account the risks and uncertainties of our plans, we believe that we will have adequate liquidity to finance and operate our businesses and repay our obligations as they become due during the next twelve months.
It is possible that the actual outcome of one or more of our plans could be materially different than we expect 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 and such actual results could materially adversely affect us.
23. 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 were eligible to participate. The Retirement Plan was based on substantially the same terms as the AIG plan it replaced. Our employees in Puerto Rico participated in a defined benefit pension plan sponsored by CommoLoCo, Inc., our Puerto Rican subsidiary. Effective December 31, 2012, the Retirement Plan and the CommoLoCo Retirement Plan were frozen. Consistent with other companies in the market, management has shifted its retirement focus away from these retirement plans and towards the 401(k) plan. Our employees will not lose any vested benefits in the Retirement Plan or the CommoLoCo Retirement Plan that accrued prior to January 1, 2013.
In addition, we sponsor unfunded defined benefit plans for certain employees and provide postretirement health and welfare and life insurance plans.
PENSION PLANS
We offer various defined benefit plans to eligible employees based on completion of a specified period of continuous service, subject to age limitations.
Retirement Plan
Our Retirement Plan is a noncontributory defined benefit plan which is subject to the provisions of ERISA. U.S. salaried employees who were employed by a participating company, had attained age 21, and completed twelve months of continuous service were eligible to participate in the plan. Employees generally vested after 5 years of service. Prior to January 1, 2013, unreduced benefits were paid to retirees at normal retirement (age 65) and were based upon a percentage of final average compensation multiplied by years of credited service, up to 44 years.
CommoLoCo Retirement Plan
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 had attained age 21 and completed one year of service were eligible to participate in the plan.
Notes to Consolidated Financial Statements, Continued
Unfunded Defined Benefit Plans
We 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) Springleaf Financial Services Excess Retirement Income Plan (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
We 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.
401(K) PLANS
We sponsor voluntary savings plans for our U.S. employees and for our employees of CommoLoco, Inc.
Springleaf Financial Services 401(k) Plan
The Springleaf Financial Services 401(k) Plan for 2012 provided for a tiered Company matching on the first 6% of the salary reduction contributions of the employees depending on the employees’ years of service (10% Company matching for 0-4 years of service, 20% Company matching for 5-9 years of service, and 30% Company matching for 10 or more years of service). The salaries and benefit expense associated with this plan was $1.9 million in 2012 and $8.4 million in 2011. Effective January 1, 2013, the employees’ contributions of up to 4% are matched 100% by the Company.
CommoLoCo Thrift Plan
The CommoLoco Thrift Plan provides for salary reduction contributions by employees and 100% matching contributions by the Company of up to 3% of annual salary and 50% matching contributions by the Company of the next 3% of annual salary depending on the respective employee’s years of service. The salaries and benefit expense associated with this plan for 2012 and 2011 was immaterial. There were no changes to the Company’s matching contributions for 2013.
SHARE-BASED COMPENSATION PLAN
We did not record any share-based compensation expense in 2012 or 2011. We recorded share-based compensation expense of $15.3 million in 2010.
Notes to Consolidated Financial Statements, Continued
OBLIGATIONS AND FUNDED STATUS
The following table presents the funded status of the defined benefit pension plans and other postretirement benefit plans, reconciled to the net amount included in other liabilities:
(a) Includes non-qualified unfunded plans, for which the aggregate projected benefit obligation was $10.1 million at December 31, 2012 and $10.0 million at December 31, 2011.
(b) We do not currently fund postretirement benefits.
The accumulated benefit obligation for U.S. pension benefit plans was $367.6 million at December 31, 2012 and $367.1 million at December 31, 2011.
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 $47,000 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, 2012 and an equivalent single discount rate was derived that resulted in the same liability. This single discount rate for each plan was used.
Investment Strategy
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.
Allocation of Plan Assets
The long-term strategic asset allocation is reviewed and revised annually. The plans’ assets are monitored by our 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, 2012, the actual asset allocation for the primary asset classes was 93% in fixed income securities, 6% in equity securities, and 1% in cash and cash equivalents. The 2013 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.
The expected long-term rate of return for the plans was 6% for the Retirement Plan and 7% for the CommoLoCo Retirement Plan for 2012. 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
Notes to Consolidated Financial Statements, Continued
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.
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 expected future benefit payments, net of participants’ contributions, of our defined benefit pension plans and other postretirement benefit plans, at December 31, 2012 are as follows:
FAIR VALUE MEASUREMENTS - PLAN ASSETS
The inputs and methodology used in determining the fair value of the plan assets are consistent with those used to measure our assets.
Notes to Consolidated Financial Statements, Continued
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 mutual 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 mutual funds in companies in emerging and developed markets.
(c) Includes investment mutual 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 mutual 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, which was completed in April 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
The following table presents changes in our Level 3 plan assets measured at fair value:
* “Purchases, sales, issues, and settlements” column consists of the final settlement from the AIG Retirement Plan to the Retirement Plan.
24. Segment Information
Subsequent to our 2012 strategic review of our operations, we have redefined our segments to coincide with how our executives are managing our businesses. At December 31, 2012, our three business segments include: consumer, insurance, and real estate. These business segments evolved primarily from management’s redefined business strategy, including its decision to cease real estate lending effective January 1, 2012 and to shift its focus to consumer loan products which we believe have significant prospects for growth and business development due to the strong demand in our target market of nonprime borrowers. Throughout 2012, management continued to refine our business strategy and operating footprint and the reporting tools necessary to manage the Company under the new segments, which were defined in final form in the fourth quarter of 2012 and led to our revision to 2012 segment reporting. See Note 1 for a description of our revised 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 2.
We report our segment totals using the historical accounting basis (which is a basis of accounting other than U.S. GAAP) because management analyzes each business segment on a historical accounting 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. Due to the changes in the composition of our previously reported business segments, we have restated the corresponding segment information presented in the following tables for the prior periods.
Notes to Consolidated Financial Statements, Continued
The “Other” column in the following tables consists of our non-core and non-originating legacy operations, including:
· our legacy operations in 14 states where we do not have a significant presence;
· our liquidating retail sales finance portfolio, including our retail sales finance accounts from our dedicated auto finance operation;
· our lending operations in Puerto Rico and the U.S. Virgin Islands; and
· Ocean.
The “Push-down Accounting Adjustments” column in the following tables consists of:
· the accretion or amortization of the valuation adjustments on the applicable revalued assets and liabilities;
· the difference in finance charges on our credit impaired finance receivables compared to the finance charges on these finance receivables on a historical accounting basis;
· the elimination of accretion or amortization of historical based discounts, premiums, and other deferred costs on our finance receivables and long-term debt; and
· the reversal of the decreases to the allowance for finance receivable losses (on a historical accounting basis).
Notes to Consolidated Financial Statements, Continued
The following tables display information about our segments as well as reconciliations to the consolidated financial statement amounts.
Notes to Consolidated Financial Statements, Continued
Notes to Consolidated Financial Statements, Continued
Notes to Consolidated Financial Statements, Continued
* Not applicable. The Consolidated Balance Sheets in Item 8 are presented at December 31, 2012 and 2011; therefore, balance sheet information at November 30, 2010 is not applicable.
Notes to Consolidated Financial Statements, Continued
25. Interim Financial Information (Unaudited)
Our quarterly statements of operations for 2012 were as follows:
* See reconciliation below of amounts previously reported in our March 31, 2012, June 30, 2012, and September 30, 2012 Quarterly Reports on Form 10-Q to revised amounts presented above and Note 2 for further information on this reclassification adjustment.
Notes to Consolidated Financial Statements, Continued
Our quarterly statements of operations for 2011 were as follows:
* See reconciliation below of amounts previously reported in our March 31, 2011, June 30, 2011, and September 30, 2011 Quarterly Reports on Form 10-Q and in our interim financial information for the fourth quarter of 2011 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 to revised amounts presented above and see Note 2 for further information on this reclassification adjustment.
