ITEM 1. BUSINESS.
INTRODUCTION
THE FOLLOWING DISCUSSION RELATES TO THE FINOVA GROUP INC. AND ITS SUBSIDIARIES (COLLECTIVELY "FINOVA" OR THE "COMPANY"), INCLUDING FINOVA CAPITAL CORPORATION AND ITS SUBSIDIARIES ("FINOVA CAPITAL").
GENERAL
The FINOVA Group Inc. is a financial services holding company. Through its principal subsidiary, FINOVA Capital, the Company provides a broad range of financing and capital market products. FINOVA concentrates on lending to mid-size businesses. FINOVA Capital has been in operation since 1954.
FINOVA extends revolving credit facilities, term loans and equipment and real estate financing primarily to "middle-market" businesses with financing needs falling generally between $100,000 and $35 million.
FINOVA operates in 20 specific industry or market niches under three market groups. FINOVA selected these niches because its expertise in evaluating the creditworthiness of prospective customers and its ability to provide value-added services enables the Company to differentiate itself from its competitors. That expertise and ability also enable FINOVA to command pricing that provides a satisfactory spread over its borrowing costs.
FINOVA seeks to maintain a high quality portfolio and to minimize non-earning assets and write-offs. FINOVA uses defined underwriting criteria and stringent portfolio management techniques. The Company diversifies its lending activities geographically and among a range of industries, customers and loan products.
Due to the diversity of FINOVA's portfolio, the Company believes it is better able to manage competitive changes in its markets and to withstand the impact of deteriorating economic conditions on a regional or national basis. There can be no assurance, however, that competitive changes, borrowers' performance, economic conditions or other factors will not result in an adverse impact on FINOVA's results of operations or financial condition.
FINOVA generates interest, lease rentals, fees and other income through charges assessed on outstanding loans, loan servicing, leasing, brokerage and other activities. FINOVA's primary expenses are the costs of funding the loan and lease business, including interest paid on debt, provisions for credit losses, marketing expenses, salaries and employee benefits, servicing and other operating expenses and income taxes.
FINOVA's principal executive offices are located at 4800 North Scottsdale Road, Scottsdale, Arizona 85251, telephone (480) 636-4800. FINOVA also has business development offices throughout the U.S. and in London, U.K. and Toronto, Canada.
BUSINESS GROUPS
FINOVA operates the following principal lines of business under three market groups:
COMMERCIAL FINANCE
* BUSINESS CREDIT offers collateral-oriented revolving credit facilities and term loans for manufacturers, retailers, distributors, wholesalers and service companies. Typical transaction sizes range from $1 million to $5 million. Fremont Capital Corporation, acquired in December 1999, was added to this line of business.
* COMMERCIAL SERVICES offers full service factoring and accounts receivable management services for entrepreneurial and larger firms, primarily in the textile and apparel industries. The annual factored volume of these companies is generally between $2 million and $100 million. This line provides accounts receivable and inventory financing in addition to loans secured by equipment and real estate. * CORPORATE FINANCE provides a full range of cash flow-oriented and asset-based term and revolving loan products for manufacturers, wholesalers, distributors, specialty retailers and commercial and consumer service businesses. Typical transaction sizes range from $2 million to $35 million. * DISTRIBUTION & CHANNEL FINANCE provides inbound and outbound inventory financing, combined inventory/accounts receivable lines of credit and purchase order financing for equipment distributors, value-added resellers and dealers nationwide. Transaction sizes generally range from $500,000 to $30 million. * GROWTH FINANCE provides collateral-based working capital financing primarily secured by accounts receivable for manufacturers, wholesale distributors, service companies and importers. Typical transaction sizes range from $100,000 to $1 million and are made to small and midsize businesses with annual sales under $10 million. * REDISCOUNT FINANCE offers revolving credit facilities to the independent consumer finance industry including direct loan, automobile, mortgage and premium finance companies. Typical transaction sizes range from $1 million to $35 million.
SPECIALTY FINANCE
* COMMERCIAL EQUIPMENT FINANCE offers equipment leases and loans to a broad range of midsize companies. Specialty markets include emerging growth technology industries (primarily biotechnology), electronics, telecommunications, corporate aircraft, supermarket/specialty retailers and most heavy industries. Typical transaction sizes range from $1 million to $20 million. * COMMUNICATIONS FINANCE specializes in term financing to advertising and subscriber-supported businesses, including radio and television broadcasting, cable television, paging, outdoor advertising, publishing and emerging technologies such as internet service providers and competitive local exchange carriers. Typical transaction sizes range from $3 million to $40 million. * FRANCHISE FINANCE offers equipment, real estate and acquisition financing for operators of established franchise concepts. Typical transaction sizes generally range from $500,000 to $40 million. * HEALTHCARE FINANCE offers a full range of working capital, equipment and real estate financing products for the U.S. healthcare industry. Transaction sizes typically range from $500,000 to $35 million. * PORTFOLIO SERVICES provides customized receivable servicing and collections for resort timeshare developers and other holders of consumer receivables. * PUBLIC FINANCE provides tax-exempt term financing to non-profit corporations, manufacturers and state and local governments. Typical transaction sizes range from $2 million to $15 million. * RESORT FINANCE focuses on construction, acquisition and receivables financing for timeshare resorts, second home communities and fractional interest resorts. Typical transaction sizes ranges from $5 million to $35 million. * SPECIALTY REAL ESTATE FINANCE provides senior term acquisition and bridge/interim loans from $5 million to $30 million or more for hotel and resort properties in the U.S., Canada and the Caribbean. Through this division, FINOVA also provides equity investments in credit-oriented real estate sale leasebacks. * TRANSPORTATION FINANCE structures equipment loans, leases and acquisition financing for commercial and cargo airlines worldwide, railroads and operators of other transportation-related equipment. Typical transaction sizes range from $5 million to $30 million. Through FINOVA Aircraft Investors LLC, FINOVA also seeks to use its market expertise and industry presence to purchase, upgrade and remarket used commercial aircraft.
CAPITAL MARKETS
* HARRIS WILLIAMS & CO. provides merger and acquisition advisory services targeting middle market businesses. * INVESTMENT ALLIANCE provides equity and debt financing for midsize businesses in partnership with institutional investors and selected fund sponsors. Typical transaction sizes range from $2 million to $15 million. * LOAN ADMINISTRATION provides servicing and subservicing of commercial mortgages, business leases and prime and sub-prime consumer loans. * MEZZANINE CAPITAL provides secured subordinated debt with warrants to midsize North American companies for expansion capital, buyouts or recapitalizations. Typical transaction sizes range from $2 million to $15 million. * REALTY CAPITAL provides commercial real estate bridge/interim mortgage loans and capital markets-funded commercial real estate loans. Typical transaction sizes range from $1 million to $25 million.
FINOVA is a Delaware corporation. The Company was incorporated in 1991 to serve as the successor to The Dial Corp's financial services businesses. In March 1992, Dial transferred those businesses to FINOVA in a spin-off. Since that time, FINOVA has increased its total assets from $2.6 billion at December 31, 1992 to $14.1 billion at December 31,1999. Income from continuing operations increased from $36.8 million in 1992 to $215.2 million in 1999. Management believes FINOVA ranks among the largest independent commercial finance companies in the U.S., based on total assets. FINOVA's common stock is traded on the New York Stock Exchange under the symbol "FNV."
PORTFOLIO COMPOSITION
The total assets under management consist of FINOVA's net investment in financing transactions plus certain assets that are owned by others but serviced by the Company. Managed assets are not reported on the Company's balance sheet (securitized assets and participations sold). The Company's investment in financing transactions is primarily settled in U.S. dollars.
INVESTMENT IN FINANCING TRANSACTIONS
The following tables detail FINOVA's investment in financing transactions (before reserve for credit losses) at December 31, 1999, 1998, 1997, 1996 and 1995.
INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1999 (DOLLARS IN THOUSANDS)
- ---------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $5.5 million on repossessed assets during 1999, including $2.2 million in Specialty Real Estate Finance, $1.0 million in Resort Finance, $0.5 million in Healthcare Finance, $1.4 million in Rediscount Finance, $0.3 million in Commercial Equipment Finance and $0.1 million in Franchise Finance. (3) Primarily includes other assets retained from disposed or discontinued operations. (4) Excludes $483.4 million of assets securitized and participations sold which the Company manages, composed of securitizations of $300.0 million in Corporate Finance and $121.3 million in Franchise Finance and participations of $28.8 million in Corporate Finance, $3.0 million in Communications Finance, $12.3 million in Rediscount Finance, $4.6 million in Transportation Finance, $6.7 million in Business Credit, $6.3 million in Resort Finance and $0.4 million in Other.
INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1998 (DOLLARS IN THOUSANDS)
- ---------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $4.7 million on repossessed assets during 1998, including $2.4 million in Specialty Real Estate Finance, $1.0 million in Resort Finance, $0.9 million in Healthcare Finance, $0.2 million in Rediscount Finance and $0.2 million in Commercial Equipment Finance. (3) Primarily includes other assets retained from disposed or discontinued operations. (4) Excludes $537.6 million of assets securitized and participations sold which the Company manages, composed of securitizations of $300.0 million in Corporate Finance and $136.1 million in Franchise Finance and participations of $49.3 million in Corporate Finance, $21.4 million in Communications Finance, $5.4 million in Resort Finance, $6.9 million in Rediscount Finance, $3.8 million in Business Credit, $12.6 million in Transportation Finance and $2.1 million in Distribution & Channel Finance.
INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
- ---------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $4.1 million on repossessed assets during 1997, including $3.1 million in Specialty Real Estate Finance and $1.0 million in Resort Finance. (3) Primarily includes other assets retained from disposed or discontinued operations. (4) Excludes assets securitized and participations sold which the Company manages, composed of securitizations of $300.0 million in Corporate Finance and $36.6 million in Franchise Finance and participations of $40.2 million in Corporate Finance, $61.0 million in Communications Finance, $8.5 million in Transportation Finance, $4.6 million in Rediscount Finance, $5.1 million in Resort Finance and $1.9 million in Distribution & Channel Finance.
INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1996 (DOLLARS IN THOUSANDS)
- ---------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $5.1 million on repossessed assets during 1996, including $4.4 million in Specialty Real Estate Finance and $0.7 million in Resort Finance. (3) Excludes assets securitized and participations sold which the Company manages, composed of securitizations of $300.0 million in Corporate Finance and participations of $24.6 million in Corporate Finance, $27.5 million in Communications Finance, $4.8 million in Rediscount Finance, $4.4 million in Resort Finance and $3.2 million in Distribution & Channel Finance.
INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1995 (DOLLARS IN THOUSANDS)
- ---------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $4.2 million on repossessed assets during 1995, including $3.2 million in Specialty Real Estate Finance, $0.6 million in Resort Finance and $0.4 million in Communications Finance. (3) Excludes $200 million of securitized assets which are managed by the Company.
The Company's geographic portfolio diversification at December 31, 1999 was as follows:
State Total Percent ----- ----- ------- (Dollars in Thousands) California $ 2,014,346 14.8% Florida 1,365,676 10.0% Texas 1,081,933 8.0% New York 866,821 6.4% Illinois 477,287 3.5% Georgia 440,981 3.2% New Jersey 429,370 3.2% Arizona 389,931 2.9% Pennsylvania 339,866 2.5% Virginia 334,518 2.5% Nevada 318,775 2.3% Missouri 303,266 2.2% South Carolina 298,393 2.2% Minnesota 274,281 2.0% Other (1) 4,669,930 34.3% ----------- ----- Total managed assets $13,605,374 100% =========== ===== - ---------- NOTE: (1) Other includes all states which on an individual basis represent less than 2% of the total; and international, which represents approximately 10% of the total.
The following is an analysis of the reserve for credit losses for the years ended December 31:
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (Dollars in Thousands) Balance, beginning of year $ 207,618 $ 177,088 $ 148,693 $ 129,077 $ 110,903 Provision for credit losses 76,800 82,200 69,200 41,751 39,568 Write-offs (60,372) (59,037) (45,487) (32,017) (27,631) Recoveries 3,518 2,279 2,287 3,296 2,104 Acquisitions and other 37,419 5,088 2,395 6,586 4,133 --------- --------- --------- --------- --------- Balance, end of year $ 264,983 $ 207,618 $ 177,088 $ 148,693 $ 129,077 ========= ========= ========= ========= =========
Included above is a specific impairment reserve of $146.7 million at December 31, 1999, which applies to $298.6 million of the $446.3 million of impaired loans. The remaining $118.3 million of the reserve for credit losses represents management's best estimate of inherent losses in the remaining portfolio considering delinquencies, loss experience and collateral. At December 31, 1998, the specific impairment reserve was $37.1 million, which applied to $98.7 million of the $225.7 million of impaired loans. Additions to general and specific reserves are reflected in current operations, and are fungible between impairment reserves and other reserves. Included in the $37.4 million of acquisition and other is $20.5 million in reserves for credit losses acquired with the acquisition of Sirrom and $12.2 million in reserves acquired in the acquisition of Fremont.
Write-offs and recoveries by line of business, during the years ended December 31, were as follows:
A further breakdown of the portfolio by line of business can be found in Consolidated Financial Statements - Annex A ("Annex A"), Notes B and C.
COST AND USE OF BORROWED FUNDS
FINOVA Capital relies on borrowed funds as well as internal cash flow to finance its operations. It also has raised funds through the sale or securitization of assets, but does not rely on those methods as a primary source of capital. FINOVA also raises funds from the sale of equity from time to time.
The following table reflects the approximate average pre-tax effective cost of borrowed funds and pre-tax equivalent rate earned on accruing assets for FINOVA Capital for each of the periods listed:
- ---------- NOTES: (1) Earning assets are net of average nonaccruing assets and average deferred taxes applicable to leveraged leases. (2) Earned amounts are net of depreciation.
The effective costs presented above include costs of commitment fees and related borrowing costs. They do not necessarily predict future costs of funds. For further information on FINOVA Capital's cost of funds, refer to Annex A, Notes E and F.
Following are the ratios of income to fixed charges and preferred stock dividends ("ratio") for each of the past five years:
Year Ended December 31, ------------------------------------------------------------ 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- 1.58 1.53 1.51 1.51 1.45 ==== ==== ==== ==== ====
Income for fixed charges consists of income from continuing operations before income taxes and fixed charges. Fixed charges include interest and related debt expense, a portion of rental expense representative of interest and preferred stock dividends grossed up to a pre-tax basis.
Variations in interest rates generally do not have a substantial impact on the ratio because fixed-rate and floating-rate assets are generally matched with liabilities of similar rate and term.
MATCHED FUNDING POLICY
FINOVA Capital follows a "matched funding" policy. Under that policy, it generally funds the floating-rate assets (loans and leases to FINOVA's borrowers) with floating-rate liabilities (FINOVA's debt) and fixed-rate assets with fixed-rate liabilities to the extent feasible. This policy helps protect FINOVA from changes in interest rates. For further discussion on FINOVA Capital's debt and matched funding policy, see Annex A, Notes E and F.
CREDIT RATINGS
FINOVA Capital currently has investment-grade credit ratings from the following rating agencies:
Commercial Paper Senior Debt ---------- ----------- Duff & Phelps Credit Rating Co. D1 A Fitch Investors Services, Inc. A Moody's Investors Service, Inc. P2 Baa1 Standard & Poor's Ratings Group A2 A-
FINOVA (Canada) Capital Corporation, a subsidiary of FINOVA Capital, has a rating with Dominion Bond Rating Service Limited of R-1 (low) for commercial paper.
In February 2000, FINOVA (Canada) Finance Inc., a subsidiary of FINOVA Capital, received a rating with Dominion Bond Rating Service Limited of A (low) for the Medium Term Note Program.
In addition, FINOVA Finance Trust, a subsidiary trust of the Company, issued mandatory redeemable convertible preferred securities ("TOPrS") in December 1996 having investment-grade ratings as follows:
Duff & Phelps Credit Rating Co. BBB+ Fitch Investors Services, Inc. A- Moody's Investors Service, Inc. Baa2 Standard & Poor's Ratings Group BBB
For further information relating to the TOPrS, refer to Annex A, Note G.
Standard & Poor's Ratings Group changed on February 26,1999, its rating of the TOPrS from BBB+ to BBB. The rating change was not a downgrade, but resulted from the new rating scale under which Standard & Poor's Ratings Group rates preferred stock two notches below the corporate or counter party credit rating of an investment-grade issuer such as FINOVA.
There can be no assurance that these ratings will be maintained. The ratings can be modified at any time. A credit rating is not a recommendation to buy, sell or hold securities. Each rating should be evaluated independently of any other rating.
RESIDUAL REALIZATION EXPERIENCE
Each year since its inception, FINOVA Capital has earned total proceeds from the sale of assets upon lease termination in excess of carrying amounts. There can be no assurance, however, that those results can be achieved in future years. Actual proceeds will depend on current market values for those assets at the time of sale. While market values are generally beyond the control of FINOVA, the Company has some discretion in the timing of sales of the assets. Sales proceeds on lease terminations in excess of carrying amounts are reported as gains on disposal of assets when the assets are sold.
Income from leasing transactions is affected by gains from asset sales on lease termination and, hence can be somewhat less predictable than income from lending activities. During the five years ended December 31, 1999, the proceeds to FINOVA Capital from sales of assets on early termination and the expiration of leases have exceeded the carrying amounts and estimated residual values as follows:
The estimated residual value of direct finance and leveraged lease assets in the accounts of FINOVA Capital at December 31, 1999 was 34.4% of the original cost of those assets (30.3% excluding the original costs of the assets and residuals applicable to real estate leveraged leases, which typically have higher residuals than other leases). The financing contracts and leases outstanding at that date had initial terms ranging from one to 25 years. The average initial term weighted by carrying amount at inception and the average remaining term weighted by remaining carrying amount of financing contracts at December 31, 1999 for financing contracts excluding leveraged leases were generally 7.0 and 5.1 years, respectively, and for leveraged leases were approximately 18.4 and 10.4 years, respectively. The comparable average initial term and remaining term at December 31, 1998 for financing contracts excluding leveraged leases were generally 7.5 and 5.4 years, respectively, and for leveraged leases were approximately 18.7 and 11.2 years, respectively. FINOVA Capital uses either employed or outside appraisers to determine the collateral value of assets to be leased or financed and the estimated residual or collateral value thereof at the expiration of each lease. Actual proceeds could differ from those appraised values.
For a discussion of accounting for lease transactions, refer to Annex A, Notes A and B.
BUSINESS DEVELOPMENT AND COMPETITION
FINOVA Capital seeks to develop business primarily through direct solicitation by its own sales force. Customers are also introduced by independent brokers and referred by other financial institutions and other sources.
FINOVA Capital is engaged in an extremely competitive activity. It competes with banks, savings and thrift institutions, insurance companies, leasing companies, the credit units of equipment manufacturers and other finance companies. Some of these competitors have substantially greater financial resources and are able to borrow at costs below those of FINOVA Capital. FINOVA Capital's principal competitive advantages are customer service, middle-market and industry niche focus, structuring expertise and its broad array of financial products. The interest rate FINOVA Capital charges for money is a function of its borrowing costs, its operating costs and other factors. While many of FINOVA Capital's larger competitors are able to offer lower interest rates due chiefly to their lower borrowing costs, FINOVA Capital seeks to maintain the competitiveness of the rates it offers by emphasizing strict discipline over its operating costs. FINOVA's ability to manage costs is, in part, dependent on factors beyond the Company's control, such as the cost of funds, outside litigation expenses and competitive salaries.
CREDIT QUALITY
FINOVA Capital has maintained its asset base generally through the use of defined underwriting standards, portfolio management techniques, monitoring of covenant compliance and active collections and workout efforts.
