1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 1-7614 FIRSTCITY FINANCIAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Delaware 76-0243729 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 6400 Imperial Drive, Waco, TX 76712 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (817) 751-1750 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 whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No ------- ------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of May 3, 1996, 4,921,422 shares of Common Stock, par value $.01 per share, were outstanding. 1 2 FIRSTCITY FINANCIAL CORPORATION TABLE OF CONTENTS TO FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996 PART I - FINANCIAL INFORMATION Page ---- Item 1. Financial Statements FirstCity Financial Corporation and Subsidiaries Consolidated Balance Sheets 3 FirstCity Financial Corporation and Subsidiaries Consolidated Statements of Income 4 FirstCity Financial Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity 5 FirstCity Financial Corporation and Subsidiaries Consolidated Statements of Cash Flows 6 FirstCity Financial Corporation and Subsidiaries Notes to Consolidated Financial Statements 7 FirstCity Liquidating Trust and Subsidiaries Consolidated Statements of Net Assets 13 FirstCity Liquidating Trust and Subsidiaries Consolidated Statements of Income and Changes in Net Asset Value 13 FirstCity Liquidating Trust and Subsidiaries Consolidated Statements of Cash Flows 14 FirstCity Liquidating Trust and Subsidiaries Notes to Consolidated Financial Statements 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 25 SIGNATURES 26 2 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS March 31, December 31, (Dollars in thousands, except per share data) 1996 1995 --------------------------------------------------------------------------------------------------------- Assets ------ Cash and equivalents . . . . . . . . . . . . . . . . . . . . . $ 4,192 $ 8,370 Purchased asset pools, net . . . . . . . . . . . . . . . . . . 87,393 95,939 Equity investments in and advances to acquisition partnerships . . . . . . . . . . . . . . . . . . . . . . . 39,622 26,187 Class "A" Certificate of FirstCity Liquidating Trust . . . . . 110,838 162,245 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . 15,673 16,148 ------------------ ----------------- Total Assets . . . . . . . . . . . . . . . . . . . . . . $ 257,718 $ 308,889 ================== ================= Liabilities, Special Preferred Stock ------------------------------------ and Shareholders' Equity ------------------------ Liabilities: Notes payable, secured . . . . . . . . . . . . . . . . . . $ 87,448 $ 85,518 Senior subordinated notes payable . . . . . . . . . . . . . 53,345 106,690 Notes payable to others . . . . . . . . . . . . . . . . . . 6,688 8,988 Other liabilities . . . . . . . . . . . . . . . . . . . . . 5,041 5,887 ------------------ ----------------- Total Liabilities . . . . . . . . . . . . . . . . . . . . . 152,522 207,083 ------------------ ----------------- Commitments and contingencies . . . . . . . . . . . . . . . . . - - Special preferred stock, including dividends of $5,814 and $3,876, respectively (nominal stated value of $21.00 per share; 2,500,000 shares authorized; 2,460,911 issued and outstanding) . . . . . . . . . . . . . . . . . . . . . . . 57,493 55,555 Shareholders' equity: Optional preferred stock (par value $.01 per share; 100,000,000 shares authorized; no shares issued or outstanding) . . . . . . . . . . . . . . . . . . . . . . - - Common stock (par value $.01 per share; 100,000,000 shares authorized; 4,921,422 shares issued and outstanding) . . 49 49 Paid in capital . . . . . . . . . . . . . . . . . . . . . . 22,916 22,916 Retained earnings . . . . . . . . . . . . . . . . . . . . . 24,738 23,286 ------------------ ----------------- Total Shareholders' Equity . . . . . . . . . . . . . . . 47,703 46,251 ------------------ ----------------- Total Liabilities, Special Preferred Stock and Shareholders' Equity . . . . . . . . . . . . . . . . $ 257,718 $ 308,889 ================== ================= See accompanying notes to consolidated financial statements. 3 4 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Three Months Ended March 31, (Amounts in thousands, ----------------------------- except per share data) 1996 1995 -------------------------------------------------------------------------------- Proceeds from disposition and payments received on purchased asset pools . . . . . . . . . $ 13,995 $ 4,109 Cost of purchased asset pools . . . . . . . . . 9,331 2,692 ------------- -------------- Net gain on purchased asset pools . . . . . 4,664 1,417 Other Income: Servicing fees . . . . . . . . . . . . . . 2,518 1,656 Interest income on Class "A" Certificate . 4,312 - Other interest income . . . . . . . . . . . 1,090 8 Rental income on purchased real estate pools 487 - Other . . . . . . . . . . . . . . . . . . . 258 259 ------------- -------------- 13,329 3,340 ------------- -------------- Expenses: Interest on senior subordinated notes payable . . . . . . . . . . . . . . . . 2,374 - Interest on other notes payable . . . . . . 2,131 742 Salaries and benefits . . . . . . . . . . . 2,569 1,374 Amortization . . . . . . . . . . . . . . . 825 - Other general and administrative . . . . . 2,614 413 ------------- -------------- 10,513 2,529 ------------- -------------- Equity in earnings of acquisition partnerships . 714 628 ------------- -------------- Earnings from operations before income taxes . . . . . . . . . . . . . . . . . 3,530 1,439 Provision for income taxes . . . . . . . . . . 140 490 ------------- -------------- Net earnings . . . . . . . . . . . . . . $ 3,390 $ 949 ============= ============= Special preferred dividends . . . . . . . . . . 1,938 - ------------- -------------- Net earnings to common shareholders . . . . . . $ 1,452 $ 949 ============= ============= Net earnings per share . . . . . . . . . . . . $ 0.30 $ 0.42 ============= ============= Weighted average shares outstanding . . . . . . 