** **

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington D.C. 20549**

** **

**FORM 10-Q**

** **

**Quarterly Report pursuant to Section 13 or 15 (d) oftheSecurities Exchange Act of 1934**

** **

**For thequarterly period ended June 30, 2003**

** **

**Commissionfile number 1-11011**

 

**THE FINOVA GROUP INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                              |   | **86-0695381**                       |
|---------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)            |   | (I.R.S. employer identification no.) |
|                                                                      |   |                                 |
| **4800  North Scottsdale Road  Scottsdale, AZ**                           |   | **85251-7623**                       |
| (Address of principal executive offices)                                  |   | (Zip code)                           |
|                                                                      |   |                                 |
| Registrant’s telephone number, including area code: **480-636-4800** |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months, (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  ý  No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).

 

Yes  o  No  ý

 

**APPLICABLEONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVEYEARS:**

** **

Indicateby check mark whether the registrant has filed all documents and reportsrequired to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Actof 1934 subsequent to the distribution of securities under a plan confirmed bythe court.

 

Yes  ý  No  o

 

**APPLICABLEONLY TO CORPORATE ISSUERS:**

Asof August 6, 2003, approximately 122,041,000 shares of Common Stock ($0.01 parvalue) were outstanding.

 

 

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**THE FINOVAGROUP INC.**

** **

**TABLE OFCONTENTS**

** **
|                                       |                                                                                        | **Page No.**                                                    |
|--------------------------------------------|---------------------------------------------------------------------------------------------|-----------------------------------------------------------------|
|                                       |                                                                                        |                                                            |
| **PART  I  FINANCIAL INFORMATION**    |
|                                       |                                                                                        |
| Item 1.                                    | Financial Statements                                                                        | 1                                                               |
|                                       |                                                                                        | Condensed  Consolidated Balance Sheets                          | 1 |
|                                       |                                                                                        | Condensed  Statements of Consolidated Operations                | 2 |
|                                       |                                                                                        | Condensed  Statements of Consolidated Cash Flows                | 3 |
|                                       |                                                                                        | Condensed  Statements of Consolidated Stockholders’ Equity | 4 |
|                                       |                                                                                        | Notes  to Interim Condensed Consolidated Financial Statements   | 5 |
|                                       |                                                                                        |                                                            |
| Item 2.                                    | Management’s Discussion and  Analysis of Financial Condition and Results of Operations | 10                                                              |
|                                       | Special  Note Regarding Forward-Looking Statements                                          | 20                                                              |
|                                       |                                                                                        |                                                            |
| Item 3.                                    | Quantitative and Qualitative  Disclosure About Market Risk                                  | 21                                                              |
|                                       |                                                                                        |                                                            |
| Item 4.                                    | Controls and Procedures                                                                     | 21                                                              |
|                                       |                                                                                        |                                                            |
| **PART  II  OTHER  INFORMATION** |
|                                       |                                                                                        |                                                            |
| Item  1.                                   | Legal  Proceedings                                                                          | 22                                                              |
|                                       |                                                                                        |                                                            |
| Item  4.                                   | Submission  of Matters to a Vote of Security Holders                                        | 22                                                              |
|                                       |                                                                                        |                                                            |
| Item 6.                                    | Exhibits and  Reports on Form 8-K                                                           | 22                                                              |
|                                       |                                                                                        |                                                            |
| Signatures                                 | 23                                                                                          |

 

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**PART I****                 FINANCIALINFORMATION**

 

**Item1****.****                     FinancialStatements**

 

**THE FINOVAGROUP INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Dollars inthousands)**

 
|                                                                                        |   | **June 30, 2003** |       | **December 31, 2002** |       |
|---------------------------------------------------------------------------------------------|--------|-------------------|------------|-----------------------|------------|
|                                                                                        |   | **(Unaudited)**   | ** ** | **(Audited)**         | ** ** |
| **ASSETS**                                                                                  |   |              | ** ** |                  | ** ** |
| Cash and cash equivalents                                                                   |   | $                 | 578,602    |                  | $          | 575,215 |   |
| **Financing Assets:**                                                                       |   |              |       |                  |       |
| Loans and other financing contracts, net                                                    |   | 1,999,406         |       | 2,655,724             |       |
| Direct financing leases                                                                     |   | 209,709           |       | 263,826               |       |
| Leveraged leases                                                                            |   | 178,050           |       | 182,410               |       |
| Total financing assets                                                                      |   | 2,387,165         |       | 3,101,960             |       |
| Reserve for credit losses                                                                   |   | (359,222          | )          | (540,268              | )          |
| Net financing assets                                                                        |   | 2,027,943         |       | 2,561,692             |       |
| **Other Financial Assets:**                                                                 |   |              |       |                  |       |
| Operating leases                                                                            |   | 100,499           |       | 111,826               |       |
| Assets held for sale                                                                        |   | 84,946            |       | 393,125               |       |
| Assets held for the production of income                                                    |   | 33,689            |       | 67,867                |       |
| Investments                                                                                 |   | 16,119            |       | 21,641                |       |
| Total other financial assets                                                                |   | 235,253           |       | 594,459               |       |
| **Total Financial Assets**                                                                  |   | 2,263,196         |       | 3,156,151             |       |
| Other assets                                                                                |   | 21,895            |       | 27,642                |       |
|                                                                                        |   | $                 | 2,863,693  |                  | $          | 3,759,008 |   |
|                                                                                        |   |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                               |   |              |       |                  |       |
| **Liabilities:**                                                                            |   |              |       |                  |       |
| Berkadia Loan                                                                               |   | $                 | 1,200,000  |                  | $          | 2,175,000 |   |
| Senior Notes - (principal amount due of $3.07 billion)                                      |   | 2,399,117         |       | 2,381,643             |       |
| Total debt                                                                                  |   | 3,599,117         |       | 4,556,643             |       |
| Accounts payable and accrued expenses                                                       |   | 123,671           |       | 156,338               |       |
| Deferred income taxes, net                                                                  |   | 2,797             |       | 16,776                |       |
| **Total Liabilities**                                                                       |   | 3,725,585         |       | 4,729,757             |       |
|                                                                                        |   |              |       |                  |       |
| **Stockholders’ Equity:**                                                              |   |              |       |                  |       |
| Common stock, $0.01 par value, 400,000,000 shares authorized and  125,873,000 shares issued |   | 1,259             |       | 1,259                 |       |
| Additional capital                                                                          |   | 75,779            |       | 53,233                |       |
| Accumulated deficit                                                                         |   | (935,860          | )          | (1,020,828            | )          |
| Accumulated other comprehensive loss                                                        |   | (2,534            | )          | (3,877                | )          |
| Common stock in treasury, 3,832,000 shares                                                  |   | (536              | )          | (536                  | )          |
| **Total Stockholders’ Equity**                                                         |   | (861,892          | )          | (970,749              | )          |
|                                                                                        |   | $                 | 2,863,693  |                  | $          | 3,759,008 |   |

 

*See notesto interim condensed consolidated financial statements.*

 

1

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**THE FINOVAGROUP INC.**

**CONDENSED STATEMENTS OF CONSOLIDATEDOPERATIONS**

**(Dollars inthousands, except per share data)**

**(Unaudited)**

 
|                                    |   | **Three Months  Ended  June 30, 2003** |   | **Three Months  Ended  June 30, 2002** |   | **Six Months  Ended  June 30, 2003** |   | **Six Months  Ended  June 30, 2002** |   |
|-----------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|--------------------------------------|--------|
| **Revenues:**                           |   |                                   |   |                                   |   |                                 |   |                                 |   |
| Interest income                         |   | $                                      | 49,949 |                                   | $      | 62,586                               |   | $                                    | 99,390 |   | $ | 143,423 |   |
| Rental income                           |   | 8,331                                  |   | 11,037                                 |   | 16,324                               |   | 21,173                               |   |
| Operating lease income                  |   | 12,398                                 |   | 10,957                                 |   | 24,501                               |   | 23,159                               |   |
| Fees and other income                   |   | 8,667                                  |   | 10,942                                 |   | 19,841                               |   | 25,284                               |   |
| **Total Revenues**                      |   | 79,345                                 |   | 95,522                                 |   | 160,056                              |   | 213,039                              |   |
| Interest expense                        |   | (80,389                                | )      | (103,782                               | )      | (164,083                             | )      | (216,072                             | )      |
| Operating lease and other depreciation  |   | (7,664                                 | )      | (10,704                                | )      | (15,838                              | )      | (20,769                              | )      |
| **Interest Margin**                     |   | (8,708                                 | )      | (18,964                                | )      | (19,865                              | )      | (23,802                              | )      |
|                                    |   |                                   |   |                                   |   |                                 |   |                                 |   |
| **Other Revenues and (Expenses):**      |   |                                   |   |                                   |   |                                 |   |                                 |   |
| Provision for credit losses             |   | 69,574                                 |   | 128,834                                |   | 123,573                              |   | 154,018                              |   |
| Net gain (loss) on financial assets     |   | 35,514                                 |   | (64,527                                | )      | 32,372                               |   | (63,559                              | )      |
| Portfolio expenses                      |   | (8,005                                 | )      | (13,580                                | )      | (18,529                              | )      | (21,555                              | )      |
| General and administrative expenses     |   | (16,161                                | )      | (27,632                                | )      | (32,583                              | )      | (53,150                              | )      |
| **Total Other Revenues and (Expenses)** |   | 80,922                                 |   | 23,095                                 |   | 104,833                              |   | 15,754                               |   |
|                                    |   |                                   |   |                                   |   |                                 |   |                                 |   |
| Income (loss) before income taxes       |   | 72,214                                 |   | 4,131                                  |   | 84,968                               |   | (8,048                               | )      |
| Income tax expense                      |   |                                   |   | (2                                     | )      |                                 |   | (4                                   | )      |
| **Net (Income) Loss**                   |   | $                                      | 72,214 |                                   | $      | 4,129                                |   | $                                    | 84,968 |   | $ | (8,052 | ) |
|                                    |   |                                   |   |                                   |   |                                 |   |                                 |   |
| Basic/diluted earnings (loss) per share |   | $                                      | 0.59   |                                   | $      | 0.03                                 |   | $                                    | 0.70   |   | $ | (0.07 | ) |
|                                    |   |                                   |   |                                   |   |                                 |   |                                 |   |
| Weighted average shares outstanding     |   | 122,041,000                            |   | 122,041,000                            |   | 122,041,000                          |   | 122,041,000                          |   |

 

*See notesto interim condensed consolidated financial statements.*

 

