10-Q 1 form10q20010930.txt MAIN TEXT SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For The Quarter Ended September 30, 2001 Commission File No. 1-10176 MFN Financial Corporation ---------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 36-3627010 -------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer identification no.) incorporation or organization) 100 Field Drive, Suite 340, Lake Forest, Illinois 60045 ------------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (847) 295-8600 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No --- --- Indicate the number of shares outstanding of each issuer's class of common stock, as of the latest practicable date. Common Stock - $.01 par value, 9,991,284 shares as of October 31, 2001. MFN FINANCIAL CORPORATION FORM 10-Q INDEX

PAGE ---- PART I FINANCIAL INFORMATION ------ --------------------- Item 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets .......................................~~..............~~ 3 Condensed Consolidated Statements of Income .................................~~..............~~ 4 Condensed Consolidated Statements of Changes in Stockholders' Equity ........~~..............~~ 5 Condensed Consolidated Statements of Cash Flows .............................~~..............~~ 6 Notes to Condensed Consolidated Financial Statements ........................~~..............~~ 7 Condensed Consolidated Average Balance Sheets ...............................~~..............~~ 1517 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ..............................~~..................~~ 1618 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ................................................................~~..................~~ 3337 PART II OTHER INFORMATION ------- ----------------- Item 1. Legal Proceedings ...........................................................~~.................~~ 3438 Item 2. Changes in Securities .......................................................~~.................~~ 3438 Item 3. Defaults Upon Senior Securities .............................................~~.................~~ 3438 Item 4. Submission of Matters to a Vote of Security Holders .........................~~.................~~ 3438 Item 5. Other Information ...........................................................~~.................~~ 3438 Item 6. Exhibits and Reports on Form 8-K ............................................~~.................~~ 3438 SIGNATURES ..........................................................................~~.................~~ 3639 INDEX OF EXHIBITS ...................................................................~~.................~~ 3740

2 PART 1 - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MFN FINANCIAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS

~~June~~September 30, (Dollars in thousands) 2001 December 31, (Unaudited) 2000 ------------ ------------ ASSETS Unrestricted cash and cash equivalents $ 5548,~~934~~103 $ 127,093 Restricted cash 3026,~~781~~379 -- Finance receivables, net of unearned income ~~475~~468,~~964~~321 484,854 Less: Allowance for finance credit losses 3840,~~211~~470 39,071 Less: Nonrefundable dealer reserves 2625,~~925~~871 28,014 ---------- ---------- Finance receivables, net ~~410~~401,~~828~~980 417,769 Income taxes receivable 71,~~532~~284 7,878 Furniture, fixtures and equipment, net 34,~~418~~608 2,650 Other assets (including repossessions) 1211,~~324~~271 5,787 ---------- ---------- TOTAL ASSETS $ ~~520~~493,~~817~~625 $ 561,177 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Notes payable to securitization trust $ ~~301~~232,~~000~~833 $ -- Warehouse credit facility 50,000 -- Senior secured debt -- 342,908 Senior subordinated debt 22,500 22,500 ~~Income~~Deferred income taxes 2410,~~236~~461 24,445 Other liabilities 13,~~686~~966 14,569 Excess of revalued net assets over liabilities and stockholders' investment 2724,~~170~~699 32,110 ---------- ---------- TOTAL LIABILITIES ~~388~~354,~~592~~459 436,532 ---------- ---------- CONTINGENCIES -- -- STOCKHOLDERS' EQUITY Common stock - $.01 par value; 50,000,000 shares authorized; 9,991,284 shares outstanding ~~June~~September 30, 2001; 10,000,003 shares outstanding December 31, 2000 100 100 Paid in capital 84,900 84,900 Retained earnings 4754,~~225~~166 39,645 ---------- ---------- TOTAL STOCKHOLDERS' EQUITY ~~132~~139,~~225~~166 124,645 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ ~~520~~493,~~817~~625 $ 561,177 ========== ==========

The condensed consolidated balance sheet as of December 31, 2000 has been derived from the audited consolidated financial statements for that date but does not include all the information in the accompanying notes required for complete financial statements. The accompanying notes to the condensed consolidated financial statements are an integral part of these statements. 3 MFN FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

Three Months Ended ~~Six~~Nine Months Ended -------------------- ------------------- ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, (In thousands, except per share data) 2001 2000 2001 2000 -------- -------- -------- -------- INTEREST INCOME Finance charges and loan fees $28 27,~~000~~907 $ 29,~~942~~519 $56 84,~~850~~757 $59 89,~~740~~259 Investment income ~~737~~691 2,~~373~~448 23,~~544~~235 46,~~464~~912 -------- -------- -------- -------- Total interest income 28,~~737~~598 3231,~~315~~967 5987,~~394~~992 6496,~~204~~171 INTEREST EXPENSE 6,~~890~~882 109,~~079~~758 1522,~~697~~579 2029,~~164~~922 -------- -------- -------- -------- Net interest income before provision for finance credit losses 21,~~847~~716 22,~~236~~209 4365,~~697~~413 4466,~~040~~249 PROVISION FOR FINANCE CREDIT LOSSES 511,~~400~~500 5,~~420~~900 921,~~597~~097 612,~~650~~550 -------- -------- -------- -------- Net interest income after provision for finance credit losses 1610,~~447~~216 16,~~816~~309 3444,~~100~~316 3753,~~390~~699 ~~------- ------- ------- -------~~ OTHER OPERATING INCOME Insurance premiums 1,~~460~~333 2,~~739~~918 35,~~688~~021 58,~~888~~805 Other revenue ~~156~~126 ~~910~~498 ~~369~~495 12,~~831~~330 -------- -------- -------- -------- Total other operating income 1,~~616~~459 3,~~649~~416 45,~~057~~516 711,~~719~~135 ~~------- ------- ------- -------~~ OTHER OPERATING EXPENSES Salaries and employee benefits 98,~~593~~811 109,~~450~~920 1928,~~726~~537 2131,~~649~~569 Occupancy expense ~~810~~860 ~~799~~787 12,~~654~~514 12,~~583~~370 Equipment expense ~~743~~675 ~~498~~484 2,090 1,~~415~~425 ~~941~~ Telecommunications ~~560~~526 ~~631~~574 1,~~181~~707 1,~~301~~875 Credit information ~~423~~416 ~~280~~455 ~~835~~1,251 ~~518~~973 Postage ~~423~~376 ~~339~~366 ~~893~~1,269 ~~664~~1,030 Insurance claims and other underwriting expense ~~935~~460 1,~~651~~774 23,~~609~~069 35,~~687~~461 Amortization (2,~~471~~470) (2,~~469~~471) (47,~~941~~411) (47,~~938~~409) Pension curtailment gain ~~(3,595)~~-- -- (3,595) -- Restructuring charges ~~3,565~~ -- (12) 3,565 (~~158~~170) Other expenses 2,~~596~~791 2,~~924~~666 58,~~513~~304 58,~~758~~424 -------- -------- -------- -------- Total other operating expenses 1312,~~582~~445 1514,~~103~~543 2841,~~855~~300 3145,~~005~~548 -------- -------- -------- -------- OPERATING INCOME ~~4,481~~(LOSS) (770) 5,~~362~~182 98,~~302~~532 1419,~~104~~286 Income tax provision (benefit) ~~794~~ (17,~~133~~711) 1,~~722~~351 1(5,~~345~~989) 2,696 -------- -------- -------- -------- Net income before extraordinary credits 6,941 3,831 14,521 16,590 Extraordinary credit: Gain on early retirement of debt, net of taxes -- 487 -- 487 -------- -------- -------- -------- NET INCOME $ 36,~~687~~941 $ 64,~~495~~318 $ 714,~~580~~521 $12 17,~~759~~077 ======== ======== ======== ======== Weighted average common shares outstanding Basic 9,991 10,000 9,~~995~~994 10,000 Diluted 10,~~037~~035 10,~~000~~003 10,~~037~~036 10,~~004~~003 Earnings per common share Basic $ 0.3769 $ 0.6543 $0 1.7645 $ 1.2871 Diluted $ 0.3769 $ 0.6543 $0 1.7645 $ 1.2871 Dividends per share declared -- -- -- --

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements. 4 MFN FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)

Total Common Paid In Retained Stockholders' (In thousands) Stock Capital Earnings Equity -------- --------- -------- ------------ Balance at January 1, 2000 $ 100 $ 84,900 $ 20,529 $ 105,529 Net income for period January 1, 2000 through March 31, 2000 -- -- 6,264 6,264 --------- --------- --------- --------- Balance at March 31, 2000 $ 100 84,900 26,793 111,793 Net income for period April 1, 2000 through June 30, 2000 -- -- 6,495 6,495 --------- --------- --------- --------- Balance at June 30, 2000 100 84,900 33,288 118,288 Net income for period July 1, 2000 through September 30, 2000 -- -- 4,318 4,318 --------- --------- --------- --------- Balance at September 30, 2000 $ 100 $ 84,900 $ 3337,~~288~~606 $ ~~118~~122,~~288~~606 ========= ========= ========= ========= Balance at January 1, 2001 $ 100 $ 84,900 $ 39,645 $ 124,645 Net income for period January 1, 2001 through March 31, 2001 -- -- 3,893 3,893 --------- --------- --------- --------- Balance at March 31, 2001 100 84,900 43,538 128,538 Net income for period April 1, 2001 through June 30, 2001 -- -- 3,687 3,687 --------- --------- --------- --------- Balance at June 30, 2001 100 84,900 47,225 132,225 Net income for period July 1, 2001 through September 30, 2001 -- -- 6,941 6,941 --------- --------- --------- --------- Balance at September 30, 2001 $ 100 $ 84,900 $ 4754,~~225~~166 $ ~~132~~139,~~225~~166 ========= ========= ========= =========

