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Time for Last Rites at Conseco

Conseco, 1982-2002?

While the lender and insurer may well try one last bid for survival, it's almost impossible to see how this debt-laden and cash-starved company can stave off a bankruptcy filing this year. After a truly horrible 2001, the bad news has been quick to come in 2002.

On Thursday, GreenPoint Financial (GPT - Get Report), a rival mobile-home lender, said it was exiting the business and forecast that bad-loan losses would skyrocket. The bombshell for Conseco (CNC - Get Report)? Applying GreenPoint's projections to Conseco's $25 billion of mobile-home loans would result in losses of $3.5 billion.

If a loss of this size materializes, it would eat a huge hole in the balance sheet of Conseco Finance, Conseco's lending subsidiary, and leave that entity in breach of its bank loan covenants. Granted, Conseco's own loss estimates are much lower than GreenPoint's, but analysts believe GreenPoint is more conservative and accurate in its accounting and credit forecasts.

Also Thursday, Conseco announced that Conseco Finance's chief executive Bruce Crittenden had resigned, to be replaced by Charles Cremens. Then Friday, Salomon Smith Barney analyst Colin Devine, a longtime Conseco bear, downgraded the company's stock to sell, pointing to further deterioration of credit quality and GreenPoint's loss projections. The stock tanked 16% Friday; it was down 66% in 2001.

Conseco didn't respond to requests for comment. Detox wrote frequently on Conseco in 2001. One article , citing employees and internal documents, alleged that the company was using nonstandard lending practices to hide bad-loan losses.

Requiem for a Heavyweight

Salomon's Devine thinks Conseco will struggle to remain solvent. "On a liquidation basis, we do not believe Conseco's common shareholders would receive any value," he wrote Friday. (Salomon hasn't done recent underwriting for Conseco.)

If Conseco were to file for bankruptcy protection this year, it would conclude one of the most dramatic boom-bust stories in the history of corporate America. The company, which originally focused chiefly on insurance, was built almost from scratch by the flamboyant entrepreneur Stephen Hilbert. Though Hilbert's rapid acquisition strategy drew the attention of short-sellers in the '80s, earnings soared, and the bears never tasted success. They had to wait until 1998, when Hilbert massively overpaid for the nation's dominant mobile-home lender, Green Tree Financial, later renamed Conseco Finance.

Accounting controversies erupted soon after the acquisition. Hilbert, consistently among the best-paid executives in the country when he headed Conseco, left in 2000 after the underlying business faltered and the stock price plunged. The company got a lifesaving investment from Boston-based buyout firm Thomas H. Lee. Then, in June 2000, Gary Wendt, the highly regarded ex-head of GE's finance business, became Conseco's chief executive, sparking a wave of optimism and a massive rally in the stock. But after achieving one big positive -- a debt restructuring -- Wendt has failed to improve on Hilbert. In fact, Wendt's lending policies have increased bad loans, and he has generated his own slew of accounting issues.

So why does GreenPoint's announcement practically add up to a death notice for Conseco? Before doing a comparison of the companies, it's worth reiterating that analysts consider GreenPoint's numbers to be more trustworthy and conservative than Conseco's. Says Bill Ryan at New York-based brokerage Ventana Capital: "GreenPoint was actually a better underwriter than Conseco." (Ventana doesn't rate Conseco, and the firm has done no underwriting for Conseco or GreenPoint.)

GreenPoint expects to lose 26% of the dollar value of its mobile loans over their lifetime, up from the previous projection of 14%. By contrast, Conseco expects lifetime losses of 12.6%.

To Dust Returneth

How do we apply GreenPoint's lifetime loss number to Conseco's portfolio?

First, we need to focus on the $18.4 billion of mobile-home loans that Conseco has accounted for as off-balance-sheet loans that it has sold. On its own pool, GreenPoint expects losses of around 33%, so let's assume that Conseco's loss will be the same (a kind act considering its underwriting standards are inferior to GreenPoint's).

GreenPoint also estimates that it will eventually recover 20% of the bad loans' value by selling the collateral. Let's be kinder still and assume Conseco recovers 30% on its bad loans. That would mean a total dollar loss of 23% (33 times 0.7).

Now, Conseco already expects lifetime losses of 12.6% on its sold loans. We subtract that from 23% to get 10.4%, which is the amount Conseco could have coming in losses beyond its expectations. To get a dollar sum, we multiply the $18.4 billion by 10.4% to get $1.9 billion. That is exactly the sum that Conseco Finance had in stockholders' equity at the end of the third quarter.

But we still haven't got to the losses on the $7 billion of loans that are accounted for as being on the balance sheet. (These were made since the third quarter of 1999, when Conseco switched accounting practices.)

The losses on these loans, many of which were made by Wendt, are running at much higher rates than older loans. But, once again showing a little mercy, we'll use the 23% loss number we had for the sold loans to the $7 billion. Doing that, we get to $1.6 billion, bringing potential total cumulative losses on Conseco's mobile home loans to $3.5 billion ($1.6 billion plus $1.9 billion).

However, because of the way they're accounted for, the losses for the on-balance-sheet loans should be calculated on an annual basis. Since these loans have an average life of around seven years, Conseco could face annual losses of around $230 million on its loans accounted for as on-balance-sheet ($1.6 billion divided by 7). At the end of September, Conseco had $120 million of mobile-home bad loan reserves. Arguably, then, Conseco should be adding another $110 million to its loss reserve to get to the likely $230 million loss rate.

Crittenden's exit is also unnerving. Many had expected the executive to leave soon after Wendt joined, partly because he was perceived to be a key player in the Hilbert era at Conseco Finance. The fact that he stayed led some to believe that Wendt needed to retain a senior person who knew where any skeletons may be buried. A pending class action lawsuit alleges that Crittenden, along with Hilbert, was involved in a scheme to artificially reduce the number of delinquent loans.

Know any companies that the market may be misvaluing? Detox would like to hear about them. Please send all feedback to peavis@thestreet.com.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

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