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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
<Table>
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
</Table>
COMMISSION FILE NUMBER 033-19694
FIRSTCITY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE 76-0243729
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
6400 IMPERIAL DRIVE, WACO, TX 76712
(Address of Principal Executive Offices) (Zip Code)
</Table>
(254) 751-1750
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS
COMMON STOCK, PAR VALUE $.01
ADJUSTING RATE PREFERRED STOCK, PAR VALUE $.01
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The number of shares of common stock outstanding at March 26, 2003 was
11,195,076. As of such date, the aggregate market value of the voting and
non-voting common equity held by non-affiliates, based upon the closing price of
the common stock on the Nasdaq National Market System, was approximately
$14,314,572.
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FIRSTCITY FINANCIAL CORPORATION
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I
Item 1 Business.................................................... 2
Item 2 Properties.................................................. 12
Item 3 Legal Proceedings........................................... 12
Item 4 Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 13
Item 6 Selected Financial Data..................................... 14
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 7A Quantitative and Qualitative Disclosures About Market
Risk........................................................ 47
Item 8 Financial Statements and Supplementary Data................. 50
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 132
PART III
Item 10 Directors and Executive Officers of the Registrant.......... 132
Item 11 Executive Compensation...................................... 135
Item 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 138
Item 13 Certain Relationships and Related Transactions.............. 139
Item 14 Controls and Procedures..................................... 141
PART IV
Item 15 Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 141
</Table>
1
FORWARD LOOKING INFORMATION
This Annual Report on Form 10-K, as amended, may contain forward-looking
statements. The factors identified under "Risk Factors" contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" are important factors (but not necessarily all of the important
factors) that could cause actual results to differ materially from those
expressed in any forward-looking statement made by, or on behalf of, FirstCity
Financial Corporation (the "Company" or "FirstCity").
When any such forward-looking statement includes a statement of the
assumptions or bases underlying such forward-looking statement, the Company
cautions that, while such assumptions or bases are believed to be reasonable and
are made in good faith, assumed facts or bases almost always vary from actual
results, and the differences between assumed facts or bases and actual results
can be material, depending upon the circumstances. When, in any forward-looking
statement, the Company, or its management, expresses an expectation or belief as
to future results, such expectation or belief is expressed in good faith and is
believed to have a reasonable basis, but there can be no assurance that the
statement of expectation or belief will result or be achieved or accomplished.
The words "believe," "expect," "estimate," "project," "anticipate" and similar
expressions identify forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL
FirstCity, a Delaware corporation, is a financial services company
headquartered in Waco, Texas with offices throughout the United States and
Mexico and a presence in France. The Company began operating in 1986 as a
specialty financial services company focused on acquiring and resolving
distressed loans and other assets purchased at a discount relative to the
aggregate unpaid principal balance of the loans or the appraised value of the
other assets ("Face Value"). To date the Company has acquired, for its own
account and through various affiliated partnerships, pools of assets or single
assets (collectively referred to as "Portfolio Assets" or "Portfolios") with a
Face Value of approximately $7.1 billion. The Company's servicing expertise,
which it has developed largely through the resolution of distressed assets, is a
cornerstone of its growth strategy. Today the Company is engaged in two
principal businesses: (i) Portfolio Asset acquisition and resolution and (ii)
consumer lending through the Company's minority investment in Drive Financial
Services LP ("Drive"). See Note 8 of the Company's Consolidated Financial
Statements for certain financial information about these two segments of the
Company.
BUSINESS STRATEGY
The Company's core business is the acquisition, management, servicing and
resolution of Portfolio Assets. Key elements of the Company's overall business
strategy include:
- Increasing the Company's investments in Portfolio Assets acquired from
financial institutions and government agencies, both for its own account
or through investment entities formed with Cargill Financial Services
Corporation ("Cargill", "CFSC" or "Cargill Financial") or one or more
other co-investors, thereby capitalizing on the expertise of partners
whose skills complement those of the Company.
- Identifying and acquiring, through non-traditional niche sources,
distressed assets that meet the Company's investment criteria, which may
involve the utilization of special acquisition structures.
- Acquiring, managing, servicing and resolving Portfolio Assets in certain
international markets, either separately or in partnership with others,
including Cargill.
- Capitalizing on the Company's servicing expertise to enter into new
markets with servicing agreements that provide for reimbursement of costs
of entry and operations plus an incentive servicing fee after certain
thresholds are met without requiring substantial equity investments.
2
- Retaining a minority interest investment in Drive.
- Maximizing growth in operations, thereby permitting the utilization of
the Company's net operating loss carryforwards ("NOLs").
BACKGROUND
The Company began operating in the financial service business in 1986 as a
purchaser of distressed assets from the Federal Deposit Insurance Corporation
("FDIC") and the Resolution Trust Corporation ("RTC"). From its original office
in Waco, Texas, with a staff of four professionals, the Company's asset
acquisition and resolution business grew to become a significant participant in
an industry fueled by the problems experienced by banks and thrifts throughout
the United States. In the late 1980s, the Company also began acquiring assets
from healthy financial institutions interested in eliminating nonperforming
assets from their portfolios. The Company began its relationship with Cargill in
1991. Since that time, the Company and Cargill have formed a series of
Acquisition Partnerships through which they have jointly acquired over $6.2
billion in Face Value of Portfolio Assets.
In July 1995, the Company acquired by merger (the "Merger") First City
Bancorporation of Texas, Inc. ("FCBOT"), a former bank holding company that had
been engaged in a proceeding under Chapter 11 of the Bankruptcy Code since
November 1992. As a result of the Merger, the common stock of the Company became
publicly held and the Company received $20 million of additional equity capital
and entered into an incentive-based servicing agreement to manage approximately
$300 million in assets for the benefit of the former equity holders of FCBOT. In
addition, as a result of the Merger, the Company retained FCBOT's rights to
approximately $596 million in NOLs, which the Company believes it can use to
offset taxable income generated by the Company and its consolidated
subsidiaries.
Following the Merger, the Company adopted a growth and diversification
strategy designed to capitalize on its servicing and credit expertise to expand
into additional financial service businesses. To that end, in July 1997 the
Company acquired Harbor Financial Group, Inc. and its subsidiaries (collectively
referred to as "Mortgage Corp."), a company engaged in the residential and
commercial mortgage banking business since 1983. During 1997, the Company also
expanded into related niche financial services markets, such as mortgage conduit
banking, conducted through FC Capital Corp. ("Capital Corp."), a subsidiary of
the Company, and such as consumer finance, conducted through FirstCity Consumer
Lending Corporation ("Consumer Corp."), a subsidiary of the Company.
Effective during the third quarter of 1999, management of the Company
adopted formal plans to discontinue the operations of Mortgage Corp. and Capital
Corp. These entities comprised the operations that were previously reported as
the Company's mortgage banking operations. Because the Company formally adopted
plans to discontinue the operations of Mortgage Corp. and Capital Corp., and
operations at each such entity have ceased, the results of historical operations
have been reflected as discontinued operations.
On October 14, 1999, Harbor Financial Group, Inc. ("Harbor Parent"), Harbor
Financial Mortgage Corporation ("Harbor") and four subsidiaries of Harbor filed
voluntary petitions under Chapter 11 of the United States Bankruptcy Code. On
December 14, 1999, these bankruptcy proceedings were converted to liquidation
proceedings under Chapter 7 of the United States Bankruptcy Code. John H.
Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the "Trustee"),
initiated adversary proceedings on May 25, 2001 against FirstCity and various
current and former directors and officers of FirstCity and Mortgage Corp.
alleging breach of fiduciary duties, mismanagement, and self-dealing by
FirstCity and Harbor directors and officers, and improper transfer of funds from
the Harbor related entities to FirstCity. The claims also included fraudulent
and preferential transfer of assets of the Harbor entities, fraud and
conspiracy. The Trustee, FirstCity, the other defendants and the insurers
providing Director's and Officer's Insurance coverage for FirstCity and its
subsidiaries (the "Insurers") settled the claims brought in the adversary
proceedings with the approval of the Bankruptcy Court. Under the terms of the
settlement agreement, the Trustee released the defendants, their affiliates and
subsidiaries from any and all claims which were brought or could have been
brought by the Trustee against any of the defendants, any past and present
officers and directors of FirstCity or any affiliates or subsidiaries of
FirstCity.
3
As a result of the liquidity constraints created by the discontinued
operations of Mortgage Corp. and Capital Corp., in the third quarter of 2000,
Consumer Corp. completed the sale of a 49% equity interest in its automobile
finance operation to IFA Drive GP Holdings LLC ("IFA-GP") and IFA Drive LP
Holdings LLC ("IFA-LP"), wholly-owned subsidiaries of BoS(USA), Inc.
("BoS(USA)"), a wholly-owned subsidiary of Bank of Scotland (together with
BoS(USA), the "Senior Lenders"), for a purchase price of $15 million cash. The
transaction generated $75 million in cash and resulted in a gain of $12.1
million ($4 million was deferred and recognized in the December 2002
recapitalization discussed below). Simultaneously, the Senior Lenders and the
Company completed a debt restructure whereby the Company reduced the outstanding
debt under its senior and subordinate facilities from $113 million to
approximately $44 million. The Company also retired approximately $6.4 million
of debt owed to other lenders.
In December 2002, FirstCity completed a recapitalization in which holders
of FirstCity's redeemable preferred stock, par value $.01 per share ("New
Preferred Stock"), representing 89.3% of the 1,222,901 share previously
outstanding, exchanged 1,092,210 shares of New Preferred Stock for 2,417,388
shares of common stock and $10.5 million. Upon the completion of the
recapitalization, 130,691 shares of New Preferred Stock remained outstanding. As
a result, common equity was increased by $18.9 million. FirstCity also
recognized the $4 million gain (previously deferred) from the release of its
guaranty of Drive's indebtedness to BoS(USA). BoS(USA)'s warrant to purchase
1,975,000 shares on non-voting common stock was cancelled. FirstCity also
acquired the minority interest in FirstCity Holdings held by Terry R. DeWitt, G.
Stephen Fillip and James C. Holmes, each of whom are Senior Vice Presidents of
FirstCity by issuing 400,000 shares of common stock of the Company and a note
payable, to be periodically redeemed by the Company for an aggregate of up to
$3.2 million in accordance with certain cash collections from servicing income
from Portfolio asset acquisitions in Mexico.
As a part of the recapitalization, BoS(USA) provided a non-recourse loan in
the amount of $16 million to FirstCity which was used to pay the cash portion of
the exchange offer to the holders of the New Preferred Stock, to pay expenses of
the exchange offer and recapitalization, and to reduce FirstCity's debt to the
Senior Lenders. The $16 million loan is secured by a 20% interest in Drive
(64.51% of FirstCity's remaining 31% interest in Drive) and other assets of
Consumer Corp. to allow BoS(USA) to realize upon the 20% Drive interest in the
event of default by FirstCity. In connection with the $16 million loan,
FirstCity is obligated to pay an arrangement fee to BoS(USA) equal to 20% of all
amounts received by FirstCity in excess of $16 million from any sale or other
disposition of FirstCity's 20% interest in Drive and all dividends and other
distributions paid by Drive or its general partner on FirstCity's 20% interest
in Drive.
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
The Company engages in the Portfolio Asset acquisition and resolution
business through its wholly owned subsidiary, FirstCity Commercial Corporation,
and its subsidiaries ("Commercial Corp."). In the Portfolio Asset acquisition
and resolution business Commercial Corp. acquires and resolves portfolios of
performing and nonperforming commercial and consumer loans and other assets that
are generally acquired at a discount to Face Value. Purchases may be in the form
of pools of assets or single assets. Performing assets are those as to which
debt service payments are being made in accordance with the original or
restructured terms of such assets. Nonperforming assets are those as to which
debt service payments are not being made in accordance with the original or
restructured terms of such assets, or as to which no debt service payments are
being made. Portfolios are designated as nonperforming unless substantially all
of the assets comprising the Portfolio are performing. Once a Portfolio has been
designated as either performing or nonperforming, such designation is generally
not changed for accounting purposes regardless of the performance of the assets
comprising the Portfolio. Portfolios are either acquired for Commercial Corp.'s
own account or through investment entities formed with Cargill or one or more
other co-investors (each such entity, an "Acquisition Partnership"). See
"-- Relationship with Cargill". To date, Commercial Corp. and the Acquisition
Partnerships have acquired over $7.1 billion in Face Value of assets, with
FirstCity's equity investment being $235 million.
4
SOURCES OF ASSETS ACQUIRED
In the early 1990s large quantities of nonperforming assets were available
for acquisition from the RTC and the FDIC. Since 1993, sellers of nonperforming
assets have included private sellers as well as government agencies such as the
Small Business Administration. Private sellers include financial institutions,
insurance companies, and other institutional lenders, both in the United States
and in various foreign countries. As a result of mergers, acquisitions and
corporate downsizing efforts, other business entities frequently seek to dispose
of excess real estate or other financial assets not meeting the strategic needs
of a seller. Sales of such assets improve the seller's balance sheet, reduce
overhead costs, reduce staffing requirements and avoid management and personnel
distractions associated with the intensive and time-consuming task of resolving
loans and disposing of real estate. Consolidations within a broad range of
industries, especially banking, have augmented the trend of financial
institutions and other sellers packaging and selling asset portfolios to
investors as a means of disposing of nonperforming loans or other surplus or
non-strategic assets.
PORTFOLIO ASSETS
Commercial Corp. acquires and manages Portfolio Assets, which are generally
purchased at a discount to Face Value by Commercial Corp. or through Acquisition
Partnerships. The Portfolio Assets are generally nonhomogeneous assets,
including loans of varying qualities that are unsecured or secured by diverse
collateral types and real estate. Some of the secured 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 either on real estate, business assets or other collateral cash flow.
Consumer loans may be secured (by real or personal property) or unsecured.
Portfolio Assets may be designated as performing or nonperforming. Commercial
Corp. generally expects to resolve Portfolio Assets within five years after
purchase.
To date, a substantial majority of the Portfolio Assets acquired by
Commercial Corp. have been designated as nonperforming. Commercial Corp. seeks
to resolve nonperforming Portfolio Assets through (i) a negotiated settlement
with the borrower in which the borrower pays all or a discounted amount of the
loan, (ii) conversion of the loan into a performing asset through extensive
servicing efforts followed by either a sale of the loan to a third party or
retention of the loan by Commercial Corp. or the Acquisition Partnership or
(iii) foreclosure of the loan and sale of the collateral securing the loan.
Commercial Corp. has substantial experience acquiring, managing and
resolving a wide variety of asset types and classes. As a result, it does not
limit itself as to the types of Portfolios it will evaluate and purchase.
Commercial Corp.'s willingness to acquire Portfolio Assets is generally
determined by factors including the information that is available regarding the
assets in a Portfolio, the price at which the Portfolio can be acquired and the
expected net cash flows from the resolution of such assets. Commercial Corp. has
acquired Portfolio Assets in virtually all 50 states, the Virgin Islands, Puerto
Rico, France, Japan and Mexico. Commercial Corp. believes that its willingness
to acquire nonhomogeneous Portfolio Assets without regard to geographic location
provides it with an advantage over certain competitors that limit their
activities to either a specific asset type or geographic location.
Commercial Corp. also seeks to capitalize on emerging opportunities in
foreign countries in which the market for nonperforming loans of the type
generally purchased by Commercial Corp. is less efficient than the market for
such assets in the United States. Through December 31, 2002, Commercial Corp.
has acquired, with Cargill and a local French partner, fifteen Portfolios in
France consisting of approximately 26,000 assets for an aggregate purchase price
of approximately $358 million. These assets had a Face Value of approximately
$1.4 billion. Commercial Corp.'s share of the equity interest in the Portfolios
acquired in France ranges from 10% to 33.33% and Commercial Corp. has made a
total equity investment in these Portfolios of approximately $28.6 million.
Commercial Corp. owns a 10% interest in MCS et Associates ("MCS"), a French
asset servicing company, and Commercial Corp. is, in conjunction with MCS and
Cargill, actively pursuing opportunities to purchase additional pools of
Portfolio Assets in France and other areas of Western Europe. In addition,
Commercial Corp. has formed a Mexican asset servicing company, which has offices
in Guadalajara and Mexico City, Mexico, that facilitates Commercial Corp.'s
participation
5
in acquisition of Portfolios in Mexico. Through December 31, 2002, Commercial
Corp. and its various partners have acquired ten Portfolios in Mexico consisting
of an aggregate of approximately 49,000 assets for an aggregate purchase price
of approximately $426 million. These assets had a Face Value of approximately
$2.2 billion. Commercial Corp.'s share of the equity interest in the Portfolios
acquired in Mexico ranges from 3.2% to 25%, and Commercial Corp. has made a
total investment in these Portfolios of approximately $31 million.
The following table presents selected data for the Portfolio Assets
acquired by Commercial Corp.
PORTFOLIO ASSETS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
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(DOLLARS IN THOUSANDS)
Face Value.......................................... $702,019 $766,904 $1,578,932
Total purchase price................................ $171,769 $224,927 $ 394,927
Total equity invested(1)............................ $ 66,932 $139,273 $ 341,736
Commercial Corp. equity invested.................... $ 16,717 $ 24,319 $ 22,140
Total number of Portfolio Assets.................... 11,453 8,099 47,320
</Table>
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(1) Includes investments made in the form of equity and notes receivable from
the Acquisition Partnerships payable to affiliates of the Company.
SOURCES OF PORTFOLIO ASSETS
Commercial Corp. develops its Portfolio Asset opportunities through a
variety of sources. The activities or contemplated activities of expected
sellers are publicized in industry publications and through other similar
sources. Commercial Corp. also maintains relationships with a variety of parties
involved as sellers or as brokers or agents for sellers. Many of the brokers and
agents concentrate by asset type and have become familiar with Commercial
Corp.'s acquisition criteria and periodically approach Commercial Corp. with
identified opportunities. In addition, repeat business referrals from Cargill or
other co-investors in Acquisition Partnerships, repeat business from previous
sellers, focused marketing by Commercial Corp. and the nationwide presence of
Commercial Corp. and the Company are important sources of business.
Commercial Corp. identifies investment opportunities in foreign markets in
much the same manner as in the United States. In varying degrees of volume and
efficiency, the markets of Europe, Asia, and Latin America all include sellers
of nonperforming assets. In some countries, such as Mexico, the government has
taken a very active role in the management and orderly disposition of these
types of assets. Commercial Corp.'s established presence in Mexico and France
provides a strong base for the identification, valuation, and acquisition of
assets in those countries, as well as in adjacent markets. Commercial Corp.
continues to identify partners who have contacts within various foreign markets
and can or assist in locating Portfolio Asset opportunities with Commercial
Corp.
ASSET ANALYSIS AND UNDERWRITING
Prior to making an offer to acquire any Portfolio, Commercial Corp.
performs an extensive evaluation of the assets that comprise the Portfolio. If,
as is often the case, the Portfolio Assets are nonhomogeneous, Commercial Corp.
will evaluate all individual assets determined to be significant to the total of
the proposed purchase. If the Portfolio Assets are homogenous in nature, a
sample of the assets comprising the Portfolio may be selected for evaluation.
The evaluation of individual assets generally includes analyzing the credit and
collateral file or other due diligence information supplied by the seller. Based
upon such seller-provided information, Commercial Corp. will undertake
additional evaluations of the asset, that, to the extent permitted by the
seller, will include site visits to, and environmental reviews of the property
securing the loan or the asset proposed to be purchased. Commercial Corp. will
also analyze relevant local economic and market conditions
6
based on information obtained from its prior experience in the market or from
other sources, such as local appraisers, real estate principals, realtors and
brokers.
The evaluation further includes an analysis of an asset's projected cash
flow and sources of repayment, including the availability of third party
guarantees. Commercial Corp. values loans (and other assets included in a
portfolio) on the basis of its estimate of the present value of estimated cash
flow to be derived in the resolution process. Once the cash flow estimates for a
proposed purchase and the financing and partnership structure, if any, are
finalized, Commercial Corp. can complete the determination of its proposed
purchase price for the targeted Portfolio Assets. Purchases are subject to
purchase and sale agreements between the seller and the purchasing affiliate of
Commercial Corp.
The analysis and underwriting procedure in foreign markets follows the same
extensive diligence philosophy as that employed by the Company domestically.
Additional risks are evaluated in foreign markets, including currency strength,
short and long-term market stability and political concerns. These risks are
evaluated and priced into the cost of the acquisition.
SERVICING
After a Portfolio is acquired, Commercial Corp. assigns the Portfolio
Assets to account servicing officers who are independent of the personnel that
performed the due diligence evaluation in connection with the purchase of the
Portfolio. Portfolio Assets are serviced either at the Company's headquarters or
in one of Commercial Corp.'s other offices. Commercial Corp. generally
establishes servicing operations in locations in close proximity to significant
concentrations of Portfolio Assets. Most of such offices are considered
temporary and are reviewed for closing after the assets in the geographic region
surrounding the office are substantially resolved. The assigned account
servicing officer develops a business plan and budget for each asset based upon
an independent review of the cash flow projections developed during the
investment evaluation, physical inspections of assets or collateral underlying
the related loans, evaluation of local market conditions and discussions with
the relevant borrower. Budgets are periodically reviewed and revised as
necessary. Commercial Corp. employs loan-tracking software and other operational
systems that are generally similar to systems used by commercial banks, but
which have been enhanced to track both the collected and the projected cash
flows from Portfolio Assets.
Commercial Corp. services all of the Portfolio Assets owned for its own
account, all of the Portfolio Assets owned by the Acquisition Partnerships and,
to a very limited extent, certain Portfolio Assets owned by third parties. In
connection with the Acquisition Partnerships in the United States, Commercial
Corp. generally earns a servicing fee, which is a percentage of gross cash
collections generated rather than a management fee based on the Face Value of
the asset being serviced. The rate of servicing fee charged is generally a
function of the average Face Value of the assets within each pool being serviced
(the larger the average Face Value of the assets in a Portfolio, the lower the
fee percentage within the prescribed range), the type of assets and the level of
servicing required on each assets. For the Mexican Acquisition Partnerships,
Commercial Corp. earns a servicing fee based on costs of servicing plus a profit
margin. The Company also has certain consulting contracts with its Mexican
investment entities pursuant to which the Company is entitled to additional
compensation for servicing once a specified return to the investors has been
achieved. The Acquisition Partnerships in France are serviced by MCS in which
the Company maintains a 10% equity interest.
STRUCTURE AND FINANCING OF PORTFOLIO ASSET PURCHASES
Portfolio Assets are either acquired for the account of a subsidiary of
Commercial Corp. or through the Acquisition Partnerships. Portfolio Assets owned
directly by a subsidiary of Commercial Corp. may be funded with loans made by
Commercial Corp. to its subsidiaries, equity financing provided by an affiliate
of Cargill, BOS(USA) or other third parties and secured debt that is recourse
only to the Acquisition Partnership.
Each Acquisition Partnership is a separate legal entity, (generally a
limited partnership, but may instead be a limited liability company, trust,
corporation or other type of entity). Commercial Corp. and an investor typically
form a corporation to serve as the corporate general partner of each Acquisition
Partnership.
7
Generally, for domestic Acquisition Partnerships, Commercial Corp. and another
investor each own 50% of the general partner and a 49.5% limited partnership
interest in the domestic Acquisition Partnership (the general partner owns the
other 1% interest). Cargill or its affiliates are the investor in the vast
majority of the Acquisition Partnerships currently in existence. See
"-- Relationship with Cargill." Certain institutional investors have also held
limited partnership interests in the Acquisition Partnerships and may hold
interests in the related corporate general partners.
The Acquisition Partnerships are generally financed by debt, secured only
by the assets of the individual entity, and are nonrecourse to the Company,
Commercial Corp., its co-investors and the other Acquisition Partnerships.
Commercial Corp. believes that this legal structure insulates it, the Company
and the other Acquisition Partnerships from certain potential risks, while
permitting Commercial Corp. to share in the economic benefits of each
Acquisition Partnership.
Senior secured acquisition financing currently provides the majority of the
funding for the purchase of Portfolios. FirstCity and the Acquisition
Partnerships have relationships with a number of senior lenders including
Cargill. Senior acquisition financing is obtained at variable interest rates
ranging from LIBOR to prime based pricing with negotiated spreads to the base
rates. The final maturity of the senior secured acquisition debt is normally two
years from the date of funding of each advance under the facility. The terms of
the senior acquisition debt of the Acquisition Partnerships may allow, under
certain conditions, distributions to equity partners before the debt is repaid
in full.
Prior to maturity of the senior acquisition debt, the Acquisition
Partnerships typically refinance the senior acquisition debt with long-term debt
secured by the assets of partnerships. Such long-term debt generally accrues
interest at a lower rate than the senior acquisition debt, has collateral terms
similar to the senior acquisition debt, and permits distributions of excess cash
flow generated by the Acquisition Partnership to the equity partners so long as
the partnership is in compliance with applicable financial covenants.
In foreign markets, Commercial Corp. conducts cautious analysis with
respect to the establishment of ownership structures. Prior to investment,
Commercial Corp., in conjunction with its co-investors, performs significant due
diligence and planning on the tax, licensing, and other ownership issues of the
particular country. As in the United States, each foreign Acquisition
Partnership is a separate legal entity, generally formed as the equivalent of a
limited liability company or a liquidating trust. Over the years, Commercial
Corp. has cultivated successful relationships with several investors in its
international acquisitions.
RELATIONSHIP WITH CARGILL
Cargill, a diversified financial services company, is a wholly owned
subsidiary of Cargill, Incorporated, which is generally regarded as one of the
world's largest privately held corporations and has offices worldwide. Cargill
and its affiliates provide significant debt and equity financing to the
Acquisition Partnerships. In addition, Commercial Corp. believes its
relationship with Cargill significantly enhances Commercial Corp.'s credibility
as a purchaser of Portfolio Assets and facilitates its ability to expand into
related businesses and foreign markets.
Under a Right of First Refusal Agreement and Due Diligence Reimbursement
Agreement effective as of January 1, 1998, as amended (the "Right of First
Refusal Agreement") among the Company, FirstCity Servicing Corporation, Cargill
and its wholly owned subsidiary CFSC Capital Corp. II ("CFSC"), if the Company
receives an invitation to bid on or otherwise obtains an opportunity to acquire
interests in loans, receivables, real estate or other assets located in the
United States, Canada, Latin America, or the Caribbean in which the aggregate
amount to be bid exceeds $4 million, or $500 thousand for consumer assets, the
Company is required to follow a prescribed notice procedure pursuant to which
CFSC has the option to participate in the proposed purchase by requiring that
such purchase or acquisition be effected through an Acquisition Partnership
formed by the Company and Cargill (or an affiliate). The Right of First Refusal
Agreement does not prohibit the Company from holding discussions with entities
other than CFSC regarding potential joint purchases of interests in loans,
receivables, real estate or other assets, provided that any such purchase is
subject to CFSC's right to participate in the Company's share of the investment.
The Right of First Refusal Agreement further provides that, subject to certain
conditions, CFSC will pay to the Company a
8
monthly amount to cover due diligence expense, plus 50% of the third party due
diligence expenses incurred by the Company in connection with proposed asset
purchases. The Right of First Refusal Agreement is a restatement and extension
of a similar agreement entered into among the Company, certain members of the
Company's management and Cargill in 1992. The Right of First Refusal Agreement
has a termination date of February 1, 2006 and will renew automatically for an
additional year on an annual basis thereafter unless either party gives notice
to the other of its desire to discontinue the arrangement six months prior to
the termination date.
Future increases in the Company's investments in Portfolio Assets acquired
from institutions and government agencies may be obtained through investment
entities formed with Cargill, whereby Cargill shares a general partner interest,
thereby capitalizing on the expertise of Cargill whose skills complement those
of the Company.
BUSINESS STRATEGY
Historically, Commercial Corp. has leveraged its expertise in asset
resolution and servicing by investing in a wide variety of asset types across a
broad geographic scope. Commercial Corp. continues to follow this investment
strategy and seeks expansion opportunities into new asset classes and geographic
areas when it believes it can achieve attractive risk adjusted returns. The
following items are significant elements of Commercial Corp.'s business strategy
in the portfolio acquisition and resolution business:
- Traditional markets. Commercial Corp. believes it will continue to
invest in Portfolio Assets acquired from financial institutions and
government agencies, both for its own account or through investment
entities formed with Cargill or one or more other co-investors.
- Niche markets. Commercial Corp. believes it will continue to pursue
profitable private market niches in which to invest. The niche investment
opportunities that Commercial Corp. has pursued to date include (i) the
acquisition of improved or unimproved real estate, including excess
retail sites, and (ii) periodic purchases of single financial or real
estate assets from banks and other financial institutions with which
Commercial Corp. has established relationships, and from a variety of
other sellers that are familiar with the Company's reputation for acting
quickly and efficiently.
- Foreign markets. Commercial Corp. believes that the foreign markets for
Portfolio Assets are less developed than the U.S. market, and therefore
provide a greater opportunity to achieve attractive risk adjusted
returns. Commercial Corp. has purchased Portfolio Assets in France, Japan
(sold in 1999) and Mexico and expects to continue to seek purchase
opportunities outside of the United States.
CONSUMER LENDING
The Company historically conducted all of its consumer receivable
origination activities through Consumer Corp. Consumer Corp.'s focus had been on
the origination and servicing of sub-prime consumer automobile loans. Such loans
are extended to borrowers who evidence an ability and willingness to repay
credit, but have experienced an adverse event, such as a job loss, illness or
divorce, or have had past credit problems, such as delinquency, bankruptcy,
repossession or charge-offs. In the third quarter of 2000, Consumer Corp. formed
Drive and transferred the entire operations of its automobile finance platform
to Drive. Consumer Corp. sold a 49% equity interest in Drive IFA-GP and IFA-LP,
subsidiaries of BoS(USA), a wholly owned subsidiary of Bank of Scotland. See
"Background" for additional information related to formation and structure of
Drive. As a result of the sale, the majority of Consumer Corp.'s operations have
been accounted for under the equity method since August 1, 2000.
Drive is a specialized consumer finance company engaged in the purchase,
securitization, and servicing of retail installment contracts originated by
automobile dealers. Drive acquires retail installment contracts principally from
manufacturer-franchised dealers in connection with their sale of used and new
automobiles and light duty trucks to "sub-prime" customers with limited credit
histories or past credit problems. At the present, Drive does not extend credit
directly to consumers, nor does it purchase retail installment contracts from
other financial institutions.
9
During 2002, Drive elected not to use gain on sale treatment when assets
were securitized. Instead, Drive pursued a strategy to grow the balance sheet
and record interest income from loans and interest expense on the related debt
as incurred to build an earnings stream over time.
GOVERNMENT REGULATION
Portfolio Asset Acquisition and Resolution -- Certain aspects of the
Company's Portfolio Asset acquisition and resolution business are subject to
regulation under various federal, state and local statutes and regulations that
impose requirements and restrictions affecting, among other things, disclosures
to obligors, the terms of secured transactions, collection, repossession and
claims handling procedures, multiple qualification and licensing requirements
for doing business in various jurisdictions, and other trade practices.
Consumer Lending -- Numerous federal and state consumer protection laws and
related regulations impose substantial requirements upon lenders and servicers
involved in consumer finance. These laws include the Truth-in-Lending Act, the
Equal Credit Opportunity Act, the Federal Trade Commission Act, the Fair Credit
Reporting Act, the Fair Debt Collection Practices Act, the Magnuson-Moss
Warranty Act, the Federal Reserve Board's Regulations B and Z, state adaptations
of the National Consumer Act and of the Uniform Consumer Credit Code, and state
motor vehicle retail installment sales acts, retail installment sales acts and
other similar laws. Also, state laws impose finance charge ceilings and other
restrictions on consumer transactions and require contract disclosures in
addition to those required under federal law. These requirements impose specific
statutory liabilities upon creditors who fail to comply with their provisions.
In addition, as an affiliate of BoS (USA), Drive is subject to regulatory
oversight by the Federal Reserve Bank and the Office of the Comptroller of
Currency, who may periodically review the operations of Drive when examining the
safety and soundness of BoS (USA)'s and Bank of Scotland's operations in the
United States.
COMPETITION
Portfolio Asset Acquisition and Resolution -- The Portfolio Asset
acquisition business is highly competitive. Some of the Company's principal
competitors are substantially larger and better capitalized than the Company.
Because of these resources, these companies may be better able than the Company
to acquire Portfolio Assets, to pursue new business opportunities or to survive
periods of industry consolidation. Generally, there are three aspects of the
distressed asset business: due diligence, Portfolio management, and servicing.
The Company is a major participant in all three areas. In comparison, certain of
its competitors (including certain securities and banking firms) have
historically competed primarily as portfolio purchasers and have customarily
engaged other parties to conduct due diligence on potential Portfolio purchases
and to service acquired assets, and certain other competitors (including certain
banking and other firms) have historically competed primarily as servicing
companies.
The Company believes that its ability to acquire Portfolios for its own
account and through Acquisition Partnerships will be an important component of
the Company's overall future growth. Acquisitions of Portfolios are often based
on competitive bidding, which involves the danger of bidding too low (which
generates no business), or bidding too high (which could result in the purchase
of a Portfolio at an economically unattractive price).
Consumer Lending -- The automobile finance industry is the second largest
consumer finance market in the United States. The vast majority of automobile
financing is provided by captive finance subsidiaries of major auto
manufacturers, banks, and credit unions for vehicles purchased by "A" credit
consumers or "prime" consumers. Primary lenders tend to avoid or do not
consistently serve the sub-prime market, in which predominantly used automobiles
are purchased by borrowers with "B," "C," or "D" credit. The sub-prime consumer
market estimated at approximately $60 billion per year is served mainly by
independent finance companies such as Drive.
The Company believes that the sub-prime, consumer automobile market is
growing because of a number of factors including (i) economic trends, (ii) the
extension of the average useful life of automobiles, and
10
(iii) the increasing number of late model used automobiles being offered for
sale including former rental cars and off-lease vehicles.
The Company believes Drive is well positioned to maximize on this
opportunity due to its talented management team, strong financial partner in
BoS(USA), growth of market saturation, consistent record of success of its
business model and an attractive net margin environment, assisted by the low
wholesale interest market.
Drive is currently represented in 20 states with concentrations in the
Texas, California, Georgia and North Carolina markets, which represent 34%, 14%,
6% and 6% respectively of business written in the last year. Drive purchased
$415 million in receivable contracts in 2002, which represents a fraction of 1%
of the potential market. The Company believes there is ample room to grow both
in current markets and in new markets not yet serviced. Sub-prime competition
varies from market to market, but the largest competitors seen in most markets
include Americredit Corporation, Household Finance, WFS Finance and Capital One.
Each of these competes in a different credit sector within Drive's market and
all are currently moving upwards in the credit cycle as the economy changes.
Drive believes it has opportunities to grow its market share, at the lowest end
of the credit spectrum, through controlled use of its business model.
EMPLOYEES
The Company had 242 employees as of December 31, 2002. No employee is a
member of a labor union or party to a collective bargaining agreement. The
Company believes that its employee relations are good.
RELATIONSHIP WITH THE BANK OF SCOTLAND
FirstCity has had a significant relationship with the Bank of Scotland or
its subsidiaries since September 1997. In connection with the recapitalization,
FirstCity and the Senior Lenders entered into a loan agreement that refinanced
the Company's existing debt with the Senior Lenders ($50 million outstanding at
December 31, 2002). The Senior Lenders also provided new financing to FirstCity,
with a total commitment of up to $59 million, consisting of (a) a $5 million
revolving credit loan and (b) an acquisition term loan in an amount up to $54
million, which were both unfunded as of December 31, 2002. The aggregate amount
of outstanding loans under the total commitment by the Senior Lenders for the
refinancing and the new financing at any time may not exceed $77 million.
BoS(USA) has a warrant to purchase 425,000 shares of the Company's voting
Common Stock at $2.3125 per share. BoS(USA) is entitled to additional warrants
in connection with the existing warrant for 425,000 shares to retain its ability
to acquire approximately 4.86% of the Company's voting Common Stock.
Drive has a warehouse line of credit with BoS(USA), which provides
borrowings up to $200 million (increased from $150 million in May 2002). Drive's
obligation under this arrangement at December 31, 2002 was $160 million. The
debt is secured by Drive's retail installment contracts and has been extended to
July 2003. Effective February 28, 2003, Drive's warehouse line of credit
agreement with BoS(USA) was amended. The amendment increased the borrowing
limits up to $250 million and changed the maturity date to February 27, 2004.
In addition, with respect to Drive, BoS(USA) has entered into certain
agreements with Drive (the "Sponsor Agreements") that require BoS(USA), under
certain circumstances to (a) purchase nonconforming contracts in the event that
the seller, the servicer, or the related originator fails to repurchase any
contract that is required to be repurchased, (b) pay certain premiums and other
expenses, (c) indemnify the collateral agent and the insurance provider from
certain types of losses, and (d) to make certain secondary servicer advances.
BoS(USA) has required FirstCity to indemnify BoS(USA) for 31% (the amount of its
direct and indirect ownership in Drive) of any losses resulting under the terms
of the Sponsor Agreements. To date, FirstCity has not paid any amounts in
connection with its obligations pursuant to the Sponsor Agreements.
BoS(USA) has also entered into agreements to pay certain fees and expenses,
to repurchase contracts under certain circumstances and to indemnify other
parties to certain securitizations of Drive from certain liabilities pursuant to
the securitization documents. BoS(USA) has required FirstCity to indemnify
11
BoS(USA) for 31% (the ownership interest held directly and indirectly by
Consumer Corp. In Drive) of any losses suffered by BoS(USA) under those
agreements. To date, FirstCity has not paid any amounts in connection with its
obligations pursuant to the those agreements.
ITEM 2. PROPERTIES
The Company leases all its office locations. The Company leases its current
headquarters building from a related party under a noncancellable operating
lease, which expires December 31, 2006. All leases of the other offices of the
Company and subsidiaries expire prior to 2005. The following is a list of the
Company's principal physical properties leased as of December 31, 2002.
<Table>
<Caption>
LOCATION FUNCTION BUSINESS SEGMENT
- -------- -------- ----------------
Waco, Texas................. Executive Offices Corporate/Commercial
Golden Valley, Minnesota.... Servicing Offices Commercial
Richmond, Virginia.......... Servicing Offices Commercial
Guadalajara, Mexico......... Servicing Offices Commercial
Mexico City, Mexico......... Servicing Offices Commercial
Dallas, Texas............... Drive Executive & Servicing Offices Consumer
Cypress, California......... Drive Servicing Offices Consumer
</Table>
ITEM 3. LEGAL PROCEEDINGS
On October 14, 1999, Harbor Financial Group, Inc. ("Harbor Parent"), Harbor
Financial Mortgage Corporation ("Harbor") and four subsidiaries of Harbor filed
voluntary petitions under Chapter 11 of the United States Bankruptcy Code before
the United States Bankruptcy Court for the Northern District of Texas, Dallas
Division. On December 14, 1999, the bankruptcy proceedings were converted to
liquidation proceedings under Chapter 7 of the United States Bankruptcy Code.
John H. Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the
"Trustee"), initiated adversary proceedings on May 25, 2001 against FirstCity
and various current and former directors and officers of FirstCity and Harbor
alleging breach of fiduciary duties, mismanagement, and self-dealing by
FirstCity and Harbor directors and officers, and improper transfer of funds from
the Harbor related entities to FirstCity. The claims also included fraudulent
and preferential transfer of assets of the Harbor entities, fraud and
conspiracy. The Trustee, FirstCity, the other defendants and the insurers
providing Director's and Officer's Insurance coverage for FirstCity and its
subsidiaries (the "Insurers") agreed to a settlement and compromise of the
claims brought in the adversary proceedings, which was approved by the
Bankruptcy Court. Under the terms of the settlement agreement, the Trustee
released the defendants, their affiliates and subsidiaries from any and all
claims which were brought or could have been brought by the Trustee against any
of the defendants, any past and present officers and directors of FirstCity or
any affiliates or subsidiaries of FirstCity in consideration of (i) the payment
of the sum of $3,575,000 by the Insurers to the Trustee, (ii) a payment by
FirstCity to the Trustee in the sum of $225,000, and (iii) the release of any
and all claims of FirstCity and its affiliates and subsidiaries and of the
individual defendants in the bankruptcy proceedings against the Trustee,
including administrative and expense claims, with the exception of a portion of
the administrative claim of FirstCity as noted below. FirstCity's administrative
claim in the Bankruptcy Case was allowed in the amount of $300,000, which claim
FirstCity assigned to the Insurers and was paid by the Trustee directly to the
Insurers.
Periodically, FirstCity, its subsidiaries, its affiliates and the
Acquisition Partnerships are parties to or otherwise involved in legal
proceedings arising in the normal course of business. FirstCity does not believe
that there is any proceeding threatened or pending against it, its subsidiaries,
its affiliates or the Acquisition Partnerships which, if determined adversely,
would have a material adverse effect on the consolidated financial position,
results of operations or liquidity of FirstCity, its subsidiaries, its
affiliates or the Acquisition Partnerships.
12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of stockholders (the "Annual Meeting")
on December 17, 2002. The following items for business were considered at the
Annual Meeting.
(a) ELECTION OF DIRECTORS
The following were elected as directors to serve as members of the
Company's Board of Directors until the Company's 2003 annual meeting of
stockholders. The number of votes cast for each nominee was as follows:
<Table>
<Caption>
VOTES
NOMINEE VOTES FOR AGAINST ABSTAINED
- ------- --------- ------- ---------
James R. Hawkins...................................... 6,459,638 162,000 0
C. Ivan Wilson........................................ 6,459,638 52,000 0
James T. Sartain...................................... 6,459,638 162,000 0
Richard E. Bean....................................... 6,459,638 52,000 0
Dane Fulmer........................................... 6,459,638 52,000 0
Robert E. Garrison II................................. 6,459,638 52,000 0
Jeffery D. Leu........................................ 6,459,638 52,000 0
</Table>
(b) RATIFICATION OF APPOINTMENT OF AUDITORS
A proposal to ratify the Board of Directors' appointment of KPMG LLP as the
Company's independent auditors for 2002 was approved by the stockholders. The
number of votes for the proposal: 6,580,995; votes against: 17,543; abstentions:
23,100.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON AND PREFERRED STOCK DATA
The Company's common stock, $.01 par value per share ("Common Stock"), and
redeemable preferred stock, par value $.01 per share ("New Preferred Stock") are
listed on the Nasdaq National Market System under the symbols FCFC and FCFCO,
respectively. The number of holders of record of Common Stock on March 12, 2003
was approximately 527. High and low stock prices for the Common Stock and New
Preferred Stock in 2002 and 2001 are displayed in the following table:
<Table>
<Caption>
2002 2001
-------------- --------------
MARKET PRICE MARKET PRICE
-------------- --------------
QUARTER ENDED HIGH LOW HIGH LOW
- ------------- ------ ----- ------ -----
Common Stock:
March 31........................................... $ 1.52 $1.07 $ 2.03 $1.00
June 30............................................ 1.39 0.74 1.74 1.00
September 30....................................... 1.30 0.40 2.00 1.35
December 31........................................ 1.41 0.40 2.00 0.90
New Preferred Stock:
March 31........................................... $10.30 $7.00 $10.31 $7.06
June 30............................................ 10.50 5.30 8.74 7.25
September 30....................................... 12.78 8.50 8.50 5.00
December 31........................................ 14.60 9.00 8.63 6.05
</Table>
13
The Company has never declared or paid a dividend on the Common Stock. The
Company currently intends to retain future earnings to finance its growth and
development and therefore does not anticipate that it will declare or pay any
dividends on the Common Stock in the foreseeable future. Any future
determination as to payment of dividends will be made at the discretion of the
Board of Directors of the Company and will depend upon the Company's operating
results, financial condition, capital requirements, general business conditions
and such other factors that the Board of Directors deems relevant. The Company's
loan facilities with the Senior Lenders and certain other credit facilities to
which the Company and its subsidiaries are parties contain restrictions relating
to the payment of dividends and other distributions. In the third quarter of
1999, dividends on the New Preferred Stock were suspended. Given the continued
high debt levels of the Company, and management's priority of assuring adequate
levels of liquidity, the Company does not anticipate that dividends on shares of
New Preferred Stock will be paid in 2003.
FirstCity also acquired the minority interest in FirstCity Holdings held by
Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, each of whom are Senior
Vice Presidents of FirstCity by issuing 400,000 shares of unregistered common
stock of the Company and a note payable, to be periodically redeemed by the
Company for an aggregate of up to $3.2 million in accordance with certain cash
collections from servicing income from Portfolio asset acquisitions in Mexico.
The sale of the 400,000 shares of Common Stock was an exempt transaction
pursuant to Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA
In December 2002, FirstCity completed a recapitalization in which holders
of the New Preferred Stock exchanged 1,092,210 shares of New Preferred Stock,
representing 89.3% of the 1,222,901 shares previously outstanding, for 2,417,388
shares of common stock and $10.5 million. As a result, common equity was
increased by $18.9 million. Upon the completion of the recapitalization, 130,691
shares of New Preferred Stock remained outstanding. FirstCity also recorded a $4
million gain from the release of its guaranty of Drive's indebtedness to
BoS(USA). BoS(USA)'s warrant to purchase 1,975,000 shares of non-voting common
stock was cancelled in connection with the recapitalization. FirstCity issued
400,000 shares of common stock to acquire the minority interest in FirstCity
Holdings Inc.
Simultaneously with the closing of the exchange offer for New Preferred
Stock in December 2002 and the other transactions contemplated by the
recapitalization, FirstCity and the Senior Lenders entered into a loan agreement
that refinanced the Company's existing financings with the Senior Lenders. The
Senior Lenders also provided new financing to FirstCity, with a total commitment
by Bank of Scotland of up to $59 million, consisting of (a) a $5 million
revolving credit loan and (b) an acquisition term loan in an amount up to $54
million. The aggregate amount of outstanding loans under the total commitment by
the Senior Lenders for the refinancing and the new financing at any time may not
exceed $77 million.
In the third quarter of 2000, Consumer Corp. completed a sale of a 49%
equity interest in its automobile finance operation to IFA-GP and IFA-LP. As a
result of this sale, the Company no longer consolidates the financial statements
of its automobile finance operation since August 1, 2000, but instead records
its investment under the equity method of accounting.
Effective during the third quarter of 1999, management of the Company
adopted formal plans to discontinue the operations of Mortgage Corp and Capital
Corp. These entities comprise the operations that were previously reported as
the Company's residential and commercial mortgage banking business. Because the
Company formally adopted plans to discontinue the operations of Mortgage Corp.
and Capital Corp., and operations at each such entity have ceased, the results
of historical operations have been reflected as discontinued operations.
On October 14, 1999, Harbor Financial Group, Inc. ("Harbor Parent"), Harbor
Financial Mortgage Corporation ("Harbor") and four subsidiaries of Harbor filed
voluntary petitions under Chapter 11 of the United States Bankruptcy Code. On
December 14, 1999, these bankruptcy proceedings were converted to liquidation
proceedings under Chapter 7 of the United States Bankruptcy Code. John H.
Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the "Trustee"),
initiated adversary proceedings on May 25, 2001 alleging various claims against
FirstCity and various current and former directors and officers of FirstCity
14
and Mortgage Corp. The Trustee, FirstCity, the other defendants and the insurers
providing Director's and Officer's Insurance coverage for FirstCity and its
subsidiaries (the "Insurers") settled the all claims brought in the adversary
proceedings with the approval of the Bankruptcy Court. Under the terms of the
settlement agreement, the Trustee released the defendants, their affiliates and
subsidiaries from any and all claims which were brought or could have been
brought by the Trustee against any of the defendants, any past and present
officers and directors of FirstCity or any affiliates or subsidiaries of
FirstCity. FirstCity did not guarantee the indebtedness of Mortgage Corp. and
has previously reached agreement with its Senior lenders to permanently waive
any events of default related to Mortgage Corp., including bankruptcy.