4,921 2,285 ============= ============= See accompanying notes to consolidated financial statements. 4 5 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Total Common Paid in Retained Shareholders' (Dollars in thousands) Stock Capital Earnings Equity ---------------------------------------------------------------------------------------------------------- Balances, January 1, 1995 . . . . . . . . . . $ 1,574 $ 1,812 $ 17,781 $ 21,167 Common stock issued (5,935 shares) . . . . . 59 720 - 779 Common stock retired (11,080 shares) . . . . (111) (1,089) - (1,200) Net assets spun off to Combined Financial Corporation . . . . . . . . . . . - - (5,352) (5,352) Merger with First City Bancorporation of Texas, Inc. . . . . . . . . . . . . . . (1,473) 21,473 - 20,000 Net earnings for 1995 . . . . . . . . . . . . - - 14,733 14,733 Preferred stock dividends . . . . . . . . . . - - (3,876) (3,876) --------- --------- ---------- ----------- Balances, December 31, 1995 . . . . . . . . . 49 22,916 23,286 46,251 --------- --------- ---------- ----------- Net earnings for the three months ended March 31, 1996 . . . . . . . . . . . - - 3,390 3,390 Preferred stock dividends . . . . . . . . . . - - (1,938) (1,938) --------- --------- ---------- ----------- Balances, March 31, 1996 . . . . . . . . . . $ 49 $ 22,916 $ 24,738 $ 47,703 ========= ========== ========== =========== See accompanying notes to consolidated financial statements. 5 6 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, ----------------- (Dollars in thousands) 1996 1995 - ------------------------------------------------------------------------------- Cash flows from operating activities: Net earnings . . . . . . . . . . . . . . . . . . . . . . $ 3,390 $ 949 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Cost of collections . . . . . . . . . . . . . . . . . 9,331 2,692 Purchase of asset pools. . . . . . . . . . . . . . . . (1,424) - Equity in earnings of acquisition partnerships . . . . (714) (628) Collections on performing asset pools. . . . . . . . . 915 - Depreciation and amortization . . . . . . . . . . . . 1,353 215 Increase in other assets . . . . . . . . . . . . . . . (2,977) (1,658) Decrease in other liabilities . . . . . . . . . . . . (846) (2,794) -------- ------- Net cash provided by (used in) operating activities. 9,028 (1,224) -------- ------- Cash flows from investing activities: Payments on advances to acquisition partnerships . . . . 177 - Principal payment on Class "A" Certificate . . . . . . . 53,345 - Property and equipment, net . . . . . . . . . . . . . . . (115) (32) Contributions to acquisition partnerships . . . . . . . . (13,132) (1,338) Distributions from acquisition partnerships . . . . . . . 234 1,214 -------- ------- Net cash provided by (used in) investing activities. . 40,509 (156) -------- ------- Cash flows from financing activities: Borrowings under notes . . . . . . . . . . . . . . . . . 18,974 2,700 Payments of notes payable . . . . . . . . . . . . . . . . (19,344) (3,653) Payment of senior subordinated notes payable. . . . . . . (53,345) - Additions to notes payable to stockholders and officers . - 1,788 Reduction of notes payable to stockholders and officers . - (1,137) Retirement of common stock . . . . . . . . . . . . . . . - (1,200) -------- ------- Net cash used in financing activities. . . . . . . . . (53,715) (1,502) -------- ------- Net decrease in cash . . . . . . . . . . . . . . . . . . . (4,178) (2,882) Cash, beginning of period . . . . . . . . . . . . . . . . . 8,370 4,150 -------- ------- Cash, end of period . . . . . . . . . . . . . . . . . . . . $ 4,192 $ 1,268 ======== ======= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest . . . . . . . . . . . . . . . . . . . . . . . $ 4,484 $ 762 ======== ======= Income taxes . . . . . . . . . . . . . . . . . . . . . $ - $ - ======== ======= See accompanying notes to consolidated financial statements. 6 7 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements March 31, 1996 (1) Summary of Significant Accounting Policies (a) Basis of Presentation As more fully discussed in Note 2, on July 3, 1995, FirstCity Financial Corporation was formed by the merger of J-Hawk Corporation and First City Bancorporation of Texas, Inc. Historical financial statements prior to the merger date reflect the financial position and results of operations of J-Hawk Corporation and are not necessarily indicative of results expected to be achieved in the future. The preparation of financial statements in conformity with generally accepted accounting principles 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 asset pools used in the calculation of net gain on purchased asset pools. Actual results could differ materially from those estimates. The unaudited consolidated financial statements of FirstCity Financial Corporation reflect, in the opinion of management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly FirstCity Financial Corporation's financial position at March 31, 1996, and the results of operations and cash flows for the three month periods ended March 31, 1996 and 1995. (b) Description of Business FirstCity Financial Corporation is a specialized financial services company which evaluates, acquires, manages, services and disposes of portfolios of performing loans, non-performing loans, other real estate and other financial assets, (collectively, purchased asset pools). A significant amount of loans are secured by real estate located throughout the United States. The Company purchases these asset pools at substantial discounts from their original legal principal amounts from financial institutions, other lenders and regulatory agencies of the United States. Purchased asset pools are acquired in privately negotiated transactions, in sealed bid sales limited to a small number of invited participants, and in public sealed bid sales. Purchased asset pools are acquired on behalf of the Company or its wholly-owned subsidiaries, and on behalf of legally independent partnerships (acquisition partnerships) in which an affiliate of the Company is the general partner and the Company and other investors are limited partners. The Company also services, manages and disposes of all of the assets it, its affiliated acquisition partnerships, or other related entities acquire. The Company services all such assets until they are collected or sold but does not service or manage assets for non-affiliated third parties. In the ordinary course of business, the Company sells assets to commercial banks, investment banks, finance companies and other investment partnerships. 