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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
----- -----
Commission File Number 1-08916
CONSECO FINANCE CORP.
Delaware No. 41-1807858
--------------------- ---------------------
State of Incorporation IRS Employer Identification No.
1100 Landmark Towers
Saint Paul, Minnesota 55102-1639 (651) 293-3400
-------------------------------------- --------------
Address of principal executive offices Telephone
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [ X ] No [ ]
Shares of common stock outstanding as of October 31, 2000: 101
The Registrant meets the conditions set forth in general instruction H(1)(a)
and H(1)(b) to Form 10-Q. Accordingly, the disclosures in this filing have been
reduced as permitted by such instructions.
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<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
CONSECO FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
September 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Actively managed fixed maturities at fair value (amortized cost: 2000 - $715.7;
1999 - $712.6)............................................................................. $ 475.6 $ 694.3
Interest-only securities at fair value (amortized cost: 2000 - $637.2; 1999 - $916.2)......... 640.1 905.0
Cash and cash equivalents..................................................................... 542.2 533.4
Cash held in segregated accounts for investors in securitizations............................. 637.8 849.7
Cash held in segregated accounts related to servicing agreements and
securitization transactions................................................................ 547.0 270.6
Fixed maturities due from subsidiaries of Conseco, Inc........................................ - 104.6
Finance receivables........................................................................... 5,090.3 4,978.5
Finance receivables - securitized............................................................. 11,604.6 4,730.5
Receivables due from Conseco, Inc............................................................. 341.3 435.1
Servicing rights.............................................................................. 85.6 111.9
Income tax assets............................................................................. 66.5 -
Goodwill...................................................................................... 48.0 50.2
Other assets.................................................................................. 687.0 790.9
--------- ---------
Total assets........................................................................... $20,766.0 $14,454.7
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Investor payables.......................................................................... $ 637.8 $ 853.0
Liabilities related to certificates of deposit............................................. 1,574.4 870.5
Other liabilities.......................................................................... 685.8 743.5
Income tax liabilities..................................................................... - 230.4
Notes payable:
Related to securitized finance receivables structured as collateralized borrowings....... 10,944.6 4,641.8
Master repurchase agreements............................................................. 2,642.8 1,620.9
Credit facility collateralized by retained interests in securitizations.................. 600.0 499.0
Due to Conseco, Inc...................................................................... 916.2 2,116.7
Other.................................................................................... 441.8 443.9
--------- ---------
Total liabilities................................................................... 18,443.4 12,019.7
--------- ---------
Shareholder's equity:
Preferred stock............................................................................ 750.0 -
Common stock and additional paid-in capital................................................ 1,209.4 1,641.0
Accumulated other comprehensive loss (net of applicable deferred income tax benefit:
2000 - $87.8; 1999 - $11.0).............................................................. (149.6) (18.8)
Retained earnings.......................................................................... 512.8 812.8
--------- ---------
Total shareholder's equity.......................................................... 2,322.6 2,435.0
--------- ---------
Total liabilities and shareholder's equity.......................................... $20,766.0 $14,454.7
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
CONSECO FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
-------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Net investment income:
Finance receivables and other................................... $ 528.5 $ 158.5 $1,372.9 $ 398.7
Interest-only securities........................................ 28.9 46.7 85.0 137.9
Gain on sale:
Securitization transactions..................................... - 156.7 - 525.3
Other loan sales................................................ 1.9 - 4.5 -
Servicing income.................................................. 30.5 42.6 85.8 123.7
Fee revenue and other income...................................... 56.0 53.3 211.5 142.3
------- ------- -------- ---------
Total revenues.............................................. 645.8 457.8 1,759.7 1,327.9
------- ------- -------- ---------
Expenses:
Provision for losses.............................................. 91.3 28.3 234.0 76.8
Interest expense.................................................. 335.2 86.0 806.6 210.2
Other operating costs and expenses................................ 179.4 170.4 604.7 487.9
Special charges................................................... 226.6 - 290.0 -
Impairment charge................................................. 205.0 100.1 217.1 183.9
------- ------- -------- ---------
Total expenses.............................................. 1,037.5 384.8 2,152.4 958.8
------- ------- -------- ---------
Income (loss) before income taxes and cumulative
effect of accounting change............................... (391.7) 73.0 (392.7) 369.1
Income tax expense (benefit)......................................... (140.6) 16.6 (139.9) 105.7
------- ------- -------- ---------
Income (loss) before cumulative effect of accounting
change.................................................... (251.1) 56.4 (252.8) 263.4
Cumulative effect of accounting change, net of taxes................. 45.5 - 45.5 -
------- ------- -------- ---------
Net income (loss)........................................... (296.6) 56.4 (298.3) 263.4
Preferred stock dividends............................................ 1.7 - 1.7 -
------- ------- -------- ---------
Net income (loss) applicable to common stock................ $(298.3) $ 56.4 $ (300.0) $ 263.4
======= ======= ======== =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
CONSECO FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(Dollars in millions)
(unaudited)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital loss earnings
----- ----- --------------- ---- --------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 2000....................... $2,435.0 $ - $1,641.0 $ (18.8) $ 812.8
Comprehensive loss, net of tax:
Net loss.................................. (298.3) - - - (298.3)
Change in unrealized depreciation of
actively managed fixed maturity
investments and interest-only
securities (net of applicable
income benefit of $76.8)................ (130.8) - - (130.8) -
--------
Total comprehensive loss.............. (429.1)
Issuance of preferred stock................. 750.0 750.0 - - -
Repurchase of shares of common stock........ (126.0) - (126.0) - -
Return of capital........................... (306.3) - (306.3) - -
Dividends on preferred stock................ (1.7) - - - (1.7)
Other ...................................... .7 - .7 - -
-------- ------ -------- ------- --------
Balance, September 30, 2000.................... $2,322.6 $750.0 $1,209.4 $(149.6) $ 512.8
======== ====== ======== ======= ========
Balance, January 1, 1999....................... $2,292.2 $ - $1,338.3 $ (11.0) $ 964.9
Comprehensive income, net of tax:
Net income................................ 263.4 - - - 263.4
Change in unrealized depreciation of
actively managed fixed maturity
investments and interest-only
securities (net of applicable
income tax benefit of $16.5)............ (27.1) - - (27.1) -
Change in minimum pension liability
(net of applicable income
tax expense of $2.7).................... 4.4 - - 4.4 -
--------
Total comprehensive income............ 240.7
Tax benefit related to issuance of
shares under stock option plans........... 2.7 - 2.7 - -
Dividends on common stock................... (200.0) - - - (200.0)
-------- ------ -------- ------- --------
Balance, September 30, 1999.................... $2,335.6 $ - $1,341.0 $ (33.7) $1,028.3
======== ====== ======== ======= ========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
CONSECO FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
Nine months ended
September 30,
---------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net investment income.................................................................... $ 1,466.9 $ 726.6
Points and origination fees.............................................................. - 359.0
Fee revenue and other income............................................................. 308.5 279.4
Interest expense......................................................................... (710.1) (210.2)
Other operating costs.................................................................... (662.2) (499.8)
Special charges.......................................................................... (31.7) -
Taxes.................................................................................... (47.5) (175.3)
----------- -----------
Net cash provided by operating activities............................................ 323.9 479.7
----------- -----------
Cash flows from investing activities:
Cash received from the sale of finance receivables, net of expenses...................... 1,964.0 8,567.2
Principal payments received on finance receivables....................................... 6,225.4 6,718.5
Finance receivables originated........................................................... (15,602.6) (18,784.9)
Other.................................................................................... (206.0) (115.4)
----------- -----------
Net cash used by investing activities ............................................... (7,619.2) (3,614.6)
----------- -----------
Cash flows from financing activities:
Issuance of liabilities related to deposit products...................................... 1,532.0 863.2
Payments on liabilities related to deposit products...................................... (828.1) (148.4)
Issuance of notes payable................................................................ 18,939.4 13,276.1
Payments on notes payable................................................................ (11,858.9) (10,678.3)
Change in cash held in restricted accounts for settlement of collateralized borrowings... (354.3) -
Repurchase of shares of common stock..................................................... (126.0) -
Common stock dividends paid.............................................................. - (200.0)
----------- -----------
Net cash provided by financing activities............................................ 7,304.1 3,112.6
----------- -----------
Net increase (decrease) in cash and cash equivalents................................. 8.8 (22.3)
Cash and cash equivalents, beginning of period.............................................. 533.4 195.2
----------- -----------
Cash and cash equivalents, end of period.................................................... $ 542.2 $ 172.9
=========== ===========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The following notes should be read in conjunction with the notes to the
consolidated financial statements included in the 1999 Form 10-K of Conseco
Finance Corp. ("we", "Conseco Finance" or the "Company").