The Selected Financial Data presented below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" under Item 7 and with the related Consolidated Financial Statements
and Notes thereto under Item 8 of this Annual Report on Form 10-K, respectively.
SELECTED FINANCIAL DATA
<Table>
<Caption>
2002 2001 2000 1999 1998
-------- -------- -------- --------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues(2)............................ $ 35,988 $ 38,411 $ 53,009 $ 58,928 $ 51,544
Expenses............................... 28,688 33,860 56,288 58,197 51,719
Earnings (loss) from continuing
operations(2)........................ 5,943 2,171 (10,900) (5,819) 785
Loss from discontinued operations...... (9,714) (5,200) (5,000) (102,337) (20,977)
Net loss............................... (3,771) (3,029) (15,900) (108,156) (20,192)
Redeemable preferred dividends......... 2,478 2,568 2,568 2,568 5,186
Net loss to common stockholders(1)..... (6,249) (5,597) (18,468) (110,724) (25,378)
Earnings (loss) from continuing
operations before accounting change
per common share --
Basic(1)............................. 0.40 (0.01) (1.61) (0.92) (0.58)
Diluted(1)........................... 0.40 (0.01) (1.61) (0.92) (0.58)
Net loss per common share --
Basic(1)............................. (0.74) (0.67) (2.21) (13.33) (3.35)
Diluted(1)........................... (0.74) (0.67) (2.21) (13.33) (3.35)
Dividends per common share............. -- -- -- -- --
At year end:
Total assets......................... 126,456 138,893 140,991 230,622 336,643
Total notes payable.................. 96,673 91,209 93,764 169,792 165,922
Preferred stock...................... 3,705 32,101 29,533 26,965 26,323
Total common equity.................... 18,752 3,877 8,478 26,587 136,955
</Table>
- ---------------
(1) Includes $1.2 million of deferred tax benefits related to the recognition of
benefits to be realized from net operating loss carryforwards (NOLs) in 1998
and deferred tax provisions of $7.0 million and $4.9 million, respectively,
in 2000 and 1999.
(2) Refer to SFAS 145 for 2000 reclassification as discussed in note 1(r) to the
consolidated financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a financial services company engaged in Portfolio Asset
acquisition and resolution, conducted through Commercial Corp., and in consumer
lending, through its investment in Drive.
15
The Company's financial results are affected by many factors including
levels of and fluctuations in interest rates, fluctuations in the underlying
values of real estate and other assets, the timing of and ability to liquidate
assets, and the availability and prices for loans and assets acquired in all of
the Company's businesses. The Company's business and results of operations are
also affected by the availability of financing with terms acceptable to the
Company and the Company's access to capital markets, including the
securitization markets.
As a result of the significant period to period fluctuations in the
revenues and earnings of the Company's Portfolio Asset acquisition and
resolution business, the sale of the interest in the automobile finance
operation, and the timing of securitization transactions and structuring of
Drive, period to period comparisons of the Company's results of continuing
operations may not be meaningful.
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements of the Company (including the Notes
thereto) included elsewhere in this Annual Report on Form 10-K.
2002 COMPARED TO 2001
The Company reported earnings from continuing operations of $5.9 million,
including a $4 million gain from the release of its guaranty of Drive's
indebtedness, in 2002 compared to $2.2 million in 2001. Loss from discontinued
operations was $9.7 million in 2002 and $5.2 million in 2001. Net loss to common
stockholders was $6.2 million in 2002 compared to $5.6 million in 2001. On a per
share basis, basic and diluted net loss attributable to common stockholders was
$.74 in 2002 compared to $.67 in 2001.
Portfolio Asset Acquisition and Resolution
The operating contribution of $11.2 million in 2002 increased by $3.5
million, or 45%, compared with 2001. Commercial Corp. purchased $172 million of
Portfolio Assets during 2002 through the Acquisition Partnerships compared to
$225 million in acquisitions in 2001. Commercial Corp.'s investment in Portfolio
Assets decreased to $9.8 million in 2002 from $14.2 million in 2001 as a result
of normal liquidation. Commercial Corp. invested $16.7 million in equity in
Portfolio Assets in 2002 compared to $24.3 million in 2001.
Servicing fee revenues. Servicing fee revenues increased by 32% to $12.7
million in 2002 from $9.6 million in 2001 primarily as a result of increased
collections in domestic Acquisition Partnerships. In June 2002, three domestic
Acquisition Partnerships completed a bulk loan sale of performing and
non-performing Portfolio Assets with a carrying value of $59 million for
proceeds of $71 million. As a result of the sale, the Company recorded servicing
fee revenues of $.9 million. Also, FirstCity received higher service fees on one
portfolio acquired in 2002 due to the type of assets and level of servicing
required on each asset.
Gain on resolution of Portfolio Assets. The net gain on resolution of
Portfolio Assets was flat from year to year.
Equity in earnings of investments. Equity in earnings of Acquisition
Partnerships decreased 14% to $8.4 million in 2002 compared to $9.7 million in
2001. Net loss in the combined Acquisition Partnerships was $13.2 million in
2002 compared to earnings of $14.2 million in 2001 due to significant losses in
Mexico, in which the Company has smaller equity investments compared to
investments in the United States and France. See Note 6 of the Company's
consolidated financial statements for a comparison of earnings of the
Acquisition Partnerships and equity in earnings of those entities summarized by
geographic region. Equity in earnings of Servicing Entities was $.8 million in
2002 compared to $1.0 million in 2001.
Interest income. Interest income decreased $.7 million or 12% due to
average balances in Portfolio Assets and loans receivable decreasing to $31.6
million in 2002 from $40.7 million in 2001.
16
Gain on sale of interest in equity investments. During 2002, the Company
sold its investment in eight French Acquisition Partnerships to existing
investors in those entities. FirstCity received proceeds of $3.4 million on the
sale resulting in a gain of $1.8 million. During 2001, the Company sold equity
investments in two domestic Acquisition Partnerships for $7.6 million resulting
in a gain of $3.3 million.
Operating expenses. Operating expenses decreased $3.9 million or 16%
primarily as a result of decreased debt costs and lower write-downs of Portfolio
Assets, offset by increased operating costs in Mexico.
Interest and fees on notes payable decreased $1.2 million or 29% due to
average debt for 2002 decreasing to $28.9 million from $42.3 million in 2001.
Also, the average cost of borrowing decreased from 9.8% in 2001 to 9.2% in 2002.
Salaries and benefits increased $1.9 million or 25% primarily due to
increased servicing personnel in Mexico. Total personnel within the Portfolio
Asset acquisition and resolution segment increased from 150 at year end 2001 to
212 at year end 2002, with the personnel in Mexico increasing from 81 at year
end 2001 to 137 at year end 2002.
The provision for loan and impairment losses was $.3 million in 2002
compared to $3.3 million in 2001.
Minimal provisions were recorded in 2002 for performing and non-performing
Portfolios, as the economic conditions during that period did not negatively
impact the Company's expectation of future cash flows. In 2001, provisions of
$1.6 million in four non-performing Portfolios and $.6 million in two performing
Portfolios were recorded as estimated future collections were reduced primarily
due to the Company accepting discounted payoffs in lieu of extended payouts.
Impairment on performing Portfolio Assets is measured based on the present value
of the expected future cash flows in the aggregate discounted at the loans' risk
adjusted rates, which approximates the effective interest rates, or the fair
value of the collateral, less estimated selling costs, if any loans are
collateral dependent and foreclosure is probable. The evaluation of impairment
on non-performing Portfolios is determined based on the review of the estimated
future cash receipts, which represents the net realizable value of the
non-performing pool. The expected future cash flows are reviewed monthly and
adjusted as deemed necessary. Changes in various factors including, but not
limited to, economic conditions, deterioration of collateral values,
deterioration in the borrowers financial condition and other conditions
described in the risk factors discussed later in this document, could have a
negative impact on the estimated future cash flows of the Portfolio. Significant
decreases in estimated future cash flows can reduce a Portfolio's present value
to below the Company's carrying value of that Portfolio, causing impairment.
The Company recorded permanent valuation impairments of $.2 million in 2002
and $1.1 million in 2001 on one real estate Portfolio due to deterioration of
property values and market conditions, as well as additional expected disposal
costs. For real estate Portfolios, the evaluation of impairment is determined
quarterly based on the review of the estimated future cash receipts less
estimated costs to sell, which represents the net realizable value of the real
estate Portfolio. A valuation allowance is established for any impairment
identified through provisions charged to operations in the period the impairment
is identified.
Impairment on loans receivable from Acquisition Partnerships is determined
based on the review of the estimated future cash receipts of the underlying
nonperforming Portfolio Assets of each related Acquisition Partnership.
Principally all of the loans receivable are from certain Acquisition
Partnerships located in Mexico. The cash flows used to pay down these loans come
from collections received on non-performing Portfolio Assets owned by the
Acquisition Partnerships. The estimated future cashflows of Portfolio Assets
owned by Acquisition Partnerships are reviewed in a similar manner to Portfolio
Assets owned by the Company. No impairment was required in 2002 and 2001 as the
estimated future cash flows from the underlying Portfolio Assets of the
Acquisition Partnerships supported the pay-down of the loans receivable from
Acquisition Partnerships.
Occupancy, data processing and other expenses decreased $1.7 million or 18%
during the period due to a decrease in servicing fee expense in Mexico of $2.9
million offset by increases in foreign currency exchange rate expense of $.5
million, minority interest expense of $.3 million, occupancy expense of $.3
million and travel expense of $.1 million. In 2001 fees to third party servicers
in Mexico were paid by the Company
17
through August of 2001,from September 2001 to the present the Mexican
Acquisition Partnerships have paid third party servicers directly.
Consumer Lending
The operating contribution for 2002 was $3.5 million compared to $4.4
million (net of a $.3 million cumulative effect of accounting change) during
2001.
Equity in earnings of investment. FirstCity recorded equity in loss of
Drive of $.5 million in 2002 compared to equity in earnings of $5.9 million in
2001. Drive recorded a net loss of $1.6 million in 2002 compared to earnings of
$14.5 million in 2001. In 2002, Drive structured its securitizations as
financings and did not to use gain on sale treatment when assets were
securitized. Drive pursued a strategy to grow the balance sheet and record
interest income from loans and interest expense on the related debt as incurred
to build an earnings stream over time.
Gain on sale of interest in Drive. FirstCity recognized a $4 million
deferred gain in the fourth quarter of 2002 as a result of the release of
FirstCity's guaranty of a $60 million loan to Drive by BoS(USA). The guaranty
was released in connection with the closing of the Company's recapitalization in
December 2002.
Operating expenses. Total operating expenses declined primarily as a
result of minority interest income of $.1 million in 2002 compared to minority
interest expense of $1.1 million in 2001. Minority interest expense is directly
attributable to earnings and losses of Drive.
Other Items Affecting Operations
The following items affect the Company's overall results of operations and
are not directly related to any one of the Company's businesses discussed above.
Corporate overhead. Company level interest expense decreased by 17% to
$3.9 million in 2002 from $4.6 million in 2001 as a result of lower levels of
debt. Other corporate overhead expenses were flat from year to year.
Income taxes. Federal income taxes are provided at a 35% rate applied to
taxable income or loss and are offset by NOLs that the Company believes are
available. The tax benefit of the NOLs is recorded in the period during which
the benefit is realized. The Company recorded no deferred tax provision in 2002
and 2001.
2001 COMPARED TO 2000
The Company reported earnings from continuing operations of $2.2 million in
2001 compared to a loss from continuing operations of $10.9 million in 2000.
Loss from discontinued operations was $5.2 million in 2001 and $5.0 million in
2000. Net loss to common stockholders was $5.6 million in 2001 compared to a
loss of $18.5 million in 2000. On a per share basis, basic and diluted net loss
attributable to common stockholders was $.67 in 2001 compared to a loss of $2.21
in 2000.
Portfolio Asset Acquisition and Resolution
The operating contribution of $7.7 million in 2001 increased by $4.4
million, or 130%, compared with 2000. Commercial Corp. purchased $225 million of
Portfolio Assets during 2001 through the Acquisition Partnerships compared to
$395 million in acquisitions in 2000. Commercial Corp.'s investment in Portfolio
Assets decreased to $14.2 million in 2001 from $30.0 million in 2000. Commercial
Corp. invested $24.3 million in equity in Portfolio Assets in 2001 compared to
$22.1 million in 2000.
Servicing fee revenues. Servicing fees increased by 27% to $9.6 million in
2001 from $7.6 million in 2000 primarily as a result of increased operations
from Acquisition Partnerships in Mexico formed during 2000 and 1999. The
servicing fees for the Mexico Acquisition Partnerships are based on operating
expenses, unlike the Acquisition Partnerships in the United States and France,
which are primarily based on collections.
18
Gain on resolution of Portfolio Assets. Proceeds from the resolution of
Portfolio Assets decreased by 39% to $8.8 million in 2001 from $14.4 million in
2000. The net gain on resolution of Portfolio Assets decreased 66% or $2.1
million, primarily as a result of the decreased proceeds and lower gross profit.
The weighted average gross profit percentage on the resolution of Portfolio
Assets in 2001 was 11.9% as compared to 21.7% in 2000.
Equity in earnings of investments. Commercial Corp.'s equity in earnings
of Acquisition Partnerships increased 35% to $9.7 million in 2001 compared to
$7.2 million in 2000. Net earnings in the combined Acquisition Partnerships
declined 61% to $14.2 million in 2001 compared to $36.8 million in 2000 due to
significant losses in Mexico, in which the Company has smaller equity
investments compared to investments in the United States and France. See Note 6
of the Company's consolidated financial statements for a comparison of earnings
of the Acquisition Partnerships and equity in earnings of those entities
summarized by geographic region. Equity in earnings of Servicing Entities were
$1.0 million in 2001 due to earnings recorded by one French entity, in which the
Company has a 10% ownership.
Interest income. Interest income increased $3.7 million as a result of
increased balances of investment loans receivable from the Mexico Acquisition
Partnerships.
Gain on sale of interest in equity investments. During the period, the
Company sold equity investments in domestic Acquisition Partnerships for $7.6
million resulting in a gain of $3.3 million.
Operating expenses. Operating expenses increased $6.7 million or 38%
primarily as a result of increased debt costs, the write-down of a Portfolio
Asset, and increased operating costs in Mexico.
Interest and fees on notes payable increased $.9 million or 26% due to
average debt for 2001 increasing to $42.3 million from $32.9 million in 2000.
Salaries and benefits increased $2.1 million or 39% primarily due to
increased servicing personnel in Mexico. Total personnel within the Portfolio
Asset acquisition and resolution segment increased from 105 at year end 2000 to
150 at year end 2001, with the personnel in Mexico increasing from 31 at year
end 2000 to 81 at year end 2001.
The provision for loan and impairment losses totaled $3.3 million in 2001
and is primarily attributed to write-downs of $1.6 million and $.6 million in
estimated future collections of four nonperforming Portfolios and two performing
Portfolios, respectively. Also, the Company recorded permanent valuation
impairments of $1.1 million on one real estate Portfolio. In 2000, the provision
of $2.0 million was related to an impairment valuation on one real estate
Portfolio.
In 2001, provisions of $1.6 million in four non-performing Portfolios and
$.6 million in two performing Portfolios were recorded as estimated future
collections were reduced primarily due to the Company accepting discounted
payoffs in lieu of extended payouts. No provision was recorded in 2000 for
performing or non-performing Portfolios as the economic conditions during that
period did not negatively impact the Company's expectation of future cash flows.
Impairment on both performing and non-performing Portfolio Assets is measured
based on the present value of the expected future cash flows in the aggregate
discounted at the loans' risk adjusted rates, which approximates the effective
interest rates, or the fair value of the collateral, less estimated selling
costs, if any loans are collateral dependent and foreclosure is probable. The
expected future cash flows are reviewed monthly and adjusted as deemed
necessary. Changes in various factors including, but not limited to, economic
conditions, deterioration of collateral values, deterioration in the borrowers
financial condition and other conditions described in the risk factors discussed
later in this document, could have a negative impact on the estimated future
cash flows of the Portfolio. Significant decreases in estimated future cash
flows can reduce a Portfolio's present value to below the Company's carrying
value of that Portfolio, causing impairment.
The Company recorded permanent valuation impairments of $1.1 million in
2001 and $2.0 million in 2000 on one real estate Portfolio due to deterioration
of property values and market conditions, as well as additional expected
disposal costs. For Real estate Portfolios, the evaluation of impairment is
determined quarterly based on the review of the estimated future cash receipts
less estimated costs to sell, which
19
represents the net realizable value of the real estate Portfolio. A valuation
allowance is established for any impairment identified through provisions
charged to operations in the period the impairment is identified.
Impairment on loans receivable from Acquisition Partnerships is determined
based on the review of the estimated future cash receipts of the underlying
nonperforming Portfolio Assets of each related Acquisition Partnership.
Principally all of the loans receivable are from certain Acquisition
Partnerships located in Mexico. The cash flows used to pay down these loans come
from collections received on non-performing Portfolio Assets owned by the
Acquisition Partnerships. The estimated future cashflows of Portfolio Assets
owned by Acquisition Partnerships are reviewed in a similar manner to Portfolio
Assets owned by the Company. No impairment was required in 2001 and 2000 as the
estimated future cash flows from the underlying Portfolio Assets of the
Acquisition Partnerships supported the pay-down of the loans receivable from
Acquisition Partnerships.
Occupancy, data processing and other expenses increased $2.4 million or 34%
during the period due to increased operations in Mexico.
Consumer Lending
The operating contribution for 2001 was $4.4 million (net of a $.3 million
cumulative effect of accounting change) compared to $10.4 million during 2000.
In 2001, the contribution resulted primarily from equity in earnings of $5.9
million from Drive. The automobile finance operations were consolidated with the
Company until the Company's sale of a 49% interest in Drive on August 1, 2000.
Excluding equity in earnings of investment, revenues decreased due to the
sale of 49% of the Company's equity interest in the automobile finance
operation.
Equity in earnings of investment. As a result of the sale of 49% of the
equity interest in the Company's automobile finance operation, the Company's
interest in the net operations of Drive has been recorded (since August 1, 2000)
as equity in earnings of investments.
Operating expenses. Total operating expenses declined primarily as a
result of the sale of 49% of the Company's equity interest in its automobile
finance operation.
Other Items Affecting Operations
The following items affect the Company's overall results of operations and
are not directly related to any one of the Company's businesses discussed above.
Corporate overhead. Other revenue of $1.7 million in 2000 consisted of $.8
million gain on early debt extinguishment, $.6 million from the sale of other
assets and $.3 million in management fee income paid to the Company by certain
Acquisition Partnerships. Company level interest expense decreased by 62% to
$4.6 million in 2001 from $12.2 million in 2000 as a result of lower levels of
debt. Other corporate overhead expenses declined $1.7 million.
Income taxes. Federal income taxes are provided at a 35% rate applied to
taxable income or loss and are offset by NOLs that the Company believes are
available. The tax benefit of the NOLs is recorded in the period during which
the benefit is realized. The Company recorded no deferred tax provision in 2001
and a $7.0 million deferred tax provision in 2000.
ANALYSIS OF REVENUES AND EXPENSES
The Company reported a net loss to common stockholders for 2002 of $6.2
million. As a result of the sale of interest in the automobile finance
operation, the net operations of Drive have been recorded (since August 1, 2000)
as equity in earnings (loss) of investments.
20
The following table summarizes the revenues and expenses of each of the
Company's business segments and presents the contribution that each business
makes to the Company's operating margin.
ANALYSIS OF REVENUES AND EXPENSES
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
PORTFOLIO ASSET ACQUISITION AND RESOLUTION:
Revenues:
Servicing fees......................................... $12,665 $ 9,580 $ 7,555
Gain on resolution of Portfolio Assets................. 1,138 1,049 3,120
Gain on sale of interest in equity investments......... 1,779 3,316 --
Equity in earnings of investments...................... 9,212 10,771 7,369
Interest income........................................ 5,122 5,847 2,143
Other.................................................. 2,185 1,836 1,129
------- ------- --------
Total................................................ $32,101 32,399 21,316
Expenses:
Interest and fees on notes payable..................... 2,946 4,128 3,266
Salaries and benefits.................................. 9,611 7,679 5,531
Provision for loan and impairment losses............... 295 3,277 1,971
Occupancy, data processing and other................... 7,815 9,503 7,083
------- ------- --------
Total................................................ 20,667 24,587 17,851
------- ------- --------
Operating contribution before direct taxes................ $11,434 $ 7,812 $ 3,465
======= ======= ========
Operating contribution, net of direct taxes............... $11,214 $ 7,713 $ 3,354
======= ======= ========
CONSUMER LENDING:
Revenues:
Servicing fees......................................... $ -- $ -- $ 3,887
Equity in earnings (loss) of investments............... (532) 5,923 2,223
Interest income........................................ -- 5 12,882
Gain on sale of automobile loans....................... -- -- 2,836
Gain on sale of interest in Drive...................... 4,000 -- 8,091
Other.................................................. 1 9 71
------- ------- --------
Total................................................ 3,469 5,937 29,990
------- ------- --------
Expenses:
Interest and fees on notes payable..................... 18 -- 3,217
Salaries and benefits.................................. -- -- 7,277
Provision for loan and impairment losses............... -- -- 2,420
Occupancy, data processing and other (net of minority
interest)............................................ (93) 1,473 6,706
------- ------- --------
Total................................................ (75) 1,473 19,620
------- ------- --------
Operating contribution before direct taxes................ $ 3,544 $ 4,464 $ 10,370
======= ======= ========
Operating contribution, net of direct taxes............... $ 3,544 $ 4,448 $ 10,362
======= ======= ========
Total operating contribution, net of direct taxes......... $14,758 $12,161 $ 13,716
======= ======= ========
</Table>
21
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CORPORATE OVERHEAD:
Other revenue............................................. $ 418 $ 75 $ 1,703
Corporate interest expense................................ (3,858) (4,649) (12,175)
Salaries and benefits, occupancy, professional and other
expenses.................................................. (5,375) (5,416) (7,144)
Deferred tax valuation allowance.......................... -- -- (7,000)
------- ------- --------
Earnings (loss) from continuing operations................ 5,943 2,171 (10,900)
Loss from discontinued operations......................... (9,714) (5,200) (5,000)
------- ------- --------
Net loss.................................................. (3,771) (3,029) (15,900)
Preferred dividends....................................... (2,478) (2,568) (2,568)
------- ------- --------
Net loss to common stockholders........................... $(6,249) $(5,597) $(18,468)
======= ======= ========
SHARE DATA:
Basic and diluted earnings (loss) per common share are as
follows:
Earnings (loss) from continuing operations before
accounting change...................................... $ 0.40 $ (0.01) $ (1.61)
Discontinued operations................................ (1.14) (0.62) (0.60)
Cumulative effect of accounting change................. -- (0.04) --
Net loss............................................... $ (0.74) $ (0.67) $ (2.21)
Weighted average common shares outstanding............. 8,500 8,374 8,351
</Table>
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
In 2002 the Company invested in excess of $16 million in portfolios
acquired through Acquisition Partnerships. Acquisitions by the Company over the
last five years are summarized as follows:
<Table>
<Caption>
FIRSTCITY
PURCHASE INVESTED
PRICE EQUITY
-------- ---------
(IN THOUSANDS)
1st Quarter................................................. $ 24,479 $ 5,375
2nd Quarter................................................. 52,169 3,738
3rd Quarter................................................. 44,191 2,571
4th Quarter................................................. 50,930 5,033
-------- -------
Total 2002.................................................. $171,769 $16,717
Total 2001.................................................. $224,927 $24,319
Total 2000.................................................. $394,927 $22,140
Total 1999.................................................. $210,799 $11,203
Total 1998.................................................. $139,691 $28,478
</Table>
The Company believes that prospects for investment in distressed assets in
2003 continue to be positive. In the U.S. due to the current economic conditions
opportunities remain strong. Additionally, in the foreign markets, the
availability of distressed assets in France and Mexico remains strong. The
Company is looking to expand its franchise base into Central and South America
as well as other parts of Europe. To capitalize on these opportunities FirstCity
has implemented marketing programs to identify new opportunities for investment
in Portfolio assets, both on a bid and negotiated basis.
Revenues with respect to the Company's Portfolio Asset acquisition and
resolution segment consist primarily of (i) servicing fees from Acquisition
Partnerships for the servicing activities performed related to the assets held
in the Acquisition Partnerships, (ii) equity in earnings of affiliated
Acquisition Partnerships
22
and servicing entities, (iii) interest income on performing Portfolio Assets and
loans receivable, and (iv) gains on disposition of assets. The following table
presents selected information regarding the revenues and expenses of the
Company's Portfolio Asset acquisition and resolution business.
ANALYSIS OF SELECTED REVENUES AND EXPENSES
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
INCOME FROM PORTFOLIO ASSETS AND LOANS RECEIVABLE:
Average investment in Portfolio Assets and loans
receivable:
Domestic........................................ $ 13,068 $ 23,674 $ 34,498
Mexico.......................................... 18,534 17,012 4,898
France.......................................... -- -- --
-------- -------- --------
Total......................................... $ 31,602 $ 40,686 $ 39,396
======== ======== ========
Income from Portfolio Assets and loans receivable:
Domestic........................................ $ 2,208 $ 2,856 $ 3,817
Mexico.......................................... 3,910 3,820 1,088
France.......................................... -- -- --
-------- -------- --------
Total......................................... $ 6,118 $ 6,676 $ 4,905
======== ======== ========
Average return:
Domestic........................................ 16.9% 12.1% 11.1%
Mexico.......................................... 21.1% 22.5% 22.2%
France.......................................... -- -- --
Total......................................... 19.4% 16.4% 12.5%
SERVICING FEE REVENUES:
Domestic partnerships:
$ Collected..................................... $188,081 $126,591 $ 83,689
Servicing fee revenue........................... 5,469 3,207 2,712
Average servicing fee %......................... 2.9% 2.5% 3.2%
Mexico partnerships:
$ Collected..................................... $ 85,303 $147,540 $ 83,931
Servicing fee revenue........................... 6,592 5,965 2,923
Average servicing fee % (1)..................... 7.7% 4.0% 3.5%
Incentive service fees............................. $ 604 $ 408 $ 1,920
Total Service Fees:
$ Collected..................................... $273,384 $274,131 $167,620
Servicing fee revenue........................... 12,665 9,580 7,555
Average servicing fee %......................... 4.6% 3.5% 4.5%
PERSONNEL:
Personnel expenses................................... $ 9,611 $ 7,679 $ 5,531
Number of personnel (at period end):
Production...................................... 25 23 23
Servicing....................................... 187 127 82
</Table>
23
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
INTEREST EXPENSE:
Average debt....................................... $ 31,960 $ 42,310 $ 32,878
Interest expense................................... 2,946 4,128 3,266
Average cost....................................... 9.2% 9.8% 9.9%
PROVISION FOR IMPAIRMENT ON PORTFOLIO ASSETS:
Non-performing..................................... $ 97 $ 1,627 $ 47
Performing......................................... 4 552 --
Real estate........................................ 194 1,098 1,924
-------- -------- --------
$ 295 $ 3,277 $ 1,971
======== ======== ========
</Table>
- ---------------
(1) For the Mexican Acquisition Partnerships, the Company earns a servicing fee
based on costs of servicing plus a profit margin.
The following table presents selected information regarding the revenues
and expenses of the Acquisition Partnerships.
ANALYSIS OF SELECTED REVENUES AND EXPENSES
ACQUISITION PARTNERSHIPS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
REVENUES:
Gain on resolution of Portfolio Assets............. $ 89,824 $103,599 $ 75,788
Gross profit percentage on resolution of Portfolio
Assets.......................................... 33.0% 41.6% 46.4%
Interest income.................................... $ 14,380 $ 24,473 $ 18,049
Other income....................................... 2,348 2,929 2,195
INTEREST EXPENSE(1):
Interest expense................................... 63,281 72,151 38,289
Average debt....................................... 418,075 472,987 292,707
Average cost (annualized).......................... 15.14% 15.25% 13.1%
OTHER EXPENSES:
Service fees....................................... $ 17,909 $ 13,735 $ 8,034
Other operating costs.............................. 16,689 22,203 8,639
Income taxes....................................... (3,022) 12,139 2,225
Foreign currency transaction....................... 24,919 (3,399) 2,079
-------- -------- --------
Total other expenses.......................... 56,495 44,678 20,977
-------- -------- --------
Net earnings (loss)........................... $(13,224) $ 14,172 $ 36,766
======== ======== ========
Equity in earnings of Acquisition Partnerships....... $ 8,418 $ 9,742 $ 7,203
Equity in earnings of servicing entities............. 794 1,029 166
-------- -------- --------
$ 9,212 $ 10,771 $ 7,369
======== ======== ========
</Table>
- ---------------
(1) Interest expense for 2002, 2001 and 2000 includes interest on loans to the
Acquisition Partnerships located in Mexico from affiliates of the investor
groups. The rates on these loans range between 19% and
24
20%. The average cost on debt excluding the Mexican Acquisition Partnerships
was 6.0%, 7.5% and 9.4% for 2002, 2001 and 2000, respectively.
CONSUMER LENDING
As previously noted, the Company sold a 49% equity interest in the
automobile finance operation (conducted through Drive) effective August 1, 2000.
Subsequent to the sale, operating activity is recorded using the equity method
of accounting. As a result, the majority of operations reported in the Consumer
Lending segment are for activity prior to August 1, 2000. Therefore,
period-to-period comparisons of Consumer Corp.'s results of operations may not
be meaningful.
During 2002, Drive structured its securitizations as secured financings and
did not use gain on sale treatment when assets were securitized. Instead, Drive
pursued a strategy to grow the balance sheet and record interest income from
loans and interest expense on the related debt as incurred to build an earnings
stream over time. This change in focus resulted in FirstCity recording a loss
from the equity interest in Drive of $.5 million for the year. During 2001,
Drive completed securitizations of $372 million of face value of automobile
receivables and those securitizations were structured as sales and Drive
recorded gains from those sales. FirstCity's portion of the earnings from Drive
was $5.9 million.
ANALYSIS OF SELECTED DATA
CONSUMER LENDING
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
Retail installment contracts acquired $..................... $415,713 $412,760 $238,437
Origination characteristics
Face value to wholesale value............................. 99.85% 100.10% 100.79%
Weighted average coupon................................... 21.02% 20.65% 20.42%
Purchase discount (% of face value)....................... 15.54% 15.19% 15.18%
Servicing portfolio
Owned $................................................... $255,174 $ 82,798 $103,719
Securitized............................................... $428,098 472,381 253,569
Other..................................................... -- -- --
-------- -------- --------
Total $................................................... $683,272 $555,179 $357,288
======== ======== ========
Owned -- number of contracts.............................. 20,806 7,416 8,096
Securitized -- number of contracts........................ 40,521 40,862 24,015
Other -- number of contracts.............................. -- -- --
-------- -------- --------
Total number of contracts................................. 61,327 48,278 32,111
======== ======== ========
Defaults (% of total loans acquired)........................ 20.14% 18.05% 15.40%
Loss on defaults (% of original loan balance at time of
default).................................................. 10.26% 8.91% 6.69%
Delinquencies (% of total serviced portfolio)............... 7.25% 8.43% 9.05%
</Table>
LIQUIDITY AND CAPITAL RESOURCES
Generally, the Company requires liquidity to fund its operations, working
capital, payment of debt, equity for acquisition of Portfolio Assets,
investments in and advances to the Acquisition Partnerships and other
investments by the Company. The potential sources of liquidity are funds
generated from operations, equity distributions from the Acquisition
Partnerships, interest and principal payments on subordinated intercompany debt,
dividends from the Company's subsidiaries, short-term borrowings from revolving
lines of credit, equity
25
financing available under the Cargill Facility and acquisition term loan
provided by the Senior Lenders, proceeds from equity market transactions and
securitizations and other structured finance transactions and other special
purpose short-term borrowings.
In December 2002, FirstCity completed a recapitalization whereby 1,092,210
shares of New Preferred Stock, representing 89.3% of the 1,222,901 shares
previously outstanding, were exchanged for 2,417,388 shares of common stock and
$10.5 million. As a result, common equity was increased $18.9 million. Upon
completion of the recapitalization, 130,691 shares of New Preferred Stock
remained outstanding. FirstCity also recorded a $4 million gain from the release
of its guaranty of Drive's indebtedness to BoS(USA). BoS(USA)'s warrant to
purchase 1,975,000 shares of non-voting common stock was cancelled. FirstCity
also acquired the minority interest in FirstCity Holdings held by Terry R.
DeWitt, G. Stephen Fillip and James C. Holmes, each of whom are Senior Vice
Presidents of FirstCity by issuing 400,000 shares of common stock and a note
payable, to be periodically redeemed by the Company for an aggregate of up to
$3.2 million in accordance with certain cash collections from servicing income
from Portfolio asset acquisitions in Mexico.
As a part of the recapitalization, BoS(USA) provided a non-recourse loan in
the amount of $16 million to FirstCity which was used to pay the cash portion of
the exchange offer to the holders of the New Preferred Stock, to pay expenses of
the exchange offer and recapitalization, and to reduce FirstCity's debt to the
Senior Lenders. The $16 million loan is secured by a 20% interest in Drive
(64.51% of FirstCity's remaining 31% interest in Drive) and other assets of
Consumer Corp. to allow BoS(USA) to realize upon the 20% Drive interest in the
event of default by FirstCity. In connection with the $16 million loan,
FirstCity is obligated to pay an arrangement fee to BoS(USA) equal to 20% of all
amounts received by FirstCity in excess of $16 million from any sale or other
disposition of FirstCity's 20% interest in Drive and all dividends and other
distributions paid by Drive or its general partner on FirstCity's 20% interest
in Drive.
In connection with the recapitalization, FirstCity and the Senior Lenders
entered into a loan agreement that refinanced the Company's existing debt with
the Senior Lenders ($50 million outstanding at December 31, 2002). The Senior
Lenders also provided new financing to FirstCity, with a total commitment of up
to $59 million, consisting of (a) a $5 million revolving credit loan and (b) an
acquisition term loan in an amount up to $54 million, which were both unfunded
as of December 31, 2002. The aggregate amount of outstanding loans under the
total commitment by the Senior Lenders for the refinancing and the new financing
at any time may not exceed $77 million.
On November 4, 2002, the Nasdaq Stock Market, Inc. ("Nasdaq") notified the
Company that its common stock had failed to meet the listing requirements for
the Nasdaq National Market because the common stock had closed below the minimum
bid price of $1.00 per share for thirty (30) consecutive trading days.
Accordingly, Nasdaq provided the Company ninety (90) calendar days, or until
February 2, 2003, to regain compliance. On November 21, 2002, Nasdaq notified
the Company that it had regained compliance with this requirement and the matter
was closed.
BoS(USA) has a warrant to purchase 425,000 shares of the Company's voting
Common Stock at $2.3125 per share. BoS(USA) is entitled to additional warrants
in connection with this existing warrant for 425,000 shares to retain its
ability to acquire approximately 4.86% of the Company's voting Common Stock.
Currently, the Company has approximately 130,691 shares of New Preferred
Stock outstanding with accrued and unpaid dividends of approximately $1.0
million. The Company's loan agreement with the Senior Lenders restricts the
payment of dividends on these shares until it is repaid in full. Given the
continued high debt levels of the Company, and management's priority of assuring
adequate levels of liquidity, the Company does not anticipate that dividends on
shares of New Preferred Stock will be paid in the foreseeable future.
The Portfolio Asset acquisition and resolution group of the Company has a
$35 million loan facility (increased from $30 million in August 2002) with CFSC
Capital Corp. XXX, a subsidiary of Cargill. This facility is being used
exclusively to provide equity in new Portfolio acquisitions in partnerships with
Cargill and its affiliates and matures in March, 2005. At December 31, 2002,
approximately $25 million was outstanding under this facility.
26
Drive has a warehouse line of credit with BoS(USA), which provides
borrowings up to $200 million (increased from $150 million in May 2002). Drive's
obligation under this arrangement at December 31, 2002 was $160 million. The
debt is secured by Drive's retail installment contracts and has been extended to
July 2003. Effective February 28, 2003, Drive's warehouse line of credit
agreement with BoS(USA) was amended. The amendment increased the borrowing
limits up to $250 million and changed the maturity date to February 27, 2004.
Drive also has a warehouse line of credit agreement with Variable Funding
Capital Corporation, a subsidiary of First Union National Bank, which provides
borrowings up to $100 million. Drive's obligation under the arrangement at
December 31, 2002 was $58 million. The debt will be secured by Drive's retail
installment contracts and terminates September 2003. FirstCity has not
guaranteed and is not otherwise liable for this indebtedness.
The Company and each of its major operating subsidiaries have entered into
one or more credit facilities to finance their respective operations. Each of
the operating subsidiary credit facilities is nonrecourse to the Company. The
Company has agreed to indemnify BoS(USA) for up to 31% of losses, which might
arise as a result of agreements BoS(USA) executed as a sponsor in connection
with the securitizations completed by Drive. The Company also agreed to provide
support in connection with securitizations by Consumer Corp. and Drive prior to
the acquisition by BoS(USA) of the interest in Drive in August 2000.
Excluding the term acquisition facilities of the unconsolidated Acquisition
Partnerships and the term and warehouse facilities of Drive, as of December 31,
2002, the Company and its subsidiaries had credit facilities providing for
borrowings in an aggregate principal amount of $134 million and outstanding
borrowings of $97 million.
Management believes that the BoS(USA) loan facilities, along with the
liquidity from the Cargill Facility, the related fees generated from the
servicing of assets, equity distributions from existing Acquisition Partnerships
and wholly owned portfolios, as well as sales of interests in equity
investments, will allow the Company to meet its obligations as they come due
during the next twelve months.
27
The following table summarizes the material terms of the credit facilities
to which the Company, its major operating subsidiaries and the Acquisition
Partnerships were parties to as of March 17, 2003 and the outstanding borrowings
under such facilities as of December 31, 2002.
CREDIT FACILITIES
<Table>
<Caption>
FUNDED AND
UNFUNDED OUTSTANDING
COMMITMENT BORROWINGS
AMOUNT AS OF AS OF
MARCH 17, DECEMBER 31, OTHER TERMS
2003 2002 INTEREST RATE AND CONDITIONS
------------ ------------ ------------- --------------
(DOLLARS IN MILLIONS)
FIRSTCITY
Company Senior
Facility:
Revolving Line of
Credit........... $ 5 $ -- LIBOR + 2.75% Secured by the assets
of the Company,
matures December 2003
Portfolio
Acquisition Loan
(Term)........... 22 -- LIBOR + 2.75% Secured by the assets
of the Company,
matures November 2006
Tranche I (Term).... 38 38 Prime + 2.5% Secured by the assets
of the Company,
matures December 2006
Tranche II (Term)... 12 12 Fixed at 8.77% Secured by the assets
of the Company,
matures December 2007
Term credit
facility............ 2 2 LIBOR + 5.0% Secured by ownership
interests in certain
Acquisition
partnerships Matures
June 2003
COMMERCIAL CORP.
Acquisition term
facility............ 2 2 LIBOR + 5.0% Secured by existing
Portfolio Assets,
matures June 2003
Term facility......... 1 1 Fixed at 10.0% Secured by Portfolio
Assets, matured June
2002
Equity investment
facility............ 35 25 Maximum of Fixed at Acquisition facility
8.5% or LIBOR + 4.5% for the investment in
future Acquisition
partnerships, Matures
March 2005
Unsecured loans....... 1 1 Fixed at 4.5% to 7.0%
CONSUMER CORP. Non-recourse
Term loan............. 16 16
---- ---- LIBOR + 1.0% Secured by equity
interest in Drive,
matures December 2007
Total............ $134 $ 97
==== ====
</Table>
28
<Table>
<Caption>
FUNDED AND
UNFUNDED OUTSTANDING
COMMITMENT BORROWINGS
AMOUNT AS OF AS OF
MARCH 17, DECEMBER 31, OTHER TERMS
2003 2002 INTEREST RATE AND CONDITIONS
------------ ------------ ------------- --------------
(DOLLARS IN MILLIONS)
UNCONSOLIDATED
ACQUISITION
PARTNERSHIPS TERM
FACILITIES(1)....... $155 $155
==== ==== Various rates Secured by Portfolio
Assets, various
Maturities
UNCONSOLIDATED DRIVE
$200 $160
Warehouse Facility.... LIBOR + 1%; Prime -- Secured by warehouse
1.5% inventory, matures
July 2003
100 58
Warehouse Facility.... Rate based on Secured by warehouse
Commercial paper rates inventory, matures
combined with Certain September 2003
facility fees
152 152
Bonds payable......... Fixed at 1.87% To Secured by retail
4.09% installment Contracts,
various maturities
Through January 2008
Subordinate capital 65 48
Facility............ Fixed at 16% Secured by all assets
of Drive, matures
February 2006
Term Facility......... 14 14
---- ---- LIBOR + 1%; Secured by residual
interests, matures
August 2003
$531 $432
==== ====
</Table>
- ---------------
(1) In addition to the term acquisition facilities of the unconsolidated
Acquisition Partnerships, the Mexican Acquisition Partnerships also have
term debt of approximately $258 million outstanding as of December 31, 2002
owed to affiliates of the investor groups. Of this amount, the Company has
recorded approximately $16.4 million as Loans Receivable on the Consolidated
Balance Sheets.
FOURTH QUARTER
Net earnings for the fourth quarter of 2002 were $1.7 million, including a
$2.0 million loss from discontinued operations. After deducting the accrual of
dividends on the New Preferred Stock, net earnings to common equity were $1.1
million, or $0.36 per basic and diluted share. Net loss for the fourth quarter
of 2001 was $1.9 million. After deducting accrual of dividends on New Preferred
Stock, net loss attributable to
29
common equity was $2.6 million in 2001, or $0.05 per basic and diluted share.
The following table presents a summary of operations for the fourth quarters of
2002 and 2001.
CONDENSED CONSOLIDATED SUMMARY OF OPERATIONS
<Table>
<Caption>
FOURTH QUARTER
-----------------------
2002 2001
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
Revenues.................................................... $11,324 $ 8,918
Expenses.................................................... 7,376 7,993
Earnings from continuing operations......................... 3,712 287
Loss from discontinued operations........................... (2,014) (2,200)
------- -------
Net earnings (loss)......................................... 1,698 (1,913)
------- -------
Preferred dividends......................................... 552 642
------- -------
Net earnings (loss) to common shareholders.................. $ 1,146 $(2,555)
======= =======
Net earnings (loss) from continuing operations per common
share -- basic and diluted................................ $ 0.36 $ (0.05)
</Table>
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
In the ordinary course of business, the Company has made a number of
estimates and assumptions relating to the reporting of results of operations and
financial condition in the preparation of its consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America. Actual results could differ significantly from those estimates under
different assumptions and conditions. The Company believes that the following
discussion addresses the Company's most critical accounting policies, which are
those that are most important to the portrayal of the Company's consolidated
financial condition and results and require management's most difficult,
subjective and complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain.
REVENUE RECOGNITION: PERFORMING, NON-PERFORMING AND REAL ESTATE POOLS.
In its Portfolio Asset acquisition and resolution business, Commercial
Corp. acquires Portfolio Assets that are designated as non-performing,
performing or real estate. Each Portfolio is accounted for as a pool and not on
an individual asset basis, except for real estate Portfolios. To date, a
substantial majority of the Portfolio Assets acquired by Commercial Corp. have
been designated as non-performing. Once a Portfolio has been designated as
either non-performing or performing, such designation is not changed regardless
of the performance of the assets comprising the Portfolio. The Company
recognizes revenue from Portfolio Assets and Acquisition Partnerships based on
proceeds realized from the resolution of Portfolio Assets, which proceeds have
historically varied significantly and likely will continue to vary significantly
from period to period.
Non-Performing Portfolio Assets
Non-performing Portfolio Assets consist primarily of distressed loans and
loan related assets, such as foreclosed upon collateral. Portfolio Assets are
designated as non-performing unless substantially all of the loans in the
Portfolio are being repaid in accordance with the contractual terms of the
underlying loan agreements. Such Portfolios are acquired on the basis of an
evaluation by the Company of the timing and amount of cash flow expected to be
derived from borrower payments or other resolution of the underlying collateral
securing the loan.
All non-performing Portfolio Assets are purchased at substantial discounts
from their outstanding legal principal amount, the total of the aggregate of
expected future sales prices and the total payments to be
30
received from obligors. Subsequent to acquisition, the amortized cost of
non-performing Portfolio Assets is evaluated for impairment on a quarterly
basis. The evaluation of impairment is determined based on the review of the
estimated future cash receipts, which represents the net realizable value of the
non-performing pool. Once it is determined that there is impairment, a valuation
allowance is established for any impairment identified through provisions
charged to operations in the period the impairment is identified. The Company
recorded an allowance for impairment of $.1 million in 2002 and $1.6 million in
2001. No allowance was required in 2000.
Net gain on resolution of non-performing Portfolio Assets is recognized as
income to the extent that proceeds collected exceed a pro rata portion of
allocated cost from the Portfolio. Cost allocation is based on a proration of
actual proceeds divided by total estimated proceeds of the pool. No interest
income is recognized separately on non-performing Portfolio Assets. All
proceeds, of whatever type, are included in proceeds from resolution of
Portfolio Assets in determining the gain on resolution of such assets.
Accounting for Portfolios is on a pool basis as opposed to an individual
asset-by-asset basis.
The actual future proceeds of the pool could vary materially from the
estimated proceeds of the pool due to changes in economic conditions,
deterioration of collateral values, deterioration in the borrowers financial
condition and other conditions described in the risk factors discussed later in
this document. In the event that the actual future proceeds of the pool exceed
the current estimates the reported future results of the Company could be higher
than anticipated and would result in a higher net gain on resolution of
non-performing Portfolio Assets. In the event that actual future proceeds of the
pool are less than current estimates the reported future results of the Company
could be lower than anticipated and would result in lower net gain on resolution
of non-performing Portfolio Assets or possibly require the Company to recognize
impairment in the value of the pool.
Performing Portfolio Assets
Performing Portfolio Assets consist primarily of Portfolios of consumer and
commercial loans acquired at a discount from the aggregate amount of the
borrowers' obligation. Portfolios are classified as performing if substantially
all of the loans in the Portfolio are being repaid in accordance with the
contractual terms of the underlying loan agreements.
Performing Portfolio Assets are carried at the unpaid principal balance of
the underlying loans, net of acquisition discounts. Interest is accrued when
earned in accordance with the contractual terms of the loans. The accrual of
interest is discontinued once a loan becomes past due 90 days or more.
Acquisition discounts for the Portfolio as a whole are accreted as an adjustment
to yield over the estimated life of the Portfolio. Accounting for these
Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.
Gains are recognized on the performing Portfolio Assets when sufficient
funds are received to fully satisfy the obligation on loans included in the
pool, either from funds from the borrower or sale of the loan. The gain
recognized represents the difference between the proceeds received and the
allocated carrying value of the individual loan in the pool.
Impairment on each performing Portfolio is measured based on the present
value of the expected future cash flows in the aggregate discounted at the
loans' risk adjusted rate, which approximates the effective interest rates, or
the fair value of the collateral, less estimated selling costs, if any loans are
collateral dependent and foreclosure is probable. The Company recorded an
allowance for impairment of $.6 million in 2001. No allowance was required in
either 2002 or 2001.
The actual future cash flows of the pool could vary materially from the
expected future cash flows of the pool due to changes in economic conditions,
changes in collateral values, deterioration in the borrowers financial
condition, restructure or renewal of individual loans in the pool, sale of loans
within the pool and other conditions described in the risk factors discussed
later in this document. In the event that the actual future cash flows of the
pool exceed the current estimates, the reported future results of the Company
could be higher than anticipated and would result in a higher level of interest
income due to greater amounts of discount accretion being included in revenue
derived from the performing Portfolio Assets as well as higher
31
gains recognized on the sale of individual loans from a pool. In the event that
actual future cash flows of the pool are less than current estimates, the
reported future results of the Company could be lower than anticipated and would
result in a lower level of interest income and reduced gains from the sale of
assets from a pool, lower levels of interest income as a result of lower amounts
of discount accretion being included in revenue derived from performing
Portfolio Assets or possibly require the Company to recognize impairment in the
value of the pool due to a decline in the present value of the expected future
cash flows.
