UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One) | |
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended September 30, 2010 | |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 033-19694
FirstCity Financial Corporation
(Exact name of registrant as specified in its charter)
Delaware |
| 76-0243729 |
(State or other jurisdiction of |
| (I.R.S. Employer |
incorporation or organization) |
| Identification No.) |
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6400 Imperial Drive, |
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Waco, TX |
| 76712 |
(Address of principal executive offices) |
| (Zip Code) |
(254) 761-2800
(Registrant’s telephone number, including area code)
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 requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one.)
Large accelerated filer £ |
| Accelerated filer £ |
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Non-accelerated filer £ |
| Smaller reporting company x |
(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of common stock, par value $.01 per share, outstanding at November 10, 2010 was 10,198,214.
TABLE OF CONTENTS
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Management’s Discussion and Analysis of Financial Condition and Results of Operations | 42 | |
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FINANCIAL INFORMATION
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
(Dollars in thousands, except share data)
|
| September 30, |
| December 31, |
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| 2010 |
| 2009 |
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| (Unaudited) |
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ASSETS |
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Cash and cash equivalents |
| $ | 35,549 |
| $ | 80,368 |
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Restricted cash |
| 1,356 |
| 1,364 |
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Portfolio Assets: |
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Loan portfolios, net of allowance for loan losses of $47,578 and $65,825, respectively |
| 175,100 |
| 197,946 |
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Real estate held for sale |
| 29,557 |
| 17,051 |
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Real estate held for investment, net |
| 7,095 |
| 9,387 |
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Total Portfolio Assets |
| 211,752 |
| 224,384 |
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Loans receivable: |
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Loans receivable - affiliates, net of allowance for loan losses of $433 and $67, respectively |
| 18,101 |
| 26,122 |
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Loans receivable - SBA held for sale |
| 8,336 |
| 821 |
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Loans receivable - SBA held for investment, net of allowance for loan losses of $244 and $490, respectively |
| 15,008 |
| 15,445 |
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Loans receivable - other, net of allowance for loan losses of $1,083 and $-0-, respectively |
| 14,393 |
| 10,233 |
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Total loans receivable, net |
| 55,838 |
| 52,621 |
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Investment securities available for sale |
| 2,189 |
| 1,836 |
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Equity investments |
| 101,524 |
| 71,491 |
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Service fees receivable ($2,265 and $809 from affiliates, respectively) |
| 2,325 |
| 850 |
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Servicing assets - SBA loans |
| 839 |
| 1,056 |
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Other assets, net |
| 33,791 |
| 31,104 |
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Total Assets (1) |
| $ | 445,163 |
| $ | 465,074 |
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LIABILITIES AND EQUITY |
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Liabilities: |
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Notes payable to banks and other |
| $ | 285,975 |
| $ | 305,888 |
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Note payable to affiliate |
| 7,686 |
| 7,838 |
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Other liabilities |
| 29,839 |
| 26,077 |
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Total Liabilities |
| 323,500 |
| 339,803 |
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Commitments and contingencies (Note 19) |
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Stockholders’ equity: |
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Optional preferred stock (par value $.01 per share; 98,000,000 shares authorized; no shares issued or outstanding) |
| — |
| — |
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Common stock (par value $.01 per share; 100,000,000 shares authorized; shares issued: 11,698,214 and 11,483,824, respectively ; shares outstanding: 10,198,214 and 9,983,824, respectively) |
| 117 |
| 115 |
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Treasury stock, at cost: 1,500,000 shares |
| (10,923 | ) | (10,923 | ) | ||
Paid in capital |
| 105,070 |
| 103,326 |
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Accumulated deficit |
| (7,604 | ) | (18,329 | ) | ||
Accumulated other comprehensive income (loss) |
| (2,867 | ) | 3,460 |
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FirstCity Stockholders’ Equity |
| 83,793 |
| 77,649 |
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Noncontrolling interests |
| 37,870 |
| 47,622 |
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Total Equity |
| 121,663 |
| 125,271 |
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Total Liabilities and Equity |
| $ | 445,163 |
| $ | 465,074 |
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(1) Our consolidated assets at September 30, 2010 include the following assets of certain variable interest entities (“VIEs”) that can only be used to settle the liabilities of those VIEs: Cash and cash equivalents, $19.7 million; Portfolio Assets, $198.5 million; Loans receivable, $55.8 million; Equity investments, $69.4 million; Other assets, $30.9 million; and Total assets, $374.3 million.
See accompanying notes to consolidated financial statements.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share data)
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| Three Months Ended |
| Nine Months Ended |
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| September 30, |
| September 30, |
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| 2010 |
| 2009 |
| 2010 |
| 2009 |
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Revenues: |
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Finance and Servicing: |
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Servicing fees ($2,083 and $2,019 from affiliates for the three month periods, respectively, and $5,529 and $6,282 from affiliates for the nine month periods, respectively) |
| $ | 2,252 |
| $ | 2,222 |
| $ | 5,998 |
| $ | 7,017 |
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Income from Portfolio Assets |
| 8,195 |
| 12,134 |
| 34,280 |
| 35,254 |
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Gain on sale of SBA loans held for sale, net |
| 197 |
| 301 |
| 360 |
| 911 |
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Gain on sale of investment securities |
| — |
| — |
| 3,250 |
| — |
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Interest income from SBA loans |
| 314 |
| 299 |
| 895 |
| 940 |
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Interest income from loans receivable - affiliates |
| 864 |
| 1,078 |
| 2,591 |
| 2,940 |
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Interest income from loans receivable - other |
| 233 |
| 99 |
| 594 |
| 892 |
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Other income |
| 1,856 |
| 1,701 |
| 4,552 |
| 3,699 |
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| 13,911 |
| 17,834 |
| 52,520 |
| 51,653 |
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Manufacturing, Railroad and Coal Mine: |
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Operating revenues - manufacturing |
| — |
| — |
| 10,466 |
| — |
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Operating revenues - railroad |
| 998 |
| 776 |
| 3,455 |
| 2,228 |
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Operating revenues - coal mine |
| 15,329 |
| — |
| 28,429 |
| — |
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Other |
| — |
| 121 |
| 4 |
| 1,192 |
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| 16,327 |
| 897 |
| 42,354 |
| 3,420 |
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Total revenues |
| 30,238 |
| 18,731 |
| 94,874 |
| 55,073 |
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Costs and expenses: |
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Finance and Servicing: |
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Interest and fees on notes payable to banks and other |
| 4,211 |
| 3,043 |
| 10,587 |
| 9,177 |
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Interest and fees on note payable to affiliate |
| 393 |
| 428 |
| 1,185 |
| 1,305 |
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Salaries and benefits |
| 4,995 |
| 5,048 |
| 16,067 |
| 15,654 |
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Provision for loan and impairment losses |
| 4,090 |
| 425 |
| 8,417 |
| 2,208 |
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Asset-level expenses |
| 2,257 |
| 1,992 |
| 5,981 |
| 4,646 |
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Other |
| 2,158 |
| 2,868 |
| 8,660 |
| 7,819 |
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| 18,104 |
| 13,804 |
| 50,897 |
| 40,809 |
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Manufacturing, Railroad and Coal Mine: |
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Cost of revenues and operating costs - manufacturing |
| — |
| — |
| 10,788 |
| — |
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Cost of revenues and operating costs - railroad |
| 635 |
| 506 |
| 1,868 |
| 1,532 |
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Cost of revenues and operating costs - coal mine |
| 15,662 |
| — |
| 28,957 |
| — |
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| 16,297 |
| 506 |
| 41,613 |
| 1,532 |
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Total costs and expenses |
| 34,401 |
| 14,310 |
| 92,510 |
| 42,341 |
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Earnings (loss) before other revenue and income taxes |
| (4,163 | ) | 4,421 |
| 2,364 |
| 12,732 |
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Equity in earnings of unconsolidated subsidiaries |
| 9,962 |
| 421 |
| 14,007 |
| 1,473 |
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Gain on business combinations |
| — |
| — |
| 5,729 |
| 1,455 |
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Earnings before income taxes |
| 5,799 |
| 4,842 |
| 22,100 |
| 15,660 |
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Income tax expense |
| 473 |
| 1,254 |
| 1,192 |
| 2,103 |
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Net earnings |
| 5,326 |
| 3,588 |
| 20,908 |
| 13,557 |
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Less: Net income attributable to noncontrolling interests |
| 2,767 |
| 1,588 |
| 10,183 |
| 3,167 |
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Net earnings attributable to FirstCity |
| $ | 2,559 |
| $ | 2,000 |
| $ | 10,725 |
| $ | 10,390 |
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Basic earnings per share |
| $ | 0.25 |
| $ | 0.20 |
| $ | 1.07 |
| $ | 1.06 |
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Diluted earnings per share |
| $ | 0.25 |
| $ | 0.19 |
| $ | 1.06 |
| $ | 1.02 |
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See accompanying notes to consolidated financial statements.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
|
| Nine Months Ended |
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|
| September 30, |
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| 2010 |
| 2009 |
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Net earnings |
| $ | 20,908 |
| $ | 13,557 |
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Other comprehensive income (loss): |
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Net unrealized gain (loss) on securities available for sale |
| (1,358 | ) | 1,636 |
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Reclassification adjustment for unrealized gain on security available for sale included in net earnings |
| (1,352 | ) | — |
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Foreign currency translation adjustments |
| (5,623 | ) | 2,313 |
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Total other comprehensive income (loss) |
| (8,333 | ) | 3,949 |
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Total comprehensive income |
| 12,575 |
| 17,506 |
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Less comprehensive (income) loss attributable to noncontrolling interests: |
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Net income |
| (10,183 | ) | (3,167 | ) | ||
Net unrealized loss (gain) on securities available for sale |
| 241 |
| (326 | ) | ||
Foreign currency translation adjustments |
| 1,765 |
| (356 | ) | ||
Comprehensive income attributable to FirstCity |
| $ | 4,398 |
| $ | 13,657 |
|
See accompanying notes to consolidated financial statements.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)
(Dollars in thousands)
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| FirstCity Stockholders |
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| Accumulated |
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| Other |
| Non- |
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| Common |
| Treasury |
| Paid in |
| Accumulated |
| Comprehensive |
| controlling |
| Total |
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| Stock |
| Stock |
| Capital |
| Deficit |
| Income (Loss) |
| Interests |
| Equity |
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Balances, December 31, 2008 |
| $ | 113 |
| $ | (10,923 | ) | $ | 101,875 |
| $ | (37,073 | ) | $ | (3,726 | ) | $ | 15,609 |
| $ | 65,875 |
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Net earnings |
| — |
| — |
| — |
| 10,390 |
| — |
| 3,167 |
| 13,557 |
| |||||||
Change in net unrealized gain on securities available for sale |
| — |
| — |
| — |
| — |
| 1,310 |
| 326 |
| 1,636 |
| |||||||
Foreign currency translation adjustments |
| — |
| — |
| — |
| — |
| 1,957 |
| 356 |
| 2,313 |
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Exercise of common stock options |
| — |
| — |
| 113 |
| — |
| — |
| — |
| 113 |
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Stock-based compensation expense |
| — |
| — |
| 438 |
| — |
| — |
| — |
| 438 |
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Purchases of subsidiary shares in noncontrolling interests |
| — |
| — |
| 641 |
| — |
| — |
| (3,458 | ) | (2,817 | ) | |||||||
Investments in majority-owned entities |
| — |
| — |
| — |
| — |
| — |
| 46,306 |
| 46,306 |
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Distributions to noncontrolling interests |
| — |
| — |
| — |
| — |
| — |
| (9,961 | ) | (9,961 | ) | |||||||
Balances, September 30, 2009 |
| $ | 113 |
| $ | (10,923 | ) | $ | 103,067 |
| $ | (26,683 | ) | $ | (459 | ) | $ | 52,345 |
| $ | 117,460 |
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Balances, December 31, 2009 |
| $ | 115 |
| $ | (10,923 | ) | $ | 103,326 |
| $ | (18,329 | ) | $ | 3,460 |
| $ | 47,622 |
| $ | 125,271 |
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Net earnings |
| — |
| — |
| — |
| 10,725 |
| — |
| 10,183 |
| 20,908 |
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Change in net unrealized gain on securities available for sale |
| — |
| — |
| — |
| — |
| (2,469 | ) | (241 | ) | (2,710 | ) | |||||||
Foreign currency translation adjustments |
| — |
| — |
| — |
| — |
| (3,858 | ) | (1,765 | ) | (5,623 | ) | |||||||
Exercise of common stock options |
| — |
| — |
| 70 |
| — |
| — |
| — |
| 70 |
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Issuance of common stock |
| 2 |
| — |
| 888 |
| — |
| — |
| — |
| 890 |
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Stock-based compensation expense |
| — |
| — |
| 496 |
| — |
| — |
| — |
| 496 |
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Purchases of subsidiary shares in noncontrolling interests |
| — |
| — |
| — |
| — |
| — |
| (324 | ) | (324 | ) | |||||||
Other activity |
| — |
| — |
| 290 |
| — |
| — |
| (328 | ) | (38 | ) | |||||||
Investments in majority-owned entities |
| — |
| — |
| — |
| — |
| — |
| 5,495 |
| 5,495 |
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Distributions to noncontrolling interests |
| — |
| — |
| — |
| — |
| — |
| (22,772 | ) | (22,772 | ) | |||||||
Balances, September 30, 2010 |
| $ | 117 |
| $ | (10,923 | ) | $ | 105,070 |
| $ | (7,604 | ) | $ | (2,867 | ) | $ | 37,870 |
| $ | 121,663 |
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See accompanying notes to consolidated financial statements.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
|
| Nine Months Ended |
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| September 30, |
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| 2010 |
| 2009 |
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Cash flows from operating activities: |
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Net earnings |
| $ | 20,908 |
| $ | 13,557 |
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Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: |
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Net principal advances on SBA loans held for sale |
| (11,857 | ) | (13,491 | ) | ||
Proceeds from sales of SBA loans held for sale, net |
| 4,964 |
| 18,155 |
| ||
Proceeds applied to income from Portfolio Assets |
| 2,170 |
| 15,324 |
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Income from Portfolio Assets |
| (34,280 | ) | (35,254 | ) | ||
Capitalized interest and costs on Portfolio Assets and loans receivable |
| (564 | ) | (955 | ) | ||
Provision for loan and impairment losses |
| 8,417 |
| 2,208 |
| ||
Foreign currency transaction losses (gains), net |
| 433 |
| (441 | ) | ||
Equity in earnings of unconsolidated subsidiaries |
| (14,007 | ) | (1,473 | ) | ||
Gain on sale of SBA loans held for sale, net |
| (360 | ) | (911 | ) | ||
Gain on sale of railroad property |
| — |
| (920 | ) | ||
Gain on business combinations |
| (5,729 | ) | (1,455 | ) | ||
Gain on sale of investment security |
| (3,250 | ) | — |
| ||
Depreciation and amortization |
| 10,298 |
| 3,007 |
| ||
Net premium amortization of loans receivable |
| (225 | ) | (96 | ) | ||
Stock-based compensation expense |
| 496 |
| 438 |
| ||
Decrease in restricted cash |
| (294 | ) | 178 |
| ||
Increase in service fees receivable |
| (1,475 | ) | (254 | ) | ||
Increase in other assets |
| (1,818 | ) | (1,756 | ) | ||
Deferred income tax benefit |
| (530 | ) | — |
| ||
Increase in other liabilities |
| 3,619 |
| 5,594 |
| ||
Net cash provided by (used in) operating activities |
| (23,084 | ) | 1,455 |
| ||
Cash flows from investing activities: |
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Purchases of property and equipment, net |
| (1,719 | ) | (2,071 | ) | ||
Proceeds from sale of railroad property |
| — |
| 1,350 |
| ||
Proceeds from sale of subsidiaries and equity investments |
| 125 |
| — |
| ||
Cash paid for business combinations, net of cash acquired |
| (1,570 | ) | (7,149 | ) | ||
Decrease in cash from deconsolidation of subsidiary |
| (875 | ) | — |
| ||
Net principal payments (advances) on loans receivable |
| 1,434 |
| (1,946 | ) | ||
Net principal payments (advances) on SBA loans held for investment |
| 227 |
| (1,830 | ) | ||
Purchase of investment securities available for sale |
| (2,636 | ) | — |
| ||
Net principal payments on investment securities available for sale |
| 797 |
| 3,469 |
| ||
Proceeds from sale of investment security |
| 3,250 |
| — |
| ||
Purchases of Portfolio Assets |
| (33,861 | ) | (171,921 | ) | ||
Proceeds applied to principal on Portfolio Assets |
| 91,570 |
| 109,120 |
| ||
Contributions to unconsolidated subsidiaries |
| (32,755 | ) | (3,890 | ) | ||
Distributions from unconsolidated subsidiaries |
| 8,226 |
| 9,297 |
| ||
Net cash provided by (used in) investing activities |
| 32,213 |
| (65,571 | ) | ||
Cash flows from financing activities: |
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Borrowings under notes payable to banks and other |
| 46,766 |
| 160,872 |
| ||
Principal payments of notes payable to affiliates |
| (154 | ) | (600 | ) | ||
Principal payments of notes payable to banks and other |
| (83,858 | ) | (110,082 | ) | ||
Payments of debt issuance costs and loan fees |
| (3,068 | ) | (854 | ) | ||
Proceeds from secured borrowings, net |
| 3,591 |
| — |
| ||
Contributions from noncontrolling interests |
| 4,947 |
| 40,991 |
| ||
Distributions to noncontrolling interests |
| (22,772 | ) | (9,961 | ) | ||
Cash paid for subsidiary shares in noncontrolling interests |
| (324 | ) | (2,796 | ) | ||
Proceeds from issuance of common stock |
| 960 |
| 113 |
| ||
Net cash provided by (used in) financing activities |
| (53,912 | ) | 77,683 |
| ||
Effect of exchange rate changes on cash and cash equivalents |
| (36 | ) | 322 |
| ||
Net increase (decrease) in cash and cash equivalents |
| (44,819 | ) | 13,889 |
| ||
Cash and cash equivalents, beginning of period |
| 80,368 |
| 19,103 |
| ||
Cash and cash equivalents, end of period |
| $ | 35,549 |
| $ | 32,992 |
|
Supplemental disclosure of cash flow information: |
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Cash paid during the period for: |
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Interest |
| $ | 8,368 |
| $ | 7,279 |
|
Income taxes, net of refunds |
| 276 |
| 222 |
|
See accompanying notes to consolidated financial statements.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(1) Basis of Presentation and Summary of Significant Accounting Policies
Nature of Operations
FirstCity Financial Corporation, a Delaware corporation, is a financial services company headquartered in Waco, Texas with offices throughout the United States and Mexico and a presence in Europe and South America. When we refer to “FirstCity,” “the Company,” “we,” “our” or “us” in this Quarterly Report on Form 10-Q, we mean FirstCity Financial Corporation and subsidiaries (consolidated).
The Company engages in two major business segments — Portfolio Asset Acquisition and Resolution and Special Situations Platform. The Portfolio Asset Acquisition and Resolution business has been the Company’s core business segment since it commenced operations in 1986. In the Portfolio Asset Acquisition and Resolution business, the Company acquires portfolios of performing and non-performing loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), generally at a discount to their legal principal balances or appraised values, and services and resolves such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. FirstCity acquires the Portfolio Assets for its own account or through investment entities formed with one or more other co-investors (each such entity, an “Acquisition Partnership”). The Company engages in its Special Situations Platform business through its majority ownership in an investment company that was formed in April 2007. Through its Special Situations Platform, the Company provides investment capital to privately-held middle-market companies through flexible capital structuring arrangements to generate an attractive risk-adjusted return. These capital investments primarily take the form of senior and junior financing arrangements, but also include direct equity investments, common equity warrants, distressed debt transactions, and leveraged buyouts. Refer to Note 18 for additional information on the Company’s major business segments.
Basis of Presentation
The accompanying unaudited consolidated financial statements in this Form 10-Q were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the consolidated financial statements do not include all of the information and footnote disclosures required by GAAP for complete consolidated financial statements. In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and results of operations. The interim results of operations disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period. Certain amounts in the consolidated financial statements and disclosures for prior periods were reclassified to conform to the current period presentation. These interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended December 31, 2009, as amended (“2009 Form 10-K”).
The consolidated financial statements in this Form 10-Q include the accounts of FirstCity, its wholly-owned and majority-owned subsidiaries, and certain variable interest entities (“VIEs”). All significant intercompany transactions and balances have been eliminated in consolidation. We consolidate all VIEs where we are the primary beneficiary as prescribed by the Financial Accounting Standards Board’s (the “FASB”) accounting guidance on the consolidation of VIEs. The primary beneficiary of a VIE is the party that has the power to direct the activities that most-significantly impact the economic performance of the entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. Refer to Note 16 for more information.
The Company does not consolidate equity investments in 20%- to 50%-owned entities that are not VIEs where the Company does not have an effective controlling interest, or equity investments in 20%- to 50%-owned entities that are VIEs where the Company is not the primary beneficiary. Rather, such investments are accounted for under the equity-method of accounting since the Company has the ability to exercise significant influence over the investees’ operating and financial policies. The Company also accounts for its unconsolidated equity investments in less than 20%-owned entities under the equity-method of accounting. FirstCity has the ability to exercise significant influence over the operating and financial policies of these entities, despite its comparatively smaller ownership percentage, due primarily to its active participation in the policy-making process as well as its involvement in the daily management activities.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Out-of-Period Adjustments
In the first quarter of 2010, upon the determination that deferred tax items related to our foreign jurisdictions had been misstated by $1.5 million as of December 31, 2009, the Company recorded a $1.0 million adjustment to deferred tax benefit and a $0.5 million adjustment to equity in earnings of unconsolidated subsidiaries in order to properly state the net deferred tax asset. The adjustment was not material to our consolidated financial statements for the quarterly or year-to-date periods ended March 31, 2010 or September 30, 2010 or the year ended December 31, 2009.
In addition, in the first quarter of 2010, the Company recorded certain loan impairments that included $1.2 million in impairments that should have been recorded during the year ended December 31, 2009. The out-of-period adjustments were not material to our consolidated financial statements for the quarterly or year-to-date periods ended March 31, 2010 or September 30, 2010 or the year ended December 31, 2009.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates that are particularly susceptible to significant change in the near-term relate to the estimation of future collections on Portfolio Assets used in the calculation of income from Portfolio Assets; valuation of deferred tax assets and assumptions used in the calculation of income taxes; valuation of servicing assets, investment securities, loans receivable (including loans receivable held in securitization trusts), and real estate; valuation of assets, liabilities, non-controlling interests and contingencies attributable to business combinations; guarantee obligations and indemnifications; and legal contingencies. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. The continuance of challenging economic conditions and disruptions in the financial, capital, real estate and foreign currency markets, have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
Portfolio Assets
The Company invests in Portfolio Assets and services and resolves such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. The Portfolio Assets are generally non-homogeneous assets, including loans of varying qualities that are secured by diverse collateral types and real estate. Some Portfolio Assets are loans for which resolution is tied primarily to the real estate securing the loan, while others may be collateralized business loans, the resolution of which may be based on the cash flows of the business or the underlying collateral.
The following is a description of the classifications and related accounting policies for the Company’s significant classes of Portfolio Assets:
Purchased Credit-Impaired Loans
The Company accounts for acquired loans and loan portfolios with evidence of credit deterioration since origination (“Purchased Credit-Impaired Loans”) at fair value on the acquisition date. The amounts paid for Purchased Credit-Impaired Loans reflect the Company’s determination that the loans have experienced deterioration in credit quality since origination and that it is probable the Company will be unable to collect all amounts due according to the contractual terms of the underlying loans. At acquisition, the Company reviews each individual loan to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that the Company will be unable to collect all amounts due according to the loan’s contractual terms. If both conditions exist, the Company determines whether each such loan is to be accounted for individually or whether such loans will be assembled into static pools based on common risk characteristics (primarily loan type and collateral). Static pools of individual loan accounts may be established and accounted for as a single economic unit for the recognition of income, principal payments and loss provision. Once a static loan pool is established, individual accounts are generally not added to or removed from the pool (unless the Company
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
sells, forecloses or writes-off the loan). At acquisition, the Company determines the excess of the scheduled contractual payments over all cash flows expected to be collected for the loan or loan pool as an amount that should not be accreted (“nonaccretable difference”). The excess of the cash flows from the loan or loan pool expected to be collected at acquisition over the initial investment (“accretable difference”) is recognized as interest income over the remaining life of the loan or loan pool on a level-yield basis (“accretable yield”). The discount (i.e. the difference between the cost of each loan or loan pool and the related aggregate contractual receivable balance) is not recorded because the Company does not expect to fully collect each contractual receivable balance. As a result, these loans and loan pools are recorded at cost (which approximates fair value) at the time of acquisition.
The Company accounts for Purchased Credit-Impaired Loans using either the interest method or a non-accrual method (through application of the cost-recovery or cash basis method of accounting). Application of the interest method is dependent on management’s ability to develop a reasonable expectation as to both the timing and amount of cash flows expected to be collected. In the event the Company cannot develop or establish a reasonable expectation as to both the timing and amount of cash flows expected to be collected, the Company uses the cost-recovery or cash basis method of accounting.
Interest method of accounting. Under the interest method, an effective interest rate, or internal rate of return (“IRR”), is applied to the cost basis of the loan or loan pool. The excess of the contractual cash flows over expected cash flows cannot be recognized as an adjustment of income or expense or on the balance sheet. The IRR that is calculated when the loan is purchased remains constant as the basis for subsequent impairment testing (performed at least quarterly) and income recognition. Subsequent decreases in projected cash flows do not change the IRR, but are recognized as an impairment of the cost basis of the loan or loan pool (to maintain the then-current IRR), and are reflected in the consolidated statements of operations through provisions charged to operations, with a corresponding allowance offsetting the loan or loan pool in the consolidated balance sheets. FirstCity establishes allowances for loans and loan pools acquired with credit deterioration to reflect only those losses incurred after acquisition — that is, the cash flows expected at acquisition that are no longer expected to be collected. Significant increases in actual or expected future cash flows are used first to reverse any existing allowance for that loan or loan pool, and any remaining increase may be recognized prospectively through an upward adjustment of the IRR over the remaining life of the loan or loan pool. Any increase to the IRR then becomes the new benchmark for impairment testing and income recognition. Income from loans and loan pools accounted for under the interest method is accrued based on the IRR of each loan or loan pool applied to the respective adjusted cost basis. Gross collections in excess of the interest accrual and impairments will reduce the carrying value of the loan or loan pool, while gross collections less than the interest accrual will increase the carrying value. The IRR is calculated based on the timing and amount of anticipated cash flows using the Company’s proprietary collection models.
Cost-recovery method of accounting. If the amount and timing of future cash collections on a loan are not reasonably estimable, the Company accounts for such asset on the cost-recovery method. Under the cost-recovery method, no income is recognized until the Company has fully collected the cost of the loan, or until such time as the Company considers the timing and amount of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. At least quarterly, the Company performs an evaluation to determine if the remaining amount that is probable of collection is less than the carrying value of the loan or loan pool, and if so, recognizes impairment through provisions charged to operations. The carrying value of Purchased Credit-Impaired Loans accounted for under the cost-recovery method approximated $59.1 million (including $8.2 million of loans pending management’s post-purchase evaluation) at September 30, 2010, and $96.3 million (including $12.7 million of loans pending management’s post-purchase evaluation) at December 31, 2009.
Cash basis method of accounting. If only the amount of future cash collections on a loan is reasonably estimable, the Company accounts for such asset on an individual loan basis under the cash basis method of accounting. Under the cash basis method, no income is recognized unless collections are received during the period, or until such time as the Company considers the timing of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. Income is recognized for the difference between the collections and a pro-rata portion of cost on a loan. Cost allocation is based on a proration of actual collections divided by total projected collections on the loan. Significant increases in future cash flows may be recognized prospectively as income over the remaining life of the loan through increased amounts allocated to income when collections are subsequently received. Subsequent decreases in projected cash flows are recognized as impairment of the loan’s cost basis to maintain a constant cost allocation based on initial projections. Management implemented the cash basis method of accounting for such eligible loans in 2009 as a result of increased uncertainty in the timing of future collections (attributable primarily to the borrowers’ inability to obtain financing to refinance the loans). The carrying value of Purchased Credit-Impaired Loans accounted for under the cash basis method approximated $106.8 million and $42.1 million at September 30, 2010 and December 31, 2009, respectively.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
UBN Loan Portfolio
In September 2008, the Company, through a wholly-owned subsidiary, acquired an additional ownership interest in UBN, SA (“UBN”) in a transaction that was accounted for as a step acquisition under FASB’s business combination accounting guidance. As a result of the transaction, UBN became a consolidated subsidiary of the Company. As such, FirstCity added UBN’s loan portfolio to its consolidated balance sheet in September 2008. On the date of the acquisition, the amount of loans and allowance for loan losses related to UBN’s loan portfolio approximated $69.1 million (including $67.3 million of non-performing loans) and $66.6 million, respectively.
The allowance for loan losses on the UBN loan portfolio represents management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. Management establishes an allowance for loan losses through a provision charged to operations when a loan is determined to be impaired. A loan is considered to be impaired when, based on current information and events, it is probable the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. Loans are charged-off against the allowance when all possible means of collection have been exhausted and the remaining balance due is deemed uncollectible. At least quarterly, management evaluates the need for an allowance on an individual-loan basis for the UBN loan portfolio by considering information about specific borrower situations, legal collection proceedings, estimated collateral values, general economic conditions, and other factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revisions as more information becomes available.
