SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) August 11, 1997
Mercury Finance Company
(Exact name of registrant as specified in charter)
Delaware 1-10176 36-3627010
(State of other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
100 Field Drive, Lake Forest, Illinois 60045
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (847) 295-8600
N/A
(Former name or former address, if changed since last report)
Item 5. Other Events.
The Registrant hereby files its Consolidated Financial Statements for the
three months ended March 31, 1997, along with an explanatory discussion of
certain factors affecting the Financial Statement, copies of which are attached
as Exhibits 99.1 and 99.2, respectively, to this Form 8-K and incorporated
herein by reference.
Item 7. Financial Statements and Exhibits.
(c) Exhibits.
Exhibit No. Description of Document
99.1 The Registrant's Consolidated Financial Statements for
the three months ended March 31, 1997.
99.2 Management's Discussion.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned hereunto duly authorized.
Mercury Finance Company
Date: August 11, 1997 By: /s/ William A. Brandt, Jr.
Its:_____________________________
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Mercury Finance Company:
We have reviewed the accompanying consolidated balance sheet of Mercury Finance
Company and subsidiaries as of March 31, 1997, and the related consolidated
statements of income, changes in shareholders' equity and cash flows for the
three-month period then ended. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 15 to the
financial statements, on January 29, 1997 the Company announced accounting
irregularities, discovered subsequent to December 31, 1996, causing it to
violate its debt covenants which curtailed the availability of credit and caused
the Company to miss scheduled debt payments. Also, as discussed in Note 15, the
Company incurred significant losses in 1996 and is continuing to incur losses in
1997. In addition, as further described in Note 8, the Company has been named
as a defendant in litigation generally arising from the restatement of earnings
for 1995 and interim earnings for 1996 as a result of the accounting
irregularities. The Securities and Exchange Commission and the United States
Attorney for the Northern District of Illinois have also commenced
investigations. Management's plans with regard to these matters are described
in Notes 8 and 15 to the consolidated financial statements. As discussed in our
auditors' report on the December 31, 1996 balance sheet dated May 13, 1997, and
as discussed further in Notes 8 and 15 to the accompanying financial statements,
there are several matters that raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Chicago, Illinois
July 21, 1997
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Balance Sheets
<CAPTION>
As of As of
March 31, December 31,
1997 1996
(dollars in thousands) (unaudited)
<S> <C> <C>
Assets
Cash and cash equivalents $25,790 $20,957
Short-term investments (at amortized cost which approximates fair 20,437 43,411
value)
Investments available-for-sale, at fair value 192,937 161,781
Investments held-to-maturity, at cost (fair value of $8,215 and 8,047 7,765
$8,025)
Finance Receivables 1,126,119 1,160,423
Less allowance for finance credit losses (111,584) (97,762)
Less nonrefundable dealer reserves (80,677) (89,378)
Finance receivables, net 933,858 973,283
Deferred income taxes, net 39,260 33,356
Income taxes receivable 51,072 53,764
Premises and equipment (at cost, less accumulated depreciation of 7,043 7,266
$9,681 and $9,157)
Goodwill 14,248 14,463
Reinsurance receivable 98,353 93,458
Deferred acquisition costs and present value of future profits 43,503 62,809
Other assets (including repossessions) 61,087 71,047
Total Assets $1,495,635 $1,543,360
Liabilities and Shareholders' Equity
Liabilities
Senior debt, commercial paper and notes $503,619 $525,051
Senior debt, term notes 488,625 488,625
Subordinated notes 22,500 22,500
Accounts payable and other liabilities 70,779 81,282
Unearned premium and claim reserves 227,450 239,573
Reinsurance payable 30,026 17,444
Reserve for loss on sale of Lyndon 29,528 0
Total Liabilities 1,372,527 1,374,475
Contingencies (Note 8)
Shareholders' Equity
Common stock - $1.00 par value per share: 300,000,000 shares 177,901 177,719
authorized
March 31, 1997 - 177,900,671 shares outstanding December 31, 1996 -
177,719,447 shares outstanding
Paid in capital 8,244 6,539
Retained earnings (deficit) (8,756) 37,349
Unrealized appreciation (depreciation) on available-for-sale (617) 942
securities, net of tax
Treasury stock - 5,402,957 shares at cost (53,664) (53,664)
Total Shareholders' Equity 123,108 168,885
Total Liabilities and Shareholders' Equity $1,495,635 $1,543,360
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Statement of Income
<CAPTION>
3 months ended
March 31,
1997
(dollars in thousands, except per share amounts) (unaudited)
<S> <C>
Interest Income
Finance charges and loan fees $63,491
Investment income 3,289
Total finance charges, fees and investment income 66,780
Interest expense 20,716
Interest income before provision for finance credit losses 46,064
Provision for finance credit losses 30,462
Net interest income 15,602
Other Income
Insurance commissions 1,712
Insurance premiums 23,220
Fees and other income 1,791
Total other income 26,723
Other Expenses
Salaries and employee benefits 14,644
Occupancy expense 1,555
Equipment expense 852
Data processing expense 543
Incurred insurance claims and other underwriting expense 16,715
Other operating expenses 8,692
Total other expenses 43,001
Loss on sale of Lyndon 29,528
Other non-operating expenses 5,129
Loss before income taxes (35,333)
Credit for income taxes (2,165)
Net Loss ($33,168)
Net Loss Per Common Share ($0.19)
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Statement of Changes in Shareholders' Equity
(unaudited)
(dollars in thousands, except per share amounts)
<CAPTION>
Common Paid in Retained Unrealized Treasury Total
Stock Capital Earnings Appreciation Stock
(Deficit) (Depreciation)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $177,719 $6,539 $37,349 $942 ($53,664) $168,885
Net loss (33,168) (33,168)
Stock options exercised 182 1,705 1,887
Dividends declared ($0.075 per (12,937) (12,937)
share)
Unrealized depreciation on (1,559) (1,559)
available for sale
securities, net of taxes
Balance at March 31, 1997 $177,901 $8,244 ($8,756) ($617) ($53,664) $123,108
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Statement of Cash Flows
<CAPTION>
3 Months ended
March 31,
1997
(dollars in thousands) (unaudited)
<S> <C>
Cash Flows From Operating Activities
Net loss ($33,168)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for finance credit losses 30,462
Net finance receivables charged off against allowance for finance credit losses (16,640)
Credit for deferred income taxes (5,904)
Loss on sale of Lyndon 29,528
Depreciation and amortization 739
Net increase in reinsurance receivable (4,895)
Net decrease in deferred acquisition costs and present value of future profits 19,306
Net decrease in other assets 12,652
Net increase in reinsurance payable 12,582
Net decrease in unearned premium and claim reserves (12,123)
Net decrease in other liabilities (23,440)
Net decrease in nonrefundable dealer reserves (8,701)
Net cash provided by operating activities 398
Cash Flows From Investing Activities
Principal collected on finance receivables 197,052
Finance receivables originated or acquired (162,746)
Purchases of short term and available for sale investment securities (43,448)
Purchases of held to maturity investment securities (306)
Proceeds from sales and maturities of short term and available for sale 34,102
investment securities
Proceeds from maturities of held to maturity investment securities 24
Net purchase of premises and equipment (301)
Net cash provided by investing activities 24,377
Cash Flows From Financing Activities
Net repayments of senior debt, commercial paper and notes (21,432)
Stock options exercised 1,490
Net cash used in financing activities (19,942)
Net increase in cash and cash equivalents 4,833
Cash and Cash Equivalents at Beginning of Quarter 20,957
Cash and Cash Equivalents at End of Quarter $25,790
Supplemental Disclosures
Income taxes paid to federal and state government $0.00
Interest paid to creditors $17,463
See accompanying notes to consolidated financial statements.