Real Estate Portfolios
Real estate Portfolios consist of real estate acquired from a variety of
sellers. Such Portfolios are carried at the lower of cost or fair value less
estimated costs to sell. Costs relating to the development and improvement of
real estate for its intended use are capitalized, whereas those relating to
holding assets are charged to expense. Income or loss is recognized upon the
disposal of the real estate. Rental income, net of expenses, on real estate
Portfolios is recognized when received. Accounting for the Portfolios is on an
individual asset-by-asset basis as opposed to a pool basis. Subsequent to
acquisition, the amortized cost of real estate Portfolios is evaluated for
impairment on a quarterly basis. The evaluation of impairment is determined
based on the review of the estimated future cash receipts, which represents the
net realizable value of the real estate Portfolio. A valuation allowance is
established for any impairment identified through provisions charged to
operations in the period the impairment is identified. The Company recorded an
allowance for impairment of $.2 million in 2002, $1.1 million in 2001 and $2.0
million in 2000.
DEFERRED TAX ASSET
As a part of the process of preparing its consolidated financial
statements, the Company is required to estimate its income taxes in each of the
jurisdictions in which it operates. This process involves estimating the
Company's actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax asset and liabilities.
Deferred tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statement carrying amounts and
the tax basis of existing assets and liabilities and operating loss and tax
credit carry forwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effects
of future changes in tax laws or changes in tax rates are not anticipated. The
measurement of deferred tax assets, if any, is reduced by the amount of any tax
benefits that, based on available evidence, are not expected to be realized.
As a result of the Merger, the Company has substantial federal NOLs that
can be used to offset 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 the NOLs by recording the benefit as an
asset and then establishing an allowance to value the net deferred tax asset at
a value commensurate with the Company's expectation of being able to utilize the
recognized benefit in the foreseeable future. Such estimates are reevaluated on
a quarterly basis with the adjustment to the allowance recorded as an adjustment
to the income tax expense generated by the quarterly operating results.
Significant events that change the Company's view of its currently estimated
ability to utilize the tax benefits, such as the acquisition of Harbor in the
third quarter of 1997, result in substantial changes to the estimated allowance
required to value the deferred tax benefits recognized in the Company's periodic
consolidated financial statements. The Company's analysis resulted in no change
in 2002 and 2001 and an increase to the valuation allowance of $7.0 million in
2000. Due to the evaluation of the recoverability of the deferred tax asset
recognized related to the mortgage banking operations, the Company increased its
valuation allowance by $5.1 million in 1999. Similar events could occur in the
future, and would impact the recognition of the Company's estimate of the
required valuation allowance associated with its NOLs. If there are changes in
the estimated level of the required reserve, operating results will be affected
accordingly.
The Company has recorded a net deferred tax asset of $20 million in the
consolidated balance sheet as of December 31, 2002, which is composed of a gross
deferred tax asset of $203 million net of a valuation allowance of $183 million.
Realization is dependent on generating sufficient taxable income in a look
forward
32
period over the next four years. Although realization is not assured, management
believes it is more likely than not that all of the net deferred tax asset will
be realized. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable income
during the look forward period are reduced. In the event that actual results
differ from these estimates or the Company adjusts these estimates in future
periods, the Company may need to establish an additional valuation allowance
which could materially impact its consolidated financial position and results of
operations.
EQUITY INVESTMENT IN DRIVE
The Company has an equity investment in Drive from which it records 31% of
the results of Drive using the equity method of accounting. The following
discussion addresses the critical accounting policies associated with Drive.
Retail Installment Contracts, Net -- Retail installment contracts, net
consist of sub-prime automobile finance receivables, which are acquired from
third-party dealers at a nonrefundable discount from the contractual principal
amount. At December 31, 2001, all retail installment contracts at Drive were
held for sale and stated at the lower of cost or fair value in the aggregate.
On July 1, 2002, Drive made a decision to change the structure of its
securitization transactions to treat the transactions as secured financings for
accounting purposes. Therefore, retail installment contracts at Drive are
classified as held to maturity and carried at amortized cost, net of credit loss
reserves at December 31, 2002, and include retail installment contracts pledged
under secured financings. Drive does not hedge its retail installment contracts
at this time. Management of Drive does not believe that Drive is exposed to
material interest rate risk during the period contracts are not securitized.
Interest is accrued when earned in accordance with the contractual terms of
the retail installment contract. The accrual of interest is discontinued once a
retail installment contract becomes past due 60 days or more. Discounts on
retail installment contracts are recognized as adjustments to the yield of the
related contract.
Gain on Sale of Retail Installment Contracts prior to July 2002 -- Drive
accounts for sales of retail installment contracts from securitizations in
accordance with Statement of Financial Accounting Standards No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities -- A Replacement of FASB Statement No. 125 ("SFAS 140"). In applying
SFAS 140 to Drive's securitized retail installment contract sales, Drive
recognizes revenue (gain on sales of retail installment contracts) and allocates
the total cost of the loans sold to financial components based on their relative
fair values. During the year ended December 31, 2001, Drive sold $402 million of
auto retail installment contracts in securitization transactions and recognized
pre-tax gains of $39 million. Drive retained servicing responsibilities and
interests in the receivables in the form of residual certificates. As of
December 31, 2002, Drive was servicing $260 million of auto receivables that
have been sold to certain special purpose financing trusts (the "Trusts"). In
connection with the sales of retail installment contracts from securitizations,
Drive receives certain residual certificates associated with the securitizations
as described below. Drive and certain of its subsidiaries have entered into an
agreement whereby Drive receives all the economic benefits associated with the
residual certificates and conversely assumes all the risks.
Under the above agreement, Drive has retained unrated interests in retail
installment contracts sold which are subordinate to senior investors and
certificated interest only strips for the benefit of Drive which represents the
present value of the right to the excess cash flows generated by the securitized
contracts which represents the difference between (a) interest at the stated
rate paid by borrowers and (b) the sum of (i) pass-through interest paid to
third-party investors, (ii) trustee fees, (iii) third-party credit enhancement
fees (if applicable), (iv) stipulated servicing fees, and (v) estimated contract
portfolio credit losses. Drive's right to receive the cash flows begins after
certain over-collateralization requirements have been met, which are specific to
each securitization and used as a means of credit enhancement.
Valuation of Residual Interests at Drive -- Fair value of the residual
interests at Drive is determined by calculating the present value of the
anticipated cash flows at the time each securitization transaction closes,
33
utilizing valuation assumptions appropriate for each particular transaction. The
significant valuation assumptions are related to the anticipated average lives
of the retail installment contracts sold, including the effect of anticipated
prepayment speeds and anticipated credit losses.
The residual interests are accounted for under Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Because such assets can be contractually prepaid or otherwise
settled in such a way that the holder would not receive all of the recorded
investment, the assets are classified as available-for-sale investments and are
carried at estimated fair value with any accompanying increases or decreases in
estimated fair value being recorded as unrealized gains or losses in other
comprehensive income (loss). The determination of fair value is based on the
present value of the anticipated excess cash flows utilizing various discount
rates, prepayment speeds and cumulative loss rates. Drive assesses the carrying
value of its securitization related securities for impairment in accordance with
the provisions of EITF 99-20 as discussed below under "-- Effect of New
Accounting Standards." There can be no assurance that the estimates used to
determine the fair value of the residual certificates will remain appropriate
for the life of each asset and it is reasonably possible that circumstances
could change in future periods which could result in a material change in the
estimates used to prepare the accompanying financial statements. If actual
retail installment contract prepayments or credit losses exceed the Drive's
current estimates, other than temporary impairment may be required to be
recognized. The implementation of EITF 99-20 required Drive to record a
cumulative effect of accounting change for other-than-temporary impairments on
retained beneficial interests in certain securitized assets, which had
previously been recorded as unrealized losses. As a result, in the second
quarter of 2001, the Company recognized a charge for the cumulative effect of a
change in accounting principle of $.3 million relating to the Company's share of
Drive's cumulative effect because the Company believed it to be material to the
consolidated results of operations.
EQUITY INVESTMENTS IN ACQUISITION PARTNERSHIPS
Commercial Corp. accounts for its investments in Acquisition Partnerships
using the equity method of accounting. This accounting method generally results
in the pass-through of its pro rata share of earnings from the Acquisition
Partnerships' activities as if it had a direct investment in the underlying
Portfolio Assets held by the Acquisition Partnership. The revenues and earnings
of the Acquisition Partnerships are determined on a basis consistent with the
accounting methodology applied to non-performing, performing and real estate
Portfolios described in the preceding paragraphs. Commercial Corp. has ownership
interests in the various partnerships that range from 3% to 50%. The Company
also holds investments in servicing entities that are accounted for on the
equity method.
Distributions of cash flow from the Acquisition Partnerships are a function
of the terms and covenants of the loan agreements related to the secured
borrowings of the Acquisition Partnerships. Generally, the terms of the
underlying loan agreements permit some distribution of cash flow to the equity
partners so long as loan to cost and loan to value relationships are in
compliance with the terms and covenants of the applicable loan agreement. Once
the secured borrowings of the Acquisition Partnerships are fully paid, all cash
flow in excess of operating expenses is available for distribution to the equity
partners.
DISCONTINUED OPERATIONS
The Company recorded provisions of $9.7 million in 2002, $5.2 million in
2001 and $5.0 million in 2000 for additional losses from discontinued
operations. The additional provisions primarily relate to a decrease in the
estimated future gross cash receipts on residual interests in securitizations.
These securities are in "run-off," and the Company is contractually obligated to
service these assets. The assumptions used in the valuation model consider both
industry as well as the Company's historical experience. The decrease in the
estimated future gross cash receipts is a result of the actual losses exceeding
the losses projected by the valuation model. As the securities "run off,"
assumptions are reviewed in light of historical evidence in revising the
prospective results of the model. These revised assumptions could potentially
result in either an increase or decrease in the estimated cash receipts. An
additional provision is booked based on the output of the valuation model if
deemed necessary. Effective during the third quarter of 1999, management of the
Company adopted formal plans to discontinue the operations of Harbor Financial
Group, Inc. (formerly known as FirstCity Financial
34
Mortgage Corp.) and its subsidiaries (collectively referred to as "Mortgage
Corp."), and FC Capital Corp. ("Capital Corp."). These entities comprise the
operations that were previously reported as the Company's residential and
commercial mortgage banking business. As formal termination plans were adopted
and historical business operations at each entity have ceased, the results of
operations for 1999 have been reflected as discontinued operations in the
accompanying consolidated statements of operations. Additionally, the net assets
related to the resolution of activity from the discontinued operations have been
reflected in the accompanying consolidated balance sheets. Revenues from
discontinued operations were zero in 2002, 2001 and 2000.
The only assets remaining from discontinued operations are the investment
securities resulting from the retention of residual interests in securitization
transactions. These residual interests are classified as discontinued operations
even though the liquidation or run-off of the securitized assets extends longer
than one year because the Company is contractually obligated to service the
securitized assets as master servicer. The Company has considered the estimated
future gross cash receipts for such investment securities in the computation of
the loss from discontinued operations. The cash flows are collected over a
period of time and are valued using prepayment assumptions of 28% to 33% for
fixed rate loans and 25% to 33% for variable rate loans. Overall loss rates are
estimated from 3% to 10% of collateral. The Company uses modeling techniques to
estimate future results from discontinued operations that consider the
contractual terms of the securitization structures and using the assumptions
stated above. The actual cash flows received from the residual interests in the
future could differ materially positively or negatively due to factors such as
economic conditions, changes in collateral values, fluctuating interest rates,
differences between actual prepayments and actual losses, which differ from the
assumptions used in the estimating process.
ESTIMATES OF FUTURE CASH RECEIPTS
The Company uses estimates to determine future cash receipts from Portfolio
Assets. These estimates of future cash receipts from acquired portfolio asset
pools are utilized in four primary ways:
(i) to calculate the allocation of cost of sales of non-performing
Portfolios;
(ii) to determine the effective yield of performing Portfolios;
(iii) to determine the reasonableness of settlement offers received in
the liquidation of the Portfolio Assets; and
(iv) to determine whether or not there is impairment in a pool of
Portfolio Assets
Calculation of the estimates of future cash receipts
The Company uses a proprietary asset management software program to manage
the Portfolio Assets it owns and services. Each asset within a pool is analyzed
by an account manager who is responsible for analyzing the characteristics of
each asset within a pool. The account manager projects future cash receipts and
expenses related to each asset and the sum of which provides the total estimated
future cash receipts related to a particular purchased asset pool. These
estimates are routinely monitored by the Company to determine reasonableness of
the estimates provided.
Risks associated with these estimates
The Company has in the past been able to establish with reasonable accuracy
the estimated future cash receipts over the life of a purchased asset pool.
Changes in economic conditions, fluctuations in interest rates, deterioration of
collateral values, and other factors described in the risk factors section could
cause the estimates of future cash flows to be materially different than actual
cash receipts.
The effects of an increase in the estimated future cash receipts would
generally increase revenues from Portfolio Assets by increasing gross profit on
a non-performing or real estate pool and increasing the effective yield on a
performing Portfolio while a decrease in future cash receipts would generally
have the effect of reducing revenues by reducing gross profit on a
non-performing or real estate pool and decreasing the effective
35
yield on a performing Portfolio. In some cases a reduction in the total future
cash receipts by collecting those cash receipts sooner than expected could have
a positive impact on the Company's revenues from portfolio assets due to reduced
interest expense and other carrying costs associated with the Portfolio Assets.
Likewise an increase in future cash receipts, although generally a positive
trend, could have a negative impact on future revenues of the Company due to
higher levels of interest expense and other carrying costs of the Portfolios
negating any potentially positive effects.
CONSOLIDATION POLICY
The accompanying consolidated financial statements include the accounts of
all of the majority owned subsidiaries of the Company. All significant
intercompany transactions and balances have been eliminated in consolidation.
Investments in 20% to 50% owned affiliates are accounted for on the equity
method since the Company has the ability to exercise significant influence over
operating and financial policies of those affiliates. For domestic Acquisition
Partnerships, the Company owns a limited partner interest and generally shares
in a general partner interest. Regarding the foreign investments, the Company
participates as a limited partner. In all cases the Company's direct and
indirect equity interest never exceeds 50%.
Investments in less than 20% owned affiliates are also accounted for on the
equity method. These investments are partnerships formed to share in the risks
and rewards in developing new markets as well as to pool resources. Also, the
Company has the ability to exercise significant influence over operating and
financial policies, despite its comparatively smaller equity percentage, due to
its leading role in the formation of these partnerships as well as its
involvement in the day-to-day management activities.
RELATIONSHIP WITH CARGILL
Cargill is a wholly owned subsidiary of Cargill, Incorporated, which is
generally regarded as one of the world's largest privately held corporations and
has offices worldwide. Cargill and its affiliates provide significant debt and
equity financing to the Acquisition Partnerships. In addition, Commercial Corp.
believes its relationship with Cargill significantly enhances Commercial Corp.'s
credibility as a purchaser of Portfolio Assets and facilitates its ability to
expand into related businesses and foreign markets.
Under the Right of First Refusal Agreement, if the Company receives an
invitation to bid on or otherwise obtains an opportunity to acquire interests in
loans, receivables, real estate or other assets located in the United States,
Canada, Latin America, or the Caribbean in which the aggregate amount to be bid
exceeds $4 million, or $500 thousand for consumer assets, the Company is
required to follow a prescribed notice procedure pursuant to which CFSC has the
option to participate in the proposed purchase by requiring that such purchase
or acquisition be effected through an Acquisition Partnership formed by the
Company and Cargill (or an affiliate). The Right of First Refusal Agreement does
not prohibit the Company from holding discussions with entities other than CFSC
regarding potential joint purchases of interests in loans, receivables, real
estate or other assets, provided that any such purchase is subject to CFSC's
right to participate in the Company's share of the investment. The Right of
First Refusal Agreement further provides that, subject to certain conditions,
CFSC will bear 50% of the due diligence expenses incurred by the Company in
connection with proposed asset purchases. The Right of First Refusal Agreement
is a restatement and extension of a similar agreement entered into among the
Company, certain members of the Company's management and Cargill in 1992. The
Right of First Refusal Agreement has a termination date of February 1, 2006 and
will renew automatically for an additional year on an annual basis thereafter
unless either party gives notice to the other of its desire to discontinue the
arrangement six months prior to the termination date.
Future increases in the Company's investments in Portfolio Assets acquired
from institutions and government agencies may be obtained through investment
entities formed with Cargill, whereby Cargill shares a general partner interest,
thereby capitalizing on the expertise of Cargill whose skills complement those
of the Company.
36
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following tables present contractual cash obligations and commercial
commitments of the Company as of December 31, 2002. See Notes 7, 9, 12 and 14 of
the Notes to Consolidated Financial Statements (dollars in thousands).
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
-----------------------------------------------
LESS THAN ONE TO FOUR TO
TOTAL ONE YEAR THREE YEARS FIVE YEARS
-------- --------- ----------- ----------
CONTRACTUAL CASH OBLIGATIONS
Notes payable secured by Portfolio Assets,
loans receivable and equity in
Acquisition Partnerships................. $ 29,875 $5,276 $24,599 $ --
Note payable secured by equity interest in
Drive.................................... 16,000 -- -- 16,000
Unsecured notes............................ 225 225 -- --
Company credit facility.................... 49,290 3,782 33,508 12,000
Operating leases........................... 966 296 515 155
New Preferred Stock(1)..................... 4,289 -- 4,289 --
-------- ------ ------- -------
$100,645 $9,579 $62,911 $28,155
======== ====== ======= =======
</Table>
<Table>
<Caption>
AMOUNT OF COMMITMENT EXPIRATION PERIOD
----------------------------------------
UNFUNDED LESS THAN ONE TO
COMMITMENTS ONE YEAR THREE YEARS
------------ ---------- ------------
COMMERCIAL COMMITMENTS............................. $ -- $ -- $ --
</Table>
- ---------------
(1) New Preferred Stock as shown above includes $3.7 million payable at December
31, 2002 plus $.6 million of unaccrued dividends through September 2005.
CHANGES IN INTERNAL CONTROLS
There have been no changes in internal controls or in other factors that
significantly changed internal controls during the fiscal year ended December
31, 2002.
EFFECT OF NEW ACCOUNTING STANDARDS
In March 2001, the Company adopted the provisions of EITF 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets ("EITF 99-20"), which
requires that other-than-temporary impairments in beneficial interests be
written down to fair value with the resulting charge being included in
operations. The implementation of EITF 99-20 required Drive to record a
cumulative effect of accounting change for other-than-temporary impairments on
retained beneficial interests in certain securitized assets, which had
previously been recorded as unrealized losses. As a result, in the second
quarter of 2001, the Company recognized a charge for the cumulative effect of a
change in accounting principle of $.3 million relating to the Company's share of
Drive's cumulative effect because the Company believed it to be material to the
consolidated results of operations.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") 142, Goodwill and Other Intangible Assets ("SFAS 142") and
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
("SFAS 144").
SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized but instead be tested for impairment at
least annually in accordance with the provisions of SFAS 142. SFAS 142 requires
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with the SFAS 121, Accounting for the
Impairment of Long-Lived Assets to Be Disposed Of ("SFAS 121") and SFAS 144
after it
37
superceded SFAS 121. The adoption of SFAS 142 did not have a material impact on
the Company's consolidated financial statements, as unamortized goodwill at
December 31, 2001 was $.1 million.
SFAS 144 addresses the accounting model for long-lived assets to be
disposed of by sale and resulting implementation issues. This statement requires
that those long-lived assets be measured at the lower of carrying amount or fair
value less cost to sell, whether reported in continuing operations or in
discontinued operations. It also broadens the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. Additionally,
discontinued operations that are not disposed of within one year must be
reclassified as assets held and used unless the discontinued segment will be (1)
abandoned through the liquidation or run-off of operations because the entity is
obligated by regulation or contract to provide services after it ceases
accepting all new business and (2) is being reported as a discontinued operation
when SFAS 144 is initially applied. The only assets remaining from discontinued
operations are the investment securities resulting from the retention of
residual interests in securitization transactions. Since the Company is
contractually obligated to service the securitized assets, the adoption of SFAS
144 had no impact on the Company's consolidated financial statements.
On April 1, 2002, the Company elected early adoption of SFAS No. 145,
Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections ("SFAS 145"). SFAS 145 updates, clarifies and
simplifies existing accounting pronouncements. As it relates to FirstCity, SFAS
145 eliminates the extraordinary gain classification on early debt
extinguishments. Instead, the gains associated with the early extinguishment of
debt have been recorded in other income in the consolidated statements of
operations. The result of this adoption did not modify or adjust net loss for
any period and does not impact the Company's compliance with various debt
covenants. The effect of SFAS 145 resulted in the extinguishment of debt of $.7
million in 2002 being included in other income in the consolidated statements of
operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure, an Amendment of FASB Statement No.
123 ("SFAS 148"). SFAS 148 amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition to SFAS
123's fair value method of accounting for stock-based employee compensation.
SFAS 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion
No. 28, Interim Financial Reporting, to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income or loss
and earnings (loss) per share in annual and interim consolidated financial
statements. SFAS 148 does not amend SFAS 123 to require companies to account for
stock-based employee compensation using the fair value method, regardless of
whether they account for that compensation using the fair value method of SFAS
123 or the intrinsic value method of APB Opinion No. 25. As allowed by SFAS 123,
the Company has elected to continue to utilize the accounting method prescribed
by APB Opinion No. 25 and has adopted the disclosure requirements of SFAS 148 as
of December 31, 2002.
In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No.
5, 57 and 107 and Rescission of FASB Interpretation No. 34 ("FIN 45"). FIN 45
requires that a liability be recorded in the guarantor's balance sheet upon
issuance of a guarantee. In addition, FIN 45 requires disclosures about the
guarantees that an entity has issued, including a reconciliation of changes in
the entity's product warranty liabilities. The initial recognition and initial
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the
guarantor's fiscal year-end. The disclosure requirements of FIN 45 are effective
for financial statements of interim or annual periods ending after December 15,
2002. The Company believes that the adoption of FIN 45 will have no material
impact on its consolidated financial statements and applicable disclosure
requirements are included in the notes to its consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51 ("FIN 46"). FIN
46 requires certain variable interest entities to be
38
consolidated by the primary beneficiary of the entity if the equity investors in
the entity do not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN 46 is effective immediately for all new variable interest entities created
or acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after June 15, 2003. FIN 46 also
requires certain disclosures in financial statements issued after January 31,
2003 if it is reasonably possible that the entity will consolidate or disclose
information about variable interest entities when FIN 46 becomes effective.
Although management is still evaluating the impact of FIN 46, the adoption is
not expected to have a material effect. Presently the Company has identified one
Acquisition Partnership, which may qualify for consolidation in accordance with
FIN 46. This Acquisition Partnership holds real estate that is being developed
for its intended use. As of December 31, 2002, the total assets that would be
consolidated into the Company's consolidated financial statements were $1.4
million. The maximum loss exposure to the Company related to this Acquisition
Partnership is estimated to be $.3 million as of December 31, 2002.
RISK FACTORS
AVAILABILITY OF PORTFOLIO ASSETS
The Portfolio Asset acquisition and resolution business is affected by
long-term cycles in the general economy. The Company cannot predict its future
annual acquisition volume of Portfolio Assets. Moreover, future Portfolio Asset
purchases will depend on the availability of Portfolios offered for sale, the
availability of capital and the Company's ability to submit successful bids to
purchase Portfolio Assets. The acquisition of Portfolio Assets is highly
competitive in the United States. This may require the Company to acquire
Portfolio Assets at higher prices thereby lowering profit margins on the
resolution of such Portfolios. To offset these changes in the domestic arena,
the Company continues to develop its presence in other markets. Under certain
circumstances, the Company may choose not to bid for Portfolio Assets that it
believes cannot be acquired at attractive prices. As a result of all the above
factors, Portfolio Asset purchases, and the revenue derived from the resolution
of Portfolio Assets, may vary significantly from quarter to quarter.
ASSUMPTIONS UNDERLYING PORTFOLIO ASSET PERFORMANCE
The purchase price and carrying value of Portfolio Assets acquired by
Commercial Corp. are determined largely by estimating expected future cash flows
from such assets. Commercial Corp. develops and revises such estimates based on
its historical experience and current market conditions, and based on the
discount rates that the Company believes are appropriate for the assets
comprising the Portfolios. In addition, many obligors on Portfolio Assets have
impaired credit, with risks associated with such obligors similar to the risks
described in respect of borrowers under "Credit Impaired Borrowers at Drive." If
the amount and timing of actual cash flows is materially different from
estimates, the Company's consolidated financial position, results of operations
and business prospects could be materially adversely affected.
RISK ASSOCIATED WITH FOREIGN OPERATIONS
Commercial Corp. has acquired, and manages and resolves, Portfolio Assets
located in France and Mexico and is actively pursuing opportunities to purchase
additional pools of distressed assets in these locations as well as other areas
of Western Europe, Southeast Asia and Central and South America. Foreign
operations are subject to various special risks, including currency translation
risks, currency exchange rate fluctuations, exchange controls and different
political, social and legal environments within such foreign markets. To the
extent future financing in foreign currencies is unavailable at reasonable
rates, the Company would be further exposed to currency translation risks,
currency exchange rate fluctuations and exchange controls. In addition, earnings
of foreign operations may be subject to foreign income taxes that reduce cash
flow available to meet debt service requirements and other obligations of the
Company, which may be payable even if the Company has no earnings on a
consolidated basis. Any or all of the foregoing could have a material adverse
effect on the Company's consolidated position, results of operations and
business prospects.
39
IMPACT OF CHANGING INTEREST RATES
Because most of the Company's borrowings are at variable rates of interest,
the Company will be impacted by fluctuations in interest rates. However, certain
effects of changes in interest rates, such as increased prepayments of
outstanding loans, cannot be mitigated. Fluctuations in interest rates could
have a material adverse effect on the Company's consolidated financial position,
results of operations and business prospects.
A substantial and sustained decline in interest rates may adversely impact
the amount of distressed assets available for purchase by Commercial Corp. The
value of the Company's interest-earning assets and liabilities may be directly
affected by the level of and fluctuations in interest rates, including the
valuation of any residual interests in securitizations that would be severely
impacted by increased loan prepayments resulting from declining interest rates.
Conversely, a substantial and sustained increase in interest rates could
adversely affect the ability of the Company to originate loans and could reduce
the gains recognized by the Company upon their securitization and sale.
Fluctuating interest rates also may affect the net interest income earned by the
Company resulting from the difference between the yield to the Company on loans
held pending sale and the interest paid by the Company for funds borrowed under
the Company's warehouse credit facilities or otherwise. See "Item 7A. --
Quantitative and Qualitative Disclosures About Market Risk."
CONTINUING NEED FOR FINANCING
General. The successful execution of the Company's business strategy
depends on its continued access to financing. In addition to the need for such
financing, the Company must have access to liquidity to invest as equity or
subordinated debt to meet its capital needs. Liquidity is generated by the cash
flow to the Company from subsidiaries, access to the public debt and equity
markets and borrowings incurred by the Company. The Company's access to the
capital markets is affected by such factors as changes in interest rates,
general economic conditions, and the perception in the capital markets of the
Company's business, results of operations, leverage, financial position and
business prospects. In addition, the Company's ability to issue and sell common
equity (including securities convertible into, or exercisable or exchangeable
for, common equity) is limited as a result of the tax laws relating to the
preservation of the NOLs available to the Company as a result of the Merger.
There can be no assurance that the Company's funding relationships with
commercial banks, investment banks and financial services companies (including
Cargill and the Senior Lenders) that have previously provided financing for the
Company and its subsidiaries will continue past their respective current
maturity dates. Some credit facilities to which the Company and its subsidiaries
are parties have short-term maturities. If these credit facilities are not
extended and the Company or its subsidiaries cannot find alternative funding
sources on satisfactory terms, or at all, the Company's consolidated financial
position, results of operations and business prospects would be materially
adversely affected. See "Liquidity and Capital Resources."
Each of the Company and its major operating subsidiaries has its own source
of debt financing. In certain circumstances, a default by the Company or any of
its major operating subsidiaries in respect of indebtedness owed to a third
party constitutes a default under the Company's credit facility. Although the
Company intends to segregate the debt obligations of each such subsidiary, there
can be no assurance that its existing financing sources will continue to agree
to such arrangements or that alternative financing sources that would accept
such arrangements would be available. In the event the Company's major operating
subsidiaries are compelled to accept cross-guarantees, or cross-default or
cross-acceleration provisions in connection with their respective credit
facilities, financial difficulties experienced by one of the Company's
subsidiaries could adversely impact the Company's other subsidiaries.
Dependence on Warehouse Financing at Drive. As is customary in the
consumer lending businesses, Drive depends upon warehouse credit facilities with
financial institutions or institutional lenders to finance the origination and
purchase of loans on a short-term basis pending sale or securitization.
Implementation of the Drive's business strategy requires the continued
availability of warehouse credit facilities, and may require increases in the
permitted borrowing levels under such facilities. There can be no assurance that
such
40
financing will be available on terms satisfactory to Drive. The inability of
Drive or its subsidiaries to arrange additional warehouse credit facilities, to
extend or replace existing facilities when they expire or to increase the
capacity of such facilities may have a material adverse effect on the Company's
consolidated position, results of operations and business prospects.
RISK OF DECLINING VALUE OF COLLATERAL
The value of the collateral securing automobile and other consumer loans
and loans acquired for resolution, as well as real estate or other acquired
distressed assets, is subject to various risks, including uninsured damage,
change in location or decline in value caused by use, age or market conditions.
Any material decline in the value of such collateral could adversely affect the
consolidated financial position, results of operations and business prospects of
the Company.
RISKS OF SECURITIZATION BY DRIVE
Significance of Securitization. The Company continues to believe that
Drive's ability to securitize sub-prime automobile loans is necessary to
efficiently finance the volume of assets expected to be generated. Accordingly,
adverse changes in the secondary market for such loans could impair Drive's
ability to purchase and securitize on a favorable or timely basis. Any such
impairment could have a material adverse effect upon Drive's consolidated
position, results of operations and business prospects. Proceeds from the
securitization of acquired loans are required to be used to repay borrowings
under warehouse credit facilities, which makes such facilities available to
finance the purchase of additional loan assets. There can be no assurance that,
as Drive's volume of loans purchased increases, Drive will be able to securitize
its loan production efficiently. An inability of Drive to efficiently securitize
its loan production could have a material adverse effect on the Company's
consolidated position, results of operations and business prospects.
Securitization transactions may be affected by a number of factors, some of
which are beyond Drive's control, including, among other things, the adverse
financial condition of, or developments related to, some of Drive's competitors,
conditions in the securities markets in general, and conditions in the
asset-backed securitization market. Drive's securitizations typically utilize
credit enhancements in the form of financial guaranty insurance policies in
order to achieve enhanced credit ratings. Failure to obtain insurance company
credit enhancement could adversely affect the timing of or ability of Drive to
effect securitizations. In addition, the failure to satisfy rating agency
requirements with respect to loan pools would adversely impact Drive's ability
to effect securitizations.
Contingent Risks. During 2002, Drive began structuring securitization
transactions as secured financings and retaining the assets on the balance sheet
and thus retains the credit risk on substantially all loans securitized in this
manner. Drive is subject to various business risks associated with the lending
business, including the risk of borrower default, the risk of foreclosure and
the risk that a rapid increase in interest rates would result in a decline in
the future net interest margins on future securitizations. Drive expects that
the terms of its securitizations will require it to establish deposit accounts
or build over-collateralization levels through retention of distributions
otherwise payable to Drive who holds the subordinated interests in the
securitization. Drive also expects to be required to commit to repurchase or
replace loans that do not conform to the representations and warranties made by
Drive at the time of securitization.
Retained Risks of Securitized Loans. Drive makes various representations
with respect to the loans that it securitizes. With respect to acquired loans,
Drive's representations rely in part on similar representations made by the
originators of such loans when Drive purchased them. In the event of a breach of
its representations, Drive may be required to repurchase or replace the related
loan using its own funds. While Drive may have a claim against the originator in
the event of a breach of any of these representations made by the originators,
the Company's ability to recover on any such claim will be dependent on the
financial condition of the originator. There can be no assurance that Drive will
not experience a material loss associated with any of these contingencies.
Performance Assumptions. Securitizations completed by Drive for the
foreseeable future will be structured as debt financings and will result in a
growth of the net interest margin and grow Drive's balance
41
sheet. Prior to July 2002 Drive structured the securitizations as sales and
retains subordinated interests in those securitizations. Management of Drive
makes a number of assumptions in determining the estimated fair value for the
subordinated interests. These assumptions include, but are not limited to,
prepayment speeds, default rates and subsequent losses on the underlying loans,
and the discount rates used to present value the future cash flows. All of the
assumptions are subjective. Varying the assumptions can have a material effect
on the present value determination in one securitization as compared to any
other. Subsequent events will cause the actual occurrences of prepayments,
losses and interest rates to be different from the assumptions used for such
factors at the time of the recognition of the sale of the loans. The effect of
the subsequently occurring events could cause a re-evaluation of the carrying
values of the previously estimated values of the subordinated interests and
excess spreads and such adjustment could be material. Defaults and losses on
defaults increased in 2002 and 2001 due to recession related factors. Of major
importance was the reduction in used car values caused by the events of
September 11, 2001, when, facing significant slowdowns in travel, the car rental
agencies reduced their fleets dramatically. This, compounded by the zero percent
financing offered on new cars, flooded the used car market creating downward
pressure on used car values.
Because the subordinated interests to be retained by Drive represent claims
to future cash flow that are subordinated to holders of senior interests, Drive
retains a significant portion of the risk of whether the full value of the
underlying loans may be realized. In addition, holders of the senior interests
may have the right to receive certain additional payments on account of
principal in order to reduce the balance of the senior interests in proportion
to the credit enhancement requirements of any particular transaction. Such
payments for the benefit of the senior interest holders will delay the payment,
if any, of excess cash flow to Drive as the holder of the subordinated
interests.
RISK OF MINORITY INVESTMENT IN DRIVE
Although the Company continues to have some influence on Drive and its
operations, due to the sale of 49% of its interest, the Company now maintains a
minority interest in Drive. There can be no guarantee that Drive's future
operations will be consistent with the Company's goals
CREDIT IMPAIRED BORROWERS AT DRIVE
Drive's sub-prime borrowers generally are unable to obtain credit from
traditional financial institutions due to factors such as an impaired or poor
credit history, low income or other adverse credit events. Drive is subject to
various risks associated with these borrowers, including, but not limited to,
the risk that the borrowers will not satisfy their debt service obligations and
that the realizable value of the assets securing their loans will not be
sufficient to repay the borrowers' debt. While the Company believes that the
underwriting criteria and collection methods Drive employs enable it to identify
and control the higher risks inherent in loans made to such borrowers, and that
the interest rates charged compensate Drive for the risks inherent in such
loans, no assurance can be given that such criteria or methods, or such interest
rates, will afford adequate protection against, or compensation for, higher than
anticipated delinquencies, foreclosures or losses. The actual rate of
delinquencies, foreclosures or losses could be significantly accelerated by an
economic downturn or recession. Consequently, the Company's consolidated
financial position, results of operations (primarily Consumer Corp.'s 31% equity
earnings in Drive) and business prospects could be materially adversely
affected. Retail installment contracts at Drive are held for sale and stated at
the lower of cost or fair value in the aggregate. Drive does not hedge its
retail installment contracts while held for sale. While management of Drive does
not believe Drive is exposed to material interest rate risk during the period
contracts are held for sale, there can be no assurance that future material
valuation impairments will not be required.
AVAILABILITY OF NET OPERATING LOSS CARRYFORWARDS
The Company believes that, as a result of the Merger, approximately $596
million of NOLs were available to the Company to offset future taxable income as
of December 31, 1995. Since December 31, 1995, the Company has generated an
additional $134 million in tax operating losses. Accordingly, as of December 31,
2002, the Company believes that it has approximately $730 million of NOLs
available to offset future taxable income. Out of the total $730 million of
NOLs, the Company estimates it will be able to utilize
42
$57.4 million, which equates to a $20.1 million deferred tax asset on the
Company's books and records. However, because the Company's position in respect
of its $596 million NOLs resulting from the Merger is based upon factual
determinations and upon legal issues with respect to which there is uncertainty
and because no ruling has been obtained from the Internal Revenue Service (the
"IRS") regarding the availability of the NOLs to the Company, there can be no
assurance that the IRS will not challenge the availability of such NOLs and, if
challenged, that the IRS will not be successful in disallowing this portion of
the Company's NOLs, with the result that the Company's $20.1 million deferred
tax asset would be reduced or eliminated.
Some of the NOLs may be carried forward to offset future federal taxable
income of the Company through the year 2022; however, the availability of some
of the NOLs begins to expire beginning in 2005. The ability of the Company to
utilize such NOLs will be severely limited if there is a more than 50% ownership
change of the Company during a three-year testing period within the meaning of
section 382 of the Internal Revenue Code of 1986, as amended (the "Tax Code").
If the Company were unable to utilize its NOLs to offset future taxable
income, it would lose significant competitive advantages that it now enjoys.
Such advantages include, but are not limited to, the Company's ability to offset
non-cash income recognized by the Company in connection with certain
securitizations, to generate capital to support its expansion plans on a
tax-advantaged basis, to offset its and its consolidated subsidiaries' pretax
income, and to have access to the cash flow that would otherwise be represented
by payments of federal tax liabilities.
ASSUMPTIONS REGARDING RECOGNITION OF DEFERRED TAX ASSET
As noted above, the Company has NOLs available for federal income tax
purposes to offset future federal taxable income, if any, through the year 2022.
A valuation allowance is provided to reduce the deferred tax assets to a level,
which, more likely than not, will be realized. Realization is determined based
on management's expectation of generating sufficient taxable income in a look
forward period over the next four years. The ultimate realization of the
resulting net deferred tax asset is dependent upon generating sufficient taxable
income prior to expiration of the net operating loss carryforwards. Although
realization is not assured, management believes it is more likely than not that
all of the recorded deferred tax asset, net of the allowance, will be realized.
The amount of the deferred tax asset considered realizable, however, could be
adjusted in the future if estimates of future taxable income during the
carryforward period change. The change in valuation allowance represents a
change in the estimate of the future taxable income during the carryforward
period since the prior year-end and utilization of net operating loss
carryforwards since the Merger. The ability of the Company to realize the
deferred tax asset is periodically reviewed and the valuation allowance is
adjusted accordingly. See "Discussion of Critical Accounting
Policies -- Deferred Tax Asset."
ENVIRONMENTAL LIABILITIES
The Company, through its subsidiaries and affiliates, acquires real
property in its Portfolio Asset acquisition and resolution business. There is a
risk that properties acquired by the Company could contain hazardous substances
or waste, contaminants or pollutants. The Company may be required to remove such
substances from the affected properties at its expense, and the cost of such
removal may substantially exceed the value of the affected properties or the
loans secured by such properties. Furthermore, the Company may not have adequate
remedies against the prior owners or other responsible parties to recover its
costs, either as a matter of law or regulation, or as a result of such prior
owners' financial inability to pay such costs. The Company may find it difficult
or impossible to sell the affected properties either prior to or following any
such removal.
COMPETITION
All of the businesses in which the Company operates are highly competitive.
Some of the Company's principal competitors are substantially larger and better
capitalized than the Company. Because of their resources, these companies may be
better able than the Company to obtain new customers for loan production, to
acquire Portfolio Assets, to pursue new business opportunities or to survive
periods of industry
43
consolidation. Access to and the cost of capital are critical to the Company's
ability to compete. Many of the Company's competitors have superior access to
capital sources and can arrange or obtain lower cost of capital, resulting in a
competitive disadvantage to the Company with respect to such competitors.
In addition, certain of the Company's competitors may have higher risk
tolerances or different risk assessments, which could allow these competitors to
establish lower margin requirements and pricing levels than those established by
the Company. In the event a significant number of competitors establish pricing
levels below those established by the Company, the Company's ability to compete
would be adversely affected.
GENERAL ECONOMIC CONDITIONS
Periods of economic slowdown or recession, or declining demand for
commercial real estate, automobile loans or other commercial or consumer loans
may adversely affect the Company's business. Economic downturns may reduce the
number of loan originations by the Company's consumer business and negatively
impact its securitization activity and generally reduce the value of the
Company's assets. In addition, periods of economic slowdown or recession,
whether general, regional or industry-related, may increase the risk of default
on loans and could have a material adverse effect on the Company's consolidated
financial condition, results of operations and business prospects. Such periods
also may be accompanied by declining values of automobiles and other property
securing outstanding loans, thereby weakening collateral coverage and increasing
the possibility of losses in the event of default. Due to significant increases
in automobiles for sale during the recent recessionary economic period have
depressed the prices at which such collateral may be sold or delayed the timing
of such sales. There can be no assurance that there will be adequate markets for
the sale of repossessed automobiles. Any additional deterioration of such
markets could reduce recoveries from the sale of collateral.
Such economic conditions could also adversely affect the resolution of
Portfolio Assets, lead to a decline in prices or demand for collateral
underlying Portfolio Assets, or increase the cost of capital invested by the
Company and the length of time that capital is invested in a particular
Portfolio. All or any one of these events could decrease the rate of return and
profits to be realized from such Portfolio and materially adversely affect the
Company's consolidated financial position, results of operations and business
prospects.
GOVERNMENT REGULATION
Some aspects of the Company's business are subject to regulation,
examination and licensing under various federal, state and local statutes and
regulations that impose requirements and restrictions affecting, among other
things, credit activities, maximum interest rates, finance and other charges,
disclosures to obligors, the terms of secured transactions, collection,
repossession and claims handling procedures, multiple qualification and
licensing requirements for doing business in various jurisdictions, and other
trade practices. The Company believes it is currently in compliance in all
material respects with applicable regulations, but there can be no assurance
that the Company will be able to maintain such compliance. Failure to comply
with, or changes in, these laws or regulations, or the expansion of the
Company's business into jurisdictions that have adopted more stringent
regulatory requirements than those in which the Company currently conducts
business, could have an adverse effect on the Company by, among other things,
limiting the income the Company may generate on existing and additional loans,
limiting the states in which the Company may operate or restricting the
Company's ability to realize on the collateral securing its loans. See "Item
1 -- Business -- Government Regulation."
LITIGATION
On October 14, 1999, Harbor Financial Group, Inc. ("Harbor Parent"), Harbor
Financial Mortgage Corporation ("Harbor") and four subsidiaries of Harbor filed
voluntary petitions under Chapter 11 of the United States Bankruptcy Code before
the United States Bankruptcy Court for the Northern District of Texas, Dallas
Division. On December 14, 1999, the bankruptcy proceedings were converted to
liquidation proceedings under Chapter 7 of the United States Bankruptcy Code.
John H. Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the
"Trustee"), initiated adversary proceedings on May 25, 2001 against
44
FirstCity and various current and former directors and officers of FirstCity and
Harbor alleging breach of fiduciary duties, mismanagement, and self-dealing by
FirstCity and Harbor directors and officers, and improper transfer of funds from
the Harbor related entities to FirstCity. The claims also included fraudulent
and preferential transfer of assets of the Harbor entities, fraud and
conspiracy. The Trustee, FirstCity, the other defendants and the insurers
providing Director's and Officer's Insurance coverage for FirstCity and its
subsidiaries (the "Insurers") have settled the claims brought in the adversary
proceedings with the approval of the Bankruptcy Court. Under the terms of the
settlement agreement, the Trustee released the defendants, their affiliates and
subsidiaries from any and all claims which were brought or could have been
brought by the Trustee against any of the defendants, any past and present
officers and directors of FirstCity or any affiliates or subsidiaries of
FirstCity. Other claims could be asserted by parties alleging to be harmed by
the failure of Harbor, Harbor Parent and their subsidiaries.
Periodically, FirstCity, its subsidiaries, its affiliates and the
Acquisition Partnerships are parties to or otherwise involved in legal
proceedings arising in the normal course of business. FirstCity does not believe
that there is any proceeding threatened or pending against it, its subsidiaries,
its affiliates or the Acquisition Partnerships which, if determined adversely,
would have a material adverse effect on the consolidated financial position,
results of operations or liquidity of FirstCity, its subsidiaries, its
affiliates or the Acquisition Partnerships.
Industry participants in the consumer lending businesses from time to time
are named as defendants in litigation involving alleged violations of federal
and state consumer protection or other similar laws and regulations. A judgment
against FirstCity or Drive in connection with any such litigation could have a
material adverse effect on the Company's consolidated financial position,
results of operations and business prospects.
RELATIONSHIP WITH AND DEPENDENCE UPON CARGILL
The Company's relationship with Cargill is material in a number of
respects. Cargill, a subsidiary of Cargill, Incorporated, a privately held,
multi-national agricultural and financial services company, provides equity and
debt financings for many of the Acquisition Partnerships. Cargill owns
approximately 2.7% of the Company's outstanding Common Stock, and a Cargill
designee, Jeffery Leu, serves as a director of the Company. The Company believes
its relationship with Cargill significantly enhances the Company's credibility
as a purchaser of Portfolio Assets and facilitates its ability to expand into
other businesses and foreign markets. Although management believes that the
Company's relationship with Cargill is excellent, there can be no assurance that
such relationship will continue in the future. Absent such relationship, the
Company and the Acquisition Partnerships would be required to find alternative
sources for the financing that Cargill has historically provided. There can be
no assurance that such alternative financing would be available. Any termination
of such relationship could have a material adverse effect on the Company's
consolidated financial position, results of operations and business prospects.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent on the efforts of its senior executive officers,
particularly James R. Hawkins (Chairman of the Board) and James T. Sartain
(President and Chief Executive Officer). The Company is also dependent on
several of the key members of management of each of its operating subsidiaries,
many of whom were instrumental in developing and implementing the business
strategy for such subsidiaries. The inability or unwillingness of one or more of
these individuals to continue in his present role could have a material adverse
effect on the Company's consolidated condition, results of operations and
business prospects. There can be no assurance that any of the foregoing
individuals will continue to serve in his current capacity or for what time
period such service might continue. The Company does not maintain key person
life insurance for any of its senior executive officers.
The borrowing facilities for the Company and Commercial Corp. each include
key personnel provisions. These provisions generally provide that if certain key
personnel are no longer employed and suitable replacements are not found within
a defined time limit certain facilities become due and payable.
45
INFLUENCE OF CERTAIN STOCKHOLDERS
The directors and executive officers of the Company collectively
beneficially own 25.99% of the Common Stock. Although there are no agreements or
arrangements with respect to voting such Common Stock among such persons except
as described below, such persons, if acting together, may effectively be able to
control any vote of stockholders of the Company and thereby exert considerable
influence over the affairs of the Company. James R. Hawkins, the Chairman of the
Board, is the beneficial owner of 11.41% of the Common Stock. James T. Sartain,
President and Chief Executive Officer of the Company, is the beneficial owner of
4.90% of the Common Stock. ATARA I, Ltd. ("ATARA"), an entity associated with
Rick R. Hagelstein, former Executive Vice President of the Company and former
Chief Executive Officer of Mortgage Corp., beneficially owns 3.06% of the
outstanding Common Stock. In addition, Cargill owns approximately 1.98% of the
Common Stock. Mr. Hawkins, Mr. Sartain, Cargill and ATARA are parties to a
shareholder voting agreement (the "Stockholder Voting Agreement"). Under the
Stockholder Voting Agreement, Mr. Hawkins, Mr. Sartain and ATARA are required to
vote their shares in favor of Cargill's designee for director of the Company,
and Cargill is required to vote its shares in favor of one or more of the
designees of Messrs. Hawkins and Sartain and ATARA. There can be no assurance
that the interests of management or the other entities and individuals named
above will be aligned with the Company's other stockholders.