Real Estate
Portfolio Assets consisting of real estate include properties that were purchased from a variety of sellers or acquired through loan foreclosure. Rental income, net of expenses, is generally recognized when received. The Company accounts for its real estate properties on an individual-asset basis as opposed to a pool basis. The following is a description of the classifications and related accounting policies for the Company’s various classes of real estate Portfolio Assets:
Classification and Impairment Evaluation
Real estate held for sale primarily includes real estate acquired through loan foreclosure. The Company classifies a property as held for sale if (1) management commits to a plan to sell the property; (2) the Company actively markets the property in its current condition for a price that is reasonable in comparison to its fair value; and (3) management considers the sale of such property within one year of the balance sheet date to be probable. Real estate held for sale is stated at the lower of cost or fair value less estimated disposition costs. Real estate is not depreciated while it is classified as held for sale. Impairment losses are recorded if a property’s fair value less estimated disposition costs is less than its carrying amount, and charged to operations in the period the impairment is identified.
Real estate held for investment generally includes acquired properties and is carried at cost less depreciation and amortization, as applicable. The Company classifies a property as held for investment if the property is still under development and/or management does not expect the property to be sold within one year of the balance sheet date. The Company periodically reviews its property held for investment for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability of property held for investment is measured by comparison of the carrying amount of the asset to future net undiscounted cash flows expected to be generated by the property. If the property is considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property exceeds its fair value. Fair value is determined by discounted cash flows or market comparisons.
Cost Capitalization and Allocation
Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of cost (i.e. the underlying loan’s carrying value) or estimated fair value less disposition costs at the date of foreclosure — establishing a new cost basis. The amount, if any, by which the carrying value of the underlying loan exceeds the property’s fair value less estimated disposition costs at the foreclosure date is charged as a loss against operations. Expenditures for repairs, maintenance, and other holding costs are charged to operations as incurred.
Real estate properties acquired through a purchase transaction are initially recorded at the cost of the acquisition. The cost of acquired property includes the purchase price of the property, legal fees, and certain other acquisition costs. Subsequent to acquisition,
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
the Company capitalizes capital improvements and expenditures related to significant betterments and replacements, including costs related to the development and improvement of the property for its intended use. Expenditures for repairs, maintenance, and other holding costs are charged to operations as incurred.
Disposition of Real Estate
Gains on disposition of real estate are recognized upon the sale of the underlying property if the transaction qualifies for gain recognition under the full accrual method, as prescribed by the FASB’s accounting guidance on real estate sales transactions. If the transaction does not meet the criteria for the full accrual method of profit recognition based on our assessment, we account for the sale based on an appropriate deferral method determined by the nature and extent of the buyer’s investment and our continuing involvement.
Loans Receivable
The portions of U.S. Small Business Administration (“SBA”) loans that are guaranteed by the SBA are classified by management as loans held for sale. These loans are recorded at the lower of aggregate cost or estimated fair value. The fair value of SBA loans held for sale is based primarily on what secondary markets are currently offering for loans with similar characteristics, or the contractual price for loan sales already consummated but which cannot be recognized as accounting sales until the expiration of a recourse period. Net unrealized losses, if any, are recognized through a valuation allowance through a charge to income. The carrying value of SBA loans held for sale is net of premiums as well as deferred origination fees and costs. Premiums and net origination fees and costs are deferred and included in the basis of the loans in calculating gains and losses upon sale. SBA loans are generally secured by the borrowing entities’ assets such as accounts receivable, property and equipment, and other business assets. The Company generally sells the guaranteed portion of each loan to a third-party investor and retains the servicing rights. The non-guaranteed portion of SBA loans is classified as held for investment. As described in Note 2, effective January 1, 2010, the Company adopted new accounting guidance that requires SBA loan transactions subject to the SBA’s premium recourse provision to be accounted for initially as secured borrowings rather than asset sales. After the premium recourse provisions have elapsed, the transaction will be recorded as a sale and the resulting net gain on sale will be recognized — which is based on the difference between the proceeds received and the allocated carrying value of the loan sold.
Loans receivable consisting of loans made to affiliated entities (including Acquisition Partnerships and other equity-method investees) and non-affiliated entities, and the non-guaranteed portions of SBA loans, are classified by management as held for investment. These loans are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan origination fees and costs, as well as purchase premiums and discounts, are amortized as level-yield adjustments over the respective loan terms. Unamortized net fees, costs, premiums or discounts are recognized upon early repayment or sale of the loan. Repayment of the loans is generally dependent upon future cash flows of the borrowers, future cash flows of the underlying collateral, and distributions made from affiliated entities. Interest is accrued when earned in accordance with the contractual terms of the loans. Interest is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding.
The Company evaluates the need for impairment on loans receivable held for investment on an individual-loan basis at least quarterly by reviewing the collectibility of the loans in light of various factors, as applicable, such as estimated future cash receipts of the borrower or underlying collateral, historical experience, estimated value of underlying collateral, prevailing economic conditions, and industry concentrations. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. We consider a loan to be impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan’s contractual terms (including scheduled interest payments). When management identifies a loan as impaired, we measure the impairment based on discounted future cash flows, except when the source of repayment is the operation or liquidation of the collateral. In these cases, we use the current fair value of the collateral, less estimated selling costs, instead of discounted cash flows. When a loan is determined to be impaired, we cease to accrue interest on the note and interest previously accrued but not collected becomes part of our recorded investment in the loan and is collectively reviewed for impairment. When ultimate collectibility of the impaired note is in doubt, all collections are applied to reduce the principal amount of such notes until the principal has been recovered, and collections thereafter are recognized as interest income. We return a loan to accrual status when we determine that the collectibility of principal and interest is reasonably assured. Impairment losses are charged against an allowance account through provisions charged to operations in the period impairment is identified. Loans are written-off against the allowance when all possible means of collection have been exhausted and the potential for recovery is considered remote.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Revenue Recognition — Special Situations Platform Subsidiaries
The Company’s consolidated railroad subsidiary, which interchanges rail cars with connecting carriers and provides rail freight services for on-line customers, recognizes freight revenue at the time the shipment is either delivered to or received from the connecting carrier at the point of interchange. Industrial switching and other service revenues are recognized as such services are provided.
The Company’s consolidated coal mine subsidiary, which engages primarily in the purchase and sale of coal and coal-related products, generates revenue under a short-term coal sales contract with a major utility company (the contract is scheduled to expire on or around December 2010). Revenue is recognized when coal is delivered to the customer at an agreed-upon destination as specified in the related contract (at which point title and risk of loss passes to the customer). The Company consolidated the coal mine subsidiary effective April 1, 2010 after it obtained control of the entity at such time (refer to Note 3 for additional information).
The Company’s manufacturing subsidiary, which engages principally in the design, production and sale of wireless transmission equipment and software solutions, recognizes revenue derived from the sale of equipment upon shipment of the product. Revenue associated with software solutions is recognized ratably over the period of the underlying agreements. Effective June 30, 2010, the Company began accounting for its investment in this manufacturing subsidiary as an equity-method investment (instead of a controlled, consolidated subsidiary) — refer to Note 3 for additional information.
(2) New Accounting Guidance
Recently Adopted Accounting Guidance
Consolidation of Variable Interest Entities (“VIEs”)
Effective January 1, 2010, the Company adopted the FASB’s accounting guidance on the consolidation of VIEs (issued in June 2009). This new guidance eliminates the exemption for QSPEs; revises previous guidance by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a VIE with a qualitative approach focused on identifying which enterprise has both the power to direct the activities of the VIE that most-significantly impacts the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits that could be significant to the entity; requires reconsideration of whether an entity is a VIE when any changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE and additional disclosures about an enterprise’s involvement in VIEs. The adoption of this guidance did not have a material impact on our consolidated financial statements. Refer to Note 16 for additional information about the Company’s involvement with VIEs.
Transfers of Financial Assets
Effective January 1, 2010, the Company adopted the FASB’s guidance on accounting for transfers of financial assets (issued in June 2009). This guidance amends previous guidance which, among other changes, eliminates the concept of a QSPE, changes the requirements for de-recognizing financial assets, defines the term “participating interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale, and requires additional disclosures. The recognition and measurement provisions are effective for transfers occurring on or after January 1, 2010. The new accounting guidance delays the Company’s recognition of the sale of guaranteed portions of SBA loans until expiration of the premium recourse provisions, and requires such transactions to be accounted for initially as a secured borrowing. As such, the Company did not recognize any gains related to SBA loan sales for the first three months of 2010. Once the premium recourse provisions have elapsed, the transaction will be recorded as a sale with the guaranteed portion of the SBA loan and the secured borrowing removed from the balance sheet and the resulting gain on sale recorded. Refer to Notes 1 and 5 for additional information.
Fair Value Measurements Disclosure
In January 2010, the FASB issued new accounting guidance that amended existing guidance for fair value disclosures. This guidance requires separate disclosures of significant transfers of items in and out of Levels 1 and 2 in the fair value hierarchy, and to
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
describe the reasons for the transfers. The updated guidance also clarifies, among other things, that fair value measurement disclosures should be provided for each class of assets and liabilities, and that disclosures of inputs and valuation techniques should be provided for both recurring and non-recurring Level 2 and Level 3 fair value measurements. We adopted this new guidance for the quarterly period ended March 31, 2010. Since this guidance is disclosure-only in nature, our adoption of the guidance did not significantly impact the Company’s consolidated financial statements. Refer to Note 15 for additional information.
Subsequent Events Disclosure
In March 2010, the FASB issued guidance that amends existing guidance (issued in May 2009) that established the general standards of accounting and disclosure for subsequent events. Among other things, the new guidance eliminates the requirement for SEC filers, as defined in the guidance, to disclose the date through which subsequent events have been evaluated. That change is effective immediately. SEC filers continue to be required to evaluate subsequent events through the date the financial statements are issued. Although the new guidance eliminates the requirement for SEC filers to disclose the date through which subsequent events have been evaluated, it does not prohibit SEC filers from disclosing such date. The new guidance also clarifies the requirement to disclose the date through which subsequent events have been evaluated in reissued financial statements to apply only to such statements that have been restated to correct an error or to apply U.S. GAAP retrospectively. The adoption of this guidance did not have a material impact on our consolidated financial statements.
Loan Modifications and Loan Pool Accounting
In April 2010, the FASB issued guidance that clarifies the accounting for loan modifications when the loan is part of a pool that is accounted for as a single asset. The new guidance provides that modifications of loans that are accounted for within a pool do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. This guidance does not affect the accounting for loans that are not accounted for within pools. Loans accounted for individually continue to be subject to the troubled debt restructuring accounting provisions. The new guidance also allows entities to make a one-time election to terminate accounting for loans in a pool, which may be made on a pool-by-pool basis, upon adoption of this new guidance. We early-adopted the provisions of this new guidance, as permitted, effective April 1, 2010. The adoption of this guidance did not have a material impact on our consolidated financial statements.
Recently Issued Accounting Guidance
Finance Receivables and Allowance for Credit Losses Disclosure
In July 2010, the FASB issued updated guidance related to credit risk disclosures for finance receivables and the related allowance for credit losses. The updated guidance requires entities to disclose information at disaggregated levels, specifically defined as “portfolio segments” and “classes”. Expanded disclosures include, among other things, roll-forward schedules of the allowance for credit losses and information regarding the credit quality of receivables (including their aging) as of the end of a reporting period. The Company will adopt the period-end provisions of this new guidance in its consolidated financial statements for the year ended December 31, 2010, and the activity-related provisions of the guidance in the first quarter 2011. While the provisions of this new guidance will require significant expansion of our disclosures on the credit quality of financing receivables and the allowance for credit losses, we do not expect the adoption to have an effect on our financial condition and results of operations.
Fair Value Measurements Disclosure
In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately, a reconciliation for fair value measurements using significant unobservable inputs (Level 3) information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2010 and for interim periods within the fiscal year. Since this guidance is disclosure-only in nature, management does not expect the adoption of this updated guidance to have a material impact on our financial condition and results of operations.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(3) Business Combinations and Deconsolidation of a Subsidiary
Coal Mine Operation — Business Combination
Effective April 1, 2010, the Company, through its majority-owned Special Situations Platform subsidiary, obtained control of an equity-method investee (coal mine operation) after the investee acquired and redeemed the 55.5% ownership interest held by the then-majority shareholder in exchange for a $4.6 million note payable. As a result of the equity interest redemption, the Company’s ownership interest in the investee increased to 88.8% from 39.5% and the coal mine operation became a consolidated subsidiary of the Company. The transfer of a controlling interest in the investee to the Company was accounted for as a business combination, and accordingly, all of the assets and liabilities of the coal mine operation were measured at fair value on the date control was obtained and included in the Company’s consolidated balance sheet, net of intercompany account balances that were eliminated in consolidation. The following table reflects the estimated fair value of the coal mine operation’s identifiable assets and liabilities, and the estimated fair value of the noncontrolling interest, that were included in the Company’s consolidated balance sheet at April 1, 2010 (in thousands):
Cash |
| $ | 1,597 |
|
Coal supply agreement (1) |
| 13,092 |
| |
Accounts receivable and other assets (1) |
| 3,699 |
| |
Total assets |
| $ | 18,388 |
|
|
|
|
| |
Note payable |
| $ | 4,615 |
|
Coal purchase agreement (2) |
| 2,394 |
| |
Intercompany liability (3) |
| 4,086 |
| |
Accounts payable and other liabilities (2) |
| 2,415 |
| |
Total liabilities |
| $ | 13,510 |
|
|
|
|
| |
Noncontrolling interest |
| $ | 548 |
|
(1) Included in “Other assets” on the Company’s consolidated balance sheet.
(2) Included in “Other liabilities” on the Company’s consolidated balance sheet.
(3) Eliminated in consolidation with the Company’s consolidated financial statements.
In addition to measuring the subsidiary’s assets and liabilities at fair value at the date control was obtained on April 1, 2010, the Company’s carrying value of its previously-held equity-method investment in the coal mine subsidiary was re-measured to fair value under accounting guidance applicable to business combinations. The fair value of the Company’s total interest in the subsidiary after the business combination exceeded the carrying value of its previously-held equity interest by approximately $4.8 million, which the Company recognized as “Gain on business combinations” in its consolidated statement of operations for the nine-month period ended September 30, 2010. The Company’s carrying value of its previously-held equity investment in the coal mine subsidiary included the effects of the investee’s distribution of a wholly-owned equipment subsidiary (i.e. spin-off transaction), effective April 1, 2010, to the owners in proportion to their then-existing ownership percentages. The spin-off transaction effected by the investee was recorded at carrying value and the Company’s proportionate share of equity in the distributed entity approximated $2.7 million — which it continued to record as an equity-method investment after the spin-off.
The Company’s application of business combination accounting in connection with obtaining control of the coal mine subsidiary resulted in the Company’s recognition of an asset for an above-market-price coal supply agreement and a liability for an above-market-price coal purchase agreement. The fair values of the coal supply and coal purchase agreements were based on discounted cash flow calculations of the difference between the expected contract revenues and costs based on the stated contractual terms and the estimated net contract revenues and costs derived from applying forward-market commodity prices as of April 1, 2010. The discount rate used for the calculations was obtained from independent pricing reflecting broker market quotes. The coal supply asset and coal purchase liability are being amortized over the actual amount of tons shipped under each contract (which are both scheduled to expire in December 2010).
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Domestic Acquisition Partnerships — Business Combinations
On March 31, 2010, the Company acquired an additional 50% ownership interest in three domestic Acquisition Partnerships for $4.4 million. As a result of this transaction, the Company’s ownership interest in each of these entities increased to 100% and the Company obtained control of such entities, resulting in these Acquisition Partnerships becoming consolidated subsidiaries of the Company. The transaction was accounted for as a business combination, and accordingly, all of the assets and liabilities of these Acquisition Partnerships were measured at fair value on the acquisition date and included in the Company’s consolidated balance sheet. The following table reflects the fair value of the Acquisition Partnerships’ assets and liabilities that were included in the Company’s consolidated balance sheet on the acquisition date (in thousands):
Recognized amounts of identified assets acquired and liabilities assumed (at fair value):
Cash |
| $ | 1,427 |
|
Portfolio Assets |
| 21,765 |
| |
Other assets |
| 82 |
| |
Total assets |
| $ | 23,274 |
|
|
|
|
| |
Notes payable to banks |
| $ | 13,811 |
|
Other liabilities |
| 235 |
| |
Total liabilities |
| $ | 14,046 |
|
Pursuant to accounting provisions applicable to business combinations, the Company’s carrying value of its previously-held equity-method investments in these Acquisition Partnerships was re-measured to fair value at the acquisition date. The fair value of the Company’s previously-held equity interests exceeded the aggregate carrying values by approximately $0.9 million. As such, the Company recognized a $0.9 million gain attributable to the re-measurement of its previously-held equity interests on the acquisition date (included in “Gain on business combinations” in the Company’s consolidated statement of operations for the nine-month period ended September 30, 2010).
Manufacturing Subsidiary — Deconsolidation
In December 2009, the Company, through its majority-owned Special Situations Platform subsidiary, acquired a majority controlling interest in a manufacturing subsidiary (involved in the design, production and sale of wireless transmission equipment and software solutions). The manufacturing subsidiary’s accounts and results of operations have been included in the Company’s consolidated financial statements since the acquisition. However, effective June 30, 2010, the Company and the noncontrolling owners consented to certain amendments to the subsidiary’s operating agreement that resulted in the Company ceasing to have a controlling interest, but retaining a noncontrolling interest and elevated economic interests, in the manufacturing entity. Accordingly, the Company deconsolidated and removed the carrying values of the manufacturing subsidiary’s assets ($9.9 million) and liabilities ($9.6 million) and the carrying value of the noncontrolling interest ($39,000) attributed to the subsidiary from its consolidated balance sheet on June 30, 2010. The Company also recorded its retained noncontrolling interest in the manufacturing entity at estimated fair value of approximately $0.3 million at June 30, 2010. No gain or loss was recognized by the Company as a result of deconsolidating this subsidiary. On June 30, 2010, the Company started to account for its retained investment in the manufacturing entity using the equity-method of accounting. Consequently, the Company no longer reports the individual revenue and expense line-items of the manufacturing entity’s operations in its consolidated statements of operations (rather, the Company began recording its share of the subsidiary’s net earnings as “Equity in earnings of unconsolidated subsidiaries” beginning July 1, 2010).
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(4) Portfolio Assets
Portfolio Assets are summarized as follows:
|
| September 30, 2010 |
| |||||||
|
| (Dollars in thousands) |
| |||||||
|
| Outstanding |
| Allowance for |
| Outstanding |
| |||
|
| Balance |
| Loan Losses |
| Balance, net |
| |||
Loan Portfolios: |
|
|
|
|
|
|
| |||
Purchased Credit-Impaired Loans |
| $ | 167,722 |
| $ | 1,297 |
| $ | 166,425 |
|
Purchased performing loans |
| 4,070 |
| 9 |
| 4,061 |
| |||
UBN: |
|
|
|
|
|
|
| |||
Non-performing loans |
| 48,123 |
| 46,217 |
| 1,906 |
| |||
Performing loans |
| 1,069 |
| — |
| 1,069 |
| |||
Other |
| 1,694 |
| 55 |
| 1,639 |
| |||
Total |
| $ | 222,678 |
| $ | 47,578 |
| $ | 175,100 |
|
|
| December 31, 2009 |
| |||||||
|
| (Dollars in thousands) |
| |||||||
|
| Outstanding |
| Allowance for |
| Outstanding |
| |||
|
| Balance |
| Loan Losses |
| Balance, net |
| |||
Loan Portfolios: |
|
|
|
|
|
|
| |||
Purchased Credit-Impaired Loans |
| $ | 192,920 |
| $ | 6,927 |
| $ | 185,993 |
|
Purchased performing loans |
| 3,986 |
| 25 |
| 3,961 |
| |||
UBN: |
|
|
|
|
|
|
| |||
Non-performing loans |
| 60,929 |
| 58,624 |
| 2,305 |
| |||
Performing loans |
| 1,555 |
| — |
| 1,555 |
| |||
Other |
| 4,381 |
| 249 |
| 4,132 |
| |||
Total |
| $ | 263,771 |
| $ | 65,825 |
| $ | 197,946 |
|
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Real Estate Portfolios: |
|
|
|
|
| ||
Real estate held for sale |
| $ | 29,557 |
| $ | 17,051 |
|
Real estate held for investment, net (1) |
| 7,095 |
| 9,387 |
| ||
Total |
| $ | 36,652 |
| $ | 26,438 |
|
(1) Includes lease-related intangible balances (net) of approximately $0.7 million and $0.8 million at September 30, 2010 and December 31, 2009, respectively.
Income from Portfolio Assets is summarized as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Loan Portfolios: |
|
|
|
|
|
|
|
|
| ||||
Purchased Credit-Impaired Loans |
| $ | 6,051 |
| $ | 10,626 |
| $ | 28,791 |
| $ | 32,879 |
|
Purchased performing loans |
| 87 |
| 59 |
| 213 |
| 232 |
| ||||
UBN |
| 130 |
| 260 |
| 766 |
| 535 |
| ||||
Other |
| 1,245 |
| 91 |
| 1,633 |
| 520 |
| ||||
Real Estate Portfolios |
| 682 |
| 1,098 |
| 2,877 |
| 1,088 |
| ||||
Income from Portfolio Assets |
| $ | 8,195 |
| $ | 12,134 |
| $ | 34,280 |
| $ | 35,254 |
|
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
For the nine-month period ended September 30, 2010, the Company recorded provisions for loan and impairment losses, net of recoveries, by a charge to income of $6.7 million — which is composed of a $2.7 million provision for loan losses, net of recoveries, and a $4.0 million impairment charge on real estate portfolios. For the nine-month period ended September 30, 2009, the Company recorded a provision for loan and impairment losses on Portfolio Assets of $0.8 million — which is composed of a $0.6 million impairment charge on real estate portfolios and a $0.2 million provision for loan losses, net of recoveries.
The changes in the allowance for loan losses on Portfolio Assets are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | (45,719 | ) | $ | (69,082 | ) | $ | (65,825 | ) | $ | (76,365 | ) |
Provisions |
| (943 | ) | (2,958 | ) | (3,268 | ) | (3,618 | ) | ||||
Recoveries |
| 154 |
| 3,023 |
| 614 |
| 3,405 |
| ||||
Charge-offs |
| 523 |
| 7,372 |
| 11,932 |
| 15,019 |
| ||||
Translation adjustments |
| (1,593 | ) | (643 | ) | 8,969 |
| (729 | ) | ||||
Ending Balance |
| $ | (47,578 | ) | $ | (62,288 | ) | $ | (47,578 | ) | $ | (62,288 | ) |
Accretable yield represents the amount of income the Company can expect to generate over the remaining life of its existing Purchased Credit-Impaired Loans based on estimated future cash flows as of September 30, 2010 and December 31, 2009. Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimates of future cash flows. Reclassifications to nonaccretable difference from accretable yield primarily results from the Company’s decrease in its estimates of future cash flows. Changes in accretable yield related to the Company’s Purchased Credit-Impaired Loans for the three- and nine-month periods ended September 30, 2010 and 2009 are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | 2,449 |
| $ | 52,936 |
| $ | 12,923 |
| $ | 58,114 |
|
Additions |
| — |
| — |
| — |
| 23,077 |
| ||||
Accretion |
| (37 | ) | (3,769 | ) | (2,163 | ) | (14,229 | ) | ||||
Reclassification (to) from nonaccretable difference |
| 4 |
| 656 |
| (2,138 | ) | 2,115 |
| ||||
Disposals |
| 328 |
| (2,353 | ) | (2,613 | ) | (8,545 | ) | ||||
Transfer to non-accrual |
| — |
| (25,127 | ) | (3,039 | ) | (38,412 | ) | ||||
Translation adjustments |
| 6 |
| (90 | ) | (220 | ) | 133 |
| ||||
Ending Balance |
| $ | 2,750 |
| $ | 22,253 |
| $ | 2,750 |
| $ | 22,253 |
|
Acquisitions of Purchased Credit-Impaired Loans for the three- and nine-month periods ended September 30, 2010 and 2009, respectively, are summarized in the table below:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Face value at acquisition |
| $ | 11,390 |
| $ | 53,358 |
| $ | 63,146 |
| $ | 306,188 |
|
Cash flows expected to be collected at acquisition, net of adjustments |
| 12,939 |
| 70,252 |
| 51,557 |
| 234,680 |
| ||||
Basis in acquired loans at acquisition |
| 8,267 |
| 36,932 |
| 32,632 |
| 171,620 |
| ||||
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(5) Loans Receivable
The following is a composition of the Company’s loans receivable by loan type and region:
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Domestic: |
|
|
|
|
| ||
Commercial and industrial: |
|
|
|
|
| ||
Affiliates, net of allowance for loan losses of $-0- and $67, respectively |
| $ | 7,094 |
| $ | 13,177 |
|
SBA, net of allowance for loan losses of $244 and $490, respectively |
| 23,344 |
| 16,266 |
| ||
Other |
| 8,054 |
| 1,402 |
| ||
Real estate: |
|
|
|
|
| ||
Other, net of allowance for loan losses of $1,083 and $-0-, respectively |
| 6,339 |
| 8,831 |
| ||
|
|
|
|
|
| ||
Foreign - commercial and industrial: |
|
|
|
|
| ||
Affiliates, net of allowance for loan losses of $433 and $-0-, respectively |
| 11,007 |
| 12,945 |
| ||
|
|
|
|
|
| ||
Total loans, net |
| $ | 55,838 |
| $ | 52,621 |
|
Loans receivable — affiliates
Loans receivable — affiliates, which are designated by management as held for investment, are summarized as follows:
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Outstanding balance |
| $ | 17,291 |
| $ | 24,757 |
|
Allowance for loan losses |
| (433 | ) | (67 | ) | ||
Discounts, net |
| (170 | ) | (237 | ) | ||
Capitalized interest |
| 1,413 |
| 1,669 |
| ||
Carrying amount of loans, net |
| $ | 18,101 |
| $ | 26,122 |
|
A summary of activity in loans receivable — affiliates follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | 21,867 |
| $ | 29,746 |
| $ | 26,122 |
| $ | 27,080 |
|
Advances |
| 23 |
| 3,486 |
| 573 |
| 8,638 |
| ||||
Payments received |
| (4,336 | ) | (2,334 | ) | (7,226 | ) | (4,944 | ) | ||||
Capitalized interest |
| 96 |
| 103 |
| 233 |
| 272 |
| ||||
Provision for loan impairment |
| 68 |
| — |
| (365 | ) | — |
| ||||
Discount accretion, net |
| 23 |
| 15 |
| 67 |
| 15 |
| ||||
Other noncash adjustments (1) |
| — |
| — |
| (1,001 | ) | — |
| ||||
Foreign exchange gains (losses) |
| 360 |
| 195 |
| (302 | ) | 150 |
| ||||
Ending Balance |
| $ | 18,101 |
| $ | 31,211 |
| $ | 18,101 |
| $ | 31,211 |
|
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(1) Represents the removal of a $4.1 million loan to a former equity-method investee (coal mine subsidiary) upon consolidation of the entity effective April 1, 2010, and the addition of a $3.1 million loan to a former consolidated entity (manufacturing subsidiary) upon the deconsolidation of the entity effective June 30, 2010. Refer to Note 3 for additional information.
Loans receivable — affiliates represent (1) advances to Acquisition Partnerships and other affiliates to acquire portfolios of performing and non-performing commercial and consumer loans and other assets; and (2) senior debt financing arrangements with equity-method investees to provide capital for business expansion and operations. Loans receivable — affiliates are generally secured by the underlying collateral that was acquired with the loan proceeds. Advances to affiliates to acquire loan portfolios are secured by the underlying collateral of the individual notes within the portfolios (which is generally real estate), whereas advances to affiliates for capital investments and working capital are generally secured by business assets (i.e. accounts receivable, inventory and equipment). The Company recorded $0.4 million of net provisions for impairment on loans receivable — affiliates for the nine months ended September 30, 2010. The Company recorded no provisions for impairment for the nine-month period ended September 30, 2009.
At September 30, 2010, the Company’s recorded investment in impaired and non-accrual loans receivable — affiliates totaled $0.9 million. The average recorded investment in these impaired and non-accrual loans approximated $0.4 million for the nine-month period ended September 30, 2010. At September 30, 2010, the Company had $0.4 million of allowances specifically related to these loans.
Loans receivable — SBA held for sale
Loans receivable — SBA held for sale are summarized as follows:
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Outstanding balance |
| $ | 8,227 |
| $ | 821 |
|
Capitalized costs, net of fees |
| 109 |
| — |
| ||
Carrying amount of loans, net |
| $ | 8,336 |
| $ | 821 |
|
Changes in loans receivable — SBA held for sale are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | 7,697 |
| $ | 3,492 |
| $ | 821 |
| $ | 4,901 |
|
Originations and advances of loans |
| 2,992 |
| 2,115 |
| 11,881 |
| 13,715 |
| ||||
Payments received |
| (17 | ) | (61 | ) | (24 | ) | (224 | ) | ||||
Capitalized costs |
| 27 |
| (43 | ) | 110 |
| (61 | ) | ||||
Loans sold, net |
| (2,363 | ) | (3,920 | ) | (4,452 | ) | (16,748 | ) | ||||
Ending Balance |
| $ | 8,336 |
| $ | 1,583 |
| $ | 8,336 |
| $ | 1,583 |
|
Loans receivable — SBA held for sale represent the portions of SBA loans acquired and originated by the Company that are guaranteed by the SBA. These loans are secured by the borrowing entities’ assets such as accounts, property, equipment and other business assets. The Company recorded no write-downs of SBA loans held for sale below their cost for the nine months ended September 30, 2010 and 2009.
