-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Wzu09/7onigQVGe7A+bhpGF18LXj07PAje70bRneJ9V3OJCqGCaCnmAPm6fhlAqb yg6h6vx4NRFHu7Bdis3a+Q== 0000950147-98-000201.txt : 19980323 0000950147-98-000201.hdr.sgml : 19980323 ACCESSION NUMBER: 0000950147-98-000201 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980319 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FINOVA CAPITAL CORP CENTRAL INDEX KEY: 0000043960 STANDARD INDUSTRIAL CLASSIFICATION: SHORT-TERM BUSINESS CREDIT INSTITUTIONS [6153] IRS NUMBER: 941278569 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-07543 FILM NUMBER: 98569194 BUSINESS ADDRESS: STREET 1: 1850 N CENTRAL AVE STREET 2: PO BOX 2209 CITY: PHOENIX STATE: AZ ZIP: 85004-2209 BUSINESS PHONE: 6022074900 MAIL ADDRESS: STREET 1: 1850 N. CENTRAL AVENUE STREET 2: P.O. BOX 2209 CITY: PHOENIX STATE: AZ ZIP: 85002-2209 FORMER COMPANY: FORMER CONFORMED NAME: GREYHOUND FINANCIAL CORP DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: GREYHOUND LEASING & FINANCIAL CORP DATE OF NAME CHANGE: 19870330 10-K405 1 ANNUAL REPORT ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20594 -------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934 -------------------- For the Fiscal Year Ended December 31, 1997 Commission File Number 1-7543 FINOVA CAPITAL CORPORATION (Exact Name of Registrant as Specified in Its Charter) Delaware 94-1278569 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 1850 North Central Ave., P. O. Box 2209 Phoenix, AZ 85002-2209 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code - 602-207-4900 -------------------- Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on Which Registered ------------------- ------------------- $175,000,000 Principal Amount New York Stock Exchange of 9 - 1/8% Note Due February 27, 2002 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, (or for such shorter period that the registrant was required to file such reports), 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 Registration 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 10K or any amendment of this Form 10-K. [X] As of March 13, 1998, 25,000 shares of Common Stock ($1.00 par value) were outstanding and held by an affiliate. Registrant meets the conditions set forth in General instruction I (1) (a) and (b) of form 10-K and is therefore filing this form with the reduced disclosure format. DOCUMENTS INCORPORATED BY REFERENCE Document Part Where - -------- Incorporated ------------ None. ================================================================================ TABLE OF CONTENTS Name of Item ------------ Item # Page - -------------------------------------------------------------------------------- Part I Item 1 Business: Introduction 1 General 1 Business Groups 1 Portfolio Composition 3 Investment in Financing Transactions 3 Cost and Use of Borrowed Funds 11 Matched Funding Policy 12 Credit Ratings 13 Residual Realization Experience 13 Business Development and Competition 14 Credit Quality 15 Risk Management 15 Portfolio Management 15 Delinquencies and Workouts 16 Governmental Regulation 16 Employees 16 Special Note Regarding Forward-Looking Statements 16 Item 2 Properties 17 Item 3 Legal Proceedings 17 Item 4 Submission of Matters to a Vote of Security Holders 18 Part II Item 5 Market Price of and Dividends on the Registrant's Common Equity & Related Shareowner Matters 19 Item 6 Selected Financial Data 20 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Item 8 Financial Statements & Supplementary Data 21 Item 9 Changes in and Disagreements with Accountants on Accounting & Financial Disclosure 21 Part III Item 10 Directors & Executive Officers of the Registrant 21 Item 11 Executive Compensation 22 Item 12 Security Ownership of Certain Beneficial Owners & Management 22 Item 13 Certain Relationships & Related Transactions 22 Part IV Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 22 PART I ITEM 1. BUSINESS. INTRODUCTION The following discussion relates to FINOVA Capital Corporation and its subsidiaries (collectively "FINOVA" or the "Company"). FINOVA is a wholly owned subsidiary of The FINOVA Group Inc. ("FINOVA Group"). GENERAL FINOVA Capital Corporation is a financial services company engaged in providing capital and collateralized financing products to commercial enterprises focusing on midsize businesses in various market niches, principally in the United States. FINOVA extends revolving credit facilities, term loans and equipment and real estate financing primarily to "middle-market" businesses with financing needs falling generally between $500,000 and $35 million. FINOVA operates in 16 specific industry or market niches under three market groups. FINOVA selected these groups because its expertise in evaluating the credit-worthiness of prospective customers and its ability to provide value-added services enable the Company to differentiate itself from its competitors. That expertise and ability also enables FINOVA to command pricing that provides a satisfactory spread over its borrowing costs. FINOVA seeks to maintain a high quality portfolio and to minimize non-earning assets and write-offs. FINOVA uses clearly defined underwriting criteria and stringent portfolio management techniques. The Company diversifies its lending activities geographically and among a range of industries, customers and financing products. Due to the diversity of FINOVA's portfolio, the Company believes it is better able to manage competitive changes in its markets and to withstand the impact of deteriorating economic conditions on a regional or national basis. There can be no assurance, however, that competitive changes, borrowers' performance, economic conditions or other factors will not result in an adverse impact on FINOVA's results of operations or financial condition. FINOVA generates interest income, leasing income, fees and other income through charges assessed on outstanding loans, loan servicing, leasing, brokerage and other activities. FINOVA's primary expenses are the costs of funding the loan and lease business, including interest paid on debt, provisions for credit losses, marketing expenses, salaries and employee benefits, servicing and other operating expenses and income taxes. FINOVA is headquartered in Phoenix, Arizona with business development offices throughout the U.S. and in London, U.K. and Toronto, Canada. Business Groups FINOVA operates the following principal lines of business under three market groups: Commercial Finance o Business Credit offers collateral-oriented revolving credit facilities and term loans for manufacturers, distributors, wholesalers and service companies. Typical transaction sizes range from $500,000 to $3 million. o Corporate Finance provides a full range of cash flow-oriented and asset-based term and revolving loan products for manufacturers, wholesalers, distributors, specialty retailers and commercial and consumer service businesses. Typical transaction sizes range from $2 million to $35 million. o Inventory Finance provides inbound and outbound inventory financing, combined inventory/accounts receivable lines of credit and purchase order financing for equipment distributors, value-added resellers and dealers nationwide. Transaction sizes generally range from $500,000 to $30 million. o Factoring Services offers full service factoring and accounts receivable management services for entrepreneurial and larger firms, primarily in the textile and apparel industries. The annual factored volume of these companies is generally between $5 million and $25 million. 1 o Rediscount Finance offers revolving credit facilities to the independent consumer finance industry including sales, automobile, mortgage and premium finance companies. Typical transaction sizes range from $1 million to $35 million. Specialty Finance o Commercial Equipment Finance offers equipment leases, loans and "turnkey" financing to a broad range of midsize companies. Specialty markets include the corporate aircraft and emerging growth technology industries, primarily biotechnology and electronics. Typical transaction sizes range from $500,000 to $15 million. o Specialty Real Estate Finance focuses on first mortgage loans for hotel and resort properties and equity investments in real estate sale-leasebacks. Typical transaction sizes range from $5 million to $30 million. o Communications Finance specializes in term financing to advertising and subscriber-supported businesses, including radio and television stations, cable operators, outdoor advertising firms and publishers. Typical transaction sizes range from $1 million to $40 million. o Franchise Finance offers equipment, real estate and acquisition financing for operators of established franchise concepts. Transaction sizes generally range from $500,000 to $15 million. o Healthcare Finance offers a full range of working capital, equipment and real estate financing products for the U.S. healthcare industry. Transaction sizes typically range from $500,000 to $25 million. o Public Finance provides tax-exempt term financing to state and local governments, non-profit corporations and entities using Industrial Revenue and Industrial Development Bonds. Typical transaction sizes range from $100,000 to $5 million. o Portfolio Services provides customized receivable servicing and collections for timeshare developers and other generators of consumer receivables. o Resort Finance focuses on construction, acquisition and receivables financing of timeshare resorts worldwide as well as term financing for established golf resort hotels and receivables funding for developers of second home communities. Typical transaction sizes range from $5 million to $35 million. o Transportation Finance structures equipment loans, leases, acquisition financing and leveraged lease equity investments for commercial and cargo airlines worldwide, railroads and operators of other transportation related equipment. Typical transaction sizes range from $5 million to $30 million. Through FINOVA Aircraft Investors, LLC, FINOVA also seeks to use its market expertise and industry presence to purchase, upgrade and resell used commercial aircraft. Capital Markets o FINOVA Realty Capital specializes in providing capital markets-funded commercial real estate financing products and commercial mortgage banking services. Typical transaction sizes range from $1 million to $5 million. o FINOVA Investment Alliance provides equity and debt financing for midsize businesses in partnership with institutional investors and selected fund sponsors. Typical transaction sizes range from $2 million to $15 million. FINOVA is a Delaware corporation. The Company was incorporated in 1965 and is the successor to a California corporation that was formed in 1954. In March 1992, The Dial Corp transferred those businesses to FINOVA Group in a spin-off. Since that time, FINOVA has increased its total assets from about $2.5 billion at December 31, 1992 to $8.8 billion at December 31, 1997. Income from continuing operations increased from $36.8 million in 1992 to $143.1 million in 1997. Management believes FINOVA ranks among the largest independent commercial finance companies in the U.S., based on total assets. 2 Portfolio Composition The total assets under management of the Company consist of FINOVA's net investment in financing transactions plus certain assets that are owned by others but managed by the Company and are not reported on the Company's balance sheet (securitized assets and participations sold). The Company's investment in financing transactions is primarily settled in U.S. dollars. Investment in Financing Transactions The following tables detail FINOVA's investment in financing transactions (before reserve for credit losses) at December 31, 1997, 1996, 1995, 1994, and 1993. 3 INVESTMENT IN FINANCING TRANSACTIONS BY TYPES OF FINANCING (Dollars in Thousands)
December 31, ---------------------------------------------------------------------------------------------------- 1997 % 1996 % 1995 % 1994 % 1993 % ---------------------------------------------------------------------------------------------------- Loans, conditional sale and other financing contracts: Commercial $ 4,299,909 51.2 $ 3,592,193 49.2 $ 3,389,363 53.4 $2,732,734 51.1 $ 1,397,863 49.1 Real estate 1,656,075 19.7 1,713,485 23.5 1,534,177 24.1 1,237,488 23.2 945,892 33.2 Factored receivables 750,399 8.9 564,430 7.7 189,486 3.0 157,862 3.0 Operating leases 712,927 8.5 517,690 7.1 460,798 7.3 412,782 7.7 147,222 5.2 Leveraged leases 619,557 7.4 514,573 7.1 366,196 5.8 287,518 5.4 283,782 10.0 Direct financing leases 360,589 4.3 396,388 5.4 408,059 6.4 514,595 9.6 71,812 2.5 ----------- ----- ----------- ----- ----------- ----- ---------- ----- ----------- ----- Total investment in financing transactions 8,399,456 100.0 7,298,759 100.0 6,348,079 100.0 5,342,979 100.0 2,846,571 100.0 ===== ===== ===== ===== ===== Securitized assets 336,607 300,000 200,000 -- -- Participations sold 121,360 64,546 -- -- -- ----------- ----------- ----------- ---------- ----------- Total managed assets $ 8,857,423 $ 7,663,305 $ 6,548,079 $5,342,979 $ 2,846,571 =========== =========== =========== ========== ===========
4 INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1997 (Dollars in Thousands)
Revenue Accruing Nonaccruing -------------------------------------- ----------------------------- Repos- Repos- Total Market sessed sessed Lease & Carrying Rate (1) Impaired Assets (2) Impaired Assets Other Amount % -------------------------------------- ----------------------------- ------------ -------- Transportation Finance (3) (4) $ 1,631,685 $ $ $ $ $ $ 1,631,685 19.4% Resort Finance (4) 1,166,199 14,450 3,974 26,240 1,210,863 14.4% Corporate Finance (4) 791,733 981 26,888 819,602 9.8% Specialty Real Estate Finance 610,711 24,120 38,055 7,648 10,853 196 691,583 8.2% Communications Finance (4) 628,947 8,724 24,452 662,123 7.9% Commercial Equipment Finance 614,712 1,816 11,802 4,030 632,360 7.5% Rediscount Finance (4) 609,641 993 610,634 7.3% Inventory Finance(4) 544,108 4,333 548,441 6.5% Healthcare Finance 525,846 1,515 666 528,027 6.3% Franchise Finance(4) 430,651 808 2,171 305 433,935 5.2% Factoring Services 196,843 30,205 227,048 2.7% Business Credit 195,897 7,559 203,456 2.4% Public Finance 135,826 135,826 1.6% Other (5) 40,347 23,526 63,873 0.8% ------------ ---------- ---------- --------- -------- -------- ----------- ------ TOTAL(4) $ 8,123,146 $ 36,449 $ 52,505 $ 121,540 $ 37,093 $ 28,723 $ 8,399,456 100.0% ============ ========== ========== ========= ======== ======== =========== ======
- -------------------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $4.1 million on repossessed assets during 1997, including $3.1 million in Specialty Real Estate Finance and $1.0 million in Resort Finance. (3) Transportation Finance includes $302.9 million of aircraft financing business booked through the London office. (4) Excludes assets securitized and participations sold which the Company manages, including securitizations of $300.0 million in Corporate Finance and $36.6 million in Franchise Finance and participations of $40.2 million in Corporate Finance, $61.0 million in Communications Finance, $8.5 in Transportation Finance, $4.6 million in Rediscount Finance, $5.1 million in Resort Finance, and $1.9 million in Inventory Finance. (5) Primarily includes London-based FINOVA Capital Limited and assets retained subsequent to the sale of the Manufacturer and Dealer Services line of business which occurred in November 1996. -------------------- 5 INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1996 (Dollars in Thousands)
Revenue Accruing Nonaccruing ------------------------------------- --------------------------------- Repos- Repos- Total Market sessed sessed Lease & Carrying Rate (1) Impaired Assets (2) Impaired Assets Other Amount % ------------------------------------- --------------------------------- ------------------- Transportation Finance (3) $ 1,330,578 $ $ $ $ $ $ 1,330,578 18.2 Resort Finance (4) 1,124,462 2,963 13,878 77 25,136 1,166,516 16.0 Corporate Finance (4) 630,399 3,211 14,695 335 648,640 8.9 Specialty Real Estate Finance 700,932 30,245 46,068 6,748 9,853 940 794,786 10.9 Communications Finance (4) 535,701 8,796 14,129 3,095 561,721 7.7 Commercial Equipment Finance 570,574 7,900 6,564 585,038 8.0 Rediscount Finance (4) 421,232 245 421,477 5.8 Inventory Finance (4) 314,446 1,273 315,719 4.3 Healthcare Finance 497,540 1,304 1,194 500,038 6.9 Franchise Finance 366,202 1,104 1,985 996 370,287 5.0 Factoring Services 220,701 3,419 224,120 3.1 Business Credit 160,006 11,963 171,969 2.3 Public Finance 150,361 13 150,374 2.1 Other 52,998 4,498 57,496 0.8 ------------- ---------- ---------- -------- --------- --------- ----------- ----- Total Continuing Operations (4) $ 7,076,132 $ 46,319 $ 59,946 $ 63,751 $ 38,419 $ 14,192 $ 7,298,759 100.0 ============= ========== ========== ======== ========= 39,143 =========== ===== Discontinued Operations (5) --------- $ 53,335 TOTAL =========
- -------------------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $5.1 million on repossessed assets during 1996, including $4.4 million in Specialty Real Estate Finance and $0.7 million in Resort Finance. (3) Transportation Finance includes $160.8 million of aircraft financing business booked through the London office. (4) Excludes assets securitized and participations sold which the Company manages, including securitizations of $300.0 million in Corporate Finance and participations of $24.6 million in Corporate Finance, $27.5 million in Communications Finance, $4.8 million in Rediscount Finance, $4.4 million in Resort Finance and $3.2 million in Inventory Finance. (5) Reflects assets retained by FINOVA subsequent to the sale of the Manufacturer and Dealer Services' line of business. -------------------- 6 INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1995 (Dollars in Thousands)
Revenue Accruing Nonaccruing ------------------------------------ ------------------------------ Repos- Repos- Total Market sessed sessed Lease & Carrying Rate (1) Impaired Assets (2) Impaired Assets Other Amount % ------------------------------------ ------------------------------ -------------------- Transportation Finance (3) $ 929,043 $ $ $ $ $ $ 929,043 14.6 Resort Finance 943,661 2,849 12,064 2,583 26,559 987,716 15.6 Corporate Finance (4) 631,295 5,274 19,592 335 656,496 10.3 Specialty Real Estate Finance 703,018 3,898 42,304 15,264 18,231 988 783,703 12.3 Communications Finance 662,191 2,502 2,217 16,817 4,863 688,590 10.8 Commercial Equipment Finance 345,039 69 6,079 351,187 5.5 Rediscount Finance 345,264 345,264 5.4 Inventory Finance 202,879 430 203,309 3.2 Healthcare Finance 451,503 81 1,231 452,815 7.2 Franchise Finance 327,356 1,462 6,408 1,850 337,076 5.3 Factoring Services 188,892 594 189,486 3.0 Business Credit 200,365 12,685 213,050 3.4 Public Finance 121,956 47 122,003 1.9 Other 78,645 1,275 2,360 6,061 88,341 1.5 ----------- ---------- --------- -------- --------- --------- ------------ ------ Total Continuing Operations (4) $ 6,131,107 $ 17,260 $ 56,585 $ 76,883 $ 49,988 $ 16,256 $ 6,348,079 100.0 =========== ========== ========= ======== ========= ========= ============ ======
