Exhibit 99.4 - Financial Statements
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
MFN FINANCIAL CORPORATION
DECEMBER 31, 2001 AND 2000
7
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To The Board of Directors and Stockholders of
MFN Financial Corporation (f/k/a Mercury Finance Company)
We have audited the accompanying consolidated balance sheets of MFN Financial
Corporation and subsidiaries as of December 31, 2001 and 2000 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows of MFN Financial Corporation for the years ended December 31, 2001 and
December 31, 2000 (Reorganized Company) and the nine-month period from April 1,
1999 through December 31, 1999 and of Mercury Finance Company (Predecessor
Company) for the three-month period ended March 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of MFN Financial
Corporation and subsidiaries as of December 31, 2001 and December 31, 2000, and
the consolidated results of operations and cash flows of MFN Financial
Corporation for the years ended December 31, 2001 and December 31, 2000 and the
nine-month period from April 1, 1999 through December 31, 1999 and of Mercury
Finance Company for the three-month period ended March 31, 1999, in conformity
with accounting principles generally accepted in the United States of America.
As more fully described in Note 1 to the consolidated financial statements, MFN
Financial Corporation emerged from bankruptcy on March 23, 1999. In accordance
with Statement of Position 90-7 of the American Institute of Certified Public
Accountants, MFN Financial Corporation has adopted "fresh start" reporting
whereby its assets, liabilities and new capital structure have been adjusted to
reflect estimated fair values as of March 31, 1999. As a result, the
consolidated financial statements for periods subsequent to March 31, 1999,
reflect this basis of reporting and are not necessarily comparable to the
Predecessor Company's consolidated financial statements.
/s/ Grant Thornton LLP
Chicago, Illinois
January 30, 2002
(Except for Note 23, as to which
the date is March 8, 2002)
8
MFN FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31
(In thousands) 2001 2000
--------- ---------
ASSETS
Unrestricted cash and cash equivalents $ 75,684 $127,093
Restricted cash 24,206 --
Finance receivables, net of unearned income 413,044 484,854
Less: Allowance for finance credit losses 39,013 39,071
Less: Nonrefundable dealer reserves 20,923 28,014
--------- ---------
Finance receivables, net 353,108 417,769
Income taxes receivable 354 7,878
Furniture, fixtures and equipment, net 5,085 2,650
Other assets (including repossessions) 10,147 5,787
--------- ---------
TOTAL ASSETS $468,584 $561,177
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Notes payable to securitization trust $181,330 $ --
Warehouse credit facility 80,800 --
Senior secured debt -- 342,908
Senior subordinated debt 22,500 22,500
Deferred income taxes 11,283 24,445
Other liabilities 9,757 14,569
Excess of revalued net assets over liabilities
and stockholders' investment 22,229 32,110
--------- ---------
TOTAL LIABILITIES 327,899 436,532
--------- ---------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value; 50,000,000 shares authorized;
Outstanding: December 31, 2001 - 9,992,956 shares
December 31, 2000 - 10,000,003 shares 100 100
Paid in capital 84,911 84,900
Retained earnings 55,674 39,645
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 140,685 124,645
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $468,584 $561,177
========= =========
The accompanying notes to the consolidated financial statements
are an integral part of these statements.
9
MFN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Predecessor
Reorganized Company Company
------------------- -------
Nine Three
Year Year Months Months
Ended Ended Ended Ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
(In thousands, except per share data) 2001 2000 1999 1999
- --------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Finance charges and loan fees $110,224 $117,965 $100,235 $35,313
Investment income 3,663 9,175 4,932 414
--------- --------- --------- ---------
Total interest income 113,887 127,140 105,167 35,727
INTEREST EXPENSE 28,561 39,126 32,191 474
--------- --------- --------- ---------
Net interest income before provision for finance
credit losses 85,326 88,014 72,976 35,253
PROVISION FOR FINANCE CREDIT LOSSES 29,097 20,380 23,071 9,857
--------- --------- --------- ---------
Net interest income after provision for finance
credit losses 56,229 67,634 49,905 25,396
--------- --------- --------- ---------
OTHER OPERATING INCOME
Insurance premiums 5,557 11,344 6,286 815
Fees and insurance commissions 515 1,059 2,208 1,240
Other revenue 159 1,544 1,273 998
Gain on sale of finance receivables and assets - 77 7,058 -
Write-down of commercial paper - (1,585) - -
--------- --------- --------- ---------
Total other operating income 6,231 12,439 16,825 3,053
--------- --------- --------- ---------
OTHER OPERATING EXPENSES
Salaries and employee benefits 36,656 40,430 33,081 13,150
Occupancy expense 3,198 3,183 2,617 999
Equipment expense 2,754 2,149 1,146 767
Telecommunications 2,256 2,444 2,226 873
Credit information 1,402 1,378 855 349
Postage 1,650 1,557 1,049 387
Insurance claims and other underwriting expense 3,258 7,178 2,841 (29)
Amortization (9,881) (9,881) (7,407) 215
Pension curtailment gain (3,595) - - -
Reorganization expenses, net - - - 1,105
Restructuring charges 4,738 (249) 1,950 -
Other operating expenses 11,720 11,220 8,072 3,249
--------- --------- --------- ---------
Total other operating expenses 54,156 59,409 46,430 21,065
--------- --------- --------- ---------
OPERATING INCOME 8,304 20,664 20,300 7,384
NON-OPERATING EXPENSES
Reorganization expenses - - - 33,719
--------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES
AND EXTRAORDINARY CREDITS 8,304 20,664 20,300 (26,335)
Income tax provision (benefit) (7,725) 2,265 1,291 (5,287)
--------- --------- --------- ---------
Net income (loss) before extraordinary credits 16,029 18,399 19,009 (21,048)
Extraordinary credits:
Gain on discharge of indebtedness, net of taxes - - - 45,570
Gain on early retirement of debt, net of taxes - 717 1,520 -
--------- --------- --------- ---------
NET INCOME $ 16,029 $ 19,116 $ 20,529 $ 24,522
========= ========= ========= =========
10
MFN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Continued
Predecessor
Reorganized Company Company
------------------- -------
Nine Three
Year Year Months Months
Ended Ended Ended Ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
(In thousands, except per share data) 2001 2000 1999 1999
- ---------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding:
Basic 9,993 10,000 10,000 **
Diluted 10,039 10,002 10,001 **
Earnings per common share:
Basic $ 1.60 $ 1.91 $ 2.05 **
Diluted $ 1.60 $ 1.91 $ 2.05 **
Dividends per common share declared: $ - $ - $ - **
** Earnings per common share and dividends per common share amounts as they relate to the Predecessor Company
are not meaningful due to the Voluntary Case. See note 1.
The accompanying notes to the consolidated financial statements
are an integral part of these statements.
11
MFN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
Retained Total
(In thousands) Common Paid In Earnings Treasury Stockholders'
Stock Capital (Deficit) Stock Equity
----- ------- --------- ----- ------
PREDECESSOR COMPANY
Balance at January 1, 1999 $ 177,901 $ 8,244 $ (103,351) $ (53,664) $ 29,130
Net income for period January 1,
1999 through March 31, 1999 - - 24,522 - 24,522
Effect of Reorganization and
Fresh Start Reporting:
Extinguishment of old stock (177,901) (8,244) 78,829 53,664 (53,652)
Issuance of new stock 100 84,900 - - 85,000
---------- ---------- ----------- ---------- ---------
Balance at March 31, 1999 100 84,900 - - 85,000
- -----------------------------------------------------------------------------------------------------------------------
POST-EMERGENCE
REORGANIZED COMPANY
Net income for period April 1, 1999
through December 31, 1999 - - 20,529 - 20,529
---------- ---------- ----------- ---------- ---------
Balance at December 31, 1999 100 84,900 20,529 - 105,529
Net income for year ended
December 31, 2000 - - 19,116 - 19,116
---------- ---------- ----------- ---------- ---------
Balance at December 31, 2000 100 84,900 39,645 - 124,645
Proceeds from stock options exercised - 11 - - 11
Net income for year ended
December 31, 2001 - - 16,029 - 16,029
---------- ---------- ----------- ---------- ---------
Balance at December 31, 2001 $ 100 $ 84,911 $ 55,674 $ - $140,685
========== ========== =========== ========== =========
The accompanying notes to the consolidated financial statements
are an integral part of these statements.