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997 (unaudited) and December 31, 1996
(dollars in thousands except per share amounts)
1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Mercury Finance Company ("Mercury" or the "Company") is a consumer finance
company doing business in 31 states under its own name and through its
subsidiaries MFC Finance Company, MERC Finance Company, Gulfco Investment
Inc. and subsidiary and Midland Finance Co. (the "consumer finance
subsidiaries"). The Company also offers certain insurance services through
its subsidiary, Lyndon Property Insurance Company and subsidiaries
("Lyndon"). 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 Mercury conform to generally
accepted accounting principles for the finance and insurance industries. The
consolidated financial statement include the accounts of the Company, the
consumer finance subsidiaries and Lyndon. All significant intercompany
accounts and transactions have been eliminated.
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
acquired. Interest income is calculated using the interest (actuarial)
method to produce constant rates of interest (yields). If a precompute
account becomes greater than 60 days contractually delinquent and no full
contractual payment is received in the month the account attains such
delinquency status, the accrual of income is suspended until one or more full
contractual monthly payments are received. Interest on interest bearing
loans and sales finance contracts is calculated on a 360-day basis and
recorded on the accrual basis; accrual is suspended when an account is 60 or
more days contractually delinquent. 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 their lending practices, the consumer finance
subsidiaries, as agents for Lyndon and unaffiliated insurers, offer credit
life, accident and health and property insurance to borrowers who obtain
finance receivables directly from the consumer finance subsidiaries, and to
borrowers under sales finance contracts and financing contracts purchased
from merchants and automobile dealers. Commissions on credit life, accident
and health and property insurance from unaffiliated insurers are earned by
Mercury over the average terms of the related policies on the sum-of-the
months digits method. See Note 2 for a discussion of the disposition of
Lyndon.
Lyndon is engaged in the business of reinsuring and direct writing of credit
life, accident and health and various other property and casualty insurance
policies issued to borrowers under direct consumer loan and sales finance
contracts originated by Mercury and other companies. The policies insure the
holder of a sales finance contract or other debt instrument for the
outstanding balance payable in the event of death or disability of the
debtor. Insurance premiums are 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 policy holders.
Lyndon has established policy liabilities and claim reserves. The claim
reserves are based upon accumulated estimates of claims reported, plus
estimates of incurred but unreported claims.
FINANCE RECEIVABLES, ALLOWANCE FOR FINANCE CREDIT LOSSES AND NONREFUNDABLE
DEALER RESERVES
Mercury originates direct consumer loans and acquires individual sales
finance contracts from third party dealers. Finance receivables consist of
contractually scheduled payments from sales finance contracts net of unearned
finance charges, direct finance receivables and credit card receivables. The
Company's borrowers typically have limited access to traditional sources of
consumer credit due to past credit history or insufficient cash to make the
required down payment on an automobile. As a result, receivables originated
or acquired by the Company are generally considered to have a higher risk of
default and loss than those of other consumer financings.
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
costs be deferred and amortized as an adjustment to the related loan's yield.
Mercury has not adopted the provisions of this statement because adoption
would not have a material effect on the Company's reported results of
operations or financial condition.
Unearned finance charges represent the balance of finance income (interest)
remaining from the capitalization of the total interest to be earned over the
original term of the related precompute account.
Mercury acquires a majority of its sales finance contracts from dealers at a
discount. The level of discount is based on, among other things, the credit
risk of the borrower. The discount, which is the difference between the
amount financed and the acquisition cost, represents nonrefundable dealer
reserves which are available to absorb future credit losses over the life of
the acquired loan. Historical loss experience on the Company's sales finance
receivables has shown that the acquisition discount recorded as nonrefundable
dealer reserves is not adequate to cover potential losses over the life of
the loans. Mercury uses a new reserving methodology commonly referred to as
"static pooling". The static pooling reserving methodology allows Mercury to
stratify components of its sales finance receivables portfolio (i.e., non
refundable dealer reserves, principal loan balances, and related loan charge-
offs) into separately identified and chronologically ordered monthly pools.
A portion of the dealer reserve is made available to cover estimated credit
losses for each identified monthly pool based on a pro rata calculation over
the weighted average term of each specific pool.
The allowance for credit losses is maintained by direct charges to operations
in amounts that are intended to provide adequate reserves on the Company's
finance receivables portfolio to absorb possible credit losses incurred on
loans that are considered to be impaired in excess of the available
nonrefundable dealer reserves. Management evaluates the allowance
requirements by examining current delinquencies, the characteristics of the
accounts, the value of the underlying collateral, the availability of the
nonrefundable dealer reserves to absorb credit losses on impaired loans and
general economic conditions and trends.
The Company applies SFAS 114 and 118, which address the accounting by
creditors for impairment of a loan and related income recognition and
disclosures. In accordance with SFAS 114, the Company's approach for
estimating losses results in a measure of impairment based on discounting
expected future cash flows (including the anticipated proceeds from
repossessed collateral) at the loan's original yield. If the measure of the
impaired receivable is less than the net recorded investment in the
receivable, the Company recognizes an impairment by creating an additional
allowance for finance credit losses in excess of the nonrefundable dealer
reserves available to absorb losses, with a corresponding charge to the
provision for finance credit losses. Generally, the Company considers
receivables more than 60 days contractually delinquent to be impaired.