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements. 5 MFN FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Three Months Ended ~~Six~~Nine Months Ended -------------------- ------------------- ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, (In thousands) 2001 2000 2001 2000 -------- -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 36,~~687~~941 $ 64,~~495~~318 $ 714,~~580~~521 $ 1217,~~759~~077 Adjustments to reconcile net income to net cash provided by operating activities: Provision for finance credit losses 511,~~400~~500 5,~~420~~900 921,~~597~~097 612,~~650~~550 Gain on early retirement of debt -- (804) -- (804) Provision for restructuring charge ~~3,162~~-- -- 3,162 ~~(158)~~-- Pension curtailment gain ~~(3,595)~~-- -- (3,595) -- Gain on sale of finance receivables -- -- -- (77) Amortization of deferred financing costs 12,~~475~~239 -- 13,~~602~~841 -- Net decrease in income tax receivable ~~346~~6,248 ~~654~~339 ~~346~~6,594 1,~~573~~912 Net increase (decrease) in taxes payable (113,~~078~~775) ~~896~~1,377 (~~209~~13,984) 24,~~966~~343 Depreciation and amortization (2,~~196~~172) (2,~~301~~278) (46,~~436~~608) (46,~~630~~908) Net (increase) decrease in other assets ~~834~~(3,132) (~~582~~965) ~~3,221~~89 54,~~677~~712 Net increase (decrease) in other liabilities (1,~~132)~~213 ~~(566) (~~1,~~329)~~439 (~~1,007~~117) 274 --------- --------- --------- --------- Net cash provided by operating activities 69,~~903~~062 109,~~016~~326 1525,~~939~~000 2333,~~753~~079 CASH FLOWS FROM INVESTING ACTIVITIES Principal collected on finance receivables and recoveries of charged-off finance receivables 70,~~957~~532 8077,~~100~~646 ~~145~~216,~~961~~492 ~~163~~240,~~335~~981 Finance receivables purchased or originated (7371,~~200~~253) (8276,~~321~~657) (~~150~~221,~~685~~937) (~~163~~239,~~020~~677) Proceeds from sale of finance receivables and assets -- -- -- 2,075 Purchases of furniture, fixtures and equipment (~~661~~1,489) (~~453~~230) (12,~~434~~922) (~~951~~1,181) --------- --------- --------- --------- Net cash provided by (used in) investing activities (2,~~904~~210) ~~(2,674)~~759 (68,~~158~~367) 12,~~439~~198 CASH FLOWS FROM FINANCING ACTIVITIES Repayment of senior secured debt -- --(20,909) (342,908) --(20,909) Proceeds from warehouse credit facility --50,000 -- ~~285~~335,000 -- Repayment of warehouse credit facility ~~(285,000)~~-- -- (285,000) -- Proceeds from notes payable to securitization trust -- -- 301,000 -- ~~301~~Repayment of notes payable to securitization trust (68,~~000~~167) -- (68,167) -- (Increase) decrease in restricted cash ~~(30~~4,~~781)~~402 -- (3026,~~781~~379) -- Payment of deferred financing costs (~~2,499~~918) -- (89,~~251~~169) -- --------- --------- --------- --------- Net cash ~~provided by (~~used in) financing activities (1714,~~280~~683) --(20,909) (8095,~~940~~623) --(20,909) --------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents (137,~~281~~831) 7(10,~~342~~824) (7178,~~159~~990) 2514,~~192~~368 Unrestricted cash and cash equivalents Beginning of period 6955,~~215~~934 ~~141~~148,~~485~~827 127,093 123,635 --------- --------- --------- --------- End of period $ 5548,~~934~~103 $~~148~~ 138,~~827~~003 $ 5548,~~934~~103 $ ~~148~~138,~~827~~003 ========= ========= ========= ========= SUPPLEMENTAL CASH DISCLOSURES Income taxes paid to federal and state governments $ ~~1,872~~34 $ ~~201~~825 $ 1,~~931~~965 $ ~~610~~1,427 Net interest paid 54,~~646~~218 9,~~912~~353 1519,~~558~~776 1929,~~831~~184

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements. 6 MFN FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 Note 1 - Basis of Presentation The accompanying condensed consolidated financial statements include the accounts of MFN Financial Corporation and its wholly owned subsidiaries ("the Company"). All significant inter-company transactions and accounts have been eliminated in consolidation. The condensed consolidated financial statements as of September 30, 2001 and December 31, 2000, and for the periods ended September 30, 2001 and 2000, are unaudited, but in management's opinion include all necessary adjustments (consisting solely of normal recurring matters) for a fair presentation of the results for such interim periods. Certain prior year amounts have been reclassified to conform to the current period presentation. The results for interim periods are not necessarily indicative of results for a full year. The interim period financial statements, including the notes thereto, are condensed and do not include all disclosures required by accounting principles generally accepted in the United States of America. These interim period financial statements should be read in conjunction with the Company's consolidated financial statements which are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. 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. At September 30, 2001, the Company held an interest rate cap that is subject to the provisions of SFAS 133. This derivative instrument will expire in January 2003. The fair value of the interest rate cap is not significant at September 30, 2001. The Company may, from time to time, purchase derivative instruments to hedge certain financial risks. Any such instruments will be accounted for and disclosed in accordance with SFAS 133 and SFAS 138. Management does not expect this statement to 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 of 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. Management does not expect this statement to have a material impact on the Company's financial position or results of operations. 7 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. Management does not expect this statement to have a material impact 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. 142, "Goodwill and Other Intangible Assets" ("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. The Company will continue to amortize the balance of the excess of revalued net assets over liabilities and stockholders' investment through December 31, 2001 in accordance with its existing amortization policy. On March 23, 1999, the Company emerged from bankruptcy proceedings in the United States Bankruptcy Court for the Northern District of Illinois pursuant to a Second Amended Plan of Reorganization. Note 2 - Unrestricted Cash and Cash Equivalents Unrestricted cash and cash equivalents include marketable securities with purchased maturities of three months or less. At September 30, 2001, unrestricted cash and cash equivalents had an amortized cost and market value of $48.1 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 3 - Restricted Cash In connection with its warehouse credit facility (see Note 5) and in connection with the notes payable to securitization trust (see Note 6), 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 September 30, 2001, the aggregate restricted cash accounts totaled approximately $26.4 million. 8 Note 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 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 September 30, 2001, customers whose mailing addresses were in Illinois, Florida and Ohio comprised 8.2%, 7.8% and 7.6% of the finance receivable portfolio, respectively. The following table summarizes the composition of finance receivables outstanding, net of unearned income (in thousands):

~~June~~September 30, December 31, 2001 2000 ----------- ----------- Sales Finance Receivables Automobile Simple interest $~~104~~ 132,~~758~~949 $ 63,641 Precompute, net of unearned income ~~346~~314,~~102~~301 386,287 ----------- ----------- Total automobile, net of unearned income ~~450~~447,~~860~~250 449,928 Non-automobile, net of unearned income 1614,~~782~~107 21,845 ----------- ----------- Total sales finance receivables, net of unearned income ~~467~~461,~~642~~357 471,773 Direct loans, net of unearned income 86,~~322~~964 13,081 ----------- ----------- Finance Receivables, net of unearned income $~~475~~ 468,~~964~~321 $ 484,854 =========== ===========

Note 5 - Warehouse Credit Facility 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 6). 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. The Financing Agreement 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 9 borrowings under the facility, even if no borrowing is necessary. Based on delinquency totals at September 30, 2001, the Company had exceeded a level 4 trigger under the Financing Agreement. Exceeding this trigger will require a $3.2 million transfer of cash to a restricted status in October 2001 (see Note 15). 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 September 30, 2001 the restricted cash totaled $1.5 million. At September 30, 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 $72.2 million. As of September 30, 2001, the Company had an outstanding balance on the warehouse credit facility of $50.0 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 one-year period ending March 19, 2002. 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 difference between the carrying amount and the fair value of the interest rate cap is not significant at September 30, 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 terms of the agreement, MFN Funding LLC would receive a payment from a counterparty for the rate in excess of 6.750%. As of September 30, 2001, one month LIBOR was 2.637%. Note 6 - 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 10 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 September 30, 2001 (dollars in thousands):

Outstanding Stated Final Scheduled Principal Interest Rate Distribution Date (1) ----------- -------------- --------------------- Class A-1 Notes $ ~~116~~47,~~000~~833 4.05125% July 15, 2002 Class A-2 Notes $ 185,000 5.07000% July 15, 2007 ----------- Total principal outstanding $ ~~301~~232,~~000~~833 =========== (1) Payment in full of the Securitized Notes could occur earlier than the final scheduled distribution date.