12
MFN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Predecessor
Reorganized Company Company
------------------- -------
Nine Three
Year Year Months Months
Ended Ended Ended Ended
Dec 31, Dec 31, Dec 31, Mar 31,
(In thousands) 2001 2000 1999 1999
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 16,029 $ 19,116 $ 20,529 $ 24,522
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Provision for finance credit losses 29,097 20,380 23,071 9,857
Provision for restructuring charge, net of payments 1,968 (1,237) 1,237 -
Gain on sale of finance receivables and assets - (77) (7,058) -
Gain on early retirement of debt - (1,184) (2,513) -
Pension curtailment gain (3,595) - - -
Provision (benefit) for deferred income taxes (13,162) 5,156 1,918 (5,287)
Amortization of deferred financing costs 5,687 - - -
Net (increase) decrease in income tax receivable 7,524 814 10,534 (15,913)
Net (decrease) in taxes payable - - (9,761) (7,528)
Net gain on discharge of indebtedness - - - (68,229)
Extinguishment of dividend payable - - - (12,937)
Write-off of goodwill and fixed assets, net - - - 16,022
Depreciation and amortization (8,705) (9,178) (7,280) 607
Net decrease in other assets 797 3,521 6,421 16,074
Net increase (decrease) in other liabilities (2,980) (1,829) (47,236) 43,752
---------- --------- --------- ---------
Net cash provided by (used in) operating activities 32,660 35,482 (10,138) 940
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected and recoveries of charged-
off finance receivables 285,752 311,168 267,369 108,424
Finance receivables originated or purchased (250,686) (306,290) (231,882) (101,074)
Proceeds from sale of finance receivables - 2,075 35,214 -
Proceeds from sale of credit card portfolio - - - 22,414
Purchases of furniture, fixtures and equipment (3,816) (1,437) (2,048) (175)
---------- --------- --------- ---------
Net cash provided by investing activities 31,250 5,516 68,653 29,589
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments of senior secured debt (342,908) (37,540) (150,985) (774)
Proceeds from warehouse credit facility 365,800 - - -
Repayment of warehouse credit facility (285,000) - - -
Proceeds from notes payable to securitization trust 301,000 - - -
Repayments of notes payable to securitization trust (119,670) - - -
(Increase) in restricted cash (24,206) - - -
Proceeds from stock options exercised 11 - - -
Payment of deferred financing costs (10,346) - - -
---------- --------- --------- ---------
Net cash used in financing activities (115,319) (37,540) (150,985) (774)
---------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents (51,409) 3,458 (92,470) 29,755
Cash and equivalents at beginning of period 127,093 123,635 216,105 186,350
---------- --------- --------- ---------
Cash and equivalents at end of period $ 75,684 $127,093 $123,635 $216,105
========== ========= ========= =========
13
MFN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Continued
Predecessor
Reorganized Company Company
------------------- -------
Nine Three
Year Year Months Months
Ended Ended Ended Ended
Dec 31, Dec 31, Dec 31, Mar 31,
(In thousands) 2001 2000 1999 1999
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH DISCLOSURES
Income taxes paid to federal and state governments $ 2,091 $ 1,630 $ 364 $ 13,133
Net interest paid 23,717 38,134 51,999 44
SUPPLEMENTAL NON-CASH DISCLOSURES
Write-down of commercial paper - $ 1,585 - -
Cancellation of indebtedness - - - $ 148,978
Extinguishment of old stock - - - (53,652)
Issuance of new stock - - - 85,000
The accompanying notes to the consolidated financial statements
are an integral part of these statements.
14
MFN FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
Note 1 - Organization and Summary of Significant Accounting Policies
MFN Financial Corporation, f/k/a/ Mercury Finance Company ("MFN" or the
"Company") is a consumer finance company doing business through its subsidiaries
(the "consumer finance subsidiaries"). The Company also offers certain insurance
services through MFN Insurance Company ("MFN Insurance"), a subsidiary. The
Company's borrowers generally would not be expected to qualify for traditional
financing, such as that provided by commercial banks or automobile
manufacturers' captive finance companies.
BASIS OF PRESENTATION
The accounting and reporting policies of MFN conform to accounting principles
generally accepted in the United States of America for the finance and insurance
industries. The consolidated financial statements include the accounts of the
Company, the consumer finance subsidiaries and MFN Insurance. All significant
intercompany accounts and transactions have been eliminated. See Note 9 for
additional information regarding the Company's voluntary petition (the
"Voluntary Case") in the United States Bankruptcy Court for the Northern
District of Illinois (the "Court") for relief under chapter 11 of title 11 of
the United States Code (the "Code"). The Voluntary Case was filed with the Court
by the Company on July 15, 1998. The Company's Second Amended Plan of
Reorganization (the "Plan" or "Plan of Reorganization") was confirmed by order
of the Court on March 10, 1999. The effective date of the Plan was March 23,
1999 (the "Effective Date"). Due to the Company's emergence from the Voluntary
Case and implementation of Fresh Start Reporting, Consolidated Financial
Statements for the Reorganized Company as of March 31, 1999 and for the periods
subsequent to March 31, 1999 (the "Reorganized Company") are not comparable to
those of the Company for the periods prior to March 31, 1999 (the "Predecessor
Company"). For financial reporting purposes, the effective date (the "Fresh
Start Effective Date") of the Plan of Reorganization is considered to be the
close of business on March 31, 1999. The results of operations for the period
from March 23, 1999 through March 31, 1999 were not material.
The Plan provided (a) for the Company to transfer to a certain trust established
under the Plan (the "Liquidating Trust"), (i) $5 million in cash, (ii) the
Company's claims against the Company's previous auditors and (iii) $250,000 in
cash for fees and costs to be incurred in connection with the Liquidating Trust
and (b) for the holders of Securities Fraud Claims to receive a share of the
beneficial interests in the Liquidating Trust in complete settlement,
satisfaction and discharge of their claims. In addition, the Plan provided for
the Company to pay (i) $13.35 million into funds established for the benefit of
holders of certain indemnification claims against the Company and (ii) up to an
aggregate amount of $250,000, for costs and expenses of certain officers, agents
and employees who were no longer employed by the Company as of the first day
immediately following March 23, 1999, in connection with their participation in
a government investigation. The Company also agreed to pay a former employee
$100,000 in connection with a mutual release. All of these costs were fully
provided for as of December 31, 1998 and all amounts were paid during 2000 and
1999, with the exception of approximately $174,000 which remains set aside for
costs and expenses of certain officers, immediately following March 23, 1999 in
connection with their participation in a government investigation.
15
As of March 31, 1999, the Company adopted Fresh Start Reporting in accordance
with the American Institute of Certified Public Accountants' Statement of
Position 90-7 "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code" (SOP 90-7). The adoption of Fresh Start Reporting resulted in
material changes to the Consolidated Balance Sheet, including valuation of
assets at fair value in accordance with principles of the purchase method of
accounting, valuation of liabilities pursuant to provisions of the Plan and
valuation of equity based on the appraised reorganization value of the ongoing
business.
The reorganization value of $85.0 million (the approximate fair value) was based
on the consideration of many factors and various valuation methods, including
discounted cash flows, selected publicly traded company market multiples and
other applicable ratios and valuation techniques believed by the Company and its
financial advisors to be representative of the Company's business and industry.
The Predecessor Company's equity was eliminated in Fresh Start Reporting.
In accordance with Fresh Start Reporting guidelines, certain noncurrent assets,
including goodwill, recorded on the Company's Consolidated Balance Sheet at the
Fresh Start Effective Date aggregating $16.0 million were reduced to zero as a
result of the fair value of the Company's assets exceeding the fair value of its
liabilities and stockholders' investment. In addition, as a result of
reorganization, the dividends payable liability in the amount of $12.9 million
was extinguished. The net result of the adjustment of assets and liabilities to
fair value was a charge to earnings of $3.1 million during the period ended
March 31, 1999. After reducing the fair value of certain noncurrent assets to
zero, the excess of the fair value of the remaining assets over the fair value
of liabilities and stockholders' investment, totaling $49.4 million, was
recorded as a deferred credit, "Excess of Revalued Net Assets Over Liabilities
and Stockholders' Investment". This balance is being amortized over 5 years.
16
The Company's emergence from the Voluntary Case and the adoption of Fresh Start
Reporting resulted in the following adjustments to the Company's Consolidated
Balance Sheet as of March 31, 1999 (in thousands):
Predecessor Fresh Start Reorganized
Company Adjustments Company
March 31, 1999 Debit Credit March 31, 1999
-------------- ----- ------ --------------
Assets
Cash and cash equivalents $216,105 $ - $ - $216,105
Finance receivables, net 535,523 - - 535,523
Other assets 31,200 - - 31,200
--------- ----------- ----------- ---------
Total Assets $782,828 $ - $ - $782,828
========= =========== =========== =========
Predecessor Fresh Start Reorganized
Company Adjustments Company
March 31, 1999 Debit Credit March 31, 1999
-------------- ----- ------ --------------
Liabilities and Stockholders' Equity
Liabilities
Senior Debt $674,471 $ 240,306(a) $ - $434,165
Excess cash payments to senior
debt holders - - 100,707(b) 100,707
Subordinated debt 22,500 - - 22,500
Interest payable 30,552 9,008(a) - 21,544
Other liabilities 23,801 371(c) - 23,430
Income taxes 4,472 - 22,659(d) 27,131
Litigation accrual 18,950 - - 18,950
Excess of revalued net assets over liabilities
and stockholders' investment - - 49,401(e) 49,401
--------- ----------- ----------- ---------
Total Liabilities 774,746 249,685 172,767 697,828
Stockholders' Equity
Common stock 177,901 177,901(f) 100(g) 100
Paid-in capital 8,244 8,244(f) 84,900(g) 84,900
Accumulated deficit (124,399) - 78,829(f) -
45,570(h) -
Treasury stock (53,664) - 53,664(f) -
--------- ----------- ----------- ---------
Total Stockholders' Equity 8,082 186,145 263,063 85,000
--------- ----------- ----------- ---------
Total Liabilities and Stockholders' Equity $782,828 $ 435,830 $435,830 $782,828
========= =========== =========== =========
(a) To reflect the cancellation of the old debt and related accrued interest.
