UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File Number 1-6155
AMERICAN GENERAL FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-0416090
(State of incorporation) (I.R.S. Employer Identification No.)
601 N.W. Second Street, Evansville, IN 47708
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (812) 424-8031
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
8.45% Senior Notes due October 15, 2009 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]. Not applicable.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes No X
The registrant meets the conditions set forth in General Instructions I(1)(a)
and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced
disclosure format.
As the registrant is an indirect wholly owned subsidiary of American
International Group, Inc., none of the registrant's common stock is held by
non-affiliates of the registrant.
At March 10, 2004, there were 10,160,012 shares of the registrant's common
stock, $.50 par value, outstanding.
2
TABLE OF CONTENTS
Item Page
Part I 1. Business . . . . . . . . . . . . . . . . . . . . . . 3
2. Properties . . . . . . . . . . . . . . . . . . . . . 26
3. Legal Proceedings . . . . . . . . . . . . . . . . . 26
4. Submission of Matters to a Vote of Security
Holders . . . . . . . . . . . . . . . . . . . . . *
Part II 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities . . . . . . . . . . . . . . . . 27
6. Selected Financial Data . . . . . . . . . . . . . . 27
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . 28
7A. Quantitative and Qualitative Disclosures About
Market Risk . . . . . . . . . . . . . . . . . . . 49
8. Financial Statements and Supplementary Data . . . . 49
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure . . . . . . 93
9A. Controls and Procedures . . . . . . . . . . . . . . 93
Part III 10. Directors and Executive Officers of the Registrant . *
11. Executive Compensation . . . . . . . . . . . . . . . *
12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters . . *
13. Certain Relationships and Related Transactions . . . *
14. Principal Accountant Fees and Services . . . . . . . 94
Part IV 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K . . . . . . . . . . . . . . . 95
* Items 4, 10, 11, 12, and 13 are not included, per conditions met by
Registrant set forth in General Instructions I(1)(a) and (b) of
Form 10-K.
AVAILABLE INFORMATION
American General Finance Corporation (AGFC) files annual, quarterly,
and current reports and other information with the Securities and
Exchange Commission (the SEC). The SEC maintains a website that
contains annual, quarterly, and current reports and other information
that issuers (including AGFC) file electronically with the SEC. The
SEC's website is www.sec.gov. This Annual Report on Form 10-K for the
year ended December 31, 2003, our Annual Report on Form 10-K for the
year ended December 31, 2002, and our 2003 Quarterly Reports on Form
10-Q are available free of charge on our Internet website
www.agfinance.com. The information on our website is not incorporated
by reference into this report. The website addresses listed above are
provided for the information of the reader and are not intended to be
active links.
3
PART I
Item 1. Business.
GENERAL
American General Finance Corporation will be referred to as "AGFC" or
collectively with its subsidiaries, whether directly or indirectly
owned, as the "Company" or "we". AGFC was incorporated in Indiana in
1927 as successor to a business started in 1920. All of the common
stock of AGFC is owned by American General Finance, Inc. (AGFI), which
was incorporated in Indiana in 1974. Since August 29, 2001, AGFI has
been an indirect wholly owned subsidiary of American International
Group, Inc. (AIG), a Delaware corporation. AIG is a holding company
which, through its subsidiaries, is engaged in a broad range of
insurance and insurance-related activities, financial services, and
retirement services and asset management in the United States and
abroad.
AGFC is a financial services holding company with subsidiaries engaged
primarily in the consumer finance and credit insurance businesses. We
conduct the credit insurance business to supplement our consumer
finance business through Merit Life Insurance Co. (Merit) and Yosemite
Insurance Company (Yosemite), which are both wholly owned subsidiaries
of AGFC.
Effective January 1, 2003, we acquired 100% of the common stock of
Wilmington Finance, Inc. (WFI) in a purchase business combination.
WFI provides services for the origination of non-conforming
residential real estate loans for sale to investors.
At December 31, 2003, the Company had 1,365 offices in 44 states,
Puerto Rico, and the U.S. Virgin Islands and approximately 8,400
employees. Our executive offices are located in Evansville, Indiana.
Selected Financial Information
Selected financial information of the Company was as follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Average net receivables $13,800,558 $12,135,806 $11,411,464
Average borrowings $12,952,422 $11,180,394 $10,373,630
4
Item 1. Continued
At or for the
Years Ended December 31,
2003 2002 2001
Yield - finance charges as a
percentage of average net
receivables 12.41% 13.83% 14.62%
Borrowing cost - interest
expense as a percentage
of average borrowings 4.17% 4.95% 5.98%
Interest spread - yield
less borrowing cost 8.24% 8.88% 8.64%
Operating expenses as a
percentage of average
net receivables 4.90% 4.54% 4.64%
Allowance ratio - allowance for
finance receivable losses as
a percentage of net finance
receivables 3.07% 3.34% 3.74%
Charge-off ratio - net charge-offs
as a percentage of the average
of net finance receivables at
the beginning of each month
during the period 2.21% 2.41% 2.27%
Charge-off coverage - allowance
for finance receivable losses
to net charge-offs 1.50x 1.56x 1.70x
Delinquency ratio - gross finance
receivables 60 days or more
past due as a percentage
of gross finance receivables 3.33% 3.68% 3.73%
Return on average assets 2.28% 2.51% 1.91%
Return on average equity 18.79% 21.69% 14.46%
Ratio of earnings to fixed charges
(refer to Exhibit 12 for
calculations) 2.03x 1.87x 1.62x
Debt to tangible equity ratio -
debt to equity less goodwill
and accumulated other
comprehensive income 7.51x 7.34x 7.50x
Debt to equity ratio 6.76x 6.98x 7.04x
5
Item 1. Continued
CONSUMER FINANCE BUSINESS SEGMENT
Through its 1,365 branch offices and its centralized services and
support operations, the consumer finance business segment:
* makes loans directly to individuals;
* offers retail sales financing to merchants;
* purchases portfolios of finance receivables originated by
other lenders;
* provides for a fee, marketing, certain origination processing
services, and loan servicing for a non-subsidiary affiliate;
* originates real estate loans for sale to investors; and
* offers credit and non-credit insurance products.
Most of our customers are usually described as non-conforming, non-
prime, or subprime.
Products and Services
We make home equity loans, originate secured and unsecured consumer
loans, and extend lines of credit. We generally take a security
interest in the real property and/or personal property of the
borrower. Real estate loans are secured by first or second mortgages
on residential real estate and generally have maximum original terms
of 360 months. Non-real estate loans are secured by consumer goods,
automobiles, or other personal property or are unsecured and generally
have maximum original terms of 60 months.
We purchase retail sales contracts and provide revolving retail
services arising from the retail sale of consumer goods and services
by retail merchants. We also purchase private label receivables
originated by AIG Federal Savings Bank, a non-subsidiary affiliate,
under a participation agreement. Retail sales contracts, revolving
retail, and private label receivables are generated at approximately
24,000 retail merchant locations across the United States, Puerto
Rico, and the U.S. Virgin Islands. Retail sales contracts are closed-
end accounts that consist of a single purchase transaction. Revolving
retail and private label are open-end accounts that can be used for
repeated purchases. Retail sales contracts are secured by the real
property or personal property giving rise to the contract and
generally have maximum original terms of 60 months. Revolving retail
and private label are secured by the goods purchased and generally
require minimum monthly payments based on outstanding balances.
To supplement our lending and retail sales financing activities, we
purchase portfolios of real estate loans, non-real estate loans, and
retail sales finance receivables originated by other lenders whose
customers meet our credit quality standards and profitability
objectives. We also purchase real estate loans originated by AIG
Federal Savings Bank under a purchase agreement. Additionally, we
provide for a fee, marketing, certain origination processing services,
and loan servicing for AIG Federal Savings Bank's origination and sale
of non-conforming residential real estate loans. We also originate
real estate loans, primarily through broker relationships and, to a
lesser extent, directly to consumers, and sell the originated loans to
investors with servicing released.
6
Item 1. Continued
We offer credit life, credit accident and health, credit related
property and casualty, credit involuntary unemployment, and non-credit
insurance to eligible consumer finance customers. These products are
issued by affiliated as well as non-affiliated insurance companies and
are described under "Insurance Business Segment".
Customer Development and Servicing
Retail sales finance obligations that we purchase from merchants
provide an important source of new loan customers. These customers
have demonstrated an apparent need to finance a retail purchase and a
willingness to use credit. After purchase of the retail sales finance
obligation, we contact the customer using various marketing methods to
invite the customer to discuss his or her overall credit needs with
our consumer lending specialists. Any resulting loan may pay off the
customer's retail sales finance obligation and consolidate his or her
debts with other creditors.
Our consumer lending specialists, who, where required, are licensed to
offer insurance products, explain our credit and non-credit insurance
products to the customer. The customer then determines whether to
purchase any of these products.
We also originate loans by soliciting former customers who have
recently paid off their loans as well as current customers. In
addition, we purchase prospect lists from major list compilers based
on our predetermined selection criteria. We market our financial
products to these potential customers using various solicitation
methods. We also use various Internet loan application sources,
including our own website, to obtain potential customers. We forward
this information to our branch offices where consumer lending
specialists contact the potential customers in attempts to initiate
loans.
Our branch offices are supported by centralized administrative and
operational functions. Our centralized operations include the
following:
* customer solicitations;
* real estate loan approvals;
* real estate loan servicing;
* real estate owned processing;
* retail sales finance approvals;
* retail sales finance collections;
* retail sales finance payment processing;
* revolving retail and private label processing;
* merchant services; and
* charge-off recovery operations.
We continually seek to identify functions that could be more cost-
effective if centralized, thereby reducing costs and freeing our
consumer lending specialists in our branches to concentrate on
providing service to our customers.
7
Item 1. Continued
Operational Controls
We control and monitor our consumer finance business segment through a
variety of methods including the following:
* Our operational policies and procedures standardize various
aspects of lending, collections, and business development
processes.
* Our finance receivable systems control amounts, rates, terms,
and fees of our customers' accounts; create loan documents
specific to the state in which the branch operates; and
control cash receipts and disbursements.