~~June~~Three Months Ended Nine Months Ended -------------------- ------------------- Sept. 30, ~~2001~~Sept. ~~December~~30, 31Sept. 30, Sept. 30, 2001 2000 2001 2000 -------- ------ -- -------- -------- ~~Balance~~BASIC ~~Rate~~Net ~~Balance~~income ~~Rate~~before extraordinary credits .. $ 6,941 $ 3,831 $ 14,521 $ 16,590 Extraordinary gain from early retirement of debt ................. -- 487 -- 487 ---------- ---------- ---------- ---------- ~~Senior~~Net ~~secured~~income ............................... $ 6,941 $ 4,318 $ 14,521 $ 17,077 ========== ========== ========== ========== Average shares of common stock outstanding 9,991,284 10,000,003 9,993,903 10,000,002 Earnings before extraordinary credit ..... $ 0.69 $ 0.38 $ 1.45 $ 1.66 Extraordinary gain from early retirement of debt ................. -- 0.05 -- 0.05 ---------- ---------- ---------- ---------- Earnings per share of common stock ....... $ 0.69 $ 0.43 $ 1.45 $ 1.71 ========== ========== ========== ========== DILUTED Net income before extraordinary credits .. $ 6,941 $ 3,831 $ 14,521 $ 16,590 Extraordinary gain from early retirement of debt ................. -- 487 --% 487 ---------- ---------- ---------- ---------- Net income ............................... $ ~~342~~6,941 $ 4,318 $ 14,521 $ 17,077 ========== ========== ========== ========== Average shares of common stock outstanding and common stock equivalents outstanding ............... 10,035,085 10,002,908 10,036,084 10,003,192 Earnings before extraordinary credit ..... $ 0%.69 ~~Senior~~$ ~~subordinated~~0.38 ~~debt~~$ ~~22,500~~1.45 11$ 1.0%66 ~~22,500~~Extraordinary 11gain from early retirement of debt ................. -- 0%.05 -- 0.05 ---------- ---------- ---------- ---------- ~~Total~~Earnings $per ~~22,500~~share 11of common stock ....... $ 0%.69 $ ~~365,408~~0.43 10$ 1.0%45 $ 1.71 ========== ========== ========== ==========

13 Note 10 - 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 September 30, December 31, Expiration Date Price 2001 2000 --------------- -------- ------------ ----------- Series A March 23, 2002 $15.34 569,841 579,999 Series B March 23, 2003 $21.81 569,841 579,999 Series C March 23, 2004 $28.27 569,841 579,999 Note 11 - Pension Curtailment Gain On June 30, 2001 the Company froze future benefits under the Company's noncontributory defined benefit pension plan as a part of redesigning its employee benefit plans. This change resulted in the recognition of a $3.6 million curtailment gain in the second quarter of 2001. Note 12 - Restructuring Charges On May 7, 2001 the Company internally announced its plans to consolidate its Mercury Finance Company collection operations into regional centers. In addition, the Company eliminated the Dealer Development Manager ("DDM") position and added additional Regional Business Development Managers ("RBDMs"). The RBDMs have multiple-state responsibility for developing new business relationships with automobile dealers. The employees who make the buy/decline decisions are the underwriters or "Buyers", located at each of the Company's Central Purchasing Offices. The Buyers are responsible for managing and expanding relationships with existing dealers. During the second quarter of 2001, the Company recorded a provision against earnings in the amount of $3.6 million to cover estimated severance, lease termination, relocation, payroll tax costs, and disposal of furniture, fixtures and equipment.

~~(Dollars~~Amounts inAmounts ~~thousands,~~Balance ~~Three~~Charged ~~Months~~Utilized ~~Ended~~Sept. ~~Six Months Ended except per share amounts) ------------------------ ------------------------ June~~ 30, ~~June~~(in ~~30,~~thousands) ~~June~~In ~~30,~~2001 ~~June~~In ~~30,~~ 2001 ~~2000~~ 2001 ~~2000~~ -------~~----~~ --------~~---~~ --------~~---~~ ~~-----------~~Lease ~~BASIC~~termination ~~Net income~~ $ 31,~~687~~648 $ ~~6,495~~180 $ 71,~~580~~468 $Disposal ~~12,759 Average shares~~ of ~~common stock outstanding 9~~furniture,~~991,284~~ ~~10,000,003~~fixtures ~~9,995,234~~and ~~10,000,003~~equipment ~~Earnings~~161 ~~per~~161 ~~share~~-- ofEmployee ~~common~~severance, ~~stock~~payroll $taxes ~~0.37~~and $relocation ~~0.65~~1,756 $963 ~~0.76~~793 $------ ~~1.28~~------ ~~DILUTED~~------ ~~Net~~Total ~~income~~ $ 3,~~687~~565 $ 61,~~495~~304 $ 72,~~580~~261 $====== ~~12,759~~====== ~~Average shares of common stock outstanding and common stock equivalents outstanding 10,036,715 10,000,003 10,036,621 10,004,296 Earnings per share of common stock $ 0.37 $ 0.65 $ 0.76 $ 1.28~~======

During the second quarter of 1999, the Company implemented a plan to close a total of 46 branches, at which time it recorded a provision against earnings in the amount of $1.9 million to cover estimated severance, relocation costs and lease termination costs. Credits for $12,000 and $170,000 were recorded to restructuring expense during the three- and nine-month period ended September 30, 2000, respectively, to reflect changes in estimated reserve requirements. 14 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 arrangement. The reserve for lease buyouts is considered utilized when the remaining lease obligations are settled or the space has been subleased. It is the Company's policy to continue to charge depreciation, rental and other operating costs related to excess space to ongoing operations while they remain in business use. Salaries, benefits and related payroll taxes are charged to operations while the employee is actively employed. Note 13 - Contingencies and Legal Matters 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 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 the Company's subsidiaries conduct 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 or 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 14 - Income Taxes The 2001 provision for income taxes was calculated using a 39.5% tax rate on earnings before income taxes adjusted for the amortization of the excess of revalued net assets over liabilities and stockholders' investment. The 2001 provision for income taxes also reflects a favorable $6.4 million adjustment as a result of a tentative settlement with the Internal Revenue Service concerning its examination of the Company's 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. 15 Note 15 - Subsequent Events As of October 31, 2001, delinquencies under the Warehouse Credit Facility continued above the level 4 trigger. In addition, charge-offs exceeded the level 5 trigger as of October 31, 2001. The combination of these two trigger events will require a $1.7 million additional transfer of cash to a restricted status in November 2001. This is the maximum amount that will be required under the Financing Agreement given current outstanding balances. If delinquencies or charge-offs 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 or charge-offs drop below the trigger levels in a subsequent month, certain restricted cash balances may be returned to an unrestricted category. The Company is closing its Midland Finance Company operations and effective October 2001 has discontinued originating direct loans and purchasing non-automobile sales finance receivables. The Company anticipates it will take approximately 12 months to wind down its Midland Finance Company operations. The decision to discontinue these operations is not expected to have a material impact on the Company. 16 MFN FINANCIAL CORPORATION CONDENSED CONSOLIDATED AVERAGE BALANCE SHEETS PERIODS ENDED SEPTEMBER 30 (Unaudited)

~~Amounts~~Three ~~Amounts~~Months ~~Balance~~Ended ~~Charged~~Nine ~~Utilized~~Months ~~June~~Ended -------------------- -------------------- Sept. 30, Sept. 30, Sept. 30, Sept. 30, (Dollars in thousands) In 2001 In2000 2001 ~~2001~~2000 -------- -------- -------- ~~Lease~~-------- ~~termination~~ASSETS Cash and cash equivalents $ 182,~~648~~666 $143,855 --$ 99,422 $142,324 1Finance receivables,~~648~~ ~~Disposal~~net of ~~furniture~~unearned income 473,125 ~~fixtures~~501,086 ~~and~~476,334 ~~equipment~~506,566 ~~161~~Less: ~~161~~Allowance for credit losses 38,629 37,794 38,295 38,349 Less: Nonrefundable dealer reserves 26,604 32,286 27,055 32,829 -------- ~~Employee~~-------- ~~severance~~-------- -------- Finance receivables, ~~payroll~~net ~~taxes~~407,892 ~~and~~431,006 ~~relocation~~410,984 1435,~~756~~388 ~~403~~Other 1assets 21,~~353~~896 14,767 19,979 15,776 -------- -------- -------- ~~Total~~-------- TOTAL ASSETS $512,454 3$589,~~565~~628 $530,385 ~~564~~$593,488 ======== ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities $317,305 3$390,~~001~~517 $333,369 $398,452 Other liabilities 60,648 78,686 66,118 80,465 -------- -------- -------- -------- TOTAL LIABILITIES 377,953 469,203 399,487 478,917 STOCKHOLDERS' EQUITY 134,501 120,425 130,898 114,571 -------- -------- -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $512,454 $589,628 $530,385 $593,488 ======== ======== ======== ======== Ratios: Net interest margin 15.63% 13.77% 15.15% 13.61% Net income to average total assets 5.42% 2.93% 3.65% 3.84% Net income to average stockholders' equity 20.64% 14.34% 14.79% 19.87%