SHARES ELIGIBLE FOR FUTURE SALE
The utilization of the Company's $596 million in NOLs resulting from the
Merger may be limited or prohibited under the Tax Code in the event of certain
ownership changes. The Company's Amended and Restated Certificate of
Incorporation (the "Certificate of Incorporation") contains provisions
restricting the transfer of its securities that are designed to avoid the
possibility of such changes. Such restrictions may prevent certain holders of
Common Stock of the Company from transferring such stock even if such holders
are permitted to sell such stock without restriction under the Securities Act of
1933, as amended, and may limit the Company's ability to sell Common Stock to
certain existing holders of Common Stock at an advantageous time or at a time
when capital may be required but unavailable from any other source.
PERIOD TO PERIOD VARIANCES
The revenue of Commercial Corp. and Acquisition Partnerships is based on
proceeds realized from the resolution of the Portfolio Assets, which proceeds
have historically varied significantly and likely will continue to vary
significantly from period to period. Likewise, earnings from Drive are dependent
on the timing of securitization transactions of Drive. Consequently, the
Company's period-to-period revenue and results of operations have historically
varied, and are likely to continue to vary, correspondingly. Such variances,
alone or with other factors, such as conditions in the economy or the financial
services industries or other developments affecting the Company, may result in
significant fluctuations in the reported operations of the Company and in the
trading prices of the Company's securities, particularly the Common Stock.
TAX, MONETARY AND FISCAL POLICY CHANGES
The Company originates and acquires financial assets, the value and income
potential of which are subject to influence by various state and federal tax,
monetary and fiscal policies in effect from time to time. The nature and
direction of such policies are entirely outside the control of the Company, and
the Company cannot predict the timing or effect of changes in such policies.
Changes in such policies could have a material adverse effect on the Company's
consolidated financial position, results of operations and business prospects.
DEPENDENCE ON AUTOMOBILE DEALERSHIP RELATIONSHIPS
The ability of the Drive to expand into new geographic markets and to
maintain or increase its volume of automobile loans is dependent upon
maintaining and expanding the network of franchised automobile dealerships from
which it purchases contracts. Increased competition, including competition from
captive finance affiliates of automobile manufacturers, could have a material
adverse effect on the Drive's ability to maintain or expand its dealership
network.
46
ANTI-TAKEOVER CONSIDERATIONS
The Company's Certificate of Incorporation and by-laws contain a number of
provisions relating to corporate governance and the rights of stockholders.
Certain of these provisions may be deemed to have a potential "anti-takeover"
effect to the extent they are utilized to delay, defer or prevent a change of
control of the Company by deterring unsolicited tender offers or other
unilateral takeover proposals and compelling negotiations with the Company's
Board of Directors rather than non-negotiated takeover attempts even if such
events may be in the best interests of the Company's stockholders. The
Certificate of Incorporation also contains certain provisions restricting the
transfer of its securities that are designed to prevent ownership changes that
might limit or eliminate the ability of the Company to use its NOLs resulting
from the Merger.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
interest rates. The Company's operations are materially impacted by net gains on
sales of loans and net interest margins. The level of gains from loan sales the
Company achieves is dependent on demand for the products originated. Net
interest margins are dependent on the Company ability to maintain the spread or
interest differential between the interest it charges the customer for loans and
the interest the Company is charged for the financing of those loans. The
following describes each component of interest bearing assets held by the
Company and how each could be affected by changes in interest rates.
The Company invests in Portfolio Assets both directly through consolidated
subsidiaries and indirectly through equity investments in Acquisition
Partnerships. Portfolio Assets consist of investments in pools of non-homogenous
assets that predominantly consist of loan and real estate assets. Earnings from
these assets are based on the estimated future cash flows from such assets and
recorded when those cash flows occur. The underlying loans within these pools
bear both fixed and variable rates. Due to the non-performing nature and history
of these loans, changes in prevailing benchmark rates (such as the prime rate or
LIBOR) generally have a nominal effect on the ultimate future cash flow to be
realized from the loan assets. Furthermore, these pools of assets are held for
sale, not for investment; therefore, the disposition strategy is to liquidate
these assets as quickly as possible.
Loans receivable consist of investment loans made to Acquisition
Partnerships located in Mexico and bear interest at predominately fixed rates.
The collectibility of these loans is directly related to the underlying
Portfolio Assets of those Acquisition Partnerships, which are non-performing in
nature. Therefore, changes in benchmark rates would have minimal effect on the
collectibility of these loans.
The Company's equity investment in Drive is materially impacted by net
interest margins and the ability to securitize the loans Drive originates.
During 2002, Drive elected not to use gain on sale treatment when assets were
securitized. Instead, Drive pursued a strategy to grow the balance sheet and
record interest income from loans and interest expense on the related debt as
incurred to build an earnings stream over time. Demand from potential investors
in Drive's securitizations is affected by the perception of credit quality and
prepayment risk associated with the loans Drive originates and securitizes. The
timing and size and interest rates of the bonds issued as a part of the
securitizations could also have a material effect on the net income of Drive.
Interest rates offered to customers also affect prices paid for loans. These
rates are determined by review of competitors' rate offerings to the public and
current prices being paid to Drive for the products. Drive does not hedge these
price risks.
Drive's residual interests in securitizations represent the present value
of the excess cash flows Drive expects to receive over the life of the
underlying sub-prime automobile loans. The sub-prime automobile residual
interests are affected less by prepayment speeds due to the shorter term of the
underlying assets and the fact that the loans are fixed rate, generally at the
highest rate allowable by law.
Additionally the Company has various sources of financing which have been
previously described in "Item 7 -- Management's Discussion and analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
47
In summary, the Company would be negatively impacted by rising interest
rates and declining prices of its sub-prime loans. Rising interest rates would
negatively impact the value of residual interests in securitizations currently
held and costs of borrowings under the warehouse lines and new secured
financings. Declining prices of the Company's sub-prime loans would adversely
affect the levels of gains achieved in the event Drive elects to sell those
loans. The Company has not entered into any instruments to minimize this market
risk of adverse changes in interest rates or declining prices.
The following table is a summary of the interest earning assets and
interest bearing liabilities, as of December 31, 2002, segregated by asset type
as described in the previous paragraphs, with expected maturity or sales dates
as indicated (dollars in thousands):
<Table>
<Caption>
WEIGHTED GREATER
AVERAGE 0-3 3-6 6-9 9-12 THAN 12
RATE MONTHS MONTHS MONTHS MONTHS MONTHS TOTAL
-------- ------ ------ ------ ------ ------- -------
INTEREST BEARING ASSETS
Portfolio assets(1)................. N/A $2,477 $ 647 $1,491 $2,680 $ 2,525 $ 9,820
Loans receivable(2)................. 19.79% 2,264 843 1,074 1,571 11,948 17,700
Equity investments(3)
Acquisition Partnerships.......... N/A 3,689 2,410 1,019 2,062 40,096 49,276
Drive............................. N/A -- -- -- -- 9,066 9,066
------ ------ ------ ------ ------- -------
$8,430 $3,900 $3,584 $6,313 $63,635 $85,862
====== ====== ====== ====== ======= =======
INTEREST BEARING LIABILITIES
Notes payable secured by Portfolio
Assets, loans receivable and
equity in Acquisition
Partnerships(4)................... 8.10% $4,369 $4,684 $4,542 $6,056 $11,507 $31,158
Unsecured notes..................... 6.50% 185 40 -- -- -- 225
Consumer Lending.................... 2.44% -- -- -- -- 16,000 16,000
Company credit facility............. 7.27% 3,436 1,279 1,262 2,204 41,109 49,290
------ ------ ------ ------ ------- -------
$7,990 $6,003 $5,804 $8,260 $68,616 $96,673
====== ====== ====== ====== ======= =======
</Table>
- ---------------
(1) Portfolio assets are shown based on estimated proceeds from disposition,
which could occur much faster or slower than anticipated or as directed.
(2) Loans receivable are shown in the table based upon the expected date of sale
or repayment.
(3) Equity investments are shown based on anticipated equity disbursements,
which could occur much faster or slower than anticipated.
(4) Notes payable mature in the periods indicated. This does not necessarily
indicate when the outstanding balances would be paid. Notes payable secured
by Portfolio Assets fund up to 100% of the corresponding asset class. If the
asset balance declines whether through a sale or a payment from the
borrower, the corresponding liability must be paid.
The Company currently has investments in Mexico and France. In France, the
Company's investments are in the form of equity and represent a significant
portion of the Company's total equity investments. As of December 31, 2002, one
U.S. dollar equaled .95 Euros. A sharp change of the Euro relative to the U.S.
dollar could materially adversely affect the financial position and results of
operations of the Company. The Company has not entered into any instruments to
minimize this market risk of adverse changes in currency rates. A 5% and 10%
incremental depreciation of the Euro would result in an estimated decline in the
valuation of the Company's equity investments in France of approximately $.5
million and $1.0 million, respectively. These amounts are estimates of the
financial impact of a depreciation of the Euro relative to the U.S. dollar.
Consequently, these amounts are not necessarily indicative of the actual effect
of such changes with respect to the Company's consolidated financial position or
results of operations.
48
In Mexico, approximately 95% of the Company's investments in Mexico are
made through U.S. dollar denominated loans to the Partnerships located in
Mexico. The remaining investment is in the form of equity in these same
Partnerships. The loans receivable are required to be repaid in U.S. dollars.
Although the U.S. dollar balance of these loans will not change due to a change
in the Mexican peso, the future estimated cash flows of the underlying assets in
Mexico could become less valuable as a result of a change in the exchange rate
for the Mexican peso, and thus could affect the overall total returns to the
Company on these investments. As of December 31, 2002, one U.S. dollar equaled
10.31 Mexican pesos. A 5% and 10% incremental depreciation of the peso would
result in an estimated decline in the valuation of the Company's total
investments in Mexico of approximately $.7 million and $1.4 million,
respectively. These amounts are estimates of the financial impact of a
depreciation of the Mexican peso relative to the U.S. dollar. Consequently,
these amounts are not necessarily indicative of the actual effect of such
changes with respect to the Company's consolidated financial position or results
of operations.
49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
-----------------------
2002 2001
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
ASSETS
Cash and cash equivalents................................... $ 4,118 $ 5,583
Portfolio Assets, net....................................... 9,820 14,218
Loans receivable from acquisition partnerships held for
investment................................................ 17,700 19,377
Equity investments.......................................... 58,342 55,652
Deferred tax benefit, net................................... 20,101 20,101
Service fees receivable from affiliates..................... 2,235 1,546
Other assets, net........................................... 6,376 5,759
Net assets of discontinued operations....................... 7,764 16,657
-------- --------
Total Assets........................................... $126,456 $138,893
======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable to affiliates............................... $ 95,560 $ 83,957
Notes payable other....................................... 1,113 7,252
Deferred gain from sale of interest in subsidiary......... -- 4,000
Minority interest......................................... 4,052 5,158
Other liabilities......................................... 3,274 2,548
-------- --------
Total Liabilities...................................... 103,999 102,915
Commitments and contingencies (Notes 2, 3, 7, 9, 10, 12 and
14)....................................................... -- --
Redeemable preferred stock, including accumulated dividends
in arrears of $960 and $6,420, respectively (par value
$.01, redemption value of $21 per share; 2,000,000 shares
authorized; shares issued and outstanding: 130,691 and
1,222,901 shares, respectively)........................... 3,705 32,101
Stockholders' equity:
Optional preferred stock (par value $.01 per share;
98,000,000 shares authorized; no shares issued or
outstanding)........................................... -- --
Common stock (par value $.01 per share; 100,000,000 shares
authorized; issued and outstanding: 11,195,076 and
8,376,500 shares, respectively)........................ 112 84
Paid in capital............................................. 98,934 79,645
Accumulated deficit......................................... (82,977) (76,728)
Accumulated other comprehensive income...................... 2,683 876
-------- --------
Total Shareholders' Equity............................. 18,752 3,877
-------- --------
Total Liabilities, Redeemable Preferred Stock and
Stockholders' Equity.................................. $126,456 $138,893
======== ========
</Table>
See accompanying notes to consolidated financial statements.
50
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Servicing fees from affiliates............................ $12,665 $ 9,580 $ 11,442
Gain on resolution of Portfolio Assets.................... 1,138 1,049 3,120
Equity in earnings of investments......................... 8,680 16,694 9,592
Interest income from affiliates........................... 4,060 3,993 1,237
Interest income, other.................................... 1,068 1,892 13,857
Gain on sale of interest in equity investments............ 1,779 3,316 --
Gain on sale of automobile loans.......................... -- -- 2,836
Gain on sale of interest in subsidiary.................... 4,000 -- 8,091
Other income.............................................. 2,598 1,887 2,834
------- ------- --------
Total revenues......................................... 35,988 38,411 53,009
Expenses:
Interest and fees on notes payable to affiliates.......... 6,456 7,838 13,814
Interest and fees on notes payable, other................. 366 939 4,844
Salaries and benefits..................................... 12,609 10,606 16,329
Provision for loan and impairment losses.................. 295 3,277 4,391
Occupancy, data processing, communication and other....... 8,962 11,200 16,910
------- ------- --------
Total expenses......................................... 28,688 33,860 56,288
------- ------- --------
Earnings (loss) from continuing operations before income
taxes, minority interest and accounting change............ 7,300 4,551 (3,279)
Provision for income taxes.................................. (153) (15) (7,414)
------- ------- --------
Earnings (loss) from continuing operations before minority
interest and accounting change............................ 7,147 4,536 (10,693)
Minority interest........................................... (1,204) (2,061) (207)
Cumulative effect of accounting change...................... -- (304) --
------- ------- --------
Earnings (loss) from continuing operations.................. 5,943 2,171 (10,900)
Loss from discontinued operations........................... (9,714) (5,200) (5,000)
------- ------- --------
Net loss.................................................... (3,771) (3,029) (15,900)
Accumulated preferred dividends in arrears.................. (2,478) (2,568) (2,568)
------- ------- --------
Net loss to common stockholders............................. $(6,249) $(5,597) $(18,468)
======= ======= ========
Basic and diluted earnings (loss) per common share are as
follows:
Earnings (loss) from continuing operations before
accounting change...................................... $ 0.40 $ (0.01) $ (1.61)
Discontinued operations................................... (1.14) (0.62) (0.60)
Cumulative effect of accounting change.................... -- (0.04) --
Net loss.................................................. $ (0.74) $ (0.67) $ (2.21)
Weighted average common shares outstanding................ 8,500 8,374 8,351
</Table>
See accompanying notes to consolidated financial statements.
51
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE LOSS
<Table>
<Caption>
ACCUMULATED
OTHER
NUMBER OF COMPREHENSIVE TOTAL
COMMON COMMON PAID IN ACCUMULATED INCOME STOCKHOLDERS'
SHARES STOCK CAPITAL DEFICIT (LOSS) EQUITY
---------- ------ ------- ----------- ------------- -------------
(DOLLARS IN THOUSANDS)
BALANCES, DECEMBER 31, 1999... 8,333,300 $ 83 $79,562 $(52,663) $ (395) $ 26,587
Purchase of shares through
employee stock purchase
plan........................ 35,044 1 72 -- -- 73
Comprehensive loss:
Net loss for 2000........... -- -- -- (15,900) -- (15,900)
Foreign currency items...... -- -- -- -- 286 286
--------
Total comprehensive loss...... (15,614)
--------
Preferred dividends........... -- -- -- (2,568) -- (2,568)
---------- ---- ------- -------- ------ --------
BALANCES, DECEMBER 31, 2000... 8,368,344 84 79,634 (71,131) (109) 8,478
Purchase of shares through
employee stock purchase
plan........................ 8,156 -- 11 -- -- 11
Comprehensive loss:
Net loss for 2001........... -- -- -- (3,029) -- (3,029)
Foreign currency items...... -- -- -- -- (218) (218)
Unrealized net gain on
securitization........... -- -- -- -- 1,203 1,203
--------
Total comprehensive loss...... (2,044)
--------
Preferred dividends........... -- -- -- (2,568) -- (2,568)
---------- ---- ------- -------- ------ --------
BALANCES, DECEMBER 31, 2001... 8,376,500 84 79,645 (76,728) 876 3,877
Issuance of common stock in
exchange for redeemable
preferred stock............. 2,417,388 24 18,891 -- -- 18,915
Issuance of common stock to
acquire minority interest in
subsidiary.................. 400,000 4 396 -- -- 400
Purchase of shares through
employee stock purchase
plan........................ 1,188 -- 2 -- -- 2
Comprehensive loss:
Net loss for 2002........... -- -- -- (3,771) -- (3,771)
Foreign currency items...... -- -- -- -- 1,782 1,782
Unrealized net gain on
securitization........... -- -- -- -- 25 25
--------
Total comprehensive loss...... (1,964)
--------
Preferred dividends........... -- -- -- (2,478) -- (2,478)
---------- ---- ------- -------- ------ --------
BALANCES, DECEMBER 31, 2002... 11,195,076 $112 $98,934 $(82,977) $2,683 $ 18,752
========== ==== ======= ======== ====== ========
</Table>
See accompanying notes to consolidated financial statements.
52
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
-------- -------- ---------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net loss.................................................. $ (3,771) $ (3,029) $ (15,900)
Adjustments to reconcile net loss to net cash used in
operating activities:
Loss from discontinued operations....................... 9,714 5,200 5,000
Proceeds from resolution of Portfolio Assets............ 4,210 8,801 14,398
Gain on resolution of Portfolio Assets.................. (1,138) (1,049) (3,120)
Purchase of Portfolio Assets and loans receivable,
net................................................... (4,412) (10,606) (25,914)
Origination of automobile receivables, net of purchase
discount.............................................. -- -- (106,311)
Provision for loan and impairment losses................ 295 3,277 4,391
Equity in earnings of investments....................... (8,680) (16,694) (9,592)
Proceeds from performing Portfolio Assets and loans
receivable, net....................................... 5,675 10,328 54,172
Capitalized interest and costs on Portfolio Assets and
loans receivable...................................... (15) (509) (247)
Decrease in net deferred tax asset...................... -- -- 7,000
Depreciation and amortization........................... 721 899 1,994
(Increase) decrease in service fees receivable from
affiliate............................................. (689) (282) 96
(Increase) decrease in other assets..................... (2,528) 1,713 (1,070)
Gain on sale of interest in equity investments or
subsidiary............................................ (5,779) (3,316) (8,091)
Gain on early debt extinguishment....................... (899) -- (833)
Increase (decrease) in other liabilities................ 1,790 3,228 (871)
-------- -------- ---------
Net cash used in operating activities............... (5,506) (2,039) (84,898)
-------- -------- ---------
Cash flows from investing activities:
Proceeds from sale of interest in equity investments or
subsidiary.............................................. 3,373 7,567 15,000
Proceeds on notes receivable from sale of interest in
subsidiary.............................................. -- -- 60,000
Property and equipment, net............................... (412) (983) 210
Contributions to Acquisition Partnerships and Servicing
entities................................................ (14,011) (14,088) (6,715)
Distributions from Acquisition Partnerships and Servicing
entities................................................ 23,440 11,259 10,313
-------- -------- ---------
Net cash provided by investing activities........... 12,390 3,755 78,808
-------- -------- ---------
Cash flows from financing activities:
Borrowings under notes payable to affiliates.............. 45,189 30,700 48,465
Borrowings under notes payable -- other................... 437 170 99,845
Payments of notes payable to affiliates................... (35,519) (27,415) (93,454)
Payments of notes payable -- other........................ (5,678) (6,229) (46,741)
Proceeds from issuance of common stock.................... 2 11 73
Payments for tender of redeemable preferred stock......... (10,456) -- --
Payments for closing costs of recapitalization............ (1,503) -- --
-------- -------- ---------
Net cash provided by (used in) financing
activities........................................ (7,528) (2,763) 8,188
-------- -------- ---------
Net cash provided by (used in) continuing operations...... $ (644) $ (1,047) $ 2,098
Net cash used by discontinued operations.................. (821) (1,413) (5,318)
-------- -------- ---------
Net increase decrease in cash and cash equivalents.......... $ (1,465) $ (2,460) $ (3,220)
Cash and cash equivalents, beginning of year................ 5,583 8,043 11,263
-------- -------- ---------
Cash and cash equivalents, end of year...................... $ 4,118 $ 5,583 $ 8,043
======== ======== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest................................................ $ 5,580 $ 7,700 $ 15,932
======== ======== =========
Income taxes............................................ $ 46 $ 13 $ 637
======== ======== =========
Non-cash operating activities:
Equity method losses recorded to reduce loans and
interest receivable on Mexican partnerships (note
5).................................................... $ 3,025 $ 997 $ --
======== ======== =========
Non-cash investing activities:
Residual interests received as a result of sales of
loans through securitizations......................... $ -- $ -- $ 5,713
======== ======== =========
Non-cash financing activities:
Dividends accumulated and not paid on redeemable
preferred stock....................................... $ 2,478 $ 2,568 $ 2,568
======== ======== =========
Balance of redeemable preferred stock and associated
dividends relinquished in recapitalization
transaction........................................... $ 30,874 $ -- $ --
======== ======== =========
Issuance of note payable -- affiliate to purchase
minority interest in FirstCity Holdings, Inc. ........ $ 1,715 $ -- $ --
======== ======== =========
Issuance of common stock to purchase minority interest
in FirstCity Holdings, Inc at fair value.............. $ 400 $ -- $ --
======== ======== =========
</Table>
See accompanying notes to consolidated financial statements.
53
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001 AND 2000
(DOLLARS IN THOUSANDS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
On July 3, 1995, FirstCity Financial Corporation (the "Company" or
"FirstCity") was formed by the merger of J-Hawk Corporation and First City
Bancorporation of Texas, Inc. (the "Merger"). The Company's merger with Harbor
Financial Group, Inc. ("Mortgage Corp.") on July 1, 1997 was accounted for as a
pooling of interests.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant estimates include the
estimation of future collections on purchased portfolio assets used in the
calculation of net gain on resolution of portfolio assets, interest rate
environments, valuation of the deferred tax asset, and prepayment speeds and
collectibility of loans held in inventory, securitization trusts and for
investment. Actual results could differ materially from those estimates.
(b) DESCRIPTION OF BUSINESS
The Company is a financial services company with offices throughout the
United States and Mexico, with a presence in France. At December 31, 2002, the
Company was engaged in two principal reportable segments: (i) portfolio asset
acquisition and resolution and (ii) consumer lending through the Company's
minority investment in Drive Financial Services LP ("Drive"). Refer to Note 8
for operational information related to each of these principal segments.
Effective in the third quarter of 1999, the Company adopted formal plans to
discontinue its mortgage banking operations (refer to Note 3), which had
previously also been reported as a segment. Activities related to the mortgage
banking operations have been reclassified in the accompanying consolidated
financial statements to discontinued operations.
In December 2002, FirstCity completed a recapitalization in which holders
of redeemable preferred stock, par value $.01 per share ("New Preferred Stock")
exchanged 1,092,210 shares of New Preferred Stock for 2,417,388 shares of common
stock and $10.5 million. As a result, common equity was increased by $18.9
million. FirstCity also recorded a $4 million gain from the release of its
guaranty of Drive's indebtedness to BoS(USA). BoS(USA)'s warrant to purchase
1,975,000 shares of non-voting common stock was cancelled. FirstCity also
acquired the minority interest in FirstCity Holdings held by Terry R. DeWitt, G.
Stephen Fillip and James C. Holmes, each of whom are Senior Vice Presidents of
FirstCity by issuing 400,000 shares of common stock of the Company and a note
payable, to be periodically redeemed by the Company for an aggregate of up to
$3.2 million in accordance with certain cash collections from servicing income
from Portfolio asset acquisitions in Mexico.
In the third quarter of 2000, FirstCity Consumer Lending Corporation
("Consumer Corp."), a wholly-owned subsidiary of FirstCity, completed a sale of
a 49% equity interest in its automobile finance operation to IFA Drive GP
Holdings LLC ("IFA-GP") and IFA Drive LP Holdings LLC ("IFA-LP"), wholly-owned
subsidiaries of BoS(USA), Inc. (formerly known as IFA Incorporated)
("BoS(USA)"), a wholly-owned subsidiary of Bank of Scotland (together with
BoS(USA), the "Senior Lenders"), for a purchase price of $15 million cash
pursuant to the terms of a Securities Purchase Agreement dated as of August 18,
2000 (the "Securities Purchase Agreement"), by and among the Company, Consumer
Corp., FirstCity Funding LP ("Funding LP"), and FirstCity Funding GP Corp.
("Funding GP"), IFA-GP and IFA-LP (see Note 2 for further discussion). As a
result of this sale, the Company no longer consolidates the financial statements
of its automobile finance operation since August 1, 2000, but instead records
its investment under the equity method
54
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of accounting. Also, in relation to the sale, the Senior Lenders forgave a loan
fee in the amount of $2.5 million, which resulted in accrued loan fees of $.8
million owed to the senior lender being recorded as other income in the
consolidated financial statements. This amount from 2000 was originally recorded
as extraordinary gain but was reclassified to other income due to the early
adoption of SFAS 145 (see note 1(r)).
In the portfolio asset acquisition and resolution business the Company
acquires and resolves portfolios of performing and nonperforming commercial and
consumer loans and other assets (collectively, "Portfolio Assets" or
"Portfolios"), 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 single assets. The Portfolio Assets are generally aggregated,
including loans of varying qualities that are secured or unsecured by diverse
collateral types and foreclosed properties. 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 either on real estate, business assets or other collateral cash flow.
Portfolio Assets are acquired on behalf of the Company or its wholly owned
subsidiaries, and on behalf of legally independent domestic and foreign
partnerships and other entities ("Acquisition Partnerships" or "WAMCO
Partnerships") in which a partially owned affiliate of the Company is the
general partner and the Company and other investors (including but not limited
to Cargill) are limited partners.
The Company services, manages and ultimately resolves or otherwise disposes
of substantially all of the assets it, its Acquisition Partnerships, or other
related entities acquire. The Company services all such assets until they are
collected or sold and normally does not manage assets for non-affiliated third
parties.
(c) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
all majority owned subsidiaries of the Company. All significant intercompany
transactions and balances have been eliminated in consolidation. Investments in
20 to 50 percent owned affiliates are accounted for on the equity method since
the Company has the ability to exercise significant influence over operating and
financial policies of those affiliates. For domestic Acquisition Partnerships,
the Company owns a limited partner interest and generally shares in a general
partner interest. Regarding the foreign investments, the Company participates as
a limited partner only. In all cases, the Company's direct and indirect equity
interest never exceeds 50%. The following is a listing of the 20 to 50 percent
owned affiliates accounted for on the equity method and held at December 31,
2002:
<Table>
<Caption>
PERCENTAGE
AFFILIATE OWNERSHIP
- --------- ----------
BIDMEX 4, LLC............................................... 20.00
BIDMEX 5, LLC............................................... 20.00
UHR Limited................................................. 20.00
Namex, LLC.................................................. 22.22
FCS Fischer, Ltd............................................ 24.70
NEVVS Limited............................................... 25.00
Drive GP LLC................................................ 31.00
Compagnie Transatlantique de Portefeuilles.................. 33.33
MinnTex Investment Partners LP.............................. 33.00
FCS Fischer GP, Corp........................................ 33.33
Drive Financial Services LP................................. 38.71
First B Realty, L.P......................................... 49.00
WAMCO III, Ltd.............................................. 49.00
</Table>
55
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
PERCENTAGE
AFFILIATE OWNERSHIP
- --------- ----------
WAMCO IX, Ltd............................................... 49.00
WAMCO XXIV, Ltd............................................. 49.00
WAMCO XXV, Ltd.............................................. 49.00
WAMCO XXVIII, Ltd........................................... 49.50
WAMCO XXX, Ltd.............................................. 49.50
FCS Creamer Ltd............................................. 49.75
FCS Wildhorse, Ltd.......................................... 49.75
FCS Wood, Ltd............................................... 49.75
WAMCO XXVI, Ltd............................................. 49.75
Calibat Fund, LLC........................................... 50.00
FCS Creamer GP, Corp........................................ 50.00
FCS Wildhorse GP Corp....................................... 50.00
FCS Wood GP, Corp........................................... 50.00
FCS Wood GP, Corp........................................... 50.00
MinnTex GP Corp. ........................................... 50.00
WAMCO III of Texas, Inc. ................................... 50.00
WAMCO V of Texas, Inc. ..................................... 50.00
WAMCO IX of Texas, Inc. .................................... 50.00
WAMCO XVII of Texas, Inc. .................................. 50.00
WAMCO XXIV of Texas, Inc. .................................. 50.00
WAMCO XXV of Texas, Inc. ................................... 50.00
WAMCO XXVI of Texas, Inc. .................................. 50.00
WAMCO XXVII of Texas, Inc. ................................. 50.00
WAMCO XXVIII of Texas, Inc. ................................ 50.00
WAMCO XXIX of Texas, Inc. .................................. 50.00
WAMCO XXX of Texas, Inc. ................................... 50.00
</Table>
Investments in less than 20 percent owned partnerships are also accounted
for on the equity method. FirstCity has the ability to exercise significant
influence over operating and financial policies of these entities, despite its
comparatively smaller equity percentage, due primarily to its active
participation in the policy making process as well as its involvement in the
day-to-day management activities. These partnerships are formed to share in the
risks and rewards in developing new markets as well as to pool resources.
Following is a
56
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
listing of the less than 20 percent owned partnerships accounted for on the
equity method and held at December 31, 2002:
<Table>
<Caption>
PERCENTAGE
AFFILIATE OWNERSHIP
- --------- ----------
BIDMEX, LLC................................................. 3.21
WAMCO XXVII, Ltd............................................ 4.00
BIDMEX II, LLC.............................................. 4.12
WAMCO XXIX, Ltd............................................. 4.50
BIDMEX 6, LLC............................................... 10.00
WHBE Limited................................................ 10.00
BIDMEX 3, LLC............................................... 10.02
ResMex, LLC................................................. 11.12
FC Properties, Ltd.......................................... 14.50
</Table>
The Company has a ten percent ownership in a French servicing corporation,
MCS et Associes, S.A., which is accounted for on the equity method. FirstCity
has the ability to exercise significant influence over operating and financial
policies of this entity, despite its comparatively smaller equity percentage,
due primarily to its active participation in the policy making process as well
as its involvement in the day-to-day management activities.
During 2002, the Company sold all of its equity interest in the following
entities:
<Table>
<Caption>
PERCENTAGE
AFFILIATE OWNERSHIP
- --------- ----------
Credit Finance Corporation Limited.......................... 10.00
Miromesnil Limited.......................................... 33.30
Societe Immobilere Lincoln, S.A. ........................... 10.00
CATX Limited................................................ 25.00
Transalp Limited............................................ 25.00
Finin Limited............................................... 33.30
Mirom Limited............................................... 10.00
</Table>
The Company also has loans receivable from certain Acquisition Partnerships
(see note 1(f)). In situations where the Company is not required to advance
additional funds to the Acquisition Partnership and previous losses have reduced
the equity investment to zero, the Company continues to report its share of
equity method losses in its consolidated statements of operations to the extent
of and as an adjustment to the adjusted basis of the related loan receivable in
compliance with EITF 98-13, Accounting by an Equity Method Investor for Investee
losses When the Investor Has Loans to and Investments in Other Securities of the
Investee ("EITF 98-13") (See Note 5).
(d) CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid debt instruments with original maturities of three
months or less to be cash equivalents. The Company has maintained balances in
various operating and money market accounts in excess of federally insured
limits.
(e) PORTFOLIO ASSETS
Portfolio Assets are held for sale and reflected in the accompanying
consolidated financial statements as non-performing Portfolio Assets, performing
Portfolio Assets or real estate Portfolios. Such designation is
57
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
made at the acquisition of the pool and does not change even though the actual
mix of the loans may change. The following is a description of each
classification and the related accounting policy accorded to each Portfolio
type:
Non-Performing Portfolio Assets
Non-performing Portfolio Assets consist primarily of distressed loans and
loan related assets, such as foreclosed upon collateral. Portfolio Assets are
designated as non-performing unless substantially all of the loans in the
Portfolio are being repaid in accordance with the contractual terms of the
underlying loan agreements at date of acquisition. Such Portfolios are acquired
on the basis of an evaluation by the Company of the timing and amount of cash
flow expected to be derived from borrower payments or other resolution of the
underlying collateral securing the loan.
All non-performing Portfolio Assets are purchased at substantial discounts
from their outstanding legal principal amount, the total of the aggregate of
expected future sales prices and the total payments to be received from
obligors. Subsequent to acquisition, the amortized cost of non-performing
Portfolio Assets is evaluated for impairment on a quarterly basis. The
evaluation of impairment is determined based on the review of the estimated
future cash receipts, which represents the net realizable value of the
non-performing pool. Once it is determined that there is impairment, a valuation
allowance is established for any impairment identified through provisions
charged to operations in the period the impairment is identified. The Company
recorded an allowance for impairment of $.1 million and $1.6 million in 2002 and
2001, respectively. No allowance was required in 2000.
Net gain on resolution of non-performing Portfolio Assets is recognized as
income to the extent that proceeds collected exceed a pro rata portion of
allocated cost from the pool. Cost allocation is based on a proration of actual
proceeds divided by total estimated proceeds of the pool. No interest income is
recognized separately on non-performing Portfolio Assets. All proceeds, of
whatever type, are included in proceeds from resolution of Portfolio Assets in
determining the gain on resolution of such assets. Accounting for Portfolios is
on a pool basis as opposed to an individual asset-by-asset basis.
Performing Portfolio Assets
Performing Portfolio Assets consist primarily of Portfolios of consumer and
commercial loans acquired at a discount from the aggregate amount of the
borrowers' obligation. Portfolios are classified as performing if substantially
all of the loans in the Portfolio are being repaid in accordance with the
contractual terms of the underlying loan agreements at date of acquisition.
Performing Portfolio Assets are carried at the unpaid principal balance of
the underlying loans, net of acquisition discounts. Interest is accrued when
earned in accordance with the contractual terms of the loans. The accrual of
interest is discontinued once a loan becomes past due 90 days or more.
Acquisition discounts for the Portfolio as a whole are accreted as an adjustment
to yield over the estimated life of the Portfolio. Accounting for these
Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.
Gains are recognized on the performing Portfolio Assets when sufficient
funds are received to fully satisfy the obligation on loans included in the
pool, either from funds from the borrower or sale of the loan. The gain
recognized represents the difference between the proceeds received and the
allocated carrying value of the individual loan in the pool.
Impairment on each Portfolio is measured based on the present value of the
expected future cash flows in the aggregate discounted at the loans' risk
adjusted rates, which approximates the effective interest rates, or the fair
value of the collateral, less estimated selling costs, if any loans are
collateral dependent and foreclosure is probable. The Company recorded an
allowance for impairment of $.6 million in 2001. No allowance was required in
either 2002 or 2000.
58
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Real Estate Portfolios
Real estate Portfolios consist of real estate acquired from a variety of
sellers. Such Portfolios are carried at the lower of cost or fair value less
estimated costs to sell. Costs relating to the development and improvement of
real estate for its intended use are capitalized, whereas those relating to
holding assets are charged to expense. Income or loss is recognized upon the
disposal of the real estate. Rental income, net of expenses, on real estate
Portfolios is recognized when received. Accounting for the Portfolios is on an
individual asset-by-asset basis as opposed to a pool basis. Subsequent to
acquisition, the amortized cost of a real estate Portfolio is evaluated for
impairment on a quarterly basis. The evaluation of impairment is determined
based on the review of the estimated future cash receipts, which represents the
net realizable value of the real estate Portfolio. A valuation allowance is
established for any impairment identified through provisions charged to
operations in the period the impairment is identified. The Company recorded an
allowance for impairment of $.2 million in 2002, $1.1 million in 2001 and $2.0
million in 2000.
(f) LOANS RECEIVABLE
Loans receivable consist primarily of loans made to Acquisition
Partnerships located in Mexico at fixed rates ranging between 19% and 20%, the
repayment of which is generally dependent upon future cash flows and
distributions made from those Acquisition Partnerships. Interest is accrued when
earned in accordance with the contractual terms of the loans. If there is not
sufficient cash flow to pay interest, default provisions in the loan agreement
increase the interest rate to between 23% and 30% until the interest owed in
arrears is paid in full. The evaluation for impairment is determined based on
the review of the estimated future cash receipts of the underlying nonperforming
Portfolio Assets of each related Acquisition Partnership. The Company recorded
no allowance for impairment in 2002, 2001 and 2000.
(g) PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation
and are included in other assets. Depreciation is provided using straight-line
method over the estimated useful lives of the assets.
(h) INTANGIBLES
Intangible assets represent the excess of purchase price over fair value of
assets acquired in connection with purchase transactions (goodwill) as well as
the purchase price of future service fee revenues and are included in other
assets. Goodwill and intangible assets with indefinite useful lives are tested
for impairment in accordance with the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets
("SFAS 142"). See note 1(r).
(i) REVENUE RECOGNITION ON SERVICE FEES
The Company has no capitalized servicing rights because servicing is not
contractually separated from the underlying assets by sale or securitization of
the assets with servicing retained or separate purchase or assumption of the
servicing. The Company services all of the Portfolio Assets owned for its own
account, all of the Portfolio Assets owned by the Acquisition Partnerships and,
to a very limited extent, certain Portfolio Assets owned by third parties. In
connection with the Acquisition Partnerships in the United States, the Company
generally earns a servicing fee, which is a percentage of gross cash collections
generated rather than a management fee based on the Face Value of the asset
being serviced. The rate of servicing fee charged is generally a function of the
average Face Value of the assets within each pool being serviced (the larger the
average Face Value of the assets in a Portfolio, the lower the fee percentage
within the prescribed range), the type of assets and the level of servicing
required on each assets. For the Mexican Acquisition Partnerships, the Company
earns a servicing fee based on costs of servicing plus a profit margin. The
Acquisition Partnerships in
59
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
France are serviced by MCS et Associes, S.A., in which the Company maintains a
10% equity interest. In all cases, service fees are recognized as they are
earned in accordance with the servicing agreements.
(j) REVENUE RECOGNITION ON CONTINGENT FEES
The Company currently has certain servicing contracts with its Mexican
investment entities whereby the Company is entitled to additional compensation
for servicing once a specified return to the investors has been achieved. The
Company will not recognize any revenue related to these contracts until the
investors have received the required level of returns specified in the contracts
and the Mexican investment entity has received cash in an amount greater than
the required returns. There is no guarantee that the required level of returns
to the investors will be achieved or that any additional compensation to the
Company related to the contracts will be realized. The amount of these fees
recognized by the Company was $604 in 2002, $409 in 2001 and $763 in 2000.
The Mexican investment entities, on the other hand, record an accrued
expense for these contingent fees provided that these fees are probable and
reasonably estimable.
(k) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income ("SFAS 130"), established standards for reporting and
displaying comprehensive income (loss) and its components in a financial
statement that is displayed with the same prominence as other financial
statements. SFAS 130 also requires the accumulated balance of other
comprehensive income (loss) to be displayed separately in the equity section of
the consolidated balance sheet. The Company's other comprehensive income (loss)
consists of foreign currency transactions and unrealized gains on securitization
transactions.
(l) FOREIGN CURRENCY TRANSLATIONS
The Company has determined that the local currency is the functional
currency for its operations outside the United States (primarily France and
Mexico). Assets and liabilities denominated in foreign functional currencies are
translated at the exchange rate as of the balance sheet date. Translation
adjustments are recorded as a separate component of stockholders' equity in
accumulated other comprehensive income (loss). Revenues, costs and expenses
denominated in foreign currencies are translated at the weighted average
exchange rate for the period. An analysis of the changes in the cumulative
adjustments during 2002, 2001 and 2000 follows (dollars in thousands):
<Table>
BALANCE, DECEMBER 31, 1999.................................. $ (395)
Aggregate adjustment for the period resulting from
translation adjustments................................ 286
------
BALANCE, DECEMBER 31, 2000.................................. (109)
Aggregate adjustment for the period resulting from
translation adjustments................................ (218)
------
BALANCE, DECEMBER 31, 2001.................................. (327)
Aggregate adjustment for the period resulting from
translation adjustments................................ 1,782
------
BALANCE, DECEMBER 31, 2002.................................. $1,455
======
</Table>
Increases or decreases in expected functional currency cash flows upon
settlement of a foreign currency transaction are recorded as foreign currency
transaction gains or losses and included in the results of operations in the
period in which the exchange rate changes. Aggregate foreign currency
transaction gains (losses) included in the consolidated statements of operations
for 2002, 2001 and 2000 were $143, $(331), and $(765), respectively.
60
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(m) UNREALIZED GAINS ON SECURITIZATION TRANSACTIONS
The Company has equity investments in certain entities which have retained
unrated interests in securitization transactions, which represent the present
value of the right to the excess cash flow generated by the securitized
contracts. The residual certificates are accounted for under Statement of
Financial Accounting Standards No. 115, Accounting for Certain Investments in
Debt and Equity Securities. Because such assets can be contractually prepaid or
otherwise settled in such a way that the holder would not receive all of the
recorded investment, the assets are classified as available-for-sale investments
and are carried at estimated fair value with any accompanying increases or
decreases in estimated fair value being recorded as unrealized gains or losses
in other comprehensive income (loss) in the accompanying statements of
stockholders' equity and comprehensive loss. The determination of fair value is
based on the present value of the anticipated excess cash flows utilizing the
valuation assumptions discussed above. The carrying value of each retained
certificate is assessed for impairment in accordance with the provisions of EITF
99-20 as discussed in note 1(r). There can be no assurance that the estimates
used to determine the fair value of the residual certificates will remain
appropriate for the life of each asset and it is reasonably possible that
circumstances could change in future periods which could result in a material
change in the estimates used to prepare the accompanying consolidated financial
statements. If actual prepayments or credit losses exceed the current estimates,
other than temporary impairment may be required to be recognized.
An analysis of the changes in the unrealized net gains on securitization
transactions during 2002 and 2001 follows (dollars in thousands). There were no
unrealized gains or losses on securitization transactions in 2000.
<Table>
BALANCE, DECEMBER 31, 2000.................................. $ --
Aggregate adjustment for the period resulting from
unrealized net gains on securitizations................ 1,203
------
BALANCE, DECEMBER 31, 2001.................................. 1,203
Aggregate adjustment for the period resulting from
unrealized net gains on securitizations................ 25
------
BALANCE, DECEMBER 31, 2002.................................. $1,228
======
</Table>
(n) INCOME TAXES
The Company files a consolidated federal income tax return with its 80% or
greater owned subsidiaries. The Company records all of the allocated federal
income tax provision of the consolidated group in the parent corporation.
Deferred tax assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts and the tax basis of existing assets and liabilities and
operating loss and tax credit carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effects of future changes in tax laws or changes in
tax rates are not anticipated. The measurement of deferred tax assets, if any,
is reduced by the amount of any tax benefits that, based on available evidence,
are not expected to be realized.
(o) NET LOSS PER COMMON SHARE
Basic net loss per common share calculations are based upon the weighted
average number of common shares outstanding. Losses included in the loss per
common share calculation are reduced by minority interest and increased for
preferred stock dividends. Potentially dilutive common share equivalents include
warrants and stock options in the diluted loss per common share calculations.
61
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The effects of any common stock equivalents are antidilutive for 2002, 2001
and 2000 due to the net loss for the periods; therefore, diluted loss per common
share is reported the same as basic loss per common share.
(p) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company assesses the impairment of long-lived assets and certain
identifiable intangibles whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell (see note
1(r)).
(q) STOCK-BASED COMPENSATION
At December 31, 2002, the Company has two stock-based employee compensation
plans, which are described more fully in Note 9. The Company accounts for those
plans under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in the consolidated
statements of operations, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. As required by SFAS 148 as discussed under "Effects of New
Accounting Standards", the following table illustrates the effect on net loss
and loss per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
------- ------- --------
Net loss to common stockholders, as reported........... $(6,249) $(5,597) $(18,468)
Add: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects................... (147) (168) (668)
------- ------- --------
Pro forma net loss to common stockholders.............. $(6,396) $(5,765) $(19,136)
======= ======= ========
Net loss per common share:
Basic -- as reported................................... $ (0.74) $ (0.67) $ (2.21)
======= ======= ========
Basic -- pro forma..................................... $ (0.75) $ (0.69) $ (2.29)
======= ======= ========
Diluted -- as reported................................. $ (0.74) $ (0.67) $ (2.21)
======= ======= ========
Diluted -- pro forma................................... $ (0.75) $ (0.69) $ (2.29)
======= ======= ========
</Table>
The per share weighted-average fair value of stock options granted during
2001 and 2000 was $0.99 and $1.84, respectively, on the grant date using the
Black-Scholes option pricing model with the following assumptions: $0 expected
dividend yield, risk-free interest rate of 6.0%, expected volatility of 30%, and
an expected life of 10 years.
(r) EFFECT OF NEW ACCOUNTING STANDARDS
In March 2001, the Company adopted the provisions of EITF 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets ("EITF 99-20"), which
requires that other-than-temporary impairments in beneficial interests be
written down to fair value
62
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
with the resulting charge being included in operations. The implementation of
EITF 99-20 required Drive to record a cumulative effect of accounting change for
other-than-temporary impairments on retained beneficial interests in certain
securitized assets, which had previously been recorded as unrealized losses. As
a result, in the second quarter of 2001, the Company recognized a charge for the
cumulative effect of a change in accounting principle of $.3 million relating to
the Company's share of Drive's cumulative effect because the Company believed it
to be material to the consolidated results of operations.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") 142, Goodwill and Other Intangible Assets ("SFAS 142") and
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
("SFAS 144").
SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized but instead be tested for impairment at
least annually in accordance with the provisions of SFAS 142. SFAS 142 requires
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with the SFAS 121, Accounting for the
Impairment of Long-Lived Assets to Be Disposed Of ("SFAS 121") and SFAS 144
after it superceded SFAS 121. The adoption of SFAS 142 did not have a material
impact on the Company's consolidated financial statements, as unamortized
goodwill at December 31, 2001 was $.1 million.
SFAS 144 addresses the accounting model for long-lived assets to be
disposed of by sale and resulting implementation issues. This statement requires
that those long-lived assets be measured at the lower of carrying amount or fair
value less cost to sell, whether reported in continuing operations or in
discontinued operations. It also broadens the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. Additionally,
discontinued operations that are not disposed of within one year must be
reclassified as assets held and used unless the discontinued segment will be (1)
abandoned through the liquidation or run-off of operations because the entity is
obligated by regulation or contract to provide services after it ceases
accepting all new business and (2) is being reported as a discontinued operation
when SFAS 144 is initially applied. The only assets remaining from discontinued
operations are the investment securities resulting from the retention of
residual interests in securitization transactions. Since the Company is
contractually obligated to service the securitized assets, the adoption of SFAS
144 had no impact on the Company's consolidated financial statements.
On April 1, 2002, the Company elected early adoption of SFAS No. 145,
Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections ("SFAS 145"). SFAS 145 updates, clarifies and
simplifies existing accounting pronouncements. As it relates to FirstCity, SFAS
145 eliminates the extraordinary gain classification on early debt
extinguishments. Instead, the gains associated with the early extinguishment of
debt have been recorded in other income in the consolidated statements of
operations. The result of this adoption did not modify or adjust net loss for
any period and does not impact the Company's compliance with various debt
covenants. The effect of SFAS 145 resulted in the extinguishment of debt of $.7
million in 2002 being included in other income in the consolidated statements of
operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure, an Amendment of FASB Statement No.
123 ("SFAS 148"). SFAS 148 amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition to SFAS
123's fair value method of accounting for stock-based employee compensation.
