10-K 1 a13-1313_110k.htm 10-K

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

þ                                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2012

 

OR

 

o                                  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 1-06155

 

SPRINGLEAF FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

 

Indiana

 

35-0416090

(State of incorporation)

 

(I.R.S. Employer Identification No.)

 

 

 

601 N.W. Second Street, Evansville, IN

 

47708

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (812) 424-8031

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 

Name of each exchange on which registered

6.90% Medium-Term Notes, Series J, due December 15, 2017

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o      No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.

Yes o      No þ

 

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 þ      No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ      No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K þ.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer þ

 

Smaller reporting company o

 

 

 

 

(Do not check if a smaller

reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o      No þ

 

All of the registrant’s common stock is held by Springleaf Finance, Inc. The registrant is indirectly owned by certain investment funds managed by affiliates of Fortress Investment Group LLC (80% economic interest) and American International Group, Inc. (20% economic interest).

 

At March 18, 2013, there were 10,160,017 shares of the registrant’s common stock, $.50 par value, outstanding.

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Forward-Looking Statements

 

 

 

 

PART I

 

 

Item 1.

Business

4

Item 1A.

Risk Factors

12

Item 1B.

Unresolved Staff Comments

30

Item 2.

Properties

30

Item 3.

Legal Proceedings

30

Item 4.

Mine Safety Disclosures

30

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

31

Item 6.

Selected Financial Data

31

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

73

Item 8.

Financial Statements and Supplementary Data

74

 

Reports of Independent Registered Public Accounting Firm

75

 

Consolidated Balance Sheets

77

 

Consolidated Statements of Operations

78

 

Consolidated Statements of Comprehensive Income (Loss)

79

 

Consolidated Statements of Shareholder’s Equity

80

 

Consolidated Statements of Cash Flows

81

 

Notes to Consolidated Financial Statements

83

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

171

Item 9A.

Controls and Procedures

172

Item 9B.

Other Information

173

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

174

Item 11.

Executive Compensation

181

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

194

Item 13.

Certain Relationships and Related Transactions, and Director Independence

196

Item 14.

Principal Accounting Fees and Services

201

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

202

 

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Forward-Looking Statements

 

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts but instead reflect our current expectations that involve risks and uncertainties. When used in this report, the words “believe,” “anticipate,” “expect,” “intend,” “plan,” “estimate,” “may,” “will,” “could,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These statements may address, among other things, our strategy, future performance, future financial condition, growth opportunities, product development, and market position. Our actual results and financial condition may differ from the anticipated results and financial condition indicated in these forward-looking statements. The important factors, many of which are outside of our control, that could cause our actual results to differ, possibly materially, include, but are not limited to, the following:

 

·                 changes in general economic conditions, including the interest rate environment in which we conduct business and the financial markets through which we can access capital and also invest cash flows from the insurance business segment;

·                 shifts in collateral values, delinquencies, or credit losses;

·                 shifts in residential real estate values;

·                 levels of unemployment and personal bankruptcies;

·                 changes in the rate at which we can collect or potentially sell our finance receivable portfolio;

·                 natural or accidental events such as earthquakes, hurricanes, tornadoes, fires, or floods affecting our customers, collateral, or branches or other operating facilities;

·                 war, acts of terrorism, riots, civil disruption, pandemics, or other events disrupting business or commerce;

·                 the effectiveness of our credit risk scoring models in assessing the risk of customer unwillingness or inability to repay;

·                 changes in our ability to attract and retain employees or key executives to support our businesses;

·                 our substantial indebtedness, which could prevent us from meeting our obligations under our debt instruments and limit our ability to react to changes in the economy or our industry, or our ability to incur additional borrowings;

·                 our ability to generate sufficient cash to service all of our indebtedness;

·                 our continued ability to access the capital markets or the sufficiency of our current sources of funds to satisfy our cash flow requirements;

·                 the impacts of our securitizations and borrowings;

·                 our ability to comply with our debt covenants, including the borrowing base for Springleaf Finance Corporation’s secured term loan;

·                 changes in the competitive environment in which we operate, including the demand for our products, customer responsiveness to our distribution channels, and the formation of business combinations among our competitors;

·                 the potential for increasing costs and difficulty in servicing our loan portfolio, especially our real estate loan portfolio (including costs and delays associated with foreclosure on real estate collateral), as a result of heightened nationwide regulatory scrutiny of loan servicing and foreclosure practices in the industry generally, and related costs that could be passed on to us in connection with the subservicing of our real estate loans that were originated or acquired centrally;

·                 potential liability relating to real estate and personal loans which we have sold or may sell in the future, or relating to securitized loans, if it is determined that there was a non-curable breach of a warranty made in connection with the transaction;

 

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Item 1.  Continued

 

·                 changes in federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (which, among other things, established a federal Consumer Financial Protection Bureau with broad authority to regulate and examine financial institutions), that affect our ability to conduct business or the manner in which we conduct business, such as licensing requirements, pricing limitations or restrictions on the method of offering products, as well as changes that may result from increased regulatory scrutiny of the sub-prime lending industry;

·                 the effects of participation in the Home Affordable Modification Program by subservicers of our loans;

·                 the costs and effects of any litigation or governmental inquiries or investigations involving us, particularly those that are determined adversely to us;

·                 the potential for further downgrade of our debt by rating agencies, which would have a negative impact on our cost of, and access to, capital;

·                 changes in accounting standards or tax policies and practices and the application of such new policies and practices to the manner in which we conduct business; and

·                 our ability to maintain sufficient capital levels in our regulated and unregulated subsidiaries.

 

See Item 1A in Part I of this report for further information on our risks and uncertainties. We are under no obligation (and expressly disclaim any obligation) to update or alter any forward-looking statement, whether written or oral, that we may make from time to time, whether as a result of new information, future events or otherwise.

 

PART I

 

Item 1.  Business.

 

GENERAL

 

Springleaf Finance Corporation (SLFC or, collectively with its subsidiaries, whether directly or indirectly owned, the Company, we, us, or our) was incorporated in Indiana in 1927 as successor to a business started in 1920. All of the common stock of SLFC is owned by Springleaf Finance, Inc. (SLFI), which was incorporated in Indiana in 1974.

 

On November 30, 2010, FCFI Acquisition LLC (FCFI), an affiliate of Fortress Investment Group LLC (Fortress), indirectly acquired an 80% economic interest in SLFI from AIG Capital Corporation (ACC), a direct wholly-owned subsidiary of American International Group, Inc. (AIG) (the FCFI Transaction). AIG, through ACC, indirectly retained a 20% economic interest in SLFI.

 

SLFC is a financial services holding company with subsidiaries engaged in the consumer finance and credit insurance businesses. We provide secured and unsecured personal loans to customers who generally need timely access to cash and also offer associated insurance products. At December 31, 2012, we had $11.7 billion of net finance receivables due from over 973,000 customer accounts and $3.4 billion of credit and non-credit life insurance policies in force covering over 630,000 customer accounts.

 

Our headquarters is located in Evansville, Indiana. At December 31, 2012, we had 852 branch offices in the United States, Puerto Rico, and the U.S. Virgin Islands and over 3,600 employees. In December 2012, over 1,000 of our employees were redeployed to a subsidiary of SLFI, which now provides management services to us. See Note 12 of the Notes to Consolidated Financial Statements in Item 8 for further information.

 

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Item 1.  Continued

 

As part of a strategic effort to streamline operations and reduce expenses, we initiated the following restructuring activities during the first half of 2012: (1) ceased originating real estate loans nationwide and in the United Kingdom; (2) ceased personal lending and retail sales financing in 14 states; (3) consolidated certain branch operations in 26 states; and (4) closed 231 branch offices. As a result of these initiatives, we reduced our workforce in our branch operations, at our Evansville, Indiana headquarters, and operations in the United Kingdom by 820 employees and incurred a pretax charge of $23.5 million during the first half of 2012.

 

SEGMENTS

 

Prior to our 2012 restructuring initiatives and further refinement of our business strategy, we had three business segments:  branch, centralized real estate, and insurance, which were defined by the types of financial service products we offered, the nature of our production processes, and the methods we used to distribute our products and to provide our services, as well as our management reporting structure.

 

Subsequent to our 2012 strategic review of our operations, we have redefined our segments to coincide with how our businesses are currently managed. At December 31, 2012, our three business segments include: consumer, insurance, and real estate. These business segments evolved primarily from management’s redefined business strategy, including its decision to cease real estate lending effective January 1, 2012 and to shift its focus to consumer loan products which we believe have significant prospects for growth and business development due to the strong demand in our target market of nonprime borrowers. Throughout 2012, management continued to refine our business strategy and operating footprint and the reporting tools necessary to manage the Company under the new segments, which were defined in final form in the fourth quarter of 2012 and led to our revision to 2012 segment reporting.

 

Due to the nature of the FCFI Transaction, we revalued our assets and liabilities based on their fair values at the date of the FCFI Transaction in accordance with business combination accounting standards (push-down accounting). However, we continue to report our segment financial information using the same accounting basis that we employed prior to the FCFI Transaction, which we refer to as “historical accounting basis,” to provide a consistent basis for both management and other interested third parties to better understand our operating results. The historical accounting basis (which is a basis of accounting other than generally accepted accounting principles in the United States of America (U.S. GAAP)) also provides better comparability of our operating results to our competitors and other companies in the financial services industry.

 

The segment financial information disclosed below and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 is discussed on a historical accounting basis. See Note 24 of the Notes to Consolidated Financial Statements in Item 8 for reconciliations of segment information on a historical accounting basis to consolidated financial statement amounts.

 

Consumer Business Segment

 

The consumer business segment is the core of the Company’s operations with over 3,480 employees, 834 branch offices in 26 states, which are our core operating states, and its centralized support operations located in Evansville, Indiana. The consumer business segment serviced over 729,100 personal loan accounts totaling $2.5 billion at December 31, 2012.

 

Products and Services. We originate and service personal loans, which are typically closed-end accounts with a fixed rate and a fixed, original term of 2 to 4 years. These loans are secured by titled personal property (such as automobiles), consumer goods, or other personal property or are unsecured.

 

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Item 1.  Continued

 

Customer Development. Our branch network helps solicit new prospects for our consumer business segment due to the geographical proximity that typically exists between our branch offices and our current customers. Our employees at these branch offices are typically on a “first name basis” with these customers. Many of these customers develop an affinity with their local office representatives that can lead to additional lending opportunities with our customers’ friends and family members.

 

We also solicit new prospects for our consumer business segment, as well as current and former customers, through a variety of direct mail offers. Our data warehouse is a central, proprietary source of information regarding current and former customers. We use this information to tailor offers to specific customer segments. In addition to internal data, we purchase lists of new potential consumer loan borrowers from major list vendors based on predetermined selection criteria. Mail solicitations include invitations to apply for personal loans and pre-qualified offers of guaranteed personal loan credit.

 

E-commerce provides another significant source of new customers. Search engine marketing is used to drive prospects to our website at www.SpringleafFinancial.com. Our website includes a brief, user-friendly credit application that, upon completion, is automatically routed to the branch office nearest the consumer. Our website also has a branch office locator feature so potential customers can find the branch office nearest to them and can contact branch personnel directly.

 

Credit Risk. In our consumer business segment, we use credit risk scoring models at the time of credit application to assess the applicant’s ability and willingness to repay. We develop these models using numerous factors, including past customer credit repayment experience and application data, and periodically revalidate these models based on recent portfolio performance. Our underwriting process also includes the development of a budget (net of taxes and monthly expenses) for the applicant. Finally, we attempt to obtain a security interest in either titled non-real estate property or other household goods.

 

Our consumer business segment customers are typically considered non-prime or sub-prime (less creditworthy) and require significantly higher levels of servicing than prime or near-prime customers. As a result, we charge these customers higher interest rates to compensate us for the related credit risks and servicing.

 

Account Servicing. The account servicing and collection processing for our personal loans are generally handled at the branch office where the personal loans were originated. All servicing and collection activity is conducted and documented on the Customer Lending and Solicitation System (CLASS), a proprietary system which logs and maintains, within our centralized information systems, a permanent record of all transactions and notations made with respect to the servicing and/or collection of a personal loan and is also used to assess a personal loan application. CLASS permits all levels of branch management to review on a daily basis the individual and collective performance of all branch offices for which they are responsible.

 

Insurance Business Segment

 

We conduct the insurance business segment through Merit Life Insurance Co. (Merit) and Yosemite Insurance Company (Yosemite), which are both wholly-owned subsidiaries of SLFC. Merit is a life and health insurance company that writes or reinsures credit life, credit accident and health, and non-credit insurance and is licensed in 46 states, the District of Columbia, and the U.S. Virgin Islands. Yosemite is a property and casualty insurance company that writes or reinsures credit-related property and casualty and credit involuntary unemployment insurance and is licensed in 46 states.

 

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Item 1.  Continued

 

The insurance business segment markets its products to eligible finance receivable customers. We invest cash generated from operations in investment securities, commercial mortgage loans, and policy loans and also use it to pay dividends. The insurance business segment entails numerous underwriting, compliance, and service responsibilities for the insurance companies and also provides services to the consumer and real estate business segments.

 

Products and Services. We write and reinsure credit life, credit accident and health, credit related property and casualty, and credit involuntary unemployment insurance policies covering our customers and the property pledged as collateral through products that the consumer and real estate business segments offer to its customers. We also offer non-credit insurance and ancillary products.

 

Our credit life insurance policies insure the life of the borrower in an amount typically equal to the unpaid balance of the finance receivable and provide for payment in full to the lender of the finance receivable in the event of the borrower’s death. Our credit accident and health insurance policies provide, to the lender, payment of the installments on the finance receivable coming due during a period of the borrower’s disability due to illness or injury. Our credit-related property and casualty insurance policies are written to protect the lender’s interest in property pledged as collateral for the finance receivable. Our credit involuntary unemployment insurance policies provide, to the lender, payment of the installments on the finance receivable coming due during a period of the borrower’s involuntary unemployment. The borrower’s purchase of credit life, credit accident and health, credit-related property and casualty, or credit involuntary unemployment insurance is voluntary with the exception of lender-placed property damage coverage for property pledged as collateral. In these instances, our consumer or real estate business segment personnel obtain property damage coverage through Yosemite either on a direct or reinsured basis under the terms of the lending agreement if the borrower does not provide evidence of coverage with another insurance carrier. Non-credit insurance policies are primarily traditional level term life policies. The purchase of this coverage is also voluntary.

 

The ancillary products we offer are home security and auto security membership plans and home appliance service contracts of unaffiliated companies. These products are generally not considered to be insurance policies. Our insurance business segment has no risk of loss on these products. The unaffiliated companies providing these membership plans and service contracts are responsible for any required reimbursement to the customer on these products.

 

Customers usually either pay premiums for insurance products monthly with their finance receivable payment or finance the premiums and contract fees for ancillary products as part of the finance receivable, but they may pay the premiums and contract fees in cash to the insurer or financial services company.

 

Reinsurance. Merit and Yosemite enter into reinsurance agreements with other insurers, including subsidiaries of AIG, for reinsurance of various non-credit life, group annuity, credit life, credit accident and health, credit-related property and casualty, and credit involuntary unemployment insurance where our insurance subsidiaries reinsure the risk of loss.