* Our home office accounting personnel reconcile bank accounts,
investigate discrepancies, and resolve differences.
* Our credit risk management system reports are used by various
personnel to compare lending and collection activities with
predetermined parameters.
* Our field operations management structure is designed to
control a large, decentralized organization with each
succeeding level staffed with more experienced personnel.
* Our field operations incentive compensation plan aligns the
operating activities and goals with corporate strategies by
basing a portion of field personnel total compensation on
profitability and credit quality.
* Our internal audit department audits for operational policy
and procedure and state law and regulation compliance.
Internal audit reports directly to AIG to enhance
independence.
See Note 24. of the Notes to Consolidated Financial Statements in Item
8. for further information on the Company's consumer finance business
segment.
Finance Receivables
We carry finance receivables at amortized cost which includes accrued
finance charges on interest bearing finance receivables, unamortized
deferred origination costs, and unamortized net premiums and discounts
on purchased finance receivables. They are net of unamortized finance
charges on precomputed receivables and unamortized points and fees.
Although a significant portion of insurance claims and policyholder
liabilities originate from the finance receivables, our policy is to
report them as liabilities and not net them against finance
receivables. Finance receivables relate to the financing activities
of our consumer finance business segment, and insurance claims and
policyholder liabilities relate to the underwriting activities of our
insurance business segment.
8
Item 1. Continued
Amount, number, and average size of net finance receivables originated
and renewed and net purchased by type (retail sales contracts,
revolving retail, and private label comprise retail sales finance)
were as follows:
Years Ended December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
Originated and renewed
Amount (in thousands):
Real estate loans $4,747,121 52% $2,518,226 37% $2,129,623 33%
Non-real estate loans 2,769,548 31 2,690,135 39 2,704,901 41
Retail sales finance 1,577,749 17 1,611,943 24 1,695,115 26
Total $9,094,418 100% $6,820,304 100% $6,529,639 100%
Number:
Real estate loans 71,161 5% 57,909 4% 55,935 3%
Non-real estate loans 755,595 48 748,226 46 765,716 45
Retail sales finance 753,303 47 810,598 50 889,863 52
Total 1,580,059 100% 1,616,733 100% 1,711,514 100%
Average size (to nearest
dollar):
Real estate loans $66,710 $43,486 $38,073
Non-real estate loans 3,665 3,595 3,533
Retail sales finance 2,094 1,989 1,905
Net purchased
Amount (in thousands):
Real estate loans $ 555,774 94% $2,343,636 92% $ 945,621 85%
Non-real estate loans 3,052 1 124,665 5 25,327 2
Retail sales finance 30,044 5 83,576 3 142,875 13
Total $ 588,870 100% $2,551,877 100% $1,113,823 100%
Number:
Real estate loans 5,563 30% 38,948 38% 15,169 23%
Non-real estate loans 1,735 9 35,096 35 12,790 19
Retail sales finance 11,533 61 27,791 27 38,516 58
Total 18,831 100% 101,835 100% 66,475 100%
Average size (to nearest
dollar):
Real estate loans $99,905 $60,173 $62,339
Non-real estate loans 1,759 3,552 1,980
Retail sales finance 2,605 3,007 3,709
Net purchased for 2003 included a sale of $266.8 million of real
estate loans to an AGFI subsidiary for securitization. We had no
sales in 2002 or 2001.
9
Item 1. Continued
Amount, number, and average size of total net finance receivables
originated, renewed, and net purchased by type were as follows:
Years Ended December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
Originated, renewed,
and net purchased
Amount (in thousands):
Real estate loans $5,302,895 55% $4,861,862 52% $3,075,244 40%
Non-real estate loans 2,772,600 28 2,814,800 30 2,730,228 36
Retail sales finance 1,607,793 17 1,695,519 18 1,837,990 24
Total $9,683,288 100% $9,372,181 100% $7,643,462 100%
Number:
Real estate loans 76,724 5% 96,857 6% 71,104 4%
Non-real estate loans 757,330 47 783,322 45 778,506 44
Retail sales finance 764,836 48 838,389 49 928,379 52
Total 1,598,890 100% 1,718,568 100% 1,777,989 100%
Average size (to nearest
dollar):
Real estate loans $69,117 $50,196 $43,250
Non-real estate loans 3,661 3,593 3,507
Retail sales finance 2,102 2,022 1,980
Amount of net purchased as a percentage of total originated, renewed,
and net purchased was as follows:
Years Ended December 31,
2003 2002 2001
Real estate loans 10% 48% 31%
Non-real estate loans - 4 1
Retail sales finance 2 5 8
Total 6% 27% 15%
10
Item 1. Continued
Amount, number, and average size of net finance receivables by type
were as follows:
December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
Net finance receivables
Amount (in thousands):
Real estate loans $10,657,742 72% $ 9,313,496 69% $ 7,444,484 64%
Non-real estate loans 2,877,825 19 2,905,339 21 2,865,985 24
Retail sales finance 1,302,922 9 1,355,503 10 1,408,111 12
Total $14,838,489 100% $13,574,338 100% $11,718,580 100%
Number:
Real estate loans 205,391 11% 212,082 11% 183,406 9%
Non-real estate loans 876,083 49 907,405 48 932,165 48
Retail sales finance 730,861 40 789,703 41 850,123 43
Total 1,812,335 100% 1,909,190 100% 1,965,694 100%
Average size (to nearest
dollar):
Real estate loans $51,890 $43,915 $40,590
Non-real estate loans 3,285 3,202 3,075
Retail sales finance 1,783 1,716 1,656
Geographic Distribution
Geographic diversification of finance receivables reduces the
concentration of credit risk associated with a recession in any one
region. The largest concentrations of net finance receivables were as
follows:
December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
California $ 2,263,038 15% $ 2,160,846 16% $ 1,374,599 12%
Florida 921,092 6 840,182 6 772,830 7
N. Carolina 883,866 6 887,243 7 850,995 7
Illinois 835,156 6 786,593 6 731,238 6
Ohio 833,064 6 785,506 6 741,702 7
Georgia 658,833 4 591,970 4 510,140 4
Virginia 657,683 4 553,386 4 500,137 4
Indiana 618,636 4 598,832 4 586,625 5
Other 7,167,121 49 6,369,780 47 5,650,314 48
Total $14,838,489 100% $13,574,338 100% $11,718,580 100%
11
Item 1. Continued
Average Net Receivables
Average net receivables by type were as follows:
Years Ended December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
Real estate loans $ 9,687,738 70% $ 7,995,507 66% $ 7,133,476 63%
Non-real estate loans 2,831,197 21 2,804,579 23 2,897,617 25
Retail sales finance 1,281,623 9 1,335,720 11 1,380,371 12
Total $13,800,558 100% $12,135,806 100% $11,411,464 100%
Growth in average net receivables by type was as follows:
Years Ended December 31,
2003 2002 2001
Percent Percent Percent
Amount Change Amount Change Amount Change
(dollars in thousands)
Real estate loans $1,692,231 21% $ 862,031 12% $ 121,037 2%
Non-real estate loans 26,618 1 (93,038) (3) 148,954 5
Retail sales finance (54,097) (4) (44,651) (3) 22,356 2
Total $1,664,752 14% $ 724,342 6% $ 292,347 3%
Finance Charges and Yield
We recognize finance charges as revenue on the accrual basis using the
interest method. We amortize premiums and discounts on purchased
finance receivables as a revenue adjustment using the interest method.
We defer the costs to originate certain finance receivables and the
revenue from nonrefundable points and fees on loans and amortize them
to revenue using the interest method over the lesser of the
contractual term or the estimated life based upon prepayment
experience. If a finance receivable liquidates before amortization is
completed, we charge or credit any unamortized premiums, discounts,
origination costs, or points and fees to revenue at the date of
liquidation. We recognize late charges, prepayment penalties, and
deferment fees as revenue when received.
We stop accruing finance charges when the fourth contractual payment
becomes past due for loans and retail sales contracts and when the
sixth contractual payment becomes past due for revolving retail and
private label. Beginning in third quarter 2001, in conformity with
AIG policy, we reverse amounts previously accrued upon suspension.
Prior to AIG's indirect acquisition of the Company, we did not reverse
amounts previously accrued upon suspension. After suspension, we
recognize revenue for loans and retail sales contracts only to the
extent of any additional payments we receive.
12
Item 1. Continued
Finance charges and yield by type of finance receivable were as
follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Real estate loans:
Finance charges $ 926,109 $ 880,021 $ 847,110
Yield 9.56% 11.01% 11.88%
Non-real estate loans:
Finance charges $ 600,903 $ 604,005 $ 625,159
Yield 21.22% 21.54% 21.57%
Retail sales finance:
Finance charges $ 185,082 $ 194,897 $ 196,344
Yield 14.44% 14.59% 14.22%
Total:
Finance charges $1,712,094 $1,678,923 $1,668,613
Yield 12.41% 13.83% 14.62%
See Management's Discussion and Analysis in Item 7. for information on
the trends in yield.
Finance Receivable Credit Quality Information
A risk in all consumer lending and retail sales financing transactions
is the customer's unwillingness or inability to repay obligations.
Unwillingness to repay is usually evidenced in a consumer's historical
credit repayment record. An inability to repay usually results from
lower income due to unemployment or underemployment, major medical
expenses, or divorce. Occasionally, these types of events are so
economically severe that the customer files for bankruptcy. Because
we evaluate credit applications with a view toward ability to repay,
our customer's inability to repay occurs after our initial credit
evaluation and funding of an outstanding loan.
We use credit risk scoring models at the time of credit application to
assess our risk of the applicant's unwillingness or inability to
repay. These models are developed and based upon numerous factors
including past customer credit repayment experience. The risk scoring
models are periodically revalidated based on recent portfolio
performance. We extend credit to those consumers who fit our risk
guidelines as determined by these models and, in some cases, manual
underwriting. Price and size of the loan or retail sales finance
transaction are generally in relation to the estimated credit risk
assumed.
Our policy is to charge off each month to the allowance for finance
receivable losses non-real estate loans on which payments received in
the prior six months have totaled less than 5% of the original loan
amount and retail sales finance that are six installments past due.