- -------------------- NOTES: (1) Represents original or renegotiated market rate terms, excluding impaired transactions. (2) The Company earned income totaling $4.2 million on repossessed assets during 1995, including $3.2 million in Specialty Real Estate Finance, $0.6 million in Resort Finance and $0.4 million in Communications Finance. (3) Transportation Finance included $144 million of aircraft financing business booked through the London office. (4) Excludes $200 million of securitized assets which are managed by the Company. -------------------- 7 INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1994 (Dollars in Thousands)
Revenue Accruing Nonaccruing ----------------------------------- ----------------------------- Repos- sessed Delin- Repos- Leases Total Original Rewritten Assets quent sessed & Carrying Rate Contracts (1) Loans Assets Other Amount % ----------------------------------- ----------------------------- -------------------- Transportation Finance (2) $ 706,242 $ 14,620 $ $ $ $ $ 720,862 13.5 Resort Finance 634,735 4,506 7,314 2,582 30,393 679,530 12.7 Corporate Finance 746,671 21,275 6,952 2,674 777,572 14.5 Specialty Real Estate Finance 672,522 7,237 40,510 7,622 21,519 749,410 14.0 Communications Finance 551,218 6,288 7,282 17,377 5,863 671 588,699 11.0 Commercial Equipment Finance 293,609 769 7,589 301,967 5.6 Rediscount Finance 99,353 99,353 1.9 Inventory Finance 58,595 642 59,237 1.1 Healthcare Finance 467,131 1,719 468,850 8.8 Franchise Finance 281,890 7,632 12,242 301,764 5.6 Factoring Services 157,090 772 157,862 3.0 Business Credit 181,741 12,003 193,744 3.6 Public Finance 93,491 144 93,635 1.8 FINOVA Capital Limited (3) 93,700 1,561 4,265 2 4,800 104,328 2.0 Other 36,951 8,918 297 46,166 0.9 ------------ --------- -------- -------- --------- -------- ----------- ------ Total Continuing Operations $ 5,074,939 $ 63,888 $ 55,106 $ 73,519 $ 60,451 $ 15,076 $ 5,342,979 100.0 ============ ========= ======== ======== ========= ======== =========== ======
- -------------------- NOTES: (1) The Company earned income totaling $3.3 million on repossessed assets during 1994, including $2.0 million in Specialty Real Estate Finance, $0.8 million in Communications Finance and $0.5 million in Resort Finance. (2) Transportation Finance included $66.9 million of aircraft finance business booked through the London office. (3) Includes transactions in Europe and elsewhere (including the U.S.) originated from the Company's London office. Also includes $39.2 million of Consumer Finance assets, of which $4.8 million were nonaccruing. Consumer Finance accounts were generally considered nonaccruing after being 180 days delinquent. -------------------- 8 INVESTMENT IN FINANCING TRANSACTIONS BY LINE OF BUSINESS DECEMBER 31, 1993 (Dollars in Thousands)
Revenue Accruing Nonaccruing ---------------------------------- ------------------------------- Repos- sessed Delin- Repos- Leases Total Original Rewritten Assets quent sessed & Carrying Rate Contracts (1) Loans Assets Other Amount % ---------------------------------- ------------------------------- ----------------------- Transportation Finance (2) $ 604,416 $ $ $ 841 $ $ $ 605,257 21.2 Resort Finance 530,617 4,869 12,163 11,597 7,404 440 567,090 19.9 Corporate Finance 397,779 27,921 4,243 5,462 386 435,791 15.3 Specialty Real Estate Finance 500,598 1,574 27,844 5,759 20,838 556,613 19.6 Communications Finance 487,890 7,989 8,949 21,730 11,564 538,122 18.9 Rediscount Finance 19,439 19,439 0.7 FINOVA Capital Limited (3) 107,486 4,430 2,720 23 9,600 124,259 4.4 ---------- ---------- -------- -------- -------- -------- ------------ ------- TOTAL $2,648,225 $ 46,783 $ 48,956 $ 46,890 $ 45,291 $ 10,426 $ 2,846,571 100.0 ========== ========== ======== ======== ======== ======== ============ =======
- -------------------- NOTES: (1) The Company earned income totaling $2.7 million on repossessed accruing assets during 1993, including $1.5 million in Specialty Real Estate Finance, $0.6 million in Communications Finance and $0.6 million in Resort Finance. (2) Transportation Finance included $31.9 million of aircraft finance business booked through the London office. (3) Includes transactions in Europe and elsewhere (including the U.S.) originated from the Company's London office. Also includes $45.3 million of Consumer Finance assets, of which $9.6 million were nonaccruing. Consumer Finance accounts were generally considered nonaccruing after being 180 days delinquent. -------------------- 9 The Company's geographic portfolio diversification at December 31, 1997 was as follows: GEOGRAPHIC PORTFOLIO DIVERSIFICATION December 31, 1997 (Dollars in thousands) State Total Percent -------------------------- ---------------- ---------- California $ 1,386,337 15.7% Florida 928,459 10.5 Texas 713,368 8.1 New York 617,428 7.0 Arizona 304,706 4.6 New Jersey 320,502 3.6 Illinois 308,994 3.5 Virginia 286,399 3.2 Pennsylvania 253,255 2.9 Nevada 245,830 2.8 Massachusetts 214,617 2.4 Georgia 174,778 2.0 Other (1) 3,102,750 33.7 ------------ -------- $ 8,857,423 100.0% ============ ======== - -------------------- NOTE: (1) Other includes all other states which, on an individual basis, represent less than 2% of the total and international, which represents approximately 6% of the total. -------------------- The following is an analysis of the reserve for credit losses for the years ended December 31: RESERVE FOR CREDIT LOSSES (Dollars in Thousands)
1997 1996 1995 1994 1993 ----------------------------------------------------------- Balance, beginning of year $ 148,693 $ 129,077 $ 110,903 $ 64,280 $ 69,291 Provision for credit losses 69,200 41,751 37,568 10,439 5,706 Write-offs (45,487) (32,017) (25,631) (28,109) (12,575) Recoveries 2,287 3,296 2,104 1,780 717 Other (including reserves related to acquisitions) 2,395 6,586 4,133 62,513 1,141 ---------- ---------- ---------- ---------- --------- Balance, end of year $ 177,088 $ 148,693 $ 129,077 $ 110,903 $ 64,280 ========== ========== ========== ========== =========
-------------------- Included above is a specific impairment reserve of $24.5 million at December 31, 1997, which applies to $158.0 million of impaired loans. The remaining $152.6 million of the reserve for credit losses is designated for general purposes and represents management's best estimate of potential losses in the portfolio considering delinquencies, loss experience and collateral. At December 31, 1996, the specific impairment reserve was $6.2 million, which applied to $110.1 million of impaired loans. Additions to general and specific reserves are reflected in current operations. Management may transfer reserves between the general and specific reserves as appropriate. 10 Write-offs by line of business during the years ended December 31, were as follows: WRITE-OFFS BY LINE OF BUSINESS (Dollars in Thousands)
1997 1996 1995 1994 1993 ----------------------------------------------------------- Factoring Services (1) $ 24,382 $ 5,098 $ 3,728 $ 1,148 $ Corporate Finance 6,577 9,470 4,660 4,233 3,741 Commercial Equipment Finance (1) 3,722 3,207 2,271 1,257 Resort Finance 2,700 4,275 2,000 2,730 Specialty Real Estate Finance 2,106 1,793 2,275 1,461 2,320 Healthcare Finance (1) 1,798 1,018 314 377 Inventory Finance (1) 1,777 201 442 Communications Finance 750 2,994 4,037 8,300 1,488 Franchise Finance (1) 696 3,267 3,448 2,247 FINOVA Capital Limited (UK) 47 895 1,523 5,140 5,026 Business Credit (1) 452 774 Other 932 722 --------- --------- --------- --------- --------- $ 45,487 $ 32,017 $ 25,631 $ 28,109 $ 12,575 ========= ========= ========= ========= ========= Write-offs as a percentage of average managed assets (2) 0.56% 0.46% 0.44% 0.66% 0.48% ========= ========= ========= ========= =========
- -------------------- NOTES: (1) Acquired in 1994. (2) Excludes participations sold in which FINOVA has transferred credit risk. -------------------- A further breakdown of the portfolio by line of business can be found in Annex A, Notes C and D. Cost and Use of Borrowed Funds FINOVA relies on borrowed funds as well as internal cash flow to finance its operations. It has also raised funds through the sale or securitization of assets, but does not rely on those methods as a primary source of capital. 11 The following table reflects the approximate average pre-tax effective cost of borrowed funds and pre-tax equivalent rate earned on accruing assets for FINOVA for each of the periods listed:
Year Ended December 31, ---------------------------------------------- 1997 1996 1995 1994 1993 ---------------------------------------------- Short-term and variable rate long-term debt (1) 6.4% 6.5% 7.2% 5.5% 4.7% Fixed-rate long-term debt (1) 7.1% 7.2% 7.3% 8.1% 11.4% Aggregate borrowed funds (1) 6.6% 6.8% 7.2% 6.3% 6.3% Rate earned on average earning assets (2) (3) 12.3% 11.8% 12.1% 11.3% 10.9% Spread percentage (4) 6.2% 5.8% 5.7% 5.9% 5.4%
- --------------------- NOTES: (1) Includes the effects of interest rate swap and hedge agreements. (2) Earning assets are net of average nonaccruing assets and average deferred taxes applicable to leveraged leases. (3) Earned amounts are net of depreciation and include gains on sale of assets. (4) Spread percentages represent interest margins earned as a percentage of average earning assets. -------------------- The effective costs presented above include costs of commitment fees and related borrowing costs. They do not necessarily predict future costs of funds. For further information on FINOVA `s cost of funds, refer to Annex A, Notes E and F. Following are the ratios of income to combined fixed charges and preferred stock dividends ("ratio") for each of the past five years: Year Ended December 31, -------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- 1.54 1.50 1.44 1.58 1.46 ========== ========== ========== ========== ========== Variations in interest rates generally do not have a substantial impact on the ratio because fixed-rate and floating-rate assets are generally matched with liabilities of similar rate and term. Income available for fixed charges, for purposes of the computation of the above ratio, consists of income from continuing operations before income taxes and fixed charges. Combined fixed charges include interest and related debt expense and a portion of rental expense representing interest and preferred stock dividends grossed up to a pre-tax basis. Matched Funding Policy FINOVA follows a "matched funding" policy. Under that policy, it funds its floating-rate assets (loans and leases to FINOVA's borrowers) with floating rate liabilities (FINOVA's debt) and fixed-rate assets with fixed rate liabilities, to the extent feasible. This policy helps protect FINOVA from changes in interest rates. For further discussion on FINOVA's debt and matched funding policy, see Annex A, Notes E and F. 12 Credit Ratings FINOVA currently has investment-grade credit ratings from the following rating agencies: Commercial Senior Paper Debt -------------- --------- Duff & Phelps Credit Rating Co. D1 A Fitch Investors Services, Inc. F1 A Moody's Investors Service, Inc. P2 Baa1 Standard & Poor's Ratings Group A2 A- There can be no assurance that these ratings will be maintained. The ratings can be modified at any time. A credit rating is not a recommendation to buy, sell or hold securities. Each rating should be evaluated independently of any other rating. None of FINOVA`s subsidiaries have applied for credit ratings. Residual Realization Experience Each year since its inception, FINOVA and its predecessors have earned total proceeds from the sale of assets upon lease terminations (other than foreclosures) in excess of carrying amounts. There can be no assurance, however, that those results can be achieved in future years. Actual proceeds will depend on current market values for those assets at the time of sale. While market values are generally beyond the control of FINOVA, the Company has some discretion in the timing of sales of the assets. Sales proceeds on lease terminations in excess of carrying amounts are reported as gains on sale of assets when the assets are sold. 13 Income from leasing transactions is affected by gains from asset sales on lease termination and, hence, can be somewhat less predictable than income from non-leasing activities. During the five years ended December 31, 1997, the proceeds to FINOVA from sales of assets on early termination of leases and at the expiration of leases have exceeded the carrying amounts and estimated residual values as follows: PROCEEDS FROM SALES OF LEASED ASSETS (Dollars in Thousands)
Early Terminations (1) Terminations at End of Lease Term - -------------------------------------------------------- -------------------------------------------- Proceeds Proceeds Estimated as a % of Carrying as a % of Residual Estimated Sales Amount Carrying Sales Value of Residual Year Proceeds of Assets Amount Proceeds Assets Value - -------------------------------------------------------- -------------------------------------------- 1997 $ 114,680 $ 96,656 119% $ 63,733 $ 58,127 110% 1996 87,311 75,910 115% 15,634 13,872 113% 1995 1,402 905 155% 44,395 37,053 120% 1994 6,477 5,865 110% 15,287 14,164 108% 1993 --- --- --- 486 248 196%
- -------------------- NOTE: (1) Excludes foreclosures for credit reasons, which are immaterial. -------------------- The estimated residual value of direct finance and leveraged lease assets in the accounts of FINOVA at December 31, 1997 was 31.2% of the original cost of those assets (27.1% excluding the original costs of the assets and residuals applicable to real estate leveraged leases, which typically have higher residuals than other leases). The financing contracts and leases outstanding at that date had initial terms ranging generally from one to 25 years. The average initial term weighted by carrying amount at inception and the average remaining term weighted by remaining carrying amount of financing contracts at December 31, 1997 for financing contracts excluding leveraged leases were 7.6 and 5.1 years, respectively, and for leveraged leases were approximately 17.5 and 11.9 years, respectively. The comparable average initial term and remaining term at December 31, 1996 for financing contracts excluding leveraged leases were 7.2 and 4.6 years, respectively, and for leveraged leases were approximately 18.6 and 11.9 years, respectively. FINOVA uses either employed or outside appraisers to determine the collateral value of assets to be leased or financed and the estimated residual or collateral value thereof at the expiration of each lease. Actual proceeds could differ from those appraised values. For a discussion of accounting for lease transactions, refer to Annex A, Notes A and C. Business Development and Competition FINOVA develops business primarily through direct solicitation by its own sales force. Customers are also introduced by independent brokers and referred by other financial institutions and other sources. FINOVA is engaged in an extremely competitive activity. It competes with banks, insurance companies, leasing companies, the credit units of equipment manufacturers and other finance companies. Some of these competitors have substantially greater financial resources and are able to borrow at costs below those of FINOVA. FINOVA's principal means of competition is through a combination of service, structure and innovation in transactions, the interest rate charged for money and concentration in focused market niches. The interest rate FINOVA charges for money is a function of its borrowing costs, its operating costs and other factors. While many of FINOVA's larger competitors are able to offer lower interest rates based upon their lower borrowing costs, FINOVA seeks to maintain the competitiveness of the interest rates it offers by emphasizing strict control of its operating costs. FINOVA's ability to manage costs is, in part, dependent on factors beyond the Company's control, such as the cost of funds, outside litigation expenses and competitive salaries. 