At September 30, 2010, SBA loans held for sale include $3.2 million in guaranteed portions of SBA loans sold and subject to premium recourse provisions. In accordance with FASB’s accounting guidance on transfers of financial assets (issued in June 2009) that became effective in the first quarter of 2010, an off-setting secured borrowing has been recorded and is included in “Other liabilities” in the Company’s consolidated balance sheet. After the premium recourse provisions have elapsed, the Company will recognize the gain related to the sale, and remove the guaranteed portion of the SBA loan (i.e. the pledged asset) and the secured borrowing from the balance sheet. Refer to Note 2 for additional information.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Loans receivable — SBA held for investment, net
Loans receivable — SBA held for investment are summarized as follows:
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Outstanding balance |
| $ | 16,206 |
| $ | 17,072 |
|
Allowance for loan losses |
| (243 | ) | (490 | ) | ||
Discounts, net |
| (1,078 | ) | (1,245 | ) | ||
Capitalized costs |
| 123 |
| 108 |
| ||
Carrying amount of loans, net |
| $ | 15,008 |
| $ | 15,445 |
|
Changes in loans receivable — SBA held for investment are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | 15,165 |
| $ | 16,203 |
| $ | 15,445 |
| $ | 14,405 |
|
Originations and advances of loans |
| 371 |
| 288 |
| 1,421 |
| 3,055 |
| ||||
Payments received |
| (355 | ) | (484 | ) | (1,671 | ) | (1,277 | ) | ||||
Capitalized costs |
| 5 |
| 3 |
| 15 |
| 46 |
| ||||
Change in allowance for loan losses |
| 103 |
| (329 | ) | 247 |
| (407 | ) | ||||
Discount accretion, net |
| 7 |
| 6 |
| 95 |
| (135 | ) | ||||
Charge-offs |
| (203 | ) | (25 | ) | (459 | ) | (25 | ) | ||||
Transfers to other real estate owned |
| (85 | ) | — |
| (85 | ) | — |
| ||||
Ending Balance |
| $ | 15,008 |
| $ | 15,662 |
| $ | 15,008 |
| $ | 15,662 |
|
Loans receivable — SBA held for investment represent the non-guaranteed portions of SBA loans purchased and originated by the Company. These loans are secured by the borrowing entities’ assets such as accounts, property, equipment and other business assets. The Company recorded net impairment provisions to SBA loans held for investment of $0.2 million and $0.4 million for the nine-month periods ended September 30, 2010 and 2009, respectively.
Changes in the allowance for loan losses related to loans receivable — SBA held for investment are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | (346 | ) | $ | (112 | ) | $ | (490 | ) | $ | (34 | ) |
Provisions |
| (107 | ) | (364 | ) | (299 | ) | (461 | ) | ||||
Recoveries |
| 4 |
| 12 |
| 84 |
| 31 |
| ||||
Charge-offs |
| 206 |
| 23 |
| 462 |
| 23 |
| ||||
Ending Balance |
| $ | (243 | ) | $ | (441 | ) | $ | (243 | ) | $ | (441 | ) |
At September 30, 2010, the Company’s recorded investment in impaired and non-accrual loans receivable — SBA held for investment totaled $0.3 million. The average recorded investment in these impaired and non-accrual loans approximated $0.4 million for the nine-month period ended September 30, 2010. At September 30, 2010, the Company had $0.2 million of allowances specifically related to these loans.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Loans receivable — other
Loans receivable — other, which are designated by management as held for investment, are summarized as follows:
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Outstanding balance |
| $ | 15,257 |
| $ | 9,992 |
|
Allowance for loan losses |
| (1,083 | ) | — |
| ||
Discounts, net |
| (27 | ) | (7 | ) | ||
Capitalized interest and costs |
| 246 |
| 248 |
| ||
Carrying amount of loans, net |
| $ | 14,393 |
| $ | 10,233 |
|
Changes in loans receivable — other are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | 14,654 |
| $ | 11,698 |
| $ | 10,233 |
| $ | 13,533 |
|
Advances |
| 1,953 |
| 1,737 |
| 12,505 |
| 5,105 |
| ||||
Payments received |
| (2,225 | ) | (2,554 | ) | (7,286 | ) | (6,853 | ) | ||||
Capitalized interest and costs |
| — |
| — |
| (2 | ) | 44 |
| ||||
Change in allowance for loan losses |
| — |
| 1,548 |
| (1,083 | ) | 581 |
| ||||
Discount accretion, net |
| 11 |
| 2 |
| 26 |
| 11 |
| ||||
Charge-offs |
| — |
| (1,548 | ) | — |
| (1,548 | ) | ||||
Foreign exchange gains |
| — |
| — |
| — |
| 10 |
| ||||
Ending Balance |
| $ | 14,393 |
| $ | 10,883 |
| $ | 14,393 |
| $ | 10,883 |
|
Loans receivable — other include loans made to non-affiliated entities and are secured by the borrowing entities’ assets such as accounts receivable, inventory, property and equipment, real estate and various other assets. The Company recorded impairment provisions on loans receivable — other of approximately $1.1 million and $1.0 million for the nine-month periods ended September 30, 2010 and 2009, respectively.
Changes in the allowance for loan losses related to loans receivable — other are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | (1,083 | ) | $ | (1,548 | ) | $ | — |
| $ | (581 | ) |
Provisions |
| — |
| — |
| (1,083 | ) | (967 | ) | ||||
Charge-offs |
| — |
| 1,548 |
| — |
| 1,548 |
| ||||
Ending Balance |
| $ | (1,083 | ) | $ | — |
| $ | (1,083 | ) | $ | — |
|
At September 30, 2010, the Company’s recorded investment in impaired and non-accrual loans receivable — other totaled $6.3 million. The average recorded investment in these impaired and non-accrual loans approximated $7.3 million for the nine-month period ended September 30, 2010. At September 30, 2010, the Company had $1.1 million of allowances specifically related to these loans.
(6) Equity Investments
The Company has non-marketable equity investments in Acquisition Partnerships and their general partners, and non-marketable equity investments in various servicing and operating entities, that are accounted for under the equity-method of accounting. The
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
condensed combined financial position and results of operations of the Acquisition Partnerships (which include the domestic and foreign Acquisition Partnerships and their general partners) and the servicing and operating entities (collectively, the “Equity Investees”), are summarized as follows:
Condensed Combined Balance Sheets
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Acquisition Partnerships: |
|
|
|
|
| ||
Assets |
| $ | 360,058 |
| $ | 282,999 |
|
Liabilities |
| $ | 62,835 |
| $ | 97,135 |
|
Net equity |
| 297,223 |
| 185,864 |
| ||
|
| $ | 360,058 |
| $ | 282,999 |
|
Servicing and operating entities: |
|
|
|
|
| ||
Assets |
| $ | 169,302 |
| $ | 134,384 |
|
Liabilities |
| $ | 97,942 |
| $ | 79,375 |
|
Net equity |
| 71,360 |
| 55,009 |
| ||
|
| $ | 169,302 |
| $ | 134,384 |
|
Total: |
|
|
|
|
| ||
Assets |
| $ | 529,360 |
| $ | 417,383 |
|
Liabilities |
| $ | 160,777 |
| $ | 176,510 |
|
Net equity |
| 368,583 |
| 240,873 |
| ||
|
| $ | 529,360 |
| $ | 417,383 |
|
|
|
|
|
|
| ||
Equity investment in Acquisition Partnerships |
| $ | 53,477 |
| $ | 41,029 |
|
Equity investment in servicing and operating entities |
| 48,047 |
| 30,462 |
| ||
|
| $ | 101,524 |
| $ | 71,491 |
|
Condensed Combined Summary of Operations
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Acquisition Partnerships: |
|
|
|
|
|
|
|
|
| ||||
Revenues |
| $ | 9,554 |
| $ | 7,191 |
| $ | 24,964 |
| $ | 28,693 |
|
Costs and expenses |
| 13,774 |
| 10,476 |
| 34,052 |
| 27,884 |
| ||||
Net earnings (loss) |
| $ | (4,220 | ) | $ | (3,285 | ) | $ | (9,088 | ) | $ | 809 |
|
|
|
|
|
|
|
|
|
|
| ||||
Servicing and operating entities: |
|
|
|
|
|
|
|
|
| ||||
Revenues |
| $ | 39,254 |
| $ | 21,889 |
| $ | 84,794 |
| $ | 58,760 |
|
Costs and expenses |
| 22,504 |
| 19,117 |
| 56,478 |
| 56,701 |
| ||||
Net earnings |
| $ | 16,750 |
| $ | 2,772 |
| $ | 28,316 |
| $ | 2,059 |
|
|
|
|
|
|
|
|
|
|
| ||||
Equity in earnings (loss) of Acquisition Partnerships |
| $ | (1,806 | ) | $ | (797 | ) | $ | (2,689 | ) | $ | 445 |
|
Equity in earnings of servicing and operating entities |
| 11,768 |
| 1,218 |
| 16,696 |
| 1,028 |
| ||||
|
| $ | 9,962 |
| $ | 421 |
| $ | 14,007 |
| $ | 1,473 |
|
In March 2010, the Company acquired a controlling interest in three domestic Acquisition Partnerships in which it previously held a noncontrolling interest. In addition, in April 2010, the Company obtained a controlling interest in a coal mine subsidiary in which it previously held a noncontrolling interest. As a result of these transactions, the Acquisition Partnerships and coal mine subsidiary converted from equity-method investments to consolidated subsidiaries of the Company. As such, the assets, liabilities and equity of
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
these entities are not included in the applicable balance sheet tables above and below at September 30, 2010; and their results of operations since the respective transaction dates are not included in the applicable earnings tables above and below for the nine-month period ended September 30, 2010. Furthermore, in connection with the activity related to the coal mine subsidiary, the Company obtained a direct noncontrolling interest in an equipment subsidiary that was previously wholly-owned and consolidated by the coal mine subsidiary (obtained through a spin-off transaction effected by the coal mine subsidiary in April 2010). As such, the assets, liabilities and equity of this equipment subsidiary are included in the applicable balance sheet tables above and below at September 30, 2010; and its results of operations since the transaction date are included in the applicable earnings tables above and below for the nine-month period ended September 30, 2010. Refer to Note 3 for additional information related to these transactions.
On June 30, 2010, the Company entered into an arrangement with a then-consolidated manufacturing subsidiary that resulted in the Company ceasing to have a controlling interest, but retaining a noncontrolling interest, in the entity. As a result, the manufacturing subsidiary converted to an equity-method investment from a consolidated subsidiary of the Company. As such, the assets, liabilities and equity of this manufacturing subsidiary are included in the applicable balance sheet tables above and below at September 30, 2010, and its results of operations since the transaction date are included in the applicable earnings tables above and below for the nine-month period ended September 30, 2010. Refer to Note 3 for additional information related to this transaction.
At September 30, 2010 and December 31, 2009, the Acquisition Partnerships’ total carrying value of loans accounted for under non-accrual methods of accounting (i.e. cost-recovery or cash basis method) approximated $271.5 million and $180.0 million, respectively.
The combined assets and equity of the Equity Investees, and the Company’s carrying value of its equity investments in the Equity Investees, are summarized by geographic region below.
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Combined assets of the Equity Investees: |
|
|
|
|
| ||
Domestic: |
|
|
|
|
| ||
Acquisition Partnerships |
| $ | 177,582 |
| $ | 58,190 |
|
Operating entities |
| 62,265 |
| 31,481 |
| ||
Latin America: |
|
|
|
|
| ||
Acquisition Partnerships |
| 130,305 |
| 139,214 |
| ||
Servicing entities |
| 10,298 |
| 13,328 |
| ||
Europe: |
|
|
|
|
| ||
Acquisition Partnerships |
| 52,171 |
| 85,595 |
| ||
Servicing entities |
| 96,739 |
| 89,575 |
| ||
|
| $ | 529,360 |
| $ | 417,383 |
|
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Combined equity of the Equity Investees: |
|
|
|
|
| ||
Domestic: |
|
|
|
|
| ||
Acquisition Partnerships |
| $ | 172,909 |
| $ | 36,696 |
|
Operating entities |
| 22,435 |
| 5,574 |
| ||
Latin America: |
|
|
|
|
| ||
Acquisition Partnerships |
| 110,989 |
| 115,768 |
| ||
Servicing entities |
| (1,231 | ) | 427 |
| ||
Europe: |
|
|
|
|
| ||
Acquisition Partnerships |
| 13,325 |
| 33,400 |
| ||
Servicing entities |
| 50,156 |
| 49,008 |
| ||
|
| $ | 368,583 |
| $ | 240,873 |
|
|
|
|
|
|
| ||
Company’s carrying value of its equity investments in the Equity Investees: |
|
|
|
|
| ||
Domestic: |
|
|
|
|
| ||
Acquisition Partnerships |
| $ | 33,032 |
| $ | 13,575 |
|
Operating entities |
| 15,048 |
| 1,659 |
| ||
Latin America: |
|
|
|
|
| ||
Acquisition Partnerships |
| 16,205 |
| 17,532 |
| ||
Servicing entities |
| 1,806 |
| 2,677 |
| ||
Europe: |
|
|
|
|
| ||
Acquisition Partnerships |
| 4,240 |
| 9,922 |
| ||
Servicing entities |
| 31,193 |
| 26,126 |
| ||
|
| $ | 101,524 |
| $ | 71,491 |
|
Revenues and earnings (losses) of the Equity Investees, and the Company’s share of equity in earnings (losses) of those entities, are summarized by geographic region below. The tables below include individual entities and combined entities under common management that are considered to be significant subsidiaries of FirstCity at September 30, 2010.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Revenues of the Equity Investees: |
|
|
|
|
|
|
|
|
| ||||
Domestic: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| $ | 4,558 |
| $ | 1,087 |
| $ | 7,168 |
| $ | 5,693 |
|
FC Crestone Oak LLC (operating entity) (1) |
| 21,374 |
| 379 |
| 25,824 |
| 534 |
| ||||
Other operating entities |
| 6,274 |
| 9,729 |
| 19,173 |
| 22,767 |
| ||||
Latin America: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| 4,666 |
| 3,805 |
| 14,990 |
| 9,242 |
| ||||
Servicing entity |
| 2,345 |
| 2,427 |
| 6,855 |
| 7,751 |
| ||||
Europe: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| 330 |
| 2,299 |
| 2,806 |
| 13,758 |
| ||||
MCS et Associes (servicing entity) |
| 8,420 |
| 8,116 |
| 30,326 |
| 23,826 |
| ||||
Other servicing entities |
| 841 |
| 1,238 |
| 2,616 |
| 3,882 |
| ||||
|
| $ | 48,808 |
| $ | 29,080 |
| $ | 109,758 |
| $ | 87,453 |
|
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Net earnings (loss) of the Equity Investees: |
|
|
|
|
|
|
|
|
| ||||
Domestic: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| $ | 1,586 |
| $ | (277 | ) | $ | 2,129 |
| $ | 1,137 |
|
FC Crestone Oak LLC (operating entity) (1) |
| 17,408 |
| (3 | ) | 20,236 |
| (347 | ) | ||||
Other operating entities |
| (1,089 | ) | 3,325 |
| 1,352 |
| 3,687 |
| ||||
Latin America: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| (2,324 | ) | (2,015 | ) | (4,456 | ) | (3,044 | ) | ||||
Servicing entity |
| (226 | ) | (439 | ) | (1,676 | ) | (1,374 | ) | ||||
Europe: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| (3,481 | ) | (993 | ) | (6,761 | ) | 2,716 |
| ||||
MCS et Associes (servicing entity) |
| 855 |
| (20 | ) | 8,985 |
| 203 |
| ||||
Other servicing entities |
| (199 | ) | (91 | ) | (581 | ) | (110 | ) | ||||
|
| $ | 12,530 |
| $ | (513 | ) | $ | 19,228 |
| $ | 2,868 |
|
|
|
|
|
|
|
|
|
|
| ||||
Company’s equity in earnings (loss) of the Equity Investees: |
|
|
|
|
|
|
|
|
| ||||
Domestic: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| $ | (98 | ) | $ | (300 | ) | $ | (61 | ) | $ | 216 |
|
FC Crestone Oak LLC (operating entity) (1) |
| 12,440 |
| 19 |
| 14,293 |
| (3 | ) | ||||
Other operating entities |
| (1,032 | ) | 1,445 |
| (33 | ) | 1,664 |
| ||||
Latin America: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| (550 | ) | (207 | ) | (505 | ) | (460 | ) | ||||
Servicing entity |
| (113 | ) | (220 | ) | (838 | ) | (687 | ) | ||||
Europe: |
|
|
|
|
|
|
|
|
| ||||
Acquisition Partnerships |
| (1,157 | ) | (290 | ) | (2,123 | ) | 689 |
| ||||
MCS et Associes (servicing entity) |
| 505 |
| (11 | ) | 3,369 |
| 72 |
| ||||
Other servicing entities |
| (33 | ) | (15 | ) | (95 | ) | (18 | ) | ||||
|
| $ | 9,962 |
| $ | 421 |
| $ | 14,007 |
| $ | 1,473 |
|
(1) FC Crestone Oak LLC operates in the prefabricated building manufacturing industry.
At September 30, 2010, the Company had $25.6 million in Euro-denominated debt for the purpose of hedging a portion of the Company’s net equity investments in Europe. Refer to Note 11 for additional information.
(7) Servicing Assets — SBA Loans
The Company recognizes servicing assets through the sale of originated SBA loans when the rights to service those loans are retained. Servicing rights resulting from the sale of loans are initially recognized at fair value at the date of transfer. The Company subsequently measures the carrying value of the servicing assets by using the amortization method, which amortizes the servicing assets in proportion to and over the period of estimated net servicing income, and evaluates servicing assets for impairment based on fair value at each reporting date. The Company evaluates the possible impairment of servicing assets based on the difference between the carrying amount and current fair value of the servicing assets. Impairment is charged to servicing fees in the period recognized.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Changes in the Company’s amortized servicing assets are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Beginning Balance |
| $ | 949 |
| $ | 1,001 |
| $ | 1,115 |
| $ | 785 |
|
Servicing Assets capitalized |
| 45 |
| 97 |
| 85 |
| 409 |
| ||||
Servicing Assets amortized |
| (51 | ) | (59 | ) | (257 | ) | (155 | ) | ||||
Ending Balance |
| $ | 943 |
| $ | 1,039 |
| $ | 943 |
| $ | 1,039 |
|
|
|
|
|
|
|
|
|
|
| ||||
Reserve for impairment of servicing assets: |
|
|
|
|
|
|
|
|
| ||||
Beginning Balance |
| $ | (73 | ) | $ | (27 | ) | $ | (59 | ) | $ | (63 | ) |
Impairments |
| (31 | ) | (27 | ) | (46 | ) | (43 | ) | ||||
Recoveries |
| — |
| — |
| 1 |
| 52 |
| ||||
Ending Balance |
| $ | (104 | ) | $ | (54 | ) | $ | (104 | ) | $ | (54 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Ending Balance (net of reserve) |
| $ | 839 |
| $ | 985 |
| $ | 839 |
| $ | 985 |
|
|
|
|
|
|
|
|
|
|
| ||||
Fair value of amortized servicing assets: |
|
|
|
|
|
|
|
|
| ||||
Beginning balance |
| $ | 971 |
| $ | 974 |
| $ | 1,162 |
| $ | 722 |
|
Ending balance |
| $ | 907 |
| $ | 985 |
| $ | 907 |
| $ | 985 |
|
The Company relies primarily on a discounted cash flow model to estimate the fair value of its servicing assets. This model calculates estimated fair value of the servicing assets using significant assumptions including a discount rate of 15.0% and prepayment speeds of 14.0% to 15.0% (depending on certain characteristics of the related loans). In the event future prepayments are significant or impairments are incurred, and future expected cash flows are inadequate to cover the unamortized servicing assets, additional amortization or impairment charges would be recognized.
(8) Notes Payable — Senior Credit Facilities with Bank of Scotland plc and BoS(USA), Inc.
On June 25, 2010, FirstCity Commercial Corporation (“FC Commercial”) and FH Partners LLC (“FH Partners”), as borrowers, and FLBG Corporation (“FLBG Corp.”), as guarantor, all of which are wholly-owned subsidiaries of FirstCity, and Bank of Scotland and BoS(USA), Inc. (collectively, “Bank of Scotland”), as lenders, entered into a Reducing Note Facility Agreement (“Reducing Note Facility”). In addition, on June 25, 2010, FirstCity executed a Limited Guaranty Agreement guarantying payment of the indebtedness under the Reducing Note Facility to a maximum amount of $75.0 million.
The Reducing Note Facility amended and restated the following loan facilities previously provided by Bank of Scotland to FirstCity and FH Partners: (a) Revolving Credit Agreement dated November 12, 2004, as amended, to FirstCity ($225.0 million loan facility); (b) Revolving Credit Agreement dated August 26, 2005, as amended, to FH Partners ($100.0 million loan facility); and (c) Subordinated Delayed Draw Credit Agreement dated September 5, 2007, as amended, to FirstCity ($25.0 million loan facility) (collectively, “Prior Credit Agreements”). The Prior Credit Agreements were guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity and secured by substantially all of the assets of FirstCity and its wholly-owned subsidiaries. The outstanding indebtedness and letter of credit obligations under the Prior Credit Agreements in the amount of $268.6 million were refinanced into the Reducing Note Facility, which provides for a scheduled amortization over 3 years ($43.6 million in the first year, $80.0 million in the second year, $60.0 million in the first nine months of the third year, and $85.0 million due on June 25, 2013, the maturity date).
The material terms of the Reducing Note Facility and related agreements are as follows:
· Limited guaranty provided by FirstCity for the repayment of the indebtedness under the Reducing Note Facility to a maximum amount of $75.0 million, plus costs of enforcement and certain contingent indemnities;
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
· No advances will be made under the loan facility, except for draws on outstanding letters of credit in the amount of $22.35 million which are included in the amount of the loan facility ($11.9 million was advanced in October 2010 — see discussion below);
· Repayment will be made from the cash flow from assets and equity investments which were pledged to secure the Prior Credit Agreements;
· FirstCity will receive unencumbered cash of 20% of the monthly net cash flows (i.e. cash “leak-through”) up to $25.0 million, after (a) payment to Bank of Scotland of interest and fees; and (b) payment of a scheduled overhead allowance to FirstCity Servicing Corporation (“FC Servicing”), a wholly-owned subsidiary of FirstCity, of $38.9 million over 3 years ($1.5 million per month for the first year, $1.03 million per month for the second year, and $0.7 million per month for the third year);
· Fluctuating interest rate equal to, at FC Commercial’s option, either (a) the greater of (i) one month London Interbank Offering Rate (“LIBOR”) plus 3.5% (subject to LIBOR floor of 1.0%) or (ii) 4.5%, or (b) Bank of Scotland’s prime rate plus 3.0%;
· FC Commercial and FH Partners may designate a portion of the debt under the Reducing Note Facility to be borrowed in Euros up to a maximum amount of Euros equivalent to USD $27.5 million; and
· FirstCity must maintain a minimum tangible net worth (as defined) requirement of $60.0 million.
Fees paid to Bank of Scotland in connection with the Reducing Note Facility through September 30, 2010 totaled $1.85 million, with $683,000 paid in March 2010 (in connection with an extension of the Prior Credit Facilities), $675,000 paid in June 2010, and $501,000 paid from July to September 2010. A final loan fee payment of $167,000 was made in October 2010.
The Reducing Note Facility is guaranteed by FLBG Corp. and all of its subsidiaries (“Covered Entities”), which represent the entities that were subject to the obligations of the Prior Credit Facilities other than FirstCity and FC Servicing. The Reducing Note Facility is secured by substantially all of the assets of the Covered Entities. FC Investment Holdings Corporation (a newly-formed wholly-owned subsidiary of FirstCity) and its current and future subsidiaries, or other entities in which such subsidiaries own any equity interest (“Non-Covered Entities”), are not subject to, do not guarantee and do not provide security interests in their assets to secure the Reducing Note Facility. FC Servicing only provides a non-recourse security interest in certain equity interests owned by it and in most of the servicing fees from previously-existing agreements which secured the Prior Credit Facilities. FC Servicing does not provide a security interest in servicing agreements entered into with the Non-Covered Entities or in any of its other assets and does not guarantee the Reducing Note Facility.
The Reducing Note Facility contains covenants, representations and warranties on the part of FLBG Corp., FC Commercial and FH Partners that are typical for transactions of this type. In addition, the Reducing Note Facility contains customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other indebtedness, certain events of bankruptcy and insolvency, and failure to pay certain judgments. In the event that an event of default occurs and is continuing, Bank of Scotland may accelerate the indebtedness under the Reducing Note Facility.
At September 30, 2010, the unpaid principal balance on this loan facility was $227.9 million. In October 2010, a letter of credit under the Reducing Note Facility was funded in the amount of $11.9 million, and the proceeds were used to pay-off a bank note payable that was owed by an affiliated Mexican entity of the Company (see Note 19). The entire amount of the funded letter of credit was added to the unpaid principal obligation under the terms and conditions of the Reducing Note Facility.
(9) Stockholders’ Equity
On June 29, 2010, the Company issued and sold 150,000 shares of its common stock to an accredited investor pursuant to a securities purchase agreement at a price of $5.93 per share, resulting in aggregate proceeds of $0.9 million.
(10) Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) is composed of the following as of September 30, 2010 and December 31, 2009:
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Cumulative foreign currency translation adjustments |
| $ | (2,903 | ) | $ | 956 |
|
Net unrealized gains on securities available for sale (1) |
| 36 |
| 2,504 |
| ||
Total accumulated other comprehensive income (loss) |
| $ | (2,867 | ) | $ | 3,460 |
|
(1) Includes $0.5 million and $1.4 million at September 30, 2010 and December 31, 2009, respectively, attributable to FirstCity’s proportionate share of net unrealized gains recorded by an investee accounted for under the equity-method of accounting.
(11) Foreign Currency Exchange Risk Management
We use Euro-denominated debt as a non-derivative financial instrument to partially off-set the Company’s business exposure to foreign currency exchange risk attributable to our net investments in Europe. Our focus is to manage the economic risks associated with our European subsidiaries, which are the foreign currency exchange risks that will ultimately be realized when we exchange one currency for another. To help protect the Company’s net investment in certain of its European subsidiary operations from adverse changes in foreign currency exchange rates, we denominate a portion of our debt in the same functional currency used by the European subsidiaries. At September 30, 2010, the Company carried $25.6 million in Euro-denominated debt and designated the debt as a non-derivative hedge of its net investment in certain European subsidiaries. The Company designated the hedging relationship such that changes in the net investments being hedged are expected to be naturally off-set by corresponding changes in the value of the Euro-denominated debt. We consider our investments in European subsidiaries to be denominated in a relatively stable currency and of a long-term nature.
The effective portion of the net foreign investment hedge is reported in accumulated other comprehensive income (loss) as part of the cumulative translation adjustment. Any ineffective portion of the net foreign investment hedge is recognized in earnings as other income (expense) during the period of change. Effectiveness of the hedging relationship is measured and designated at the beginning of each month by comparing the outstanding balance of the Euro-denominated debt to the carrying value of the designated net equity investments.
At September 30, 2010 and December 31, 2009, the carrying value and line item caption of the Company’s non-derivative instrument was reported on the consolidated balance sheets as follows (in thousands):
Non-Derivative |
|
|
|
|
|
|
| ||
Instrument in |
|
|
|
|
|
|
| ||
Net Investment |
| Balance Sheet |
| Carrying Value at: |
| ||||
Hedging Relationship |
| Location |
| September 30, 2010 |
| December 31, 2009 |
| ||
|
|
|
|
|
|
|
| ||
Euro-denominated debt |
| Notes payable to banks |
| $ | 25,578 |
| $ | 24,824 |
|
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
The effect of the non-derivative instrument qualifying and designated as a hedging instrument in net foreign investment hedges on the consolidated financial statements for the three- and nine-month month periods ended September 30, 2010 and 2009 was as follows (in thousands):
|
|
|
|
|
|
|
| Amount of Gain (Loss) |
| ||||||
|
|
| �� |
|
|
|
| Recognized in Income |
| ||||||
|
| Amount of Gain (Loss) |
|
|
| (Ineffective Portion and |
| ||||||||
|
| Recognized in AOCI |
|
|
| Amount Excluded from |
| ||||||||
Non-Derivative |
| (Effective Portion) |
| Location of Gain (Loss) |
| Effectiveness Testing) |
| ||||||||
Instrument in |
| Three Months Ended |
| Reclassified from |
| Three Months Ended |
| ||||||||
Net Investment |
| September 30, |
| AOCI into Income |
| September 30, |
| ||||||||
Hedging Relationship |
| 2010 |
| 2009 |
| (Effective Portion) |
| 2010 |
| 2009 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
Euro-denominated debt |
| $ | (2,665 | ) | $ | (857 | ) | Other income (expense) |
| $ | — |
| $ | — |
|
|
|
|
|
|
|
|
|
|
| ||||||
|
|
|
|
|
|
|
| Amount of Gain (Loss) |
| ||||||
|
|
|
|
|
|
|
| Recognized in Income |
| ||||||
|
| Amount of Gain (Loss) |
|
|
| (Ineffective Portion and |
| ||||||||
|
| Recognized in AOCI |
|
|
| Amount Excluded from |
| ||||||||
Non-Derivative |
| (Effective Portion) |
| Location of Gain (Loss) |
| Effectiveness Testing) |
| ||||||||
Instrument in |
| Nine Months Ended |
| Reclassified from |
| Nine Months Ended |
| ||||||||
Net Investment |
| September 30, |
| AOCI into Income |
| September 30, |
| ||||||||
Hedging Relationship |
| 2010 |
| 2009 |
| (Effective Portion) |
| 2010 |
| 2009 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
Euro-denominated debt |
| $ | 726 |
| $ | (598 | ) | Other income (expense) |
| $ | — |
| $ | — |
|
(12) Income Taxes
We are subject to income taxes in both the United States and the non-U.S. jurisdictions in which we operate. Income tax expense for the three- and nine-month periods ended September 30, 2010 and 2009 is composed of the following components:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
State current income tax expense (benefit) |
| $ | (28 | ) | $ | (141 | ) | $ | 516 |
| $ | 408 |
|
Federal current income tax benefit |
| (171 | ) | — |
| — |
| — |
| ||||
Foreign current income tax expense |
| 378 |
| 1,357 |
| 963 |
| 1,559 |
| ||||
Foreign deferred income tax expense (benefit) |
| 294 |
| 38 |
| (287 | ) | 136 |
| ||||
Total |
| $ | 473 |
| $ | 1,254 |
| $ | 1,192 |
| $ | 2,103 |
|
The Company recognizes deferred tax assets and liabilities in both the U.S. and foreign jurisdictions based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss and tax credit carryforwards. The Company’s deferred tax assets, net of valuation allowances, totaled $0.4 million at September 30, 2010 (included in “Other assets” in our consolidated balance sheet). The net deferred tax asset at September 30, 2010 relates to our recognition of foreign tax benefits associated with U.S. GAAP adjustments to a consolidated foreign subsidiary’s local financial statements, combined with the timing of income tax payments made by the foreign subsidiary in its local jurisdiction. The recognition of these foreign tax benefits is not dependent upon future taxable income in the subsidiary’s foreign jurisdiction, but rather upon reversal of the U.S. GAAP adjustments in future periods.