Direct installment loans on which no payment is received within 149 days, on
a recency basis, are charged off. Sales finance accounts (net of unearned
finance charges) which are contractually delinquent 150 days are charged off
monthly before they become 180 days delinquent. Accounts which are deemed
uncollectable prior to the maximum charge-off period are charged off
immediately. Management may authorize a temporary extension if collection
appears imminent during the next calendar month.
INVESTMENTS
The Company classifies its investments as held-to-maturity securities and
available-for-sale securities. Held-to-maturity securities are reported at
cost, adjusted for amortization of premium or discount, and available-for-
sale securities are reported at fair value with unrealized gains and losses
excluded from earnings and reported in a separate component of stockholder's
equity, net of applicable income taxes.
Fair values for held-to-maturity and available-for-sale fixed maturity
securities are based on quoted market prices, where available. For
securities not actively traded, fair values are estimated using values
obtained from independent pricing services. Short-term investments are
carried at amortized cost, which approximates their fair value. Realized
gains and losses from sales or liquidation of investments are determined
using the specific identification basis.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation,
and are depreciated on a straight-line basis over their estimated useful
lives.
REINSURANCE ACTIVITIES
In the normal course of business, Lyndon assumes and cedes reinsurance on
both a pro rata and excess basis. Reinsurance provides greater
diversification of business and limits the maximum net loss potential arising
from large claims. Although the ceding of reinsurance does not discharge an
insurer from its primary legal liability to a policy holder, the reinsuring
company assumes the related insurance risk. Lyndon monitors the financial
condition of its reinsurers on a periodic basis.
DEFERRED ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
Policy acquisition costs, representing commissions, premium taxes and certain
other underwriting expenses, are deferred and amortized over policy terms.
Estimates of future revenues, including investment income and tax benefits,
are compared to estimates of future costs, including amortization of policy
acquisition costs, to determine if business currently in force is expected to
result in a net loss. No revenue deficiencies have been determined in the
period presented. The present value of future profits represents the portion
of the purchase price of Lyndon allocated to the future profits attributable
to the insurance in force at the date of acquisition. The present value of
future profits is amortized in relationship to the expected emergence of such
future profits.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax
return and individual state tax returns in most states.
Mercury 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 periodically evaluates deferred tax assets to determine whether
they are deemed to be likely of realization. In making its determination,
management considers the possible recovery of taxes already paid but does not
assume the generation of additional taxable income in the future. No
reserves against deferred tax assets were considered necessary.
IMPAIRMENT OF LONG-LIVED ASSETS
In March, 1995, the Financial Accounting Standards Board ("the FASB") issued
SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Assets
to be Disposed of," which is effective for financial statements issued for
fiscal years beginning after December 15, 1995. SFAS 121 requires that long-
lived assets and certain identifiable intangibles that are used in operations
be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of assets might not be recoverable. The
adoption of SFAS 121 did not have a material effect on the Company's
financial condition or results of operations.
At each balance sheet date, the Company evaluates the realizability of
goodwill (and other intangibles) based on expectations of non-discounted cash
flows and operating income for each subsidiary having a material goodwill
balance. Based on the most recent analysis, the Company believes that no
material impairment of goodwill exists at March 31, 1997.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation under the provisions of
SFAS 123. This statement 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS 128, "Earnings per Share" and SFAS
129, "Disclosure of Information about Capital Structure". SFAS 128
establishes standards for computing and presenting earnings per share. SFAS
129 establishes standards for disclosing information about an entity's
capital structure. These statements are effective for financial statements
issued for periods ending after December 15, 1997. Management does not
expect the adoption of these statements to have a significant impact on the
financial position and results of operations of the Company.
In July 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income"
which establishes standards for reporting and displaying comprehensive
income. Management does not expect the adoption of this statement to have a
significant impact on the financial position and results of operations of the
Company. This statement is effective for financial statements issued for
periods ending after December 15, 1997.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the 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 4. Actual results could differ from these estimates.
DISPOSITIONS
As a result of the matters described in Notes 8 and 15, Lyndon's claims
paying ability was downgraded by A.M. Best to a rating of B with negative
implications. This action, together with regulatory concerns and the
liquidity needs of Mercury, caused Mercury to decide to dispose of its
investment in Lyndon. On March 28, 1997, Mercury executed a Stock Purchase
Agreement between Mercury Finance Company and Frontier Insurance Group, Inc.
("Frontier") for the sale of Lyndon to Frontier. The net sale price versus
the carrying value at March 31, 1997 resulted in a net loss of $29,528 which
was recorded in the first quarter of 1997. Management has determined that it
is in the best interest of the Company to remain in the insurance business
and formed a new captive insurance subsidiary during 1997. As a result, the
sale of Lyndon will not be considered the discontinuation of a business. The
loss associated with the sale of Lyndon will not be tax deductible to the
Company as a loss on the sale of a consolidated subsidiary is, under certain
circumstances, not allowed for tax purposes.