2

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**THE FINOVAGROUP INC.**

**CONDENSED STATEMENTS OF CONSOLIDATED CASHFLOWS**

**(Dollars inthousands)**

**(Unaudited)**

 
|                                                                                  |   | **Six Months Ended June 30,** |    |
|---------------------------------------------------------------------------------------|--------|-------------------------------|---------|
|                                                                                  |   | **2003**                      |    | **2002** | ** ** |
| **Operating Activities:**                                                             |   |                          |    |   |   |
| Net income (loss)                                                                     |   | $                             | 84,968  |   | $ | (8,052 | ) |
| Adjustments to reconcile net income (loss) to net cash used by  operating activities: |   |                          |    |   |   |
| Provision for credit losses                                                           |   | (123,573                      | )       | (154,018 | ) |
| Net cash gain on disposal of financial assets                                         |   | (50,887                       | )       | (57,543 | ) |
| Net non-cash charge-offs of financial assets                                          |   | 18,515                        |    | 121,102 |   |
| Depreciation and amortization                                                         |   | 17,525                        |    | 22,537 |   |
| Deferred income taxes, net                                                            |   | 6,608                         |    | 3,335 |   |
| Other amortization                                                                    |   | 1,201                         |    | (4,226 | ) |
| Change in assets and liabilities:                                                     |   |                          |    |   |   |
| Decrease in other assets                                                              |   | 4,664                         |    | 17,383 |   |
| Decrease in accounts payable and accrued expenses                                     |   | (29,775                       | )       | (45,018 | ) |
| **Net Cash Used by Operating Activities**                                             |   | (70,754                       | )       | (104,500 | ) |
|                                                                                  |   |                          |    |   |   |
| **Investing Activities:**                                                             |   |                          |    |   |   |
| Proceeds from disposals of leases and other owned assets                              |   | 80,279                        |    | 20,294 |   |
| Proceeds from sales of investments                                                    |   | 5,120                         |    | 148,004 |   |
| Proceeds from sales of financial assets                                               |   | 310,706                       |    | 507,675 |   |
| Collections from financial assets                                                     |   | 832,118                       |    | 1,515,370 |   |
| Fundings under existing customer commitments                                          |   | (223,519                      | )       | (609,010 | ) |
| Recoveries of loans previously written off                                            |   | 44,437                        |    | 25,642 |   |
| **Net Cash Provided by Investing Activities**                                         |   | 1,049,141                     |    | 1,607,975 |   |
|                                                                                  |   |                          |    |   |   |
| **Financing Activities:**                                                             |   |                          |    |   |   |
| Repayments of Berkadia Loan                                                           |   | (975,000                      | )       | (2,050,000 | ) |
| **Net Cash Used by Financing Activities**                                             |   | (975,000                      | )       | (2,050,000 | ) |
|                                                                                  |   |                          |    |   |   |
| **Increase (Decrease) in Cash and Cash Equivalents**                                  |   | 3,387                         |    | (546,525 | ) |
|                                                                                  |   |                          |    |   |   |
| **Cash and Cash Equivalents, beginning of period**                                    |   | 575,215                       |    | 1,027,241 |   |
|                                                                                  |   |                          |    |   |   |
| **Cash and Cash Equivalents, end of period**                                          |   | $                             | 578,602 |   | $ | 480,716 |   |

 

*See notes to interim condensed consolidated financialstatements.*

 

3

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**THE FINOVAGROUP INC.**

**CONDENSED STATEMENTS OF CONSOLIDATEDSTOCKHOLDERS’ EQUITY**

**(Dollars inthousands)**

**(Unaudited)**

 
|                                                       |   | **Common  Stock** |   | **Additional  Capital** |   | **Accumulated  Deficit** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |       | **Common  Stock in  Treasury** |   | **Total  Stockholders’  Equity** |   |
|------------------------------------------------------------|--------|-------------------|--------|-------------------------|--------|--------------------------|--------|------------------------------------------------------|------------|--------------------------------|--------|---------------------------------------|--------|
| **Balance, January 1, 2002**                               |   | $                 | 1,259  |                    | $      | 16,928                   |   | $                                                    | (1,142,300 | )                              | $      | 4,080                                 |   | $ | (536 | ) | $ | (1,120,569 | ) |
| Comprehensive income:                                      |   |              |   |                    |   |                     |   |                                                 |       |                           |   |                                  |   |
| Net income                                                 |   |              |   |                    |   | 121,472                  |   |                                                 |       |                           |   | 121,472                               |   |
| Net change in unrealized  holding gains (losses)           |   |              |   |                    |   |                     |   | (10,743                                              | )          |                           |   | (10,743                               | )      |
| Net change in foreign  currency translation                |   |              |   |                    |   |                     |   | 2,786                                                |       |                           |   | 2,786                                 |   |
| Comprehensive income                                       |   |              |   |                    |   |                     |   |                                                 |       |                           |   | 113,515                               |   |
| Benefits realized from  pre-confirmation NOLs              |   |              |   | 36,029                  |   |                     |   |                                                 |       |                           |   | 36,029                                |   |
| Other                                                      |   |              |   | 276                     |   |                     |   |                                                 |       |                           |   | 276                                   |   |
| **Balance,  December 31, 2002**                            |   | 1,259             |   | 53,233                  |   | (1,020,828               | )      | (3,877                                               | )          | (536                           | )      | (970,749                              | )      |
| Comprehensive income:                                      |   |              |   |                    |   |                     |   |                                                 |       |                           |   |                                  |   |
| Net income                                                 |   |              |   |                    |   | 84,968                   |   |                                                 |       |                           |   | 84,968                                |   |
| Net change in unrealized  holding gains (losses)           |   |              |   |                    |   |                     |   | 1,367                                                |       |                           |   | 1,367                                 |   |
| Net change in foreign  currency translation                |   |              |   |                    |   |                     |   | (24                                                  | )          |                           |   | (24                                   | )      |
| Comprehensive income                                       |   |              |   |                    |   |                     |   |                                                 |       |                           |   | 86,311                                |   |
| Benefits realized from  pre-confirmation tax contingencies |   |              |   | 22,546                  |   |                     |   |                                                 |       |                           |   | 22,546                                |   |
| **Balance,  June 30, 2003**                                |   | $                 | 1,259  |                    | $      | 75,779                   |   | $                                                    | (935,860   | )                              | $      | (2,534                                | )      | $ | (536 | ) | $ | (861,892 | ) |

 

*See notes to interim condensed consolidated financialstatements.*

 

4

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**THE FINOVA GROUP INC.**

**NOTESTO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30, 2003**

**(Dollars in thousands in tables)**

**(Unaudited)**

** **

**A.****                                   ****Nature of Operations and Basis of Presentation**

 

The accompanying financial statementsand notes thereto should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form10-K for the year ended December 31, 2002. Capitalized terms not defined hereinare used as defined in the Form 10-K.

 

The following discussion relates toThe FINOVA Group Inc. and its subsidiaries (collectively “FINOVA” or the“Company”), including its principal operating subsidiary, FINOVA CapitalCorporation and its subsidiaries (“FINOVA Capital”). FINOVA, a Delawarecorporation incorporated in 1991, is a financial services holding company.Through FINOVA Capital, the Company has provided a broad range of financing andcapital markets products, primarily to mid-size businesses. FINOVA’s business isbeing operated under a Management Services Agreement with Leucadia NationalCorporation (“Leucadia”), which expires in 2011. Leucadia has designated itsemployees to act as Chairman of the Board (Ian M. Cumming), President (JosephS. Steinberg) and Chief Executive Officer (Thomas E. Mara). FINOVA Capital hasbeen in operation since 1954.

 

Since emergence from chapter 11 inAugust 2001, the Company’s business activities have been limited to maximizingthe value of its portfolio through the orderly collection of its assets. Theseactivities include collection efforts pursuant to underlying contractual termsand may include efforts to retain certain customer relationships andrestructure or terminate other relationships. The Company has not and does notexpect to engage in any new lending activities, except to honor existingcustomer commitments and in certain instances, to restructure financingrelationships with existing customers to maximize value. Operations have beenrestructured to more efficiently manage these collection efforts. The Companyhas sold portions of asset portfolios and will consider future sales if buyerscan be found at acceptable prices; however, there can be no assurance that theCompany will be successful in efforts to sell additional assets. Any fundsgenerated from these activities in excess of cash reserves permitted in theCompany’s debt agreements are used to reduce FINOVA’s obligations to itscreditors.

 

***Going Concern***

*** ***

FINOVA has a substantial negativenet worth and it is highly unlikely that the Company will be able to repay itsSenior Notes in their entirety at maturity in November 2009. While FINOVAcontinues to pay its obligations as they become due, the ability of the Companyto continue as a going concern is dependent upon many factors, particularly theability of its borrowers to repay their obligations to FINOVA and the Company’sability to realize the value of its portfolio. The accompanying condensedconsolidated financial statements do not include any adjustments relating tothe recoverability and classification of assets or the amounts andclassification of liabilities that might be necessary should the Company beunable to continue as a going concern. The Company’s independent publicaccountants qualified their report on the Company’s 2002, 2001 and 2000financial statements due to concerns regarding the Company’s ability tocontinue as a going concern.

 

**B.****                                   ****Significant Accounting Policies**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnites States requires FINOVA to use estimates and assumptions that affectreported amounts of assets and liabilities, revenues and expenses anddisclosure of contingent assets and liabilities. Those estimates are subject toknown and unknown risks, uncertainties and other factors that could materiallyimpact the amounts reported and disclosed in the financial statements.Significant estimates include anticipated amounts and timing of future cashflows used in the calculation of Fresh-Start Reporting adjustments, the reservefor credit losses and measurement of impairment. Other estimates includeselection of appropriate risk adjusted discount rates used in net present valuecalculations, determination of fair values of certain financial assets forwhich there is not an active market, residual assumptions for leasingtransactions and determination of appropriate valuation allowances againstdeferred tax assets. Actual results could differ from those estimated.

 

5

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For a listing of the Company’ssignificant accounting policies, see Note B “Significant Accounting Policies”in the Company’s Annual Report on Form 10-K for the year ended December 31,2002.

 

***Consolidation Policy for Interim Reporting***

 

The interim condensed consolidatedfinancial statements present the financial position, results of operations andcash flows of FINOVA and its subsidiaries, including FINOVA Capital and itssubsidiaries. These financial statements have been prepared in accordance withaccounting principles generally accepted in the United States. All intercompanybalances have been eliminated in consolidation.

 

The interim condensed consolidatedfinancial information is unaudited. In the opinion of management, all adjustmentsconsisting of normal recurring items necessary to present fairly the financialposition as of June 30, 2003 and the results of operations and cash flowspresented herein have been included in the condensed consolidated financialstatements. Interim results are not necessarily indicative of results ofoperations for the full year.

 

***New Accounting Standards***

 

In January 2003, The FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities” (“FIN 46”). FIN 46 addresses consolidation ofvariable interest entities, which are defined as entities whose equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. FIN 46 applies immediately to variable interest entities created afterJanuary 31, 2003 and to those in which an enterprise obtains an interest afterthat date. FIN 46 is to be applied in the first fiscal year or interim periodbeginning after June 15, 2003, for variable interest entities held by anenterprise acquired before February 1, 2003.