7 8 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (c) Principles of Consolidation The accompanying consolidated financial statements include the accounts of FirstCity Financial Corporation, a Delaware corporation, and its subsidiaries (collectively referred to as "FirstCity"). Investments in 20 percent to 50 percent owned affiliates are accounted for on the equity method. All significant intercompany transactions and balances have been eliminated in consolidation. (d) Purchased Asset Pools The purchased asset pools consist of consumer loans, commercial and industrial loans, commercial real estate loans, multi-family residential loans, single family residential loans and various types of other real estate, all purchased at substantial discounts from their original legal principal amount or expected future sales price. Loans are considered performing if debt service payments are made in accordance with the original or restructured terms of the notes. At the acquisition date, the aggregate cost of the purchased asset pools is allocated to individual assets based on their relative values within the pool. Subsequent to acquisition, the purchased asset pools are periodically revalued and carried at the lower of cost or fair value. Any allowance to reduce cost to fair value on purchased asset pools is recorded as a provision for possible loss on the purchased asset pools during the period determined. No material allowances or provisions were required to adjust the carrying values of the purchased asset pools for any of the periods presented. Gross profit from dispositions and payments received on purchased non-performing asset pools is recognized as income to the extent that proceeds collected on the asset pool exceed a pro-rata portion of allocated cost from the purchased asset pool. Cost allocation is based on a proration of actual collections divided by total estimated collections of the pool. Interest collected on loans in the purchased non-performing asset pools is recognized as part of the proceeds from disposition of purchased asset pools. Interest on purchased performing asset pools is recognized when earned, including accretion of related discounts. Servicing fees are accrued when collections are received on serviced assets. Rental income on purchased real estate pools is recorded when received. (e) Foreclosed Assets Foreclosed assets which were acquired in settlement of notes are recorded at the lower of allocated cost or fair value. Costs relating to the development and improvement of foreclosed assets are capitalized, whereas those relating to holding foreclosed assets are charged to expense. (f) Net Earnings Per Share Net earnings per common share calculations are based upon the weighted average number of common shares outstanding restated to reflect the equivalent number of FirstCity common shares which were issued to the J-Hawk shareholders in connection with the Merger discussed in Note 2. Earnings included in the earnings per share calculation are reduced by special preferred stock dividends. Potentially dilutive common stock equivalents include warrants and stock options. 8 9 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (2) Merger and Acquisition As more fully discussed in FirstCity's Form 10-K, the Joint Plan of Reorganization by First City Bancorporation of Texas, Inc. (the "Debtor"), Official Committee of Equity Security Holders, and J-Hawk Corporation ("J-Hawk"), with the Participation of Cargill Financial Services Corporation, Under Chapter 11 of the United States Bankruptcy Code, Case No. 392-39474-HCA-11 (the "Plan of Reorganization"), was confirmed by the Bankruptcy Court for the Northern District of Texas, Dallas Division, by an order entered on May 31, 1995, and became effective on July 3, 1995. Pursuant to the Plan of Reorganization, and an Agreement and Plan of Merger between the Debtor and J-Hawk, on July 3, 1995, J-Hawk was merged (the "Merger") with and into First City Bancorporation of Texas, Inc. Pursuant to the Merger, (i) the former holders of common stock of J-Hawk received, in the aggregate, approximately 49.9% of the outstanding common stock of the surviving entity, in exchange for their shares of J-Hawk common stock, (ii) approximately 50.1% of the outstanding common stock of the surviving entity was distributed among former security holders of the Debtor pursuant to the Plan, and (iii) the name of the corporation was changed to FirstCity Financial Corporation. As a result of the implementation of the Plan and the consummation of the Merger, FirstCity also issued (i) 9% senior subordinated notes, (ii) warrants to purchase 500,000 shares of its common stock at an exercise price of $25 per share, and (iii) special preferred stock to certain former security holders of the Debtor. J-Hawk contributed substantially all of its interests in its acquisition partnerships, all of its servicing operations, substantially all of its leasehold improvements and equipment and its entire management team to FirstCity. All remaining assets and liabilities of J-Hawk were spun out to Combined Financial Corporation (owned by the former J-Hawk shareholders) in June 1995. The Debtor contributed $20 million in cash to FirstCity. While the transaction was legally structured as a merger, substantively, the transaction is treated for accounting purposes as a purchase of