================================================================================
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 June 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 July 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
June 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Actively managed fixed maturities at fair value (amortized cost: 2000 - $714.7;
1999 - $712.6)............................................................................. $ 468.9 $ 694.3
Interest-only securities at fair value (amortized cost: 2000 - $897.4; 1999 - $916.2)......... 852.8 905.0
Cash and cash equivalents..................................................................... 876.6 533.4
Cash held in segregated accounts for investors in securitizations............................. 731.6 849.7
Cash held in segregated accounts related to servicing agreements and
securitization transactions................................................................ 982.8 270.6
Fixed maturities due from subsidiaries of Conseco, Inc........................................ - 104.6
Finance receivables........................................................................... 5,586.1 4,978.5
Finance receivables - securitized............................................................. 8,942.1 4,730.5
Receivables due from Conseco, Inc............................................................. 340.9 435.1
Servicing rights.............................................................................. 104.0 111.9
Goodwill...................................................................................... 48.7 50.2
Other assets.................................................................................. 754.1 790.9
--------- -----------
Total assets........................................................................... $19,688.6 $14,454.7
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Investor payables.......................................................................... $ 731.6 $ 853.0
Liabilities related to certificates of deposit............................................. 1,398.9 870.5
Other liabilities.......................................................................... 783.4 743.5
Income tax liabilities..................................................................... 98.3 230.4
Notes payable:
Related to securitized finance receivables structured as collateralized borrowings....... 9,136.4 4,641.8
Due to Conseco, Inc...................................................................... 2,210.8 2,116.7
Other.................................................................................... 3,492.0 2,563.8
--------- ---------
Total liabilities................................................................... 17,851.4 12,019.7
--------- ---------
Shareholder's equity:
Common stock and additional paid-in capital................................................ 1,209.3 1,641.0
Accumulated other comprehensive loss (net of applicable deferred income tax benefit:
2000 - $107.5; 1999 - $11.0)............................................................. (183.2) (18.8)
Retained earnings.......................................................................... 811.1 812.8
--------- ---------
Total shareholder's equity.......................................................... 1,837.2 2,435.0
--------- ---------
Total liabilities and shareholder's equity.......................................... $19,688.6 $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 Six months ended
June 30, June 30,
-------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Net investment income:
Finance receivables and other................................... $453.1 $133.3 $ 844.4 $240.2
Interest-only securities........................................ 28.6 47.4 56.1 91.1
Gain on sale:
Securitization transactions..................................... - 169.4 - 368.6
Other loan sales................................................ 2.6 - 2.6 -
Servicing income.................................................. 26.5 41.8 55.3 81.1
Fee revenue and other income...................................... 72.5 45.8 155.5 89.1
------ ------ -------- ------
Total revenues.............................................. 583.3 437.7 1,113.9 870.1
------ ------ -------- ------
Expenses:
Provision for losses.............................................. 84.1 27.2 142.7 48.5
Interest expense.................................................. 266.9 69.6 471.4 124.2
Other operating costs and expenses................................ 203.2 156.8 425.3 317.5
Special charges................................................... 63.4 - 63.4 -
Impairment charge................................................. 9.6 71.6 12.1 83.8
------ ------ -------- ------
Total expenses.............................................. 627.2 325.2 1,114.9 574.0
------ ------ -------- ------
Income (loss) before income taxes........................... (43.9) 112.5 (1.0) 296.1
Income tax expense (benefit)......................................... (15.4) 34.1 .7 89.1
------ ------ -------- ------
Net income (loss)........................................... $(28.5) $ 78.4 $ (1.7) $207.0
====== ====== ======== ======
</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
and additional comprehensive Retained
Total paid-in capital loss earnings
----- --------------- ---- --------
<S> <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.................................................. (1.7) - - (1.7)
Change in unrealized depreciation of actively managed
fixed maturity investments and interest-only securities
(net of applicable income tax benefit of $96.5)......... (164.4) - (164.4) -
--------
Total comprehensive loss.............................. (166.1)
