is employing lax lending practices to hide bad loans, according to three people who recently left Conseco's finance operations, as well as internal company documents obtained by
In an email, Conseco spokesman Mark Lubbers called this charge "tiresome and wrong" and ardently defended his company's lending policies. Asked about this article in an interview with
Monday, Conseco CEO Gary Wendt said the company's loan deferral policy hadn't been changed to help reduce delinquent loan numbers.
Wendt, a former
top executive, joined 14 months ago with the aim ofrepairing many of the problems attributed to the company's former management team, most importantly a burdensome debt level. Wendt's been telling investors that efforts to turn around Conseco Finance, the company's troubled lending arm, are progressing well. But the ex-employees' comments and the documents suggest that the credit quality of a portion of Conseco's $26 billion mobile-home loan portfolio is worse than the company publicly reports.
The ex-employees say the company holds down loan losses by allowing delinquent borrowers to defer mobile-home loan repayments. The skipped payments are added to the principal of the loan, which is then classified as current, they say.
Banks and lending companies often allow borrowers to defer payments, but it's usually done under strict guidelines and only in extenuating circumstances, such as extreme hardship. Also, borrowers typically have to make a payment to get a deferral, and some lenders give deferrals only on accounts that are current. However, the three ex-employees say Conseco is indiscriminately using these deferrals, also known as extensions, to understate the true number of defaults in its mobile-home loan business.
Investors closely track credit quality indicators like delinquencies, home repossessions and losses. When a loan doesn't get paid, the lender loses the cash flow from that credit and its portfolio can become incrementally less profitable. Signs that loans are going bad at a faster-than-expected rate can spark a selloff in a lender's stock. Spiraling losses have ended up sinking banks and finance companies.
"Our managers were most concerned about reducing loans that were more than 60 to 90 days past due, so that they didn't get into numbers reported to Wall Street," alleges Joan Busch, who worked as a mobile-home loan collector in the Federal Way, Wash., regional office of Conseco Finance. "Extensions were demanded of us."
Another ex-employee at the Federal Way office concurs: "If they took away extensions, delinquencies would skyrocket." (This person requested anonymity. The third person interviewed for this piece also requested anonymity.)
The Federal Way office, one of Conseco's largest regional operations, services around 16,000 accounts. The office's operations manager Greg Aest didn't return calls.
Conseco's Lubbers didn't make Aest or other senior Conseco employees available for comment. But in the email he writes: "Loss mitigation practices are an essential element of our business. They are subject to specific guidelines."
What's Your Extension?
The ex-employees' claims about extensions appear to be supported by individual loan records, as well as a July memo sent to Federal Way collectors telling them to avoid repossessions by using extensions, interest rate cuts and loan transferals. The memo and loan records were given to
by a person familiar with Conseco's business. (Links to the memo and the loan records can be found below.)
Busch, who claims over 10 years' experience as a loan collector, says she resigned from Conseco in July. "I didn't like their practices," she says. "They are hiding numbers from shareholders." Lubbers, apparently claiming to know with whom this publication has spoken, says all ex-employees interviewed were dismissed. He offered no further explanation for this allegation.
Since reporting disappointing second-quarter earnings in August, Conseco has seen its stock sink 45%. Problems in the company's insurance business were the biggest black spot on second-quarter numbers, but there are worries surrounding Conseco Finance as well.
"No lender has ever been able to extend its way out of trouble," says Bill Ryan, consumer finance analyst at Ventana Capital, a New York-based brokerage that doesn't do underwriting. (Ryan doesn't rate Conseco.) "When you look at Conseco's publicly disclosed credit quality data, you have to step back and ask yourself what you're really looking at."
Conseco says 2.2% of its mobile-home loans were more than 60 days past due at the end of June, while losses were equivalent to 1.93% of the portfolio. Loans on repossessed houses totaled 2.18% of the portfolio. Monthly delinquency numbers released by Conseco appear to show a further deterioration since June.
What's more, extensions require Conseco to forgo cash that's needed to finance the company's heavy debt load. Wendt's turnaround effort envisions Conseco Finance providing $335 million of cash to Conseco's debt-laden parent company in 2002. But if extensions continue to be widely used, and delinquencies and losses continue to mount, the company could miss that cash flow target, possibly making it more difficult for the company to service its debt.
Last year, banking regulators moved to establish industry practice for doing extensions. The
Office of the Comptroller of the Currency
and three other federal bank regulators issued a joint communique in June 2000 stating that banks needed to adopt standards for extensions that "would be based on the borrower's willingness and ability to repay the loan." The communique isn't legally binding.