the Debtor by J-Hawk. Pursuant to the Plan, substantially all of the legal and beneficial interest in the assets of the Debtor, other than the above described $20 million in cash, were transferred to the newly-formed FirstCity Liquidating Trust (the "Trust"), or to subsidiaries of the Trust. Such assets will be liquidated over the life of the Trust pursuant to the terms thereof. FirstCity, as the sole holder of the Class "A" Certificate under the Trust, will receive from the Trust amounts sufficient to pay certain expenses and its obligations under the 9% senior subordinated notes and the special preferred stock. Any amounts in excess of such sums shall be paid to certain of the former security holders of the Debtor pursuant to the terms of the Class "B" and Class "C" certificates of beneficial interests in the Trust. The liquidation of the assets transferred to the Trust will be managed by FirstCity pursuant to an Investment Management Agreement between the Trust and FirstCity. On September 21, 1995, FirstCity acquired the capital stock of Diversified Financial Systems, Inc. and Diversified Performing Assets, Inc. (collectively, "Diversified") for $12.9 million in cash and notes. Diversified also specializes in the acquisition and disposition of distressed loans and loan-related assets. The acquisition, accounted for as a purchase, increased FirstCity's assets by approximately $79 million, including $4.8 million assigned to servicing rights held by Diversified and $4.6 million of goodwill. 9 10 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (3) Purchased Asset Pools The purchased asset pools are summarized as follows (dollars in thousands): March 31, December 31, 1996 1995 --------- ----------- Non-performing asset pools: Loans: Borrowers' obligation on outstanding balance of: Performing loans $ 37,439 $ 55,337 Non-performing loans 340,316 339,465 --------- ---------- 377,755 394,802 Real estate assets 9,326 10,052 --------- ---------- 387,081 404,854 Performing assets pools: Loans: Borrowers' obligation on outstanding balance of: Performing loans 15,789 16,714 Non-performing loans - - --------- ---------- 15,789 16,714 Purchased real estate pool (at amortized cost) 30,641 35,179 --------- ---------- Total purchased asset pools 433,511 456,747 Discount required to reflect purchased asset pools at unamortized cost (346,118) (360,808) --------- ---------- Purchased asset pools, net $ 87,393 $ 95,939 ========= ========== The purchased asset pools are pledged to secure non-recourse notes payable. (4) Acquisition Partnerships The Company has investments in partnerships and related general partners that are accounted for on the equity method. These partnerships invest in asset pools in a manner similar to the Company, as described in Note 1. The combined financial position and results of operations of the acquisition partnerships and general partners are summarized below (in thousands): Condensed Combined Balance Sheets March 31, December 31, 1996 1995 --------- ------------ Assets $ 316,962 $ 235,820 ========== ============ Liabilities 234,888 180,659 Net equity 82,074 55,161 ---------- ------------ $ 316,962 $ 235,820 ========== ============ 10 11 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) March 31, December 31, 1996 1995 ------------ ------------- Company's equity in acquisition partnerships $ 30,213 $ 16,601 ============ ============= Advances to acquisition partnerships $ 9,409 $ 9,586 ============ ============= Condensed Combined Statements of Income Three months ended March 31, ------------------ 1996 1995 ---- ---- Collections $ 25,322 $ 40,006 Gross margin 8,186 11,302 Interest income on performing asset pools 1,768 - Net income 1,439 1,481 ========== ========= Company's equity in net income of acquisition partnerships $ 714 $ 628 ========== ========= (5) Class "A" Certificate of FirstCity Liquidating Trust Pursuant to the terms of the Plan of Reorganization and Merger, FirstCity is the sole holder of the Class "A" Certificate of the Trust. Redemption by the Trust of the balance due on the Class "A" Certificate will be used to retire the senior subordinated notes payable, which are general obligations of FirstCity, and to redeem the special preferred stock. On March 29, 1996, $53.3 million of the senior subordinated notes were redeemed, reducing the "A" Certificate by a like amount. At March 31, 1996, the Trust held (through purchase) $2 million principal of senior subordinated notes. Under the terms of the special preferred stock, FirstCity is only required to redeem such stock and to declare dividends thereon to the extent it receives sufficient funds from the Trust to make such payments. Interest income on the Class "A" Certificate consists of reimbursement to FirstCity (by the Trust) of interest expense on senior subordinated notes and of accrued (but not declared) dividends on special preferred stock. At March 31, 1996, dividends accrued but not declared totaled $5.8 million, or $2.36 a share. In the opinion of management, sufficient funds will be available from the Trust to redeem the special preferred stock at its stated redemption price and accrued dividends, on the redemption date of September 30, 1998. See financial statements of the FirstCity Liquidating Trust included elsewhere herein. 