Mercury Insurance 2008 Annual Report Download - page 80

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70
(5) Notes Payable
Notes Payable consists of the following:
2008 2007
Unsecured senior notes 158,625$ 134,062$
Secured promissory note - 4,500
Total 158,625$ 138,562$
(Amounts in thousands)
In February 2008, the Company acquired an 88,300 square foot office building in Folsom, California for approximately
$18.4 million. The Company financed the transaction through an $18 million bank loan. On January 2, 2009, the loan was
secured by municipal bonds pledged as collateral. The loan matures on March 1, 2013 with interest payable quarterly at an annual
floating rate of LIBOR plus 50 basis points. On March 3, 2008, the Company entered into an interest rate swap of its floating
LIBOR rate on the loan for a fixed rate of 3.75%, resulting in a total fixed rate of 4.25%, which expires on March 1, 2013. The
purpose of the swap is to offset the variability of cash flows resulting from the variable interest rate. The swap is designated as a
cash flow hedge. The fair value of the interest rate swap was negative $1,348,000, pre-tax, at December 31, 2008 and has been
recorded as a component of accumulated other comprehensive income and amortized into earnings over the life of the hedged
transaction. The interest rate swap was determined to be highly effective and no amount of ineffectiveness was recorded in
earnings during 2008.
The Company’s acquisition of AIS was effective January 1, 2009 for $120 million. The acquisition was financed by a
$120 million credit facility that is secured by municipal bonds pledged as collateral. The credit facility calls for the minimum
amount of collateral pledged multiplied by the bank's “advance rates” to be greater than the loan amount. The collateral
requirement is calculated as the fair market value of the municipal bonds pledged multiplied by the advance rates, which vary
based on the credit quality and duration of the assets pledged and range between 75% and 100% of the fair value of each
bond. The loan matures on January 1, 2012 with interest payable at a floating rate of LIBOR rate plus 125 basis points. On
February 6, 2009, the Company entered into an interest rate swap of its floating LIBOR rate on the loan for a fixed rate of 1.93%,
resulting in a total fixed rate of 3.18%. The purpose of the swap is to offset the variability of cash flows resulting from the
variable interest rate. The swap is not designated as a hedge. Changes in the fair value are adjusted through the consolidated
statement of operations in the period of change.
On August 7, 2001, the Company issued $125 million of senior notes payable. The notes are unsecured, senior
obligations of the Company with a 7.25% annual coupon rate payable on February 15 and August 15 each year. The notes mature
on August 15, 2011. The Company incurred debt issuance costs of approximately $1.3 million, inclusive of underwriter’s
fees. These costs are deferred and then amortized as a component of interest expense over the term of the notes. The notes were
issued at a slight discount of 99.723%, resulting in the effective annualized interest rate including debt issuance costs of
approximately 7.44%.
Effective January 2, 2002, the Company entered into an interest rate swap of its fixed rate obligation on the senior notes
for a floating rate of LIBOR plus 107 basis points. The swap agreement terminates on August 15, 2011 and includes an early
termination option exercisable by either party on the fifth anniversary or each subsequent anniversary by providing sufficient
notice, as defined. The swap reduced interest expense in 2006, 2007 and 2008, but does expose the Company to higher interest
expense in future periods if LIBOR rates increase. The effective annualized interest rate was 3.3%, 6.4% and 6.6% in 2008, 2007
and 2006, respectively. The swap is designated as a fair value hedge and qualifies for the “shortcut method” under SFAS No. 133,
because the hedge is deemed to have no ineffectiveness. The fair value of the interest rate swap was $14,393,000 and $9,218,000
at December 31, 2008 and 2007, respectively, and has been recorded in other assets in the consolidated balance sheets with a
corresponding increase in notes payable. The interest rate swap was determined to be highly effective and no amount of
ineffectiveness was recorded in earnings during 2008, 2007 and 2006.