3) INVESTMENTS
Substantially all investment are securities held by Lyndon. See Note 2 for
discussion of disposition of Lyndon. The amortized cost, gross unrealized
gains and losses and approximate fair values for available-for-sale and held-
to-maturity securities by major security type at March 31, 1997 and December
31, 1996 were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
<S> <C> <C> <C> <C>
March 31, 1997
AVAILABLE-FOR-SALE:
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $ 47,731 $ - $ (761) $ 46,970
Obligations of states and
political subdivisions 65,898 741 (550) 66,089
Corporate securities 65,101 308 (679) 64,730
Mortgage backed
securities 15,159 58 (69) 15,148
Total available-for-sale $193,889 $ 1,107 $(2,059) $192,937
HELD-TO-MATURITY:
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $2,813 $ 4 $(55) $2,762
Obligations of states and
political subdivisions 4,083 38 (11) 4,110
Corporate securities 850 16 0 866
Other securities 301 308 (132) 477
Total held-to-maturity $8,047 $366 $(198) $8,215
December 31, 1996
AVAILABLE-FOR-SALE:
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $ 9,490 $ 13 $ (78) $ 9,425
Obligations of states and
political subdivisions 68,397 1,378 (391) 69,384
Corporate securities 63,629 882 (443) 64,068
Mortgage backed
securities 18,816 166 (78) 18,904
Total available-for-sale $160,332 $ 2,439 $(990) $161,781
HELD-TO-MATURITY:
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $2,833 $ 17 $(31) $2,819
Obligations of states and
political subdivisions 3,787 75 (1) 3,861
Corporate securities 850 33 0 883
Other securities 295 174 (7) 462
Total held-to-maturity $7,765 $299 $ (39) $8,025
</TABLE>
At March 31, 1997 the amortized cost and estimated market value of
available-for-sale and held-to-maturity securities are shown below (dollars
in thousands). Actual maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
<TABLE>
<CAPTION> Estimated
Amortized Market
Cost Value
<S> <C> <C>
March 31, 1997
AVAILABLE-FOR-SALE
Due in one year or less $ 41,940 $ 42,114
Due after one year through five years 91,100 90,340
Due after five years through ten years 35,695 35,404
Due after ten years 25,154 25,079
Total available-for-sale 193,889 192,937
HELD-TO-MATURITY
Due in one year or less 1,531 1,526
Due after one year through five years 2,969 2,970
Due after five years through ten years 2,433 2,421
Due after ten years 1,114 1,298
Total held-to-maturity 8,047 8,215
Total debt investment securities $201,936 $201,152
</TABLE>
4) 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 18 to 36 months with maximum terms of 48
months. Mercury Card receivables are mainly unsecured balances. The
Company's finance receivables are primarily with individuals located in the
southeastern, central and western United States. As of March 31, 1997,
approximately 18.6%, 9.4% and 18.1% of finance receivables were from branches
located in Florida, Texas and Louisiana respectively. Loans outstanding were
as follows (dollars in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
<S> <C> <C>
DIRECT FINANCE RECEIVABLES
Interest bearing $ 23,643 $ 25,117
Precompute 128,016 127,516
Total direct finance receivables 151,659 152,633
SALES FINANCE RECEIVABLES
Total sales finance receivables 1,117,535 1,159,848
Total gross finance receivables 1,269,194 1,312,481
Less: Unearned finance charges (218,428) (228,405)
Unearned commissions,
insurance premiums and
insurance claim reserves (8,326) (7,253)
Total net finance receivables 1,042,440 1,076,823
UNSECURED CREDIT CARD
Total unsecured credit card 83,679 83,600
Total finance receivables $1,126,119 $1,160,423
</TABLE>
Included in finance receivables at March 31, 1997 and December 31, 1996 were
$71,532 and $69,507, respectively, of receivables for which interest accrual
had been suspended. Repossessed assets held for resale primarily consists of
repossessed vehicles awaiting liquidation. Repossessed assets are carried at
estimated fair value. At March 31, 1997 and December 31, 1996, repossessed
assets of approximately $5,685 and $6,700, respectively, were awaiting
liquidation. Included are vehicles held for resale, vehicles which have been
sold for which payment has not been received and unlocated vehicles (skips),
the value of which may be reimbursed from insurance. Contractual maturities
of the finance receivables by year are not readily available at March 31,
1997, but experience has shown that such information is not an accurate
forecast of the timing of future cash collections due to the amount of
renewals, conversions, repossessions, or payoffs prior to actual maturity.
Principal cash collections (excluding finance charges earned) for the three
months ended March 31, 1997 were as follows (dollars in thousands):
<TABLE>
<CAPTION>
March 31,
1997
<S> <C>
DIRECT FINANCE RECEIVABLES
Principal cash collections $ 32,657
Percent of average net balances 25.5%
SALES FINANCE RECEIVABLES
Principal cash collections $164,395
Percent of average net balance 17.5%
</TABLE>
A summary of the activity in the allowance for finance credit losses for the
three months ended March 31, 1997 was as follows:
<TABLE>
<CAPTION>
March 31,
1997
<S> <C>
Balance at beginning of quarter $97,762
Provision for finance credit losses 30,462
Finance receivables charged off,
net of recoveries (16,640)
Balance at end of quarter $111,584
</TABLE>
A summary of the activity in nonrefundable dealer reserves for the three
months ended March 31, 1997 was as follows (dollars in thousands):
<TABLE>
<CAPTION>
March 31,
1997
<S> <C>
Balance at beginning of quarter $ 89,378
Discounts acquired on new volume 13,994
Losses absorbed, net of recoveries (22,695)
Balance at end of quarter $ 80,677
</TABLE>
5) SENIOR AND SUBORDINATED DEBT AND LINES OF CREDIT
As a result of the 1996 net loss, accounting irregularities, and related
matters, Mercury violated its debt and financial covenants permitting the
holders of its Senior Term Notes and Subordinated Debt to accelerate all such
debt which, if accelerated, would result in all of such debt being currently
due and payable. In addition, the Company is no longer permitted by the
terms of certain debt instruments to pay dividends. Senior and subordinated
debt at March 31, 1997 and December 31, 1996, consisted of the following
(assuming that the Company remained in compliance with its debt
covenants)(dollars in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
<S> <C> <C>
REVOLVING CREDIT FACILITY-$50,000
LINE, Interest at prime, secured by
generally all assets, due January
1998 $ 10,000 $ -
SENIOR DEBT, COMMERCIAL PAPER
AND NOTES $493,619 $525,051
SENIOR DEBT, TERM NOTES
Due 1997 - interest rate 7.67% 15,000 15,000
Due 1997 - interest rate 8.15% 17,500 17,500
Due 1997 - interest rate 6.29% 24,000 24,000
Due 1997 - interest rate 7.13% 125 125
Due 1997 - interest rate 6.41% 40,000 40,000
Due 1998 - interest rate 6.70% 35,000 35,000
Due 1998 - interest rate 6.16% 76,000 76,000
Due 1998 - interest rate 8.62% 20,000 20,000
Due 1998 - interest rate 8.50% 10,000 10,000
Due 1998 - interest rate 7.13% 1,000 1,000
Due 1998 - interest rate 7.16% 25,000 25,000
Due 1999 - interest rate 6.56% 20,000 20,000
Due 1999 - interest rate 6.76% 31,000 31,000
Due 1999 - interest rate 7.33% 30,000 30,000
Due 2000 - interest rate 6.66% 10,000 10,000
Due 2000 - interest rate 6.94% 15,000 15,000
Due 2000 - interest rate 7.42% 58,000 58,000
Due 2001 - interest rate 7.02% 10,000 10,000
Due 2001 - interest rate 7.50% 30,000 30,000
Due 2002 - interest rate 7.14% 4,000 4,000
Due 2002 - interest rate 7.59% 17,000 17,000
TOTAL SENIOR DEBT, TERM NOTES $488,625 $488,625
SUBORDINATED DEBT
Due 1997 - interest rate 9.76% 12,000 12,000
Due 1997 - interest rate 10.86% 3,000 3,000
Due 1998 - interest rate 10.86% 7,500 7,500
TOTAL SUBORDINATED DEBT $ 22,500 $22,500
</TABLE>
The following table sets forth information with respect to future maturities
of senior and subordinated debt at March 31, 1997 (assuming that the Company
remained in compliance with its debt covenants) (dollars in thousands):