The Company also has a substantial amount of domestic deferred tax assets attributable primarily to net operating loss and capital loss carryforwards for U.S. federal income tax purposes, and differences between the carrying amounts and the tax bases of Acquisition Partnership investments. At September 30, 2010 and December 31, 2009, the Company established a full valuation
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
allowance for its U.S. deferred tax assets due to the lack of sufficient objective evidence regarding the realization of these assets in the foreseeable future. We will continue to evaluate the deferred tax asset valuation allowance balances in all of our U.S. and foreign subsidiaries throughout 2010 to determine the appropriate level of valuation allowances.
(13) Stock-Based Compensation
Accounting for stock-based compensation requires that the cost resulting from all stock-based payments be recognized in the financial statements based on the grant-date fair value of the award. The Company’s stock-based compensation expense consists of stock options and restricted stock awards (2010 only). We recognized stock-based compensation cost of approximately $0.2 million and $0.5 million for the three- and nine-month periods ended September 30, 2010, respectively, and $0.3 million and $0.4 million for the three- and nine-month periods ended September 30 2009, respectively.
Stock Options
A summary of the Company’s stock options and related activity as of and for the nine months ended September 30, 2010 is presented below:
|
|
|
|
|
| Weighted |
|
|
| ||
|
|
|
|
|
| Average |
|
|
| ||
|
|
|
| Weighted |
| Remaining |
|
|
| ||
|
|
|
| Average |
| Contractual |
| Aggregate |
| ||
|
|
|
| Exercise |
| Term |
| Intrinsic |
| ||
|
| Shares |
| Price |
| (Years) |
| Value |
| ||
|
|
|
|
|
|
|
| (in thousands) |
| ||
Options outstanding at January 1, 2010 |
| 921,400 |
| $ | 7.10 |
|
|
|
|
| |
Granted |
| — |
| — |
|
|
|
|
| ||
Exercised |
| (35,500 | ) | 2.00 |
|
|
|
|
| ||
Expired |
| (31,000 | ) | 9.09 |
|
|
|
|
| ||
Forfeited |
| — |
| — |
|
|
|
|
| ||
Options outstanding at September 30, 2010 |
| 854,900 |
| $ | 7.24 |
| 5.92 |
| $ | 1,250 |
|
Options exercisable at September 30, 2010 |
| 602,900 |
| $ | 7.13 |
| 4.83 |
| $ | 1,025 |
|
The total intrinsic value of stock options exercised during the nine-month period ended September 30, 2010 was $0.2 million. As of September 30, 2010, there was approximately $1.2 million of total unrecognized compensation cost related to unvested stock options. That cost is expected to be recognized over a weighted average period of 2.6 years.
Restricted Stock Awards
In February 2010, the Company granted 28,890 restricted stock awards that vest in one installment on the first anniversary of the date of grant. The grant-date fair value of each award was $5.97 — which was based on the grant-date fair value of our common stock. Holders of the restricted stock awards have voting rights, and vesting of the grants is based on their continued service. Sales of the restricted stock are prohibited until the awards vest. At September 30, 2010, the Company had 28,890 outstanding, unvested restricted stock awards with total unrecognized compensation cost of $0.1 million to be recognized over a weighted average period of 0.2 years.
(14) Net Earnings per Common Share
Earnings per share (“EPS”) is presented for both basic EPS and diluted EPS. We compute basic EPS by dividing net earnings available to common stockholders by the weighted-average number of common shares outstanding during the year. Diluted EPS is computed by dividing net earnings available to common stockholders by the weighted-average number of common shares outstanding during the year, plus the dilutive effect of common stock equivalents such as stock options and warrants. We exclude these common stock equivalents from the computation of diluted EPS when the effect of inclusion would be anti-dilutive.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Basic and diluted net earnings per common share were computed as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands, except per share data) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Net earnings |
| $ | 5,326 |
| $ | 3,588 |
| 20,908 |
| 13,557 |
| ||
Less: net income attributable to the noncontrolling interest |
| 2,767 |
| 1,588 |
| 10,183 |
| 3,167 |
| ||||
Net earnings attributable to FirstCity |
| $ | 2,559 |
| $ | 2,000 |
| $ | 10,725 |
| $ | 10,390 |
|
|
|
|
|
|
|
|
|
|
| ||||
Weighted average outstanding shares of common stock (in thousands) |
| 10,160 |
| 9,838 |
| 10,054 |
| 9,834 |
| ||||
Dilutive effect of: |
|
|
|
|
|
|
|
|
| ||||
Warrants |
| — |
| 276 |
| — |
| 194 |
| ||||
Dilutive effect of stock options |
| 120 |
| 211 |
| 108 |
| 132 |
| ||||
Weighted average outstanding shares of common stock and common stock equivalents |
| 10,280 |
| 10,325 |
| 10,162 |
| 10,160 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net earnings per share: |
|
|
|
|
|
|
|
|
| ||||
Basic |
| $ | 0.25 |
| $ | 0.20 |
| $ | 1.07 |
| $ | 1.06 |
|
Diluted |
| $ | 0.25 |
| $ | 0.19 |
| $ | 1.06 |
| $ | 1.02 |
|
(15) Fair Value
Fair Value Measurements
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. The accounting guidance on fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
· Level 1 — Valuations are based upon quoted prices (unadjusted) in active exchange markets involving identical assets and liabilities that the Company has the ability to access at the measurement date.
· Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar instruments in active markets; quoted prices and valuations for identical or similar instruments in markets that are not active; and model-based valuation techniques with significant assumptions and inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
· Level 3 — Valuations are derived from model-based techniques that use inputs and significant assumptions that are supported by little or no observable market data. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of pricing models, discounted cash flow models and similar techniques.
The level of fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest level input that is most-significant to the fair value measurement in its entirety.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Assets Measured at Fair Value on a Recurring Basis
The table below presents the Company’s balances of assets measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009. The Company did not have any liabilities that were measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009.
|
| At September 30, 2010 |
| ||||||||
(Dollars in thousands) |
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||
Investment securities available for sale: |
|
|
|
|
|
|
|
|
| ||
Marketable equity security |
| $ | 268 |
| — |
| — |
| $ | 268 |
|
Asset-backed security |
| — |
| — |
| 1,921 |
| 1,921 |
| ||
|
| $ | 268 |
| — |
| 1,921 |
| $ | 2,189 |
|
|
|
|
| ||||||||
|
| At December 31, 2009 |
| ||||||||
(Dollars in thousands) |
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||
Investment security available for sale: |
|
|
|
|
|
|
|
|
| ||
Asset-backed security |
| $ | — |
| — |
| 1,836 |
| $ | 1,836 |
|
The Company measures fair value for its asset-backed securities using discounted cash flow models based on assumptions and inputs that are corroborated by little or no observable market data (Level 3 measurement). The Company uses this measurement technique because pricing information and market-participant assumptions for its asset-backed securities are not readily accessible and frequently released to the public. At September 30, 2010 and December 31, 2009, the carrying value of the Company’s asset-backed securities (at fair value) approximated $1.9 million and $1.8 million, respectively. The table below summarizes the changes to these Level 3 assets measured at fair value on a recurring basis for the three- and nine-month periods ended September 30, 2010 and 2009, respectively:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
(Dollars in thousands) |
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
Balance, beginning of period |
| $ | 692 |
| $ | 2,993 |
| $ | 1,836 |
| $ | 5,251 |
|
Total net gains (losses) for the period included in: |
|
|
|
|
|
|
|
|
| ||||
Net income |
| — |
| — |
| 3,250 |
| — |
| ||||
Other comprehensive income (loss) |
| — |
| (10 | ) | (1,115 | ) | (26 | ) | ||||
Purchases, sales, issuances and settlements, net |
| 1,211 |
| (1,228 | ) | (2,049 | ) | (3,470 | ) | ||||
Foreign currency translation adjustments |
| 18 |
| — |
| (1 | ) | — |
| ||||
Net transfers into Level 3 |
| — |
| — |
| — |
| — |
| ||||
Balance, end of period |
| $ | 1,921 |
| $ | 1,755 |
| $ | 1,921 |
| $ | 1,755 |
|
There were no transfers of assets or liabilities recorded at fair value on a recurring basis into or out of Level 3 fair value measurements during the three- or nine-month periods ended September 30, 2010 and 2009.
Assets Measured at Fair Value on a Non-Recurring Basis
The Company may be required, from time to time, to measure certain financial and non-financial assets at fair value on a non-recurring basis. These adjustments to fair value generally result from write-downs of financial and non-financial assets as a result of impairment or application of lower-of-cost or fair value accounting. For assets measured at fair value on a non-recurring basis that were still on the Company’s consolidated balance sheet at September 30, 2010 and December 31, 2009, the following table provides the fair value hierarchy and the carrying value of the related individual assets at each respective period end:
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
|
| Carrying Value at September 30, 2010 |
| ||||||||||
(Dollars in thousands) |
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||||
Portfolio Assets - loans (1) |
| $ | — |
| $ | — |
| $ | 504 |
| $ | 504 |
|
Loans receivable - SBA held for investment (1) |
| — |
| — |
| 563 |
| 563 |
| ||||
Loans receivable - other (1) |
| — |
| — |
| 1,917 |
| 1,917 |
| ||||
Real estate held for sale (2) |
| — |
| 13,563 |
| — |
| 13,563 |
| ||||
Real estate held for investment |
| — |
| 7,095 |
| — |
| 7,095 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
|
| Carrying Value at December 31, 2009 |
| ||||||||||
(Dollars in thousands) |
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||||
Portfolio Assets - loans (1) |
| $ | — |
| $ | — |
| $ | 12,460 |
| $ | 12,460 |
|
Loans receivable - SBA held for investment (1) |
| — |
| — |
| 829 |
| 829 |
| ||||
Real estate held for sale (2) |
| — |
| 7,231 |
| — |
| 7,231 |
|
(1) Represents the carrying value of impaired loans that were measured for impairment using the estimated fair value of the collateral for collateral-dependent loans.
(2) Represents the carrying value of foreclosed real estate properties that were impaired and measured at fair value subsequent to their initial classification as foreclosed assets.
The following table presents the decrease in value of certain assets held at the respective period end that were measured at fair value on a non-recurring basis for which a fair value adjustment was included in the Company’s results of operations during the respective period:
|
| Nine Months Ended |
| ||||
|
| September 30, |
| ||||
(Dollars in thousands) |
| 2010 |
| 2009 |
| ||
Portfolio Assets - loans (1) |
| $ | (519 | ) | $ | (1,007 | ) |
Loans receivable - SBA held for investment (1) |
| (215 | ) | (430 | ) | ||
Loans receivable - other (1) |
| (1,168 | ) | — |
| ||
Real estate held for sale (2) |
| (2,079 | ) | (583 | ) | ||
Real estate held for investment |
| (1,922 | ) | — |
| ||
Total |
| $ | (5,903 | ) | $ | (2,020 | ) |
(1) Represents write-downs of loans based on the estimated fair value of the collateral for collateral-dependent loans.
(2) Represents losses on foreclosed real estate properties that were measured at fair value subsequent to their initial classification as foreclosed assets.
The fair values of “Portfolio Assets — loans,” “Loans receivable — SBA held for investment” and “Loans receivable — other,” as measured on a non-recurring basis, are based on collateral valuations using observable and unobservable inputs, adjusted for various considerations such as market conditions, economic and competitive environment, and other assets with similar characteristics (i.e. type, location, etc.) that, in management’s opinion, reflect elements a market participant would consider. The Company classifies its fair value measurement techniques for these assets as Level 3 inputs for the following reasons: (1) distressed asset transactions generally occur in inactive markets for which observable market prices are not readily available (i.e. price quotations vary substantially over time and among market-makers, and pricing information is generally not released to the public); and (2) the Company’s valuation techniques that are most-significant to the fair value measurements are principally derived from assumptions and inputs that are corroborated by little or no observable market data.
The fair values of “Real estate held for sale” and “Real estate held for investment,” as measured on a non-recurring basis, are generally based on collateral valuations using observable inputs.
We attempt to base our fair values on the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs, when reasonably available and without undue cost, and minimize the use of unobservable inputs when developing fair value measurements in accordance with the fair value hierarchy. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based principally on our own estimates and assumptions, are often calculated based on collateral valuations adjusted for the economic and
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
competitive environment, the characteristics of the asset, and other such factors. Additionally, there may be inherent weaknesses in any valuation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future values.
Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis
In addition to the methods and assumptions we use to measure the fair value of financial instruments as discussed in the section above, we used the following methods and assumptions to estimate the fair value of our financial instruments that are not recorded at fair value in their entirety on a recurring basis in the Company’s consolidated balance sheets. The fair value estimates were based on pertinent information that was available to management as of the respective dates. The fair value estimates have not been revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented. The amounts provided herein are estimates of the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (i.e. not a forced transaction, such as liquidation or distressed sale). Because active markets do not exist for a significant portion of the Company’s financial instruments, management used present value techniques and other valuation models to estimate the fair values of its financial instruments. These valuation methods require considerable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current exchange. The Company believes the imprecision of an estimate could be significant.
Cash and Cash Equivalents: The carrying amount of cash and cash equivalents approximated fair value at September 30, 2010 and December 31, 2009.
Loans Receivable Held-for-Sale: Loans held-for-sale (primarily SBA loans held-for-sale) are carried on the Company’s consolidated balance sheet at the lower of cost or fair value. The fair value of loans held-for-sale is generally based on what secondary markets are currently offering for loans with similar characteristics, or prices of the Company’s SBA loan transactions that were previously consummated and pending sales accounting treatment. At September 30, 2010 and December 31, 2009, the carrying amount of loans held-for-sale approximated $8.3 million and $0.8 million, respectively, and the estimated fair values approximated $9.2 million and $0.9 million, respectively.
Loan Portfolio Assets and Loans Receivable: Estimated fair values of loan Portfolio Assets and fixed-rate loans receivable are generally determined using a discounted cash flow model, adjusted by an amount for estimated losses, that employs market discount rates and other adjustments that would be expected to be made by a market participant. The estimated fair value for variable-rate loans that re-price frequently is based on carrying values adjusted for estimated credit losses and other adjustments that would be expected to be made by a market participant. The estimated fair value for impaired loans is generally based on collateral valuations using observable and unobservable inputs, adjusted for various considerations that would be expected to be made by a market participant; or discounted cash flow models that employ market discount rates and other adjustments that would be expected to be made by a market participant. Management’s estimates and assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market and specific borrower information. At September 30, 2010 and December 31, 2009, the carrying amounts of Portfolio Assets — loans and loans receivable (including accrued interest) approximated $226.6 million and $253.0 million, respectively, and the estimated fair values approximated $343.6 million and $371.1 million, respectively.
Servicing Assets: The fair value of servicing assets is based on a combination of a discounted cash flow model of future net servicing income and analysis of current market data to estimate the fair value of our servicing assets. The key assumptions used to calculate estimated fair value of the servicing assets include prepayment speeds and discount rate. The fair value estimate excludes the value of servicing rights for loans sold with premium recourse provisions in which the servicing rights have not been capitalized. See Note 7 for the carrying amount and estimated fair values of servicing assets as of September 30, 2010 and December 31, 2009.
Notes Payable: Management believes the interest rates and terms on its debt obligations approximate the rates and terms currently offered by other lenders for similar debt instruments of comparable terms. As such, management believes that the carrying amount of notes payable approximates fair value at September 30, 2010 and December 31, 2009.
Note Payable to Affiliate: Estimated fair value of the Company’s note payable to affiliate (including related interest payable) is based on the present value of future projected cash flows using a discount rate that reflects the risks inherent in those cash flows. At September 30, 2010 and December 31, 2009, the carrying amount of the note and interest payable to affiliate was $11.3 million and $10.3 million, respectively, and the estimated fair values approximated $7.5 million and $6.5 million, respectively.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(16) Variable Interest Entities
In the normal course of business, the Company enters into various types of on- and off-balance sheet transactions with entities that involve variable interests. Variable interests are generally defined as contractual, ownership or other economic interests in an entity that change with fluctuations in the entity’s net asset value. If certain characteristics are present in these transactions, the entity is subject to a variable interests consolidation analysis, and consolidation is based on variable interests, and not solely on ownership of the entity’s outstanding voting stock. In making the determination as to whether an entity is considered to be a variable interest entity (“VIE”), we first perform a qualitative analysis, which requires certain subjective decisions regarding our assessments, including, but not limited to, the design of the entity, the variability that the entity was designed to create and pass along to its interest holders, the rights of the parties, and the purpose of the arrangement. If we cannot conclude after a qualitative analysis whether an entity is a VIE, we perform a quantitative analysis.
If an entity is determined to be a VIE, we determine if our variable interest causes us to be considered the primary beneficiary. We are the primary beneficiary and are required to consolidate the entity if we have the power to direct the activities of the VIE that most-significantly impact the entity’s economic performance and we have the obligation to absorb losses or the right to receive returns that could be significant to the entity. The assessment of the party that has the power to direct the activities of the VIE may require significant management judgment when more than one party has power, or more than one party is involved in the design of the VIE but no party has the power to direct the ongoing activities that could be significant. We are required to continually assess whether we are the primary beneficiary and, therefore, may consolidate a VIE through the duration of our involvement.
The following provides a summary for which the Company has entered into significant transactions with different types of VIEs:
Acquisition Partnership VIEs — The Company is involved with Acquisition Partnerships that were formed with one or more investors to invest in Portfolio Assets. These Acquisition Partnerships are typically financed through debt and/or equity provided by the investors (including FirstCity). Certain of these Acquisition Partnerships are VIEs because generally they do not have sufficient equity to finance their activities without additional subordinated financial support, or the investors do not have the ability to make significant decisions about the Acquisition Partnership’s activities. The voting interests for all but three of the Acquisition Partnership VIEs are either wholly-owned or majority-owned by non-affiliated investors, and the Company determined that it was not the primary beneficiary of these minority-owned Acquisition Partnership VIEs. However, the Company is deemed to be the primary beneficiary for three Acquisition Partnership VIEs in which the Company and respective non-affiliated investors each hold equal ownership and voting interests. The investors and third-party creditors, including FirstCity, generally have recourse only to the extent of the assets held by the Acquisition Partnership VIEs. Certain third-party creditors have recourse to both FirstCity and the non-affiliated investors where we jointly provide a guaranty to the Acquisition Partnership VIE. The Company does not generally provide financial support to any Acquisition Partnership VIE beyond that which is contractually required, but may provide additional liquidity alongside the non-affiliated investors to fund additional investments.
Operating Entity VIEs — The Company has significant variable interests with various commercial enterprise entities (attributable primarily to certain equity and debt investments made by FirstCity Denver — our Special Situations Platform business). FirstCity provided financing in the form of debt and/or equity to help finance the activities of the Operating Entity VIEs. These Operating Entities are VIEs because generally they do not have sufficient equity to finance their activities without additional subordinated financial support. The voting interests for all of the Operating Entity VIEs are either wholly-owned or majority-owned by non-affiliated investors, and the Company determined that it was not the primary beneficiary of these minority-owned Operating Entity VIEs. The investors and creditors, including FirstCity, generally have recourse only to the extent of the assets held by the Operating Entity VIEs. The Company does not generally provide financial support to any Operating Entity VIE beyond that which is contractually required.
Special-Purpose Investment Entity VIEs — The Company has significant variable interests with special-purpose investment entities that were created to invest in Portfolio Assets, debt and equity investments, and various other types of investments. Certain of these special-purpose investment entities are VIEs because they do not have sufficient equity to finance their activities without additional subordinated financial support. The Company owns all of the voting and equity interests in the Special-Purpose Investment Entity VIEs, and the Company was determined to be the primary beneficiary of these entities. A third-party creditor has recourse to FirstCity up to $75.0 million under a limited guaranty provision related to the debt of these entities, which is collateralized by their assets, only to the extent that such pledged assets of the Special-Purpose Investment Entity VIEs do not generate sufficient cash to service and
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
repay the debt (see Note 8). The Company does not generally provide financial support to the Special-Purpose Investment Entity VIEs beyond that which is contractually required.
The following table displays the carrying amount and classification of assets and liabilities of the Company’s consolidated VIEs, for which the Company does not hold a majority voting interest, that are included in its consolidated balance sheet as of September 30, 2010. We record third-party ownership in these consolidated VIEs in “Noncontrolling interests” in our consolidated balance sheet.
|
| Acquisition |
| |
|
| Partnership VIEs |
| |
|
| (Dollars in |
| |
Cash |
| $ | 1,418 |
|
Portfolio Assets, net |
| 39,155 |
| |
Other assets |
| 14 |
| |
Total assets of consolidated VIEs |
| $ | 40,587 |
|
|
|
|
| |
Total liabilities of consolidated VIEs |
| $ | 468 |
|
The following table summarizes the carrying amounts of the assets included in the Company’s consolidated balance sheet and the maximum loss exposure as of September 30, 2010 related to the Company’s variable interests in unconsolidated VIEs.
|
| Assets on FirstCity’s |
| FirstCity’s |
| |||||
|
| Loans |
| Equity |
| Exposure |
| |||
Type of VIE |
| Receivable |
| Investment |
| to Loss (1) |
| |||
|
| (Dollars in thousands) |
| |||||||
Acquisition Partnership VIEs |
| $ | 1,575 |
| $ | 2,058 |
| $ | 5,462 |
|
Operating Entity VIEs |
| 10,072 |
| (408 | ) | 9,664 |
| |||
Total |
| $ | 11,647 |
| $ | 1,650 |
| $ | 15,126 |
|
(1) Includes maximum exposure to loss attributable to FirstCity’s debt guarantees provided for certain Acquisition Partnership VIEs.
(17) Other Related Party Transactions
The Company has contracted with the Acquisition Partnerships and related parties as a third party loan servicer. Servicing fees and due diligence fees (included in other income) derived from such affiliates totaled $2.1 million and $2.0 million for the three month periods ended September 30, 2010 and 2009, respectively, and $5.5 million and $6.3 million for the nine month periods ended September 30, 2010 and 2009, respectively.
FC Servicing and MCS et Associates (“MCS”), an equity-method investee of FirstCity in which FC Servicing has a direct 11.89% ownership interest, are parties to certain agreements in which FC Servicing provides consultation services and personnel to be employed by MCS to assist in developing and managing due diligence and servicing systems. Under these agreements, MCS provides the supplied personnel with compensation, tax equalization payments, housing allowances, transportation allowance, and tax preparation services. MCS also pays consulting fees to FC Servicing and reimburses FC Servicing for travel, hotel, airfare, and meal expenses incurred related to the provision of the services. FirstCity recorded fees from MCS of $0.1 million during each of the three-month periods ended September 30, 2010 and 2009, and $0.3 million during each of the nine-month periods ended September 30, 2010 and 2009.
Through a series of related-party transactions in 2008, FC Acquisitions SRL de CV (“FC Acquisitions”), a majority-owned Mexican subsidiary of FirstCity, acquired a loan portfolio in Mexico. The final funding for this transaction resulted in a note payable to MCS Trust SA de CV (“MCS Trust”) by FC Acquisitions, and a note receivable from MCS Trust held by BMX Holding III LLC (“BMX Holding III”), a majority-owned subsidiary of FirstCity. The accounts of MCS Trust are consolidated by BMX Holding II, a FirstCity equity-method investee in which it has an 8.0% ownership interest. At September 30, 2010 and December 31, 2009, the note
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
receivable held by BMX Holding III had a carrying amount of $7.7 million and $7.8 million, respectively (included in “Loans receivable — affiliates” on the Company’s consolidated balance sheet), and accrued interest of $3.7 million and $2.5 million, respectively (included in “Other assets, net” on the Company’s consolidated balance sheet). At September 30, 2010 and December 31, 2009, the note payable to MCS Trust had a carrying amount of $7.7 million and $7.8 million, respectively (reported as “Notes payable to affiliate” on the Company’s consolidated balance sheet), and accrued interest of $3.7 million and $2.5 million, respectively (included in “Other liabilities” on the Company’s consolidated balance sheet). Should the note payable be forgiven at some future date, the corresponding note receivable would be forgiven as well.
(18) Segment Reporting
At September 30, 2010 and 2009, the Company was engaged in two major business segments — Portfolio Asset Acquisition and Resolution business and Special Situations Platform business.
In the Portfolio Asset Acquisition and Resolution business, the Company acquires and resolves Portfolio Assets, which are generally acquired at a discount to their legal principal balance or appraised value. Purchases may be in the form of pools of assets or individual assets. The Portfolio Assets are generally aggregated, including loans of varying qualities that are secured or unsecured by diverse collateral types and real estate. Some Portfolio Assets are loans for which resolution is linked primarily to the real estate securing the loan, while others may be collateralized business loans for which resolution may be based either on real estate, business assets or other collateral cash flow. Portfolio Assets are acquired on behalf of the Company or its consolidated subsidiaries, and on behalf of domestic and foreign Acquisition Partnerships in which a partially-owned affiliate of the Company is the general partner and the Company and other investors are limited partners. The Company services, manages and ultimately resolves or otherwise disposes of substantially all Portfolio Assets acquired by the Company, its Acquisition Partnerships, or other related entities. The Company services such assets until they are collected or sold.
The Company engages in its Special Situations Platform business through its majority ownership interest in FirstCity Denver — which was formed in April 2007. Through its Special Situations Platform business, the Company provides investment capital to privately-held middle-market companies through flexible capital structuring arrangements. The nature of the capital investments primarily takes the form of senior and junior financing arrangements, but also includes direct equity investments, common equity warrants, distressed debt transactions, and leveraged buyouts. FirstCity Denver’s primary investment objective is to generate both current income and capital appreciation through debt and equity investments, and to generally structure the investments to be repaid or exited in 24 to 60 months.
Operating segment revenues and profitability, and a reconciliation to net earnings for the three and nine months ended September 30, 2010 and 2009, are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Portfolio Asset Acquisition and Resolution: |
|
|
|
|
|
|
|
|
| ||||
Total revenues |
| $ | 12,823 |
| $ | 16,817 |
| $ | 49,358 |
| $ | 49,083 |
|
Operating contribution, net of direct taxes |
| $ | (3,346 | ) | $ | 2,028 |
| $ | 2,795 |
| $ | 14,082 |
|
|
|
|
|
|
|
|
|
|
| ||||
Special Situations Platform: |
|
|
|
|
|
|
|
|
| ||||
Total revenues |
| $ | 17,410 |
| $ | 1,820 |
| $ | 45,422 |
| $ | 5,733 |
|
Operating contribution (loss), net of direct taxes |
| $ | 8,013 |
| $ | 1,615 |
| $ | 13,991 |
| $ | 1,820 |
|
|
|
|
|
|
|
|
|
|
| ||||
Total operating contribution, net of direct taxes |
| $ | 4,667 |
| $ | 3,643 |
| $ | 16,786 |
| $ | 15,902 |
|
|
|
|
|
|
|
|
|
|
| ||||
Corporate Overhead: |
|
|
|
|
|
|
|
|
| ||||
Salaries and benefits and other income and expenses, net |
| 2,223 |
| 1,754 |
| 5,996 |
| 5,533 |
| ||||
Income tax expense (benefit) |
| (115 | ) | (111 | ) | 65 |
| (21 | ) | ||||
Net earnings attributable to FirstCity |
| $ | 2,559 |
| $ | 2,000 |
| $ | 10,725 |
| $ | 10,390 |
|
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Revenues and equity in earnings of investments from the Special Situations Platform segment are all attributable to domestic operations. Revenues and equity in earnings of unconsolidated equity-method investments from the Portfolio Asset Acquisition and Resolution segment are attributable to domestic and foreign operations as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Domestic |
| $ | 7,543 |
| $ | 12,506 |
| $ | 31,752 |
| $ | 38,024 |
|
Latin America |
| 2,466 |
| 2,811 |
| 7,159 |
| 8,085 |
| ||||
Europe |
| 1,368 |
| 457 |
| 10,194 |
| 2,770 |
| ||||
Other |
| — |
| — |
| — |
| 16 |
| ||||
Total |
| $ | 11,377 |
| $ | 15,774 |
| $ | 49,105 |
| $ | 48,895 |
|
Total assets for each of the segments and a reconciliation to total assets follows:
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Cash and cash equivalents |
| $ | 35,549 |
| $ | 80,368 |
|
Restricted cash |
| 1,356 |
| 1,364 |
| ||
Portfolio acquisition and resolution assets: |
|
|
|
|
| ||
Domestic |
| 246,732 |
| 225,406 |
| ||
Latin America |
| 39,077 |
| 41,248 |
| ||
Europe |
| 50,060 |
| 57,888 |
| ||
Special situations platform assets |
| 50,337 |
| 41,688 |
| ||
Other non-earning assets, net |
| 22,052 |
| 17,112 |
| ||
Total assets |
| $ | 445,163 |
| $ | 465,074 |
|
(19) Commitments and Contingencies
Legal Proceedings
There have been no material developments regarding any matters disclosed under Part I, Item 3 “Legal Proceedings” in our 2009 Form 10-K.