Conseco Finance is a financial services holding company that originates,
securitizes and services manufactured housing, home equity, retail credit and
floorplan loans throughout the United States. Conseco Finance is a wholly owned
subsidiary of Conseco, Inc. ("Conseco"), a financial services holding company.
During the third quarter of 2000, Conseco announced several courses of
action with respect to the Company, including: (i) the sale, closing or runoff
of five units (i.e., asset-based lending, vendor finance, bankcards,
transportation and park construction); (ii) efforts to better utilize existing
assets so as to increase cash; and (iii) cost savings and restructuring of
ongoing businesses such as the streamlining of the field force in the
manufactured housing and home equity lending divisions. Conseco believes these
contemplated actions offer better opportunities than the previously announced
plan to explore the sale of Conseco Finance. The planned actions have resulted
in a significant decrease in new loan originations, allowing the Company to
enhance net interest margins, reduce the amount of available cash required for
new loan originations and transfer cash to Conseco. However, no assurance can be
provided as to the timing, proceeds, or other terms related to the possible
disposition of assets, the timing or extent of the cost savings to be achieved,
or the amount of the restructuring or other charges to be incurred with respect
to these actions.
Several elements of the plans we previously announced were completed during
the second and third quarters of 2000:
(i) We completed the restructuring of our operations (see the note
entitled "Special Charges and Recent Events");
(ii) We completed the sales of: (a) our bankcard business; and (b) certain
asset-based loans (see the note entitled "Special Charges and Recent
Events"); and
(iii) We have completed various financing transactions which allow better
use of existing assets to generate cash.
(iv) We amended an agreement with Lehman Brothers Holdings Inc.
(collectively with its direct and indirect subsidiaries "Lehman")
which significantly reduced the restrictions on intercompany payments
to Conseco as required by the previous agreement (see note entitled
"Notes Payable (Excluding Notes Payable Related to Securitized
Finance Receivables Structured as Collateralized Borrowings")).
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Our unaudited consolidated financial statements reflect normal recurring
adjustments that are necessary to present fairly Conseco Finance's financial
position and results of operations on a basis consistent with that of our prior
audited consolidated financial statements. As permitted by rules and regulations
of the Securities and Exchange Commission applicable to quarterly reports on
Form 10-Q, we have condensed or omitted certain information and disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles ("GAAP"). We have also reclassified certain
amounts from the prior periods to conform to the 2000 presentation. Results for
interim periods are not necessarily indicative of the results that may be
expected for a full year.
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for certain fixed maturity securities,
interest-only securities, servicing rights, goodwill, liabilities related to
litigation, gain on sale of finance receivables, provision for losses and
deferred income taxes. If our future experience differs from these estimates and
assumptions, our financial statements could be materially affected.
6
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Net income, as previously reported in our Form 10-Q, as amended, for the
three and nine months ended September 30, 1999, has been restated to reflect
adjustments, principally related to: (i) impairment charges relating to
interest-only securities and servicing rights; (ii) delaying the recognition of
revenue from sales of loans to certain commercial paper conduit trusts until the
loans were subsequently placed in their final securitization structures; (iii)
adjusting loan origination cost deferrals; and (iv) adjusting income tax and
expense allocations from Conseco. These changes reduced previously reported net
income by $14.8 million and $78.4 million, in the three and nine months ended
September 30, 1999, respectively.
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
During the third quarter of 2000, the Emerging Issues Task Force of the
Financial Accounting Standards Board reached a consensus on a new accounting
requirement for the recognition of impairments on interest-only securities and
other retained beneficial interests in securitized finance assets. The new
guidance is summarized in EITF Issue No. 99-20, "Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets" ("EITF 99-20").
Under the prior accounting rule, declines in the value of our interest-only
securities and other retained beneficial interests in securitized financial
assets were recognized in the statement of operations when the present value of
estimated cash flows discounted at a risk-free rate using current assumptions
was less than the carrying value of the interest-only security.
Under the new accounting rule, declines in value are recognized when: (i)
the fair value of the security is less than its carrying value; and (ii) the
timing and/or amount of cash expected to be received from the security has
changed adversely from the previous valuation which determined the carrying
value of the security. When both occur, the security is written down to fair
value.
Although adoption is not required until January 1, 2001, we adopted the new
accounting rule on July 1, 2000, as permitted. The cumulative effect of the
accounting change for periods prior to July 1, 2000 was a decrease to net income
of $45.5 million (net of an income tax benefit of $24.7 million) related to
interest-only securities.
FINANCE RECEIVABLES AND INTEREST-ONLY SECURITIES
On September 8, 1999, we announced that we would no longer structure our
securitizations in a manner that results in recording a sale of the loans.
Instead, we are using the portfolio method to account for securitization
transactions structured after that date. Our new securitizations are structured
to include provisions that entitle the Company to repurchase assets transferred
to the special purpose entity when the aggregate unpaid principal balance
reaches a specified level. Until these assets are repurchased, however, the
assets are the property of the special purpose entity and are not available to
satisfy claims of creditors of the Company. Pursuant to Financial Accounting
Standards Board Statement No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" ("SFAS 125"), such
securitization transactions are accounted for under the portfolio method,
whereby the loans and securitization debt remain on our balance sheet, rather
than as sales.
The Financial Accounting Standards Board recently issued Financial
Accounting Standards Board Statement No. 140 ("SFAS 140"), which is a
replacement of SFAS 125, and a preliminary draft of an implementation guide for
SFAS 140 (the "preliminary draft"). The preliminary draft proposes a change that
could require the Company to structure securitization transactions in a
different manner to avoid
7
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
recording a sale under the new proposed guidance. The Company is studying the
effects of the proposed change, which could be effective for securitization
transactions completed after March 31, 2001.
We classify the finance receivables transferred to the securitization
trusts and held as collateral for the notes issued to investors as "finance
receivables-securitized." We are generally able to repurchase these receivables
from the trust when the aggregate unpaid principal balance reaches 20 percent of
the initial principal balance of the finance receivables. The average interest
rate earned on these receivables at September 30, 2000, was approximately 11.9
percent. We classify the notes issued to investors in the securitization trusts
as "notes payable related to securitized finance receivables structured as
collateralized borrowings."
During the third quarter of 2000, we completed three securitization
transactions, securitizing $2.2 billion of finance receivables. During the first
nine months of 2000, we have securitized or sold over $6.9 billion of finance
receivables. We continue to be able to finance loans through: (i) our warehouse
and bank credit facilities; (ii) the sale of securities through securitization
transactions; and (iii) whole-loan sales.