Notes to Consolidated Financial Statements, Continued
26. 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 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. We conduct price reviews for all assets. Assets that fall outside a price change tolerance are sent to our third-party valuation provider for further review. 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.
FAIR VALUE HIERARCHY
We measure and classify assets and liabilities 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 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.
Notes to Consolidated Financial Statements, Continued
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.
The following table summarizes the fair values and carrying values of our financial instruments and indicates the fair value hierarchy based on the level of inputs we utilized to determine such fair values:
Notes to Consolidated Financial Statements, Continued
The following table summarizes the fair values and carrying values of our financial instruments:
Notes to Consolidated Financial Statements, Continued
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:
(a) Other long-term investments excludes our interest in a limited partnership of $0.6 million at December 31, 2012 and $1.4 million at December 31, 2011 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, 2012 and 2011.
We had no transfers between Level 1 and Level 2 during 2012.
Notes to Consolidated Financial Statements, Continued
The following table presents changes during 2012 in Level 3 assets and liabilities measured at fair value on a recurring basis:
(a) “Purchases, sales, issues, and settlements” column only consist of settlements. There were no purchases, sales, or issues of investment securities during 2012.
(b) Other long-term investments excludes our interest in a limited partnership of $0.6 million at December 31, 2012 that we account for using the equity method.
During 2012, we transferred $19.3 million of assets into Level 3, consisting of certain private placement corporate debt and CDO/ABS. During 2012, we transferred $9.4 million of assets out of Level 3, consisting of certain CMBS, RMBS, and CDO/ABS. Transfers into Level 3 and transfers out of Level 3 for the investment securities in 2012 were primarily the result of obtaining additional information regarding inputs used to price our investment portfolio.
Notes to Consolidated Financial Statements, Continued
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) 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, issues, and settlements of Level 3 assets and liabilities measured at fair value on a recurring basis during 2011:
Notes to Consolidated Financial Statements, Continued
There were no unrealized gains or losses recognized in earnings on instruments held at December 31, 2012 or 2011.
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.
The unobservable inputs and quantitative data used in our Level 3 valuations for our investment securities were developed and used in models created by our third-party valuation service providers. We applied the third party exception which allows us to omit certain quantitative disclosures about unobservable inputs for other long-term investments. As a result, the weighted average ranges of the inputs for these investment securities are not applicable in the following table.
Quantitative information about Level 3 inputs for our assets measured at fair value on a recurring basis for which information about the unobservable inputs is reasonably available to us is as follows:
Range (Weighted
Valuation Technique(s)
Unobservable Input
Average)
2.74% - 7.35%
Corporate debt
Discounted cash flows
Yield
(4.45%)
Historical costs
Nature of investment
Local market conditions
Comparables
Other long-term investments
Discounted cash flows and indicative valuations
Operating performance
Recent financing activity
N/A*
* Not applicable.
The fair values of the assets using significant unobservable inputs are sensitive and can be impacted by significant increases or decreases in any of those inputs. Level 3 broker-priced instruments (RMBS, CMBS, and CDO/ABS) are excluded from the table above because the unobservable inputs are not reasonably available to us.
Our RMBS, CMBS, and CDO/ABS securities have unobservable inputs that are reliant on and sensitive to the quality of their underlying collateral. The inputs, although not identical, have similar characteristics and interrelationships. Generally a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment speeds. An improvement in the workout criteria related to the restructured debt and/or debt covenants of the underlying collateral may lead to an improvement in the cash flows and have an inverse impact on other inputs, specifically a reduction in the amount of discount applied for marketability and liquidity, making the structured bonds more attractive to market participants.
FAIR VALUE MEASUREMENTS - NON-RECURRING BASIS
We measure the fair value of certain assets on a non-recurring basis when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.
Notes to Consolidated Financial Statements, Continued
Assets measured at fair value on a non-recurring basis on which we recorded impairment charges were as follows:
In accordance with the authoritative guidance for the accounting for the impairment of finance receivables held for sale, we wrote down certain finance receivables held for sale reported in our real estate business segment to their fair value during 2012 and recorded the writedowns in other revenues.
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 real estate business segment to their fair value during 2012 and 2011 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 wrote off the following intangible assets and recognized the related impairment charges in operating expenses:
· customer lists $0.6 million write down during the fourth quarter of 2011 as a result of accelerated liquidations of our branch network loan portfolio and subsequent $4.6 million write off during the third quarter of 2012 as a result of the sale of Ocean finance receivables and mortgage brokerage business in August 2012;
· trade names $11.2 million write off during the fourth quarter of 2011 related to the cessation of new loan originations in our Ocean operations effective January 1, 2012; and
· customer relationships $1.0 million write off during the fourth quarter of 2011 related to the cessation of new loan originations in our Ocean operations effective January 1, 2012.
The unobservable inputs and quantitative data used in our Level 3 valuations for our real estate owned and finance receivables held for sale were developed and used in models created by our third-party valuation service providers or valuations provided by external parties. We applied the third party
Notes to Consolidated Financial Statements, Continued
exception which allows us to omit certain quantitative disclosures about unobservable inputs. As a result, the weighted average ranges of the inputs are not applicable in the following table.
Quantitative information about Level 3 inputs for our assets measured at fair value on a non-recurring basis is as follows:
Valuation Technique(s)
Unobservable Input
Range (Weighted
Average)
Finance receivables held for sale
Market approach
Negotiated prices with prospective purchasers
N/A*
Real estate owned
Market approach
Third party valuation
N/A*
Other intangible assets
Discounted cash flows
N/A*
N/A*
* Not applicable.
FAIR VALUE MEASUREMENTS - VALUATION METHODOLOGIES AND ASSUMPTIONS
We used the following methods and assumptions to estimate fair value.
Cash and Cash Equivalents
The carrying amount reported in our consolidated balance sheets approximates fair value.
Investment Securities
We utilized third-party valuation service providers to measure the fair value of our investment securities (which consist primarily of bonds). 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.
Finance Receivables
The fair value of net finance receivables, less allowance for finance receivable losses, both non-impaired and purchased 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
Notes to Consolidated Financial Statements, Continued
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.
Finance Receivables Held for Sale
We determined the fair value of finance receivables held for sale that were originated as held for investment based on negotiations with prospective purchasers (if any) or by using projected cash flows discounted at the weighted-average interest rates offered by us in the market for similar finance receivables. We based cash flows on contractual payment terms adjusted for estimates of prepayments and credit related losses.
Note Receivable from Parent
The fair value of the note receivable from parent approximated the fair value because the note is payable on a demand basis prior to its due date on May 31, 2022 and the interest rate on this note adjusts with changing market interest rates.
Commercial Mortgage Loans
We utilized third-party valuation service providers to estimate the fair value of commercial mortgage loans using projected cash flows discounted at an appropriate rate based upon market conditions.
Real Estate Owned
We initially based our estimate of the fair value on independent third-party valuations at the time we took title to real estate owned. Subsequent changes in fair value are based upon independent third-party valuations obtained periodically to estimate a price that would be received in a then current transaction to sell the asset.
Other Intangible Assets
Each of our 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, we first complete a qualitative assessment of the licenses to determine whether it is necessary to perform a quantitative impairment test. If the qualitative assessment indicates that the licenses are more likely than not to have been impaired, we proceed with the fair value calculation of the licenses. 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. Prior to our adoption of a new accounting standard for the impairment testing of indefinite-lived intangible assets effective December 31, 2012, we did not perform a qualitative assessment of our licenses before calculating the fair value.
Notes to Consolidated Financial Statements, Continued
Derivatives
Our derivatives are not traded on an exchange. The valuation model used by our third-party valuation service provider 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.
Payable to Affiliate
The fair value of the payable to affiliate approximates the carrying value due to its short-term nature.