SFAS 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion
No. 28, Interim Financial Reporting, to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income or loss
and earnings (loss) per share in annual and interim consolidated financial
statements. SFAS 148 does not amend SFAS 123 to require companies to account for
stock-based employee compensation using the fair value
63
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
method, regardless of whether they account for that compensation using the fair
value method of SFAS 123 or the intrinsic value method of APB Opinion No. 25. As
allowed by SFAS 123, the Company has elected to continue to utilize the
accounting method prescribed by APB Opinion No. 25 and has adopted the
disclosure requirements of SFAS 148 as of December 31, 2002.
In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No.
5, 57 and 107 and Rescission of FASB Interpretation No. 34 ("FIN 45"). FIN 45
requires that a liability be recorded in the guarantor's balance sheet upon
issuance of a guarantee. In addition, FIN 45 requires disclosures about the
guarantees that an entity has issued, including a reconciliation of changes in
the entity's product warranty liabilities. The initial recognition and initial
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the
guarantor's fiscal year-end. The disclosure requirements of FIN 45 are effective
for financial statements of interim or annual periods ending after December 15,
2002. The Company believes that the adoption of FIN 45 will have no material
impact on its consolidated financial statements and applicable disclosure
requirements are included in note 14.
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51 ("FIN 46"). FIN
46 requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective
immediately for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. FIN 46 also requires certain
disclosures in financial statements issued after January 31, 2003 if it is
reasonably possible that the entity will consolidate or disclose information
about variable interest entities when FIN 46 becomes effective. Although
management is still evaluating the impact of FIN 46, the adoption is not
expected to have a material effect. Presently the Company has identified one
Acquisition Partnership, which may qualify for consolidation in accordance with
FIN 46. This Acquisition Partnership holds real estate that is being developed
for its intended use. As of December 31, 2002, the total assets that would be
consolidated into the Company's consolidated financial statements were $1.4
million. The maximum loss exposure to the Company related to this Acquisition
Partnership is estimated to be $.3 million as of December 31, 2002.
(s) RECLASSIFICATIONS
Certain amounts in the financial statements for prior years have been
reclassified to conform with current financial statement presentation.
(2) RESTRUCTURE, LIQUIDITY AND CAPITAL RESOURCES
Generally, the Company requires liquidity to fund its operations, working
capital, payment of debt, equity for acquisition of Portfolio Assets,
investments in and advances to the Acquisition Partnerships, retirement of and
dividends on preferred stock, and other investments by the Company. The
potential sources of liquidity are funds generated from operations, equity
distributions from the Acquisition Partnerships, interest and principal payments
on subordinated intercompany debt and dividends from the Company's subsidiaries,
short-term borrowings from revolving lines of credit, proceeds from equity
market transactions, securitization and other structured finance transactions
and other special purpose short-term borrowings.
In December 2002, FirstCity completed a recapitalization in which holders
of New Preferred Stock exchanged 1,092,210 shares of New Preferred Stock for
2,417,388 shares of common stock and $10.5 million. As a result, common equity
was increased by $18.9 million. FirstCity also recorded a $4 million gain from
the
64
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
release of its guaranty of Drive's indebtedness to BoS(USA). BoS(USA)'s warrant
to purchase 1,975,000 shares of non-voting common stock was cancelled. FirstCity
also acquired the minority interest in FirstCity Holdings held by Terry R.
DeWitt, G. Stephen Fillip and James C. Holmes, each of whom are Senior Vice
Presidents of FirstCity by issuing 400,000 shares of common stock of the Company
and a note payable, to be periodically redeemed by the Company for an aggregate
of up to $3.2 million in accordance with certain cash collections from servicing
income from Portfolio asset acquisitions in Mexico.
As a part of the recapitalization, BoS(USA) provided a non-recourse loan in
the amount of $16 million to FirstCity which was used to pay the cash portion of
the exchange offer to the holders of the New Preferred Stock, to pay expenses of
the exchange offer and recapitalization, and to reduce FirstCity's debt to the
Senior Lenders. The $16 million loan is secured by a 20% interest in Drive
(64.51% of FirstCity's remaining 31% interest in Drive) and other assets of
Consumer Corp. to allow BoS(USA) to realize upon the 20% Drive interest in the
event of default by FirstCity. In connection with the $16 million loan,
FirstCity is obligated to pay an arrangement fee to BoS(USA) equal to 20% of all
amounts received by FirstCity in excess of $16 million from any sale or other
disposition of FirstCity's 20% interest in Drive and all dividends and other
distributions paid by Drive or its general partner on FirstCity's 20% interest
in Drive.
In connection with the recapitalization, the Senior Lenders refinanced the
remainder of the Company's debt facilities. The Senior Lenders also provided new
financing to FirstCity, with a total commitment of up to $59 million, consisting
of (a) a $5 million revolving credit loan and (b) an acquisition term loan in an
amount up to $54 million. The aggregate amount of outstanding loans under the
total commitment by the Senior Lenders for the refinancing and the new financing
at any time may not exceed $77 million.
On November 4, 2002, the NASDAQ Stock Market, Inc. ("Nasdaq") notified the
Company that its common stock had failed to meet the listing requirements for
the Nasdaq National Market because the common stock had closed below the minimum
bid price of $1.00 per share for thirty (30) consecutive trading days.
Accordingly, Nasdaq provided the Company ninety (90) calendar days, or until
February 2, 2003, to regain compliance. On November 21, 2002, Nasdaq notified
the Company that it had regained compliance with this requirement and the matter
was closed.
On November 21, 2002, Nasdaq notified the Company that it did not comply
with the minimum $10 million stockholders' equity requirement for continued
listing on the Nasdaq National Market. After the recapitalization, Nasdaq
notified the Company on January 2, 2003 that it complied with this rule and the
matter was closed.
As stated in Note 1, in the third quarter of 2000, Consumer Corp. completed
the sale of a 49% equity interest in its automobile finance operation to IFA-GP
and IFA-LP. The transaction generated $75 million in cash as described below and
resulted in a gain of $12.1 million ($4 million was deferred and recognized in
the December 2002 recapitalization). The new entity formed to facilitate the
transaction is Drive Financial Services LP ("Drive"). BoS(USA), through wholly
owned subsidiaries formed for the purpose of the acquisition, purchased 49% of
this newly formed entity for $15 million and BoS(USA) provided $60 million in
term financing to Drive and its subsidiary, Drive ABS LP, which was used to
repay indebtedness owed to FirstCity by its automobile finance operation. After
taking into effect the sale of the 49% interest to IFA-GP and IFA-LP, the
ownership of Drive is allocated as follows: 49% of Drive is owned (directly and
indirectly) by IFA-GP and IFA-LP, 31% of Drive is owned (directly and
indirectly) by Consumer Corp., and 20% of Drive is owned (directly and
indirectly) by Thomas R. Brower, Scot A. Foith, Thomas G. Dundon, R. Tyler
Whann, Bradley C. Reeves, Stephen H. Trent and Blake P. Bozman (the "Auto
Finance Management Group"). The Auto Finance Management Group consists of
officers and shareholders of Funding GP and limited partners of Funding LP who
indirectly and directly owned the remaining 20% equity interest in Funding LP.
The Company has reflected the Auto Finance Management Group's 20% equity
interest in Funding LP as a minority interest in the consolidated financial
statements.
65
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
BoS(USA) has a warrant to purchase 425,000 shares of the Company's voting
Common Stock at $2.3125 per share. BoS(USA) is entitled to additional warrants
in connection with this existing warrant for 425,000 shares to retain its
ability to acquire approximately 4.86% of the Company's voting Common Stock.
In the third quarter of 1999, dividends on the Company's redeemable
preferred stock ("New Preferred Stock") were suspended. At December 31, 2002,
accumulated dividends in arrears on New Preferred Stock totaled $1.0 million, or
$7.35 per share. Since the Company failed to pay quarterly dividends for six
consecutive quarters, the holders of New Preferred Stock are entitled to elect
two directors to the Company's Board until cumulative dividends have been paid
in full. Dividends on outstanding shares of New Preferred Stock of FirstCity
will be restricted until the Tranche II term loan is paid in full. Given the
continued high debt levels of the Company, and management's priority of assuring
adequate levels of liquidity, the Company does not anticipate that dividends on
New Preferred Stock will be paid in the foreseeable future.
The Portfolio Asset acquisition and resolution group of the Company has a
$35 million loan facility (increased from $30 million in August 2002) with CFSC
Capital Corp. XXX, a subsidiary of Cargill. This facility is being used
exclusively to provide equity in new Portfolio acquisitions in partnerships with
Cargill and its affiliates and matures in March, 2005. At December 31, 2002,
approximately $25 million was outstanding under this facility.
FirstCity receives cash from its investments in foreign Acquisition
Partnerships. The Company received cash from return on investments in France in
the amount of $4.3 million and $3.6 million and invested $4.6 million and $3.3
million during 2002 and 2001, respectively. The Company received cash from its
investments and notes receivable in Mexico in the amount of $4.0 million and
$5.4 million and invested $4.0 million and $11.1 million during 2002 and 2001,
respectively.
Management believes that the BoS(USA) loan facilities along with the
liquidity from the Cargill Facility, the related fees generated from the
servicing of assets and equity distributions from existing Acquisition
Partnerships and wholly owned portfolios will allow the Company to meet its
obligations as they come due during the next twelve months.
(3) DISCONTINUED OPERATIONS
The Company recorded provisions of $9.7 million in 2002, $5.2 million in
2001 and $5.0 million in 2000 for additional losses from discontinued
operations. Effective during the third quarter of 1999, management of the
Company adopted formal plans to discontinue the operations of Harbor Financial
Group, Inc. (formerly known as FirstCity Financial Mortgage Corp.) and its
subsidiaries (collectively referred to as "Mortgage Corp."), and FC Capital
Corp. ("Capital Corp."). These entities comprise the operations that were
previously reported as the Company's residential and commercial mortgage banking
business. Additionally, the net assets related to the resolution of activity
from the discontinued operations have been reflected in the accompanying
consolidated balance sheets.
The net assets from discontinued operations consist of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------
Estimated future gross cash receipts on residual interests
in securitizations........................................ $ 8,764 $18,775
Accrual for loss on operations and disposal of discontinued
operations................................................ (1,000) (2,118)
------- -------
Net assets of discontinued operations..................... $ 7,764 $16,657
======= =======
</Table>
The only assets remaining from discontinued operations are the investment
securities resulting from the retention of residual interests in securitization
transactions. Although the liquidation or run-off of these investment securities
will last longer than one year, the Company is contractually obligated to
service the
66
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
securitized assets. The Company has considered the estimated future gross cash
receipts for such investment securities in the computation of the loss from
discontinued operations. The cash flows are collected over a period of time and
are valued using prepayment assumptions of 28% to 33% for fixed rate loans and
25% to 33% for variable rate loans. Overall loss rates are estimated from 3% to
10% of collateral. If the prepayment speeds were to increase by 10% and 20%, the
estimated future gross cash receipts would decrease by $.8 million and $1.5
million, respectively. Additionally, if the loss rates were to increase by 10%
and 20%, the estimated future gross cash receipts would decrease by $.7 million
and $1.3 million, respectively.
(4) PORTFOLIO ASSETS
Portfolio Assets are summarized as follows:
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Non-performing Portfolio Assets............................. $ 39,241 $ 45,123
Performing Portfolio Assets................................. 7,761 10,227
Real estate Portfolios...................................... 1,242 1,766
-------- --------
Total Portfolio Assets.................................... 48,244 57,116
Adjusted purchase discount required to reflect Portfolio
Assets at carrying value.................................. (38,424) (42,898)
-------- --------
Portfolio Assets, net..................................... $ 9,820 $ 14,218
======== ========
</Table>
The Company recorded an allowance for impairment on Portfolio Assets of
approximately $.3 million, $3.3 million and $2.0 million in 2002, 2001 and 2000,
respectively. The Company recorded permanent valuation impairments of $.2
million in 2002 on two real estate Portfolios due to deterioration of property
values and market conditions, as well as additional expected disposal costs.
Minimal provisions were recorded in 2002 for performing or non-performing
Portfolios as the economic conditions during the year did not negatively impact
the Company's expectation of future cash flows. In 2001, provisions of $1.6
million in four non-performing Portfolios and $.6 million in two performing
Portfolios were recorded as estimated future collections were reduced primarily
due to the Company accepting discounted payoffs in lieu of extended payouts.
Also, the Company recorded permanent valuation impairments of $1.1 million in
2001 and $2.0 million in 2000 on one real estate Portfolio due to deterioration
of property values and market conditions. Portfolio Assets are pledged to secure
non-recourse notes payable.
(5) LOANS RECEIVABLE FROM ACQUISITION PARTNERSHIPS HELD FOR INVESTMENT
Loans receivable from Acquisition Partnerships held for investment consist
primarily of loans from certain partnerships located in Mexico and are
summarized as follows:
<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------
Mexico...................................................... $16,399 $18,221
Domestic.................................................... 1,301 1,156
------- -------
$17,700 $19,377
======= =======
</Table>
There were no provisions recorded on these loans during 2002 and 2001. The
loans receivable from the Mexican partnerships are secured by the assets/loans
acquired by the Mexican partnerships with purchase money loans provided by the
investors to the Mexican partnerships to purchase the asset pools held in those
entities. These loans are evaluated for impairment by analyzing the expected
future cash flows from the
67
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
underlying assets within each pool to determine that the cash flows were
sufficient to repay these notes. The Company applies the asset valuation
methodology consistently in all venues and uses the same proprietary asset
management system to evaluate impairment on all asset pools. The results of this
evaluation indicated that cash flows from the pools will be sufficient to repay
the loans and no allowances for impairment were necessary. Equity method losses
which were recorded to reduce the loans and interest receivable from the Mexican
partnerships was $3.0 million and $1.0 million during 2002 and 2001,
respectively, in compliance with EITF 98-13.
In 2000, the Company recorded an allowance for impairment on loans
receivable of approximately $.8 million relating to automobile finance
receivables generated by the Company's automobile platform, which was sold to
Drive in August 2000. In addition, provisions of $1.6 million during 2000 were
recorded for permanent impairment of value in residual interests in automobile
finance securitizations, which were also sold to Drive in August 2000.
(6) EQUITY INVESTMENTS
The Company has investments in Acquisition Partnerships and their general
partners that are accounted for under the equity method. The Company also has
investments in servicing entities that are accounted for on the equity method.
The condensed combined financial position and results of operations of the
Acquisition Partnerships (excluding servicing entities), which include the
domestic and foreign Acquisition Partnerships and their general partners, are
summarized as follows:
CONDENSED COMBINED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Assets...................................................... $585,435 $654,883
======== ========
Liabilities................................................. 480,713 498,361
Net equity.................................................. 104,722 156,522
-------- --------
$585,435 $654,883
======== ========
Equity investment in Acquisition Partnerships............... $ 46,029 $ 43,657
Equity investment in servicing entities..................... 3,247 2,118
-------- --------
$ 49,276 $ 45,775
======== ========
</Table>
CONDENSED COMBINED SUMMARY OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
Proceeds from resolution of Portfolio Assets......... $271,929 $249,219 $163,386
Gain on resolution of Portfolio Assets............... 89,824 103,599 75,788
Interest income on performing Portfolio Assets....... 14,380 24,473 18,049
Net earnings (loss).................................. $(13,224) $ 14,172 $ 36,766
======== ======== ========
Equity in earnings of Acquisition Partnerships....... $ 8,418 $ 9,742 $ 7,203
Equity in earnings of servicing entities............. 794 1,029 166
-------- -------- --------
$ 9,212 $ 10,771 $ 7,369
======== ======== ========
</Table>
68
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The assets and equity (deficit) of the Acquisition Partnerships and equity
investments in those entities are summarized by geographic region below. The
WAMCO Partnerships represent domestic Texas limited partnerships and limited
liability companies in which the Company has a common ownership with Cargill.
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Assets:
Domestic:
WAMCO Partnerships..................................... $189,392 $259,617
Other.................................................. 19,491 15,607
Mexico.................................................... 246,087 305,324
France.................................................... 130,465 74,335
-------- --------
$585,435 $654,883
======== ========
Equity (deficit):
Domestic:
WAMCO Partnerships..................................... $ 80,059 $ 90,249
Other.................................................. 7,212 3,207
Mexico.................................................... (51,567) 2,546
France.................................................... 69,018 60,520
-------- --------
$104,722 $156,522
======== ========
Equity investment in Acquisition Partnerships:
Domestic:
WAMCO Partnerships..................................... $ 29,951 $ 30,806
Other.................................................. 3,494 2,313
Mexico.................................................... 1,108 1,289
France.................................................... 11,476 9,249
-------- --------
$ 46,029 $ 43,657
======== ========
</Table>
69
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenues and earnings (loss) of the Acquisition Partnerships and equity in
earnings (loss) of those entities are summarized by geographic region below.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------
2002 2001 2000
-------- -------- -------
Revenues:
Domestic:
WAMCO Partnerships............................... $ 44,158 $ 45,603 $33,778
Other............................................ 8,265 1,512 235
Mexico.............................................. 37,230 63,687 44,084
France.............................................. 16,899 20,199 17,934
-------- -------- -------
$106,552 $131,001 $96,031
======== ======== =======
Net earnings (loss):
Domestic:
WAMCO Partnerships............................... $ 27,541 $ 21,128 $12,357
Other............................................ 5,208 1,190 (147)
Mexico.............................................. (56,480) (21,816) 12,857
France.............................................. 10,507 13,670 11,699
-------- -------- -------
$(13,224) $ 14,172 $36,766
======== ======== =======
Equity in earnings (loss) of Acquisition Partnerships:
Domestic:
WAMCO Partnerships............................... $ 8,099 $ 7,363 $ 4,667
Other............................................ 1,885 798 123
Mexico.............................................. (3,493) (1,153) 210
France.............................................. 1,927 2,734 2,203
-------- -------- -------
$ 8,418 $ 9,742 $ 7,203
======== ======== =======
</Table>
As discussed in Note 2, in the third quarter of 2000, the Company completed
the sale of a 49% equity interest in its automobile finance operation to certain
subsidiaries of BoS(USA). As a result of the sale, the net operations of Drive
have been recorded (since August 1, 2000) as equity investments. The Company's
investment in Drive is accounted for under the equity method. As of December 31,
2001, Drive's fiscal year
70
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
end changed from February 28 to December 31. The condensed consolidated
financial position and results of operations of Drive are summarized below:
CONDENSED CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31, DECEMBER 31, FEBRUARY 28, DECEMBER 31,
2002 2001 2001 2000
------------ ------------ ------------ ------------
Cash........................................ $ 14,337 $ 7,303 $ 7,589 $ 10,567
Restricted cash............................. 12,124 -- -- --
Retail installment contracts, net........... 367,520 70,447 139,377 90,652
Residual interests in securitizations....... 63,202 77,407 55,739 56,190
Other assets................................ 14,494 10,321 10,158 6,799
-------- -------- -------- --------
Total assets.............................. $471,677 $165,478 $212,863 $164,208
======== ======== ======== ========
Notes payable............................... $434,422 $126,665 $187,365 $143,923
Other liabilities........................... 14,123 13,323 17,473 10,638
-------- -------- -------- --------
Total liabilities......................... 448,545 139,988 204,838 154,561
Net equity.................................. 23,132 25,490 8,025 9,647
-------- -------- -------- --------
$471,677 $165,478 $212,863 $164,208
======== ======== ======== ========
Equity investment in Drive.................. $ 9,066 $ 9,877 $ 3,110 $ 3,738
Minority interest......................... (1,812) (1,975) (622) (748)
-------- -------- -------- --------
Net investment in Drive................ $ 7,254 $ 7,902 $ 2,488 $ 2,990
======== ======== ======== ========
</Table>
71
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATED SUMMARY OF OPERATIONS
<Table>
<Caption>
MARCH 1, AUGUST 1, AUGUST 1,
2001 2000 2000
YEAR ENDED YEAR ENDED THROUGH THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, FEBRUARY 28, DECEMBER 31,
2002 2001 2001 2001 2000
------------ ------------ ------------ ------------ ------------
Interest income................. $101,238 $45,224 $37,506 $22,031 $14,313
Gain on sale of loans........... -- 39,033 39,033 9,434 9,434
Service fees and other.......... 12,320 12,376 10,391 4,256 2,271
-------- ------- ------- ------- -------
Revenues...................... 113,558 96,633 86,930 35,721 26,018
-------- ------- ------- ------- -------
Interest expense................ 16,366 11,744 9,329 8,165 5,750
Salaries and benefits........... 41,648 33,185 28,706 13,674 9,195
Provision for loan and
impairment losses............. 32,078 12,688 10,425 4,129 1,866
Other expenses.................. 25,106 24,516 19,207 8,777 3,468
-------- ------- ------- ------- -------
Expenses...................... 115,198 82,133 67,667 34,745 20,279
-------- ------- ------- ------- -------
Net earnings (loss)............. $ (1,640) $14,500 $19,263 $ 976 $ 5,739
======== ======= ======= ======= =======
Equity in earnings (loss) of
Drive......................... $ (532) $ 5,923 $ 7,768 $ 378 $ 2,223
Cumulative effect of accounting
change........................ -- (304) (304) -- --
Minority interest............... 106 (1,124) (1,493) (75) (444)
-------- ------- ------- ------- -------
Net equity in earnings (loss)
of Drive................... $ (426) $ 4,495 $ 5,971 $ 303 $ 1,779
======== ======= ======= ======= =======
</Table>
72
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) NOTES PAYABLE
Notes payable consisted of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------
Notes payable to affiliates:
Collateralized loans, secured by Portfolio Assets:
LIBOR (1.4% at December 31, 2002) plus 5%, due at various
dates through 2003, affiliate.......................... 4,314 7,650
Senior Credit Facility with affiliate, secured and with
recourse to the Company:
Prime (4.25% at December 31, 2002) plus 2.5%; fixed rate
at 8.77%, due at various dates through 2007............ 49,290 --
LIBOR plus 2.5%; Prime.................................... -- 48,600
Acquisition Facility with affiliate, secured by certain
equity interests of the Company, fixed rate at 8.5%, due
2005...................................................... 24,599 27,422
Term loan to affiliate, secured by equity interest in Drive,
LIBOR (1.4% at December 31, 2002) plus 1.0%, due 2007..... 16,000 --
Unsecured notes payable to affiliates, fixed rate at 4.5% to
7.0%, due at various dates through 2011................... 1,357 285
------- -------
Total notes payable to affiliates.................... $95,560 $83,957
------- -------
Notes payable -- other:
Collateralized loans, secured by Portfolio Assets:
Fixed rate (10.00% at December 31, 2002), matured 2002.... $ 962 $ 7,181
Unsecured note payable, fixed rate at 6.26%, due 2003....... 151 71
------- -------
Total notes payable -- other......................... $ 1,113 $ 7,252
------- -------
Total notes payable.................................. $96,673 $91,209
======= =======
</Table>
Refer to Note 2 for a description of terms related to the Company's Senior
Credit Facility at December 31, 2002 and other matters concerning the Company's
liquidity.
Under terms of certain borrowings, the Company and its subsidiaries are
required to maintain certain tangible net worth levels and debt to equity and
debt service coverage ratios. The terms also restrict future levels of debt. At
December 31, 2002, the Company was in compliance with the aforementioned
covenants. The aggregate maturities of notes payable for the five years ending
December 31, 2007 are as follows: $9,283 in 2003, $12,553 in 2004, $36,599 in
2005, $8,955 in 2006 and $28,000 in 2007.
73
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) SEGMENT REPORTING
The Company is engaged in two reportable segments (i) Portfolio Asset
acquisition and resolution and (ii) consumer lending through the Company's
minority investment in Drive. These segments have been segregated based on
products and services offered by each. As a result of the sale of a 49% equity
interest in the Company's automobile finance operation, the net operations of
Drive have been recorded (since August 1, 2000) as equity in earnings of
investments. The following is a summary of results of operations for each of the
two segments and reconciliation to earnings (loss) from continuing operations.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
------- ------- --------
PORTFOLIO ASSET ACQUISITION AND RESOLUTION:
Revenues:
Servicing fees.................................... $12,665 $ 9,580 $ 7,555
Gain on resolution of Portfolio Assets............ 1,138 1,049 3,120
Gain on the sale of interest in investments....... 1,779 3,316 --
Equity in earnings of investments................. 9,212 10,771 7,369
Interest income................................... 5,122 5,847 2,143
Other............................................. 2,185 1,836 1,129
------- ------- --------
Total........................................... 32,101 32,399 21,316
Expenses:
Interest and fees on notes payable................ 2,946 4,128 3,266
Salaries and benefits............................. 9,611 7,679 5,531
Provision for loan and impairment losses.......... 295 3,277 1,971
Occupancy, data processing and other.............. 7,815 9,503 7,083
------- ------- --------
Total........................................... 20,667 24,587 17,851
------- ------- --------
Operating contribution before direct taxes........... $11,434 $ 7,812 $ 3,465
======= ======= ========
Operating contribution, net of direct taxes.......... $11,214 $ 7,713 $ 3,354
======= ======= ========
CONSUMER LENDING:
Revenues:
Servicing fees.................................... $ -- $ -- $ 3,887
Equity in earnings (loss) of Drive................ (532) 5,923 2,223
Gain on sale of automobile loans.................. -- -- 2,836
Interest income................................... -- 5 12,882
Gain on sale of interest in Drive................. 4,000 -- 8,091
Other............................................. 1 9 71
------- ------- --------
Total........................................... 3,469 5,937 29,990
</Table>
74
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
------- ------- --------
Expenses:
Interest and fees on notes payable................ 18 -- 3,217
Salaries and benefits............................. -- -- 7,277
Provision for loan and impairment losses.......... -- -- 2,420
Occupancy, data processing and other (net of
minority interest).............................. (93) 1,473 6,706
------- ------- --------
Total........................................... (75) 1,473 19,620
------- ------- --------
Operating contribution before direct taxes........... $ 3,544 $ 4,464 $ 10,370
======= ======= ========
Operating contribution, net of direct taxes.......... $ 3,544 $ 4,448 $ 10,362
======= ======= ========
Total operating income, net of direct taxes..... $14,758 $12,161 $ 13,716
======= ======= ========
CORPORATE OVERHEAD:
Other revenue........................................ $ 418 $ 75 $ 1,703
Corporate interest expense........................... (3,858) (4,649) (12,175)
Salaries and benefits, occupancy, professional and
other Expenses.................................... (5,375) (5,416) (7,144)
Deferred tax valuation allowance..................... -- -- (7,000)
------- ------- --------
Earnings (loss) from continuing operations........... $ 5,943 $ 2,171 $(10,900)
======= ======= ========
</Table>
Revenues from the Consumer Lending segment are all attributable to domestic
operations. Revenues from the Portfolio Asset acquisition and resolution segment
attributable to domestic and foreign operations are summarized as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
Domestic................................................ $19,444 $18,978 $13,527
Mexico.................................................. 7,985 9,460 5,237
France.................................................. 4,646 3,941 2,552
Other foreign........................................... 26 20 --
------- ------- -------
Total................................................. $32,101 $32,399 $21,316
======= ======= =======
</Table>
Total assets for each of the segments and a reconciliation to total assets
is as follows:
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Portfolio acquisition and resolution assets................. $ 77,744 $ 79,335
Consumer assets............................................. 9,127 10,205
Deferred tax benefit, net................................... 20,101 20,101
Other assets, net........................................... 11,720 12,595
Net assets of discontinued operations....................... 7,764 16,657
-------- --------
Total assets.............................................. $126,456 $138,893
======== ========
</Table>
75
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) PREFERRED STOCK, STOCKHOLDERS' EQUITY AND LOSS PER SHARE
On July 17, 1998, the Company filed a shelf registration statement with the
Securities and Exchange Commission, which allows the Company to issue up to $250
million in debt and equity securities from time to time in the future. The
registration statement became effective July 28, 1998. As of December 31, 2002,
there have been no securities issued under this registration statement.
In connection with the recapitalization discussed in Note 2, 400,000 shares
of common stock were issued to purchase a minority interest.
BoS(USA) is entitled to additional warrants in connection with its existing
warrant for 425,000 shares to retain its ability to acquire approximately 4.86%
of the Company's Common Stock.
The holders of shares of Common Stock are entitled to one vote for each
share on all matters submitted to a vote of common stockholders. In order to
preserve certain tax benefits available to the Company, transactions involving
stockholders holding or proposing to acquire more than 4.75% of outstanding
common shares are prohibited unless the prior approval of the Board of Directors
is obtained.
The redeemable preferred stock has a redemption value of $21.00 per share
and cumulative quarterly cash dividends at the annual rate of $2.10 per share
through the redemption date of September 30, 2005. The Company may redeem the
New Preferred Stock after September 30, 2003 for $21 per share plus accrued
dividends. The New Preferred Stock carries no voting rights except in the event
of non-payment of dividends, in which case, the holders of New Preferred Stock
have the right to elect two directors to the Company's Board. In the third
quarter of 1999, dividends on the Company's New Preferred Stock were suspended.
In connection with the recapitalization discussed in Note 2, 1,092,210 shares of
New Preferred Stock were exchanged for 2,417,388 shares of common stock and
$10.5 million. At December 31, 2002, accumulated dividends in arrears on
remaining New Preferred Stock totaled $1.0 million, or $7.35 per share. Since
the Company failed to pay quarterly dividends for six consecutive quarters, the
holders of New Preferred Stock are entitled to elect two directors to the
Company's Board until cumulative dividends have been paid in full; the right to
elect the additional directors has not been exercised by the holders of the New
Preferred Stock.
The Board of Directors of the Company may designate the relative rights and
preferences of the optional preferred stock when and if issued. Such rights and
preferences can include liquidation preferences, redemption rights, voting
rights and dividends and shares can be issued in multiple series with different
rights and preferences. The Company has no current plans for the issuance of an
additional series of optional preferred stock.
The Company has stock option and award plans for the benefit of key
individuals, including its directors, officers and key employees. The plans are
administered by a committee of the Board of Directors and provide for the grant
of up to a total of 730,000 shares (net of shares cancelled and forfeited) of
Common Stock.
76
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock option activity during the periods indicated is as follows:
<Table>
<Caption>
2002 2001 2000
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- ------- -------- ------- --------
Outstanding at beginning of
Year...................... 623,250 $ 8.07 347,750 $12.03 236,650 $22.96
Granted..................... -- -- 275,500 3.06 183,000 2.00
Exercised................... -- -- -- -- -- --
Cancelled................... -- -- -- -- (22,500) 22.00
Forfeited................... (29,000) 11.04 -- -- (49,400) 23.60
------- ------ ------- ------ ------- ------
Outstanding at end of
year...................... 594,250 $ 7.89 623,250 $ 8.07 347,750 $12.03
======= ====== ======= ====== ======= ======
</Table>
The following table summarizes stock options granted by grant date.
<Table>
<Caption>
SHARES
OUTSTANDING AT
SHARES DECEMBER 31, EXERCISE
DATE OF GRANT GRANTED 2002 PRICE
- ------------- ------- -------------- --------
October 27, 1995..................................... 229,600 92,000 $20.00
February 27, 1997.................................... 95,200 56,250 27.25
May 21, 1998......................................... 15,000 5,000 29.69
December 1, 2000..................................... 183,000 173,000 2.00
December 20, 2001.................................... 275,500 268,000 3.06
------- -------
798,300 594,250
======= =======
</Table>
In December 2001, the Company granted 275,500 stock options with an
exercise price of $3.06 (greater than the fair market value of the Company's
common stock on the date of grant). At December 31, 2002, the range of exercise
prices and weighted-average remaining contractual life of outstanding options
was $2.00 to $29.69 and 7.23 years, respectively. In addition, 439,750, 346,375
and 146,938 options were exercisable with a weighted-average exercise price of
$9.73, $12.34 and $22.62 at December 31, 2002, 2001 and 2000, respectively.
The Company has an employee stock purchase plan, which allows employees to
acquire approximately 251,000 shares of Common Stock of the Company at 85% of
the fair value at the end of each quarterly plan period. The value of the shares
purchased under the plan is limited to the lesser of 10% of compensation or
$25,000 per year. Under the plan, 1,188 shares were issued in 2002, 8,156 shares
were issued in 2001 and 35,044 shares were issued in 2000. At December 31, 2002,
approximately 77,000 shares of Common Stock are available for issuance pursuant
to the plan.
No effect was given to dilutive securities in the 2002, 2001 and 2000 loss
per share calculations as such had an anti-dilutive effect. However, the options
outstanding at December 31, 2002 could have a potentially dilutive per share
calculation effect in the future.
77
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) INCOME TAXES
Income tax expense from continuing operations consists of:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------
2002 2001 2000
------ ----- --------
Federal and state current expense........................... $(153) $(15) $ (414)
Federal deferred expense.................................... -- -- (7,000)
----- ---- -------
Total..................................................... $(153) $(15) $(7,414)
===== ==== =======
</Table>
The actual income tax benefit (expense) attributable to earnings (loss)
from continuing operations differs from the expected tax benefit (expense)
(computed by applying the federal corporate tax rate of 35% to earnings (loss)
from continuing operations before income taxes, minority interest and accounting
change) as follows:
<Table>
<Caption>
2002 2001 2000
------- ------- -------
Computed expected tax benefit (expense)................. $(2,555) $(1,593) $ 1,148
(Increase) reduction in income taxes resulting from:
Change in valuation allowance......................... 2,555 1,593 (8,148)
Alternative minimum tax and state income tax.......... (153) (15) (414)
------- ------- -------
$ (153) $ (15) $(7,414)
======= ======= =======
</Table>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at December 31, 2002 and 2001 are as
follows:
<Table>
<Caption>
2002 2001
--------- ---------
Deferred tax assets:
Investments in Acquisition Partnerships, principally due
to differences in basis for tax and financial reporting
purposes............................................... $ 2,931 $ 4,453
Intangibles, principally due to differences in
amortization........................................... 158 214
Tax basis in fixed assets less than book.................. (161) (165)
Other..................................................... (2,210) (583)
Federal net operating loss carryforwards.................. 202,285 201,639
--------- ---------
Total gross deferred tax assets........................ 203,003 205,558
Valuation allowance....................................... (182,902) (185,457)
--------- ---------
Net deferred tax assets................................ $ 20,101 $ 20,101
========= =========
</Table>
The Company has net operating loss carryforwards for federal income tax
purposes of approximately $578 million from continuing operations and $152
million from discontinued operations at December 31, 2002, available to offset
future federal taxable income, if any, through the year 2022. A valuation
allowance is provided to reduce the deferred tax assets to a level, which, more
likely than not, will be realized. During 2002, 2001 and 2000, the Company
adjusted the previously established valuation allowance to recognize a deferred
tax benefit (expense) of $2.6 million, $1.6 million and $(8.1) million,
respectively. Realization is determined based on management's expectation of
generating sufficient taxable income in a look forward period over the next four
years. The ultimate realization of the resulting net deferred tax asset is
dependent upon generating sufficient taxable income from its continuing
operations prior to expiration of the net operating loss carryforwards. The
expense recognized in 2000 is attributed to a reduction in anticipated taxable
income. Although realization is not assured, management believes it is more
likely than not that all of the recorded
78
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
deferred tax asset, net of the allowance, will be realized. The amount of the
deferred tax asset considered realizable, however, could be adjusted in the
future if estimates of future taxable income during the carryforward period
change. The ability of the Company to realize the deferred tax asset is
periodically reviewed and the valuation allowance is adjusted accordingly.
(11) EMPLOYEE BENEFIT PLAN
The Company has a defined contribution 401(k) employee profit sharing plan
pursuant to which the Company matches employee contributions at a stated
percentage of employee contributions to a defined maximum. The Company's
contributions to the 401(k) plan were $184 in 2002, $152 in 2001 and $263 in
2000.
(12) LEASES
The Company leases its current headquarters from a related party under a
noncancellable operating lease. The lease calls for monthly payments of $10
through its expiration in December 2006 and includes an option to renew for an
additional five-year period. Rental expense for 2002, 2001 and 2000 under this
lease was $120, $90 and $90, respectively. The Company also leases office space
and equipment from unrelated parties under operating leases expiring in various
years through 2006. Rental expense under these leases for 2002, 2001 and 2000
was $.7 million, $.6 million and $1.7 million, respectively. As of December 31,
2002, the future minimum lease payments under all noncancellable operating
leases are: $296 in 2003, $285 in 2004, $230 in 2005 and $155 in 2006.
(13) OTHER RELATED PARTY TRANSACTIONS
The Company has contracted with the Acquisition Partnerships and related
parties as a third party loan servicer. Servicing fees totaling $12.7 million,
$9.6 million and $11.4 million, for 2002, 2001 and 2000, respectively, and due
diligence fees (included in other income) were derived from such affiliates.
Park Central Recreation, Inc., a Texas corporation of which James R.
Hawkins is a 50% shareholder, is indebted to an Acquisition Partnership under a
note dated March 1, 1996, which has an outstanding principal balance of $2.1
million as of December 31, 2002. The note is secured by a first lien on real
estate in Port Arthur, Texas, which is operated as a bowling alley. The note
bears a fixed interest rate of 10%, matures on March 1, 2006 and requires annual
payments of $289,500.
During 2001, the Company sold equity investments in two domestic
Acquisition Partnerships to affiliates of Cargill for $7.6 million resulting in
a gain of $3.3 million.
(14) COMMITMENTS AND CONTINGENCIES
On October 14, 1999, Harbor Financial Group, Inc. ("Harbor Parent"), Harbor
Financial Mortgage Corporation ("Harbor") and four subsidiaries of Harbor filed
voluntary petitions under Chapter 11 of the United States Bankruptcy Code. On
December 14, 1999, these bankruptcy proceedings were converted to liquidation
proceedings under Chapter 7 of the United States Bankruptcy Code. John H.
Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the "Trustee"),
initiated adversary proceedings on May 25, 2001 against FirstCity and various
current and former directors and officers of FirstCity and Mortgage Corp.
alleging breach of fiduciary duties, mismanagement, and self-dealing by
FirstCity and Harbor directors and officers, and improper transfer of funds from
the Harbor related entities to FirstCity. The claims also included fraudulent
and preferential transfer of assets of the Harbor entities, fraud and
conspiracy. The Trustee, FirstCity, the other defendants and the insurers
providing Director's and Officer's Insurance coverage for FirstCity and its
subsidiaries (the "Insurers") settled the claims brought in the adversary
proceedings with the approval of the Bankruptcy Court. Under the terms of the
settlement agreement, the Trustee released the
79
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
defendants, their affiliates and subsidiaries from any and all claims which were
brought or could have been brought by the Trustee against any of the defendants,
any past and present officers and directors of FirstCity or any affiliates or
subsidiaries of FirstCity.
Periodically, FirstCity, its subsidiaries, its affiliates and the
Acquisition Partnerships are parties to or otherwise involved in legal
proceedings arising in the normal course of business. FirstCity does not believe
that there is any proceeding threatened or pending against it, its subsidiaries,
its affiliates or the Acquisition Partnerships which, if determined adversely,
would have a material adverse effect on the consolidated financial position,
results of operations or liquidity of FirstCity, its subsidiaries, its
affiliates or the Acquisition Partnerships.
The Company is a 50% owner in an entity that is obligated to advance up to
$2.5 million toward the acquisition of Portfolio Assets from financial
institutions in California. At December 31, 2002, advances of $2.4 million had
been made under the obligation.
In connection with the transactions contemplated by the Securities Purchase
Agreement, effective August 1, 2000, Consumer Corp. and Funding LP contributed
all of the assets utilized in the operations of the automobile finance operation
to Drive pursuant to the terms of a Contribution and Assumption Agreement by and
between Consumer Corp. and Drive, and a Contribution and Assumption Agreement by
and between Funding LP and Drive (collectively, the "Contribution Agreements").
Drive assumed substantially all of the liabilities of the automobile finance
operation as set forth in the Contribution Agreements.
In addition, in the Securities Purchase Agreement, the Company, Consumer
Corp., Funding LP and Funding GP made various representations and warranties
concerning (i) their respective organizations, (ii) the automobile finance
operation conducted by Consumer Corp. and Funding LP, and (iii) the assets
transferred by Consumer Corp. and Funding LP to Drive. The Company, Consumer
Corp., Funding LP and Funding GP also agreed to indemnify BoS(USA), IFA-GP and
IFA-LP from damages resulting from a breach of any representation or warranty
contained in the Securities Purchase Agreement or otherwise made by the Company,
Consumer Corp. or Funding LP in connection with the transaction. The indemnity
obligation under the Securities Purchase Agreement survives for a period of
seven (7) years from August 25, 2000 (the "Closing Date") with respect to
tax-related representations and warranties and for thirty months from the
Closing Date with respect to all other representations and warranties. Neither
the Company, Consumer Corp., Funding LP, or Funding GP is required to make any
payments as a result of the indemnity provided under the Securities Purchase
Agreement until the aggregate amount payable exceeds $.25 million, and then only
for the amount in excess of $.25 million in the aggregate; however certain
representations and warranties are not subject to this $.25 million threshold.
Pursuant to the terms of the Contribution Agreements, Consumer Corp. and Funding
LP have agreed to indemnify Drive from any damages resulting in a material
adverse effect on Drive resulting from breaches of representations or
warranties, failure to perform, pay or discharge liabilities other than the
assumed liabilities, or claims, lawsuits or proceedings resulting from the
transactions contemplated by the Contribution Agreements. Pursuant to the terms
of the Contribution Agreements, Drive has agreed to indemnify Consumer Corp. and
Funding LP for any breach of any representation or warranty by Drive, the
failure of Drive to discharge any assumed liability, or any claims arising out
of any failure by Drive to properly service receivables after August 1, 2000.
Liability for indemnification pursuant to the terms of the Contribution
Agreements will not arise until the total of all losses with respect to such
matters exceeds $.25 million and then only for the amount by which such losses
exceed $.25 million; however this limitation will not apply to any breach of
which the party had knowledge at the time of the Closing Date or any intentional
breach by a party of any covenant or obligation under the Contribution
Agreements.
The Company has agreed to indemnify BoS(USA) for up to 31% of losses, which
might arise as a result of agreements BoS(USA) executed as a sponsor in
connection with the securitizations completed by Drive.
80
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also agreed to provide support in connection with securitizations by
Consumer Corp. and Drive prior to the acquisition by BoS(USA) of the interest in
Drive in August 2000.
FirstCity is obligated to pay BOS(USA) an arrangement fee related to the
$16 million loan equal to 20% of all proceeds and other amounts paid to
FirstCity from any sale or other disposition (regardless of when such sale or
other disposition occurs) of, and of all dividends and other distributions paid
to FirstCity by Drive or its general partner (regardless of when such dividend
or other distribution occurs) on, its 20% interest in Drive, in each case in
excess of $16 million in the aggregate. As of December 31, 2002 the Company has
not accrued any amount related to this contingent liability. The Company's
maximum loss exposure related to this contingency is the amount of the
arrangement fee that would be calculated in the event the fair value of Drive
exceeds $16 million in the future.
(15) FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires that the Company disclose estimated fair values of its financial
instruments. Fair value estimates, methods and assumptions are set forth below.
(a) CASH AND CASH EQUIVALENTS
The carrying amount of cash and cash equivalents approximated fair value at
December 31, 2002 and 2001.
(b) PORTFOLIO ASSETS AND LOANS RECEIVABLE
The Portfolio Assets and loans receivable are carried at the lower of cost
or estimated fair value. The estimated fair value is calculated by discounting
projected cash flows on an asset-by-asset basis using estimated market discount
rates that reflect the credit and interest rate risks inherent in the assets.
The carrying value of the Portfolio Assets and loans receivable was $27.5
million and $33.6 million, respectively, at December 31, 2002 and 2001. The
estimated fair value of the Portfolio Assets and loans receivable was
approximately $29.7 million and $35.2 million, respectively, at December 31,
2002 and 2001.
(c) RESIDUAL INTERESTS IN SECURITIZATIONS
Residual interests in securitizations included in discontinued operations
are carried at estimated future gross cash receipts. The estimated fair value is
calculated using various assumptions regarding prepayment speeds and credit
losses. The carrying value of the residual interests was $8.8 million and $18.8
million at December 31, 2002 and 2001, respectively. The estimated fair value of
the residual interests was $5.5 million and $11.4 million at December 31, 2002
and 2001, respectively.
(d) NOTES PAYABLE
Management believes that the repayment terms for similar rate financial
instruments with similar credit risks and the stated interest rates at December
31, 2002 and 2001 approximate the market terms for similar credit instruments.
Accordingly, the carrying amount of notes payable is believed to approximate
fair value.
(e) REDEEMABLE PREFERRED STOCK
Redeemable Preferred Stock is carried at redemption value plus accrued but
unpaid dividends. Carrying values were $3.7 million and $32.1 million at
December 31, 2002 and 2001, respectively. Fair market values based on quoted
market rates were $1.8 million and $9.0 million at December 31, 2002 and 2001,
respectively.
81
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
FirstCity Financial Corporation:
We have audited the accompanying consolidated balance sheets of FirstCity
Financial Corporation and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of operations, stockholders' equity and
comprehensive loss, and cash flows for each of the years in the three-year
period ended December 31, 2002. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of FirstCity
Financial Corporation and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, in 2001
the Company changed its method of accounting for residual interests in
securitized financial assets in accordance with the Financial Accounting
Standards Board's EITF 99-20, Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial Assets.
Also, discussed in Note 1, the Company early adopted Statement of Financial
Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13 and Technical Corrections.
KPMG LLP
Dallas, Texas
February 17, 2003
82
FIRSTCITY FINANCIAL CORPORATION
SELECTED QUARTERLY FINANCIAL DATA
<Table>
<Caption>
2002 2001
------------------------------------- -------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Revenues.................... $ 5,486 $12,637 $ 6,541 $11,324 $9,442 $15,762 $ 4,289 $ 8,918
Expenses.................... 6,292 7,532 7,488 7,376 8,033 9,590 8,244 7,993
Earnings (loss) from
continuing operations
before accounting
change(1)................. (834) 4,202 (1,137) 3,712 1,625 4,168 (3,605) 287
Accounting change........... -- -- -- -- -- (304) -- --
Loss from discontinued
operations................ (500) (1,500) (5,700) (2,014) -- (1,000) (2,000) (2,200)
Net earnings (loss)......... (1,334) 2,702 (6,837) 1,698 1,625 2,864 (5,605) (1,913)
Preferred dividends......... 642 642 642 552 642 642 642 642
Net earnings (loss) to
common stockholders....... $(1,976) $ 2,060 $(7,479) $ 1,146 $ 983 $ 2,222 $(6,247) $(2,555)
Net earnings (loss) from
continuing operations
before accounting change
per common share -- Basic
and diluted............... $ (0.18) $ 0.43 $ (0.21) $ 0.36 $ 0.12 $ 0.43 $ (0.51) $ (0.05)
</Table>
- ---------------
(1) Significant losses from continuing operations in the third quarter 2002
primarily related to a decrease in equity earnings in investments during the
quarter and lower earnings from Drive as a result of Drive structuring its
securitizations as secured financings versus gain on sale treatment.
Significant losses from continuing operations during the third quarter of
2001 related to $1.0 million in provisions for loan and impairment losses
and $1.7 million in equity in loss of Drive.