The following table summarizes our finance receivables - securitized by
business line and categorized as either: (i) a part of our continuing lines; or
(ii) a part of the business units we have decided to sell, close or runoff (the
"discontinued lines"):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufactured housing............................................................... $ 4,575.2 $ 953.0
Mortgage services.................................................................. 4,498.0 2,077.3
Retail credit...................................................................... 738.9 -
Floorplan.......................................................................... 637.0 637.0
--------- --------
10,449.1 3,667.3
Less allowance for credit losses................................................... 110.7 4.4
--------- --------
Net finance receivables - securitized for continuing lines....................... 10,338.4 3,662.9
--------- --------
Discontinued lines:
Consumer finance................................................................... 262.5 278.9
Transportation..................................................................... 447.4 581.9
Vendor finance..................................................................... 579.4 216.1
--------- --------
1,289.3 1,076.9
Less allowance for credit losses................................................... 23.1 9.3
--------- --------
Net finance receivables - securitized for discontinued lines..................... 1,266.2 1,067.6
--------- --------
Total finance receivables - securitized.......................................... $11,604.6 $4,730.5
========= ========
</TABLE>
8
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The following table summarizes our other finance receivables by business
line and categorized as either: (i) a part of our continuing lines; or (ii) a
part of our discontinued lines:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufactured housing............................................................... $ 770.5 $ 795.8
Mortgage services.................................................................. 1,813.2 1,277.0
Retail credit...................................................................... 977.2 867.8
Floorplan.......................................................................... 261.3 602.7
-------- --------
3,822.2 3,543.3
Less allowance for credit losses................................................... 63.7 38.8
-------- --------
Net other finance receivables for continuing lines............................... 3,758.5 3,504.5
-------- --------
Discontinued lines:
Consumer finance................................................................... 580.5 142.2
Transportation..................................................................... 333.3 337.8
Vendor finance..................................................................... 203.6 423.3
Park construction.................................................................. 229.3 188.7
Other ............................................................................ 26.2 417.9
-------- --------
1,372.9 1,509.9
Less allowance for credit losses................................................... 41.1 35.9
-------- --------
Net other finance receivables for discontinued lines............................. 1,331.8 1,474.0
-------- --------
Total other finance receivables.................................................. $5,090.3 $4,978.5
======== ========
</TABLE>
The changes in the allowance for credit losses included in finance
receivables were as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Allowance for credit losses, beginning of period..................... $153.2 $ 55.2 $ 88.4 $ 43.0
Additions to the allowance........................................... 156.0 (a) 28.3 298.7 76.8
Credit losses........................................................ (70.6) (21.9) (148.5) (58.2)
------ ------ ------ ------
Allowance for credit losses, end of period........................... $238.6 $ 61.6 $238.6 $ 61.6
====== ====== ====== ======
<FN>
--------------------
(a) Additions to the allowance for the three months ended September 30, 2000
includes: (i) $91.3 million related to continuing lines and classified as
"provision for losses"; (ii) $45.9 million related to discontinued lines
and classified as a component of "special charges" (see the note entitled
"Special Charges and Recent Events"); and (iii) $18.8 million related to a
block of finance receivables purchased during the third quarter of 2000.
</FN>
</TABLE>
The securitizations structured prior to our September 8, 1999 announcement
met the applicable criteria to be accounted for as sales. At the time the loans
were securitized and sold, we recognized a gain and recorded our retained
interest represented by the interest-only security. The interest-only security
represents the right to receive, over the life of the pool
9
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
of receivables, the excess of the principal and interest received on the
receivables transferred to the special purpose entity over the sum of: (i)
principal and interest paid to the holders of other interests in the
securitization; and (ii) contractual servicing fees. In some of those
securitizations, we also retained certain lower-rated securities that are senior
in payment priority to the interest-only securities. Such retained securities
had a par value, fair market value and amortized cost of $769.8 million, $475.6
million and $715.7 million, respectively, at September 30, 2000, and were
classified as "actively managed fixed maturity securities."
During the first nine months of 1999, the Company sold $9.2 billion of
finance receivables in various securitized transactions and recognized gains of
$525.3 million. We recognized no gain on sale related to securitized
transactions during the first nine months of 2000.
The interest-only securities on our consolidated balance sheet represent an
allocated portion of the cost basis of the finance receivables in the
securitization transactions accounted for as sales related to transactions
structured prior to September 8, 1999. We used the following assumptions to
adjust the amortized cost to estimated fair value at September 30, 2000 and
December 31, 1999. We include the difference between estimated fair value and
the amortized cost of the interest-only securities (after adjustments for
impairments required to be recognized in earnings) in "accumulated other
comprehensive loss, net of taxes."
<TABLE>
Manufactured Home equity/ Consumer/
September 30, 2000 housing home improvement equipment Total
------------------ ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value............. $ 399.6 $ 222.7 $ 17.8 $ 640.1
Cumulative principal balance of sold finance
receivables at September 30, 2000............... 20,846.9 7,022.4 2,132.8 30,002.1
Weighted average stated customer interest rate
on sold finance receivables..................... 10.0% 11.6% 10.8%
Assumptions to determine estimated fair value
of interest-only securities at September 30, 2000:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).. 9.7% 20.6% 22.4%
Expected nondiscounted credit losses as a
percentage of principal balance of
related finance receivables (a)............. 8.9% 6.0% 6.4%
Weighted average discount rate ............... 15.0% 15.0% 15.0%
Manufactured Home equity/ Consumer/
December 31, 1999 housing home improvement equipment Total
----------------- ------- ---------------- --------- -----
(Dollars in millions)
Interest-only securities at fair value............. $ 528.3 $ 318.0 $ 58.7 $ 905.0
Cumulative principal balance of sold finance
receivables at December 31, 1999................ 22,854.6 8,804.8 3,049.4 34,708.8
Weighted average stated customer interest rate on
sold finance receivables........................ 10.0% 11.5% 11.0%
Assumptions to determine estimated fair value of
interest-only securities at December 31, 1999:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).. 9.4% 21.7% 22.4%
Expected nondiscounted credit losses as a
percentage of principal balance of related
finance receivables (a)..................... 9.0% 5.8% 5.1%
Weighted average discount rate................ 14.0% 14.0% 14.0%
10
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
<FN>
------------------
(a) The valuation of interest-only securities is affected not only by the
projected level of prepayments of principal and net credit losses, but also
by the projected timing of such prepayments and net credit losses. Should
such timing differ materially from our projections, it could have a
material effect on the valuation of our interest-only securities.
Additionally, such valuation is determined by discounting cash flows over
the entire expected life of the receivables sold.
</FN>
</TABLE>
As described above under the note entitled "Cumulative Effect of Accounting
Change", the Company adopted the requirements of EITF 99-20 effective July 1,
2000. During the third quarter of 2000, management analyzed the assumptions used
to determine the estimated fair value of the interest-only securities and made
changes to the credit loss assumptions and the discount rate used to determine
the value of several securities. These changes were made considering recent
adverse default and loss trends and other economic factors. As a result of these
changes, the cash flows from interest-only securities changed adversely from
previous estimates. Pursuant to the requirements of EITF 99-20, the effect of
these changes are reflected immediately in earnings as an impairment charge. The
effect of the impairment charge and adjustments to the value of our servicing
rights totaled $205.0 million ($133.3 million after the income tax benefit) for
the third quarter of 2000 (in addition to the cumulative effect of adopting EITF
99-20 of $70.2 million ($45.5 million after the income tax benefit)).
Activity in the interest-only securities account was as follows:
<TABLE>
<CAPTION>
Nine months ended
September 30,
------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Balance, beginning of period................................................................... $ 905.0 $1,305.4
Additions resulting from securitizations during the period.................................. - 378.6
Additions resulting from clean-up calls (a)................................................. 74.0 -
Investment income........................................................................... 85.0 137.9
Cash received............................................................................... (164.6) (343.0)
Impairment charge to reduce carrying value.................................................. (203.2) (180.1)
Cumulative effect of change in accounting principle......................................... (70.2) -
Change in unrealized appreciation (depreciation) charged to shareholder's equity............ 14.1 (5.8)
------- --------
Balance, end of period......................................................................... $ 640.1 $1,293.0
======= ========
<FN>
------------------
(a) During the first nine months of 2000, clean-up calls were exercised for
seven securitizations that were previously recognized as sales. The
interest-only securities related to these securitizations had previously
been separately securitized with other interest-only securities in
transactions recognized as sales. The repurchase of the collateral
underlying the seven securitizations triggered a requirement for the
Company to repurchase a portion of the interest-only securities.