27. Subsequent Events
CESSATION OF PURCHASES OF RETAIL SALES FINANCE RECEIVABLES
Effective January 16, 2013, we ceased purchasing retail sales finance receivables so that we could focus our lending efforts on personal loans.
SECURITIZATION
On February 19, 2013, SLFC effected a private securitization transaction in which SLFC caused Tenth Street Funding LLC (Tenth Street), a special purpose vehicle wholly owned by SLFC, to sell $567.9 million of notes backed by personal loans of Springleaf Funding Trust 2013-A (the 2013-A Trust), at a 2.83% weighted average yield, to certain investors. Tenth Street sold the asset-backed notes for $567.5 million, after the price discount but before expenses and a $6.6 million interest reserve requirement of the transaction. 2013-A Trust subordinate asset-backed notes totaling $36.4 million were initially retained by Tenth Street.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .
None.
Item 9A.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and our 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, 2012, our 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
Our 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.
Our 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. Our 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 our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer and Controller. We do not allow loans to executive officers. Our 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 our 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.
Item 9A. Continued
Our management, including our Chief Executive Officer and our 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, 2012, our management, including our 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 our internal control over financial reporting during the three months ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
DIRECTORS
Our directors are elected for one year terms at the annual meeting of the shareholder. Information regarding our directors is presented below:
Wesley R. Edens, age 51
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 the founding principal and Co-Chairman of the board of directors of Fortress (a global investment management firm) and has been a principal and the Chairman of the Management Committee of Fortress since co-founding Fortress in May 1998. Investment funds managed by affiliates of Fortress indirectly own 80% of the Company. 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 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), Brookdale Senior Living Inc. (an operator of senior living communities), 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 us.
Item 10. Continued
Roy A. Guthrie, age 59
Director
Mr. Guthrie has served as a director of the Company since December 2012. Mr. Guthrie served as Executive Vice President and Chief Financial Officer of Discover Financial Services from 2005 through April 2011. He retired from Discover Financial Services in January 2012. Mr. Guthrie also served as a director of Discover Bank, a subsidiary of Discover Financial Services, from 2006 through the end of 2011. Discover Financial Services is a direct banking and payment services company and is a publicly held bank holding company that is listed on the New York Stock Exchange. Discover Financial Services offers credit cards, student loans, personal loans and deposit products through its subsidiary, Discover Bank. Prior to joining Discover Financial Services, Mr. Guthrie was President and Chief Executive Officer of CitiFinancial International, LTD, a Consumer Finance Business of Citigroup, from 2000 to 2004. In addition, Mr. Guthrie served on Citigroup’s Management Committee during this period of time. Mr. Guthrie also served as the President and Chief Executive Officer of CitiCapital from 2000 to 2001. Mr. Guthrie served as Chief Financial Officer of Associates First Capital Corporation from 1996 to 2000, while it was a public company, and served as a member of its board of directors from 1998 to 2000. Prior to this, Mr. Guthrie served in various positions at Associates First Capital Corporation, including serving as its Corporate Controller from 1989 to 1996.
He has also served as a director and member of the audit committee of Bluestem Brands, Inc. (a direct marketing company) since November 2010, a director and member of the audit committee of Garrison Capital LLC (a private capital finance company) since June 2011, a director and member of the audit committee of Nationstar Mortgage, Inc. (a national mortgage lender and servicer) since February 2012, a director and member of the audit committee of Dell Bank International (a wholly owned indirect subsidiary of Dell, Inc., a computer manufacturer and technology company) since September 2012, and a director and member of the audit committee of Lifelock, Inc. (an identity theft protection company) since October 2012. Mr. Guthrie also served as a director of Student Loan Corporation from December 2010 until January 2012 and as a director of Enova International, Inc. from January 2012 until July 2012.
We believe Mr. Guthrie should serve on our board of directors due to his experience as a Chief Financial Officer of two publicly traded companies, his vast experience with and knowledge of the consumer finance industry, his experience and background in finance and accounting and his experience as a director and executive officer of publicly traded companies.
Douglas L. Jacobs, age 65
Director
Mr. Jacobs was elected to the Board as an independent director on November 30, 2010. He is also the Chairman of the Audit Committee. Mr. Jacobs is also a director of Fortress (a global investment management firm), where he chairs the Audit Committee and is a member of the Compensation Committee. Investment funds managed by affiliates of Fortress indirectly own 80% of the Company. He is also a director of 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. He also serves as a director, Treasurer, and Chairman of the Finance Committee of Care New England (a health care system). 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
Item 10. Continued
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 and the Board has determined that Mr. Jacobs is an “audit committee financial expert” for purposes of membership on our Audit Committee.
Anahaita N. Kotval, age 45
Director
Ms. Kotval has served as a director and Chairman of our Compliance Committee since December 2012. Since November 2011, Ms. Kotval has served as Chief Operating Officer and General Counsel of Inspirica, Inc., a nonprofit organization providing residential, case management, counseling, job training, and job and housing placement services for homeless individuals and families. Prior to joining Inspirica, Ms. Kotval served in various positions with RBS Securities Inc. (formerly Greenwich Capital Markets, Inc.), a U.S. broker-dealer and affiliate of the Royal Bank of Scotland, including serving as its General Counsel from 2007 until October 2011, Deputy General Counsel from 2004 until 2007 and Associate General Counsel from 1998 until 2004. Prior to RBS, Ms. Kotval spent 5 years in the Enforcement Division of the U.S. Securities and Exchange Commission’s New York Regional Office.
Ms. Kotval has a B.Sc. from Brown University in Applied Mathematics and Economics and a J.D. from Harvard Law School. Ms. Kotval brings extensive management, legal and regulatory compliance expertise to the Board.
Jay N. Levine, age 51
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 our industry.
Item 10. Continued
Randal A. Nardone, age 57
Director
Mr. Nardone was elected to the Board on November 30, 2010 and serves on the Compensation Committee. Mr. Nardone is a principal and has been a member of the board of directors of Fortress (a global investment management firm) 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. Investment funds managed by affiliates of Fortress indirectly own 80% of the Company.
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 J.D. 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 45
Director
Mr. Smith was elected to the Board on November 30, 2010. Mr. Smith is a managing director in the Private Equity business at Fortress (a global investment management firm) 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. Investment funds managed by affiliates of Fortress indirectly own 80% of the Company. 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 our executive officers is presented below:
Jay N. Levine, age 51
President and Chief Executive Officer
See Mr. Levine’s biography in “- Directors”.
Item 10. Continued
John C. Anderson, age 54
Executive Vice President, Capital Markets
Mr. Anderson has served as Executive Vice President, Capital Markets of the Company since October 2011. Prior to joining the Company, Mr. Anderson was Managing Director at Royal Bank of Scotland in Stamford, Connecticut where he spent the previous 20 years. Mr. Anderson has a bachelor’s degree from the University of South Dakota and a J.D. from the University of Nebraska.
Bradford D. Borchers, age 49
Executive Vice President
Mr. Borchers has been Executive Vice President of Branch Operations since April 2008. Mr. Borchers started as a management trainee with the Company in 1983 and has held positions of increasing responsibility over the intervening 30 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 also served as a director of the Company from April 2008 until December 2012.
Vincent Ciuffettelli, age 45
Senior Vice President and Chief Information Officer
Mr. Ciuffettelli has served as Senior Vice President and Chief Information Officer of the Company since December 2010. He was appointed Vice President, Information Management Systems, in August 2005, and was appointed Vice President and Chief Information Officer in February 2007. Mr. Ciuffettelli has been employed by the Company since 1993.
