Conseco (CNC) - Get Report is increasing use of high-risk lending practices in a bid to hold down the number of past-due loans in its $26 billion mobile home portfolio, according to a manager who recently left Conseco Finance, the company's loan business, and a current employee at the unit.

These two people say greater deployment of these measures may reduce loan delinquencies in the short term at the Carmel, Ind.-based insurer and lender. But bad-loan numbers will spike in a year's time, they predict, saying the company's practices will merely defer losses rather than permanently reduce them. That's because the delinquency suppression measures include transferring loans to new borrowers who are prone to default and allowing doubtful debtors to defer loan repayments, they say.

Most recently, the manager worked as a collections manager at Conseco's large call center in Tempe, Ariz. The current employee is a loan collections representative in the mobile home department at the center, which is one of three such operations at Conseco (the others are in Atlanta and Rapid City, S.D.). Both people requested anonymity.

Keeping bad-loan numbers low is crucial to Conseco's turnaround hopes. Conseco Finance funds itself chiefly by selling its loans, which it bundles into bonds that are sold to investors. Sharply higher delinquency figures would reduce investor demand for Conseco's loan-backed bonds, driving up funding costs and casting a question mark over the debt-laden company's ability to finance its core businesses.

Conseco spokesman Mark Lubbers dismisses the notion that his company is using risky measures to artificially hold down delinquencies and bad-loan-related losses.

Lion's Share

Acquired in 1998, when it was called

Green Tree Financial

, Conseco Finance became the chief source of Conseco's problems in 2000. The company nearly collapsed last year after several years of mismanagement and alleged accounting tricks by a team led by the former CEO, Stephen Hilbert.

Going Mobile
Tracking Conseco's 2001 rise

Since June 2000, Conseco has been fronted by highly regarded ex-


(GE) - Get Report

executive Gary Wendt, whose restructuring plan has drawn much support from investors. Conseco stock has more than doubled since Wendt joined last June. Wednesday, Conseco fell 6 cents to $17.80.

The past months' rally has largely been based on what appear to be improved results from Conseco Finance, which Wendt believes will provide the lion's share of profit growth.

However, the run-up in the stock has been greeted with skepticism in some quarters. For example, billionaire investor Carl Icahn has sold Conseco stock short, which means he stands to profit if the company's shares fall. "Every so often I find one or two shorts I think will be absolute winners. The last one was



-- and Conseco, in my opinion, is just as good," Icahn said in an interview.

His main beef is Conseco's valuation. Combining the market capitalization of Conseco's common stock with its debt and preferred securities, and then subtracting around a $1 billion of cash, the company has a so-called enterprise value of around $13 billion.

"Ask yourself a simple question: If you were running family money, would you spend $13 billion on Conseco Finance and Conseco's questionable insurance company?" Icahn remarks. "You'd laugh someone out of the office if they tried to sell Conseco to you for that -- and yet that's how the market is valuing this thing."

At a

Lehman Brothers

-hosted investor conference last week, Wendt said Conseco was considering raising capital through a securities issue. Reputedly, the company is mulling an issue of $500 million to $1 billion of equity securities that have many of the features of a bond.

While amassing more capital now would certainly alleviate concerns about the company's ability to meet debt payments, investors are keeping a close eye on credit quality at Conseco.

Despite the economic slowdown and the crunch in the mobile home market, Conseco Finance reported a drop in past-due loans in the first quarter of this year.

And the unit's chief executive, Bruce Crittenden, one of the few senior Hilbert-era staffers Wendt has retained, predicted that delinquencies will decline still further in the second quarter and the rest of 2001.

However, this forecast appears to clash with comments Wendt made at the Lehman conference, where he said bankruptcies and delinquencies were rising, due to borrowers rushing to file for bankruptcy before Congress passes a tougher set of bankruptcy laws. He didn't specify whether that forecast was for mobile home loans, Conseco Finance's largest business, or for other lending products, like home equity credits.

Whatever the second-quarter past-due loan numbers, the collections rep and the ex-manager say concerted efforts are being made to hold down mobile home delinquencies. The methods are unsound and unsustainable, they say.

Their main concern is that these loss-reduction methods target extremely low-quality borrowers, many of whom won't honor their loans, they claim.

Lean on Me

These two people say that about two months ago, managers at the Tempe center leaned on staff to substantially increase the use of a practice called "default transfer of equity." In a default transfer of equity, a past-due loan and its housing collateral are passed over to a new borrower for a fee. Also around two months ago, Tom Franco, head of mobile home lending at Conseco, sent an email to managers in all three call centers asking them to do more default transfers of equity, according to the ex-manager. (Franco didn't return calls.)

In a default TOE, the missed payments on the transferred loan, as well as other costs associated with the transaction, are added to the principal that is taken on by the new borrower. The loan is then reclassified as current and thus subtracted from Conseco's delinquency tally. However, the ex-manager and the collections officer claim most of the new borrowers in recent default TOEs are even less creditworthy than those who first defaulted.

In addition, they say that managers at Tempe two months ago started a push to get staff to use a lot more loan extensions and also introduced a measure called forbearances. Both of these involve granting loan repayment deferrals, they say.