17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Safe Harbor" Statement under the Securities Litigation Reform Act of 1995: This Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, contains certain forward-looking statements pertaining to the success of the Company's new technology to process sales finance applications, expected operating results, loss provisions, other operating income and expenses, consolidating collection centers, ability to finance its operations, changing business development practices, the impact of the terrorist attacks on the United States, the general economic slowdown and other matters. These statements are subject to uncertainties and other factors. Should one or more of these uncertainties or other factors materialize or fail to materialize, or should underlying assumptions prove incorrect, actual events or results may vary materially from those anticipated. Such uncertainties and other factors include the Company's ability to purchase finance receivables on terms it deems acceptable, changes in the quality of finance receivables, success of new business methods and systems including centralized lockbox operations, consolidating the Company's collection operations, changing the way the Company's services are marketed, the impact of eliminating collateral protection insurance on certain receivables, trends in the automobile and finance industries, and general economic conditions. The Company undertakes no obligation to update any such factor or to publicly announce the results of any revisions to any forward-looking statements contained herein to reflect future events or developments. Background MFN Financial Corporation, f/k/a Mercury Finance Company ("MFN" or the "Company") is a consumer finance concern engaged, through its operating subsidiaries, in the business of purchasing, securitizing and servicing individual installment sales finance contracts acquired from automobile dealers and selling credit insurance and other related products. Notwithstanding anything herein to the contrary, all operations of the Company are conducted through its subsidiaries and all references herein to offices (except the Company's home office) or locations, refer to the Company's operating subsidiaries only. MFN was organized in 1988, as a wholly owned subsidiary of First Illinois Corporation (an Evanston, Illinois based bank holding company). On April 24, 1989, First Illinois Corporation distributed to its stockholders one share of MFN for each two shares of First Illinois Corporation stock held. MFN's primary strategic focus is the purchasing of individual installment sales finance contracts from automobile dealers. The Company ceased purchasing non-automobile retail installment sales contracts and originating direct loans to consumers effective October 2001. Substantially all of the Company's sales finance contracts and loans are written with "non-prime" borrowers. These are borrowers which generally would not be expected to qualify for traditional financing such as that provided by commercial banks or automobile manufacturers' captive finance companies. The business mix of MFN's net finance receivables portfolio at September 30, 2001 is 95.5% automobile sales finance receivables, 3.0% non-automobile sales 18 finance receivables and 1.5% direct consumer loans. The sales finance receivables are serviced through the Company's collection office network. The non-automobile sales finance receivables and the consumer loan receivables are serviced through Midland Finance Company, a wholly owned subsidiary of the Company located in the Chicago, Illinois market. Sales finance contracts are generally purchased on a discount basis and typically have terms of 24 to 48 months with a maximum term of 60 months. MFN's direct consumer loans generally have terms of 12 to 24 months with a maximum term of 36 months. Real or personal property generally collateralizes secured loans. Annual interest rates on MFN's sales finance contracts and loans range, with minor exception, from 18% to 40%. Generally all sales finance contracts and loans are repayable in equal monthly installments. Late payment fees generally are assessed on contracts which fail to make their scheduled payments within 10 days of the scheduled due date. MFN purchases its installment retail sales finance contracts from automobile dealers through its Central Purchasing Offices ("CPOs"). The CPOs serve as the centralized underwriter of credit. In 2000, the Company began implementing a new automated application processing and risk control system. This new system was fully implemented in July 2000. The system automatically performs a number of tasks that were performed manually in the past, including pulling a credit report, checking the valuation of the vehicle against published information, computing debt ratios and comparing information to Company policy. The Company believes that applying consistent underwriting standards improves the predictability of the underlying credit performance. On March 23, 1999, the Company emerged from bankruptcy proceedings in the United States Bankruptcy Court for the Northern District of Illinois pursuant to a Second Amended Plan of Reorganization, a copy of which is filed as Exhibit 2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998. Overview The results for the interim periods shown for the Company are not to be considered as being indicative of the results that are expected for the full year. The following is management's discussion and analysis of the condensed consolidated financial condition of the Company at September 30, 2001 and December 31, 2000. Condensed consolidated results of operations are presented for the three- and nine-month periods ended September 30, 2001 and September 30, 2000 for the Company. This discussion should be read in conjunction with the Company's condensed consolidated financial statements and notes thereto appearing elsewhere in this report. 19 FINANCIAL CONDITION Assets and Finance Receivables Total assets of the Company at September 30, 2001 decreased 12.0% to $493.6 million compared to $561.2 million at December 31, 2000. The decrease was primarily due to a reduction in cash as the Company paid down debt and secured new sources of financing. As of September 30, 2001, customers whose mailing addresses were in Illinois, Florida and Ohio comprised 8.2%, 7.8% and 7.6% of the finance receivable portfolio, respectively. The following table summarizes the composition of finance receivables at the dates indicated (in thousands):

~~Three~~September ~~Months~~30, ~~Ended~~December ~~Six~~31, ~~Months~~2001 ~~Ended~~2000 ------------~~------~~ ------------~~----~~ ~~June~~Sales ~~30,~~Finance ~~June~~Receivables ~~30,~~Automobile ~~June~~Simple ~~30,~~interest ~~June 30, (Dollars in thousands) 2001 2000 2001 2000 ---- ---- ---- ---- ASSETS Cash and cash equivalents~~ $ 69132,~~573~~949 $~~147,706~~ ~~$ 99~~63,~~570~~641 ~~$142~~Precompute,~~379~~ ~~Finance receivables,~~ net of unearned income ~~476~~314,~~574~~301 ~~507~~386,~~245~~287 ~~478,110 509,500 Less: Allowance for credit losses 38,173 38,083 38,093 38,490 Less: Nonrefundable dealer reserves 26,990 33,005 27,294 33,187~~ -------- ---~~-----~~ -------- ---~~-----~~ ~~Finance~~Total ~~receivables~~automobile, net ~~411,411~~of ~~436~~unearned income 447,~~157~~250 ~~412~~449,~~723~~928 ~~437~~Non-automobile,~~823~~ ~~Other~~net ~~assets~~of ~~21,815~~unearned income 14,~~870~~107 1921,~~361~~845 ~~16,164~~ -------- ---~~-----~~ -------- ---~~-----~~ ~~TOTAL~~Total ~~ASSETS~~sales ~~$502,799~~finance ~~$598~~receivables,~~733~~ ~~$531,654~~net ~~$596,366~~of ~~========~~unearned ~~========~~income ~~======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities $305~~461,~~014~~357 ~~$403~~471,~~742~~773 ~~$333,527~~Direct ~~$403~~loans,~~742~~ ~~Other~~net ~~liabilities~~of ~~66,432~~unearned ~~80,028~~income 696,~~098~~964 8013,~~866~~081 -------- ---~~-----~~ -------- ---~~-----~~ ~~TOTAL~~Finance ~~LIABILITIES 371~~Receivables,~~446~~ ~~483,770~~net ~~402,625~~of ~~484,608~~unearned ~~STOCKHOLDERS'~~income ~~EQUITY 131,353 114,963 129,029 111,758 -------- -------- -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY~~ $~~502,799~~ ~~$598~~468,~~733~~321 $~~531,654~~ ~~$596~~484,~~366~~854 ======== ===~~=====~~ ======== ===~~===== Ratios: Net interest margin 16.00% 13.58% 15.13% 13.51% Net income to average total assets 2.93% 4.34% 2.85% 4.28% Net income to average stockholders' equity 11.23% 22.60% 11.75% 22.83%~~

The following sets forth a summary of sales finance receivable purchases and direct loan originations, net of unearned income for the three- and nine-month periods ended September 30, (in thousands):

~~June~~Three ~~30,~~Months ~~December~~Ended ~~31,~~Nine ~~2001~~Months ~~2000~~Ended -------- ------------ ~~Sales Finance Receivables Automobile Simple interest $104,758 $ 63,641 Precompute, net of unearned income 346,102 386,287~~ -------- ----------- ~~Total~~Sept. ~~automobile~~30, ~~net~~Sept. of30, ~~unearned~~Sept. ~~income 450~~30,~~860~~ ~~449,928~~Sept. ~~Non-automobile~~30, ~~net~~2001 of2000 ~~unearned~~2001 ~~income~~2000 ~~16,782~~-------- ~~21,845~~-------- -------- -------- ~~Total~~Automobile sales finance ~~receivables~~receivable purchases $ 74,178 ~~net~~$ of76,435 ~~unearned~~$228,490 ~~income~~$237,988 ~~467~~Non-automobile sales finance receivable purchases 1,~~642~~771 ~~471~~5,~~773~~312 ~~Direct~~7,836 ~~loans~~16,356 ~~net~~Direct ofloan ~~unearned~~originations ~~income~~797 81,~~322~~868 133,~~081~~066 7,514 -------- -------- ~~Finance~~-------- ~~Receivables,~~-------- ~~net~~Total ofpurchases ~~unearned~~and ~~income~~originations $~~475~~ 76,~~964~~746 $~~484~~ 83,~~854~~615 $239,392 $261,858 ======== ======== ======== ========