Repurchase of shares of common stock........................ (126.0) (126.0) - -
Return of capital........................................... (306.3) (306.3) - -
Other ...................................................... .6 .6 - -
-------- -------- ------- -------
Balance, June 30, 2000......................................... $1,837.2 $1,209.3 $(183.2) $ 811.1
======== ======== ======= =======
Balance, January 1, 1999....................................... $2,292.2 $1,338.3 $ (11.0) $ 964.9
Comprehensive income, net of tax:
Net income................................................ 207.0 - - 207.0
Change in unrealized depreciation of actively managed
fixed maturity investments and interest-only
securities (net of applicable income tax benefit
of $6.5)................................................ (11.6) - (11.6) -
Change in minimum pension liability (net of
applicable income tax expense of $2.7).................. 4.4 - 4.4 -
--------
Total comprehensive income............................ 199.8
Tax benefit related to issuance of shares under stock option
plans..................................................... 2.7 2.7 - -
Dividends on common stock................................... (200.0) - - (200.0)
-------- -------- ------- -------
Balance, June 30, 1999......................................... $2,294.7 $1,341.0 $ (18.2) $ 971.9
======== ======== ======= =======
</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)
Six months ended
June 30,
---------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net investment income.................................................................... $ 922.5 $ 465.7
Points and origination fees.............................................................. - 243.2
Fee revenue and other income............................................................. 218.7 175.2
Interest expense......................................................................... (419.6) (83.5)
Other operating costs.................................................................... (435.1) (352.1)
Special charges.......................................................................... (25.0) -
Taxes.................................................................................... (29.0) (133.3)
---------- ----------
Net cash provided by operating activities............................................ 232.5 315.2
---------- ----------
Cash flows from investing activities:
Cash received from the sale of finance receivables, net of expenses...................... 1,774.6 5,737.4
Principal payments received on finance receivables....................................... 4,485.1 3,960.3
Finance receivables originated........................................................... (11,198.2) (11,793.4)
Other.................................................................................... (234.5) (120.9)
---------- ----------
Net cash used by investing activities ............................................... (5,173.0) (2,216.6)
---------- ----------
Cash flows from financing activities:
Issuance of liabilities related to deposit products...................................... 1,007.2 430.0
Payments on liabilities related to deposit products...................................... (478.8) (55.6)
Issuance of notes payable................................................................ 14,068.9 8,724.0
Payments on notes payable................................................................ (8,437.8) (6,959.0)
Change in cash held in restricted accounts for settlement of collateralized borrowings... (749.8) -
Repurchase of shares of common stock..................................................... (126.0) -
Common stock dividends paid.............................................................. - (200.0)
----------- ----------
Net cash provided by financing activities............................................ 5,283.7 1,939.4
---------- ----------
Net increase in cash and cash equivalents............................................ 343.2 38.0
Cash and cash equivalents, beginning of period.............................................. 533.4 195.2
---------- ----------
Cash and cash equivalents, end of period.................................................... $ 876.6 $ 233.2
========== ==========
</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,
purchases, sells and services consumer and commercial finance loans throughout
the United States. Conseco Finance is a wholly owned subsidiary of Conseco, Inc.
("Conseco"), a financial services holding company.
On July 27, 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. We have already completed the sale of the bankcard business, generating
cash proceeds of over $150 million. 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.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Our unaudited consolidated financial statements reflect all adjustments,
consisting only of normal recurring items, 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 certain fixed maturity investments, 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.
Net income, as previously reported in our Form 10-Q, as amended, for the
three and six months ended June 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 $56.1 million and $63.6 million, in the three and six months ended
June 30, 1999, respectively.
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
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
6
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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. We are
currently evaluating the impact of SFAS 133, which is required to be implemented
in 2001. Because of ongoing changes to implementation guidance, we do not plan
on adopting the new standard until the first quarter of 2001.
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.