14 Credit Quality FINOVA has maintained a high-quality asset base through the use of clearly defined underwriting standards, portfolio management techniques, monitoring of covenant compliance and active collections and workout efforts. Risk Management FINOVA generally investigates its prospective customers through a review of historical financial statements, published credit reports, credit references, discussions with management, analysis of location feasibility, personal visits and collateral appraisals and inspections. In many cases, depending upon the results of its credit investigations and the nature of the financing being provided, FINOVA obtains additional collateral or guarantees from others. As part of its underwriting process, FINOVA considers the management, industry, financial position and collateral being provided by a proposed borrower or lessee. The purpose, term, amortization and amount of any proposed transaction generally must be clearly defined and within established corporate guidelines. In addition, FINOVA attempts to avoid undue concentrations in any one customer, industry or geographic region. o Management. FINOVA considers the reputation, experience and depth of management; quality of product or service; adaptability to changing markets and demand; and prior banking, finance and trade relationships. o Industry. FINOVA evaluates critical aspects of each industry to which it lends, including general trend, seasonality and cyclicality; governmental regulation; the effects of taxes; the economic value of goods or services provided; and potential environmental or other liabilities. o Financial. FINOVA's review of a prospective borrower normally includes a thorough analysis of the borrower's financial performance. Items considered include net worth; composition of assets and liabilities; debt service coverage; liquidity; sales growth and earning power; and cash flow generation and reliability. o Collateral. FINOVA regards collateral as an important factor in a credit evaluation and, for collateral dependent transactions, has established maximum loan to value ratios, normally ranging from 60% - 90%, for each of its lines of business. The underwriting process includes, in addition to the analysis of the factors noted above, the design and implementation of transaction structures and strategies to mitigate identified risks; a review of transaction pricing relative to product-specific return requirements and acknowledged risk elements; a multi-step, interdepartmental review and approval process with varying levels of authority based on the size of the transaction; and periodic interdepartmental reviews and revision of underwriting guidelines. FINOVA also monitors portfolio concentrations in the areas of total exposure to a single borrower and related entities, within a given geographical area and with respect to an industry and/or product type within an industry. FINOVA has established concentration guidelines for each line of business. Geographic concentrations are reviewed periodically and evaluated based on historic loan experience and prevailing market and economic conditions. FINOVA's financing contracts and leases generally require the customer to pay taxes, license fees and insurance premiums and to perform maintenance and repairs at the customer's expense. Contract payment rates are based on several factors, including the cost of borrowed funds, term of contract, credit-worthiness of the prospective customer, type and nature of collateral and other security and, in leasing transactions, the timing of tax effects and estimated residual values. In direct finance lease transactions, lessees generally are granted an option to purchase the equipment at the end of the lease term at its then fair market value or, in some cases, are granted an option to renew the lease at its then fair rental value. The extent to which lessees exercise their options to purchase leased equipment varies from year to year, depending on, among other factors, the state of the economy, the financial condition of the lessee, interest rates and technological developments. Portfolio Management In addition to the review at the time of original underwriting, FINOVA attempts to preserve and enhance the earnings quality of its portfolio through proactive management of its financing relationships with its clients. This process includes the periodic appraisal or verification of the collateral to determine loan exposure and residual values; sales of residuals and warrants to generate supplemental income; and review and management of covenant compliance. The Portfolio Management department or dedicated personnel within the business units regularly review financial statements to assess customer cash flow performance and trends; periodically confirm operations of the customer; conduct periodic reappraisals of the underlying 15 collateral; seek to identify issues concerning the vulnerabilities of the customer; seek to resolve outstanding issues with the borrower; and prepare periodic summaries of the aggregate portfolio quality and concentrations for management review. Evaluation for loan impairment is performed as a part of the portfolio management review process. When a loan is determined to be impaired, a write-down is taken or an impairment reserve is established based on the difference between the recorded balance of the loan ("carrying amount") and the fair value of the asset. Delinquencies and Workouts FINOVA monitors the timing of payments on its accounts. For term loans and leases, when an invoice is 10 days past due, the customer is generally contacted, and a determination is made as to the extent of the problem, if any. A commitment for immediate payment is pursued and the account is observed closely. If satisfactory results are not obtained in communication with the customer, the guarantor(s) are contacted to advise them of the situation and the potential obligation under the guarantee agreement. If an invoice becomes 31 days past due, it is reported as delinquent. A notice of default is generally sent prior to an invoice becoming 45 days past due and, between 60 and 90 days past the due date, if satisfactory negotiations are not underway, outside counsel is generally retained to help protect FINOVA's rights and to pursue its remedies. When accounts become more than 90 days past due income recognition is usually suspended, and FINOVA vigorously pursues its legal remedies. Foreclosed or repossessed assets are considered to be nonperforming, and are reported as such unless the assets generate sufficient cash to result in a reasonable rate of return. Those accounts are continually reviewed, and write-downs are taken as deemed necessary. While pursuing collateral and obligors, FINOVA generally continues to negotiate the restructuring or other settlement of the debt, as appropriate. Management believes that collateral values significantly reduce loss exposure and that the reserve for credit losses is adequate. For additional information regarding the reserve for credit losses, see Annex A, Note D. Governmental Regulation FINOVA's domestic activities, including the financing of its operations, are subject to a variety of federal and state regulations such as those imposed by the Federal Trade Commission, the Securities and Exchange Commission, the Consumer Credit Protection Act, the Equal Credit Opportunity Act and the Interstate Land Sales Full Disclosure Act. Additionally, a majority of states have ceilings on interest rates chargeable to customers in financing transactions. Some of FINOVA's s financing transactions and mortgage broker activities are subject to additional government regulation. For example, aircraft leasing is regulated by the Federal Aviation Authority, and communications finance is regulated by the Federal Communication Commission. FINOVA's international activities are also subject to a variety of laws and regulations of the countries in which the business is conducted. EMPLOYEES At December 31, 1997, the Company had 923 employees compared to 864 at December 31, 1996. None of the employees were covered by collective bargaining agreements. FINOVA believes its employee relations are satisfactory. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements in this report are "forward-looking," in that they do not discuss historical fact but instead note future expectations, projections, intentions or other items relating to the future. These forward-looking statements include matters in the sections of this report captioned "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." They are also made in documents incorporated in this report by reference, or in which this report may be incorporated, such as a prospectus. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause FINOVA's actual results or performance to differ materially from those contemplated by the forward-looking statements. Many of those factors are noted in conjunction with the forward-looking statements in the text. Other important factors that could cause actual results to differ include: 16 o The results of FINOVA's efforts to implement its business strategy. Failure to fully implement its business strategy might result in decreased market penetration, adverse effects on results of operations and other adverse results. o The effect of economic conditions and the performance of FINOVA's borrowers. Economic conditions in general or in particular market segments could impact the ability of FINOVA's borrowers to operate or expand their businesses, which might result in decreased performance for repayment of their obligations or reduce demand for additional financing needs. o Actions of FINOVA's competitors and FINOVA's ability to respond to those actions. As noted in "Business Development and Competition," FINOVA seeks to remain competitive without sacrificing prudent lending standards. Doing business under those standards becomes more difficult, however, when competitors offer financing with less stringent criteria. FINOVA seeks to maintain credit quality at the risk of growth in assets, if necessary. o The cost of FINOVA's capital. That cost depends on many factors, some of which are beyond FINOVA's control, such as its portfolio quality, ratings, prospects and outlook. o Changes in government regulations, tax rates and similar matters. For example, government regulations could significantly increase the cost of doing business or could eliminate certain tax advantages of some of FINOVA's financing products. o Other risks detailed in FINOVA's other SEC reports or filings. ITEM 2. PROPERTIES. FINOVA's principal executive offices are located in premises leased from Viad Corp (formerly The Dial Corp) in Phoenix, Arizona. FINOVA operates various additional offices in the United States, one in Canada and one in Europe. All these properties are leased. Alternative office space could be obtained without difficulties in the event leases are not renewed. FINOVA has entered into a lease agreement for new executive offices which are presently under construction. Those facilities are expected to be completed in 1999. ITEM 3. LEGAL PROCEEDINGS. FINOVA is a party either as plaintiff or defendant to various actions, proceedings and pending claims, including legal actions, some of which involve claims for compensatory, punitive or other damages in significant amounts. Litigation often results from the FINOVA's attempts to enforce its lending agreements against borrowers and other parties to those transactions. Litigation is subject to many uncertainties, and it is possible that some of the legal actions, proceedings or claims could be decided against FINOVA. Although the ultimate amount for which FINOVA may be held liable, if any, is not ascertainable, FINOVA believes that any resulting liability would not materially affect its financial position or results of operations. 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Omitted OPTIONAL ITEM. EXECUTIVE OFFICERS OF REGISTRANT. Omitted PART II ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY & RELATED SHAREOWNER MATTERS. There is no market for the Company's common stock as the Company is wholly owned by FINOVA Group. The preferred stock was redeemed through a contribution from FINOVA Group in March 1994 and none has been outstanding since that time. Dividends paid on common stock for the first through fourth quarters of 1997 were $6,588,000, $6,506,000, $7,619,000 and $7,871,000, respectively. Dividends paid on the common stock for the first through fourth quarters of 1996 were $6,012,000, $6,020,000, $6,596,000 and $6,602,000, respectively. The agreements pertaining to senior debt and revolving credit agreements of FINOVA include various restrictive covenants and require the maintenance of certain defined financial ratios with which FINOVA has complied. Under one such covenant, dividend payments from FINOVA to FINOVA Group are limited to 50 percent of accumulated earnings after December 31, 1991. As of December 31, 1997, FINOVA had $126,400,000 of excess accumulated earnings available for distribution. ITEM 6. SELECTED FINANCIAL DATA. Omitted. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. See pages 1 - 6 of Annex A. ITEM 8. FINANCIAL STATEMENTS & SUPPLEMENTARY DATA. 1. Financial Statements - See Item 14 hereof and Annex A. 2. Supplementary Data - See Condensed Quarterly Results included in Supplemental Selected Financial Data of Notes to Consolidated Financial Statements included in Annex A. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING & FINANCIAL DISCLOSURE. NONE. PART III 18 ITEM 10. DIRECTORS & EXECUTIVE OFFICERS OF THE REGISTRANT. Omitted. ITEM 11. EXECUTIVE COMPENSATION. Omitted. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS & MANAGEMENT. Omitted. ITEM 13. CERTAIN RELATIONSHIPS & RELATED TRANSACTIONS. Omitted. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed. 1. Financial Statements. (i) The following financial statements of FINOVA are included in Annex A: Annex Page --------------- Management's Discussion and Analysis of Financial Condition and Results of Operations 1-6 Report of Management and Independent Auditors' Report 7-8 Consolidated Balance Sheet 9-10 Statement of Consolidated Income 11 Statement of Consolidated Shareowner's Equity 12 Statement of Consolidated Cash Flows 13 Notes to Consolidated Financial Statements 14-28 Supplemental Selected Financial Data 29-30 2. All Schedules have been omitted because they are not applicable or the required information is shown in the financial statements or related notes. 3. Exhibits. Exhibit No. ----------- (3.A) Certificate of Incorporation, as amended through the date of this filing (incorporated by reference from FINOVA's report on Form 10-K for the year ended December 31, 1994 (the "1994 10-K"), Exhibit 3.A). (3.B) Bylaws, as amended through the date of this filing (incorporated by reference from FINOVA's report on Form 10-K for the year ended December 31, 1995 (the "1995 10-K") Exhibit 3.B). (4.A) Form of FINOVA's Common Stock Certificate (incorporated by reference from the 1994 10-K, Exhibit 4.B). 19 Exhibit No. ----------- (4.B) Relevant portions of FINOVA's Certificate of Incorporation and Bylaws included in Exhibits 3.A and 3.B above are incorporated by reference. (4.C) Long-term debt instruments with principal amounts not exceeding 10% of FINOVA's total consolidated assets are not filed as exhibits to this report. FINOVA will furnish a copy of those agreements to the SEC upon its request. (4.D) Form of Indenture dated as of September 1, 1992 between FINOVA and the Trustee named therein (incorporated by reference from the Greyhound Financial Corporation Registration Statement on Form S-3, Registration No. 33-51216, Exhibit 4). (4.E) Form of Indenture dated as of October 1, 1995 between FINOVA and the Trustee named therein (incorporated by reference from FINOVA's report on Form 8-K dated October 25, 1995, Exhibit 4.1). (4.F) Form of Indenture between FINOVA, FINOVA Group and The First National Bank of Chicago as Trustee (incorporated by reference from FINOVA and FINOVA Group's registration statement on Form S-3, Registration No. 333-38171, Exhibit 4.8). 20 Exhibit No. ----------- (10.A) Sixth Amendment and Restatement dated as of May 16, 1994 of the Credit Agreement dated as of May 31, 1976 among FINOVA and the lender parties thereto, and Bank of America National Trust and Savings Association, Bank of Montreal, Chemical Bank, Citibank, N.A. and National Westminister Bank USA, as agents (the "Agents") and Citibank, N.A., as Administrative Agent (incorporated by reference from FINOVA's report on Form 8-K dated May 23, 1994, Exhibit 10.1). (10.A.1) First Amendment dated as of September 30, 1994, to the Sixth Amendment and Restatement, noted in 10.A above (incorporated by reference from the 1994 10-K, Exhibit 10.A.1). (10.A.2) Second Amendment dated as of May 11, 1995 to the Sixth Amendment and Restatement noted in 10.A above (incorporated by reference from FINOVA's Quarterly Report on Form 10-Q for the period ending September 30, 1995 ( the "3Q95 10-Q"), Exhibit 10.A). (10.A.3) Third Amendment dated as of November 1, 1995 to Sixth Amendment noted in 10.A above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.B). (10.A.4) Fourth Amendment dated as of May 15, 1996, to Sixth Amendment noted in 10.A above (incorporated by reference from the 1996 10-K, Exhibit 10.A.4). (10.A.5) Fifth Amendment dated as of May 20, 1997 to Sixth Amendment noted in 10.A above (incorporated by reference from FINOVA Group's Report on Form 10-K for the year ended December 31, 1997 (the "FINOVA Group 1997 10-K"), Exhibit 10.A.5). (10.B) Credit Agreement (Short-Term Facility) dated as of May 16, 1994 among FINOVA Capital, the Lender parties thereto, the Agents and Citibank, N.A., as Administrative Agent (incorporated by reference from FINOVA's report on Form 8-K dated May 23, 1994, Exhibit 10.2). (10.B.1) First Amendment dated as of September 30, 1994 to the Credit Agreement noted in 10.B above (incorporated by reference from the 1994 10-K, Exhibit 10.B.1). (10.B.2) Second Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.C). (10.B.3) Third Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.D). (10.B.4) Fourth Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from 1996 10-K, Exhibit B.4). (10.B.5) Fifth Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the FINOVA Group 1997 10-K, Exhibit 10.B.5). (10.C) Exhibits relating to management compensation are omitted due to the reduced disclosure format, but can be found as exhibits to the FINOVA Group 1997 10-K. 21 (10.D) Tax Sharing Agreement dated February 19, 1992 among FINOVA, The Dial Corp and others (incorporated by reference from the 1992 10-K, Exhibit 10.KK). (12) Computation of Ratio of Income to Combined Fixed Charges and Preferred Stock Dividends.* (23) Independent Auditors' Consent.* (24) Powers of Attorney.* (27) Financial Data Schedule.* *Filed with this report. +Relating to management compensation (b) Reports on Form 8-K A report on Form 8-K, dated January 20, 1998, was filed by FINOVA which reported under Item 5 and 7 the revenues, net income and selected financial data and ratios for the fourth quarter and year ended December 31, 1997 (unaudited). 22 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the capacities indicated, in Phoenix, Arizona on the 17th day of March, 1998. THE FINOVA GROUP INC. By: /s/ Samuel L. Eichenfield ----------------------------------------------------------- Samuel L. Eichenfield Chairman, President and Chief Executive Officer (Chief Executive Officer) By: /s/ Bruno A. Marszowski ----------------------------------------------------------- Bruno A. Marszowski Senior Vice President - Controller and Chief Financial Officer (Chief Accounting and Financial Officer) 23 Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: * /s/ Samuel L. Eichenfield - -------------------------------------- ------------------------------------ W. Carroll Bumpers (Director) Samuel L. Eichenfield (Chairman) March 17, 1998 March 17, 1998 * * - -------------------------------------- -------------------------------- Robert J. Fitzsimmons (Director) Gregory C. Smalis (Director) March 17, 1998 March 17, 1998 * Signed pursuant to Powers of Attorney dated February 17, 1998 or February 26, 1998 as appropriate. /s/ Bruno A. Marszowski ---------------------------------- Bruno A. Marszowski Attorney-in-Fact March 17, 1998 24 ANNEX A FINOVA CAPITAL CORPORATION INDEX TO FINANCIAL STATEMENTS
Page ---- Management's Discussion and Analysis of Financial Condition and Results of Operations..................1 Management's Report on Responsibility for Financial Reporting..........................................7 Independent Auditors' Report...........................................................................8 Consolidated Balance Sheet.............................................................................9 Statement of Consolidated Income......................................................................11 Statement of Consolidated Shareowner's Equity.........................................................12 Statement of Consolidated Cash Flows..................................................................13 Notes to Consolidated Financial Statements............................................................14 Supplemental Selected Financial Data..................................................................29
ii FINOVA CAPITAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion relates to FINOVA Capital Corporation and its subsidiaries (collectively, "FINOVA" or the "Company"). FINOVA is a wholly owned subsidiary of The FINOVA Group Inc.("FINOVA Group"). Results of Operations The following table summarizes FINOVA's operating results for the years ended December 31, 1997, 1996 and 1995:
- -------------------------------------------------------------------------------------------------------- For the Year Ended December 31, For the Year Ended December 31, ------------------------------- ------------------------------- Percent Percent (Dollars in millions) 1997 1996 Change 1996 1995 Change - -------------------------------------------------------------------------------------------------------- Interest margins earned $ 455.6 $ 369.1 23% $ 369.1 $ 309.1 19% Provision for credit losses (69.2) (41.8) 66% (41.8) (37.6) 11% Gains on sale of assets 30.3 12.9 134% 12.9 10.9 19% Selling, administrative and other operating expenses (190.5) (154.5) 23% (154.5) (131.6) 17% Income taxes (83.1) (69.3) 20% (69.3) (57.0) 22% Income from continuing 23% operations 143.1 116.5 116.5 93.8 24% Income and gain from discontinued operations -- 0.5 n/a 0.5 3.8 n/a -------- -------- -------- -------- Net Income $ 143.1 $ 117.0 22% $ 117.0 $ 97.6 20% ======== ======== ======== ======== - --------------------------------------------------------------------------------------------------------
1997 Compared to 1996 Net income for 1997 increased 22% to $143.1 million from $117.0 million in 1996. The increase reflected growth in managed assets, increased fee-related business, higher gains on sale of assets and a lower effective income tax rate, partially offset by higher provisions for credit losses and increased operating expenses. Income from continuing operations for 1997 increased to $143.1 million from $116.5 million in 1996. Continuing operations in 1996 excluded the operating results of FINOVA's discontinued Manufacturer & Dealer Services line of business ("MDS") and FINOVA Medical Systems and a $6 million gain resulting from the sale of MDS. See Note B of Notes to Consolidated Financial Statements for further discussion. Interest Margins Earned. Interest margins earned, which represent the difference between (a) interest, fee and other income earned from financing transactions and operating lease income and (b) interest expense and operating lease depreciation, increased 23% to $455.6 million in 1997 from $369.1 million in 1996 due primarily to a higher level of average earning assets and the expansion of the fee-based businesses. Average earning assets, which represent FINOVA's investment in financing transactions less nonaccruing assets and deferred taxes related to leveraged leases, increased 16% to $7.36 billion in 1997 from $6.32 billion a year earlier. This increase primarily resulted from a 21% increase in funded new business of $3.31 billion compared to $2.74 billion in 1996, and, to a lesser extent, from portfolios purchased during 1997 (totaling $122 million). These increases were partially offset by the normal amortization of the portfolio and prepayments during the year. The Company's interest margins earned as a percentage of average earning assets ("spread") also increased during 1997, to 6.2% from 5.8%. A portion of the increase in spread was due to a 54% growth in fee-based business (to $4.53 billion from $2.94 billion in 1996), which provides interest, fee and other income while requiring less investment in 1 FINOVA CAPITAL CORPORATION earning assets than term loans and leases. Contributing to the increase in fee-based business was FINOVA Realty Capital ("FRC," formerly Belgravia Capital Corporation), a commercial mortgage banking organization which was acquired in October 1997 (and which has historically had its highest volume in the fourth quarter). Excluding the impact of the FRC acquisition, FINOVA's spread improved to 6.1% in 1997. The increase in interest margins earned was also partially attributable to lower aggregate borrowing costs and lower debt leverage during 1997 compared to 1996. Provision for Credit Losses. The provision for credit losses increased 66% to $69.2 million in 1997 compared to $41.8 million in 1996. In addition to growth in FINOVA's managed assets, the increase in the provision for credit losses primarily resulted from an increase in write-offs to $45.5 million in 1997 from $32.0 million in 1996. The higher write-offs in 1997 were primarily attributable to FINOVA's Factoring Services line of business, due to credit problems experienced among the line of business' wholesale textile customers. Currently, Factoring Services is refocusing its portfolio toward retail businesses and new industries. Total write-offs for FINOVA's other lines of business were lower in 1997 than in 1996. FINOVA's total write-offs during 1997 represented 0.56% of average managed assets (excluding participations) compared to 0.46% in 1996. Details of write-offs and other changes in the reserve for credit losses can be found in Note D of Notes to Consolidated Financial Statements. Gains on Sale of Assets. Gains on sale of assets totaled $30.3 million in 1997, higher than the $12.9 million in 1996. In addition to the sale of assets coming off lease, FINOVA recognized a significant gain from the early termination of a real estate leveraged lease transaction in 1997. While FINOVA has consistently recognized gains on the sale of assets it holds, the gains are sporadic in their timing and amount. There can be no assurance FINOVA will recognize such gains in the future, depending, in part, on market conditions at the time of sale. Selling, Administrative and Other Operating Expenses. Selling, administrative and other operating expenses ("operating expenses") were higher in 1997 than in 1996, primarily as a result of increased costs necessary to manage FINOVA's larger portfolio. Also contributing to the increase in operating expenses were incentives paid to employees based on performance criteria such as new business, profitability and the increased value of FINOVA Group's stock (which increased by 54.7% to $49.69 per share at year-end). The Company also incurred additional costs in administering problem loan accounts in 1997, including an increase with respect to the Factoring Services line of business. As a percentage of interest margins earned, operating expenses declined slightly to 41.8% in 1997 from 41.9% in 1996. FINOVA's acquisition of FRC in the fourth quarter of 1997 is expected to increase operating expenses as a percentage of interest margins earned in future periods. See Note M of Notes to Consolidated Financial Statements for further detail of operating expenses. Income Taxes. Income taxes were higher in 1997 than in 1996 due to the increase in pre-tax income. Partially offsetting the increase was a lower effective tax rate in 1997 of 36.7% compared to 37.3% in 1996, principally caused by FINOVA's ability to use certain capital loss carryforwards in 1997. See Note I of Notes to Consolidated Financial Statements for further discussion of income taxes. 1996 Compared to 1995 Income from continuing operations for 1996 increased 24% to $116.5 million from $93.8 million in 1995. Continuing operations exclude the operating results and a $6 million gain, after taxes and allocation of related costs and expenses, resulting from the sale of FINOVA's Manufacturer & Dealer Services line of business, and the operating results of FINOVA Medical Systems, which was liquidated in 1996. Net income for 1996 increased to $117.0 million from $97.6 million in 1995. Interest Margins Earned. Interest margins earned were $369.1 million for 1996, compared with $309.1 million in 1995, an increase of 19%. The increase was primarily due to a 17% increase in managed assets (investment in financing transactions plus securitizations and participations sold), resulting primarily from $2.7 billion in funded new business in 1996, up from $2.3 billion in 1995, and $2.9 billion in fee-based volume in 1996, compared to $2.0 billion in 1995. In 2 FINOVA CAPITAL CORPORATION addition, FINOVA added funds employed of approximately $318 million through acquisitions in 1996. These increases were partially offset by the normal amortization of the portfolio as well as significantly higher prepayments in 1996, partially due to consolidation in the communications industry resulting from changes in regulation at the federal level. Interest margins earned as a percentage of average earning assets increased to 5.8% for 1996 compared to 5.7% for 1995. This increase was the result of FINOVA's ability to maintain rates and fees charged on its financing transactions while benefiting from reduced interest expense due to generally declining interest rates, improved credit ratings and the maturity of certain interest rate hedges. Provision for Credit Losses. The provision for credit losses increased to $41.8 million in 1996 from $37.6 million in 1995, primarily due to the increase in managed assets. FINOVA's reserves remained at 2.0% of ending managed assets (excluding participations), while the credit quality of the portfolio continued to improve. Reserves as a percentage of nonaccruing assets increased to 95.6% at December 31, 1996 from 90.2% a year earlier. Nonaccruing assets as a percentage of ending managed assets (excluding participations) declined to 2.0% at December 31, 1996 from 2.2% at the end of 1995. Details of write-offs and other changes in the reserve for credit losses can be found in Note D of Notes to Consolidated Financial Statements. Gains on Sale of Assets. Gains on sale of assets were higher in 1996 than 1995, primarily due to the amount and type of assets coming off lease during the respective years. While the Company has consistently recognized gains on the sale of assets it holds, the amount and timing of such gains is sporadic in nature. Selling, Administrative and Other Operating Expenses. Selling, administrative and other operating expenses were 17% higher in 1996 than in 1995, due primarily to the growth in managed assets and incentives related to FINOVA's improved results and stock performance. However, as a percentage of interest margins earned, these expenses decreased to 41.9% in 1996 from 42.6% during 1995. See Note M of Notes to Consolidated Financial Statements for additional detail. Income Taxes. Income taxes increased during the year ended December 31, 1996, primarily due to the increase in pre-tax income, partially offset by a lower effective tax rate. The lower tax rate, which decreased to 37.3% in 1996 from 37.8% in 1995, was primarily related to lower foreign tax effects and increased tax exempt municipal and ESOP income. See Note I of Notes to Consolidated Financial Statements for further discussion of income taxes. Financial Condition, Liquidity and Capital Resources Managed assets at December 31, 1997 increased 16% to $8.86 billion from $7.66 billion at December 31, 1996. The increase was the result of a 21% increase in funded new business of $3.31 billion in 1997 compared to $2.74 billion in 1996, partially offset by normal loan and lease amortization and approximately $0.7 billion in prepayments during 1997. In addition, an early termination of a leveraged lease occurred in the Specialty Real Estate line of business, which experienced a reduction in managed assets of approximately $103 million. The major causes of this reduction were the sale of this leveraged lease combined with the business decision not to aggressively pursue new deals at the cost of compromising rate and/or underwriting standards. FINOVA recorded $4.53 billion in fee-based volume during 1997 compared to $2.94 billion in 1996. The 54% increase in fee-based volume was due to growth in FINOVA's on-going fee-based lines of business and the addition of FRC in the fourth quarter of 1997. FINOVA's reserve for credit losses increased to $177.1 million at December 31, 1997 compared to $148.7 million at year-end 1996 primarily due to a provision for credit losses of $69.2 million during the year, partially offset by write-offs totaling $45.5 million. At December 31, 1997 the reserve represents 2.0% of managed assets (excluding participations sold), the same level as one year ago. Nonaccruing assets have increased to $187.4 million at December 31, 1997 which represents 2.1% of ending managed assets compared to $155.5 million in nonaccruing assets as of December 31, 1996 which constituted 2.0% of ending managed assets. At December 31, 1997, the reserve represents 94.5% of nonaccruing 3 FINOVA CAPITAL CORPORATION assets compared to 95.6% at December 31, 1996. The increase in nonaccruing assets is primarily in the Factoring Services line of business. See Note D of Notes to Consolidated Financial Statements for more information on the reserves, write-offs and nonaccruing assets. The Company had total debt outstanding of $6.76 billion at December 31, 1997 or 5.37 times its equity of $1.26 billion. At December 31, 1996, the Company had debt leverage of 5.47 ($5.85 billion debt outstanding and $1.07 billion of equity). The Company also had $277.6 million in deferred taxes at year-end 1997 compared to $264.4 million at year-end 1996. Growth in managed assets is generally financed by internally generated cash flow and borrowings. During 1997, FINOVA issued $1.1 billion in new senior debt and increased its commercial paper and other short-term borrowings by $650 million. These funds were used to finance new business, redeem or retire $818 million of debt and acquire a $122 million inventory finance portfolio. During 1997, FINOVA Group also issued approximately 1.7 million shares of its common stock as the primary consideration for the acquisition of FRC (see Note B of Notes to Consolidated Financial Statements for further detail). In December 1996, FINOVA Group issued $111.6 million (net of transaction costs) in company-obligated mandatory redeemable convertible preferred securities ("TOPrS") through FINOVA Finance Trust. The FRC assets and the proceeds from the issuance of the TOPrS were contributed by FINOVA Group to the Company. See Note G of Notes to Consolidated Financial Statements for additional discussion. FINOVA satisfies a significant portion of its cash requirements from a diversified group of worldwide funding sources and is not dependent on any one lender. FINOVA also relies on the issuance of commercial paper as a major funding source. During 1997, FINOVA issued $15.1 billion of commercial paper (with an average of $2.9 billion outstanding during the year) and raised $1.1 billion, as noted above, through new long-term financing of one to 10 year durations. At December 31, 1997 and 1996, commercial paper and short-term bank borrowings totaled $3.1 billion and $2.5 billion, respectively, and were supported by available unused revolving credit lines which, if not renewed, are convertible to long-term debt at FINOVA's option. FINOVA currently maintains a five-year revolving credit facility with numerous lenders in the aggregate principal amount of $1.0 billion. Separately, FINOVA also has a 364-day revolving credit facility with the same lenders in the aggregate principal amount of $1.0 billion, two five-year facilities with numerous lenders for $700 million each and one 364-day facility with one lender for $200 million. These $3.6 billion of credit facilities support FINOVA's outstanding commercial paper and short-term borrowings. FINOVA intends to borrow under the domestic revolving credit agreements to refinance commercial paper and short-term bank loans if it encounters significant difficulties in rolling over its outstanding commercial paper and short-term bank loans. FINOVA rarely borrows under these facilities. The 364 day $1.0 billion and $200 million revolving credit agreements will be subject to renewal in 1998, while the two $700 million and the other $1.0 billion credit facilities are subject to renewal in 2002. FINOVA, through one of its subsidiaries, maintains a five-year multi-currency facility with a group of lenders for $100 million. Through another subsidiary, FINOVA maintains two five-year revolving credit facilities with two separate lenders in Canada for $25 million Canadian each. FINOVA is the guarantor of these credit facilities, which are subject to renewal in 2002. FINOVA also maintains one $10 million Canadian 364-day revolving credit facility with a lender. That agreement will be subject to renewal in 1998. In 1997, FINOVA and FINOVA Group jointly filed a universal shelf registration statement with the SEC allowing for the issuance of $2 billion of senior debt securities, common stock, preferred stock, depositary shares and warrants to purchase common stock or debt securities, all of which remained available as of December 31, 1997. The agreements pertaining to long-term debt include various restrictive covenants and require the maintenance of certain defined financial ratios with which FINOVA and FINOVA Group have complied. Under one such covenant, dividend payments by FINOVA to FINOVA Group are limited to 50 percent of accumulated earnings after December 31, 1991. 