</FN>
</TABLE>
11
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Credit quality of managed finance receivables was as follows:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
60-days-and-over delinquencies as a percentage of managed finance
receivables at period end:
Manufactured housing.................................................... 2.12% 1.57%
Mortgage services....................................................... .85 1.00
Retail credit........................................................... 2.87 3.02
Floorplan............................................................... .23 .07
Total continuing lines................................................ 1.67 1.36
Total discontinued lines................................................ 2.07 1.72
Total................................................................. 1.71% 1.42%
Net credit losses incurred during the last twelve months as a percentage of
average managed finance receivables during the period:
Manufactured housing.................................................... 1.47% 1.25%
Mortgage services....................................................... 1.09 .99
Retail credit........................................................... 5.17 4.33
Floorplan............................................................... .25 .17
Total continuing lines................................................ 1.41 1.20
Total discontinued lines................................................ 3.28 1.97
Total................................................................. 1.62% 1.31%
Repossessed collateral inventory as a percentage of managed finance receivables
at period end:
Manufactured housing.................................................... 1.23% 1.09%
Mortgage services....................................................... 2.71 2.29
Floorplan............................................................... .37 .07
Total continuing lines................................................ 1.61 1.36
Total discontinued lines................................................ 2.35 1.18
Total................................................................. 1.68% 1.34%
</TABLE>
NOTES PAYABLE (EXCLUDING NOTES PAYABLE RELATED TO SECURITIZED FINANCE
RECEIVABLES STRUCTURED AS COLLATERALIZED BORROWINGS)
Notes payable (excluding notes payable related to securitized finance
receivables structured as collateralized borrowings) were as follows (interest
rates as of September 30, 2000):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Note payable to Conseco (8.16%).............................................. $ 916.2 $2,116.7
Master repurchase agreements due on various dates in 2000 and 2001
(7.82%)................................................................... 2,642.8 1,620.9
Credit facility collateralized by retained interests in securitizations due
2001 (8.62%).............................................................. 600.0 499.0
Medium term notes due September 2002 to April 2003 (6.52%)................... 223.7 226.7
10.25% senior subordinated notes due 2002.................................... 217.3 217.3
Other........................................................................ 3.2 3.1
-------- --------
Total principal amount.................................................. 4,603.2 4,683.7
Unamortized net discount..................................................... 2.4 3.2
-------- --------
Total notes payable..................................................... $4,600.8 $4,680.5
======== ========
</TABLE>
12
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Amounts borrowed under master repurchase agreements have increased as the
balance of finance receivables eligible as collateral for these agreements has
increased. At September 30, 2000, we had $4.3 billion in master repurchase
agreements, commercial paper conduit facilities and other facilities with
various banking and investment banking firms for the purpose of financing our
consumer and commercial finance loan production. These facilities typically
provide financing of a certain percentage of the underlying collateral and are
subject to the availability of eligible collateral and, in many cases, the
willingness of the banking firms to continue to provide financing. Some of these
agreements provide for annual terms which are extended either quarterly or
semi-annually by mutual agreement of the parties for an additional annual term
based upon receipt of updated quarterly financial information. At September 30,
2000, we had borrowed $2.6 billion of the $4.3 billion available under such
agreements.
During the third quarter of 2000, the Company amended an agreement with
Lehman related to certain master repurchase agreements and the collateralized
credit facility. Such amendment significantly reduced the restrictions on
intercompany payments we can make to our parent as required by the previous
agreement. In conjunction with the amendment, Conseco agreed to convert $750
million principal balance of its intercompany note to $750 million stated value
of our 9 percent redeemable cumulative preferred stock (the "intercompany
preferred stock"). After such conversion and prepayments made during the third
quarter of 2000, the intercompany note had a balance of $916.2 million.
Pursuant to the amended agreement, Conseco Finance may make the following
payments to Conseco: (i) interest on the intercompany note; (ii) payments for
products and services provided by Conseco; and (iii) intercompany tax sharing
payments. Conseco Finance may also make the following payments to Conseco
provided the minimum liquidity requirements defined in the amended agreement are
met and the cash payments are applied in the order summarized: (i) unpaid
interest on the intercompany note; (ii) prepayments of principal on the
intercompany note or repayments of any increase to the intercompany receivable
balance; (iii) dividends on the intercompany preferred stock; (iv) redemption of
the intercompany preferred stock; and (v) common stock dividends. The liquidity
test of the amended agreement requires Conseco Finance to have minimum levels of
cash liquidity immediately after making payments to Conseco. Cash liquidity, as
defined, includes unrestricted cash and may include up to $150 million of
liquidity available at Conseco Finance's bank subsidiaries and the aggregate
amount available to be drawn under Conseco Finance's master repurchase
facilities (based on eligible excess collateral pledged to the lender multiplied
by the appropriate advance rate). The minimum cash liquidity must equal or
exceed $250 million, plus: (i) 50 percent of cash up to $100 million generated
by Conseco Finance subsequent to September 21, 2000; and (ii) 25 percent of cash
generated by Conseco Finance in excess of $100 million, provided the total
minimum cash liquidity shall not exceed $350 million and the cash generated by
Conseco Finance (used in the calculation to increase the minimum) will exclude
operating cash flows and the net proceeds received from certain asset sales and
other events listed in the amended agreement (which are consistent with the
courses of actions we have previously announced).
The amended agreement requires Conseco Finance to maintain various
financial ratios, commencing December 31, 2000, as defined in the agreement.
These ratios include: (i) an adjusted tangible net worth of at least $1.95
billion (such balance was in excess of $2.1 billion at September 30, 2000); (ii)
a fixed charge coverage ratio of not less than 1.0:1.0 for the three-month
period ending December 31, 2000, and defined periods thereafter (such ratio was
in excess of 1.0:1.0 for the quarter ended September 30, 2000); (iii) a ratio of
net worth to total managed receivables of not less than 4:100 (such ratio
exceeded 4.80:100 at September 30, 2000); and (iv) a ratio of total
non-warehouse debt (excluding master repurchase agreements and the
collateralized credit facility) to net worth of less than 1.0:2.0 (such ratio
was less than .5:2.0 at September 30, 2000).
In connection with the modification of certain master repurchase agreements
and other transactions with Lehman, the Company and Conseco agreed to the
dividend and prepayment on the Conseco note described in the note entitled
"Related Party Transactions."
NOTES PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS
COLLATERALIZED BORROWINGS
Notes payable related to securitized finance receivables structured as
collateralized borrowings were $10,944.6 million at September 30, 2000. The
principal and interest on these notes are paid using the cash flows from the
underlying finance
13
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
receivables which serve as collateral for the notes. Accordingly, the timing of
the principal payments on these notes is dependent on the payments received on
the underlying finance receivables which back the notes. The average interest
rate on these notes at September 30, 2000 was 7.6 percent.
RELATED PARTY TRANSACTIONS
In 1998, we entered into a $2 billion promissory note with Conseco. The
note bore interest at LIBOR plus a margin of .35 percent and both the principal
and interest were due on demand. On January 1, 2000, the promissory note was
amended and restated to provide for borrowings up to $5 billion and quarterly
interest payments at a rate of LIBOR plus a margin of 1.5 percent. In connection
with the transaction with Lehman (as described in the note entitled "Special
Charges and Recent Events"), the promissory note from the Company to Conseco was
replaced with a one-year term note and the Company repaid $450.0 million of this
note. In conjunction with amendments to its warehouse credit facilities, the
Company converted $750.0 million principal balance of the promissory note due to
Conseco to $750.0 million stated value of 9 percent redeemable cumulative
preferred stock and repaid $544.6 million of this note. At September 30, 2000,
the outstanding balance under the note was $916.2 million. Interest expense
incurred under the note totaled $136.4 million and $47.3 million during the nine
months ended September 30, 2000 and 1999, respectively.
At September 30, 2000, $23.7 million par value of the 10.25% senior
subordinated notes were held by Conseco.
In 1999, Conseco contributed certain assets then having a book value of
approximately $300 million to the Company. These assets were returned to Conseco
in 2000 concurrently with the Lehman transaction. Such distribution is reflected
as a return of capital in the consolidated statement of shareholder's equity at
the book value of the assets transferred.
In the first quarter of 2000, the Company repurchased shares of its common
stock from Conseco for $126.0 million.
The Company has entered into management and service agreements with
subsidiaries of Conseco. Fees for such services (including data processing,
executive management and investment management services) are based on Conseco's
direct and allocable costs. Total fees incurred by the Company under such
agreements were $31.3 million and $30.9 million for the nine months ended
September 30, 2000 and 1999, respectively.