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 June 30, 2000, was approximately 11.8
percent. We classify the notes issued to investors in the securitization trusts
as "notes payable related to securitized finance receivables structured as
collateralized borrowings."
After the March 31, 2000 announcement that Conseco planned to explore the
sale of the Company and other events described elsewhere herein, it was
difficult to complete new securitization transactions for a period of time.
However, these markets eventually became available to the Company. During the
second quarter of 2000, we completed five transactions, securitizing over $2.5
billion of finance receivables. In May 2000, we sold $1.3 billion of finance
receivables to Lehman Brothers Holdings, Inc. and its affiliates (collectively,
with its direct and indirect subsidiaries, referred to as "Lehman"). The
proceeds from such sale were used to repay various warehouse credit lines,
creating increased warehousing capacity for Conseco Finance. Lehman also amended
its repurchase and other financing facilities with Conseco Finance to expand the
types of assets financed. See the note entitled "Special Charges and Recent
Events" for further description of the transaction with Lehman. 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.
Finance receivables-securitized, summarized by type, were as follows at
June 30, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----- ----
(Dollars in millions)
<S> <C> <C>
Manufactured housing.................................................................. $3,216.9 $ 953.0
Mortgage services..................................................................... 4,190.6 2,077.3
Consumer/credit card.................................................................. 256.5 1,076.9
Commercial............................................................................ 1,330.5 637.0
-------- --------
8,994.5 4,744.2
Less allowance for credit losses...................................................... 52.4 13.7
-------- --------
Net finance receivables-securitized........................................... $8,942.1 $4,730.5
======== ========
</TABLE>
7
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The other finance receivables, summarized by type, were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----- ----
(Dollars in millions)
<S> <C> <C>
Manufactured housing.................................................................. $ 834.4 $ 795.8
Mortgage services..................................................................... 1,404.4 1,277.0
Consumer/credit card.................................................................. 1,668.2 824.7
Commercial............................................................................ 1,779.9 2,281.3
-------- --------
5,686.9 5,178.8
Less allowance for credit losses...................................................... 100.8 74.7
-------- --------
Net other finance receivables................................................. $5,586.1 $5,104.1
======== ========
</TABLE>
The changes in the allowance for credit losses included in finance
receivables were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Allowance for credit losses, beginning of period..................... $119.1 $ 53.1 $ 88.4 $ 43.0
Provision for losses................................................. 84.1 27.2 142.7 48.5
Credit losses........................................................ (50.0) (25.1) (77.9) (36.3)
------ ------ ------ ------
Allowance for credit losses, end of period........................... $153.2 $ 55.2 $153.2 $ 55.2
====== ====== ====== ======
</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 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, $468.9 million and $714.7 million,
respectively, at June 30, 2000, and were classified as "actively managed fixed
maturity securities."
During the first six months of 1999, the Company sold $6.5 billion of
finance receivables in various securitized transactions and recognized gains of
$368.6 million. We recognized no gain on sale related to securitized
transactions during the first six months of 2000.
8
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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 June 30, 2000 and December
31, 1999. We include the difference between estimated fair value and the
amortized cost of the interest-only securities in "accumulated other
comprehensive loss, net of taxes. "
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
June 30, 2000 housing home improvement equipment Total
------------- ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value............. $ 522.2 $ 280.7 $ 49.9 $ 852.8
Cumulative principal balance of sold finance
receivables at June 30, 2000.................... 21,451.5 7,590.6 2,386.1 31,428.2
Weighted average stated customer interest rate
on sold finance receivables..................... 10.0% 11.5% 10.9%
Assumptions to determine estimated fair value
of interest-only securities at June 30, 2000:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).. 9.6% 21.0% 22.2%
Expected nondiscounted credit losses as a
percentage of principal balance of
related finance receivables (a)............. 8.7% 5.9% 5.1%
Weighted average discount rate ............... 14.0% 14.0% 14.0%
Manufactured Home equity/ Consumer/
December 31, 1999 housing home improvement equipment Total
----------------- ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
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%
<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>
9
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Activity in the interest-only securities account was as follows:
<TABLE>
<CAPTION>
Six months ended
June 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.................................. - 266.4
Additions resulting from clean-up calls (a)................................................. 64.9 -
Investment income........................................................................... 56.1 91.5
Cash received............................................................................... (126.5) (234.1)
Impairment charge to reduce carrying value.................................................. (13.3) (83.2)
Change in unrealized depreciation charged to shareholder's equity........................... (33.4) 3.5
------- --------
Balance, end of period......................................................................... $ 852.8 $1,349.5
======= ========
----------
<FN>
(a) During the first six months of 2000, clean-up calls were exercised for five
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 five
securitizations triggered a requirement for the Company to repurchase a
portion of the interest-only securities.