 

Real Estate Business Segment

 

As a result of the cessation of real estate lending effective January 1, 2012, our real estate loans are in a liquidating status. At December 31, 2012, our real estate business segment loans totaled $10.4 billion. Our real estate loans are secured by first or second mortgages on residential real estate and are usually considered non-conforming. These loans may be closed-end accounts or open-end home equity lines of credit and are primarily fixed-rate products. Our real estate loans generally have maximum original terms of 360 months, but we also have offered loans with maximum original terms of 480 months and 600

 

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Item 1.  Continued

 

months, some of which require a balloon payment at the end of 360 months. Our real estate loans do not contain any borrower payment options that allow the loan principal balance to increase through negative loan amortization.

 

Real estate loans previously originated through our branch offices are either serviced by our branch personnel or centrally serviced at our Evansville, Indiana location or other specialized servicing centers. Real estate loans previously acquired or originated through centralized distribution channels are serviced by MorEquity, Inc. (MorEquity), a wholly-owned subsidiary of SLFC, all of which are subserviced by Nationstar Mortgage LLC (Nationstar), except for certain securitized real estate loans, which are serviced and subserviced by third parties. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar.

 

CENTRALIZED SUPPORT

 

We continually seek to identify functions that could be more effective if centralized to achieve reduced costs or free our consumer and real estate business segment lending specialists to service our customers and market our products. Our centralized operational functions support the following:

 

·                 mail and telephone solicitations;

·                 payment processing and collections;

·                 foreclosure and real estate owned processing;

·                 real estate escrow accounts;

·                 collateral protection insurance tracking; and

·                 charge-off recovery operations.

 

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Item 1.  Continued

 

OPERATIONAL CONTROLS

 

We control and monitor our business segments through a variety of methods including the following:

 

·                 Our operational policies and procedures standardize various aspects of lending, collections, and business development processes.

·                 Our branch finance receivable systems control amounts, rates, terms, and fees of our customers’ accounts; create loan documents specific to the state in which the branch operates; and control cash receipts and disbursements.

·                 Our headquarters accounting personnel reconcile bank accounts, investigate discrepancies, and resolve differences.

·                 Our credit risk management system reports are used by various personnel to compare branch lending and collection activities with predetermined parameters.

·                 Our executive information system is available to headquarters and field operations management to review the status of activity through the close of business of the prior day.

·                 Our branch field operations management structure is designed to control a large, decentralized organization with succeeding levels of supervision staffed with more experienced personnel.

·                 Our field operations compensation plan aligns the operating activities and goals with corporate strategies by basing the incentive portion of field personnel compensation on profitability and credit quality.

·                 Our compliance department assesses the Company’s compliance with federal and state regulations, as well as its compliance with our internal policies and procedures; manages our regulatory examination process; and maintains our consumer complaint resolution and reporting process.

·                 Our internal audit department audits the Company for adherence to operational policy and procedure and compliance with federal and state law and regulation.

 

REGULATION

 

Consumer and Real Estate Business Segments

 

Federal Laws. Various federal laws and regulations govern our consumer and real estate business segments including:

 

·                 the Equal Credit Opportunity Act (prohibits discrimination against creditworthy applicants) and Consumer Financial Protection Bureau (the Bureau) Regulation B, which implements that Act;

·                 the Fair Credit Reporting Act (governs the accuracy and use of credit bureau reports);

·                 the Truth in Lending Act (governs disclosure of applicable charges and other finance receivable terms) and Bureau Regulation Z, which implements that Act;

·                 the Fair Debt Collection Practices Act;

·                 the Fair Housing Act (prohibits discrimination in housing lending);

·                 the Real Estate Settlement Procedures Act and the Department of Housing and Urban Development’s Regulation X (both of which regulate the making and servicing of certain loans secured by real estate);

·                 the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act);

·                 the Gramm-Leach-Bliley Act (governs the handling of personal financial information) and Bureau Regulation P, which implements that Act; and

·                 the Federal Trade Commission Act.

 

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Item 1.  Continued

 

In many states, federal law preempts state law restrictions on interest rates and points and fees for first lien residential mortgage loans (but not on other types of loans). The federal Alternative Mortgage Transactions Parity Act preempts certain state law restrictions on variable rate loans in many states. Historically, we made residential mortgage loans under this and other federal laws. Federal laws also govern our practices and disclosures when dealing with consumer or customer information.

 

In third quarter 2009, MorEquity entered into a Commitment to Purchase Financial Instrument and Servicer Participation Agreement (the Agreement) with the Federal National Mortgage Association as financial agent for the United States Department of the Treasury, which provides for participation in the Home Affordable Modification Program (HAMP). On February 1, 2011, MorEquity entered into subservicing agreements for the servicing of its real estate loans with Nationstar. Loans subserviced by Nationstar that are eligible for modification pursuant to HAMP guidelines are subject to HAMP.

 

On July 21, 2010, the President of the United States signed into law the Dodd-Frank Act. This law, and the regulations promulgated under it, is likely to affect our operations in terms of increased oversight of financial services products by the Bureau and the imposition of restrictions on the terms of certain loans. The Bureau has significant authority to implement and enforce Federal consumer finance laws, including the new protections established in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive, and abusive acts and practices. In addition, under the Dodd-Frank Act, securitizations of loan portfolios are subject to certain restrictions and additional requirements, including requirements that the originator retain a portion of the credit risk of the securities sold and the reporting of buyback requests from investors. Many of these regulations will be phased in over the next year.

 

The Dodd-Frank Act gave the Bureau broad powers to supervise financial services entities and enforce consumer protection laws. Currently, the Bureau only has supervisory authority over us with respect to mortgage servicing and mortgage origination, which allows the Bureau to conduct an examination of our mortgage servicing practices and our prior mortgage origination practices. The Dodd-Frank Act also gives the Bureau supervisory authority over entities that are designated as “larger participants” in certain financial services markets, including consumer installment loans and related products. The Bureau has not yet promulgated regulations which designate “larger participants” for consumer finance companies. If we are designated as a “larger participant” for this market, we also will be subject to supervision and examination by the Bureau with respect to our consumer loan business. We expect to be designated as a “larger participant.” In addition to its supervision and examination authority, the Bureau is authorized to conduct investigations to determine whether any person is engaging in, or has engaged in, conduct that violates Federal consumer financial protection laws, and to initiate enforcement actions for such violations, regardless of its direct supervisory authority. Investigations may be conducted jointly with other regulators. We have not been notified of any planned examinations or enforcement actions by the Bureau.

 

State Laws. Various state laws and regulations also govern our consumer and real estate business segments. Many states have laws that are similar to the federal laws referred to above. While federal law preempts state law in the event of certain conflicts, compliance with state laws and regulations is still required in the absence of conflicts.

 

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Item 1.  Continued

 

Many states also have laws and regulations that regulate consumer lending. The degree and nature of such regulation vary from state to state. These additional state laws and regulations, under which we conduct a substantial amount of our business, generally:

 

·                 provide for state licensing and periodic examination of lenders and loan originators, including state laws adopted or amended to comply with licensing requirements of the federal SAFE Act (which requires licensing of individuals who perform real estate loan originations and, in some states, real estate loan modifications);

·                 require the filing of reports with regulators;

·                 impose maximum term, amount, interest rate, and other charge limitations;

·                 regulate whether and under what circumstances we may offer insurance and other ancillary products in connection with a lending transaction; and

·                 provide for additional consumer protections.

 

There is a clear trend of increased state regulation, as well as more detailed reporting, more detailed examinations, and coordination of examinations among the states.

 

Prospective Lending Legislation. The U.S. government and a number of states, counties, and cities have enacted or may be considering, laws, regulations, or rules that restrict the credit terms or other aspects of residential mortgage loans that are typically described as “high cost mortgage loans” or “higher-priced mortgage loans.” These laws or regulations, if adopted, may limit or restrict the terms of covered loan transactions and may also impose specific statutory liabilities in cases of non-compliance. Additionally, some of these laws may restrict our other business activities.

 

Insurance Business Segment

 

State authorities regulate and supervise our insurance business segment. The extent of such regulation varies by product and by state, but relates primarily to the following:

 

·                 licensing;

·                 conduct of business, including marketing and sales practices;

·                 periodic financial and market conduct examination of the affairs of insurers;

·                 form and content of required financial reports;

·                 standards of solvency;

·                 limitations on the payment of dividends and other affiliate transactions;

·                 types of products offered;

·                 approval of policy forms and premium rates;

·                 permissible investments;

·                 reserve requirements for unearned premiums, losses, and other purposes; and

·                 claims processing.

 

Every jurisdiction in which we operate regulates credit insurance premium rates and premium refund calculations.

 

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Item 1.  Continued

 

COMPETITION

 

The consumer finance industry is highly competitive, and the barriers to entry for new competitors are relatively low in the market segment in which we operate. We compete with other consumer finance companies, as well as other types of financial institutions within our geographic footprint and over the Internet, including community banks, credit unions, and smaller regional finance companies, that offer similar products and services. These companies compete with us in terms of price and speed of service, as well as flexibility of credit underwriting requirements.

 

Our insurance business segment supplements our consumer and real estate business segments. We believe that our insurance companies’ abilities to market insurance products through our distribution systems provide a competitive advantage.

 

Available Information

 

SLFC files annual, quarterly, and current reports and other information with the Securities and Exchange Commission (the SEC). The SEC’s website, www.sec.gov, contains these reports and other information that registrants (including SLFC) file electronically with the SEC. Readers may also read and copy any document that SLFC files at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room.

 

The following reports are available free of charge through our website, www.SpringleafFinancial.com (posted on the “About Us – Investor Information – Financial Information” section), as soon as reasonably practicable after we file them with or furnish them to the SEC:

 

·                 Annual Reports on Form 10-K;

·                 Quarterly Reports on Form 10-Q;

·                 Current Reports on Form 8-K; and

·                 any amendments to those reports.

 

In addition, our Code of Ethics for Principal Executive and Senior Financial Officers (the Code of Ethics) is posted on the “About Us – Investor Information – Corporate Governance” section of our website at www.SpringleafFinancial.com. We will post on our website any amendments to the Code of Ethics and any waivers that are required to be described.

 

The information on our website is not incorporated by reference into this report. The website addresses listed above are provided for the information of the reader and are not intended to be active links.

 

 

 

Item 1A.  Risk Factors.

 

 

We face a variety of risks that are inherent in our business. Accordingly, you should carefully consider the following discussion of risks in addition to the other information regarding our business provided in this Annual Report on Form 10-K and in other documents we file with the SEC. These risks are subject to contingencies which may or may not occur, and we are not able to express a view on the likelihood of any such contingency occurring. New risks may emerge at any time, and we cannot predict those risks or estimate the extent to which they may affect our business or financial performance.

 

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RISKS RELATED TO OUR BUSINESS

 

Our consolidated results of operations and financial condition have been adversely affected by economic conditions and other factors, including high unemployment and the troubled residential real estate market, and we do not expect these conditions to significantly improve in the near future.

 

Our actual consolidated results of operations or financial condition may differ from the consolidated results of operations or financial condition that we anticipate or that we achieved in the past. We believe that generally the factors affecting our consolidated results of operations or financial condition relate to: general economic conditions, such as unemployment levels, housing markets, and interest rates; our ability to successfully underwrite lending risk; our ability to cost-effectively access the capital markets to support our business; fluctuations in the demand for our products and services and the effectiveness of our distribution channels; and natural disasters, acts of war, terrorism or catastrophes or high energy costs, major medical expenses, divorce or death that affect our customers, collateral, and branches or other operating facilities.

 

In 2008 and 2009, the U.S. residential real estate markets and credit markets experienced significant disruption as housing prices generally declined, unemployment increased, consumer delinquencies increased, and credit availability contracted and became more expensive for consumers and many financial institutions (including us). High unemployment levels negatively affect the ability and willingness of many borrowers to make the required interest and principal payments on their loans. Decreased real estate values that accompany a market downturn can reduce a borrower’s ability to refinance his or her mortgage, as well as increase the loan-to-value (LTV) ratios of our real estate loans. In addition, adverse changes in the real estate market increase the probability of default, as the incentive for a borrower to continue making payments declines if the borrower has little or no equity in the property securing the loan. Further, declining real estate values significantly increase the likelihood that we will incur losses on our real estate loans in the event of default because the value of our collateral may be insufficient to recover the amount due on the loan.

 

Defaults by borrowers on finance receivables could cause losses to us, could lead to increased claims relating to non-prime or sub-prime loan origination practices, and could encourage increased or changing regulation. Any increased or changing regulation could limit the availability of, or require changes in, the terms of personal loan products that we offer, and could also require us to devote additional resources to comply with the new and changing regulation.

 

The market developments discussed above have adversely affected our operating results significantly. As a result, we have ceased our real estate lending as of January 1, 2012. The continuation or worsening of these conditions could further adversely affect our business and results of operations. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our revenue from finance receivables in our portfolio and our ability to acquire, sell and securitize finance receivables, which would significantly harm our revenues, financial condition, liquidity, results of operations, and business prospects.

 

We are exposed to credit risk and the risk of loss in our lending activities.

 

Our ability to collect on finance receivables depends on our borrowers’ ability and willingness to repay the amounts that they have borrowed. Any material adverse change in the ability or willingness of a significant portion of our borrowers to meet their obligations to us, whether due to changes in economic conditions, the cost of consumer goods, interest rates or home values, unemployment, high energy costs, major medical expenses, divorce or death or due to natural disasters, acts of war or terrorism, or other

 

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causes over which we have no control, could have a material adverse effect on our earnings and financial condition. Further, a substantial majority of our borrowers are subprime or non-prime borrowers, who are more likely to be affected, and more severely affected, by adverse macroeconomic conditions such as those that have persisted over the last few years. In addition, although the vast majority of our real estate loans are fixed-rate loans, rising interest rates may increase the credit risks associated with certain types of residential real estate loans in our portfolio, such as adjustable-rate real estate loans. At December 31, 2012, 5% of our real estate loan portfolio was subject to adjustable rates. Accordingly, when short-term interest rates rise, required monthly payments from homeowners who have adjustable rate loans will rise under the terms of these real estate loans, and this may increase borrower delinquencies and defaults. In addition, we cannot be certain that our policies and procedures will adequately adapt to changes in economic or any other conditions affecting customers and the quality of the finance receivable portfolio.

 

In the event of default under a finance receivable held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral, if any, and the outstanding principal and accrued but unpaid interest of the finance receivable, which could adversely affect our cash flow from operations. Foreclosure of a real estate loan can be an expensive and lengthy process, which would negatively affect our anticipated return on the foreclosed loan.

 

We may be required to indemnify, or repurchase finance receivables from, purchasers of finance receivables that we have sold or securitized, or which we will sell or securitize in the future, if our finance receivables fail to meet certain criteria or characteristics or under other circumstances.

 

The documents governing our finance receivable sales and securitizations contain provisions that require us to indemnify the purchasers of securitized finance receivables, or to repurchase the affected finance receivables, under certain circumstances. While our sale and securitization documents vary, they generally contain provisions that may require us to repurchase finance receivables if:

 

·                 our representations and warranties concerning finance receivable quality and circumstances are inaccurate, including representations concerning the licensing of a mortgage broker;

·                 there is borrower fraud or if a payment default occurs on a finance receivable shortly after its origination;

·                 we fail to comply, at the individual finance receivable level or otherwise, with regulatory requirements; and

·                 in limited instances, an individual finance receivable reaches certain defined finance delinquency limits.

 

As a result of the current market environment, we believe that many purchasers of real estate loans (including through securitizations) are particularly aware of the conditions under which originators must indemnify purchasers or repurchase finance receivables, and would benefit from enforcing any repurchase remedies that they may have. Theoretically our exposure to repurchases or our indemnification obligations under our representations and warranties could include the current unpaid balance of all finance receivables that we have sold or securitized and which are not subject to settlement agreements with purchasers.