In the three- and nine-month periods ended September 30, 2001, the Company experienced a decline in automobile sales finance contract purchases of $2.3 million or 3.0% and $9.5 million or 4.0%, respectively, compared to the same period one year ago. The Company believes that acquisition of automobile sales finance receivables was negatively impacted in September 2001 as a result of consumers deferring purchases of used automobiles following the terrorist attacks on the United States. In addition to the September impact, the decline in nine-month comparative results is due to competitive market conditions and changes in the Company's underwriting criteria. 20 The Company anticipates that purchases of automobile sales finance receivables in the fourth quarter of 2001 will be negatively influenced by lower consumer confidence. In addition, the Company believes that special financing arrangements offered by franchise dealerships on new automobile sales in October 2001 has also led to a reduction in used automobile sales by independent automobile dealers which the Company relies on for approximately 70% of its purchases of installment sales contracts. The Company continues to monitor its underwriting standards and anticipates lower levels of automobile sales finance receivable purchases until improved economic conditions are evident. Through September 30, 2001, the Company purchased non-automobile sales finance receivables and originated direct loans exclusively through Midland Finance Company, a wholly owned subsidiary of the Company located in the Chicago, Illinois market. The declines in the purchases and originations of these finance receivables from the three month and nine month periods ended September 30, 2000 to the same periods of 2001 are primarily the result of the Company's strategic decision to discontinue this line of business. The Company is closing its Midland Finance Company operations and effective October 2001 has discontinued originating direct loans and purchasing non-automobile sales finance receivables. The Company anticipates it will take approximately 12 months to wind down its Midland Finance Company operations. The decision to discontinue these operations is not expected to have a material impact on the Company. Loss Reserves and Provision for Finance Credit Losses MFN originates direct consumer loans and purchases individual retail sales finance contracts from third party dealers. The total net receivables purchased and originated within a given calendar month are identified as a pool. Sales finance contracts are generally purchased 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 available to absorb credit losses over the life of each pool of receivables. The nonrefundable dealer reserve is not immediately used to offset the provision for finance credit losses, but rather is amortized over the life of the pool to offset future losses. 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. Each period, the Company segregates each pool by delinquency classification (i.e., not delinquent, 30, 60 and 90+ 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. 21 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 was earlier estimated, a recovery is recorded. Net repossessed assets are carried in other assets and at September 30, 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 reduction in reserve from 75% to 70% was due to improved recovery rates. The repossessed asset reserve is established as a transfer from the allowance for finance credit losses upon initiation of the repossession proceedings when the finance receivable balance is reclassified 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. Although the Company uses many resources to assess the adequacy of loss reserves, there is no precise method for estimating the ultimate losses in the finance receivable portfolio. The loss reserves as a percent of finance receivables, net of unearned income at September 30, are as follows: 2001 2000 ------ ------ Allowance for finance credit losses 8.64% 7.70% Nonrefundable dealer reserves 5.53% 6.26% ------ ------ Total loss reserves 14.17% 13.96% ====== ====== 22 A summary of the activity in the allowance for finance credit losses for the three- and nine-month periods ended September 30 was as follows (dollars in thousands):

Three Months Ended ~~Six~~Nine Months Ended ------------------- ------------------- ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, 2001 2000 2001 2000 -------- -------- -------- -------- ~~Automobile~~Balance ~~sales~~at ~~finance~~beginning ~~receivable~~of ~~purchases~~period $ 7438,~~657~~210 $ 8237,~~020~~113 $ ~~154~~39,~~313~~071 $ ~~161~~39,~~553~~543 ~~Non~~Reserves recaptured in conjunction with sale of finance receivables -~~automobile~~- ~~sales~~-- -- (90) Provision for finance ~~receivable~~credit ~~purchases~~losses 211,~~915~~500 5,~~633~~900 621,~~064~~097 1112,~~044~~550 ~~Direct~~Finance ~~loan~~receivables ~~originations~~charged-off, 1net of recoveries (7,~~254~~310) 2(4,~~444~~338) 2(19,~~269~~835) 5(15,~~646~~868) Net amount transferred from (to) reserve for repossessed assets (1,930) (313) 137 2,227 -------- -------- --------- --------- ~~Total~~Balance ~~purchases~~at ~~and~~end ~~originations~~of period $ 7840,~~826~~470 $ 9038,~~097~~362 $ ~~162~~40,~~646~~470 $ ~~178~~38,~~243~~362 ======== ======== ========= =========

The amount of the provision for finance credit losses for the third quarter of 2001 increased due to a rise in delinquencies, higher net charge-offs absorbed by the allowance for credit losses account and higher transfers of reserves to repossessed assets than experienced in the same period one year ago. The effects of the terrorist attacks on the United States, the general economic slowdown and the reorganization of the collection operations all contributed to the increased delinquencies. The amount of the provision for finance credit losses for the nine months ended September 30, 2001 increased due to a rise in delinquencies, higher net charge-offs absorbed by the allowance for credit losses account and lower transfers of reserves from repossessed assets than experienced over the same period one year ago. A summary of the activity in nonrefundable dealer reserves for the periods ended September 30, was as follows (dollars in thousands):

Three Months Ended ~~Six~~Nine Months Ended -------------------- ------------------- ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, 2001 2000 2001 2000 -------- -------- -------- -------- Balance at beginning of period $ 3726,~~974~~926 $ 3733,~~961~~164 $ 3928,~~071~~014 $ 3934,~~543~~062 ~~Reserves~~Discounts ~~recaptured~~acquired inon ~~conjunction~~new ~~with~~volume ~~sale of finance receivables -- -- -- (90) Provision for finance credit losses~~ 5,~~400~~492 56,~~420~~958 917,~~597~~455 622,~~650~~181 ~~Finance~~Net ~~receivables charged~~charge-~~off,~~offs ~~net~~absorbed ~~of recoveries~~ (56,~~711~~547) (58,~~447~~971) (1219,~~525~~598) (1125,~~530~~092) ~~Net amount transferred from (to) reserve for repossessed assets 548 (821) 2,068 2,540~~ -------- -------- -------- -------- Balance at end of period $ 3825,~~211~~871 $ 3731,~~113~~151 $ 3825,~~211~~871 $ 3731,~~113~~151 ======== ======== ======== ======== Nonrefundable dealer reserves as a percent of sales finance receivables, net of unearned income 5.61% 6.46% ===== ===== Discounts acquired as a percent of sales finance receivable purchases, net of unearned income 7.23% 8.51% 7.39% 8.72% ===== ===== ===== =====

The decrease in the ratio of nonrefundable dealer reserves to sales finance receivables, net of unearned income at September 30, 2001 compared to one year ago is attributable to the lower discounts acquired on new volume in 2001 and 23 the amount of amortization of nonrefundable dealer reserves scheduled for pools originated prior to adoption of static pooling which were fully amortized at the end of 2000. The decrease in the level of discounts acquired on new volume is primarily due to elimination of lower quality credits that carry higher discounts and to competitive pressures for better credit quality business. The Company has eliminated purchasing certain finance receivables that historically carried higher discounts due to their quality. As a result, the percentage discount on new volume may continue to decline. Warehouse Credit Facility 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. 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. The Financing Agreement 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 September 30, 2001, the Company had exceeded a level 4 trigger under the Financing Agreement. Exceeding this trigger will require a $3.2 million transfer of cash to a restricted status in October 2001. As of October 31, 2001, delinquencies under the Warehouse Credit Facility continued above the level 4 trigger. In addition, charge-offs exceeded the level 5 trigger as of October 31, 2001. The combination of these two trigger events will require a $1.7 million additional transfer of cash to a restricted status in November 2001. This is the maximum amount that will be required under the Financing Agreement given current outstanding balances. If delinquencies or charge-offs 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 or charge-offs drop below the trigger levels in a subsequent month, certain restricted cash balances may be returned to an unrestricted category. As of September 30, 2001 the restricted cash totaled $1.5 million. At September 30, 2001, the maximum available credit limit was $150 million and, based upon eligible automobile sales finance receivables held by MFN Funding 24 LLC, the maximum amount of advance available to the Company under the Financing Agreement was $72.2 million. As of September 30, 2001, the Company had an outstanding balance on the warehouse credit facility of $50.0 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 one-year period ending March 19, 2002. 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 difference between the carrying amount and the fair value of the interest rate cap is not significant at September 30, 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 terms of the agreement, MFN Funding LLC would receive a payment from a counterparty for the rate in excess of 6.750%. As of September 30, 2001, one month LIBOR was 2.637%. 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. 25 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 September 30, 2001 (dollars in thousands):

~~Three~~Outstanding ~~Months~~Stated ~~Ended~~Final ~~Six~~Scheduled ~~Months~~Principal ~~Ended~~Interest Rate Distribution Date (1) --------- ---------- --- ---------------- ~~June 30, June 30, June 30, June 30, 2001 2000 2001 2000~~ ---- -~~---~~ ~~----~~Class A-~~---~~1 ~~Balance~~Notes at$ ~~beginning~~47,833 of4.05125% ~~period~~July ~~$ 27~~15,~~368~~ $2002 ~~33,113~~Class $A-2 ~~28,014~~Notes $ 34185,~~062~~000 ~~Discounts acquired on new volume~~ 5~~,626~~.07000% ~~7,776~~July ~~11,961~~ 15,~~223~~ ~~Net~~2007 ~~charge~~-~~offs absorbed (6,069) (7,725) (13,050) (16,121)~~ -------- ~~--------~~Total ~~--------~~principal ~~--------~~outstanding ~~Balance at end of period~~ $ 26232,~~925~~833 ~~$ 33,164 $ 26,925 $ 33,164~~ ======== =~~=======~~ ~~========~~(1) ~~========~~Payment ~~Nonrefundable~~in ~~dealer~~full ~~reserves as a percent~~ of ~~sales~~the ~~finance~~Securitized ~~receivables,~~Notes ~~net~~could ofoccur ~~unearned~~earlier ~~income~~than ~~5.76%~~the ~~6.85%~~final ~~========~~scheduled ~~========~~distribution ~~Discounts acquired as a percent of sales finance receivable purchases, net of unearned income 7~~date.~~25% 8.87% 7.46% 8.82% ======= ======= ======== ========~~