</FN>
</TABLE>
Credit quality of managed finance receivables was as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
<S> <C> <C>
60-days-and-over delinquencies as a percentage of managed finance
receivables at period end................................................. 1.47% 1.42%
==== ====
Net credit losses incurred during the last twelve months as a percentage
of average managed finance receivables during the period.................. 1.49% 1.31%
==== ====
Repossessed collateral inventory as a percentage of managed finance
receivables at period end................................................. 1.41% 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 June 30, 2000):
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Note payable to Conseco (8.28%).............................................. $2,210.8 $2,116.7
Master repurchase agreements due on various dates in 2000 and 2001
(7.89%)................................................................... 2,525.3 1,620.9
Credit facility collateralized by retained interests in securitizations due
2001 (8.62%).............................................................. 525.0 499.0
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.................................................. 5,705.3 4,683.7
Unamortized net discount..................................................... 2.5 3.2
--------- --------
Total notes payable..................................................... $5,702.8 $4,680.5
======== ========
</TABLE>
10
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The credit facility collateralized by retained interests in securitizations
requires the Company to maintain various financial ratios, as defined in the
agreement, including: (i) an adjusted tangible net worth of at least $1.8
billion (such amount was $2.0 billion at June 30, 2000); (ii) a fixed charge
coverage ratio of not less than 1.10:1.0 (such ratio was 1.11:1 at June 30,
2000); (iii) a debt to equity ratio of not more than 12.0:1.0 (such ratio was
9.0:1.0 at June 30, 2000); and (iv) a net worth to average managed receivable
ratio of not less than .0375:1 (such ratio was .0393:1 at June 30, 2000). Our
current plans to restructure our finance operations could adversely affect such
financial ratios.
At June 30, 2000, we had $5.7 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. These agreements generally
provide for annual terms, some of 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 June 30, 2000,
we had $3.3 billion borrowed under such agreements.
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 $9,136.4 million at June 30, 2000. The principal
and interest on these notes are paid using the cash flows from the underlying
finance 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 June 30, 2000 was 8.0 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. At June 30, 2000, the one-year term note had a balance of $2,210.8
million. Conseco has agreed that without Lehman's consent, it will limit
additional prepayments on this note to $50 million, as long as certain financing
arrangements with Lehman remain outstanding. In addition, the Company has agreed
that it will not pay dividends until 2001 and then pay such dividends only to
the extent certain financial covenants are met. Interest expense incurred under
the note totaled $92.7 million and $26.6 million during the six months ended
June 30, 2000 and 1999, respectively.
At June 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
11
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
direct and allocable costs. Total fees incurred by the Company under such
agreements were $22.7 million and $20.3 million for the six months ended June
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.
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. 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
We have provided guarantees of approximately $1.6 billion at June 30, 2000,
in conjunction with certain sales of finance receivables. 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.