RISK MANAGEMENT
FINOVA Capital generally investigates its prospective customers through a review of historical financial statements, published credit reports, credit references, discussion with management, analysis of location feasibility, personal visits and collateral appraisals and inspections. In many cases, depending upon the results of its credit investigations and the nature of the financing being provided, FINOVA Capital obtains additional collateral or guarantees from other parties. As part of its underwriting process, FINOVA Capital considers the management, industry, financial position and collateral being provided by a proposed borrower or lessee. The purpose, term, amortization and amount of any proposed transaction generally must be clearly defined and within established corporate guidelines. In addition, FINOVA attempts to avoid undue concentrations in any one customer, industry or geographic region.
* MANAGEMENT. FINOVA Capital considers the reputation, experience and depth of management; quality of product or service; adaptability to changing markets and demand; and prior banking, finance and trade relationships.
* INDUSTRY. FINOVA Capital evaluates critical aspects of each industry to which it lends, including general trend, seasonality and cyclicality; governmental regulation; the effects of taxes; the economic value of goods or services provided; and potential environmental or other liabilities.
* FINANCIAL POSITION. FINOVA Capital's review of a prospective borrower normally includes a thorough analysis of the borrower's financial performance. Items considered include net worth; composition of assets and liabilities; debt service coverage; liquidity; sales growth and earning power; and cash flow generation and reliability.
* COLLATERAL. FINOVA Capital regards collateral as an important factor in a credit evaluation and, for collateral dependent transactions, has established maximum loan to value ratios, normally ranging from 60% - 90%, for each of its lines of business.
The underwriting process includes, in addition to the analysis of the factors noted above, the design and implementation of transaction structure and strategies to mitigate identified risks; a review of transaction pricing relative to product-specific return requirements and acknowledged risk elements; a multi-step, interdepartmental review and approval process with varying levels of authority dependent on the size of the transaction; and periodic interdepartmental reviews and revision of underwriting guidelines.
FINOVA Capital also monitors portfolio concentrations in the areas of total exposure to a single borrower and related entities, within a given geographical area and with respect to an industry and/or product type within an industry. FINOVA Capital has established concentration guidelines for each line of business. Geographic concentrations are reviewed periodically and evaluated based on historic loan experience and prevailing market and economic conditions.
FINOVA Capital's financing contracts and leases generally require the customer to pay taxes, license fees and insurance premiums and to perform maintenance and repairs at the customer's expense. Contract payment rates are based on several factors, including the costs of borrowed funds, term of contract, creditworthiness of the prospective customer, type and nature of collateral and other security and, in leasing transactions, the timing of tax effects and estimated residual values. In direct finance lease transactions, lessees generally are granted an option to purchase the equipment at the end of the lease term at its then fair market value or, in some cases, are granted an option to renew the lease at its then fair rental value. The extent to which lessees exercise their options to purchase leased equipment varies from year to year, depending on, among other factors, the state of the economy, the financial condition of the lessee, interest rates and technological developments.
PORTFOLIO MANAGEMENT
In addition to the review at the time of original underwriting, FINOVA Capital attempts to preserve and enhance the earnings quality of its portfolio through proactive management of its financing relationships with its clients. Generally, this process includes the periodic appraisal or verification of the collateral to determine loan exposure and residual values; sales of residuals and warrants to generate supplemental income; and review and management of covenant compliance. Generally, the Portfolio Management department or dedicated personnel within the business units regularly review financial statements to assess customer cash flow performance and trends; periodically confirm operations of the customer; conduct periodic assessments of the underlying collateral; seek to identify issues concerning the vulnerabilities of the customer; seek to resolve outstanding issues with the borrower; periodically review and address covenant compliance issues; and prepare periodic summaries of the aggregate portfolio quality and concentrations for management review.
Evaluation for loan impairment is performed as a part of the portfolio management review process. When a loan is determined to be impaired, a write-down is taken or an impairment reserve is established, if required, based on the difference between the recorded balance of the loan ("carrying amount") and the fair value of the collateral.
DELINQUENCIES AND WORKOUTS
FINOVA Capital monitors the timing of payments on its accounts. For term loans and leases, when an invoice is 10 days past due, the customer is typically contacted, and a determination is made as to the extent of the problem, if any. A commitment for immediate payment is pursued and the account is observed closely. If satisfactory results are not obtained in communication with the customer, the guarantor(s) are usually contacted to advise them of the situation and the potential obligation under the guarantee agreement, if any. If an invoice becomes 31 days past due, it is reported as delinquent. A notice of default is generally sent prior to an invoice becoming 45 days past due. Between 60 and 90 days past the due date, if satisfactory negotiations are not underway, outside counsel generally is retained to help protect FINOVA Capital's rights and to pursue its remedies.
When accounts become more than 90 days past due income recognition is usually suspended, and FINOVA Capital vigorously pursues its legal remedies. Foreclosed or repossessed assets are considered to be nonperforming, and are reported as such unless the assets generate sufficient cash to result in a reasonable rate of return. Those accounts are continually reviewed, and write-downs are taken as deemed necessary. While pursuing collateral and obligors, FINOVA Capital generally continues to negotiate the restructuring or other settlement of the debt, as appropriate.
Management believes that collateral values significantly reduce loss exposure and that the reserve for credit losses is adequate. For additional information regarding the reserve for credit losses, see Annex A, Note C.
GOVERNMENTAL REGULATION
FINOVA Capital's domestic activities, including the financing of its operations, are subject to a variety of federal and state regulations such as those imposed by the Federal Trade Commission, the Securities and Exchange Commission, the Consumer Credit Protection Act, the Equal Credit Opportunity Act and the Interstate Land Sales Full Disclosure Act. Additionally, a majority of states have ceilings on interest rates chargeable to customers in financing transactions. Some of FINOVA Capital's financing transactions and mortgage broker activities are subject to additional government regulation. For example, aircraft leasing is regulated by the Federal Aviation Administration, and Communications Finance is regulated by the Federal Communication Commission. FINOVA Capital's international activities are also subject to a variety of laws and regulations of the countries in which the business is conducted.
EMPLOYEES
At December 31,1999, the Company had 1,465 employees compared to 1,262 at December 31, 1998. The increase primarily included employees from companies acquired in 1999. None of these employees were covered by collective bargaining agreements. FINOVA believes its employee relations are satisfactory.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this report are "forward-looking," in that they do not discuss historical fact but instead note future expectations, projections, intentions or other items. These forward-looking statements include matters in the sections of this report captioned "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosure About Market Risk." They are also made in documents incorporated in this report by reference, or in which this report may be incorporated, such as a prospectus.
Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause FINOVA's actual results or performance to differ materially from those contemplated by the forward-looking statements. Many of those factors are noted in conjunction with the forward-looking statements in the text. Other important factors that could cause actual results to differ include:
* The results of FINOVA's efforts to implement its business strategy. Failure to fully implement its business strategy might result in decreased market penetration, adverse effects on results of operations and other adverse results.
* The effect of economic conditions and the performance of FINOVA's borrowers. Economic conditions in general or in particular market segments could impact the ability of FINOVA's borrowers to operate or expand their businesses, which might result in decreased performance for repayment of their obligations or reduce demand for additional financing needs. The rate of borrower defaults or bankruptcies may increase. Economic conditions could adversely affect FINOVA's ability to realize gains from sales of assets and investments. Those items could be particularly sensitive to changing market conditions. Certain changes in fair market values must be reflected in FINOVA's reported financial results.
* Actions of FINOVA's competitors and FINOVA's ability to respond to those actions. As noted in "Business Development and Competition," FINOVA seeks to remain competitive without sacrificing prudent lending standards. Doing business under those standards becomes more difficult, however, when competitors offer financing with lower pricing or less stringent criteria. FINOVA may not be successful in maintaining and continuing asset growth at historic levels.
* The cost of FINOVA's capital. That cost depends on many factors, some of which are beyond FINOVA's control, such as its portfolio quality, ratings, prospects and outlook. Changes in the interest rate environment may reduce profit margins.
* Changes in government regulations, tax rates and similar matters. For example, government regulations could significantly increase the cost of doing business or could eliminate certain tax advantages of some of FINOVA's financing products.
* Necessary technological changes may be more difficult, expensive or time consuming than anticipated.
* Costs or difficulties related to integration of acquisitions.
* Other risks detailed in FINOVA's other SEC reports or filings.
FINOVA does not intend to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements. FINOVA cannot predict the risk from reliance on forward-looking statements in light of the many factors that could affect their accuracy.
ITEM 2.
ITEM 2. PROPERTIES
FINOVA's principal executive offices are located in Scottsdale, Arizona. FINOVA Capital operates various additional offices in the United States, one in Canada and one in Europe. All these properties are leased. Alternative office space could be obtained without difficulties in the event leases are not renewed.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
FINOVA is a party either as plaintiff or defendant to various actions, proceedings and pending claims, including legal actions, some of which involve claims for compensatory, punitive or other damages in significant amounts. Litigation often results from FINOVA's attempts to enforce its lending agreements against borrowers and other parties to those transactions. Litigation is subject to many uncertainties. It is possible that some of the legal actions, proceedings or claims could be decided against FINOVA. Although the ultimate amount for which FINOVA may be held liable, if any, is not ascertainable, FINOVA believes that any resulting liability would not materially affect its financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth quarter of 1999.
OPTIONAL ITEM. EXECUTIVE OFFICERS OF REGISTRANT.
Set forth below is information with respect to those individuals who serve as executive officers of FINOVA, including those officers of FINOVA Capital who are responsible for its principal business units.
Name Age Position and Background ---- --- ----------------------- Samuel L. Eichenfield 62 Chairman, President and Chief Executive Officer of FINOVA and Chairman and Chief Executive Officer or similar positions of FINOVA Capital for more than five years.
Matthew M. Breyne 42 President, Chief Operating Officer and a Director of FINOVA Capital since June 1999. Executive Vice President of FINOVA since 1998. Before that he was Group Vice President - Communications Finance and Franchise Finance or similar positions of FINOVA Capital for more than five years.
Derek C. Bruns 40 Senior Vice President - Internal Audit or similar positions of FINOVA for more than five years.
Glenn E. Gray 45 Senior Vice President - Corporate Finance Business of FINOVA Capital since January 2000; Vice President of FINOVA and Senior Vice President - Corporate Development or similar positions of FINOVA Capital since 1997. Previously he was Vice President - Business Development, Money Management of Bessemer Trust Company from 1996 to 1997. From 1994 to 1997, he was Vice President - Marketing of FINOVA Capital. From 1985 to 1993 he held various positions with a securities subsidiary and the corporate banking divisions of Wells Fargo Bank.
William J. Hallinan 57 Senior Vice President - General Counsel and Secretary of FINOVA and FINOVA Capital for more than five years.
Bruno A. Marszowski 58 Senior Vice President - Controller and Chief Financial Officer or similar positions of FINOVA and FINOVA Capital for more than five years.
William C. Roche 46 Senior Vice President - Human Resources & Facilities Planning or similar positions of FINOVA and FINOVA Capital for more than five years.
Meilee Smythe 44 Senior Vice President - Treasurer of FINOVA and FINOVA Capital since 1998. Before that she was Vice President - Assistant Treasurer of FINOVA and FINOVA Capital for more than five years and a Director of FINOVA Capital since 1998.
Stuart A. Tashlik 43 Senior Vice President - Planning & Communications of FINOVA since 1999, and Senior Vice President or similar positions of FINOVA Capital for more than five years.
John J. Bonano 57 Executive Vice President or similar positions of FINOVA Capital for more than five years.
Jack Fields, III 45 Executive Vice President or similar positions of FINOVA Capital for more than five years.
Robert M. Korte 44 Executive Vice President of FINOVA Capital since 1998. Before that he was Senior Vice President - Strategy and Technology of FINOVA since 1994 and Vice President - Human and Corporate Development of FINOVA and FINOVA Capital since 1991.
Gregory C. Smalis 47 Executive Vice President - Portfolio Management or similar positions for more than five years and a Director of FINOVA Capital since 1993.
PART II
ITEM 5.
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY & RELATED SHAREOWNER MATTERS.
The FINOVA Group Inc.'s common stock trades on the New York Stock Exchange under the symbol "FNV." The following tables summarize the high and low market prices as reported on the New York Stock Exchange Composite Tape and the cash dividends declared from January 1, 1998 through December 31, 1999.
SALES PRICE RANGE OF COMMON STOCK ---------------------------------------------- 1999 1998 --------------------- -------------------- Quarters: HIGH LOW HIGH LOW --------- -------- ------- -------- First $62-7/16 $48-1/8 $60-1/4 $45-1/2 Second 53-15/16 45-5/16 63-1/2 53-5/16 Third 54-1/2 34-3/8 65-1/8 41-1/16 Fourth 44-5/8 32-1/2 56-3/8 35-9/16
DIVIDENDS DECLARED ON COMMON STOCK ----------------------------------- 1999 1998 ------ ------ February $ 0.16 $ 0.14 May 0.16 0.14 August 0.18 0.16 November 0.18 0.16 ------ ------ $ 0.68 $ 0.60 ====== ======
Quarterly dividends have been paid on the first business day of each calendar quarter. FINOVA anticipates it will continue to pay regular quarterly dividends on the first business day of January, April, July and October. In February 2000, the Board of Directors declared a dividend of $0.18 per share, payable April 3, 2000, for shareowners of record on February 29, 2000. The declaration of dividends and their amounts are at the discretion of the Board of Directors of FINOVA, and there can be no assurance that additional dividends will be declared.
As of March 3, 2000, there were approximately 20,700 holders of record of The FINOVA Group Inc.'s common stock. The closing price of the common stock on that date was $27.75.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table summarizes selected financial data of FINOVA, which have been derived from the audited Consolidated Financial Statements of FINOVA for each of the years ended December 31, 1999, 1998, 1997, 1996 and 1995. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements of FINOVA and the Notes included in Annex A, as well as the remainder of this report. Prior year amounts have been reclassified to conform to 1999 presentation and restated to exclude operations which were discontinued in 1996 and to reflect a two-for-one stock split in 1997. For further detail, see Annex A, Note H.
December 31, ------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- RATIOS: Reserve for credit losses/managed assets (1) (2) 2.0% 2.0% 2.0% 2.0% 2.0% Nonaccruing assets/managed assets (1) 2.2% 2.0% 2.1% 2.0% 2.2% Total debt to equity (3) 6.4x 6.6x 5.6x 5.6x 6.8x Return on average common equity 14.4% 14.1% 14.1% 13.5% 12.0% Return on average funds employed (4) 2.0% 1.8% 1.8% 1.8% 1.7% Equity to assets (3) 12.6% 12.2% 13.8% 13.9% 11.8%
- ---------- NOTES: (1) Managed assets exclude participations. (2) Managed assets exclude financing contracts held for sale. (3) Equity in 1999, 1998, 1997 and 1996 includes the TOPrS noted above. (4) Average funds employed excludes deferred taxes applicable to leveraged leases.
----------
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
See pages 3 - 12 of Annex A.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
See page 13 of Annex A.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS & SUPPLEMENTAL DATA.
1. Financial Statements - See Item 14 hereof and Annex A.
2. Supplementary Data - See Condensed Quarterly Results included in Supplemental Selected Financial Data of Notes to Consolidated Financial Statements included in Annex A.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING & FINANCIAL DISCLOSURE.
See Recent Developments and Business Outlook on page 11-12 of Annex A.
PART III
ITEM 10.
ITEM 10. DIRECTORS & EXECUTIVE OFFICERS OF THE REGISTRANT.
The information concerning FINOVA's directors is incorporated by reference from FINOVA's Proxy Statement issued in connection with its 2000 Annual Meeting of Shareowners (the "Proxy Statement").
For information regarding FINOVA's executive officers, see the Optional Item in Part I, following Item 4.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference from the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS & MANAGEMENT.
The information required by this item is incorporated by reference from the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS & RELATED TRANSACTIONS.
The information required by this item is incorporated by reference from the Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed.
1. Financial Statements.
The following financial statements of FINOVA are included in Annex A:
Annex A Page ------- Financial Highlights 1-2 Management's Discussion and Analysis of Financial Condition and Results of Operations 3-12 Quantitative and Qualitative Disclosure about Market Risk 13 Report of Management, Report of Independent Auditors and Independent Auditors' Report 14-16 Consolidated Balance Sheets 17 Statements of Consolidated Income 18 Statements of Consolidated Shareowners' Equity 19 Statements of Consolidated Cash Flows 20 Notes to Consolidated Financial Statements 21-42 Supplemental Selected Financial Data 43
2. All Schedules have been omitted because they are not applicable or the required information is shown in the financial statements or related notes.
3. Exhibits.
Exhibit No. ----------- (3.A) Amended and Restated Certificate of Incorporation through the date of this filing (incorporated by reference from FINOVA's Registration Statement on Form S-3/A, SEC File No. 333-74473, filed on May 28, 1999, Exhibit 4.1).
(3.B) Bylaws, as amended through the date of this filing (incorporated by reference from FINOVA's report on Form 10-K for the year ended December 31, 1995 (the "1995 10-K") Exhibit 3.B).
(4.A) Form of FINOVA's Common Stock Certificate (incorporated by reference from the 1994 10-K, Exhibit 4.B).
(4.B) Relevant portions of FINOVA's Certificate of Incorporation and Bylaws included in Exhibits 3.A and 3. B above are incorporated by reference.
(4.C) Rights Agreement dated as of February 15, 1992 between FINOVA and the Rights Agent named therein, as amended (incorporated by reference from FINOVA's report on Form 8-K dated September 21, 1995, Exhibit 4.1).
(4.C.1) Acceptance of Successor Trustee to Appointment under Rights Agreement noted in 4-C above (incorporated by reference from FINOVA's report on Form 8-K, dated November 30, 1995, Exhibit 4).
(4.D) Long-term debt instruments with principal amounts not exceeding 10% of FINOVA's total consolidated assets are not filed as exhibits to this report. FINOVA will furnish a copy of those agreements to the SEC upon its request.
(4.E) Form of Indenture dated as of September 1, 1992 between FINOVA Capital and the Trustee named therein (incorporated by reference from the Greyhound Financial Corporation Registration Statement on Form S-3, Registration No. 33-51216, Exhibit 4).
(4.F) Form of Indenture dated as of October 1, 1995 between FINOVA Capital and the Trustee named therein (incorporated by reference from FINOVA Capital's report on Form 8-K dated October 24, 1995, Exhibit 4.1).
(4.G) Indenture, dated as of December 11, 1996, between FINOVA and Fleet National Bank as trustee (incorporated by reference from FINOVA's report on Form 8-K dated December 20, 1996, (the "December 1996 8-K") Exhibit 4.1).
(4.G.1) Indenture, dated as of May 15, 1999, between FINOVA Capital and Norwest Bank Minnesota, National Association (incorporated by reference from FINOVA's Registration Statement on Form S-3/A, SEC File No. 333-74473, filed on May 28, 1999, Exhibit 4.8.B).
(4.G.2) Indenture, dated as of May 15, 1999, between FINOVA Capital and FMB Bank (incorporated by reference from FINOVA's Registration Statement on Form S-3/A, SEC File No. 333-74473, filed on May 28, 1999, Exhibit 4.8.C).
(4.G.3) Indenture, dated as of May 15, 1999 between FINOVA Capital and The First National Bank of Chicago (incorporated by reference from FINOVA's Registration Statement on Form S-3/A, SEC File No. 333-74473, filed on May 28, 1999, Exhibit 4.8.A).
Exhibit No. ----------- (4.G.4) Form of Trust Indenture among FINOVA (Canada) Finance Inc., FINOVA Capital Corporation and CIBC Mellon Trust Company made as of February 25, 2000.