4 FINOVA CAPITAL CORPORATION FINOVA's aggregate cost of funds decreased to 6.6% for 1997 from 6.8% for 1996 as a result of declining interest rates, higher credit ratings and the elimination of costs associated with $250 million of maturing interest rate hedges. FINOVA's cost of and access to capital is dependent, in large part, on its credit ratings. FINOVA has maintained investment-grade ratings since 1976. FINOVA currently has investment-grade ratings from the following agencies: Commercial Senior Paper Debt ------------- --------- Duff & Phelps Credit Rating Co. D1 A Fitch Investors Services, Inc. F1 A Moody's Investors Service, Inc. P2 Baa1 Standard & Poor's Ratings Group A2 A- None of FINOVA's subsidiaries have applied for credit ratings. Derivative Financial Instruments FINOVA enters into interest rate and basis swap agreements as part of its interest rate risk management policy of match funding its assets and liabilities. The derivative instruments used are straightforward. FINOVA continually monitors its derivative position and uses derivative instruments for non-trading and non-speculative purposes only. At December 31, 1997, FINOVA had outstanding interest rate conversion agreements with notional principal amounts totaling $2.6 billion. Agreements with notional principal amounts of $550 million were arranged to effectively convert certain floating interest rate obligations into fixed interest rate obligations. These agreements require interest payments on the stated principal amount at rates ranging from 6.21% to 9.10% (remaining terms of one to four years) in return for receipts calculated on the same notional amounts at floating interest rates. In addition, agreements with notional principal amounts of $1.4 billion were arranged to effectively convert certain fixed interest rate obligations into floating interest rate obligations. They require interest payments on the stated principal amount at the three month or six month London interbank offered rates ("LIBOR") (remaining terms of one to nine years) in return for receipts calculated on the same notional amounts at fixed interest rates of 5.51% to 7.71%. FINOVA has also entered into basis swap agreements with notional principal amounts of $628 million and remaining terms of one year. See Note F of Notes to Consolidated Financial Statements for further discussion of FINOVA's derivatives. Year 2000 Date Conversion FINOVA continues to implement changes necessary to assure accurate date recognition and data processing with respect to the year 2000. Primary internal activities related to this issue are modifications to existing computer programs and conversions to new programs. The Company is also communicating with software vendors, financial institutions, clients and others with whom it conducts business to determine the nature of any impact on FINOVA. If needed modifications and conversions are not accomplished in a timely manner, this issue could have a material effect on the operations of FINOVA. As of this time, however, management believes that necessary corrections will be achieved on time. Costs related to this issue, which have been immaterial to date, are being expensed as incurred and are not expected to have a material impact on FINOVA's financial position. Recent Developments and Business Outlook FINOVA continues to seek new business by emphasizing customer service, providing competitive interest rates and focusing on selected market niches. Additionally, FINOVA continues to evaluate potential acquisition opportunities that it believes are consistent with its business strategies. In October 1997, FINOVA acquired Belgravia Capital Corporation, a commercial mortgage banking organization headquartered in Irvine, California. Consideration for the acquisition included approximately 1.7 million shares of FINOVA Group's 5 FINOVA CAPITAL CORPORATION common stock, $10 million in cash and the agreement to pay additional amounts up to approximately $30 million per year for the next three years, based on future results of the operations. Historically, Belgravia originated mid-size commercial mortgage loans which were funded by third parties who typically sold or securitized the loans. In October 1997, FINOVA also announced the reorganization of its businesses into three operating groups. The Commercial Finance Group comprises FINOVA's asset-based lending businesses such as Business Credit, Corporate Finance, Factoring Services, Inventory Finance and Rediscount Finance. The Specialty Finance Group contains FINOVA's Commercial Equipment Finance, Specialty Real Estate Finance, Communications Finance, Franchise Finance, Healthcare Finance, Portfolio Services, Public Finance, Resort Finance and Transportation Finance businesses. The new Capital Markets Group consists of FINOVA Realty Capital and the bridge financing, mezzanine debt and equity funds formed under the FINOVA Investment Alliance program. In February 1998, FINOVA announced the formation of a $125 million investment alliance with Credit Suisse First Boston PTG known as FINOVA Aircraft Investors, LLC. The alliance will use FINOVA's market expertise and industry presence to purchase, upgrade and resell used commercial aircraft. New Accounting Standards In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income," which is effective for fiscal years beginning after December 15, 1997. The statement changes the reporting of certain items currently reported in the shareowner's equity section of the balance sheet and establishes standards for reporting of comprehensive income and its components in a full set of general purpose financial statements. Adoption of this standard will require additional disclosure only. FINOVA will adopt this standard effective January 1, 1998, as required. In June 1997, the FASB also issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which is effective for fiscal years beginning after December 15, 1997. This standard requires certain information regarding segments of a business enterprise to be reported based on the way management organizes and evaluates segments within the company. The standard also requires disclosures regarding products and services, geographical areas and major customers. Adoption of this standard will require FINOVA to include additional detail in its disclosures, including certain disaggregated operating information. FINOVA will adopt this standard in 1998, as required, but is not currently planning to elect early adoption for interim financial periods during the year. At this time, management anticipates that FINOVA's reported segments will be composed of its three operating groups: Specialty Finance, Commercial Finance and Capital Markets. 6 FINOVA CAPITAL CORPORATION MANAGEMENT'S REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING The management of FINOVA Capital Corporation is responsible for the preparation, integrity and objectivity of the financial statements and other financial information included in this Annual Report. The financial statements are presented in accordance with generally accepted accounting principles reflecting, where applicable, management's best estimates and judgments. FINOVA's management has established and maintains a system of internal controls to reasonably assure the fair presentation of the financial statements, the safeguarding of FINOVA's assets and the prevention or detection of fraudulent financial reporting. The internal control structure is supported by careful selection and training of personnel, policies and procedures and regular review by both internal auditors and the independent auditors. The Board of Directors of FINOVA Group, through its Audit Committee, also oversees the financial reporting of FINOVA and its adherence to established procedures and controls. Periodically, the Audit Committee meets, jointly and separately, with management, the internal auditors and the independent auditors to review auditing, accounting and financial reporting matters. FINOVA's financial statements have been audited by Deloitte & Touche LLP, independent auditors. Management has made available to Deloitte & Touche LLP all of FINOVA's financial records and related data and has made valid and complete written and oral representations and disclosures in connection with the audit. Management believes it is essential to conduct its business in accordance with the highest ethical standards, which are characterized and set forth in FINOVA's written Code of Conduct. These standards are communicated to and acknowledged by all of FINOVA's employees. /s/ Samuel L. Eichenfield Samuel L. Eichenfield Chairman, President and Chief Executive Officer /s/ Bruno A. Marszowski Bruno A. Marszowski Senior Vice President - Controller and Chief Financial Officer /s/ Derek C. Bruns Derek C. Bruns Senior Vice President - Internal Audit 7 FINOVA CAPITAL CORPORATION INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareowner of FINOVA Capital Corporation We have audited the accompanying consolidated balance sheet of FINOVA Capital Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareowner's equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of FINOVA's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of FINOVA Capital Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP Deloitte & Touche LLP Phoenix, Arizona February 11, 1998 8 FINOVA CAPITAL CORPORATION CONSOLIDATED BALANCE SHEET (Dollars in Thousands)
ASSETS - -------------------------------------------------------------------------------------------------------- December 31, 1997 1996 - -------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 33,193 $ 31,285 Investment in financing transactions: Loans and other financing contracts 5,955,984 5,305,678 Factored receivables 750,399 564,430 Operating leases 712,927 517,690 Leveraged leases 619,557 514,573 Direct financing leases 360,589 396,388 - -------------------------------------------------------------------------------------------------------- 8,399,456 7,298,759 Less reserve for credit losses (177,088) (148,693) - -------------------------------------------------------------------------------------------------------- Investment in financing transactions - net 8,222,368 7,150,066 Goodwill and other assets 502,362 370,575 - -------------------------------------------------------------------------------------------------------- $ 8,757,923 $ 7,551,926 ========================================================================================================
See notes to consolidated financial statements. 9 FINOVA CAPITAL CORPORATION
LIABILITIES AND SHAREOWNER'S EQUITY - -------------------------------------------------------------------------------------------------------- December 31, 1997 1996 - -------------------------------------------------------------------------------------------------------- Liabilities: Accounts payable and accrued expenses $ 124,491 $ 97,080 Due to clients 278,571 218,494 Interest payable 52,643 52,677 Senior debt 6,764,581 5,850,223 Deferred income taxes 277,569 264,409 - -------------------------------------------------------------------------------------------------------- 7,497,855 6,482,883 - -------------------------------------------------------------------------------------------------------- Shareowner's equity: Common stock $1.00 par value, 100,000 shares authorized, 25,000 shares issued 25 25 Additional capital 870,485 792,948 Retained income 389,568 275,062 Cumulative translation adjustments (10) 1,008 - -------------------------------------------------------------------------------------------------------- 1,260,068 1,069,043 - -------------------------------------------------------------------------------------------------------- $ 8,757,923 $ 7,551,926 ========================================================================================================
See notes to consolidated financial statements. 10 FINOVA CAPITAL CORPORATION STATEMENT OF CONSOLIDATED INCOME (Dollars in Thousands)
- -------------------------------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Interest, fees and other income $ 750,755 $ 640,132 $ 568,115 Financing lease income 77,049 61,985 49,310 Operating lease income 116,920 95,817 84,691 - -------------------------------------------------------------------------------------------------------- Income earned from financing transactions 944,724 797,934 702,116 Interest expense 416,093 366,543 337,814 Operating lease depreciation 72,989 62,286 55,218 - -------------------------------------------------------------------------------------------------------- Interest margins earned 455,642 369,105 309,084 Provision for credit losses 69,200 41,751 37,568 - -------------------------------------------------------------------------------------------------------- Net interest margins earned 386,442 327,354 271,516 Gains on sale of assets 30,261 12,949 10,889 - -------------------------------------------------------------------------------------------------------- 416,703 340,303 282,405 Selling, administrative and other operating expenses 190,525 154,481 131,571 - -------------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes 226,178 185,822 150,834 Income taxes 83,088 69,329 57,036 - -------------------------------------------------------------------------------------------------------- Income from continuing operations 143,090 116,493 93,798 Income and gain from sale of discontinued operations, net of tax 507 3,831 - -------------------------------------------------------------------------------------------------------- NET INCOME $ 143,090 $ 117,000 $ 97,629 ========================================================================================================
See notes to consolidated financial statements. 11 FINOVA CAPITAL CORPORATION STATEMENT OF CONSOLIDATED SHAREOWNER'S EQUITY (Dollars in Thousands)
- -------------------------------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- COMMON STOCK: Balance $ 25 $ 25 $ 25 - -------------------------------------------------------------------------------------------------------- ADDITIONAL CAPITAL: Balance, beginning of year 792,948 677,948 677,947 Contributions from The FINOVA Group, Inc. 77,537 115,000 1 - -------------------------------------------------------------------------------------------------------- Balance, end of year 870,485 792,948 677,948 - -------------------------------------------------------------------------------------------------------- RETAINED INCOME: Balance, beginning of period 275,062 183,292 108,740 Net income 143,090 117,000 97,629 Dividends (28,584) (25,230) (23,077) - -------------------------------------------------------------------------------------------------------- Balance, end of period 389,568 275,062 183,292 - -------------------------------------------------------------------------------------------------------- CUMULATIVE TRANSLATION ADJUSTMENTS: Balance, beginning of period 1,008 (5,686) (4,726) Unrealized translation (loss) gain (1,018) 6,694 (960) - -------------------------------------------------------------------------------------------------------- Balance, end of year (10) 1,008 (5,686) - -------------------------------------------------------------------------------------------------------- SHAREOWNER'S EQUITY $ 1,260,068 $ 1,069,043 $ 855,579 ========================================================================================================
See notes to consolidated financial statements. 12 FINOVA CAPITAL CORPORATION STATEMENT OF CONSOLIDATED CASH FLOWS (Dollars in Thousands)
- ------------------------------------------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 143,090 $ 117,000 $ 97,629 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 69,200 41,751 37,568 Depreciation and amortization 90,396 76,471 70,017 Gains on sale of assets (30,261) (12,949) (10,889) Gains on dispositions of discontinued operations, net (3,521) Deferred income taxes 13,160 31,272 17,617 Change in assets and liabilities, net of effects from subsidiaries purchased: Increase in other assets (81,611) (64,280) (55,204) Increase (decrease) in accounts payable and accrued expenses 20,922 (17,563) (11,583) (Decrease) increase in interest payable (34) 5,853 7,843 Other 954 7,971 361 - ------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 225,816 182,005 153,359 - ------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Proceeds from sales of assets 178,413 102,945 50,028 Proceeds from sales of securitized assets 36,565 100,000 200,000 Principal collections on financing transactions 2,087,619 1,781,985 1,088,420 Expenditures for financing transactions (2,507,822) (2,221,363) (1,853,330) Net change in short-term financing transactions (844,584) (624,952) (442,405) Acquisitions, net of cash acquired (120,883) (7,455) (261,868) Sale of discontinued operation 616,434 Other 2,399 3,296 2,104 - ------------------------------------------------------------------------------------------------------------------- Net cash used for investing activities (1,168,293) (249,110) (1,217,051) - ------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Net borrowings under commercial paper and short-term loans 649,653 62,156 373,566 Long-term borrowings 1,080,625 564,988 1,272,450 Repayment of long-term borrowings (817,892) (681,401) (570,002) Net advances and contributions from parent 20,088 119,691 (16,578) Dividends (28,584) (25,230) (23,077) Net change in due to clients 40,495 (32,143) 64,909 - ------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 944,385 8,061 1,101,268 - ------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents 1,908 (59,044) 37,576 Cash and cash equivalents, beginning of year 31,285 90,329 52,753 - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 33,193 $ 31,285 $ 90,329 ===================================================================================================================
See notes to consolidated financial statements. 13 FINOVA CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 and 1995 (Dollars in Thousands in Tables) NOTE A SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation -- The consolidated financial statements present the financial position, results of operations and cash flows of FINOVA Capital Corporation and its subsidiaries (collectively, "FINOVA" or the "Company"). FINOVA is a wholly owned subsidiary of The FINOVA Group Inc. ("FINOVA Group"). FINOVA Capital Corporation is a financial services company engaged in providing capital and collateralized financing products to commercial enterprises focusing on mid-size businesses in various market niches, principally in the United States. These consolidated financial statements are prepared in accordance with generally accepted accounting principles. Described below are those accounting policies particularly significant to FINOVA, including those selected from acceptable alternatives: Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition -- For loans and other financing contracts, earned income is recognized over the life of the contract, using the interest method. For operating leases, earned income is recognized on a straight-line basis over the lease term and depreciation is taken on a straight-line basis over the estimated useful lives of the leased assets. Leases that are financed by nonrecourse borrowings and meet certain other criteria are classified as leveraged leases. For leveraged leases, aggregate rentals receivable are reduced by the related nonrecourse debt service obligation including interest ("net rentals receivable"). The difference between (a) the net rentals receivable and (b) the cost of the asset less estimated residual value at the end of the lease term is recorded as unearned income. Earned income is recognized over the life of the lease at a constant rate of return on the positive net investment, which includes the effects of deferred income taxes. For leases classified as direct financing leases, the difference between (a) aggregate lease rentals and (b) the cost of the related assets less estimated residual value at the end of the lease term is recorded as unearned income. Earned income is recognized over the life of the contracts using the interest method. Fees received in connection with loan commitments are deferred in accounts payable and accrued expenses until the loan is advanced and are then recognized over the term of the loan as an adjustment of the yield. Fees on commitments that expire unused are recognized at expiration. Income recognition is generally suspended for leases, loans and other financing contracts at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed or when foreclosed or repossessed assets generate a reasonable rate of return. Cash Equivalents -- FINOVA classifies highly liquid investments with original maturities of three months or less from date of purchase as cash equivalents. Marketable Securities -- As discussed in Note J, FINOVA owns certain marketable securities which are considered trading securities. Trading securities are stated at fair value with gains or losses recorded in income in the period they occur. 