11 12 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (6) Federal Income Taxes Federal income taxes subsequent to the Merger are provided at a 35% rate. Net operating loss carry forwards are available to FirstCity and are recognized as an offset to the provision in the period during which the benefit is realized. (7) Other Related Party Transactions In January, 1995, the Company entered into an agreement with a shareholder to repurchase 11,080 shares of J-Hawk common stock for $1.2 million. The Company paid the former shareholder $.4 million in cash and issued a $.8 million note, which was assumed by Combined Financial Corporation in June 1995. The Company has contracted with FirstCity Liquidating Trust, the acquisition partnerships and related parties as third party loan servicer. All servicing fees and due diligence fees (included in other income) reflected in the Consolidated Statements of Income were derived from such affiliates. (8) Commitments and Contingencies FirstCity has pledged a portion of its interest in the future distributions of certain acquisition partnerships, after FirstCity's initial investment has been returned, to the subordinated debt lender under a Residual Share Agreement (the Agreement). Under the Agreement, this pledge is limited to twice FirstCity's original investment in the respective partnership. In the opinion of management, this pledge does not currently represent a material contingent claim on the future distributions from the acquisition partnerships to FirstCity. The Company is involved in various legal proceedings in the ordinary course of business. In the opinion of management, the resolution of such matters should not have a material adverse impact on the financial condition of the Company. 12 13 The following financial information of FirstCity Liquidating Trust and Subsidiaries is the responsibility of FirstCity Liquidating Trust's Portfolio Committee. This information is presented as a supplement to FirstCity Financial Corporation's financial statements. FIRSTCITY LIQUIDATING TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF NET ASSETS (DOLLARS IN THOUSANDS) March 31, December 31, Assets, at estimated fair value 1996 1995 ------------------------------- -------- ------------ Cash and cash equivalents . . . . . . . . . . . . . . . $ 9,617 $ 11,260 Receivables . . . . . . . . . . . . . . . . . . . . . . 2,089 2,000 Investment in FirstCity senior subordinated notes payable . . . . . . . . . . . . . . . . . . . . . . . 2,000 - Trust assets, net, pledged to secure senior notes payable to banks . . . . . . . . . . . . . . . . . . 166,865 193,204 -------- -------- Total assets . . . . . . . . . . . . . . . . . . . 180,571 206,464 -------- -------- Less liabilities at face or estimated amount -------------------------------------------- Senior notes payable to banks, secured. . . . . . . . . 19,800 - Estimated administrative claims . . . . . . . . . . . . 1,107 3,486 Payables and accrued liabilities . . . . . . . . . . . 1,296 1,197 -------- -------- Total liabilities . . . . . . . . . . . . . . . . . 22,203 4,683 -------- -------- Commitments and contingencies . . . . . . . . . . . . . - - Trust net asset value attributable to: -------------------------------------- Class "A" Certificate, held by FirstCity Financial Corporation . . . . . . . . . . . . . . . . . . . . . 110,838 162,245 Class "B" Certificate, 2,460,911 units outstanding. . . 47,530 39,536 Class "C" Certificate, 738,273 units outstanding . . . - - -------- -------- Total net asset value . . . . . . . . . . . . . . . $158,368 $201,781 ======== ======== CONSOLIDATED STATEMENTS OF INCOME AND CHANGES IN NET ASSET VALUE (DOLLARS IN THOUSANDS) Three Months Inception Ended to March 31, December 31, 1996 1995 -------- ------------ Changes in fair value of trust assets. . . . . . . . . $ 15,323 $ 33,548 Interest income on short-term investments . . . . . . 323 375 Interest expense . . . . . . . . . . . . . . . . . . . (15) (1,741) Administrative expense . . . . . . . . . . . . . . . . (3,325) (8,552) -------- -------- Net income . . . . . . . . . . . . . . . . . . . 12,306 23,630 -------- -------- Net asset value, beginning of period . . . . . . . . . 201,781 - Contribution of net assets by First City Bancorporation of Texas, Inc. . . . . . . . . . . . - 182,872 Principal distribution on Class "A" Certificate. . . . (53,345) - Interest distribution on Class "A" Certificate . . . . (2,374) (4,721) -------- -------- Net asset value, end of period . . . . . . . . . . . . $158,368 $201,781 ======== ======== See accompanying notes to consolidated financial statements. 13 14 FIRSTCITY LIQUIDATING TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) Three Months Inception to Ended March 31, December 31, 1996 1995 --------------- ------------- Cash flows from operating activities: Net income................................... $ 12,306 $ 23,630 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Changes in fair value of trust assets .... (15,323) (33,548) Collections on trust assets, net of advances................................ 41,573 107,371 Purchase of Loss-Sharing assets........... - (205,513) Decrease in other liabilities............. (2,280) (9,319) ------------- ------------ Net cash provided by (used in) operating activities............................ 36,276 (117,379) ------------- ------------ Cash flows from financing activities: Borrowings under notes payable to banks..... 19,800 73,000 Payments of notes payable to banks.......... - (73,000) Advance from FirstCity Financial Corporation - 4,728 Repayment of advance from FirstCity Financial Corporation .................... - (4,728) Advance to FirstCity Financial Corporation.. - (2,000) Repayment of advance to FirstCity Financial Corporation .............................. 2,000 - Purchase of FirstCity senior subordinated notes .................................... (4,000) - Capital contribution of First City Bancorporation of Texas, Inc. ............ - 135,360 Interest and principal distribution on Class "A" Certificate .................... (55,719) (4,721) ------------- ------------ Net cash provided by (used in) financing activities ................. (37,919) 128,639 ------------- ------------ Net increase (decrease) in cash................ $ (1,643) $ 11,260 Cash, beginning of period ..................... 11,260 - ------------- ------------ Cash, end of period ........................... $ 9,617 $ 11,260 ============= ============ Supplemental disclosure of cash flow information: Cash paid during the period for: Interest................................. $ - $ 1,741 ============= ============ Non-cash financing activities: Non-cash net assets contributed by First City Bancorporation of Texas, Inc. ........ $ - $ 47,512 ============= ============ See accompanying notes to consolidated financial statements. 14 15 FIRSTCITY LIQUIDATING TRUST AND SUBSIDIARIES Notes to Consolidated Financial Statements March 31, 1996 (A) Summary of Significant Accounting Policies The unaudited consolidated financial statements of FirstCity Liquidating Trust reflect, in the opinion of management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly FirstCity Liquidating Trust's financial position at March 31, 1996, and the results of operations and cash flows for the three month period ended March 31, 1996. (1) Description of Business The Joint Plan of Reorganization by First City Bancorporation of Texas, Inc. (the "Debtor"), Official Committee of Equity Security Holders, and J-Hawk Corporation ("J-Hawk"), with the Participation of Cargill Financial Services Corporation, Under Chapter 11 of the United States Bankruptcy Code, Case No. 392-39474-HCA-11 (the "Plan of Reorganization"), was confirmed by the Bankruptcy Court for the Northern District of Texas, Dallas Division, by an order entered on May 31, 1995, and became effective on July 3, 1995. Pursuant to the Plan of Reorganization, and an Agreement and Plan of Merger between the Debtor and J-Hawk, on July 3, 1995, J-Hawk was merged (the "Merger") with and into First City Bancorporation of Texas, Inc., and the name of the corporation was changed to FirstCity Financial Corporation ("FirstCity"). Pursuant to the Plan, substantially all of the legal and beneficial interests in the assets of the Debtor, other than $20 million in cash contributed to FirstCity, were transferred to FirstCity Liquidating Trust (the "Trust"), or to subsidiaries of the Trust. Such assets will be liquidated over the life of the Trust pursuant to the terms thereof. FirstCity, as the sole holder of the Class "A" Certificate under the Trust, will receive from the Trust amounts sufficient to pay certain expenses and FirstCity's obligations under its 9% senior subordinated notes and its special preferred stock. Any amounts in excess of such sums shall be paid to certain of the former security holders of the Debtor pursuant to the terms of the Class B and the Class C certificates of beneficial interests in the Trust. The Trust is administered by a four-person portfolio committee (the "Portfolio Committee"). The liquidation of the Trust's assets is managed by FirstCity pursuant to an Investment Management Agreement between the Trust and FirstCity. In connection with the sale of the Debtor's banks by the FDIC to third-party acquirers (the "Loss-Sharing Banks"), the FDIC guaranteed certain recoveries on loans acquired by the Loss-Sharing Banks. (These agreements are referred to as "Loss-Sharing Agreements".) On July 12, 1995, in order to reduce the uncertain effect of the Loss-Sharing Agreements on future distributions to the Trust by the FDIC, the Trust purchased assets (the "Loss-Sharing Settlement") for approximately $206 million from the Loss-Sharing Banks. With the purchase of these assets, the Loss-Sharing Banks released the FDIC from its future obligations under the Loss-Sharing Agreements. (2) Principles of Consolidation The accompanying consolidated financial statements include the accounts of FirstCity Liquidating Trust and its subsidiaries (collectively referred to as the "Trust"). All significant intercompany transactions and balances have been eliminated in consolidation. (3) Trust Assets 15 16 FIRSTCITY LIQUIDATING TRUST AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) The net assets of the Trust are carried at estimated fair values which are the results of discounting, at appropriate discount rates, the currently estimated cash flows projected to be realized from the collection, liquidation and disposition of the non-cash assets held by the Trust. Such assets consist principally of performing and non-performing loans, income producing real estate and interests in real estate, and miscellaneous other assets and receivables (principally from the FDIC) transferred to the Trust upon the consummation of the Plan. The estimates of the future cash flows from which the net asset value of the Trust was derived are made under the direction of the management of the Trust based upon information available and believed to be reliable. There can be no assurance, however, that the estimates resulting from such reviews or the net asset values derived from such estimates will ultimately be realized due to the highly judgmental assumptions which were made in developing estimates of the amount and timing of future cash flows to be realized upon the liquidation of the types of assets such as those held by the Trust. In addition to the assets described above, the Trust also holds certain contingent asset claims, such as claims against the former Directors and Officers of First City Bancorporation of Texas, Inc., claims under fidelity bonds, and judgments and deficiencies arising from charged off loans to former borrowers of the Debtor's banks. The estimated future cash flows from which the net asset value of the Trust was derived include estimated future collections which might be realized from such claims only when such amounts are reasonably certain and estimable. As a result, there can be no assurance that there will ever be any material collections realized from such contingent asset claims. Trust assets are periodically revalued and adjustments to estimated fair values are included in operating results in the period in which they become known. Loans are considered performing if debt service payments are made in accordance with the original or restructured terms of the notes. Interest on loans is recognized as part of the proceeds from disposition of trust assets. Foreclosed assets acquired in settlement of notes are recorded at estimated fair value. Costs relating to the development and improvement of property and holding costs are considered in the development of estimated