<TABLE>
<CAPTION>
Senior Debt
Commercial Senior Debt Subordinated
Paper & Notes Term Notes Debt Total
<S> <C> <C> <C> <C>
1997 $ 503,619 $ 96,625 $ 15,000 $ 615,244
1998 - 167,000 7,500 174,500
1999 - 81,000 - 81,000
2000 - 83,000 - 83,000
2001 - 40,000 - 40,000
2002 - 21,000 - 21,000
TOTAL $ 503,619 $488,625 $ 22,500 $1,014,744
</TABLE>
As noted above, the Company is in default of its credit agreements. The
Company continues to negotiate with all of its lenders in an attempt to reach
a consensual agreement and has a forbearance agreement through October 1,
1997. See Notes 8 and 15 for additional information.
6) DIVIDEND RESTRICTIONS
Management does not expect that dividends will be paid in the foreseeable
future.
7) STOCK OPTIONS
Under the terms of Mercury's 1989 Stock Option and Incentive Compensation
Plan ("the Plan"), 24,837,036 common shares were reserved for the future
granting of options to officers, non-employee directors and other key
employees. Options become exercisable in whole or in part up to two years
after the date of grant at the closing price of Mercury's common stock on the
date of grant. Options are forfeited upon termination of employment. Shares
available for future grants totaled 1,901,033 at March 31, 1997.
Activity with respect to stock options was as follows (as adjusted for all
stock splits):
<TABLE>
<CAPTION>
<S> <C>
Outstanding January 1, 1997 7,967,919
Options granted (average price of
$12.02 for three months ended March 31, 1997) 135,000
Forfeited (1,901,978)
Options exercised (average price of
$8.21 for three months ended March 31, 1997) (181,224)
Outstanding March 31, 1997 6,019,717
</TABLE>
The average option price under the plan was $10.39 at March 31, 1997.
Under the provisions of SFAS 123, the Company has elected to continue to
account for the Plan under the provisions of APB Opinion No. 25 and make the
necessary pro forma net income and earnings per share disclosures required by
SFAS 123. Upon the announcement of the discovery of the accounting
irregularities and financial statement restatement described in Notes 8 and
15, the market value of the Company's common stock declined dramatically.
Management thus believes that the market value of the Company's common stock
during 1996 and early 1997 was overstated. Because a key component of the
fair value calculation (and the related pro forma net income and earnings per
share disclosures) is the market value of the Company's stock, the fair value
and other disclosures required under SFAS 123 for 1996 and 1997 are not
considered meaningful.
On June 13, 1997, in accordance with Mercury's 1989 Stock Option and
Incentive Compensation Plan, Mercury cancelled a number of the above options.
Most employees were re-granted their existing options at a new price of $3
per share. New options were also granted to certain employees on this date.
8) CONTINGENCIES AND LEGAL MATTERS
The Company has been named as a defendant in a variety of lawsuits generally
arising from the Company's announcement on January 29, 1997 that it would
restate previously reported financial information for prior years and
interim earnings for 1996 as a result of the discovery of accounting
irregularities. To date, forty-three actions against the Company are pending
in United States District Court for the Northern District of Illinois, six
cases are pending against the Company in Illinois Chancery Court, and nine
cases are pending in the Delaware Chancery Court. One case is pending in
Hamilton County, Ohio, Municipal Court. The complaints seek compensatory
damages, attorneys' fees and costs.
Forty of the lawsuits pending in the Northern District of Illinois are
class actions which allege claims under Section 10 of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder. These lawsuits name one
or more officers or directors of the Company as additional defendants. One
case pending in the Northern District of Illinois alleges derivative claims
seeking to recover damages on behalf of the Company from certain of the
Company's officers and directors. Thirty-nine of the non-derivative cases
pending in the Northern District of Illinois were consolidated pursuant to a
Stipulation entered on April 30, 1997. Certain plaintiffs have filed motions
for appointment of one or more lead plaintiffs, each of which is pending. One
of the cases pending in the Northern District of Illinois seeks to represent
a class of participants in Mercury's employee retirement plan and alleges
ERISA violations arising out of the plan's investment in Mercury's allegedly
overvalued stock. Two cases pending in the Northern District of Illinois
allege non-class securities fraud and common law claims. Three of the
Illinois state court actions are class actions alleging claims under the
Illinois Securities Act, the Illinois Consumer Fraud and Deceptive Business
Practices Act and common law claims of fraud and negligent misrepresentation.
The other Illinois state court actions are derivative actions which seek to
recover damages on behalf of the Company from certain of the Company's
officers and directors. Each of the Delaware state court actions is a
derivative action which seeks to recover damages on behalf of the Company
from certain of the Company's officers and directors. The case pending in
Municipal Court in Hamilton, Ohio, alleges violations of Ohio State
securities law and common law. The Company is unable to predict the
potential financial impact of the litigation.
The Securities and Exchange Commission is investigating the events giving
rise to the accounting irregularities. Those events are also under
investigation by the United States Attorney for the Northern District of
Illinois and the Federal Bureau of Investigation, which executed a search
warrant on the Company's premises on February 3, 1997. The Company is
cooperating fully in these investigations.
A Special Committee of the Board of Directors has substantially completed its
ongoing investigation of the matters discussed above. In the opinion of
management, the accompanying financial statements reflect all material
information learned to date.
On January 10, 1997, the Company entered into an agreement (the "Agreement")
with BankBoston Corporation ("BankBoston") pursuant to which the Company was
to acquire all of the outstanding stock of Fidelity Acceptance Corporation, a
subsidiary of BankBoston, in return for the issuance of approximately 32.7
million shares of the Company's common stock. On January 30, 1997,
BankBoston notified the Company that it was terminating the Agreement as a
result of breaches of the Agreement resulting from the accounting
irregularities described above. On July 10, 1997, BankBoston notified
Mercury that BankBoston intended to seek appropriate compensation for its
damages resulting from such breaches.
In the normal course of its business, Mercury and its subsidiaries are named
as defendants in legal proceedings. A number of such actions, including
fifteen cases which have been brought as putative class actions, are pending
in the various states in which subsidiaries of Mercury do business. It is
the policy of Mercury and its subsidiaries to vigorously defend litigation,
but Mercury and (or) its subsidiaries have and may in the future enter into
settlements of claims where management deems appropriate. Although
management is of the opinion that the resolution of these proceedings will
not have a material effect on the financial position of Mercury, it is not
possible at this time to estimate the amount of damages or settlement
expenses that may be incurred.