LITIGATION
Conseco Finance was served with various related lawsuits filed in the
United States District Court for the District of Minnesota. These lawsuits were
generally filed as purported class actions on behalf of persons or entities who
purchased common stock or options to purchase common stock of Conseco Finance
during alleged class periods that generally run from February 1995 to January
1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp.,
Case No. 98-1162) did not include class action claims. In addition to Conseco
Finance, certain current and former officers and directors of Conseco Finance
are named as defendants in one or more of the lawsuits. Conseco Finance and
other defendants obtained an order consolidating the lawsuits seeking class
action status into two actions, one of which pertains to a purported class of
common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No.
97-2666) and the other which pertains to a purported class action of stock
option traders (In re Green Tree Financial Corp. Options Litig., Case No.
97-2679). Plaintiffs in the lawsuits assert claims under Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that Conseco Finance and the other defendants violated federal securities laws
by, among other things, making false and misleading statements about the current
state and future prospects of Conseco Finance (particularly with respect to
prepayment assumptions and performance of certain loan portfolios of Conseco
Finance) which allegedly rendered Conseco Finance's financial statements false
and misleading. On August 24, 1999, the United States District Court for the
District of Minnesota issued an order to dismiss with prejudice all claims
alleged in the lawsuits. The plaintiffs subsequently appealed the decision to
the U.S. Court of Appeals for the 8th Circuit, and the appeal is currently
pending. The Company believes that the lawsuits are without merit and intends to
continue to defend them vigorously. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
14
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Conseco Finance is a defendant in two arbitration proceedings in South
Carolina (Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp. and Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp.) where the arbitrator, over Conseco Finance's objection, allowed the
plaintiffs to pursue purported class action claims in arbitration. The two
purported arbitration classes consist of South Carolina residents who obtained
real estate secured credit from Conseco Finance's Manufactured Housing Division
(Lackey) and Home Improvement Division (Bazzle) in the early and mid 1990s, and
did not received a South Carolina specific disclosure form relating to selection
of attorneys in connection with the credit transactions. The arbitrator, in
separate awards issued on July 24, 2000, awarded a total of $26.8 million in
penalties and attorneys' fees. Plaintiffs have filed motions in South Carolina
courts to have the awards confirmed as judgments. The Bazzle award was confirmed
as a judgment and the matter is currently on appeal. The Lackey award has not
been confirmed as a judgment. Conseco Finance intends to vigorously challenge
the awards and believes that the arbitrator erred by, among other things,
conducting class action arbitrations without the authority to do so and
misapplying South Carolina law when awarding the penalties. The ultimate outcome
of these proceedings cannot be predicted with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits related to their operations. Although the ultimate
outcome of certain of such matters cannot be predicted, such lawsuits currently
pending against the Company or its subsidiaries are not expected, individually
or in the aggregate, to have a material adverse effect on the Company's
consolidated financial condition, cash flows or results of operations.
GUARANTEES
In conjunction with certain sales of finance receivables, we have provided
guarantees of approximately $1.6 billion at September 30, 2000. We consider any
potential payments related to these guarantees in the projected net cash flows
used to determine the value of our interest-only securities. We believe the
likelihood of a significant loss from such guarantees is remote.
RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended by
Statement of Financial Accounting Standards No. 137, "Deferral of the Effective
Date of FASB Statement No. 133" requires all derivative instruments to be
recorded on the balance sheet at estimated fair value. Changes in the fair value
of derivative instruments are to be recorded each period either in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, on the type of hedge
transaction. Currently, we are continuing our implementation efforts, including
reviewing investments and other financial instruments for potential embedded
derivatives, and finalizing the actual impact of adopting SFAS 133 as of its
required implementation date of January 1, 2001.
Effective July 1, 2000, the Company adopted the new accounting principles
required by EITF 99-20 (see note entitled "Cumulative Effect of Accounting
Change").
The Financial Accounting Standards Board recently issued SFAS 140 and a
preliminary draft of an implementation guide which could affect future loan
securitization transactions (see note entitled "Finance Receivables and
Interest-Only Securities.")
15
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
The following disclosures supplement our consolidated statement of cash
flows:
<TABLE>
<CAPTION>
Nine months ended
September 30,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................................................... $(298.3) $ 263.4
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Gain on sale of finance receivables................................................... (4.5) (525.3)
Points and origination fees received.................................................. - 359.0
Interest-only securities investment income............................................ (85.0) (137.9)
Cash received from interest-only securities........................................... 164.6 343.0
Servicing income...................................................................... (85.8) (123.7)
Cash received from servicing activities............................................... 97.1 137.0
Provision for losses.................................................................. 234.0 76.8
Amortization and depreciation......................................................... 19.2 37.4
Income taxes.......................................................................... (212.7) (69.6)
Accrual and amortization of investment income......................................... (70.6) (12.1)
Special charges....................................................................... 258.3 -
Impairment charge..................................................................... 217.1 183.9
Change in accounting principle........................................................ 70.2 -
Other ............................................................................... 20.3 (52.2)
------- -------
Net cash provided by operating activities........................................... $ 323.9 $ 479.7
======= =======
</TABLE>
In 1999, the noncash transaction related to the tax benefit related to the
issuance of shares under stock option plans was not reflected in the
consolidated statement of cash flows.
16
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
SPECIAL CHARGES AND RECENT EVENTS
The following table summarizes the special charges incurred by the Company
during the third quarter of 2000 and for the nine months ended September 30,
2000, which are further described in the paragraphs which follow:
<TABLE>
<CAPTION>
Three months Nine months
ended ended
September 30, September 30,
2000 2000
---- ----
(Dollars in millions)
<S> <C> <C>
Lower of cost or market adjustment for other lines of business
identified for sale...................................................... $103.3 $103.3
Loss on sale of asset-based loans........................................... 53.0 53.0
Costs related to closing offices and streamlining businesses................ 29.5 29.5
Abandonment of computer processing systems.................................. 35.8 35.8
Transaction fee paid and warrant issued to Lehman........................... - 73.1
Net gain on sale of certain loans and other items........................... 5.0 (4.7)
------ ------
Special charges before income tax benefit.......................... $226.6 $290.0
====== ======
</TABLE>
Lower of cost or market adjustment for finance receivables identified for
sale
On July 27, 2000, we announced several courses of action to restructure our
finance business, including the sale or runoff of the finance receivables of
several business lines. The carrying value of the loans held for sale has been
reduced to the lower of cost or market, consistent with our accounting policy
for such loans. The reduction in value of these loans of $103.3 million
(including a $45.9 million increase to the allowance for credit losses)
primarily relates to transportation finance receivables (primarily loans for the
purchase of trucks and buses). These loans have experienced a significant
decrease in value as a result of the adverse economic effect that the recent
increases in oil prices and competition have had on borrowers in the
transportation business.
Loss on sale of asset-based loans
During the third quarter of 2000, we sold asset-based loans with a carrying
value of $152.2 million in whole loan sale transactions. We recognized a loss of
$53.0 million on these sales.
Costs related to closing offices and streamlining businesses
Our restructuring activities included the closing of several branch offices
and streamlining our businesses. These activities included a reduction in the
work force of approximately 1,700 employees. The Company incurred a charge of
$6.9 million related to severance costs paid to terminated employees in the
third quarter of 2000. The Company also incurred lease termination and direct
closing costs of $12.3 million associated with the branch offices closed in
conjunction with the restructuring activities. In addition, fixed assets and
leasehold improvements of $10.3 million were abandoned when the branch offices
were closed.
Abandonment of computer processing systems
During the third quarter of 2000, we recorded a $35.8 million charge to
write off the carrying value of capitalized computer software costs for projects
that have been abandoned in conjunction with our restructuring. These costs are
primarily associated with: (i) computer processing systems under development
that would require significant additional expenditures to complete and that are
inconsistent with our current business plan; and (ii) computer systems related
to the lines of business discontinued by the Company and therefore are no longer
required.
17
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Transaction fee paid to and warrant issued to Lehman
In May 2000, we sold approximately $1.3 billion of finance receivables to
Lehman and its affiliates for cash and a right to share in future profits from a
subsequent sale or securitization of the assets sold. We paid a $25.0 million
transaction fee to Lehman in conjunction with the sale, which was included in
special charges. Such loans were sold to Lehman at a value which approximated
net book value, less the fee paid to Lehman.