 

The risk of loss on the finance receivables that we have securitized is recognized in our allowance for finance receivable losses since all of our securitizations are recorded on-balance sheet. If we are required to indemnify purchasers or repurchase finance receivables that we sell that result in losses that exceed our reserve for sales recourse, or recognize losses on securitized finance receivables that exceed our recorded allowance for finance receivable losses associated with our securitizations, this could adversely affect our business, financial condition, or results of operations.

 

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If our estimates of finance receivable losses are not adequate to absorb actual losses, our provision for finance receivable losses would increase, which would adversely affect our results of operations.

 

We maintain an allowance for finance receivable losses. To estimate the appropriate level of allowance for finance receivable losses, we consider known and relevant internal and external factors that affect finance receivable collectability, including the total amount of finance receivables outstanding, historical finance receivable charge-offs, our current collection patterns, and economic trends. Our methodology for establishing our allowance for finance receivable losses is based in large part on our historic loss experience. If customer behavior changes as a result of economic conditions and if we are unable to predict how the unemployment rate, housing foreclosures, and general economic uncertainty may affect our allowance for finance receivable losses, our provision may be inadequate. Our allowance for finance receivable losses is an estimate, and if actual finance receivable losses are materially greater than our allowance for finance receivable losses, our financial condition and results of operations could be adversely affected. Neither state regulators nor federal regulators regulate our allowance for finance receivable losses. Additional information regarding our allowance for finance receivable losses is included in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates – Allowance for Finance Receivable Losses.”

 

We may be required to take impairment charges for intangible assets related to the FCFI Transaction.

 

As a result of the application of push-down accounting, we recorded intangible assets related to the FCFI Transaction. We recorded no goodwill associated with the FCFI Transaction. Additionally, we have no remaining goodwill from previous transactions. As a result of our future quarterly reviews and evaluation of our intangible assets for potential impairment, we may be required to take an impairment charge to the extent that the carrying values of our intangible assets exceed their fair value. Also, if we sell a business for less than the book value of the assets sold, including intangible assets attributable to that business, we may be required to take an impairment charge on all or part of the intangible assets attributable to that business.

 

We have recognized impairments on several of the intangible assets related to the FCFI Transaction. We cannot give assurances that we will not have to recognize additional material impairment charges in the future. See Note 26 of the Notes to Consolidated Financial Statements in Item 8 for further information on the impairments of our intangible assets.

 

Our risk management efforts may not be effective.

 

We could incur substantial losses and our business operations could be disrupted if we are unable to effectively identify, manage, monitor, and mitigate financial risks, such as credit risk, interest rate risk, prepayment risk, liquidity risk, and other market-related risks, as well as operational risks related to our business, assets and liabilities. We use a proprietary credit risk management system, which provides decision support to the underwriters and is used in automated underwriting as a key control function. A key component of the system is the credit risk modeling component used to assess the credit risk of potential borrowers. That assessment is derived from the applicant’s credit profile and application information and evaluated by proprietary credit risk scoring models. To the extent the models do not adequately identify potential risks, the valuations produced would not adequately represent the risk profile of the borrower and could result in a riskier finance receivable profile than originally identified. Our risk management policies, procedures, and techniques, including our scoring technology, may not be sufficient to identify all of the risks we are exposed to, mitigate the risks we have identified or identify additional risks to which we may become subject in the future.

 

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Item 1A.  Continued

 

We may be unable to maintain or grow our finance receivable origination volume, which could cause us to implement changes to our business and adversely affect our business prospects, liquidity, financial condition, results of operations, or cash flows.

 

Our finance receivable origination business consists of personal loans. Through January 15, 2013, we also purchased retail sales contracts and revolving retail accounts arising from the retail sale of consumer goods and services by retail merchants. Prior to January 1, 2012, we also originated real estate loans. We continually evaluate the type and mix of finance receivables that we believe are prudent to originate. Our ability to originate new finance receivables is dependent on a number of factors, including, but not limited to, consumer demand for finance receivables, economic conditions, interest rates and property values, as well as our access to financing, the terms of such financing, and the amount of capital we have available to originate finance receivables. Since September 2008, one or more of these factors has contributed to a significant reduction in the number and dollar amount of our real estate loan originations. In particular, our traditional borrowing sources, including our ability to cost effectively issue large amounts of unsecured debt in the capital markets, have not been available. We currently expect our near-term sources of funding to originate finance receivables and for other purposes to be more limited than those that were available to us prior to September 2008.

 

We have ceased our real estate loan originations as of January 1, 2012. In addition, in the first half of 2012, we closed 231 branches and ceased consumer lending and retail sales financing in certain states. Any or all of these events could adversely affect our business prospects, liquidity, financial condition, results of operations, or cash flows, in particular by reducing the amount of cash generated from operations that is available to service our significant indebtedness. Moreover, the benefit to our liquidity positions from these measures may not be as significant as we anticipate or may not materialize at all.

 

Any additional decisions to close branches or cease consumer lending may result in the recording of additional special charges, such as workforce reduction costs. Furthermore, ceasing to originate real estate loans impairs our ability to offer our customers a broad suite of products. Customers may decide to seek out our competitors that have the ability to offer products that address all of our customers’ lending needs. Loss of business due to our inability to provide a full service option to our customers as we have done in the past could adversely affect our business prospects, liquidity, financial condition, results of operations, or cash flows.

 

Recent market conditions may upset the historical relationship between interest rate changes and prepayment trends, which could adversely affect our liquidity and reduce the value our finance receivable portfolio.

 

Our liquidity position and the value of our finance receivable portfolio (and in particular, our real estate loan portfolio) will be affected by prepayment rates, which cannot be predicted with certainty. Prepayment rates may be affected by a number of factors, including, but not limited to, the availability of credit, changes in housing prices, changes in interest rates, the relative economic vitality of the area in which the borrowers and the related properties are located, possible changes in tax laws, other opportunities for investment, homeowner mobility, and other economic, social, geographic, demographic, and legal factors beyond our control. Prepayment rates typically increase during periods of declining interest rates, and decrease during periods of increasing interest rates. The current challenging economic conditions and recent significant declines in home values (and the resulting loss of homeowner equity) has limited many homeowners’ ability to refinance mortgage loans, which has reduced the rate of repayment for real estate loans, even in the current low interest rate environment. The slower rate of prepayment for finance receivables could adversely affect our liquidity by reducing our cash flow received from prepayments and lowering the market value of the finance receivables for sale or as collateral for secured funding.

 

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Increases in interest rates could adversely affect the value of our finance receivables and increase our financing cost, which could negatively affect our profitability and liquidity.

 

The vast majority of our finance receivables are fixed-rate finance receivables that will generally decline in value if interest rates increase. Declines in market value could reduce the proceeds of a sale or secured financing of these finance receivables.

 

A significant risk associated with these finance receivables is a substantial increase in interest rates. If rates increased substantially, the market value of these finance receivables would decline, and the weighted-average life of the finance receivables would increase if prepayments slowed. Moreover, an increase in interest rates could increase the cost to finance our assets.

 

In addition to interest rate changes, the market values of our finance receivables may also decline for a number of reasons, such as increases or expected increases in defaults, increases or expected increases in voluntary prepayments for those finance receivables that are subject to prepayment risk, or widening of credit spreads.

 

Our finance receivable approval process is decentralized, which may result in variability of finance receivable structures, and could adversely affect our results of operations.

 

Our branch finance receivable origination system is decentralized. Subject to approval by district managers and/or directors of operations in certain cases, our branches have the authority to approve and structure finance receivables within broadly written underwriting guidelines rather than having all finance receivable terms approved centrally. As a result, there may be variability in finance receivable structure (e.g., whether or not collateral is taken for the finance receivable) and finance receivable quality among branches or regions, even when underwriting policies are followed. This decentralized approach could adversely affect our operating results.

 

We are not able to track the default status of the senior lien loans for our second mortgages if we are not the holder of the senior loan.

 

Second mortgages constituted 7% of our real estate loans as of December 31, 2012. When we hold the second mortgage, either we or another creditor holds the first mortgage on the property, and our second mortgage is subordinate in right of payment to the first mortgage holder’s right to receive payment. We are not able to track the default status of a first mortgage for our second mortgages if we are not the holder of the related first mortgage. In such instances, the value of our second mortgage may be lower than our records indicate.

 

We are a party to various lawsuits and proceedings which, if resolved in a manner adverse to us, could materially adversely affect our consolidated results of operations or financial condition.

 

We are a party to various legal proceedings, including certain purported class action claims, arising in the ordinary course of our business. Some of these proceedings are pending in jurisdictions that permit damage awards disproportionate to the actual economic damages alleged to have been incurred. The continued occurrences of large damage awards in general in the United States, including, in some jurisdictions, large punitive damage awards that bear little or no relation to actual economic damages incurred by plaintiffs, create the potential for an unpredictable result in any given proceeding. A large judgment that is adverse to us could have a material adverse effect on our consolidated results of operations or financial condition. See “Legal Contingencies” in Note 21 of the Notes to Consolidated Financial Statements in Item 8 for further information.

 

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If we lose the services of any of our key management personnel, our business could suffer.

 

Our future success significantly depends on the continued service and performance of our key management personnel. Competition for these employees is intense and our current financial condition could adversely affect our ability to attract and retain key personnel. The loss of the service of members of our senior management or key team members, or the inability to attract additional qualified personnel as needed, could materially harm our business.

 

Employee misconduct could harm us by subjecting us to significant legal liability, regulatory scrutiny, and reputational harm.

 

Our reputation is critical to maintaining and developing relationships with our existing and potential customers and third parties with whom we do business. There is a risk that our employees could engage in misconduct that adversely affects our business. For example, if an employee were to engage – or be accused of engaging – in illegal or suspicious activities, we could be subject to regulatory sanctions and suffer serious harm to our reputation, financial condition, customer relationships, and ability to attract future customers. Employee misconduct could prompt regulators to allege or to determine based upon such misconduct that we have not established adequate supervisory systems and procedures to inform employees of applicable rules or to detect and deter violations of such rules. It is not always possible to deter employee misconduct, and the precautions we take to detect and prevent misconduct may not be effective in all cases. Misconduct by our employees, or even unsubstantiated allegations, could result in a material adverse effect on our reputation and our business.

 

Security breaches in our information systems, in the information systems of third parties or in our branches could adversely affect our reputation and could subject us to significant costs and regulatory penalties.

 

Our operations rely heavily on the secure processing, storage and transmission of confidential customer and other information in our computer systems and networks. Each branch is part of an electronic information network that is designed to permit us to originate and track finance receivables and collections, and perform several other tasks that are part of our everyday operations. Although we take extensive measures to protect our information systems, which we refer to as cyber security, our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code that could result in disruption to our business, or the loss or theft of confidential information, including customer information. Any failure, interruption, or breach in our cyber security, including any failure of our back-up systems, could result in reputational harm, disruption in the management of our customer relationships, or the inability to originate, process and service our finance receivable products. Further, any of these cyber security and operational risks could result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. In addition, we may be required to incur significant costs to increase our cyber security to address any vulnerabilities that may be discovered or to remediate the harm caused by any security breaches.

 

As part of our business, we may share confidential customer information and proprietary information with clients, vendors, service providers, and business partners. The information systems of these third parties may be vulnerable to security breaches and we may not be able to ensure that these third parties have appropriate security controls in place to protect the information we share with them. If our confidential information is intercepted, stolen, misused, or mishandled while in possession of a third party, it could result in reputational harm to us, loss of customer business, and additional regulatory scrutiny, and it

 

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could expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

Our branches have physical customer records necessary for day-to-day operations that contain extensive confidential information about our customers, including financial and personally identifiable information. We also retain physical records in various storage locations outside of our branches. The loss or theft of customer information and data from our branches or other storage locations could subject us to additional regulatory scrutiny and penalties, and could expose us to civil litigation and possible financial liability, which could have a material adverse effect on our financial condition and results of operations.

 

The nature of our operations exposes us to security and other risks that could adversely affect our operations.

 

Many of our account payments occur at our branches, either in person or by mail, and frequently consist of cash payments, which we deposit at local banks throughout the day. This business practice exposes us daily to the potential for employee or other theft of funds. Despite controls and procedures to prevent such losses, we have in the past sustained losses due to employee fraud and theft. We also have had break-ins at our branches, where money and/or customer records have been taken. A breach in the security of our branches or in the safety of our employees could result in employee injury, loss of funds or records and adverse publicity, and could result in a loss of customer business or expose us to civil litigation and possible financial liability. Although we have insurance that is intended to cover certain losses from such events, there can be no assurance that such insurance will be adequate or available, and in certain circumstances, these events could have a material adverse effect on our financial condition and results of operations.

 

We could face environmental liability and costs for damage caused by hazardous waste (including the cost of cleaning up contaminated property) if we foreclose upon or otherwise take title to property pledged as collateral.

 

If a real estate loan goes into default, we will start foreclosure proceedings in appropriate circumstances, which could result in our taking title to the mortgaged real estate. We also will consider alternatives to foreclosure, such as “short sales,” where we do not take title to mortgaged real estate. There is a risk that toxic or hazardous substances could be found on property after we take title. As the owner of any property where hazardous waste is present, we could be held liable for clean-up and remediation costs, as well as damages for personal injuries or property damage caused by the condition of the property. We can be responsible for these costs if we are in the chain of title for the property, even if we were not responsible for the contamination, and even if the contamination is not discovered until after we have sold the property. Costs related to these activities and damages could be substantial. Although we have policies and procedures in place to investigate properties for potential hazardous substances before taking title to properties, these reviews may not always uncover potential environmental hazards.

 

Our insurance operations are subject to a number of risks and uncertainties, including claims, catastrophic events, underwriting risks and dependence on a sole distribution channel.

 

Insurance claims and policyholder liabilities are difficult to predict and may exceed the related reserves for losses and loss adjustment expenses. Additionally, events such as hurricanes, earthquakes, pandemic disease, cyber security breaches, and other catastrophes could adversely affect our insurers’ financial condition or results of operations. Other risk factors for our insurance operations include the regulatory environment, capital/reserve requirements, and our insurers’ dependence on our lending operations for their sole source of business and product distribution.

 

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The financial condition of counterparties, including other financial institutions, could adversely affect our financial condition and results of operations.

 

We have entered into, and may in the future enter into, derivative transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by the counterparty or client, which can be exacerbated during periods of market illiquidity. During such periods, our credit risk may be further increased when any collateral held by us cannot be realized upon or is liquidated at prices that are not sufficient to recover the full amount of our exposure.

 

 

RISKS RELATED TO OUR INDEBTEDNESS

 

If current market conditions deteriorate and our financial performance does not improve, we may not be able to generate sufficient cash to service all of our indebtedness, and we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

 

Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business, and other factors beyond our control.

 

Continued challenging economic conditions have negatively affected our financial condition and results of operations. Current economic conditions have negatively affected the markets in which we conduct our business and the capital markets on which we depend to finance our operation. If current market conditions deteriorate and our financial performance does not improve, we may not be able to generate sufficient cash to service our debt. At December 31, 2012, we had $1.4 billion of cash and cash equivalents and in 2012 we generated a net loss of $220.7 million and net cash inflow from operating and investing activities of $1.6 billion. At December 31, 2012, our scheduled principal and interest payments for 2013 on our existing debt (excluding securitizations) totaled $2.1 billion. As of December 31, 2012, we had unpaid principal balances of $2.0 billion of unencumbered personal loans and $609.7 million of unencumbered real estate loans. In addition, SLFC may demand payment of some or all of its note receivable from SLFI ($538.0 million outstanding at December 31, 2012); however, SLFC does not anticipate the need for additional liquidity during 2013 and does not expect to demand payment from SLFI in 2013. In order to meet our debt obligations in 2013 and beyond, we are exploring a number of other options, including additional debt financings (particularly new securitizations involving real estate and personal loans and possible new issuances and/or debt refinancing transactions), or a combination of the foregoing. We are also considering finance receivable portfolio sales.