Generally, we start foreclosure proceedings on real estate loans when
four monthly installments are past due. When foreclosure is completed
13
Item 1. Continued
and we have obtained title to the property, we obtain an unrelated
party's valuation of the property, which is either a full appraisal or
a real estate broker's or appraiser's estimate of the property's sale
value without the benefit of a full interior and exterior appraisal
and lacking sales comparisons. We reduce finance receivables by the
amount of the real estate loan, establish a real estate owned asset
valued at lower of loan balance or 85% of the valuation, and charge
off any loan amount in excess of that value to the allowance for
finance receivable losses. We occasionally extend the charge-off
period for individual accounts when, in our opinion, such treatment is
warranted and consistent with our credit risk policies. We increase
the allowance for finance receivable losses for recoveries on accounts
previously charged off.
Charge-offs, recoveries, net charge-offs, and charge-off ratio by type
of finance receivable were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Real estate loans:
Charge-offs $ 66,846 $ 56,602 $ 53,875
Recoveries (4,149) (4,467) (4,459)
Net charge-offs $ 62,697 $ 52,135 $ 49,416
Charge-off ratio .65% .66% .69%
Non-real estate loans:
Charge-offs $224,716 $220,557 $196,947
Recoveries (27,699) (26,788) (26,640)
Net charge-offs $197,017 $193,769 $170,307
Charge-off ratio 6.96% 6.91% 5.87%
Retail sales finance:
Charge-offs $ 54,210 $ 53,601 $ 47,439
Recoveries (9,912) (9,346) (8,427)
Net charge-offs $ 44,298 $ 44,255 $ 39,012
Charge-off ratio 3.45% 3.31% 2.83%
Total:
Charge-offs $345,772 $330,760 $298,261
Recoveries (41,760) (40,601) (39,526)
Net charge-offs $304,012 $290,159 $258,735
Charge-off ratio 2.21% 2.41% 2.27%
Establishing and maintaining customer relationships is very important
to us. A delinquent payment often indicates that the customer is
experiencing temporary financial difficulties. We view collection
efforts as opportunities to help our customers solve their temporary
financial problems and retain our customer relationships.
We may renew a delinquent account if the customer has sufficient
income and it does not appear that the cause of past delinquency will
affect the customer's ability to repay the new loan. We subject all
renewals, whether the customer's account is current or delinquent, to
the same credit risk underwriting process as we would a new
application for credit.
14
Item 1. Continued
We may allow a deferment, which is a partial payment that extends the
term of an account. The partial payment amount is usually the greater
of one-half of a regular monthly payment or the amount necessary to
bring the interest on the account current. We limit a customer to two
deferments in a rolling twelve-month period.
To accommodate a customer's preferred monthly payment pattern, we may
agree to a customer's request to change a payment due date on an
account. An account's due date will not be changed if the change will
affect the thirty day plus delinquency status of the account at month
end.
Delinquency (gross finance receivables 60 days or more past due) based
on contract terms in effect and delinquency ratio by type of finance
receivable were as follows:
December 31,
2003 2002 2001
(dollars in thousands)
Real estate loans:
Delinquency $302,242 $295,244 $248,266
Delinquency ratio 2.85% 3.20% 3.34%
Non-real estate loans:
Delinquency $164,638 $175,167 $168,001
Delinquency ratio 5.16% 5.40% 5.22%
Retail sales finance:
Delinquency $ 40,217 $ 43,381 $ 40,586
Delinquency ratio 2.80% 2.88% 2.55%
Total:
Delinquency $507,097 $513,792 $456,853
Delinquency ratio 3.33% 3.68% 3.73%
We establish the allowance for finance receivable losses primarily
through the provision for finance receivable losses charged to
expense. We believe the amount of the allowance for finance
receivable losses is the most significant estimate we make. Our
Credit Strategy and Policy Committee evaluates our finance receivable
portfolio monthly. This review determines any adjustment necessary to
maintain the allowance for finance receivable losses at a level we
consider adequate to absorb losses inherent in the existing portfolio.
15
Item 1. Continued
Changes in the allowance for finance receivable losses were as
follows:
At or for the
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Balance at beginning of year $ 453,668 $ 438,860 $ 372,825
Provision for finance receivable
losses 308,451 296,365 284,735
Allowance related to sale of
finance receivables to AGFI
subsidiary for securitization (2,705) - -
Allowance related to net
acquired receivables - 8,602 15,035
Charge-offs (345,772) (330,760) (298,261)
Recoveries 41,760 40,601 39,526
Other charges - additional
provision - - 25,000
Balance at end of year $ 455,402 $ 453,668 $ 438,860
See Management's Discussion and Analysis in Item 7. for further
information on finance receivable loss and delinquency experience and
the related allowance for finance receivable losses.
Real Estate Owned
We acquire real estate owned through foreclosure on real estate loans.
We record real estate owned in other assets, initially at lower of
loan balance or 85% of the unrelated party's valuation, which
approximates the fair value less the estimated cost to sell. If we do
not sell a property within one year of acquisition, we reduce the
carrying value by five percent of the initial value each month
beginning in the thirteenth month. Prior to AIG's indirect
acquisition of the Company in August 2001, we did not begin this
writedown until the nineteenth month. The other charges recorded in
third quarter 2001 included $5.0 million to adjust for this
difference. We continue the writedown until the property is sold or
the carrying value is reduced to ten percent of the initial value. We
charge these writedowns to other revenues. We record the sale price
we receive for a property less the carrying value and any amounts
refunded to the customer as a recovery or loss in other revenues. We
do not profit from foreclosures in accordance with the American
Financial Services Association's Voluntary Standards for Consumer
Mortgage Lending. We only attempt to recover our investment in the
property, including expenses incurred.
16
Item 1. Continued
Changes in the amount of real estate owned were as follows:
At or for the
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Balance at beginning of year $ 47,289 $ 48,359 $ 45,033
Properties acquired 75,627 71,329 57,533
Properties sold or disposed of (65,003) (63,794) (44,651)
Monthly writedowns (8,018) (8,605) (9,556)
Balance at end of year $ 49,895 $ 47,289 $ 48,359
Real estate owned as a percentage
of real estate loans 0.47% 0.51% 0.65%
Net recovery (loss) on sales of
real estate owned $ 1,843 $ 2,943 $ (1,063)
Changes in the number of real estate owned properties were as follows:
At or for the
Years Ended December 31,
2003 2002 2001
Balance at beginning of year 897 970 817
Properties acquired 1,384 1,355 1,526
Properties sold or disposed of (1,336) (1,428) (1,373)
Balance at end of year 945 897 970
Sources of Funds
We fund our consumer finance business segment principally through the
following sources:
* net cash flows from operating activities;
* issuances of long-term debt;
* short-term borrowings in the commercial paper market;
* borrowings from banks under credit facilities;
* sales of finance receivables for securitizations; and
* capital contributions from parent.
17
Item 1. Continued
Average Borrowings
Average borrowings by term of debt were as follows:
Years Ended December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
Long-term debt $ 9,584,778 74% $ 7,343,929 66% $ 6,022,033 58%
Short-term debt 3,367,644 26 3,836,465 34 4,351,597 42
Total $12,952,422 100% $11,180,394 100% $10,373,630 100%
Average borrowings by rate of debt were as follows:
Years Ended December 31,
2003 2002 2001
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
Fixed-rate debt $ 7,640,490 59% $ 7,416,047 66% $ 7,240,971 70%
Floating-rate debt 5,311,932 41 3,764,347 34 3,132,659 30
Total $12,952,422 100% $11,180,394 100% $10,373,630 100%
Interest Expense and Borrowing Cost
Interest expense and borrowing cost by term of debt were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Long-term debt:
Interest expense $444,380 $432,737 $400,920
Borrowing cost 4.64% 5.89% 6.66%
Short-term debt:
Interest expense $ 94,478 $121,140 $219,567
Borrowing cost 2.82% 3.16% 5.04%
Total:
Interest expense $538,858 $553,877 $620,487
Borrowing cost 4.17% 4.95% 5.98%
18
Item 1. Continued
Interest expense and borrowing cost by rate of debt were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Fixed-rate debt:
Interest expense $433,748 $480,258 $484,661
Borrowing cost 5.68% 6.48% 6.69%
Floating-rate debt:
Interest expense $105,110 $ 73,619 $135,826
Borrowing cost 1.99% 1.96% 4.33%
Total:
Interest expense $538,858 $553,877 $620,487
Borrowing cost 4.17% 4.95% 5.98%
The Company's use of interest rate swap agreements to fix floating-
rate debt or float fixed-rate debt, the effect of which is included in
the rates above, is described in Note 13. of the Notes to Consolidated
Financial Statements in Item 8.
Contractual Maturities
Contractual maturities of net finance receivables and debt at December
31, 2003 were as follows:
Net Finance
Receivables Debt
(dollars in thousands)
2004 $ 1,329,392 $ 5,283,718
2005 1,537,085 1,822,330
2006 1,135,178 2,454,296
2007 704,280 1,387,618
2008 472,996 540,668
2009 and thereafter 9,659,558 2,382,786
Total $14,838,489 $13,871,416
See Note 5. of the Notes to Consolidated Financial Statements in Item
8. for contractual maturities and principal cash collections of net
finance receivables by type.
19
Item 1. Continued
INSURANCE BUSINESS SEGMENT
The insurance business segment markets its products to our eligible
consumer finance customers. Cash generated from operations is
invested in investment securities, commercial mortgage loans,
investment real estate, and policy loans and is also used to pay
dividends.
Merit is a life and health insurance company domiciled in Indiana and
licensed in 46 states, the District of Columbia, and the U.S. Virgin
Islands. Merit principally writes or reinsures credit life, credit
accident and health, and non-credit insurance.
Yosemite is a property and casualty insurance company domiciled in
Indiana and licensed in 45 states. Yosemite principally writes or
reinsures credit-related property and casualty and credit involuntary
unemployment insurance.
