S&L; Champion Shane Finds Trouble in His Own Back Yard : Thrifts: The prospect of losing insolvent Mercury Savings & Loan is tough to take for its chairman, but he continues to be upbeat.

HUNTINGTON BEACH —  Leonard Shane quit college in 1942 after taking all the courses that were offered in his favorite subject--semantics.

His studies in linguistics, in the shadings and meanings of speech, have stood him well in stints as a news reporter, television producer and talk-show host, public relations and advertising executive, city official and, finally, chairman of Mercury Savings & Loan here.

As a national thrift industry leader--he is a former chairman of the U.S. League of Savings Institutions--Shane is regarded as one of the most articulate and effective spokesmen for “the American dream of home ownership.”

It is an issue he has taken to heart. A liberal Democrat, the short, rotund Shane can talk for hours in his deep, mellifluent voice about the necessity for a specialized industry to help working folks buy homes of their own.

“The ability to translate savings, which must increase, into life style, which must improve, is vital to the future generations of Americans,” he once intoned to a group of Boston investment leaders.

But Shane hasn’t always practiced what he preaches, some analysts and shareholders say. While proselytizing about the evils of deregulation and the need to continue making safe home loans, his own thrift was making some risky business and commercial real estate loans and employing aggressive accounting techniques that later backfired.

Today, Mercury is insolvent. The thrift--with 24 branches in Southern California and $2.3 billion in assets as of Sept. 30--is operating under tight federal restrictions and facing possible seizure by federal regulators.

The prospect of losing Mercury is tough to take for a man who helped build it from the ground up, all the while espousing the American dream and pushing for tougher industry regulations.

Despite Shane’s reputation for being gregarious and straightforward, stock analysts and shareholders have found him somewhat silent and evasive about Mercury’s problems.

“I enjoy talking with him, but he doesn’t stick to the topic much,” said Michael Abrahams, an analyst with Bateman Eichler, Hill Richards brokerage in Los Angeles. “He weasels out of a lot of questions.”

Shareholder Michael Shack, a Newport Beach optometrist, is more direct about Shane’s reassurances of Mercury’s condition. “He misled us,” Shack said.

Mercury’s already precarious financial condition suffered a sharp blow when it revealed on Jan. 24 that its two biggest borrowers--the owners of the Irvine Marriott and the Tulsa Marriott--had stopped making payments on a total of $60.7 million in loans. Mercury, which has initiated foreclosure proceedings on the two hotels, was forced to write down the value of the loans substantially.

The $32-million writedown, which also included some accounting adjustments unrelated to the hotel loans, pushed the S&L; into insolvency. Federal regulators quickly ordered Mercury to halt all new lending and investing, an order that has been sent to three other large, insolvent Southern California thrifts as well.

With a combination of buoyant optimism and stubborn insistence, Shane puts his own spin on the bad news about his S&L;’s condition. He remains confident that he can work things out--remove, at least partly, the lid regulators have put on his operations and find a buyer for Mercury.

If he fails, the 67-year-old executive would become one of the industry’s most visible leaders to have his institution seized by the government. Regulators say privately that no other thrift has ever come back from insolvency on its own and that no S&L; can operate for long under such restrictions before the government moves in.

Shane also could be in trouble with some Mercury shareholders. They hope that Shane can work something out, but they also are talking to lawyers about possible lawsuits for what they claim is misleading information he presented about the S&L;’s condition.

Shane prides himself on fully disclosing all information about Mercury.

Shack and another shareholder, Newport Beach real estate broker Robert Koop, said that at a shareholders meeting last July, Shane repeatedly reassured them that the institution was over the worst of its problems and was in a healthy capital position.

Koop and Shack also said a former Mercury director told them that Shane had turned down an offer in 1987 to sell the S&L; for $14 a share without presenting the bid to shareholders. The former director did not return telephone calls to his office.

Mercury’s stock lately has been trading at less than $1 a share on the New York Stock Exchange.

When Shane was asked about the bid last week, he turned the questions aside vehemently, saying: “I refuse to engage in a fishing discussion.”

Mercury’s road to insolvency has not been a short one. The thrift has long been plagued by big periodic setbacks that reduced its earnings.

Like most financial institutions, it suffered losses in the early 1980s from the twin blows of high inflation and a bust in the real estate market. Under one of today’s strict new capital standards, it was insolvent at the end of 1984.

In 1986, two separate and apparently isolated sets of fraudulent transactions by employees cost the S&L; $17 million. The next year, increasing interest rates played havoc with the S&L;’s earnings.

A year ago, Shane issued annual results for 1988 showing a $6.1-million profit, but he later had to reverse himself twice when certain accounting assumptions made in the mid-1980s proved incorrect. Mercury eventually posted a $13.8-million loss for the year.

At the shareholders meeting last July, Shane described the accounting problems as “bizarre” and laid the blame on the S&L;’s outside auditors, Kenneth Leventhal & Co., for “intolerable behavior.”

During a long, persuasive talk to shareholders, Shane promised, “This very large hit (is) behind us.” At the end of his talk, the audience applauded.

But Mercury lost $3.8 million in the third quarter of 1989, bringing the cumulative loss for the first nine months to $5.4 million.

Shane continues to blame accounting errors. In fact, he asserts that bad accounting--not bad loans--was at the root of the four straight quarterly losses.

Mercury has not yet released annual or fourth-quarter results for 1989, however, so the effect that the troubled Marriott loans will have on income is still unknown.