No provision has been made in the consolidated income statement for the three
months ended March 31, 1997 for the costs or expenses that have been or will
be incurred subsequent to March 31, 1997 with respect to any of the above
matters.
9) PENSION PLANS AND OTHER EMPLOYEE BENEFITS
Substantially all employees of Mercury are covered by non-contributory
defined benefit pension plans. Total pension expense aggregated $770 in
1996.
The following table sets forth the funded status of Mercury's qualified plans
amounts recognized in 1996 consolidated financial statements (dollars in
thousands):
<TABLE>
<CAPTION>
1996
<S> <C>
Actuarial Present Value of
Benefit Obligation:
Accumulated benefit obligations,
including vested benefits of
$6,231 $ 7,024
Projected benefit obligation
for service rendered to date $(10,686)
Plan assets at fair value 13,638
Plan assets in excess of
projected benefit obligation 2,952
Unrecognized net asset
as of December 31, being
recognized over 15-22 years (391)
Unrecognized net gain (3,272)
Unrecognized prior service cost 100
Prepaid (accrued) pension expense $ (611)
Components of net pension expense:
Service cost-benefits earned
during the period $ 1,060
Interest cost on projected
benefit obligation 727
Actual return on plan assets (2,085)
Net amortization and deferral 1,068
Net periodic pension expense $ 770
</TABLE>
No actuarial information was available subsequent to December 31, 1996. The
weighted average discount rate used in determining the actuarial present
value of the projected benefit obligation was 7.5% at December 31, 1996. The
rates of increase in future compensation were 5.5% - 7.0% at December 31,
1996. The expected long-term rate of return on plan assets in 1996 was 9.0%.
Mercury also maintains a nonqualified, unfunded pension benefit plan for
certain employees whose calculated benefit payments under the qualified plan
are expected to exceed the limits imposed by Federal tax law. The projected
benefit obligations of the plan, and the expenses related to this plan, are
not material.
Mercury has an employee stock purchase plan and a tax deferred Retirement
Savings Trust (401(k)) plan. Employees are eligible to participate in the
plans after having attained specified terms of service. Both plans cover
substantially all full time employees of Mercury and provide for employee
contributions and partial matching contributions by Mercury. The expenses
related to these plans are not material.
As discussed in Note 7, the market value of the Company's common stock
declined dramatically. Both the employee stock purchase plan and Retirement
Savings Trust (401(k)) plan held significant shares of Mercury's stock at
March 31, 1997. All Mercury stock held by the Retirement Savings Trust was
sold as of June 6, 1997.
10) INCOME TAXES
The components of the credit for income taxes for the three months ended
March 31, 1997 were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Quarter ended
March 31,
1997
<S> <C>
CURRENT INCOME TAX EXPENSE
Federal $ 3,444
State 295
Total 3,739
Deferred income tax benefit (5,904)
Total income tax benefit $ (2,165)
</TABLE>
The differences between the U.S. federal statutory income tax rate and the
Company's effective rate are:
<TABLE>
<CAPTION>
Quarter ended
March 31,
1997
<S> <C>
Statutory federal income tax (35.0)%
State income taxes, net of
federal tax benefit (3.0)%
Loss on sale of Lyndon 32.8 %
Other, net (0.9)%
Total (6.1)%
</TABLE>
The total income tax benefit reflected in shareholders' equity for stock
options exercised was $397 for the quarter ended March 31, 1997. 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 March 31, 1997 and December 31, 1996, were as
follows (dollars in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
<S> <C> <C>
DEFERRED TAX ASSETS:
Allowance for finance credit losses
and prepaid pension expense $ 42,737 $ 37,382
Unearned premiums and ceding fees 12,073 13,632
Other 2,673 2,919
Deferred tax assets 57,483 53,933
DEFERRED TAX LIABILITIES:
Policy acquisition costs 15,951 18,011
Other 2,272 2,566
Deferred tax liabilities 18,223 20,577
Net deferred tax assets $ 39,260 $ 33,356
</TABLE>
No valuation allowance for deferred tax assets has been recorded at March 31,
1997, as Mercury believes it is more likely than not that the deferred tax
assets will be realized in the future. This conclusion is based on the
extremely short period in which the existing deductible temporary
differences, primarily related to finance credit losses, will reverse and the
existence of sufficient taxable income within the carryback period available
under the tax law.
11) LEASES
Mercury and its subsidiaries lease office space generally under cancelable
operating leases expiring in various years through 2003. 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
March 31, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
Year Amount
<S> <C>
1997 $ 2,965
1998 3,409
1999 2,280
2000 1,192
2001 and after 730
Total $10,576
</TABLE>
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 $ 1,187 for the quarter ended March 31, 1997.
12) DISCLOSURES OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value. Fair value estimates are made at a specific point in time for
Mercury's financial instruments; they are subjective in nature and involve
uncertainties, and matters of significant judgment and, therefore, cannot be
determined with precision. Fair value estimates assume the continuation of
Mercury as a going concern.
CASH AND CASH EQUIVALENTS
Due to the short term nature of these items, management believes that the
carrying amount is a reasonable estimate of fair value.
INVESTMENTS
For bonds, the estimated fair value is based on quoted market price. For
other investments, which consist primarily of short-term money market
instruments, the carrying amount is a reasonable estimate of fair value.
FINANCE RECEIVABLES
The Company's financing program allows for the establishment of interest
rates on contracts which typically is the maximum rate allowable by the state
in which the branch is doing business. The Company's financing revenues are
not materially impacted by changes in interest rates given that the stated
rates on existing contracts are the highest allowed by law. As such, the
finance receivable balances recorded on a historical basis in the financial
statements approximate fair value.
SENIOR DEBT, COMMERCIAL PAPER
The debt consists principally of short term commercial paper for which the
carrying amount is a reasonable estimate of fair value.
SENIOR AND SUBORDINATED DEBT, TERM NOTES
Rates currently available to Mercury for debt with similar terms and
remaining maturities are used to discount the future cash flows related to
existing debt and arrive at an estimate of fair value.