Products and Services
Our credit life insurance policies insure the life of the borrower in
an amount typically equal to the unpaid balance of the finance
receivable and provide for payment in full to the lender of the
finance receivable in the event of the borrower's death. Our credit
accident and health insurance policies provide, to the lender, payment
of the installments on the finance receivable coming due during a
period of the borrower's disability due to illness or injury. Our
credit-related property and casualty insurance policies are written to
protect the lender's interest in property pledged as collateral for
the finance receivable. Our credit involuntary unemployment insurance
policies provide, to the lender, payment of the installments on the
finance receivable coming due during a period of the borrower's
involuntary unemployment. The borrower's purchase of credit life,
credit accident and health, credit-related property and casualty, or
credit involuntary unemployment insurance is voluntary with the
exception of lender-placed property damage coverage for property
pledged as collateral. In these instances, our consumer finance
business segment obtains property damage coverage through Yosemite
either on a direct or reinsured basis under the terms of the lending
agreement if the borrower does not provide evidence of coverage with
another insurance carrier. Non-credit insurance policies are
primarily traditional life level term coverage. The purchase of this
coverage is voluntary. Customers usually either finance premiums for
insurance products as part of the finance receivable or pay premiums
monthly with their finance receivable payment, but they may pay the
premiums in cash to the insurer. We do not offer single premium
credit insurance products to our real estate loan customers.
20
Item 1. Continued
Reinsurance
Merit and Yosemite have entered into reinsurance agreements with other
insurance companies, including certain affiliated companies, for
reinsurance of various non-credit life, individual annuity, group
annuity, credit life, credit accident and health, and credit-related
property and casualty insurance where our insurance subsidiaries
reinsure the risk of loss. The reserves for this business fluctuate
over time and in certain instances are subject to recapture by the
insurer. At December 31, 2003, reserves on the books of Merit and
Yosemite for these reinsurance agreements totaled $93.5 million.
See Note 24. of the Notes to Consolidated Financial Statements in Item
8. for further information on the Company's insurance business
segment.
Insurance Premium Revenue Recognition
We recognize credit insurance premiums on closed-end real estate loans
and revolving finance receivables as revenue when billed monthly. We
defer credit insurance premiums collected in advance in unearned
premium reserves which are included in insurance claims and
policyholder liabilities. We recognize unearned premiums on credit
life insurance as revenue using the sum-of-the-digits or actuarial
methods, except in the case of level-term contracts, for which we
recognize unearned premiums as revenue using the straight-line method
over the terms of the policies. We recognize unearned premiums on
credit accident and health insurance as revenue using an average of
the sum-of-the-digits and the straight-line methods. We recognize
unearned premiums on credit-related property and casualty and credit
involuntary unemployment insurance as revenue using the straight-line
method over the terms of the policies. We recognize non-credit life
insurance premiums as revenue when collected but not before their due
dates.
21
Item 1. Continued
Premiums earned and premiums written by type of insurance were as
follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Premiums Earned
Credit insurance premiums earned:
Credit life $ 35,026 $ 37,576 $ 41,046
Credit accident and health 45,114 47,726 50,405
Property and casualty 58,371 55,645 53,537
Other insurance premiums earned:
Non-credit life 32,934 38,097 39,157
Non-credit accident and health 7,719 7,323 6,136
Premiums assumed under
coinsurance agreements (654) 2,631 2,725
Total $178,510 $188,998 $193,006
Premiums Written
Credit insurance premiums written:
Credit life $ 26,057 $ 23,263 $ 29,333
Credit accident and health 39,754 40,458 44,570
Property and casualty 50,697 55,186 54,048
Other insurance premiums written:
Non-credit life 32,934 38,097 39,157
Non-credit accident and health 7,719 7,323 6,136
Premiums assumed under
coinsurance agreements (654) 2,631 2,725
Total $156,507 $166,958 $175,969
Insurance Losses Incurred
Insurance losses incurred represent claims paid on behalf of the
insured plus changes in various insurance reserves. We base claim
reserves on Company experience. We estimate reserves for losses and
loss adjustment expenses for credit-related property and casualty
insurance based upon claims reported plus estimates of incurred but
not reported claims. We accrue liabilities for future life insurance
policy benefits associated with non-credit life contracts when we
recognize premium revenue and base amounts on assumptions as to
investment yields, mortality, and surrenders. We base annuity
reserves on assumptions as to investment yields and mortality. We
base insurance reserves assumed under coinsurance agreements where we
assume the risk of loss on various tabular and unearned premium
methods.
22
Item 1. Continued
Losses incurred by type of insurance were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Credit insurance losses incurred:
Credit life $ 20,661 $ 21,869 $ 21,830
Credit accident and health 16,501 26,494 24,814
Property and casualty 13,917 9,247 15,715
Other insurance losses incurred:
Non-credit life 6,800 11,996 11,102
Non-credit accident and health 4,632 4,485 3,751
Losses incurred under
coinsurance agreements 5,338 9,184 10,899
Total $ 67,849 $ 83,275 $ 88,111
Life Insurance in Force
Life insurance in force by type of insurance was as follows:
December 31,
2003 2002 2001
(dollars in thousands)
Credit life $3,050,535 $3,091,211 $3,126,473
Non-credit life 2,900,944 3,104,772 3,275,199
Total $5,951,479 $6,195,983 $6,401,672
Investments and Investment Results
We invest cash generated by our insurance business segment primarily
in bonds. We invest in, but are not limited to, the following:
* bonds;
* commercial mortgage loans;
* short-term investments;
* limited partnerships;
* preferred stock;
* investment real estate;
* policy loans; and
* common stock.
AIG subsidiaries manage substantially all of our insurance business
segment's investments on our behalf.
We currently classify all investment securities as available-for-sale
and record them at fair value. We specifically identify realized
gains and losses on investment securities.
23
Item 1. Continued
We recognize interest on interest bearing fixed maturity investment
securities, commercial mortgage loans, and policy loans as revenue on
the accrual basis using the interest method. We amortize any premiums
or discounts as a revenue adjustment using the interest method. We
stop accruing interest revenue when collection of interest becomes
uncertain. We record dividends as revenue on ex-dividend dates. We
recognize income on mortgage-backed securities as revenue using a
constant effective yield based on estimated prepayments of the
underlying mortgages. We recognize the pretax operating income from
our investment real estate as revenue monthly and from our investments
in limited partnerships as revenue quarterly.
Investment results of our insurance business segment were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in thousands)
Net investment revenue (a) $ 82,630 $ 82,812 $ 81,711
Average invested assets (b) $1,302,509 $1,252,625 $1,231,187
Adjusted portfolio yield (c) 6.56% 6.84% 7.03%
Net realized losses on
investments (d) $ (8,361) $ (4,400) $ (2,989)
(a) Net investment revenue is after deducting investment expense but
before net realized gains or losses on investments and provision
for income taxes.
(b) Average invested assets excludes the effect of Statement of
Financial Accounting Standards 115.
(c) Adjusted portfolio yield is calculated based upon the definitions
of net investment revenue and average invested assets listed in
(a) and (b) above.
(d) Includes net realized gains or losses on investment securities
and other invested assets before provision for income taxes.
The increase in net realized losses on investments in 2003 was
primarily due to a write-off of a limited partnership, which was
considered other than temporary. See Note 7. of the Notes to
Consolidated Financial Statements in Item 8. for information regarding
investment securities for all operations of the Company.
24
Item 1. Continued
REGULATION
Consumer Finance
The Company's consumer finance subsidiaries are subject to various
state and federal laws and regulations. Applicable federal laws
include:
* the Equal Credit Opportunity Act (prohibits discrimination
against credit-worthy applicants);
* the Fair Credit Reporting Act (governs the accuracy and use of
credit bureau reports);
* the Truth in Lending Act (governs disclosure of applicable
charges and other finance receivable terms);
* the Fair Housing Act (prohibits discrimination in housing
lending);
* the Real Estate Settlement Procedures Act (regulates certain
loans secured by real estate);
* the Federal Trade Commission Act; and
* the Federal Reserve Board's Regulations B, C, P, and Z.
In many states, federal law preempts state law restrictions on
interest rates and points and fees for first lien residential mortgage
loans. The federal Alternative Mortgage Transactions Parity Act
preempts certain state law restrictions on variable rate loans and
loans with balloon payments in many states. The Company makes
residential mortgage loans under the provisions of other federal laws.
The Company is also subject to federal laws governing practices and
disclosures when dealing with consumer or customer information.
Various state laws also regulate our consumer lending and retail sales
financing businesses. The degree and nature of such regulation vary
from state to state. The laws under which a substantial amount of our
business is conducted generally:
* provide for state licensing of lenders;
* impose maximum term, amount, interest rate, and other charge
limitations;
* regulate whether and under what circumstances insurance and
other ancillary products may be offered in connection with a
lending transaction; and
* provide for consumer protection.
The federal government is considering, and a number of states,
counties, and cities have enacted or may be considering, laws or rules
that restrict the credit terms or other aspects of residential
mortgage loans that are typically described as "high cost mortgage
loans". These laws or regulations, if adopted, may impose specific
statutory liabilities in cases of non-compliance and may also limit or
restrict the terms of covered loan transactions. Additionally, some
of these laws may restrict other business activities or business
dealings of affiliates of the Company under certain conditions.
25
Item 1. Continued
Insurance
State authorities regulate and supervise our insurance subsidiaries.
The extent of such regulation varies by product and by state, but
relates primarily to the following:
* conduct of business;
* types of products offered;
* standards of solvency;
* limitations on dividend payments and other related party
transactions;
* licensing;
* deposits of securities for the benefit of policyholders;
* permissible investments;
* approval of policy forms and premium rates;
* periodic examination of the affairs of insurers;
* form and content of required financial reports;
* reserve requirements for unearned premiums, losses, and other
purposes; and
* claims processing.
The states in which we operate regulate credit insurance premium rates
and premium refund calculations.
COMPETITION
Consumer Finance
The consumer finance industry is highly competitive due to the large
number of companies offering financial products and services, the
sophistication of those products, the capital market resources of some
competitors, and the general acceptance and widespread usage of
available credit. We compete with other consumer finance companies as
well as other types of financial institutions that offer similar
products and services.
Insurance
Our insurance business segment supplements our consumer finance
business segment. We believe that our insurance companies' abilities
to market insurance products through our distribution systems provide
a competitive advantage over our insurance competitors.