(b) To setup a payable of Excess Cash to Senior Debt Holders in accordance
with the Plan of Reorganization. Payment occurred on April 1, 1999.
(c) To write-off cancelled liabilities of the Company.
(d) To establish deferred income tax liability on the cancellation of
indebtedness.
(e) The excess of revalued net assets over liabilities and stockholders'
investment is calculated below (in thousands):
Fair value of identifiable assets $ 782,828
Less: reorganized value of new debt 456,665
Less: reorganized value of new equity 85,000
Less: fair value of identifiable liabilities 191,762
----------
$ 49,401
==========
(f) To eliminate stockholders' equity of the Predecessor Company.
(g) To record 10,000,000 shares of new common stock at an assumed market value
of $8.50 per share.
(h) To record the extraordinary gain resulting from discharge of indebtedness.
17
The extraordinary gain, net of taxes is calculated below (in thousands):
Historical carrying value of old debt securities $ 696,971
Historical carrying value of related accrued interest 29,405
Value exchanged for old debt:
Excess cash payment, including interest (121,104)
New Senior secured notes (434,165)
New Senior subordinated notes (22,500)
New common stock (9.5 million shares to creditors) (80,750)
Other 372
-----------
Extraordinary gain before tax 68,229
Tax provision (22,659)
-----------
Extraordinary gain $ 45,570
===========
The consolidated balance sheets as of December 31, 2001 and 2000 and the
statements of income, cash flows and changes in stockholders' equity for the
years ended December 31, 2001 and December 31, 2000 and the nine months ended
December 31, 1999 are of MFN Financial Corporation. The consolidated statements
of income, cash flows and changes in stockholders' equity for the three months
ended March 31, 1999 are of Mercury Finance Company.
To facilitate a comparison where the Company's year-to-date operating
performance compares fiscal years 2001, 2000 and 1999, the following discussion
of certain consolidated financial information may be presented on a traditional
comparative basis for all periods even though the accounting requirements for
companies upon emergence from bankruptcy calls for separate reporting for the
reorganized company and the predecessor company. Consolidated results of
operations for the year ended December 31, 1999 may be presented as a
combination of Reorganized Company and the Predecessor Company and careful
analysis should be used when interpreting these results.
REVENUE RECOGNITION - CONSUMER FINANCE SUBSIDIARIES
Finance charges on precomputed loans and sales finance contracts (collectively
referred to as "precompute accounts") are credited to unearned finance charges
at the time the loans and sales finance contracts are made or purchased.
Interest income is calculated using the effective interest method to produce
constant rates of interest (yields). Contracts are placed in non-accrual status
once they are greater than 60 days contractually delinquent at any month end.
Interest on interest-bearing loans and sales finance contracts is calculated on
a 360-day or actual-day year basis depending upon state law and recorded on the
accrual basis. Late charges and deferment charges on all contracts are taken
into income as collected. Fees and other income are derived from the sale of
other products and services.
INSURANCE OPERATIONS
In conjunction with MFN's lending business and through contractual arrangements
with insurance companies, the operating subsidiaries offered credit life,
accident and health, property and involuntary unemployment insurance to
borrowers at the borrower's discretion. Borrowers may obtain financing for these
insurance products under sales finance contracts purchased from merchants and
automobile dealers. Effective December 2001, the Company no longer offers these
insurance products. Policies written prior to this date will remain in effect
until the contract is paid off or charged-off.
18
The policies insure the holder of a sales finance contract or other debt
instrument for the outstanding balance (or portion thereof as specified in the
policy) payable in the event of (i) death or disability of the debtor (ii)
damage to, or destruction of, property collateralizing the account or (iii) the
debtor's unemployment. Premiums were earned over the life of the contracts
principally using pro-rata and sum-of-the-months digits methods or in relation
to anticipated benefits to the policyholder. These products, provided on sales
finance contracts, did not generate a material amount of fee income.
Also in conjunction with their lending business, the Company purchased insurance
coverage and charged its customers who let their insurance coverage lapse on
automobiles that are collateral on the outstanding retail sales contracts.
During the second quarter of 1997, the Company formed a captive insurance
company, MFN Insurance Company, to reinsure coverage under such policies. MFN
Insurance Company provides aggregate coverage for incurred losses in excess of
targeted loss ratios through a reinsurance agreement with the primary carrier.
Effective April 2001, the Company discontinued purchasing collateral protection
insurance for customers who failed to provide evidence of coverage.
FINANCE RECEIVABLES, ALLOWANCE FOR FINANCE CREDIT LOSSES AND NONREFUNDABLE
DEALER RESERVES
MFN typically purchases individual retail sales finance contracts from third
party dealers at a discount from the principal amount financed. This discount is
referred to as a nonrefundable dealer reserve. The amount of the discount is
based upon the credit risk of the borrower, the note rate of the contract and
competitive factors. The nonrefundable dealer reserve is amortized as a
reduction to the provision for finance credit losses over the life of the
individual sales finance contract using the actuarial method. Management
believes this method provides for an appropriate matching of finance charge
income and provision for finance credit losses. Historical loss experience on
the Company's sales finance receivables has shown that the nonrefundable dealer
reserves are not adequate to cover potential losses over the life of the
contracts. Therefore, the Company maintains an allowance for finance credit
losses that is available to absorb credit losses that are inherent in the
portfolio and which exceed the unamortized nonrefundable dealer reserve.
Management utilizes a loss reserving methodology commonly referred to as "static
pooling" which stratifies its sales finance receivable portfolio into separately
identified pools. The Company segregates each pool by delinquency classification
(i.e. not delinquent, 30, 60, 90 and 120 days past due) and utilizes a
formula-based approach to estimate the required allowance. The change in the
required allowance from the prior period to the current period results in a
charge or credit to the provision for finance credit losses. Management also
performs an ongoing analysis measuring prior period estimates of such inherent
credit losses against actual net charge-offs, accounting for the seasonality of
the Company's business cycle, to support the level of allowance.
19
The provision for finance credit losses results from a combination of (a)
charge-offs (b) recoveries (c) an adjustment from the aforementioned allowance
calculation and (d) the amortization of nonrefundable dealer reserves. When a
customer experiences delinquency problems, the allowance for credit losses is
increased with an offsetting charge to the provision for credit losses on the
income statement. As the amount of a credit loss is confirmed by gathering
additional customer information, the Company typically secures and liquidates
the collateral in full or partial settlement of the account. Deficiency balances
are charged-off with an amount being absorbed by the nonrefundable dealer
reserve and the remainder absorbed by the allowance for finance credit losses.
If, subsequent to a charge-off, the Company is able to collect additional
amounts from the borrower or obtain control of collateral worth more than
earlier estimated, a recovery is recorded.
Net repossessed assets are carried in other assets and at December 31, 2001 are
reserved at 70% of the outstanding balance owed. Prior to September 30, 2000,
net repossessed assets were carried net of a 75% reserve. The repossessed asset
reserve is established as a transfer from the allowance for credit losses upon
initiation of the repossession proceedings when the finance receivable balance
is classified to other assets. Proceeds from the sale of repossessed assets are
applied against the outstanding balance owed and any deficiency is charged-off.
Reserves on sold repossessed assets are transferred back to the allowance for
finance credit losses.
The Company applies Statement of Financial Accounting Standards No. 114 ("SFAS
114") "Accounting by Creditors for Impairment of a Loan--an amendment of FASB
Statements No. 5 and 15" and Statement of Financial Accounting Standards No. 118
("SFAS 118") "Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures--an amendment of FASB Statement No. 114", which
address the accounting by creditors for impairment of a loan and related income
recognition and disclosures. During 2000, the Company changed its method of
application of SFAS 114 to eliminate discounting of future cash flows on
identified impaired receivables. Due to the short period of time that finance
receivables are managed from impairment to charge-off, the Company factors into
its reserving methodology a higher amount of allowance for accounts
contractually delinquent 60 or more days.
Statement of Financial Accounting Standards No. 91 ("SFAS 91"), "Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," requires that loan origination and commitment
fees and certain direct loan origination and account purchase costs be deferred
and amortized as an adjustment to the related loan's yield. MFN adopted the
provisions of this statement during 1999 and the results did not have a material
effect on the Company's reported results of operations or financial condition.
Unearned income represents the balance of interest income and insurance
commission income remaining from the capitalization of the total interest and
insurance to be earned over the original term of the related account. Unearned
interest income relates only to precompute accounts. Unearned income also
includes capitalized FAS 91 costs.
Finance receivable accounts that are contractually delinquent four payments are
charged off monthly before they become contractually delinquent five payments.
Accounts that are deemed uncollectible prior to the maximum charge-off period
are charged off immediately. Management may authorize a temporary extension of
the charge-off period if collection appears imminent during the next calendar
month.
20
FURNITURE, FIXTURES AND EQUIPMENT, NET
Furniture, fixtures and equipment are carried at cost, less accumulated
depreciation, and are depreciated on a straight-line basis over their estimated
useful lives. The depreciable lives of the fixed assets range from three to
seven years.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return
and individual state tax returns in most states.
MFN recognizes deferred tax assets and liabilities for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The Company evaluates deferred tax assets to determine whether they are likely
to be realized. In making its determination, management considers the possible
recovery of taxes already paid and the likelihood of generating additional
taxable income in the future.