 

The Company is currently evaluatingthe impact of implementing FIN 46, which it expects could be material ifcertain entities with which the Company has contractual lending arrangementsare considered variable interest entities and are required to be consolidated.Implementation will be complex because as a lender, FINOVA does not have operatingcontrol over these entities (many of which are financially troubled) and maynot have the contractual right to require them to provide the Company withfinancial information that is of a quality necessary to ensure compliance withvarious rules and regulations for a public company.

 

**C.****                                   ****Total Financial Assets**

 

Total financial assets representsthe Company’s portfolio of investment activities, primarily consisting ofsecured financing to commercial and real estate enterprises principally underfinancing contracts (such as loans and other financing contracts, directfinancing leases and leveraged leases). In addition to its financing contracts,the Company has other financial assets, including assets held for sale, ownedassets (such as operating leases and assets held for the production of income)and investments (debt and equity securities and partnership interests). As ofJune 30, 2003 and December 31, 2002, the carrying amount of total financialassets (before reserve for credit losses) was $2.6 billion and $3.7 billion,respectively.

 

To date, the asset liquidationprocess has resulted in significant reductions in size of many of the Company’sniche portfolios. As a result, these former portfolios (commercial equipment,communications, corporate finance, franchise, healthcare, mezzanine andrediscount) have been combined in the table below. The resort, transportationand specialty real estate portfolios are reported separately.

 

6

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The following table details thecomposition and carrying amounts of FINOVA’s total financial assets:

 
|                        |   | **Revenue  Accruing  Assets** |      | **Revenue  Accruing  Impaired** |   | **Nonaccruing  Impaired  Loans** |   | **Nonaccruing  Leases  & Other** |    | **Owned  Assets &  Investments** |   | **Total  Financial  Assets** |      | **%**  |    |
|-----------------------------|--------|-------------------------------|-----------|---------------------------------|--------|----------------------------------|--------|--------------------------------------|---------|--------------------------------------|--------|------------------------------|-----------|--------|---------|
| Resort                      |   | $                             | 821,559   |                            | $      | 2,178                            |   | $                                    | 77,757  |                                 | $      | 18,453                       |      | $      | 3,500   |   | $ | 923,447 |   | 35.2 |   |
| Transportation              |   |                          |      | 258,420                         |   | 135,418                          |   | 25,989                               |    | 131,497                              |   | 551,324                      |      | 21.0   |    |
| Specialty Real Estate       |   | 383,690                       |      | 2,798                           |   | 65,737                           |   |                                 |    | 970                                  |   | 453,195                      |      | 17.3   |    |
| All Other Portfolios        |   | 212,173                       |      | 95,245                          |   | 339,888                          |   | 32,806                               |    | 14,340                               |   | 694,452                      |      | 26.5   |    |
| **Total  financial assets** |   | $                             | 1,417,422 |                            | $      | 358,641                          |   | $                                    | 618,800 |                                 | $      | 77,248                       |      | $      | 150,307 |   | $ | 2,622,418 |   | 100.0 |   |
| Reserve for credit losses   |   |                          |      |                            |   |                             |   |                                 |    |                                 |   | (359,222                     | )         |   |    |
| **Total (1)**               |   |                          |      |                            |   |                             |   |                                 |    |                                 |   | $                            | 2,263,196 |   |    |   |

 

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**Notes:**

(1)                           Excludes$107.3 million of assets sold that the Company manages.

 

Since FINOVA’s total financialassets are concentrated in certain specialized industries, such astransportation and resort, the Company is subject to both general economic riskand the additional risk of economic downturns within individual sectors of theeconomy. Additionally, the Company has completed multiple financialtransactions with individual borrowers and their affiliates, resulting in agreater total exposure to those borrowers beyond the typical transaction sizeand increased concentration risk of economic events affecting the industries ofthose borrowers and their affiliates.

 

At June 30, 2003, the Company’stransportation portfolio consisted of the following aircraft:

 
| **Aircraft Type**                                  |   | **Number of  Aircraft** |   | **Passenger** |   | **Cargo** |   | **Approximate****Average Age (years)** |   |
|----------------------------------------------------|--------|-------------------------|--------|---------------|--------|-----------|--------|----------------------------------------|--------|
| Airbus 300                                         |   | 8                       |   | 4             |   | 4         |   | 13                                     |   |
| Boeing 727                                         |   | 34                      |   | 9             |   | 25        |   | 26                                     |   |
| Boeing 737                                         |   | 27                      |   | 27            |   |      |   | 19                                     |   |
| Boeing 747                                         |   | 15                      |   | 8             |   | 7         |   | 22                                     |   |
| Boeing 757                                         |   | 8                       |   | 8             |   |      |   | 10                                     |   |
| Boeing 767                                         |   | 1                       |   | 1             |   |      |   | 17                                     |   |
| McDonnell Douglas DC 8 and  DC 9                   |   | 32                      |   | 23            |   | 9         |   | 30                                     |   |
| McDonnell Douglas DC 10                            |   | 18                      |   | 7             |   | 11        |   | 25                                     |   |
| McDonnell Douglas MD  series                       |   | 30                      |   | 30            |   |      |   | 18                                     |   |
| Regional jets, corporate  aircraft and turbo props |   | 43                      |   | 42            |   | 1         |   | 11                                     |   |
| Total                                              |   | 216                     |   | 159           |   | 57        |   | 20                                     |   |

 

At June 30, 2003, 78 aircraft witha carrying value of $319.5 million were operated by U.S. domiciled carriers and71 aircraft with a carrying value of $180.0 million were operated by foreigncarriers. Additionally, 67 aircraft with a carrying value of $30.8 million wereoff-lease, classified as held for the production of income and were parked atvarious storage facilities in the United States and Europe, including 14aircraft which are currently being dismantled to be sold in the parts market.Some of these off-lease aircraft are periodically placed in rental agreementswith payments based on aircraft usage, commonly known as power-by-the-houragreements. Often under these agreements, there are no minimum rents due, andfuture cash flows are difficult to project. FINOVA’s railroad portfolio (alldomestic) and other transportation equipment had a carrying value of $21.0million at June 30, 2003.

 

7

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In addition to the concentratedexposures within the transportation portfolio, the Company has certaingeographic concentrations within its resort portfolio. At June 30, 2003, thecarrying amount of the resort portfolio by state was as follows:

 
|                       |   | **Carrying  Amount** |    | **%**  |   |
|----------------------------|--------|----------------------|---------|--------|--------|
| Florida                    |   | $                    | 248,205 |   | 26.9   | % |
| California                 |   | 155,182              |    | 16.8   | %      |
| Hawaii                     |   | 120,415              |    | 13.0   | %      |
| Nevada                     |   | 99,770               |    | 10.8   | %      |
| Other (each less than 10%) |   | 299,875              |    | 32.5   | %      |
| Total                      |   | $                    | 923,447 |   | 100.0  | % |

 

An analysis of nonaccruing assetsincluded in total financial assets is as follows:

 
|                                                                            |   | **June 30,  2003** |    | **December 31,  2002** |   |
|---------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
| Contracts                                                                       |   | $                  | 666,576 |                   | $      | 1,345,191 |   |
| Repossessed assets (1)                                                          |   | 29,472             |    | 48,041                 |   |
| Total nonaccruing assets                                                        |   | $                  | 696,048 |                   | $      | 1,393,232 |   |
| Nonaccruing assets as a  percentage of total financial assets (before reserves) |   | 26.5               | %       | 37.7                   | %      |

 

----

**Notes:**

(1)                           Excludesaircraft, which upon repossession are classified as assets held for theproduction of income.

 

Accounts classified as nonaccruingwere $696.0 million or 26.5% of total financial assets (before reserves) atJune 30, 2003 as compared to $1.4 billion or 37.7% at December 31, 2002. Thedecline in nonaccruing assets was primarily attributed to collections and assetsales of $586.5 million and write-offs and net valuation markdowns of $88.7million. Also contributing to the decline was the return of certain assets toaccruing status following demonstration of sustained performance and theclassification of newly repossessed aircraft as assets held for the productionof income, which are excluded from nonaccruing assets.

 

At June 30, 2003, total financialassets included $84.9 million of assets held for sale, down $308.2 million fromDecember 31, 2002. The decrease was due to $203.3 million of asset sales(primarily rediscount assets), $54.3 million of assets no longer being held forsale and reclassified to loans, net runoff of $39.9 million and markdowns of$10.7 million.

 

**D.****                                   ****Reserve for Credit Losses**

 

The following table presents thebalances and changes to the reserve for credit losses:

 
|                                    |   | **Six Months Ended  June 30,** |    |
|-----------------------------------------|--------|--------------------------------|---------|
|                                    |   | **2003**                       |    | **2002** | ** ** |
| Balance, beginning of year              |   | $                              | 540,268 |   | $ | 1,019,878 |   |
| Provision for credit  losses (reversal) |   | (123,573                       | )       | (154,018 | ) |
| Write-offs                              |   | (101,943                       | )       | (91,154 | ) |
| Recoveries                              |   | 44,437                         |    | 25,642 |   |
| Other                                   |   | 33                             |    | 317 |   |
| Balance, end of period                  |   | $                              | 359,222 |   | $ | 800,665 |   |

 

For the six months ended June 30,2003, the Company recorded a $123.6 million negative provision for creditlosses to reduce its reserve for credit losses. The negative provision wasprimarily due to proceeds received from prepayments and asset sales in excessof recorded carrying amounts (net of reserves), collections and recoveries ofamounts previously written off. Partially offsetting these reversals were newimpairment reserves established on specific accounts.

 

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A summary of the reserve for creditlosses by impaired and other assets is as follows:

 
|                         |   | **June 30,  2003** |    | **December 31,  2002** | ** ** |
|------------------------------|--------|--------------------|---------|------------------------|------------|
| Reserves on impaired  assets |   | $                  | 284,017 |                   | $          | 438,172 |   |
| Other reserves               |   | 75,205             |    | 102,096                |       |
| Reserve for credit losses    |   | $                  | 359,222 |                   | $          | 540,268 |   |

 

At June 30, 2003, the totalcarrying amount of impaired loans and leases was $1.0 billion, of which $358.6million were revenue accruing. The Company has established impairment reservesof $284.0 million related to $659.5 million of nonaccruing and impaired assets.At December 31, 2002, the total amount of impaired loans and leases was $1.8billion, of which $471.1 million were revenue accruing. The impairment reserveat December 31, 2002 totaled $438.2 million related to $1.2 billion ofnonaccruing and impaired assets.

 

Reserves on impaired assetsdecreased due to write-offs (primarily upon the repossession of aircraft), animprovement in pay-off and collection experience on certain assets previouslyreserved and the Company’s application of cash received on nonaccruing assets,thus reducing the impairment reserves required on those assets. Partiallyoffsetting these reductions were new impairment reserves established for assetsreclassified to impaired status during 2003 and additional reserves recorded onexisting impaired assets.