26
Item 2. Properties.
We generally conduct branch office operations, branch office
administration, other operations, and operational support in leased
premises. Lease terms generally range from three to five years.
Our investment in real estate and tangible property is not significant
in relation to our total assets due to the nature of our business.
AGFC subsidiaries own two branch offices in Riverside and Barstow,
California and two branch offices in Hato Rey and Isabela, Puerto
Rico. AGFI owns eight buildings in Evansville, Indiana. These
buildings primarily include certain of our administrative offices, our
centralized services and support operations facilities, and one of our
branch offices. Merit owns an office building in Houston, Texas that
is leased to third parties and affiliates and also owns a consumer
finance branch office in Terre Haute, Indiana that is leased to an
AGFC subsidiary.
Item 3. Legal Proceedings.
AGFC and certain of its subsidiaries are parties to various lawsuits
and proceedings, including certain purported class action claims,
arising in the ordinary course of business. In addition, many of
these proceedings are pending in jurisdictions, such as Mississippi,
that permit damage awards disproportionate to the actual economic
damages alleged to have been incurred. Based upon information
presently available, we believe that the total amounts, if any, that
will ultimately be paid arising from these lawsuits and proceedings
will not have a material adverse effect on our consolidated results of
operations or financial position. However, the continued occurrences
of large damage awards in general in the United States, including
large punitive damage awards that bear little or no relation to actual
economic damages incurred by plaintiffs in some jurisdictions, create
the potential for an unpredictable judgment in any given suit.
27
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.
No trading market exists for AGFC's common stock. AGFC is an indirect
wholly owned subsidiary of AIG. AGFC paid the following cash
dividends on its common stock:
Quarter Ended 2003 2002
(dollars in thousands)
March 31 $ 897 $ 89,920
June 30 118,779 61,972
September 30 56,387 -
December 31 - -
Total $176,063 $151,892
See Management's Discussion and Analysis in Item 7., and Note 18. of
the Notes to Consolidated Financial Statements in Item 8., regarding
limitations on the ability of AGFC and its subsidiaries to pay
dividends.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction
with the consolidated financial statements and related notes in Item
8., Management's Discussion and Analysis in Item 7., and other
financial information in Item 1.
At or for the Years Ended December 31,
2003 2002 2001 2000 1999
(dollars in thousands)
Total revenues $ 2,162,373 $ 1,980,974 $ 1,975,536 $ 1,902,826 $ 1,715,869
Net income (a) 363,573 349,495 252,791 260,130 224,653
Total assets 16,771,141 15,400,722 13,447,626 13,193,153 12,464,102
Long-term debt 10,686,887 9,566,256 6,300,171 5,667,567 5,709,755
(a) Per share information is not included because all of AGFC's common stock
is owned by AGFI.
28
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the
consolidated financial statements and related notes in Item 8. and
other financial information in Item 1.
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K and our other publicly available
documents may include, and the Company's officers and representatives
may from time to time make, statements which may constitute "forward-
looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are not historical
facts but instead represent only our belief regarding future events,
many of which are inherently uncertain and outside of our control.
These statements may address, among other things, the Company's
strategy for growth, product development, regulatory approvals, market
position, financial results and reserves. The Company's actual
results and financial condition may differ, possibly materially, from
the anticipated results and financial condition indicated in these
forward-looking statements. The important factors, many of which are
outside of our control, which could cause the Company's actual results
to differ, possibly materially, include, but are not limited to, the
following:
* changes in general economic conditions, including the interest
rate environment in which we conduct business and the
financial markets through which we access capital and invest
cash flows from the insurance business segment;
* changes in the competitive environment in which we operate,
including the demand for our products, customer responsiveness
to our distribution channels and the formation of business
combinations among our competitors;
* the effectiveness of our credit risk scoring models in
assessing the risk of customer unwillingness or inability to
repay;
* shifts in collateral values, contractual delinquencies, credit
losses and the levels of unemployment and personal
bankruptcies;
* our ability to access capital markets and maintain our credit
rating position;
* changes in laws or regulations that affect our ability to
conduct business or the manner in which we conduct business,
such as licensing requirements, pricing limitations or
restrictions on the method of offering products;
* the costs and effects of any litigation or governmental
inquiries or investigations that are determined adversely to
the Company;
* changes in accounting standards or tax policies and practices
and the application of such new policies and practices to the
manner in which we conduct business;
* our ability to integrate the operations of our acquisitions
into our businesses;
* changes in our ability to attract and retain employees or key
executives to support our businesses; and
* natural or accidental events such as fires or floods affecting
our branches or other operating facilities.
29
Item 7. Continued
Readers are also directed to other risks and uncertainties discussed
in other documents we file with the SEC. We are under no obligation
to (and expressly disclaim any such obligation to) update or alter any
forward-looking statement, whether written or oral, that may be made
from time to time, whether as a result of new information, future
events or otherwise.
OVERVIEW
We are in the consumer finance and credit insurance businesses. Our
consumer finance business segment borrows money at wholesale prices,
lends money at retail prices, and offers credit and non-credit
insurance products to eligible customers. Our insurance business
segment writes and reinsures credit and non-credit insurance products
for eligible customers of our consumer finance business segment and
invests premiums received in various investments.
BASIS OF REPORTING
We prepared our consolidated financial statements using accounting
principles generally accepted in the United States (GAAP). The
statements include the accounts of AGFC and its subsidiaries, all of
which are wholly owned. We eliminated all intercompany items. We
made estimates and assumptions that affect amounts reported in our
financial statements and disclosures of contingent assets and
liabilities. Ultimate results could differ from our estimates.
At December 31, 2003, 86% of our assets were net finance receivables
less allowance for finance receivable losses. Our finance charge
revenue is a function of the amount of average net receivables and the
yield on those average net receivables. GAAP requires that we
recognize finance charges as revenue on the accrual basis using the
interest method. The only discretion we have is the point of
suspension of the accrual of this finance charge revenue.
At December 31, 2003, 94% of our liabilities were debt issued
primarily to support our net finance receivables. Our interest
expense is a function of the amount of average borrowings and the
borrowing cost on those average borrowings. GAAP requires that we
recognize interest on borrowings as expense on the accrual basis using
the interest method. Interest expense includes the effect of our
interest rate swap agreements.
Our insurance revenues consist primarily of insurance premiums
resulting from our consumer finance customers purchasing various
credit and non-credit insurance policies. Insurance premium revenue
is a function of the premium amounts and policy terms. GAAP dictates
the methods of insurance premium revenue recognition.
We invest cash generated by our insurance business segment primarily
in investment securities, which were 8% of our assets at December 31,
2003, and to a lesser extent in commercial mortgage loans, investment
real estate, and policy loans, which are included in other assets. We
report the resulting investment revenue in other revenue. GAAP
requires that we recognize interest on these investments as revenue on
the accrual basis using the interest method. The only areas of
30
Item 7. Continued
discretion we have are determining the classification of the
investment, the point of suspension of the accrual of this investment
revenue, and when the investment security's decline in fair value is
considered to be other than temporary and is to be reduced to its fair
value.
Our other revenue includes service fees we charge for marketing,
certain origination processing services, and loan servicing of real
estate loans under our agreement with AIG Federal Savings Bank. As
required by GAAP, we recognize these fees as revenue when we perform
the services. Other revenue also includes net gain on sale of real
estate loans held for sale and net interest income on real estate
loans held for sale. GAAP requires that we recognize the difference
between the sales price we receive when we sell a real estate loan
held for sale and our investment in that loan as a gain or loss at the
time of sale. GAAP also requires that we recognize interest as
revenue on the accrual basis using the interest method during the
periods we hold real estate loans held for sale. The only discretion
we have is the point of suspension of the accrual of this interest
revenue.
CRITICAL ACCOUNTING POLICIES
Our finance receivable portfolio consists of approximately $14.8
billion of net finance receivables due from approximately 1.8 million
customer accounts. These accounts were originated or purchased and
are serviced by our 1,365 branch offices or by our centralized
services and support operations.
To manage our exposure to credit losses, we use credit risk scoring
models for finance receivables that we originate or perform due
diligence investigations for finance receivables that we purchase. We
also have standard collection procedures supplemented with data
processing systems to aid branch and centralized services and support
operations personnel in their finance receivable collection processes.
Despite our efforts to avoid losses on our finance receivables, our
customers are subject to national, regional, and local economic
situations and personal circumstances that affect their abilities to
repay their obligations. These circumstances include lower income due
to unemployment or underemployment, major medical expenses, and
divorce. Occasionally, these types of events are so economically
severe that the customer files for bankruptcy.
Our Credit Strategy and Policy Committee evaluates our finance
receivable portfolio monthly. Within our three main finance
receivable types are sub-portfolios, each consisting of a large number
of relatively small, homogenous accounts. We evaluate these sub-
portfolios as groups. None of our accounts are large enough to
warrant individual evaluation for impairment. Our Credit Strategy and
Policy Committee considers numerous factors in estimating losses
inherent in our finance receivable portfolio, including the following:
* prior finance receivable loss and delinquency experience;
* the composition of our finance receivable portfolio; and
* current economic conditions, including the levels of
unemployment and personal bankruptcies.
31
Item 7. Continued
Our Credit Strategy and Policy Committee uses several ratios to aid in
the process of evaluating prior finance receivable loss and
delinquency experience. Each ratio is useful, but each has its
limitations. These ratios include:
* Delinquency ratio - gross finance receivables 60 days or more
past due (3 or more contractual payments have not been made)
as a percentage of gross finance receivables.
* Allowance ratio - allowance for finance receivable losses as a
percentage of net finance receivables.
* Charge-off ratio - net charge-offs as a percentage of the
average of net finance receivables at the beginning of each
month during the period.
* Charge-off coverage - allowance for finance receivable losses
to net charge-offs.
We use migration analysis as one of the tools to determine the
appropriate amount of allowance for finance receivable losses.
Migration analysis is a statistical technique that attempts to predict
the future amount of losses for existing pools of finance receivables.