During the second and third quarters of 2000, we repurchased a significant
portion of the finance receivables sold to Lehman. These finance receivables
were subsequently included in securitization transactions structured as
financings. The cost of the finance receivables purchased from Lehman did not
differ materially from the book value of the loans prior to their sale to
Lehman.
Lehman has also amended its master repurchase financing facilities with the
Company to expand the types of assets financed. As partial consideration for the
financing transaction, Lehman received a warrant, with a nominal exercise price,
for five percent of the Company's common stock. The warrant has a five-year
term. After three years, the holder of the warrant or the Company may cause the
warrant and any stock issued upon its exercise to be purchased for cash at an
appraised value. Since the warrant permits cash settlement at fair value at the
option of the holder of the warrant, it has been classified as a liability
measured at fair value, with changes in its value reported in earnings. The
warrant would be cancelled in certain circumstances in the event the holder
thereof or an affiliate participates in a group that purchases the Company. The
initial $48.1 million estimated value of the warrant was recognized as an
expense during the second quarter of 2000. The estimated fair value of the
warrant did not change materially during the third quarter of 2000.
Gain on sale of certain loans and other items
During the second quarter of 2000, we sold substantially all of the finance
receivables related to our bankcard (Visa and Mastercard) portfolio. We
recognized a gain of $9.7 million on the sale.
On April 28, 2000, the Company's former Chief Executive Officer, Stephen C.
Hilbert, and former Chief Financial Officer, Rollin M. Dick, terminated their
positions with the Company.
Following Conseco's March 31, 2000, announcement that it planned to explore
the sale of the Company and other events described elsewhere herein, rating
agencies lowered their ratings and placed certain ratings on review.
During the third quarter of 2000, we recognized $5.0 million of other costs
related to recent events associated with the restructuring of the Company.
18
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion highlights material factors affecting our results
of operations. This discussion should be read in conjunction with the
consolidated financial statements and notes included herein and in our 1999 Form
10-K. The Registrant meets the conditions set forth in the General Instructions
(H)(1)(a) and (b) of the Form 10-Q and is therefore omitting certain information
otherwise required by Item 2.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Contract originations:
Manufactured housing............................................... $ 1,107.5 $ 1,794.5 $ 3,769.9 $ 5,189.2
Mortgage services.................................................. 933.6 1,726.5 3,948.9 5,095.8
Consumer/credit card............................................... 821.7 1,123.7 2,662.6 2,404.9
Commercial......................................................... 1,055.6 2,367.2 3,966.4 6,506.1
--------- --------- --------- ---------
Total............................................................ $ 3,918.4 $ 7,011.9 $14,347.8 $19,196.0
========= ========= ========= =========
Securitization of finance receivables accounted for as sales:
Manufactured housing............................................... $ - $ 1,854.5 $ - $ 5,335.6
Home equity/home improvement....................................... - 999.6 - 3,648.4
Consumer/equipment................................................. - - - 600.0
Commercial and retail revolving credit............................. - 25.2 - 117.7
Retained bonds..................................................... - (143.8) - (515.2)
--------- --------- --------- ---------
Total............................................................ $ - $ 2,735.5 $ - $ 9,186.5
========= ========= ========= =========
Managed receivables (average):
Manufactured housing............................................... $26,153.4 $23,469.1 $25,509.3 $22,426.4
Mortgage services.................................................. 13,720.3 10,810.8 13,197.2 9,740.5
Consumer/credit card............................................... 3,868.2 3,444.9 3,913.6 3,178.1
Commercial......................................................... 4,533.5 5,492.1 4,884.6 5,388.3
--------- ----------- ---------- ----------
Total............................................................ $48,275.4 $43,216.9 $47,504.7 $40,733.3
========= ========= ========= =========
Revenues:
Net investment income:
Finance receivables and other.................................... $ 528.5 $ 158.5 $ 1,372.9 $ 398.7
Interest-only securities......................................... 28.9 46.7 85.0 137.9
Gain on sale:
Securitization transactions...................................... - 156.7 - 525.3
Whole-loan sales................................................. 1.9 - 4.5 -
Fee revenue and other income....................................... 86.5 95.9 297.3 266.0
--------- --------- --------- ---------
Total revenues................................................... 645.8 457.8 1,759.7 1,327.9
--------- --------- --------- ---------
Expenses:
Provision for losses............................................... 91.3 28.3 234.0 76.8
Interest expense................................................... 335.2 86.0 806.6 210.2
Other operating costs and expenses................................. 179.4 170.4 604.7 487.9
--------- --------- --------- ---------
Total expenses................................................... 605.9 284.7 1,645.3 774.9
--------- --------- --------- ---------
Operating income before special charges, impairment charges
and income taxes............................................... 39.9 173.1 114.4 553.0
Special charges....................................................... 226.6 - 290.0 -
Impairment charges.................................................... 205.0 100.1 217.1 183.9
--------- --------- --------- ---------
Income (loss) before income taxes................................ $ (391.7) $ 73.0 $ (392.7) $ 369.1
========= ========= ========= =========
</TABLE>
19
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
General: The Company provides financing for manufactured housing, home
equity, home improvements, consumer products and equipment, and provide consumer
and commercial revolving credit. Finance products include both fixed-term and
revolving loans and leases. The Company also markets physical damage and term
mortgage life insurance and other credit protection relating to the loans it
services.
During the third quarter of 2000, Conseco announced several courses of
action with respect to the Company, including: (i) the sale, closing or runoff
of five units (i.e., asset-based lending, vendor finance, bankcards,
transportation and park construction); (ii) efforts to better utilize existing
assets so as to increase cash; and (iii) cost savings and restructuring of
ongoing businesses such as the streamlining of the field force in the
manufactured housing and home equity lending divisions. Conseco believes these
contemplated actions offer better opportunities than the previously announced
plan to explore the sale of Conseco Finance. However, no assurance can be
provided as to the timing, proceeds, or other terms related to the possible
disposition of assets, the timing or extent of the cost savings to be achieved,
or the amount of the restructuring or other charges to be incurred with respect
to these actions.
On September 8, 1999, we announced that we would no longer structure our
securitizations in a manner that results in recording a sale of the loans.
Instead, new securitization transactions after that date are being structured to
include provisions that entitle the Company to repurchase assets transferred to
the special purpose entity when the aggregate unpaid principal balance reaches a
specified level. Until these assets are repurchased, however, the assets are the
property of the special purpose entity and are not available to satisfy the
claims of creditors of the Company. Pursuant to SFAS 125, such securitization
transactions are accounted for as secured borrowings whereby the loans and
securitization debt remain on the consolidated balance sheet, rather than as
sales.
The change to the structure of our new securitizations will have no effect
on the total profit we recognize over the life of each new loan, but it will
change the timing of profit recognition. Under the portfolio method (the
accounting method required for our securitizations which are structured as
secured borrowings), we will recognize: (i) earnings over the life of new loans
as interest revenues are generated; (ii) interest expense on the securities
which are sold to investors in the loan securitization trusts; and (iii)
provisions for losses. As a result, our reported earnings from new loans
securitized in transactions accounted for under the portfolio method will be
lower in the period in which the loans are securitized (compared to our
historical method) and higher in later periods, as interest spread is earned on
the loans.
During the third quarter of 2000, we completed three securitization
transactions, securitizing $2.2 billion of finance receivables. During the first
nine months of 2000, we have securitized or sold over $6.9 billion of finance
receivables.