83
WAMCO PARTNERSHIPS
COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001 AND 2000
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
84
INDEPENDENT AUDITORS' REPORT
The Partners
WAMCO Partnerships:
We have audited the accompanying combined balance sheets of the WAMCO
Partnerships as of December 31, 2002 and 2001, and the related combined
statements of operations, changes in partners' capital, and cash flows for each
of the years in the three-year period ended December 31, 2002. These combined
financial statements are the responsibility of the Partnerships' management. Our
responsibility is to express an opinion on these combined financial statements
based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of the WAMCO
Partnerships as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
KPMG LLP
Dallas, Texas
February 17, 2003
85
WAMCO PARTNERSHIPS
COMBINED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
<Table>
<Caption>
2002 2001
---------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash........................................................ $ 13,035 $ 13,397
Portfolio Assets, net....................................... 147,686 218,731
Investments in partnerships................................. 2,302 2,302
Investments in trust certificates........................... 7,883 8,223
Deferred profit sharing..................................... 17,671 15,506
Other assets, net........................................... 815 1,458
-------- --------
$189,392 $259,617
======== ========
LIABILITIES AND PARTNERS' CAPITAL
Notes payable (including $46,137 and $101,178 affiliates in
2002 and 2001, respectively).............................. $ 79,891 $140,411
Deferred compensation....................................... 21,706 20,552
Other liabilities (including $625 and $558 to affiliates in
2002 and 2001, respectively).............................. 3,392 3,800
-------- --------
Total liabilities......................................... 104,989 164,763
Commitments and contingencies (notes 7 and 11).............. -- --
Preferred equity............................................ 4,344 4,605
Partners' capital........................................... 80,059 90,249
-------- --------
$189,392 $259,617
======== ========
</Table>
See accompanying notes to combined financial statements.
86
WAMCO PARTNERSHIPS
COMBINED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
(DOLLARS IN THOUSANDS)
Proceeds from resolution of Portfolio Assets................ $133,198 $ 69,188 $ 44,182
Cost of Portfolio Assets resolved........................... 102,170 44,916 30,115
-------- -------- --------
Gain on resolution of Portfolio Assets...................... 31,028 24,272 14,067
Interest income on performing Portfolio Assets.............. 11,280 19,543 18,049
Interest and fees on notes -- affiliate..................... (5,187) (12,104) (14,594)
Interest and fees on notes payable -- other................. (1,957) (1,234) (182)
Provision for loan losses................................... (904) (1,254) (58)
Servicing fees -- affiliate................................. (3,779) (3,131) (2,528)
General, administrative and operating expenses.............. (4,790) (6,752) (4,059)
Other income, net........................................... 1,850 1,788 1,662
-------- -------- --------
Net earnings................................................ $ 27,541 $ 21,128 $ 12,357
======== ======== ========
</Table>
See accompanying notes to combined financial statements.
87
WAMCO PARTNERSHIPS
COMBINED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
<Table>
<Caption>
CLASS B
CLASS A EQUITY EQUITY
------------------- --------
GENERAL LIMITED LIMITED GENERAL LIMITED
PARTNERS PARTNERS PARTNERS PARTNERS PARTNERS TOTAL
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
BALANCE AT DECEMBER 31, 1999........ $129 $ 6,284 $1,424 $ 945 $ 54,237 $ 63,019
Contributions..................... 6 325 -- 60 5,742 6,133
Distributions..................... (36) (1,778) (283) (341) (17,467) (19,905)
Net earnings...................... 18 884 6 206 11,243 12,357
Unrealized net gain on
securitization................. -- -- -- -- -- --
---- ------- ------ ------ -------- --------
Total comprehensive income........ 18 884 6 206 11,243 12,357
---- ------- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 2000........ 117 5,715 1,147 870 53,755 61,604
Contributions..................... -- -- -- 265 26,265 26,530
Distributions..................... (26) (1,271) (145) (311) (18,194) (19,947)
Comprehensive income:
Net earnings...................... 26 1,291 106 253 19,452 21,128
Unrealized net gain on
securitization................. 14 667 -- 5 248 934
---- ------- ------ ------ -------- --------
Total comprehensive income........ 40 1,958 106 258 19,700 22,062
---- ------- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 2001........ 131 6,402 1,108 1,082 81,526 90,249
Contributions..................... -- -- -- 159 15,812 15,971
Distributions..................... (43) (2,119) (126) (605) (51,305) (54,198)
Comprehensive income:
Net earnings...................... 28 1,376 76 300 25,761 27,541
Unrealized net gain on
securitization................. 7 351 5 3 130 496
---- ------- ------ ------ -------- --------
Total comprehensive income........ 35 1,727 81 303 25,891 28,037
---- ------- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 2002........ $123 $ 6,010 $1,063 $ 939 $ 71,924 $ 80,059
==== ======= ====== ====== ======== ========
</Table>
See accompanying notes to combined financial statements.
88
WAMCO PARTNERSHIPS
COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
<Table>
<Caption>
2002 2001 2000
--------- --------- --------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net earnings............................................. $ 27,541 $ 21,128 $ 12,357
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Amortization of loan origination and commitment
fees................................................ 522 768 376
Amortization of deferred profit sharing............... 720 1,228 1,117
Accretion of unrealized gain on trust certificates.... (287) -- --
Provision for loan losses............................. 904 1,254 58
Gain on resolution of Portfolio Assets................ (31,028) (24,272) (14,067)
Purchase of Portfolio Assets.......................... (48,713) (118,147) (17,852)
Capitalized costs on Portfolio Assets................. (4,059) (536) (1,497)
Capitalized interest on Portfolio Assets.............. (897) (1,228) --
Proceeds from resolution of Portfolio Assets.......... 133,198 69,188 44,182
Proceeds from sell back of Portfolio Assets........... -- 1,594 --
Principal payments on Performing Portfolio Assets..... 21,640 34,071 27,791
Increase in deferred profit sharing................... (2,885) (560) (9,409)
(Increase) decrease in other assets................... 170 (43) 595
Increase in deferred compensation..................... 2,885 560 9,409
Deferred compensation and profit sharing paid......... (1,730) (2,365) --
(Increase) decrease in other liabilities.............. (458) 258 1,260
--------- --------- --------
Net cash provided by (used in) operating activities... 97,523 (17,102) 54,320
Cash flows from investing activities:
Contribution to subsidiaries............................. -- (48) (573)
Change in trust certificates............................. 1,123 (381) (420)
--------- --------- --------
Net cash provided by (used) in investing activities... 1,123 (429) (993)
Cash flows from financing activities:
Borrowing of debt -- affiliate........................... 53,143 93,569 22,057
Borrowing of debt........................................ 28,500 45,901 --
Repayment of debt -- affiliate........................... (108,184) (113,327) (61,008)
Repayment of debt........................................ (33,979) (8,930) (919)
Capitalized interest on preferred equity................. 150 1,049 --
Repayment of preferred equity............................ (411) -- --
Capital contributions.................................... 15,971 26,530 6,133
Capital distributions.................................... (54,198) (19,947) (19,905)
--------- --------- --------
Net cash provided by (used in) financing activities... (99,008) 24,845 (53,642)
--------- --------- --------
Net increase (decrease) in cash............................ (362) 7,314 (315)
Cash at beginning of year.................................. 13,397 6,083 6,398
--------- --------- --------
Cash at end of year........................................ $ 13,035 $ 13,397 $ 6,083
========= ========= ========
</Table>
Supplemental disclosure of cash flow information:
Cash paid for interest was approximately $6,782, $12,533, and $14,643 for 2002,
2001, and 2000, respectively.
See accompanying notes to combined financial statements.
89
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001, AND 2000
(DOLLARS IN THOUSANDS)
(1) ORGANIZATION AND PARTNERSHIP AGREEMENTS
The combined financial statements represents domestic Texas limited
partnerships and limited liability companies ("Acquisition Partnerships" or
"Partnerships") and include the accounts of WAMCO III, Ltd. ("WAMCO III"); WAMCO
V, Ltd. ("WAMCO V"); WAMCO IX, Ltd. ("WAMCO IX"); WAMCO XVII, Ltd. ("WAMCO
XVII"); WAMCO XXIV, Ltd. ("WAMCO XXIV"); WAMCO XXV, Ltd. ("WAMCO XXV"); WAMCO
XXVI Ltd.; WAMCO XXVII Ltd.; WAMCO XXVIII, Ltd. ("WAMCO XXVIII"); WAMCO XXIX,
Ltd.; WAMCO XXX, Ltd. ("WAMCO XXX"); Calibat Fund, LLC; First B Realty, Ltd.;
First Paradee, Ltd.; FirstStreet Investments LLC ("FirstStreet"); FC Properties;
Ltd. ("FC Properties"); Imperial Fund I, Ltd.; Community Development Investment,
LLC; and VOJ Partners, Ltd. FirstCity Financial Corporation or its subsidiaries,
FirstCity Commercial Corporation and FirstCity Holdings Corporation (together
"FirstCity"), share limited partnership interests and participate as general
partners in common with Cargill Financial Services, Inc. in all of the
Partnerships. FC Properties and WAMCO XXVIII are considered to be significant
subsidiaries of FirstCity.
The Partnerships were formed to acquire, hold and dispose of Portfolio
Assets acquired from the Federal Deposit Insurance Corporation, Resolution Trust
Corporation and other nongovernmental agency sellers, pursuant to certain
purchase agreements or assignments of such purchase agreements. In accordance
with the purchase agreements, the Partnerships retain certain rights of return
regarding the assets related to defective title, past due real estate taxes,
environmental contamination, structural damage and other limited legal
representations and warranties.
Generally, the partnership agreements of the Partnerships provide for
certain preferences as to the distribution of cash flows. Proceeds from
disposition of and payments received on the Portfolio Assets are allocated based
on the partnership and other agreements which ordinarily provide for the payment
of interest and mandatory principal installments on outstanding debt before
payment of intercompany servicing fees and return of capital and restricted
distributions to partners.
The partnership agreement for WAMCO III provides for Class A and Class B
Equity partners. The Class A Equity partners are WAMCO III of Texas, Inc.,
FirstCity Commercial Corporation and CFSC Capital Corp. II, and the Class B
Equity partner is CFSC Capital Corp. II. The Class B Equity limited partner is
allocated 20 percent net income or loss, excluding equity earnings in
FirstStreet, recognized by the partnership prior to allocation of net income or
loss to the Class A Equity partners. Net earnings in FirstStreet are allocated
to the Class A Equity partners in proportion to their respective ownership
percentages. Net income or loss is credited or charged to the Class A Equity
partners' capital accounts in proportion to their respective capital account
balances after the 20% allocation to the Class B Equity limited partner.
Distributions are allocated using the same methodology as net income or loss.
The Class B Equity limited partner is not required to make capital
contributions.
During June 2001, First Paradee, Ltd. was merged with and into WAMCO XXV
with WAMCO XXV being the surviving entity. Also during June 2001, WAMCO IX sold,
at cost, its remaining Portfolio Assets that had projected estimated remaining
collections to WAMCO XXV. During November 2000, WAMCO V and WAMCO XVII were
merged with and into WAMCO III, with WAMCO III being the surviving entity. The
mergers of the acquisition partnerships have no effect on the comparability of
the combined financial statements. The sales of assets between acquisition
partnerships and all significant intercompany balances have been eliminated.
90
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) PORTFOLIO ASSETS
The Partnerships acquire and resolve portfolios of performing and
nonperforming commercial and consumer loans and other assets (collectively,
"Portfolio Assets" or "Portfolios"), which are generally acquired at a discount
to their legal principal balance. Purchases may be in the form of pools of
assets or single assets. The Portfolio Assets are generally non-homogeneous
assets, including loans of varying qualities that are secured by diverse
collateral types and foreclosed properties. 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 either on business or real estate or other collateral cash flow. Portfolio
Assets are acquired on behalf of Acquisition Partnerships in which a corporate
general partner, FirstCity and other investors are limited partners.
Portfolio Assets are held for sale and reflected in the accompanying
combined financial statements as non-performing Portfolio Assets, performing
Portfolio Assets or real estate Portfolios. The following is a description of
each classification and the related accounting policy accorded to each Portfolio
type:
Non-Performing Portfolio Assets
Non-performing Portfolio Assets consist primarily of distressed loans and
loan related assets, such as foreclosed upon collateral. Portfolio Assets are
designated as non-performing unless substantially all of the loans in the
Portfolio are being repaid in accordance with the contractual terms of the
underlying loan agreements at date of acquisition. Such Portfolios are acquired
on the basis of an evaluation by the Partnerships of the timing and amount of
cash flow expected to be derived from borrower payments or other resolution of
the underlying collateral securing the loan.
All non-performing Portfolio Assets are purchased at substantial discounts
from their outstanding legal principal amount, the total of the aggregate of
expected future sales prices and the total payments to be received from
obligors. Subsequent to acquisition, the amortized cost of non-performing
Portfolio Assets is evaluated for impairment on a quarterly basis. A valuation
allowance is established for any impairment identified through provisions
charged to earnings in the period the impairment is identified. Impairments on
non-performing Portfolio Assets were $97, $497, and zero for 2002, 2001 and
2000, respectively.
Net gain on resolution of non-performing Portfolio Assets is recognized as
income to the extent that proceeds collected exceed a pro rata portion of
allocated cost from the Portfolio. Cost allocation is based on a proration of
actual proceeds divided by total estimated proceeds of the pool. No interest
income is recognized separately on non-performing Portfolio Assets. All
proceeds, of whatever type, are included in proceeds from resolution of
Portfolio Assets in determining the gain on resolution of such assets.
Accounting for Portfolios is on a pool basis as opposed to an individual
asset-by-asset basis.
Performing Portfolio Assets
Performing Portfolio Assets consist primarily of Portfolios of consumer and
commercial loans acquired at a discount from the aggregate amount of the
borrowers' obligation. Portfolios are classified as performing if substantially
all of the loans in the Portfolio are being repaid in accordance with the
contractual terms of the underlying loan agreements at date of acquisition.
Performing Portfolio Assets are carried at the unpaid principal balance of
the underlying loans, net of acquisition discounts. Interest is accrued when
earned in accordance with the contractual terms of the loans. The accrual of
interest is discontinued once a loan becomes past due 90 days or more.
Acquisition discounts for the Portfolio as a whole are accreted as an adjustment
to yield over the estimated life of the Portfolio. Accounting for these
Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.
91
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Gains are recognized on the performing Portfolio Assets when sufficient
funds are received to fully satisfy the obligation on loans included in the
pool, either from funds from the borrower or sale of the loan. The gain
recognized represents the difference between the proceeds received and the
allocated carrying value of the individual loan in the pool.
Impairment on each Portfolio is measured based on the present value of the
expected future cash flows in the aggregate discounted at the loans' risk
adjusted rates, which approximates the effective interest rates, or the fair
value of the collateral, less estimated selling costs, if any loans are
collateral dependent and foreclosure is probable. Impairments on performing
Portfolio Assets were $790, $757, and $58 for 2002, 2001 and 2000, respectively.
Real Estate Portfolios
Real estate Portfolios consist of real estate assets acquired from a
variety of sellers. Such Portfolios are carried at the lower of cost or fair
value less estimated costs to sell. Costs relating to the development and
improvement of real estate for its intended use are capitalized, whereas those
relating to holding assets are charged to expense. Income or loss is recognized
upon the disposal of the real estate. Rental income, net of expenses, on real
estate Portfolios is recognized when received. Accounting for the Portfolios is
on an individual asset-by-asset basis as opposed to a pool basis. Subsequent to
acquisition, the amortized cost of real estate Portfolios is evaluated for
impairment on a quarterly basis. The evaluation of impairment is determined
based on the review of the estimated future cash receipts, which represents the
net realizable value of the real estate Portfolio. A valuation allowance is
established for any impairment identified through provisions charged to earnings
in the period the impairment is identified. Impairments on real estate
Portfolios were $17 in 2002. There were no impairments on real estate Portfolios
in 2001 and 2000.
Assets are foreclosed when necessary through an arrangement with an
affiliated entity whereby title to the foreclosed asset is held by the
affiliated entity and a note receivable from the affiliate is held by the
Partnerships. For financial statement presentation, the affiliated entity note
receivable created by the arrangement is included in Portfolio Assets and is
recorded at the lower of allocated cost or fair value less estimated cost to
sell the underlying asset.
(b) INVESTMENT IN TRUST CERTIFICATES
The Partnerships hold an investment in trust certificates, representing a
residual interest in a REMIC created by the sale of certain Partnership assets.
This residual interest is subordinate to the senior tranches of the certificate
and represents the present value of the right to the excess cash flows generated
by the securitized assets. The residual certificates are accounted for under
Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Because such assets can be
contractually prepaid or otherwise settled in such a way that the holder would
not receive all of the recorded investment, the assets are classified as
available-for-sale investments and are carried at estimated fair value with any
accompanying increases or decreases in estimated fair value being recorded as
unrealized gains or losses in other comprehensive income in the accompanying
combined statements of changes in partners' capital. The determination of fair
value is based on the present value of the anticipated excess cash flows
utilizing the certain valuation assumptions. The significant valuation
assumptions include expected credit losses and timing of cash collected.
The Partnerships assess the carrying value of this investment for
impairment in accordance with the provisions of EITF 99-20, Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets, which requires that other-than-temporary
impairments in beneficial interests be written down to fair value with the
resulting change being included in operations. As of December 31, 2002, no
impairments have been recorded relating to the investment in trust certificate.
There can be no assurance that the Partnerships' estimates used to determine the
fair value of the investment in trust
92
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
certificate will remain appropriate for the life of each asset and it is
reasonably possible that circumstances could change in future periods which
could result in a material change in the estimates used to prepare the
accompanying combined financial statements. If actual credit losses or timing of
cash collected exceed the Company's current estimates, other than temporary
impairment may be required to be recognized.
(c) INCOME TAXES
Under current Federal laws, partnerships are not subject to income taxes;
therefore, no provision has been made for such taxes in the accompanying
combined financial statements. For tax purposes, income or loss is included in
the individual tax returns of the partners.
(d) USE OF ESTIMATES
The preparation of combined financial statements in conformity with
accounting principles generally accepted in the United States of America
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 combined financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
(e) RECLASSIFICATIONS
Certain amounts in the financial statements for prior years have been
reclassified to conform with current financial statement presentation.
93
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(3) COMBINING FINANCIAL STATEMENTS
FC Properties and WAMCO XXVIII are considered to be significant
subsidiaries of FirstCity. The following tables summarize the combining balance
sheets of the WAMCO Partnerships as of December 31, 2002 and 2001, and the
related combining statements of operations, changes in partners' capital, and
cash flows for each of the years' in the three-year period ended December 31,
2002.
COMBINING BALANCE SHEETS
DECEMBER 31, 2002
<Table>
<Caption>
WAMCO OTHER
FC PROPERTIES XXVIII PARTNERSHIPS COMBINED
------------- ------- ------------ --------
(DOLLARS IN THOUSANDS)
ASSETS
Cash.................................... $ 1,484 $ 2,440 $ 9,111 $ 13,035
Portfolio Assets, net................... 15,182 32,341 100,163 147,686
Investments in partnerships............. -- -- 2,302 2,302
Investments in trust certificates....... -- -- 7,883 7,883
Deferred profit sharing................. 17,671 -- -- 17,671
Other assets, net....................... 5 346 464 815
------- ------- -------- --------
$34,342 $35,127 $119,923 $189,392
======= ======= ======== ========
LIABILITIES AND PARTNERS' CAPITAL
Notes payable........................... $ -- $18,882 $ 61,009 $ 79,891
Deferred compensation................... 21,706 -- -- 21,706
Other liabilities....................... 540 1,301 1,551 3,392
------- ------- -------- --------
Total liabilities..................... 22,246 20,183 62,560 104,989
Preferred equity........................ -- -- 4,344 4,344
Partners' capital....................... 12,096 14,944 53,019 80,059
------- ------- -------- --------
$34,342 $35,127 $119,923 $189,392
======= ======= ======== ========
Notes payable owed to affiliates
included in above balances............ $ -- $ -- $ 46,137 $ 46,137
Other liabilities owed to affiliates
included in above balances............ 20 69 536 625
</Table>
94
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINING BALANCE SHEETS
DECEMBER 31, 2001
<Table>
<Caption>
WAMCO OTHER
FC PROPERTIES XXVIII PARTNERSHIPS COMBINED
------------- ------- ------------ --------
(DOLLARS IN THOUSANDS)
ASSETS
Cash.................................... $ 1,942 $ 3,510 $ 7,945 $ 13,397
Portfolio Assets, net................... 15,566 70,283 132,882 218,731
Investments in partnerships............. -- -- 2,302 2,302
Investments in trust certificates....... -- -- 8,223 8,223
Deferred profit sharing................. 15,506 -- -- 15,506
Other assets, net....................... 5 143 1,310 1,458
------- ------- -------- --------
$33,019 $73,936 $152,662 $259,617
======= ======= ======== ========
LIABILITIES AND PARTNERS' CAPITAL
Notes payable........................... $ -- $47,964 $ 92,447 $140,411
Deferred compensation................... 20,552 -- -- 20,552
Other liabilities....................... 443 1,162 2,195 3,800
------- ------- -------- --------
Total liabilities..................... 20,995 49,126 94,642 164,763
Preferred equity........................ -- -- 4,605 4,605
Partners' capital....................... 12,024 24,810 53,415 90,249
------- ------- -------- --------
$33,019 $73,936 $152,662 $259,617
======= ======= ======== ========
Notes payable owed to affiliates
included in above balances............ $ -- $47,964 $ 53,214 $101,178
Other liabilities owed to affiliates
included in above balances............ 1 95 462 558
</Table>
95
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINING STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- ------- ------------ --------
(DOLLARS IN THOUSANDS)
Proceeds from resolution of Portfolio Assets....... $ 6,803 $47,892 $78,503 $133,198
Cost of Portfolio Assets resolved.................. 2,000 34,418 65,752 102,170
------- ------- ------- --------
Gain on resolution of Portfolio Assets............. 4,803 13,474 12,751 31,028
Interest income on performing Portfolio Assets..... -- 2,767 8,513 11,280
Interest and fees expense -- affiliate............. -- (1,826) (3,361) (5,187)
Interest and fees expense -- other................. (9) (585) (1,363) (1,957)
Provision for loan losses.......................... (17) -- (887) (904)
Service fees -- affiliate.......................... (204) (1,574) (2,001) (3,779)
General, administrative and operating expenses..... (1,923) (1,488) (1,379) (4,790)
Other income, net.................................. 18 34 1,798 1,850
------- ------- ------- --------
Net earnings..................................... $ 2,668 $10,802 $14,071 $ 27,541
======= ======= ======= ========
</Table>
COMBINING STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- ------- ------------ --------
(DOLLARS IN THOUSANDS)
Proceeds from resolution of Portfolio Assets....... $ 9,509 $32,142 $27,537 $ 69,188
Cost of Portfolio Assets resolved.................. 2,115 23,513 19,288 44,916
------- ------- ------- --------
Gain on resolution of Portfolio Assets............. 7,394 8,629 8,249 24,272
Interest income on performing Portfolio Assets..... -- 3,047 16,496 19,543
Interest and fees expense -- affiliate............. (160) (3,507) (8,437) (12,104)
Interest and fees expense -- other................. -- -- (1,234) (1,234)
Provision for loan losses.......................... -- -- (1,254) (1,254)
Service fees -- affiliate.......................... (285) (1,067) (1,779) (3,131)
General, administrative and operating expenses..... (2,710) (1,330) (2,712) (6,752)
Other income, net.................................. 32 64 1,692 1,788
------- ------- ------- --------
Net earnings..................................... $ 4,271 $5,836 $11,021 $ 21,128
======= ======= ======= ========
</Table>
COMBINING STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2000
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- ------ ------------ --------
(DOLLARS IN THOUSANDS)
Proceeds from resolution of Portfolio Assets....... $ 8,500 $2,532 $ 33,150 $ 44,182
Cost of Portfolio Assets resolved.................. 4,346 1,854 23,915 30,115
------- ------ -------- --------
Gain on resolution of Portfolio Assets............. 4,154 678 9,235 14,067
Interest income on performing Portfolio Assets..... -- 286 17,763 18,049
Interest and fees expense -- affiliate............. (580) (573) (13,441) (14,594)
Interest and fees expense -- other................. -- -- (182) (182)
Provision for loan losses.......................... -- -- (58) (58)
Service fees -- affiliate.......................... (255) (104) (2,169) (2,528)
General, administrative and operating expenses..... (2,240) (57) (1,762) (4,059)
Other income, net.................................. 58 8 1,596 1,662
------- ------ -------- --------
Net earnings..................................... $ 1,137 $ 238 $ 10,982 $ 12,357
======= ====== ======== ========
</Table>
See accompanying notes to combined financial statements.
96
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINING STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- -------- ------------ --------
(DOLLARS IN THOUSANDS)
BALANCE AT DECEMBER 31, 1999...................... $ 8,005 $ -- $ 55,014 $ 63,019
Contributions................................... -- 4,421 1,712 6,133
Distributions................................... (296) (443) (19,166) (19,905)
Net earnings.................................... 1,137 238 10,982 12,357
------- -------- -------- --------
Total comprehensive income...................... 1,137 238 10,982 12,357
------- -------- -------- --------
BALANCE AT DECEMBER 31, 2000...................... 8,846 4,216 48,542 61,604
Contributions................................... -- 18,890 7,640 26,530
Distributions................................... (1,093) (4,132) (14,722) (19,947)
Net earnings.................................... 4,271 5,836 11,021 21,128
Unrealized net gain on securitization........... -- -- 934 934
------- -------- -------- --------
Total comprehensive income...................... 4,271 5,836 11,955 22,062
------- -------- -------- --------
BALANCE AT DECEMBER 31, 2001...................... 12,024 24,810 53,415 90,249
------- -------- -------- --------
Contributions................................... -- 15,971 15,971
Distributions................................... (2,596) (20,668) (30,934) (54,198)
Net earnings.................................... 2,668 10,802 14,071 27,541
Unrealized net gain on securitization........... -- -- 496 496
------- -------- -------- --------
Total comprehensive income...................... 2,668 10,802 14,567 28,037
------- -------- -------- --------
BALANCE AT DECEMBER 31, 2002...................... $12,096 $ 14,944 $ 53,019 $ 80,059
======= ======== ======== ========
</Table>
97
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINING STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2002
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- -------- ------------ ---------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net earnings....................................... $ 2,668 $ 10,802 $ 14,071 $ 27,541
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Amortization of loan origination and commitment
fees.......................................... -- 87 435 522
Amortization of deferred profit sharing......... 720 -- -- 720
Accretion of unrealized gain on trust
certificates.................................. -- -- (287) (287)
Provision for loan losses....................... 17 -- 887 904
Gain on resolution of Portfolio Assets.......... (4,803) (13,474) (12,751) (31,028)
Purchase of Portfolio Assets.................... -- -- (48,713) (48,713)
Capitalized costs on Portfolio Assets........... (1,633) (2,177) (249) (4,059)
Capitalized interest on Portfolio Assets........ -- (102) (795) (897)
Proceeds from resolution of Portfolio Assets.... 6,803 47,892 78,503 133,198
Proceeds from sell back of Portfolio Assets..... -- -- -- --
Principal payments on Performing Portfolio
Assets........................................ -- 5,803 15,837 21,640
Increase in deferred profit sharing............. (2,885) -- -- (2,885)
(Increase) decrease in other assets............. -- (295) 465 170
Increase in deferred compensation............... 2,885 -- -- 2,885
Deferred compensation and profit sharing paid... (1,730) -- -- (1,730)
Increase (decrease) in other liabilities........ 96 144 (698) (458)
------- -------- -------- ---------
Net cash provided by operating activities..... 2,138 48,680 46,705 97,523
Cash flows from investing activities:
Contribution to subsidiaries....................... -- -- -- --
Change in trust certificates....................... -- -- 1,123 1,123
------- -------- -------- ---------
Net cash provided by investing activities..... -- -- 1,123 1,123
Cash flows from financing activities:
Borrowing of debt -- affiliate..................... -- -- 53,143 53,143
Borrowing of debt.................................. -- 28,500 -- 28,500
Repayment of debt -- affiliate..................... -- (47,964) (60,220) (108,184)
Repayment of debt.................................. -- (9,618) (24,361) (33,979)
Capitalized interest on preferred equity........... -- -- 150 150
Repayment of preferred equity...................... -- -- (411) (411)
Capital contributions.............................. -- -- 15,971 15,971
Capital distributions.............................. (2,596) (20,668) (30,934) (54,198)
------- -------- -------- ---------
Net cash used in financing activities......... (2,596) (49,750) (46,662) (99,008)
------- -------- -------- ---------
Net increase (decrease) in cash...................... (458) (1,070) 1,166 (362)
Cash at beginning of year............................ 1,942 3,510 7,945 13,397
------- -------- -------- ---------
Cash at end of year.................................. $ 1,484 $ 2,440 $ 9,111 $ 13,035
======= ======== ======== =========
Supplemental disclosure of cash flow information
Approximate cash paid for interest................. $ 9 $ 2,412 $ 4,361 $ 6,782
</Table>
98
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINING STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2001
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- -------- ------------ ---------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net earnings....................................... $ 4,271 $ 5,836 $ 11,021 $ 21,128
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Amortization of loan origination and commitment
fees.......................................... -- -- 768 768
Amortization of deferred profit sharing......... 1,228 -- -- 1,228
Provision for loan losses....................... -- -- 1,254 1,254
Gain on resolution of Portfolio Assets.......... (7,394) (8,629) (8,249) (24,272)
Purchase of Portfolio Assets.................... -- (82,951) (35,196) (118,147)
Capitalized costs on Portfolio Assets........... (375) (149) (12) (536)
Capitalized interest on Portfolio Assets........ -- (7) (1,221) (1,228)
Proceeds from resolution of Portfolio Assets.... 9,509 32,142 27,537 69,188
Proceeds from sell back of Portfolio Assets..... -- -- 1,594 1,594
Principal payments on Performing Portfolio
Assets........................................ -- 4,936 29,135 34,071
Increase in deferred profit sharing............. (560) -- -- (560)
(Increase) decrease in other assets............. 157 (252) 52 (43)
Increase in deferred compensation............... 560 -- -- 560
Deferred compensation and profit sharing paid... (2,365) -- -- (2,365)
Increase (decrease) in other liabilities........ (142) 957 (557) 258
------- -------- -------- ---------
Net cash provided by (used in) operating
activities................................. 4,889 (48,117) 26,126 (17,102)
Cash flows from investing activities:
Contribution to subsidiaries....................... -- -- (48) (48)
Change in trust certificates....................... -- -- (381) (381)
------- -------- -------- ---------
Net cash used in investing activities......... -- -- (429) (429)
Cash flows from financing activities:
Borrowing of debt affiliate........................ 41 64,187 29,341 93,569
Borrowing of debt.................................. -- -- 45,901 45,901
Repayment of debt affiliate........................ (3,165) (28,191) (81,971) (113,327)
Repayment of debt.................................. -- -- (8,930) (8,930)
Capitalized interest on preferred equity........... -- -- 1,049 1,049
Repayment of preferred equity...................... -- -- -- --
Capital contributions.............................. -- 18,890 7,640 26,530
Capital distributions.............................. (1,093) (4,132) (14,722) (19,947)
------- -------- -------- ---------
Net cash provided by (used in) financing
activities................................. (4,217) 50,754 (21,692) 24,845
------- -------- -------- ---------
Net increase in cash................................. 672 2,637 4,005 7,314
Cash at beginning of year............................ 1,270 873 3,940 6,083
------- -------- -------- ---------
Cash at end of year.................................. $ 1,942 $ 3,510 $ 7,945 $ 13,397
======= ======== ======== =========
Supplemental disclosure of cash flow information:
Approximate cash paid for interest................. $ 107 $ 3,365 9,061 $ 12,533
</Table>
99
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINING STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2000
<Table>
<Caption>
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- -------- ------------ --------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net earnings.................................... $ 1,137 $ 238 $ 10,982 $ 12,357
Adjustments to reconcile net earnings to net
cash provided by (used in) operating
activities:
Amortization of loan origination and
commitment fees............................ -- -- 376 376
Amortization of deferred profit sharing...... 1,117 -- -- 1,117
Provision for loan losses.................... -- -- 58 58
Gain on resolution of Portfolio Assets....... (4,154) (678) (9,235) (14,067)
Purchase of Portfolio Assets................. -- (17,852) -- (17,852)
Capitalized costs on Portfolio Assets........ (610) (287) (600) (1,497)
Capitalized interest on Portfolio Assets..... -- -- -- --
Proceeds from resolution of Portfolio
Assets..................................... 8,500 2,532 33,150 44,182
Proceeds from sell back of Portfolio
Assets..................................... -- -- -- --
Principal payments on Performing Loan
pools...................................... -- 660 27,131 27,791
Increase in deferred profit sharing.......... (9,409) -- -- (9,409)
(Increase) decrease in other assets.......... (144) (17) 756 595
Increase in deferred compensation............ 9,409 -- -- 9,409
Deferred compensation and profit sharing
paid....................................... -- -- -- --
Increase (decrease) in other liabilities..... 425 331 504 1,260
------- -------- -------- --------
Net cash provided by (used in) operating
activities.............................. 6,271 (15,073) 63,122 54,320
Cash flows from investing activities:
Contribution to subsidiaries.................... -- -- (573) (573)
Change in trust certificates.................... -- -- (420) (420)
------- -------- -------- --------
Net cash used in investing activities...... -- -- (993) (993)
Cash flows from financing activities:
Borrowing of debt- affiliate.................... 171 13,265 8,621 22,057
Borrowing of debt............................... -- -- -- --
Repayment of debt-affiliate..................... (5,939) (1,297) (53,772) (61,008)
Repayment of debt............................... -- -- (919) (919)
Capitalized interest on preferred equity........ -- -- -- --
Repayment of preferred equity................... -- -- -- --
Capital contributions........................... -- 4,421 1,712 6,133
Capital distributions........................... (296) (443) (19,166) (19,905)
------- -------- -------- --------
Net cash provided by (used in) financing
activities.............................. (6,064) 15,946 (63,524) (53,642)
------- -------- -------- --------
Net increase (decrease) in cash................. 207 873 (1,395) (315)
Cash at beginning of year....................... 1,063 -- 5,335 6,398
------- -------- -------- --------
Cash at end of year............................. $ 1,270 $ 873 $ 3,940 $ 6,083
======= ======== ======== ========
Supplemental disclosure of cash flow information:
Approximate cash paid for interest.............. $ 521 $ 511 13,611 $ 14,643
</Table>
100
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(4) PORTFOLIO ASSETS
Portfolio Assets are summarized as follows:
<Table>
<Caption>
DECEMBER 31, 2002
------------------------------------------------
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- -------- ------------ ---------
Non-performing Portfolio Assets.............. $ -- $ 60,386 $ 141,468 $ 201,854
Performing Portfolio Assets.................. -- 20,404 59,461 79,865
Real estate Portfolios....................... 15,182 -- 1,129 16,311
------- -------- --------- ---------
Total Portfolio Assets..................... 15,182 80,790 202,058 298,030
Discount required to reflect Portfolio Assets
at carrying value.......................... -- (48,449) (101,895) (150,344)
------- -------- --------- ---------
Portfolio Assets, net...................... $15,182 $ 32,341 $ 100,163 $ 147,686
======= ======== ========= =========
</Table>
<Table>
<Caption>
DECEMBER 31, 2001
------------------------------------------------
FC WAMCO OTHER
PROPERTIES XXVIII PARTNERSHIPS COMBINED
---------- -------- ------------ ---------
Non-performing Portfolio Assets.............. $ -- $104,735 $ 62,548 $ 167,283
Performing Portfolio Assets.................. -- 39,762 148,307 188,069
Real estate Portfolios....................... 15,566 -- 1,526 17,092
------- -------- -------- ---------
Total Portfolio Assets..................... 15,566 144,497 212,381 372,444
Discount required to reflect Portfolio Assets
at carrying value.......................... -- (74,214) (79,499) (153,713)
------- -------- -------- ---------
Portfolio Assets, net...................... $15,566 $ 70,283 $132,882 $ 218,731
======= ======== ======== =========
</Table>
Portfolio Assets are pledged to secure non-recourse notes payable.
(5) INTEREST RELATED TO RESIDUAL INTEREST IN TRUST CERTIFICATES
Residual certificates held by the Partnerships to which the Partnerships
receives all the economic benefits and risks consist of retained interests in
the amount of $7,883 and $8,223 at December 31, 2002 and 2001, respectively. The
Partnerships recognized interest income on these certificates utilizing a yield
of 20.90%, 19.63% and 20.23% for the years ended December 31, 2002, 2001 and
2000, respectively.
An analysis of the changes in the unrealized net gains on securitization
transactions during 2002 and 2001 follows (dollars in thousands). There were no
unrealized gains or losses on securitization transactions in 2000.
<Table>
BALANCE, DECEMBER 31, 2000.................................. $ --
Aggregate adjustment for the period resulting from
unrealized net gains on securitizations................. 934
------
BALANCE, DECEMBER 31, 2001.................................. 934
Aggregate adjustment for the period resulting from
unrealized net gains on securitizations................. 496
------
BALANCE, DECEMBER 31, 2002.................................. $1,430
======
</Table>
SFAS 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities -- A Replacement of FASB Statement No. 125
requires that the effect on the fair value of the retained interests of two
adverse changes in each key assumption be independently calculated.
101
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 2002 key economic assumptions and the sensitivity of the
current fair value of residual cash flows to immediate 10% and 20% adverse
changes in those assumptions are as follows:
<Table>
Balance sheet carrying value of retained interests -- fair
value..................................................... $ 7,883
Expected credit losses......................................
Impact on fair value of 10% adverse change.................. (788)
Impact on fair value of 20% adverse change.................. (1,576)
Timing of cash collected....................................
Impact on fair value of 10% adverse change.................. (630)
Impact on fair value of 20% adverse change.................. (1,209)
</Table>
These sensitivities are hypothetical and should be used with caution. As
the amounts indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increase in market interest rates may result in increased credit
losses), which might magnify or counteract the sensitivities.
(6) DEFERRED PROFIT SHARING AND DEFERRED COMPENSATION
In connection with the formation of FC Properties, an agreement was entered
into which provided for potential payments to the project manager based on a
percentage of total estimated sales. An equal amount of deferred profit
participation and deferred compensation is recorded based on such estimates with
the deferred profit participation being amortized into expense in proportion to
actual sales realized. No profit participation was paid until the limited
partners recognized a 20% return on their investment. This return threshold was
met in 2001. At December 31, 2002 and 2001, the estimated liability for this
profit participation was $21,706 and $20,552, respectively, and was included in
deferred compensation in the accompanying combined balance sheets. Additionally,
amortization of $720, $1,228 and $1,117 was recognized during 2002, 2001 and
2000, respectively, and has been included in general, administrative and
operating expenses in the accompanying combined statements of operations.
The achievement of the 20% return on investment resulted in payments of
$1,730 and $2,365 in deferred profit sharing and commissions in 2002 and 2001,
respectively.
(7) NOTES PAYABLE
Notes payable at December 31, 2002 and 2001 consist of the following:
<Table>
<Caption>
2002 2001
------- --------
London Interbank Offering Rate (LIBOR) (1.38% at December
31, 2002) based:
WAMCO XXVIII (LIBOR plus 2.5%)............................ $18,882 $ --
WAMCO XXVIII (LIBOR plus 2.31% to 4.0%) -- affiliate...... -- 47,964
Other Partnerships (LIBOR plus 2.5% to 5%) -- affiliate... 34,177 43,334
Other Partnerships (LIBOR plus 1.75% to 5%)............... 14,872 37,692
Other Partnerships (LIBOR plus 5%, with floor
9.0%) -- affiliate..................................... 4,061 --
------- --------
Total LIBOR............................................ 71,992 128,990
Fixed rate:
Other Partnerships (9.8% to 10.17%) -- affiliate.......... 7,899 9,880
Other Partnerships (6.5%)................................. -- 1,541
------- --------
$79,891 $140,411
======= ========
</Table>
102
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Collateralized loans are typically payable based on proceeds from
disposition of and payments received on the Portfolio Assets.
Contractual maturities (excluding principal and interest payments payable
from proceeds from dispositions of and payments received on the Portfolio
Assets) of notes payable are as follows:
<Table>
<Caption>
WAMCO OTHER
XXVIII PARTNERSHIPS COMBINED
------- ------------ --------
YEAR ENDING DECEMBER 31:
2003.................................................. $2,382 $15,676 $18,058
2004.................................................. 16,500 34,948 51,448
2005.................................................. -- 6,385 6,385
2006.................................................. -- -- --
2007.................................................. -- 4,000 4,000
Thereafter............................................ -- -- --
------- ------- -------
$18,882 $61,009 $79,891
======= ======= =======
</Table>
It is anticipated that the notes payable maturing in 2003 will be renewed
or refinanced into financing arrangements with terms similar to current
facilities.
The loan agreements and master note purchase agreements, under which notes
payable were incurred, contain various covenants including limitations on other
indebtedness, maintenance of service agreements and restrictions on use of
proceeds from disposition of and payments received on the Portfolio Assets. As
of December 31, 2002, the Partnerships were in compliance with the
aforementioned covenants.
In connection with notes payable, the Partnerships incurred origination and
commitment fees. These fees are amortized over the stated maturity of the
related notes and are included in interest and fees on notes payable. At
December 31, 2002 and 2001, approximately $447 and $603, respectively, of
origination and commitment fees are included in other assets, net.
(8) TRANSACTIONS WITH AFFILIATES
Under the terms of the various servicing agreements between the
Partnerships and FirstCity, FirstCity receives a servicing fee based on proceeds
from resolution of the Portfolio Assets for processing transactions on the
Portfolio Assets and for conducting settlement, collection and other resolution
activities. Included in general, administrative and operating expenses in the
accompanying combined statements of operations is approximately $3,779, $3,131,
and $2,528 in servicing fees incurred by the Partnerships in 2002, 2001 and
2000, respectively.
In March 2001, FirstCity sold 35% of its equity interest in FC Properties,
Ltd. to CFSC Capital Corp. II.
During 2001, WAMCO IX sold its portfolio assets that had projected
estimated remaining collections to WAMCO XXV. The assets were sold for their
historical cost book value of $1,206. The sale resulted in no gain or goodwill
being recorded. This transaction was eliminated in the combining statements of
operations for 2001.
During 2000, WAMCO V merged with WAMCO III, with WAMCO III being the
surviving entity. As a result of the merger, WAMCO V contributed $3,370 in
assets and $1,461 in liabilities to WAMCO III. The contributed assets and
liabilities were recorded at historical cost on WAMCO III. The partners in WAMCO
V received interests in WAMCO III reflecting the net contribution from WAMCO V
to WAMCO III.
103
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
During 2000, WAMCO XVII merged with WAMCO III, with WAMCO III being the
surviving entity. As a result of the merger, WAMCO XVII contributed $4,024 in
assets and $2,275 in liabilities to WAMCO III. The contributed assets and
liabilities were recorded at historical cost on WAMCO III. The partners in WAMCO
XVII received interests in WAMCO III reflecting the net contribution from WAMCO
XVII to WAMCO III.
(9) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires that the Partnerships disclose
estimated fair values of their financial instruments. Fair value estimates,
methods and assumptions are set forth below.
(a) CASH AND OTHER LIABILITIES
The carrying amount of cash and other liabilities approximates fair value
at December 31, 2002 and 2001 due to the short-term nature of such accounts.
(b) PORTFOLIO ASSETS
Portfolio Assets are carried at the lower of cost or estimated fair value.
The estimated fair value is calculated by discounting projected cash flows on an
asset-by-asset basis using estimated market discount rates that reflect the
credit and interest rate risk inherent in the assets. The carrying value of
Portfolio Assets was $147,686 and $218,731 at December 31, 2002 and 2001,
respectively. The estimated fair value of the Portfolio Assets was approximately
$200,881 and $287,302 at December 31, 2002 and 2001, respectively.
(c) INVESTMENTS IN TRUST CERTIFICATES
Investments in trust certificates are carried at estimated fair value. The
determination of fair value is based on the present value of the anticipated
excess cash flows utilizing the certain valuation assumptions. The carrying
value of Investments in Trust Certificates was $7,883 and $8,223 at December 31,
2002 and 2001, respectively. The estimated fair value of the Investments in
Trust Certificates was approximately $7,883 and $8,223 at December 31, 2002 and
2001, respectively.
(d) NOTES PAYABLE
Management believes that for similar financial instruments with comparable
credit risks, the stated interest rates at December 31, 2002 and 2001
approximate market rates. Accordingly, the carrying amount of notes payable is
believed to approximate fair value. Additional, the majority of the
partnerships' debt is at variable rates of interest.
(10) PREFERRED EQUITY
In 1999, CFSC Capital Corp. XXX contributed $3,556 as preferred equity in
Community Development Investment, LLC. The preferred equity agreement requires
interest to be paid at a rate equal to the LIBOR plus 5% (6.38% at December 31,
2002). Interest in the amount of $11 and $18 has been accrued at December 31,
2002 and 2001, respectively. Interest expense on the preferred equity totaled
$311, $458 and $411 during 2002, 2001 and 2000, respectively.
(11) COMMITMENTS AND CONTINGENCIES
Calibat Fund, LLC has committed to make additional investments in
partnerships up to $89 at December 31, 2002.
104
WAMCO PARTNERSHIPS
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The Partnerships are involved in various legal proceedings in the ordinary
course of business. In the opinion of management, the resolution of such matters
will not have a material adverse impact on the combined financial position,
results of operations or liquidity of the Partnerships.
(12) INTEREST RATE SWAP
In 2001, WAMCO XXVIII entered into an interest rate swap contract in order
to manage a portion of the interest rate risk associated with WAMCO XXVIII's
long-term debt. Under this swap agreement, WAMCO XXVIII pays fixed/floating rate
interest and receives floating rate interest at specified periodic intervals
based on an agreed upon notional amount.
By using derivative financial instruments to hedge exposures to changes in
interest rates, WAMCO XXVIII exposes itself to credit risk and market risk.
Credit risk is the failure of the counterparty to perform under the terms of the
derivative contract. When the fair value of a derivative contract is positive,
the counterparty owes WAMCO XXVIII, which creates credit risk for WAMCO XXVIII.
When the fair value of a derivative contract is negative, WAMCO XXVIII owes the
counterparty and, therefore, it does not possess credit risk. WAMCO XXVIII
minimizes the credit risk in derivative instruments by entering into
transactions with high-quality counterparties.
Income or expense associated with these periodic payments is recorded on an
accrual basis. WAMCO XXVIII recorded $783 and $404 of net swap expense for the
years ended December 31, 2002 and 2001, respectively, associated with these
periodic payments. Net swap expense is included in interest and fees expense --
affiliate in the accompanying combined statements of operations.
Market risk is the adverse effect on the value of a financial instrument
that results from a change in interest rates, currency exchange rates, or
commodity prices. The market risk associated with interest-rate,
commodity-price, and foreign-exchange contracts is managed by establishing and
monitoring parameters that limit the types and degree of market risk that may be
undertaken.
WAMCO XXVIII has not met the criteria necessary to categorize its swap
agreement as a hedging activity under the provisions of FASB No. 133, Accounting
for Derivative Instruments and Hedging Activities, therefore, changes in fair
value of the interest rate swap are reported in current earnings.
The following table summarizes WAMCO XXVIII's interest rate swap contract,
included in other liabilities, and unrealized depreciation of $216 and $840
included in general, administrative and operating expenses at December 31, 2002
and 2001, respectively:
<Table>
<Caption>
SWAP SWAP
LIABILITY AT LIABILITY AT
NOTIONAL CONTACT DECEMBER 31, DECEMBER 31,
AMOUNT MATURITY DATE FIXED RATE FLOATING RATE 2002 2001
- -------- ------------- ---------- ------------- ------------ ------------
$ 4,510 12/15/02 6.136% One Month LIBOR (1.38% at 12/31/02) $ -- $157
4,510 12/15/03 6.139% One Month LIBOR (1.38% at 12/31/02) 199 225
4,510 12/15/04 6.167% One Month LIBOR (1.38% at 12/31/02) 368 232
4,510 12/15/05 6.195% One Month LIBOR (1.38% at 12/31/02) 489 226
- ------- ------ ----
$18,040 $1,056 $840
======= ====== ====
</Table>
105
DRIVE FINANCIAL SERVICES LP
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001 AND FEBRUARY 28, 2001
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
106
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Drive Financial Services LP:
We have audited the accompanying consolidated balance sheets of Drive
Financial Services LP (a Texas Limited Partnership) and subsidiaries (the
Company) as of December 31, 2002 and 2001, and the related consolidated
statements of operations, partners' equity, and cash flows for the year ended
December 31, 2002 and the periods March 1, 2001 through December 31, 2001 and
August 1, 2000 through February 28, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Drive
Financial Services LP and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for the year ended December 31,
2002 and the periods March 1, 2001 through December 31, 2001 and August 1, 2000
through February 28, 2001, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in note 2(k) to the consolidated financial statements, the
Company changed its method of accounting for residual interests in
securitizations in 2001 as a result of the adoption of EITF 99-20, Recognition
of Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets.