 

We cannot give any assurance that we would be able to take any of these actions, that these actions would be successful even if undertaken, that these actions would permit us to meet our scheduled debt obligations, or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of sufficient cash resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt and other obligations. Our secured term loan contains certain covenants that may restrict our ability to dispose of assets and use the proceeds from the disposition for certain purposes.

 

Further, our ability to refinance our debt on attractive terms or at all, as well as the timing of any refinancings, depends upon a number of factors over which we have little or no control, including general economic conditions, such as unemployment levels, housing markets and interest rates, disruptions in the financial markets, the market’s view of the quality, value, and liquidity of our assets, our current and

 

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potential future earnings and cash flows, and our credit ratings. In addition, any financing, particularly any securitization, that is reviewed by a rating agency is subject to the rating agency’s view of the quality and value of any assets supporting such financing, our processes to generate cash flows from, and monitor the status of, such assets, and changes in the methodology used by the rating agencies to review and rate the applicable financing. This process may require significant time and effort to complete and may not result in a favorable rating or any rating at all, which could reduce the effectiveness of such financing or render it unexecutable.

 

If we cannot make scheduled payments on our debt, we will be in default and, as a result:

 

·                 our debt holders could declare all outstanding principal and interest to be due and payable, which could also result in an event of default and declaration of acceleration under certain of our other debt agreements; and

·                 the lenders under our secured term loan could realize related proceeds on the assets securing our borrowings.

 

Our indebtedness is significant, which could affect our ability to meet our obligations under our debt instruments and could materially and adversely affect our business and our ability to react to changes in the economy or our industry.

 

We currently have a significant amount of indebtedness. At December 31, 2012, we had $13.4 billion in principal amount of indebtedness outstanding (including securitizations and secured indebtedness). Interest expense on our indebtedness was $1.1 billion in 2012. There can be no assurance that we will be able to repay or refinance our debt in the future.

 

The amount of indebtedness could have important consequences, including the following:

 

·                  it may require us to dedicate a significant portion of our cash flow from operations to the payment of the principal of, and interest on, our indebtedness, which reduces the funds available for other purposes, including finance receivable originations;

·                  it could limit our ability to withstand competitive pressures and reduce our flexibility in responding to changing regulatory, business and economic conditions;

·                  it may limit our ability to incur additional borrowings or securitizations for working capital, capital expenditures, business development, debt service requirements, acquisitions or general corporate or other purposes, or to refinance our indebtedness;

·                  it may require us to seek to change the maturity, interest rate and other terms of our existing debt;

·                  it may cause a further downgrade of our debt and long-term corporate ratings; and

·                  it may cause us to be more vulnerable to periods of negative or slow growth in the general economy or in our business.

 

In addition, meeting our anticipated liquidity requirements is contingent upon our continued compliance with our existing debt agreements. An event of default or declaration of acceleration under one of our existing debt agreements could also result in an event of default and declaration of acceleration under certain of our other existing debt agreements. Such an acceleration of our debt would have a material adverse effect on our liquidity and our ability to continue as a going concern.

 

Furthermore, our existing debt agreements do not restrict us from incurring significant additional indebtedness. If our debt obligations increase, whether due to the increased cost of existing indebtedness or the incurrence of additional indebtedness, the consequences described above could be magnified.

 

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Our secured term loan and certain of our outstanding notes contain covenants that restrict our operations and may inhibit our ability to grow our business and increase revenues.

 

Springleaf Financial Funding Company (SFFC), a subsidiary of SLFC, is the borrower under the secured term loan. SLFC and most of its consumer finance operating subsidiaries guarantee the secured term loan. The secured term loan contains restrictions, covenants, and representations and warranties that apply to SLFC and certain of its subsidiaries. If SLFC, SFFC or any subsidiary guarantor fails to comply with any of these covenants or breaches these representations or warranties, such noncompliance would constitute a default under the secured term loan (subject to applicable cure periods), and the lenders could elect to declare all amounts outstanding under the agreements related thereto to be immediately due and payable and enforce their respective interests against collateral pledged under such agreements.

 

The covenants and restrictions in the secured term loan generally restrict certain of SLFC’s subsidiaries’ ability to, among other things:

 

·                  incur or guarantee additional debt;

·                  make certain investments or acquisitions;

·                  transfer or sell assets;

·                  make distributions on common stock;

·                  engage in mergers or consolidations;

·                  create or incur liens;

·                  enter into transactions with affiliates; and

·                  make certain amendments to organizational documents or documents relating to intercompany secured loans.

 

In certain cases (e.g., the restriction on incurring liens), the restrictions also apply to SLFC. The secured term loan also generally restricts the ability of SLFC and SFFC to engage in mergers or consolidations. Certain of SLFC’s indentures and notes also contain a covenant that limits SLFC’s and its subsidiaries’ ability to create or incur liens.

 

The restrictions described above may interfere with our ability to obtain new or additional financing or may affect the manner in which we structure such new or additional financing or to engage in other business activities, which may significantly limit or harm our business, financial condition, liquidity, and results of operations. A default and resulting acceleration of obligations could also result in an event of default and declaration of acceleration under certain of our other existing debt agreements. Such an acceleration of our debt would have a material adverse effect on our liquidity and our ability to continue as a going concern. A default could also significantly limit our alternatives to refinance both the debt under which the default occurred and other indebtedness. This limitation may significantly restrict our financing options during times of either market distress or our financial distress, which are precisely the times when having financing options is most important.

 

An inability to access adequate sources of liquidity may adversely affect our ability to fund operational requirements and satisfy financial obligations.

 

Our ability to access capital and credit was significantly affected by the substantial disruption in the U.S. residential mortgage and credit markets and credit rating downgrades on our debt. Historically, we funded our operations and repaid our debt and other obligations using funds collected from our finance receivable portfolio and new debt issuances. Since September 2008, our traditional borrowing sources, including our ability to cost effectively issue large amounts of unsecured debt in the capital markets, have not been available. We currently expect our near-term sources of capital markets funding to be from debt transactions, including securitizations.

 

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The assessment of our liquidity is based upon significant judgments or estimates that could prove to be materially incorrect.

 

In assessing our current financial position and developing operating plans for the future, management has made significant judgments and estimates with respect to our liquidity, including but not limited to:

 

·                  our ability to generate sufficient cash to service all of our outstanding debt;

·                  SLFI’s ability to pay some or all of its note payable to SLFC ($538.0 million at December 31, 2012), if needed by SLFC to meet its liquidity needs;

·                  our continued ability to access debt and securitization markets and other sources of funding on favorable terms;

·                  our ability to complete on favorable terms, as needed, additional borrowings, securitizations, finance receivable portfolio sales, or other transactions to support liquidity, and the costs associated with these funding sources, including sales at less than carrying value and limits on the types of assets that can be securitized or sold, which would affect profitability;

·                  the potential for further downgrade of our debt by rating agencies, which would have a negative impact on our cost of, and access to, capital;

·                  our ability to comply with our debt covenants, including the borrowing base for SLFC’s $3.75 billion six-year secured term loan facility (secured term loan);

·                  the amount of cash expected to be received from our finance receivable portfolio through collections (including prepayments) and receipt of finance charges, which could be materially different than our estimates;

·                  the potential for declining financial flexibility and reduced income should we use more of our assets for securitizations and finance receivable portfolio sales; and

·                  the potential for reduced income due to the possible deterioration of the credit quality of our finance receivable portfolios.

 

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Item 1A.  Continued

 

Additionally, there are numerous risks to our financial results, liquidity, and capital raising and debt refinancing plans which are not quantified in our current liquidity forecasts. These risks include, but are not limited, to the following:

 

·                  the liquidation and related losses within our real estate portfolio could be substantial and result in reduced cash receipts;

·                  our inability to grow our consumer loan portfolio with adequate profitability to fund operations, loan losses, and other expenses;

·                  our inability to monetize assets including, but not limited to, our access to debt and securitization markets and our note receivable from parent;

·                  the effect of federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Act (which, among other things, established the Bureau with broad authority to regulate and examine financial institutions), on our ability to conduct business or the manner in which we conduct business, such as licensing requirements, pricing limitations or restrictions on the method of offering products, as well as changes that may result from increased regulatory scrutiny of the sub-prime lending industry;

·                  the potential for increasing costs and difficulty in servicing our loan portfolio, especially our real estate loan portfolio (including costs and delays associated with foreclosure on real estate collateral), as a result of heightened nationwide regulatory scrutiny of loan servicing and foreclosure practices in the industry generally, and related costs that could be passed on to us in connection with the subservicing of our real estate loans that were originated or acquired centrally;

·                  potential liability relating to real estate and personal loans which we have sold or may sell in the future, or relating to securitized loans, if it is determined that there was a non-curable breach of a warranty made in connection with the transaction;

·                  the potential for additional unforeseen cash demands or accelerations of obligations;

·                  reduced income due to loan modifications where the borrower’s interest rate is reduced, principal payments are deferred, or other concessions are made;

·                  the potential for declines in bond and equity markets; and

·                  the potential effect on us if the capital levels of our regulated and unregulated subsidiaries prove inadequate to support current business plans.

 

We intend to support our liquidity position by managing originations (including our decision to cease real estate loan originations effective January 1, 2012) and purchases of finance receivables (including our decision to no longer purchase retail sales finance receivables after January 15, 2013) and maintaining disciplined underwriting standards and pricing on such finance receivables. We intend to support operations and repay indebtedness with one or more of the following activities, among others: finance receivable collections, cash on hand, additional debt financings (particularly new securitizations and possible new issuances and/or debt refinancing transactions), finance receivable portfolio sales, or a combination of the foregoing. There can be no assurance that we will be successful in undertaking any of these activities to support our operations and repay our obligations.

 

However, the actual outcome of one or more of our plans could be materially different than expected or one or more of our significant judgments or estimates about the potential effects of these risks and uncertainties could prove to be materially incorrect. In the event of such an occurrence, if third-party financing is not available, our liquidity could be substantially and materially affected, and as a result, substantial doubt could exist about our ability to continue as a going concern.

 

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Item 1A.  Continued

 

Our current ratings could adversely affect our ability to raise capital in the debt markets at attractive rates, which could negatively impact our results of operations and financial condition.

 

Each of Standard & Poor’s Rating Services (Standard & Poor’s), Moody’s Investors Service, Inc. (Moody’s), and Fitch, Inc. (Fitch) rates our debt. On September 7, 2011, Fitch downgraded SLFC’s ratings, and on February 3, 2012, Standard & Poor’s downgraded SLFC’s ratings. On June 1, 2012, Moody’s downgraded the Company’s debt. These rating actions resulted in downward price pressure for SLFC’s outstanding debt.

 

Ratings reflect the rating agencies’ opinions of our financial strength, operating performance, strategic position and ability to meet our obligations. Agency ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating.

 

If our current ratings continue in effect or our ratings are further downgraded, it will likely increase the interest rate that we would have to pay to raise money in the capital markets, making it more expensive for us to borrow money and adversely impacting our access to capital. As a result, our ratings could negatively impact our business, results of operations, liquidity, and financial condition.

 

Our securitizations may expose us to financing and other risks, and there can be no assurance that we will be able to access the securitization market in the future, which may require us to seek more costly financing.

 

We have securitized, and may in the future securitize, certain of our finance receivables to generate cash to originate or purchase new finance receivables or pay our outstanding indebtedness. In each such transaction, we conveyed a pool of finance receivables to a special purpose entity (SPE), which, in turn, conveyed the finance receivables to a trust (the issuing entity). Concurrently, the trust issued non-recourse notes or certificates pursuant to the terms of an indenture or pooling and servicing agreement, respectively, which then were transferred to the SPE in exchange for the finance receivables. The securities issued by the trust were secured by the pool of finance receivables. In exchange for the transfer of finance receivables to the issuing entity, we received the cash proceeds from the sale of the trust securities, all residual interests, if any, in the cash flows from the finance receivables after payment of the trust securities, and a 100% beneficial interest in the issuing entity. As a result of the challenging credit and liquidity conditions, the value of the subordinated securities we retain in our securitizations might be reduced or, in some cases, eliminated.

 

The more limited securitization markets since 2007 have impaired our ability to complete securitizations. Although we were able to complete a securitization during the third quarter of 2011 and three during 2012, the securitization market remains constrained, and we can give no assurances that we will be able to complete additional securitizations.

 

Rating agencies also can affect our ability to execute a securitization transaction, or increase the costs we expect to incur from executing securitization transactions, not only by deciding not to issue ratings for our securitization transactions, but also by altering the criteria and process they follow in issuing ratings. Rating agencies could alter their ratings processes or criteria after we have accumulated finance receivables for securitization in a manner that effectively reduces the value of those finance receivables by increasing our financing costs or otherwise requires that we incur additional costs to comply with those processes and criteria. We have no ability to control or predict what actions the rating agencies may take.

 

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Table of Contents

 

Item 1A.  Continued

 

Further, other matters, such as (i) accounting standards applicable to securitization transactions and (ii) capital and leverage requirements applicable to banks and other regulated financial institutions holding residential mortgage-backed securities or other asset-backed securities, could result in less investor demand for securities issued through our securitization transactions, or increased competition from other institutions that undertake securitization transactions.

 

If it is not possible or economical for us to securitize our finance receivables in the future, we might seek alternative financing to support our operations and to meet our existing debt obligations, which could be less efficient and have a material adverse effect on our results of operations and liquidity.

 

 

RISKS RELATED TO OUR INDUSTRY AND REGULATION

 

We operate in a highly competitive market, and we cannot ensure that the competitive pressures we face will not have a material adverse effect on our business, financial condition, liquidity, and results of operations.

 

The consumer finance industry is highly competitive, and the barriers to entry for new competitors are relatively low in the markets in which we operate. Our profitability depends, in large part, on our ability to originate finance receivables. We compete with other consumer finance companies as well as other types of financial institutions that offer similar products and services in originating finance receivables. Some of these competitors may have considerably greater financial, technical, and marketing resources than we possess. Some competitors may also have a lower cost of funds and access to funding sources that may not be available to us. There can be no assurance that the competitive pressures we face will not have a material adverse effect on our business, financial condition, liquidity, and results of operations.

 

We cannot predict the consequences and market distortions that may stem from anticipated far-ranging governmental intervention in the economic and financial system or from regulatory reform of the oversight of financial markets.

 

The U.S. Government, the Federal Reserve, the U.S. Treasury Department (the Treasury), the SEC, and other governmental and regulatory bodies have taken or are taking various actions to address the recent financial crisis.

 

The far-ranging government intervention in the economic and financial system may carry intended and unintended consequences and cause market distortions that may have a negative impact on our business. We are unable to predict the extent and nature of such consequences and market distortions, if any. For example, to the extent that new government programs are designed, in part, to restart the market for origination of finance receivables, the establishment of these programs may result in increased competition and higher prices for origination.