This technique applies empirically measured historical movement of
like finance receivables through various levels of repayment,
delinquency, and loss categories to existing finance receivable pools.
These results are aggregated for all segments of the Company's
portfolio to arrive at an estimate of future finance receivable losses
for the finance receivables existing at the time of analysis. We
calculate migration analysis using several different scenarios based
on varying assumptions in order to evaluate the widest range of
possible outcomes. We adjust the amounts determined by migration
analysis for management's best estimate of the effects of current
economic conditions, including the levels of unemployment and personal
bankruptcies, on the amounts determined from historical loss and
delinquency experience.
If we had chosen to establish the allowance for finance receivable
losses at the highest and lowest levels produced by the various
migration analysis scenarios, our allowance for finance receivable
losses at December 31, 2003 and 2002 and provision for finance
receivable losses and net income for 2003 and 2002 would have changed
as follows:
At or for the
Years Ended December 31,
2003 2002
(dollars in millions)
Highest level:
Increase in allowance for finance
receivable losses $ 31.8 $ 16.0
Increase in provision for finance
receivable losses 31.8 16.0
Decrease in net income (20.2) (11.3)
Lowest level:
Decrease in allowance for finance
receivable losses $(100.6) $(103.8)
Decrease in provision for finance
receivable losses (100.6) (103.8)
Increase in net income 64.0 73.1
32
Item 7. Continued
The Credit Strategy and Policy Committee exercises its judgment, based
on quantitative analyses, qualitative factors, and each committee
member's experience in the consumer finance industry, when determining
the amount of the allowance for finance receivable losses. If its
review concludes that an adjustment is necessary, we charge or credit
this adjustment to expense through the provision for finance
receivable losses. We consider this estimate to be a critical
accounting estimate that affects the net income of the Company in
total and the pretax operating income of our consumer finance business
segment. We document the adequacy of the allowance for finance
receivable losses, the analysis of the trends in credit quality, and
the current economic conditions considered by the Credit Strategy and
Policy Committee to support its conclusions. See Provision for
Finance Receivable Losses for further information on the allowance for
finance receivable losses.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any material off-balance sheet arrangements as defined
by SEC rules.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our sources of funds include operations, issuances of long-term debt,
short-term borrowings in the commercial paper market, borrowings from
banks under credit facilities, and sales of finance receivables for
securitizations. AGFC has also historically received capital
contributions from its parent to support finance receivable growth and
maintain targeted leverage.
In second quarter 2003, AGFC began issuing long-term debt under a
retail note program. These senior, unsecured notes are sold by
brokers to individual investors for a minimum investment of $1,000 in
increments of $1,000.
Also in second quarter 2003, a consolidated special purpose subsidiary
of AGFI purchased $266.8 million of real estate loans from seven
subsidiaries of AGFC.
33
Item 7. Continued
Principal sources and uses of cash were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Principal sources of cash:
Net issuances of debt $1,239.0 $1,727.8 $ 361.0
Operations 736.3 563.2 750.1
Sale of finance receivables to
AGFI subsidiary for
securitization 284.7 - -
Capital contributions - 66.7 -
Total $2,260.0 $2,357.7 $1,111.1
Principal uses of cash:
Net originations and purchases
of finance receivables $1,899.0 $1,876.1 $ 551.2
Dividends paid 176.1 151.9 428.9
Total $2,075.1 $2,028.0 $ 980.1
Net cash from operations increased in 2003 primarily due to net sales
of real estate loans held for sale, higher finance charges, lower
interest expense, and routine operating activities. Net issuances of
debt decreased in 2003 in response to the increase in net cash from
operations and the sale of finance receivables for securitization.
Net originations and purchases of finance receivables and net
issuances of debt increased in 2002 due to significant increases in
real estate loan acquisitions. Net cash from operations decreased in
2002 due to routine operating activities, partially offset by higher
finance charges and lower interest expense.
Dividends paid, less capital contributions received, reflect changes
in net income retained by AGFC to maintain equity and total debt at a
targeted ratio. At year end 2001, we increased our leverage target to
7.5 to 1 for debt to tangible equity. Approximately $195.0 million of
the $245.1 million fourth quarter 2001 dividend was due to our change
in targeted leverage.
34
Item 7. Continued
We believe that our overall sources of liquidity will continue to be
sufficient to satisfy our foreseeable operational requirements and
financial obligations. The principal risk factors that could decrease
our sources of liquidity are delinquent payments from our customers
and an inability to access capital markets. The principal factors
that could increase our cash needs are significant increases in net
originations and purchases of finance receivables. We intend to
mitigate liquidity risk factors by continuing to operate the Company
by utilizing the following existing strategies:
* maintain a finance receivable portfolio comprised mostly of
real estate loans, which generally represent a lower risk of
customer non-payment;
* originate and monitor finance receivables with our proprietary
credit risk management system;
* maintain an investment securities portfolio of predominantly
investment grade, liquid securities; and
* maintain a capital structure appropriate to our asset base.
Consistent execution of our business strategies should result in
continued profitability, strong credit ratings, and investor
confidence. These results should allow continued access to capital
markets for issuances of our commercial paper and long-term debt. At
December 31, 2003, we had $9.1 billion of long-term debt securities
registered under the Securities Act of 1933 that had not yet been
issued. We also maintain committed bank credit facilities and have
the ability to sell a portion of our finance receivables for
securitization to provide additional sources of liquidity for needs
potentially not met through other funding sources. See Note 12. of
the Notes to Consolidated Financial Statements in Item 8. for
information on our credit facilities.
At December 31, 2003, material contractual obligations were as
follows:
Less than From 1-3 From 4-5 Over 5
1 year years years years Total
(dollars in millions)
Debt:
Long-term debt $ 2,099.2 $ 4,276.6 $ 1,928.3 $ 2,382.8 $10,686.9
Short-term debt 3,184.5 - - - 3,184.5
Operating leases 49.7 60.0 21.0 14.6 145.3
Total $ 5,333.4 $ 4,336.6 $ 1,949.3 $ 2,397.4 $14,016.7
Debt
With consistent execution of our business strategies, we expect to
refinance maturities of our debt in the capital markets. Any adverse
changes in our operating performance or credit ratings could limit our
access to capital markets to accomplish these refinancings.
35
Item 7. Continued
Operating Leases
Operating leases represent annual rental commitments for leased office
space, automobiles, and data processing and related equipment.
Capital Resources
December 31,
2003 2002
Amount Percent Amount Percent
(dollars in millions)
Long-term debt $10,686.9 67% $ 9,566.3 66%
Short-term debt 3,184.5 20 3,061.1 21
Total debt 13,871.4 87 12,627.4 87
Equity 2,051.4 13 1,809.9 13
Total capital $15,922.8 100% $14,437.3 100%
Net finance receivables $14,838.5 $13,574.3
Debt to equity ratio 6.76x 6.98x
Debt to tangible equity ratio 7.51x 7.34x
Reconciliations of equity to tangible equity were as follows:
December 31,
2003 2002
(dollars in millions)
Equity $ 2,051.4 $ 1,809.9
Goodwill (220.4) (157.6)
Accumulated other comprehensive loss 14.9 68.9
Tangible equity $ 1,845.9 $ 1,721.2
Our capital varies primarily with the level of net finance
receivables. The increase in total capital at December 31, 2003 when
compared to December 31, 2002 was greater than our finance receivable
growth for the same period primarily due to capital required to
support the acquisition of WFI and its operations. The capital mix of
debt and equity is based primarily upon maintaining leverage that
supports cost-effective funding. AGFC has historically paid dividends
to (or received capital contributions from) its parent to manage our
leverage of debt to tangible equity to a targeted amount. Since year-
end 2001, that tangible leverage target has been 7.5 to 1.
Certain AGFC financing agreements effectively limit the amount of
dividends AGFC may pay. These agreements have not prevented AGFC from
managing its capital to targeted leverage. See Note 18. of the Notes
to Consolidated Financial Statements in Item 8. for information on
dividend restrictions.
36
Item 7. Continued
We issue a combination of fixed-rate debt, principally long-term, and
floating-rate debt, principally short-term. AGFC obtains our fixed-
rate funding through public issuances of long-term debt with
maturities generally ranging from three to ten years. Most floating-
rate funding is through AGFC sales and refinancing of commercial paper
and through AGFC issuances of long-term, floating-rate debt.
Commercial paper, with maturities ranging from 1 to 270 days, is sold
to banks, insurance companies, corporations, and other accredited
investors. At December 31, 2003, short-term debt included $2.7
billion of commercial paper. AGFC also sells extendible commercial
notes with initial maturities of up to 90 days, which may be extended
by AGFC to 390 days. At December 31, 2003, short-term debt included
$530.4 million of extendible commercial notes.
We maintain credit facilities to support the issuance of commercial
paper and to provide an additional source of funds for operating
requirements. At December 31, 2003, credit facilities totaled $3.1
billion (including $3.0 billion of committed credit facilities) with
remaining availability of $3.1 billion. See Note 12. of the Notes to
Consolidated Financial Statements in Item 8. for additional
information on credit facilities.
Our committed credit facilities at December 31, 2003 expire as
follows:
Committed Credit Facilities
(dollars in millions)
2004 $1,503.0
2007 1,500.0
Total $3,003.0
ANALYSIS OF OPERATING RESULTS
Net Income
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Net income $363.6 $349.5 $252.8
Amount change $ 14.1 $ 96.7 $ (7.3)
Percent change 4% 38% (3)%
Return on average assets 2.28% 2.51% 1.91%
Return on average equity 18.79% 21.69% 14.46%
Ratio of earnings to fixed charges 2.03x 1.87x 1.62x
37
Item 7. Continued
Net income for 2002 included a $30.0 million reduction in the
provision for income taxes resulting from a favorable settlement of
income tax audit issues. Net income for 2003 and 2002 did not include
goodwill amortization due to the adoption of Statement of Financial
Accounting Standards 142 on January 1, 2002. Net income included
goodwill amortization of $6.4 million for 2001.
Net income for 2001 included charges of $58.0 million ($37.7 million
aftertax) resulting from our review of our businesses and the assets
supporting those businesses, as well as the adoption of AIG's
accounting policies and methodologies, in connection with AIG's
indirect acquisition of the Company. See Note 19. of the Notes to
Consolidated Financial Statements in Item 8. for further information
on these charges.