AMORTIZATION
Prior to Fresh Start Reporting, the excess of the Predecessor Company's cost of
acquisitions over the fair value of net assets acquired ("Goodwill") was being
amortized on a straight-line basis over a period of 20 years. In accordance with
Fresh Start Reporting guidelines, the goodwill recorded on the Company's
Consolidated Balance Sheet at the Fresh Start Effective Date was reduced to
zero.
The excess of revalued net assets over liabilities and stockholders' investment
totaling $49.4 million, recorded on March 23, 1999 as a result of Fresh Start
Reporting, is being amortized over a 60 month period and appears as a credit to
amortization. The adoption of Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142") will result in the
remaining unamortized balance of the excess of revalued net assets over
liabilities and stockholders' investment on January 1, 2002 of approximately
$22.2 million being recognized as a gain from a change in accounting principle
in the first quarter of 2002. See "Recent Accounting Pronouncements".
STOCK-BASED COMPENSATION
SFAS 123, "Accounting for Stock-based Compensation," ("SFAS 123") defines a fair
value based method of accounting for an employee stock option or similar equity
instrument and encourages all entities to adopt that method of accounting. The
Company has elected, as permitted under SFAS 123, to continue to measure
compensation cost for its plan using the intrinsic value based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25. For
additional information, see Note 13.
21
BUSINESS SEGMENT DATA
The Company has determined it has a single reportable segment in accordance with
the management approach specified in SFAS 131, "Disclosure About Segments of an
Enterprise and Related Information". Reportable segments are strategic business
units that differ and are managed separately because of the nature of their
businesses. Management has organized the Company as a single reportable segment
for making operating decisions and assessing performance.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. The accounts, which are subject to
such estimation techniques, include the allowance for finance credit losses as
more fully discussed in Note 6. Actual results could differ from these
estimates.
RECLASSIFICATIONS
Certain data from the prior periods has been reclassified to conform to the
current period presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 138 ("SFAS 138") "Accounting for
Certain Derivative Instruments and Certain Hedging Activities" amends Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities" and is effective for fiscal years
beginning after June 15, 2000. The adoption of these statements as of January 1,
2001 did not have a material impact on the Company's financial position or
results of operations.
In September 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities: a replacement of
Financial Accounting Standards Board Statement No. 125" ("SFAS 140"), which
revises the standards for accounting for securitizations and other transfers of
financial assets and collateral and requires certain disclosures; however, SFAS
140 carries over most of Statement No. 125's provisions without reconsideration.
SFAS 140 is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001, and is effective
for disclosures relating to securitization transactions and collateral and for
recognition and reclassification of collateral for fiscal years ending after
December 15, 2000. The adoption of this statement did not have a material effect
on the Company's financial position or results of operations.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"),
which requires accounting for business combinations under the purchase method.
SFAS 141 is effective for all business combinations initiated after June 30,
2001. The adoption of this statement will not have a material effect on the
Company's financial position or results of operations.
22
In June 2001, the Financial Accounting Standards Board issued SFAS 142, which
addresses how intangible assets that are acquired individually or with a group
of other assets (but not those acquired in a business combination) should be
accounted for in the financial statements upon their acquisition. SFAS 142 also
addresses how goodwill and other intangible assets should be accounted for after
they have been initially recognized in the financial statements. SFAS 142 is
effective starting with fiscal years beginning after December 15, 2001. The
Company will adopt SFAS 142 on January 1, 2002. The adoption of SFAS 142 will
result in the remaining unamortized balance of the excess of revalued net assets
over liabilities and stockholders' investment on January 1, 2002 of
approximately $22.2 million being recognized as a gain from a change in
accounting principle in the first quarter of 2002.
NOTE 2 - PENDING MERGER
On November 19, 2001, the Company announced that it had entered into a
definitive agreement with Consumer Portfolio Services, Inc. ("CPS"),
headquartered in Irvine, California, for CPS to acquire all the outstanding
common stock of the Company for $10.00 a share. See Note 23 for a further
description of the consummation of the merger.
NOTE 3 - DISPOSITIONS
On July 29, 1999, the Company announced it had entered into a definitive
agreement to sell substantially all of the non-automotive loan accounts and
certain other assets of 47 direct loan offices of subsidiaries located in Texas,
Louisiana, Mississippi and Alabama. The sale was completed in September 1999 for
$32.9 million of net receivables held at 39 of the 47 direct loan offices,
resulting in a gain of $7.1 million. The sale of the remaining eight offices,
all located in Texas, closed during the first quarter of 2000. The financial
impact of this transaction was not material. The 47 direct loan offices sold did
not fit the strategic focus of the Company of purchasing automobile retail
installment contracts.
NOTE 4 - UNRESTRICTED CASH AND CASH EQUIVALENTS
Unrestricted cash and cash equivalents include marketable securities with
purchased maturities of three months or less. At December 31, 2001, unrestricted
cash and cash equivalents had an amortized cost and market value of $75.7
million. At December 31, 2000, unrestricted cash and cash equivalents had an
amortized cost basis of $128.7 million and a market value of $127.1 million. The
difference between the amortized cost basis and the market value represented a
$1.6 million write-down related to investments in commercial paper in a
California utility company.
NOTE 5 - RESTRICTED CASH
In connection with its warehouse credit facility (see Note 7) and in connection
with the notes payable to securitization trust (see Note 8), the Company is
required to hold certain funds in restricted cash accounts to provide additional
collateral for borrowings under the facility. In addition, cash balances equal
to certain insurance claim reserves must be held in custodial trust accounts
under arrangements made with insurance carriers. At December 31, 2001, the
aggregate restricted cash accounts totaled approximately $24.2 million.
23
NOTE 6 - FINANCE RECEIVABLES
Direct loans generally have terms of 12 to 24 months with maximum terms of 36
months; secured loans are generally collateralized by real or personal property.
Sales finance contracts are generally accounted for on a discount basis and
generally have terms of 24 to 48 months with maximum terms of 60 months. The
Company's finance receivables are with individuals located throughout the United
States. As of December 31, 2001, customers whose mailing addresses were in
Florida, Ohio and Virginia comprised 7.9%, 7.8% and 7.5% of the finance
receivable portfolio, respectively.
The following table summarizes the composition of finance receivables
outstanding, net of unearned income (in thousands):
2001 2000
---- ----
Sales Finance Receivables
Automobile
Simple interest $ 136,849 $ 63,641
Precompute, net of unearned income 267,468 386,287
---------- ----------
Total automobile, net of unearned income 404,317 449,928
Non-automobile, net of unearned income 6,001 21,845
---------- ----------
Total sales finance receivables,
net of unearned income 410,318 471.773
Direct loans, net of unearned income 2,726 13,081
---------- ----------
Finance Receivables, net of unearned income $ 413,044 $ 484,854
========== ==========
Included in finance receivables at December 31, 2001 and 2000 were $10.5 million
and $8.0 million, respectively, of receivables for which interest accrual had
been suspended.
The following table shows the contractual maturities of finance receivables, net
of unearned income, at December 31 (dollars in thousands):
2001 2000
---------------------- ----------------------
Due in One Year: $ 45,627 11.0% $ 62,574 12.9%
Due in Two Years: 103,936 25.2% 133,244 27.5%
Due in Three Years: 137,275 33.2% 169,305 34.9%
Due After Three Years: 126,206 30.6% 119,731 24.7%
----------- -------- ----------- --------
Total $ 413,044 100.0% $ 484,854 100.0%
=========== ======== =========== ========
The following sets forth a summary of sales finance receivable purchases and
direct loan originations, net of unearned income for the years ended December 31
(dollars in thousands):
2001 2000
---- ----
Automobile sales finance receivable purchases $ 259,246 $ 304,250
Non-automobile sales finance receivables purchases 8,073 20,804
Direct loan originations 3,090 9,239
----------- -----------
Total purchases and originations $ 270,409 $ 334,293
=========== ===========
24
Principal cash collections (excluding finance charges earned) for the years
ended December 31, were as follows (in thousands):
2001 2000
---- ----
Automobile sales finance receivables
Principal cash collections $ 239,753 $ 251,589
Percentage of average net balances 54% 55%
Non-automobile sales finance receivables
Principal cash collections $ 19,670 $ 20,866
Percentage of average net balances 125% 86%
Direct loans
Principal cash collections $ 10,684 $ 25,428
Percentage of average net balances 131% 115%
The loss reserves as a percent of finance receivables, net of unearned income at
December 31, are as follows:
2001 2000
---- ----
Allowance for finance credit losses 9.45% 8.06%
Nonrefundable dealer reserves 5.06% 5.78%
-------- --------
Total loss reserves 14.51% 13.84%
A summary of the activity in the allowance for finance credit losses for the
years ended December 31, was as follows (in thousands):
2001 2000 1999
---- ---- ----
Balance at beginning of year $ 39,071 $ 39,543 $ 53,485
Reserves recaptured in conjunction
with sale of finance receivables - (91) (3,694)
Provision for finance credit losses 29,097 20,380 32,928
Net charge-offs absorbed (29,651) (22,148) (47,058)
Net amount transferred from reserve
for repossessed assets 496 1,387 3,882
----------- ----------- -----------
Balance at end of year $ 39,013 $ 39,071 $ 39,543
=========== =========== ===========
A summary of the activity in nonrefundable dealer reserves for the years ended
December 31, was as follows (in thousands):
2001 2000 1999
---- ---- ----
Balance at beginning of year $ 28,014 $ 34,062 $ 36,820
Reserve adjustment in conjunction
with sale of finance receivables - - 495
Discounts acquired on new volume 19,724 28,003 29,713
Net charge-offs absorbed (26,815) (34,051) (32,966)
---------- ---------- ----------
Balance at end of year $ 20,923 $ 28,014 $ 34,062
========== ========== ==========
Under the static pooling methodology, the total balances of nonrefundable dealer
reserves are not available to offset current finance credit losses immediately,
but instead are amortized and made available to absorb credit losses over the
life of the corresponding pool of receivables.