Busch and the two ex-employees claim most recipients of extensions showed little, or no, willingness or ability to repay their loans. Many of the borrowers were already many months behind on their payments, and some had never even managed to make a single full payment, these three say. "Only about 20% of the people who got extensions were willing and able to repay," estimates one of the ex-employees who requested anonymity.
Conseco Finance may not come squarely under the gaze of bank regulators. It's what's known in the lending industry as an independent finance company, and, as such, is not directly overseen by federal watchdogs. However, its banking affiliate, Salt Lake City-based Conseco Bank, is covered by these regulators.
The Bond Business
In a process known as securitization, Conseco packages thousands of mobile-home loans together and sells them as bonds to investors. In a January securitization document filed with the
Securities and Exchange Commission
, Conseco says that borrowers whose loans are included in the securitization "may not be solicited for extensions." This would imply that extensions can only be given if a borrower approaches Conseco and requests that he or she can defer a payment.
The SEC filing adds that "no more than one extension under a
loan contract may be granted in any 12-month period."
To the extent that Conseco Finance is doing extensions on loans included in its securitizations, it may be contravening its own internal guidelines on granting extensions. There's no direct evidence that Conseco Finance has extended the terms of these securitized loans.
Busch and the two other ex-employees claim that the Federal Way office solicited extensions, and didn't wait for borrowers to initiate the process. Managers asked collectors to do so-called blind extensions, the ex-employees say. With these, collectors sent out extension invitations to borrowers without speaking to the debtors first, they say. Collectors were encouraged to do these on accounts that were more than 90 days delinquent, Busch adds.
Conseco's Lubbers wrote that it's "demonstrably false" that Conseco has failed to meet any of its own disclosed standards.
One borrower's loan document, obtained by
, shows more than one extension being given in a 12-month period. Richard S., based in Washington state, was selected for a two-month extension on Nov. 29, 2000, and a five-month one on July 31, 2001, according to loan records seen by this publication. His $60,000 loan was taken out only in April last year. (Details of the account, showing the number of months his loan has been extended, can be viewed
Extensions have been given on young loans.
John T., living in Oregon, was given a three-month extension on June 27, only nine months after Conseco lent him $110,000, and a mere three and a half months after his first payment date, according to a document this publication obtained.
Conseco Finance also apparently offered delinquent borrowers lower interest rates to encourage them to pay.
In a July 13 memo, Federal Way manager Dennis Osborn told collectors that, in order "to slow down the repossession process," collectors had to offer interest rate reductions to borrowers more than 90 days past due. (Osborn declined to comment.) A repossession describes the act of retrieving the house for which a defaulted loan was originally made.
Busch and the ex-employees who requested anonymity say that these "rate modifications" generally came with extensions. As the result of a rate modification,
records passed to this publication show Aimee P., also from Oregon, paying a 6% interest rate on her $108,000 loan, which she was behind on. She was originally paying an interest rate of 8.49%, according to one of the ex-employees who requested anonymity. The average mortgage rate in the U.S. is currently around 6.9%. Conseco operates as a so-called sub-prime lender, meaning its borrowers tend to have spotty credit histories. Sub-prime borrowers normally pay interest rates well above the average rate.
The Repossession Question
One possible reason for the measures outlined in the July 13 memo was to avoid repos, according to the two people who declined to be named. Once Conseco claims back a house, it holds it in its repo inventory. Wall Street closely follows repo numbers, as they give a leading indicator of losses. A loss is booked if the proceeds from reselling the repossessed house are below that of the principal of the loan at the time of default. Conseco claims it makes around a 50% loss on these transactions.
Other methods Osborn advocated in the memo include extensions and something called default transfers of equity, or DTOEs. This transaction allows a delinquent borrower to pass the loan and housing collateral to another borrower. Using this practice allows Conseco to avoid booking a loss. (
looked at this practice on May 30.)
Busch and the two other employees say the memo was sent after Osborn participated in a conference call with Conseco Finance Vice President Randy Shannon, who is based at the unit's headquarters in St. Paul, Minn. The July 13 memo concerns "a collection meeting" between Shannon and Osborn, according to the memo. (Shannon didn't return calls seeking comment.)
It's hard to gauge the impact of the loss-reduction effort. One of the ex-employees says Federal Way managers told collectors at the end of last year to do a combined 100 extensions a month, though this person says more were often done. With the average balance of a Conseco mobile home around $40,000, TheStreet.com roughly calculates that at least $4 million of loans are being extended every month.
Lubbers states that only some "fraction of 1%" of Federal Way's 16,000 accounts "end up utilizing" the loss reduction measures listed in the July memo. "The reason that Conseco Finance is arguably the most successful company in this niche is that we are expert at executing effective loss mitigation practices," Lubbers added in the email.
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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.