(4.G.5) Amended and Restated Declaration of Trust, dated as of December 11, 1996, among Bruno A. Marszowski and Robert J. Fitzsimmons, as Regular Trustees, First Union Bank of Delaware, as Delaware Trustee, Fleet National Bank, as Property Trustee, and FINOVA (incorporated by reference from the December 1996 8-K, Exhibit 4.2).
(4.G.6) Preferred Security Guarantee, dated as of December 11, 1996, between FINOVA and Fleet National Bank, as trustee (incorporated by reference from the December 1996 8-K, Exhibit 4.3).
(4.G.7) Form of 5 1/2% Convertible Subordinated Debenture (incorporated by reference from the December 1996 8-K, Exhibit 4.4).
(4.G.8) Form of Preferred Security (TOPrS) (incorporated by reference from the December 1996 8-K, Exhibit 4.5).
(4.H) Form of Indenture, dated as of March 20, 1998, between FINOVA, FINOVA Capital and The First National Bank of Chicago as Trustee (incorporated by reference from FINOVA and FINOVA Capital's registration statement on Form S-3, Registration No. 333-38171, Exhibit 4.8).
(4.I) Announcement of 2-for-1 Stock Split (incorporated by reference from FINOVA's August 14, 1998 8-K, Exhibit 28).
(4.I.1) Letter to shareowners regarding FINOVA's 2-for-1 Stock Split (incorporated by reference from FINOVA's October 1, 1998 8-K, Exhibit 28.A)
(4.I.2) Letter to holders of Preferred Securities regarding the 2-for-1 common stock split and resulting adjustment in conversion price applicable to the Convertible Trust Originated Preferred Securities of FINOVA Finance Trust (incorporated by reference from FINOVA's October 1, 1998 8-K, Exhibit 28.B).
(4.J) 1992 Stock Incentive Plan, as amended through the date of this filing (incorporated by reference from the 1997 10-K, Exhibit 4.J).+
(4.K) Sirrom Capital Corporation Amended and Restated 1994 Stock Option Plan (incorporated by reference from FINOVA's report on Form 10-K/A for the year ended December 31, 1998 (the "1998 10-K/A") Exhibit 4.K).
(4.L) Sirrom Capital Corporation Amended and Restated Stock Option Plan for Non-employee Directors (incorporated by reference from the 1998 10-K/A, Exhibit 4.L).
(4.M) Director resolutions dated February 11, 1999, regarding adoption of the Sirrom stock option plans (incorporated by reference from the 1998 10-K/A, Exhibit 4.N).
(4.N) Sirrom Capital Corporation Amended and Restated 1996 Incentive Stock Option Plan (incorporated by reference from the 1998 10-K, Exhibit 4.M).
Exhibit No. ----------- (10.A) Sixth Amendment and Restatement dated as of May 16, 1994 of the Credit Agreement, dated as of May 31, 1976 among FINOVA Capital and the lender parties thereto, and Bank of America National Trust and Savings Association, Bank of Montreal, Chemical Bank, Citibank, N.A. and National Westminister Bank USA, as agents (the "Agents") and Citibank, N.A., as Administrative Agent (incorporated by reference from FINOVA's report on Form 8-K dated May 23, 1994, Exhibit 10.1).
(10.A.1) First Amendment dated as of September 30, 1994, to the Sixth Amendment and Restatement, noted in 10.A above (incorporated by reference from the 1994 10-K, Exhibit 10.A.1).
(10.A.2) Second Amendment dated as of May 11, 1995 to the Sixth Amendment and Restatement noted in 10.A above (incorporated by reference from FINOVA's Quarterly Report on Form 10-Q for the period ending September 30, 1995 (the "3Q95 10-Q"), Exhibit 10.A).
(10.A.3) Third Amendment dated as of November 1, 1995 to Sixth Amendment noted in 10.A above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.B).
(10.A.4) Fourth Amendment dated as of May 15, 1996, to Sixth Amendment noted in 10.A above (incorporated by reference from the 1996 10-K, Exhibit 10.A.4).
(10.A.5) Fifth Amendment dated as of May 20, 1997 to Sixth Amendment noted in 10.A above (incorporated by reference from the 1997 10-K, Exhibit 10.A.5).
(10.A.6) Sixth Amendment dated as of May 17 1999 to Sixth Amendment and Restatement of Credit Agreement dated as of May 16, 1994. *
(10.B) Credit Agreement (Short-Term Facility) dated as of May 16, 1994 among FINOVA Capital, the Lender parties thereto, the Agents and Citibank, N.A., as Administrative Agent (incorporated by reference from FINOVA's report on Form 8-K dated May 23, 1994, Exhibit 10.2).
(10.B.1) First Amendment dated as of September 30, 1994 to the Credit Agreement noted in 10.B above (incorporated by reference from the 1994 10-K, Exhibit 10.B.1).
(10.B.2) Second Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.C).
(10.B.3) Third Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.D).
(10.B.4) Fourth Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from 1996 10-K, Exhibit B.4).
(10.B.5) Fifth Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 1997 10-K, Exhibit 10.B.5).
(10.B.6) Sixth Amendment to Short-Term Facility noted in 10.B above. *
(10.C) 1999 Management Incentive Plan (incorporated by reference from the 1998 10-K/A, Exhibit 10.D). +
(10.D) 2000 Management Incentive Plan.*+
Exhibit No. ----------- (10.E.1) 1997-1999 Performance Share Incentive Plan (incorporated by reference from the 1997 10-K, Exhibit 10.E.3).+
(10.E.2) 1998-2000 Performance Share Incentive Plan (incorporated by reference from the 1997 10-K, Exhibit 10.E.4).+
(10.E.3) 1999-2001 Performance Share Incentive Plan (incorporated by reference from the 1998 10-K, Exhibit 10.E.4). +
(10.E.4) 2000-2002 Performance Share Incentive Plan.*+
(10.F) Employment Agreement with Samuel L. Eichenfield dated March 16, 1996 (incorporated by reference from the 1995 10-K, Exhibit 10.F.3).+
(10.F.1) Amendment to Employment Agreement referenced in 10.G above (incorporated by reference from the 1996 10-K, Exhibit 10.F.2).+
(10.F.2) Second Amendment to Employment Agreement referenced in 10.G above (incorporated by reference from the 2Q97 10-Q, Exhibit 10).+
(10.G) Employment Agreement with William J. Hallinan, dated February 25, 1992 (incorporated by reference from the 1992 10-K, Exhibit 10.1).+
(10.H) Amended and Restated Supplemental Pension Plan, (incorporated by reference from the 1996 10-K, Exhibit 10.1).+
(10.I) A description of FINOVA's policies regarding compensation of directors is incorporated by reference from the 2000 Proxy Statement. +
(10.J) Directors Deferred Compensation Plan (incorporated by reference from the 1992 10-K, Exhibit 10.O).+
(10.K) Directors' Retirement Benefit Plan (incorporated by reference from FINOVA's report on Form 10-K for the year ended December 31, 1993 (the "1993 10-K"), Exhibit 10.OO).+
(10.L) Directors' Charitable Awards Program (incorporated by reference from the 1994 10-K, Exhibit 10.CC).+
(10.M) Deferred Compensation Plan (incorporated by reference from the 1995 10-K, Exhibit 10.N).+
(10.N) Bonus KEYSOP Plan (incorporated by reference from the 1997 10-K, Exhibit 10.N).+
(10.N.1) Bonus KEYSOP Trust Agreement (incorporated by reference from the 1997 10-K, Exhibit 10.N.1).+
(10.O) FINOVA's Executive Officer Loan Program Policies and Procedures, (incorporated by reference from the 1996 10-K, Exhibit 10.U).+
(10.O.1) FINOVA's Executive Severance Plan for Tier 1 Employees (incorporated by reference from the 1995 10-K, Exhibit 10.C.1).+
Exhibit No. ----------- (10.O.2) FINOVA's Executive Severance Plan for Tier 2 Employees (incorporated by reference from the 1995 10-K, Exhibit 10.C.2).+
(10.P.1) Value Sharing Plan for the Chief Executive Officer (incorporated by reference from the 3Q95 10-Q, Exhibit 10.L).+
(10.P.2) Value Sharing Plan for Executive Officers and Key Employees (incorporated by reference from the 3Q95 10-Q, Exhibit 10-K).+
(12) Computation of ratio of Income to Fixed Charges and Preferred Stock Dividends.*
(21) Subsidiaries.*
(23) Consent of Independent Auditors from Ernst & Young LLP.*
(23.1) Independent Auditors' Consent from Deloitte & Touche LLP.*
(24) Powers of Attorney.*
(27) Financial Data Schedule for the year ended December 31, 1999.*
- ---------- * Filed with this report. + Relating to management compensation
(b) Reports on Form 8-K.
A report on Form 8-K, dated January 20, 2000, was filed by FINOVA which reported under Items 5 and 7 the revenues, net income and selected Financial and ratios for fourth quarter and year ended December 31, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the capacities indicated, in Scottsdale, Arizona on March 7, 2000.
THE FINOVA GROUP INC.
By /s/ Samuel L. Eichenfield ---------------------------------------- Samuel L. Eichenfield Chairman, President and Chief Executive Officer (Chief Executive Officer)
By: /s/ Bruno A. Marszowski ---------------------------------------- Bruno A. Marszowski Senior Vice President - Controller and Chief Financial Officer (Chief Accounting and Financial Officer)
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
* * - -------------------------------- ------------------------------ Robert H. Clark, Jr. (Director) G. Robert Durham (Director)
/s/ Samuel L. Eichenfield * - -------------------------------- ------------------------------ Samuel L. Eichenfield (Chairman) James L. Johnson (Director)
* * - -------------------------------- ------------------------------ Kenneth R. Smith (Director) Shoshana B. Tancer (Director)
* * - -------------------------------- ------------------------------ John W. Teets (Director) Constance R. Curran (Director)
* Signed on March 7, 2000, pursuant to Powers of Attorney dated February 10, 2000.
/s/ Bruno A. Marszowski ----------------------- Bruno A. Marszowski Attorney-in-Fact
ANNEX A
THE FINOVA GROUP INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Financial Highlights ..................................................... A-1
Management's Discussion and Analysis of Financial Condition and Results of Operations .................................................. A-3
Quantitative and Qualitative Disclosure about Market Risk ................ A-13
Management's Report on Responsibility for Financial Reporting ............ A-14
Report of Independent Auditors ........................................... A-15
Independent Auditors' Report ............................................. A-16
Consolidated Balance Sheet ............................................... A-17
Statements of Consolidated Income ........................................ A-18
Statements of Consolidated Shareowners' Equity ........................... A-19
Statements of Consolidated Cash Flows .................................... A-20
Notes to Consolidated Financial Statements ............................... A-21
Supplemental Selected Financial Data ..................................... A-43
A-i
THE FINOVA GROUP INC.
FINANCIAL HIGHLIGHTS (Dollars in Thousands, except per share data)
YEARS ENDED DECEMBER 31, 1999 1998 1997 - ------------------------ ---- ---- ---- OPERATIONS: Interest margins earned $ 567,798 $ 459,515 $ 392,124 Volume-based fees 50,080 77,723 39,378 Operating expenses 253,754 216,653 168,444 Net income 215,244 160,341 137,910
FINANCIAL POSITION: Ending funds employed 13,121,977 10,020,221 8,420,462 Ending managed assets (1) 13,605,374 10,557,817 8,878,429 Average managed assets (2) 11,845,460 9,502,823 8,156,242 Average earning assets (3) 10,718,941 8,546,715 7,360,012 Reserve for credit losses 264,983 207,618 177,088 Nonaccruing assets 295,123 205,233 187,356 Funded new business 4,865,746 3,979,265 3,311,105 Fee-based volume 6,315,296 7,257,003 4,532,494 Net write-offs 56,854 56,758 43,200
CAPITALIZATION: Total debt 11,407,767 8,394,578 6,764,581 Company-obligated mandatory redeemable convertible preferred securities of a subsidiary trust solely holding convertible debentures of FINOVA ("TOPrS") 111,550 111,550 111,550 Shareowners' equity 1,663,381 1,167,231 1,092,254
PORTFOLIO QUALITY: Net write-offs as a % of average managed assets (4) 0.48% 0.60% 0.53% Nonaccruing assets as a % of ending managed assets (4) 2.2% 2.0% 2.1% Reserve for credit losses as a % of: Ending managed assets (4) (5) 2.0% 2.0% 2.0% Nonaccruing assets 89.8% 101.2% 94.5% As a multiple of net write-offs 4.7x 3.7x 4.1x
A-1
FINANCIAL HIGHLIGHTS Continued
1999 1998 1997 ---- ---- ---- PERFORMANCE HIGHLIGHTS: Return as a % of average funds employed (6) 2.0% 1.8% 1.8% Operating margin earned as a % of average earning assets (3) 5.8% 6.3% 5.9% Interest margins earned as a % of average earning assets (3) 5.3% 5.4% 5.3% Operating expenses as a % of operating margin 41.1% 40.3% 39.0% Operating expenses as a % of operating margin plus gains 37.0% 38.3% 36.5% Aggregate cost of funds 6.1% 6.4% 6.6% Ratio of income to fixed charges and preferred stock dividends 1.58x 1.53x 1.51x Return from continuing operations on average equity 14.4% 14.1% 14.1% Basic earnings per common share: Net income $ 3.59 $ 2.87 $ 2.53 Adjusted weighted average shares 59,880,000 55,946,000 54,405,000 Diluted earnings per share: Net income $ 3.41 $ 2.70 $ 2.40 Adjusted weighted average shares 64,300,000 60,705,000 59,161,000 Cash earnings per diluted share (7) $ 5.06 $ 4.18 $ 3.65 Book value per share outstanding $ 27.16 $ 20.95 $ 19.41 Shares outstanding 61,252,000 55,721,000 56,282,000
- ---------- (1) Includes assets sold under securitization and participation agreements that are serviced by the Company. (2) Includes average securitizations and participations of $520.7 million, $484.5 million and $388.9 million for 1999, 1998 and 1997, respectively. (3) Represents average funds employed excluding average deferred taxes on leveraged leases of $356.4 million, $275.9 million and $234.4 million for 1999, 1998 and 1997, respectively and average nonaccruing assets. (4) Excludes participations sold of $62.1 million, $101.5 million and $121.4 million for 1999, 1998 and 1997, respectively, in which the Company has transferred credit risk. (5) Excludes financing contracts held for sale of $168.0 million and $220.1 million for 1999 and 1998, respectively. (6) Average funds employed excludes average deferred taxes on leveraged leases. (7) Cash earnings exclude goodwill amortization, non-cash loss provisions and non-cash taxes.
A-2
THE FINOVA GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION RELATES TO THE FINOVA GROUP INC. AND ITS SUBSIDIARIES (COLLECTIVELY, "FINOVA" OR THE "COMPANY") INCLUDING FINOVA CAPITAL CORPORATION AND ITS SUBSIDIARIES (COLLECTIVELY, "FINOVA CAPITAL").
RESULTS OF OPERATIONS
The following table summarizes FINOVA's operating results for the years ended December 31, 1999, 1998 and 1997:
1999 COMPARED TO 1998
Net income for 1999 increased 34% to $215.2 million from $160.3 million in 1998. The increase was due to 25% growth in average earning assets, higher gains on disposal of assets and a lower provision for credit losses, partially offset by lower volume-based fees and higher operating expenses in 1999. Net income in 1999 included activity from the Sirrom Capital Corporation ("Sirrom") and Preferred Business Credit acquisitions, which were acquired during the first quarter of 1999 and to a much lesser extent, the Fremont Financial Corporation acquisition, which occurred late in the fourth quarter of 1999. See Note R of Notes to Consolidated Financial Statements for further discussion.
INTEREST MARGINS EARNED. The net spread from the portfolio is represented by interest margins earned, which is the difference between (a) income earned from financing transactions and (b) interest expense and depreciation on operating leases and other owned assets. Interest margins earned increased 24% to $567.8 million in 1999 from $459.5 million in 1998, due primarily to the growth in average earning assets.
Average earning assets, which represents the average of FINOVA's investment in financing transactions less nonaccruing assets and deferred taxes related to leveraged leases, increased to $10.72 billion in 1999 from $8.55 billion in 1998. The increase was primarily due to an increase in funded new business to $4.87 billion from $3.98 billion in 1998 and $453.7 million of average earning assets added through acquisitions in 1999, partially offset by normal amortization of the portfolio and prepayments during the year.
VOLUME-BASED FEES. Volume-based fees are generated by FINOVA's Distribution & Channel Finance, Commercial Services and Realty Capital lines of business on the volume of purchased accounts receivable and mortgage loan originations transacted during the year. Due to the short-term nature of volume-originated business, these fees are recognized as income in the period of origination.
A majority of Realty Capital's mortgage loan originations are funded by other lenders and, therefore, are not recorded on FINOVA's balance sheet. FINOVA took steps to eliminate balance sheet exposure in 2000 from the commercial mortgage backed securities ("CMBS") product by entering into a Preferred Partner Program with a prominent investment banking firm during the fourth quarter of 1999. See the Recent Developments and Business Outlook section for a further discussion.
Volume-based fees were down by $27.6 million to $50.1 million in 1999 from $77.7 million in 1998 due to lower fee-based volume in 1999 and returns on that volume that were lower by 0.27% (0.80% in 1999 vs 1.07% in 1998). Fee-based volume was down by $942 million to $6.32 billion in 1999 from $7.26 billion in 1998 primarily due to lower volume originated by Realty Capital. Realty Capital curtailed its CMBS volume in 1999, which declined to $757.8 million from $1.76 billion in 1998; while its structured finance volume increased to $1.31 billion
A-3
THE FINOVA GROUP INC.
from $1.05 billion in 1998. The shift in product mix resulted in a decline in Realty Capital's commission rate to 0.50% from 0.88% in 1998. Structured finance deals carry a lower net rate than CMBS transactions.
OPERATING MARGIN. Lower volume-based fees in 1999 was the major reason for the decrease in FINOVA's operating margin as a percentage of average earning assets to 5.8% in 1999 from 6.3% in 1998. The interest rate spread portion of this margin decreased slightly to 5.3% in 1999 from 5.4% in 1998 primarily due to the effects of competitive pricing pressures and increased debt costs related to the strategic decisions to utilize a global debt offering, which increased debt costs in the short-term, but is anticipated to help control costs in future periods and the extension of maturities on commercial paper over year end 1999, thereby avoiding potential liquidity issues associated with Year 2000 concerns. The liquidity issues anticipated ultimately did not materialize in the marketplace. The proceeds from the global debt offering were used to pay down lower costing commercial paper. FINOVA expects competitive pressures on pricing to continue, which may offset any cost of funds benefits realized from the global debt offering and by reducing maturities on commercial paper to an average term of 30 to 60 days in 2000.
PROVISION FOR CREDIT LOSSES. The provision for credit losses was $76.8 million in 1999 compared to $82.2 million in 1998. Provision for credit losses is taken to maintain the reserve for credit losses at a level deemed by management to be adequate to cover inherent losses in the portfolio. During 1999, it was determined that the Company did not need to record as large a provision for credit losses as was necessary in 1998 to maintain the reserve for credit losses at an appropriate level.
The provision for credit losses was affected by net write-offs. Net write-offs in 1999 of $56.9 million were comparable to 1998 levels of $56.8 million. As a percent of average managed assets, net write-offs in 1999 were 0.48% compared to 0.60% in 1998. The decline in the write-off percentage was primarily due to the Commercial Services line of business, which experienced problems in 1998 with its wholesale textile customers. As a result of refocusing its portfolio toward more retail customers in 1999, net write-offs in this business unit decreased to $7.4 million from $35.7 million in 1998. Conversely, Corporate Finance experienced a higher level of problem accounts resulting in $17.9 million of net write-offs in 1999 compared to $6.7 million in 1998, accompanied by $8.2 million of net write-offs for the Mezzanine Capital (Sirrom) portfolio which was acquired in the first quarter of 1999.