 

Other reserves related to estimatedinherent losses on unimpaired assets decreased primarily as a result ofcollections, asset sales and changes in historical loss experience.

 

**E.****                                     ****Debt**

 

A summary of the Company’s total debtoutstanding is as follows:

 
|                            |   | **June 30,  2003** |      | **December 31,  2002** | ** ** |
|---------------------------------|--------|--------------------|-----------|------------------------|------------|
| Berkadia Loan                   |   | $                  | 1,200,000 |                   | $          | 2,175,000 |   |
| Senior Notes:                   |   |               |      |                   |       |
| Principal                       |   | 3,067,949          |      | 3,067,949              |       |
| Fresh-Start Reporting  discount |   | (668,832           | )         | (686,306               | )          |
| Total Senior Notes, net         |   | 2,399,117          |      | 2,381,643              |       |
| Total debt                      |   | $                  | 3,599,117 |                   | $          | 4,556,643 |   |

 

During the second quarter of 2003,prepayments of the Berkadia Loan totaled $325.0 million. Principal paymentsmade to Berkadia since emergence from chapter 11 have reduced the Berkadia Loanto $1.2 billion as of June 30, 2003. The pace of loan repayments depends onnumerous factors, including the rate of collections from borrowers and assetsales.

 

At June 30, 2003, the Senior Notesare reflected in the Company’s balance sheet net of a remaining $668.8 millionunamortized discount, which was originally recorded with the adoption ofFresh-Start Reporting upon emergence from chapter 11. The recorded book valueof the Senior Notes is scheduled to increase to $3.07 billion over time throughamortization of the discount as interest expense. The Company is obligated torepay the full $3.07 billion principal amount of the Senior Notes.

 

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**F.****                                     ****Costs Associated with Exit or Disposal Activities**

 
|                       |   | **Termination  Benefits** |        | **Contract****TerminationCosts** |   |
|----------------------------|--------|---------------------------|-------------|----------------------------------|--------|
| Balance, beginning of year |   | $                         |  8,878 |                             | $      |  9,581 |   |
| Payments                   |   | (5,129                    | )           | (4,123                           | )      |
| Net additions              |   | 401                       |        | 1,757                            |   |
| Balance, end of period     |   | $                         | 4,150       |                             | $      | 7,215 |   |

 

As of June 30, 2003, FINOVA had aliability for termination benefits of $4.2 million for approximately 50individuals at various levels within the Company. During the six months endedJune 30, 2003, the Company paid termination benefits of $5.1 million andrecorded a net charge of $0.4 million for employees notified during that periodof their pending termination.

 

As of June 30, 2003, the remainingliability for contract termination costs related to office leases totaled $7.2million. The decrease since December 31, 2002 was due to the payment ofscheduled lease rentals and termination costs, partially offset by subleaseincome and accruals related to additional idle office space.

 

**G.****                                   ****Income Taxes**

 

For the six months ended June 30,2003, income tax expense related to pre-tax book income was entirely offset bya decrease in valuation allowances, which were previously established due tothe Company’s concern regarding its ability to utilize deferred tax assetsgenerated from losses in prior periods. The reasons the Company may not be ableto utilize all the deferred tax assets include uncertainty about the amount offuture earnings, a variety of loss or other tax attribute carryover limitationsin the various jurisdictions in which the Company files tax returns anduncertainty regarding the timing of the reversal of deferred tax liabilities.As of June 30, 2003, the Company had federal net operating losses of $1.1billion available for carryforward.

 

During the second quarter of 2003,the Company was able to favorably resolve certain pre-confirmation taxcontingencies, which were recorded as a direct addition to paid-in-capital inaccordance with the provisions of the American Institute of Certified PublicAccountants’ Statement of Position 90-7, “Financial Reporting by Entities inReorganization Under the Bankruptcy Code.” As a result, the Company’s deferredincome taxes were reduced to $2.8 million as of June 30, 2003 from $16.8million at December 31, 2002.

 

**Item 2****.****          ****Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

Management’s Discussion andAnalysis of Financial Condition and Results of Operations should be read inconjunction with the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2002. Capitalized terms not defined herein are used as defined inthe Form 10-K.

 

The following discussion relates toThe FINOVA Group Inc. and its subsidiaries (collectively “FINOVA” or the“Company”), including its principal operating subsidiary, FINOVA CapitalCorporation and its subsidiaries (“FINOVA Capital”). FINOVA, a Delaware corporationincorporated in 1991, is a financial services holding company. Through FINOVACapital, the Company has provided a broad range of financing and capitalmarkets products, primarily to mid-size businesses. FINOVA’s business is beingoperated under a Management Services Agreement with Leucadia NationalCorporation (“Leucadia”), which expires in 2011. Leucadia has designated itsemployees to act as Chairman of the Board (Ian M. Cumming), President (JosephS. Steinberg) and Chief Executive Officer (Thomas E. Mara). FINOVA Capital hasbeen in operation since 1954.

 

***CurrentBusiness Activities***

 

Since emergence from chapter 11 inAugust 2001, the Company’s business activities have been limited to maximizingthe value of its portfolio through the orderly collection of its assets. Theseactivities include collection efforts pursuant to underlying contractual termsand may include efforts to retain certain customer relationships andrestructure or terminate other relationships. The Company has not and does notexpect to engage in any new lending activities, except to honor existingcustomer commitments and

 

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incertain instances, to restructure financing relationships with existingcustomers to maximize value. Operations have been restructured to moreefficiently manage these collection efforts. The Company has sold portions ofasset portfolios and will consider future sales if buyers can be found atacceptable prices; however, there can be no assurance that the Company will besuccessful in efforts to sell additional assets. Any funds generated from theseactivities in excess of cash reserves permitted in the Company’s debtagreements are used to reduce FINOVA’s obligations to its creditors.

 

**Application of CriticalAccounting Policies and Use of Estimates**

 

The Company’s consolidatedfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires FINOVA to use estimates and assumptions that affectreported amounts of assets and liabilities, revenues and expenses anddisclosure of contingent assets and liabilities. These estimates are subject toknown and unknown risks, uncertainties and other factors that could materiallyimpact the amounts reported and disclosed in the financial statements. TheCompany believes the following to be among the most critical judgment areas inthe application of its accounting policies.

 

***Carrying Amounts, Impairment and Use of Estimates***

 

Several of the Company’s accountingpolicies pertain to the ongoing determination of impairment reserves onfinancing assets and the carrying amount valuation of other financial assets.Determination of impairment reserves and carrying amounts rely, to a greatextent, on the estimation and timing of future cash flows. FINOVA’s cash flowestimates assume that its asset portfolios are collected in an orderly fashionover time. These cash flows do not represent estimated recoverable amounts ifFINOVA were to liquidate its asset portfolios over a short period of time.Management believes that a short-term asset liquidation could have a materialnegative impact on the Company’s ability to recover recorded asset amounts.

 

FINOVA’s process of determining impairmentreserves and carrying amounts includes a periodic assessment of its portfolioson a transaction by transaction basis. Cash flow estimates are based on currentinformation and numerous assumptions concerning future general economicconditions, specific market segments, the financial condition of the Company’scustomers and FINOVA’s collateral. In addition, assumptions are sometimesnecessary concerning the customer’s ability to obtain full refinancing ofballoon obligations or residuals at maturity. As a result, the Company’s cashflow estimates assume FINOVA incurs refinancing discounts for certaintransactions.

 

Changes in facts and assumptionshave resulted in, and may in the future result in, significant positive ornegative changes to estimated cash flows and therefore, impairment reserves andcarrying amounts.

 

Impairment of financing assets isrecorded through the Company’s reserve for credit losses, and accounting rulespermit the reserve for credit losses to be increased or decreased as facts andassumptions change. Impairment of other financial assets is marked downdirectly against the asset’s carrying amount. Accounting rules permit furthermarkdown if changes in facts and assumptions result in additional impairment;however, most of these assets (except certain investments and assets held forsale, which may be marked up for subsequent events) may not be marked up ifsubsequent facts and assumptions result in a projected increase in value.Recoveries of previous markdowns are recorded through operations when realized.

 

The carrying amounts and reservefor credit losses recorded on FINOVA’s financial statements reflect theCompany’s expectation of collecting less than the full contractual amounts owedby some of its customers and recovering less than its original investment incertain owned assets. The Company continues to pursue collection of fullcontractual amounts and original investments, where appropriate, in an effortto maximize the value of its asset portfolios.

 

FINOVA has a significant number ofaircraft that are off lease and anticipates that additional aircraft will bereturned as leases expire or operators are unable or unwilling to continuemaking payments. In accordance with the provisions of SFAS No. 144 “Accountingfor the Impairment or Disposal of Long-Lived Assets,” FINOVA has recordedimpairment losses on owned aircraft by calculating the present value ofestimated cash flows. For many of these aircraft, scrap value was assumed, butfor certain aircraft, the Company elected (or anticipates electing upon returnof the aircraft) to park and maintain the aircraft under the assumption thatthey will be re-leased or sold in the future despite the lack of demand forthose aircraft today. While the current inactive market makes it difficult toquantify, the Company believes that the recorded values determined under thismethodology significantly exceed the values that the Company would realize ifit were to liquidate those aircraft today.

 

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The current state of the aircraftindustry includes significant excess capacity for both new and used aircraftand lack of demand for certain classes and configurations of aircraft in theportfolio. Accordingly, the Company reduced the useful lives and anticipatedscrap values of various aircraft and reduced its estimates regarding itsability to lease or sell certain returned aircraft.

 

The process of determiningappropriate carrying amounts for these aircraft is particularly difficult andsubjective, as it requires the Company to estimate future demand, lease ratesand scrap values for assets for which there is currently little or no demand.The Company re-assesses its estimates and assumptions each quarter. Inparticular, the Company assesses market activity and the likelihood thatcertain aircraft types, which are forecast to go back on lease in the future,will in fact be re-leased, and may further reduce carrying amounts if it isdetermined that such re-leasing is unlikely to occur or that lower marketvalues have been established.

 

**Reserve forCredit Losses.** The reserve for credit lossesrepresents FINOVA’s estimate of losses inherent in the portfolio and includesreserves on impaired assets and on assets that are not impaired. Impairment reservesare created if the carrying amount of an asset exceeds its estimated recovery,which is measured by estimating the present value of expected future cash flows(discounted at contractual rates), market value, or the fair value ofcollateral. These methodologies include the use of significant estimates andassumptions regarding future customer performance, amount and timing of futurecash flows and collateral value. Reserves on assets that are not impaired arebased upon assumptions including general economic conditions, overall portfolioperformance, including loss experience, delinquencies and other inherentportfolio characteristics. Actual results could differ from these estimates andthere can be no assurance that existing reserves will approximate actual futurelosses. As of June 30, 2003 and December 31, 2002, the reserve for creditlosses totaled $359.2 million and $540.3 million, respectively.