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 September 30, 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 September 30, 2001, restricted cash under the 2001-A Securitization totaled approximately $24.1 million. Senior Secured Debt and Senior Subordinated Debt The following table presents the Company's senior secured debt and senior subordinated debt amounts outstanding and their stated interest rates at both September 30, 2001 and December 31, 2000 (dollars in thousands): September 30, 2001 December 31, 2000 ------------------ ----------------- Balance Rate Balance Rate --------- ----- --------- ----- Senior secured debt $ -- --% $ 342,908 10.0% Senior subordinated debt 22,500 11.0% 22,500 11.0% --------- ----- --------- ----- Total $ 22,500 11.0% $ 365,408 10.0% ========= ===== ========= ===== The senior secured debt at December 31, 2000 was comprised of (i) Series A Notes Due March 23, 2001, which had a 10% annual fixed rate of interest, payable quarterly and (ii) Series B Notes Due March 23, 2001, which had a floating rate of interest based on three month LIBOR, payable quarterly. While the Series B Notes bore a variable rate of interest, the Company had 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 three month LIBOR. All principal obligations under the senior secured debt were retired at maturity on March 23, 2001. 26 The senior subordinated debt, with an aggregate principal amount of $22.5 million, has an 11% annual fixed rate of interest, payable quarterly and is due March 23, 2002. Principal payments on the subordinated debt are not due until maturity. Income Tax Accounts The 2001 provision for income taxes was calculated using a 39.5% tax rate on earnings before income taxes adjusted for the amortization of the excess of revalued net assets over liabilities and stockholders' investment. The 2001 provision for income taxes also reflects a favorable $6.4 million adjustment as a result of a tentative settlement with the Internal Revenue Service concerning its examination of the Company's 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. The following table summarizes the Company's income tax accounts at the dates indicated (in thousands): September 30, December 31, 2001 2000 ------------ ----------- Income tax receivable 1,284 7,878 Deferred income taxes 10,461 24,445 The changes in income tax account balances are primarily the result of a tentative settlement reached during the third quarter 2001 with the Internal Revenue Service concerning its examination of the Company's 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. Stockholders' Equity Total stockholders' equity at September 30, 2001 was $139.2 million or 28.2% of total assets compared with $124.6 million or 22.2% of total assets at December 31, 2000. During the three- and nine-month periods ended September 30, 2001 the Company reported net income of $6.9 million and $14.5 million, respectively, and did not declare any dividends or repurchase any shares of common stock. On March 23, 2001, the Company's exchange agent completed certain agreed-upon services pursuant to the Exchange Agent Agreement dated March 29, 1999 between Norwest Bank Minnesota and the Company, and the Company's Second Amended Plan of Reorganization. These services included the distribution to stockholders of record on March 22, 1999 of new common stock, $0.01 par value per share (the "New Common Stock") of the Company and three series of warrants to purchase New Common Stock. On March 23, 2001, 8,719 shares of New Common Stock and 10,158 warrants from each series of warrants to purchase New Common Stock were forfeited due to the failure of the eligible stockholders to properly tender their exchange requests within the two year time period set forth in the Second Amended Plan of Reorganization ended March 23, 2001. 27 RESULTS OF OPERATIONS Net Income For the three- and nine-month periods ended September 30, 2001, the Company reported net income of $6.9 million and $14.5 million, respectively, compared with net income for the same periods one year ago of $4.3 million and $17.1 million, respectively. Current year results were negatively impacted by the provision for finance credit losses, which increased from $5.9 million to $11.5 million during the third quarter and from $12.5 million to $21.1 million for the nine months ended September 30, 2001 compared to the same periods one year ago. Income tax expense in the current year results was positively impacted by a $6.4 million adjustment of tax reserves in the third quarter 2001 when compared to the same periods in the prior year. Current year results were impacted by the Company's decision to discontinue participation in a collateral protection insurance program. The Company believes that the negative effect of the decision on other operating revenue is short-term in nature and that a long-term positive effect will result from reductions in related administrative, claims and charge-off expenses. Current year results were also impacted by a pension curtailment gain of $3.6 million and by restructuring charges of $3.6 million. Interest Income and Interest Expense The largest single component of net income is net interest income, which is the difference between interest income and interest expense before provision for finance credit losses. For the three-month periods ended September 30, 2001 and September 30, 2000, net interest income was $21.7 million and $22.2 million, respectively. The net interest margin, which is the ratio of net interest income divided by average interest earning assets, was 15.63% for the three month period ended September 30, 2001 compared to 13.77% one year ago. For the nine-month periods ended September 30, 2001 and September 30, 2000, net interest income was $65.4 million and $66.2 million, respectively. The net interest margin was 15.15% for the nine month period ended September 30, 2001 compared to 13.61% one year ago. The improvement in the interest margin for both reporting periods was due to the utilization of cash to reduce the level of debt outstanding and a lower cost of funds. Outstanding debt dropped during the first quarter of 2001 when the Company retired at maturity its senior secured debt and began operating under the Receivable Financing Agreement (see Notes Payable to Securitization Trust and Warehouse Credit Facility). The yield on finance receivables in the three- and nine-month periods ended September 30, 2001 remained relatively flat compared to the same periods one year ago. The decrease in yield on cash and cash equivalents is the result of a declining rate environment. 28 The following table summarizes net interest income and the net interest margin for the three- and nine-month periods ended September 30 (dollars in thousands):

~~Outstanding~~Three ~~Stated~~Months ~~Final~~Ended ~~Scheduled~~Nine ~~Principal~~Months ~~Interest~~Ended ~~Rate~~------------------ ~~Distribution~~------------------ ~~Date~~Sept. ~~(1)~~30, Sept. 30, Sept. 30, Sept. 30, 2001 2000 2001 2000 -------- -------- -------- -------- Average interest earning assets: Cash and cash equivalents $ 82,666 $143,855 $ 99,422 $142,324 Finance receivables, net of unearned income 473,125 501,086 476,334 506,566 -------- -------- -------- ~~Class~~-------- ATotal average earning assets 555,791 644,941 575,756 648,890 Average interest bearing liabilities 317,305 390,517 333,369 398,452 -1------- ~~Notes~~-------- -------- -------- Net $~~116~~238,~~000~~486 ~~4.05125%~~$254,424 ~~July~~$242,387 15$250,438 ~~2002~~======== ~~Class~~======== A-======== ======== Interest income: Cash and cash equivalents $ 691 $ 2,448 ~~Notes~~$ 3,235 $~~185~~ 6,~~000~~912 ~~5.07000%~~Finance ~~July~~receivables, 15net of unearned income 27,907 ~~2007~~29,519 84,757 89,259 -------- -------- -------- -------- Total ~~principal~~interest ~~outstanding~~income 28,598 31,967 87,992 96,171 Interest expense 6,882 9,758 22,579 29,922 -------- -------- -------- -------- Net interest income before provision for finance credit losses $~~301~~ 21,~~000~~716 $ 22,209 $ 65,413 $ 66,249 ======== ======== ======== ======== Yield: Cash and cash equivalents 3.32% 6.77% 4.35% 6.49% Finance receivables, net of unearned income 23.59% 23.56% 23.73% 23.49% -------- -------- -------- -------- Earning assets 20.58% 19.83% 20.38% 19.76% Cost of funds 8.68% 10.00% 9.03% 10.01% -------- -------- -------- -------- Net interest spread 11.90% 9.83% 11.35% 9.75% ======== ======== ======== ======== Net interest margin 15.63% 13.77% 15.15% 13.61% ======== ======== ======== ========

Other Operating Income In addition to finance charges and interest, the Company receives other income from the sale of credit-related products. These products include insurance for credit life, accident and health and other credit insurance policies marketed to borrowers of the Company. 29 The following table summarizes the components of other operating income for the three- and nine-month periods ended September 30 (dollars in thousands):

Three Months Ended ~~Six~~Nine Months Ended ------------------ ------------------ ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, 2001 2000 2001 2000 ---- ---- ---- ---- ~~Average interest earning assets: Cash and cash equivalents $ 69,573 $147,706 $ 99,570 $142,379 Finance receivables, net of unearned income 476,574 507,245 478,110 509,500~~ -------- -------- ~~--------~~Insurance ~~--------~~premiums ~~Total~~$ ~~average~~1,333 ~~earning~~$ ~~assets 546~~2,~~147~~918 ~~654,951~~$ ~~577~~5,~~680~~021 ~~651~~$ 8,~~879~~805 ~~Average~~Other ~~interest~~income ~~bearing~~126 ~~liabilities~~498 ~~305,014~~495 ~~403~~2,~~742~~330 ~~333,527 403,742~~ -------- -------- -------- -------- ~~Net~~Total $~~241~~ 1,~~133~~459 $~~251~~ 3,~~209~~416 $~~244~~ 5,~~153~~516 $~~248~~11,~~137~~135 ======== ======== ======== ======== ~~Interest~~Other operating income: ~~Cash~~as ~~and~~a ~~cash~~percent ~~equivalents~~of $average ~~737~~interest $earning ~~2,373~~assets $1.05% 2~~,544~~.12% ~~$ 4,464 Finance receivables, net of unearned income~~ 1.28~~,000~~% 2.29~~,942~~% 56,850 59,740 -------- -------- -------- -------- Total interest income 28,737 32,315 59,394 64,204 Interest expense 6,890 10,079 15,697 20,164 -------- -------- -------- -------- Net interest income before provision for finance credit losses $ 21,847 $ 22,236 $ 43,697 $ 44,040 =====~~===~~ =====~~===~~ =====~~===~~ =====~~===~~

Other operating income in the third quarter of 2001 decreased $2.0 million or 57.3% from the third quarter of 2000, and for the nine months ended September 30, 2001 it decreased $5.6 million or 50.5% from the same period a year ago. Insurance premiums generated by a revenue sharing program on collateral protection insurance declined $1.6 million and $3.8 million for these same periods, respectively, as the result of the Company's decision to exit this business. The Company completely discontinued underwriting this coverage effective April 2001. This will have a negative impact on future other operating income; however, the Company believes this decision will have an overall positive impact on earnings by reducing insurance administration expense, claims expense and charge-offs. Other income in both reporting periods decreased compared to the same periods one year ago as insurance commissions have declined as a result of a shift away from the direct lending business. Other Operating Expenses In addition to interest expense and the provision for finance credit losses, the Company incurs other operating expenses in the conduct of its business. 30 The following table summarizes the components of other operating expenses for the three- and nine-month periods ended September 30 (dollars in thousands):