GAINS ON DISPOSAL OF ASSETS. Gains on disposal of assets were $68.0 million in 1999 compared to $27.9 million in 1998. Gains in 1999 included $20.6 million from the sale of residuals coming off lease, $35.6 million from the sale of investments and $11.8 million of CMBS gains as compared to 1998 gains which were predominately related to residual sales and included a net loss of $7.2 million on CMBS transactions. This shift in the composition of gain activity is expected to continue due to FINOVA's expansion into capital market activities.
While in the aggregate, FINOVA has historically recognized gains on the disposal of assets it holds, the timing and amount of these gains are sporadic in nature. There can be no assurance FINOVA will recognize such gains in the future, depending in part on market conditions at the time of disposal. The range of gain activity is dependent upon the level of residuals coming off lease and the level of capital market activity which will fluctuate with market conditions and management's discretion whether to sell marketable investments. FINOVA generally anticipates gains on disposal of assets to range from 15% to 25% of pretax income.
OPERATING EXPENSES. Operating expenses, which include selling, administrative and other expenses, were generally higher in all major categories and increased to $253.8 million in 1999 compared to $216.7 million in 1998. Personnel costs increased due to the acquisitions of Preferred Business Credit (included in Growth Finance) in February 1999, Sirrom Capital Corporation (included in Mezzanine Capital and Harris Williams & Co.) in March 1999 and Fremont Financial Corporation (included in Business Credit) in December 1999 and due to higher sales incentive compensation related to the increased new business levels in 1999. Problem accounts costs increased in 1999 due to increases in nonearning and impaired accounts. Additions to deferred acquisition costs increased in 1999 due to acquisitions and the deferral of expenses incurred to book new business. Operating expenses as a percentage of operating margin plus gains was 37.0% in 1999, an improvement from 38.3% in 1998. See Note O of Notes to Consolidated Financial Statements for additional detail.
INCOME TAXES. Income taxes were $136.3 million in 1999 compared to $102.2 million in 1998. The increase was primarily due to higher pre-tax income in 1999. See Note J of Notes to Consolidated Financial Statements for further discussion of income taxes.
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THE FINOVA GROUP INC.
PREFERRED DIVIDENDS. Dividends, net of tax, paid on $111.6 million of outstanding Company-obligated mandatory redeemable convertible preferred securities ("TOPrS") was $3.8 million in 1999 and in 1998.
1998 COMPARED TO 1997
Net income for 1998 increased 16.3% to $160.3 million from $137.9 million in 1997. The increase was due to the growth in average earning assets and the expansion of the fee-related businesses, partially offset by a $10.0 million loss on the sale of commercial mortgage-backed securities (CMBS) through mini-CMBS transactions. See Note B of Notes to Consolidated Financial Statements for a further discussion. Other offsetting items included a higher provision for credit losses, increased operating expenses and a higher effective tax rate. Net income in 1998 included a full year of Realty Capital and AT&T Capital's Inventory Finance unit, both of which were acquired in the fourth quarter of 1997.
INTEREST MARGINS EARNED. Interest margins earned increased 17.2% to $459.5 million in 1998 from $392.1 million in 1997, due primarily to a 16.1% increase in average earning assets in 1998.
Average earning assets increased to $8.55 billion in 1998 from $7.36 billion in 1997. The increase was primarily due to a 20.2% increase in funded new business of $3.98 billion compared to $3.31 billion in 1997, partially offset by normal amortization of the portfolio and prepayments during the year.
VOLUME-BASED FEES. The 97.4% increase in volume-based fees to $77.7 million in 1998 from $39.4 million in 1997 was primarily due to fee-based volume increasing by 60.1% to $7.26 billion in 1998 compared to $4.53 billion in 1997. The increased volume was attributable to the addition of Realty Capital and AT&T Capital's Inventory Finance unit.
The increase in volume-based fees in 1998 was the major reason for the growth of FINOVA's operating margin as a percentage of average earning assets to 6.3% in 1998 from 5.9% in 1997. The interest rate spread portion of this margin increased slightly to 5.4% in 1998 from 5.3% in 1997.
PROVISION FOR CREDIT LOSSES. The provision for credit losses increased 18.8% to $82.2 million in 1998 compared to $69.2 million in 1997. The increase in the provision reflected the growth in managed assets of 18.9% to $10.56 billion in 1998 from $8.88 billion in 1997 and an increase in net write-offs in 1998 to $56.8 million compared to $43.2 million in 1997. The higher level of write-offs in 1998 was primarily due to prior credit problems experienced in FINOVA's Commercial Services line of business which had net write-offs of $35.7 million in 1998 principally related to the business' wholesale textile customers. The 1998 Commercial Services write-offs represented problems identified in 1997 that the Company believed could be worked out. Unfortunately, the results of those efforts were unsuccessful, resulting in increased write-offs for 1998. Net write-offs by line of business and other changes in the reserve for credit losses can be found in Note C of Notes to Consolidated Financial Statements.
GAINS ON DISPOSAL OF ASSETS. Gains on disposal of assets were $27.9 million in 1998 compared to $30.3 million in 1997. Gains on disposal of assets included the sale of loans via the CMBS market, the sale of assets coming off lease and the sale of other assets. Sales of CMBS transactions (permanent and mini-CMBS structures) resulted in a net loss of $7.2 million in 1998 and consisted of gross gains of $25.0 million offset by hedge losses, commissions, expenses and recourse obligations of $32.2 million. The total net loss on CMBS transactions of $7.2 million included a net mini-CMBS loss of $10.0 million from the utilization of the mini-CMBS structure to sell loans warehoused by FINOVA Realty Capital and gains of $2.8 million from other CMBS securitizations. The other $35.1 million of net gains in 1998 resulted from the sale of assets coming off lease, Franchise Finance loans and other assets. In April 1999, approximately 70% of the assets within the mini-CMBS structure were sold into a permanent CMBS structure. See Note B of Notes to the Consolidated Financial Statements for a further discussion of the mini-CMBS transactions.
OPERATING EXPENSES. Operating expenses were generally higher in all major categories and increased to $216.7 million in 1998 compared to $168.4 million in 1997. This increase was partially attributable to the growth in managed assets during the year and to incentives paid to employees based on performance criteria such as profitability and the increased value of FINOVA's stock. Also contributing to the increase was the addition of Realty Capital, which had a higher operating cost structure than other FINOVA lines of business, including over 80 business development officers and support staff. Operating expenses were 38.3% of operating margin plus gains for 1998 compared to 36.5% in 1997. See Note O of Notes to Consolidated Financial Statements for additional data.
INCOME TAXES. Income taxes were $102.2 million in 1998 compared to $82.3 million in 1997. The increase was primarily due to higher pre-tax income and a higher effective tax rate in 1998 due to the realization of certain tax credits in 1997.
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THE FINOVA GROUP INC.
PREFERRED DIVIDENDS. Dividends, net of tax, paid on $111.6 million of outstanding TOPrS were $3.8 million in 1998 compared to $4.0 million in 1997.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Managed assets at December 31, 1999 increased 29% to $13.61 billion from $10.56 billion at December 31, 1998. The increase was due to funded new business of $4.9 billion in 1999 compared to $4.0 billion in 1998, plus $1.1 billion of assets acquired in 1999, partially offset by normal loan and lease amortization, asset sales and prepayments. Excluding acquired assets, managed assets grew by $1.9 billion or 18% during 1999. See Note R of Notes to Consolidated Financial Statements for a further discussion of acquisitions.
FINOVA's reserve for credit losses increased to $265.0 million at December 31, 1999 from $207.6 million at year-end 1998. The increase primarily consisted of provisions of $76.8 million and acquired reserves of $37.4 million, partially offset by net write-offs totaling $56.9 million. At December 31, 1999, the reserve represented 2.0% of managed assets (excluding participations sold and financing contracts held for sale); the same level as one year ago. Nonaccruing assets increased to $295.1 million at December 31, 1999 representing 2.2% of ending managed assets (excluding participations sold) compared to $205.2 million in nonaccruing assets as of December 31, 1998, which constituted 2.0% of ending managed assets. The increase in nonaccruing assets was primarily due to the transition of FINOVA's $33 million share of a large syndicated credit facility held by its Healthcare Finance line of business to nonaccruing status in the third quarter and the addition of nonaccruing assets in the acquired Sirrom portfolio. At December 31, 1999, the reserve represented 89.8% of nonaccruing assets compared to 101.2% at December 31, 1998. See Note C of Notes to Consolidated Financial Statements for more information on the reserves, net write-offs and nonaccruing assets.
Revenue accruing impaired assets increased to $240.1 million in 1999, from $106.0 million in 1998. This increase was primarily due to the addition of a large computer and computer components distribution account ($69.6 million) in Distribution & Channel Finance, the addition of 9 accounts included in the acquired Sirrom portfolio ($22.0 million), the addition of a home health services account ($17.7 million) in Healthcare Finance and the addition of a trucking company account ($17.1 million) in Corporate Finance.
The Company had total debt outstanding of $11.41 billion at December 31, 1999 or 6.4 times its equity base (shareowners' equity plus convertible preferred securities) of $1.77 billion (FINOVA Capital's leverage as of December 31, 1999 was 6.5 to 1). At December 31, 1998, the Company had debt leverage of 6.6 times its equity base ($8.39 billion debt outstanding to $1.28 billion of equity). Deferred income taxes, which are used to finance a portion of FINOVA's assets, grew 28.4% during 1999 to $439.5 million from $342.3 million at year-end 1998.
Growth in managed assets is generally financed by internally generated cash flows and borrowings. During 1999, FINOVA Capital issued $3.4 billion in new senior debt. These funds were used to finance new business and to redeem or retire $809 million of debt. During 1999, the Company also issued approximately 6.1 million and 0.2 million shares of its common stock as the primary consideration for the acquisitions of Sirrom and Preferred Business Credit, respectively. See Note R of Notes to Consolidated Financial Statements for further detail.
FINOVA satisfies a significant portion of its cash requirements from a diversified group of worldwide funding sources and is not dependent on any one lender. FINOVA also relies on the issuance of commercial paper as a major funding source. During 1999, FINOVA Capital issued $19.0 billion of commercial paper, at a weighted average cost of 5.4% (with an average of $4.1 billion outstanding during the year) and raised $3.4 billion, as noted above, through new long-term financings of one to ten year maturities. Commercial paper and short-term bank borrowings totaled $3.9 billion at December 31, 1999 and 1998, and were supported by available unused revolving credit lines which, if not renewed, are convertible to long-term debt at FINOVA's option. During 1999, FINOVA extended maturities on commercial paper over year end, beyond the average 58-day maturity, thereby avoiding potential liquidity issues associated with Year 2000 concerns. The liquidity issues anticipated ultimately did not materialize.
At December 31, 1999, FINOVA Capital maintained a multi-year revolving credit facility and a 364-day facility with numerous lenders, in the aggregate principal amount of $2.0 billion. Separately, FINOVA Capital also had two multi-year facilities with numerous lenders for $700 million each and two 364-day facilities with numerous lenders for $600 million and $500 million, respectively. These credit facilities, aggregating $4.5 billion, support FINOVA's outstanding commercial paper and short-term borrowings. The Company does not intend to borrow under the domestic revolving credit agreements to refinance commercial paper and short-term bank loans unless it encounters significant difficulties in rolling over its outstanding commercial paper and short-term bank loans. The 364-day $1.0 billion, $600 million and $500 million
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revolving credit agreements are subject to renewal in 2000, while the two $700 million and the other $1.0 billion credit facilities are subject to renewal in 2002. In addition to the above, FINOVA has a 364-day revolving credit facility with one lender for $25 million, which is subject to renewal in 2000.
The Company, through one subsidiary, utilizes a multi-year multi-currency facility with a small group of lenders for $100 million. Through another subsidiary, the Company maintains a 364-day revolving credit facility with three lenders in Canada for C$150 million. FINOVA Capital is the guarantor of these credit facilities, which are subject to renewal in 2002 and 2000, respectively.
The Company, through the acquisition of Fremont Financial Corporation in December 1999, assumed a trust financed with floating-rate debt and commercial paper. The commercial paper program is backed by a 364-day facility with a small group of lenders for $150 million. The facility is drawn upon to fund assets in the trust. As of December 31, 1999, $46 million of commercial paper was outstanding under this program.
In 1998, FINOVA Capital commenced a Euro Medium-Term Note Program allowing for the issuance of up to $1.0 billion of debt securities. In 1999, FINOVA Capital plc, FINOVA's U.K. subsidiary, was added to the program. As of December 31, 1999, there was $581 million available to issue under the program.
In 1999, FINOVA and FINOVA Capital jointly filed a universal shelf registration statement with the SEC allowing for the issuance of $3.0 billion of senior debt securities, common stock, preferred stock, depositary shares and warrants to purchase common stock or debt securities. Under this shelf, the Company issued an aggregate $2.35 billion of debt in 1999 including a global debt offering of $1.5 billion in November 1999. At December 31, 1999, $645 million remained available under the shelf registration, of which $120 million had been designated for the issuance of medium term notes.
The agreements pertaining to long-term debt include various restrictive covenants and require the maintenance of certain defined financial ratios with which FINOVA, FINOVA Capital and FINOVA Capital plc have complied, as applicable.
FINOVA Capital's aggregate cost of funds decreased to 6.1% for 1999 from 6.4% for 1998 as a result of a decline in market rates, partially offset by the additional cost related to the extension of maturities on commercial paper over year end 1999 to avoid potential liquidity issues associated with Year 2000 concerns. FINOVA's cost of and access to capital is dependent, in large part, on its credit ratings. FINOVA Capital has maintained investment-grade ratings since 1976. FINOVA Capital currently has investment-grade ratings from the following agencies:
Senior Commercial Paper Debt ---------------- ------ Duff & Phelps Credit Rating Co. D1 A Fitch Investors Services, Inc. A Moody's Investors Service, Inc. P2 Baa1 Standard & Poor's Ratings Group A2 A-
FINOVA (Canada) Capital Corporation, a subsidary of FINOVA Capital, has a rating with Dominion Bond Rating Service Limited of R-1 (low) for commercial paper.
In February 2000, FINOVA (Canada) Finance Inc., a subsidiary of FINOVA Capital, received a rating with Dominion Bond Rating Service Limited of A (low) for the Medium Term Note Program.
In addition, FINOVA Finance Trust, a subsidiary trust of FINOVA, has issued TOPrS with investment-grade ratings as follows:
TOPrS ----- Duff & Phelps Credit Rating Co. BBB+ Fitch Investors Services, Inc. A- Moody's Investors Service, Inc. Baa2 Standard & Poor's Ratings Group BBB
Standard & Poor's Ratings Group changed on February 26, 1999, its rating of the TOPrS from BBB+ to BBB. The rating change was not a downgrade, but resulted from the new rating scale under which Standard & Poor's Ratings Group rates preferred stock two notches below the corporate or counterparty credit rating of an investment-grade issuer such as FINOVA.
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THE FINOVA GROUP INC.
FINOVA periodically repurchases its securities on the open market to fund its obligations pursuant to employee stock options, benefit plans and similar obligations. During the years 1999 and 1998, FINOVA repurchased 1,833,200 and 1,299,200 shares, respectively. This program may be discontinued at any time.
DERIVATIVE FINANCIAL INSTRUMENTS
FINOVA enters into derivative transactions as part of its interest rate risk management policy of match funding its assets and liabilities. The derivative instruments used are straightforward. FINOVA continually monitors its derivative position and uses derivative instruments for non-trading and non-speculative purposes only.
At December 31, 1999, FINOVA Capital had outstanding interest rate conversion agreements with notional principal amounts totaling $2.4 billion. Agreements with notional principal amounts of $200 million were arranged to effectively convert certain floating interest rate obligations into fixed interest rate obligations. These agreements require interest payments on the stated principal amount at rates ranging from 6.67% to 8.09% (remaining terms of one to two years) in return for receipts calculated on the same notional amounts of floating interest rates. Agreements with notional principal amounts of $1.93 billion were arranged to effectively convert certain fixed interest rate obligations into floating interest rate obligations. They require interest payments on the stated principal amount at the three month or six month London interbank offered rates ("LIBOR") (remaining terms of one to ten years) in return for receipts calculated on the same notional amounts at fixed interest rates of 5.70% to 7.71%. FINOVA has also entered into a fixed-rate foreign currency-denominated transaction (Japanese Yen ("JPY") 5 billion) maturing in 2002. Two derivatives are associated with this transaction, a receive fixed-rate swap (JPY 5 billion) versus 3-month JPY LIBOR and a basis swap, converting JPY LIBOR to US Dollar ("USD") LIBOR, both of which mature in 2002. The receive side of the basis swap has a notional of JPY 5 billion paying 3-month JPY LIBOR and the pay side has a notional of USD 43.6 million paying 3-month USD LIBOR. See Note F of Notes to Consolidated Financial Statements for further discussion of FINOVA's derivatives.
FINOVA also enters into short-term treasury rate locks, options, swaptions and other derivative instruments to hedge interest rate risks associated with the warehousing of CMBS loans primarily for FINOVA Realty Capital. FINOVA entered into a partnership with a prominent investment banking firm which will reduce the hedging activity previously associated with the CMBS program. See the Recent Developments and Business Outlook section for a further discussion.
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THE FINOVA GROUP INC.
SEGMENT REPORTING
Information for FINOVA's reportable segments reconciles to FINOVA's consolidated totals as follows:
Dollars in Thousands 1999 1998 - -------------------- ---- ---- TOTAL NET REVENUE: Commercial Finance $ 216,083 $ 187,461 Specialty Finance 384,789 344,541 Capital Markets 101,414 24,170 Corporate and other (16,388) 8,978 ----------- ----------- Consolidated total $ 685,898 $ 565,150 =========== =========== INCOME (LOSS) BEFORE ALLOCATIONS: Commercial Finance $ 87,406 $ 67,013 Specialty Finance 307,377 273,674 Capital Markets 31,235 (2,775) Corporate and other, overhead and unallocated provision for credit losses (70,674) (71,615) ----------- ----------- Income before income taxes and preferred dividends $ 355,344 $ 266,297 =========== =========== MANAGED ASSETS: Commercial Finance $ 4,195,237 $ 3,005,130 Specialty Finance 8,265,497 7,211,164 Capital Markets 1,051,367 255,575 Corporate and other 93,273 85,948 ----------- ----------- Consolidated total $13,605,374 $10,557,817 Less securitizations and participations sold (483,397) (537,596) ----------- ----------- Investment in financing transactions $13,121,977 $10,020,221 =========== ===========
FINOVA's business is organized into three market groups, which are also its reportable segments: Commercial Finance, Specialty Finance and Capital Markets. Management principally relies on total net revenue, income before allocations and managed assets in evaluating the business performance of each reportable segment. See Note Q of Notes to Consolidated Financial Statements for additional detail.
Total net revenue is the sum of operating margin and gains on disposal of assets. Income before allocations is income before income taxes, preferred dividends, corporate overhead expenses and the unallocated portion of the provision for credit losses. Managed assets include each segment's investment in financing transactions plus securitizations and participations sold.
COMMERCIAL FINANCE. Commercial Finance includes traditional asset-based businesses that provide financing through revolving credit facilities and term loans secured by assets such as receivables and inventories, as well as providing factoring and management services. This segment includes the following lines of business: Business Credit, Commercial Services, Corporate Finance, Distribution & Channel Finance, Growth Finance and Rediscount Finance. In December 1999, the Company acquired Fremont Financial Corporation, which was added to Business Credit.