14 FINOVA CAPITAL CORPORATION Reserve for Credit Losses -- The reserve for credit losses is available to absorb credit losses. The provision for credit losses is the charge to income to increase the reserve for credit losses to the level that management estimates to be adequate considering delinquencies, loss experience and collateral. Other factors considered include changes in geographic and product diversification, size of the portfolio and current economic conditions. Accounts are either written-off or written-down when the loss is considered probable and determinable, after giving consideration to the customer's financial condition and the value of the underlying collateral, including any guarantees. Any deficiency between the carrying amount of an asset and the net sales price of repossessed collateral is charged to the reserve for credit losses. Recoveries of amounts previously written-off as uncollectible are credited to the reserve for credit losses. Repossessed Assets -- Repossessed assets are carried at the lower of cost or fair value less estimated selling expenses. Residual Values -- FINOVA has a significant investment in residual values in its leasing portfolios. These residual values represent estimates of the value of leased assets at the end of the contract terms and are initially recorded based upon appraisals and estimates. Actual residual values realized could differ from these estimates. Residual values are periodically reviewed to determine that recorded amounts are appropriate. Goodwill -- FINOVA amortizes the excess of cost over the fair value of net assets acquired ("goodwill") on a straight-line basis primarily over 20 to 25 years. Goodwill at December 31, 1997 and 1996 was $288.2 million and $179.5 million (net of amortization), respectively. Amortization totaled $10.1 million ($6.3 million after-tax), $9.6 million ($5.7 million after-tax) and $8.2 million ($4.9 million after-tax) for the years ended December 31, 1997, 1996 and 1995, respectively. FINOVA periodically evaluates the carrying value of its intangible assets for impairment. This evaluation is based principally on projected, undiscounted cash flows generated by the underlying assets. At December 31, 1997, approximately $272.0 million of goodwill was deductible for federal income tax purposes over 15 years under Section 197 of the Internal Revenue Code. Pension and Other Benefits -- Trusteed, noncontributory pension plans cover substantially all employees. Benefits are based primarily on final average salary and years of service. Funding policies provide that payments to pension trusts shall be at least equal to the minimum funding required by applicable regulations. Other postretirement benefit costs are recorded during the period the employees provide service to FINOVA. FINOVA funds its postretirement benefit obligation as benefits are paid. FINOVA records postemployment benefit costs at the time employees leave active service. Postemployment benefits are any benefits other than retirement benefits. Savings Plan -- FINOVA participates in The FINOVA Group Inc. Savings Plan (the "Savings Plan"), a qualified 401(k) program. The Savings Plan is available to substantially all employees. Voluntary wage reductions may be elected by the employee ranging from 0% to 15% of taxable compensation. The Company's matching contributions are based on employee pre-tax salary reductions, up to a maximum of 100% of the first 6% of salary contributions, the first 3% of which are matched in FINOVA Group stock through the Employee Stock Ownership Plan, discussed below. Employee Stock Ownership Plan -- Employees of FINOVA are eligible to participate in FINOVA Group's Employee Stock Ownership Plan in the month following the first 12 consecutive month period during which they have at least 1,000 hours of service with FINOVA. Company contributions are made in the form of matching stock contributions of 100% of the first 3% of salary reduction contributions made by participants of the Savings Plan. 15 FINOVA CAPITAL CORPORATION Expenses under the Savings Plan and Employee Stock Ownership Plan were $2.5 million, $2.1 million and $1.7 million in 1997, 1996 and 1995, respectively. Income Taxes -- Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax law. Derivative Financial Instruments -- As more fully described in Note F, FINOVA uses derivative financial instruments as part of its interest rate risk management policy of match funding its assets and liabilities. The derivative instruments used include interest rate swaps which are accounted for using settlement or matched swap accounting. Each derivative used as a hedge is matched with an asset or liability with which it has a high correlation. The swap agreements are generally held to maturity and FINOVA does not use derivative financial instruments for trading or speculative purposes. Upon early termination of the designated matched asset or liability, the related derivative is matched to another appropriate item or marked to fair market value. Securitizations -- Effective January 1, 1997, FINOVA adopted the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" which requires receivable transfers occurring after December 31, 1996 to be accounted for as sales when legal and effective control over the transferred receivables is surrendered. Reclassifications -- Certain reclassifications have been made to the 1996 and 1995 financial statements to conform to the 1997 presentation. NOTE B ACQUISITIONS AND DISPOSITIONS During 1997 and 1996, FINOVA, in transactions accounted for as purchases, acquired various businesses and portfolios having initial funds employed totaling $122 million and $318 million, respectively. In October 1997, FINOVA Group also purchased Belgravia Capital Corporation, a commercial mortgage banking organization, for $77.5 million of FINOVA Group's common stock (1.7 million shares), $10.0 million in cash and an agreement to pay additional amounts up to approximately $30 million per year for the next three years, contingent upon future results of the operations. The acquisition was comprised of $91.5 million in assets, including $88.0 million in goodwill and $4.0 million in liabilities and acquisition costs. The results of these operations have been included in FINOVA's results since the date of acquisition. Goodwill related to this transaction is being amortized over 25 years. In 1996, the company sold its Manufacturer & Dealer Services operations for $616.4 million, recognizing a gain on sale, net of taxes, of $6.0 million after allocation of related costs and expenses. In connection with the sale, the Company retained a portfolio of leases relating to one vendor program. Also in 1996, the Company closed FINOVA Medical Systems, a remanufacturer of medical equipment, recognizing a loss on disposal of approximately $2.5 million, net of tax. Income (losses) from these operations, net of tax, for the two years ended December 31, 1996 and 1995 were ($3.0 million) and $3.8 million, respectively. Assumptions used to calculate these results were similar to those used by FINOVA to evaluate its other lines of business and included the allocation of interest expense based on certain leverage ratios and the allocation of indirect operating expenses. Results for 1995 have been restated to classify these operations as discontinued. 16 FINOVA CAPITAL CORPORATION NOTE C INVESTMENT IN FINANCING TRANSACTIONS FINOVA provides secured financing to commercial and real estate enterprises principally under financing contracts (such as loans and other financing contracts, direct financing leases, operating leases, leveraged leases and factored receivables). At December 31, 1997 and 1996, the carrying amount of the investment in financing transactions, including the estimated residual value of leased assets upon lease termination, was $8.4 billion and $7.3 billion (before reserve for credit losses), respectively, and consisted of the following percentage of carrying amount by line of business: - -------------------------------------------------------------------------------- Percent of Total Carrying Amount - -------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------- Transportation Finance 19.4% 18.2% Resort Finance 14.4 16.0 Corporate Finance 9.8 8.9 Specialty Real Estate Finance 8.2 10.9 Communications Finance 7.9 7.7 Commercial Equipment Finance 7.5 8.0 Rediscount Finance 7.3 5.8 Inventory Finance 6.5 4.3 Healthcare Finance 6.3 6.9 Franchise Finance 5.2 5.0 Factoring Services 2.7 3.1 Business Credit 2.4 2.3 Public Finance 1.6 2.1 Other 0.8 0.8 - -------------------------------------------------------------------------------- 100.0% 100.0% ================================================================================ 17 FINOVA CAPITAL CORPORATION Aggregate installments on loans and other financing contracts, direct financing leases, operating leases, leveraged leases and factored receivables at December 31, 1997 (excluding repossessed assets of $37.1 million and estimated residual values) are contractually due during each of the years ending December 31, 1998 to 2002 and thereafter as follows:
- -------------------------------------------------------------------------------------------------------- There- 1998 1999 2000 2001 2002 after - -------------------------------------------------------------------------------------------------------- Loans and other financing contracts: Commercial: Fixed interest rate 332,773 $ 376,445 $ 270,568 $ 306,517 $ 150,631 $ 405,615 Floating interest rate 640,324 538,160 545,215 417,486 220,807 95,437 Real estate: Fixed interest rate 90,091 93,535 40,530 50,152 31,311 130,954 Floating interest rate 447,377 349,907 132,069 144,931 37,301 70,755 Factored receivables 750,399 Leases, primarily at fixed interest rates: Operating leases 127,053 143,946 103,196 71,510 39,513 112,453 Leveraged leases 31,582 25,456 15,859 13,010 8,073 402,266 Direct financing leases 100,174 74,040 48,073 33,378 23,401 88,714 - -------------------------------------------------------------------------------------------------------- 2,519,773 $ 1,601,489 $ 1,155,510 $1,036,984 $ 511,037 $ 1,306,194 ========================================================================================================
The investment in operating leases at December 31 consisted of the following:
- -------------------------------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------------------------------- Cost of assets $ 855,670 $ 646,918 Accumulated depreciation (142,743) (129,228) - -------------------------------------------------------------------------------------------------------- Investment in operating leases $ 712,927 $ 517,690 ========================================================================================================
The net investment in leveraged leases at December 31 consisted of the following:
- -------------------------------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------------------------------- Rentals receivable $ 2,287,233 $ 1,898,996 Less principal and interest payable on nonrecourse debt (1,790,987) (1,486,249) - -------------------------------------------------------------------------------------------------------- Net rentals receivable 496,246 412,747 Estimated residual values 575,234 479,850 Less unearned income (451,923) (378,024) - -------------------------------------------------------------------------------------------------------- Investment in leveraged leases 619,557 514,573 Less deferred taxes arising from leveraged leases (249,710) (246,075) - -------------------------------------------------------------------------------------------------------- Net investment in leveraged leases $ 369,847 $ 268,498 ========================================================================================================
18 FINOVA CAPITAL CORPORATION The components of income from leveraged leases, after the effects of interest on nonrecourse debt and other related expenses, for the years ended December 31 were as follows:
- -------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Lease and other income, net $ 41,605 $ 30,230 $ 12,080 Income tax expense 19,476 11,321 4,201 - --------------------------------------------------------------------------------------------------------
The investment in direct financing leases at December 31 consisted of the following:
- -------------------------------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------------------------------- Rentals receivable $ 367,780 $ 398,928 Estimated residual values 120,020 100,039 Unearned income (127,211) (102,579) - -------------------------------------------------------------------------------------------------------- Investment in direct financing leases $ 360,589 $ 396,388 ========================================================================================================
FINOVA has a substantial number of loans and leases with payments that fluctuate with changes in index rates, primarily prime interest rates and the London interbank offered rates ("LIBOR"). The investment in loans and leases with floating interest rates (excluding nonaccruing contracts and repossessed assets) was $4.34 billion and $3.70 billion at December 31, 1997 and 1996, respectively. Interest earned from financing transactions with floating interest rates was approximately $491 million in 1997, $436 million in 1996 and $402 million in 1995. The adjustments which arise from changes in index rates can have a significant effect on interest earned from financing transactions; however, the effects on interest margins earned and net income are substantially offset by related interest expense changes on debt obligations with floating interest rates. FINOVA's matched funding policy is more fully described in Note F. At December 31, 1997, FINOVA had a committed backlog of new business of approximately $1.6 billion compared to $1.5 billion at December 31, 1996. The committed backlog includes lines of credit totaling $666 million and $702 million at December 31, 1997 and 1996, respectively. Historically, FINOVA has booked a substantial portion of its backlog, although there can be no assurance that the trend will continue. Loan commitments and lines of credit have generally the same credit risk as extending loans to borrowers. These commitments are generally subject to the same credit quality and collateral requirements involved in lending transactions. Commitments generally have a fixed expiration and usually require payment of a fee. Securitizations - On a limited basis, FINOVA sells receivables in transactions subject to limited recourse provisions and remains a servicer for which it is paid a fee. Normal servicing fees are earned on a level yield basis over the remaining terms of the related receivables sold. In 1996 and 1995, FINOVA, under a securitization agreement, sold a total of $300 million in undivided proportionate interests in a revolving loan portfolio totaling approximately $736.2 million as of December 31, 1997. Under this agreement, there is recourse to FINOVA based on the outstanding balance of the proportionate interest sold. In 1997, under a separate securitization agreement, FINOVA sold $36.6 million of loan receivables with limited recourse. FINOVA will service these loan contracts for the transferee and has deferred a portion of the proceeds to be recognized as service fee income over the term of the agreements. 19 FINOVA CAPITAL CORPORATION NOTE D RESERVE FOR CREDIT LOSSES The following is an analysis of the reserve for credit losses for the years ended December 31:
- -------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 148,693 $ 129,077 $ 110,903 Provision for credit losses 69,200 41,751 37,568 Write-offs (45,487) (32,017) (25,631) Recoveries 2,287 3,296 2,104 Other (including reserves related to acquisitions) 2,395 6,586 4,133 - -------------------------------------------------------------------------------------------------------- Balance, end of year $ 177,088 $ 148,693 $ 129,077 ========================================================================================================
Write-offs by lines of business during the years ended December 31 are as follows:
- -------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Factoring Services $ 24,382 $ 5,098 $ 3,728 Corporate Finance 6,577 9,470 4,660 Commercial Equipment Finance 3,722 3,207 2,271 Resort Finance 2,700 4,275 2,000 Specialty Real Estate Finance 2,106 1,793 2,275 Healthcare Finance 1,798 1,018 314 Inventory Finance 1,777 201 Communications Finance 750 2,994 4,037 Franchise Finance 696 3,267 3,448 FINOVA Capital Limited (UK) 47 895 1,523 Business Credit 452 Other 932 722 - -------------------------------------------------------------------------------------------------------- $ 45,487 $ 32,017 $ 25,631 ======================================================================================================== Write-offs as a percentage of average managed assets (excluding participations) 0.56% 0.46% 0.44% ========================================================================================================
An analysis of nonaccruing assets included in the investment in financing transactions at December 31 is as follows:
- -------------------------------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------------------------------- Contracts $ 150,263 $ 117,086 Repossessed assets 37,093 38,419 - -------------------------------------------------------------------------------------------------------- Total nonaccruing assets $ 187,356 $ 155,505 ======================================================================================================== Nonaccruing assets as a percentage of managed assets (excluding participations) 2.1% 2.0% ========================================================================================================