Three Months Ended ~~Six~~Nine Months Ended ------------------ ------------------ ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, 2001 2000 2001 2000 -------- -------- -------- -------- ~~Yield:~~Salaries ~~Cash~~ and ~~cash~~employee ~~equivalents~~benefits ~~4.25%~~$ ~~6.46%~~8,811 ~~5.15%~~$ 6.9,920 $28,537 $31%,569 ~~Finance~~Occupancy ~~receivables~~expense 860 787 2,514 ~~net~~2,370 Equipment expense 675 484 2,090 1,425 Telecommunications 526 574 1,707 1,875 Credit information 416 455 1,251 973 Postage 376 366 1,269 1,030 Insurance claims and other underwriting expense 460 1,774 3,069 5,461 Amortization of ~~unearned~~excess ~~income~~of ~~23.50%~~revalued ~~23.61%~~net ~~23.78%~~assets ~~23.45%~~over ~~-----~~liabilities and stockholders' equity (2,470) (2,471) (7,411) (7,409) Pension curtailment gain --~~---~~ --~~---~~ (3,595) --~~---~~ ~~Earning~~Restructuring ~~assets~~expenses ~~21.05%~~-- ~~19.74%~~(12) ~~20.56%~~3,565 ~~19.70%~~(170) ~~Cost~~Other ofexpenses ~~funds~~2,791 ~~9.04%~~2,666 ~~9.99%~~8,304 ~~9.41%~~8,424 ~~9.99%~~ ------- ------- -------- ------- ~~Net~~Total ~~interest spread~~ $12~~.01%~~,445 ~~9.75%~~$14,543 ~~11.15%~~$ ~~9.71%~~41,300 $45,548 ======= ======= ======== ======= ~~Net~~Other operating expense as a percent of average interest ~~margin~~bearing 16assets 8.0096% 139.5802% 159.1356% 139.5136% ===== ===== ===== =====

Other operating expenses in the third quarter of 2001 decreased $2.1 million or 14.4% from the third quarter of 2000. Other operating expenses for the first nine months of 2001 decreased $4.2 million or 9.3% compared to the same period one year ago. The following explanations are applicable to both reporting periods. The reduction in salaries and employees benefits is attributable to staff reductions and a decrease in pension expense. The increase in occupancy costs is due to new office locations and older locations targeted for closure being open concurrently. The increase in equipment expense is due to higher depreciation on new technology deployed. The postage expense increases are due to implementation of the Company's statement billing mailing program. Insurance claims and underwriting expenses associated with the collateral protection insurance program decreased due to improved claims experience and the discontinuation of the program, resulting in fewer policies written. The credit information expense decrease for the third quarter ended 2001 versus 2000 is due to a decline in purchases of sales finance receivables. The increase for the nine months ended September 30, 2001 over the same period one year ago is due to costs associated with the implementation of the Company's credit underwriting system. 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 operating expense. See "Recent Accounting Pronouncements." On June 30, 2001 the Company froze future benefits under the Company's non-contributory 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 in the second quarter of 2001. 31 On May 7, 2001, the Company internally announced its plans to consolidate its Mercury Finance Company collection operations into regional centers. The Company expects this consolidation effort to be fully implemented by December 31, 2001. During the transition period, the Company has experienced an increase in delinquencies and charge-offs as the responsibility for servicing the accounts is shifted to the new collection centers. While no assurances can be given, the Company anticipates this condition to be temporary and believes this reorganization will result in better account coverage and improved efficiencies when fully implemented. In addition, the Company eliminated the Dealer Development Manager ("DDM") position and added additional Regional Business Development Managers ("RBDMs"). The RBDMs have multiple-state responsibilities for developing new business relationships with automobile dealers. The employees who make the buy/decline decisions are the underwriters or "Buyers", located at each of the Company's CPOs. The Buyers are responsible for managing and expanding relationships with existing dealers. This change has allowed the Buyers to focus on improving the efficiency and effectiveness of the Company's dealer relationships and improving the level of service provided to the dealers. While the Company does not believe this shift of responsibility has had or will have a negative impact on purchases of installment sales contracts and should result in improved efficiencies, there can be no assurances that this new approach will be successful. The Company recorded a provision against earnings in the amount of $3.6 million in the second quarter ended June 30, 2001 to cover estimated severance, lease termination, relocation, payroll tax costs, and disposal of furniture, fixtures and equipment. The Company believes that estimated savings from this reorganization combined with freezing the Company's defined benefit pension plan will be approximately $5.0 million on an annualized basis; however, there can be no assurances that these estimates will be met.

~~Three~~Amounts ~~Months~~Amounts ~~Ended~~Balance ~~Six~~Charged ~~Months~~Utilized ~~Ended~~Sept. 30, (in thousands) In 2001 In 2001 2001 ------- --------~~---~~ --------~~--------~~ ~~June~~Lease ~~30,~~termination ~~June 30~~$1,648 ~~June~~$ 30180 $1,468 ~~June~~Disposal 30of furniture, ~~2001~~fixtures ~~2000~~and ~~2001~~equipment ~~2000~~161 ~~----~~161 ---- ~~----~~Employee ~~---- Insurance premiums $1~~severance,~~460~~ ~~$2,739~~payroll ~~$3,688~~taxes ~~$5,888~~and ~~Other~~relocation ~~income 156 910 369~~ 1,~~831~~756 ~~------~~963 793 ------ ------ ------ Total $~~1,616 $~~3,~~649~~565 $41,~~057~~304 $72,~~719~~261 ====== ====== ====== ~~====== Other operating income as a percent of average interest earning assets 1.18% 2.23% 1.40% 2.37% ====== ====== ====== ======~~

Three Months Ended ~~Six~~Nine Months Ended -------------------- -------------------- ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, ~~June~~Sept. 30, 2001 2000 2001 2000 -------- -------- -------- -------- ~~Salaries~~Provision ~~and~~for ~~employee~~finance ~~benefits~~credit $losses 9$11,~~593~~500 $10 5,~~450~~900 $1921,~~726~~097 $2112,~~649~~550 ~~Occupancy~~Net ~~expense~~charge-offs: ~~810~~Absorbed ~~799~~by 1allowance for credit losses 7,~~654~~310 14,~~583~~338 ~~Equipment~~19,835 ~~expense~~15,868 ~~743~~Absorbed ~~498~~by ~~1,415~~nonrefundable ~~941~~dealer ~~Telecommunications~~reserves ~~560~~6,547 ~~631~~8,971 119,~~181~~598 125,~~301~~092 ~~Credit~~------- ~~information~~------- ~~423~~------- ~~280~~------- ~~835~~Total ~~518~~net ~~Postage~~charge-offs ~~423~~$13,857 ~~339~~$13,309 ~~893~~$39,433 ~~664~~$40,960 ~~Insurance~~======= ~~claims~~======= ~~and~~======= ~~other~~======= ~~underwriting~~Allowance ~~expense~~for ~~935~~finance ~~1,651~~credit ~~2,609~~losses ~~3,687~~at ~~Amortization~~end of ~~excess~~period of$40,470 ~~revalued~~$38,362 ~~net~~Nonrefundable ~~assets~~dealer ~~over~~reserves ~~liabilities~~at ~~and~~end ~~stockholders'~~of ~~equity~~period (225,~~471)~~871 (231,~~469)~~151 ~~(4,941)~~Ratios ~~(4,938)~~------ ~~Pension~~Net ~~curtailment~~charge-offs ~~gain~~as ~~(3,595)~~a --percent ~~(3,595)~~of --average ~~Restructuring~~total ~~expenses~~finance 3receivables,~~565~~ --net of unearned income Absorbed by allowance for credit losses 6.18% 3~~,565~~.46% ~~(158)~~5.55% ~~Other~~4.18% ~~expenses~~Absorbed ~~2,596~~by ~~2,924~~nonrefundable dealer reserves 5~~,513~~.54% 7.16% 5~~,758~~.49% 6.60% ------- ------- ------- ------- Total ~~$13,582~~11.72% ~~$15,103~~10.62% ~~$28,855~~11.04% ~~$31,005~~10.78% ======= ======= ======= ======= ~~Other~~Reserves ~~operating expense~~ as a percent of ~~average~~finance ~~interest~~receivables, ~~bearing~~net ~~assets~~of 9unearned income Allowance for finance credit losses 8.9564% 97.2270% 9Nonrefundable dealer reserves 5.9953% 96.5126% ------ ------ Total 14.17% 13.96% ======= ======= Nonrefundable dealer reserves as a percent of sales finance receivables, net of unearned income 5.61% 6.46% ======= =======

33 Nonaccrual Accounts and Repossessions If an account is 60 or more days contractually delinquent at the end of any month, it is placed on nonaccrual status. The following table sets forth certain information regarding nonaccrual accounts and repossessed assets at September 30 (dollars in thousands):