David P. Hogan, age 43
Senior Vice President and Chief Risk and Analytics Officer
Mr. Hogan has served as Senior Vice President and Chief Risk and Analytics Officer of the Company since August 2012. Prior to joining the Company, Mr. Hogan served as Head of New Customer Acquisition Decision Management for Citicards, the credit card issuing division of Citibank, from March 2012 until August 2012. From August 2010 until March 2012, he served as Head of Payments Strategy and Analytics of PNC Financial, a regional banking corporation. Prior to that, Mr. Hogan served as Chief Risk Officer Small Business Cards and Head of Portfolio Risk Management at JP Morgan Chase’s Card Services’ division from January 2008 until August 2010.
William E. Kandel, age 55
Vice President and Chief Accounting Officer
Mr. Kandel has served as Vice President and Chief Accounting Officer of the Company since January 1, 2013. Since January 1, 2008, Mr. Kandel has served as Senior Vice President and Chief Financial officer of Wilmington Finance, Inc., an indirect wholly-owned subsidiary of the Company. Mr. Kandel served as Assistant Controller of the Company from January 1, 2008 until December 31, 2012.
Minchung (Macrina) Kgil, age 37
Senior Vice President and Chief Financial Officer
Ms. Kgil has served as Senior Vice President and Chief Financial Officer of the Company since January 1, 2013. She served as Vice President and Group Controller of the Company from October 1, 2012 until December 31, 2012. Prior to joining the Company, Ms. Kgil was Vice President at Fortress Investment Group LLC (a global investment management firm) from January 2008 until September 30, 2012.
Item 10. Continued
Investment funds managed by affiliates of Fortress indirectly own 80% of the Company. Prior to that, she was employed by PricewaterhouseCoopers LLC from 2000 until 2007.
Scott P. Lascelles, age 45
Senior Vice President and Chief Marketing Officer
Mr. Lascelles has served as Senior Vice President and Chief Marketing Officer of the Company since December 2012. Prior to joining the Company, he served as Senior Vice President of Retail Risk of PNC Financial Services Group (a financial services company) from March 2011 until November 2012. From February 2008 until March 2011, Mr. Lascelles served as Senior Director Customer Experience and Marketing of Barclaycard US (a financial services company).
Mark E. Lefanowicz, age 56
Senior Vice President, Internet Lending
Mr. Lefanowicz has served as Senior Vice President, Internet Lending of the Company since December 2012. Prior to joining the Company, Mr. Lefanowicz served as the Chief Executive Officer of MLDW Consulting, Inc. (a financial services consulting firm) from June 2012 until November 2012. Prior to that, he served as Chief Financial officer of Provident Funding Associates LLP (a mortgage lender). From January 2008 until December 2008, Mr. Lefanowicz served as the President of E-Loan, Inc. (an Internet lending company).
Lenis McClain, age 60
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.
Scott D. McKinlay, age 61
Senior Vice President and General Counsel
Mr. McKinlay has served as Senior Vice President and General Counsel of the Company since December 2012. Prior to joining the Company, Mr. McKinlay served as the General Counsel of McKinlay General Counsel (a legal services boutique) from August 2008 until November 2012. Prior to that, he served as Chief Legal Officer and Senior Vice President of Corporate Development of E-Loan, Inc. (an Internet lending company) from March 2004 until November 2008. From March 2000 to March 2004, Mr. McKinlay was the General Counsel of Command Audio Corporation (an intellectual property and broadcasting company) and Chief Operating Officer of InPro Biotechnology, Inc. (a diagnostic testing company), two Silicon Valley start-up companies. From March 1991 to February 2000, he worked for First Nationwide Bank, initially as Vice President and Associate General Counsel (March 1991 to September 1993) and later as Senior Vice President and General Counsel (October 1993 to February 2000). Mr. McKinlay has also served as a Director of Tri-Valley Bank (a California community bank) since June 2011.
Item 10. Continued
Mohsin Y. Meghji, age 48
Executive Vice President
Mr. Meghji has served as Executive Vice President and Head of Strategy and Corporate Development since January 2012 and as President and Chief Executive Officer of Merit Life Insurance Co. and Yosemite Insurance Company, Inc. (the Company’s insurance subsidiaries) since January 2013. Prior to joining the Company, Mr. Meghji served as Senior Managing Director of C-III Capital Partners (a real estate/merchant banking firm) from October 2011 until January 2012. Prior to that, he served as Principal and Managing Director of Loughlin Meghji & Company (a financial advisory firm) from February 2002 until October 2011.
LeaAnn V. Newman, age 51
Senior Vice President, Human Resources
Ms. Newman has served as the Senior Vice President of Human Resources of the Company since December 2012 and as Vice President of Human Resources from July 2012 until December 2012. Prior to joining the Company, Ms. Newman served as the Vice President of Human Resources of Daymar Colleges Group (an educational institution) from June 2010 until March 2012. From May 1987 until June 2010, Ms. Newman served as Director of Human Resources of Mead Johnson Nutrition (a nutrition/manufacturing company and former division of Bristol Myers Squibb).
AUDIT COMMITTEE
The Board has established a separately-designated standing Audit Committee. The Audit Committee has responsibility for, among other things, assisting the Board of Directors with reviewing financial reporting and other internal control processes, our financial statements, the independent auditors’ qualifications and independence, the performance of our internal audit function and the independent auditors, and our compliance with legal and regulatory requirements. Mr. Jacobs is the Chairman and sole member of the Audit Committee. The Board has determined that Mr. Jacobs meets the definition of independence under Rule 10A-3 of the Securities Exchange Act of 1934, as required by Section 303A.06 of the New York Stock Exchange Listed Company Manual. The Board has also determined that Mr. Jacobs is an “audit committee financial expert” within the meaning of SEC rules. A copy of the Audit Committee charter is posted on “About Us - Financial Information” of our website at www.SpringleafFinancial.com.
CODE OF ETHICS
We have adopted a Code of Ethics for Principal Executive and Senior Financial Officers (the Code of Ethics) that is applicable to our 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 it 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 2012. 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, 2012, 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 2012 are Jay N. Levine, Donald R. Breivogel, Jr., John C. Anderson, Bradford D. Borchers, and Robert A. Cole. These five executive officers are referred to as the “named executives.”
Organizational Overview. Executive compensation decisions have been made in the context of the results achieved by the Company’s executive team during 2010, 2011, and 2012 in maintaining the underlying operating performance of our business as the organization is realigned and the capital structure stabilized.
Objectives and Design of Compensation Framework
In 2012, our compensation philosophy focused on the following strategies, which are designed to advance the short- and long-term goals of the Company:
· stabilizing capital structure;
· realigning branch footprint to better match target markets;
· exiting non-core businesses; and
· executing expense initiative to reduce overall expenses.
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 December 19, 2012, the Compensation Committee of the Board set the annual base salary for Jay Levine, as the President and Chief Executive Officer of the Company, at $400,000, effective retroactive to December 10, 2012 (the beginning of the then-current pay period). The Compensation Committee also approved a lump sum payment of $476,923.08 to Mr. Levine (which was paid later in December 2012), as compensation for services provided by Mr. Levine from October 1, 2011 through December 9, 2012, calculated based on the prospective annual base salary set by the Compensation Committee. Prior to December 2012, Mr. Levine had not received a base salary. Mr. Levine is not currently eligible for any annual or long-term incentive programs, although such programs may be developed in the future.
Item 11. Continued
Compensation for the Other Named Executives. The following chart sets forth various compensation elements under the executive compensation program for 2012 for the named executives other than Mr. Levine, 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 Other Named Executives
In 2012, the Chief Executive Officer determined each compensation element for Messrs. Breivogel, Borchers, and Cole 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 these named executives, as well as the amounts earned by or paid to them in 2012.
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 Cole were not increased for 2012. On December 19, 2012, the Compensation Committee of the Board approved the annual base salary for John Anderson at $350,000 effective retroactive to December 10, 2012 (the beginning of the then-current pay period). The Compensation Committee also approved a lump sum payment of $417,308 to Mr. Anderson (which was paid later in December 2012), as compensation for services provided by Mr. Anderson from October 1, 2011 through December 9, 2012, calculated based on the annual base salary approved by the Compensation Committee.