 

On July 21, 2010, the President of the United States signed into law the Dodd-Frank Act. This law, and the regulations already promulgated and to be promulgated under it, are likely to affect our operations in terms of increased oversight of financial services products by the Bureau, and the imposition of restrictions on the allowable terms for certain consumer credit finance receivables. The Bureau has significant authority to implement and enforce Federal consumer finance laws, including the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive, or abusive acts and practices. In addition, the Dodd-Frank Act provides the Bureau with broad supervisory, examination, and enforcement authority over various consumer financial products and services. The Dodd-Frank Act and accompanying regulations will be phased in over a one-

 

26



Table of Contents

 

Item 1A.  Continued

 

to three-year period, and we cannot predict the terms of the final regulations, their intended consequences, or how such regulations will affect us or our industry. A Director for the Bureau was appointed as a recess appointment in early January 2012. Although there is a question over whether the appointment was valid, the Bureau and Director are taking the position that the Bureau has the authority to supervise and examine non-depository institutions such as SLFC and its subsidiaries.

 

The Dodd-Frank Act may adversely affect the securitization market because it requires, among other things, that a securitizer generally retain not less than 5% of the credit risk for certain types of securitized assets that are transferred, sold, or conveyed through issuance of asset-backed securities (ABS). Moreover, the SEC has proposed significant changes to Regulation AB, which, if adopted in their present form, could result in sweeping changes to the commercial and residential mortgage loan securitization markets, as well as to the market for the re-securitization of mortgage-backed securities. The SEC also has proposed rules that would require issuers and underwriters to make any third-party due diligence reports on ABS publicly available. In addition to the foregoing, the Federal Reserve, the Treasury, and other federal, state, and local governmental and regulatory bodies may continue to enact additional legislation or undertake regulatory actions designed to address the recent economic crisis or for other purposes that could have a material and adverse effect on our ability to execute our business strategies. We cannot predict whether or when such additional actions may occur. However, such actions could have an impact on our business, results of operations, liquidity, and financial condition, and the cost of complying with any additional laws and regulations could have a material adverse effect on our financial condition, liquidity, and results of operations.

 

The SEC recently solicited public comment on a wide range of issues relating to certain existing provisions of the Investment Company Act of 1940, as amended (Investment Company Act), including the nature of the assets that qualify for purposes of certain exemptions. There can be no assurance that the laws and regulations governing our Investment Company Act status, or SEC guidance regarding these exemptions, will not change in a manner that adversely affects our operations.

 

Real estate loan modification and refinancing programs and future legislative action may adversely affect the value of, and the returns on, our portfolio.

 

The U.S. Government has implemented a number of federal programs designed to assist homeowners, including HAMP, which provides homeowners with assistance in avoiding residential real estate loan foreclosures. HAMP involves, among other things, the modification of real estate loans to reduce the principal amount of the loans (through forbearance and/or forgiveness) and/or the rate of interest payable on the loans, or to extend payment terms of the loans. Some of the real estate loans serviced by various third parties for certain of our subsidiaries may be eligible for modification under HAMP. Other existing or future government programs designed to assist homeowners also could affect the servicing of, and our ability to foreclose on, real estate loans.

 

HAMP (as it applies to those real estate loans serviced by third parties) and other existing or future legislative or regulatory actions, including possible amendments to the bankruptcy laws, which result in the modification of outstanding real estate loans, may adversely affect the value of, and the returns on, our initial portfolio and the assets we acquire in the future.

 

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Table of Contents

 

Item 1A.  Continued

 

High-cost and other lending laws could adversely impact our results of operations, liquidity, financial condition, and business.

 

Various U.S. federal, state and local laws are designed to discourage or prohibit certain lending practices, including by restricting finance receivable terms, amounts, interest rates, and other charges. For example, the federal Home Ownership and Equity Protection Act of 1994, or HOEPA, prohibits inclusion of certain provisions in residential mortgage loans that have mortgage rates or origination costs in excess of prescribed levels and requires that borrowers be given certain disclosures prior to origination. Some states and municipalities have enacted, or may enact, similar laws or regulations, which in some cases impose restrictions and requirements greater than those in the HOEPA. In addition, under the lending laws of some states, the origination of certain residential mortgage loans, including loans that are not classified as “high-cost” loans under applicable law, must satisfy a “tangible net benefits” or similar test with respect to the related borrower. This test may be highly subjective and open to interpretation. As a result, a court may determine that a residential mortgage loan, for example, does not meet the test even if the related originator reasonably believed that the test was satisfied.

 

Lawsuits have been brought in various states making claims against owners of high-cost finance receivables for violations of federal or state law. If any of our finance receivables are found to have been originated in violation of high-cost or unfair lending laws, we could incur losses, including monetary penalties and finance receivable rescissions, which could adversely affect our results of operations, financial condition, liquidity, and business.

 

Real estate loan servicing has come under increasing scrutiny from government officials and others, which could make servicing our portfolio more costly and difficult.

 

Real estate loan servicers have recently come under increasing scrutiny. Certain state Attorneys General, court administrators and governmental agencies, as well as representatives of the federal government, have issued letters of inquiry to real estate loan servicers, including our branch operations and certain of our third party real estate loan servicers, requesting written responses to questions regarding policies and procedures, especially with respect to notarization and affidavit preparation procedures. These requests, and any subsequent administrative, judicial, or legislative actions taken by these regulators, court administrators, or other governmental entities may subject us or our third party real estate loan servicers to fines and other sanctions, including a moratorium or suspension on foreclosures.

 

In addition, some states and municipalities have passed laws that impose additional duties on foreclosing lenders and real estate loan servicers, such as mandatory mediation, or extensive requirements for maintenance of vacant properties, which, in some cases, begin even before a lender has taken title to property. These additional requirements can delay foreclosures, make it uneconomical to foreclose on mortgaged real estate, or result in significant additional costs.

 

These developments could adversely affect our business. For example, our servicing expenses would likely increase if we or the companies servicing our loans were subject to increased costs. Moreover, real estate loan servicing companies may shut down or restrict their servicing operations in response to these developments, which would limit our servicing options. Without effective servicing at a competitive price, the value of our portfolio would be adversely affected. Any of these or other external influences could delay foreclosures on the loans in our portfolio, which could materially affect the value of our portfolio.

 

28



Table of Contents

 

Item 1A.  Continued

 

 

Our businesses are subject to extensive regulation in the jurisdictions in which we conduct our business.

 

Our businesses are subject to various U.S. state and federal laws and regulations, and various U.S. state authorities regulate and supervise our insurance business segment. The laws under which a substantial amount of our branch and centralized real estate businesses are conducted generally: provide for state licensing of lenders and, in many cases, licensing of employees involved in real estate lending; impose limits on the term of a finance receivable, amounts, interest rates and charges on the finance receivables; regulate whether and under what circumstances insurance and other ancillary products may be offered to consumers in connection with a lending transaction; and provide for other consumer protections. The extent of state regulation of our insurance business varies by product and by jurisdiction, but relates primarily to the following: licensing; conduct of business; periodic examination of the affairs of insurers; form and content of required financial reports; standards of solvency; limitations on dividend payments and other related party transactions; types of products offered; approval of policy forms and premium rates; permissible investments; deposits of securities for the benefit of policyholders; reserve requirements for unearned premiums, losses and other purposes; and claims processing.

 

All of our operations are subject to regular examination by state and federal regulators, and as a whole, our entities are subject to several hundred regulatory examinations in a given year. These examinations may result in requirements to change our policies or practices, and in some cases, we are required to pay monetary fines or make reimbursements to customers. Many states have indicated an intention to pool their resources in order to conduct examinations of licensed entities, including us, at the same time (referred to as a “multi-state” examination). This could result in more in-depth examinations, which could be more costly and lead to more significant enforcement actions.

 

In addition, the Bureau has extensive authority to enforce consumer protection laws, and likely will have supervisory authority over our consumer lending business once it promulgates “larger participant” regulations for consumer lending. The Bureau’s broad supervisory and enforcement powers could affect our business and operations significantly in terms of increased operating and regulatory compliance costs, and limits on the types of products we offer and the manner in which they are offered, among other things.

 

We believe that we maintain all material licenses and permits required for our current operations and are in substantial compliance with all applicable federal, state and local regulations. We may not be able to maintain all requisite licenses and permits, and the failure to satisfy those and other regulatory requirements could have a material adverse effect on our operations. In addition, changes in laws or regulations affecting us could affect our ability to conduct business or the manner in which we conduct business and, accordingly, could have a material adverse effect on our consolidated results of operations or financial condition.

 

29



Table of Contents

 

Item 1B. Unresolved Staff Comments.

 

 

None.

 

 

 

Item 2. Properties.

 

 

We generally conduct branch office operations, branch office administration, other operations, and operational support in leased premises. Lease terms generally range from three to five years. Ocean Finance and Mortgages Limited (Ocean), our United Kingdom subsidiary, currently leases one facility under a lease that expires in 2018. Ocean also leases land on which it owns an office facility in Tamworth, England under a 999 year land lease that expires in 3001. Since January 2013, we have leased an additional executive office in Connecticut under a lease that expires in 2015 and an administrative office in Delaware under a lease that expires in 2020.

 

Our investment in real estate and tangible property is not significant in relation to our total assets due to the nature of our business. At December 31, 2012, SLFC subsidiaries owned two branch offices in Riverside and Barstow, California, one branch office in Isabela, Puerto Rico, one branch office in Terre Haute, Indiana, and seven buildings in Evansville, Indiana. The Evansville buildings house our administrative offices, our centralized services and support operations for our consumer and real estate business segments, and one of our branch offices. On February 28, 2013, the branch office in Evansville, Indiana was sold.

 

 

 

Item 3.  Legal Proceedings.

 

 

See Note 21 of the Notes to Consolidated Financial Statements in Item 8.

 

 

 

Item 4.  Mine Safety Disclosures.

 

 

Not applicable.

 

30



Table of Contents

 

PART II

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

 

No trading market exists for SLFC’s common stock. All of SLFC’s common stock is held by SLFI. SLFC did not pay any cash dividends on its common stock in 2012 or 2010. SLFC paid $45.0 million of cash dividends on its common stock in May 2011. See Note 16 of the Notes to Consolidated Financial Statements in Item 8 regarding limitations on the ability of SLFC and its subsidiaries to pay dividends.

 

On each of January 10, 2012 and July 11, 2012, SLFC issued one share of SLFC common stock to SLFI for $10.5 million each in order to satisfy a non-debt capital funding requirement with respect to SLFC’s hybrid debt. Similarly, on January 11, 2013, SLFC issued one share of SLFC common stock to SLFI for $10.5 million in order to satisfy SLFC’s hybrid debt semi-annual interest payments due in January 2013. Each share of SLFC common stock was issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. See “Capital Resources and Liquidity – Capital Resources” in Item 7 of this Annual Report on Form 10-K for further information on SLFC’s hybrid debt.

 

Item 6. Selected Financial Data.

 

 

As a result of the FCFI Transaction, a new basis of accounting was established and, for accounting purposes, the old entity (the Predecessor Company) was terminated and a new entity (the Successor Company) was created. This distinction is made throughout this Annual Report on Form 10-K through the inclusion of a vertical black line between the Successor Company and the Predecessor Company columns.

 

The financial information for 2010 includes the financial information of the Successor Company for the one month ended December 31, 2010 and of the Predecessor Company for the eleven months ended November 30, 2010. These separate periods are presented to reflect the new accounting basis established for our Company as of November 30, 2010.

 

As a result of the application of push-down accounting, the bases of the assets and liabilities of the Successor Company are not comparable to those of the Predecessor Company, nor would the income statement items for the one month ended December 31, 2010 and the years ended December 31, 2011 and 2012 have been the same as those reported if push-down accounting had not been applied. Additionally, key ratios of the Successor Company are not comparable to those of the Predecessor Company, nor are they comparable to other institutions due to the new accounting basis established.

 

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Table of Contents

 

Item 6.  Continued

 

 

You should read the following selected financial data in conjunction with the consolidated financial statements and related notes in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

 

 

 

 

 

Successor

 

 

 

 

 

 

Predecessor

 

 

 

 

 

 

 

Company

 

 

 

 

 

 

Company

 

 

 

 

 

 

 

 

 

At or for the

 

 

At or for the

 

 

 

 

 

 

 

At or for the

 

At or for the

 

One Month

 

 

Eleven Months

 

At or for the

 

At or for the

 

 

 

Year Ended

 

Year Ended

 

Ended

 

 

Ended

 

Year Ended

 

Year Ended

 

 

 

December 31,

 

December 31,

 

December 31,

 

 

November 30,

 

December 31,

 

December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

 

2010 (a)

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

1,686,202

 

$

1,859,492

 

$

178,807

 

 

$

1,673,465

 

$

2,069,236

 

$

2,587,167

 

Interest expense

 

1,060,950

 

1,258,279

 

117,676

 

 

978,364

 

1,050,164

 

1,209,920

 

Provision for finance receivable losses

 

337,603

 

332,321

 

38,705

 

 

444,273

 

1,263,761

 

1,068,829

 

Other revenues

 

108,003

 

151,798

 

31,125

 

 

241,529

 

147,600

 

147,099

 

Other expenses

 

707,492

 

743,748

 

61,968

 

 

736,897

 

791,558

 

1,380,210

 

Income (loss) before provision for (benefit from) income taxes

 

(311,840

)

(323,058

)

1,460,765

 

 

(244,540

)

(888,647

)

(924,693

)

Net income (loss)

 

(220,686

)

(224,723

)

1,462,904

(b)

 

(4,454

)

(473,865

)

(1,307,234

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net finance receivables

 

$

11,696,727

 

$

13,016,119

 

$

14,171,598

 

 

N/A

 

$

18,215,373

 

$

23,843,816

 

Allowance for finance receivable losses

 

(180,136

)

(72,000

)

(7,120

)

 

N/A

 

(1,516,298

)

(1,126,233

)

Net finance receivables, less allowance for finance receivable losses

 

11,516,591

 

12,944,119

 

14,164,478

 

 

N/A

 

16,699,075

 

22,717,583

 

Total assets

 

14,654,771

 

15,382,414

 

18,132,960

 

 

N/A

 

22,587,597

 

26,078,492

 

Long-term debt

 

12,454,316

 

12,885,392

 

14,940,989

 

 

N/A

 

17,475,107

 

20,482,271

 

Total liabilities

 

13,391,578

 

13,973,615

 

16,441,834

 

 

N/A

 

20,211,983

 

23,984,012

 

Total shareholder’s equity

 

1,263,193

 

1,408,799

 

1,691,126

 

 

N/A

 

2,375,614

 

2,094,480

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Operating Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of earnings to fixed charges (c)

 

N/A

 

N/A

 

N/M

(d)

 

N/A

 

N/A

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Historical Accounting Basis Data (e):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss before provision for (benefit from) income taxes

 

$

(41,771

)

$

(142,071

)

$

(24,520

)

 

$

(244,540

)

$

(888,647

)

$

(924,693

)

Net loss

 

(42,893

)

(107,082

)

(22,381

)

 

(4,454

)

(473,865

)

(1,307,234

)

 

__________________

 

(a)           Not applicable. The Consolidated Balance Sheets are presented at December 31; therefore, balance sheet information at November 30, 2010 is not applicable.

 

(b)          Net income for the one month ended December 31, 2010 included a bargain purchase gain of $1.5 billion resulting from the FCFI Transaction.

 

(c)           Earnings did not cover total fixed charges by $311.8 million in 2012, $323.1 million in 2011, $244.5 million during the eleven months ended November 30, 2010, $888.6 million in 2009, and $924.7 million in 2008.

 

(d)          Not meaningful

 

(e)           The historical accounting basis uses the same accounting basis that we employed prior to the FCFI Transaction, which is a basis of accounting other than U.S. GAAP.