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<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
Loan originations in the third quarter of 2000 were $3.9 billion, down 44
percent from 1999. Loan originations in the first nine months of 2000 were $14.3
billion, down 25 percent over 1999. The primary reason for the decrease was our
decision to no longer originate certain lines and to manage our growth
consistent with our revised business plan. The significant decrease in new loan
originations allowed the Company to enhance net interest margins, to reduce the
amount of available cash required for new loan originations, and to transfer
cash to Conseco. The following table summarizes our loan originations in the
third quarters of 2000 and 1999 summarized by product and whether part of our
continuing or discontinued lines:
<TABLE>
<CAPTION>
Three months ended
September 30,
---------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufacturing housing............................................. $1,107.5 $1,794.5
Mortgage services................................................. 933.6 1,726.5
Retail credit..................................................... 652.3 796.6
Floorplan......................................................... 933.1 1,573.3
-------- --------
Total continuing lines........................................ 3,626.5 5,890.9
-------- --------
Discontinued lines:
Consumer finance.................................................. 166.6 194.8
Bankcard.......................................................... 2.8 132.3
Vendor finance.................................................... 95.6 125.4
Transportation.................................................... 2.3 262.0
Park construction and asset-based loans........................... 24.6 406.5
-------- --------
Total discontinued lines...................................... 291.9 1,121.0
-------- --------
Total......................................................... $3,918.4 $7,011.9
======== ========
</TABLE>
Sales of finance receivables decreased as a result of the change in the
structure of our securitizations.
Managed receivables include finance receivables transferred to special
purpose entities in securitization transactions (whether accounted for as sales
or on the portfolio method) and finance receivables recorded on our consolidated
balance sheet that have not been securitized. Average managed receivables
increased to $48.3 billion in the third quarter of 2000, up 12 percent over
1999, and to $47.5 billion in the first nine months of 2000, up 17 percent over
the same period in 1999.
The following table summarizes our average managed receivables at September
30, 2000 and 1999 summarized by product and whether part of our continuing or
discontinued lines:
<TABLE>
<CAPTION>
September 30,
---------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufactured housing.............................................. $26,153.4 $23,469.1
Mortgage services................................................. 13,720.3 10,810.8
Retail credit..................................................... 1,670.2 1,032.5
Floorplan......................................................... 2,018.0 2,210.1
--------- ---------
Total continuing lines.......................................... 43,561.9 37,522.5
--------- ---------
Discontinued lines:
Consumer finance.................................................. 2,161.2 2,139.5
Bankcard.......................................................... 36.8 272.9
Vendor finance.................................................... 970.5 948.1
Transportation.................................................... 1,170.6 1,570.3
Park construction and asset-based loans........................... 374.4 763.6
--------- ---------
Total discontinued lines........................................ 4,713.5 5,694.4
--------- ---------
Total........................................................... $48,275.4 $43,216.9
========= =========
</TABLE>
21
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CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
Net investment income on finance receivables and other consists of: (i)
interest earned on finance receivables; and (ii) interest income on short-term
and other investments. Such income increased by 233 percent, to $528.5 million,
in the third quarter of 2000 and by 244 percent, to $1,372.9 million, in the
first nine months of 2000, consistent with the increase in average on-balance
sheet finance receivables. The weighted average yields earned on finance
receivables and other investments were 13.0 percent and 10.1 percent during the
third quarters of 2000 and 1999, respectively, and such weighted average yields
were 13.0 percent and 10.8 percent during the first nine months of 2000 and
1999, respectively. As a result of the change in the structure of our
securitizations, future interest earned on finance receivables should increase
as our average on-balance sheet finance receivables increase. The weighted
average yield on our securitized on- balance sheet receivables increased 28
basis points to 11.71 percent from the second to third quarter of 2000. The
weighted average margin on these loans increased 7 basis points to 3.94 percent.
Net investment income on interest-only securities is the accretion
recognized on the interest-only securities we retain after we sell finance
receivables. Such income decreased by 38 percent, to $28.9 million, in the third
quarter of 2000 and by 38 percent, to $85.0 million, in the first nine months of
2000. The decrease is consistent with the change in the average balance of
interest-only securities. The weighted average yields earned on interest-only
securities were 13.1 percent and 13.8 percent during the first nine months of
2000 and 1999, respectively. As a result of the change in the structure of our
securitizations, we will account for future securitizations as secured
borrowings and we will not recognize gain-on-sale revenue or additions to
interest-only securities from such transactions. Accordingly, future investment
income accreted on the interest-only security will decrease, as cash remittances
from the prior gain-on-sale securitizations reduce the interest- only security
balances. The balance of the interest-only securities was reduced by $533.8
million during 1999 (of which only $180.1 million was incurred in the first nine
months of 1999) and by $273.4 million during 2000 (including $70.2 million due
to the accounting change described in the note to the accompanying consolidated
financial statements entitled "Cumulative Effect of Accounting Change") due to
impairment charges which will cause a reduction in interest income accreted to
this security in future years. We regularly analyze future expected cash flows
from this security to determine whether an impairment has occurred. Under
current accounting principles, we are required to recognize declines in value of
our interest-only securities in earnings when: (i) the fair value of the
security is less than its carrying value; and (ii) the timing and amount of cash
expected to be received from the security has changed adversely from the
previous valuation which determined the carrying value of the security.
Gain on sale related to securitization transactions was nil in the 2000
periods, reflecting our decision to no longer structure our securitizations as
sales. Our new securitizations are being structured as secured borrowings and no
gain on sale is recognized. The gain recognized for our previous securitizations
fluctuated when changes occurred in: (i) the amount of loans sold; (ii) market
conditions (such as the market interest rates available on securities sold in
these securitizations); (iii) the amount and type of interest we retained in the
receivables sold; and (iv) assumptions used to calculate the gain.
Conditions in the credit markets have frequently resulted in
less-attractive pricing of certain lower-rated securities in our securitization
structures. As a result, we have chosen to hold rather than sell some of the
securities in the securitization trusts, particularly securities having
corporate guarantee provisions. Prior to our September 8, 1999, announcement,
the securities that we held were treated as retained interests in the
securitization trusts. We recognized no gain on the portion of the assets
related to such securities, but we expect to recognize greater interest income,
net of related interest expense, over the term we hold them. At September 30,
2000, we held $475.6 million of such securities which are classified as actively
managed fixed maturities.
Gain on whole-loan sales totaled $1.9 million during the third quarter of
2000 and $4.5 million during the first nine months of 2000. During the second
quarter of 2000, we sold approximately $1.3 billion of finance receivables to
Lehman for cash and a right to share in future profits from a subsequent sale or
securitization of the assets sold. We paid a $25.0 million transaction fee to
Lehman in conjunction with the sale which was included in special charges. Such
loans were sold to Lehman at a value which approximated net book value, less the
fee paid to Lehman. Gain on whole-loan sales excludes the gain realized on the
sale of our bankcard portfolio which is included in special charges.
Fee revenue and other income includes servicing income, commissions earned
on insurance policies written in conjunction with financing transactions and
other income from late fees. Such income decreased by 9.8 percent, to $86.5
million, in the third quarter of 2000, and increased by 12 percent, to $297.3
million, in the first nine months of 2000. As a result of the change in the
structure of our future securitizations announced on September 8, 1999, we no
longer record an
22
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
asset for servicing rights at the time of our securitizations, nor do we record
servicing fee revenue; instead, the entire amount of interest income is recorded
as investment income. Accordingly, the amount of servicing income has declined
in the current period, and will decline further in future periods.
Provision for losses increased by 223 percent, to $91.3 million, in the
third quarter of 2000, and by 205 percent, to $234.0 million, in the first nine
months of 2000. The increase is principally due to the increase in loans held on
our balance sheet. Under the portfolio method (which is used for securitizations
structured as collateralized borrowings), we recognize the credit losses on the
loans on our balance sheet as the losses are incurred. For loans previously
recorded as sales, the anticipated discounted credit losses are reflected
through a reduction in the gain-on-sale revenue recorded at the time of
securitization.
Interest expense increased by 290 percent, to $335.2 million, in the third
quarter of 2000, and by 284 percent, to $806.6 million, in the first nine months
of 2000. Our borrowings grew in order to fund the increase in finance
receivables. In addition, our average borrowing rate increased to 7.9 percent in
the third quarter of 2000 from 5.6 percent in the third quarter of 1999. Our
average borrowing rate during the first nine months of 2000 was 7.6 percent
compared to 5.6 percent during the first nine months of 1999.
Under the portfolio method, we recognize interest expense on the securities
issued to investors in the securitization trusts. These securities typically
have higher interest rates than our other debt, which increases our average
borrowing rate as compared to prior periods.