Investment Agreement with Värde Investment Partners, L.P.
Effective April 1, 2010, FC Diversified Holdings LLC (“FC Diversified”) and FC Servicing, wholly-owned subsidiaries of FirstCity, and Värde Investment Partners, L.P. (“Värde”), entered into an Investment Agreement that provides, among other things, a “right of first refusal” provision. Pursuant to the Investment Agreement, FC Diversified and FC Servicing granted Värde a right of first refusal to participate in distressed asset investment opportunities in which the aggregate amount of the proposed investment is to exceed $3.0 million. FC Diversified and FC Servicing are required to follow a prescribed notice procedure pursuant to which Värde has the option to participate in a proposed investment, whether in the form of a direct purchase, equity investment or loan, by requiring that the purchase, acquisition or loan be effected through an acquisition entity formed by FC Diversified (or its affiliate) and Värde (or its affiliate). An affiliate of FC Diversified will own from 5% to 25% of the acquisition entity at FC Diversified’s determination. The Investment Agreement has a termination date of June 30, 2015, which is subject to consecutive automatic one-year extensions without any action by FC Diversified, FC Servicing and Värde. FC Servicing will be the servicer for all of the acquisition entities formed by FC Diversified and Värde. The parties may terminate the Investment Agreement prior to June 30, 2015 under certain conditions.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Indemnification Obligation Commitments
On August 8, 2006, an Interest Purchase and Sale Agreement (“IP&S Agreement”) was entered into by and among Bidmex Holding LLC (“Bidmex Holding”), as buyer, and Strategic Mexican Investment Partners L.P. (“SMIP”), a wholly-owned subsidiary of FirstCity, and Cargill Financial Services International Inc. (“CFSI”), (collectively, the “Sellers”), as seller, and eleven U.S. limited liability companies (“LLCs”) which invested in Mexican portfolio acquisition entities (“SRLs”) and the AIG entities as additional parties. In the IP&S Agreement, the Sellers and the LLCs made various representations and warranties concerning (i) the existence and ownership of the LLCs and the related SRLs, (ii) the assets and liabilities of the LLCs, (iii) taxes related to periods prior to August 8, 2006, and (iv) the operations of the LLCs and SRLs. The Sellers agreed to indemnify Bidmex Holding and AIG Entities from damages resulting from a breach of any representation or warranty contained in the IP&S Agreement on a several and not joint basis according to their respective ownership percentages in each LLC as to any matter related to a particular LLC, or on the basis of 80% to CFSI and 20% to SMIP as to any matter that could not be identified to a particular LLC. The indemnity obligation under the IP&S Agreement survives for a period of the statute of limitations for matters related to taxes, existence and authority, capitalization and good standing of the LLCs and SRLs. The Sellers are not required to make any payments as a result of the indemnity provisions of the IP&S Agreement until the aggregate amount payable under that agreement and the Asset Purchase Agreement (defined below) exceeds $250,000; however, claims related to taxes and fraud are not subject to this $250,000 threshold. The IP&S Agreement limits the liability of the Sellers for indemnifiable losses to the Aggregate Purchase Price (defined below) (without duplication of amounts recovered pursuant to the terms of the Asset Purchase Agreement). At this time, management does not believe that this potential obligation will have a material adverse impact on the Company’s consolidated results of operations, financial position or liquidity.
Also on August 8, 2006, Bidmex Holding entered into an Agreement for the Onerous Transfer of Loans and Litigious Rights (the “Asset Purchase Agreement”) between and among Residencial Oeste S. de R.L. de C.V., as seller (the “Asset Seller”), an affiliate of CFSI and SMIP, Residencial Oeste 2 S. de R.L. de C.V., as purchaser (the “Asset Purchaser”), and CFSI, SMIP, and Bidmex Acquisition LLC, the parent of the Asset Purchaser, as additional parties. The Asset Purchase Agreement provided for the sale of the loan portfolio owned by the Asset Seller to the Asset Purchaser for a purchase price of $10.1 million on the closing date, which purchase price is part of the Aggregate Purchase Price. In the Asset Purchase Agreement, the Asset Seller and the Sellers made various representations and warranties concerning (i) the existence and ownership of the Seller, (ii) the ownership of the loan portfolio, (iii) taxes related to periods arising prior to the closing date, and (iv) the existence of the loans comprising the loan portfolio and other matters related to the loan portfolio. The Asset Seller agreed to indemnify the Asset Purchaser from damages resulting from a breach of any representation or warranty. The indemnity obligation under the Asset Purchase Agreement survives for a period of the statute of limitations for matters related to existence and ownership of the Seller, ownership of the loans, and taxes for periods prior to August 8, 2006. The Seller is not required to make any payments as a result of the indemnity provisions of the Asset Purchase Agreement until the aggregate amount payable under that Agreement exceeds $25,000; however, claims related to taxes and fraud are not subject to this $25,000 threshold. The IP&S Agreement limits the liability of the Sellers for indemnifiable losses under the Asset Purchase Agreement to the Aggregate Purchase Price. At this time, management does not believe that this potential obligation will have a material adverse impact on the Company’s consolidated results of operations, financial position or liquidity.
Subordinated Equity Investment
During the period from December 1998 to March 2005, FirstCity Mexico Inc. and SMIP, each wholly-owned subsidiaries of FirstCity, and CFSI and, in some instances, other investors, acquired 12 residential and commercial non-performing loan portfolios from financial institutions in Mexico (the “Mexican Portfolios”). Each portfolio was acquired by a Mexican limited liability company (each a “Mexican SRL”) that was owned by a Delaware limited liability company formed by each investor group. On August 8, 2006, SMIP and National Union Fire Insurance Company of Pittsburgh, Pa., American General Life Insurance Company and American General Life and Accident Insurance Company, affiliates of AIG Global Asset Management Holdings Corp. (collectively the “AIG Entities”) formed Bidmex Holding for the purpose of acquiring the Mexican Portfolios by purchasing the interests of Cargill and SMIP in eleven of the Mexican limited liability companies (the “LLCs”) and purchasing the loan portfolio of one of the Mexican limited liability companies (the “Purchased Portfolio”) for an aggregate purchase price of U.S. $119.3 million as of that date (the “Aggregate Purchase Price”). SMIP acquired 15% of the membership interests in Bidmex Holding. A 9% interest acquired by SMIP is of equivalent standing to membership interests held by the AIG affiliates representing 85% of the membership interests. The remaining 6% membership interest acquired by SMIP is subordinate to the other owners of interests in Bidmex Holding, who will receive the return of and a return on their contribution equivalent to an 9% internal rate of return with respect to their interests prior to SMIP receiving the return of and a return on its capital contribution equivalent to a 9% internal rate of return with respect to its 6% interest. At September 30, 2010, the carrying value of SMIP’s membership interests in Bidmex Holding that is included in the
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Company’s consolidated balance sheet as an equity-method investment approximated $11.0 million ($5.2 million for the 9% membership interest and $5.8 million for the 6% membership interest).
Guarantees and Letters of Credit
FC Commercial and FH Partners, as borrowers, have a term loan with Bank of Scotland. FirstCity provides a limited guaranty for the repayment of the indebtedness under this loan to a maximum amount of $75.0 million, plus costs of enforcement and certain contingent indemnities. At September 30, 2010, the unpaid principal balance on this loan was $227.9 million. Refer to Note 8 for additional information.
American Business Lending, Inc. (“ABL”), a wholly-owned subsidiary of FirstCity, has a $25.0 million revolving loan facility with Wells Fargo Capital Finance (“WFCF”). The obligations under this facility are secured by substantially all of the assets of ABL, and FirstCity provides WFCF with an unconditional guaranty on ABL’s obligations under the loan facility up to a maximum of $5.0 million plus enforcement cost. At September 30, 2010, the unpaid principal balance on this loan facility was $15.1 million.
FC Commercial provides guarantees to various financial institutions related to their financing arrangements with certain Acquisition Partnerships. The underlying financing arrangements of these Acquisitions Partnerships have various maturities ranging from October 2011 to July 2013, and are secured primarily by certain real estate properties held by the Acquisition Partnerships. At September 30, 2010, the unpaid debt obligations of these Acquisition Partnerships attributed to FC Commercial’s underlying guaranties approximated $1.4 million.
Fondo de Inversion Privado NPL Fund One (“PIF1”), an equity-method investment of FirstCity, has a credit facility with Banco Santander Chile, S.A. with an unpaid principal balance of $9.2 million at September 30, 2010. PIF1 uses the credit facility to finance the purchases of loan portfolios. Pursuant to terms of the credit facility, FirstCity was required to provide a stand-by letter of credit from Bank of Scotland that would satisfy the current loan balance upon demand. At September 30, 2010, FirstCity had a letter of credit in the amount of $9.5 million from Bank of Scotland under the terms of FirstCity’s loan facility with Bank of Scotland, with Banco Santander Chile, S.A. as the letter of credit beneficiary. In the event that a demand is made under the $9.5 million letter of credit, FirstCity would be required to reimburse Bank of Scotland by making payment to Bank of Scotland for all amounts disbursed or to be disbursed by Bank of Scotland under the letter of credit.
FirstCity Mexico SA de CV, a wholly-owned Mexican affiliate of FirstCity, has a loan agreement with Banco Santander, S.A. that allows loans to be made in Mexican pesos. At September 30, 2010, the Company had 142,240,000 in Mexican peso-denominated debt, which was equivalent to $11.4 million U.S. dollars. The proceeds were used to pay down the acquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CV was required to provide a stand-by letter of credit from Bank of Scotland that would satisfy the loan balance upon demand. At September 30, 2010, FirstCity had a letter of credit in the amount of $12.6 million from Bank of Scotland under the terms of FirstCity’s Reducing Note Facility with Bank of Scotland. In October 2010, the letter of credit was funded in the amount of $11.9 million, and the proceeds were used to pay-off FirstCity Mexico SA de CV’s note payable to Banco Santander, S.A. The entire amount of the funded letter of credit was added to the unpaid principal obligation of FirstCity’s Reducing Note Facility with Bank of Scotland (see Note 8).
Environmental Matters
The Company generally retains environmental consultants to conduct or update environmental assessments in connection with the Company’s foreclosed and acquired real estate properties. These environmental assessments have not revealed environmental conditions that the Company believes will have a material adverse effect on its business, assets, financial condition, results of operations or liquidity, and the Company is not otherwise aware of environmental conditions with respect to properties that the Company believes would have such a material adverse effect. However, from time to time, environmental conditions at the Company’s properties have required and may in the future require environmental testing and/or regulatory filings, as well as remedial action. Liabilities for future remediation costs are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Other than for assessments, the timing and magnitude of these accruals generally are based on the completion of investigations or other studies or a commitment to a formal plan of action.
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Limited-Life Subsidiaries
At September 30, 2010, the estimated settlement value of the Company’s noncontrolling interests in consolidated limited-life subsidiaries approximated $2.0 million. The Company’s carrying value of the noncontrolling interests recognized on the consolidated balance sheet related to these limited-life subsidiaries approximated $0.5 million at September 30, 2010.
Income Taxes
We are subject to income taxes in both the United States and the non-U.S. jurisdictions in which we operate. Certain of our entities are under examination by the relevant taxing authorities for various tax years. We regularly assess the potential outcome of current and future examinations in each of the taxing jurisdictions when determining the adequacy of the provision for income taxes. We have only recorded financial statement benefits for tax positions which we believe reflect the “more-likely-than-not” criteria incorporated in the FASB’s authoritative guidance on accounting for uncertainty in income taxes, and we have established income tax reserves in accordance with this authoritative guidance where necessary. Once a financial statement benefit for a tax position is recorded or a tax reserve is established, we adjust it only when there is more information available or when an event occurs necessitating a change. While we believe that the amount of the recorded financial statement benefits and tax reserves reflect the more-likely-than-not criteria, it is possible that the ultimate outcome of current or future examinations may result in a reduction to the tax benefits previously recorded on the financial statements or may exceed the current income tax reserves in amounts that could be material.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
FirstCity is a multi-national specialty financial services company that engages in two major business segments — Portfolio Asset Acquisition and Resolution and Special Situations Platform. The Portfolio Asset Acquisition and Resolution business has been the Company’s core business segment since it commenced operations in 1986. In the Portfolio Asset Acquisition and Resolution business, the Company acquires portfolios of performing and non-performing loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), generally at a discount to their legal principal balances or appraised values, and services and resolves (i.e. liquidates) such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. FirstCity acquires the Portfolio Assets for its own account or through investment entities formed with co-investors (each such entity, an “Acquisition Partnership”).
Through its Special Situations Platform, the Company provides investment capital to privately-held middle-market companies through flexible capital structuring arrangements to generate an attractive risk-adjusted return. These capital investments primarily take the form of senior and junior financing arrangements, but also include direct equity investments, common equity warrants, distressed debt transactions, and leveraged buyouts.
Summary Financial Results
FirstCity recorded net earnings of $2.6 million, or $0.25 per common share diluted, for the third quarter of 2010 (“Q3 2010”), compared to $2.0 million, or $0.19 per common share diluted, for the third quarter of 2009 (“Q3 2009”). FirstCity recorded net earnings of $10.7 million, or $1.06 per common share diluted, for the nine-month period ended September 30, 2010 (“YTD 2010”), compared to $10.4 million, or $1.02 per common share diluted, for the nine-month period ended September 30, 2009 (“YTD 2009”). Components of FirstCity’s results of operations for the three and nine-month periods ended September 30, 2010 and 2009, respectively, are detailed below (dollars in thousands, except per share data):
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
| (Dollars in thousands, except per share data) |
| ||||||||||
Portfolio Asset Acquisition and Resolution |
| $ | (3,346 | ) | $ | 2,028 |
| $ | 2,795 |
| $ | 14,082 |
|
Special Situations Platform |
| 8,013 |
| 1,615 |
| 13,991 |
| 1,820 |
| ||||
Operating contribution |
| 4,667 |
| 3,643 |
| 16,786 |
| 15,902 |
| ||||
Corporate overhead |
| (2,108 | ) | (1,643 | ) | (6,061 | ) | (5,512 | ) | ||||
Net earnings attributable to FirstCity |
| $ | 2,559 |
| $ | 2,000 |
| $ | 10,725 |
| $ | 10,390 |
|
Diluted earnings per common share |
| $ | 0.25 |
| $ | 0.19 |
| $ | 1.06 |
| $ | 1.02 |
|
Refer to the heading “Results of Operations” below for a detailed review of the Company’s operations for the comparative periods presented in the table above.
Portfolio Asset Acquisition and Resolution. The Company’s quarterly earnings related to its Portfolio Asset Acquisition and Resolution business segment decreased to a $3.3 million loss in Q3 2010 from $2.0 million of earnings in Q3 2009. The decrease in earnings in Q3 2010 compared to Q3 2009 was primarily due to a $1.8 million increase in net impairment provisions recorded to consolidated assets and a $3.9 million decrease in Portfolio Assets income. The Company’s year-to-date earnings related to this business segment decreased to $2.8 million in YTD 2010 from $14.1 million in YTD 2009. The decrease in earnings in YTD 2010 compared to YTD 2009 was primarily due to a $4.2 million increase in net impairment provisions recorded to consolidated assets, a $4.4 million increase in net income attributable to noncontrolling interests, a $1.3 million increase in interest and fees on notes payable, and a $1.3 million increase in asset-level expenses, off-set partially by a $3.3 million gain that was recorded in YTD 2010 on the sale of an investment security. Refer to the heading “Results of Operations” below for a detailed review of the Company’s operations in this business segment for the comparative periods presented in the table above.
Special Situations Platform. The Company’s quarterly earnings related to its Special Situations Platform business segment increased to $8.0 million in Q3 2010 from $1.6 million in Q3 2009. The increase in earnings in Q3 2010 compared to Q3 2009 was primarily due to a $9.9 million increase in equity in earnings of unconsolidated subsidiaries, off-set partially by a $1.9 million increase in net impairment provisions recorded to consolidated assets and a $1.3 million increase in net income attributable to noncontrolling
interests. The Company’s year-to-date earnings related to this business segment increased to $14.0 million in YTD 2010 from $1.8 million in YTD 2009. The increase in earnings in YTD 2010 compared to YTD 2009 was primarily due to a $12.6 million increase in equity in earnings of unconsolidated subsidiaries and a $4.8 million business combination gain that was recorded in YTD 2010, off-set partially by a $2.1 million increase in net impairment provisions recorded to consolidated assets and a $2.6 million increase in net income attributable to noncontrolling interests. Refer to the heading “Results of Operations” below for a detailed review of the Company’s operations in this business segment for the comparative periods presented in the table above.
Summary Investment Activity
In Q3 2010, FirstCity and its investment partners acquired $15.0 million of domestic Portfolio Asset investments with a face value of approximately $27.0 million — of which FirstCity’s investment acquisition share was $10.5 million. In addition to its Portfolio Asset acquisitions in Q3 2010, FirstCity invested $5.1 million in non-portfolio investments, consisting of $3.4 million in the form of SBA loan originations and advances; $1.6 million of equity investments in foreign partnerships; and $0.1 million in the form of equity investments under its Special Situations Platform (“FirstCity Denver”).
At September 30, 2010, the carrying value of FirstCity’s earning assets (primarily Portfolio Assets, equity investments, loans receivable and entity-level earning assets) approximated $386.2 million — compared to $366.2 million at December 31, 2009 and $393.0 million a year ago. The global distribution of FirstCity’s earning assets (at carrying value) at September 30, 2010 included $297.0 million in the United States; $50.1 million in Europe; and $39.1 million in Latin America.
Refer to the headings “Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment” and “Middle-Market Company Capital Investments — Special Situations Platform Business Segment” below for additional information related to our investment activities and composition.
Management’s Outlook
Our revenues consist primarily of (1) income from our Portfolio Assets, loan investments and Acquisition Partnerships; (2) servicing fee income and incentive income based on the performance of the portfolio assets that we manage; and (3) income generated by our debt and equity investments (consolidated and unconsolidated) in privately-held middle-market companies. Our ability to maintain and grow revenues depends on our ability to secure investment opportunities, obtain financing for transactions, and to consummate investments and deliver attractive risk-adjusted returns. Our ability to execute this strategy depends upon a number of market conditions — including the strength and liquidity of U.S. and global economies and financial markets.
While we are seeing signs of improvement and stabilization in U.S. and global economic conditions and financial markets, these conditions and markets remain challenging and their recovery has been imbalanced. Despite substantial losses reported in the financial services sector over the past two years, and continued volatility and uncertainty in U.S. and global economies and financial markets, management remains positive on the outlook of the Company and believes that current market conditions should not hinder FirstCity’s ability to expand its business. While disruptions and uncertainty in the markets may adversely effect our existing positions, we believe such conditions generally present significant new investment opportunities for distressed asset acquisition and middle-market transactions. At the moment, however, we believe that challenging market conditions and government-implemented programs and regulations have reduced transaction flow in the marketplace, and that distressed asset prices have yet to fall to levels commensurate with expectations of market participants. Due to the difficulty and challenges related to servicing and resolving these underperforming and non-performing assets, we believe that financial institutions and other entities will actively seek to shed these assets over time as economic conditions and financial markets stabilize and government-imposed restrictions lapse. Sales of such assets improve the sellers’ financial position (i.e. asset quality and capital positions), reduce overhead costs and staffing requirements, and reduce management and personnel distractions associated with the intensive and time-consuming task of resolving loans and disposing of real estate.
Market commentators and analysts have expressed the belief that it will take some time for the U.S. and global economies and financial markets to fully recover, but it is not clear if adverse conditions will again intensify. As a result, the continued challenging economic conditions could still materially and adversely impact (i) our ability to price and fund new distressed asset and middle-market capital investment opportunities on attractive terms; (ii) the ability of our borrowers to repay or refinance their debt obligations to us; (iii) the value of the underlying real estate properties and other assets securing our purchased and originated loan investments; and/or (iv) the financial condition, operations and liquidity of the underlying servicing and operating entities in which we have an equity investment. There can be no assurance that the value of our Portfolio Assets, loan investments and other investment assets, or
the performance of our equity-method investees and consolidated subsidiaries, will not be negatively impacted by challenging economic conditions which could have a negative impact on our future results.
In addition to various other debt and equity investment opportunities, we continue to seek distressed asset investment opportunities under our investment agreement with Värde (see Note 19 of the consolidated financial statements included in Item 1 of this Form 10-Q). The Company’s involvement in these investments will come in the form of minority ownership (ranging from 5% to 25% at FirstCity’s determination) of an acquisition entity formed by FirstCity and Värde. FirstCity will also be the servicer for the acquisition entities formed with Värde. FirstCity’s increased holdings in the minority-owned, unconsolidated acquisition entities under this investment agreement represent a shift in the Company’s portfolio asset acquisition history over the past 2-3 years — which came in the form of consolidated portfolio assets. As such, in the context of the Company’s Portfolio Asset Acquisition and Resolution business segment, management expects to see a gradual shift in the composition of FirstCity’s income attributed to distressed asset investments to “Equity in earnings of unconsolidated subsidiaries” (unconsolidated equity-method investments) from “Income from Portfolio Assets” (consolidated portfolio assets). Management also expects to see a gradual increase in service fee income over time related to the performance of our servicing responsibilities related to these unconsolidated acquisition entities. Refer to the heading “Results of Operations” below for additional information related to our Portfolio Asset Acquisition and Resolution operations.
Our ability to make new investments is dependent on (1) the cash leak-through and overhead allowance provisions included in our loan facility with Bank of Scotland (see Note 8 of the consolidated financial statements included in Item 1 of this Form 10-Q); (2) residual cash flows from the pledged assets and equity investments after full repayment of the Bank of Scotland debt; (3) our current holdings of unencumbered cash and portfolio assets; and (4) our investment agreement in place with Värde (see Note 19 of the consolidated financial statements included in Item 1 of this Form 10-Q). While management believes that these cash flow sources will provide FirstCity with funding and liquidity to supports its operations and investment activities, FirstCity continues to actively seek additional sources of liquidity and alternative funding sources.
Results of Operations
The following discussion and analysis is based on the segment reporting information presented in Note 18 to the consolidated financial statements of the Company included in Item 1 of this Form 10-Q, and should be read in conjunction with the consolidated financial statements (including the notes thereto) included elsewhere in this Form 10-Q.
As a result of significant period-to-period fluctuations in our revenues and earnings, period-to-period comparisons of the results of our operations may not be meaningful. The Company’s financial results are impacted by many factors including, but not limited to, general economic conditions; fluctuations in interest rates and foreign currency exchange rates; fluctuations in the underlying values of real estate and other assets; the timing and ability to collect and liquidate assets; increased competition from other market players in the industries in which we operate; and the availability, pricing and terms for Portfolio Assets, middle-market transactions and other investments in all of the Company’s businesses. The Company’s business and results of operations are also impacted by the availability of liquidity to fund its investment activity and operations, and our access to capital markets. Such factors, individually or combined with other factors, may result in significant fluctuations in our reported operations and in the trading price of our common stock.
Q3 2010 Compared to Q3 2009
FirstCity’s net earnings to common stockholders totaled $2.6 million in Q3 2010 compared to net earnings of $2.0 million in Q3 2009. On a per share basis, diluted net earnings to common stockholders were $0.25 in Q3 2010 compared to $0.19 in Q3 2009. The following is a discussion and analysis of FirstCity’s net earnings based on its reportable business segments.
Portfolio Asset Acquisition and Resolution
Through our Portfolio Asset Acquisition and Resolution (“PAA&R”) business segment, FirstCity and its investment partners acquired $15.0 million of Portfolio Assets in Q3 2010 with an approximate face value of $27.0 million, compared to the Company’s involvement in acquiring $48.7 million of Portfolio Assets in Q3 2009 with an approximate face value of $115.1 million. In Q3 2010, FirstCity’s investment acquisition share in the Portfolio Asset acquisitions was $10.5 million — consisting of $8.9 million acquired through consolidated Portfolios and $1.6 million acquired through unconsolidated Portfolios. In Q3 2009, FirstCity’s investment acquisition share in Portfolio Asset acquisitions was $21.0 million — consisting of $18.6 million acquired through consolidated Portfolios and $2.4 million acquired through unconsolidated Portfolios. Generally speaking, income recognized from our investments in consolidated portfolio assets is reported as “Income from Portfolio Assets” on our consolidated statements of operations, whereas income from our
investments in unconsolidated subsidiaries that acquire portfolio assets is reported as “Equity in earnings of unconsolidated subsidiaries.” Furthermore, since we function as the servicer for the vast majority of our domestic and Latin American unconsolidated portfolio assets, we also recognize fee income related to the performance of our servicing responsibilities. This fee income is reported as “Servicing fees” on our consolidated statements of operations. We also generate service fee income from our domestic and Latin American consolidated portfolio assets that we service; however, this income is eliminated in consolidation and, as such, is not included on our consolidated statements of operations.
In Q3 2010, FirstCity invested an additional $5.0 million in non-portfolio investments in the form of SBA loan originations and advances, direct equity investments, and other loan investments, compared to $2.4 million of additional non-portfolio investments in the form of SBA loan originations and advances in Q3 2009. Refer to the heading “Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment” below for additional information related to our investment activities and composition in our PAA&R segment.
The operating contribution from our PAA&R business segment resulted in a $3.3 million operating loss in Q3 2010 compared to a $2.0 million operating gain for the same period in 2009. The following is a summary of the results of operations for the Company’s PAA&R business segment for the Q3 2010 and Q3 2009:
|
| Three Months Ended |
| ||||
|
| September 30, |
| ||||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Portfolio Asset Acquisition and Resolution: |
|
|
|
|
| ||
Revenues: |
|
|
|
|
| ||
Servicing fees |
| $ | 2,252 |
| $ | 2,222 |
|
Income from Portfolio Assets |
| 8,195 |
| 12,134 |
| ||
Gain on sale of SBA loans held for sale, net |
| 197 |
| 301 |
| ||
Interest income from SBA loans |
| 314 |
| 299 |
| ||
Interest income from loans receivable - affiliates |
| 435 |
| 471 |
| ||
Other income |
| 1,430 |
| 1,390 |
| ||
Total revenues |
| 12,823 |
| 16,817 |
| ||
Expenses: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 4,483 |
| 3,366 |
| ||
Salaries and benefits |
| 3,664 |
| 3,687 |
| ||
Provision for loan and impairment losses, net of recoveries |
| 2,236 |
| 425 |
| ||
Asset-level expenses |
| 2,083 |
| 1,858 |
| ||
Other |
| 821 |
| 1,653 |
| ||
Total expenses |
| 13,287 |
| 10,989 |
| ||
Equity in losses of unconsolidated subsidiaries |
| (1,446 | ) | (1,043 | ) | ||
Net income attributable to noncontrolling interests |
| (1,219 | ) | (1,326 | ) | ||
Operating contribution (loss) before direct taxes |
| $ | (3,129 | ) | $ | 3,459 |
|
Operating contribution (loss), net of direct taxes |
| $ | (3,346 | ) | $ | 2,028 |
|
Servicing fee revenues. Servicing fee revenues remained steady at $2.3 million in Q3 2010 compared to $2.2 million in Q3 2009. Servicing fees from domestic Acquisition Partnerships totaled $0.8 million in Q3 2010 compared to $0.5 million in Q3 2009, while servicing fees from Latin American Acquisition Partnerships totaled $1.4 million in Q3 2010 and $1.7 million in Q3 2009. Servicing fees from domestic Acquisition Partnerships are generally based on a percentage of the collections received from Portfolio Assets held by these unconsolidated partnerships; whereas servicing fees from Latin American Acquisition Partnerships are generally based on the cost of servicing plus a profit margin. The increase in servicing fees from domestic Acquisition Partnerships for Q3 2010 in comparison to Q3 2009 was attributable primarily to an increase in collections from unconsolidated domestic partnerships to $21.3 million for Q3 2010 compared to $4.7 million for Q3 2009. The decline in servicing fees from the Latin American Acquisition Partnerships was attributable to a decrease in the servicing costs related to those unconsolidated partnerships in Q3 2010 compared to Q3 2009 (i.e. the lower the servicing costs incurred by these partnerships, the lower the service fee income recognized by the Company).