Total net revenue was $216.1 million in 1999 compared to $187.5 million in 1998, an increase of 15.3%. The increase was primarily due to 24.1% growth in average earnings assets in 1999, partially offset by the effects of competitive pricing pressures, a 4.5% decrease in fee-based volume, which fell to $4.24 billion from $4.45 billion in 1998, and a reduction in the rate earned on the volume in 1999. Distribution & Channel Finance had fee-based volume of $2.87 billion in 1999 compared to $3.21 billion in 1998. The rate earned on the volume declined from 1.27% to 0.99%. Commercial Services fee-based volume rose to $1.37 billion from $1.24 billion in 1998, an increase of $136.7 million; however, the rate earned on that volume declined to 0.82% from 0.94% in 1998.
Income before allocations was $87.4 million in 1999 compared to $67.0 million in 1998. The increase in 1999, which was twice the increase in revenue, was primarily due to lower net write-offs ($37.2 million in 1999 as compared to $47.3 million for 1998) and to a lesser extent to the growth in earning assets noted above, partially offset by higher operating expenses. The Commercial
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THE FINOVA GROUP INC.
Services line of business, which experienced problems in 1998 with its wholesale textile customers, refocused its portfolio toward more retail customers in 1999. As a result, the net write-offs decreased to $7.4 million from $35.7 million in 1998. Conversely, Corporate Finance experienced a higher level of problem accounts resulting in $17.9 million of net write-offs in 1999 compared to $6.7 million in 1998. Net write-offs as a percentage of average managed assets for the Commercial Finance Group declined to 1.2% compared to 1.8% in 1998.
Managed assets grew to $4.20 billion in 1999 from $3.01 billion in 1998, an increase of 39.6%. The growth in managed assets was primarily due to the addition of $661.9 million of managed assets acquired in connection with the acquisition of Fremont Financial Corporation and strong growth in the Rediscount Finance operation, which grew to $1.09 billion from $777.9 million, an increase of 40.0%. Excluding the acquired assets, managed assets for the group grew by $528.2 million, or 17.6% during 1999. This internal growth was driven by new loan business of $1.12 billion in 1999 compared to $792.8 million in 1998.
SPECIALTY FINANCE. Specialty Finance provides a wide variety of lending products such as leases, loans, accounts receivable and cash flow based financing, as well as servicing and collection services to a number of highly focused industry specific niches. This segment includes the following lines of business: Commercial Equipment Finance, Communications Finance, Franchise Finance, Healthcare Finance, Portfolio Services, Public Finance, Resort Finance, Specialty Real Estate Finance and Transportation Finance.
Total net revenue increased 11.7% to $384.8 million in 1999 compared to $344.5 million in 1998, while income before allocations grew 12.3% to $307.4 million in 1999 compared to $273.7 million in 1998. Both increases were primarily due to 18.1% growth in average earning assets, partially offset by the effects of competitive pricing pressures in certain of the business units and a lower level of prepayment related penalties and fees. The lower amount of prepayment income was not based solely on the level of prepayments, since $538.1 million of contracts prepaid in 1999 compared to $560.0 million in 1998. Income will vary depending on where the deal is in its life cycle at time of prepayment and which businesses are experiencing the prepayments because only certain lines of business can structure prepayment penalties into their transactions.
Managed assets grew to $8.27 billion in 1999 from $7.21 billion in 1998, an increase of 14.6%. The growth in managed assets was driven by new business of $3.33 billion in 1999 compared to $3.08 billion in 1998. The growth in managed assets was spread across most business units with Resort Finance, Healthcare Finance and Franchise Finance contributing the most to the growth in managed assets, while Communications Finance and Public Finance experienced declines. The Communications Finance line of business experienced a greater amount of prepayments in 1999 than 1998, which partially offset the growth in managed assets for the segment as a whole. Communications' higher prepayments primarily resulted from customers opting to seek capital infusion from the equity markets and continued consolidation in the industry.
CAPITAL MARKETS. Capital Markets, in conjunction with institutional investors, provides commercial mortgage banking services and debt and equity capital funding. The Capital Markets Group expanded its product base to include mezzanine debt with associated warrant positions and merger and acquisition advisory services through the acquisition of Sirrom Capital Corporation and Harris Williams & Co. in the first quarter of 1999. This segment now includes Realty Capital, Investment Alliance, Loan Administration, Mezzanine Capital and Harris Williams & Co.
Total net revenue was $101.4 million in 1999 compared to $24.2 million in 1998. The increase in 1999 was primarily due to the addition of Mezzanine Capital and Harris Williams & Co. to this segment. Also contributing to the increase in net revenue was the continued growth of Realty Capital's bridge and mezzanine financing activities.
The Mezzanine Capital and Harris Williams & Co. units provided $59.9 million of net revenue during 1999, of which $16.9 million related to gains from the sale of equity and warrant positions. Included in this amount was $4.6 million of gains generated from the sale of 140,000 shares of Healtheon/WebMD stock. FINOVA recorded a pretax unrealized gain of $36.9 million through other comprehensive income on the balance sheet related to 1,246,332 shares of Healtheon/WebMD stock in its portfolio at December 31, 1999.
Mezzanine Capital provides mezzanine financing with the intent of receiving stock warrants or other equity instruments in anticipation that the customers will ultimately seek equity capital. As such, FINOVA periodically assesses its position in this unit's investment portfolio and will exercise its position based on various factors, including management's discretion.
Realty Capital increased its net revenue over 1998 primarily due to a higher level of average earning assets related to the expansion of their bridge and mezzanine financing products and higher CMBS gains, partially offset by a reduction in volume-based fees. Realty Capital had $11.8 million of CMBS gains in 1999, compared to a net loss on CMBS transactions of $7.2 million in 1998.
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THE FINOVA GROUP INC.
Realty Capital curtailed its CMBS volume in 1999, which declined to $757.8 million from $1.76 billion in 1998; while its structured finance volume increased to $1.31 billion from $1.05 billion in 1998. The shift in product mix resulted in a decline in Realty Capital's commission rate to 0.50% from 0.88% in 1998. Structured finance deals carry a lower net rate than CMBS transactions. FINOVA took steps to eliminate the balance sheet exposure from the CMBS product entirely in 2000 by entering into a Preferred Partner Program with a prominent investment banking firm during the fourth quarter of 1999. See the Recent Developments and Business Outlook section for a further discussion.
Income before allocations grew to $31.2 million in 1999 from a loss of $2.8 million in 1998 for the segment. This increase was primarily attributable to the addition of Mezzanine Capital and Harris Williams & Co. and the turnaround in gain activity for Realty Capital, all of which was partially offset by $8.2 million of net write-offs in the Mezzanine Capital portfolio and increased operating expenses associated with the acquired operations.
Capital Markets was able to grow its managed asset base to $1.05 billion from $255.6 million in 1998. This growth was primarily due to the addition of $469.3 million of acquired assets combined with $339.1 million of new business related to Realty Capital's bridge and mezzanine financing products. The acquired assets of Mezzanine Capital declined to $442.7 million by year end. FINOVA expects this portfolio to further compress during the first part of 2000 as it transitions to originating new business using FINOVA's underwriting standards.
YEAR 2000 COMPLIANCE
FINOVA successfully completed all work necessary to make its mission-critical systems Year 2000 compliant in 1999 and experienced no significant problems during the transition to the new year. The Company incurred expenses of $207,000 and capital costs of $1.7 million related to its Year 2000 compliance efforts. No material expenditures related to the Year 2000 issue are expected to be incurred in the future.
FINOVA's estimate of future costs does not include time and costs that may be incurred as a result of the failure of any third parties to become Year 2000 compliant. FINOVA is monitoring activity with customers and others during the first quarter of 2000 to determine if their applications are Year 2000 compliant and to assess the potential impact on FINOVA related to this issue. At the date of this filing, no significant impact has been noted.
RECENT DEVELOPMENTS AND BUSINESS OUTLOOK
In December 1999, FINOVA acquired Fremont Financial Corporation, the commercial lending subsidiary of Fremont General Corporation. Fremont Financial Corporation was headquartered in Santa Monica, Calif., had account management and operations in Santa Monica and Atlanta and provided secured working capital and term loans averaging $2 million to $4 million to midsize businesses throughout the U.S. Those operations were integrated into the Business Credit line of business.
In December 1999, FINOVA entered into a formal partnership with a prominent investment banking firm known as the "Preferred Partner Program." Under the program, FINOVA Realty Capital will originate and close CMBS loans; the investment banking firm will fund and warehouse the loans, then securitize them in pools mixed with other similar loans originated by the investment banking firm. FINOVA and the investment banking firm will share in all aspects of the transactions (fees, commissions, interest margin, hedge costs and gains). FINOVA is contractually exposed to losses from sales only up to its share of fees, margin and commissions related to the transactions; therefore, FINOVA expects to maintain no balance sheet exposure or additional downside risk to the CMBS product.
FINOVA and FINOVA Capital dismissed their independent auditors, Deloitte & Touche LLP, effective July 15, 1999 and appointed Ernst & Young LLP as independent auditors. These actions were approved by FINOVA's Board of Directors upon recommendation of its Audit Committee. The change was also approved by FINOVA Capital's Board of Directors.
The selection of Ernst & Young was approved by FINOVA and FINOVA Capital after an extended evaluation process initiated by FINOVA's Audit Committee. Neither company sought the advice of Ernst & Young on specific audit issues relating to their financial statements prior to engagement of that firm.
The change in independent auditors did not occur due to any existing or previous accounting disagreements with Deloitte & Touche. Deloitte & Touche has expressed no disclaimer of opinion, adverse opinion, qualification or limitation regarding the financial statements of FINOVA or FINOVA Capital or the audit process, for the years ended December 31, 1998 or 1997, or the interim periods ended March 31, 1999 or June 30, 1999. Neither have there been any accounting disagreements or reportable events within the meaning of Item 304 of SEC Regulation S-K for those periods. Deloitte & Touche has stated in a letter addressed to the SEC its concurrence with the foregoing statements in this paragraph.
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THE FINOVA GROUP INC.
In February 2000, FINOVA Capital commenced a Canadian Medium-Term Note Program through a newly formed subsidiary, FINOVA (Canada) Finance Inc., allowing for the issuance of up to C$300 million of debt securities.
On February 15, 2000, FINOVA terminated all agreements and paid all amounts associated with Corporate Finance's $300 million securitization.
On February 23, 2000, FINOVA Capital began seeking consents from security holders of the Fremont Small Business Loan Master Trust ("Trust") to accelerate the first date on which FINOVA Capital can cause an optional redemption of the Trust's Series D Securities. A proposed amendment to the Trust would accelerate the first optional redemption date to March 15, 2000 from April 16, 2001. The Trust was acquired with Fremont Financial Corporation in December 1999. Approval of the amendment would permit FINOVA to redeem or retire the debt in the trust and to terminate its activities during the first half of 2000.
NEW ACCOUNTING STANDARDS
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivatives and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." This statement defers the effective date of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS No. 133") to all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS No. 133 standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, by recognition of those items as assets or liabilities in the statement of financial position and measurement at fair value. The impact of SFAS No. 133 on the Company's financial position and results of operations has not yet been determined.
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THE FINOVA GROUP INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
FINOVA's primary market risk exposure is the volatility of interest rates. FINOVA seeks to manage interest rate risk and preserve income through a diversified borrowing base and a matched-funding policy. A diversified borrowing base consists of short and long-term debt with a fixed or variable rate. FINOVA's matched funding policy, approved by the Board of Directors or Audit Committee and administered by the Finance Committee, requires that floating-rate assets be financed with similar floating-rate liabilities and fixed-rate assets be financed with similar fixed-rate liabilities. Under the matched-funding policy, the difference between floating-rate assets and floating-rate liabilities should not exceed 3% of total assets for any extended period.
FINOVA engages in hedging transactions using primarily interest rate swaps, and to a lesser extent, other derivative instruments to lower its interest costs and to manage its interest rate risk. Derivative instruments are used for non-trading and non-speculative purposes only. A hedge consists of a position that is substantially equal and opposite of the asset or liability being hedged. It is structured to provide a high degree of correlation at the inception of the hedge and throughout the hedge period so that hedging results will substantially offset the effects of interest rate changes on the exposed item during the term of the hedge.
Hedge transactions are authorized to be executed with financial institutions rated "A" or better by Standard & Poor's Rating Group or Moody's Investors Service, Inc. The notional principal amount of aggregate hedges on a net basis with a given counterparty cannot exceed 10% of FINOVA's total debt outstanding as of the time of entering into the derivative transaction.
FINOVA uses various sensitivity analysis models to measure the exposure of net income to increases or decreases in interest rates. These models measure the change in annual net income if interest rates on floating-rate assets, liabilities and derivative instruments increase or decrease, assuming no prepayments. Based on models used, a 100 basis point shift in interest rates would affect net income by less than 1%.
Certain limitations are inherent in the models used for interest rate risk measurements. Modeling changes require certain assumptions that may oversimplify the manner in which actual yields and costs respond to changes in market interest rates. For example, the models assume a more static composition of FINOVA's interest sensitive assets, liabilities and derivative instruments than would actually exist over the period being measured. The models also assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the maturity or repricing of specific assets and liabilities. Although the sensitivity analysis models provide an indication of FINOVA's interest rate risk exposure at a particular point in time, the models are not intended to and do not provide a precise forecast of the effects of changes in market interest rates on FINOVA's net income and will likely differ from actual results.
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THE FINOVA GROUP INC.
MANAGEMENT'S REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING
The management of The FINOVA Group Inc. is responsible for the preparation, integrity and objectivity of the financial statements and other financial information included in this Annual Report. The financial statements are presented in accordance with generally accepted accounting principles reflecting, where applicable, management's best estimates and judgments.
FINOVA's management has established and maintains a system of internal controls to reasonably assure the fair presentation of the financial statements, the safeguarding of FINOVA's assets and the prevention or detection of fraudulent financial reporting. The internal control structure is supported by careful selection and training of personnel, policies and procedures and regular review by both internal auditors and the independent auditors.
The Board of Directors, through its Audit Committee, also oversees the financial reporting of FINOVA and its adherence to established procedures and controls. Periodically, the Audit Committee meets, jointly and separately, with management, the internal auditors and the independent auditors to review auditing, accounting and financial reporting matters.
FINOVA's financial statements have been audited by Ernst & Young LLP, independent auditors. Management has made available to Ernst & Young LLP all of FINOVA's financial records and related data and has made valid and complete written and oral representations and disclosures in connection with the audit.
Management believes it is essential to conduct its business in accordance with the highest ethical standards, which are characterized and set forth in FINOVA's written Code of Conduct. These standards are communicated to and acknowledged by all of FINOVA's employees.
/s/ Samuel L. Eichenfield - ------------------------- Samuel L. Eichenfield Chairman, President and Chief Executive Officer
/s/ Bruno A. Marszowski - ------------------------- Bruno A. Marszowski Senior Vice President - Controller and Chief Financial Officer
/s/ Derek C. Bruns - ------------------------- Derek C. Bruns Senior Vice President - Internal Audit
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THE FINOVA GROUP INC.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareowners of The FINOVA Group Inc.
We have audited the accompanying consolidated balance sheet of The FINOVA Group Inc. and subsidiaries as of December 31, 1999, and the related consolidated statements of income, shareowners' equity, and cash flows for the year then ended. These financial statements are the responsibility of The FINOVA Group Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with accounting standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The FINOVA Group Inc. and subsidiaries at December 31, 1999 and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States.
Ernst & Young LLP
Phoenix, Arizona January 19, 2000
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THE FINOVA GROUP INC.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareowners of The FINOVA Group Inc.
We have audited the accompanying consolidated balance sheet of The FINOVA Group Inc. and subsidiaries as of December 31, 1998, and the related consolidated statements of income, shareowners' equity and cash flows for each of the two years in the period then ended. These financial statements are the responsibility of The FINOVA Group Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The FINOVA Group Inc. and subsidiaries as of December 31, 1998, and the results of their operations and their cash flows for each of the two years in the period then ended in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP Phoenix, Arizona
April 23, 1999
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THE FINOVA GROUP INC.
CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)
1999 1998 ------------ ------------ ASSETS Cash and cash equivalents $ 100,344 $ 49,518 Investment in financing transactions: Loans and other financing contracts 10,446,356 7,354,736 Leveraged leases 837,083 773,942 Operating leases 592,495 648,185 Fee-based receivables 583,885 626,499 Direct financing leases 494,175 396,759 Financing contracts held for sale 167,983 220,100 ------------ ------------ 13,121,977 10,020,221 Less reserve for credit losses (264,983) (207,618) ------------ ------------ Net investment in financing transactions 12,856,994 9,812,603 Investments 446,489 173,977 Goodwill, net of accumulated amortization 367,241 286,042 Other assets 279,225 119,096 ------------ ------------ $ 14,050,293 $ 10,441,236 ============ ============ LIABILITIES AND SHAREOWNERS' EQUITY
Liabilities: Accounts payable and accrued expenses $ 167,073 $ 154,137 Due to clients 146,607 205,655 Interest payable 114,397 65,817 Senior debt 11,407,767 8,394,578 Deferred income taxes 439,518 342,268 ------------ ------------ 12,275,362 9,162,455 ------------ ------------ Commitments and contingencies Company-obligated mandatory redeemable convertible preferred securities of subsidiary trust solely holding convertible debentures of FINOVA, net of expenses ("TOPrS") 111,550 111,550
Shareowners' equity: Common stock, $0.01 par value, 400,000,000 shares authorized, 64,849,000 and 58,555,000 shares issued, respectively 648 585 Additional capital 1,109,521 765,050 Retained income 689,466 515,057 Accumulated other comprehensive income 33,812 686 Common stock in treasury, 3,597,000 and 2,834,000 shares, respectively (170,066) (114,147) ------------ ------------ 1,663,381 1,167,231 ------------ ------------ $ 14,050,293 $ 10,441,236 ============ ============
See notes to consolidated financial statements.
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THE FINOVA GROUP INC.
STATEMENTS OF CONSOLIDATED INCOME (Dollars in Thousands, except per share data)
See notes to consolidated financial statements.
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THE FINOVA GROUP INC.
STATEMENTS OF CONSOLIDATED SHAREOWNERS' EQUITY (Dollars in Thousands)
See notes to consolidated financial statements.
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THE FINOVA GROUP INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS (Dollars in Thousands)
See notes to consolidated financial statements.
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THE FINOVA GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (Dollars in Thousands in Tables, except per share data)
NOTE A SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION - The consolidated financial statements present the financial position, results of operations and cash flows of The FINOVA Group Inc. and its subsidiaries (collectively, "FINOVA" or the "Company"), including FINOVA Capital Corporation and its subsidiaries (collectively, "FINOVA Capital").
The FINOVA Group Inc. is a financial services company engaged principally in providing collateralized financing products to commercial enterprises focusing on mid-size businesses in various market niches, primarily in the United States.
These consolidated financial statements are prepared in accordance with generally accepted accounting principles. All significant intercompany balances have been eliminated in consolidation. Described below are those accounting policies particularly significant to FINOVA, including those selected from acceptable alternatives:
USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION - For loans and other financing contracts, earned income is recognized over the life of the contract, using the interest method.
Leases that are financed by nonrecourse borrowings and meet certain other criteria are classified as leveraged leases. For leveraged leases, aggregate rental receivables are reduced by the related nonrecourse debt service obligation including interest ("net rental receivables"). The difference between (a) the net rental receivables and (b) the cost of the asset less estimated residual value at the end of the lease term is recorded as unearned income. Earned income is recognized over the life of the lease at a constant rate of return on the positive net investment, which includes the effects of deferred income taxes.
For operating leases, earned income is recognized on a straight-line basis over the lease term and depreciation is taken on a straight-line basis over the estimated useful lives of the leased assets.
Origination fees net of direct origination costs are deferred and amortized over the life of the originated asset as an adjustment to yield.
Original issue discounts are established when equity interests are received in connection with a funded loan based on the fair value of the equity interest. The assigned value is amortized to income over the term of the loan as an adjustment to yield.