25
NOTE 7 - WAREHOUSE CREDIT FACILITY
In March 2001, the Company entered into a $300 million Receivable Financing
Agreement (the "Financing Agreement") with Deutsche Bank AG, as agent ("Agent
Bank") and MFN Funding LLC, a wholly owned subsidiary of Mercury Finance Company
LLC. MFN Funding LLC is a special purpose company that holds certain automobile
sales finance receivables of the Company and borrows funds under the Financing
Agreement. The Financing Agreement contained a provision that reduced the amount
that could be borrowed under it from $300 million to $150 million after the
first take-out securitization (see Note 8). Under the Financing Agreement,
Mercury Finance Company LLC transfers certain automobile sales finance
receivables to MFN Funding LLC, which in turn issues a note to Agent Bank,
collateralized by eligible automobile sales finance receivables. Agent Bank
provides financing under the note to MFN Funding LLC pursuant to an advance
formula and MFN Funding LLC remits the funds to Mercury Finance Company LLC in
consideration for the transfer of certain automobile sales finance receivables.
While MFN Funding LLC is included in the Company's consolidated financial
statements, it is a separate legal entity. The automobile sales finance
receivables and other assets held by MFN Funding LLC are legally owned by MFN
Funding LLC and are not available to creditors of the Company or its
subsidiaries. Advances under the Financing Agreement bear interest at a rate
tied to the borrowing rate of the commercial paper conduit, or the Eurodollar
rate plus specified fees depending upon the source of funds provided by Agent
Bank.
In November 2001, the Financing Agreement was amended to revise certain loss and
delinquency triggers. This amendment also extended the maturity of the Financing
Agreement to November 29, 2002 and additional financing costs were incurred.
The Financing Agreement, as amended, contains various covenants requiring
certain minimum financial ratios and results. The Financing Agreement also
requires certain funds be held in restricted cash accounts to provide additional
collateral for borrowings under the facility, even if no borrowing is necessary.
Based on delinquency totals at December 31, 2001, the Company exceeded level 7
and level 8 triggers under the Financing Agreement. Exceeding these triggers
will require a $4.7 million transfer of cash to a restricted status on January
17, 2002 (see Note 23). If delinquencies continue to rise beyond their current
levels and remain sufficiently high for an extended period, the Company could
then be in default under the current terms of the Financing Agreement. If
delinquencies drop below the trigger levels in a subsequent month, this cash may
be returned to an unrestricted category. As of December 31, 2001, the restricted
cash under the Financing Agreement totaled $2.2 million.
At December 31, 2001, the maximum available credit limit was $150 million and,
based upon eligible automobile sales finance receivables held by MFN Funding
LLC, the maximum amount of advance available to the Company under the Financing
Agreement was $82.6 million. As of December 31, 2001, the Company had an
outstanding balance on the warehouse credit facility of $80.8 million.
The warehouse facility is accounted for as a secured financing in accordance
with the provisions of SFAS 140.
Interest expense on the warehouse credit facility is composed of the stated rate
of interest plus a spread, amortization of deferred financing costs and other
costs. Deferred financing costs related to the warehouse credit facility are
amortized on a straight-line, pro-rata basis over the initial or extended term
of the Financing Agreement.
26
Under the terms of the Financing Agreement, MFN Funding LLC purchased an
amortizing interest rate cap based on one month LIBOR (London Interbank Offered
Rate) on March 23, 2001. The fair value is not significant at December 31, 2001.
The amortizing cap is set at 6.750% and is effective from March 23, 2001 through
January 16, 2003. In the event one month LIBOR would exceed this rate during the
term of the agreement, MFN Funding LLC would receive a payment from a
counterparty for the rate in excess of 6.750%. As of December 31, 2001, one
month LIBOR was 1.876%.
NOTE 8 - NOTES PAYABLE TO SECURITIZATION TRUST
On June 28, 2001, the Company issued $301 million of notes secured by automobile
sales finance receivables (the "Securitized Notes") in a private placement (the
"Secured Financing Agreement"). The issuance was completed through the MFN Auto
Receivables Trust 2001-A of MFN Securitization LLC, a wholly owned subsidiary of
Mercury Finance Company LLC. MFN Securitization LLC is a special purpose company
that holds certain automobile sales finance receivables of the Company and
borrowed funds under the Secured Financing Agreement. MFN Securitization LLC
remits the funds to Mercury Finance Company LLC in consideration for the
transfer of certain automobile sales finance receivables. Both classes of the
Securitized Notes issued under the Secured Financing Agreement bear a fixed rate
of interest until their final distribution. While MFN Securitization LLC is
included in the Company's consolidated financial statements, it is a separate
legal entity. The automobile sales finance receivables and other assets held by
MFN Securitization LLC are legally owned by MFN Securitization LLC and are not
available to creditors of the Company or its subsidiaries.
Automobile contract asset-backed securitization transactions are treated as
either sales or secured financings for accounting purposes depending upon the
securitization structure. SFAS No. 140 defines the criteria used to evaluate the
securitization structure in determining the proper accounting treatment. These
criteria pertain to whether or not the transferor has surrendered control over
the transferred assets for purposes of accounting principles generally accepted
in the United States of America ("USGAAP"). Under the terms of the Securitized
Notes, the Company has a one-time right to repurchase at any time 10% of the
original pool balance at a 3% premium. The Company effectively maintains control
over these assets for USGAAP purposes and therefore the securitization is
accounted for as a secured financing rather than as a sale.
Interest payments on the Securitized Notes are payable monthly, in arrears,
based on the respective notes' interest rates. The following table presents the
Company's Securitized Notes outstanding and their stated interest rates at
December 31, 2001 (dollars in thousands):
Outstanding Stated Final Scheduled
Principal Interest Rate Distribution Date
--------- ------------- -----------------
Class A-2 Notes $ 181,330 5.07000% July 15, 2007
The Class A-1 Notes were initially issued in the amount of $116 million at a
stated interest rate of 4.05125% with a final scheduled distribution date of
July 15, 2002. The Class A-1 Notes were repaid in full in December 2001. Payment
27
in full of the Class A-2 Notes could also occur earlier than the final scheduled
distribution date.
Interest expense on the Securitized Notes is composed of the stated rate of
interest plus additional costs of borrowing. Additional costs of borrowing
include facility fees, insurance and amortization of deferred financing costs.
Deferred financing costs related to the Securitized Notes are amortized in
proportion to the principal distributed to the noteholders. Accordingly, the
effective cost of borrowing of the Securitized Notes is greater than the stated
rate of interest.
The Securitized Notes contain various covenants requiring certain minimum
financial ratios and results. As of December 31, 2001, the Company was in
compliance with these covenants. The Securitized Notes also require certain
funds be held in restricted cash accounts to provide additional collateral for
the borrowings or to be applied to make payments on the Securitized Notes. As of
December 31, 2001, restricted cash under the Secured Financing Agreement totaled
approximately $21.3 million.
NOTE 9 - SENIOR SECURED AND SUBORDINATED DEBT
The following table presents the Company's debt instruments and the stated
interest rates on the debt at December 31, (dollars in thousands):
2001 2000
----------------------- ---------------------
Balance Rate Balance Rate
------- ---- ------- ----
Senior secured debt $ -- N/A $342,908 10.00%
Senior subordinated debt 22,500 11.00% 22,500 11.00%
---------- ------- --------- -------
Total $ 22,500 11.00% $365,408 10.06%
========== ======= ========= =======
The senior secured debt at December 31, 2000 was comprised of both fixed and
variable rate notes. Due to the purchase of an interest rate cap, the
all-inclusive cost on this debt at December 31, 2000 was 10.0% to the Company
and is combined in the above table.
Pursuant to the Voluntary Case, no interest was accrued or paid on the
Predecessor Company's debt subsequent to July 15, 1998, the date the Voluntary
Case was filed, until March 23, 1999, the date the Reorganized Company emerged
from the Voluntary Case. This resulted in the reduction of 1999 interest expense
of approximately $11.5 million (calculated using a rate of ten percent (10.0%)
on the senior debt and at a rate of eleven percent (11.0%) on the subordinated
debt) and a reduction of 1998 interest expense of $27.8 million (assuming
default rates of interest), from what the Company would have expected to incur
had the Voluntary Case not been filed.
On April 1, 1999, $100.7 million of outstanding principal and $20.4 million of
interest were paid to senior lenders pursuant to the Plan of Reorganization. The
interest payment covered the period from October 14, 1998 through March 23, 1999
at a rate of ten percent (10.0%) on the senior debt and at a rate of eleven
percent (11.0%) on the subordinated debt. This interest payment was recorded as
a non-operating expense in 1999.