12
<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>
Six months ended
June 30,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................................................... $ (1.7) $ 207.0
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Gain on sale of finance receivables................................................... (2.6) (368.6)
Points and origination fees received.................................................. - 243.2
Interest-only securities investment income............................................ (56.1) (91.1)
Cash received from interest-only securities........................................... 126.5 234.1
Servicing income...................................................................... (55.3) (81.1)
Cash received from servicing activities............................................... 63.2 86.1
Provision for losses.................................................................. 142.7 48.5
Amortization and depreciation......................................................... 14.7 24.8
Income taxes.......................................................................... (28.3) (44.2)
Accrual and amortization of investment income......................................... (48.4) (8.6)
Special charges....................................................................... 38.4 -
Impairment charges.................................................................... 12.1 83.8
Other ............................................................................... 27.3 (18.7)
------ -------
Net cash provided by operating activities........................................... $232.5 $ 315.2
====== =======
</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.
SPECIAL CHARGES AND RECENT EVENTS
During the second quarter of 2000, the Company incurred the following
charges which are further described in the paragraphs which follow (dollars in
millions):
<TABLE>
<S> <C>
Transaction fee paid to Lehman............................................................... $ 25.0
Warrant issued to Lehman..................................................................... 48.1
Gain recognized on sale of bankcard business................................................. (9.7)
------
Special charges before income tax benefit............................................. 63.4
Income tax benefit related to special charges................................................ (22.2)
------
Special charges, net of income tax benefit............................................ $ 41.2
======
</TABLE>
Lehman transactions
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.
13
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
During the second quarter of 2000, we repurchased approximately $.7 billion
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 repurchase and other 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, the warrant 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.
Sale of bankcard business
In the second quarter of 2000, the Company sold substantially all of its
bankcard (Visa and Mastercard) portfolio. We recognized a net gain on the sale
of $9.7 million.
Other items
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.
14
<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.
15
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Contract originations:
Manufactured housing............................................... $ 1,478.7 $ 1,983.6 $ 2,662.4 $ 3,394.7
Mortgage services.................................................. 1,471.1 1,931.7 3,015.3 3,369.3
Consumer/credit card............................................... 1,066.4 742.6 1,840.9 1,281.2
Commercial......................................................... 1,404.1 2,152.0 2,910.8 4,138.9
--------- --------- --------- ---------
Total............................................................ $ 5,420.3 $ 6,809.9 $10,429.4 $12,184.1
========= ========= ========= =========
Securitizations of receivables recorded as sales:
Manufactured housing............................................... $ 597.8 $ 1,681.1 $ 597.8 $ 3,481.1
Home equity/home improvement....................................... 824.0 1,687.7 824.0 2,648.8
Consumer/equipment................................................. - 600.0 - 600.0
Leases............................................................. - - - -
Commercial and retail revolving credit............................. 409.0 92.5 409.0 92.5
Retained bonds..................................................... - (348.2) - (371.4)
--------- --------- --------- ---------
Total............................................................ $ 1,830.8 $ 3,713.1 $ 1,830.8 $ 6,451.0
========= ========= ========= =========
Managed receivables (average):
Manufactured housing............................................... $25,518.4 $22,362.8 $25,198.3 $21,905.1
Mortgage services.................................................. 13,340.2 9,725.0 12,962.4 9,205.3
Consumer/credit card............................................... 3,971.6 3,101.0 3,924.2 3,044.7
Commercial......................................................... 5,043.2 5,551.5 5,082.4 5,336.4
--------- --------- --------- ---------
Total............................................................ $47,873.4 $40,740.3 $47,167.3 $39,491.5
========= ========= ========= =========
Revenues:
Net investment income:
Finance receivables and other.................................... $ 453.1 $ 133.3 $ 844.4 $ 240.2
Interest-only securities......................................... 28.6 47.4 56.1 91.1
Gain on sale:
Securitization transactions...................................... - 169.4 - 368.6
Whole-loan sales................................................. 2.6 - 2.6 -
Fee revenue and other income....................................... 99.0 87.6 210.8 170.2
--------- --------- --------- ---------
Total revenues................................................... 583.3 437.7 1,113.9 870.1
--------- --------- --------- ---------
Expenses:
Provision for losses............................................... 84.1 27.2 142.7 48.5
Finance interest expense........................................... 266.9 69.6 471.4 124.2
Other operating costs and expenses................................. 203.2 156.8 425.3 317.5
--------- --------- --------- ---------
Total expenses................................................... 554.2 253.6 1,039.4 490.2
--------- --------- --------- ---------
Operating income before special charges, impairment charges
and income taxes............................................... 29.1 184.1 74.5 379.9
Special charges....................................................... 63.4 - 63.4 -
Impairment charges.................................................... 9.6 71.6 12.1 83.8
--------- --------- --------- ---------
Income (loss) before income taxes................................ $ (43.9) $ 112.5 $ (1.0) $ 296.1
========= ========= ========= =========
</TABLE>
16
<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.