Fees received in connection with loan commitments are deferred in accounts payable and accrued expenses until the loan is advanced and are then recognized over the term of the loan as an adjustment to the yield. Fees on commitments that expire unused are recognized at expiration.
Fees are also generated on the volume of purchased accounts receivable and mortgage loan originations. Fees on the volume of purchased accounts receivable represent discounts or commissions to FINOVA in return for handling the accounts receivable collection process. These fees are recognized as income in the period the receivables are purchased due to the short-term nature of the accounts receivable, which are generally collected from one to three months after purchase. FINOVA's commercial mortgage operation originates and sells loans and typically would only retain assets on the balance sheet for a short period of time. Fees on mortgage loan originations represent broker commissions on the loan originations and are recognized as income in the period of origination.
Income recognition is generally suspended for leases, loans and other financing contracts at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan, lease or other financing contract becomes contractually current and performance is demonstrated to be resumed or when foreclosed or repossessed assets generate a reasonable rate of return.
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THE FINOVA GROUP INC.
CASH EQUIVALENTS - FINOVA classifies highly liquid investments with original maturities of three months or less from date of purchase as cash equivalents.
FINANCING CONTRACTS HELD FOR SALE - Financing contracts held for sale are composed of assets held for sale and retained interests from sales to a private CMBS ("mini-CMBS") structure that are available for sale. Assets held for sale are carried at the lower of cost or market with adjustment, if any, recorded in operations. Assets available for sale are carried at fair value using the specific identification method with unrealized gains and losses being recorded as a component of accumulated other comprehensive income within the equity section of the balance sheet. FINOVA had no retained interest available for sale at December 31, 1999.
Since FINOVA is exposed to losses from asset sales under the Preferred Partner Program with a prominent investment banking firm up to its share of fees, margin and commissions related to the transactions, revenues and expenses associated with the origination of CMBS loans under this program are deferred until a determination of the gain or loss on sale of the loans has been finalized.
FINOVA anticipates that the investment banking firm will execute securitizations every four months on average. The timing of those securitizations could vary, depending on market conditions, available volume for securitization and other factors. See Notes B and P.
RESERVE FOR CREDIT LOSSES - The reserve for credit losses is available to absorb credit losses and is not provided for financing contracts held for sale and other owned assets, including assets on operating lease. The provision for credit losses is the charge to income to increase the reserve for credit losses to the level that management estimates to be adequate considering delinquencies, loss experience and collateral. Other factors considered include changes in geographic and product diversification, size of the portfolio and current economic conditions. Accounts are either written off or written down when the loss is considered probable and determinable, after giving consideration to the customer's financial condition and the value of the underlying collateral, including any guarantees. Any deficiency between the carrying amount of an asset and the net sales price of repossessed collateral is charged to the reserve for credit losses. Recoveries of amounts previously written off as uncollectible are credited to the reserve for credit losses.
IMPAIRED LOANS - Impaired loans represent loans with probable significant delays in collection of all of the scheduled principal and interest payments in accordance with the original contractual terms or a deterioration of the collateral net present value position below FINOVA's loan balance. The amount of the specific impairment reserve is equal to the difference between the current carrying amount of a loan and the greater of (a) the net present value of expected cash flows from the borrower, discounted at the original effective interest rate of the transaction, or (b) the net fair value of collateral. Accruing impaired loans are paying in accordance with the current modified loan agreement or have adequate collateral protection.
REPOSSESSED ASSETS - Repossessed assets are carried at the lower of cost or fair value less estimated selling expenses.
RESIDUAL VALUES - FINOVA has a significant investment in residual values in its leasing portfolios. These residual values represent estimates of the value of leased assets at the end of the contract terms and are initially recorded based upon appraisals and estimates. Residual values are periodically reviewed to determine that recorded amounts are appropriate. Actual residual values realized could differ from these estimates and updates.
INVESTMENTS - The Company's investments include government debt securities, equity securities and partnership interests. The Company's investments have increased significantly in connection with the acquisition of Sirrom Capital Corporation ("Sirrom") in March 1999.
Certain marketable securities, as discussed in Notes D and K, are considered trading securities and are stated at fair value with gains or losses recorded in income in the period they occur.
Debt and equity securities that are being held for an indefinite period of time are designated as available for sale and carried at fair value using the specific identification method.
Partnership interests are accounted for under either the cost or equity method depending on the Company's level of influence in the investee. Under the equity method, the Company recognizes its share of income or losses of the partnership in the period in which they are earned. Under the cost method, the Company recognizes income based on distributions received.
The carrying value of debt and equity securities and partnership interests are periodically reviewed for impairment which, if identified, is recorded as a change to current operations.
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THE FINOVA GROUP INC.
GOODWILL - FINOVA amortizes the excess of cost over the fair value of net assets acquired ("goodwill") on a straight-line basis primarily over 20 to 25 years. Amortization totaled $20.4 million ($13.2 million after-tax), $14.5 million ($10.6 million after-tax) and $9.7 million ($6.1 million after tax) for the years ended December 31, 1999, 1998 and 1997, respectively. FINOVA periodically evaluates the carrying value of its intangible assets for impairment. This evaluation is based on projected, undiscounted cash flows generated by the underlying assets. No portion of the Company's goodwill was considered impaired at December 31, 1999 and 1998. At December 31, 1999, approximately $289.8 million of goodwill (net of amortization), or 81% of the original goodwill balance, was deductible for federal income tax purposes over 15 years.
PENSION AND OTHER BENEFITS - Trusteed, noncontributory pension plans cover substantially all employees. Benefits are based primarily on final average salary and years of service. Funding policies provide that payments to pension trusts shall be at least equal to the minimum funding required by applicable regulations.
Other post-retirement benefit costs are recorded during the period the employees provide service to FINOVA. Post-retirement benefit obligations are funded as benefits are paid.
Post-employment benefits are any benefits other than retirement benefits. FINOVA records post-employment benefit costs at the time employees leave active service.
SAVINGS PLAN - FINOVA maintains The FINOVA Group Inc. Savings Plan (the "Savings Plan"), a qualified 401(k) program. The Savings Plan is available to substantially all employees. The employee may elect voluntary wage reductions ranging from 0% to 15% of taxable compensation. The Company's matching contributions are based on employee pre-tax salary reductions, up to a maximum of 100% of the first 6% of salary contributions, the first 3% of which are matched in FINOVA stock through the Employee Stock Ownership Plan, discussed below.
EMPLOYEE STOCK OWNERSHIP PLAN - Employees of FINOVA are eligible to participate in the Employee Stock Ownership Plan in the month following the first 12 consecutive month period during which they have at least 1,000 hours of service with FINOVA. Company contributions are made in the form of matching stock contributions of 100% of the first 3% of salary reduction contributions made by participants of the Savings Plan.
Expenses under the Savings Plan and Employee Stock Ownership Plan were $4.0 million, $3.1 million and $2.5 million in 1999, 1998 and 1997, respectively.
INCOME TAXES - Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax law.
EARNINGS PER SHARE - Basic earnings per share exclude the effects of dilution and are computed by dividing income available to common shareowners by the weighted average amount of common stock outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if options, convertible preferred stock or other contracts to issue stock were exercised or converted into common stock. These calculations are presented for the years ended December 31, 1999, 1998 and 1997 on the Statements of Consolidated Income and are more fully discussed in Note L.
DERIVATIVE FINANCIAL INSTRUMENTS - As more fully described in Note F, FINOVA uses derivative financial instruments as part of its interest rate risk management policy of match funding its assets and liabilities. The derivative instruments used include interest rate swaps, and to a lesser extent treasury locks, options, futures and swaptions which are subject to hedge accounting determination.
Each derivative used as a hedge is matched with an asset or liability with which it has a high correlation. The swap agreements are generally held to maturity and FINOVA does not use derivative financial instruments for trading or speculative purposes. Upon early termination of the designated matched asset or liability, the related derivative is matched to another appropriate item or marked to fair market value. Any gain or loss is not recognized immediately but is amortized to operations over the remaining life of the hedged transaction.
SECURITIZATIONS - In accordance with SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," receivable transfers are accounted for as sales when legal and effective control over the transferred receivables is surrendered.
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THE FINOVA GROUP INC.
RECLASSIFICATIONS - Certain reclassifications have been made to the prior years financial statements to conform to the 1999 presentation.
NOTE B INVESTMENT IN FINANCING TRANSACTIONS
FINOVA provides secured financing to commercial and real estate enterprises principally under financing contracts (such as loans and other financing contracts, direct financing leases, operating leases, leveraged leases, fee-based receivables and financing contracts held for sale). At December 31, 1999 and 1998, the carrying amount of the investment in financing transactions, including the estimated residual value of leased assets upon lease termination, was $13.1 billion and $10.0 billion (before reserve for credit losses), respectively, and consisted of the following percentage of carrying amount by segment and line of business:
Percent of Total Carrying Amount --------------- 1999 1998 ---- ---- Commercial Finance Group Rediscount Finance 8.2% 7.7% Business Credit 7.5 3.0 Corporate Finance 7.2 7.9 Distribution & Channel Finance 4.3 5.7 Commercial Services 1.7 1.7 Growth Finance 0.4 0.5 ----- ----- 29.3% 26.5% ----- ----- Specialty Finance Group Transportation Finance 19.0 22.0 Resort Finance 12.4 12.5 Commercial Equipment Finance 6.5 7.5 Franchise Finance 5.9 6.0 Specialty Real Estate Finance 5.9 7.0 Healthcare Finance 5.8 6.1 Communications Finance 5.2 7.2 Public Finance 1.3 1.8 ----- ----- 62.0% 70.1% ----- ----- Capital Markets Group Realty Capital 4.4 2.4 Mezzanine Capital 3.4 Investment Alliance 0.2 0.1 ----- ----- 8.0% 2.5% ----- ----- Other 0.7 0.9 ----- ----- 100.0% 100.0% ===== =====
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THE FINOVA GROUP INC.
Aggregate installments on investments in financing transactions at December 31,1999 (excluding nonaccruing repossessed assets of $55.8 million and estimated residual values of $998.7 million) are contractually due or anticipated during each of the years during December 31, 2000 to 2004 and thereafter as follows:
The investment in operating leases at December 31 consisted of the following:
1999 1998 ---- ---- Cost of assets $ 725,829 $ 757,921 Accumulated depreciation (133,334) (109,736) --------- --------- Investment in operating leases $ 592,495 $ 648,185 ========= =========
The net investment in leveraged leases at December 31 consisted of the following:
1999 1998 ---- ---- Rental receivables $ 2,987,277 $ 2,885,352 Less principal and interest payable on nonrecourse debt (2,517,839) (2,403,623) ----------- ----------- Net rental receivables 469,438 481,729 Estimated residual values 848,236 794,112 Less unearned income (480,591) (501,899) ----------- ----------- Investment in leveraged leases 837,083 773,942 Less deferred taxes from leveraged leases (411,642) (314,243) ----------- ----------- Net investment in leveraged leases $ 425,441 $ 459,699 =========== ===========
The components of income from leveraged leases, after the effects of interest on nonrecourse debt and other related expenses, for the years ended December 31 were as follows:
1999 1998 1997 ---- ---- ---- Lease and other income, net $60,936 $60,484 $35,834 Income tax expense 24,136 24,063 17,156
The investment in direct financing leases at December 31 consisted of the following:
1999 1998 ---- ---- Rental receivables $ 575,434 $ 398,303 Estimated residual values 150,483 126,095 Unearned income (231,742) (127,639) --------- --------- Investment in direct financing leases $ 494,175 $ 396,759 ========= =========
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THE FINOVA GROUP INC.
FINOVA has a substantial number of loans and leases with payments that fluctuate with changes in index rates, primarily prime interest rates and the London interbank offered rates ("LIBOR"). The investment in loans and leases with floating interest rates (excluding nonaccruing contracts and repossessed assets) was $7.10 billion and $4.75 billion at December 31, 1999 and 1998, respectively.
FINOVA had loans and leases of $1.87 billion in 1999 and $1.65 billion in 1998 collateralized by real estate.
Income earned from financing transactions with floating interest rates was approximately $655 million in 1999, $562 million in 1998 and $491 million in 1997. The adjustments which arise from changes in index rates can have a significant effect on income earned from financing transactions; however, the effects on interest margins earned and net income are substantially offset by related interest expense changes on debt obligations with floating interest rates. FINOVA's matched funding policy is more fully described in Note F.
At December 31,1999, FINOVA had a committed backlog of new business of approximately $2.0 billion compared to $1.9 billion at December 31, 1998. The committed backlog includes unused lines of credit totaling $710 million and $549 million at December 31, 1999 and 1998, respectively. Historically, FINOVA has booked a substantial portion of its backlog, although there can be no assurance that the trend will continue. Loan commitments and lines of credit have generally the same credit risk as extending loans to borrowers. These commitments are generally subject to the same credit quality and collateral requirements involved in lending transactions. Commitments generally have a fixed expiration and usually require payment of a fee.
SECURITIZATIONS - In the later part of 1998, the Company used for the first time a private CMBS structure ("mini-CMBS") to sell loans originated by FINOVA Realty Capital ("FRC"). Under this structure, the Company sold $724.3 million of loans originated by FRC to a trust with limited recourse. The trust held those loans with plans to resell them to the permanent CMBS market. The trust paid cash to the Company upon acquisition of the assets, issued a senior security interest to an investment banking firm and a subordinated residual interest to the Company. The Company retained the servicing rights and obligations related to the assets transferred to the trust. FINOVA maintained no retained interest in CMBS transactions at December 31, 1999 compared to a retained interest at December 31, 1998 that was valued at $65.4 million.
In April 1999, approximately 70% of the mini-CMBS assets were sold into a permanent CMBS structure and in June 1999 the remaining 30% were sold, resulting in the elimination of the trust. The majority of the remaining assets were sold to an investment banking firm, with an amount below cleanup call provisions being repurchased by the Company.
In December 1999, FINOVA took steps to eliminate the balance sheet exposure from the CMBS product entirely by entering into a formal partnership with a prominent investment banking firm known as the "Preferred Partner Program." Under the program, FRC will originate and close CMBS loans; the investment banking firm will fund and warehouse the loans, then securitize them in pools mixed with other similar loans originated by the investment banking firm. FINOVA and the investment banking firm will share in all aspects of the transactions (fees, commissions, interest margin, hedge costs and gains). FINOVA will only have contractual liability for losses from sales up to its share of fees, margin and commissions related to the transactions; therefore, FINOVA expects to maintain no balance sheet exposure or additional downside risk to the CMBS product.
In 1998 and 1997, under a separate securitization agreement, FINOVA sold receivables totaling $103.2 million and $36.8 million, respectively with limited recourse. Outstanding securitized assets under this agreement were $123.2 million at December 31, 1999. FINOVA will service these loan contracts for the transferee and has defined a portion of the proceeds to be recognized as service fee income over the term of the agreements.
In 1996 and 1995, FINOVA, under securitization agreements, sold a total of $300 million in undivided proportionate interests in a revolving loan portfolio totaling approximately $717.9 million as of December 31, 1999. Under this agreement, there was limited recourse to FINOVA based on the outstanding balance of the proportionate interest sold. This securitization was paid off in February 2000.
In general, the servicing fees earned on securitizations are approximately equal to the cost of servicing; therefore, no material servicing assets or liabilities have been recognized in those transactions.
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THE FINOVA GROUP INC.
NOTE C RESERVE FOR CREDIT LOSSES
The following is an analysis of the reserve for credit losses for the years ended December 31:
1999 1998 1997 ---- ---- ---- Balance, beginning of year $ 207,618 $ 177,088 $ 148,693 Provision for credit losses 76,800 82,200 69,200 Write-offs (60,372) (59,037) (45,487) Recoveries 3,518 2,279 2,287 Acquisitions and other 37,419 5,088 2,395 --------- --------- --------- Balance, end of year $ 264,983 $ 207,618 $ 177,088 ========= ========= =========
Net write-offs by segment and line of business for the years ended December 31 are as follows:
1999 1998 1997 ---- ---- ---- Commercial Finance Group Corporate Finance $17,854 $ 6,680 $ 6,478 Commercial Services 7,378 35,663 23,255 Distribution & Channel Finance 3,924 2,609 1,777 Rediscount Finance 3,477 1,500 Growth Finance 2,590 Business Credit 1,986 819 ------- -------- ------- 37,209 47,271 31,510 ------- -------- ------- Specialty Finance Group Commercial Equipment Finance 5,773 3,645 3,208 Communications Finance 3,100 494 750 Healthcare Finance 1,188 960 1,704 Resort Finance 656 2,700 Franchise Finance 240 2,780 433 Specialty Real Estate Finance 129 1,785 2,106 ------- -------- ------- 11,086 9,664 10,901 ------- -------- ------- Capital Markets Group Mezzanine Capital 8,154 ------- -------- ------- 8,154 ------- -------- ------- Other 405 (177) 789 ------- -------- ------- Total net write-offs by segment and line of business $56,854 $ 56,758 $43,200 ======= ======== ======= Net write-offs as a percentage of average managed assets (excluding average participations) 0.48% 0.60% 0.53% ======= ======== =======
An analysis of nonaccruing assets included in the investment in financing transactions at December 31 is as follows:
1999 1998 ---- ---- Contracts $239,287 $150,787 Repossessed assets 55,836 54,446 -------- -------- Total nonaccruing assets $295,123 $205,233 ======== ======== Nonaccruing assets as a percentage of managed assets (excluding participations) 2.2% 2.0% ======== ========
In addition to the repossessed assets included in the above table, FINOVA had repossessed assets with a total carrying amount of $74.9 million and $65.3 million at December 31, 1999 and 1998, respectively, which earned income of $5.5 million and $4.7 million during 1999 and 1998, respectively.
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THE FINOVA GROUP INC.
At December 31, 1999, the total carrying amount of impaired loans was $446.3 million, of which $240.1 million were revenue accruing. A reserve for credit losses of $78.2 million has been established for $153.7 million of nonaccruing impaired loans and $68.5 million has been established for $144.9 of accruing impaired loans. At December 31, 1998, the total carrying amount of impaired loans was $225.7 million, of which $106.0 million were revenue accruing. A reserve for credit losses of $30.9 million was established for $74.3 million of nonaccruing impaired loans and $6.2 million was established for $24.4 million of accruing impaired loans. For the three years ended December 31, 1999, 1998 and 1997, the average carrying amount of impaired loans was $341.7 million, $172.0 million and $130.3 million, respectively. Income earned on accruing impaired loans was approximately $13.9 million in 1999, $4.0 million in 1998 and $4.0 million in 1997. Income earned on impaired loans is recognized in the same manner as it is on other accruing loans. Cash collected on all nonaccruing loans is applied to the carrying amount.
Had all nonaccruing assets outstanding at December 31, 1999, 1998 and 1997 remained accruing, pre-tax income earned would have increased by approximately $26 million, $19 million and $22 million, respectively.
NOTE D INVESTMENTS
Debt and equity securities that are being held for an indefinite period of time, including those securities which may be sold in response to needs for liquidity are classified as securities available for sale and are carried at fair value using the specific identification method with unrealized gains and losses, net of deferred taxes, reported as a component of accumulated other comprehensive income in the equity section of the balance sheet. A summary of securities classified as available for sale at December 31 is as follows:
1999 1998 ---- ---- Debt securities $ 54,553 $ 1,311 Equity securities 183,622 32,415 Partnership interests 121,995 63,909 Other 15,798 27,157 -------- -------- $375,968 $124,792 ======== ========
The net unrealized holding gains were $37.1 million and net unrealized holding losses were $0.9 million (net of deferred tax liability of $26.1 million and $0.6 million, respectively) at December 31, 1999 and 1998, respectively. The increase in the unrealized gains during 1999 was due primarily to $36.9 million of pretax unrealized gains on Healtheon/WebMD stock. Net gains of $35.6 million and $0.2 million were recognized on sales of marketable investments in 1999 and 1998, respectively. Scheduled maturities of debt securities range from 2012 to 2014.