In connection with the Plan of Reorganization, the Company issued Senior Secured
Notes and Senior Subordinated Notes. The Senior Secured Notes were comprised of
(i) Series A Notes Due March 23, 2001, which have a 10% annual fixed rate of
interest, payable quarterly and (ii) Series B Notes Due March 23, 2001, which
have a floating rate of interest based on three month LIBOR (London Interbank
Offered Rate), payable quarterly.
28
Prior to the Effective Date, the Company's senior lenders were given the option
to receive either Series A Notes or Series B Notes in connection with the Plan.
During the second quarter of 1999, holders of the old senior debt elected to
receive $232.8 million of the Series A Notes and $201.3 million of the Series B
Notes totaling an aggregate principal amount of the Senior Secured Notes of
$434.2 million. During 2000 and 1999, MFN retired debt with face values of $38.4
million and $52.9 million, respectively, prior to scheduled maturity. See Note 9
to the Consolidated Financial Statements. The principal amounts of Series A
Notes and Series B Notes outstanding at December 31, 2000 were $164.5 million
and $178.4 million, respectively, for a total of $342.9 million. While the
Series B Notes had a variable rate of interest, the Company purchased interest
rate protection to cap the annual rate of interest at 10.0%, the cost of which
was amortized in determining the spread to LIBOR. The total interest cost of
either series of Senior Secured Notes did not exceed a 10.0% annual rate to the
Company.
The Company's Senior Secured Notes were secured by substantially all of the
assets of the Company and its domestic subsidiaries, which guaranteed the
Company's obligations under the Senior Secured Notes. No principal payments were
required prior to maturity.
The Senior Subordinated Notes, with an aggregate principal amount of $22.5
million, have an 11% annual fixed rate of interest, payable quarterly. Principal
payments are not due until maturity on March 23, 2002.
Debt is used as the primary source for funding the Company's finance
receivables. As a result of the Plan of Reorganization, the Company cancelled
all of its senior debt in exchange for Senior Secured Notes, New Common Stock
and Excess Cash (as defined in the Plan of Reorganization). The Company also
cancelled its subordinated debt in exchange for Senior Subordinated Notes.
NOTE 10 - DIVIDEND RESTRICTIONS
Dividends may be paid on the Company's Common Stock subject to certain financial
conditions contained in the Company's indentures governing the Financing
Agreement, the Secured Financing Agreement and the Senior Subordinated Debt. At
December 31, 2001, under the most restrictive provision of these funding
arrangements, $14.4 million was available for payment.
NOTE 11 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company has purchased derivative instruments to hedge certain financial
risks. Management documents the Company's risk management objectives, the nature
of risk being hedged and how hedge effectiveness will be measured at inception.
Management monitors the Company's hedging activities to ensure that the value of
hedges, their correlation to the contracts being hedged and the amount being
hedged continue to provide effective protection against interest rate risk. All
transactions are entered into for purposes other than trading. There can be no
assurance that the Company's strategies will be effective in minimizing interest
rate risk or that changes in interest rates will not have an adverse effect on
the Company's profitability.
29
NOTE 12 - EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average number of shares of the Company's common stock outstanding during the
period. Diluted earnings per share is computed by dividing net income by the
weighted average number of shares of common stock outstanding and the dilutive
common stock equivalents outstanding during the period. Common stock equivalents
include options granted under the Company's stock option plan, options granted
pursuant to an employment agreement with the Company's Executive Chairman and
outstanding warrants to purchase shares of common stock of the Company using the
treasury stock method.
(Dollars in thousands, except per share amounts)
2001 2000
---- ----
Net income before extraordinary credits $ 16,029 $ 18,399
Extraordinary gain from early retirement of debt, net of taxes - 717
------------ ------------
Net income $ 16,029 $ 19,116
BASIC
Average common shares outstanding 9,993,376 10,000,002
Earnings per common share before extraordinary credit $ 1.60 $ 1.84
Extraordinary gain from early retirement of debt - 0.07
------------ ------------
Earnings per common share $ 1.60 $ 1.91
============ ============
DILUTED
Average common shares outstanding and common
stock equivalents outstanding 10,038,757 10,002,399
Earnings per common share before extraordinary credit $ 1.60 $ 1.84
Extraordinary gain from early retirement of debt - 0.07
------------ ------------
Earnings per common share $ 1.60 $ 1.91
============ ============
Due to the Company's emergence from the Voluntary Case and the implementation of
Fresh Start Reporting, the presentation of earnings per share for the
Predecessor Company is not meaningful.
NOTE 13 - STOCK OPTIONS
Under the Plan of Reorganization, options to purchase 950,000 shares of the
Company's authorized and unissued New Common Stock were reserved under the
Amended and Restated 1989 Stock Option Plan ("Stock Option Plan"). An amendment
to the Stock Option Plan was approved by stockholders on April 24, 2001 to
increase the number of shares authorized for issuance thereunder by 500,000
shares.
Under the Stock Option Plan, options to purchase 500,000 shares were granted to
officers and directors, effective March 23, 1999 ("First Grant Date"), at an
exercise price of $8.50 per share (the estimated reorganization value per common
share). Of the shares granted, fifty percent (50%) vested and became exercisable
on the First Grant Date, twenty-five percent (25%) vest and become exercisable
30
in twelve (12) equal monthly portions, beginning with the first anniversary of
the First Grant Date and twenty-five percent (25%) vest and become exercisable
in twelve (12) equal monthly portions, beginning with the second anniversary of
the First Grant Date. The options expire ten (10) years from the First Grant
Date.
The following grants of options all vest 1/3 per year beginning with the first
anniversary of the Grant Date and expire ten (10) years from the Grant Date.
Grant Date Options Granted Exercise Price
---------- --------------- --------------
October 26, 1999 85,000 $7.875
January 11, 2000 100,000 $6.500
April 27, 2000 20,000 $6.500
January 1, 2001 200,000 $4.125
February 6, 2001 85,000 $7.000
May 1, 2001 32,000 $5.750
In addition to shares granted under the Stock Option Plan, an option to purchase
1,000,000 shares was granted to the Executive Chairman of the Company effective
March 23, 1999 pursuant to an employment agreement approved as part of the Plan
of Reorganization. The terms and conditions of the option granted are similar to
the options granted on March 23, 1999 as described above. Shares issued under
the employment agreement do not count against the 1,450,000 aggregate number of
options to purchase shares of New Common Stock that may be granted under the
Stock Option Plan.
A summary of the status of the Reorganized Company's Stock Option Plan as of
December 31, 2001 and December 31, 2000 is presented below:
2001 2000
------------------------- ---------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ ----- ------ -----
Outstanding at beginning of year 1,684,000 $ 8.35 1,585,000 $ 8.47
Granted 317,000 5.06 120,000 6.50
Exercised (1,667) 6.50 - -
Forfeited (89,667) 7.14 (21,000) 6.50
----------- -----------
Outstanding at end of year 1,909,666 7.86 1,684,000 8.35
=========== ===========
Options exercisable at year-end 1,484,603 $ 8.46 1,090,789 $ 8.48
Weighted-average fair value of
options granted during the year $ 3.25 $ 4.29
31
MFN applies APB Opinion 25 and its Interpretations in accounting for its Plan,
and accordingly, no compensation cost has been recognized for its stock options
in the consolidated financial statements. Had the Reorganized Company determined
compensation cost based on the fair value at the grant date for its stock
options under SFAS 123, the Reorganized Company's net income and earnings per
share would have been decreased to the pro forma amounts indicated below (in
thousands, except per share amounts):
Nine
Year Ended Year Ended Months Ended
Dec. 31, 2001 Dec. 31, 2000 Dec. 31, 1999
------------- ------------- -------------
Net income As reported $16,029 $19,116 $20,529
Pro forma $14,375 $16,981 $16,040
Earnings per share - basic As reported $1.60 $1.91 $2.05
Pro forma $1.44 $1.70 $1.60
Earnings per share - diluted As reported $1.60 $1.91 $2.05
Pro forma $1.44 $1.70 $1.60
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:
Risk-Free Dividend Stock Price
Grant Date Interest Rate Yield Expected Life Volatility
---------- ------------- ----- ------------- ----------
March 23, 1999 5.19% 0% 5 years 85%
October 26, 1999 6.42% 0% 5 years 75%
January 11, 2000 6.72% 0% 5 years 75%
April 27, 2000 6.55% 0% 5 years 75%
January 1, 2001 4.89% 0% 5 years 75%
February 6, 2001 4.99% 0% 5 years 75%
May 1, 2001 4.97% 0% 5 years 75%
32
Information pertaining to options outstanding at December 31, 2001 is as
follows:
Options Outstanding Options Exercisable
-------------------------------------------- ----------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
--------------- ----------- -------------- ----------- ----------- -----------
$4.12 - $6.49 232,000 9.06 years $ 4.35 - $ -
$6.50 - $7.87 117,666 8.68 years $ 6.80 14,442 $ 6.50
$7.88 - $8.50 1,560,000 7.26 years $ 8.47 1,470,161 $ 8.48
---------- ----------
Outstanding at
end of year 1,909,666 1,484,603
========== ==========
NOTE 14 - WARRANTS
The Company has warrants outstanding that entitle the holder to purchase common
stock at targeted exercise prices before their expiration date. The following
table summarizes the number of warrants outstanding:
Exercise December 31, December 31,
Expiration Date Price 2001 2000
--------------- ----- ---- ----
Series A March 23, 2002 $15.34 569,841 579,999
Series B March 23, 2003 $21.81 569,836 579,999
Series C March 23, 2004 $28.27 569,841 579,999
NOTE 15 - EXTRAORDINARY CREDITS
During 2000 and 1999, MFN retired debt with face values of $38.3 million and
$52.9 million, respectively, prior to scheduled maturity. The debt repurchases
resulted in extraordinary gains of $1.18 million less taxes of $0.46 million in
2000 and $2.51 million less taxes of $0.99 million in 1999. See Note 12 for the
impact of the extraordinary item on basic and diluted earnings per share.