 

**OwnedAssets.** Assets held for the production of income and operatingleases are carried at amortized cost with impairment adjustments, if any,recorded as permanent markdowns through operations. An owned asset isconsidered impaired if anticipated undiscounted cash flows are less than thecarrying amount of the asset. Once the asset has been deemed impaired,accounting rules allow for several acceptable methods for measuring the amountof impairment. FINOVA’s typical method of measuring impairment is based on thecomparison of the carrying amount of those assets to the present value ofestimated future cash flows, using risk adjusted discount rates. Theseestimates include assumptions regarding lessee performance, the amount andtiming of future cash flows, selection of risk adjusted discount rates for netpresent value calculations and residual value assumptions for leases. If futureportfolio assessments indicate additional impairment, additional markdowns maybe necessary. If recoveries of previous markdowns are realized, gains arerecorded at that time. As of June 30, 2003 and December 31, 2002, owned assetstotaled $134.2 million and $179.7 million, or 5.1% and 4.9% of total financialassets (before reserves), respectively.

 

**Assets Heldfor Sale.** Assets held for sale are comprised of assets previouslyclassified as financing transactions and other financial assets that managementdoes not have the intent and/or the ability to hold to maturity. These assetsare carried at the lower of cost or market less anticipated selling expenses,with adjustment to estimated market value, if any, recorded as a loss on financialassets. Market value is often determined by the estimation of anticipatedfuture cash flows discounted at risk adjusted market rates to determine netpresent value. Valuation of assets held for sale includes estimates regardingmarket conditions and ultimate sales prices. Actual sales prices could differfrom estimates, impacting results from operations. As of June 30, 2003 andDecember 31, 2002, assets held for sale totaled $84.9 million and $393.1million, or 3.2% and 10.6% of total financial assets (before reserves),respectively.

 

**NonaccruingAssets.** Accounts are generally classified as nonaccruing andrecognition of income is suspended when a customer becomes 90 days past due onthe payment of principal or interest, or earlier, if in the opinion ofmanagement, full recovery of contractual income and principal becomes doubtful.The decision to classify accounts as nonaccruing on the basis of criteria otherthan delinquency, is based on certain assumptions and estimates includingcurrent and future general economic conditions, industry specific economicconditions, customer financial performance, the ability of customers to obtainfull refinancing of balloons or residuals at maturity and FINOVA’s ability orwillingness to provide such refinancing. In certain instances, accounts may bereturned to accruing status if sustained contractual performance isdemonstrated. Changes in borrower performance, assumptions or estimates couldresult in a material change in nonaccruing account classification and incomerecognition. As of June 30, 2003 and December 31, 2002, $696.0 million and $1.4billion, or 26.5% and 37.7% of total financial assets (before reserves), wereclassified as nonaccruing, respectively.

 

**Fresh-StartReporting.**Upon emergence from chapter 11, the Company adoptedFresh-Start Reporting, which resulted in material adjustments to the carryingamounts of the Company’s assets and liabilities. The $863.7 million adjustmentto assets was based on the present value of estimated future cash flows discountedat appropriate risk adjusted interest rates. Of this amount, $365.4 million wasscheduled to amortize into income over the life of the underlying transactions.If the underlying transactions are

 

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subsequently classified asnonaccruing, amortization ceases. The Senior Notes were initially recorded at$2.48 billion, reflecting their estimated fair value. The $771.3 milliondiscount to the Senior Notes is amortized as additional interest expense over theterm of the notes and the liability recorded on the Reorganized Company’sbalance sheet increases in an amount equal to such amortization. In the eventthat any Senior Notes are repurchased and extinguished, as occurred in 2002,the unamortized fresh-start adjustment related to those notes is recorded as anoffset to any gain recognized from extinguishment of the debt. Although therecorded balance is net of the unamortized discount, the Company’s repaymentobligation is the principal amount, which was $3.07 billion at June 30, 2003.Based on the Company’s current financial condition, it is highly unlikely thatthere will be funds available to fully repay the principal amount of the SeniorNotes at maturity.

 

The adjustments relating to theadoption of Fresh-Start Reporting were based on estimates of anticipated futurecash flows, risk adjusted discount rates and the market value of the Company’sdebt securities shortly after emergence, but prior to September 11, 2001.Changes to estimated cash flows could further impact the reserve for creditlosses or cause additional write downs of assets. Generally accepted accountingprinciples in the U.S. do not permit additional fair value adjustments to theSenior Notes after the initial Fresh-Start Reporting date, including those thatwould have resulted from the impact of September 11.

 

**NewAccounting Standards.**In January 2003, The FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities” (“FIN 46”). FIN 46 addresses consolidation ofvariable interest entities, which are defined as entities whose equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance its activitieswithout additional subordinated financial support from other parties. FIN 46applies immediately to variable interest entities created after January 31,2003 and to those in which an enterprise obtains an interest after that date.FIN 46 is to be applied in the first fiscal year or interim period beginningafter June 15, 2003, for variable interest entities held by an enterpriseacquired before February 1, 2003.

 

The Company is currently evaluatingthe impact of implementing FIN 46, which it expects could be material ifcertain entities with which the Company has contractual lending arrangementsare considered variable interest entities and are required to be consolidated.Implementation will be complex because as a lender, FINOVA does not haveoperating control over these entities (many of which are financially troubled)and may not have the contractual right to require them to provide the Companywith financial information that is of a quality necessary to ensure compliancewith various rules and regulations for a public company.

 

**Results of Operations**

 
|                                 |   | **Three Months  Ended June 30,** |       | **Six Months Ended  June 30,** |       |
|--------------------------------------|--------|----------------------------------|------------|--------------------------------|------------|
|                                 |   | **2003**                         |       | **2002**                       | ** ** | **Change** | ** ** | **2003** | ** ** | **2002** | ** ** | **Change** | ** ** |
|                                 |   | **(Dollars in thousands)**       | ** ** |
| Interest margin                      |   | $                                | (8,708     | )                              | $          | (18,964 | ) | $ | 10,256 |   | $ | (19,865 | ) | $ | (23,802 | ) | $ | 3,937 |   |
| Provision for credit  losses         |   | 69,574                           |       | 128,834                        |       | (59,260 | ) | 123,573 |   | 154,018 |   | (30,445 | ) |
| Net gain (loss) on  financial assets |   | 35,514                           |       | (64,527                        | )          | 100,041 |   | 32,372 |   | (63,559 | ) | 95,931 |   |
| Portfolio expenses                   |   | (8,005                           | )          | (13,580                        | )          | 5,575 |   | (18,529 | ) | (21,555 | ) | 3,026 |   |
| General and administrative  expenses |   | (16,161                          | )          | (27,632                        | )          | 11,471 |   | (32,583 | ) | (53,150 | ) | 20,567 |   |
| Income tax expense                   |   |                             |       | (2                             | )          | 2 |   |   |   | (4 | ) | 4 |   |
| Net income (loss)                    |   | $                                | 72,214     |                           | $          | 4,129 |   | $ | 68,085 |   | $ | 84,968 |   | $ | (8,052 | ) | $ | 93,020 |   |

 

***Six Months Ended June 30, 2003 and 2002***

 

**Net Income(Loss).**For the six months ended June 30, 2003, the Companyreported net income of $85.0 million compared to a net loss of $8.1 million forthe six months ended June 30, 2002. The results for 2003 included a $123.6 millionnegative provision for credit losses and a net gain on financial assets of$32.4 million, partially offset by a negative interest margin of $19.9 million,portfolio expenses of $18.5 million and general administrative expenses of$32.6 million. In general, the net income in 2003 was attributable to betterthan anticipated realization on FINOVA’s asset portfolios, with the exceptionof its transportation assets. The $8.1 million loss for 2002 was primarily theresult of a $23.8 million negative interest margin, a $63.6 million net loss onfinancial assets, portfolio expenses of $21.6 million and general andadministrative expenses of $53.1 million, partially offset by a $154.0 millionnegative provision for credit losses.

 

**Interest Margin.**Forthe six months ended June 30, 2003, interest margin was negative $19.9 millionas compared to a negative $23.8 million for the six months ended June 30, 2002.The negative margin was primarily due to a significantly lower

 

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levelof earning assets ($1.8 billion and $2.7 billion at June 30, 2003 and 2002,respectively) than outstanding debt ($3.6 billion and $5.4 billion at June 30,2003 and 2002, respectively) and the Company’s high rate aggregate cost offunds (8.0% and 6.9% for the six months ended June 30, 2003 and 2002,respectively). The cost of debt is expected to increase as the lower costBerkadia Loan (LIBOR plus 2.25%) is repaid and the higher cost Senior Notes(7.5% stated rate and 10.83% aggregate fixed cost including fresh-startdiscount amortization) become a higher percentage of the outstanding debt.Significantly offsetting the negative interest margin for 2003 has been thepartial recognition of suspended income as a result of improved performance andpayoffs on certain nonaccruing assets and a recent return to earning status ofcertain assets following demonstration of sustained performance.

 

**Provisionfor Credit Losses.** For the six months ended June 30,2003, the Company recorded a $123.6 million negative provision for creditlosses to reduce its reserve for credit losses. The negative provision wasprimarily due to proceeds from prepayments and asset sales exceeding recordedcarrying amounts (net of reserves), collections and recoveries of amounts previouslywritten off. In addition, the Company’s income recognition policy fornonaccruing accounts can result in periodic reserve reductions. In accordancewith SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,”impairment reserves are recorded if the carrying amount of a loan exceeds thenet present value of expected cash flows. For nonaccruing accounts, all cashreceived is applied against the carrying amount of the transaction. As aresult, carrying amounts decline at a faster pace than net present value, thusreducing the impairment reserve.

 

The $154.0 million negativeprovision for credit losses in 2002 primarily resulted from the sale of $485million of franchise assets in April 2002, portfolio runoff and the Company’sdetailed assessment of estimated inherent losses in its portfolio, whichindicated a slight improvement in estimated cash collections.

 

The pace of collections and accountpayoffs has been somewhat faster than expected. In most portfolios, amountscollected have, to a certain extent, exceeded anticipated cash flows, resultingin a partial reversal of previously established reserves.

 

The measurement of creditimpairment and asset valuation is dependent upon the significant use ofestimates and management discretion when predicting expected cash flows. Theseestimates are subject to known and unknown risks, uncertainties and otherfactors that could materially impact the amounts reported and disclosed herein.See the “Special Note Regarding Forward-Looking Statements” for a discussion ofthese and additional factors impacting the use of estimates.