Annual Bonuses. Typically, in the first quarter of each fiscal year, the Chief Executive Officer makes a recommendation to the Compensation Committee regarding bonus awards for the other named executives for their performance during the prior fiscal year. The Compensation Committee evaluates the recommendation of the Chief Executive Officer, approves bonus awards, if any, with any modifications it deems appropriate, and makes 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. At the time this analysis was filed, 2012 annual bonus decisions had not been made.
Long-Term Incentive Compensation. No long-term incentive program was in place for 2012.
Item 11. Continued
Other Compensation Elements Available to Named Executives
Termination Benefits and Policies. During 2012, Messrs. Breivogel and Cole were participants in the Springleaf Finance, Inc. Executive Severance Plan (ESP). This plan was adopted by Springleaf Finance, Inc. in March 2011, effective as of November 30, 2010. This plan is maintained for participants previously eligible for severance benefits under the predecessor American International Group plan. No additional plan participants have been approved since its adoption.
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).
If a participating executive is terminated without Cause by the Company or resigns for Good Reason, the executive is 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. Any unvested long-term incentive awards would 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. Effective upon the cessation of their employment on December 31, 2012, Messrs. Breivogel and Cole began receiving payments and benefits under the ESP formula outlined above.
The remaining named executives were eligible for the Company’s generally applicable severance plan, which applies to all employees. This practice provides for severance based upon an employee’s length of service and current salary.
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. 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 2012 was $4,500 for Messrs. Breivogel, Borchers, and Cole and $1,700 for Messrs. Levine and Anderson.
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.” As of December 31, 2012, the Retirement Plan, a tax-qualified defined benefit pension plan, as well as the Excess Retirement Income Plan, were frozen with respect to both salary and service levels to prevent future increases in the benefit liabilities established under the plan. Springleaf continues to have liability to fund the plan’s trust to the extent the assets in the trust are less than liabilities for benefits.
Item 11. Continued
Process for Compensation Decisions
Role of the Compensation Committee. Our Board of Directors has established a 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 our executive compensation plans, and determine and approve the Chief Executive Officer’s compensation level based on this evaluation. The Committee also makes recommendations to our 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 named executives other than the Chief Executive Officer is recommended by the Chief Executive Officer and is then approved by the Compensation Committee, with such modifications as the Committee deems appropriate, and recommended to our 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 our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 (the 2012 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 2012 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
2012 Executive Compensation
The following tables contain compensation information with respect to our named executives for 2012. An affiliate of SLFC pays the compensation presented below to such individuals for services they provide to SLFC and all of its subsidiaries. Under applicable SEC rules, our named executives include our Chief Executive Officer, Chief Financial Officer, and the three other most highly compensated executive officers who were serving as executive officers of the Company on December 31, 2012.
Item 11. Continued
2012 Summary Compensation Table
(1) The amounts in this column reflect cash base salary.
(2) As of the filing of this Annual Report on Form 10-K, bonuses for the named executive officers for 2012 had not been determined and, therefore, have been omitted from the Summary Compensation Table. It is expected that bonuses will be determined by April 30, 2013, and the Company will report the amount of any bonuses awarded to the named executive officers for 2012 pursuant to Item 5.02(f) of Form 8-K.
The amounts reported in this column for 2012 represent the previously disclosed discretionary cash award paid in August 2012 to the executives who remained actively employed at the time of payment and who otherwise met the eligibility requirements. The amount for Mr. Cole also includes an additional bonus ($65,000) paid in December 2012.
The amounts reported in this column for 2011 represent a discretionary cash award.
The amounts reported in this column for 2010 represent (i) special discretionary bonuses (Mr. Breivogel ($7,521), Mr. Borchers ($4,658), and Mr. Cole ($6,016)), and (ii) 2010 year-end cash bonuses (Mr. Breivogel ($150,000), Mr. Borchers ($150,000), 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 a majority interest in the Company from AIG to FCFI.
(3) No stock awards were made in 2010, 2011, or 2012.
(4) No option awards were made in 2011 or 2012.
In 2010, Messrs. Breivogel, Borchers, and Cole 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
Item 11. Continued
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; 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 our 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, and Mr. Cole received $306,923, $203,125, 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 $8.09 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 (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 2010). The expected term used was based on the period of time the SARs were expected to be outstanding, with the expected term of 3.76 years for 2010. 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.
(5) No Non-Equity Incentive Plan awards were made in 2011 or 2012.
The amounts reported in 2010 in the Non-Equity Incentive Plan column represent (i) a sale completion bonus payable to Mr. Breivogel ($316,200), Mr. Borchers ($275,000), 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), and Mr. Cole ($814,933). In connection with the sale of the Company, the 2010-2011 cash awards were paid out at 100% of target pursuant to the terms of the AIG LTIP.
(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 our non-qualified deferred compensation programs. The pension benefit of the named executives was frozen effective December 31, 2012.
(7) “All Other Compensation” for 2012 includes 401(k) employer matching contributions of $4,500 for Messrs. Breivogel, Borchers, and Cole and $1,700 for Messrs. Levine and Anderson.
(8) On December 19, 2012, the Compensation Committee of the Board set the annual base salary for Jay Levine at $400,000, effective retroactive to December 10, 2012 (the beginning of the then-current pay period). In addition, the Compensation Committee also approved a lump sum payment of $476,923.08 to Mr. Levine (which was paid later in December 2012), as compensation for services provided by Mr. Levine from October 1, 2011 through December 9, 2012, calculated based on the prospective annual base salary set by the Compensation Committee, $400,000 of which is reported as Mr. Levine’s base salary in 2012 and $92,308 of which is reported as other compensation. Prior to December 2012, Mr. Levine had not received a base salary. Mr. Levine is not currently eligible for any annual or long-term incentive programs, although such programs may be developed in the future.
(9) On December 19, 2012, the Compensation Committee of the Board set the annual base salary for John Anderson at $350,000, effective retroactive to December 10, 2012 (the beginning of the then-current pay period). In addition, the Compensation Committee also approved a lump sum payment to Mr. Anderson (which was paid later in December 2012), as compensation for services provided by Mr. Anderson from October 1, 2011 through December 9, 2012, calculated based on the prospective annual base salary set by the Compensation Committee, $350,000 of which is reported as Mr. Anderson’s base salary in 2012 and
Item 11. Continued
$80,769 of which is reported as other compensation. Prior to December 2012, Mr. Anderson had not received a base salary.
2012 Grants of Plan-Based Awards
No plan-based awards were granted in 2012.
Exercises and Holdings of Previously Awarded Equity
Outstanding Equity Awards at December 31, 2012. There were no outstanding Company equity awards at December 31, 2012.
Vesting of Stock-Based Awards During 2012
The equity-based awards shown below that vested in January 2012 were awards under various AIG stock incentive plans that were granted to our named executives by AIG before its sale of its majority interest in the Company to FCFI. All equity-based awards relate to shares of AIG Common Stock pursuant to awards outstanding under AIG stock incentive plans.
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 2012.
(1) No option awards were settled in 2011.
(2) Represents the following stock-based awards held by Messrs. Breivogel and Cole that vested in 2012: (i) 33 RSUs vested in January 2012 under the AIG Partners Plan for the January 1, 2006 - December 31, 2007 performance period and (ii) 68 time-vested RSUs granted in 2007 under the AIG Deferred Compensation Profit Participation Plan vested in January 2012.
Pension Benefits
Eligible employees of the Company participate in the 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
Item 11. Continued
created the Retirement Plan and assumed the obligations under the AIG Retirement Plan with respect to our employees, vested terminated participants, 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, a tax-qualified defined benefit pension plan, was frozen effective December 31, 2012. No additional participants are allowed entry into the plan and no additional benefits will accrue for any existing participants of the plan as a result of this pension freeze. A corresponding freeze of future accruals of benefits under the Excess Retirement Income Plan was also implemented at the end of 2012. At the time the pension was frozen, the Board also approved modification of the pension plan allowing for individuals terminated from employment with Springleaf prior to July 31, 2012 and not currently receiving a plan benefit, a one-time option to elect a payment of the present value of their Retirement Plan benefit in the form of a lump sum.