The estimated fair values of Mercury's financial instruments at March 31,
1997, prior to the events disclosed in Notes 8 and 15 which have a
substantial negative impact on these estimates, were as follows (dollars in
thousands):
<TABLE>
<CAPTION>
March 31, 1997 December, 31, 1996
Carrying Fair Carrying Fair
Amount Value Value Value
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash $ 25,790 $ 25,790 $ 20,957 $20,957
Investments 221,421 221,589 212,957 213,217
Finance Receivables 933,858 933,858 973,283 973,283
Total $1,181,069 $1,181,237 $1,207,197 $1,207,457
FINANCIAL LIABILITIES:
Senior Debt, Commercial Paper and
Notes $ 503,619 $ 503,619 $525,051 $525,051
Senior Debt, Term Notes 488,625 480,962 488,625 476,469
Subordinated Debt 22,500 22,781 22,500 22,711
Total $1,014,744 $1,007,362 $1,036,176 $1,024,231
</TABLE>
13) SUBSEQUENT EVENTS
The Company began to implement a plan that resulted in 38 branches closing in
the second quarter of 1997 in order to consolidate operations in geographical
areas that were over-saturated with branches and could be effectively managed
from fewer locations. Substantially all employees were transferred to nearby
branches, along with the closing branches' loan portfolio. The costs related
to the closing are expected to be immaterial.
14) BUSINESS SEGMENT DATA
The Finance Segment consists of the noninsurance segment of Mercury. The
Insurance Segment consists of Lyndon. The following table presents the
business segment data of Mercury (in millions):
<TABLE>
<CAPTION>
March 31,
1997
<S> <C> <C>
REVENUES
Finance $ 46.4
Insurance 26.4
Total $ 72.8
OPERATING PROFITS (LOSSES)
Finance $ (7.4)
Insurance 6.7
Total $ (0.7)
NET INCOME (LOSS)
Finance $ (37.7)
Insurance 4.5 December 31,
Total $ (33.2) 1996
IDENTIFIABLE ASSETS
Finance $1,106.8 $1,123.4
Insurance 388.7 420.0
Total $1,495.5 $1,543.4
</TABLE>
15) GOING CONCERN
The Company incurred a loss in the three months ended March 31, 1997 and the
twelve months ended 1996. Substantially all of its outstanding debt is
subject to acceleration or has matured by its terms as a result of the
Company's defaults of its various lending agreements. As described in Note
5, the Company has obtained interim financing through January 1998. In
addition, the Company is under investigation by the U.S. Attorney for the
Northern District of Illinois and has been named as a defendant in various
lawsuits generally arising from the restatement of previously reported
financial information for 1995 and interim periods in 1996 as described in
Note 8. The Company is also incurring significant costs in relation to the
special investigation discussed in Note 8 and the resolution of its debt
restructuring.
As a result of the above matters, the Board has hired the services of a
crisis manager to assist in the turnaround of the business operations. In
addition, an investment banker was retained to assist in the refinancing of
existing debt and/or explore strategy alternatives. There can be no
assurances that the Company will be successful in its attempt to consummate a
refinancing or restructuring. Thus, there is substantial doubt about the
Company's ability to continue as a going concern. The accompanying financial
statements have been prepared on the basis that the Company is a going
concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
16) NON-OPERATING EXPENSES
Non-operating expenses include the costs of the investigation, professional
fees related to the negotiations with the creditors, a portion of fees for
the crisis management team and costs of the audit examination of the 1996
financial statements by the Company's new independent accounting firm.
17) COMMON STOCK
Earnings per share is computed by dividing net income by the total of
weighted average common shares and common stock equivalents outstanding
during the period, adjusted for all stock splits. The calculated averages
were as follows (as adjusted for all stock splits):
<TABLE>
<CAPTION>
Quarter ended
March 31,
1996
<S> <C>
Weighted Average:
Common Shares 177,867,800
Treasury Shares (5,402,957)
Total 172,464,843
</TABLE>
As the Company incurred a net loss for the quarter ended March 31, 1997,
common share equivalents would be anti-dilutive to earnings per share and
have not been included in the weighted average shares calculation.
The Company has determined that the implementation of SFAS 128 "Earnings Per
Share", would have had no effect on the calculated earnings per share for the
quarter ended March 31, 1997. This standard prescribes that when computing
the dilution of options, the Company is to use its average stock price for
the period, rather than the more dilutive greater of the average share price
or end-of-period share price required by APB Opinion 15. As the options are
excluded from the calculation due to the anti-dilutive characteristics
indicated above, there is no effect on the earnings per share calculation.
MERCURY FINANCE COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION
Overview
Mercury Finance Company ("Mercury") ("the Company") operates as a consumer
finance business engaged in the acquisition of individual installment sales
finance contracts from automobile dealers and retail vendors, extending short-
term installment loans directly to consumers and sales of credit insurance and
other related products.
As previously disclosed, on January 29, 1997 the Company announced that it would
restate previously reported financial information for prior years and interim
earnings for 1996 as a result of the discovery of accounting irregularities
which caused the overstatement of earnings in 1994, 1995 and 1996. On July 15,
1997 Mercury released its audited December 31, 1996 balance sheet. However, due
to issues related to the allocation of the recognition of credit loss expenses
between the years 1994, 1995 and 1996, the release of the 1996 income statement
has been delayed. As a result, the Company's discussion and analysis is limited
to those analyses that can be made using the March 31, 1997 and December 31,
1996 balance sheets and the income statement for the three months ended March
31, 1997.
Following the announcement of the accounting irregularities, the Board of
Directors removed the president and chief financial officer and hired a crisis
management firm to act as interim senior management to 1) improve operations by
stablizing branch activity, 2) reduce expenses particularly in the area of
credit losses, 3) perform a thorough review of the company's financial records
including the methodology utilized in accounting for credit losses and 4) assist
the Board in mapping the future of Mercury Finance Company.
Mercury's total number of branches in operation at the end of 1996 and the first
quarter of 1997 was 287 and 289, respectively. By June 1997, the Company had
closed 38 locations in order to improve management oversight and reduce
operating expenses in locations that were underperforming or duplicative.
FINANCIAL CONDITION
Finance Receivables
In light of the preceding discussion, Mercury set out to develop the appropriate
accounting and management policy for the acquisition and collection of loans and
the establishment of appropriate allowances for finance credit losses on loans.
The Company has made the following improvements:
Reserve Accounting
Mercury originates direct consumer loans and acquires individual sales finance
contracts from third party dealers. The sales finance contracts are generally
acquired at a discount from the principal amount. This discount is generally
referred to as a non-refundable dealer reserve. The amount of the discount is
based on the credit risk of the borrower, the note rate of the contract and the
competition faced by the Company in acquiring receivable contracts. Previously,
it was deemed that the non-refundable dealer reserve was adequate to absorb the
majority of losses on the acquired receivables. However, as the sub-prime
market has evolved and become more competitive, the dealer reserve has proven to
be inadequate to absorb all of the credit losses.