 

**Net Gain onFinancial Assets.** The Company realized a net gain onfinancial assets of $32.4 million for the six months ended June 30, 2003compared to a net loss of $63.6 million for the six months ended June 30, 2002.The net gain during 2003 was primarily attributable to sales of owned assetsand financing contracts in excess of carrying amounts, the most significant ofwhich included a $11.4 million gain from the sale of a real estate leveragedlease, a $5.8 million gain realized from the sale of nine healthcare relatedloans and a $4.4 million gain realized on the first quarter rediscountportfolio sale. The remainder of the gain activity is attributable to numerousindividual asset sales spread across several portfolios. Partially offsettingthe gain activity were $24.5 million of owned asset impairment markdowns withinthe transportation portfolio. The impairment losses on the transportationportfolio resulted from the Company’s revised estimate of future cash flowsexpected to be realized through the operation or sale of its owned aircraftportfolio. Due to the current state of the aircraft industry, which includessignificant excess capacity for both new and used aircraft and a lack of demandfor certain classes and configuration of aircraft in the Company’s portfolio,the Company reduced cash flows expected to be received on certain aircraft andreduced its estimate regarding its ability to lease or sell certain returnedaircraft. Most of the Company’s aircraft are of an older vintage with limiteddemand in the aircraft market. As a result, the Company lowered its previousestimates of future cash flows expected from certain assets within its aircraftportfolio, resulting in additional impairment losses during 2003.

 

The $63.6 million net loss for thesix months ended June 30, 2002 included $125.8 million of impairment losses,partially offset by $62.2 million of gains. Significant components of the netloss consisted of an $84.8 million net markdown of owned assets within thetransportation portfolio, partially offset by net gains of $26.1 million withinthe corporate finance portfolio.

 

The measurement of owned assetimpairment is dependent upon the significant use of estimates and managementdiscretion when predicting expected future cash flows and asset values. Anasset is considered impaired if anticipated undiscounted cash flows are lessthan the carrying amount of the asset. Once the asset has been deemed impaired,the accounting rules provide several acceptable methods for measuringimpairment. FINOVA’s typical practice is to compare the carrying amount of theasset to the present value of the estimated future cash flows, using anappropriate risk adjusted discount rate. The process of measuring impairmentrequires judgment and estimation, and the actual results may differ from theestimates. See the “Special Note Regarding Forward-Looking Statements” for adiscussion of many factors that could impact these estimates.

 

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**PortfolioExpenses.**For the six months ended June 30, 2003, portfolio expensestotaled $18.5 million compared to $21.6 million during the same period of 2002.The decrease was primarily due to a decline in the level of problem account andworkout expenses for most portfolios (except transportation), and the timing ofcertain expenses anticipated during 2003. Partially offsetting this decreasewas an increase pertaining to FINOVA’s transportation portfolio, which incurredexpenses of $12.1 million during 2003 compared to $10.8 million in 2002. Thisincrease in transportation costs is directly related to the large number ofoff-lease and older vintage aircraft and includes the cost of storing,maintaining and preparing certain of these aircraft for potential return toservice.

 

**General andAdministrative Expenses.** General and administrativeexpenses decreased $20.6 million to $32.6 million for the six months ended June30, 2003. The decrease was primarily due to $11.3 million of cost savingsresulting from staffing and office occupancy reductions (240 employees at June30, 2003 compared to 396 at June 30, 2002). The remainder of the decrease wasthe result of an overall decline in general and administrative expenses causedby decreases in portfolio and staffing levels and the inclusion in the prioryear of $5.9 million of accruals for settlement of bankruptcy claims. Partiallyoffsetting the decline were additional accruals recorded in the second quarterof 2003 related to idle office space. The Company expects the dollar level ofgeneral and administrative expenses to continue to decrease as portfolio andstaffing levels decrease; however, general and administrative expenses as apercentage of assets or revenues will likely increase over time as a result ofcertain fixed costs and the high level of work intensive assets in theportfolio.

 

**Income TaxExpense.** For the six months ended June 30, 2003, income tax expenserelated to pre-tax book income was entirely offset by a decrease in valuationallowances, which were previously established due to the Company’s concernregarding its ability to utilize income tax benefits generated from losses inprior periods. As of June 30, 2003, the Company had federal net operating lossesof $1.1 billion available for carryforward.

 

***Three Months Ended June 30, 2003 and 2002***

 

**Net Income(Loss).**For the three months ended June 30, 2003, the Companyreported net income of $72.2 million compared to $4.1 million for the threemonths ended June 30, 2002. The results for 2003 included a $69.6 millionnegative provision for credit losses and a net gain on financial assets of$35.5 million, partially offset by a negative interest margin of $8.7 million,portfolio expenses of $8.0 million and general administrative expenses of $16.2million. In general, the net income in 2003 was attributable to better thananticipated realization on FINOVA’s asset portfolios, with the exception of itstransportation assets. The $4.1 million net income for 2002 was primarily theresult of a $128.8 million negative provision for credit losses, partiallyoffset by a $19.0 million negative interest margin, a $64.5 million net loss onfinancial assets, portfolio expenses of $13.6 million and general andadministrative expenses of $27.6 million.

 

**InterestMargin.**For the three months ended June 30, 2003, interest marginwas negative $8.7 million as compared to a negative $19.0 million for the threemonths ended June 30, 2002. The negative margin was primarily due to a significantlylower level of earning assets ($1.8 billion and $2.7 billion at June 30, 2003and 2002, respectively) than outstanding debt ($3.6 billion and $5.4 billion atJune 30, 2003 and 2002, respectively) and the Company’s high rate aggregatecost of funds (8.2% and 7.1% for the three months ended June 30, 2003 and 2002,respectively). The cost of debt is expected to increase as the lower costBerkadia Loan (LIBOR plus 2.25%) is repaid and the higher cost Senior Notes(7.5% stated rate and 10.83% aggregate fixed cost including fresh-startdiscount amortization) become a higher percentage of the outstanding debt.Significantly offsetting the negative interest margin for 2003 has been thepartial recognition of suspended income as a result of improved performance andpayoffs on certain nonaccruing assets during the second quarter of 2003 and arecent return to earning status of certain assets following demonstration ofsustained performance.

 

**Provisionfor Credit Losses.** For the three months ended June30, 2003, the Company recorded a $69.6 million negative provision for creditlosses to reduce its reserve for credit losses. The negative provision wasprimarily due to proceeds from prepayments and asset sales exceeding recordedcarrying amounts (net of reserves), collections and recoveries of amountspreviously written off. In addition, the Company’s income recognition policyfor nonaccruing accounts can result in periodic reserve reductions. Inaccordance with SFAS No. 114, “Accounting by Creditors for Impairment of aLoan,” impairment reserves are recorded if the carrying amount of a loanexceeds the net present value of expected cash flows. For nonaccruing accounts,all cash received is applied against the carrying amount of the transaction. Asa result, carrying amounts decline at a faster pace than net present value,thus reducing the impairment reserve.

 

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The $128.8 million negativeprovision for credit losses in 2002 primarily resulted from the sale of $485million of franchise assets in April 2002, portfolio runoff and the Company’sdetailed assessment of estimated inherent losses in its portfolio, whichindicated a slight improvement in estimated cash collections.

 

The pace of collections and accountpayoffs has been somewhat faster than expected. In most portfolios, amountscollected have, to a certain extent, exceeded anticipated cash flows, resultingin a partial reversal of previously established reserves.

 

The measurement of creditimpairment and asset valuation is dependent upon the significant use ofestimates and management discretion when predicting expected cash flows. Theseestimates are subject to known and unknown risks, uncertainties and otherfactors that could materially impact the amounts reported and disclosed herein.See the “Special Note Regarding Forward-Looking Statements” for a discussion ofthese and additional factors impacting the use of estimates.

 

**Net Gain onFinancial Assets.** The Company realized a net gain onfinancial assets of $35.5 million for the three months ended June 30, 2003compared to a net loss of $64.5 million for the three months ended June 30,2002. The net gain during the second quarter of 2003 was primarily attributableto sales of owned assets and financing contracts in excess of carrying amounts,the most significant of which included a $11.4 million gain from the sale of areal estate leveraged lease and a $5.8 million gain realized from the sale ofnine healthcare related loans. The remainder of the gain activity isattributable to numerous individual asset sales spread across severalportfolios. Partially offsetting the gain activity during the quarter were $2.7million of owned asset impairment markdowns within the transportationportfolio. The impairment losses on the transportation portfolio resulted fromthe Company’s revised estimate of future cash flows expected to be realizedthrough the operation or sale of its owned aircraft portfolio. Due to thecurrent state of the aircraft industry, which includes significant excesscapacity for both new and used aircraft and a lack of demand for certainclasses and configuration of aircraft in the Company’s portfolio, the Companyreduced cash flows expected to be received on certain aircraft and reduced itsestimate regarding its ability to lease or sell certain returned aircraft. Mostof the Company’s aircraft are of an older vintage with limited demand in theaircraft market. As a result, the Company slightly lowered its previousestimates of future cash flows expected from certain assets within its aircraftportfolio, resulting in modest additional impairment losses during the secondquarter of 2003.

 

The $64.5 million net loss for thethree months ended June 30, 2002 included $97.6 million of impairment losses,partially offset by $33.1 million of gains. Significant components of the netloss consisted of an $86.5 million net markdown of owned assets within thetransportation portfolio, partially offset by net gains of $21.0 million withinthe corporate finance portfolio.

 

The measurement of owned assetimpairment is dependent upon the significant use of estimates and managementdiscretion when predicting expected future cash flows and asset values. Anasset is considered impaired if anticipated undiscounted cash flows are lessthan the carrying amount of the asset. Once the asset has been deemed impaired,the accounting rules provide several acceptable methods for measuringimpairment. FINOVA’s typical practice is to compare the carrying amount of theasset to the present value of the estimated future cash flows, using anappropriate risk adjusted discount rate. The process of measuring impairmentrequires judgment and estimation, and the actual results may differ from theestimates. See the “Special Note Regarding Forward-Looking Statements” for adiscussion of many factors that could impact these estimates.

 

**PortfolioExpenses.**For the three months ended June 30, 2003, portfolioexpenses totaled $8.0 million compared to $13.6 million during the same periodof 2002. The decrease was primarily due to a decline in the level of problemaccount and workout expenses for most portfolios and the timing of certainexpenses anticipated during 2003.

 

**General andAdministrative Expenses.** General and administrativeexpenses decreased $11.5 million to $16.2 million for the three months endedJune 30, 2003. The decrease was primarily due to $3.2 million of cost savingsresulting from staffing and office occupancy reductions (240 employees at June30, 2003 compared to 396 at June 30, 2002). The remainder of the decrease wasthe result of an overall decline in general and administrative expenses causedby decreases in portfolio and staffing levels and the inclusion in the prioryear of $5.4 million of accruals for settlement of bankruptcy claims. Partiallyoffsetting the decline were additional accruals recorded in the second quarterof 2003 related to idle office space. The Company expects the dollar level ofgeneral and administrative expenses to continue to decrease as portfolio and staffinglevels decrease; however, general and administrative expenses as a percentageof assets or revenues will likely increase over time as a result of certainfixed costs and the high level of work intensive assets in the portfolio.

 

**Income TaxExpense.** For the three months ended June 30, 2003, income taxexpense related to pre-tax book income was entirely offset by a decrease invaluation allowances, which were previously established due to the Company’sconcern regarding

 

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its ability to utilize income taxbenefits generated from losses in prior periods. As of June 30, 2003, theCompany had federal net operating losses of $1.1 billion available forcarryforward.