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 from April 1, 1985 to December 31, 2012, 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.
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, prior to the pension plan being frozen, 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 but no later than December 31, 2012 due to the plan freeze, 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. Mr. Cole was the only named executive who met the qualifying criteria for early retirement in 2012.
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.
Item 11. Continued
Under the Retirement Plan and the Excess Retirement Income Plan, participants continue to accrue credited service through December 31, 2012 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 but no later than December 31, 2012.
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.
2012 pension benefits. The following table details the accumulated benefits for the named executives under the Retirement Plan and the Excess Retirement Income Plan. These plans were frozen effective December 31, 2012. No additional participants will be allowed entry into the plans and no additional creditable service will be awarded after December 31, 2012. 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, 2012 (the pension plan measurement date for purposes of our financial statement reporting).
Assumptions used in the calculation of the present value of accumulated benefits were discount rates of 3.99% for the Springleaf Retirement Plan and 3.41% for the Excess Retirement Income Plan; 2013 Pension Protection Act static annuitant mortality tables, post retirement only; and normal retirement age, or current age if older.
Item 11. Continued
Potential Payments and Benefits on Termination
ESP. Messrs. Breivogel 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. Messrs. Anderson, Borchers, and Levine were not participants because they were not eligible under the AIG-ESP. They would be entitled to receive severance under our employee severance plan, which is available generally to all employees and which does not discriminate in favor of executive officers.
Under the ESP, eligible named executives 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 a material reduction in duties, responsibilities, titles, offices, base pay, or annual target bonus opportunity.
Effective with their separation of employment on December 31, 2012, Messrs. Breivogel and Cole began receiving the following severance benefits: the sum of his annual base salary and three-year-average of annual cash bonuses. The cash severance will be paid over the 12 month severance period in accordance with normal payroll practices. Any unvested long-term incentive awards would 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 from the Company if their employment had been terminated as of December 31, 2012. For Messrs. Breivogel and Cole, the table shows their actual entitlements resulting from their separation from employment effective December 31, 2012. For Messrs. Levine, Anderson, and Borchers, the table reflects benefits generally available to all salaried employees including severance and medical and life insurance benefits. Additional information about benefits upon termination is provided in “- Pension Benefits” above.
Item 11. Continued
(1) Messrs. Breivogel and Cole both separated from the organization effective December 31, 2012, making them eligible for the amounts indicated in the table. Messrs. Anderson, Borchers, and Levine are not eligible to participate in the ESP. The benefits shown for these executives are those that would have been provided under our generally applicable severance plan.
(2) The amounts reported represent the cost to the Company of continued health and group life insurance benefits provided for under the ESP or our employee severance plan, as applicable. If eligible for retiree medical and life insurance benefits, these named executives are covered under our 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
Item 11. Continued
shown for all of the termination events is the increase above the accumulated value of pension benefits shown in the 2012 Pension Benefits Table, calculated using the same assumptions.
The present value, if any, for involuntary termination by the Company reflects additional service under the qualified pension plan through December 31, 2012, the date the pension plan was frozen. 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 the 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) As of December 31, 2012, there were no unvested stock awards.
Compensation of Directors
The total 2012 compensation of our non-employee directors is shown in the following table. Directors who are not employees of the Company are eligible for an annual fee of $75,000. We do not separately compensate our directors who also are employees of the Company or who are otherwise affiliated with us, including Messrs. Edens, Nardone, and Smith. Mr. Jacobs, as the sole member and chairman of the Audit Committee, received an additional annual fee of $10,000. Mr. Guthrie and Ms. Kotval, each of whom joined the Board on December 19, 2012, received $18,750 for 2012. Ms. Givens resigned from the Board effective as of December 19, 2012. Mr. Keller ceased being a director upon his death on August 18, 2012, and received $18,750 for each board meeting held prior to his death, plus the $75,000 annual fee.
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 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,
Item 11. Continued
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, other than the Chief Executive Officer, and directors for 2011 and 2012 were approved by the Compensation Committee and the Board of Directors.
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 indirectly owns a majority interest in Nationstar through investment funds managed by affiliates of Fortress. Nationstar subservices the real estate loans that were originated or acquired centrally by MorEquity and two other subsidiaries of SLFC (collectively, the Owners), including certain securitized real estate loans.
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 2012, the Owners paid $9.8 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 $66.0 million in first mortgages were modified under the refinancing program during 2012, and Nationstar has received $4.4 million from the Owners to pay closing costs and reduce the principal amount of refinancings under the marketing agreement during 2012.
Prior to the FCFI Transaction, we did not have a separately-designated standing compensation committee and, therefore, the Board of Directors performed compensation committee functions for that entity. 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 28, 2013, information regarding the only persons that, to the Company’s knowledge, beneficially own more than 5% of the Company’s common stock. The Company is wholly owned by SLFI. SLFI 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.
Name and Address of Beneficial Owner
Title of Class
Number of Shares Beneficially
Owned
Percent of Class
Fortress Investment Group LLC (1)
1345 Avenue of the Americas
New York , New York 10105
common stock
8,128,014 common shares
80% (2)
American International Group, Inc. (3)
180 Maiden Lane
New York, New York 10038
common stock
2,032,003 common shares
20% (2)
(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, 2012, Mr. Edens owns 14.98% of Fortress (Class A and B shares), and Mr. Nardone owns 10.91% 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 SLFI.
Item 12. Continued
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, 2012 by our 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 218,286,342 Class A shares outstanding as of December 31, 2012.
(2) The percentage of beneficial ownership of Class B shares is based on 249,534,372 Class B shares outstanding as of December 31, 2012.
(3) The total percentage of voting power is based on 218,286,342 Class A shares and 249,534,372 Class B shares outstanding as of December 31, 2012.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
CERTAIN TRANSACTIONS
Affiliates of Fortress or AIG
Secured Term Loan. Springleaf Financial Funding Company, a wholly-owned subsidiary of SLFC, is party to a $3.75 billion, six-year secured 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. Affiliates of Fortress and affiliates of AIG owned or managed lending positions in the syndicate of lenders totaling $85.0 million at December 31, 2012 and $105.5 million at December 31, 2011.
Subservicing and Refinance Agreements. Effective February 1, 2011, Nationstar began subservicing the real estate loans of MorEquity and two other subsidiaries of SLFC (collectively, the Owners), including certain securitized real estate loans. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar.
The Owners paid Nationstar fees for its subservicing and to facilitate the repayment of our real estate loans through refinancings with other lenders as follows:
Investment Management Agreement. Logan Circle provides investment management services for our investments. Logan Circle is a wholly-owned subsidiary of Fortress. Costs and fees incurred for these investment management services totaled $0.8 million in 2012.
Pension Plan. At December 31, 2012, we had no plan assets included in the AIG Retirement Plan, compared to $59.9 million at December 31, 2011. The transfer due from the AIG Retirement Plan to our tax-qualified defined benefit retirement plan was completed in April 2012.
Reinsurance Agreements. Merit 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 $46.8 million at December 31, 2012 and $49.7 million at December 31, 2011.
Derivatives. At December 31, 2012 and 2011, all of our derivative financial instruments were with AIG Financial Products Corp. (AIGFP), a subsidiary of AIG. In July 2012, SLFI posted $60.0 million of cash collateral with AIGFP as security for SLFC’s two remaining Euro swap positions with AIGFP and agreed to act as guarantor for the swap positions. In August 2012, one of the swap positions was terminated and the cash collateral was reduced by $20.0 million.
Item 13. Continued
FIF HE Holdings indirectly owns a majority interest in 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 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, 2012, Mr. Edens owns 14.98% of Fortress and Mr. Nardone owns 10.91% 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.