 

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Table of Contents

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes in Item 8.

 

An index to our management’s discussion and analysis follows:

 

Topic

Page

 

 

Our Business

33

2012 Overview

34

2013 Developments and Outlook

36

Results of Operations

38

Segment Overview

44

Balance Sheet

55

Credit Quality

59

Liquidity and Capital Resources

65

Off-Balance Sheet Arrangements

69

Critical Accounting Policies and Estimates

70

Recent Accounting Pronouncements

71

Glossary of Terms

72

 

 

 

Our Business

 

We are a leading national consumer finance company offering responsible consumer lending products and related credit insurance products to “Main Street” America with over $14.7 billion of total assets at December 31, 2012. We continue to service over 973,000 finance receivable customer accounts through our 852 branch offices in the United States, Puerto Rico, and the U.S. Virgin Islands as of December 31, 2012. Although the majority of our consumer lending operations involve decentralized branch-based lending, we also utilize our centralized support operations located in Evansville, Indiana and other specialized servicing centers. Our branch-based and related centralized support personnel total over 3,600 people.

 

OUR PRODUCTS

 

Personal Loans

 

We offer personal loans to customers who generally need timely access to cash. Our personal loans are typically non-revolving with a fixed-rate and a fixed, original term of 2 to 4 years. These personal loans are generally secured by titled personal property (such as automobiles), consumer goods or other personal property, but some are unsecured. At December 31, 2012, $1.4 billion, or 52%, of our personal loan portfolio was secured by “hard” collateral such as automobiles, $865.2 million, or 33%, was secured by consumer goods or other items of personal property, and the remainder was unsecured.

 

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Item 7.  Continued

 

Insurance Products

 

In addition to personal loans, we offer credit insurance (life, accident and health insurance, and involuntary unemployment insurance), non-credit insurance, and ancillary products, such as warranty protection. We also require credit-related property and casualty insurance, when needed, to protect our interest in the property pledged as collateral for the finance receivable. Credit insurance and non-credit insurance products are provided by Merit and Yosemite, subsidiaries of SLFC. The ancillary products are home security and auto security membership plans and home appliance service contracts of unaffiliated companies. Our consumer lending specialists, who, where required, are licensed to offer insurance and ancillary products.

 

Legacy Products

 

Through January 15, 2013, we purchased retail sales contracts and revolving retail accounts arising from the retail sale of consumer goods and services by retail merchants. Retail sales contracts are closed-end accounts that represent a single purchase transaction, generally have maximum original terms of 60 months, and are secured by the personal property designated in the contract. Revolving retail are open-end accounts that can be used for financing repeated purchases from the same merchant, generally require minimum monthly payments based on the amount financed calculated after the most recent purchase or outstanding balances, and are secured by the goods purchased. We continue to service the liquidating retail sales contracts and will provide revolving retail sales financing services on our revolving retail accounts. We refer to retail sales contracts and revolving retail collectively as “retail sales finance.”

 

Prior to 2012, we also originated real estate loans. These loans may be closed-end accounts or open-end home equity lines of credit, generally have a fixed rate and maximum original terms of 360 months, and are secured by first or second mortgages on residential real estate. Although we ceased our real estate lending as of January 1, 2012, we continue to service the liquidating real estate loans and support any advances on open-end accounts.

 

OUR INDUSTRY

 

Based on independently sourced data, the consumer lending industry is a $2.1 trillion market, with 30% - 40% of the current market as non-prime customers. These customers have ongoing need for access to credit, however supply has fallen over the last decade due to macro-economic conditions and banks refocusing on the prime and super-prime segments. Additionally, many of the consumer finance companies that previously served this segment have been acquired or ceased operations. This imbalance of supply and demand has led to a proliferation in recent years of payday, title and other high cost lenders. We believe the Company's strategy of prudent underwriting of fairly priced loans to this customer segment positions it well to capitalize on these current market opportunities and to achieve its goal of growing its personal loan business.

 

2012 Overview

 

RESTRUCTURING ACTIVITIES AND CORPORATE REORGANIZATION

 

As part of our 2012 strategic review of our operations, we initiated the following restructuring activities during the first half of 2012:  (1) we ceased originating real estate loans nationwide and in the United Kingdom effective January 1, 2012 to focus on our other lending products, which we believe have greater growth potential; (2) we also ceased personal lending and retail sales financing in 14 states where we do not have a significant presence; (3) we consolidated certain branch operations in 26 states; and (4) we closed 231 branch offices. As a result of these restructuring activities, our workforce was reduced by 820

 

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Item 7.  Continued

 

 

employees, and we incurred a pretax charge of $23.5 million during the first half of 2012. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for the components of this restructuring charge.

 

In mid-2012, SLFI took the initial steps to explore additional growth opportunities, including centralized online lending and strategic acquisitions of loan portfolios. SLFI created Springleaf Consumer Loan, Inc. (SCLI) for centralized online lending to customers out of the SLFC branch footprint. In addition to direct lending, SCLI has established certain strategic alliances with our state branch operating entities to provide online loan processing services for customers who are located in the geographic footprint of our branch network, but who prefer the convenience of interacting with us primarily online. Among other things, SCLI provides loan application processing and credit underwriting services on behalf of our branch offices for loan applications submitted through a centralized online or telephone application system that are within the branch footprint. SLFI also created Springleaf Acquisition Corporation (SAC) for potential portfolio and other acquisitions. Subsidiaries of SAC and certain third parties recently entered into an agreement to purchase and service a portfolio of real estate and personal loans. SCLI and SAC are not subsidiaries of SLFC.

 

In 2012, SLFI and SLFC realigned their internal structure related to the provision of certain administrative services. Historically, the employer for all of our employees has been Springleaf Finance Management Corporation (SFMC), a subsidiary of SLFC. SFMC provided management services for all of our companies, and also provided the employees who work in the branches for our state consumer lending entities. Because employees who work at our headquarters and certain other employees provide services to all of our entities, including subsidiaries of SLFI, in late 2012 we reassigned over 1,000 employees who provide those services from SFMC to a new management corporation (Springleaf General Services Corporation) (SGSC), a subsidiary of SLFI. Employees who work in the branches or primarily provide services to our branch system remain employees of SFMC. Most SLFI subsidiaries, including SFMC and the state consumer lending entities, have entered into a services agreement with SGSC for the provision of various centralized services, such as accounting, human resources, and information technology support. These services previously had been provided by SFMC.

 

This reassignment of employees and the intercompany agreements related to the structural realignment are not expected to result in a material increase in the costs and expenses that SLFC would have incurred had this reorganization not taken place. We expect to continue to focus on the consumer business segment which is the core of our present operations. SGSC is not a subsidiary of SLFC.

 

SALE OF FINANCE RECEIVABLES AND MORTGAGE BROKERAGE BUSINESS

 

On August 29, 2012, Ocean Money Limited (Ocean Money), and Ocean Money (II) Limited (Ocean Money (II)), wholly owned subsidiaries of Ocean and our indirect subsidiaries, sold their entire finance receivable portfolios totaling $103.1 million, which resulted in a gain of $6.3 million. On August 31, 2012, Ocean, Ocean Money, and Ocean Money (II) sold their mortgage brokerage business consisting of various intangible assets including supplier lists, records, sales, marketing and promotional material, the business pipeline, the client database and records, and the Ocean brand name, which resulted in a gain of $0.6 million. As a result of the sales of these assets, as well as our decision to cease loan originations in the United Kingdom, we recorded a loss of $4.6 million in the third quarter of 2012, which represented the full impairment of our United Kingdom customer lists intangible assets and wrote off $1.4 million of related fixed assets.

 

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Table of Contents

 

Item 7.  Continued

 

SECURITIZATIONS

 

We completed the following securitization transactions during 2012:

 

2012-1 Securitization

 

On April 20, 2012, SLFC effected a private securitization transaction in which SLFC caused Eleventh Street Funding LLC (Eleventh Street), a special purpose vehicle wholly owned by SLFC, to sell $371.0 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-1 (the 2012-1 Trust), with a 4.38% weighted average yield, to certain investors. Eleventh Street sold the mortgage-backed notes for $367.8 million, after the price discount but before expenses. Eleventh Street initially retained $42.6 million of the 2012-1 Trust’s subordinate mortgage-backed notes.

 

2012-2 Securitization

 

On August 8, 2012, SLFC effected a private securitization transaction in which SLFC caused Twelfth Street Funding LLC (Twelfth Street), a special purpose vehicle wholly owned by SLFC, to sell $750.8 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-2 (the 2012-2 Trust), with a 3.59% weighted average yield, to certain investors. Twelfth Street sold the mortgage-backed notes for $749.7 million, after the price discount but before expenses. SLFC initially retained $107.7 million of the 2012-2 Trust’s subordinate mortgage-backed notes.

 

2012-3 Securitization

 

On October 25, 2012, SLFC effected a private securitization transaction in which SLFC caused Fourteenth Street Funding LLC (Fourteenth Street), a special purpose vehicle wholly owned by SLFC, to sell $787.4 million of mortgage-backed notes of Springleaf Mortgage Loan Trust 2012-3 (the 2012-3 Trust), with a 2.80% weighted average yield, to certain investors. Fourteenth Street sold the mortgage-backed notes for $787.2 million, after the price discount but before expenses. Fourteenth Street initially retained $112.3 million of the 2012-3 Trust’s subordinate mortgage-backed notes.

 

LEGAL SETTLEMENT

 

A lawsuit filed in 1996 against our South Carolina operating entity was settled on August 27, 2012, and final approval of the settlement was obtained on November 19, 2012. At December 31, 2012, the remaining reserve for this class action lawsuit totaled $3.5 million. Funds were distributed beginning in late December 2012. Aggregate settlement costs paid in 2012 totaled $30.3 million, which included $16.8 million paid to class members who made claims and $13.5 million in attorney fees and costs. In addition, we paid $3.5 million of unclaimed funds to South Carolina charities in February 2013. See Note 21 of the Notes to Consolidated Financial Statements in Item 8 for further information on this legal settlement.

 

2013 Developments and Outlook

 

CESSATION OF PURCHASES OF RETAIL SALES FINANCE RECEIVABLES

 

Effective January 16, 2013, we ceased purchasing retail sales finance receivables so that we could focus our lending efforts on personal loans.

 

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Item 7.  Continued

 

 

REPAYMENTS OF LONG-TERM DEBT

 

In January 2013, we repaid $498.9 million of long-term debt consisting of $431.6 million (€345.2 million) of Euro denominated notes, $53.6 million of securitizations, and $13.7 million of retail notes.

 

SECURITIZATION

 

On February 19, 2013, SLFC effected a private securitization transaction in which SLFC caused Tenth Street Funding LLC (Tenth Street), a special purpose vehicle wholly owned by SLFC, to sell $567.9 million of notes backed by personal loans of Springleaf Funding Trust 2013-A (the 2013-A Trust), at a 2.83% weighted average yield, to certain investors. Tenth Street sold the asset-backed notes for $567.5 million, after the price discount but before expenses and a $6.6 million interest reserve requirement of the transaction. 2013-A Trust subordinate asset-backed notes totaling $36.4 million were initially retained by Tenth Street.

 

OUTLOOK

 

Assuming the U.S. economy performs in a relatively positive manner, we expect to maintain the favorable trends in credit quality of our personal loans and liquidating retail sales finance receivables that has been achieved during 2012. The improved credit quality of our consumer loan portfolio is the result of our collection efforts, tighter underwriting guidelines, and response to changing economic conditions as we focus on our personal loans to meet the growing demand for consumer credit. With our real estate loan portfolio liquidating, we anticipate our credit quality ratios for real estate loans will likely remain under pressure.

 

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Table of Contents

 

Item 7.  Continued

 

 

Results of Operations

 

CONSOLIDATED RESULTS

 

See table below for our consolidated operating results. A further discussion of our operating results for each of our business segments is provided under “Segment Results.”

 

 

 

 

 

 

Successor

 

 

 

 

Predecessor

 

 

 

 

 

 

Company

 

 

 

 

Company

 

 

 

 

 

 

 

 

One Month

 

 

Eleven Months

 

 

 

 

Year Ended

 

Year Ended

 

Ended

 

 

Ended

 

 

 

 

December 31,

 

December 31,

 

December 31,

 

 

November 30,

 

(dollars in thousands)

 

 

2012

 

2011

 

2010

 

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

Finance charges

 

 

$

1,683,462

 

$

1,859,492

 

$

178,807

 

 

$

1,653,047

 

Finance receivables held for sale originated as held for investment

 

 

2,740

 

-

 

-

 

 

20,418

 

Total interest income

 

 

1,686,202

 

1,859,492

 

178,807

 

 

1,673,465

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

1,060,950

 

1,258,279

 

117,676

 

 

978,364

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

 

625,252

 

601,213

 

61,131

 

 

695,101

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for finance receivable losses

 

 

337,603

 

332,321

 

38,705

 

 

444,273

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for finance receivable losses

 

 

287,649

 

268,892

 

22,426

 

 

250,828

 

 

 

 

 

 

 

 

 

 

 

 

 

Other revenues:

 

 

 

 

 

 

 

 

 

 

 

Insurance

 

 

126,423

 

120,190

 

11,269

 

 

113,604

 

Investment

 

 

27,792

 

34,533

 

431

 

 

37,787

 

Other

 

 

(46,212

)

(2,925

)

19,425

 

 

90,138

 

Total other revenues

 

 

108,003

 

151,798

 

31,125

 

 

241,529

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expenses:

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

 

319,932

 

359,724

 

31,168

 

 

390,255

 

Other operating expenses

 

 

303,378

 

342,910

 

26,215

 

 

303,066

 

Restructuring expenses

 

 

23,503

 

-

 

-

 

 

-

 

Insurance losses and loss adjustment expenses

 

 

60,679

 

41,114

 

4,585

 

 

43,576

 

Total other expenses

 

 

707,492

 

743,748

 

61,968

 

 

736,897

 

 

 

 

 

 

 

 

 

 

 

 

 

Bargain purchase gain

 

 

-

 

-

 

1,469,182

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before benefit from income taxes

 

 

(311,840

)

(323,058

)

1,460,765

 

 

(244,540

)

 

 

 

 

 

 

 

 

 

 

 

 

Benefit from income taxes

 

 

(91,154

)

(98,335

)

(2,139

)

 

(240,086

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

 

$

(220,686

)

$

(224,723

)

$

1,462,904

 

 

$

(4,454

)

 

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Table of Contents

 

Item 7.  Continued

 

 

Comparison of Consolidated Results for 2012 and 2011

 

Finance charges decreased due to the net of the following:

 

(dollars in thousands)

 

 

 

 

Year Ended December 31,

 

 

2012

 

 

 

 

 

 

Decrease in average net receivables

 

 

$

(163,551

)

Decrease in yield

 

 

(16,358

)

Increase in number of days in 2012

 

 

3,879

 

Total

 

 

$

(176,030

)

 

Average net receivables decreased in 2012 when compared to 2011 primarily due to the cessation of new originations of real estate loans as of January 1, 2012 and branch office closings during 2012, partially offset by an increase in personal loans average net receivables as we focus on consumer lending that we believe will provide higher returns and allow us to operate on a more cost-effective basis.