In addition to the repossessed assets included in the above table, FINOVA had repossessed assets with a total carrying amount of $52.5 million and $60.0 million at December 31, 1997 and 1996, respectively, which earned income of $4.1 million and $5.1 million during 1997 and 1996, respectively. 20 FINOVA CAPITAL CORPORATION At December 31, 1997, the total carrying amount of impaired loans was $158.0 million, of which $36.4 million were revenue accruing. A reserve for credit losses of $24.5 million has been established for $39.0 million of nonaccruing impaired loans. At December 31, 1996, the total carrying amount of impaired loans was $110.1 million, of which $46.3 million were revenue accruing. At December 31, 1996, a reserve for credit losses of $6.2 million was established for $14.1 million of nonaccruing impaired loans. For the three years ended December 31, 1997, 1996 and 1995, the average carrying amount of impaired loans was $130.3 million, $85.1 million and $93.2 million, respectively. Income earned on accruing impaired loans was approximately $4.0 million in all three years. Income earned on impaired loans is recognized in the same manner as it is on other accruing loans. Cash collected on all nonaccruing loans is applied to the carrying amount. Had all nonaccruing assets outstanding at December 31, 1997, 1996 and 1995 remained accruing, income earned would have increased by approximately $22 million, $19 million and $17 million, respectively. NOTE E DEBT FINOVA satisfies its short-term financing requirements from the issuance of commercial paper supported by bank lines of credit, other bank loans and public notes. FINOVA's commercial paper borrowings are supported by unused long-term revolving bank credit agreements totaling $3.6 billion. FINOVA currently maintains a five-year revolving credit facility with numerous lenders, in the aggregate principal amount of $1.0 billion. Separately, FINOVA also has a 364-day revolving credit facility with the same lenders in the aggregate principal amount of $1.0 billion, two five-year facilities with numerous lenders for $700 million each and one 364-day facility with one lender for $200 million. FINOVA intends to borrow under the domestic revolving credit agreements to refinance commercial paper and short-term bank loans if it encounters significant difficulties in rolling over its outstanding commercial paper and short-term bank loans. FINOVA rarely borrows under these facilities. Under the terms of these agreements, FINOVA has the option to periodically select either domestic dollars or Eurodollars as the basis of borrowings. Interest is based on the lenders' prime rate for domestic dollar advances or London interbank offered rates ("LIBOR") for Eurodollar advances. The agreements also provide for a commitment fee on the unused credit. The 364-day $1.0 billion and $200 million revolving credit agreements will be subject to renewal in 1998, while the two $700 million and the other $1.0 billion credit facilities are subject to renewal in 2002. FINOVA, through one of its subsidiaries, maintains a five-year multi-currency facility with a small group of lenders for $100 million. Under the terms of this agreement, the subsidiary has the option to periodically select multiple currencies as the basis of borrowings. Interest is based on the Eurocurrency rate per annum for deposits in the relevant designated currency. Through another subsidiary, FINOVA maintains two five-year revolving credit facilities with two separate lenders in Canada for $25 million Canadian each. Under the terms of these agreements, the subsidiary has the option to borrow Canadian dollars through either bankers' acceptances or prime rate advances. Interest is based on the lenders' bankers' acceptance rates or prime rate for prime advances. FINOVA is the guarantor of these credit facilities, which are subject to renewal in 2002. FINOVA also maintains one $10 million Canadian 364-day revolving credit facility with one lender. That credit agreement will be subject to renewal in 1998. 21 FINOVA CAPITAL CORPORATION The following information pertains to all short-term financing, primarily commercial paper, issued by FINOVA for the years ended December 31:
------------------------------------------------------------------------------------------------------- 1997 1996 1995 ------------------------------------------------------------------------------------------------------- Maximum amount of short-term debt outstanding during year $ 3,284,118 $ 3,087,876 $ 2,518,733 Average short-term debt outstanding during year 2,886,668 2,551,316 2,210,329 Weighted average short-term interest rates at end of year: Short-term borrowings 5.6% 5.4% 5.9% Commercial paper* 5.7% 5.6% 6.0% Weighted average interest rate on short-term debt outstanding during year* 5.7% 5.6% 6.1% -------------------------------------------------------------------------------------------------------
* Exclusive of the cost of maintaining bank lines in support of outstanding commercial paper and the effects of interest rate conversion agreements. Senior debt at December 31 was as follows:
- -------------------------------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------------------------------- Commercial paper and short-term bank loans supported by unused long-term bank revolving credit agreements, less unamortized discount $ 3,132,109 $ 2,482,496 Medium-term notes due to 2005, 6.1% to 10.3% 1,343,148 1,414,500 Term loans payable to banks due to 1999, 6.0% 190,000 180,000 Senior notes due to 2007, 6.1% to 16.0%, less unamortized discount 2,083,761 1,758,176 Nonrecourse installment notes due to 2002, 10.6% (assets of $58,064 and $24,656, respectively, pledged as collateral) 15,563 15,051 - -------------------------------------------------------------------------------------------------------- Total senior debt $ 6,764,581 $ 5,850,223 ========================================================================================================
Annual maturities of senior debt outstanding at December 31, 1997 due through June 2007 (excluding the amount supported by the revolving credit agreements expected to be renewed) approximate $687.3 million (1998), $707.8 million (1999), $721.8 million (2000), $476.2 million (2001), $539.7 million (2002) and $499.7 million (thereafter). The agreements pertaining to senior debt and revolving credit agreements include various restrictive covenants and require the maintenance of certain defined financial ratios with which FINOVA has complied. Under one such covenant, dividend payments by FINOVA are limited to 50% of accumulated earnings after December 31, 1991. As of December 31, 1997, FINOVA had $126.4 million of excess accumulated earnings available for distribution. Total interest paid is not significantly different from interest expense. NOTE F DERIVATIVE FINANCIAL INSTRUMENTS FINOVA enters into interest rate and basis swap agreements as part of its interest rate risk management policy of match funding its assets and liabilities. The derivative instruments used are straightforward. The Company continually monitors its derivative position and uses derivative instruments for non-trading and non-speculative purposes only. FINOVA uses derivative instruments to minimize its exposure to fluctuations in interest rates. FINOVA strives to minimize its overall debt costs while limiting the short-term variability of interest expense and funds required for debt service. To achieve this objective, FINOVA diversifies its borrowing sources (short- and long-term debt with a fixed or a variable rate) and seeks to maintain 22 FINOVA CAPITAL CORPORATION a portfolio that is matched funded. FINOVA's matched funding policy generally requires that floating-rate assets be financed with floating-rate liabilities and fixed-rate assets be financed with fixed-rate liabilities. FINOVA's matched funding policy also requires that the difference between floating-rate liabilities and floating-rate assets, measured as a percent of total assets, should not vary by more than 3% for any extended period. The amount of derivatives used is a function of this 3% gap policy with the maturities of the derivatives being correlated to the maturities of the assets being financed. The notional amounts of derivatives do not represent amounts exchanged by the parties and, thus, are not a measure of FINOVA's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivatives. Under interest rate swaps, FINOVA agrees to exchange with the other party, at specified intervals, the payment streams calculated on a specified notional amount, with at least one stream based on a floating interest rate. Generic swap notional amounts do not change for the life of the contract. Basis swaps involve the exchange of floating-rate indices, such as the prime rate, the commercial paper composite rate and LIBOR and are used primarily to protect FINOVA's margins on floating-rate transactions by locking in the spread between FINOVA's lending and borrowing rates. FINOVA's off-balance sheet derivative instruments involve credit and interest rate risks. The credit risk would be the nonperformance by the other parties to the financial instruments. All financial instruments have been entered into with major financial institutions, which are expected to fully perform under the terms of the agreements, thereby mitigating the credit risk from the transactions, although there can be no assurance that any such institution will perform under its agreement. FINOVA's derivative policy stipulates that the maximum exposure to any one counter party, relative to the derivative products, is limited on a net basis to 10% of FINOVA's outstanding debt at the time of that transaction. Interest rate risks relate to changes in interest rates and the impact on earnings. FINOVA mitigates interest rate risks through its matched funding policy. The use of derivatives decreased interest expense by $1.0 million in 1997, a decrease in the aggregate cost of funds of 0.03%, whereas the use of derivatives increased interest expense by $3.0 million in 1996, an increase in the aggregate cost of funds of 0.05%, and $9.8 million in 1995, an increase in the aggregate cost of funds of 0.2%. These changes in interest expense from off-balance sheet derivatives effectively alter on-balance sheet costs and must be viewed as total interest rate management. There were no deferred gains or losses associated with derivatives. 23 FINOVA CAPITAL CORPORATION The following table provides annual maturities and weighted-average interest rates for each significant derivative product type in place at December 31, 1997. The rates presented are as of December 31, 1997. To the extent that rates change, variable interest information will change:
------------------------------------------------------------------------------------------------------- Maturities of Derivative Products December 31, --------------------------------------------------------- (Dollars in Millions) 1997 1998 1999 2000 2001 2002 Thereafter ------------------------------------------------------------------------------------------------------- Receive fixed-rate swaps: Notional value $ 1,402 $ 325 $ 377 $ 150 $ 150 $ 200 $ 200 Weighted average receive rate 6.77% 6.82% 6.45% 7.24% 6.66% 6.51% 7.26% Weighted average pay rate 5.82% 5.78% 5.79% 5.78% 5.83% 5.80% 5.98% Pay fixed-rate swaps: Notional value $ 550 $ 200 $ 150 $ 100 $ 100 Weighted average receive rate 5.81% 5.86% 5.80% 5.74% 5.77% Weighted average pay rate 7.14% 7.30% 7.06% 7.38% 6.70% Basis swaps: Notional value $ 628 $ 628 Weighted average receive rate 5.75% 5.75% Weighted average pay rate 6.04% 6.04% ------------------------------------------------------------------------------------------------------- TOTAL NOTIONAL VALUE $ 2,580 $ 1,153 $ 527 $ 250 $ 250 $ 200 $ 200 ======================================================================================================= Total weighted average rates on swaps: Receive rate 6.32% 6.07% 6.26% 6.64% 6.30% 6.51% 7.26% ======================================================================================================= Pay rate 6.15% 6.19% 6.15% 6.42% 6.18% 5.80% 5.98% =======================================================================================================
For the benefit of its customers, FINOVA enters into interest rate cap agreements. The total notional amount of these agreements at December 31, 1997 was $41.9 million, none of which was in a pay or receive position. These agreements will mature as follows: $16.9 million in 1998, $15.9 million in 1999, $1.5 million in 2000 and $7.6 million in 2001. At December 31, 1996, FINOVA was a party to a short-term foreign currency forward exchange agreement with a notional amount of approximately $73 million to mitigate its foreign currency risk. The exchange agreement expired in 1997. 24 FINOVA CAPITAL CORPORATION Derivative product activity for the three years ended December 31, 1997 is as follows:
- -------------------------------------------------------------------------------------------------------- Pay Interest Receive Pay Fixed-Rate Rate Fixed-Rate Fixed-Rate Amortizing Basis Hedge (Dollars in Millions) Swaps Swaps Swaps Swaps Agreements TOTAL - -------------------------------------------------------------------------------------------------------- Balance, January 1, 1995 $ 1,190 $ 780 $ 242 $ 254 $ 750 $ 3,216 Expired (40) (30) (152) (126) (348) Additions 150 50 5 750 955 - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 1,300 800 95 878 750 3,823 Expired (100) (325) (95) (750) (1,270) Additions 150 350 500 - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 1,350 825 -- 878 -- 3,053 Expired (275) (275) (250) (800) Additions 327 327 - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 $ 1,402 $ 550 $ -- $ 628 $ -- $ 2,580 ========================================================================================================
NOTE G REDEEMABLE PREFERRED STOCK In December 1996, FINOVA Finance Trust, a subsidiary trust sponsored and wholly-owned by FINOVA Group, issued (a) 2,300,000 shares of convertible trust originated preferred securities to the public for gross proceeds of $115 million (before transaction costs of $3.5 million) and (b) 71,135 shares of common securities to FINOVA Group. The gross proceeds from these transactions were invested by the trust in $118.6 million aggregate principal amount of 5 1/2% convertible subordinated debentures due 2016 (the "Debentures") newly issued by FINOVA Group. The Debentures represent all of the assets of the trust. The proceeds from the issuance of the Debentures were contributed by FINOVA Group to FINOVA, which used the proceeds to repay commercial paper and other indebtedness. NOTE H STOCK OPTIONS FINOVA Group sponsors the 1992 Stock Incentive Plan in which FINOVA participates. Consequently, any compensation related to that plan is reflected in FINOVA's operating results. The plan provides for the grant of options, restricted stock and stock appreciation rights relating to FINOVA Group common stock. Those awards are granted to directors, officers and employees. FINOVA applies APB Opinion 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. The compensation cost that has been charged against income for its performance-based plan was $7.9 million, $2.9 million and $1.6 million for 1997, 1996 and 1995, respectively. Had compensation cost for the Company's stock based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement 123, FINOVA's net income would have been $139.6 million, $115.0 million and $97.0 million for 1997, 1996 and 1995, respectively. The fair value of the options was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995: dividend yield of 1.92%, expected volatility of 43%, risk-free interest rates of 6.2% and expected lives of five to seven years. NOTE I INCOME TAXES The consolidated provision for income taxes consists of the following for the years ended December 31: - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Current: United States: Federal $ 34,936 $ 28,658 $ 32,225 State 13,973 7,654 7,194 Foreign 3,626 1,745 - -------------------------------------------------------------------------------- 52,535 38,057 39,419 - -------------------------------------------------------------------------------- Deferred: United States: Federal 31,051 26,210 12,278 State (498) 5,062 4,535 Foreign 804 - -------------------------------------------------------------------------------- 30,553 31,272 17,617 - -------------------------------------------------------------------------------- Provision for income taxes $ 83,088 $ 69,329 $ 57,036 ================================================================================ 25 FINOVA CAPITAL CORPORATION Income taxes paid in 1997, 1996 and 1995 amounted to approximately $30.3 million, $31.3 million and $47.9 million, respectively. The significant components of deferred tax liabilities and deferred tax assets at December 31, 1997 and 1996 consisted of the following: - -------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------- Deferred tax liabilities: Deferred income from leveraged leases $ 308,764 $ 274,224 Deferred income from lease financing 89,196 68,542 Goodwill 24,343 10,776 Other 1,207 15,468 - -------------------------------------------------------------------------------- Gross deferred tax liability 423,510 369,010 - -------------------------------------------------------------------------------- Deferred tax assets: Reserve for credit losses 75,670 61,083 Foreign 16,802 24,159 Alternative minimum tax 26,153 Accrued expenses 9,739 14,230 Net operating loss carryforward 4,875 Other 12,702 5,129 - -------------------------------------------------------------------------------- Gross deferred tax asset 145,941 104,601 - -------------------------------------------------------------------------------- Net deferred tax liability $ 277,569 $ 264,409 ================================================================================ The federal statutory income tax rate is reconciled to the effective income tax rate as follows: - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Federal statutory income tax rate 35.0% 35.0% 35.0% State income taxes 2.6 4.4 5.1 Foreign tax effects (0.1) (0.9) (0.5) Municipal and ESOP income (2.0) (2.2) (1.7) Other 1.2 1.0 (0.1) - -------------------------------------------------------------------------------- Provision for income taxes 36.7% 37.3% 37.8% ================================================================================ NOTE J PENSION AND OTHER BENEFITS Net periodic pension costs were $1.9 million, $1.7 million and $1.3 million for the years ended December 31, 1997, 1996 and 1995, respectively. FINOVA's pension costs were accrued at $2.8 million at December 31, 1997 and prepaid by $0.6 million at December 31, 1996. Net periodic postretirement benefit costs were $0.5 million, $0.7 million and $0.6 million for each of the years ended December 31, 1997, 1996 and 1995, respectively. FINOVA's accrued postretirement benefit costs were $2.8 million at December 31, 1997 and $2.2 million at December 31, 1996. FINOVA's investment of $47 million in trust for nonqualified compensation plans consists of securities held for trading and is recorded at market. 26 FINOVA CAPITAL CORPORATION NOTE K LITIGATION AND CLAIMS FINOVA is party either as plaintiff or defendant to various actions, proceedings and pending claims, including legal actions, some of which involve claims for compensatory, punitive or other damages in significant amounts. Such litigation often results from FINOVA's attempts to enforce its lending agreements against borrowers and other parties to those transactions. Litigation is subject to many uncertainties and it is possible that some of the legal actions, proceedings or claims referred to above could be decided against FINOVA. Although the ultimate amount for which FINOVA may be held liable, if any, is not ascertainable, FINOVA believes that any resulting liability should not materially affect FINOVA's financial position or results of operations. NOTE L FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments has been determined by FINOVA using market information obtained by FINOVA and the valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that FINOVA could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts. The carrying amounts and estimated fair values of FINOVA's financial instruments are as follows for the years ended December 31:
- -------------------------------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value - -------------------------------------------------------------------------------------------------------- Balance Sheet - Financial Instruments: Assets: Loans and other financing contracts $ 5,744,846 $ 5,872,082 $ 5,143,562 $ 5,417,865 Liabilities: Senior debt 6,764,581 6,832,327 5,850,223 5,952,108 Off-Balance Sheet - Financial Instruments: Interest rate swaps --- 15,893 --- 1,462 - --------------------------------------------------------------------------------------------------------
The carrying values of cash and cash equivalents, factored receivables, accounts payable and accrued expenses, due to clients and interest payable (including accrued amounts related to interest rate swaps and interest rate hedge agreements) approximate fair values due to the short-term maturity of these items. The methods and assumptions used to estimate the fair values of other financial instruments are summarized as follows: Loans and other financing contracts: The fair value of loans and other financing contracts was estimated by discounting expected cash flows using the current rates at which loans of similar credit quality, size and remaining maturity would be made as of December 31, 1997 and 1996. Management believes that the risk factor embedded in the entry value interest rates applicable to performing loans for which there are no known credit concerns results in a fair valuation of such loans on an entry value basis. As of December 31, 1997 and 1996, the fair value of nonaccruing impaired contracts with a carrying amount of $121.5 million and $63.8 million, respectively, was not estimated because it is not practical to reasonably assess the credit adjustment that would be applied in the marketplace for such loans. As of December 31, 1997 and 1996, the carrying amount of loans and other financing contracts excludes repossessed assets with a total carrying amount of $89.6 million and $98.4 million, respectively. 27 FINOVA CAPITAL CORPORATION Senior debt: The fair value of senior debt was estimated by discounting future cash flows using rates currently available for debt of similar terms and remaining maturities. The carrying values of commercial paper and borrowings under revolving credit facilities, if any, were assumed to approximate fair values due to their short maturities. Interest rate swaps: The fair values of interest rate swaps are based on quoted market prices obtained from participating banks and dealers. The fair value estimates presented herein were based on information obtained by FINOVA as of December 31, 1997 and 1996. Although management is not aware of any factors that would significantly affect the estimated fair values, such values have not been updated since December 31, 1997 and 1996. Therefore, current estimates of fair value may differ significantly from the amounts presented herein. NOTE M SELLING, ADMINISTRATIVE AND OTHER OPERATING EXPENSES The following represents a summary of the major components of selling, administrative and other operating expenses for the three years ended December 31: - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Salaries and employee benefits $ 112,980 $ 94,272 $ 74,884 Depreciation and amortization 17,407 14,185 14,799 Travel and entertainment 11,917 8,953 8,030 Problem account costs 11,586 7,753 7,941 Occupancy expenses 8,368 7,104 6,253 Professional services 7,654 5,738 6,121 - -------------------------------------------------------------------------------- NOTE N NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income," which is effective for fiscal years beginning after December 15, 1997. The statement changes the reporting of certain items currently reported in the shareowner's equity section of the balance sheet and establishes standards for reporting of comprehensive income and its components in a full set of general purpose financial statements. Adoption of this standard will require additional disclosure only. FINOVA will adopt this standard effective January 1, 1998, as required. In June 1997, the FASB also issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which is effective for fiscal years beginning after December 15, 1997. This standard requires certain information regarding segments of a business enterprise to be reported based on the way management organizes and evaluates segments within FINOVA. The standard also requires disclosures regarding products and services, geographical areas and major customers. Adoption of this standard will require FINOVA to include additional detail in its disclosures, including certain disaggregated operating information. FINOVA will adopt this standard in 1998, as required, but is not currently planning to elect early adoption for interim financial periods during the year. At this time, management anticipates that FINOVA's reported segments will be composed of its three operating groups: Specialty Finance, Commercial Finance and Capital Markets. 28 FINOVA CAPITAL CORPORATION SUPPLEMENTAL SELECTED FINANCIAL DATA CONDENSED QUARTERLY RESULTS (UNAUDITED) (Dollars in Thousands) The following represents the condensed quarterly results for the three years ended December 31, 1997, 1996 and 1995:
- -------------------------------------------------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------------------------------- Interest earned from financing transactions: 1997 $ 217,077 $ 228,487 $ 237,356 $ 261,804 1996 190,652 192,635 204,972 209,675 1995 161,369 170,475 176,802 193,470 - -------------------------------------------------------------------------------------------------------- Interest expense: 1997 97,172 101,883 105,592 111,446 1996 88,224 89,718 91,629 96,972 1995 78,275 83,248 85,544 90,747 - -------------------------------------------------------------------------------------------------------- Gains on sale of assets: 1997 3,233 10,468 8,706 7,854 1996 6,730 1,315 397 4,507 1995 1,710 728 2,557 5,894 - -------------------------------------------------------------------------------------------------------- Non-interest expenses: 1997 70,327 82,522 84,500 95,365 1996 66,489 56,989 65,480 69,560 1995 47,581 52,832 54,605 69,339 - -------------------------------------------------------------------------------------------------------- Income from continuing operations: 1997 32,813 34,697 35,867 39,713 1996 26,756 28,852 30,489 30,396 1995 22,205 22,279 24,417 24,897 - -------------------------------------------------------------------------------------------------------- Net income: 1997 32,813 34,697 35,867 39,713 1996 27,121 28,121 29,763 31,995 1995 22,368 23,629 25,150 26,482 - --------------------------------------------------------------------------------------------------------
29 FINOVA CAPITAL CORPORATION AVERAGE BALANCES/INTEREST MARGINS/AVERAGE ANNUAL RATES (UNAUDITED) (1) (Dollars in Thousands)
The following represents the breakdown of FINOVA's average balance sheet, interest margins and average annual rates for the years ended December 31, 1997 and 1996: - ----------------------------------------------------------------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Average Average Average Average Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and cash equivalents $ 36,899 $ $ 38,853 $ Investment in financing transactions 7,764,224 871,735 (4) 11.85% (2) 6,716,996 735,648 (4) 11.63% (2) Less reserve for credit losses (160,241) (138,896) - ------------------------------------------------------------------------------------------------------------------------------------ Investment in financing transactions - net 7,603,983 6,578,100 Goodwill and other assets 415,573 340,056 Investment in discontinued operations 2,704 487,915 - ------------------------------------------------------------------------------------------------------------------------------------ $ 8,059,159 $ 7,444,924 ==================================================================================================================================== LIABILITIES AND SHAREOWNER'S EQUITY Liabilities: Other liabilities $ 389,998 $ $ 341,370 $ Senior debt 6,253,588 416,093 6.65% 5,944,599 366,543 (5) 6.17% (5) Deferred income taxes 274,811 249,164 - ------------------------------------------------------------------------------------------------------------------------------------ $ 6,918,397 $ 6,535,133 Shareowner's equity 1,140,762 909,791 - ------------------------------------------------------------------------------------------------------------------------------------ $ 8,059,159 $ 7,444,924 ==================================================================================================================================== Interest income/average earning assets (2) $ 871,735 11.85% $ 735,648 11.63% Interest expense/average earning assets (2) (3) 416,093 5.66% 366,543 5.80% - ------------------------------------------------------------------------------------------------------------------------------------ Interest margins earned (3) $ 455,642 6.19% $ 369,105 5.83% ====================================================================================================================================
1) Averages are calculated based on monthly balances. 2) The average rate is calculated based on average earning assets ($7,356,845 and $6,324,545 for 1997 and 1996, respectively) which are net of average deferred taxes on leveraged leases and average nonaccruing assets. 3) For the year ended December 31, 1997, excluding the impact of derivatives, interest expense would have been $417,140 or 5.67% of average earning assets and interest margins earned would have been $454,595 or 6.18% of average earning assets. For the year ended December 31, 1996, excluding the impact of derivatives, interest expense would have been $363,526 or 5.75% of average earning assets and interest margins earned would have been $372,122 or 5.88% of average earning assets. (4) Interest income is shown net of operating lease depreciation. (5) Interest expense for 1996 excludes expense related to MDS which was classified as discontinued operations. The average rate would have been 6.77% if the expense had not been reclassified. 30 FINOVA CAPITAL CORPORATION COMMISSION FILE NUMBER 1-7543 EXHIBIT INDEX DECEMBER 31, 1997 FORM 10-K Exhibit No. ----------- (3.A) Certificate of Incorporation, as amended through the date of this filing (incorporated by reference from FINOVA's report on Form 10-K for the year ended December 31, 1994 (the "1994 10-K"), Exhibit 3.A). (3.B) Bylaws, as amended through the date of this filing (incorporated by reference from FINOVA's report on Form 10-K for the year ended December 31, 1995 (the "1995 10-K") Exhibit 3.B). (4.A) Form of FINOVA's Common Stock Certificate (incorporated by reference from the 1994 10-K, Exhibit 4.B). (4.B) Relevant portions of FINOVA's Certificate of Incorporation and Bylaws included in Exhibits 3.A and 3.B above are incorporated by reference. (4.C) Long-term debt instruments with principal amounts not exceeding 10% of FINOVA's total consolidated assets are not filed as exhibits to this report. FINOVA will furnish a copy of those agreements to the SEC upon its request. (4.D) Form of Indenture dated as of September 1, 1992 between FINOVA and the Trustee named therein (incorporated by reference from the Greyhound Financial Corporation Registration Statement on Form S-3, Registration No. 33-51216, Exhibit 4). (4.E) Form of Indenture dated as of October 1, 1995 between FINOVA and the Trustee named therein (incorporated by reference from FINOVA's report on Form 8-K dated October 25, 1995, Exhibit 4.1). 31 Exhibit No. ----------- (4.F) Form of Indenture between FINOVA, FINOVA Group and The First National Bank of Chicago as Trustee (incorporated by reference from FINOVA and FINOVA Group's registration statement on Form S-3, Registration No. 333-38171, Exhibit 4.8). (10.A) Sixth Amendment and Restatement dated as of May 16, 1994 of the Credit Agreement dated as of May 31, 1976 among FINOVA and the lender parties thereto, and Bank of America National Trust and Savings Association, Bank of Montreal, Chemical Bank, Citibank, N.A. and National Westminister Bank USA, as agents (the "Agents") and Citibank, N.A., as Administrative Agent (incorporated by reference from FINOVA's report on Form 8-K dated May 23, 1994, Exhibit 10.1). (10.A.1) First Amendment dated as of September 30, 1994, to the Sixth Amendment and Restatement, noted in 10.A above (incorporated by reference from the 1994 10-K, Exhibit 10.A.1). (10.A.2) Second Amendment dated as of May 11, 1995 to the Sixth Amendment and Restatement noted in 10.A above (incorporated by reference from FINOVA's Quarterly Report on Form 10-Q for the period ending September 30, 1995 ( the "3Q95 10-Q"), Exhibit 10.A). (10.A.3) Third Amendment dated as of November 1, 1995 to Sixth Amendment noted in 10.A above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.B). (10.A.4) Fourth Amendment dated as of May 15, 1996, to Sixth Amendment noted in 10.A above (incorporated by reference from the 1996 10-K, Exhibit 10.A.4). (10.A.5) Fifth Amendment dated as of May 20, 1997 to Sixth Amendment noted in 10.A above (incorporated by reference from FINOVA Group's Report on Form 10-K for the year ended December 31, 1997 (the "FINOVA Group 1997 10-K"), Exhibit 10.A.5). 32 Exhibit No. ----------- (10.B) Credit Agreement (Short-Term Facility) dated as of May 16, 1994 among FINOVA Capital, the Lender parties thereto, the Agents and Citibank, N.A., as Administrative Agent (incorporated by reference from FINOVA's report on Form 8-K dated May 23, 1994, Exhibit 10.2). (10.B.1) First Amendment dated as of September 30, 1994 to the Credit Agreement noted in 10.B above (incorporated by reference from the 1994 10-K, Exhibit 10.B.1). (10.B.2) Second Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.C). (10.B.3) Third Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the 3Q95 10-Q, Exhibit 10.D). (10.B.4) Fourth Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from 1996 10-K, Exhibit B.4). (10.B.5) Fifth Amendment to Short-Term Facility noted in 10.B above (incorporated by reference from the FINOVA Group 1997 10-K, Exhibit 10.B.5). (10.C) Exhibits relating to management compensation are omitted due to the reduced disclosure format, but can be found as exhibits to the FINOVA Group 1997 10-K. 33 Exhibit No. ----------- (10.D) Tax Sharing Agreement dated February 19, 1992 among FINOVA, The Dial Corp and others (incorporated by reference from the 1992 10-K, Exhibit 10.KK). (12) Computation of Ratio of Income to Combined Fixed Charges and Preferred Stock Dividends.* (23) Independent Auditors' Consent.* (24) Powers of Attorney.* (27) Financial Data Schedule.* *Filed with this report. +Relating to management compensation 34 EX-12 2 STATEMENT RE: COMPUTATION OF RATIOS EXHIBIT 12 FINOVA CAPITAL CORPORATION COMPUTATION OF RATIO OF INCOME TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (Dollars in Thousands)
Year Ended December 31, - ------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes $ 226,178 $ 185,822 $ 150,834 $ 122,847 $ 64,123 Add fixed charges: Interest expense 416,093 366,543 337,814 210,730 126,152 One-third of rent expense 2,789 2,368 2,084 2,053 1,387 - ------------------------------------------------------------------------------------------------------- Total fixed charges 418,882 368,911 339,898 212,783 127,539 - ------------------------------------------------------------------------------------------------------- Income as adjusted $ 645,060 $ 554,733 $ 490,732 $ 335,630 $ 191,662 - ------------------------------------------------------------------------------------------------------- Ratio of income to fixed charges 1.54 1.50 1.44 1.58 1.50 ======================================================================================================= Preferred stock dividends on a pre-tax basis $ $ $ $ $ 3,682 Total combined fixed charges and preferred stock dividends $ 418,882 $ 368,911 $ 339,898 $ 212,783 $ 131,221 - ------------------------------------------------------------------------------------------------------- Ratio of income to combined fixed charges and preferred stock dividends 1.54 1.50 1.44 1.58 1.46 =======================================================================================================
EX-23 3 INDEPENDENT AUDITORS' CONSENT Exhibit 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-38171 of FINOVA Capital Corporation (a subsidiary of The FINOVA Group Inc) on Form S-3 of our report dated February 11, 1998, appearing in this Annual Report on Form 10-K of FINOVA Capital Corporation for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Phoenix, Arizona March 17, 1998 EX-24 4 POWER OF ATTORNEY POWER OF ATTORNEY Each person whose signature appears below hereby authorizes and appoints Samuel L. Eichenfield and Bruno A. Marszowski, and each of them severally, as his attorneys-in-fact, with full power of substitution and resubstitution, to sign and file on his behalf individually and in each such capacity stated below, FINOVA Capital Corporation's Annual Report on Form 10-K, and any amendments thereto, to be filed with the Securities and Exchange Commission, the New York Stock Exchange, and otherwise, as fully as such person could do in person, hereby verifying and confirming all that said attorneys-in-fact, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof. Signatures Title Date - ---------- ----- ---- Principal Executive Officer /s/Samuel L. Eichenfield Chairman, President and February 17,1998 - ---------------------------- Chief Executive Officer Samuel L. Eichenfield Principal Financial and Accounting Officer /s/Bruno A. Marszowski Senior Vice President- February 17,1998 - ---------------------------- Controller and Chief Bruno A. Marszowski Financial Officer Directors /s/W. Carroll Bumpers February 26,1998 - ---------------------------- W. Carroll Bumpers /s/Robert J. Fitzsimmons February 17,1998 - ---------------------------- Robert J. Fitzsimmons /s/Gregory C. Smalis February 17,1998 - ---------------------------- Gregory C. Smalis EX-27 5 FINANCIAL DATA SCHEDULE
9 1,000 U.S. Dollars YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 33,193 0 0 0 0 0 0 8,399,456 (177,088) 8,757,923 0 0 733,274 6,764,581 0 0 25 1,260,043 8,757,923 944,724 0 0 0 0 416,093 455,642 69,200 0 190,525 226,178 0 0 0 143,090 0 0 6.2 187,356 0 0 0 148,693 (45,487) 2,287 177,088 0 0 0
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