fair values. (B) Trust Assets Trust assets are comprised of the following (dollars in thousands): March 31, 1996 December 31, 1995 --------------------- --------------------- Legal Estimated Legal Estimated Claim or Gross Claim or Gross Assigned Cash Assigned Cash Type of Asset Value Flow Value Flow ------------- --------- --------- --------- --------- Borrowers' obligation on outstanding balance of: Performing loans $ 135,781 $ 121,598 $ 139,705 $ 134,381 Nonperforming loans 185,661 50,020 225,921 60,454 Receivable from the FDIC 19,000 19,000 33,000 33,000 Real estate and other assets 48,022 33,224 60,734 33,305 --------- --------- --------- --------- Total 388,464 223,842 459,360 261,140 --------- --------- --------- --------- Discount required to reflect trust assets at estimated fair value (221,599) (56,977) (266,156) (67,936) --------- --------- --------- --------- Trust assets, net $ 166,865 $ 166,865 $ 193,204 $ 193,204 ========= ========= ========= ========= 16 17 FIRSTCITY LIQUIDATING TRUST AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) (C) Senior Notes Payable to Banks The Trust had a revolving line of credit with two banks for borrowings of up to $100 million. In connection with the Loss-Sharing Settlement, $73 million was borrowed by the Trust and $27 million in letters of credit were issued in favor of the Loss-Sharing Banks. Payments reduced the outstanding balance to zero in November 1995. In the first quarter of 1996, an amendment to the line of credit reduced the letters of credit to zero and established a term loan for borrowings up to $61 million. The term loan expires December 31, 1996, and can only be used for distributions on the Class A Certificate. In connection with the early redemption of senior subordinated notes (see Note E), $19.8 million was borrowed in March 1996 (and repaid in early May). Based on an election by the Trust, interest, payable monthly, on a portion of the borrowings is at prime plus 1%, and interest on the remaining balance is at one-month LIBOR (as defined) plus 3.25%. Substantially all trust assets are pledged to secure the loan. (D) Estimated Claims Estimated claims represent unpaid bankruptcy administrative claims and claims for expense reimbursement of professionals providing services to or for the benefit of the Debtor; all such claims are subject to approval of the Bankruptcy Court. (E) Distribution Priorities Pursuant to the Senior Note Loan Agreement and the Liquidating Trust Agreement, the Trust is required to apply all proceeds from liquidation and disposition of trust assets first to payment of normal operating expenses, including a servicing fee to FirstCity, and unpaid administrative claims of the Debtor. Second, trust proceeds are remitted to the senior lenders for payment of principal and interest (see Note C). Third, trust proceeds are distributed to FirstCity, the sole Class A Certificate holder, for payment of principal, due on September 30, 1997, and interest, at an annual rate of 9%, on $53.3 million senior subordinated notes payable, an obligation of FirstCity; and cumulative quarterly cash dividends ($5.8 million accrued and undeclared at March 31, 1996) at the annual rate of $3.15 per share (on 2,460,911 shares) and redemption of the nominal stated value of $51.7 million of FirstCity special preferred stock on September 30, 1998. In the first quarter of 1996, the Trust distributed $53.3 million to FirstCity for the early redemption of senior subordinated notes and held (through purchase) $2 million principal of senior subordinated notes at March 31, 1996. The fourth order of distribution is payments pursuant to employment agreements with certain former employees of the Debtor. Fifth, Class B Certificate holders (and, pursuant to bonus agreements, certain former employees of the Debtor) are entitled to distributions up to the Pour-Over Level. The Pour-Over Level (approximately $124 million at March 31,1996) is the liquidation preference on July 3, 1995, of the Debtor's Series B and Series E preferred stock, less the nominal stated value of FirstCity special preferred stock and the book value of FirstCity common stock issued to the Series B and Series E holders, plus interest at an annual rate of 6.5% from July 3, 1995. Lastly, Class C Certificate holders receive distributions, if any, after all required payments to Class B Certificate holders. No distributions to Class C Certificate holders are anticipated. The ultimate amounts to be distributed to the holders of the A, B and C Certificates will result from the cash flow realized from the liquidation of the non-cash trust assets and contingent asset claims. The determination 17 18 FIRSTCITY LIQUIDATING TRUST AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued) of the net asset value of the Trust in the accompanying consolidated statement of net assets is based upon estimates of future cash flows. The actual cash flows and the timing of such cash flows may vary significantly from those estimates, thus affecting the final distributions to the Certificate holders. (F) Investment Management Agreement Pursuant to an investment management agreement, FirstCity manages the liquidation of trust assets and the Trust will pay FirstCity a 3% servicing fee on collections (as defined) up to a specified level of collections. Thereafter, the servicing fee percentage increases with additional levels of collections. Administrative expenses include $1.1 million in the three months ended March 31, 1996 and $3.1 million for the period from inception through December 31, 1995, for servicing fees. (G) Contingencies The Trust is involved in various legal proceedings in the ordinary course of business. In the opinion of management of the Trust, the resolution of such matters should not have a material adverse impact on the financial condition of the Trust. 