In the third quarter of 1996, Mercury adopted a new reserving methodology
commonly referred to as "static pooling". The static pooling methodology
provides that the Company stratify the components of its sales finance
receivable portfolio (i.e. dealer reserve, principal loan balances and related
loan charge-offs) into separately identified pools based on the period that the
loans were acquired. Mercury defines a pool as loans acquired within a given
month whereas others in the industry may use a quarterly basis. Dealer reserves
are only utilized to offset credit losses within the same "pool" of loans.
In the fourth quarter of 1996, the Company further refined this methodology.
Under this refinement, the dealer reserve is amortized and made available to
absorb estimated credit losses over the life of the pool of receivables. With
this methodology, the dealer reserve cannot be utilized to offset provision for
finance credit losses immediately, but must be held to offset future losses.
Management believes this method provides for a more appropriate matching of
finance charge income and provision for finance credit losses. With the "pools"
established on a monthly basis and the "release" of the dealer reserve over
time, the financial statements are among the most conservative in the industry.
Reserve requirements for sales finance and direct receivables are calculated
based on the estimated losses inherent in each category of delinquency (i.e. 30,
60, 90 and 120 days past due). These assumed losses are utilized to determine
the projected cash flows from each impaired category. The projected cash flow
is then discounted to estimate the net present value of the impaired loans. A
reserve is established in an amount sufficient to reduce the book value of the
impaired receivable to its net present value. Repossessed collateral is valued
at an estimate of its net realizable value.
The finance receivables consist of direct financing and sales financing as
follows as of March 31, 1997 and December 31, 1996:
<TABLE>
<CAPTION>
March 31, %of December 31, % of
1997 Total 1996 Total
<S> <C> <C> <C> <C>
Direct financing receivable $ 151,659 11.95% $ 152,633 11.63%
Sales financing receivable 1,117,535 88.05% 1,159,848 88.37%
Gross finance receivables 1,269,194 100.00% 1,312,481 100.00%
Unearned finance charges (218,428) (228,405)
Unearned commissions,
insurance premiums and
insurance claim reserves (8,326) (7,253)
Net finance receivables $1,042,440 $1,076,823
</TABLE>
Certain activity that occurred during the three months ended March 31, 1997:
<TABLE>
<CAPTION>
Total
<S> <C>
Originations $ 241,984
Cash collections $ 197,052
Charge-offs $ 39,335
</TABLE>
Allowance for Credit losses and Non-refundable Dealer Reserves
The following tables summarizes balances and activity in the non-refundable
dealer reserves, allowance for credit losses, and charges to dealer reserves and
related ratios for March 31, 1997 and December 31, 1996.
Allowance for finance credit losses and dealer reserves as of:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
<S> <C> <C>
Allowance for credit losses $ 111,584 $ 97,762
Allowance as a percentage of
Total finance receivables outstanding
At end of period 9.91% 8.42%
Dealer reserves $ 80,677 $ 89,378
Dealer reserves as a percentage
of total finance receivables out-
standing at end of period 7.16% 7.70%
</TABLE>
The following activity occurred in the dealer reserves, allowance for finance
credit losses, and charges to dealer reserves:
<TABLE>
<CAPTION>
Allowances for Non-refundable
Credit losses Dealer reserve Total
<S> <C> <C> <C>
Balance at December 31, 1996 $ 97,762 $ 89,378 $ 187,140
Provision for finance credit
Losses 30,462 - 30,462
Charge-offs/losses,
net of recoveries (16,640) (22,695) (39,335)
Discounts acquired - 13,994 13,994
Balance March 31, 1997 $111,584 $ 80,677 $ 192,261
Total finance receivables, net at March 31, 1997 $1,126,119
Allowance for credit losses/
dealer reserves to total finance
receivables, net at end of
period 17.07%
</TABLE>
The Company believes that the allowance for finance credit losses and non-
refundable dealer reserve balances at March 31, 1997 are adequate.
Delinquencies and Repossessions
The Company generally suspends the accrual of interest when an account becomes
60 days or more contractually delinquent. The following table sets forth
certain information with respect to the contractually delinquent receivables and
repossessed assets (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
<S> <C> <C>
Delinquent gross receivables $ 71,532 $ 69,507
Repossessed assets 5,685 6,700
Total $ 77,217 $ 76,207
Delinquent gross receivables to
gross finance receivables 5.29% 4.98%
Delinquent gross receivables and repossessed
Assets to gross finance receivables plus
Repossessed assets 5.68% 5.43%
Loan collateral is repossessed when debtors are 120 days to 150 days late or
more on payments. These automobiles are generally sold within 60 days at
auction.
The Company instituted a recovery branch system during the first quarter of
1997, which is responsible for collecting the balances due on loans where the
collateral has been liquidated and a deficiency balance exists.
Debt and liquidity
The Company has been acquiring loans by using the cash flow from cash
collections on finance receivables and with funds drawn on its revolving line of
credit. Prior to January 1997, Mercury also used commercial paper extensively
to fund its operations.
The primary debt of the Company is in the form of senior commercial paper,
senior term notes and subordinated debt, which totaled $1,015 million at March
31, 1997, and $1,036 million at December 31, 1996. As a result of the Company's
announcement regarding the discovery of the accounting irregularities, the
Company is in default of its credit agreements. During the three months ended
March 31, 1997 Mercury paid all accrued interest as it came due and has since
entered into a forbearance agreement with its lenders, which terminates on
October 1, 1997. In July 1997, Mercury repaid $86.5 million in principal on
its debt.
In January 1997, Mercury established a $10 million unsecured line of credit with
Bank of America in order repay commercial paper when it matured.
In February 1997, Mercury entered into an separate agreement with Bank of
America Business Credit wherein Bank of America agreed to provide a $50 million
line of credit collateralized by all of the finance receivables which expires
January 31, 1998. At March 31, 1997, $10 million was outstanding. The $10
million was repaid in the first quarter 1997 and no amounts are currently
outstanding under the facility.
Disposition of Lyndon
On March 28, 1997, Mercury executed a Stock Purchase Agreement between Mercury
Finance Company and Frontier Insurance Group, Inc. for the sale of Lyndon to
Frontier. Lyndon's net income for the three months ended March 31, 1997 was
$4,525. On June 3, 1997 Mercury executed and closed on the stock purchase
agreement.
</TABLE>