Income from Portfolio Assets. Income from Portfolio Assets decreased to $8.2 million in Q3 2010 compared to $12.1 million in Q3 2009. The decrease in income from Portfolio Assets in Q3 2010 compared to Q3 2009 was attributed primarily to a shift in the
income-recognition methods used by management for certain of the Company’s existing and newly-acquired Portfolio Assets to non-accrual income methods (cost-recovery or cash basis) from the interest-accrual income method over the past 12-18 months. We apply non-accrual income-recognition methods to Portfolio Assets, as applicable, due to uncertainties related to estimating the timing and/or amount of collections as a result of the current economic environment. As such, income accretion from Portfolio Assets decreased by $3.7 million in Q3 2010 compared to Q3 2009. Refer to Note 1 of the consolidated financial statements included in Item 1 of this Form 10-Q for a summary of our income-recognition accounting policies related to Portfolio Assets, and Note 4 of the consolidated financial statements for a summary of income from Portfolio Assets.
Gain on sale of SBA loans held for sale. The Company recorded a $0.2 million gain on the sales of SBA loans in Q3 2010 with a $2.5 million net basis in the loans sold, compared to a $0.3 million gain on the sales of SBA loans in Q3 2009 with a $4.0 million net basis in the loans sold. Gains on SBA loan sales reflect the Company’s participation in the SBA guaranteed loan program. Under the SBA 7(a) program, the SBA guarantees up to 90 percent of the principal on a qualifying loan. The Company generally sells the guaranteed portions of originated loans into the secondary market and retains the unguaranteed portion for investment.
Interest income from SBA loans. Interest income from SBA loans remained constant at $0.3 million for both Q3 2010 and Q3 2009. FirstCity’s average investment level in SBA loans held-for-investment approximated $15.1 million for Q3 2010 compared to $16.0 million for Q3 2009.
Interest income from loans receivable — affiliates. Interest income from loans receivable — affiliates remained steady at $0.4 million in Q3 2010 compared to $0.5 million for Q3 2009. FirstCity’s average investment level in loans receivable — affiliates in its PAA&R segment approximated $11.0 million for Q3 2010 compared to $14.0 million for Q3 2009.
Interest income from loans receivable — other. The Company did not recognize interest income from loans receivable — other in Q3 2010 or Q3 2009 from its non-affiliated loan investments because management accounted for such loans under the non-accrual method of accounting during both periods. FirstCity’s average investment in loans receivable — other in its PAA&R segment was $4.6 million in Q3 2010, compared to its average investment in such loans of $6.4 million in Q3 2009 (all of which were accounted for under the non-accrual method during both periods).
Other income. Other income from the Company’s PAA&R segment remained constant at $1.4 million for both Q3 2010 and Q3 2009.
Expenses. Operating costs and expenses approximated $13.3 million and $11.0 million in Q3 2010 and Q3 2009, respectively. The following is a discussion of the major components of operating costs and expenses.
Interest expense and fees on notes payable totaled $4.5 million and $3.4 million for Q3 2010 and Q3 2009, respectively. FirstCity’s average outstanding debt in its PAA&R segment was $289.1 million in Q3 2010 compared to $292.2 million in Q3 2009. The Company’s average cost of borrowings increased to 6.2% in Q3 2010 compared to 4.6% in Q3 2009, primarily due to the higher interest and fees charged on our Reducing Note Facility with Bank of Scotland (closed in June 2010) compared to the interest rates and fees under the loan facilities we had in place with Bank of Scotland last year.
Salaries and benefits remained constant at $3.7 million for both Q3 2010 and Q3 2009. The total number of personnel within the PAA&R segment was 202 and 216 at September 30, 2010 and 2009, respectively.
Net provisions for loan and impairment losses on consolidated Portfolio Assets and loans receivable in our PAA&R segment totaled $2.2 million in Q3 2010 compared to $0.4 million in Q3 2009. The $2.2 million of net impairment provisions in Q3 2010 were attributed primarily to declines in values of loan collateral and real estate assets in our domestic loans and Portfolios. The impairment provisions were identified in connection with management’s quarterly evaluation of the collectibility of the Company’s Portfolio Assets and loans receivable. The process for evaluating and measuring impairment is critical to our financial results, as it requires subjective and complex judgments due to the need to make estimates about the impact of matters that are uncertain. This process also requires estimates that are susceptible to significant revision as more information becomes available. It remains unclear what impact the continuance of challenging economic conditions and disruptions in the financial, capital and real estate markets will ultimately have on our financial results. These conditions could adversely impact our business if commercial real estate properties experience a significant and prolonged decline in value or if borrowers cannot refinance their loans and/or continue to make payments (which in turn could lead to rising loan defaults and foreclosures on loan collateral). Therefore, we cannot provide assurance that, in any particular future period, we will not incur additional impairment provisions.
Asset-level expenses, which generally represent costs incurred by FirstCity to manage consolidated Portfolio Assets, support foreclosed properties and to protect its security interests in loan collateral, increased slightly to $2.1 million in Q3 2010 from $1.9 million in Q3 2009. The increased level of expenses is attributed primarily to the Company’s increased holdings in foreclosed real estate and other held-for-sale properties, which totaled $29.6 million at September 30, 2010 compared to $16.6 million a year ago.
Other costs and expenses in the Company’s PAA&R segment decreased to $0.8 million in Q3 2010 from $1.7 million in Q3 2009, due primarily to $0.7 million of foreign currency exchange gains attributed to our consolidated foreign operations in Q3 2010 compared to $0.1 million of foreign currency exchange gains recognized in Q3 2009 — a $0.6 million improvement (attributed mainly to our consolidated European operations). The Euro currency strengthened against the U.S. dollar more in Q3 2010 compared to Q3 2009.
Equity in losses of unconsolidated subsidiaries. Equity in losses of unconsolidated subsidiaries (Acquisition Partnership and servicing entities) from our PAA&R segment increased by $0.4 million in Q3 2010 compared to Q3 2009. Equity in losses of our unconsolidated Acquisition Partnerships increased to $1.8 million for Q3 2010 from $0.8 million for Q3 2009, whereas equity in earnings of our unconsolidated servicing entities increased to $0.4 million of earnings in Q3 2010 compared to $0.2 million in losses in Q3 2009. The following is a discussion of equity in earnings from FirstCity’s Acquisition Partnerships (by geographic region) and servicing entities. Refer to Note 6 of the consolidated financial statements included in Item 1 of this Form 10-Q for a summary of revenues, earnings and equity in earnings of FirstCity’s equity-method investments by region.
· Domestic — Total revenues reported by our domestic Acquisition Partnerships increased to $4.6 million in Q3 2010 compared to $1.1 million in Q3 2009. In addition, total net earnings reported by our domestic partnerships improved to $1.6 million in net earnings for Q3 2010 compared to $0.3 million in net losses for Q3 2009. The increase in total revenues and net earnings in Q3 2010 compared to Q3 2009 was attributable primarily to an increase in collections to $21.3 million in Q3 2010 from $4.7 million in Q3 2009; off-set partially by a $0.9 million increase in net impairment provisions in Q3 2010 compared to Q3 2009. The collective activity described above translated to a favorable decline in FirstCity’s share of domestic partnership losses to $0.1 million in losses for Q3 2010 compared to $0.3 million in losses for Q3 2009. FirstCity’s average investment in domestic Acquisition Partnerships increased to $32.5 million for Q3 2010 from $12.4 million for Q3 2009, due primarily to increased investment activity by newly-formed domestic Acquisition Partnerships under FirstCity’s investment agreement with Värde (see Note 19 of the consolidated financial statements included in Item 1 of this Form 10-Q). In light of FirstCity’s increased holdings in domestic portfolio investments acquired through equity-method investments in unconsolidated Acquisition Partnerships instead of consolidated Portfolio Assets over the past year, the Company expects equity in earnings of domestic partnerships to gradually increase over time in comparison to income from consolidated domestic Portfolio Assets.
· Latin America — Total revenues reported by our Latin American Acquisition Partnerships increased to $4.7 million in Q3 2010 from $3.8 million in Q3 2009. However, total net losses reported by our Latin American partnerships increased to $2.3 million for Q3 2010 compared to $2.0 million for Q3 2009. Total collections from Latin American partnerships decreased to $6.1 million in Q3 2010 compared to $8.7 million in Q3 2009. However, the increase in net losses reported by our Latin American partnerships in Q3 2010 compared to Q3 2009 was due primarily to $1.7 million of additional tax expense recorded in Q3 2010 compared to Q3 2009, and $0.6 million of additional foreign currency exchange losses recorded in Q3 2010 compared to Q3 2009; off-set partially by a $0.7 million decrease in net impairment provisions recorded by these partnerships in Q3 2010 compared to Q3 2009. The collective activity described above translated to an unfavorable increase in FirstCity’s share of Latin American partnership losses to $0.6 million in losses for Q3 2010 compared to $0.2 million in losses for Q3 2009. FirstCity’s average investment in Latin American Acquisition Partnerships decreased to $16.7 million for Q3 2010 compared to $18.0 million for Q3 2009.
· Europe — Total revenues reported by our European Acquisition Partnerships decreased to $0.3 million in Q3 2010 from $2.3 million in Q3 2009. In addition, total net losses reported by our European partnerships increased to $3.5 million for Q3 2010 from $1.0 million in losses for Q3 2009. The decrease in total partnership revenues and net earnings reported by our European partnerships was attributed primarily to a decrease in collections to $2.2 million in Q3 2010 compared to $7.2 million in Q3 2009, and a $1.0 million increase in net impairment provisions recorded by these partnerships in Q3 2010 compared to Q3 2009. Further contributing to the decline in European partnership revenues was the decrease in the level of Portfolio Asset holdings by these Acquisition Partnerships over the past two years (see paragraph below). The collective activity described above translated to an unfavorable increase in FirstCity’s share of European partnership losses to $1.2 million in Q3 2010 from $0.3 million in Q3 2009.
FirstCity’s average investment in European Acquisition Partnerships decreased to $5.1 million for Q3 2010 from $11.9 million for Q3 2009 — which contributed to a decline in European partnership collections and FirstCity’s share of European partnership revenues as discussed above. In light of FirstCity’s step-acquisition transaction and resulting consolidation of sixteen French entities (former unconsolidated European Acquisition Partnerships) in May 2009, the Company expects income from consolidated European Portfolio Assets to off-set the decline in our equity in earnings of European Acquisition Partnerships.
· Servicing Entities — Total revenues reported by our foreign unconsolidated servicing entities remained relatively steady at $11.6 million in Q3 2010 compared to $11.8 million in Q3 2009. However, total net earnings reported by these entities improved to $0.4 million of net earnings in Q3 2010 from $0.6 million of net losses in Q3 2009. The increase in net earnings reported by the underlying servicing entities was attributed primarily to $0.8 million of deferred tax benefits recorded by these entities in Q3 2010. The collective activity described above translated to an increase in FirstCity’s share of earnings from its foreign servicing entities to $0.4 million in earnings for Q3 2010 from $0.3 million in losses for Q3 2009.
Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests represents the portions of net earnings that are attributable to our co-investors in our majority-owned, consolidated Acquisition Partnerships. The amount of net income attributable to noncontrolling interests in these consolidated Acquisition Partnerships remained constant at $1.2 million for Q3 2010 compared to $1.3 million for Q3 2009.
Special Situations Platform Business Segment
The operating contribution from the Special Situations Platform business segment (“FirstCity Denver”) resulted in an $8.0 million operating gain in Q3 2010 compared to a $1.6 million operating gain in Q3 2009. In Q3 2010, FirstCity Denver provided $0.1 million of investment capital to privately-held middle-market companies in the form of direct equity investments, compared to $3.5 million of investment capital provided to such companies in the form of debt investments in Q3 2009. Since its inception in April 2007, FirstCity Denver has been involved in middle-market transactions with total investment values of $84.7 million, and has provided $56.9 million of investment capital in connection with these investments.
The following is a summary of the results of operations for the Company’s Special Situations Platform business segment for Q3 2010 and Q3 2009:
|
| Three Months Ended |
| ||||
|
| September 30, |
| ||||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Special Situations Platform: |
|
|
|
|
| ||
Revenues: |
|
|
|
|
| ||
Interest income from loans receivable |
| $ | 662 |
| $ | 706 |
|
Operating revenue - railroad |
| 998 |
| 776 |
| ||
Operating revenue - coal mine |
| 15,329 |
| — |
| ||
Other income |
| 421 |
| 338 |
| ||
Total revenues |
| 17,410 |
| 1,820 |
| ||
Expenses - Railroad Operations: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 36 |
| 29 |
| ||
Salaries and benefits |
| 279 |
| 252 |
| ||
Other |
| 320 |
| 225 |
| ||
Total railroad expenses |
| 635 |
| 506 |
| ||
Expenses - Coal Mine Operations: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 20 |
| — |
| ||
Salaries and benefits |
| 65 |
| — |
| ||
Cost of sales |
| 10,006 |
| — |
| ||
Amortization |
| 5,200 |
| — |
| ||
Other |
| 371 |
| — |
| ||
Total coal mine expenses |
| 15,662 |
| — |
| ||
Expenses - Other: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 121 |
| 116 |
| ||
Salaries and benefits |
| (35 | ) | 280 |
| ||
Provision for loan and impairment losses |
| 1,854 |
| — |
| ||
Other |
| 648 |
| 571 |
| ||
Total other expenses |
| 2,588 |
| 967 |
| ||
Total expenses |
| 18,885 |
| 1,473 |
| ||
Equity in earnings of unconsolidated subsidiaries |
| 11,408 |
| 1,464 |
| ||
Net income attributable to noncontrolling interests |
| (1,548 | ) | (262 | ) | ||
Operating contribution before taxes |
| $ | 8,385 |
| $ | 1,549 |
|
Operating contribution, net of direct taxes |
| $ | 8,013 |
| $ | 1,615 |
|
Interest income from loans receivable. Interest income from loans receivable remained constant at $0.7 million for both Q3 2010 and Q3 2009. FirstCity Denver’s average investment in loans receivable was $20.0 million for Q3 2010 — including $1.9 million accounted for under the non-accrual method of accounting. For Q3 2009, FirstCity Denver’s average investment in loans receivable was $20.9 million — including $3.0 million accounted for under the non-accrual method of accounting.
Revenue and expenses from railroad operations. Revenue and expenses from railroad operations represents the results of operations recorded by FirstCity Denver’s majority-owned railroad companies (engaged primarily in interchanging rail cars with connecting carriers and providing rail freight services for on-line customers). Revenue from railroad operations increased by $0.2 million in Q3 2010 compared to Q3 2009 due to an increase in rail car movement services performed in Q3 2010 compared to Q3 2009. Total expenses in Q3 2010 attributable to the railroad operations remained relatively constant in comparison to Q3 2009.
Revenue and expenses from coal mine operations. Revenue and expenses from coal mine operations represent the consolidated results of operations recorded by FirstCity Denver’s majority-owned coal mine subsidiary (engaged primarily in the purchase and sale of coal and coal-related products) which became a consolidated subsidiary on April 1, 2010 — the date FirstCity Denver increased its ownership interest and obtained a controlling interest in the entity. The coal mine entity generates revenue under a short-term coal sales contract with a major utility company. FirstCity Denver’s application of business combination accounting in connection with obtaining control of the coal mine subsidiary resulted in the recognition of an asset for the coal supply agreement and a liability for the
coal purchase agreement. The coal supply asset and coal purchase liability are being amortized over the actual amount of tons shipped under each contract (which are both scheduled to expire in December 2010). The Company does not expect the coal mine subsidiary’s operations to extend beyond the completion of its existing coal contracts. Refer to Note 3 to the consolidated financial statements included in Item 1 of this Form 10-Q for additional information on this transaction.
Other income. Other income in Q3 2010 remained relatively constant in comparison to Q3 2009.
Expenses — Other. Other expenses increased by $1.6 million in Q3 2010 compared to Q3 2009 primarily due to a $1.9 million impairment provision recorded in Q3 2010 on a commercial real estate investment. This impairment provision was attributed to a decline in value of the real estate property. The impairment provision was identified in connection with management’s regular evaluation of the collectibility of FirstCity Denver’s investments. The process for evaluating and measuring impairment is critical to our financial results, as it requires subjective and complex judgments due to the need to make estimates about the impact of matters that are uncertain. This process also requires estimates that are susceptible to significant revision as more information becomes available. It remains unclear what impact the continuance of challenging economic conditions and disruptions in the financial, capital and real estate markets will ultimately have on our financial results. These conditions could adversely impact our business if borrowers cannot refinance their loans and/or continue to make payments, or if the values of our underlying loan collateral and real estate properties continue to decline. Therefore, we cannot provide assurance that, in any particular future period, we will not incur additional impairment provisions.
Equity in earnings of unconsolidated subsidiaries. Equity in earnings of unconsolidated subsidiaries significantly increased to $11.4 million in Q3 2010 from $1.5 million in Q3 2009. The increase in Q3 2010 was due primarily to $12.4 million of additional equity in earnings recorded by FirstCity Denver in Q3 2010 compared to Q3 2009 for its share of net earnings from an equity-method investment in a prefabricated building manufacturing entity. This entity reported significantly-higher net earnings in Q3 2010 related to a short-term lease agreement with a single customer. This lease agreement does not extend beyond Q3 2010; however, under terms of a related agreement, the manufacturing entity is due another $3.9 million from the customer (although the entity has not recognized any revenue related to this receivable due to uncertainty regarding the collectibility of the amount). If the building manufacturing entity collects the entire $3.9 million, the net earnings impact to FirstCity would approximate $1.5 million. The increase in equity in earnings for Q3 2010 was off-set partially by $1.5 million of additional equity in losses recorded by FirstCity Denver in Q3 2010 compared to Q3 2009 for its share of net losses from equity-method investments in a restaurant management entity and multiple manufacturing concerns (including a new equity-method investment effective Q3 2010 in a wireless transmission equipment and software solutions entity that was formerly accounted for as a consolidated subsidiary until FirstCity Denver ceased having a controlling interest in the entity effective June 30, 2010 — refer to Note 3 to the consolidated financial statements included in Item 1 of this Form 10-Q for additional information). The increased losses reported by these entities in Q3 2010 were due primarily to lower-than-expected sales volumes during the period. The increase in equity in earnings for Q3 2010 was also off-set partially by a $0.9 million decrease in equity in earnings in Q3 2010 compared to Q3 2009 attributable to FirstCity Denver’s share of net earnings from its equity-method investments in the coal mine operation described above. FirstCity Denver did not account for the coal mine operation under the equity-method of accounting in Q3 2010 since it obtained a controlling interest in the subsidiary effective April 1, 2010 (refer to Note 3 to the consolidated financial statements included in Item 1 of this Form 10-Q for additional information).
Net income attributable to noncontrolling interests. The amount of net income attributable to noncontrolling interests related to FirstCity Denver, an 80%-owned subsidiary of FirstCity, increased to $1.5 million for Q3 2010 compared to $0.3 million for Q3 2009. The increase in Q3 2010 was due primarily to additional net earnings reported by FirstCity Denver in Q3 2010 compared to Q3 2009 (mainly related to an increase in equity in earnings from unconsolidated subsidiaries as discussed above).
First Nine Months of 2010 Compared to First Nine Months of 2009
FirstCity recorded net earnings of $10.7 million, or $1.06 per common share diluted, for YTD 2010, compared to $10.4 million, or $1.02 per common share diluted, for YTD 2009. The following is a discussion and analysis of FirstCity’s net earnings based on its reportable business segments.
Portfolio Asset Acquisition and Resolution
Through our PAA&R business segment, FirstCity and its investment partners acquired $174.7 million of Portfolio Assets in YTD 2010 with an approximate face value of $312.5 million, compared to the Company’s involvement in acquiring $186.0 million of Portfolio Assets in YTD 2009 with an approximate face value of $373.6 million. In YTD 2010, FirstCity’s investment acquisition share in the Portfolio Asset acquisitions was $53.2 million — with $29.4 million acquired through consolidated Portfolios and $23.8 million acquired through unconsolidated Portfolios. In YTD 2009, FirstCity’s investment acquisition share in Portfolio Asset
acquisitions was $134.5 million — with $131.5 million acquired through consolidated Portfolios and $3.0 million acquired through unconsolidated Portfolios. Generally speaking, income recognized from our investments in consolidated portfolio assets is reported as “Income from Portfolio Assets” on our consolidated statements of operations, whereas income from our investments in unconsolidated subsidiaries that acquire portfolio assets is reported as “Equity in earnings of unconsolidated subsidiaries.” Furthermore, since we function as the servicer for the vast majority of our domestic and Latin American unconsolidated portfolio assets, we also recognize fee income related to the performance of our servicing responsibilities. This fee income is reported as “Servicing fees” on our consolidated statements of operations. We also generate service fee income from our domestic and Latin American consolidated portfolio assets that we service; however, this income is eliminated in consolidation and, as such, is not included on our consolidated statements of operations.
In YTD 2010, FirstCity invested an additional $28.4 million in non-portfolio investments in the form of SBA loan originations and advances, direct equity investments, and other loan investments, compared to $28.0 million of additional non-portfolio investments in the form of SBA loan originations and advances and direct equity investments in YTD 2009. Refer to the heading “Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment” below for additional information related to our investment activities and composition in our PAA&R segment.
The operating contribution from our PAA&R business segment resulted in a $2.8 million operating gain in YTD 2010 compared to a $14.1 million operating gain in YTD 2009. The following is a summary of the results of operations for the Company’s PAA&R business segment for YTD 2010 and YTD 2009:
|
| Nine Months Ended |
| ||||
|
| September 30, |
| ||||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Portfolio Asset Acquisition and Resolution: |
|
|
|
|
| ||
Revenues: |
|
|
|
|
| ||
Servicing fees |
| $ | 5,998 |
| $ | 7,017 |
|
Income from Portfolio Assets |
| 34,280 |
| 35,254 |
| ||
Gain on sale of SBA loans held for sale, net |
| 360 |
| 911 |
| ||
Gain on sale of investment securities |
| 3,250 |
| — |
| ||
Interest income from SBA loans |
| 895 |
| 940 |
| ||
Interest income from loans receivable - affiliates |
| 1,371 |
| 1,560 |
| ||
Interest income from loans receivable - other |
| — |
| 414 |
| ||
Other income |
| 3,204 |
| 2,987 |
| ||
Total revenues |
| 49,358 |
| 49,083 |
| ||
Expenses: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 11,420 |
| 10,128 |
| ||
Salaries and benefits |
| 11,764 |
| 11,208 |
| ||
Provision for loan and impairment losses, net of recoveries |
| 5,394 |
| 1,241 |
| ||
Asset-level expenses |
| 5,519 |
| 4,208 |
| ||
Other |
| 5,212 |
| 4,674 |
| ||
Total expenses |
| 39,309 |
| 31,459 |
| ||
Equity in losses of unconsolidated subsidiaries |
| (253 | ) | (188 | ) | ||
Gain on business combinations |
| 891 |
| 1,455 |
| ||
Net income attributable to noncontrolling interests |
| (7,290 | ) | (2,854 | ) | ||
Operating contribution before direct taxes |
| $ | 3,397 |
| $ | 16,037 |
|
Operating contribution, net of direct taxes |
| $ | 2,795 |
| $ | 14,082 |
|
Servicing fee revenues. Servicing fee revenues decreased to $6.0 million in YTD 2010 from $7.0 million in YTD 2009. Servicing fees from domestic Acquisition Partnerships totaled $1.3 million in YTD 2010 compared to $1.8 million in YTD 2009, while servicing fees from Latin American Acquisition Partnerships totaled $4.7 million in YTD 2010 and $5.2 million in YTD 2009. Servicing fees from domestic Acquisition Partnerships are generally based on a percentage of the collections received from Portfolio Assets held by these unconsolidated partnerships; whereas servicing fees from Latin American Acquisition Partnerships are generally based on the cost of servicing plus a profit margin. The decline in servicing fees from domestic Acquisition Partnerships was due primarily to $0.8 million of performance-based fees (based on certain domestic partnerships achieving economic thresholds) recognized in YTD 2009 compared to YTD 2010, off-set partially by the impact of increased collections from unconsolidated domestic partnerships to
$29.2 million for YTD 2010 from $19.0 million for YTD 2009. The decline in servicing fees from the Latin American Acquisition Partnerships was attributable to a decrease in the servicing costs related to those unconsolidated partnerships in YTD 2010 compared to YTD 2009 (i.e. the lower the servicing costs incurred by these partnerships, the lower the service fee income recognized by the Company).
Income from Portfolio Assets. Income from Portfolio Assets decreased slightly to $34.3 million in YTD 2010 compared to $35.3 million in YTD 2009. The net decrease in income from Portfolio Assets was attributed primarily to a shift in the income-recognition methods used by management for certain of the Company’s existing and newly-acquired Portfolio Assets to non-accrual income methods (cost-recovery or cash basis) from the interest-accrual income method over the past 12-18 months. We apply non-accrual income-recognition methods to Portfolio Assets, as applicable, due to uncertainties related to estimating the timing and/or amount of collections as a result of the current economic environment. As such, income accretion from Portfolio Assets decreased by $12.1 million in YTD 2010 compared to YTD 2009. This income decrease was off-set partially by $11.1 million of additional Portfolio Asset liquidation income and gains recognized in YTD 2010 compared to YTD 2009. Although collections from consolidated Portfolio Assets decreased to $94.0 million in YTD 2010 from $124.6 million in YTD 2009, FirstCity was able to recognize significantly-higher margins on certain Portfolio Asset liquidations in YTD 2010 compared to YTD 2009. Refer to Note 1 of the consolidated financial statements included in Item 1 of this Form 10-Q for a summary of our income-recognition accounting policies related to Portfolio Assets, and Note 4 of the consolidated financial statements for a summary of income from Portfolio Assets.
Gain on sale of SBA loans held for sale. The Company recorded $0.4 million of gains on the sales of SBA loans in YTD 2010 with a $4.6 million net basis in the loans sold, compared to $0.9 million of gains on the sales of SBA loans in YTD 2009 with a $17.2 million net basis in the loans sold. Gains on SBA loan sales reflect the Company’s participation in the SBA guaranteed loan program. Under the SBA 7(a) program, the SBA guarantees up to 90 percent of the principal on a qualifying loan. The Company generally sells the guaranteed portions of originated loans into the secondary market and retains the unguaranteed portion for investment.
Gain on sale of investment securities. In YTD 2010, the Company recognized a $3.3 million gain related to the sale of its investment security that represented a beneficial interest in securitized financial assets. No such sales were recorded in YTD 2009.
Interest income from SBA loans. Interest income from SBA loans remained constant at $0.9 million for both YTD 2010 and YTD 2009. FirstCity’s average investment level in SBA loans held-for-investment approximated $15.2 million for YTD 2010 compared to $15.6 million for YTD 2009.
Interest income from loans receivable — affiliates. Interest income from loans receivable — affiliates decreased slightly to $1.4 million in YTD 2010 compared to $1.6 million YTD 2009. The interest income decline is attributed to a decline in FirstCity’s average investment level in loans receivable — affiliates in its PAA&R segment to $11.8 million for YTD 2010 compared to $14.0 million for YTD 2009.
Interest income from loans receivable — other. Interest income from loans receivable — other decreased by $0.4 million for YTD 2010 compared to YTD 2009. The Company did not recognize interest income from loans receivable — other in YTD 2010 from its non-affiliated loan investments because management accounted for such loans under the non-accrual method of accounting during the entire period. FirstCity’s average investment in loans receivable — other in its PAA&R segment was $5.0 million in YTD 2010, compared to its average investment in such loans of $6.9 million in YTD 2009 (including $2.1 million accounted for under the non-accrual method).
Other income. Other income from the Company’s PAA&R segment remained relatively constant at $3.2 million in YTD 2010 compared to $3.0 million in YTD 2009.
Expenses. Operating expenses approximated $39.3 million and $31.5 million in YTD 2010 and YTD 2009, respectively. The following is a discussion of the major components of operating expenses.
Interest expense and fees on notes payable totaled $11.4 million for YTD 2010 and $10.1 million for YTD 2009. FirstCity’s average outstanding debt in its PAA&R segment increased to $291.7 million in YTD 2010 from $279.5 million in YTD 2009 — primarily to finance its increased investment activity and to provide working capital to support future growth. The Company’s average cost of borrowings increased to 5.2% in YTD 2010 compared to 4.8% in YTD 2009, primarily due to the higher interest and fees charged on our Reducing Note Facility with Bank of Scotland (closed in June 2010) compared to the interest rates and fees under the loan facilities we had in place with Bank of Scotland last year.
Salaries and benefits increased modestly to $11.8 million in YTD 2010 from $11.2 million in YTD 2009, due primarily to increased costs related to base salaries, payroll taxes and employee benefits and bonuses in the PAA&R segment in YTD 2010 compared to YTD 2009. The total number of personnel within the PAA&R segment was 202 and 216 at September 30, 2010 and 2009, respectively.
Net provisions for loan and impairment losses on our consolidated Portfolio Assets and loans receivable in our PAA&R segment totaled $5.4 million in YTD 2010 and $1.2 million in YTD 2009. The $5.4 million of net impairment provisions in YTD 2010 were attributed primarily to declines in values of real estate properties and loan collateral related to our domestic Portfolio Assets and loans. The impairment provisions were identified in connection with management’s quarterly evaluation of the collectibility of the Company’s Portfolio Assets and loans receivable. The process for evaluating and measuring impairment is critical to our financial results, as it requires subjective and complex judgments due to the need to make estimates about the impact of matters that are uncertain. This process also requires estimates that are susceptible to significant revision as more information becomes available. It remains unclear what impact the continuance of challenging economic conditions and disruptions in the financial, capital and real estate markets will ultimately have on our financial results. These conditions could adversely impact our business if commercial real estate properties experience a significant and prolonged decline in value or if borrowers cannot refinance their loans and/or continue to make payments (which in turn could lead to rising loan defaults and foreclosures on loan collateral). Therefore, we cannot provide assurance that, in any particular future period, we will not incur additional impairment provisions.