 

**FinancialCondition, Liquidity and Capital Resources**

 

Because virtually all of theCompany’s assets are pledged to secure the obligations under the Berkadia Loanand the Senior Notes, FINOVA’s ability to obtain additional or alternatefinancing is severely restricted. Berkadia has no obligation to lend additionalsums to or to further invest in the Company. Accordingly, FINOVA intends torely on internally generated cash flows to meet its liquidity needs.

 

At June 30, 2003, the Senior Notesare reflected in the Company’s balance sheet net of a remaining $668.8 millionunamortized discount, which was originally recorded with the adoption ofFresh-Start Reporting upon emergence from chapter 11. The recorded book valueof the Senior Notes is scheduled to increase to $3.07 billion over time throughamortization of the discount as interest expense. The Company is obligated torepay the full $3.07 billion principal amount of the Senior Notes.

 

During the second quarter of 2003,repayments of the Berkadia Loan totaled $325.0 million. Principal payments madeto Berkadia since emergence from chapter 11 have reduced the Berkadia Loan to$1.2 billion as of June 30, 2003. The pace of loan repayments depends onnumerous factors, including the rate of collections from borrowers and assetsales.

 

As a result of FINOVA’s currentfinancial condition and restrictions contained in its debt agreements that donot allow FINOVA to incur any meaningful amount of new debt, the estimation ofcash reserves is critical to the overall liquidity of the Company. Cash reserveestimations are subject to known and unknown risks, uncertainties and otherfactors that could materially impact the amounts determined. Failure toadequately estimate a cash reserve in one period could result in insufficientliquidity to meet obligations in that period, or in a subsequent period, ifactual cash requirements exceed the cash reserve estimates.

 

**Based onthe Company’s current financial condition, it is highly unlikely that therewill be funds available to fully repay the outstanding principal on the SeniorNotes at maturity, and as a result, there will not be a return to the Company’sstockholders**. The Company has a negative networth of $861.9 million as of June 30, 2003 ($1.5 billion if the Senior Notesare considered at their principal amount due); the financial condition of manyof its customers is weakened, impairing their ability to meet obligations tothe Company; much of the Company’s portfolio of owned assets is not incomeproducing and the Company is restricted from entering into new businessactivities or issuing new securities to generate substantial cash flow. Forthese reasons, **the Company believes thatinvesting in FINOVA’s debt and equity securities involves a high level of riskto the investor.**

 

In August 2002, in accordance with theCompany’s debt agreements, FINOVA’s Board of Directors, with Berkadia’sconsent, approved the use of up to $300 million of cash to repurchase SeniorNotes rather than make mandatory prepayments of the Berkadia Loan. Inconsideration for Berkadia’s consent, FINOVA and Berkadia agreed that theywould share equally in the “Net Interest Savings” resulting from anyrepurchase. Net Interest Savings will be calculated as the difference between(a) the reduction in interest expense on the Senior Notes (resulting from therepurchase of such Senior Notes) and (b) the increase in interest expense onthe Berkadia Loan (resulting from the use of cash to repurchase Senior Notesand to pay 50% of the Net Interest Savings to Berkadia rather than makemandatory prepayments on the Berkadia Loan). On each date that interest is paidon the outstanding Senior Notes (a “Note Interest Payment Date”), 50% of theNet Interest Savings accrued since the last Note Interest Payment Date will bepaid to Berkadia. The other 50% of the Net Interest Savings will be retained byFINOVA. Upon repayment in full of the Berkadia Loan, Berkadia will not have theright to receive any Net Interest Savings accruing after that repayment.Because it is highly unlikely there will be sufficient funds to repay theSenior Notes at maturity, the Company, if it elects to repurchase additionalSenior Notes, intends to do so only at substantial discounts to par. Theagreement between FINOVA and Berkadia was approved by the “Special Committee”of FINOVA’s Board of Directors, which is comprised solely of directorsunaffiliated with Berkadia, Berkshire or Leucadia.

 

During 2002, the Companyrepurchased $185.0 million (face amount) of Senior Notes at an average price of29.93% or $55.4 million, plus accrued interest. There can be no assurance thatthe Company will repurchase any additional Senior Notes or that additionalSenior Notes will become available at an acceptable price.

 

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**Obligationsand Commitments.**The following is a listing ofFINOVA’s significant contractual obligations and contingent commitments at June30, 2003 and December 31, 2002. A detailed repayment schedule has not beenprovided because the Company’s most significant obligations are contractual asto amount but contingent regarding the timing of repayment. The listing is notintended to be all encompassing and excludes normal recurring trade and otheraccounts payable obligations.

 
|                                                            |   | **June 30, 2003**          |       | **December 31,  2002** |       |            |
|-----------------------------------------------------------------|--------|----------------------------|------------|------------------------|------------|-----------------|
| **Obligations and Commitments**                                 |   | **Contractual**            | ** ** | **Contingent**         | ** ** | **Contractual** | ** ** | **Contingent** | ** ** |   |
|                                                            |   | **(Dollars in thousands)** | ** ** |                   |
| Berkadia Loan                                                   |   | $                          | 1,200,000  |                   | $          |            |   | $ | 2,175,000 |   | $ |   |   |   |
| Management Services  Agreement                                  |   | 60,000                     |       |                   |       | 64,000          |   |   |   |   |
| New Senior Notes                                                |   | 3,067,949                  |       |                   |       | 3,067,949       |   |   |   |   |
| Contingent interest on  Senior Notes                            |   |                       |       | 94,313                 |       |            |   | 94,313 |   |   |
| Unfunded customer  commitments                                  |   |                       |       | 244,639                |       |            |   | 568,267 |   |   |
| Nonrecourse debt  associated with the leveraged lease portfolio |   | 925,390                    |       |                   |       | 990,908         |   |   |   |   |
| Lease obligations                                               |   | 20,739                     |       |                   |       | 25,878          |   |   |   |   |
|                                                            |   | $                          | 5,274,078  |                   | $          | 338,952         |   | $ | 6,323,735 |   | $ | 662,580 |   |
|                                                                 |        |                            |            |                        |            |                 |  |  |  |  |  |  |  |  |  |

 

Principal repayment of the BerkadiaLoan is contingent on available cash in excess of cash reserves. Unpaidprincipal and accrued interest are due at maturity on August 20, 2006. Inaddition to amounts included in the table, FINOVA is obligated to pay Berkadia50% of the Net Interest Savings, resulting from the Senior Note repurchasesnoted above. Based on interest rates in effect as of June 30, 2003, 50% of theNet Interest Savings for repurchases to date is estimated to be approximately$6.0 million per year. The Net Interest Savings will fluctuate with changes ininterest rates and would change if additional Senior Notes were repurchased.

 

FINOVA’s business is being operatedunder a Management Services Agreement with Leucadia, which expires in 2011.FINOVA pays Leucadia an annual management fee of $8.0 million, paid quarterlyin advance.

 

Principal repayments of the SeniorNotes, other than repurchases approved by Berkadia and the Company’s Board ofDirectors, cannot commence until the Berkadia Loan is paid in full and iscontingent on the availability of excess cash. Contingent interest cannotcommence until the Senior Notes are paid in full. Based on the Company’scurrent financial condition, it is highly unlikely that there will be fundsavailable to fully repay the outstanding principal on the Senior Notes atmaturity in November 2009 or to pay any contingent interest through itsexpiration in 2016.

 

Unfunded customer commitments(primarily unused lines of credit) have declined from $568.3 million atDecember 31, 2002 to $244.6 million at June 30, 2003, primarily due to theelimination of outstanding commitments associated with asset sales during 2003and the termination and/or expiration of other outstanding committed lines ofcredit. Because of the primarily revolving nature of its commitments, theCompany is unable to estimate with accuracy what portion of the commitmentswill be funded. Historically, in the aggregate, actual fundings have beensignificantly below the commitment amounts.

 

The nonrecourse debt associatedwith leveraged leases represents principal amounts due to third party lendersunder lease arrangements. Nonrecourse debt declined to $925.4 million during2003, primarily due to scheduled principal payments of $57.7 million and theelimination of $14.5 million of nonrecourse debt as a result of a senior debtholder proceeding against the underlying asset, partially offset by $6.7million of additional nonrecourse debt assumed in a foreclosure proceeding.

 

Lease obligations represent totalcontractual obligations (rent and operating costs) due under operating leases(primarily leased office space), as well as commitments made for tenantimprovements and lease damages related to the resolution of previously rejectedlease space. Lease obligations declined to $20.7 million during 2003, primarilydue to scheduled rent payments.

 

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**Collectionof the Portfolio.** As noted previously, the Company’scurrent business activities are limited to maximizing the value of itsportfolio through the orderly collection of its receivables. These activitiesinclude continued collection of its portfolio pursuant to contractual terms andmay include efforts to retain certain customer relationships and restructure orterminate other relationships. The Company will consider the sale of certainportfolios if buyers can be found at acceptable prices. Due to restrictionscontained in FINOVA’s debt agreements as well as its general inability toaccess capital in the public and private markets, the Company’s only viablesource of cash flow is from the collection of its portfolio. The followingtable presents the activity in total financial assets, net of the reserve forcredit losses for the six months ended June 30, 2003:

 
|                                             |   | **(Dollars in thousands)** |      |
|--------------------------------------------------|--------|----------------------------|-----------|
| **Total financial  assets at December 31, 2002** |   | $                          | 3,156,151 |   |
|                                             |   |                       |      |
| **Cash  activity:**                              |   |                       |      |
| Fundings under outstanding  customer commitments |   | 223,519                    |      |
| Collections and proceeds  from financial assets  |   | (1,221,773                 | )         |
| Net cash flows                                   |   | (998,254                   | )         |
|                                             |   |                       |      |
| **Non-cash  activity:**                          |   |                       |      |
| Reversal of provision for  credit losses         |   | 123,573                    |      |
| Net charge-offs of  financial assets             |   | (20,052                    | )         |
| Other non-cash activity                          |   | 1,778                      |      |
| Net non-cash activity                            |   | 105,299                    |      |
| **Total financial  assets at June 30, 2003**     |   | $                          | 2,263,196 |   |

 

Total financial assets, net of thereserve for credit losses, declined to $2.3 billion at June 30, 2003, down from$3.2 billion at December 31, 2002. During 2003, net cash flows from theportfolio totaled $998.3 million, while non-cash activity resulted in a $105.3million increase in net financial assets. Components of net cash flow included$876.6 million from collections on financial assets (including recoveries),$345.2 million from the sale of assets (excluding cash gains), offset by $223.5million of fundings under outstanding customer commitments. Collections onfinancial assets included a significant level of prepayments (customer paymentsin advance of scheduled due dates). Prepayments are not predictable and giventhe decline in the size of FINOVA’s asset portfolio, prepayment levels as wellas scheduled amortization are expected to decline over time. Non-cash activityincluded the reversal of $123.6 million of provision for credit losses andother non-cash activity of $1.8 million, partially offset by a $20.1 millionreduction related to markdowns of owned assets.