KPMG LLP
Dallas, Texas
February 15, 2003, except as to notes 6 and 11,
which are as of February 28, 2003
107
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND, 2001
<Table>
<Caption>
2002 2001
-------- --------
(IN THOUSANDS)
ASSETS
Cash and cash equivalents................................... $ 14,337 $ 7,303
Restricted cash............................................. 12,124 --
Retail installment contracts, net........................... 367,520 70,447
Residual interests in securitizations....................... 63,202 77,407
Accrued interest receivable................................. 4,915 1,089
Furniture and equipment, net of accumulated depreciation of
$5,077 in 2002 and $2,796 in 2001......................... 4,905 6,201
Other assets................................................ 4,674 3,031
-------- --------
Total assets...................................... $471,677 $165,478
======== ========
LIABILITIES, SUBORDINATED CAPITAL NOTE, AND PARTNERS' EQUITY
Notes payable, including $176,936 in 2002 and $94,665 in
2001 to affiliate......................................... $235,036 $ 94,665
Notes payable related to securitized retail installment
contracts................................................. 151,386 --
Capital lease obligations................................... 268 830
Accrued interest............................................ 1,387 539
Accounts payable and accrued expenses....................... 12,468 11,954
-------- --------
Total liabilities................................. 400,545 107,988
-------- --------
Subordinated capital note................................... 48,000 32,000
Partners' equity............................................ 23,132 25,490
Commitments and contingencies (notes 10 and 11)............. -- --
-------- --------
Total liabilities, subordinated capital note, and
partners' equity................................. $471,677 $165,478
======== ========
</Table>
See accompanying notes to consolidated financial statements.
108
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 AND THE PERIODS MARCH 1, 2001 THROUGH DECEMBER 31,
2001 AND
AUGUST 1, 2000 THROUGH FEBRUARY 28, 2001
<Table>
<Caption>
DECEMBER 31, DECEMBER 31, FEBRUARY 28,
2002 2001 2001
------------ ------------ ------------
(IN THOUSANDS)
Finance and other interest income....................... $101,238 $37,506 $22,031
Interest expense, including $13,046, $7,679 and $5,373,
respectively, to an affiliate......................... 16,366 9,329 8,165
-------- ------- -------
Net interest margin.............................. 84,872 28,177 13,866
-------- ------- -------
Provision for credit losses on retail installment
contracts............................................. 28,663 5,377 4,129
Impairment of residual interests in securitizations,
including servicing asset............................. 3,415 5,048 --
-------- ------- -------
Net interest margin after provision for credit
losses and impairments........................ 52,794 17,752 9,737
-------- ------- -------
Other revenues:
Gain on sale of retail installment contracts.......... -- 39,033 9,434
Servicing income...................................... 11,115 9,952 4,083
Other income.......................................... 1,205 439 173
-------- ------- -------
Total other revenues............................. 12,320 49,424 13,690
-------- ------- -------
Costs and expenses:
Salaries and benefits................................. 41,648 28,706 13,674
Servicing expense..................................... 7,980 4,434 2,211
Occupancy, data processing, communication, and
other.............................................. 17,126 13,990 6,566
-------- ------- -------
Total costs and expenses......................... 66,754 47,130 22,451
-------- ------- -------
(Loss) income before cumulative effect of change
in accounting principle....................... (1,640) 20,046 976
Cumulative effect of change in accounting
principle -- permanent impairments of residual
interests............................................. -- (783) --
-------- ------- -------
Net (loss) income................................ $ (1,640) $19,263 $ 976
======== ======= =======
</Table>
See accompanying notes to consolidated financial statements.
109
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY
YEAR ENDED DECEMBER 31, 2002 AND FOR THE PERIODS MARCH 1, 2001 THROUGH DECEMBER
31, 2001 AND
AUGUST 1, 2000 THROUGH FEBRUARY 28, 2001
<Table>
<Caption>
ACCUMULATED
OTHER TOTAL
GENERAL LIMITED COMPREHENSIVE PARTNERS'
PARTNER PARTNERS INCOME EQUITY
------- -------- ------------- ---------
(IN THOUSANDS)
Contribution of net assets (note 1)................. $ 3 $ 2,889 $ 1,106 $ 3,998
Comprehensive income:
Net income........................................ 1 975 -- 976
Net change in unrealized gains on residual
interests in securitizations................... -- -- 3,051 3,051
-------
Comprehensive income......................... 4,027
--- ------- ------- -------
Partners' equity at February 28, 2001............... 4 3,864 4,157 8,025
Comprehensive income:
Net income........................................ 19 19,244 -- 19,263
Net change in unrealized losses on residual
interests in securitizations................... -- -- (1,798) (1,798)
-------
Comprehensive income......................... 17,465
--- ------- ------- -------
Partners' equity at December 31, 2001............... 23 23,108 2,359 25,490
Comprehensive loss:
Net loss.......................................... (1) (1,639) -- (1,640)
Net change in unrealized losses on residual
interests in securitizations................... -- -- (718) (718)
-------
Comprehensive loss........................... (2,358)
--- ------- ------- -------
Partners' equity at December 31, 2002............... $22 $21,469 $ 1,641 $23,132
=== ======= ======= =======
</Table>
See accompanying notes to consolidated financial statements.
110
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2002 AND FOR THE PERIODS MARCH 1, 2001 THROUGH DECEMBER
31, 2001
AND AUGUST 1, 2000 THROUGH FEBRUARY 28, 2001
<Table>
<Caption>
DECEMBER 31, DECEMBER 31, FEBRUARY 28,
2002 2001 2001
------------ ------------ ------------
(IN THOUSANDS)
Cash flows from operating activities:
Net (loss) income........................................ $ (1,640) $ 19,263 $ 976
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Decrease (increase) in retail installment contracts,
net of securitization activity...................... (293,279) 56,884 (56,431)
Provision for credit losses on retail installment
contracts........................................... 28,663 5,377 4,129
Depreciation and amortization......................... 2,281 1,951 859
Gain on sale of retail installment contracts.......... -- (39,033) (9,434)
Accretion of discount and capitalized origination
costs............................................... (27,093) -- --
Accretion of interest related to residual interests... (11,965) (12,020) (3,126)
Impairment of residual interests in securitizations,
including servicing asset........................... 3,415 5,048 --
Cumulative effect of change in accounting principle --
permanent impairment of residual interests.......... -- 783 --
Changes in assets and liabilities:
Accrued interest receivable......................... (3,826) 671 (635)
Other assets........................................ (1,643) 141 269
Accrued interest payable............................ 848 (564) 923
Accounts payable and accrued expenses............... 514 (3,135) 11,138
--------- -------- --------
Net cash provided by (used in) operating
activities..................................... (303,725) 35,366 (51,332)
--------- -------- --------
Cash flows from investing activities:
Purchases of furniture and equipment..................... (985) (3,956) (1,614)
Collections on residual interests in securitizations..... 16,673 29,455 10,640
--------- -------- --------
Net cash provided by investing activities........ 15,688 25,499 9,026
--------- -------- --------
Cash flows from financing activities:
Net increase (decrease) in warehouse line of credit...... 153,771 (56,725) (18,879)
Net change in restricted cash............................ (12,124) -- --
Proceeds from term notes payable......................... -- -- 60,000
Payments on term notes payable........................... (13,400) (15,975) (16,525)
Payments on capital leases............................... (562) (451) (312)
Proceeds from subordinated capital note.................. 16,000 12,000 20,000
Proceeds from notes payable related to securitized retail
installment contracts, net of debt issuance costs..... 174,141 -- --
Payments on notes payable related to securitized retail
installment contracts................................. (22,755) -- --
--------- -------- --------
Net cash provided by (used in) financing
activities..................................... 295,071 (61,151) 44,284
--------- -------- --------
Net increase (decrease) in cash.................. 7,034 (286) 1,978
Cash at beginning of period................................ 7,303 7,589 5,611
--------- -------- --------
Cash at end of period...................................... $ 14,337 $ 7,303 $ 7,589
========= ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest................. $ 15,518 $ 9,894 $ 7,216
========= ======== ========
</Table>
See accompanying notes to consolidated financial statements.
111
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001 AND FEBRUARY 28, 2001
(DOLLARS IN THOUSANDS)
(1) ORGANIZATION AND BUSINESS
Drive Financial Services LP (Drive FS), a Texas Limited Partnership, was
formed on August 1, 2000. Pursuant to the terms of various Contribution and
Assumption Agreements, Drive FS assumed substantially all the assets and the
business of the former auto finance group of FirstCity Funding and FirstCity
Consumer Lending, including the origination and servicing platforms, all rights
and obligations under asset-backed securities, and 100% of the stock of all
special purpose entities formed to be "sellers" in securitization transactions.
Drive FS contributed the assets and liabilities and business of FirstCity
Servicing to Drive Servicing LLC and the asset-backed securities to Drive ABS LP
both wholly owned and consolidated entities. The assets and liabilities were
contributed at their historical net book value of $3,998.
Drive FS is a specialized consumer finance company engaged in the purchase,
securitization, and servicing of retail installment contracts originated by
automobile dealers. Drive FS acquires retail installment contracts principally
from manufacturer-franchised dealers in connection with their sale of used and
new automobiles and light duty trucks to "sub-prime" customers with limited
credit histories or past credit problems. At the present, Drive FS does not
extend credit directly to consumers, nor does it purchase retail installment
contracts from other financial institutions.
The accompanying consolidated financial statements include the accounts of
Drive Financial Services LP, Drive ABS LP, Drive ABS GP, FCAR Receivables Corp.
(FCAR), Drive Servicing LLC, Drive BOS GP, Drive BOS LP and Drive VFC LP
(collectively referred to as the Company). Significant intercompany transactions
have been eliminated in the preparation of the consolidated financial
statements.
The Company owns 100% of the membership interests of FCAR, Drive BOS LP,
and Drive VFC LP, special purpose entities formed to acquire retail installment
contracts, which are pledged as collateral on warehouse lines of credit.
Drive GP LLC (Drive GP) is the sole general partner of Drive FS and owns
0.1% of the Drive FS. FirstCity Consumer Lending owns 31% of the membership
interests of Drive GP. Management Group LP, a Texas limited partnership that is
owned by members of management of the Company, owns 20% of the membership
interests of Drive GP. IFA Drive GP Holdings LLC, a Delaware limited liability
company and a wholly owned subsidiary of BoS (USA), owns the remaining 49% of
the membership interests of Drive GP. BoS (USA) formerly known as IFA
Incorporated is a wholly owned subsidiary of Bank of Scotland. On September 10,
2001, Bank of Scotland merged with Halifax Group plc, a personal and commercial
lending institution, to form HBOS plc. As a result of the merger, the Company's
fiscal year end changed from February 28 to December 31.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(a) RETAIL INSTALLMENT CONTRACTS, NET
Retail installment contracts, net consist of sub-prime automobile finance
receivables, which are acquired from third-party dealers at a nonrefundable
discount from the contractual principal amount. At December 31, 2001, all retail
installment contracts were held for sale and stated at the lower of cost or fair
value in the aggregate.
On July 1, 2002, the Company made a decision to change the structure of its
securitization transactions to treat the transactions as secured financings for
accounting purposes. Therefore, retail installment contracts are classified as
held to maturity and carried at amortized cost, net of credit loss reserves at
December 31, 2002, and include retail installment contracts pledged under
secured financings. The Company does not hedge
112
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
its retail installment contracts at this time. Management of the Company does
not believe that the Company is exposed to material interest rate risk during
the period contracts are not securitized.
Interest is accrued when earned in accordance with the contractual terms of
the retail installment contract. The accrual of interest is discontinued once a
retail installment contract becomes past due 60 days or more. Discounts on
retail installment contracts are recognized as adjustments to the yield of the
related contract.
(b) SALES OF RETAIL INSTALLMENT CONTRACT FROM SECURITIZATION AND INTEREST
RELATED TO RESIDUAL CERTIFICATES
The Company accounts for sales of retail installment contracts into
securitizations in accordance with the Statement of Financial Accounting
Standards No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities -- a replacement of FASB Statement No. 125
(SFAS No. 140).
Prior to July 1, 2002, the Company securitized and sold certain auto retail
installment contracts to investors with limited risk. The Company has retained
the servicing rights to these retail installment contracts. In connection with
the sales by FCAR, VFC LP, and Drive BOS of retail installment contracts through
securitizations, Drive ABS retained certain residual certificates associated
with the securitization as described below. Drive LP and Drive ABS have entered
into an agreement whereby Drive LP receives all the economic benefits associated
with the residual certificates and conversely assumes all the risks. Upon sale,
retail installment contracts were removed from the consolidated balance sheet,
and a gain on sale was recognized for the difference between the allocated
carrying value of the retail installment contracts and the adjusted sales
proceeds.
The risk to the Company is limited to the rights on future cash flows on
the residual certificates that the Company has retained. Future cash flows are
based on estimates of prepayments, the impact of interest rate movements on
yields of receivables and securities issued, delinquency of receivables sold,
servicing fees, and other factors. Gain on sale, servicing income and the
interest income on residual certificates are reported in the accompanying
consolidated statements of operations. Residual certificates are accounted for
under Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Because such assets can be
contractually prepaid or otherwise settled in such a way that the holder would
not receive all of the recorded investment, the assets are classified as
available-for-sale investments and are carried at estimated fair value with any
accompanying increases or decreases in estimated fair value being recorded as
unrealized gains or losses in accumulated other comprehensive income in the
accompanying consolidated statements of partners' equity.
The Company assesses the carrying value of its securitization related
securities for impairment in accordance with the provisions of EITF 99-20 as
discussed in note 2(k). There can be no assurance that the Company's estimates
used to determine the fair value of the residual certificates will remain
appropriate for the life of each asset and it is reasonably possible that
circumstances could change in future periods which could result in a material
change in the estimates used to prepare the accompanying consolidated financial
statements. If actual retail installment contract prepayments or credit losses
exceed the Company's current estimates, an other than temporary impairment may
be required to be recognized.
Subsequent to July 1, 2002, the Company has issued notes payable backed by
auto retail installment contracts. For accounting purposes, the transactions
were structured as secured financings, therefore, the retail installment
contracts, and the related debt remains on the consolidated balance sheets.
(c) PROVISION AND CREDIT LOSSES
Provisions for credit losses are charged to operations in amounts
sufficient to maintain the credit loss allowance at a level considered adequate
to cover probable credit losses on retail installment contracts.
113
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Probable losses are estimated based on contractual delinquency status and
historical loss experience. In addition, loss allowances are maintained to
reflect the Company's judgment of estimates of the value of the underlying
collateral, bankruptcy trends, economic conditions, such as unemployment rates,
and other information in order to make the necessary judgments as to probable
credit losses on retail installment contracts.
Receivables are charged off against the allowance for credit losses for the
full amount of the carrying value at the earlier of repossession and sale of the
underlying collateral, collateral in our possession for 90 days, or the contract
becoming 120 days contractually delinquent. Charge-offs may occur sooner for
receivables involving a bankruptcy although the amount charged off will be
limited to the bankruptcy court judgment.
(d) FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives of the respective assets, which range from three to
ten years. Leasehold improvements are amortized over the shorter of the lease
term or the estimated useful lives of the improvements. Expenditures for major
renewals and betterments are capitalized. Repairs and maintenance expenditures
are charged to operations as incurred.
(e) CASH AND CASH EQUIVALENTS
For purposes of the consolidated statement of cash flows, the Company
considers all highly liquid debt instruments with original maturities of three
months or less to be cash equivalents. The Company has maintained balances in
various operating and money market accounts in excess of federally insured
limits. At December 31, 2002 and 2001, cash and cash equivalents, which consist
of money market accounts and cash, were $14,337 and $7,303, respectively.
(f) RESTRICTED CASH
Subsequent to July 1, 2002, the Company's securitization transactions were
structured as secured financings. Cash is deposited to support the
securitization transactions and recorded in the Company's consolidated balance
sheets as restricted cash. Excess cash flows generated by the securitization
trusts (Trusts) are added to the restricted cash account, creating additional
over-collateralization until the required percentage level of assets has been
reached. Once the targeted percentage level of assets is reached, additional
excess cash flows generated by the Trusts are released to the Company as
distributions from Trusts.
(g) INCOME TAXES
No effect for income taxes is provided in the consolidated financial
statements because the Company's results of operations are allocated to its
partners.
(h) INVENTORY OF REPOSSESSED VEHICLES
Inventory of repossessed vehicles included in other assets represent
vehicles the Company has repossessed due to the borrowers' default on the
payment terms of the contracts. The Company records the vehicles at estimated
fair value, net of costs to sell.
(i) USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities, revenue and expenses, and
the disclosure of contingent assets and liabilities to prepare these
consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America. Actual results could differ
from those estimates.
114
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(j) ACCUMULATED OTHER COMPREHENSIVE INCOME
Statement of Financial Standards No. 130 (SFAS 130), Reporting
Comprehensive Income, establishes standards for reporting and displaying
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. SFAS 130 also
requires the accumulated balance of other comprehensive income to be displayed
separately in the equity section. The Company's other comprehensive income
consists of net unrealized gains on residual interests in securitizations and
had accumulated balances of $1,641, $2,359 and $4,157 at December 31, 2002, 2001
and February 28, 2001, respectively.
(k) RECOGNITION OF INTEREST INCOME AND IMPAIRMENT OF RESIDUAL INTERESTS
The Company adopted the provisions of EITF 99-20, Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets (EITF 99-20) on April 1, 2001. EITF 99-20
established the rules (effective in the second quarter of 2001) for (1)
recognizing interest income on (a) all credit-sensitive asset-backed securities
and (b) certain prepayment-sensitive securities including agency interest-only
strips and (2) determining when these securities must be written down to fair
value due to other than temporary impairment.
EITF 99-20 requires the use of the prospective method for adjusting the
level yield used to recognize interest income when estimates of future cash
flows on the security either increase or decrease since the date of the last
evaluation. The Company adopted the use of prospective method to recognize
interest income as of the adoption date of April 1, 2001.
Prior to the adoption of EITF 99-20, the Company recognized interest income
using the discount rate based on the carrying value of the securities.
The cumulative affect of the change in accounting principle at the time of
adoption of EITF 99-20 was $783. During the year ended December 31, 2002 and the
period ended December 31, 2001, the Company recorded additional impairment of
$3,415 and $4,017, respectively.
(3) RETAIL INSTALLMENT CONTRACTS, NET
Retail installment contracts are comprised of the following:
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Owned retail installment contracts (note 6)................. $253,208 $ 81,650
Pledged retail installment contracts (note 7)............... 165,741 --
Credit loss allowance....................................... (12,101) --
Discount.................................................... (43,207) (12,830)
Capitalized origination costs............................... 3,879 1,627
-------- --------
Total retail installment contracts........................ $367,520 $ 70,447
======== ========
</Table>
As of December 31, 2001, retail installment contracts were held for sale
and stated at the lower of cost or fair value in the aggregate, and therefore
there was no credit loss allowance at December 31, 2001.
115
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The activity in the credit loss allowance for the year ended December 31,
2002 was as follows:
<Table>
Balance at beginning of period.............................. $ --
Provision for credit losses................................. 28,663
Charge-offs................................................. (16,562)
--------
Balance at end of period.................................... $ 12,101
========
</Table>
Contractual maturities of total retail installment contracts at December
31, 2002 are as follows:
<Table>
2003........................................................ $ 3,539
2004........................................................ 3,373
2005........................................................ 10,090
2006........................................................ 93,383
2007........................................................ 306,693
2008........................................................ 1,871
--------
$418,949
========
</Table>
The retail installment contracts are collateralized by vehicle titles, and
the Company has the right to repossess the vehicle in the event the borrower
defaults on the payment terms of the contract.
Pledged retail installment contracts are auto receivables that have been
securitized under a secured financing agreement.
Borrowers on the Company's retail installment contracts are located
primarily in Texas, Georgia, California, North Carolina, Florida, and Illinois.
The accrual of interest income of $596 and $287 has been suspended on
delinquent retail installment contracts as of December 31, 2002 and 2001,
respectively.
(4) INTEREST RELATED TO RESIDUAL CERTIFICATES IN SECURITIZATIONS
Prior to July 1, 2002, the Company securitized retail installment contracts
and recognized revenue (gain on sales of retail installment contracts) and
allocated the total cost of the loans sold to financial components based on
their relative fair values. During the period ended December 31, 2001, the
Company sold $401,973 of auto retail installment contracts in securitization
transactions and recognized gains of $39,033.
For retail installment contracts securitized prior to July 1, 2002, the
Company retained servicing responsibilities and interests in the receivables in
the form of residual certificates. As of December 31, 2002 and 2001, the Company
was servicing $260,048 and $472,381, respectively, of auto receivables that had
been securitized to certain special purpose financing trusts (the Trusts). In
connection with the sales by FCAR, VFC LP, and Drive BOS of retail installment
contracts from securitizations, Drive ABS receives certain residual certificates
associated with the securitizations as described below. Drive LP and Drive ABS
have entered into an agreement whereby Drive LP receives all the economic
benefits associated with the residual certificates and, conversely, assumes all
the risks. Residual interests in securitizations are carried at estimated fair
value.
Beginning with transactions closed subsequent to July 1, 2002, the Company
changed the structure of its securitization transactions to no longer meet the
criteria for sale of retail installment contracts. Accordingly, following a
securitization, the retail installment contracts and the related securitization
debt remain on the consolidated balance sheets. The Company recognizes finance
charges and fee income on the retail installment contract and interest expense
on the debt issued in the securitization transaction, and records a
116
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
provision for loan losses to cover probable future losses on the contracts. The
Company securitized $200,001 of auto retail installment contracts under secured
financings and issued notes payable related to securitized retail installment
contracts of $175,000 during 2002 (note 7). In addition, residual interests in
securitizations are pledged on a term loan by BoS (USA), an affiliate (note 6).
This change has significantly impacted the Company's 2002 results of operations
compared to the prior period because there is no gain on sale of retail
installment contracts in the year ended December 31, 2002.
Residual certificates held by Drive ABS to which the Company receives all
the economic benefits and risks (see note 2(b)) consist of the following at:
<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------
Retained interests.......................................... $63,202 $75,205
Interest only strips........................................ -- 2,202
------- -------
$63,202 $77,407
======= =======
</Table>
The residual certificates were valued at fair value using the following key
assumptions.
<Table>
<Caption>
DECEMBER 31,
----------------------------------
2002 2001
---------------- ---------------
Discount rates..................................... 13.5% 12% - 15%
Prepayment rates................................... 11% - 20% CPR 9% - 30% CPR
Cumulative loss rates.............................. 11.83% - 18.74% 10.72% - 7.10%
</Table>
SFAS 140 requires that the effect on the fair value of the retained
interests of two adverse changes in each key assumption be independently
calculated.
At December 31, 2002, key economic assumptions and the sensitivity of the
current fair value of residual cash flows to immediate 10% and 20% adverse
changes in those assumptions are as follows:
<Table>
<Caption>
2002 2001
-------- --------
Balance sheet carrying value of retained interests:
Fair value................................................ $ 63,202 $ 77,407
PREPAYMENT SPEED ASSUMPTION
Impact on fair value of 10% adverse change.................. (1,113) (1,250)
Impact on fair value of 20% adverse change.................. (2,173) (2,471)
EXPECTED CREDIT LOSSES
Impact on fair value of 10% adverse change.................. (9,964) (9,486)
Impact on fair value of 20% adverse change.................. (19,842) (18,922)
RESIDUAL CASH FLOWS DISCOUNT RATE
Impact on fair value of 10% adverse change.................. (905) (1,667)
Impact on fair value of 20% adverse change.................. (1,789) (3,280)
</Table>
These sensitivities are hypothetical and should be used with caution. As
the amounts indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
117
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Expected static pool credit losses are as follows:
<Table>
<Caption>
AUTO RETAIL INSTALLMENT CONTRACTS SECURITIZED
ACTUAL AND PROJECTED --------------------------------------------------------------
CREDIT LOSSES(%) 1998-3 1999-1 1999-2 F2000-1 D2000-1 2001-1 2001-2
- -------------------- ------ ------ ------ ------- ------- ------ ------
December 31, 2002:
Actual date............... 10.23% 12.16% 11.21% 16.31% 13.33% 14.58% 9.53%
Projected................. 10.30% 12.30% 11.83% 17.37% 15.74% 18.74% 18.34%
December 31, 2001:
Actual to date............ 10.20% 11.58% 9.58% 12.66% 7.31% 5.41% 0.06%
Projected................. 10.72% 12.77% 11.54% 16.58% 15.21% 17.10% 16.65%
</Table>
(5) ACCUMULATED OTHER COMPREHENSIVE INCOME
The accumulated balance of other comprehensive income at December 31, 2002
and 2001 is as follows:
<Table>
<Caption>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME -- NET
UNREALIZED GAINS
(LOSSES) ON
RESIDUAL INTEREST
IN SECURITIZATIONS
------------------
Beginning balance at August 1, 2000......................... $ 1,106
Unrealized gains related to 2000 securitizations............ 1,538
Current period change....................................... 1,513
-------
Ending balance at February 28, 2001......................... 4,157
Unrealized gains related to 2001 securitizations............ 6,163
Current period change....................................... (4,727)
Reclassification adjustments for unrealized losses
reclassified into income due to permanent impairment...... (4,017)
Reclassification adjustment for unrealized losses
reclassified into income due to the cumulative effect of
change in accounting principle............................ 783
-------
Ending balance at December 31, 2001......................... 2,359
Current period change....................................... 2,697
Reclassification adjustments for unrealized losses
reclassified into income due to permanent impairment...... (3,415)
-------
Ending balance at December 31, 2002......................... $ 1,641
=======
</Table>
Accumulated other comprehensive income has not been allocated between the
general and limited partners in the consolidated statements of partners' equity.
(6) NOTES PAYABLE
The Company has a warehouse line of credit with BoS (USA), which provides
borrowings up to $200,000. The Company's obligations under this arrangement at
December 31, 2002 and 2001 include $160,000 and $30,000, respectively, which
bear interest at LIBOR plus 1% (2.43% and 3% at December 31, 2002 and 2001,
respectively) and $2,836 and $37,165, respectively, which bear interest at Prime
minus 1.5% (2.75% and 3.25% at December 31, 2002 and 2001, respectively). The
debt is secured by $162,738 (note 3) of the Company's retail installment
contracts and has been extended to June 30, 2003. Additionally, the note
118
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
payable contains various covenants, which the Company was in compliance with at
December 31, 2002 and 2001. Effective February 28, 2003, the Company's warehouse
line of credit agreement with BOS (USA) was amended. The amendment increased the
borrowing limits up to $250,000 and changed the maturity date to February 27,
2004.
Effective September 6, 2001, the Company entered into a warehouse line of
credit agreement with Variable Funding Capital Corporation, a subsidiary of
Wachovia Corporation, which provided borrowings up to $100,000. The Company's
obligation under the arrangement at December 31, 2002 was $58,100 and bears
interest at a commercial paper rate (2.00% at December 31, 2002 plus associated
fees). At December 31, 2001, the warehouse line obligation was zero. The debt is
secured by $58,398 of the Company's retail installment contracts and terminates
on September 5, 2003.
The Company has a term loan with BOS (USA) with $14,100 outstanding at
December 31, 2002. The Company's obligation under this arrangement includes
$10,000, which bears interest at LIBOR plus 1% (2.47%) and $4,100, which bears
interest at LIBOR plus 1% (2.42%). At December 31, 2001, the term debt with BOS
(USA) was $27,500. The Company's obligation under this arrangement at December
31, 2001 includes $25,000, which bears interest at LIBOR plus 1% (3.41%) and
$2,500, which bears interest at LIBOR plus 1% (2.92%). The loan matures on
August 18, 2003. Residual interests in securitization transactions secure the
loan. Effective February 28, 2003, the Company's term loan agreement with BOS
(USA) was amended. The amended agreement changed the maturity date of the term
loan to March 31, 2004.
(7) NOTES PAYABLE RELATED TO SECURITIZED RETAIL INSTALLMENT CONTRACTS
Notes payable related to securitized retail installment contracts
structured as a secured financing with a third party were $152,245 at December
31, 2002. The principal and interest on these notes are paid using the cash
flows from the underlying retail installment contracts which serve as collateral
for the notes. Accordingly, the timing of the principal payments on these notes
is dependent on the payments received on the underlying retail installment
contracts which back the notes. The average interest rate and contractual
maturity on these notes at December 31, 2002 were as follows:
<Table>
1.87%; final maturity 2003.................................. $ 12,409
2.73%; final maturity 2005.................................. 58,343
3.68%; final maturity 2006.................................. 48,333
4.09%; final maturity 2008.................................. 33,160
--------
152,245
Less unamortized debt issuance costs........................ (859)
--------
Notes payable related to securitized retail installment
contracts, net of unamortized debt issuance costs..... $151,386
========
</Table>
Unamortized debt issuance costs are amortized as interest expense over the
terms of the related notes payable.
(8) SUBORDINATED CAPITAL NOTE
The Company has a note payable to BOS (USA), for $48,000 at December 31,
2002 and $32,000 at December 31, 2001, which bears interest at a predefined rate
of 16% at December 31, 2002 and 14% at December 31, 2001. The note allows
borrowings up to $65,000 and matures February 15, 2006. Such note is subordinate
to all other obligations of the Company. At December 31, 2002, there was no
required amortization of the debt.
119
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) SECURITIZATION ACTIVITY
The table below summarizes the cash flows received from securitization
trusts during the following periods:
<Table>
<Caption>
DECEMBER 31, DECEMBER 31, FEBRUARY 28,
2002 2001 2001
------------ ------------ ------------
Gross proceeds from new securitizations......... $175,000 $357,698 $ 87,400
Servicing fees received......................... 11,739 9,344 3,149
Cash flows received on interest-only strips..... -- 787 1,430
Cash flows received on subordinated holdings.... 10,357 21,059 5,670
Cash received upon release from reserve
accounts...................................... 6,316 7,609 3,540
-------- -------- --------
Total cash received from
securitization trusts............... $203,412 $396,497 $101,189
======== ======== ========
</Table>
Substantially all of the proceeds from new securitizations were used to
reduce borrowings on the warehouse line of credit. For presentation in the
consolidated statement of cash flows, these proceeds have been included in the
net decrease in the warehouse line of credit with affiliate.
For the periods ended December 31, 2001 and February 28, 2001, the Company
recognized $39,033 and $9,434, respectively, of gains on sales of retail
installment contracts. There were no transactions treated as sales in 2002.
During 2002, the Company exercised early purchase options on the 1998-2 and
1999-1 securitizations. The receivables were recorded at a fair value of $9,744.
Cash paid for the exercise of early purchase options was $4,797.
During the period ended December 31, 2001, the Company exercised early
purchase options on the 1998-1 and 1998-2 securitizations. The receivables were
recorded at a fair value of $7,886. Cash paid for the exercise of early purchase
options was $3,900.
The table below summarizes delinquencies at December 31, 2002 and 2001, and
historical losses for the year ended December 31, 2002 and the period March 1,
2001 to December 31, 2001:
<Table>
<Caption>
PRINCIPAL AVERAGE
AMOUNT OF BALANCE OF
RETAIL DELINQUENT RETAIL CREDIT
INSTALLMENT PRINCIPAL OVER INSTALLMENT LOSSES -- (NET
CONTRACTS SIXTY DAYS CONTRACTS OF RECOVERIES)
----------- -------------- ----------- --------------
December 31, 2002:
Retail installment contracts:
Owned........................... $253,208 $ 4,599 $172,101 $10,769
Pledged......................... 165,741 5,719 184,497 9,214
Securitized..................... 260,048 10,995 354,284 46,349
-------- ------- -------- -------
Total managed retail
installment contracts.... $678,997 $21,313 $710,882 $66,332
======== ======= ======== =======
</Table>
120
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
PRINCIPAL AVERAGE
AMOUNT OF BALANCE OF
RETAIL DELINQUENT RETAIL CREDIT
INSTALLMENT PRINCIPAL OVER INSTALLMENT LOSSES -- (NET
CONTRACTS SIXTY DAYS CONTRACTS OF RECOVERIES)
----------- -------------- ----------- --------------
December 31, 2001:
Retail installment contracts:
Owned........................... $ 81,650 $ 4,578 $133,782 $10,679
Securitized..................... 472,381 15,182 375,916 29,994
-------- ------- -------- -------
Total managed retail
installment contracts.... $554,031 $19,760 $509,698 $40,673
======== ======= ======== =======
</Table>
(10) LEASES
The Company has obligations under various lease agreements for computer
equipment and office furniture with multiple equipment lease schedules. The
leases are classified as capital leases. The total future minimum rental
payments are included in the future minimum rental payments schedule below.
Future minimum rental payments under capital leases together with the
present value of minimum lease payments at December 31, 2002 are as follows:
<Table>
Year ending December 31:
2003...................................................... $326
----
Total minimum lease payments........................... 326
----
Less amounts representing interest.......................... 58
----
Present value of minimum lease payments................ $268
====
</Table>
The Company has entered into various operating leases, primarily for office
space and certain equipment, which expire over the next three years. Lease
expense incurred during the periods ended December 31, 2002, December 31, 2001
and February 28, 2001 totaled $2,959, $840 and $842, respectively. The remaining
obligations under the lease commitments are $2,504 in 2003, $2,421 in 2004, and
$2,202 in 2005.
(11) COMMITMENTS AND CONTINGENCIES
In connection with the sale of retail installment contracts through
securitizations, the Company has made standard representations and warranties
customary to the consumer finance industry. Violations of these representations
and warranties may require the Company to repurchase loans previously sold. As
of December 31, 2002 and 2001, the Company had no repurchase requests
outstanding. In the opinion of management, the potential exposure or other
recourse obligations related to the Company's retail installment contract sales
agreements will not have a material adverse effect on the consolidated financial
position or results of operations of the Company.
The Company has letters of credit issued by Bank of Scotland totaling
$24,250 and $19,000 at December 31, 2002 and 2001, respectively, of which none
has been drawn. The letters of credit are collateral for the Drive 2000-1,
2001-1, 2001-2, and 2002-1 Securitization Reserves, IBM Credit Corporation
operating lease, and a CIT operating lease. The letters of credit expire at
various dates through June 2003. Effective February 28, 2003, the Company's
letter of credit facility agreement with Bank of Scotland was amended to
increase the commitment amount to $50,000 and to extend the commitment
termination date to February 27, 2004.
121
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Periodically, the Company is party to or otherwise involved in legal
proceedings arising in the normal course of business. The Company does not
believe that there are any proceedings threatened or pending, if determined
adversely, would have a material adverse effect on the consolidated financial
position, results of operations, or liquidity of the Company.
(12) RELATED-PARTY TRANSACTIONS
The Company has the aforementioned subordinated capital note payable to BoS
(USA) totaling $48,000 and $32,000 at December 31, 2002 and 2001, respectively
(see note 8). Interest costs incurred on such subordinated capital note payable
totaled $6,169, $2,564 and $70 for the periods ended December 31, 2002, December
31, 2001 and February 28, 2001, respectively.
Additionally, the Company has letters of credit issued by Bank of Scotland,
as discussed in note 11. Fees associated with these letters totaled $997 during
2002 and $65 during 2001.
Interest costs incurred in connection with other debt with BoS (USA)
totaled $5,880, $5,115 and $5,303 for the periods ended December 31, 2002,
December 31, 2001 and February 28, 2001, respectively (see note 6).
(13) FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires that the Company disclose estimated fair values of its financial
instruments. Fair value, estimates, methods, and assumptions are set forth
below.
(a) CASH AND CASH EQUIVALENTS
The carrying amount of cash and cash equivalents approximated fair value at
December 31, 2002 and 2001 due to the short maturity of these instruments.
(b) RETAIL INSTALLMENT CONTRACTS
Retail installment contracts are carried at amortized cost at December 31,
2002. Retail installment contracts were carried at lower of cost or market value
in aggregate at December 31, 2001. The estimated fair value is calculated by
using estimated fair values from securitizations of the contracts and
discounting projected cash flows using estimated market discount rates that
reflect the credit and interest rate risks inherent in the assets at December
31, 2002 and 2001. The carrying value of the retail installment contracts was
$367,520 and $70,447 at December 31, 2002 and 2001, respectively. The estimated
fair value of the retail installment contracts was $424,734 and $88,159 at
December 31, 2002 and 2001, respectively.
(c) NOTES PAYABLE AND SUBORDINATED CAPITAL NOTE
Management believes that the repayment terms for similar rate financial
instruments with similar credit risks and the stated interest rates at December
31, 2002 and 2001 approximate the market terms for similar credit instruments.
Accordingly, the carrying amount of notes payable and subordinated capital note
is believed to approximate fair value.
The fair value of the variable rate warehouse lines of credits is equal to
the carrying value as the effective variable rates are considered to be the
market rate.
122
DRIVE FINANCIAL SERVICES LP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) NOTES PAYABLE RELATED TO SECURITIZED RETAIL INSTALLMENT CONTRACTS
Fair value of the notes payable related to securitized retail installment
contracts is estimated to be $155,000 and is calculated by using repayment terms
and rates for similar financial instruments using the market interest rates at
December 31, 2002.
(14) EMPLOYEE BENEFIT PLANS
The Company sponsors a defined contribution plan offered to substantially
all salaried employees. Employees participating in the plan may contribute up to
15% of their base salary, subject to federal limitations on absolute amounts
contributed. The Company will match up to 6% of their base salary, with matching
contributions of 50% of employee contributions. The total amount contributed by
the Company for the periods ended December 31, 2002 and 2001 and February 28,
2001 was $364, $210 and $23, respectively.
(15) NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements Nos.
5, 57, and 107 and a rescission of FASB Interpretation No. 34. This
interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after December
31, 2002 and are not expected to have a material effect on the Company's
consolidated financial statements. The disclosure requirements are effective for
financial statements of interim or annual periods ending December 15, 2002. The
Company has disclosed its potential guarantees related to this Interpretation in
note 11.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51 (FIN 46). This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. For nonpublic entities, such as the Company,
with a variable interest in a variable interest entity created before February
1, 2003, the Interpretation is applied to the enterprise no later than the end
of the first annual reporting period beginning after June 15, 2003. The
application of this Interpretation is not expected to have a material impact on
the Company's consolidated financial statements. The Interpretation requires
certain disclosures in financial statements issued after January 31, 2003 if it
is reasonably possible that the Company will consolidate or disclose information
about variable interest entities when the Interpretation becomes effective.
The Company enters into transactions or has contractual relationships with
various legal entities that are commonly referred to as special purpose entities
(SPEs) or QSPEs. Certain of these entities, and where applicable, the assets
sold to them by the Company, are not included in the Company's consolidated
balance sheets. These nonconsolidated entities have legal standing separate from
the Company, are not controlled by the Company and are typically established for
a single purpose such as securitization of financial assets. The Company may
have certain relationships with these entities, including sponsorship and
servicer of the assets held by the entity. In addition, the Company may retain
certain interests in these entities, which are recognized on the consolidated
balance sheet. FIN 46 may impact the accounting treatment of the entities.
SPEs and QSPEs sponsored by the Company hold assets sold to them by the
Company and issue debt collateralized by the assets held in the trust. In order
for the assets and liabilities of a QSPE to be excluded from the Company's
consolidated balance sheet, these transactions must meet the requirements of
SFAS No. 140, at the inception of the transaction and on an ongoing basis.
123
MINNTEX INVESTMENT PARTNERS LP
(A TEXAS LIMITED PARTNERSHIP)
FINANCIAL STATEMENTS
DECEMBER 31, 2002
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
124
INDEPENDENT AUDITORS' REPORT
The Partners
MinnTex Investment Partners LP:
We have audited the accompanying balance sheet of MinnTex Investment
Partners LP (a Texas limited partnership) as of December 31, 2002, and the
related statements of operations, changes in partners' capital, and cash flows
for the period March 11, 2002 (date of inception) through December 31, 2002.
These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of MinnTex Investment Partners
LP as of December 31, 2002, and the results of its operations and its cash flows
for the period March 11, 2002 (date of inception) through December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.
KPMG LLP
Dallas, Texas
February 17, 2003
125
MINNTEX INVESTMENT PARTNERS LP
(A TEXAS LIMITED PARTNERSHIP)
BALANCE SHEET
DECEMBER 31, 2002
<Table>
<Caption>
(IN THOUSANDS)
ASSETS
Cash........................................................ $1,603
Portfolio Asset, net (note 3)............................... 2,130
------
$3,733
======
LIABILITIES AND PARTNERS' CAPITAL
Accounts payable and accrued liabilities.................... $ 12
Service fees payable -- affiliate (note 4).................. 152
------
Purchased loan pools, net................................. 164
Partners' capital........................................... 3,569
------
$3,733
======
</Table>
See accompanying notes to financial statements.
126
MINNTEX INVESTMENT PARTNERS LP
(A TEXAS LIMITED PARTNERSHIP)
STATEMENT OF OPERATIONS
THE PERIOD MARCH 11, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2002
<Table>
<Caption>
(IN THOUSANDS)
Proceeds from resolution of Portfolio Asset................. $16,655
Cost of Portfolio Asset resolved............................ 9,292
-------
Gain on resolution of Portfolio Asset..................... 7,363
Interest expense -- affiliate (note 4)...................... (201)
General, administrative, and operating expenses (note 4).... (1,773)
Other income................................................ 8
-------
Net income................................................ $ 5,397
=======
</Table>
See accompanying notes to financial statements.
127
MINNTEX INVESTMENT PARTNERS LP
(A TEXAS LIMITED PARTNERSHIP)
STATEMENT OF CHANGES IN PARTNERS' CAPITAL
THE PERIOD MARCH 11, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2002
<Table>
<Caption>
GENERAL LIMITED PARTNERS
PARTNER --------------------------------
-------- FIRSTCITY CFSC
MINNTEX HOLDINGS OF CAPITAL LENDERS
GP CORP. MINNESOTA CORP. II TRUST TOTAL
-------- ----------- -------- ------- -------
(IN THOUSANDS)
Inception Date March 11, 2002............... $ -- $ -- $ -- $ -- $ --
Contributions............................... 39 1,264 1,264 1,264 3,831
Distributions............................... (58) (1,867) (1,867) (1,867) (5,659)
Net income.................................. 54 1,781 1,781 1,781 5,397
---- ------- ------- ------- -------
Balance at December 31, 2002................ $ 35 $ 1,178 $ 1,178 $ 1,178 $ 3,569
==== ======= ======= ======= =======
</Table>
See accompanying notes to financial statements.
128
MINNTEX INVESTMENT PARTNERS LP
(A TEXAS LIMITED PARTNERSHIP)
STATEMENT OF CASH FLOWS
THE PERIOD MARCH 11, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2002
<Table>
<Caption>
(IN THOUSANDS)
Cash flows from operating activities:
Net income................................................ $ 5,397
Adjustments to reconcile net income to net cash provided
by operating activities:
Purchase of Portfolio Asset............................ (11,422)
Gain on resolution of Portfolio Asset.................. (7,363)
Proceeds from resolution of Portfolio Asset............ 16,655
Increase in service fees payable -- affiliate.......... 152
Increase in accounts payable and accrued liabilities... 12
--------
Net cash provided by operating activities............ 3,431
--------
Cash flows from financing activities:
Borrowing on long-term debt -- affiliate.................. 8,939
Repayment of long-term debt -- affiliate.................. (8,939)
Capital contributions..................................... 3,831
Capital distributions..................................... (5,659)
--------
Net cash used in financing activities................ (1,828)
--------
Net increase in cash................................. 1,603
Cash, beginning of period................................... --
--------
Cash, end of period......................................... $ 1,603
========
Supplemental disclosure of cash flow information:
Cash paid for interest was $201.
</Table>
See accompanying notes to financial statements.
129
MINNTEX INVESTMENT PARTNERS LP
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2002
(DOLLARS IN THOUSANDS)
(1) ORGANIZATION AND PARTNERSHIP AGREEMENT
MinnTex Investment Partners LP, a Texas limited partnership (the
Partnership), was formed to acquire, hold, and dispose of the loan pool
purchased from a nongovernmental agency seller, pursuant to certain purchase
agreements. The Partnership began operations on March 11, 2002 and is scheduled
to terminate on December 31, 2022.
Net income or loss is credited or charged to the partners' capital accounts
in proportion to their respective capital account balances.
The partnership and other agreements governing the Partnership's affairs
provide for certain preferences as to the distribution of cash flows from the
Partnership. Proceeds from disposition of and payments received on the purchased
loan pool are allocated in the following order, (1) to pay for tax and insurance
escrow, (2) to pay fees payable under custodial and lockbox agreements, (3) to
pay accrued interest on the notes payable, (4) to pay late charges, fees, and
expenses, if any, on the notes payable, (5) to pay protective advances, if any,
(6) to replenish an operating reserve, (7) to pay a servicing fee to FirstCity
Servicing Corporation (FirstCity), an affiliate of a limited partner, (8) to pay
shortfall amounts from prior month disbursements of items (1) through (7), (9)
to pay principal on the notes payable, and (10) return of partners' capital.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) PORTFOLIO ASSET
The Partnership acquires and resolves a portfolio of performing and
nonperforming loans to small businesses that are unsecured ("Portfolio Asset").
Accounting for the Portfolio Asset is on a pool basis as opposed to an
individual asset-by-asset basis. At December 31, 2002, the Portfolio Asset was
designated as nonperforming as described more fully below.
The Partnership's Portfolio Asset is designated as nonperforming unless
substantially all of the loans in the pool are being repaid in accordance with
the contractual terms of the underlying loan agreements. Such designation is
made at the acquisition of the pool and does not change even though the actual
mix of the loans may change. The pool is acquired on the basis of an evaluation
of the timing and amount of cash flow expected to be derived from borrower
payments on the loans. The carrying value of the nonperforming Portfolio Asset
at December 31, 2002 totaled $2,130.
A nonperforming Portfolio Asset is purchased at a substantial discount from
its outstanding legal principal amount, the total of the aggregate of expected
future sales prices and the total payments to be received from obligors.
Subsequent to acquisition, the amortized cost of the nonperforming Portfolio
Asset is evaluated for impairment on a quarterly basis. A valuation allowance is
established for any impairment identified through provisions charged to earnings
in the period the impairment is identified. No valuation allowance was required
at December 31, 2002.
Gain on resolution of the nonperforming Portfolio Asset is recognized as
income to the extent that proceeds collected exceed a pro rata portion of
allocated cost from the pool. Cost allocation is based on a proration of actual
proceeds divided by total estimated proceeds of the pool. No interest income is
recognized separately on the nonperforming Portfolio Asset. All proceeds, of
whatever type, are included in proceeds from resolution of Portfolio Asset in
determining the gain on resolution of such assets.
130
MINNTEX INVESTMENT PARTNERS LP
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(b) INCOME TAXES
Under current income tax laws, partnerships are not subject to income
taxes; therefore, no provision has been made for such taxes in the accompanying
financial statements. For tax purposes, income or loss is included in the
individual tax returns of the partners.
(c) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
(3) PORTFOLIO ASSET
The Portfolio Asset (note 2) at December 31, 2002 is summarized as follows:
<Table>
Loans:
Borrowers' obligations on outstanding balance of:
Performing loans....................................... $ 21,457
Nonperforming loans.................................... 37,940
--------
59,397
Discount required to reflect the Portfolio Asset at
unamortized cost.......................................... (57,267)
--------
Portfolio Asset, net.............................. $ 2,130
========
</Table>
(4) TRANSACTIONS WITH AFFILIATES
During March 2002, the Partnership borrowed $8,939 from CFSC Capital Corp.