Affiliates of SLFI (Other than Affiliates of Fortress or AIG)
Affiliate Lending
Note Receivable from Parent. SLFC’s note receivable from SLFI is payable in full on May 31, 2022, and SLFC may demand payment at any time prior to May 31, 2022; however, SLFC does not anticipate the need for additional liquidity during 2013 and does not expect to demand payment from SLFI in 2013. The note receivable from SLFI totaled $538.0 million at December 31, 2012 and 2011. Interest receivable on this note totaled $1.5 million at December 31, 2012 and $11.8 million at December 31, 2011. The interest rate for the unpaid principal balance is the prime rate. Interest revenue on the note receivable from SLFI totaled $17.3 million during 2012, $17.4 million during 2011, $1.9 million during the one month ended December 31, 2010, and $16.4 million during the eleven months ended November 30, 2010.
Receivables from Parent and Affiliates. At December 31, 2012 and 2011, receivables from our parent and affiliates totaled $16.2 million and $24.8 million, respectively, primarily due to a receivable from Second Street Funding Corporation, a subsidiary of SLFI, for income taxes payable under current and prior tax sharing agreements, which were paid by SLFC. The receivables from our parent and affiliates also include interest receivable on SLFC’s note receivable from SLFI discussed above.
Intercompany Demand Note. Pursuant to a prepayable, intercompany demand note (the Note) dated October 1, 2012, between SLFI and SLAH, a subsidiary of SLFC, SLFI advanced $20.0 million to SLAH. Under the terms of the Note, SLFI may elect to make advances to SLAH from time to time in an aggregate amount not to exceed $50.0 million. The annual interest rate for the principal balance is 6%. SLAH used the advance to pay a cash dividend to SLFC on October 1, 2012, which SLFC plans to use for general corporate purposes. On October 26, 2012, SLAH repaid the $20.0 million advance, plus accrued interest.
Cash Collateral
In August 2012, SLFSSC and SLFI entered into the Reimbursement Agreement and a related Fee Agreement whereby SLFI agreed to post $25.0 million of cash collateral on behalf of SLFSSC in connection with a judgment entered against SLFSSC, subject to SLFSSC’s agreement to repay the collateral in full in the event it was applied to the judgment and to pay a fee equal to an annual rate of 8.00% of the average monthly amount of unreimbursed collateral until fully repaid. SLFSSC agreed to settle the litigation in late August 2012.
Item 13. Continued
In December 2012, SLFSSC and SLFI amended the Reimbursement Agreement and the Fee Agreement to provide that the collateral could be applied toward the settlement and that SLFI would pay up to an additional $11.0 million toward the settlement on behalf of SLFSSC, subject to SLFSSC’s agreement to repay such amounts in full and to pay a fee equal to an annual rate of 8.00% of the average monthly amount paid by SLFI toward the settlement until fully repaid. During 2012, SLFSSC paid SLFI $0.6 million of fees under the Fee Agreement and the amended Fee Agreement.
Subsequently, SLFI paid an additional $5.8 million in December 2012, on SLFSSC’s behalf, to satisfy the remaining portion of the settlement. At December 31, 2012, the resulting payable to SLFI totaled $30.8 million and interest payable to SLFI totaled $0.1 million.
See Note 21 of the Notes to Consolidated Financial Statements in Item 8 for further information on this legal settlement.
Capital Contributions
On each of January 10, 2012 and July 11, 2012, SLFC received capital contributions from SLFI of $10.5 million to satisfy SLFC’s hybrid debt semi-annual interest payments due in January and July 2012, respectively.
Derivatives
As previously discussed, SLFI posted $60.0 million of cash collateral with AIGFP as security for SLFC’s two remaining Euro swap positions with AIGFP in July 2012, and in August 2012, one of the swap positions was terminated and the cash collateral was reduced by $20.0 million. Fees payable to SLFI totaled $0.3 million at December 31, 2012. In 2012, SLFC paid SLFI $6.9 million of collateral and guarantee fees.
Intercompany Agreements
In mid-2012, SLFI took the initial steps to explore additional growth opportunities, including centralized online lending and strategic acquisitions of loan portfolios. SLFI created SCLI for centralized online lending to customers out of the SLFC branch footprint. In addition to direct lending, SCLI has established certain strategic alliances with our state branch operating entities to provide online loan processing services for customers who are located in the geographic footprint of our branch network, but who prefer the convenience of interacting with us primarily online. Among other things, SCLI provides loan application processing and credit underwriting services on behalf of our branch offices for loan applications submitted through a centralized online or telephone application system that are within the branch footprint. SLFI also created SAC for potential portfolio and other acquisitions. Subsidiaries of SAC and certain third parties recently entered into an agreement to purchase and service a portfolio of real estate and personal loans. SCLI and SAC are not subsidiaries of SLFC.
In 2012, SLFI and SLFC realigned their internal structure related to the provision of certain administrative services. Historically, the employer for all of our employees has been SFMC, a subsidiary of SLFC. SFMC provided management services for all of our companies, and also provided the employees who work in the branches for our state consumer lending entities. Because employees who work at our headquarters and certain other employees provide services to all of our entities, including subsidiaries of SLFI, in late 2012 we reassigned over 1,000 employees who provide those services from SFMC to a new management corporation, SGSC, a subsidiary of SLFI. Employees who work in the branches or primarily provide services to our branch system remain employees of SFMC. Most SLFI subsidiaries, including SFMC and the state consumer lending entities, have entered into a services
Item 13. Continued
agreement with SGSC for the provision of various centralized services, such as accounting, human resources, and information technology support. These services previously had been provided by SFMC. This reassignment of employees and the intercompany agreements related to the structural realignment are not expected to result in a material increase in the costs and expenses that SLFC would have incurred had this reorganization not taken place. We expect to continue to focus on the consumer business segment which is the core of our present operations. SGSC is not a subsidiary of SLFC.
On December 24, 2012, SGSC entered into the following intercompany agreements with SFMC and with certain other subsidiaries of SLFI (collectively, the “Recipients”):
Services Agreement. SGSC provides the following services to the Recipients: management and administrative services; financial, accounting, treasury, tax, and audit services; facilities support services; capital funding services; legal services; human resources services (including payroll); centralized collections and lending support services; insurance, risk management, and marketing services; and information technology services. The fees payable by each Recipient to SGSC is equal to 100% of the allocated cost of providing the services to such Recipient. SGSC allocates its cost of providing these services among the Recipients and any of the companies to which it provides similar services based on an allocation method defined in the agreement. SFMC recorded $1.9 million of service fee expenses during this eight-day period in 2012, which are included in other operating expenses. At December 31, 2012, services fees payable to SGSC totaled $1.9 million. The agreement has a term of 5 years provided that each of SGSC and SFMC may terminate the agreement upon one year’s prior written notice. The agreement will terminate automatically with respect to a Recipient if such Recipient ceases to be an affiliate of SGSC. In addition, each party has the right to terminate the agreement upon the occurrence of certain events, including the filing of a petition of bankruptcy, if the other party becomes or is declared insolvent, makes an assignment on behalf of its creditors or takes any corporate action for its winding up or dissolution.
License Agreement. The agreement provides for use by SGSC of SFMC’s information technology systems and software and other related equipment. The monthly license fee payable by SGSC for its use of the information technology systems and software is 100% of the actual costs incurred by SFMC plus a 7% margin. The fee payable by SGSC for its use of the related equipment is 100% of the actual costs incurred by SFMC. The agreement has a term of 5 years provided that each of SGSC and SFMC may terminate the agreement upon one year’s prior written notice. The agreement will terminate automatically with respect to a Recipient if such Recipient ceases to be an affiliate of SGSC. In addition, each party has the right to terminate the agreement upon the occurrence of certain events, including the filing of a petition of bankruptcy, if the other party becomes or is declared insolvent, makes an assignment on behalf of its creditors or takes any corporate action for its winding up or dissolution.