"There may be a large reduction in delinquencies and repossessions over the next nine months to a year, but after that they'll soar," the ex-manager says. "It'll all come back to bite them -- like a snake."

However, it appears that the immediate need is for lower delinquencies. "The managers

at Tempe are really panicking because we haven't given them enough default TOEs, extensions and forbearances," says the collections rep.

In an email, Conseco spokesman Lubbers described measures like default TOEs and forbearances as "loss mitigation practices."

He wrote: "You understand that we have 1,500 people whose job it is to mitigate losses, right? People on the phone, calling to find out why a loan payment is late, to get it sent in. And if it doesn't come in, to figure out how to best preserve the principal."

"That's just plain silly," the ex-manager says of Lubbers' characterization of these measures. "These are loss-deferral tactics."

Lubbers added that the use of such practices have been factored into Conseco earnings projections and assumptions for its loan-backed bonds. It "sounds like you think you are breaking news here. And I just want to make sure you understand that you're not," wrote Lubbers.

When asked for a default TOE number, Lubbers replied: "I think I remember hearing that March was the lowest since 1999. But I'll check it." When prodded to find out if had checked up on default TOE numbers, Lubbers didn't provide the data requested.

Big Book

Conseco's mobile home book consists of some 720,000 loans worth just over $26 billion, making it the nation's largest lender in this field.

Mobile home loans more than 60 days past due fell to 1.96% of the portfolio at the end of March, from 2.20% at the end of 2000, according to Conseco's first-quarter earnings release. In a December investor presentation, Crittenden forecast the delinquency ratio at 1.71% at the end of the second quarter.

Any improvement in headline credit quality numbers could be due to the recent initiatives described by the ex-manager and the collections rep.

For example, the collections rep says two months ago a Tempe-based vice president named Bob Warren started the push to do more default TOEs and payment deferrals. (Warren didn't comment.)

Before March, she says, she was doing three to four default TOEs a month. Now she says she does six, and some people on her team now do as many as 12 per month.

The ex-manager says that at the end of March, managers began pressing collections staff "to at least double the amount of default TOE referrals."

At the Tempe collection center, the push was made through flyers and wall posters, and by offering prizes like electronics goods and sports tickets to staff members doing the most default TOEs. Collections reps also get $100 for each successful default TOE referral.

Forms of transfer of equity have long been used in the mobile home lending industry. However, some other big players in the field almost never use it. For example,



, a thrift that has a $5 billion mobile home loan portfolio, is doing almost no default TOEs, according to a person closely familiar with the bank's mobile home business.

Default TOEs can work if the collection officer is skilled at finding dependable new borrowers.

However, the collections rep says that the new borrowers usually have worse credit than the original borrower. In one transferred loan she recently tried to collect, she found that the new borrower was unemployed.

She alleges that the Conseco department responsible for checking up on the credit credentials of the new borrower has become very lax. "About 75% of the default TOE candidates are coming back in our delinquency numbers two to three months out," she estimates.

Stepping on TOEs

It's hard to gauge to what extent default TOEs are affecting Conseco's delinquency numbers, since the company doesn't publicly break out how many it's doing. And it's not clear whether Conseco does default TOEs in all states it operates in. Greenpoint has chosen not to do them in certain states for legal reasons, according to the person familiar with the thrift's mobile home business. And Conseco may be focusing its default TOEs on loans of a certain age.

The ex-Conseco manager doesn't know an exact companywide average for default TOEs. But in regions he has worked in they have recently averaged around 25 per month for every 12,000 loans, he says.

Absent guidance from the company, this number can be applied to Conseco as a whole in a purely hypothetical exercise. With around 720,000 mobile home loans, and an average loan balance of $35,000, that could mean default TOEs totaling $600 million a year for the whole company.

It's impossible to know if that number is anywhere close to the real figure. It's certainly large. For instance, at the end of the first quarter, some $515 million of Conseco's mobile home loans were more than 60 days past due and it had loans on repossessed homes totaling around $540 million.

Delinquency numbers at Conseco may also be getting reduced by repayment extensions and forbearances. Both practices involve offering borrowers the chance to defer loan repayments.

The collections rep says that Warren told collections staff in April that they could do "unlimited extensions." Before that, the limit was four per collector per month, she says. An extension allows a borrower to delay one or two repayments.

With a forbearance, the borrower gets to skip as many as six loan repayments. The sum of these deferred payments is added to the end of the loan.

Payment deferral schemes are used by


( ACF), the company that makes auto loans to people with tainted credit. But even though Americredit charges a fee for granting deferrals and regularly discloses how many it's doing, many investors aren't comfortable about the practice. The Conseco collections rep says that she doesn't charge borrowers a fee on extensions.

The collections rep says most of the borrowers who get extensions soon fall behind again. "I just don't feel comfortable doing these extensions," she says. "Nearly all of these people are soon in the same boat as before. It doesn't do any good."

She has found that borrowers are quickly discovering that they can fall well behind on loans yet keep their homes. "People are laughing at us. Word soon gets round a mobile home park that you can stay in your home and not pay Conseco," she says.

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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.