Asset-level expenses, which generally represent costs incurred by FirstCity to manage consolidated Portfolio Assets in its PAA&R business segment, support foreclosed properties and to protect its security interests in loan collateral, increased to $5.5 million in YTD 2010 from $4.2 million in YTD 2009. The increased level of expenses is attributed primarily to the Company’s increased holdings in foreclosed real estate properties, which totaled $29.6 million at September 30, 2010 compared to $16.6 million a year ago, and an increase in the Company’s average investment level in consolidated Portfolio Assets to $212.0 million for YTD 2010 from $196.3 million for YTD 2009.
Other costs and expenses in the Company’s PAA&R segment increased to $5.2 million for YTD 2010 from $4.7 million for YTD 2009, primarily due to $0.4 million of foreign currency exchange losses attributed to our consolidated foreign operations in YTD 2010 compared to $0.4 million of foreign currency exchange gains recognized in YTD 2009 — a $0.8 million favorable swing (attributed mainly to our consolidated European operations). The Euro currency strengthened against the U.S. dollar more in YTD 2010 compared to YTD 2009.
Equity in losses of unconsolidated subsidiaries. Equity in losses of unconsolidated subsidiaries (Acquisition Partnership and servicing entities) from our PAA&R segment increased slightly by $0.1 million in YTD 2010 compared to YTD 2009. Equity in losses of our unconsolidated Acquisition Partnerships totaled $2.7 million in YTD 2010 compared to equity in earnings of $0.4 million in YTD 2009, whereas equity in earnings of our unconsolidated servicing entities increased to $2.4 million of earnings in YTD 2010 compared to $0.6 million of losses in YTD 2009. The following is a discussion of equity in earnings from FirstCity’s Acquisition Partnerships (by geographic region) and servicing entities. Refer to Note 6 of the consolidated financial statements included in Item 1 of this Form 10-Q for a summary of revenues, earnings and equity in earnings of FirstCity’s equity-method investments by region.
· Domestic — Total revenues reported by domestic Acquisition Partnerships increased to $7.2 million in YTD 2010 compared to $5.7 million in YTD 2009. In addition, total net earnings reported by domestic partnerships increased to $2.1 million in YTD 2010 compared to $1.1 million in YTD 2009. The increase in total revenues and net earnings in YTD 2010 compared to YTD 2009 was attributable primarily to an increase in collections to $29.2 million in YTD 2010 from $19.0 million in YTD 2009; which was off-set partially by a $0.6 million increase in net impairment provisions recorded by these partnerships in YTD 2010 compared to YTD 2009, and a $2.5 million decline in interest and accretion income in YTD 2010 compared to YTD 2009 due primarily to an increase in the level of domestic partnership loan portfolios accounted for on a non-accrual method of accounting (cost-recovery or cash basis) instead of the interest method (i.e. accrual method). Under U.S. GAAP, the interest method of accounting for income-recognition purposes is not appropriate if management does not have the ability to develop a reasonable expectation of both the timing and amount of future cash flows to be collected. Although total revenues and net earnings reported by our domestic Acquisition Partnerships increased in YTD 2010 compared to YTD 2009, the collective activity described above translated to a decrease in FirstCity’s share of domestic partnership net earnings to a $0.1 million loss for YTD 2010 compared to $0.2 million of earnings for YTD 2009. This $0.3 million unfavorable swing is attributed to the composition of FirstCity’s ownership mix in the domestic Acquisition Partnerships that reported net earnings and losses in YTD 2010 compared to YTD 2009. FirstCity’s average investment in domestic Acquisition Partnerships increased to $21.4 million for YTD 2010 from $13.8 million for YTD 2009, due primarily to increased investment activity in newly-formed
domestic Acquisition Partnerships under FirstCity’s investment agreement with Värde (see Note 19 of the consolidated financial statements included in Item 1 of this Form 10-Q). In light of FirstCity’s increased holdings in domestic portfolio investments acquired through equity-method investments in unconsolidated Acquisition Partnerships instead of consolidated Portfolio Assets over the past year, the Company expects equity in earnings of domestic partnerships to gradually increase over time in comparison to income from consolidated Portfolio Assets.
· Latin America — Total revenues reported by Latin American Acquisition Partnerships increased to $15.0 million in YTD 2010 from $9.2 million in YTD 2009. However, total net losses reported by our Latin American partnerships increased to $4.5 million in YTD 2010 compared to $3.0 million YTD 2009. Total collections from our Latin American partnerships increased to $22.2 million in YTD 2010 compared to $20.5 million in YTD 2009, which contributed to the favorable increase in total partnership revenues. The increase in revenues reported by our Latin American partnerships in YTD 2010 was off-set by the following (which contributed to the increase in net losses these partnerships reported in YTD 2010): (1) $1.2 million of foreign currency exchange losses recorded by these partnerships in YTD 2010 compared to $2.1 million of foreign currency exchange gains recorded in YTD 2009 — a $3.3 million unfavorable swing; (2) $3.1 million of additional tax-related expense recorded in YTD 2010 compared to YTD 2009 (primarily related to increased income from collections in Brazil combined with reversals of certain value-added tax receivables in Mexico); and (3) $1.2 million of additional net impairment provisions recorded in YTD 2010 compared to YTD 2009. The collective activity described above translated to FirstCity’s share of Latin American partnership losses totaling $0.5 million for both YTD 2010 and YTD 2009. FirstCity’s average investment in Latin American Acquisition Partnerships decreased to $17.1 million for YTD 2010 compared to $17.8 million for YTD 2009.
· Europe — Total revenues reported by European Acquisition Partnerships decreased to $2.8 million in YTD 2010 from $13.8 million in YTD 2009. In addition, total net earnings reported by the European partnerships decreased sharply to $6.8 million in losses for YTD 2010 from $2.7 million in earnings for YTD 2009. The decrease in total partnership revenues and net earnings reported by our European partnerships was attributed primarily to a decrease in collections to $12.1 million in YTD 2010 compared to $22.6 million in YTD 2009, off-set partially by a $1.3 million decrease in service fee expense reported by these partnerships in YTD 2010 compared to YTD 2009. Further contributing to the decline in European partnership revenues was the decrease in the level of Portfolio Asset holdings by these Acquisition Partnerships over the past two years (see paragraph below). The collective activity described above translated to an unfavorable decrease in FirstCity’s share of European partnership earnings to $2.1 million in losses for YTD 2010 from $0.7 million in earnings for YTD 2009.
FirstCity’s average investment in European Acquisition Partnerships decreased to $6.5 million for YTD 2010 from $12.6 million for YTD 2009 — which contributed to a decline in European partnership collections and FirstCity’s share of European partnership revenues as discussed above. In light of FirstCity’s step-acquisition transaction and resulting consolidation of sixteen French entities (former unconsolidated European Acquisition Partnerships) in May 2009, the Company expects income from consolidated Portfolio Assets to off-set the decline in European partnership revenues.
· Servicing Entities — Total revenues reported by our foreign unconsolidated servicing entities increased to $39.8 million in YTD 2010 from $35.5 million in YTD 2009, and total net earnings reported by these entities improved to $6.7 million in net earnings for YTD 2010 from $1.3 million of net losses for YTD 2009. The increase in net earnings reported by the underlying servicing entities was attributed primarily to (1) additional investment income of $4.1 million recorded in YTD 2010 compared to YTD 2009; (2) a $2.5 million decrease in income tax provisions in YTD 2010 compared to YTD 2009 as a result of our ability to recognize foreign tax benefits associated with U.S. GAAP adjustments to an unconsolidated European servicing entity’s local financial statements, combined with the timing of income tax payments made by the foreign servicing entity in its local jurisdiction; and (3) a $1.1 million decrease in operating costs attributed to a Latin American servicing entity in YTD 2010 compared to YTD 2009. The collective activity described above translated to an increase in FirstCity’s share of earnings from its foreign servicing entities to $2.4 million in earnings for YTD 2010 from $0.6 million in losses for YTD 2009.
Gain on business combinations. In YTD 2010, the Company recorded a $0.9 million gain attributable to a step-acquisition transaction in which the Company acquired a controlling financial interest in three domestic Acquisition Partnerships. The Company owned a noncontrolling equity interest in these entities prior to the transaction. Under business combination accounting guidance, the Company’s previously-held noncontrolling interests in these entities were re-measured to fair value on the acquisition date — which resulted in the Company’s recognition of the $0.9 million gain. Refer to Note 3 of the consolidated financial statements included in Item 1 of this Form 10-Q for additional information on this transaction. In YTD 2009, the Company recorded a $1.5 million gain attributable to a step-acquisition transaction in which the Company acquired a controlling financial interest in certain French Acquisition Partnerships. The Company owned a noncontrolling equity interest in these entities prior to the transaction. Under business combination accounting guidance, the Company’s previously-held noncontrolling interests in the French entities were re-measured to fair value on the acquisition date (May 2009) — which resulted in the Company’s recognition of the $1.5 million gain.
Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests represents the portions of net earnings that are attributable to our co-investors in our majority-owned, consolidated Acquisition Partnerships. The amount of net income attributable to noncontrolling interests in these consolidated Acquisition Partnerships increased to $7.3 million for YTD 2010 from $2.9 million for YTD 2009. This increase is attributed to an increase in net earnings from these majority-owned, consolidated Acquisition Partnerships in YTD 2010 compared to YTD 2009 (i.e. an increase in the amount of net earnings reported by these majority-owned entities translates to an increase in the amount of net earnings apportioned to the noncontrolling investors).
Special Situations Platform Business Segment
The operating contribution from the Special Situations Platform business segment (“FirstCity Denver”) increased significantly to $14.0 million in YTD 2010 compared to $1.8 million in YTD 2009. In YTD 2010, FirstCity Denver provided $13.0 million of investment capital to privately-held middle-market companies in the form of debt and direct equity investments ($4.6 million financed through an investee entity’s debt), compared to $9.0 million of investment capital provided to such companies in the form of debt and equity in YTD 2009. Since its inception in April 2007, FirstCity Denver has been involved in middle-market transactions with total investment values of $84.7 million, and has provided $56.9 million of investment capital in connection with these investments.
The following is a summary of the results of operations for the Company’s Special Situations Platform business segment for YTD 2010 and YTD 2009:
|
| Nine Months Ended |
| ||||
|
| September 30, |
| ||||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Special Situations Platform: |
|
|
|
|
| ||
Revenues: |
|
|
|
|
| ||
Interest income from loans receivable |
| $ | 1,814 |
| $ | 1,858 |
|
Operating revenue - railroad |
| 3,455 |
| 2,228 |
| ||
Operating revenue - manufacturing |
| 10,466 |
| — |
| ||
Operating revenue - coal mine |
| 28,429 |
| — |
| ||
Other income |
| 1,258 |
| 1,647 |
| ||
Total revenues |
| 45,422 |
| 5,733 |
| ||
Expenses - Railroad Operations: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 111 |
| 84 |
| ||
Salaries and benefits |
| 815 |
| 732 |
| ||
Other |
| 942 |
| 716 |
| ||
Total railroad expenses |
| 1,868 |
| 1,532 |
| ||
Expenses - Manufacturing Operations: |
|
|
|
|
| ||
Salaries and benefits |
| 2,396 |
| — |
| ||
Cost of sales |
| 6,011 |
| — |
| ||
Other |
| 2,381 |
| — |
| ||
Total manufacturing expenses |
| 10,788 |
| — |
| ||
Expenses - Coal Mine Operations: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 57 |
| — |
| ||
Salaries and benefits |
| 132 |
| — |
| ||
Cost of sales |
| 19,316 |
| — |
| ||
Amortization |
| 8,662 |
| — |
| ||
Other |
| 790 |
| — |
| ||
Total coal mine expenses |
| 28,957 |
| — |
| ||
Expenses - Other: |
|
|
|
|
| ||
Interest and fees on notes payable |
| 352 |
| 347 |
| ||
Salaries and benefits |
| 706 |
| 750 |
| ||
Provision for loan and impairment losses |
| 3,023 |
| 967 |
| ||
Other |
| 1,417 |
| 1,496 |
| ||
Total other expenses |
| 5,498 |
| 3,560 |
| ||
Total expenses |
| 47,111 |
| 5,092 |
| ||
Equity in earnings of unconsolidated subsidiaries |
| 14,260 |
| 1,661 |
| ||
Gain on business combinations |
| 4,838 |
| — |
| ||
Net income attributable to noncontrolling interests |
| (2,893 | ) | (313 | ) | ||
Operating contribution before taxes |
| $ | 14,516 |
| $ | 1,989 |
|
Operating contribution, net of direct taxes |
| $ | 13,991 |
| $ | 1,820 |
|
Interest income from loans receivable. Interest income from loans receivable remained steady at $1.8 million in YTD 2010 compared to $1.9 million in YTD 2009. FirstCity Denver’s average investment in loans receivable was $19.3 million for YTD 2010 — including $2.4 million accounted for under the cost recovery method. For YTD 2009, FirstCity Denver’s average investment in loans receivable was $20.1 million — including $1.9 million accounted for under the cost recovery method
Revenue and expenses from railroad operations. Revenue and expenses from railroad operations represents the results of operations recorded by FirstCity Denver’s majority-owned railroad companies (engaged primarily in interchanging rail cars with connecting carriers and providing rail freight services for on-line customers). Revenue from railroad operations increased by $1.2 million in YTD 2010 compared to YTD 2009 due to an increase in rail car movement services performed in YTD 2010 compared to
YTD 2009. Total expenses in YTD 2010 attributable to the railroad operations remained relatively constant in comparison to YTD 2009.
Revenue and expenses from manufacturing operations. Revenue and expenses from manufacturing operations represents the consolidated results of operations recorded by FirstCity Denver’s manufacturing company (engaged principally in the design, production and sale of wireless transmission equipment and software solutions) through June 30, 2010. FirstCity acquired a controlling interest in this company in December 2009; however, on June 30, 2010, FirstCity Denver ceased to have a controlling interest, but retained a noncontrolling interest and elevated economic interests, in this manufacturing subsidiary. As such, on June 30, 2010, FirstCity Denver deconsolidated this subsidiary and began to account for its retained investment in the manufacturing entity using the equity-method of accounting. Consequently, subsequent to June 30, 2010, FirstCity Denver no longer reports the individual revenue and expense line-items of the manufacturing entity’s operations in its consolidated statement of operations (rather, FirstCity Denver now records its share of the subsidiary’s net earnings as “Equity in earnings of unconsolidated subsidiaries”). Refer to Note 3 to the consolidated financial statements included in Item 1 of this Form 10-Q for additional information on this transaction. The company’s sales in YTD 2010 (through June 30, 2010) were composed of $6.7 million related to equipment and $3.8 million related to software solutions. In YTD 2010, 32% of the company’s sales were made to international customers.
Revenue and expenses from coal mine operations and gain on business combinations. Revenue and expenses from coal mine operations represent the consolidated results of operations recorded by FirstCity Denver’s majority-owned coal mine subsidiary (engaged primarily in the purchase and sale of coal and coal-related products) which became a consolidated subsidiary on April 1, 2010 — the date FirstCity Denver increased its ownership interest and obtained a controlling interest in the entity. The coal mine entity generates revenue under a short-term coal sales contract with a major utility company. FirstCity Denver’s application of business combination accounting in connection with obtaining control of the coal mine subsidiary resulted in the recognition of an asset for the coal supply agreement and a liability for a coal purchase agreement. The coal supply asset and coal purchase liability are being amortized over the actual amount of tons shipped under each contract (which are both scheduled to expire in December 2010). FirstCity Denver also recognized a $4.8 million business combination gain based on the excess of the fair value of its total interest in the coal mine subsidiary after the business combination over the carrying value of its previously-held equity interest. The Company does not expect the coal mine subsidiary’s operations to extend beyond the completion of its existing coal contracts. Refer to Note 3 to the consolidated financial statements included in Item 1 of this Form 10-Q for additional information on this transaction.
Other income. Other income in YTD 2010 decreased modestly by $0.4 million in comparison to YTD 2009, primarily due to $1.2 million of gains recognized by FirstCity Denver’s consolidated subsidiaries in YTD 2009 (mainly railroad operations) in connection with property and equipment sales compared to $0.2 million of such gains recorded in YTD 2010. The decrease in other income in YTD 2010 was off-set partially by an increase in ancillary income generated by FirstCity Denver’s consolidated subsidiaries in YTD 2010 compared to YTD 2009.
Expenses — Other. Other expenses increased by $1.9 million in YTD 2010 compared to YTD 2009 primarily due to $2.1 million of additional net impairment provisions recorded on real estate properties and loan investments in YTD 2010 compared to YTD 2009. The impairment provisions were identified in connection with management’s regular evaluation of the collectibility of FirstCity Denver’s investments. The process for evaluating and measuring impairment is critical to our financial results, as it requires subjective and complex judgments due to the need to make estimates about the impact of matters that are uncertain. This process also requires estimates that are susceptible to significant revision as more information becomes available. It remains unclear what impact the continuance of challenging economic conditions and disruptions in the financial, capital and real estate markets will ultimately have on our financial results. These conditions could adversely impact our business if borrowers cannot refinance their loans and/or continue to make payments, or if the values of our underlying loan collateral and real estate properties continue to decline. Therefore, we cannot provide assurance that, in any particular future period, we will not incur additional impairment provisions.
Equity in earnings of unconsolidated subsidiaries. Equity in earnings of unconsolidated subsidiaries significantly increased to $14.3 million in YTD 2010 from $1.7 million in YTD 2009. The increase in YTD 2010 was due primarily to $14.3 million of additional equity in earnings recorded by FirstCity Denver in YTD 2010 compared to YTD 2009 for its share of net earnings from an equity-method investment in a prefabricated building manufacturing entity. This entity reported significantly-higher net earnings in YTD 2010 related to a short-term lease agreement with a single customer. This lease agreement does not extend beyond September 30, 2010; however, under terms of a related agreement, the manufacturing entity is due another $3.9 million from the customer (although the entity has not recognized any income related to this receivable due to uncertainty regarding the collectibility of the amount). If the building manufacturing entity collects the entire $3.9 million, the net earnings impact to FirstCity would approximate $1.5 million. The increase in equity in earnings for YTD 2010 was also due in part to $0.5 million of additional equity in earnings recorded by FirstCity Denver in YTD 2010 compared to YTD 2009 for its share of net earnings from its former equity-method investment in the coal mine operation (FirstCity Denver consolidated this subsidiary effective April 1, 2010 — refer to discussion above) and newly-obtained direct equity-method investment in a coal mine equipment subsidiary (refer to Note 3 to the consolidated
financial statements included in Item 1 of this Form 10-Q for additional information on this transaction). The increase in equity in earnings for YTD 2010 was off-set partially by $2.2 million of additional equity in losses recorded by FirstCity Denver in YTD 2010 compared to YTD 2009 for its share of net losses from equity-method investments in a restaurant management entity and multiple manufacturing concerns (including a new equity-method investment effective Q3 2010 in a wireless transmission equipment and software solutions entity that was formerly accounted for as a consolidated subsidiary until FirstCity Denver ceased having a controlling interest in the entity effective June 30, 2010 — refer to Note 3 to the consolidated financial statements included in Item 1 of this Form 10-Q for additional information). The increased losses reported by these entities in YTD 2010 were due primarily to lower-than-expected sales volumes during the period.
Net income attributable to noncontrolling interests. The amount of net income attributable to noncontrolling interests related to FirstCity Denver, an 80%-owned subsidiary of FirstCity, increased to $2.9 million for YTD 2010 compared to $0.3 million for YTD 2009. The increase in YTD 2010 was due primarily to additional net earnings reported by FirstCity Denver in YTD 2010 compared to YTD 2009 (mainly related to an increase in equity in earnings from unconsolidated subsidiaries as discussed above).
Financial Condition
Significant changes in FirstCity’s financial condition during the first nine months of 2010 resulted from the following:
Consolidated assets of $445.2 million at September 30, 2010 were $19.9 million lower than consolidated assets at December 31, 2009. The decrease in consolidated assets was attributed primarily to (1) a $44.8 million decrease in cash due primarily to net principal repayments on notes payable, net investment activity, and distributions paid to noncontrolling interests (refer to the consolidated statement of cash flows in Item 1 of this Form 10-Q for additional information on cash changes); and (2) a $12.6 million net decrease in the Company’s consolidated Portfolio Assets in YTD 2010 attributed to net principal collections and net impairment provisions. The decrease in total assets in YTD 2010 was off-set partially by a $30.0 million increase in equity-method investments due to increased investment activity attributed to existing and newly-formed Acquisition Partnerships (primarily domestic) in YTD 2010, and an increase in the equity in earnings attributed to the unconsolidated subsidiaries in YTD 2010 (primarily FirstCity Denver’s subsidiaries).
Consolidated liabilities of $323.5 million as of September 30, 2010 were $16.3 million lower than consolidated liabilities at December 31, 2009. The decrease in consolidated liabilities was attributed primarily to a $20.1 million net decrease in notes payable in YTD 2010 (attributed to net principal repayments), off-set partially by a $3.6 million increase in secured borrowings (included in “Other liabilities”) in YTD 2010 related to the Company’s SBA loan sales activities.
FirstCity’s reported amount of noncontrolling interests (included as a component of equity) decreased by $9.8 million since December 31, 2009 primarily due to $22.8 million of distributions paid to noncontrolling interests in YTD 2010, off-set partially by $10.2 million of net earnings and $5.5 million of investments in majority-owned entities attributed to noncontrolling interests. Refer to the consolidated statement of stockholders’ equity in Item 1 of this Form 10-Q for additional information on these changes.
Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment
Revenues with respect to the Company’s PAA&R business segment consist primarily of (i) income from Portfolio Assets and loans receivable; (ii) gains on the disposition and settlement of Portfolio Assets and other assets; and (iii) servicing fees from Acquisition Partnerships for the performance of servicing activities related to the assets held in unconsolidated Acquisition Partnerships. The Company also records equity in earnings of unconsolidated Acquisition Partnerships and servicing entities accounted for under the equity-method of accounting. Generally speaking, income recognized from our investments in consolidated portfolio assets is reported as “Income from Portfolio Assets” on our consolidated statements of operations, whereas income from our investments in unconsolidated subsidiaries that acquire portfolio assets is reported as “Equity in earnings of unconsolidated subsidiaries.” Furthermore, since we function as the servicer for the vast majority of our domestic and Latin American unconsolidated portfolio assets, we also recognize fee income related to the performance of our servicing responsibilities. This fee income is reported as “Servicing fees” on our consolidated statements of operations. We also generate service fee income from our domestic and Latin American consolidated portfolio assets that we service; however, this income is eliminated in consolidation and, as such, is not included on our consolidated statements of operations.
The following table includes information related to Portfolio Assets acquired by the Company in YTD 2010 and YTD 2009.
|
| Nine Months Ended |
| ||||||||||
|
| September 30, 2010 |
| ||||||||||
|
| (Dollars in thousands) |
| ||||||||||
|
| Wholly-Owned |
| Majority-Owned |
|
|
|
|
| ||||
|
| Consolidated |
| Consolidated |
| Unconsolidated |
| Total |
| ||||
Face Value |
| $ | 33,251 |
| $ | 31,487 |
| $ | 247,808 |
| $ | 312,546 |
|
Total purchase price |
| $ | 16,575 |
| $ | 17,650 |
| $ | 140,480 |
| $ | 174,705 |
|
Total equity invested by all investors |
| $ | 16,575 |
| $ | 17,429 |
| $ | 141,807 |
| $ | 175,811 |
|
Total equity invested by FirstCity |
| $ | 16,575 |
| $ | 12,848 |
| $ | 23,817 |
| $ | 53,240 |
|
Total number of Portfolio Assets |
| 7 |
| 31 |
| 211 |
| 249 |
|
|
| Nine Months Ended |
| ||||||||||
|
| September 30, 2009 |
| ||||||||||
|
| (Dollars in thousands) |
| ||||||||||
|
| Wholly-Owned |
| Majority-Owned |
|
|
|
|
| ||||
|
| Consolidated |
| Consolidated |
| Unconsolidated |
| Total |
| ||||
Face Value |
| $ | 174,797 |
| $ | 131,391 |
| $ | 67,440 |
| $ | 373,628 |
|
Total purchase price |
| $ | 90,795 |
| $ | 80,683 |
| $ | 14,504 |
| $ | 185,982 |
|
Total equity invested by all investors |
| $ | 90,795 |
| $ | 81,401 |
| $ | 14,851 |
| $ | 187,047 |
|
Total equity invested by FirstCity |
| $ | 90,795 |
| $ | 40,701 |
| $ | 2,970 |
| $ | 134,466 |
|
Total number of Portfolio Assets |
| 181 |
| 451 |
| 99 |
| 731 |
|
The table below provides a summary of our loan Portfolio Assets as of September 30, 2010 and December 31, 2009. Our Purchased Credit-Impaired Loans are categorized based on the common risk characteristics that management generally uses for pooling purposes (when management elects to pool groups of purchased loans).
|
| September 30, |
| December 31, |
| ||
|
| 2010 |
| 2009 |
| ||
|
| (Dollars in thousands) |
| ||||
Loan and Loan Pool Type |
|
|
|
|
| ||
Purchased Credit-Impaired Loans |
|
|
|
|
| ||
Domestic: |
|
|
|
|
| ||
Commercial real estate |
| $ | 123,964 |
| $ | 138,485 |
|
Business assets |
| 20,498 |
| 26,983 |
| ||
Other |
| 6,606 |
| 3,906 |
| ||
Latin America |
| 9,789 |
| 10,545 |
| ||
Europe |
| 6,865 |
| 13,001 |
| ||
UBN loan portfolio: |
|
|
|
|
| ||
Non-performing loans |
| 48,123 |
| 60,929 |
| ||
Performing loans |
| 1,069 |
| 1,555 |
| ||
Other |
| 5,764 |
| 8,367 |
| ||
Outstanding balance |
| 222,678 |
| 263,771 |
| ||
Allowance for loan losses |
| (47,578 | ) | (65,825 | ) | ||
Carrying amount, net |
| $ | 175,100 |
| $ | 197,946 |
|
The following table provides a summary of the changes in the allowance for loan losses related to our loan Portfolio Assets:
|
| Purchased Credit-Impaired Loans |
| Other |
|
|
| ||||||||||||||||||
|
| Domestic |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
|
| Commercial |
| Business |
|
|
| Latin |
|
|
|
|
|
|
|
|
| ||||||||
(dollars in thousands) |
| Real Estate |
| Assets |
| Other |
| America |
| Europe |
| UBN |
| Other |
| Total |
| ||||||||
Beginning Balance, January 1, 2010 |
| $ | 5,914 |
| $ | 394 |
| $ | 390 |
| $ | 100 |
| $ | 128 |
| $ | 58,624 |
| $ | 275 |
| $ | 65,825 |
|
Provisions |
| 1,990 |
| 407 |
| 141 |
| 120 |
| 484 |
| — |
| 126 |
| 3,268 |
| ||||||||
Recoveries |
| (70 | ) | (1 | ) | (7 | ) | — |
| — |
| (520 | ) | (16 | ) | (614 | ) | ||||||||
Charge offs |
| (7,392 | ) | (587 | ) | (434 | ) | — |
| (243 | ) | (2,955 | ) | (321 | ) | (11,932 | ) | ||||||||
Translation adjustments |
| — |
| — |
| — |
| (3 | ) | (35 | ) | (8,931 | ) | — |
| (8,969 | ) | ||||||||
Ending Balance, September 30, 2010 |
| $ | 442 |
| $ | 213 |
| $ | 90 |
| $ | 217 |
| $ | 334 |
| $ | 46,218 |
| $ | 64 |
| $ | 47,578 |
|
Due to uncertainties related primarily to estimating the timing and/or amount of collections on Purchased Credit-Impaired Loans as a result of the current economic environment, the Company’s levels of such loans and loan pools accounted for on a non-accrual income-recognition method of accounting (cost-recovery or cash basis) increased to $165.9 million at September 30, 2010 from $138.4 million at December 31, 2009. Under U.S. GAAP, the interest method (i.e. accrual method) of accounting is not appropriate if management does not have the ability to develop a reasonable expectation of both the timing and amount of future cash flows to be collected. Refer to Note 1 of the consolidated financial statements included in Item 1 of this Form 10-Q for additional information and accounting policies related to our Purchased Credit-Impaired Loans. The following tables provide a summary of the Company’s loan Portfolio Assets, including Purchased Credit-Impaired Loans, by income-recognition method as of September 30, 2010 and December 31, 2009 (dollars in thousands):
|
| September 30, 2010 |
| |||||||||||||||||||
|
| Income-Accruing Loans |
| Non-Accrual Loans |
|
|
| |||||||||||||||
|
| Purchased |
|
|
| Purchased Credit- |
|
|
|
|
|
|
| |||||||||
|
| Credit- |
|
|
| Impaired Loans |
| Other |
|
|
| |||||||||||
|
| Impaired |
|
|
|
|
| Cost recovery |
|
|
| Cost recovery |
|
|
| |||||||
|
| Loans |
| Other |
| Cash basis |
| basis |
| Cash basis |
| basis |
| Total |
| |||||||
United States |
| $ | 495 |
| $ | 4,061 |
| $ | 100,255 |
| $ | 49,573 |
| $ | 1,638 |
| $ | — |
| $ | 156,022 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
France |
| — |
| 1,069 |
| 3,860 |
| — |
| — |
| 1,906 |
| 6,835 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Germany |
| — |
| — |
| 2,671 |
| — |
| — |
| — |
| 2,671 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Mexico |
| — |
| — |
| — |
| 9,572 |
| — |
| — |
| 9,572 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Total |
| $ | 495 |
| $ | 5,130 |
| $ | 106,786 |
| $ | 59,145 |
| $ | 1,638 |
| $ | 1,906 |
| $ | 175,100 |
|
|
| December 31, 2009 |
| |||||||||||||||||||
|
| Income-Accruing Loans |
| Non-Accrual Loans |
|
|
| |||||||||||||||
|
| Purchased |
|
|
| Purchased Credit- |
|
|
|
|
|
|
| |||||||||
|
| Credit- |
|
|
| Impaired Loans |
| Other |
|
|
| |||||||||||
|
| Impaired |
|
|
|
|
| Cost recovery |
|
|
| Cost recovery |
|
|
| |||||||
|
| Loans |
| Other |
| Cash basis |
| basis |
| Cash basis |
| basis |
| Total |
| |||||||
United States |
| $ | 42,385 |
| $ | 5,323 |
| $ | 42,125 |
| $ | 78,165 |
| $ | 2,770 |
| $ | — |
| $ | 170,768 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
France |
| — |
| 1,555 |
| — |
| 7,648 |
| — |
| 2,305 |
| 11,508 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Germany |
| 5,225 |
| — |
| — |
| — |
| — |
| — |
| 5,225 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Mexico |
| — |
| — |
| — |
| 10,445 |
| — |
| — |
| 10,445 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Total |
| $ | 47,610 |
| $ | 6,878 |
| $ | 42,125 |
| $ | 96,258 |
| $ | 2,770 |
| $ | 2,305 |
| $ | 197,946 |
|
Middle-Market Company Capital Investments — Special Situations Platform Business Segment
Revenues with respect to the Company’s Special Situations Platform business segment consist primarily of (i) interest and fee income from loan investments; (ii) revenues from majority-owned operating entities; and (iii) equity in earnings of minority-owned investments in operating entities accounted for under the equity-method of accounting.