 

Yield decreased in 2012 when compared to 2011 primarily due to the increase in Troubled Debt Restructuring (TDR) finance receivables (which result in reduced finance charges reflecting the reductions to the interest rates on these TDR finance receivables) and lower accretion of the net discount applied to non-credit impaired personal loan and retail sales finance receivables, partially offset by a higher proportion of personal loans in our finance receivable portfolio, which have higher yields. As a result of the FCFI Transaction, we revalued our finance receivable portfolio based on its fair value on November 30, 2010, which had a greater impact on increasing our personal loan and retail sales finance yields in 2011 due to higher discount accretion. The decrease in yield in 2012 also reflected lower finance charges resulting from the out-of-period adjustment described below.

 

In the second quarter of 2012, we recorded an out-of-period adjustment, which decreased finance charge revenues by $13.9 million ($11.5 million of which related to 2011). The adjustment related to the correction of capitalized interest on purchased credit impaired finance receivables serviced by a third party. After evaluating the quantitative and qualitative aspects of this correction, management has determined that our previously issued quarterly and annual consolidated financial statements were not materially misstated.

 

Interest expense decreased due to the following:

 

(dollars in thousands)

 

 

 

 

Year Ended December 31,

 

 

2012

 

 

 

 

 

 

Decrease in average borrowings

 

 

$

(124,038

)

Decrease in interest rate

 

 

(73,291

)

Total

 

 

$

(197,329

)

 

Average borrowings decreased in 2012 when compared to 2011 primarily due to liquidity management efforts, including debt maturities and repurchases in 2012 totaling $3.0 billion. Our interest rate decreased in 2012 when compared to 2011 primarily due to debt repurchases in 2012 resulting in lower accretion of net discount applied to long-term debt and three securitization transactions in 2012, which generally have lower interest rates. As a result of the FCFI Transaction, we revalued our long-term debt based on its fair value on November 30, 2010.

 

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Table of Contents

 

Item 7.  Continued

 

 

Provision for finance receivable losses increased $5.3 million in 2012 when compared to 2011. While our overall net finance receivables declined by 10.1% and our delinquency and charge-off trends improved in 2012 when compared to 2011, we increased our allowance for finance receivable losses (through the provision for finance receivable losses) by $108.1 million. The increase in the allowance for finance receivable losses during 2012 reflected the additional allowance requirements on our finance receivables originated after the FCFI Transaction date and on our real estate loans deemed to be TDR finance receivables subsequent to the FCFI Transaction date. The allowance for finance receivables losses was eliminated as of November 30, 2010 with the application of push-down accounting as the allowance was incorporated in the new fair value basis of the finance receivables as of the FCFI Transaction date.

 

Other revenues decreased $43.3 million in 2012 when compared to 2011 primarily due to unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments and net loss on repurchases of debt in 2012, partially offset by foreign exchange transaction gains in 2012.

 

Salaries and benefits decreased $39.8 million in 2012 when compared to 2011 primarily due to having fewer employees in 2012 as a result of the restructuring activities during the first half of 2012.

 

Other operating expenses decreased $39.5 million in 2012 when compared to 2011 primarily due to fewer branch offices in 2012, lower amortization of other intangible assets resulting from the write off of Ocean trade names and customer relationships intangible assets in fourth quarter 2011 and Ocean customer lists intangible assets in third quarter 2012, lower professional services expenses, lower legal accruals, and lower real estate owned expenses, partially offset by additional expenses recorded in 2012 for refunds to Ocean customers relating to payment protection insurance.

 

We recorded restructuring expenses of $23.5 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability. However, there can be no assurance that these efforts alone will be effective in restructuring the Company to profitable operations. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 for further information on the restructuring expenses.

 

Comparison of Consolidated Results for 2011 and Eleven Months Ended November 30, 2010

 

Finance charges increased due to the net of the following:

 

 

(dollars in thousands)

 

 

 

 

Year Ended December 31,

 

 

2011*

 

 

 

 

 

 

Increase in yield

 

 

$

442,187

 

Decrease in average net receivables

 

 

(357,113

)

Increase in number of days

 

 

121,371

 

Total

 

 

$

206,445

 

 

________________

*                  Total change for the year ended December 31, 2011 (Successor Company) is compared to eleven months ended November 30, 2010 (Predecessor Company).

 

 

Yield increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of valuation discount accretion resulting from the push-down accounting adjustments, which increased yield by 343 basis points in 2011. Average net receivables decreased in 2011 when compared to the eleven months ended November 30, 2010 reflecting the impact of push-down accounting adjustments, which decreased average net receivables by $2.1 billion in 2011 and our tighter underwriting guidelines and liquidity management efforts.

 

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Table of Contents

 

Item 7.  Continued

 

 

Interest expense increased due to the net of the following:

 

 

(dollars in thousands)

 

 

 

 

Year Ended December 31,

 

 

2011*

 

 

 

 

 

 

Increase in interest rate

 

 

$

358,152

 

Decrease in average borrowings

 

 

(182,797

)

Increase in number of days

 

 

104,560

 

Total

 

 

$

279,915

 

 

___________________

*                  Total change for the year ended December 31, 2011 (Successor Company) is compared to eleven months ended November 30, 2010 (Predecessor Company).

 

Our interest rate increased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to the impact of valuation discount accretion resulting from the push-down accounting adjustments, which increased our interest rate by 290 basis points in 2011. Average borrowings decreased in 2011 when compared to the eleven months ended November 30, 2010 primarily due to liquidity management efforts and the impact of push-down accounting adjustments, which decreased average borrowings by $1.2 billion in 2011.

 

Provision for finance receivable losses decreased $112.0 million in 2011 when compared to eleven months ended November 30, 2010. The 2011 provision for finance receivable losses reflected the requirements for allowance for finance receivable losses under the application of push-down accounting as of the FCFI Transaction date compared to the historical accounting basis for the eleven months ended November 30, 2010. The two bases of accounting are not comparable. The 2011 provision for finance receivable losses primarily reflected the establishment of new allowance requirements for newly originated finance receivables and for additional allowance requirements for real estate loans deemed to be TDR finance receivables after the FCFI Transaction date. The allowance for finance receivables losses was eliminated as of November 30, 2010 with the application of push-down accounting as the allowance was incorporated in the new fair value basis of the finance receivables as of the FCFI Transaction date. The provision for finance receivable losses for the eleven months ended November 30, 2010 reflected an overall reduction of allowance for finance receivables of 8.7%, compared to a reduction in our net finance receivables of 8.4%, as well as improved delinquency and charge-off trends for the period.

 

Other revenues decreased $93.1 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to an unfavorable variance in foreign exchange gains on Euro denominated debt and higher writedowns on real estate owned and net losses on sales of real estate owned reflecting the fragile U.S. residential real estate market.

 

Salaries and benefits decreased $30.5 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to lower medical claims and premiums paid by the Company in 2011 and fewer employees, partially offset by one more month in the 2011 period.

 

Other operating expenses increased $39.8 million in 2011 when compared to the eleven months ended November 30, 2010 primarily due to one more month in the 2011 period, the impact of push-down accounting adjustments (including the amortization of other intangible assets), higher professional services expenses, and higher advertising expenses, partially offset by lower legal accruals and lower administrative expenses allocated from our former indirect parent.

 

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Table of Contents

 

Item 7.  Continued

 

 

Reconciliation of Net Income (Loss) on Push-Down Accounting Basis to Historical Accounting Basis

 

Due to the nature of the FCFI Transaction, we applied push-down accounting to SLFC. The reconciliations of net income (loss) on a push-down accounting basis to our historical accounting basis (which is a basis of accounting other than U.S. GAAP that we believe provides a consistent basis for both management and other interested third parties to better understand our operating results) were as follows:

 

 

 

 

 

 

Successor

 

 

 

 

Predecessor

 

 

 

 

 

 

Company

 

 

 

 

Company

 

 

 

 

 

 

 

 

One Month

 

 

Eleven Months

 

 

 

 

Year Ended

 

Year Ended

 

Ended

 

 

Ended

 

 

 

 

December 31,

 

December 31,

 

December 31,

 

 

November 30,

 

(dollars in thousands)

 

 

2012

 

2011

 

2010

 

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) - push-down accounting basis

 

 

$

(220,686

)

$

(224,723

)

$

1,462,904

 

 

$

(4,454

)

Finance charge adjustments (a)

 

 

(187,883

)

(248,599

)

(35,374

)

 

-

 

Interest expense adjustments (b)

 

 

222,966

 

341,246

 

28,868

 

 

-

 

Provision for finance receivable losses adjustments (c)

 

 

190,784

 

86,007

 

(1,488

)

 

-

 

Repurchases of long-term debt adjustments (d)

 

 

38,997

 

-

 

-

 

 

-

 

Amortization of other intangible assets (e)

 

 

13,618

 

41,085

 

3,797

 

 

-

 

Benefit from income taxes (f)

 

 

(92,276

)

(63,346

)

-

 

 

-

 

Bargain purchase gain (g)

 

 

-

 

-

 

(1,469,182

)

 

-

 

Other (h)

 

 

(8,413

)

(38,752

)

(11,906

)

 

-

 

Net loss - historical accounting basis

 

 

$

(42,893

)

$

(107,082

)

$

(22,381

)

 

$

(4,454

)

 

___________________

(a)           Finance charge adjustments consist of: (1) the accretion of the net discount applied to non-credit impaired net finance receivables to revalue the non-credit impaired net finance receivables to their fair value at the date of the FCFI transaction using the interest method over the remaining life of the related net finance receivables; (2) the difference in finance charges earned on our pools of credit impaired net finance receivables under a level rate of return over the expected lives of the underlying pools of credit impaired finance receivables net of the finance charges earned on these finance receivables under historical accounting basis; and (3) the elimination of the accretion or amortization of historical unearned points and fees, deferred origination costs, premiums, and discounts.

 

Components of finance charge adjustments consisted of:

 

 

 

 

 

 

 

Successor

 

 

 

 

Predecessor

 

 

 

 

 

 

Company

 

 

 

 

Company

 

 

 

 

 

 

 

 

One Month

 

 

Eleven Months

 

 

 

 

Year Ended

 

Year Ended

 

Ended

 

 

Ended

 

 

 

 

December 31,

 

December 31,

 

December 31,

 

 

November 30,

 

(dollars in thousands)

 

 

2012

 

2011

 

2010

 

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Accretion of net discount applied to non-credit impaired net finance receivables

 

 

$

(164,223

)

$

(218,534

)

$

(35,831

)

 

$

-

 

Credit impaired finance receivables finance charges

 

 

(41,210

)

(54,033

)

(2,573

)

 

-

 

Elimination of accretion or amortization of historical unearned points and fees, deferred origination costs, premiums, and discounts

 

 

17,550

 

23,968

 

3,030

 

 

-

 

Total

 

 

$

(187,883

)

$

(248,599

)

$

(35,374

)

 

$

-

 

 

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Table of Contents

 

Item 7.  Continued

 

 

(b)          Interest expense adjustments consist of: (1) the accretion of the net discount applied to long-term debt to revalue the debt securities to their fair value at the date of the FCFI transaction using the interest method over the remaining life of the related debt securities; and (2) the elimination of the accretion or amortization of historical discounts, premiums, commissions, and fees.

 

Components of interest expense adjustments were as follows:

 

 

 

 

 

 

Successor

 

 

 

 

Predecessor

 

 

 

 

 

 

Company

 

 

 

 

Company

 

 

 

 

 

 

 

 

One Month

 

 

Eleven Months

 

 

 

 

Year Ended

 

Year Ended

 

Ended

 

 

Ended

 

 

 

 

December 31,

 

December 31,

 

December 31,

 

 

November 30,

 

(dollars in thousands)

 

 

2012

 

2011

 

2010

 

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Accretion of net discount applied to long-term debt

 

 

$

280,122

 

$

388,677

 

$

34,806

 

 

$

-

 

Elimination of accretion or amortization of historical discounts, premiums, commissions, and fees

 

 

(57,156

)

(47,431

)

(5,938

)

 

-

 

Total

 

 

$

222,966

 

$

341,246

 

$

28,868

 

 

$

-

 

 

(c)           Provision for finance receivable losses consists of the allowance for finance receivable losses adjustments and net charge-offs quantified in the table below. Allowance for finance receivable losses adjustments reflects the net difference between our allowance adjustment requirements calculated under our historical accounting basis net of adjustments required under push-down accounting basis utilizing our methodologies described in Note 7 of the Notes to Consolidated Financial Statements in Item 8. Net charge-offs reflects the net charge off of loans at a higher carrying value under historical accounting basis versus the discounted basis to their fair value at date of the FCFI Transaction under push-down accounting basis.

 

Components of provision for finance receivable losses adjustments were as follows:

 

 

 

 

 

 

Successor

 

 

 

 

Predecessor

 

 

 

 

 

 

Company

 

 

 

 

Company

 

 

 

 

 

 

 

 

One Month

 

 

Eleven Months

 

 

 

 

Year Ended

 

Year Ended

 

Ended

 

 

Ended

 

 

 

 

December 31,

 

December 31,

 

December 31,

 

 

November 30,

 

(dollars in thousands)

 

 

2012

 

2011

 

2010

 

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for finance receivable losses adjustments

 

 

$

286,770

 

$

260,164

 

$

22,195

 

 

$

-

 

Net charge-offs

 

 

(95,986

)

(174,157

)

(23,683

)

 

-

 

Total

 

 

$

190,784

 

$

86,007

 

$

(1,488

)

 

$

-

 

 

(d)          Repurchases of long-term debt adjustments reflect the net loss on acceleration of the accretion of the net discount applied to long-term debt.

 

(e)           Amortization of other intangible assets reflects the amortization over the remaining estimated life of intangible assets established at the date of the FCFI transaction as a result of the application of push-down accounting.

 

(f)            Benefit from income taxes reflects the net tax impact of the net pretax impact of the other reconciling items between push-down accounting and historical accounting basis.

 

(g)          Bargain purchase gain reflects the gain realized under push-down accounting resulting from the net difference between the fair value of assets acquired and fair value of liabilities assumed less the fair value of consideration transferred that was allocated to SLFC as of the date of the FCFI Transaction.

 

(h)          “Other” items reflects less significant differences between historical accounting basis and push-down accounting basis relating to various items such as the elimination of deferred charges, adjustments to the basis of other real estate assets, fair

 

43



Table of Contents

 

Item 7.  Continued

 

 

value adjustments to fixed assets, adjustments to insurance claims and policyholder liabilities, and various other differences all as of the date of the FCFI Transaction.

 

Segment Overview

 

Prior to our 2012 restructuring initiatives and further refinement of our business strategy, we had three business segments:  branch, centralized real estate, and insurance, which were defined by the types of financial service products we offered, the nature of our production processes, and the methods we used to distribute our products and to provide our services, as well as our management reporting structure.

 

At December 31, 2012, our three business segments include: consumer, insurance, and real estate. These business segments evolved primarily from management’s redefined business strategy, including its decision to cease real estate lending effective January 1, 2012 and to shift its focus to consumer loan products which we believe have significant prospects for growth and business development due to the strong demand in our target market of nonprime borrowers. We have redefined our segments to coincide with how our businesses are currently managed. As of December 31, 2012, our revised business segments include the following:

 

·                 Consumer Business Segment. We originate and service personal loans (secured and unsecured) in 26 states, which are our core operating states.

·                 Insurance Business Segment. We write and reinsure credit life, credit accident and health, credit-related property and casualty, and credit involuntary unemployment insurance covering our customers and the property pledged as collateral through products that the consumer and real estate business segments offer to its customers. We also offer non-credit insurance and ancillary products.