FINOVA also carried investments held for trading of $71 million and $49 million at December 31, 1999 and 1998, respectively, in a trust for nonqualified compensation plans. The Company's investments in trading securities are marked to market on a quarterly basis through current operations.
FINOVA currently maintains no assets that are classified as held to maturity.
NOTE E DEBT
The Company satisfies its short-term financing requirements from the issuance of commercial paper supported by bank lines of credit, other bank loans and public notes. The Company's commercial paper borrowings are supported by unused revolving bank credit agreements totaling $4.5 billion. FINOVA Capital currently maintains a multi-year revolving credit facility and a 364-day facility with numerous lenders, in the aggregate principal amount of $2.0 billion. Separately, FINOVA Capital also has two multi-year facilities with numerous lenders for $700 million each and two 364-day facilities with numerous lenders for $600 million and $500 million, respectively. The Company does not intend to borrow under the domestic revolving credit agreements to refinance commercial paper and short-term bank loans unless it encounters significant difficulties in rolling over its outstanding commercial paper and short-term bank loans. Under the terms of these agreements, the Company has the option to periodically select either domestic dollars or Eurodollars as the basis of borrowings. Interest is based on the lenders' prime rate for domestic dollar advances or London interbank offered rates ("LIBOR") for Eurodollar advances. The agreements also provide for a commitment fee, approximately 10 basis points, on the unused credit. The 364-day $1.0 billion, $600 million and $500 million revolving credit agreements are subject to renewal in 2000, while the two $700
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THE FINOVA GROUP INC.
million and the other $1.0 billion credit facilities are subject to renewal in 2002. In addition to the above, FINOVA has a 364-day revolving credit facility with one lender for $25 million, which is subject to renewal in 2000.
The Company, through one subsidiary, utilizes a multi-year multi-currency facility with a small group of lenders for $100 million. Under the terms of this agreement, the subsidiary has the option to periodically select multiple currencies as the basis of borrowings. Interest is based on the Eurocurrency rate per annum for deposits in the relevant designated currency. Through another subsidiary, the Company maintains one 364-day revolving credit facility with three lenders in Canada for C$150 million, supporting the issuance of Canadian commercial paper. Under the terms of this agreement, the subsidiary has the option to borrow Canadian dollars through either bankers' acceptances or a prime rate advance. Interest is based on the lenders' prime rate for prime advances or bankers' acceptance rates. FINOVA Capital is the guarantor of these credit facilities, which are subject to renewal in 2002 and 2000, respectively.
The Company, through the acquisition of Fremont Financial Corporation in December 1999, assumed a trust financed with floating-rate debt and commercial paper. The commercial paper program is backed by a 364-day facility with a small group of lenders for $150 million. The facility is drawn upon to fund assets in the trust. As of December 31, 1999, $46 million of commercial paper was outstanding.
In 1998, FINOVA Capital commenced a Euro Medium-Term Note Program allowing for the issuance of up to $1 billion of debt securities. In 1999, FINOVA Capital plc, FINOVA's U.K subsidiary, was added to the program. As of December 31, 1999 there was $581 million available under the program.
The following information pertains to all short-term financing, primarily commercial paper, issued by FINOVA Capital for the years ended December 31:
- ---------- * Exclusive of the cost of maintaining bank lines in support of outstanding commercial paper and the effects of interest rate conversion agreements. The Company uses various mechanisms to manage interest rate risks. See Note F for further discussions.
Senior debt at December 31 was as follows:
1999 1998 ---- ---- Commercial paper and short-term bank loans supported by unused bank revolving credit agreements, less unamortized discount $ 3,876,955 $3,871,350 Medium term notes due to 2010, 5.7% to 10.2% 2,353,091 1,717,544 Term loans payable to banks due to 2000, 6.2% 250,000 190,000 Senior notes due to 2009, 5.9% to 16.0%, less unamortized discount 4,919,218 2,604,762 Nonrecourse installment notes due to 2002, 10.6% (assets of $21,877 and $22,838 respectively, pledged as collateral) 8,503 10,922 ----------- ---------- $11,407,767 $8,394,578 =========== ==========
Annual maturities of senior debt outstanding at December 31, 1999 due through 2010 (excluding the amount supported by the revolving credit agreements expected to be renewed) were approximately $1.17 billion (2000), $1.00 billion (2001), $1.32 billion (2002), $893.5 million (2003), $1.80 billion (2004) and $1.08 billion (thereafter).
The agreements pertaining to senior debt and revolving credit agreements include various restrictive covenants and require the maintenance of certain defined financial ratios with which FINOVA and FINOVA Capital have complied.
Total interest paid is not significantly different from interest expense.
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THE FINOVA GROUP INC.
NOTE F DERIVATIVE FINANCIAL INSTRUMENTS
FINOVA enters into interest rate swap, basis swap, foreign currency exchange, swaption and futures agreements as part of its interest rate risk management policy. Interest rate swap, basis swap, and swaption agreements are primarily used to match fund assets and liabilities. Currency swaps are used to convert both principal and interest payments on debt issued from one currency to the appropriate functional currency. Futures contracts are used to target index returns, lock funding costs, and for portfolio hedging. The Company continually monitors its derivative position and uses derivative instruments for non-trading and non-speculative purposes only.
FINOVA uses derivative instruments to minimize its exposure to fluctuations in interest rates, reduce debt expense and lock funding costs over predetermined periods of time. FINOVA strives to minimize its overall debt costs while limiting the short-term variability of interest expense and funds required for debt service. To achieve this objective, FINOVA diversifies its borrowing sources (short- and long-term debt with a fixed or a variable rate) and seeks to maintain a portfolio that is match funded. FINOVA's matched funding policy generally requires that floating-rate assets be financed with floating-rate liabilities and fixed-rate assets be financed with fixed-rate liabilities, measured as a percent of total assets, which should not vary by more than 3% for any extended period.
The notional amounts of derivatives do not represent amounts exchanged by the parties and, thus, are not a measure of FINOVA's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivatives.
Under interest rate swap agreements, FINOVA agrees to exchange with the other party, at specified intervals, the payment streams calculated on a specified notional amount, with at least one stream based on a floating interest rate. Generic swap notional amounts do not change for the life of the contract. Basis swaps involve the exchange of floating-rate indices, such as the prime rate, the commercial paper composite rate and LIBOR and are used primarily to protect FINOVA's margins on floating-rate transactions by locking in the spread between FINOVA's lending and borrowing rates.
FINOVA's off-balance sheet derivative instruments involve credit and interest rate risks. Credit risk includes the nonperformance by counterparties to the financial agreements. All financial agreements have been executed with major financial institutions to mitigate the credit risk from transactions. There can be no assurance that any such institution will perform under its agreement. FINOVA's derivative policy stipulates that the maximum exposure to any one counterparty relative to the derivative products is limited on a net basis to 10% of FINOVA's outstanding debt at the time of that transaction. Interest rate risks relate to changes in interest rates and the impact on earnings.
The use of derivatives decreased interest expense by $5.1 million in 1999, a decrease in the aggregate cost of funds of 0.07%. The use of derivatives in 1998 decreased interest expense by $5.3 million, a decrease in the aggregate cost of funds of 0.07%, and the use of derivatives in 1997 decreased interest expense by $1.0 million, a decrease in the aggregate cost of funds of 0.03%. Premiums on swaptions sold during 1999 were $4.1 million and are amortized on a straight line basis through 2009. Market values received on swap terminations in 1999 of $3.2 million were deferred and are being amortized on a straight line basis through 2003. These changes in interest expense from off-balance sheet derivatives effectively alter on-balance sheet costs and must be viewed as total interest rate management.
FINOVA also enters into short-term treasury rate locks, options, swaptions and other derivative investments to hedge interest rate risks associated with the warehousing of loans, primarily for FRC. FINOVA took steps to remove balance sheet exposure from the CMBS product in 2000 by entering into a Preferred Partner Program with a prominent investment banking firm. See Note B of Notes to Consolidated Financial Statements for additional discussion.
In a treasury rate lock, FINOVA agrees to lock in an interest rate on a U.S. Treasury security until a specified date in the future. Prior to the expiration date, if treasury rates decrease, there is an associated loss on the hedge. If treasury rates increase, FINOVA will immediately benefit from an increase in the hedge value.
In a treasury put option, FINOVA pays an up-front fee (premium) to have the right, but not the obligation to sell a pre-determined treasury security at an agreed-upon strike rate. Prior to the expiration date of the option, if treasury rates decrease, the option expires worthless and there is no additional hedge loss. If treasury rates increase and surpass the strike rate, the value of the
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THE FINOVA GROUP INC.
option will increase. In addition to the level of interest rates, the option value also depends on other variables including volatility and the time to maturity.
A swaption gives FINOVA the right, but not the obligation, to enter into a swap on the exercise date. An up-front premium is the only cost incurred by FINOVA. If swap rates rise above the strike rate, the option value will increase. If swap rates decrease, the option will not be exercised and will expire worthless. In addition to the level of the swap rates, the option value also depends on other variables including volatility and time to maturity.
The following table provides annual maturities and weighted-average interest rates for each significant derivative product type in place at December 31,1999. The rates presented are as of December 31, 1999. To the extent that rates change, variable interest information will change:
For the benefit of its customers, FINOVA enters into interest rate cap agreements. The total notional amount of these agreements at December 31, 1999 was $35.1 million, none of which was in a pay or receive position. These agreements will mature as follows: $1.5 million in 2000, $7.6 million in 2001, $21.0 million in 2002 and $5.0 million in 2003. FINOVA has also entered into a fixed-rate foreign currency-denominated transaction (Japanese Yen ("JPY") 5 billion) maturing in 2002. Two derivatives are associated with this transaction, a receive fixed-rate swap (JPY 5 billion) versus 3-month JPY LIBOR and a basis swap, converting JPY LIBOR to US Dollar ("USD") LIBOR , both of which mature in 2002. The receive side of the basis swap has a notional of JPY 5 billion paying 3-month JPY LIBOR and the pay side has a notional of USD 43.6 million paying 3-month USD LIBOR. In addition, FINOVA has another $75 million basis swap maturing in 2000. These derivatives are not reflected in the table above.
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Derivative product activity for the three years ended December 31, 1999 is as follows:
Interest Receive Pay Rate Fixed-Rate Fixed-Rate Basis Hedge (Dollars in Millions) Swaps Swaps Swaps Agreements TOTAL - --------------------- ----- ----- ----- ---------- ----- Balance, January 1, 1997 $ 1,350 $ 825 $ 878 $ $ 3,053 Expired (275) (275) (250) (800) Additions 327 327 ------- ----- ----- ------- ------- Balance December 31, 1997 1,402 550 628 2,580 Expired (325) (200) (628) (1,153) Additions 350 217 567 ------- ----- ----- ------- ------- Balance December 31, 1998 1,077 700 217 1,994 Expired (427) (500) (1,254) (2,181) Additions 1,275 75 1,168 2,518 ------- ----- ----- ------- ------- Balance December 31, 1999 $ 1,925 $ 200 $ 75 $ 131 $ 2,331 ======= ===== ===== ======= =======
The table above does not include a JPY 5 billion receive fixed-rate swap or a basis swap converting JPY LIBOR to US Dollar LIBOR. The receive side of the basis swap has a notional of JPY 5 billion and the pay side has a notional of USD 43.6 million.
NOTE G COMPANY-OBLIGATED MANDATORY REDEEMABLE CONVERTIBLE PREFERRED SECURITIES OF SUBSIDIARY TRUST SOLELY HOLDING CONVERTIBLE DEBENTURES OF FINOVA ("TOPrS")
In December 1996, FINOVA Finance Trust, a subsidiary trust sponsored and wholly-owned by FINOVA, issued (a) 2,300,000 shares of convertible trust originated preferred securities (the "Preferred Securities" or "TOPrS") to the public for gross proceeds of $115 million (before transaction costs of $3.5 million) and (b) 71,135 shares of common securities to FINOVA. The gross proceeds from these transactions were invested by the trust in $118.6 million aggregate principal amount of 5 1/2% convertible subordinated debentures due 2016 (the "Debentures") newly issued by FINOVA. The Debentures represent all of the assets of the trust. The proceeds from the issuance of the Debentures were contributed by FINOVA to FINOVA Capital, which used the proceeds to repay commercial paper and other indebtedness.
The Preferred Securities accrue and pay cash distributions quarterly when declared by FINOVA at a rate of 5 1/2% per annum of the stated liquidation amount of $50 per preferred security. FINOVA has guaranteed, on a subordinated basis, distributions and other payments due on the Preferred Securities (the "Guarantee"). The Guarantee, when taken together with FINOVA's obligations under the Debentures, the indenture under which the Debentures were issued and FINOVA's obligations under the Amended and Restated Declaration of Trust governing the trust, provides a full and unconditional guarantee on a subordinated basis of amounts due on the Preferred Securities. FINOVA can defer making distributions on the Debentures for up to 20 consecutive quarters, but does not anticipate doing so. The Preferred Securities are mandatorily redeemable upon the maturity of the Debentures on December 31, 2016, or earlier to the extent of any redemption by FINOVA of any Debentures. The redemption price in either case will be $50 per share plus accrued and unpaid distributions to the date fixed for redemption.
Prior to their maturity, the Preferred Securities are convertible into FINOVA's common stock at the election of the holders of the Preferrred Securities individually. Each debenture is convertible into 1.2774 shares of FINOVA's common stock (equivalent to a conversion price of $39.14 per share), subject to adjustment in specified circumstances. FINOVA can terminate the conversion rights noted above on 30 days notice on or after December 31,1999 if it is current on its payments for the Debentures and the closing prices of its common stock trade at or above 120% of the conversion price of the Preferred Securities ($46.97, assuming no adjustments).
NOTE H SHAREOWNERS' EQUITY
On August 14, 1997, the Board of Directors declared a two-for-one stock split of FINOVA's common stock effected as a stock distribution on October 1, 1997 to shareowners of record as of September 1, 1997. All share and per share data have been restated to reflect the split.
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THE FINOVA GROUP INC.
At December 31, 1999, 1998 and 1997, FINOVA had 64,849,000, 58,555,000 and 58,555,000 shares of common stock issued, with 61,252,000, 55,721,000 and 56,282,000 shares of common stock outstanding, respectively. Approximately 5,926,000, 6,917,000 and 7,972,000 common shares were reserved for issuance under the 1992 Stock Incentive Plan at December 31, 1999, 1998 and 1997, respectively.
In addition to the convertible preferred securities issued by FINOVA Finance Trust in 1996, FINOVA has 20,000,000 shares of preferred stock authorized, none of which was issued at December 31, 1999. The Board of Directors is authorized to provide for the issuance of shares of preferred stock in series, to establish the number of shares to be included in each series and to fix the designation, powers, preferences and rights of the shares of each series. In connection with FINOVA's stock incentive plan, 250,000 shares of preferred stock are reserved for issuance of awards under that plan.
Each outstanding share of FINOVA's common stock has a tandem junior participating preferred stock purchase right ("Right") attached to it. The Rights contain provisions to protect shareowners in the event of an unsolicited acquisition or attempted acquisition of 20% or more of FINOVA's common stock that is not believed by the Board of Directors to be in the best interest of shareowners. The Rights are represented by the common share certificates and are not exercisable or transferable apart from the common stock until such a situation arises. The Rights may be redeemable by FINOVA at $0.01 per right prior to the time any person or group has acquired 20% or more of FINOVA's shares. FINOVA has reserved 600,000 shares of Junior Participating Preferred Stock for issuance in connection with the Rights.
FINOVA periodically repurchases its securities on the open market to fund its obligations pursuant to employee stock options, benefit plans and similar obligations. During the years ended December 31, 1999, 1998 and 1997, FINOVA repurchased 1,833,200, 1,299,200 and 1,035,800 shares, respectively. The program may be discontinued at any time.
In 1999 the shareowners approved an amendment to FINOVA's certificate of incorporation that increased the authorized common stock from 100 million to 400 million shares and the preferred stock from 5 million to 20 million shares.
NOTE I STOCK OPTIONS
During 1992, the Board of Directors of FINOVA adopted The FINOVA Group Inc. 1992 Stock Incentive Plan (the "Plan") for the grant of options, restricted stock and stock appreciation rights to officers, directors and employees. The Plan provides for the following types of awards: (a) stock options (both incentive and non-qualified stock options), (b) stock appreciation rights and (c) restricted stock. The Plan generally authorizes the issuance of awards for up to 2 1/2% of the total number of shares of common stock outstanding as of the first day of each year, with some modifications. In addition, 250,000 shares of preferred stock are reserved for awards under the Plan.
The stock options outstanding at December 31, 1999 were granted for terms of 10 years and generally become exercisable between one month to five years from the date of grant. Stock options are issued at market value at the date of grant, unless a higher exercise price is established. Since 1993, the Board has issued multi-year, multi-priced stock options to senior executives. The exercise price of those option grants range in price from the fair market value on the grant date to prices up to 58.7% in excess of the grant date value. Those option grants are intended to cover anticipated grants during the years the grants are scheduled to vest, although the Board may issue additional grants at its discretion. In 1999, premium-priced options were granted with exercise prices ranging from $41.56 to $50.29.
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THE FINOVA GROUP INC.
Information with respect to options granted and exercised under the Plan for the three years ended December 31, 1999 is as follows:
Average Option Shares Price Per Share ------ --------------- Options outstanding at January 1, 1997 3,437,178 $19.17 Granted 781,108 43.57 Exercised (442,049) 15.57 Canceled (191,094) 28.05 --------- ------
Options outstanding at December 31, 1997 3,585,143 24.45 Granted 1,197,032 58.22 Exercised (626,853) 18.13 Canceled (197,680) 42.00 --------- ------
Options outstanding at December 31, 1998 3,957,642 34.79 Granted 1,125,443 42.81 Exercised (258,004) 21.35 Canceled (248,335) 51.86 --------- ------ Options outstanding at December 31, 1999 4,576,746 $36.56 ========= ======
At December 31, 1999, stock options with respect to 4,576,746 common shares were outstanding at exercise prices ranging from $6.35 to $83.21 per share.
The following table summarizes information about stock options outstanding under the Plan at December 31, 1999:
Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Outstanding Contractual Exercise Exercisable Exercise Prices at 12/31/99 Life Price at 12/31/99 Price ------ ----------- ---- ----- ----------- ----- $ 6.35 - $18.44 933,512 3.20 $13.52 933,512 $13.52 18.50 - 32.75 990,772 5.71 24.85 988,660 24.83 32.84 - 41.56 1,006,271 9.38 40.45 76,976 35.90 42.75 - 54.47 1,224,067 8.20 50.10 537,152 48.07 54.97 - 83.21 422,124 8.16 66.48 129,911 60.91 -------------- --------- ---- ------ --------- ------ $6.35 - $83.21 4,576,746 6.90 $36.56 2,666,211 $27.63 ============== ========= ==== ====== ========= ======
Since April 1992, the Board of Directors has only granted performance based restricted stock to employees. Performance based restricted stock awards (113,500 shares in 1999, 78,985 shares in 1998 and 90,100 shares in 1997), vest generally over five years from the date of grant. The holder of the performance based restricted stock, like restricted stock, has the right to receive dividends and vote the target number of shares but may not sell, assign, transfer, pledge or otherwise encumber the performance based restricted stock. All performance based restricted stock grants since 1992 were based on FINOVA share performance and may result in greater or lesser numbers of shares ultimately being delivered to the holder, depending on that performance. The target number of shares are deemed received on the grant date. Additional vesting over the target are reported as new grants as of the vesting dates. Vestings below target would be reported as a forfeiture of amounts below the target number of shares. The balance of unamortized restricted stock was $12.3 million at December 31, 1999.