We manage our operations in response to economic events and to achieve
our profitability objectives. A continued sluggish economy in the
first half of 2003 and the lowest interest rate environment in 45
years caused further decreases in both our yield and borrowing cost.
Our acquisition of WFI, effective January 1, 2003, caused increases in
our other revenue and also increased our operating expenses. Real
estate loan production of approximately $1.9 billion from the recently
acquired WFI operations more than offset the decrease in real estate
loans acquired from third party lenders. We also continued to control
operating expenses. The higher proportion of real estate loans in our
finance receivable portfolio resulted in net charge-offs that were
also well controlled. This, plus the improving economy in the second
half of 2003, resulted in lower additions to the allowance for finance
receivable losses when compared to the prior two years.
In 2002, a sluggish economy decreased our borrowing cost; however, the
low interest rate environment had the anticipated effect of also
reducing our yield. We continued to invest in business development
programs, including new branch openings and a second customer
solicitation center, but still controlled operating expenses.
In 2001, a slowing economy resulted in lower borrowing cost but higher
net charge-offs. We invested in business development programs,
including new branch openings, and increased our allowance for finance
receivable losses in response to higher delinquency, charge-offs,
unemployment, and personal bankruptcies.
See Note 24. of the Notes to Consolidated Financial Statements in Item
8. for information on the results of the Company's business segments.
38
Item 7. Continued
Our statements of income line items as percentages of each year's
average net receivables were as follows:
Years Ended December 31,
2003 2002 2001
Revenues
Finance charges 12.41% 13.83% 14.62%
Insurance 1.32 1.58 1.71
Other 1.94 0.91 0.98
Total revenues 15.67 16.32 17.31
Expenses
Interest expense 3.90 4.56 5.44
Operating expenses 4.90 4.54 4.64
Provision for finance
receivable losses 2.24 2.44 2.50
Insurance losses and loss
adjustment expenses 0.49 0.69 0.77
Other charges - - 0.51
Total expenses 11.53 12.23 13.86
Income before provision for
income taxes 4.14 4.09 3.45
Provision for income taxes 1.51 1.21 1.23
Net income 2.63% 2.88% 2.22%
Factors that specifically affected the Company's operating results
were as follows:
Finance Charges
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Finance charges $ 1,712.1 $ 1,678.9 $ 1,668.6
Amount change $ 33.2 $ 10.3 $ 91.0
Percent change 2% 1% 6%
Average net receivables $13,800.6 $12,135.8 $11,411.5
Yield 12.41% 13.83% 14.62%
39
Item 7. Continued
Finance charges increased due to the following:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Increase in average net
receivables $ 195.9 $ 89.1 $ 37.1
(Decrease) increase in yield (162.7) (78.8) 57.4
Decrease in number of days - - (3.5)
Total $ 33.2 $ 10.3 $ 91.0
Growth in average net receivables by type was as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Real estate loans $1,692.3 $ 862.0 $ 121.0
Non-real estate loans 26.6 (93.0) 149.0
Retail sales finance (54.1) (44.7) 22.4
Total $1,664.8 $ 724.3 $ 292.4
Percent change 14% 6% 3%
In 2003, the lowest interest rate environment in 45 years continued to
cause increases in both originations and liquidations of our real
estate loans. Real estate loan production of approximately $1.9
billion from the recently acquired WFI operations also increased real
estate loan originations as well as the average size of real estate
loans originated in 2003. We reduced real estate loan acquisitions in
2003 because premiums on portfolios of real estate loans produced by
third party originators and required by sellers reached levels
unacceptable to us.
In 2002, the low interest rate environment caused significant
increases in both originations and liquidations of our real estate
loans. However, we took advantage of the record real estate loan
refinancings that occurred in the market and acquired $2.3 billion of
real estate loan portfolios from third party originators.
Changes in yield in basis points (bp) by type were as follows:
Years Ended December 31,
2003 2002 2001
Real estate loans (145) bp (87) bp 49 bp
Non-real estate loans (32) (3) 5
Retail sales finance (15) 37 44
Total (142) (79) 43
40
Item 7. Continued
Yield decreased in both 2003 and 2002 primarily reflecting a lower
real estate loan yield resulting from the low interest rate
environment. We anticipate yield to level off or decrease less in
2004.
Insurance Revenues
Insurance revenues were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Earned premiums $178.5 $189.0 $193.0
Commissions 3.1 2.2 2.4
Total $181.6 $191.2 $195.4
Amount change $ (9.6) $ (4.2) $ (0.8)
Percent change (5)% (2)% -%
Earned premiums decreased for 2003 primarily due to lower premium
volume over the last three years. Premium volume decreased due to
fewer non-real estate loan customers who historically have purchased
the majority of our insurance products. Also, in April 2003, we
terminated a reinsurance agreement with a non-subsidiary affiliate and
reversed approximately $3.6 million of annuity premiums and annuity
reserve expense that we previously recorded.
Earned premiums decreased in 2002 primarily due to lower premium
volume and lower premium rates. The lower premium volume reflected a
higher proportion of average net receivables that are real estate
loans, as well as a decrease in the amount of premiums permitted to be
charged in a number of states. Our experience is that customers
purchase fewer insurance products on real estate loans than on non-
real estate loans.
41
Item 7. Continued
Other Revenues
Other revenues were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Net gain on sales of real estate
loans held for sale $ 84.0 $ - $ -
Investment revenue 82.1 85.8 86.7
Service fee income from a
non-subsidiary affiliate 49.5 3.1 -
Net gain on sale of finance
receivables to AGFI subsidiary
for securitization 20.7 - -
Net interest income on real estate
loans held for sale 14.8 - -
Interest revenue - notes
receivable from AGFI 14.0 15.8 21.0
Writedowns on real estate owned (8.0) (8.6) (4.6)
Net recovery (loss) on sales of
real estate owned 1.8 2.9 (1.1)
Other 9.7 11.8 9.5
Total $268.6 $110.8 $111.5
Amount change $157.8 $ (0.7) $(17.5)
Percent change 142% (1)% (14)%
The increase in other revenues for 2003 was primarily due to the
acquisition of WFI effective January 1, 2003 which resulted in net
gain on sales of real estate loans held for sale, higher service fee
income from a non-subsidiary affiliate, and net interest income on
real estate loans held for sale in 2003. Effective July 1, 2003, WFI
and AIG Federal Savings Bank, a non-subsidiary affiliate, entered into
an agreement whereby for a fee, WFI provides marketing, certain
origination processing services, loan servicing, and related services
for the affiliate's origination and sale of non-conforming residential
real estate loans. These WFI service activities have supplanted much
of WFI's origination and sales activity and are anticipated to do so
going forward. The increase in other revenues for 2003 also reflected
net gain on sale of finance receivables to a subsidiary of AGFI for
securitization.
The decrease in other revenues for 2002 was primarily due to lower
interest revenue on notes receivable from AGFI and higher writedowns
on real estate owned, partially offset by net recovery on sales of
foreclosed real estate in 2002 compared to net loss in 2001 and higher
service fee income from a non-subsidiary affiliate. The decrease in
interest revenue on notes receivable from AGFI reflected lower
interest rates. These notes support AGFI's funding of finance
receivables.
42
Item 7. Continued
Investment revenue was affected by the following:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Average invested assets $1,302.5 $1,252.6 $1,231.2
Adjusted portfolio yield 6.56% 6.84% 7.03%
Net realized losses on
investments $ (8.4) $ (4.4) $ (3.0)
Interest Expense
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Interest expense $ 538.9 $ 553.9 $ 620.5
Amount change $ (15.0) $ (66.6) $ (56.9)
Percent change (3)% (11)% (8)%
Average borrowings $12,952.4 $11,180.4 $10,373.6
Borrowing cost 4.17% 4.95% 5.98%
Interest expense decreased due to the following:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Decrease in borrowing cost $(102.7) $(114.8) $(64.1)
Increase in average borrowings 87.7 48.2 7.6
Decrease in number of days - - (0.4)
Total $ (15.0) $ (66.6) $(56.9)
Changes in average borrowings by type were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Long-term debt $2,240.8 $1,321.9 $ 318.4
Short-term debt (468.8) (515.1) (203.3)
Total $1,772.0 $ 806.8 $ 115.1
Percent change 16% 8% 1%
AGFC issued $2.7 billion of long-term debt in 2003, compared to $4.6
billion in 2002 and $1.9 billion in 2001. Long-term debt issuances in
2003 were lower than in 2002 primarily due to reductions in commercial
paper, higher levels of finance receivable growth, and long-term debt
refinancings in 2002.
43
Item 7. Continued
Changes in borrowing cost in basis points by type were as follows:
Years Ended December 31,
2003 2002 2001
Long-term debt (125) bp (77) bp 2 bp
Short-term debt (34) (188) (150)
Total (78) (103) (62)
Federal Reserve actions lowered the federal funds rate 50 basis points
in November 2002 and 25 basis points in June 2003 which resulted in
lower short-term debt rates and lower rates on floating-rate long-term
debt for 2003. Federal Reserve actions from 2001 through June 2003
created the lowest interest rate environment in 45 years and resulted
in lower long-term debt rates as new issuances were at substantially
lower rates than long-term debt being refinanced.
Operating Expenses
Operating expenses were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Salaries and benefits $406.8 $309.2 $294.0
Other 268.8 242.0 236.0
Total $675.6 $551.2 $530.0
Amount change $124.4 $ 21.2 $ 4.2
Percent change 23% 4% 1%
Operating expenses as a
percentage of average
net receivables 4.90% 4.54% 4.64%
The increase in operating expenses for 2003 was primarily due to
higher salaries and benefits, credit and collection expenses,
occupancy, and advertising expenses. The increase in salaries and
benefits for 2003 reflected the acquisition of WFI which resulted in
the addition of approximately 500 WFI employees effective January 1,
2003 and 400 additional WFI employees hired during 2003, competitive
compensation, and rising benefit costs. The increase in credit and
collection expenses reflected higher credit investigation, recording
and releasing, and mortgage appraisal fees resulting from higher real
estate loan originations and renewals during 2003.