See Note 1 for discussion of the gain on discharge of indebtedness resulting
from the Company's emergence from the Voluntary Case and adoption of Fresh Start
Reporting.
33
NOTE 16 - RESTRUCTURING CHARGES
During 2001, the Company announced its plans to consolidate its collection
operations into regional centers, to eliminate the Dealer Development Manager
("DDM") position and add additional Regional Business Development Managers
("RBDMs"), to close three Central Purchasing Offices and to close its Midland
Finance Company operations. During the course of the year, the Company recorded
provisions against earnings that totaled $4.8 million to cover estimated
severance, lease termination, relocation, payroll tax costs, and disposal of
furniture, fixtures and equipment. These charges and credits (included in other
operating expenses) and their utilization is summarized below (in thousands):
Amounts Amounts Adjust- Balance
Charged Utilized ments Dec. 31,
(in thousands) in 2001 in 2001 in 2001 2001
------- ------- ------- ----
Lease termination $ 1,976 $ 631 $ (305) $ 1,040
Disposal of furniture, fixtures and equipment 296 206 -- 90
Employee severance, payroll taxes and relocation 2,521 2,138 250 633
--------- --------- --------- ---------
Total $ 4,793 $ 2,975 $ (55) $ 1,763
========= ========= ========= =========
A $55,000 credit was recorded to restructuring expense in 2001 to adjust
previously recorded reserves for actual results.
During 1999, the Company implemented a plan to close a total of 46 collection
offices. The Company recorded a provision against earnings in the amount of $1.9
million to cover estimated severance, relocation costs and lease termination
costs. These charges and credits (included in other operating expenses) and
their utilization is summarized below (in thousands):
Amounts Amounts Amounts Adjust- Balance
Charged Utilized Utilized ments Dec. 31,
In 1999 In 1999 In 2000 In 2000 2000
------- ------- ------- ------- -----
Lease buyouts and other expenses $ 998 $ 380 $ 774 $ (156) $ -
Employee severance and retention 952 333 712 (93) -
--------- -------- -------- -------- --------
Total $ 1,950 $ 713 $ 1,486 $ (249) $ -
========= ======== ======== ======== ========
A $249,000 credit was recorded to restructuring expense in 2000 to adjust
previously recorded reserves to zero upon final disposition of all severance and
lease obligations.
The Company records restructuring charges against operations and provides a
reserve based on the best information available at the time the commitment is
made to undertake the restructuring action. The reserves are considered utilized
when specific restructuring criteria are met, indicating the planned
restructuring action has occurred. Work-force-related reserves are considered
utilized at payment for termination or acceptance of other contractual
arrangements.
34
The reserve for lease buyouts is utilized when the remaining lease obligations
are settled or the space has been vacated and made available for sublease. It is
the Company's policy to continue to charge depreciation, rental and other
operating costs relating to excess space to ongoing operations while they remain
in business use. Salaries and benefits are charged to operations while the
employee is actively employed. Reserves for asset and leasehold improvement
write-offs are utilized at the date of disposal or the final date of the lease.
NOTE 17 - NON-OPERATING REORGANIZATION EXPENSES
In accordance with SOP 90-7, expenses resulting from the Plan of Reorganization
are reported separately as reorganization expenses in the Consolidated
Statements of Income. These expenses were incurred by the Predecessor Company
and for the respective periods indicated are as follows (in thousands):
Three Months Ended
March 31, 1999
--------------
Interest expense $ 19,847
Management consultants 6,933
Adjustments of assets and liabilities to fair value 3,085
Creditor attorneys and advisors 1,193
Corporate counsel 846
Independent accountants 550
Board of Directors representation 100
Other 1,165
---------
Total $ 33,719
=========
NOTE 18 - REORGANIZATION EXPENSES
Reorganization expenses for the respective periods indicated are as follows (in
thousands):
Three Months Ended
March 31, 1999
--------------
Professional fees $ 2,998
Interest income (1,893)
----------
Total $ 1,105
==========
The Company estimated the amount of professional fees that related specifically
to the Voluntary Case. In accordance with Fresh Start Reporting, interest earned
on funds held for deposit that would have been paid to senior debt holders if
the Company had not filed the Voluntary Case, is off-set against expenses
related to the Voluntary Case.
35
NOTE 19 - PENSION PLANS AND OTHER EMPLOYEE BENEFITS
The following table sets forth the funded status of MFN's qualified plans and
amounts recognized in the 2001, 2000 and 1999 consolidated financial statements
(in thousands):
2001 2000 1999
---- ---- ----
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year $ 14,754 $ 14,286 $ 16,728
Service cost 577 1,135 1,797
Interest cost 934 1,074 1,118
Curtailment (3,595) -- --
Actuarial gain (loss) 608 121 (3,311)
Benefits paid (1,055) (1,862) (2,046)
--------- --------- ---------
Projected benefit obligation, end of year $ 12,223 $ 14,754 $ 14,286
========= ========= =========
CHANGE IN PLAN ASSETS
Plan assets at fair value, beginning of year $ 13,608 $ 15,655 $ 17,011
Actual return on plan assets (540) (185) 690
Benefits paid (1,055) (1,862) (2,046)
--------- --------- ---------
Plan assets at fair value, end of year $ 12,013 $ 13,608 $ 15,655
========= ========= =========
RECONCILIATION OF ACCRUED PENSION COST
AND TOTAL AMOUNT RECOGNIZED
Funded status of the plan $ (211) $ (1,146) $ 1,369
Unrecognized actuarial gain, net (806) (3,220) (5,111)
Unrecognized prior service cost -- 69 74
Unrecognized transition obligation (163) (201) (239)
--------- --------- ---------
Accrued pension cost $ (1,180) $ (4,498) $ (3,907)
========= ========= =========
WEIGHTED AVERAGE ASSUMPTIONS
Discount rate 7.25% 7.50% 7.75%
Expected return on plan assets 9.00% 9.00% 9.00%
Rate of compensation increase NA 4.25% 5.00%
TOTAL COST
Service cost $ 577 $ 1,135 $ 1,797
Interest cost 934 1,074 1,118
Expected return on plan assets (1,119) (1,382) (1,399)
Amortization of transition obligation (38) (38) (51)
Amortization of unrecognized prior service cost 3 5 5
Amortization of unrecognized net gain (81) (203) (97)
--------- --------- ---------
Net periodic pension cost 276 591 1,373
Amount recognized due to curtailment or adjustment (3,595) -- 15
--------- --------- ---------
Total benefit cost (income) $ (3,319) $ 591 $ 1,388
========= ========= =========
On June 30, 2001 the Company froze future benefits under the Company's
noncontributory defined benefit pension plan as part of redesigning its employee
benefit plans. This change resulted in the recognition of a $3.6 million
curtailment gain.
36
The Company also maintains a defined contribution plan. All employees are
eligible to participate in this plan after having attained six consecutive
months of service. Employer contributions to this plan were $843,000 in 2001,
$815,000 in 2000 and $879,000 in 1999.
Both the non-contributory defined benefit pension plan and the defined
contribution plan cover substantially all full time employees of MFN and provide
for employee contributions and partial matching contributions by MFN.
NOTE 20 - INCOME TAXES
Income taxes on income (loss) before extraordinary credits for the respective
periods are as follows (in thousands):
Predecessor
Reorganized Company Company
------------------- -------
Nine Three
Year Year Months Months
Ended Ended Ended Ended
Dec 31, Dec 31, Dec 31, Mar 31,
2001 2000 1999 1999
---- ---- ---- ----
Current income tax expense (benefit)
Federal $ 4,787 $ (390) $ (993) $ -
State 650 (2,501) 366 -
----------- ---------- --------- ---------
Total current income tax expense (benefit) $ 5,437 $ (2,891) $ (627) $ -
=========== ========== ========= =========
Deferred income tax expense (benefit) $ (13,162) $ 5,156 $ 1,918 $ (5,287)
=========== ========== ========= =========
Provision for income taxes is calculated using a combined federal and state tax
rate of 39.5% on earnings before income taxes adjusted for the amortization of
the excess of revalued assets over liabilities and stockholders' investment and
other book to tax differences not temporary in nature. The 2001 net tax benefit
reflects a favorable $7.4 million adjustment as a result of a tentative
settlement with the Internal Revenue Service concerning its examination of the
Company's federal tax returns for the fiscal years 1993 through 1997, the
estimated effect on fiscal years 1998 through 2000 and the resolution of other
tax matters. The net cash flow effect of the terms of the tentative settlement
is insignificant.