 

FINOVA’s reserve for credit lossesdecreased to $359.2 million at June 30, 2003 from $540.3 million at December31, 2002. At June 30, 2003, the total carrying amount of impaired loans andleases was $1.0 billion, of which $358.6 million were revenue accruing. TheCompany has established impairment reserves of $284.0 million related to $659.5million of nonaccruing and impaired assets. At December 31, 2002, the totalamount of impaired loans and leases was $1.8 billion, of which $471.1 millionwere revenue accruing. The impairment reserves at December 31, 2002 totaled$438.2 million related to $1.2 billion of nonaccruing and impaired assets.

 

Reserves on impaired assetsdecreased due to write-offs (primarily upon the repossession of aircraft), animprovement in pay-off and collection experience on certain assets previouslyreserved and the Company’s application of cash received on nonaccruing assets,thus reducing the impairment reserves required on those assets. Partiallyoffsetting these reductions were new impairment reserves established for assetsreclassified to impaired status during 2003 and additional reserves recorded onexisting impaired assets.

 

Other reserves related to estimatedinherent losses on unimpaired assets, decreased primarily as a result ofcollections, asset sales and changes in historical loss experience.

 

Accounts classified as nonaccruingwere $696.0 million or 26.5% of total financial assets (before reserves) atJune 30, 2003 as compared to $1.4 billion or 37.7% at December 31, 2002. Thedecline in nonaccruing assets was primarily attributed to collections and assetsales of $586.5 million and write-offs and net valuation markdowns of $88.7million. Also contributing to the decline was the return of certain assets toaccruing status following demonstration of sustained performance and theclassification of newly repossessed aircraft as assets held for the productionof income, which are excluded from nonaccruing assets.

 

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Nonaccruing assets continue to beaffected by the Company’s concerns regarding its ability to fully collectprincipal and interest on certain transactions that have significant balloonpayments or residual values due at maturity. The current economic climate hasresulted in a general reduction of operating cash flow for the typical FINOVAborrower and in more conservative industry wide lending practices. As a result,FINOVA is concerned that certain of its customers will not have the ability toobtain refinancing at maturity for the full amount of these residual/balloonpayments. FINOVA’s ability or willingness to continue to extend credit to theseborrowers may be affected by its restricted access to the capital markets andits assessment of the costs and benefits of doing so. In certain of thesecases, FINOVA has classified transactions as nonaccruing even though principaland interest payments are current. If necessary, impairment reserves on thesetransactions are established in accordance with SFAS No. 114.

 

**Special Note RegardingForward-Looking Statements**

** **

Certain statements in this reportare “forward-looking,” in that they do not discuss historical fact, but insteadnote future expectations, projections, intentions or other items.Forward-looking statements are made pursuant to the safe-harbor provisions ofthe Private Securities Litigation Reform Act of 1995. These forward-lookingstatements include assumptions, estimates and valuations implicit in thefinancial statements and related notes as well as matters discussed in thesections of this report captioned “Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations” and “Item 3. Quantitative andQualitative Disclosure About Market Risk.” They are also made in documentsincorporated in this report by reference, or in which this report may beincorporated.

 

Forward-looking statements areinherently subject to risks and uncertainties, many of which cannot bepredicted or quantified. When used in this report, the words “estimate,”“expects,” “anticipates,” “believes,” “plans,” “intends” and similarexpressions are intended to identify forward-looking statements that involveknown and unknown risks and uncertainties. Risks, uncertainties and otherfactors may cause FINOVA’s actual results or performance to differ materiallyfrom those contemplated by the forward-looking statements. Many of thesefactors are discussed in this report and include, but are not limited to:

 

•                  Theextent to which FINOVA is successful in implementing its business strategy,including the efforts to maximize the value of its portfolio through orderlycollection or sales of assets. Portfolio decisions are based on estimates ofasset value and future cash flows and actual results may differ from theestimated amounts. Failure to fully implement its business strategy mightresult in adverse effects, impair the Company’s ability to repay outstanding secureddebt and other obligations and have a materially adverse impact on itsfinancial position and results of operations. The current focus on maximizingportfolio values and the absence of new business generation will cause futurefinancial results to differ materially from prior periods. Similarly, adoptionof Fresh-Start Reporting upon emergence from bankruptcy has resulted inrevaluation of certain assets and liabilities and other adjustments to thefinancial statements, so that prior results are not indicative of futureexpectations.

 

•                  Severalof the Company’s accounting policies pertain to the ongoing determination ofportfolio impairment. These amounts rely, to a great extent, on the estimationand timing of future cash flows. Actual results may differ from the estimates.

 

•                  Theeffect of economic conditions and the performance of FINOVA’s borrowers.Economic conditions in general or in particular market segments could impairthe ability of FINOVA’s borrowers to operate or expand their businesses, whichmight result in decreased performance, adversely affecting their ability torepay their obligations. The rate of borrower defaults or bankruptcies mayincrease. Changing economic conditions could adversely affect FINOVA’s abilityto realize estimated cash flows. Conversely, economic conditions and borrowerperformance could improve, resulting in better results than anticipated in theCompany’s cash flow estimates.

 

•                  Thecost of FINOVA’s capital has increased significantly since the first quarter of2000 and will continue to negatively impact results. Failure to comply with itscredit obligations could result in additional increases in interest charges. Inaddition, changes in interest rate indices may impact interest margin due tolack of matched funding of the Company’s assets and liabilities.

 

•                  Lossof employees. FINOVA must retain a sufficient number of employees with relevantknowledge and skills to continue to monitor, collect and sell its portfolio.Failure to do so could result in additional losses. Retention incentivesintended to retain that employee base may not be successful in the future.

 

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•                  Conditionsaffecting the Company’s aircraft portfolio, including changes in FederalAviation Administration directives and conditions affecting the demand for usedaircraft and the demand for aircraft spare parts. FINOVA’s aircraft are oftenof older vintage and contain configurations of engines, avionics, fuel tanksand other components that may not be as high in demand as other availableaircraft in that class. Future demand for those aircraft may decrease furtheras newer or more desirable aircraft and components become available.

 

•                  Changesin government regulations, tax rates and similar matters. For example,government regulations could significantly increase the cost of doing businessor could eliminate certain tax advantages of some FINOVA financingtransactions. The Company has not recorded a benefit in its financialstatements for its existing tax attributes and estimated future tax deductionssince it does not expect to generate the future taxable income needed to usethose tax benefits. The Company may never be able to use those tax attributes.

 

•                  Necessarytechnological changes, such as implementation of information managementsystems, may be more difficult, expensive or time consuming to implement thananticipated.

 

•                  Potentialliabilities associated with dispositions of assets.

 

•                  Theaccuracy of information relied upon by FINOVA, which includes informationsupplied by its borrowers or prepared by third parties, such as appraisers.Inaccuracies in that information could lead to inaccuracies in the estimates.

 

•                  Asthe portfolio declines, increasing concentrations of financial assets in certainindustries such as resort and transportation could make the overall portfoliomore subject to changes in performance in those industries.

 

•                  Otherrisks detailed in this and FINOVA’s other SEC reports or filings.

 

FINOVA does not intend to updateforward-looking information to reflect actual results or changes in assumptionsor other factors that could affect those statements. FINOVA cannot predict therisk from reliance on forward-looking statements in light of the many factorsthat could affect their accuracy.

 

**Item 3****.****          ****Quantitativeand Qualitative Disclosure About Market Risk**

 

There were no material changes fromthe information provided in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2002.

 

**Item 4****.****          ****Controlsand Procedures**

 

(a)          Basedon their evaluation as of the end of the period covered by this Form 10-Q, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat the Company’s disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Exchange Act) are effective to ensure thatinformation required to be disclosed by the Company in reports that it files orsubmits under the Exchange Act are recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rulesand forms.

 

(b)         Therewere no changes in the Company’s internal controls over financial reporting orin other factors which have materially affected or are reasonably likely tomaterially affect these controls subsequent to the date of their evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

TheCompany continues to reduce its workforce, consolidate its operations andoutsource certain functions. Accordingly, responsibility for administration,management and review of many of the Company’s assets has transitioned amongFINOVA’s remaining personnel. Management has supervised these transitions andhas implemented procedures that it believes will provide effective controls andprocesses during and after this transition. The Company is assessing theefficacy of these procedures and will continue to do so in subsequent periods.

 

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**PART II****            ****OTHER INFORMATION**

 

**Item 1.****          ****Legal Proceedings**

 

There were no material changes fromthe information provided in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2002.

 

**Item4.****          ****Submissionof Matters to a Vote of Security Holders**

 

The Annual Meeting of Shareownersof the Company was held on May 14, 2003. At that meeting, stockholders owning114,933,174 shares of the Company’s Common Stock (“shares”) were present inperson or by proxy. The stockholders approved the election of each directornominee by the following plurality:

 
|                |   | **Number of Votes** |   |
|---------------------|--------|---------------------|--------|
|                |   | **For**             |   | **Withheld** | ** ** |
| Thomas F. Boland    |   | 114,266,227         |   | 666,947 |   |
| Ian M. Cumming      |   | 114,181,680         |   | 751,494 |   |
| G. Robert Durham    |   | 114,227,893         |   | 705,281 |   |
| Thomas E. Mara      |   | 114,181,878         |   | 751,296 |   |
| R. Gregory Morgan   |   | 114,252,060         |   | 681,114 |   |
| Kenneth R. Smith    |   | 114,256,053         |   | 677,121 |   |
| Joseph S. Steinberg |   | 114,069,333         |   | 863,841 |   |

 

**Item6.****          ****Exhibitsand Reports on Form 8-K**

** **
| a)     | Exhibits            |
|--------|---------------------|
|   |                |
|   | 31.1                | Certification of the Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   | 31.2                | Certification of the Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   | 32.1                | Certification of the Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   | 32.2                | Certification of the Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |                |   |
| b)     | Reports on Form 8-K |
|   | None.               |

 

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**THE FINOVA GROUP INC.**

** **

**Signatures**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

**THE FINOVA GROUP INC.**

** **

(Registrant)

** **

** **
| Dated:  August 11, 2003 | By:    | /s/ Stuart A. Tashlik                                              |
|-----------------------------------|--------|--------------------------------------------------------------------|
|                              |   | Stuart A. Tashlik, Senior Vice  President, Chief Financial Officer |
|                              |   | Principal Financial and  Accounting Officer                        |

 

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**EXHIBIT INDEX**

** **
| **Exhibit  Number** |   | **Description**                                                                                          |
|---------------------|--------|----------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                     |
| 31.1                |   | Certification of the Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                     |
| 31.2                |   | Certification of the Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                     |
| 32.1                |   | Certification of the Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                     |
| 32.2                |   | Certification of the Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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