On July 27, 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. We have already completed the sale of the bankcard business, generating
cash proceeds of over $150 million. 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.
After the March 31, 2000 announcement that Conseco planned to explore the
sale of the Company and other events described elsewhere herein, it was
difficult to complete new securitization transactions for a period of time.
However, these markets eventually became available to the Company. During the
second quarter of 2000, we completed five transactions, securitizing over $2.5
billion of finance receivables. In May 2000, we sold $1.3 billion of finance
receivables to Lehman. The proceeds from such sale were used to repay various
warehouse credit lines, creating increased warehousing capacity for Conseco
Finance. Lehman also amended its repurchase and other financing facilities with
Conseco Finance to expand the types of assets financed. See the note to the
accompanying consolidated financial statements entitled "Special Charges and
Recent Events" for a further description of the transactions with Lehman. 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.
Loan originations in the second quarter of 2000 were $5.4 billion, down 20
percent from 1999. Loan originations in the first six months of 2000 were $10.4
billion, down 14 percent over 1999. We believe there are several factors which
contribute to the decrease in loan originations during the second quarter of
2000. General levels of interest rates have increased, which has resulted in a
decrease in the demand for certain finance products. Sales of manufactured
housing have also decreased recently. The Company has also limited the
origination of certain loans, reflecting the cost and limitations of our capital
and efforts to control our growth.
Manufactured housing loan originations decreased by $504.9 million, or 25
percent, in the second quarter of 2000 and by $732.3 million, or 22 percent,
during the first six months of 2000. The decrease was primarily due to a
decrease in the number of contracts written, which is consistent with the
decrease in sales of manufactured housing during the second quarter of 2000.
17
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
Mortgage services loan originations decreased by $460.6 million, or 24
percent, in the second quarter of 2000 and by $354.0 million, or 11 percent,
during the first six months of 2000. The decrease was primarily due to a
decrease in the number of contracts written, which is generally consistent with
the reduced demand for these products in the rising interest rate environment.
Consumer/credit card loan originations increased by $323.8 million, or 44
percent, in the second quarter of 2000 and by $559.7 million, or 44 percent,
during the first six months of 2000. The increase is primarily the result of our
successful marketing efforts, including a number of new private label credit
card relationships with large retailers. During the second quarter of 2000, we
entered into an agreement to sell our bankcard portfolio, which accounted for
$203 million of our originations during the six months ended June 30, 2000.
Commercial loan originations decreased by $747.9 million, or 35 percent, in
the second quarter of 2000 and by $1,228.1 million, or 30 percent, during the
first six months of 2000. The decrease primarily reflects the sale of certain
commercial lines in September 1999, and our decision in early 2000 to
significantly limit additional transportation and certain other commercial
loans.
Sales of finance receivables decreased as a result of the change in the
structure of our securitizations. The sales in the second quarter of 2000
include the previously described sale of finance receivables to Lehman and the
sale of our bankcard portfolio.
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 $47.9 billion in the second quarter of 2000, up 18 percent over
1999, and to $47.2 billion in the first six months of 2000, up 19 percent over
the same period in 1999.