XXX (an affiliate of a limited partner) on a senior collateralized promissory
note payable. In August 2002, the Partnership paid off the senior collateralized
promissory note payable to CFSC Capital Corp. XXX. Interest expense totaled $201
on such note during 2002.
Under the terms of a servicing agreement, FirstCity receives a servicing
fee based on proceeds from resolution of Portfolio Asset, for processing
transactions on the Portfolio Asset and for conducting settlement and sale
negotiations. Included in general, administrative, and operating expenses in the
accompanying statement of operations is $1,666 in servicing fees incurred in
2002.
131
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the members
of the Board of Directors of the Company.
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
James R. Hawkins.......................... 66 Chairman of the Board
C. Ivan Wilson............................ 75 Vice Chairman of the Board
James T. Sartain.......................... 54 President, Chief Executive Officer and
Director
Richard E. Bean........................... 58 Director
Dane Fulmer............................... 52 Director
Robert E. Garrison II..................... 60 Director
Jeffery D. Leu............................ 45 Director
</Table>
Further information concerning the Board of directors, including their
business experience during the past five years, appears below.
James R. Hawkins has been Chairman of the Board since the consummation of
the Merger, and was Chairman of the Board and Chief Executive Officer of J-Hawk
from 1976 until the Merger. Mr. Hawkins was also formerly Chief Executive
Officer of the Company through January 2001.
C. Ivan Wilson has been Vice Chairman of the Board of the Company since the
Merger. From February 1998 to June 1998, Mr. Wilson was Chairman, President and
Chief Executive Officer of Mercantile Bank, N.A., Corpus Christi, Texas, a
national banking organization. Mr. Wilson was Chairman of the Board and Chief
Executive Officer of FCBOT from 1991 to the Merger. Prior to 1991, Mr. Wilson
was the Chief Executive Officer of FirstCity, Texas -- Corpus Christi, one of
FCBOT's banking subsidiaries.
James T. Sartain has been President since the Merger and Chief Executive
Officer since January 2001 and has served as a Director of the Company since the
Merger. Prior to January 2001, Mr. Sartain was President and Chief Operating
Officer. From 1988 to the Merger, Mr. Sartain was President and Chief Operating
Officer of J-Hawk.
Richard E. Bean has been a Director of the Company since the Merger and has
been Executive Vice President and Chief Financial Officer of Pearce Industries,
Inc. since 1976, which markets a variety of oil field equipment and machinery.
Mr. Bean has also been a member of the Portfolio Committee of the FirstCity
Liquidating Trust since the Merger. Prior to the Merger, Mr. Bean was Chairman
of the FCBOT's Official Committee of Equity Security Holders.
Dane Fulmer has been a Director of the Company since May 1999. Mr. Fulmer
serves as Executive Vice President and director of risk management of John
Taylor Financial Group, a broker/dealer and investment advisory firm that Mr.
Fulmer co-founded in 1995. From July 1991 until August 1996, Mr. Fulmer served
as Executive Vice President of Merchants Investment Center of Fort Smith, and as
portfolio manager for Merchants National, the parent company.
Robert E. Garrison II has been a Director of the Company since May 1999.
Mr. Garrison is the President, Chief Executive Officer and director of Sanders
Morris Harris Group, a publicly owned financial services firm. Previously, Mr.
Garrison served as Executive Vice President and director of Harris Webb &
Garrison and also served as Chairman, Chief Executive Officer, and director of
Pinnacle Management & Trust Co. Mr. Garrison co-founded both of these companies
in 1994. Both Harris Webb & Garrison and Pinnacle Management & Trust Co. are
subsidiaries of Sanders Morris Harris Group. In addition, Mr. Garrison serves
132
as Chairman of the Board of BioCyte Therapeutics, a cancer diagnostic and
therapeutic company focused on breast, ovarian, and prostate cancer. Mr.
Garrison serves as a director of TeraForce Technology Corporation, Inc., a
public defense electronics company, Somerset House Publishing, First Capital
Bank, and is a member of the Finance Committee of Memorial Hermann Hospital
System. He has over 36 years of experience in the securities industry. Mr.
Garrison is a Chartered Financial Analyst.
Jeffery D. Leu has been a Director of the Company since December 2000. Mr.
Leu is President of the Value Investment Group of Cargill, a wholly owned
subsidiary of Cargill Incorporated, which is regarded as one of the world's
largest privately-held corporations. Mr. Leu joined Cargill in 1981 and has held
various management positions in Cargill's financial businesses.
RESIGNATION OF DAVID W. MACLENNAN
Effective June 30, 2002, David W. MacLennan resigned as a Director of the
Company.
SHAREHOLDER VOTING AGREEMENT
James R. Hawkins, Chairman of the Board of the Company, James T. Sartain,
President and Chief Executive Officer of the Company, and ATARA I, LTD., a Texas
limited partnership ("ATARA"), are parties to a Shareholder Voting Agreement
(the "Shareholder Voting Agreement"), dated as of June 29, 1995, with Cargill.
The sole general partner of ATARA is ATARA Corp., a Texas corporation, the
Chairman of the Board and President of which is Rick R. Hagelstein (a former
executive officer of the Company).
Under the terms of the Shareholder Voting Agreement, Messrs. Hawkins and
Sartain, and ATARA, are required to vote their shares of Common Stock to elect
one designee of Cargill as a director of the Company, and Cargill is required to
vote its shares of Common Stock to elect one or more of the designees of Messrs.
Hawkins and Sartain, and ATARA, as directors of the Company. With respect to the
Board nominees for director,
(1) Messrs. Hawkins and Sartain, and ATARA, will vote their shares of
Common Stock for the election of such nominees as directors, including
nominee Jeffery Leu, Cargill's designee under the Shareholder Voting
Agreement, and
(2) Cargill will vote its shares of Common Stock for the election of
such nominees as directors, which nominees are the designees of Messrs.
Hawkins and Sartain, and ATARA, under the Shareholder Voting Agreement.
Information pertaining to the number of shares of Common Stock owned on December
31, 2002, by each of Messrs. Hawkins and Sartain, and ATARA and Cargill, is set
forth under "Item 12 -- Security Ownership of Certain Beneficial Owners and
Management."
133
EXECUTIVE OFFICERS
The executive officers of the Company, who are elected by the Board of
Directors of the Company and serve at its discretion, are as follows:
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
James R. Hawkins.......................... 66 Chairman of the Board
James T. Sartain.......................... 54 President and Chief Executive Officer
J. Bryan Baker............................ 42 Senior Vice President and Chief Financial
Officer
Terry R. DeWitt........................... 45 Senior Vice President and Co-President of
FirstCity Commercial Corporation
G. Stephen Fillip......................... 51 Senior Vice President and Co-President of
FirstCity Commercial Corporation
Joe S. Greak.............................. 53 Senior Vice President and Tax Director
James C. Holmes........................... 45 Senior Vice President and Executive Vice
President of FirstCity Commercial
Corporation
Jim W. Moore.............................. 52 Senior Vice President and President of
FirstCity Consumer Lending Corporation
Richard J. Vander Woude................... 48 Senior Vice President, General Counsel and
Secretary
</Table>
The business experience of Messrs. Hawkins and Sartain is set forth above.
J. Bryan Baker has been Senior Vice President and Chief Financial Officer
since June 2000. Previously, Mr. Baker served as Vice President and Treasurer
from August 1999 to June 2000, as Vice President and Controller of the Company
from November 1996 to August 1999, and as Vice President and Assistant
Controller from 1995 to November 1996. From 1990 to 1995, Mr. Baker was with
Jaynes, Reitmeier, Boyd & Therrell, P.C., an independent public accounting firm,
involved in both auditing and consulting. From 1988 to 1990, Mr. Baker was
Controller of Heights Bancshares in Harker Heights, Texas.
Terry R. DeWitt has been Senior Vice President responsible for Due
Diligence and Investment Evaluation of the Company since the Merger and has
served as Co-President of FirstCity Commercial Corporation ("FirstCity
Commercial"), a wholly-owned subsidiary of the Company, since October 1999. Mr.
DeWitt served as Senior Vice President responsible for Due Diligence and
Investment Evaluation of J-Hawk from 1992 to the Merger. From 1991 to 1992, Mr.
DeWitt was Senior Vice President of the First National Bank of Central Texas, a
national banking association, and from 1989 to 1991, he was President of the
First National Bank of Goldthwaite, a national banking association.
G. Stephen Fillip has been Senior Vice President since the Merger. Mr.
Fillip has served as President of FirstCity Servicing Corporation, a subsidiary
of the Company, since October 1999 and has served as Co-President of FirstCity
Commercial since October 1999. Mr. Fillip was Senior Vice President of J-Hawk
from 1991 to the Merger. From 1989 to 1991, Mr. Fillip was Executive Vice
President and Chief Credit Officer of BancOne, Texas, N.A. (Waco), a national
banking association.
Joe S. Greak has been Senior Vice President, Tax Director and Secretary of
the Company since the Merger. Mr. Greak was the Tax Manager of FCBOT since 1993.
From 1992 to 1993, Mr. Greak was the Tax Manager of New First City -- Houston,
N.A. Prior thereto, he was Senior Vice President and Tax Director of First City,
Texas -- Houston, N.A.
James C. Holmes has been Senior Vice President since the Merger. Mr. Holmes
has served as Executive Vice President of FirstCity Commercial since October
1999. From the Merger to August 1999 Mr. Holmes served as Senior Vice President
and Treasurer and held the same positions with J-Hawk from 1994 to the Merger.
From 1988 to 1991, Mr. Holmes was a Vice President of MBank, Waco, a national
banking association.
134
Jim W. Moore has been a senior officer of the Company or its predecessor
since November 1992. Currently, Mr. Moore is President of FirstCity Consumer
Lending Corporation, a wholly-owned subsidiary of the Company, which owns a 31%
direct and indirect interest in Drive Financial Services, LP, where he has
served as Executive Vice President and a member of the Board of Managers since
August 2000.
Richard J. Vander Woude has been General Counsel and Senior Vice President
of the Company since January 1998 and has served as Secretary since June 2000.
Prior thereto, Mr. Vander Woude was a director and shareholder in the law firm
of Vander Woude & Istre, P.C., Waco, Texas from 1992 through 1997. From 1978 to
1992, Mr. Vander Woude was a director and shareholder of Sheehy, Lovelace &
Mayfield, P.C., Waco, Texas.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors and
executive officers, and persons who own more than 10 percent of the Company's
Common Stock, to file with the Securities and Exchange Commission certain
reports of beneficial ownership of the Company's Common Stock. Based solely on
copies of such reports furnished to the Company and written representations that
no other reports were required, the Company believes that all applicable Section
16(a) filing requirements were complied with by its directors, officers and 10
percent stockholders during the last fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation
for services during each of the last three years to (1) the Company's Chief
Executive Officer during 2002, and (2) the Company's other four most highly
compensated executive officers during 2002 serving as such at the end of 2002
(collectively, the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
LONG TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION SECURITIES
--------------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) COMPENSATION(1)($)
- --------------------------- ---- --------- -------- ------------ ------------------
James T. Sartain,................... 2002 300,014 -- -- 15,190
President and Chief 2001 300,014 -- 50,000 15,190
Executive Officer 2000 300,014 130,000 50,000 16,018
Terry R. DeWitt,.................... 2002 250,000 135,000 -- 4,950
Senior Vice President and 2001 250,000 -- 25,000 4,800
Co-President of FirstCity 2000 250,000 80,640 -- 5,040
Commercial Corporation
G. Stephen Fillip,.................. 2002 250,000 135,000 -- 5,190
Senior Vice President and 2001 250,000 -- 25,000 5,190
Co-President of FirstCity 2000 250,000 83,400 -- 5,310
Commercial Corporation
Richard J. Vander Woude,............ 2002 275,000 80,000 -- 4,950
Senior Vice President, General 2001 275,000 -- 25,000 4,950
Counsel and Secretary 2000 270,883 50,000 25,000 5,378
Jim W. Moore........................ 2002 337,096 243,750 -- 5,190
Senior Vice President and 2001 250,000 125,000 25,000 5,190
President of FirstCity 2000 206,250 130,000 -- 16,977
Consumer Lending
</Table>
- ---------------
(1) With respect to Messrs. Sartain, DeWitt, Fillip, Vander Woude and Moore, the
total amounts indicated under "All Other Compensation" for 2002 consist of
(a) amounts contributed to match a portion of such
135
employee's contributions under a 401(k) plan ("401(k) Match"), (b) excess
premiums paid on supplemental life insurance policies ("Supplement Life")
and (c) personal use of a business vehicle ("Auto"), and (d) amounts paid
for moving expenses ("Other"). The following table details the amounts paid
during 2002 for each of the categories:
<Table>
<Caption>
401(K) SUPPLEMENT
EXECUTIVE MATCH($) LIFE($) AUTO($) TOTAL($)
- --------- -------- ---------- ------- --------
James T. Sartain.............................. 4,500 690 10,000 15,190
Terry R. DeWitt............................... 4,500 450 -- 4,950
G. Stephen Fillip............................. 4,500 690 -- 5,190
Richard J. Vander Woude....................... 4,500 450 -- 4,950
Jim W. Moore.................................. 4,500 690 -- 5,190
</Table>
STOCK OPTION AND PURCHASE PLANS AND 401(k) PLAN
In October 1995, on the recommendation of the Stock Option Subcommittee of
the Compensation Committee, the Board of Directors approved the grant of 229,600
stock options under the 1995 Stock Option and Award Plan. Of these options,
173,600 were granted to the Company's executive officers. The exercise price for
all such options was equal to or greater than the fair market value of the
underlying the Common Stock at the date of grant. Therefore, the holders of the
stock options will benefit from such options only when, and to the extent, the
price of the Common Stock increases after the grant of the option. The
performance of individual executive officers and other key employees was
considered by the Stock Option Subcommittee in allocating such grants, taking
into account the Company's performance, each individual's contributions thereto
and specific accomplishments in each individual's area of responsibility. In
October 1996, on the recommendation of the Stock Option Subcommittee, the Board
of Directors approved the grant of 18,000 stock options under the 1996 Stock
Option and Award Plan (no such shares were granted to executive officers). In
February 1997, on the recommendation of the Stock Option Subcommittee, the Board
of Directors approved the grant of 95,200 stock options under the 1996 Stock
Option and Award Plan Of these options, 46,200 were granted to the Company's
executive officers. In September 1997, on the recommendation of the Stock Option
Subcommittee, the Board of Directors approved the grant of 30,000 stock options
under the 1996 Stock Option and Award Plan (no such shares were granted to
executive officers).
At the Company's annual stockholders' meeting, held on April 24, 1996, the
Company's stockholders approved (1) the 1995 Stock Option and Award Plan, which
provides for the grant of up to 230,000 options to purchase the Common Stock to
plan participants (229,600 of which have been granted), (2) the 1996 Stock
Option and Award Plan, which provides for the grant of up to 500,000 options to
purchase the Common Stock to plan participants and (3) the 1995 Employee Stock
Purchase Plan, under which up to 100,000 shares of the Common Stock may be made
available for purchase by plan participants. Grants of options to purchase
15,473 shares of the Common Stock have been granted to date. The 1996 Stock
Option and Award Plan also provides for the grant of up to 50,000 performance
shares to employees of the Company, to be awarded in the discretion of the Stock
Option Subcommittee. The performance measure to be used for the purposes of
granting the performance shares will be the extent to which performance goals
are met, in addition to the factors of total stockholder return, return on
equity, earnings per share and the ratio of operating overhead to operating
revenue.
Beginning January 1, 1994, the Company also initiated a defined
contribution 401(k) employee profit sharing plan (the "401(k) Plan") in which
the Company matches employee contributions at a stated percentage of employee
contributions to a defined maximum. The Company contributed approximately
$184,000, $152,000 and $263,000 in 2002, 2001 and 2000, respectively, to the
401(k) Plan.
136
OPTION GRANTS
The Company did not grant any options under any Plan in 2002.
OPTION EXERCISES AND YEAR-END VALUES
The following table sets forth, for the Named Executive Officers, the
number of shares of the Common Stock underlying both exercisable and
non-exercisable stock options held by such persons as of December 31, 2002, and
the year-end values for unexercised "in-the-money" options, which represent the
positive spread between the exercise price of any such options and the year-end
market price of the Common Stock. All such options were granted under the 1995
Stock Option and Award Plan and 1996 Stock Option and Award Plan. No options
were exercised by the officers listed below during 2002.
AGGREGATED 2002 OPTION EXERCISES
AND YEAR-END OPTION VALUES
<Table>
<Caption>
NUMBER OF SHARES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT YEAR END AT YEAR END($)(1)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
James T. Sartain.............................. 87,300 37,500 -- --
Terry R. DeWitt............................... 36,450 6,250 -- --
G. Stephen Fillip............................. 36,450 6,250 -- --
Richard J. Vander Woude....................... 31,250 18,750 -- --
Jim W. Moore.................................. 36,050 6,250 -- --
</Table>
- ---------------
(1) Calculated using the aggregate market value (based on December 31, 2002
stock price of $1.37 per share) of the shares of the Common Stock underlying
such options, less the aggregate exercise price payable.
EQUITY COMPENSATION PLAN INFORMATION
Information about FirstCity's compensation plans at December 31, 2002 was
as follows:
<Table>
<Caption>
NUMBER OF SHARES
TO BE ISSUED WEIGHTED-AVERAGE NUMBER OF SHARES
UPON EXERCISE OF EXERCISE PRICE OF REMAINING AVAILABLE
PLAN CATEGORY OUTSTANDING OPTIONS OUTSTANDING OPTIONS FOR FUTURE ISSUANCE
- ------------- ------------------- ------------------- -------------------
Equity compensation plans approved by
stockholders(a)........................ 594,250 $7.89 191,579(b)
Equity compensation plans not approved by
stockholders........................... -- -- --
------- ----- -------
Total.................................... 594,250 $7.89 191,579
======= ===== =======
</Table>
- ---------------
(a) Consists of the 1995 and 1996 Stock Option and Award Plans.
(b) Includes 77,429 shares reserved for issuance under the 1995 Employee Stock
Purchase Plan.
DIRECTOR COMPENSATION
Directors of the Company who are not employees of the Company or any of its
subsidiaries receive a retainer of $3,000 per quarter for their services as
directors (from January 1, 2002 through December 31, 2002, each such director
received an aggregate of $12,000 for such director's services as director for
such period). Such directors also receive $1,000 plus expenses for each regular
and special Board meeting attended, and $1,000 plus expenses for each meeting of
any committee of the Board attended, and $500 per each telephonic meeting.
Directors who are employees of the Company do not receive directors' fees.
137
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Wilson (Chairman), and Garrison served as members of the
Compensation Committee of the Board of Directors during 2002. Messrs. Wilson,
and Garrison served as members of the Stock Option Subcommittee of the
Compensation Committee during 2002. Neither of Messrs. Wilson and Garrison was
an officer or employee of the Company or any of its subsidiaries during 2002 or
any prior year. No interlocking relationship exists between the members of the
Company's Board of Directors or Compensation Committee and the board of
directors and compensation committee of any other company, nor has any such
interlocking relationship existed in the past.
EMPLOYMENT AGREEMENTS
In 1999, the FirstCity Commercial entered into employment agreements with
Messrs. Terry R. DeWitt, G. Stephen Fillip and James C. Holmes. The term of each
of these contracts runs to December 31, 2004. These contracts provide for
salaries of $250,000, $250,000 and $200,000, respectively. Additionally, these
contracts provide for the establishment of a bonus pool based on the annual net
profits of FirstCity Commercial before taxes and interest expense on the
indebtedness of FirstCity Commercial to the Company exceeding certain
thresholds. Messrs. DeWitt, Fillip and Holmes participate in the benefit plans
of the Company. These employment agreements were terminated in December 2002
upon the completion of the recapitalization of the Company.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth certain information regarding the Common
Stock owned on December 31, 2002 (the "Measurement Date") by (1) each person who
is known by the Company to be the beneficial owner of more than five percent of
the Common Stock as of such date, (2) each of the Company's directors, (3) each
of the Named Executive Officers and (4) all directors and executive officers of
the Company as a group. Except as otherwise indicated, all shares of the Common
Stock shown in the table are held with sole voting and investment power.
<Table>
<Caption>
SHARES
BENEFICIALLY PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OWNED OF CLASS
- --------------------------------------- ------------ --------
James R. Hawkins............................................ 1,276,904(2)(10) 11.4%
James T. Sartain............................................ 565,047(3)(10) 5.0%
Richard E. Bean............................................. 288,208(4) 2.6%
Dane Fulmer................................................. 48,225(5) *
Robert E. Garrison II....................................... 62,825(5) *
Jeffery Leu................................................. 2,500(6) *
C. Ivan Wilson.............................................. 32,395(4) *
Terry R. DeWitt............................................. 191,332(7) 1.7%
G. Stephen Fillip........................................... 222,837(7) 2.0%
Jim W. Moore................................................ 42,207(8) *
Richard J. Vander Woude..................................... 36,685(9) *
All directors and executive officers as a group (15
persons).................................................. 3,013,650 26.1%
</Table>
- ---------------
* Less than 1%
(1) The business mailing address of each of such persons (except as otherwise
indicated) is P.O. Box 8216, Waco, Texas 76714-8216.
(2) Includes 250,994 shares of Common Stock held of record by J-Hawk, Ltd., the
sole general partner of which is Combined Funding, Inc. Mr. Hawkins may be
deemed to beneficially own such shares of Common Stock as a result of his
ownership of 50% of the common stock of Combined Funding, Inc.
138
(3) Includes 24,800 and 62,500 shares that may be acquired within 60 days of
the Measurement Date upon the exercise of options granted under the
Company's 1995 and 1996 Stock Option and Award Plan.
(4) Includes 6,375 shares that may be acquired within 60 days of the
Measurement Date upon the exercise of options granted under the Company's
1996 Stock Option and Award Plan.
(5) Includes 4,375 shares that may be acquired within 60 days of the
Measurement Date upon the exercise of options granted under the Company's
1996 Stock Option and Award Plan.
(6) Includes 2,500 shares that may be acquired within 60 days of the
Measurement Date upon the exercise of options granted under the Company's
1996 Stock Option and Award Plan. Mr. Leu is an officer of certain
affiliates of Cargill, which, as of the Measurement Date was the record
owner of 221,683 shares of Common Stock. Mr. Leu disclaims beneficial
ownership of such shares. Cargill is party to the Shareholder Voting
Agreement with Messrs. Hawkins and Sartain, and ATARA, regarding the Common
Stock.
(7) Includes 11,500 and 24,950 shares that may be acquired within 60 days of
the Measurement Date upon the exercise of options granted under the
Company's 1995 and 1996 Stock Option and Award Plan, respectively.
(8) Includes 10,200 and 25,850 shares that may be acquired within 60 days of
the Measurement Date upon the exercise of options granted under the
Company's 1995 and 1996 Stock Option and Award Plan, respectively.
(9) Includes 31,250 shares that may be acquired within 60 days of the
Measurement Date upon the exercise of options granted under the Company's
1996 Stock Option and Award Plan.
(10) Messrs. Hawkins and Sartain and ATARA, the sole general partner of which is
ATARA Corp., are parties to a Shareholder Voting Agreement with Cargill
regarding the Common Stock, pursuant to which ATARA and Messrs. Hawkins and
Sartain are required to vote their shares of Common Stock to elect one
designee of Cargill as a director of the Company, and Cargill is required
to vote its shares of Common Stock to elect one or more designees of ATARA
and Messrs. Hawkins and Sartain as directors of the company. Each of
Messrs. Hawkins and Sartain and ATARA disclaims beneficial ownership of the
shares of Common Stock owned by Cargill.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company owns equity interests in various purchased asset portfolios
through limited partnerships and limited liability companies ("Acquisition
Partnerships") in which a corporate affiliate of the Company is the sole general
partner or managing member, and the Company and other non-affiliated investors
are limited partners or members. Certain directors and executive officers of the
Company may also serve as directors and/or executive officers of the general
partner or managing member, but receive no additional compensation from or on
behalf of such general partner or managing member for serving in such capacity.
The Company provides asset servicing to such Acquisition Partnerships pursuant
to servicing agreements between the Company and such Acquisition Partnerships.
Under the Right of First Refusal Agreement, if the Company receives an
invitation to bid on or otherwise obtains an opportunity to acquire interests in
loans, receivables, real estate or other assets located in the United States,
Canada, Latin America, or the Caribbean in which the aggregate amount to be bid
exceeds $4 million, or $500 thousand for consumer assets, the Company is
required to follow a prescribed notice procedure pursuant to which CFSC has the
option to participate in the proposed purchase by requiring that such purchase
or acquisition be effected through an Acquisition Partnership formed by the
Company and Cargill (or an affiliate). The Right of First Refusal Agreement does
not prohibit the Company from holding discussions with entities other than CFSC
regarding potential joint purchases of interests in loans, receivables, real
estate or other assets, provided that any such purchase is subject to CFSC's
right to participate in the Company's share of the investment. The Right of
First Refusal Agreement further provides that, subject to certain conditions,
CFSC will bear 50% of the due diligence expenses incurred by the Company in
connection with proposed asset purchases. The Right of First Refusal Agreement
is a restatement and extension of a similar agreement entered into among the
Company, certain members of the Company's management and
139
Cargill in 1992. The Right of First Refusal Agreement has a termination date of
February 1, 2006 and will renew automatically for an additional year on an
annual basis thereafter unless either party gives notice to the other of its
desire to discontinue the arrangement six months prior to the termination date.
The Company has loans receivable, totaling $16.4 million at December 31,
2002, made to certain Acquisition Partnerships located in Mexico. These loans
are at fixed rates ranging from 19% to 20%, with default provisions allowing for
rates from 23% to 30%. The Company also has a loan receivable ($1.3 million at
December 31, 2002) to a domestic Acquisition Partnership bearing interest at
Prime plus 7%. Payments on these notes are dependent upon proceeds from the
resolution of Portfolio Assets held by the Acquisition Partnerships. See notes 1
and 5 of the Notes to Consolidated Financial Statements.
During 2002, FirstCity sold all of its equity interest in eight Acquisition
Partnerships to MCS et Associes, S.A ("MCS") and an affiliate of CFSC. MCS is an
equity investee of the Company and also a partner with FirstCity in various
Acquisition Partnerships. Proceeds from the sale were $3.4 million resulting in
a gain of $1.8 million.
FirstCity has a $35 million credit facility with CFSC, which matures in
March 2005. The loan bears interest based on the maximum of 8.5% or LIBOR plus
4.5% and is secured by investments in Acquisition Partnerships. As of December
31, 2002, the outstanding balance was $24.6 million. Jeffery D. Leu, a director
of the Company, is an officer of certain affiliates of Cargill. The Company
believes that the terms of this credit facility are generally as favorable to
the Company as the terms it would receive from an independent third party.
FirstCity has a term loan with CFSC, which matures in June 2003. This loan
bears interest at LIBOR plus 5% and is secured by the stock of Bosque Asset
Corporation and the proceeds to FirstCity from securitization certificates held
by FirstStreet Investment, LLC. The outstanding balance as of December 31, 2002
was $2.5 million. The Company believes that the terms of this loan is generally
as favorable to the Company as the terms it would receive from an independent
third party.
Pursuant to a noncancellable operating lease, the Company leases the office
space for its principal executive offices in Waco, Texas from a trust created
for the benefit of the children of James R. Hawkins, the Chairman of the Board
of the Company. This lease expires in December of 2002 and contains an option in
favor of the Company pursuant to which the Company may renew the lease for an
additional five-year period, with escalating lease payments. Rental expenses
under such lease for calendar year 2002 were $120,000. The Company believes that
the terms of such lease are generally as favorable to the Company as the terms
it would receive from an independent third party.
Park Central Recreation, Inc., a Texas corporation of which James R.
Hawkins is a 50% shareholder, is indebted to FirstStreet Investment, LLC, an
affiliate of the Company, under a note dated March 1, 1996, which has an
outstanding principal balance of $2.1 million as of December 31, 2002. The note
is secured by a first lien on real estate in Port Arthur, Texas, which is
operated as a bowling alley. The note bears a fixed interest rate of 10%,
matures on March 1, 2006 and requires annual payments of $289,500.
During 2002, Terry R. DeWitt, the Co-President of FirstCity Commercial, had
indebtedness with the Company in the amount of $125,000. The principal was paid
off in December 2002. The largest amount of principal outstanding at any time
during 2002 was $125,000. Such indebtedness was unsecured and bore interest at
the rate of 5% annually.
In December 2002, FirstCity acquired the minority interest in FirstCity
Holdings held by Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, each of
whom are Senior Vice Presidents of FirstCity by issuing 400,000 shares of common
stock of the Company and a note payable, to be periodically redeemed by the
Company for an aggregate of up to $3.2 million in accordance with certain cash
collections from servicing income from Portfolio asset acquisitions in Mexico.
140
ITEM 14. CONTROLS AND PROCEDURES
As of December 31, 2002, management of the Company performed an evaluation
of disclosure controls and procedures. Based on that evaluation, management of
the Company concluded that the disclosure controls and procedures of the Company
were effective. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of their evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The consolidated financial statements of FirstCity, the combined financial
statements of the WAMCO Partnerships (Acquisition Partnerships), the
consolidated financial statements of Drive Financial Services LP and the
financial statements of MinnTex Investment Partners L.P. are incorporated herein
by reference to Item 8, "Financial Statements and Supplementary Data," of this
Annual Report on Form 10-K.
2. Financial Statement Schedules
Financial statement schedules have been omitted because the information is
either not required, not applicable, or is included in Item 8, "Financial
Statements and Supplementary Data."
3. Exhibits
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
2.1 -- Joint Plan of Reorganization by First City Bancorporation of
Texas, Inc., Official Committee of Equity Security Holders
and J-Hawk Corporation, with the Participation of Cargill
Financial Services Corporation, Under Chapter 11 of the
United States Bankruptcy Code, Case No. 392-39474-HCA-11
(incorporated herein by reference to Exhibit 2.1 of the
Company's Current Report on Form 8-K dated July 3, 1995
filed with the Commission on July 18, 1995).
2.2 -- Agreement and Plan of Merger, dated as of July 3, 1995, by
and between First City Bancorporation of Texas, Inc. and
J-Hawk Corporation (incorporated herein by reference to
Exhibit 2.2 of the Company's Current Report on Form 8-K
dated July 3, 1995 filed with the Commission on July 18,
1995).
3.1 -- Amended and Restated Certificate of Incorporation of the
Company (incorporated herein by reference to Exhibit 3.1 of
the Company's Current Report on Form 8-K dated July 3, 1995
filed with the Commission on July 18, 1995).
3.2 -- Bylaws of the Company (incorporated herein by reference to
Exhibit 3.2 of the Company's Current Report on Form 8-K
dated July 3, 1995 filed with the Commission on July 18,
1995).
4.1 -- Certificate of Designations of the New Preferred Stock
($0.01 par value) of the Company. (incorporated herein by
reference to Exhibit 4.1 to the Company's Current Report on
Form 10-K dated March 24, 1998 filed with the Commission on
March 26, 1998).
9.1 -- Shareholder Voting Agreement, dated as of June 29, 1995,
among ATARA I Ltd., James R. Hawkins, James T. Sartain and
Cargill Financial Services Corporation. (incorporated herein
by reference to Exhibit 9.1 of the Company's Form 10-K dated
March 24, 1998 filed with the Commission on March 26, 1998).
10.1 -- Note Agreement, dated as of June 6, 1997, among Bosque Asset
Corp., SVD Realty, L.P., SOWAMCO XXII, LTD., Bosque
Investment Realty Partners, L.P. and Bankers Trust Company
of California, N.A. (incorporated herein by reference to
Exhibit 10.14 of the Company's Form 10-K dated March 24,
1998 filed with the Commission March 26, 1998).
10.2 -- Loan Agreement, dated April 8, 1998 between Bank of Scotland
and the Company (incorporated herein by reference to Exhibit
10.6 of the Company's Form 10-Q dated August 14, 1998, filed
with the Commission on August 18, 1998)
</Table>
141
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
10.3 -- First Amendment to Loan Agreement, dated July 20, 1998,
between Bank of Scotland and the Company (incorporated
herein by reference to Exhibit 10.7 of the Company's Form
10-Q dated August 14, 1998, filed with the Commission on
August 18, 1998).
10.4 -- Tenth Amendment to Loan Agreement, dated August 11, 1999
between Bank of Scotland and the Company (incorporated
herein by reference to Exhibit 10.34 of the Company's Form
10-Q dated August 16, 1999, filed with the Commission on
August 16, 1999).
10.5 -- Amended and Restated Loan Agreement, dated December 20,
1999, by and among FirstCity Financial Corporation as
Borrower and the Lenders Named therein, as Lenders and Bank
of Scotland as Agent (incorporated herein by reference to
Exhibit 10.1 of the Company's Form 8-K dated December 22,
1999, filed with the Commission on December 28, 1999).
10.6 -- Securities Purchase Agreement, dated as of August 18, 2000,
by and among the Company, Consumer Corp., Funding LP,
Funding GP, IFA-GP and IFA-LP. (incorporated herein by
reference to Exhibit 10.40 of the Company's Form 8-K dated
August 25, 2000, filed with the Commission on September 11,
2000).
10.7 -- Contribution and Assumption Agreement by and between
Consumer Corp. and Drive dated as of August 18, 2000.
(incorporated herein by reference to Exhibit 10.41 of the
Company's Form 8-K dated August 25, 2000, filed with the
Commission on September 11, 2000).
10.8 -- Contribution and Assumption Agreement by and between Funding
LP and Drive dated as of August 18, 2000. (incorporated
herein by reference to Exhibit 10.42 of the Company's Form
8-K dated August 25, 2000, filed with the Commission on
September 11, 2000).
10.9 -- Second Amendment to Amended and Restated Loan Agreement,
dated December 20, 1999, by and among the Company, as
borrower, and the Lenders, as lenders, and Bank of Scotland,
as Agent. (incorporated herein by reference to Exhibit 10.43
of the Company's Form 8-K dated August 25, 2000, filed with
the Commission on September 11, 2000).
10.10 -- Receivables Financing Agreement, dated August 18, 2000,
among Drive BOS LP, Drive Financial Services LP, each
Lender, IPA Inc. and Wells Fargo Bank Minnesota, N.A.
(incorporated herein by reference to Exhibit 10.44 of the
Company's Form 10-K dated April 13, 2001, filed with the
Commission on April 13, 2001).
10.11 -- Amendment to Loan Agreement and extension of Promissory
Note, dated January 12, 2001, by and between FirstCity
Holdings Corporation and CSFC Capital Corp. XXX
(incorporated herein by reference to Exhibit 10.45 of the
Company's Form 10-K dated April 13, 2001, filed with the
Commission on April 13, 2001).
10.12 -- Second Amendment, dated as of February 16, 2001, to the
Receivables Financing Agreement, dated as of August 18,
2000, among Drive BOS LP, Drive Financial Services LP the
Lenders party thereto, IPA Incorporated and Wells Fargo Bank
Minnesota, NA (incorporated herein by reference to Exhibit
10.46 of the Company's Form 10-K dated April 13, 2001, filed
with the Commission on April 13, 2001).
10.13 -- Subordinate Capital Loan Agreement, dated as of February 16,
2001, among Drive Financial Services LP, DRIVE BOS LP, the
financial institutions from time to time party hereto and
IFA Incorporated (incorporated herein by reference to
Exhibit 10.47 of the Company's Form 10-K dated April 13,
2001, filed with the Commission on April 13, 2001).
10.14 -- Amended and Restated Amendment #4 (Option and Option
Warrant), dated as of December 31, 2001, between the Company
and BoS(USA) Inc. (incorporated herein by reference to
Exhibit 99.1 of the Company's Form 8-K dated January 18,
2002, filed with the Commission on January 18, 2002).
10.15 -- Letter Agreement, dated November 26, 2002, between FirstCity
Consumer Lending Corporation and The Governor and Company of
the Bank of Scotland, including Form of Promissory Note to
be executed by FirstCity Consumer Lending Corporation,
payable to The Governor and Company of the Bank of Scotland.
(incorporated herein by reference to Exhibit 99(d)(5) of the
Company's Form SC TO-I/A dated November 27, 2002, filed with
the Commission on November 27, 2002).
</Table>
142
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
*10.16 -- Amended and Restated Loan Agreement, dated December 12,
2002, by and among FirstCity Financial Corporation as
Borrower and the Lenders Named therein, as Lenders and Bank
of Scotland as Agent.
*10.17 -- Term Loan and Revolving Credit Agreement, dated December 12,
2002, by and among FirstCity Financial Corporation as
Borrower and the Lenders Named therein, as Lenders and Bank
of Scotland as Agent.
21.1 -- Subsidiaries of the Registrant (incorporated herein by
reference to Exhibit 21.1 of the Company's Form 10-K/A for
dated October 21, 2002, filed with the Commission on October
21, 2002).
*23.1 -- Consent of KPMG LLP.
*23.2 -- Consent of KPMG LLP.
*23.3 -- Consent of KPMG LLP.
*23.4 -- Consent of KPMG LLP.
*99.1 -- Certification of James T. Sartain, Chief Executive Officer
of the Company, pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
and relating to the Annual Report on Form 10-K for the year
ended December 31, 2002.
*99.2 -- Certification of J. Bryan Baker, Chief Financial Officer of
the Company, pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
and relating to the Annual Report on Form 10-K for the year
ended December 31, 2002.
</Table>
- ---------------
* Filed herewith.
(b) Reports on Form 8-K
1. On December 16, 2002, the Company filed a report on Form 8-K relating to
the expiration of the Company's offer to exchange each issued and
outstanding share of its New Preferred Stock, par value $0.01 per share,
and the closing of its recapitalization, as presented in a press release
of December 16, 2002.
2. On November 14, 2002, the Company filed a report on Form 8-K attaching
the Certifications of Period Report of its Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and relating to its Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2002 filed with the SEC on November
14, 2002.
3. On December 21, 2002, the Company filed a report on Form 8-K attaching
the Certifications of Period Report of its Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and relating to its amended Annual Report on Form 10-K/A
for the fiscal year ended December 31, 2001, filed with the SEC on
October 21, 2002.
143
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ JAMES R. HAWKINS
------------------------------------
James R. Hawkins
Chairman of the Board
March 28, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JAMES R. HAWKINS Chairman of the Board and March 28, 2003
------------------------------------------------ Director
James R. Hawkins
/s/ JAMES T. SARTAIN President, Chief Executive March 28, 2003
------------------------------------------------ Officer and Director
James T. Sartain (Principal Executive Officer)
/s/ J. BRYAN BAKER Senior Vice President and March 28, 2003
------------------------------------------------ Chief Financial Officer
J. Bryan Baker (Principal financial officer)
/s/ C. IVAN WILSON Vice Chairman of the Board and March 28, 2003
------------------------------------------------ Director
C. Ivan Wilson
/s/ RICHARD E. BEAN Director March 28, 2003
------------------------------------------------
Richard E. Bean
/s/ ROBERT E. GARRISON Director March 28, 2003
------------------------------------------------
Robert E. Garrison
/s/ DANE FULMER Director March 28, 2003
------------------------------------------------
Dane Fulmer
/s/ JEFFERY D. LEU Director March 28, 2003
------------------------------------------------
Jeffery D. Leu
</Table>
144
CERTIFICATION
PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, James T. Sartain, certify that:
1. I have reviewed this annual report on Form 10-K of FirstCity Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By: /s/ JAMES T. SARTAIN
------------------------------------
James T. Sartain
Principal Executive Officer
Dated: March 28, 2003
145
CERTIFICATION
PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, J. Bryan Baker, certify that:
1. I have reviewed this annual report on Form 10-K of FirstCity Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By: /s/ J. BRYAN BAKER
------------------------------------
J. Bryan Baker
Principal Financial Officer
Dated: March 28, 2003
146
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
2.1 -- Joint Plan of Reorganization by First City Bancorporation of
Texas, Inc., Official Committee of Equity Security Holders
and J-Hawk Corporation, with the Participation of Cargill
Financial Services Corporation, Under Chapter 11 of the
United States Bankruptcy Code, Case No. 392-39474-HCA-11
(incorporated herein by reference to Exhibit 2.1 of the
Company's Current Report on Form 8-K dated July 3, 1995
filed with the Commission on July 18, 1995).
2.2 -- Agreement and Plan of Merger, dated as of July 3, 1995, by
and between First City Bancorporation of Texas, Inc. and
J-Hawk Corporation (incorporated herein by reference to
Exhibit 2.2 of the Company's Current Report on Form 8-K
dated July 3, 1995 filed with the Commission on July 18,
1995).
3.1 -- Amended and Restated Certificate of Incorporation of the
Company (incorporated herein by reference to Exhibit 3.1 of
the Company's Current Report on Form 8-K dated July 3, 1995
filed with the Commission on July 18, 1995).
3.2 -- Bylaws of the Company (incorporated herein by reference to
Exhibit 3.2 of the Company's Current Report on Form 8-K
dated July 3, 1995 filed with the Commission on July 18,
1995).
4.1 -- Certificate of Designations of the New Preferred Stock
($0.01 par value) of the Company. (incorporated herein by
reference to Exhibit 4.1 to the Company's Current Report on
Form 10-K dated March 24, 1998 filed with the Commission on
March 26, 1998).
9.1 -- Shareholder Voting Agreement, dated as of June 29, 1995,
among ATARA I Ltd., James R. Hawkins, James T. Sartain and
Cargill Financial Services Corporation. (incorporated herein
by reference to Exhibit 9.1 of the Company's Form 10-K dated
March 24, 1998 filed with the Commission on March 26, 1998).
10.1 -- Note Agreement, dated as of June 6, 1997, among Bosque Asset
Corp., SVD Realty, L.P., SOWAMCO XXII, LTD., Bosque
Investment Realty Partners, L.P. and Bankers Trust Company
of California, N.A. (incorporated herein by reference to
Exhibit 10.14 of the Company's Form 10-K dated March 24,
1998 filed with the Commission March 26, 1998).
10.2 -- Loan Agreement, dated April 8, 1998 between Bank of Scotland
and the Company (incorporated herein by reference to Exhibit
10.6 of the Company's Form 10-Q dated August 14, 1998, filed
with the Commission on August 18, 1998)
10.3 -- First Amendment to Loan Agreement, dated July 20, 1998,
between Bank of Scotland and the Company (incorporated
herein by reference to Exhibit 10.7 of the Company's Form
10-Q dated August 14, 1998, filed with the Commission on
August 18, 1998).
10.4 -- Tenth Amendment to Loan Agreement, dated August 11, 1999
between Bank of Scotland and the Company (incorporated
herein by reference to Exhibit 10.34 of the Company's Form
10-Q dated August 16, 1999, filed with the Commission on
August 16, 1999).
10.5 -- Amended and Restated Loan Agreement, dated December 20,
1999, by and among FirstCity Financial Corporation as
Borrower and the Lenders Named therein, as Lenders and Bank
of Scotland as Agent (incorporated herein by reference to
Exhibit 10.1 of the Company's Form 8-K dated December 22,
1999, filed with the Commission on December 28, 1999).
10.6 -- Securities Purchase Agreement, dated as of August 18, 2000,
by and among the Company, Consumer Corp., Funding LP,
Funding GP, IFA-GP and IFA-LP. (incorporated herein by
reference to Exhibit 10.40 of the Company's Form 8-K dated
August 25, 2000, filed with the Commission on September 11,
2000).
10.7 -- Contribution and Assumption Agreement by and between
Consumer Corp. and Drive dated as of August 18, 2000.
(incorporated herein by reference to Exhibit 10.41 of the
Company's Form 8-K dated August 25, 2000, filed with the
Commission on September 11, 2000).
10.8 -- Contribution and Assumption Agreement by and between Funding
LP and Drive dated as of August 18, 2000. (incorporated
herein by reference to Exhibit 10.42 of the Company's Form
8-K dated August 25, 2000, filed with the Commission on
September 11, 2000).
10.9 -- Second Amendment to Amended and Restated Loan Agreement,
dated December 20, 1999, by and among the Company, as
borrower, and the Lenders, as lenders, and Bank of Scotland,
as Agent. (incorporated herein by reference to Exhibit 10.43
of the Company's Form 8-K dated August 25, 2000, filed with
the Commission on September 11, 2000).
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
10.10 -- Receivables Financing Agreement, dated August 18, 2000,
among Drive BOS LP, Drive Financial Services LP, each
Lender, IPA Inc. and Wells Fargo Bank Minnesota, N.A.
(incorporated herein by reference to Exhibit 10.44 of the
Company's Form 10-K dated April 13, 2001, filed with the
Commission on April 13, 2001).
10.11 -- Amendment to Loan Agreement and extension of Promissory
Note, dated January 12, 2001, by and between FirstCity
Holdings Corporation and CSFC Capital Corp. XXX
(incorporated herein by reference to Exhibit 10.45 of the
Company's Form 10-K dated April 13, 2001, filed with the
Commission on April 13, 2001).
10.12 -- Second Amendment, dated as of February 16, 2001, to the
Receivables Financing Agreement, dated as of August 18,
2000, among Drive BOS LP, Drive Financial Services LP the
Lenders party thereto, IPA Incorporated and Wells Fargo Bank
Minnesota, NA (incorporated herein by reference to Exhibit
10.46 of the Company's Form 10-K dated April 13, 2001, filed
with the Commission on April 13, 2001).
10.13 -- Subordinate Capital Loan Agreement, dated as of February 16,
2001, among Drive Financial Services LP, DRIVE BOS LP, the
financial institutions from time to time party hereto and
IFA Incorporated (incorporated herein by reference to
Exhibit 10.47 of the Company's Form 10-K dated April 13,
2001, filed with the Commission on April 13, 2001).
10.14 -- Amended and Restated Amendment #4 (Option and Option
Warrant), dated as of December 31, 2001, between the Company
and BoS(USA) Inc. (incorporated herein by reference to
Exhibit 99.1 of the Company's Form 8-K dated January 18,
2002, filed with the Commission on January 18, 2002).
10.15 -- Letter Agreement, dated November 26, 2002, between FirstCity
Consumer Lending Corporation and The Governor and Company of
the Bank of Scotland, including Form of Promissory Note to
be executed by FirstCity Consumer Lending Corporation,
payable to The Governor and Company of the Bank of Scotland.
(incorporated herein by reference to Exhibit 99(d)(5) of the
Company's Form SC TO-I/A dated November 27, 2002, filed with
the Commission on November 27, 2002).
*10.16 -- Amended and Restated Loan Agreement, dated December 12,
2002, by and among FirstCity Financial Corporation as
Borrower and the Lenders Named therein, as Lenders and Bank
of Scotland as Agent.
*10.17 -- Term Loan and Revolving Credit Agreement, dated December 12,
2002, by and among FirstCity Financial Corporation as
Borrower and the Lenders Named therein, as Lenders and Bank
of Scotland as Agent.
21.1 -- Subsidiaries of the Registrant (incorporated herein by
reference to Exhibit 21.1 of the Company's Form 10-K/A for
dated October 21, 2002, filed with the Commission on October
21, 2002).
*23.1 -- Consent of KPMG LLP.
*23.2 -- Consent of KPMG LLP.
*23.3 -- Consent of KPMG LLP.
*23.4 -- Consent of KPMG LLP.
*99.1 -- Certification of James T. Sartain, Chief Executive Officer
of the Company, pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
and relating to the Annual Report on Form 10-K for the year
ended December 31, 2002.
*99.2 -- Certification of J. Bryan Baker, Chief Financial Officer of
the Company, pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
and relating to the Annual Report on Form 10-K for the year
ended December 31, 2002.
</Table>
- ---------------
* Filed herewith.