·                 Real Estate Business Segment. We service and hold real estate loans secured by first or second mortgages on residential real estate. Real estate loans previously originated through our branch offices are either serviced by our branch personnel or centrally serviced at our Evansville, Indiana location or other specialized servicing centers. Real estate loans previously acquired or originated through centralized distribution channels are serviced by MorEquity, a wholly-owned subsidiary of SLFC, all of which are subserviced by Nationstar, except for certain securitized real estate loans, which are serviced and subserviced by third parties. Investment funds managed by affiliates of Fortress indirectly own a majority interest in Nationstar. As a result of the cessation of real estate lending effective January 1, 2012, all of our real estate loans are in a liquidating status.

 

The remaining components (which we refer to as “Other”) consist of our non-core and non-originating legacy operations, which are isolated by geographic market and/or distribution channel from our prospective core operations. These operations include our legacy operations in 14 states where we have also ceased personal lending and retail sales financing as a result of our restructuring activities during the first half of 2012, our liquidating retail sales finance portfolio (including our retail sales finance accounts from our dedicated auto finance operation), our lending operations in Puerto Rico and the U.S. Virgin Islands, and Ocean.

 

Our revised business segment reporting allows management to better track and understand the Company’s performance, assess prospects for future net cash flows, isolate and evaluate core, growth operations versus non-core liquidating operations, and make more informed judgments about our operations as a whole.

 

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Table of Contents

 

Item 7.  Continued

 

Due to the nature of the FCFI Transaction (as described in Note 5 of the Notes to Consolidated Financial Statements in Item 8), we applied push-down accounting to SLFC. However, we continue to report our segment results using the same accounting basis that we employed prior to the FCFI Transaction, which we refer to as “historical accounting basis,” to provide a consistent basis for both management and other interested third parties to better understand our operating results. The historical accounting basis (which is a basis of accounting other than U.S. GAAP) also provides better comparability of our operating results to our competitors and other companies in the financial services industry. See Note 24 of the Notes to Consolidated Financial Statements in Item 8 for reconciliations of segment totals to consolidated financial statement amounts.

 

We allocate revenues and expenses (on a historical accounting basis) to each segment using the following methodologies:

 

 

Finance charges

 

 

 

Directly correlated with a specific segment.

Interest expense

 

 

 

Disaggregated into three categories based on the underlying debt that the expense pertains to: (1) securitizations, (2) secured term loan, and (3) unsecured debt. Securitizations and the secured term loan are allocated to the segments whose finance receivables serve as the collateral securing each of the respective debt instruments. The unsecured debt is allocated to the segments based on the remaining balance of debt by segment.

 

Provision for finance

receivable losses

 

 

 

Directly correlated with a specific segment except for allocations to “other,” which are based on the remaining delinquent accounts as a percentage of total delinquent accounts.

 

 

Insurance revenues

 

 

 

Directly correlated with a specific segment.

 

Investment revenues

 

 

 

Directly correlated with a specific segment.

Other revenues

 

 

 

Directly correlated with a specific segment except for gains and losses on foreign currency exchange, debt repurchases, and derivatives. These items are allocated to the segments based on the interest expense allocation of unsecured debt.

Salaries and benefits

 

 

 

Directly correlated with a specific segment. Salaries and benefits not directly correlated with a specific segment are allocated to each of the segments based on services provided.

 

Other operating

expenses

 

 

 

Directly correlated with a specific segment. Other operating expenses not directly correlated with a specific segment are allocated to each of the segments based on services provided.

 

 

Insurance losses and

loss adjustment

expenses

 

 

 

Directly correlated with a specific segment.

 

45



Table of Contents

 

Item 7.  Continued

 

SEGMENT RESULTS

 

We evaluate the performance of each of our business segments based on its pretax operating earnings, which are presented below. Due to the changes in the composition of our previously reported business segments, we have restated the corresponding segment information presented in the following tables for the prior year periods. The pretax operating results for each business segment presented below are also disclosed in Note 24 of the Notes to the Consolidated Financial Statements in Item 8 for each period included on our consolidated statement of operations.

 

Consumer Business Segment

 

Pretax operating results of the consumer business segment (which are reported on a historical accounting basis) were as follows:

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

Finance charges

 

  $

585,041

 

$

534,861

 

$

548,875

 

Finance receivables held for sale originated as held for investment

 

-

 

-

 

8,947

 

Total interest income

 

585,041

 

534,861

 

557,822

 

 

 

 

 

 

 

 

 

Interest expense

 

141,710

 

125,544

 

144,382

 

 

 

 

 

 

 

 

 

Net interest income

 

443,331

 

409,317

 

413,440

 

 

 

 

 

 

 

 

 

Provision for finance receivable losses

 

90,598

 

8,602

 

113,612

 

 

 

 

 

 

 

 

 

Net interest income after provision for finance receivable losses

 

352,733

 

400,715

 

299,828

 

 

 

 

 

 

 

 

 

Other revenues:

 

 

 

 

 

 

 

Intersegment - insurance commissions

 

42,203

 

37,331

 

29,731

 

Other

 

11,331

 

(1,769

)

6,147

 

Total other revenues

 

53,534

 

35,562

 

35,878

 

 

 

 

 

 

 

 

 

Other expenses:

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Salaries and benefits

 

246,916

 

261,250

 

293,095

 

Other operating expenses

 

114,431

 

141,319

 

151,427

 

Restructuring expenses

 

15,634

 

-

 

-

 

Total other expenses

 

376,981

 

402,569

 

444,522

 

 

 

 

 

 

 

 

 

Pretax operating income (loss)

 

  $

29,286

 

$

33,708

 

$

(108,816

)

 

46



Table of Contents

 

Item 7.  Continued

 

Selected financial statistics for the consumer business segment’s personal loans (which are reported on a historical accounting basis) were as follows:

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or for the Year Ended December 31,

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

Consumer business segment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net finance receivables

 

$

2,544,614

 

$

2,413,881

 

$

2,389,374

 

Number of accounts

 

729,140

 

690,509

 

674,557

 

 

 

 

 

 

 

 

 

Average net receivables

 

$

2,426,968

 

$

2,337,210

 

$

2,527,999

 

 

 

 

 

 

 

 

 

Yield

 

24.10

%

22.88

%

21.70

%

 

 

 

 

 

 

 

 

Charge-off ratio

 

3.64

%

3.95

%

6.14

%

 

 

 

 

 

 

 

 

Delinquency ratio

 

2.75

%

2.98

%

3.67

%

 

 

 

 

 

 

 

 

Originated and renewed

 

$

2,465,110

 

$

2,258,235

 

$

1,886,093

 

Number of accounts

 

652,111

 

604,844

 

522,817

 

 

Comparison of Pretax Operating Results for 2012 and 2011

 

Finance charges increased $50.2 million in 2012 when compared to 2011 primarily due to increases in yield and average net receivables. Average net receivables increased in 2012 when compared to 2011 as we focused on consumer lending that we believe will provide higher returns and allow us to operate on a more cost-effective basis.

 

Interest expense increased $16.2 million in 2012 when compared to 2011 primarily due to higher unsecured debt interest expense allocated to the consumer business segment reflecting the higher proportion of personal loans allocated to SLFC’s unsecured debt. The consumer business segment did not have any interest expense allocations from securitizations since its personal loans were not previously utilized in our securitization transactions.

 

Provision for finance receivable losses increased $82.0 million in 2012 when compared to 2011 primarily due to increasing the allowance for finance receivables losses in 2012 versus recording an allowance reduction in 2011. While the delinquency and charge-off trends of our personal loans improved in 2012 over 2011, we increased our allowance for finance receivable losses during 2012 due to 5.4% growth in these finance receivables during 2012.

 

Intersegment insurance commissions represent the commissions allocated from the insurance business segment for insurance products sold. Our consumer lending specialists also offer insurance and ancillary products to our branch customers. Intersegment insurance commissions increased $4.9 million in 2012 when compared to 2011 due to higher insurance premiums written on personal loans reflecting the increase in originations of personal loans in 2012.

 

Other revenues increased $13.1 million in 2012 when compared to 2011 primarily due to foreign exchange transaction gains in 2012, curtailment gain in 2012 as a result of our pension plan freeze, and net gain on repurchases of debt in 2012, partially offset by unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments.

 

47



Table of Contents

 

Item 7.  Continued

 

Salaries and benefits decreased $14.3 million in 2012 when compared to 2011 primarily due to having fewer employees in 2012 as a result of the restructuring activities during the first half of 2012.

 

Other operating expenses decreased $26.9 million in 2012 when compared to 2011 primarily due to fewer branch offices in 2012, lower professional services expenses, and lower legal accruals.

 

We recorded restructuring expenses of $15.6 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability.

 

Comparison of Pretax Operating Results for 2011 and 2010

 

Finance charges decreased $14.0 million in 2011 when compared to 2010 primarily due to a decrease in average net receivables, partially offset by an increase in yield. Average net receivables decreased in 2011 when compared to 2010 reflecting our tighter underwriting guidelines and liquidity management efforts.

 

Interest expense decreased $18.8 million in 2011 when compared to 2010 primarily due to lower secured term loan interest expense allocated to the consumer business segment reflecting the lower proportion of personal loans allocated to SLFC’s secured term loan.

 

Provision for finance receivable losses decreased $105.0 million in 2011 when compared to 2010 primarily due to lower required allowance for finance receivables losses. As discussed under “Critical Accounting Estimates - Allowance for Finance Receivable Losses,” effective September 30, 2011, we switched from a migration analysis to a roll rate-based model for purposes of computing our allowance for finance receivables losses for our personal loans. There was no requirement for further increase to our allowance for finance receivables losses under the new roll rate analysis and after consideration of the improved delinquency and charge-off trends of our personal loans in 2011 when compared to 2010.

 

Intersegment insurance commissions increased $7.6 million in 2011 when compared to 2010 due to higher insurance premiums written on personal loans reflecting higher originations of personal loans in 2011.

 

Other revenues decreased $7.9 million in 2011 when compared to 2010 primarily due to unfavorable variances in foreign exchange gains (losses) on Euro denominated debt and related derivative adjustments.

 

Salaries and benefits decreased $31.8 million in 2011 when compared to 2010 primarily due to lower medical claims and premiums paid by the Company in 2011 and fewer employees.

 

Other operating expenses decreased $10.1 million in 2011 when compared to 2010 primarily due to lower legal accruals and lower administrative expenses allocated from our former indirect parent, partially offset by higher professional services expenses and higher advertising expenses.

 

48



Table of Contents

 

Item 7.  Continued

 

Insurance Business Segment

 

Pretax operating results of the insurance business segment (which are reported on a historical accounting basis) were as follows:

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

Other revenues:

 

 

 

 

 

 

 

Insurance

 

  $

126,423

 

$

120,456

 

$

124,813

 

Investments

 

39,314

 

45,172

 

40,654

 

Other

 

5,347

 

3,172

 

4,065

 

Total other revenues

 

171,084

 

168,800

 

169,532

 

 

 

 

 

 

 

 

 

Other expenses:

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Salaries and benefits

 

11,767

 

12,352

 

13,303

 

Other operating expenses

 

10,489

 

12,128

 

12,353

 

Restructuring expenses

 

229

 

-

 

-

 

Insurance losses and loss adjustment expenses

 

62,092

 

44,361

 

48,268

 

Intersegment - insurance commissions

 

42,475

 

46,099

 

38,608

 

Total other expenses

 

127,052

 

114,940

 

112,532

 

 

 

 

 

 

 

 

 

Pretax operating income

 

  $

44,032

 

$

53,860

 

$

57,000

 

 

Selected financial statistics for the insurance business segment (which are reported on a historical accounting basis) were as follows:

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or for the Year Ended December 31,

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

Insurance business segment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premiums earned

 

  $

125,989

 

$

120,017

 

$

124,283

 

 

 

 

 

 

 

 

 

Premiums written

 

  $

136,703

 

$

128,939

 

$

112,590

 

 

 

 

 

 

 

 

 

Life insurance policies in force:

 

 

 

 

 

 

 

Credit

 

  $

2,032,290

 

$

1,950,809

 

$

1,887,470

 

Non-credit

 

1,356,134

 

1,333,998

 

1,432,931

 

Total

 

  $

3,388,424

 

$

3,284,807

 

$

3,320,401

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average invested assets

 

  $

863,582

 

$

941,714

 

$

942,332

 

 

 

 

 

 

 

 

 

Average invested asset yield

 

4.70

%

5.18

%

5.61

%

 

 

 

 

 

 

 

 

Net realized gains (losses) on investment securities

 

  $

239

 

$

(3,217

)

$

(8,716

)

 

Comparison of Pretax Operating Results for 2012 and 2011

 

Insurance revenues increased $6.0 million in 2012 when compared to 2011 primarily due to increases in credit earned premiums reflecting higher originations of personal loans in 2012, partially offset by a decrease in premiums assumed under reinsurance agreements.

 

49



Table of Contents

 

Item 7.  Continued

 

Investment revenues decreased $5.9 million in 2012 when compared to 2011 primarily due to decreases in average invested assets and average invested asset yield, partially offset by a favorable variance in net realized gains (losses) on investment securities.

 

Other revenues increased $2.2 million in 2012 when compared to 2011 primarily due to higher agency administrative income reflecting an increase in insurance products sold.

 

We recorded restructuring expenses of $0.2 million during the first half of 2012. The branch office closings and workforce reductions were instituted as part of our efforts to return to profitability.

 

Insurance losses and loss adjustment expenses increased $17.7 million in 2012 when compared to 2011 primarily due to an unfavorable variance in change in benefit reserves. In the second quarter of 2011, we recorded an out-of-period adjustment related to prior periods, which decreased change in benefit reserves by $14.2 million for 2011. This adjustment related to the correction of a benefit reserve error related to a closed block of annuities.

 

Intersegment insurance commissions represent the commissions allocated to the consumer and real estate business segments for insurance products sold. Our consumer lending specialists also offer insurance and ancillary products to our branch customers. Intersegment insurance commissions decreased $3.6 million in 2012 when compared to 2011 due to lower insurance premiums written on real estate loans reflecting the cessation of new originations of real estate loans as of January 1, 2012, partially offset by higher insurance premiums written on personal loans reflecting higher originations of personal loans in 2012. We include intersegment insurance commissions in other revenues of our insurance business segment in Note 24 of the Notes to Consolidated Financial Statements in Item 8 in order to reconcile our segment totals to consolidated financial statement amounts.

 

Comparison of Pretax Operating Results for 2011 and 2010

 

Insurance revenues decreased $4.4 million in 2011 when compared to 2010 primarily due to decreases in credit earned premiums reflecting lower finance receivable originations in prior years.

 

Investment revenues increased $4.5 million in 2011 when compared to 2010 primarily due to lower net realized losses on investment securities, partially offset by a decrease in average invested asset yield.

 

Insurance losses and loss adjustment expenses decreased $3.9 million in 2011 when compared to 2010 primarily due to lower claims incurred in 2011.

 

Intersegment insurance commissions increased $7.5 million in 2011 when compared to 2010 primarily due to higher insurance premiums written on personal loans reflecting higher originations of personal loans in 2011.

 

50



Table of Contents

 

Item 7.  Continued

 

Real Estate Business Segment

 

Pretax operating results of the real estate business segment (which are reported on a historical accounting basis) were as follows:

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

Finance charges

 

  $

810,441

 

$

925,889

 

$

1,038,383

 

Finance receivables held for sale originated as held for investment

 

2,734

 

-

 

11,471

 

Total interest income

 

813,175

 

925,889

 

1,049,854

 

 

 

 

 

 

 

 

 

Interest expense

 

662,499

 

742,765

 

848,663

 

 

 

 

 

 

 

 

 

Net interest income

 

150,676