Other operating costs and expenses include the costs associated with
servicing our managed receivables and non-deferrable costs related to
originating new loans. Such expense increased by 5.3 percent, to $179.4 million,
in the third quarter of 2000, and by 24 percent, to $604.7 million, in the first
nine months of 2000. Other operating costs and expenses decreased $23.8 million
to $179.4 million from the second to third quarters of 2000, as we began to
realize the cost savings from the previously announced restructuring.
Special charges include: (i) the $103.3 million adjustment to the value of
finance receivables identified for sale; (ii) the $53.0 million loss on the sale
of asset-based loans; (iii) $29.5 million of costs related to closing offices
and streamlining businesses; (iv) $35.8 million related to the disposition of
computer processing systems; (v) $25.0 million transaction fee paid to Lehman in
conjunction with the previously described sale of $1.3 billion of finance
receivables; (vi) the issuance of a warrant valued at $48.1 million related to
the modification of the Lehman master repurchase financing facilities; and (vii)
$4.7 million of net gains related to the sale of certain lines of business, net
of other items. These charges are described in greater detail in the note to the
accompanying financial statements entitled "Special Charges and Recent Events".
Impairment charges represent reductions in the value of interest-only
securities and servicing rights recognized as a loss in the statement of
operations. We carry interest-only securities at estimated fair value, which is
determined by discounting the projected cash flows over the expected life of the
receivables sold using current prepayment, default, loss and interest rate
assumptions. Estimates for prepayments, defaults and losses for manufactured
housing loans are determined based on a macroeconomic model developed by the
Company with the assistance of outside experts. When declines in value
considered to be other than temporary occur, we reduce the amortized cost to
estimated fair value and recognize a loss in the statement of operations. The
assumptions used to determine new values are based on our internal evaluations
and consultation with external advisors having significant experience in valuing
these securities. We record any unrealized gain or loss determined to be
temporary, net of tax, as a component of shareholder's equity. We adopted a new
accounting rule during the third quarter of 2000, which affects when impairments
are considered to be other than temporary and, therefore, are recognized in
earnings (see the note to the accompanying consolidated financial statements
entitled "Cumulative Effect of Accounting Change".
The Company continually evaluates its interest-only securities and
servicing rights, including the underlying assumptions, in light of loss
experience exceeding previous expectations. The principal change in the revised
assumptions resulting from this process was an increase in expected future
credit losses, relating primarily to reduced assumptions as to future housing
price inflation, recent loss experience and refinements to the methodology of
the model. The effect of this change in 1999 was offset somewhat by a revision
to the estimation methodology to incorporate the value associated with the
cleanup call rights held by the Company in securitizations. In the third
quarters of 2000 and 1999, we recognized an
23
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
impairment charge of $205.0 million and $100.1 million, respectively, to reduce
the book value of the interest-only securities and servicing rights. The change
in accounting principle described in the note to the accompanying consolidated
financial statements entitled "Cumulative Effect of Accounting Change" affected
the impairment charge recognized in the third quarter of 2000. Such impairment
charge for the first nine months of 2000 and 1999 was $217.1 million and $183.9
million, respectively.
FORWARD-LOOKING STATEMENTS
All statements, trend analyses and other information contained in this
report and elsewhere (such as in filings by the Company with the Securities and
Exchange Commission, press releases, presentations by the Company or its
management or oral statements) relative to markets for the Company's products
and trends in the Company's operations or financial results, as well as other
statements including words such as "anticipate," "believe," "plan," "estimate,"
"expect," "intend," "should," "could," "goal," "target," "on track,"
"comfortable with," and other similar expressions, constitute forward- looking
statements under the Private Securities Litigation Reform Act of 1995. These
forward-looking statements are subject to known and unknown risks, uncertainties
and other factors which may cause actual results to be materially different from
those contemplated by the forward-looking statements. Such factors include,
among other things: (i) general economic conditions and other factors, including
prevailing interest rate levels, stock and credit market performance, which may
affect (among other things) the Company's ability to sell its products, its
ability to make loans and access capital resources and the costs associated
therewith, the market value of the Company's investments and the level of
defaults and prepayments of loans made by the Company; (ii) the Company's
ability to achieve anticipated synergies and levels of operational efficiencies;
(iii) customer response to new products, distribution channels and marketing
initiatives; (iv) performance of our investments; (v) changes in the Federal
income tax laws and regulations which may affect the relative tax advantages of
some of the Company's products; (vi) increasing competition in the finance
business; (vii) regulatory changes or actions, including those relating to
regulation of financial services; (viii) the outcome of the Company's efforts to
sell assets and reduce, refinance or modify indebtedness and the availability of
capital during this process; (ix) actions by rating agencies and the effects of
past or future actions by these agencies on the Company's business; and (x) the
risk factors or uncertainties listed from time to time in the filings of the
Company or its parent, Conseco, with the Securities and Exchange Commission.
24
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Conseco Finance was served with various related lawsuits filed in the
United States District Court for the District of Minnesota. These lawsuits were
generally filed as purported class actions on behalf of persons or entities who
purchased common stock or options to purchase common stock of Conseco Finance
during alleged class periods that generally run from February 1995 to January
1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp.,
Case No. 98-1162) did not include class action claims. In addition to Conseco
Finance, certain current and former officers and directors of Conseco Finance
are named as defendants in one or more of the lawsuits. Conseco Finance and
other defendants obtained an order consolidating the lawsuits seeking class
action status into two actions, one of which pertains to a purported class of
common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No.
97-2666) and the other which pertains to a purported class action of stock
option traders (In re Green Tree Financial Corp. Options Litig., Case No.
97-2679). Plaintiffs in the lawsuits assert claims under Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that Conseco Finance and the other defendants violated federal securities laws
by, among other things, making false and misleading statements about the current
state and future prospects of Conseco Finance (particularly with respect to
prepayment assumptions and performance of certain loan portfolios of Conseco
Finance) which allegedly rendered Conseco Finance's financial statements false
and misleading. On August 24, 1999, the United States District Court for the
District of Minnesota issued an order to dismiss with prejudice all claims
alleged in the lawsuits. The plaintiffs subsequently appealed the decision to
the U.S. Court of Appeals for the 8th Circuit, and the appeal is currently
pending. The Company believes that the lawsuits are without merit and intends to
continue to defend them vigorously. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
Conseco Finance is a defendant in two arbitration proceedings in South
Carolina (Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp. and Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp.) where the arbitrator, over Conseco Finance's objection, allowed the
plaintiffs to pursue purported class action claims in arbitration. The two
purported arbitration classes consist of South Carolina residents who obtained
real estate secured credit from Conseco Finance's Manufactured Housing Division
(Lackey) and Home Improvement Division (Bazzle) in the early and mid 1990s, and
did not received a South Carolina specific disclosure form relating to selection
of attorneys in connection with the credit transactions. The arbitrator, in
separate awards issued on July 24, 2000, awarded a total of $26.8 million in
penalties and attorneys' fees. Plaintiffs have filed motions in South Carolina
courts to have the awards confirmed as judgments. The Bazzle award was confirmed
as a judgment and the matter is currently on appeal. The Lackey award has not
been confirmed as a judgment. Conseco Finance intends to vigorously challenge
the awards and believes that the arbitrator erred by, among other things,
conducting class action arbitrations without the authority to do so and
misapplying South Carolina law when awarding the penalties. The ultimate outcome
of these proceedings cannot be predicted with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits related to its operations. Although the ultimate outcome
of certain of such matters cannot be predicted, such lawsuits currently pending
against the Company or its subsidiaries are not expected, individually or in the
aggregate, to have a material adverse effect on the Company's consolidated
financial condition, cash flows or results of operations.
25
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. (a) Exhibits
3(a) Restated Certificate of Incorporation of Conseco Finance Corp.
3(d) Certificate of Designation of 9% Redeemable Cumulative
Preferred Stock of Conseco Finance Corp.
4(c) Promissory Note dated September 22, 2000, issued by the
Company to CIHC Incorporated
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
(b) Reports on Form 8-K - None
26
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONSECO FINANCE CORP.
Dated: November 14, 2000 By: /S/ JAMES S. ADAMS
------------------
James S. Adams
Senior Vice President and
Chief Accounting Officer
(authorized officer and chief
accounting officer)
27