Leventhal and other industry accountants and consultants reply that one of basic tenets of accounting is that the company produces its financial statements, while the auditor only tests the company’s numbers.

The accounting techniques at issue affect many S&Ls;, Shane said. Mercury, like other institutions, sells many of the loans it makes and retains the servicing rights--billing customers and collecting payments. Its fee is a portion of the interest rate charged on the loans, usually around half a percentage point a year. It keeps collecting the fees for as long as the loans are being paid off.

What Mercury had done--and what accounting rules allowed--was to estimate the profits it would make over the life of the $2-billion-plus portfolio of loans it was servicing. It used that estimate to assign a value to the whole servicing portfolio, which in turn boosted Mercury’s profits and net worth.

“I’ve always seen such excess loan servicing as a relatively aggressive accounting technique,” said Bert Ely, an Alexandria, Va., financial consultant and thrift industry critic. “It boosts profits and assets. If you use the technique--and many S&Ls; don’t--you ought to be conservative in making assumptions about how long the loans will remain on the books.”

Mercury learned last year that the assumptions it had been making for years about the life of the adjustable-rate mortgages it was servicing were wrong. The loans were being repaid sooner than expected, which meant that Mercury had overstated their value and had to adjust its profit and asset numbers downward.

Despite the writedown of the Marriott loans, Shane insists that the thrift’s problems are not related to bad commercial loans.

Mercury made its first major commercial loan to Marriott Corp. to build the Irvine Marriott in 1982. The following year, it provided the construction loan for the Tulsa Marriott. Marriott sold both hotels to limited partnerships, and Mercury provided permanent loans to them, with certain guarantees from Marriott.

The Irvine Marriot alone, Shane said, could fetch even more than the $60.7 million due Mercury from both hotels, in which case the writedown that pushed the S&L; into insolvency could be reversed, he said.

“The hotels will be very attractive to investors,” agreed financial consultant Edward J. Carpenter of Santa Ana. “The S&L; will get its money out of them.”

But Michael Abrahams, the Bateman Eichler analyst, said bankers would “think twice before making loans of that size.”

“When you consider the small size of Mercury’s capital base throughout the 1980s, it had no business making such large loans,” he said. “If the loans go totally bad, the capital is wiped out.”

Mercury’s involvement in such large commercial loans startled some in the industry for another reason: Shane has been the pre-eminent proponent of thrifts sticking to mortgage loans.

But Shane doesn’t find such lending inconsistent with his long-time mission at Mercury to provide home mortgages. Nor was it unique to Mercury.

And given Mercury’s asset size, Shane said, the Marriott loans are not that big. Moreover, the institution had met its capital requirements until a strict federal law was enacted in August.

Before the regulations were tightened, the maximum amount that an S&L; was allowed to lend a single customer was equal to 100% of its capital. Now the maximum loan size is 25% of capital. Neither of the Marriott loans exceeded 100% of Mercury’s capital when they were made, but the loan on the Irvine Marriott would be considered excessive today.

Among Mercury’s nagging problems is its overhead, which has been reduced with the help of a consulting firm that devised a cost-cutting plan. At the end of September, the S&L;’s overhead was 2.33% of its assets, slightly above the industry median of 2.25%, according to Sheshunoff Information Services, a branch of an Austin, Tex., consulting firm.

However, Mercury’s officer and employee compensation at the end of September was 1.31% of its assets, almost double the median of 0.67%.

In 1988, Shane earned $330,000, which is not considered high for the head of a large S&L.; He said payroll expenses were $23 million last year, including severence pay and other termination benefits. That figure is 8% lower than the $25-million payroll total for the previous year, he said.

Friends and critics alike believe that Mercury’s problems can be traced to Shane’s absence in the late 1970s and early 1980s as he worked in various trade association posts and eventually was elected president of the California League of Savings Institutions and then chairman of the U.S. League.

At a time when Mercury was coping with deregulation, Shane was logging more than 100,000 air miles a year on league business. Also during that time, Mercury bought troubled Westdale Savings & Loan in Los Angeles from secretive New York billionaire Daniel K. Ludwig for $13 million.

The 1981 acquisition hiked the S&L;’s assets to $1.1 billion and more than doubled its branch network to 29 offices. More importantly, it put over $35 million of goodwill--which represents the value of intangible assets such as the customer base--on Mercury’s books.

The goodwill, which must be written off over time and is impossible to convert to cash without selling the institution, accounted for half of Mercury’s capital base during much of the 1980s. It made the S&L;’s capital position look reasonably strong, whereas it had a very small amount of liquid reserves to stave off losses.

Shane’s friends and critics alike have speculated that, with so much going on, he wasn’t minding the store and allowed his institution to drift into the problems that now plague it.

Shane maintains that he was fully in control during his long tenure in industry affairs. And, he said, his senior management team has been exceptional in carrying out the S&L;’s business.

Whether Shane can save his S&L; could well depend on the goodness of regulators.

His once cordial relationship with federal examiners began to sour in the fall of 1987 when he ousted two agents from Mercury, telling an audience of thrift executives later that the two were “bully boys.”

Regulators have since been scrutinizing his shop more closely, especially as changes in accounting rules began to hamper profits two years ago.

Just how far the relationship has deteriorated can be seen from the recent regulatory order to halt all new lending and investing. The notice was served three days before a testimonial dinner honoring Shane for 50 years of public service.

“Why embarrass the guy after all these years?” one former industry official said. “It was very poor timing.”