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 240 percent, to $453.1 million,
in the second quarter of 2000 and by 252 percent, to $844.4 million, in the
first six 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 11.0 percent during the
second quarters of 2000 and 1999, respectively, and such weighted average yields
were 13.0 percent and 11.3 percent during the first six 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.
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 40 percent, to $28.6 million, in the
second quarter of 2000 and by 38 percent, to $56.1 million, in the first six
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 12.5 percent and 13.7 percent during the first six
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 $83.2 million was incurred in the
first six months of 1999) due to an impairment charge 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 the
appropriate interest accretion rate. If we determine that this rate should be
lower, investment income accreted on the interest-only security will decrease in
future periods.
Gain on sale related to securitization transactions were 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,
18
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
particularly securities having corporate guarantee provisions. Prior to our
September 8, 1999, announcement, the securities that we hold 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 June 30, 2000, we held $468.9 million of such securities which are
classified as actively managed fixed maturities.
Gain on whole-loan sales totaled $2.6 million in the second quarter 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 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 increased by 13 percent, to $99.0
million, in the second quarter of 2000, and by 24 percent, to $210.8 million, in
the first six months of 2000. Our net written insurance premiums and other
income both grew with managed receivables. As a result of the change in the
structure of our future securitizations announced on September 8, 1999, we no
longer record an 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 209 percent, to $84.1 million, in the
second quarter of 2000, and by 194 percent, to $142.7 million, in the first six
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 283 percent, to $266.9 million, in the second
quarter of 2000, and by 280 percent, to $471.4 million, in the first six months
of 2000. Our borrowings grew in order to fund the increase in finance
receivables. In addition, our average borrowing rate increased to 7.6 percent in
the second quarter of 2000 from 5.4 percent in the second quarter of 1999. Our
average borrowing rate during the first six months of 2000 was 7.3 percent
compared to 5.6 percent during the first six 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 30 percent, to $203.2 million,
in the second quarter of 2000, and by 34 percent, to $425.3 million, in the
first six months of 2000, reflecting: (i) the growth in our servicing portfolio;
and (ii) the growth in our loan origination offices and infrastructure.
Special charges include: (i) the $25.0 million transaction fee paid to
Lehman in conjunction with the previously described sale of $1.3 billion of
finance receivables; (ii) the issuance of a warrant valued at $48.1 million
related to the modification of the Lehman master repurchase financing
facilities; and (iii) the $9.7 million gain realized on the sale of our bankcard
portfolio and other items.
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. We record any unrealized gain or
loss determined to be temporary, net of tax, as a component of shareholder's
equity. Declines in value are considered to be other than temporary when the
present value of estimated future cash flows discounted at a risk- free rate
using current assumptions is less than the amortized cost of the interest-only
securities. 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
19
<PAGE>
CONSECO FINANCE CORP. AND SUBSIDIARIES
--------------------
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.
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 second
quarters of 2000 and 1999, we recognized an impairment charge of $9.6 million
and $71.6 million, respectively, to reduce the book value of the interest-only
securities and servicing rights. Such impairment charge for the first six months
of 2000 and 1999 was $12.1 million and $83.8 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.
20
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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. 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.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. (a) Exhibits
4(c) Promissory Note dated May 11, 2000 issued by the Company to
Conseco, Inc.
10(e) Warrant to Purchase Common Stock of Conseco Finance Corp. dated
May 11, 2000, by and between Conseco Finance Corp. and Lehman
Brothers Holdings Inc. is incorporated herein by reference to
the Form 10-Q of Conseco, Inc. for the period ended June 30,
2000.
10(f) Agreement dated May 11, 2000, by and among Conseco, Inc., CIHC,
Incorporated and Lehman Brothers Holdings Inc. is incorporated
herein by reference to the Form 10-Q of Conseco, Inc. for the
period ended June 30, 2000.
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
(b) Reports on Form 8-K - None
21
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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: August 14, 2000 By: /S/ JAMES S. ADAMS
------------------
James S. Adams
Senior Vice President and
Chief Accounting Officer
(authorized officer and chief
accounting officer)
22