37
Income taxes on extraordinary credits for the years ended December 31, 2001,
2000 and 1999 are as follows (in thousands):
Predecessor
Reorganized Company Company
------------------- -------
Nine Three
Year Year Months Months
Ended Ended Ended Ended
Dec 31, Dec 31, Dec 31, Mar 31,
2001 2000 1999 1999
---- ---- ---- ----
Current tax expense $ - $ 468 $ 993 $ -
Deferred tax expense - - - 22,659
----------- ---------- ---------- ---------
Total current taxes $ - $ 468 $ 993 $ 22,659
=========== ========== ========== =========
During 1999, the Company recorded an extraordinary gain from discharge of
indebtedness aggregating approximately $68.2 million in connection with its
March 23, 1999 emergence from the Voluntary Case. This gain was not taxable
under Section 108 of the Internal Revenue Code. Pursuant to this tax rule, the
Company has, however, reduced certain of its available tax attributes measured
as of January 1, 2000, which included unused net operating loss and tax basis in
certain Company assets. Deferred taxes have been provided for the estimated tax
effect of future reversing timing differences related to the discharge of
indebtedness gain as reduced by the tax attributes. The Company also recorded
extraordinary gains of $0.7 million and $1.5 million, net of taxes, during the
twelve months ended December 31, 2000 and the nine months ended December 31,
1999, respectively, on unrelated early retirements of debt.
The differences between the U.S. federal statutory income tax rate and the
Company's effective rate are:
2001 2000 1999
---- ---- ----
Statutory federal income tax rate 35.0% 35.0% 35.0%
Amortization of negative goodwill (41.6) (15.8) (3.9)
Tax difference on gain on debt forgiveness - - 4.6
Deferred tax valuation allowance - - (5.9)
Tentative agreement with the IRS (89.5) - -
State income taxes, net of federal tax benefit - 1.7 0.4
State income tax refunds, net of federal taxes - (9.1) -
Merger expenses 3.5 - -
Other, net (0.4) 0.7 0.2
------- ------- -------
Company's effective tax rate (93.0)% 12.5% 30.4%
======= ======= =======
38
Temporary differences between the amounts reported in the financial statements
and the tax basis of assets and liabilities result in deferred taxes. Deferred
tax assets and liabilities at December 31, were as follows (in thousands):
2001 2000 1999
---- ---- ----
Deferred Tax Assets:
Allowance for finance receivables $ 15,410 $ 8,652 $ 4,712
Accrued non-operating expenses 69 68 87
Accrued restructuring expense 697 98 489
Other 1,007 1,777 1,780
--------- --------- ---------
Deferred tax assets 17,183 10,595 7,068
Deferred Tax Liabilities:
Debt forgiveness 28,364 34,840 26,263
Other 102 200 94
--------- --------- ---------
Deferred tax liabilities 28,466 35,040 26,357
--------- --------- ---------
Net deferred tax liability $(11,283) $(24,445) $(19,289)
========= ========= =========
The Company elected to be treated as a dealer in securities under Section 475 of
the Internal Revenue Code effective for the year ended December 31, 1996.
Pursuant to this election, for tax purposes, the Company annually recognizes as
taxable income or taxable loss the difference between the fair market value of
its securities and the income tax basis of its securities. In addition to
substantially all of the finance receivables held as of December 31, 1996,
eligible securities to which this provision applies include substantially all
finance receivables purchased from the election's effective date through August
31, 2000. This mark to market requirement will not apply to finance receivables
purchased after this date. This election has no impact on the recognition of
pre-tax income for financial reporting purposes.
39
NOTE 21 - COMMITMENT AND CONTINGENCIES
LEASES
- ------
MFN and its subsidiaries lease office space generally under cancelable operating
leases expiring in various years through 2007. Most of these leases are
renewable for periods ranging from three to five years. Future minimum payments,
by year and in the aggregate, under operating leases with initial or remaining
terms of one year or more consisted of the following at December 31, 2001 (in
thousands):
Year Amount
---- ------
2002 $ 2,172
2003 1,922
2004 1,671
2005 1,533
2006 and thereafter 1,085
---------
Total $ 8,383
=========
It is expected that in the normal course of business, office leases that expire
will be renewed or replaced by leases on other properties. Total rent expense
approximated $2.6 million, $2.6 million and $3.2 million in 2001, 2000 and 1999,
respectively.
LITIGATION
- ----------
On July 15, 1998, the Company filed a voluntary petition (the "Voluntary Case")
in the United States Bankruptcy Court (the "Court") for the Northern District of
Illinois for relief under chapter 11 of title 11 of the United States Code. The
Company's Second Amended Plan of Reorganization (the "Plan") was confirmed by
order of the Court on March 10, 1999. The effective date of the Plan was March
23, 1999. The Plan provided (a) for the Company to transfer to a certain trust
established under the Plan (the "Liquidating Trust"), (i) $5 million in cash,
(ii) the Company's claims against the Company's previous auditors and (iii)
$250,000 in cash for fees and costs to be incurred in connection with the
Liquidating Trust and (b) for the holders of Securities Fraud Claims to receive
a share of the beneficial interests in the Liquidating Trust in complete
settlement, satisfaction and discharge of their claims. In addition, the Plan
provided for the Company to pay (i) $13.35 million into funds established for
the benefit of holders of certain indemnification claims against the Company and
(ii) up to an aggregate amount of $250,000, for costs and expenses of certain
officers, agents and employees who were no longer employed by the Company as of
the first day immediately following March 23, 1999, in connection with their
participation in a government investigation. The Company also agreed to pay a
former employee $100,000 in connection with a mutual release. All of these costs
were fully provided for as of December 31, 1998 and all amounts were paid during
1999 and 2000 with the exception of approximately $174,000 which remains set
aside for costs and expenses of certain officers, agents and employees who were
no longer employed by the Company as of the first day immediately following
March 23, 1999, in connection with their participation in a government
investigation.
The Securities and Exchange Commission staff has notified the Company that,
subject to Securities Act Release No. 5310, its investigation of the events
giving rise to the accounting irregularities announced in January 1997 has been
40
terminated and it has been recommended to the Commission that no enforcement
action be taken against the Company. Those events are still under investigation
by the United States Attorney for the Northern District of Illinois and the
Federal Bureau of Investigation.
In the normal course of its business, MFN and its subsidiaries are named as
defendants in legal proceedings. A number of such actions (the "Consumer Finance
Cases"), including cases which have been brought as putative class actions, are
pending in the various states in which subsidiaries of MFN conducts business. It
is the policy of MFN and its subsidiaries to vigorously defend litigation,
however, MFN and (or) its subsidiaries have and may in the future enter into
settlements of claims where management deems appropriate. Although it is not
possible at this time to estimate the amount of damages or settlement expenses
that may be incurred, management is of the opinion that the resolution of these
proceedings will not have a material effect on the financial position and
results of operations of MFN.
The Company recognizes the expense for litigation when the incurrence of loss is
probable and the amount of such loss is estimable. Because of the uncertainty
that surrounds the Consumer Finance Cases, no accrual has been made for the
majority of these lawsuits.
NOTE 22 - DISCLOSURES OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is practicable to estimate that
value. Fair value estimates are made at a specific point in time for MFN's
financial instruments; they are subjective in nature and involve uncertainties,
and matters of significant judgment and, therefore, cannot be determined with
precision.
Cash and Cash Equivalents
- -------------------------
Due to the short-term nature of these items, management believes that the
carrying amount is generally a reasonable estimate of fair value.
Finance Receivables, net
- ------------------------
Finance receivables, net have been valued based upon an estimate of the future
cash flows discounted at an imputed weighted average cost of capital.
Warehouse Credit Facility
- -------------------------
Due to the short-term nature of these items, management believes that the
carrying amount is generally a reasonable estimate of fair value.
Notes Payable to Securitization Trust
- -------------------------------------
Due to the short-term nature of these items, management believes that the
carrying amount is generally a reasonable estimate of fair value.
Senior Debt - Term Notes
- ------------------------
The fair value has been computed for the term notes and interest rate cap based
upon indicated pricing from brokers.
Subordinated Debt
- -----------------
The fair value has been computed based upon indicated pricing from brokers.
41
The carrying amount and estimated fair values of MFN's financial instruments at
December 31, are as follows (in thousands):
2001 2000
--------------------------- ------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
FINANCIAL ASSETS:
Cash and cash equivalents $ 99,890 $ 99,890 $ 127,093 $ 127,093
Finance receivables, net 353,108 379,852 417,769 442,680
FINANCIAL LIABILITIES:
Warehouse credit facility (80,800) (80,800) - -
Notes payable to securitization trust (181,330) (181,330) - -
Senior debt - term notes - - (342,908) (339,479)
Subordinated debt (22,500) (22,500) (22,500) (21,375)
NOTE 23 - SUBSEQUENT EVENTS
On January 22, 2002, the Company announced that its shareholders had approved
the Agreement and Plan of Merger ("Merger"), dated November 18, 2001, among MFN
Financial Corporation, CPS Mergersub, Inc. and Consumer Portfolio Services, Inc.
(see Note 2). On March 8, 2002, the Company announced it had consummated the
Merger and that MFN Financial Corporation shareholders would receive $10.00 cash
for each share of common stock they own. In connection with the closing of the
Merger, the Company's warehouse credit facility was paid in full and the
Financing Agreement with Deutsche Bank AG dated March 1, 2001 terminated.
On March 8, 2002, the Company issued $100 million of notes secured by automobile
sales finance receivables in a private placement through the MFN Auto
Receivables Trust 2002-A.
42