The Company applies APB Opinion 25 and related Interpretations in accounting for its plans. No compensation cost has been recognized for its fixed stock option plans because FINOVA grants options at or above market price on the date of grant. Vesting criteria for restricted stock was not met in 1999.
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THE FINOVA GROUP INC.
Therefore, no compensation expense was charged against income in 1999. The compensation cost charged against income for performance-based plans in 1998 and 1997 was $5.5 million and $7.9 million, respectively. Had compensation cost for the Company's stock based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the fair market value method, FINOVA's net income would have been $212.9 million, $153.4 million and $134.4 million for 1999, 1998 and 1997, respectively. Basic earnings per share would have been $3.56, $2.74 and $2.47 and diluted earnings per share would have been $3.37, $2.59 and $2.34 for 1999, 1998 and 1997, respectively.
The fair value of the options was estimated on the date of grant using the Black Scholes option pricing model with the following weighted-average assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield of 2.12%, 1.75% and 1.92%, expected volatility of 27%, 26% and 43%, risk-free interest rates on options with expected lives of five years of 5.4%, 5.7% and 6.2% and risk-free interest rates on options with expected lives of seven years of 5.5%, 5.8% and 6.3%. The weighted average grant date fair value of options issued for 1999, 1998 and 1997 were $13.25, $17.45 and $17.51, respectively.
With the acquisition of Sirrom Capital Corporation in March 1999, the Board of Directors of FINOVA adopted Sirrom's three existing stock option plans (the "Sirrom Plans"). Each option outstanding under the Sirrom Plans at the time of the acquisition was converted into an option exercisable for 0.1634 shares of FINOVA common stock. No new options are expected to be issued under these plans. Options from the Sirrom Plans were not included in the tables above.
The following table summarizes information about stock options outstanding under the Sirrom Plans at December 31, 1999:
Number Weighted Average Number Outstanding Remaining Exercisable Exercise Prices at 12/31/99 Contractual Life at 12/31/99 --------------- ----------- ---------------- ----------- $ 15.30 5,237 8.76 5,237 21.80 158,402 6.75 158,402 32.51 1,634 8.88 1,634 85.49 1,960 0.22 1,960 --------------- ------- ---- ------- $15.30 - $85.49 167,233 6.76 167,233 --------------- ------- ---- -------
NOTE J INCOME TAXES
The consolidated provision for income taxes consists of the following for the years ended December 31:
1999 1998 1997 -------- -------- -------- Current: United States: Federal $ 11,498 $ 25,308 $ 34,936 State 341 8,700 13,973 Foreign 5,941 1,870 3,626 -------- -------- -------- 17,780 35,878 52,535 -------- -------- -------- Deferred: United States: Federal 94,878 51,491 30,869 State 19,193 6,855 (1,115) Foreign 4,467 7,950 -------- -------- -------- 118,538 66,296 29,754 -------- -------- -------- Provision for income taxes $136,318 $102,174 $ 82,289 ======== ======== ========
Income taxes paid in 1999, 1998 and 1997 were approximately $11.5 million, $26.0 million and $30.3 million, respectively.
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THE FINOVA GROUP INC.
The significant components of deferred tax liabilities and deferred tax assets at December 31, 1999 and 1998 consisted of the following:
1999 1998 -------- -------- Deferred tax liabilities: Deferred income from leveraged leases $511,233 $396,572 Deferred income from lease financing 135,889 108,883 Goodwill 42,335 23,726 Other comprehensive income 23,467 Deferred acquisition costs 19,963 15,045 Foreign taxes 8,458 Other 14,751 16,229 -------- -------- Gross deferred tax liability 756,096 560,455 -------- --------
Deferred tax assets: Reserve for credit losses 119,457 92,784 Alternative minimum tax 66,259 52,442 Net operating loss carryforward/carryback 62,965 20,625 Basis difference in loans/investments 23,324 Accrued expenses 18,054 9,051 Foreign 10,792 Other 26,519 32,493 -------- -------- Gross deferred tax asset 316,578 218,187 -------- -------- Net deferred tax liability $439,518 $342,268 ======== ========
The federal statutory income tax rate is reconciled to the effective income tax rate as follows:
1999 1998 1997 ---- ---- ---- Federal statutory income tax rate 35.0% 35.0% 35.0% State income taxes 3.6 3.8 2.6 Foreign tax effects 0.1 (0.1) Municipal and ESOP income (1.3) (1.6) (2.0) Other 1.1 1.1 1.2 ---- ---- ---- Provision for income taxes 38.4% 38.4% 36.7% ==== ==== ====
NOTE K PENSION AND OTHER BENEFITS
Net periodic pension costs were $4.2 million, $3.0 million and $1.9 million for the years ended December 31, 1999, 1998 and 1997, respectively. FINOVA's pension costs were accrued at $9.6 million at December 31, 1999 and $5.5 million at December 31, 1998.
Net periodic other postretirement benefits costs were $0.9 million, $0.7 million and $0.5 million for each of the years ended December 31, 1999, 1998 and 1997, respectively. FINOVA's accrued postretirement benefit costs were $4.4 million at December 31, 1999 and $3.5 million at December 31, 1998.
FINOVA's investment of $71 million in trust for nonqualified compensation plans consists of securities held for trading and is recorded at market.
NOTE L EARNINGS PER SHARE
Basic earnings per share exclude the effects of dilution and are computed by dividing income available to common shareowners by the weighted average amount of common stock outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if options, convertible preferred stock or other contracts to issue stock were exercised or converted
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THE FINOVA GROUP INC.
into common stock. These per share calculations are presented for the years ended December 31, 1999, 1998 and 1997 on the Statements of Consolidated Income and are detailed below:
NOTE M LITIGATION AND CLAIMS
FINOVA is party either as plaintiff or defendant to various actions, proceedings and pending claims, including legal actions, some of which involve claims for compensatory, punitive or other damages in significant amounts. That litigation often results from FINOVA's attempts to enforce its lending agreements against borrowers and other parties to those transactions. Litigation is subject to many uncertainties and it is possible that some of the legal actions, proceedings or claims referred to above could be decided against FINOVA. Although the ultimate amount for which FINOVA may be held liable, if any, is not ascertainable, FINOVA believes that any resulting liability should not materially affect FINOVA's financial position, results of operations or cash flows.
NOTE N FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments has been determined by FINOVA using market information obtained by FINOVA and the valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that FINOVA could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.
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THE FINOVA GROUP INC.
The carrying amounts and estimated fair values of FINOVA's financial instruments are as follows for the years ended December 31:
The carrying values of cash and cash equivalents, fee-based receivables, financing contracts held for sale, accounts payable and accrued expenses, due to clients and interest payable (including accrued amounts related to interest rate swaps and interest rate hedge agreements) approximate fair values due to the short-term maturity of these items.
The methods and assumptions used to estimate the fair values of other financial instruments are summarized as follows:
Loans and Other Financing Contracts:
The fair value of loans and other financing contracts was estimated by discounting expected cash flows using the current rates at which loans of similar credit quality, size and remaining maturity would be made as of December 31, 1999 and 1998. Management believes that the risk factor embedded in the current interest rates on performing loans results in a fair valuation of performing loans. As of December 31, 1999 and 1998, the fair value of nonaccruing impaired contracts with a carrying amount of $206.2 million and $119.7 million, respectively, was not estimated because it is not practical to reasonably assess the credit adjustment that would be applied in the marketplace for such loans. As of December 31, 1999 and 1998, the carrying amount of loans and other financing contracts excludes repossessed assets with a total carrying amount of $130.7 million and $119.7 million, respectively.
Senior Debt:
The fair value of senior debt was estimated by discounting future cash flows using rates currently available for debt of similar terms and remaining maturities. The carrying values of commercial paper and borrowings under revolving credit facilities, if any, were assumed to approximate fair values due to their short maturities.
Interest Rate Swaps:
The fair values of interest rate swaps are based on quoted market prices obtained from participating banks and dealers.
Interest Rate Hedge Agreements:
The fair value of interest rate hedge agreements in place at December 31, 1999 and 1998 were based on quoted market prices obtained from participating loans and dealers for transactions of similar remaining durations.
The fair value estimates presented herein were based on information obtained by FINOVA as of December 31, 1999 and 1998. Although management is not aware of any factors that would significantly affect the estimated fair values, such values have not been updated since December 31, 1999 and 1998. Therefore, current estimates of fair value may differ significantly from the amounts presented herein.
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THE FINOVA GROUP INC.
NOTE O OPERATING EXPENSES
The following represents a summary of the major components of operating expenses for the three years ended December 31:
NOTE P OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income activity for the three years ended December 31, 1999 was as follows:
Net Accumulated Unrealized Other Foreign Currency Holding Gains Comprehensive Translation on Securities Income ----------- ------------- ------------- Balance, January 1, 1997 $ 1,008 $ $ 1,008 Change during 1997 (1,018) (1,018) ------- -------- ------- Balance, December 31, 1997 (10) (10) Change during 1998 (208) 904 696 ------- -------- ------- Balance, December 31, 1998 (218) 904 686 Change during 1999 (3,928) 37,054 33,126 ------- -------- ------- Balance, December 31, 1999 $(4,146) $ 37,958 $33,812 ======= ======== =======
For 1999 and 1998, the changes in foreign currency translation were net of income tax benefits of $2.1 million and $140,000, respectively. Net unrealized holding gains were net of income tax expenses of $25.6 million in 1999 and $608,000 in 1998.
NOTE Q SEGMENT REPORTING
Management's Policy for Identifying Reportable Segments
FINOVA's reportable business segments are strategic business units that offer distinctive products and services that are marketed through different channels.
Types of Products and Services
FINOVA has three market groups that are also its reportable segments: Commercial Finance, Specialty Finance and Capital Markets. Commercial Finance includes traditional asset-based businesses that provide financing through revolving credit facilities and term loans secured by assets such as receivables and inventory, as well as providing factoring and management services. This segment includes the following lines of business: Business Credit, Commercial Services, Corporate Finance, Distribution & Channel Finance, Growth Finance and Rediscount Finance. Specialty Finance includes businesses which lend to a variety of highly focused, industry-specific niches. This segment includes the following lines of business: Commercial Equipment Finance, Communications Finance, Franchise Finance, Healthcare Finance, Portfolio Services, Public Finance, Resort Finance, Specialty Real Estate Finance and Transportation Finance. Capital Markets, in conjunction with institutional investors, provides commercial mortgage banking services and debt and equity capital funding. This segment includes: Realty Capital, Investment Alliance, Loan Administration, Mezzanine Capital and Harris Williams & Co.
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THE FINOVA GROUP INC.
Reconciliation of Segment Information to Consolidated Amounts
Management evaluates the business performance of each group based on total net revenue, income before allocations and managed assets. Total net revenue is operating margin plus gains on disposal of assets. Income before allocations is income before income taxes and preferred dividends, excluding allocation of corporate overhead expenses and the unallocated portion of provision for credit losses. Managed assets includes each segment's investment in financing transactions plus securitizations and participations sold.
Information for FINOVA's reportable segments reconciles to FINOVA's consolidated totals as follows:
1999 1998 ---- ---- TOTAL NET REVENUE: Commercial Finance $ 216,083 $ 187,461 Specialty Finance 384,789 344,541 Capital Markets 101,414 24,170 Corporate and other (16,388) 8,978 ----------- ----------- Consolidated total $ 685,898 $ 565,150 =========== ===========
INCOME (LOSS) BEFORE ALLOCATIONS: Commercial Finance $ 87,406 $ 67,013 Specialty Finance 307,377 273,674 Capital Markets 31,235 (2,775) Corporate and other, overhead and unallocated provision for credit losses (70,674) (71,615) ----------- ----------- Income before income taxes and preferred dividends $ 355,344 $ 266,297 =========== ===========
MANAGED ASSETS: Commercial Finance $ 4,195,237 $ 3,005,130 Specialty Finance 8,265,497 7,211,164 Capital Markets 1,051,367 255,575 Corporate and other 93,273 85,948 ----------- ----------- Consolidated total $13,605,374 $10,557,817 Less securitizations and participations sold (483,397) (537,596) ----------- ----------- Investment in financing transactions $13,121,977 $10,020,221 =========== ===========
GEOGRAPHIC INFORMATION
FINOVA attributes managed assets to geographic areas based on the location of the asset. Managed assets at December 31, 1999 and 1998 by geographic area were as follows:
1999 % 1998 % ----------- ----- ----------- ----- United States $12,248,105 90.0% $ 9,932,318 94.1% Canada 258,990 1.9% 94,035 0.9% United Kingdom 214,781 1.6% 156,021 1.5% Other foreign 883,498 6.5% 375,443 3.5% ----------- ----- ----------- ----- $13,605,374 100.0% $10,557,817 100.0% =========== ===== =========== =====
Other foreign includes customer relationships in geographic areas which, on an individual basis represent less than 1.0% of the total.
Currently, it is impracticable to report revenues attributed to foreign countries.
MAJOR CUSTOMER INFORMATION
FINOVA has no single customer that accounts for 10% or more of revenue.
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NOTE R ACQUISITIONS
During 1999 and 1998, FINOVA acquired various businesses and portfolios under the purchase method with initial managed assets totaling $1.15 billion and $44 million, respectively.
In December 1999, FINOVA acquired Fremont Financial Corporation, the commercial lending subsidiary of Fremont General Corporation, headquartered in Santa Monica, California. The company, which provides secured working capital and term loans averaging $2 million to $4 million to midsize businesses throughout the U.S., was added to FINOVA's Commercial Finance Group. The purchase price was approximately $131 million, paid in cash. Total assets acquired were $723 million, including $23 million in goodwill and assumed liabilities of $592 million. Managed assets purchased were $662 million. Goodwill, amortizing over 20 years, is subject to change due to a preliminary estimate of loan balances at the date of acquisition.
In March 1999, FINOVA acquired Sirrom Capital Corporation, a specialty finance company headquartered in Nashville, Tennessee. The purchase price was approximately $343 million in FINOVA common stock, excluding converted stock options. Total assets acquired were $621 million, including $67 million in goodwill with $278 million in assumed liabilities and transaction costs. Managed assets acquired were $469 million. Goodwill is being amortized over 25 years and covenants not to compete, which are included in goodwill, are being amortized over 3 years.
The following unaudited pro forma information gives effect to the merger as if it had occurred on January 1, 1999 and 1998 and combines the historical consolidated information of FINOVA and Sirrom for the year ended December 31, 1999 and 1998.
The comparative pro forma information is not necessarily indicative of the results that actually would have occurred had the merger been consummated on the dates indicated or that may be obtained in the future. The pro forma financial information does not give effect to the potential cost savings and other synergies that may result from the merger or the possible cash-out of existing stock options held by employees of Sirrom that became fully vested by reason of the adoption of the merger agreement by Sirrom shareowners. There can be no assurance that FINOVA will realize cost savings or synergies from this or any other acquisition. Included in the historical operations of Sirrom for the year ended 1999 are approximately $27 million of nonrecurring charges, a significant portion of which related to the acquisition.
Years Ended December 31, ------------------------ 1999 1998 ---- ---- Total revenue $1,243,970 $1,080,507 Net Income $ 163,060 $ 87,853 Earnings per share-basic $ 2.72 $ 1.57 Earnings per share-diluted $ 2.59 $ 1.51
The acquisition resulted in an excess purchase price over the historical net assets acquired. The excess is allocated to the net assets acquired and liabilities assumed, as follows:
Allocation of purchase price: Purchase price $ 342,730 Elimination of historical shareowners' equity of Sirrom (262,046) ---------
Excess purchase price $ 80,684 ========= Allocation of excess purchase price: Elimination of unamortized debt costs $ (3,227) Deferred income taxes 44,152 Assumed liabilities (26,802) Goodwill 66,561 --------- Excess purchase price $ 80,684 =========
In February 1999, FINOVA acquired Preferred Business Credit, a Los Angeles-based provider of accounts receivable loans to small and midsize businesses for $12 million in FINOVA common stock. It is functioning as the West Coast operation for the Growth Finance division, acquired in October 1998. Total assets purchased were $30 million, including $12 million in goodwill that is being amortized over 25 years. Managed assets purchased were $18 million.
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THE FINOVA GROUP INC.
In October 1998, FINOVA acquired United Credit Corporation for $26 million cash. The New York-based provider of commercial financing serves small and mid-size growth-oriented businesses. Total assets purchased were $62 million, including $16 million in goodwill, which is being amortized over 25 years. Managed assets acquired were $45 million. The addition formed a new division named FINOVA Growth Finance, providing collateral-based working capital financing, primarily secured by accounts receivable. The division provides financing ranging from $100,000 to $1 million to businesses with annual sales under $10 million.
In October 1998, FINOVA acquired Electronic Payment Systems, Inc., a commercial receivables servicing business headquartered in Salt Lake City, Utah, to support the activities of FINOVA Realty Capital.
NOTE S NEW ACCOUNTING STANDARDS
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivatives and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133," ("SFAS No. 137"). This statement defers the effective date of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS No. 133") to all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS No. 133 standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, by recognition of those items as assets or liabilities in the statement of financial position and measurement at fair value. The impact of SFAS No. 133 on the Company's financial position and results of operations has not yet been determined.
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SUPPLEMENTAL SELECTED FINANCIAL DATA CONDENSED QUARTERLY RESULTS (UNAUDITED) (Dollars in Thousands, except per share data)
The following represents the condensed quarterly results for the three years ended December 31, 1999, 1998 and 1997:
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Income earned from financing transactions: 1999 $ 273,075 $ 295,846 $ 318,688 341,034 1998 232,833 246,069 253,309 275,562 1997 206,226 216,836 219,012 237,689
Interest expense: 1999 131,183 139,153 150,142 172,380 1998 110,280 114,692 121,937 131,268 1997 96,793 101,501 105,208 111,148
Volume-based fees: 1999 12,735 11,264 14,317 11,764 1998 22,156 19,103 16,687 19,777 1997 7,784 8,583 9,546 13,465
Gains on disposal of assets: 1999 12,370 18,760 14,880 22,010 1998 1,525 7,433 6,471 12,483 1997 3,233 9,768 10,305 7,027
Non-interest expenses: 1999 84,225 97,059 107,485 109,772 1998 79,548 89,702 85,922 113,762 1997 66,769 77,599 80,334 85,931
Net income: 1999 50,057 53,663 54,905 56,619 1998 39,741 40,535 41,838 38,227 1997 32,178 34,670 33,337 37,725
Basic earnings per share: 1999 0.89 0.87 0.90 0.93 1998 0.71 0.72 0.75 0.69 1997 0.60 0.64 0.62 0.68
Diluted earnings per share: 1999 0.83 0.83 0.86 0.89 1998 0.67 0.68 0.71 0.65 1997 0.57 0.61 0.58 0.64
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THE FINOVA GROUP INC.
AVERAGE BALANCES/OPERATING MARGIN/AVERAGE ANNUAL RATES (UNAUDITED) (1) (Dollars in Thousands)
The following represents the breakdown of FINOVA's average balance sheet, operating margin and average annual rates for the years ended December 31, 1999 and 1998:
- ---------- (1) Averages are calculated based on monthly balances. (2) For the years ended December 31, 1999 and 1998 interest income is shown net of operating lease depreciation. (3) The average rate is calculated based on average earning assets ($10,718,941 and $8,546,715 for 1999 and 1998, respectively) which are net of average deferred taxes on leveraged leases and average nonaccruing assets. (4) For the year ended December 31, 1999, excluding the impact of derivatives, interest expense would have been $597,919 or 5.58% of average earning assets and operating margin would have been $612,817 or 5.72% of average earning assets. For the year ended December 31, 1998, excluding the impact of derivatives, interest expense would have been $472,893 or 5.53% of average earning assets and operating margin would have been $542,522 or 6.35% of average earning assets.
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