44
Item 7. Continued
The increase in operating expenses for 2002 was primarily due to
higher salaries and benefits, data processing, and administrative
expenses allocated from AIG, partially offset by the absence of
goodwill amortization in 2002. The increases in salaries and benefits
for 2002 reflected higher competitive compensation and rising benefit
costs.
The increase in operating expenses as a percentage of average net
receivables for 2003 reflected increased operating expenses due to the
acquisition of WFI, partially offset by continued emphasis on
controlled operating expenses. Approximately $83.9 million of the
Company's 2003 operating expenses were directly related to WFI
operations. The improvements in operating expenses as a percentage of
average net receivables in 2002 reflected controlled operating
expenses and moderate finance receivable growth.
Provision for Finance Receivable Losses
At or for the
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Provision for finance
receivable losses $308.5 $296.4 $284.7
Amount change $ 12.1 $ 11.7 $ 82.2
Percent change 4% 4% 41%
Net charge-offs $304.0 $290.2 $258.7
Charge-off ratio 2.21% 2.41% 2.27%
Charge-off coverage 1.50x 1.56x 1.70x
60 day+ delinquency $507.1 $513.8 $456.9
Delinquency ratio 3.33% 3.68% 3.73%
Allowance for finance
receivable losses $455.4 $453.7 $438.9
Allowance ratio 3.07% 3.34% 3.74%
Changes in net charge-offs by type were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Real estate loans $10.6 $ 2.7 $ 4.6
Non-real estate loans 3.2 23.5 42.1
Retail sales finance - 5.3 9.5
Total $13.8 $31.5 $56.2
Real estate loan net charge-offs increased in 2003 and 2002 primarily
due to increases in real estate loan average net receivables of $1.7
billion, or 21%, in 2003 and $862.0 million, or 12%, in 2002. The
increase in non-real estate loan and retail sales finance net charge-
offs in 2002 reflected the sluggish economy during 2002.
45
Item 7. Continued
Changes in charge-off ratios in basis points by type were as follows:
Years Ended December 31,
2003 2002 2001
Real estate loans (1) bp (3) bp 5 bp
Non-real estate loans 5 104 121
Retail sales finance 14 48 65
Total (20) 14 45
The decrease in total charge-off ratio for 2003 reflected a higher
proportion of average net receivables that were real estate loans and
the improving economy during the second half of 2003. The increase in
total charge-off ratio for 2002 reflected a sluggish economy in 2002
and higher levels of unemployment and personal bankruptcies.
Changes in delinquency from the prior year end by type were as
follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Real estate loans $ 7.0 $47.0 $11.0
Non-real estate loans (10.5) 7.1 22.5
Retail sales finance (3.2) 2.8 9.5
Total $ (6.7) $56.9 $43.0
Real estate loan delinquency increased in 2003 and 2002 primarily due
to increases in real estate loans of $1.3 billion in 2003 and $1.9
billion in 2002. Delinquency was favorably impacted at December 31,
2003 by the improving economy in the second half of 2003, but was
unfavorably impacted at December 31, 2002 by the sluggish economy
during 2002.
Changes in delinquency ratio from the prior year end in basis points
by type were as follows:
Years Ended December 31,
2003 2002 2001
Real estate loans (35) bp (14) bp (2) bp
Non-real estate loans (24) 18 82
Retail sales finance (8) 33 63
Total (35) (5) 28
The delinquency ratio at December 31, 2003 and 2002 decreased
primarily due to a higher proportion of net finance receivables that
were real estate loans. The delinquency ratio at December 31, 2003
also reflected the improving economy during the second half of 2003
and improvements in non-real estate and retail sales finance
delinquency ratios.
46
Item 7. Continued
Our Credit Strategy and Policy Committee evaluates our finance
receivable portfolio monthly to determine the appropriate level of the
allowance for finance receivable losses. We believe the amount of the
allowance for finance receivable losses is the most significant
estimate we make. In our opinion, the allowance is adequate to absorb
losses inherent in our existing portfolio. The increase in the
allowance for finance receivable losses at December 31, 2003 when
compared to December 31, 2002 was due to the net result of the
following:
* net increases to the allowance for finance receivable losses
through the provision for finance receivable losses in 2003
totaling $4.4 million (these increases were necessary in
response to our levels of delinquency and net charge-offs and
the levels of both unemployment and personal bankruptcies in
the United States); and
* decrease to the allowance for finance receivable losses during
second quarter 2003 of $2.7 million resulting from the sale of
finance receivables to a subsidiary of AGFI for
securitization.
The allowance as a percentage of net finance receivables at December
31, 2003 and 2002 decreased primarily due to a higher proportion of
net finance receivables that were real estate loans. The allowance as
a percentage of net finance receivables at December 31, 2003 also
reflected the improving economy during the second half of 2003.
Charge-off coverage, which compares the allowance for finance
receivable losses to net charge-offs, declined in 2003 and 2002
primarily due to a higher proportion of net finance receivables that
were real estate loans.
Insurance Losses and Loss Adjustment Expenses
Insurance losses and loss adjustment expenses were as follows:
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Claims incurred $75.3 $85.3 $90.3
Change in benefit reserves (7.5) (2.0) (2.2)
Total $67.8 $83.3 $88.1
Amount change $(15.5) $(4.8) $(0.3)
Percent change (19)% (5)% -%
Insurance losses and loss adjustment expenses declined in 2003
primarily due to lower claims incurred and a decrease in required
benefit reserves due to lower premium volume in the last three years.
Also, in April 2003, we terminated a reinsurance agreement with a non-
subsidiary affiliate and reversed approximately $3.6 million of
annuity reserve expense and annuity premiums that we previously
recorded.
47
Item 7. Continued
Claims incurred decreased in 2002 primarily due to decreases in claim
reserves, partially offset by increases in claims paid.
Other Charges
In third quarter 2001, we recorded charges of $58.0 million ($37.7
million aftertax) resulting from our review of our businesses and the
assets supporting those businesses, as well as the adoption of AIG's
accounting policies and methodologies, in connection with AIG's
indirect acquisition of the Company. See Note 19. of the Notes to
Consolidated Financial Statements in Item 8. for further information
on these charges.
Provision for Income Taxes
Years Ended December 31,
2003 2002 2001
(dollars in millions)
Provision for income taxes $208.0 $146.8 $141.4
Amount change $ 61.2 $ 5.4 $ (7.3)
Percent change 42% 4% (5)%
Pretax income $571.6 $496.3 $394.2
Effective income tax rate 36.39% 29.58% 35.88%
Provision for income taxes increased during 2003 due to higher
effective income tax rate and higher taxable income. The increase in
the provision for income taxes for 2002 reflected higher taxable
income, partially offset by a lower effective income tax rate. During
fourth quarter 2002, we reduced the provision for income taxes by
$30.0 million resulting from a favorable settlement of income tax
audit issues. This decreased the effective income tax rate for 2002.
ANALYSIS OF FINANCIAL CONDITION
Asset Quality
We believe that our geographic diversification reduces the risk
associated with a recession in any one region. In addition, 97% of
our finance receivables at December 31, 2003 were secured by real
property or personal property. While finance receivables have some
exposure to further economic uncertainty, we believe that the
allowance for finance receivable losses is adequate to absorb losses
inherent in our existing portfolio. See Analysis of Operating Results
for further information on allowance ratio, delinquency ratio, and
charge-off ratio and Note 3. of the Notes to Consolidated Financial
Statements in Item 8. for further information on how we estimate
finance receivable losses.
Investment securities are the majority of our insurance business
segment's investment portfolio. Our investment strategy is to
optimize aftertax returns on invested assets, subject to the
constraints of safety, liquidity, diversification, and regulation.
48
Item 7. Continued
Asset/Liability Management
In an effort to reduce the risk associated with unfavorable changes in
interest rates not met by favorable changes in finance charge yields
of our finance receivables, we monitor the anticipated cash flows of
our assets and liabilities, principally our finance receivables and
debt. For 2003, real estate loans had an average life of 2.5 years
(although loan lives may change in response to interest rate changes),
while non-real estate loans had an average life of 1.6 years and
retail sales finance receivables had an average life of 9 months. The
weighted-average life until maturity for our long-term debt was 3.2
years at December 31, 2003.
We fund finance receivables with a combination of fixed-rate and
floating-rate debt and equity. Management determines the mix of
fixed-rate and floating-rate debt based, in part, on the nature of the
finance receivables being supported.
We limit our exposure to market interest rate increases by fixing
interest rates that we pay for term periods. The primary means by
which we accomplish this is by issuing fixed-rate, long-term debt. To
supplement fixed-rate debt issuances, AGFC also alters the nature of
certain floating-rate funding by using interest rate swap agreements
to synthetically create fixed-rate, long-term debt, thereby limiting
our exposure to market interest rate increases. Additionally, AGFC
has swapped fixed-rate, long-term debt to floating-rate, long-term
debt. Including the effect of interest rate swap agreements that
effectively fix floating-rate debt or float fixed-rate debt, our
floating-rate debt represented 42% of our borrowings at December 31,
2003 compared to 37% at December 31, 2002. Adjustable-rate net
finance receivables represented 26% of our net finance receivables at
December 31, 2003 compared to 22% at December 31, 2002.
REGULATION AND OTHER
Regulation
The regulatory environment of the consumer finance and insurance
businesses is described in Item 1.
Taxation
We monitor federal and state tax legislation and respond with
appropriate tax planning.
49
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The fair values of certain of our assets and liabilities are sensitive
to changes in market interest rates. The impact of changes in
interest rates would be reduced by the fact that increases (decreases)
in fair values of assets would be partially offset by corresponding
changes in fair values of liabilities. In aggregate, the estimated
impact of an immediate and sustained 100 basis point increase or
decrease in interest rates on the fair values of our interest rate-
sensitive financial instruments would not be material to our financial
position.
The estimated increases (decreases) in fair values of interest rate-
sensitive financial instruments were as follows:
December 31, 2003 December 31, 2002
+100 bp -100 bp +100 bp -100 bp
(dollars in thousands)