Building Lease. The agreement provides that SFMC will lease six of its buildings to SGSC for an annual rental amount of $3.7 million, plus additional rental amounts to cover other sums and charges, including real estate taxes, water charges, and sewer rents. SGSC is permitted to assign the lease to its affiliates or sub-let up to 50% of the rentable square footage (in aggregate) of each leased building. The agreement has a term of 10 years, which SGSC may renew for an additional 5 years by giving one year’s prior written notice and provided no event of default has occurred. SFMC has the option to cancel the lease at any time by delivering a cancellation notice to SGSC at least 9 months prior to the specified lease cancellation date, provided that no such notice can be delivered prior to January 1, 2018. SFMC may also terminate the lease by written notice and exercise its right of re-entry upon the occurrence of certain events, including failure by SGSC to pay rent for 10 days after notice thereof from SFMC, abandonment by SGSC of the property, if SGSC becomes or is declared insolvent, or if SGSC makes an assignment on behalf of its creditors or takes any corporate action for its winding up or dissolution.
Item 13. Continued
Sale of Subsidiary to SLFI
On December 19, 2012, SLFC sold 100% of the common stock of its wholly-owned subsidiary, Spingleaf Mortgage Holding Company (SMHC), to SLFI. The sale of SMHC’s common stock to SLFI was recorded at the carrying value of $0.6 million as of December 19, 2012, which approximated the fair value because the purchased assets and liabilities assumed consisted of cash and short-term duration assets and liabilities.
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 deemed appropriate by members of the Board, on a case by case basis, based on the particular facts and circumstances of each transaction and as required by Indiana law.
DIRECTOR INDEPENDENCE
We have certain debt securities listed on the NYSE, but our common stock is not listed on any exchange. The NYSE’s corporate governance standards do not generally apply to companies that list only debt securities on the exchange and, therefore, the NYSE does not require that a majority of our Board of Directors be independent. The NYSE does, however, require that, to the extent required by Rule 10A-3 under the Securities Exchange Act of 1934, debt-listed companies have an audit committee that satisfies the requirements of Rule 10A-3. Prior to the FCFI Transaction on November 30, 2010, we were exempt from the requirements of Rule 10A-3 because we were an indirect, wholly-owned, consolidated subsidiary of AIG (which has its common stock listed on the NYSE). We did not have any independent directors at that time. Effective upon consummation of the FCFI Transaction, two independent directors were elected to the Board and an Audit Committee of the Board was established. Mr. Jacobs is the Chairman and sole member of our Audit Committee. Effective March 2011, a Compensation Committee of the Board was also established. Messrs. Edens and Nardone serve as members of the Compensation Committee, with Mr. Edens serving as Chairman. We do not have a separately designated nominating committee.
The Board has determined that Messrs. Guthrie and Jacobs and Ms. Kotval are “independent” as defined in the listing standards of the NYSE. In making its “independence” determination with respect to Messrs. Jacobs and Guthrie and Ms. Kotval, the Board considered all relevant facts and circumstances, including the “independence” standards set forth in the NYSE rules. In doing so the Board affirmatively determined that neither of the Independent Directors, or any of their family members, has had any material relationship with the Company (either directly, or as a partner, stockholder or officer of an organization that has a relationship with the Company), other than as a shareholder and director, within the last three years. The Board has not determined that any of our other four directors (including the members of the Compensation Committee) are “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 Accounting Fees and Services.
Our Audit Committee 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 SLFC and the related services were as follows:
Audit fees in 2012 and 2011 were primarily for the audit of SLFC’s Annual Reports on Form 10-K, quarterly review procedures in relation to SLFC’s Quarterly Reports on Form 10-Q, statutory audits of insurance subsidiaries of SLFC, and audits of other subsidiaries of SLFC and of our 410(K) plans. Audit-related fees in 2012 were primarily due to the execution of three securitization transactions in 2012 and agreed upon procedures performed during 2012. Audit-related fees in 2011 were primarily due to the filing of a registration statement with the SEC for Springleaf REIT.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a) (1) and (2) The following consolidated financial statements of Springleaf Finance Corporation and subsidiaries are included in Item 8:
Consolidated Balance Sheets, December 31, 2012 and 2011
Consolidated Statements of Operations, years ended December 31, 2012 and 2011, one month ended December 31, 2010, and eleven months ended November 30, 2010
Consolidated Statements of Comprehensive Income (Loss), years ended December 31, 2012 and 2011, one month ended December 31, 2010, and eleven months ended November 30, 2010
Consolidated Statements of Shareholder’s Equity, years ended December 31, 2012 and 2011, one month ended December 31, 2010, and eleven months ended November 30, 2010
Consolidated Statements of Cash Flows, years ended December 31, 2012 and 2011, one month ended December 31, 2010, and eleven months ended November 30, 2010
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 208 herein.
(b) Exhibits
The exhibits required to be included in this portion of Item 15 are submitted as a separate section of this report.
(c) Schedule I - Condensed Financial Information of Registrant
Schedule I, Continued
SPRINGLEAF FINANCE CORPORATION
Condensed Balance Sheets
See Notes to Condensed Financial Statements.
Schedule I, Continued
SPRINGLEAF FINANCE CORPORATION
Condensed Statements of Operations
See Notes to Condensed Financial Statements.
Schedule I, Continued
SPRINGLEAF FINANCE CORPORATION
Condensed Statements of Cash Flows
See Notes to Condensed Financial Statements.
Schedule I, Continued
SPRINGLEAF FINANCE CORPORATION
Notes to Condensed Financial Statements
December 31, 2012
1. Accounting Policies
SLFC 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 SLFC’s consolidated financial statements.
2. Receivable from Subsidiaries
SLFC provides funding to most of its finance subsidiaries for lending activities. SLFC charges these subsidiaries for this funding based on its interest rate plus a spread.
3. Long-term Debt
Principal maturities of long-term debt for the five years after December 31, 2012 were as follows: 2013, $1.5 billion; 2014, $358.0 million; 2015, $797.7 million; 2016, $375.0 million; and 2017, $3.3 billion.
4. Subsidiary Debt Guarantee
One SLFC subsidiary is required to maintain a $1.0 million direct committed line of credit to comply with state regulations. SLFC guarantees any borrowings under this line of credit. The subsidiary has not borrowed under this line of credit.
One SLFC subsidiary is required to maintain a $100,000 direct committed line of credit to comply with state regulations. The subsidiary has not borrowed under this line of credit.
SLFC guarantees the bank borrowings of CommoLoCo, Inc., SLFC’s consumer financial services subsidiary that conducts business in Puerto Rico and the U.S. Virgin Islands. SLFC would be required to repay this debt if CommoLoCo, Inc.’s cash flows from operations and new debt issuances become inadequate. At December 31, 2012 and 2011, CommoLoCo, Inc. had no bank borrowings outstanding.
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 18, 2013.
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 18, 2013.
Exhibit Index
Exhibit
Number
Exhibit Index (Continued)
Exhibit
Number
(10.4)*
Employment Letter, dated October 1, 2012, for Minchung (Macrina) Kgil.
(10.5)*
Amendment to Springleaf Finance, Inc. Excess Retirement Income Plan effective as of December 19, 2012.
(12)
Computation of ratio of earnings to fixed charges
(21)
Subsidiaries of Springleaf Finance Corporation
(31.1)
Rule 13a-14(a)/15d-14(a) Certifications of the President and Chief Executive Officer of Springleaf Finance Corporation
(31.2)
Rule 13a-14(a)/15d-14(a) Certifications of the Senior Vice President and Chief Financial Officer of Springleaf Finance Corporation
(32)
Section 1350 Certifications
(101)**
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Shareholder’s Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements, and (vii) Schedule I - Condensed Financial Information of Registrant.
* 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.