Investments by FirstCity Denver since its inception in April 2007 are summarized below:
|
| Total |
| FirstCity Denver’s Investment |
| ||||||||
(Dollars in thousands) |
| Investment |
| Debt |
| Equity |
| Total |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
First nine months of 2010 |
| $ | 13,564 |
| $ | 8,650 |
| $ | 4,395 |
| $ | 13,045 |
|
Total 2009 |
| 20,058 |
| 12,023 |
| 392 |
| 12,415 |
| ||||
Total 2008 |
| 28,750 |
| 16,650 |
| 3,256 |
| 19,906 |
| ||||
Total 2007 |
| 22,314 |
| 5,630 |
| 5,900 |
| 11,530 |
| ||||
Provision for Income Taxes
The Company has substantial net operating loss carryforwards (“NOLs”) for U.S. federal income tax purposes which can be used to off-set the tax liability associated with the Company’s pre-tax earnings until the earlier of the expiration or utilization of such NOLs. The Company accounts for the benefit of these NOLs, and other income tax items in both the U.S. and the non-U.S. jurisdictions in which we operate, under the asset and liability method. Deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed periodically by the Company based on the more-likely-than-not realization threshold criterion. In the assessment, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other factors, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, excess of appreciated asset value over the tax basis of net assets, the duration of statutory carryforward periods, the Company’s experience with utilizing available operating loss and tax credit carryforwards, and tax planning strategies. In making such assessments, significant weight is given to evidence that can be objectively verified. At September 30, 2010, the Company carried a full valuation allowance for its U.S. deferred tax assets due to the lack of sufficient objective evidence regarding the realization of these assets in the foreseeable future. We will continue to evaluate the deferred tax asset valuation allowance balances in all of our U.S. and foreign subsidiaries throughout 2010 to determine the appropriate level of valuation allowances.
Liquidity and Capital Resources
Overview
The Company requires liquidity to fund its operations, Portfolio Asset acquisitions, investments in and advances to Acquisition Partnerships, capital investments in privately-held middle-market companies, other debt and equity investments, repayments of bank borrowings and other debt, and working capital to support our growth. Historically, our primary sources of liquidity have been funds generated from operations (primarily loan and real estate collections and service fees), equity distributions from the Acquisition Partnerships and other subsidiaries, interest and principal payments on subordinated intercompany debt, dividends from the Company’s subsidiaries, borrowings from credit facilities with external lenders, and other special-purpose short-term borrowings.
Our ability to make fund operations and new investments is dependent on (1) the cash leak-through and overhead allowance provisions included in our loan facility with Bank of Scotland (as discussed below); (2) residual cash flows from the pledged assets and equity investments after full repayment of the Bank of Scotland debt (as discussed below); (3) our current holdings of unencumbered cash and portfolio assets; and (4) our investment agreement with Värde (see discussions below and Note 1 of the consolidated financial statements included in Item 1 of this Form 10-Q for additional information). Many factors, including general economic conditions, are essential to our ability to generate cash flows. Fluctuations in our collections, investment income, credit availability, and adverse changes in other factors could have a negative impact on our ability to generate sufficient cash flows to support our business. Despite recent credit market conditions, we have continued to have access to liquidity in both our PAA&R and
Special Situations Platform business segments through our unencumbered cash and portfolio assets, credit facility commitments with external lenders, and/or an investment agreement in place with Värde. While management believes that these cash flow sources will provide FirstCity with funding and liquidity to supports its operations and investment activities, FirstCity continues to actively seek additional sources of liquidity and alternative funding sources.
Reducing Note Facility with Bank of Scotland and BoS(USA) (collectively, “Bank of Scotland”)
In June 2010, FirstCity refinanced its loan facilities with Bank of Scotland and closed on a $268.6 million Reducing Note Facility Agreement (“Reducing Note Facility”) that allows for repayment to Bank of Scotland over time as cash flows from the underlying assets securing the loan facility are realized. The Company’s outstanding indebtedness and letter of credit obligations under its then-existing loan facilities with Bank of Scotland were refinanced into the Reducing Note Facility. Refer to Credit Facilities below for the primary terms of this note facility.
Investment Agreement with Värde Investment Partners, L.P. (“Värde”)
FirstCity and Värde are parties to an investment agreement, effective April 1, 2010, whereby Värde may invest up to $750 million, at its discretion, alongside FirstCity in distressed loan portfolios and similar investment opportunities, subject to the terms and conditions contained in the agreement. The primary terms of the Investment Agreement are as follows:
· FirstCity will act as the exclusive servicer for the investment portfolios;
· FirstCity will provide Värde with a “right of first refusal” with regard to distressed asset investment opportunities in excess of $3 million sourced by FirstCity;
· FirstCity, at its determination, will co-invest between 5%-25% in each investment;
· FirstCity will receive a $200,000 monthly retainer in exchange for its services and commitments;
· FirstCity will receive a base servicing fee (based on investment portfolio collections) and will be eligible to receive additional incentive-based servicing fees (depending on the performance of the portfolios acquired); and
· FirstCity will be eligible to receive incentive-based management fees (depending on the aggregate amount and performance of the portfolios acquired).
The cash flows from the assets and equity interests from the Company’s investments made in connection with the investment agreement with Värde, which are held by FC Investment Holdings Corporation and its subsidiaries, are not subject to the security interest requirements of Bank of Scotland’s Reducing Note Facility described above.
Consolidated Statements of Cash Flows
The following is an analysis of the cash flows related to FirstCity’s consolidated operations for YTD 2010 and YTD 2009:
Our operating activities used cash of $23.1 million and provided cash of $1.5 million for YTD 2010 and YTD 2009, respectively. For YTD 2010, net cash used in operations was attributable primarily to $11.9 million of net principal advances on SBA loans held for sale; $34.3 million of non-cash deductions for income accretion and gains on Portfolio Assets; $14.0 million of non-cash deductions for equity earnings from equity-method investments; and $9.0 million of non-cash deductions attributed to gains recognized on business combination transactions and the sale of an investment security — off-set partially by $20.9 million of net earnings; $5.0 million of proceeds from SBA loan sales; $2.2 million of proceeds applied to income from Portfolio Assets; and $18.7 million of non-cash add-backs related to provisions for loan and impairment losses, depreciation and amortization (including $6.8 million of net amortization attributable to the coal supply and coal purchase contracts on the balance sheet of our consolidated coal mine subsidiary). For YTD 2009, net cash provided by operations was attributable primarily to $13.6 million of net earnings; $18.2 million of proceeds from sales of SBA loans held for sale; $15.3 million of proceeds applied to income from Portfolio Assets; $5.6 million increase in other liabilities; and $5.2 million of non-cash add-backs related to depreciation, amortization, and provisions for loan and impairment losses — off-set partially by $13.5 million of net principal advances on SBA loans held for sale; $35.3 million for income accretion and
gains on Portfolio Assets; $1.5 million of equity earnings from equity-method investments, and $1.5 million for a step acquisition gain. The remaining changes in the periods were due primarily to net changes in other accounts related to our operating activities.
Our investing activities provided cash of $32.2 million and used cash of $65.6 million for YTD 2010 and YTD 2009, respectively. For YTD 2010, net cash provided by investing activities was attributable primarily to $57.7 million of principal collections on Portfolio Assets (net of purchases); $8.2 million of distributions from our equity-method investments; $1.7 million of net principal repayments from our loan investments; and $3.3 million of proceeds from the sale of an investment security — off-set partially by $32.8 million of contributions to our equity-method investments; $1.6 million paid for business combinations (net of cash acquired); $1.7 million of property and equipment purchases; $2.6 million of investment security purchases; and a $0.9 million reduction in cash attributed to the deconsolidation of our manufacturing subsidiary. For YTD 2009, net cash used in investing activities was attributable primarily to Portfolio Asset purchases of $62.8 million (net of principal collections); $7.1 million paid for business combinations; $2.1 million of property and equipment purchases; $3.9 million of equity investment contributions; and $3.8 million of net advances and originations for loan investments — off-set partially by $9.3 million of distributions from equity-method investments; $3.5 million of principal payments on an investment security available for sale; and $1.4 million of proceeds from sales of property. The remaining changes in the periods were due primarily to net changes in other accounts related to our investing activities.
Our financing activities used cash of $53.9 million and provided cash of $77.7 million for YTD 2010 and YTD 2009, respectively. For YTD 2010, net cash used in financing activities was attributable primarily to $40.3 million of principal payments on notes payable and loan fee payments (net of borrowings), and $22.8 million of cash distributions paid to noncontrolling interests — off-set partially by $4.9 million of contributions from noncontrolling interests primarily to acquire Portfolio Assets through consolidated subsidiaries; $1.0 million of proceeds from the issuance of common stock; and $3.6 million of proceeds from secured borrowings related to SBA loan sale transactions (net of principal repayments). For YTD 2009, net cash provided by financing activities was attributable to $49.3 million of net borrowings to finance our Portfolio Asset acquisitions and other investments and $41.0 million of contributions from noncontrolling interests primarily to acquire Portfolio Assets through consolidated subsidiaries — off-set partially $10.0 million of cash distributions to noncontrolling interests and $2.8 million of cash paid to acquire additional equity in noncontrolling interests. The remaining changes in the periods were due primarily to net changes in other accounts related to our financing activities.
Cash paid for interest expense approximated $8.4 million and $7.3 million for YTD 2010 and YTD 2009. Substantially all of our interest expense was paid on our credit facilities and other borrowings. FirstCity’s average outstanding debt increased to $303.6 million for YTD 2010 from $290.6 million for YTD 2009, while the average cost of borrowings increased to 5.2% in 2010 compared to 4.9% in 2009. The increase in the Company’s debt level since September 30, 2009 is a result of increased net borrowings to finance the Company’s growth and investment transactions. The increase in the Company’s average cost of borrowings was due primarily to the higher interest and fees charged on our Reducing Note Facility with Bank of Scotland (closed in June 2010) compared to the interest rates and fees under the loan facilities we had in place with Bank of Scotland last year.
Statements of Cash Flows — Consolidated Railroad and Coal Mine Operations
The following is an analysis of the cash flows related to FirstCity’s majority-owned railroad and coal mine subsidiaries for YTD 2010 and YTD 2009, as applicable. The cash flow effects described below are included in the Company’s analysis of its consolidated cash flows for YTD 2010 and YTD 2009, as applicable, as discussed above. The cash flows related to FirstCity’s formerly-consolidated majority-owned manufacturing subsidiary were not material to the Company’s consolidated cash flows.
Railroad Operations Cash Flows
The following is an analysis of the cash flows related to FirstCity’s majority-owned railroad operation for YTD 2010 and YTD 2009. All significant intercompany balances and transactions have been eliminated in consolidation.
The operating activities of the railroad subsidiary provided cash of $2.6 million for YTD 2010, attributable primarily to $1.6 million of net earnings and a $1.0 million increase in operating liabilities. The railroad subsidiary’s investing activities used cash of $1.5 million for YTD 2010 related to property and equipment purchases. The railroad subsidiary’s financing activities used cash of $0.7 million for YTD 2010, attributable to $0.3 million of principal payments on a bank note payable and $0.4 million of distributions to the noncontrolling equity owners and FirstCity (eliminated in consolidation).
The operating activities of the railroad subsidiary provided cash of $1.6 million for YTD 2009 — attributable primarily to $1.7 million of net earnings and a $1.2 million increase in other liabilities; off-set partially by $1.2 million of gains on sales of property and equipment. The railroad subsidiary’s investing activities used cash of $0.3 million in YTD 2009, which includes $1.6 million of
proceeds from property and equipment sales; off-set by $1.5 million of property and equipment purchases. The railroad subsidiary’s financing activities used cash of $1.4 million for YTD 2009 — attributable primarily to providing $1.3 million of capital to FirstCity (parent company) through principal repayments on a capital note (eliminated in consolidation).
Coal Mine Operations Cash Flows
The following is an analysis of the cash flows related to FirstCity’s majority-owned coal mine operation for the six-month period ended September 30, 2010 (FirstCity consolidated the coal mine subsidiary effective April 1, 2010 after it obtained control of the entity at such time — refer to Note 3 of the consolidated financial statements included in Item 1 of this Form 10-Q for additional information). All significant intercompany balances and transactions have been eliminated in consolidation.
The operating activities of the coal mine subsidiary provided cash of $6.0 million for the six-month period ended September 30, 2010 — attributable primarily to a $0.8 million increase in other liabilities and a $6.8 million non-cash add-back for amortization; off-set partially by $0.7 million of net losses and a $0.9 million decrease in other assets. The financing activities of the coal mine subsidiary used $7.4 million of cash for the six-month period ended September 30, 2010, attributed primarily to $2.6 million of principal repayments on a note payable and $4.5 million of payments to the noncontrolling equity owner and FirstCity (parent company) through distributions and principal repayments on a capital note (eliminated in consolidation). The coal mine subsidiary did not record any cash flows related to investing activities during the six-month period ended September 30, 2010.
Credit Facilities
On June 25, 2010, FirstCity Commercial Corporation (“FC Commercial”) and FH Partners LLC (“FH Partners”), as borrowers, and FLBG Corporation (“FLBG Corp.”), as guarantor, all of which are wholly-owned subsidiaries of FirstCity, and Bank of Scotland and BoS(USA), Inc. (collectively, “Bank of Scotland”), as lenders, entered into a Reducing Note Facility Agreement (“Reducing Note Facility”). In addition, on June 25, 2010, FirstCity executed a Limited Guaranty Agreement guarantying payment of the indebtedness under the Reducing Note Facility to a maximum amount of $75.0 million.
The Reducing Note Facility amended and restated the following loan facilities previously provided by Bank of Scotland to FirstCity and FH Partners: (a) Revolving Credit Agreement dated November 12, 2004, as amended, to FirstCity ($225.0 million loan facility); (b) Revolving Credit Agreement dated August 26, 2005, as amended, to FH Partners ($100.0 million loan facility); and (c) Subordinated Delayed Draw Credit Agreement dated September 5, 2007, as amended, to FirstCity ($25.0 million loan facility) (collectively, “Prior Credit Agreements”). The Prior Credit Agreements were guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity and secured by substantially all of the assets of FirstCity and its wholly-owned subsidiaries. The outstanding indebtedness and letter of credit obligations under the Prior Credit Agreements in the amount of $268.6 million were refinanced into the Reducing Note Facility, which provides for a scheduled amortization over 3 years ($43.6 million in the first year, $80.0 million in the second year, $60.0 million in the first nine months of the third year, and $85.0 million due on June 25, 2013, the maturity date).
The material terms of the Reducing Note Facility and related agreements are as follows:
· Limited guaranty provided by FirstCity for the repayment of the indebtedness under the Reducing Note Facility to a maximum amount of $75.0 million, plus costs of enforcement and certain contingent indemnities;
· No advances will be made under the loan facility, except for draws on outstanding letters of credit in the amount of $22.35 million which are included in the amount of the loan facility ($11.9 million was advanced in October 2010 — see discussion below);
· Repayment will be made from the cash flow from assets and equity investments which were pledged to secure the Prior Credit Agreements;
· FirstCity will receive unencumbered cash of 20% of the monthly net cash flows (i.e. cash “leak-through”) up to $25.0 million, after (a) payment to Bank of Scotland of interest and fees; and (b) payment of a scheduled overhead allowance to FirstCity Servicing Corporation (“FC Servicing”), a wholly-owned subsidiary of FirstCity, of $38.9 million over 3 years ($1.5 million per month for the first year, $1.03 million per month for the second year, and $0.7 million per month for the third year);
· Fluctuating interest rate equal to, at FC Commercial’s option, either (a) the greater of (i) one month London Interbank Offering Rate (“LIBOR”) plus 3.5% (subject to LIBOR floor of 1.0%) or (ii) 4.5%, or (b) Bank of Scotland’s prime rate plus 3.0%;
· FC Commercial and FH Partners may designate a portion of the debt under the Reducing Note Facility to be borrowed in Euros up to a maximum amount of Euros equivalent to USD $27.5 million; and
· FirstCity must maintain a minimum tangible net worth (as defined) requirement of $60.0 million.
Fees paid to Bank of Scotland in connection with the Reducing Note Facility through September 30, 2010 totaled $1.85 million, with $683,000 paid in March 2010 (in connection with an extension of the Prior Credit Facilities), $675,000 paid in June 2010, and $501,000 paid from July to September 2010. A final loan fee payment of $167,000 was made in October 2010.
The Reducing Note Facility is guaranteed by FLBG Corp. and all of its subsidiaries (“Covered Entities”), which represent the entities that were subject to the obligations of the Prior Credit Facilities other than FirstCity and FC Servicing. The Reducing Note Facility is secured by substantially all of the assets of the Covered Entities. FC Investment Holdings Corporation (a newly-formed wholly-owned subsidiary of FirstCity) and its current and future subsidiaries, or other entities in which such subsidiaries own any equity interest (“Non-Covered Entities”), are not subject to, do not guarantee and do not provide security interests in their assets to secure the Reducing Note Facility. FC Servicing only provides a non-recourse security interest in certain equity interests owned by it and in most of the servicing fees from previously-existing agreements which secured the Prior Credit Facilities. FC Servicing does not provide a security interest in servicing agreements entered into with the Non-Covered Entities or in any of its other assets and does not guarantee the Reducing Note Facility.
The Reducing Note Facility contains covenants, representations and warranties on the part of FLBG Corp., FC Commercial and FH Partners that are typical for transactions of this type. In addition, the Reducing Note Facility contains customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other indebtedness, certain events of bankruptcy and insolvency, and failure to pay certain judgments. In the event that an event of default occurs and is continuing, Bank of Scotland may accelerate the indebtedness under the Reducing Note Facility.
At September 30, 2010, the unpaid principal balance on this loan facility was $227.9 million. In October 2010, a letter of credit under the Reducing Note Facility was funded in the amount of $11.9 million, and the proceeds were used to pay-off a bank note payable that was owed by an affiliated Mexican entity of FirstCity (described below). The entire amount of the funded letter of credit was added to the unpaid principal obligation under the terms and conditions of the Reducing Note Facility.
FirstCity has $25.6 million in Euro-denominated debt on the Reducing Note Facility for the purpose of hedging a portion of the Company’s net equity investments in Europe. Refer to Note 11 to our consolidated financial statements included in Item 1 of this Form 10-Q for additional information.
Banco Santander, S.A.
FirstCity Mexico SA de CV, a wholly-owned Mexican affiliate of FirstCity, has a loan agreement with Banco Santander, S.A. that allows loans to be made in Mexican pesos. At September 30, 2010, the Company had 142,240,000 in Mexican peso-denominated debt, which was equivalent to $11.4 million U.S. dollars. The proceeds were used to pay down the acquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CV was required to provide a stand-by letter of credit from Bank of Scotland that would satisfy the loan balance upon demand. At September 30, 2010, FirstCity had a letter of credit in the amount of $12.6 million from Bank of Scotland under the terms of FirstCity’s Reducing Note Facility with Bank of Scotland. In October 2010, the letter of credit was funded in the amount of $11.9 million, and the proceeds were used to pay-off FirstCity Mexico SA de CV’s note payable to Banco Santander, S.A. The entire amount of the funded letter of credit was added to the unpaid principal obligation of FirstCity’s Reducing Note Facility with Bank of Scotland.
Wells Fargo Foothill, LLC
At September 30, 2010, ABL had a $25.0 million revolving loan facility with Wells Fargo Capital Finance (“WFCF”) for the purpose of financing and acquiring SBA loans. This credit facility matures in January 2012 and is secured by substantially all of the assets of ABL. In addition, FirstCity provides WFCF with an unconditional guaranty for all of ABL’s obligations up to a maximum of $5.0 million plus enforcement costs. The primary terms and key covenants of this loan facility are described in our 2009 Form 10-K. At September 30, 2010, ABL was in compliance with all covenants or other requirements set forth in the credit agreement or other agreements with WFCF.
The following table summarizes the material terms of the credit facilities of FirstCity and its consolidated subsidiaries and the outstanding borrowings under such facilities as of September 30, 2010 and December 31, 2009.
|
|
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|
|
| Outstanding |
| Outstanding |
| ||
|
|
|
|
|
| Borrowings |
| Borrowings |
| ||
|
|
|
|
|
| as of |
| as of |
| ||
|
|
|
|
|
| September 30, |
| December 31, |
| ||
|
| Interest Rate |
| Other Terms and Conditions |
| 2010 |
| 2009 |
| ||
|
|
|
|
|
| (Dollars in thousands) |
| ||||
Notes payable to banks and other: |
|
|
|
|
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Bank of Scotland reducing note facility (includes $25.6 million denominated in Euros at September 30, 2010) |
| Election of (a) greater of (i) one-month LIBOR plus 3.5% (subject to LIBOR floor of 1.0%) or (ii) 4.5%, or (b) Bank of Scotland’s prime rate of 3.0% |
| Secured by substantially all assets and equity investments of FirstCity Commercial Corp. and FH Partners LLC and guaranteed by FirstCity up to $75.0 million, matures June 2013 |
| $ | 227,929 |
| $ | — |
|
|
|
|
|
|
|
|
|
|
| ||
Bank of Scotland $225 million revolving loan facility (included $24.8 million denominated in Euros at December 31, 2009) |
| LIBOR-indexed plus 2.5% |
| Secured by substantially all assets of FirstCity and certain subsidiaries and guaranteed by by substantially all of FirstCity’s consolidated subsidiaries, refinanced June 2010 |
| — |
| 182,324 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bank of Scotland $100 million revolving loan facility |
| LIBOR-indexed plus 2.0% |
| Secured by all assets of FH Partners LLC and guaranteed by FirstCity and certain of its consolidated subsidiaries, refinanced June 2010 |
| — |
| 58,506 |
| ||
|
|
|
|
|
|
|
|
|
| ||
BoS(USA) $25 million subordinated credit agreement |
| LIBOR + 5.0% |
| Secured by substantially all assets of FirstCity and certain subsidiaries and guaranteed by substantially all of FirstCity’s consolidated subsidiaries, refinanced June 2010 |
| — |
| 25,000 |
| ||
|
|
|
|
|
|
|
|
|
| ||
WFCF $25 million revolving loan facility |
| Alternate interest rates based on Wells Fargo base rate plus margin, LIBOR plus margin, or 7.5% |
| Secured by assets of ABL and guaranteed by FirstCity up to $5.0 million, matures January 2012 |
| 15,117 |
| 10,694 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Banco Santander term loan [1] |
| 28-day Mexican index rate (TIIE) plus 2.0% |
| Secured by Bank of Scotland letter of credit, matures November 2010, commitment amount 142.2 million MXN |
| 10,929 |
| 10,986 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bank of America term loan |
| Greater of (prime or federal funds rate plus 0.5%) plus margin, or LIBOR plus margin |
| Secured by assets of FirstCity’s consolidated railroad subsidiaries, matures March 2011 |
| 2,815 |
| 3,086 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bank of America $1 million revolving loan facility |
| Greater of (prime or federal funds rate + 0.5%) plus margin, or LIBOR plus margin |
| Secured by assets of FirstCity’s consolidated railroad subsidiaries, matures March 2011 |
| 395 |
| 395 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bank of America term note |
| LIBOR plus 1.65% |
| Secured by all assets of WAMCO 30, Ltd., matures November 2010 |
| 11,525 |
| — |
| ||
|
|
|
|
|
|
|
|
|
| ||
Merrill Lynch Mortgage Trust term loan |
| 6.07% fixed |
| Secured by assets of Oregon Short Line Building, matures April 2016 |
| 7,371 |
| 7,452 |
| ||
|
|
|
|
|
|
|
|
|
| ||
B.E.S.V. term loans denominated in Euros |
| Various rates at 1-month Eurobor + 3.5% or 3-month Eurobor + 3.0% |
| Secured by assets of UBN, various maturities ranging from May 2012 to May 2013 |
| 6,349 |
| 5,433 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Other notes and participations payable |
|
|
|
|
| 3,545 |
| 2,012 |
| ||
|
|
|
|
|
|
|
|
|
| ||
|
|
|
|
|
| 285,975 |
| 305,888 |
| ||
Note payable to affiliate: |
|
|
|
|
|
|
|
|
| ||
MCS Trust SA de CV term loan |
| 20.0% fixed |
| Secured by assets of FC Acquisitions, SRL de CV, matures June 2020 |
| 7,686 |
| 7,838 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total notes payable |
|
|
|
|
| $ | 293,661 |
| $ | 313,726 |
|
[1] In October 2010, a letter of credit under the Company’s Reducing Note Facility with Bank of Scotland was funded in the amount of $11.9 million, and the proceeds were used to pay-off this term note payable to Banco Santander. The entire amount of the funded letter of credit was added to the unpaid principal obligation of FirstCity’s Reducing Note Facility with Bank of Scotland.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements relate primarily to indemnification obligations and guaranty agreements (refer to Note 19 of the consolidated financial statements included in Item 1 of this Form 10-Q for information on our off-balance sheet arrangements). We do not believe that these or any other off-balance sheet arrangements have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. However, there can be no assurance that such arrangements will not have any such future effects on the Company.
Cautionary Statement Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such statements. All statements, other than statements of historical fact, are forward-looking statements, including statements regarding our expected financial position, future financial performance, overall trends, liquidity and capital needs, and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. In this context, words such as “anticipates,” “believes,” “expects,” “estimates,” “plans,” “intends,” “could,” “should,” “will,” “may” and similar words or expressions are intended to identify forward-looking statements and are not historical facts.
These forward-looking statements involve risks, uncertainties and assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. For a discussion on the risks, uncertainties and assumptions that affect our business, operating results and financial condition, you should carefully review the “CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS” qualification and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2009 Form 10-K, and Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q.
We are also subject to other risks detailed herein or detailed from time-to-time in our filings with the SEC. The listed risks referenced above are not intended to be exhaustive and the order in which the risks appear is not intended as an indication of their relative weight or importance. We operate in continually changing business environments, and new risk factors emerge from time to time. We cannot predict these new risk factors, nor can we assess the impact, if any, of these new risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements.
You are cautioned that our forward-looking statements could be wrong in light of these and other risks, uncertainties and assumptions, which change over time. Actual results, developments and outcomes may differ materially from those expressed in, or implied by, our forward-looking statements. The forward-looking statements speak only as of the date the statement is made, and we have no obligation to publicly update or revise our forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The Company’s management evaluated, with the participation of our principal executive officer and principal financial officer, or persons performing similar functions, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms relating to FirstCity, including our consolidated subsidiaries, and was accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Controls
In connection with the evaluation required by paragraph (d) of Rule 13a-15 under the Exchange Act, there was no change identified in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION
There have been no material developments regarding any matters disclosed under Part I, Item 3 “Legal Proceedings” in our 2009 Form 10-K.
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
None.
Exhibit |
| Description of Exhibit |
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31.1* | — | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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31.2* | — | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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32.1* | — | Certification of the Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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32.2* | — | Certification of the Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* Filed herewith.
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.
| FIRSTCITY FINANCIAL CORPORATION | |
Dated: November 15, 2010 |
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| By: | /s/ JAMES T. SARTAIN |
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| James T. Sartain |
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| President and Chief Executive |
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| Officer and Director |
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| (Duly authorized officer and |
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| Principal Executive Officer) |
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| By: | /s/ J. BRYAN BAKER |
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| J. Bryan Baker |
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| Senior Vice President and |
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| Chief Financial Officer |
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| (Duly authorized officer and |
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| Principal Financial and |
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| Accounting Officer) |