~~Three~~2001 ~~Months~~2000 ~~Ended Six Months Ended~~ --------~~----------~~ --------~~--------~~ ~~June 30~~Nonaccruals, ~~June~~net ~~30,~~of ~~June~~unearned ~~30,~~income ~~June~~Non-bankrupt 30receivables $ 6,043 ~~2001~~$ ~~2000~~5,468 ~~2001~~Bankrupt ~~2000~~accounts ~~-------~~1,947 ~~-------~~2,066 ------- ------- ~~Provision~~Total ~~for finance credit losses $ 5~~nonaccruals,~~400~~ $net ~~5,420~~of $unearned ~~9,597~~income ~~$ 6~~7,~~650~~990 ~~Net charge-offs: Absorbed by allowance for credit losses 5~~7,~~711~~534 ~~5,447~~Repossessed 12assets,~~525~~ ~~11,530~~net ~~Absorbed~~of ~~by nonrefundable dealer~~ reserves 62,~~069~~596 72,~~725~~315 ~~13,050 16,121~~ ------- ------- ~~-------~~Total ~~-------~~nonaccrual ~~Total~~accounts, net ~~charge-offs~~of ~~$11,780~~unearned ~~$13~~income and repossessed assets,~~172~~ net of reserves $2510,~~575~~586 $27 9,~~651~~849 ======= ======= ~~=======~~Bankrupt ~~======= Allowance for finance credit losses at end of period $38~~accounts,~~211~~ ~~$37,113 Nonrefundable dealer reserves at end of period 26,925 33,164 Ratios ------ Net charge-offs as a percent of average total finance receivables,~~ net of unearned income ~~Absorbed~~not byin ~~allowance~~nonaccrual ~~for~~status ~~credit~~$ ~~losses~~3,903 ~~4.79%~~$ ~~4.30%~~ 5~~.24% 4.53% Absorbed by nonrefundable dealer reserves 5.10% 6.09% 5.46% 6.33% ------- ------- ------- ------- Total 9.89% 10.39% 10.70% 10.86% Reserves as a percent of finance receivables~~,756 ~~net of unearned income Allowance for finance credit losses 8.03% 7.65% Nonrefundable dealer reserves 5.66% 6.85% ------- ------- Total 13.69% 14.50%~~ ======= ======= ~~Nonrefundable~~Nonaccrual ~~dealer~~accounts ~~reserves~~and repossessed assets as a percent of ~~sales~~total finance receivables, net of unearned income 52.7626% 71.0398% ======= =======

Nonaccrual and charge-off ratios typically fluctuate over time as a portfolio matures. Accordingly, the nonaccrual and charge-off data reflected above is not necessarily indicative of nonaccrual and charge-off experience that could be expected for a portfolio with a different level of seasoning. Repossession of collateral generally occurs when debtors are 45 to 90 days contractually past due. Repossession activities have been consolidated within the Company and many of the activities have been outsourced to another party, which handles the pickup of collateral and delivery to auction. Collateral is generally sold at auction within 60 days of repossession. Net repossessed assets are reserved at 70% of the outstanding balance owed at September 30, 2001 and are carried in other assets. Prior to September 30, 2000 net repossessed assets were carried net of a 75% reserve. The reduction in reserve from 75% to 70% was due to improved recovery rates. The repossessed asset reserve is established as a transfer from the allowance for finance credit losses upon initiation of the repossession proceedings when the finance receivable balance is reclassified 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. Nonaccrual accounts and repossessed assets as a percent of total finance receivables, net of unearned income, increased 28 basis points at September 30, 2001 compared to one year ago. The Company announced in the second quarter of 2001 that it planned to consolidate its Mercury Finance Company collection operations into regional centers and that delinquencies and charge-offs may increase as a result. At September 30, 2001, the Company had 21 collection facilities, 25 fewer than existed prior to the reorganization announcement. The consolidation effort will be completed by December 31, 2001 at which time the 34 Company will have seven regional Collection Centers. The effects of the terrorist attacks on the United States, the economic slowdown and the reorganization of the collection operations all contributed to the increased delinquencies and charge-offs in the third quarter. These higher levels of both delinquencies and charge-offs may persist into future periods until improved economic conditions are evident. Other external factors, such as increased unemployment rates among consumers in general may have a negative impact on delinquency and charge-off rates in future periods. LIQUIDITY AND FINANCIAL RESOURCES In the past, the Company has used cash flow from cash collections on finance receivables to meet the current funding requirements of new originations and purchases of finance receivables. On March 22, 2001, the Company announced it had signed a $300 million receivable Financing Agreement with Deutsche Bank AG. Proceeds from the Financing Agreement were used, together with available cash, to retire the Company's senior secured debt at maturity on March 23, 2001 and funded the purchase of automobile sales finance receivables through June 28, 2001. The facility limit under the Financing Agreement was reduced to $150 million on June 28, 2001 and is available to fund future purchases of automobile finance receivable contracts on a revolving basis, through the initial term expiring March 19, 2002. An additional $22.5 million of funding exists through March 23, 2002 in the form of senior subordinated debt. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Senior Secured Debt and Senior Subordinated Debt". The Company completed a term securitization on June 28, 2001 and is required to complete subsequent term securitizations every six months thereafter in accordance with the Financing Agreement. The Company's credit facility must be renewed on an annual basis. If the Company is unable to complete the scheduled securitizations or renew the credit facility on acceptable terms, there could be material adverse effects on the Company's financial position, results of operations and liquidity. In addition, at September 30, 2001 the Company had $48.1 million of unrestricted cash and cash equivalents, which can be used to fund future purchases of finance receivables and other corporate activities. 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 September 30, 2001, under the most restrictive provision of these funding arrangements, $15.3 million was available for payment. However, the Company does not anticipate payment of any dividends for the foreseeable future. CONTINGENCIES AND LEGAL MATTERS 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 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. 35 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 the Company's subsidiaries conduct 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 or 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. INTEREST RATE RISK The Company's earnings are affected by changes in interest rates as a result of the incurrence of debt to fund its operating activities. Finance receivable contracts are acquired at fixed interest rates and the Company's securitized notes payable are payable according to fixed interest rates while amounts borrowed under the warehouse credit facility bear interest at a variable rate that is subject to frequent adjustment to reflect prevailing market interest rates. Because the finance receivable contracts acquired by the Company have fixed interest rates, the Company bears the risk of smaller interest rate spreads in the event interest rates increase. The Company utilizes interest rate caps as part of its interest-rate risk-management strategy for its warehouse credit facility. Interest caps are contracts with notional principal amounts that entitle the purchaser, in exchange for a fee, to receive payments from the seller if a specified market rate rises above a fixed ceiling or index rate on specified future dates. The interest rate cap purchaser bears no obligation or liability if interest rates fall or remain below the fixed ceiling or index rate. The Company's special purpose finance subsidiary is contractually required to purchase interest rate cap agreements as a credit enhancement in connection with the warehouse credit facility. 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 increases in interest rates will not have an adverse effect on the Company's profitability. 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. At September 30, 2001, the Company held an interest rate cap that is subject to the provisions of SFAS 133 and is accounted for as a hedge under SFAS 138. This derivative instrument will expire in January 2003. The difference between the carrying amount and the fair value of the interest rate cap is not significant at September 30, 2001. The Company may, 36 from time to time, purchase derivative instruments to hedge certain financial risks. Any such instruments will be accounted for and disclosed in accordance with SFAS 133 and SFAS 138. Management does not expect this statement to have a material impact on the 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 Company does not believe that the adoption of this statement will 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. Management does not expect this statement to have a material impact 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. 142, "Goodwill and Other Intangible Assets" ("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. The Company will continue to amortize the balance of the excess of revalued net assets over liabilities and stockholders' investment through December 31, 2001 in accordance with its existing amortization policy. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Because the Company's funding strategy is dependent upon the incurrence of debt to fund its operating activities, fluctuations in interest rates impact the Company's profitability. Therefore, the Company employs various hedging strategies to minimize the risk of interest rate fluctuations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk" for additional information regarding such market risks. 37 PART II - OTHER INFORMATION Item 1. Legal Proceedings - See "Part I, Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Contingencies and Legal Matters" which is incorporated herein by reference. Item 2. Changes in Securities - None Item 3. Defaults Upon Senior Securities - None. Item 4. Submission of Matters to a Vote of Security Holders - None Item 5. Other Information - Not Applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - See Exhibit Index following the signature page (b) Reports on Form 8-K (i) Item 5 Current Report on Form 8-K filed July 6, 2001. 38 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 thereunto duly authorized. MFN FINANCIAL CORPORATION (Registrant) Date: November 6, 2001 /s/ Edward G. Harshfield ------------------------ Edward G. Harshfield Executive Chairman Date: November 6, 2001 /s/ Jeffrey B. Weeden ------------------------ Jeffrey B. Weeden President and Chief Executive Officer Date: November 6, 2001 /s/ Mark D. Whitham ------------------------ Mark D. Whitham Chief Financial Officer (Chief Accounting Officer) 39 INDEX OF EXHIBITS Exhibit No. Description 11 Computation of Earnings Per Share 40

2001 2000 ---- ---- Nonaccruals, net of unearned income Non-bankrupt receivables $4,359 $4,192 Bankrupt accounts 2,204 2,068 ------ ------ Total nonaccruals, net of unearned income 6,563 6,260 Repossessed assets, net of reserves 1,772 1,696 ------ ------ Total nonaccrual accounts, net of unearned income and repossessed assets, net of reserves $8,335 $7,956 ====== ====== Bankrupt accounts, net of unearned income not in nonaccrual status $4,732 $6,534 ====== ====== Nonaccrual accounts and repossessed assets as a percent of total finance receivables, net of unearned income 1.75% 1.58% ====== ======

For Withheld Authority --- ------------------ Thomas L. Gooding 8,902,178 8,980 Andrew C. Halvorsen 8,902,284 8,874 Edward G. Harshfield 7,812,097 1,099,061 Martin L. Solomon 8,902,212 8,946 Robert J. Stucker 8,902,242 8,916 Jeffrey B. Weeden 7,960,774 950,384 George R. Zoffinger 8,902,227 8,931

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