18 19 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FirstCity reported net earnings of $3.4 million for the first quarter of 1996. After dividends accrued but not declared on the Company's special preferred stock, earnings attributable to common equity were $1.5 million, or $.30 per share. These results represent an annualized return on equity of 12.4 percent. Earnings for the first quarter of 1995 were $.9 million, or $.42 per share. During the first quarter of 1996, FirstCity prepared for a securitization of approximately $100 million in acquisition partnership and affiliate performing assets. Revenues and earnings from the securitization, which is expected to close in the second quarter, will be recognized when the transaction is closed. FirstCity will acquire the subordinated pieces of the securitization. The securitization will enhance the net values of the underlying assets by significantly reducing FirstCity's funding costs. The first quarter of 1996 was a very successful quarter in terms of portfolio acquisitions. Since year-end, FirstCity and its acquisition partnerships have purchased in excess of $140 million in outstanding principal of assets. Comprising the growth was: o A $92 million portfolio purchased from a major banking organization. o A $28 million portfolio of automobile finance receivables. o A portfolio purchased from a state agency seeking to liquidate its investment in economic development loans. The Company has focused on growing and diversifying its asset base since year end. A considerable portion of the assets purchased during the first quarter are performing assets. The automobile receivables portfolio purchase marked the first step toward implementing FirstCity's plan to enter the consumer finance market. Along with the portfolio acquisition, FirstCity is actively seeking opportunities to acquire an origination network to result in an ongoing operating business in this sector. Background On July 3, 1995, FirstCity Financial Corporation ("FirstCity") was formed by the merger of J-Hawk Corporation ("J-Hawk") and First City Bancorporation of Texas, Inc. ("FCBOT"). For accounting purposes, the merger transaction was treated as an acquisition of FCBOT by J-Hawk. Accordingly, financial information prior to the merger date reflects the historical financial position and results of operations of J-Hawk. FirstCity is a specialized financial services company which evaluates, acquires, manages, services, and disposes of portfolios of performing loans, non-performing loans, other real estate and other financial assets (collectively, "purchased asset pools"). Purchased asset pools are acquired by FirstCity or its wholly-owned subsidiaries and through partnerships ("acquisition partnerships") in which an affiliate of FirstCity is the general partner and FirstCity and other investors are limited partners. In conjunction with the merger, the shareholders of J-Hawk received approximately 49.9% of FirstCity's common stock and the shareholders of FCBOT received approximately 50.1% of FirstCity's common stock. FirstCity also issued $106.7 million in senior subordinated notes, $51.7 million in special preferred stock and warrants to purchase 500,000 shares of its common stock at an exercise price of $25 per share. See Note 2 to the Consolidated Financial Statements of FirstCity. In connection with the merger, substantially all of the assets of FCBOT, other than $20 million in cash, were transferred to the newly-formed FirstCity Liquidating Trust ("the Trust"). FirstCity, as the sole holder of the 19 20 Class "A" Certificate under the Trust, will receive from the Trust amounts sufficient to pay certain expenses, to retire the senior subordinated notes and to redeem and pay dividends on the special preferred stock. The liquidation of the assets transferred to the Trust will be managed by FirstCity for a servicing fee. See financial statements of the Trust included elsewhere herein. J-Hawk merged substantially all of its interests in acquisition partnerships, all of its servicing operations and its entire management team into FirstCity. All of J-Hawk's remaining assets and liabilities, principally purchased asset pools, related notes payable to banks, and receivables and payables to related parties, were spun out to a company (Combined Financial Corporation) owned by former J-Hawk shareholders in June 1995. On September 21, 1995, FirstCity acquired the capital stock of Diversified Financial Systems, Inc. and Diversified Performing Assets, Inc. (Diversified) for $12.9 million in cash and notes. Diversified also specializes in the acquisition and disposition of distressed loans and loan-related assets. The acquisition, accounted for as a purchase, increased FirstCity's assets by approximately $79 million, including $4.8 million attributable to servicing rights held by Diversified and $4.6 million of goodwill. The following table summarizes FirstCity's performance for the first quarter of 1996 and 1995. CONSOLIDATED SUMMARY OF OPERATIONS =============================================================================== Three months ended (Amounts in thousands, except per share data) March 31, ------------------ 1996 1995 ------- ------- Income: Net gain on purchased asset pools $ 4,664 $ 1,417 Servicing fees 2,518 1,656 Interest income on Class A Certificate 4,312 - Other interest income 1,090 8 Rental income on purchased real estate pools 487 - Other income 258 259 ------- ------- Subtotal 13,329 3,340 ------- ------- Expenses: Interest on senior subordinated notes payable 2,374 - Interest on other notes payable 2,131 742 Salaries and benefits 2,569 1,374 Amortization 825 - Other general and administrative expense 2,614 413 ======= ====== Subtotal 10,513 2,529 ------- ------- Equity earnings of acquisition partnerships 714 628 ------- ------- Earnings before income taxes 3,530 1,439 ------- ------- Provision for income taxes 140 490 ------- ------- Net earnings $ 3,390 $ 949 ======= ======= Special preferred dividends 1,938 - ------- ------- Net earnings to common $ 1,452 $ 949 ======= ======= Net earnings per share $ 0.30 $ 0.42 Average shares outstanding 4,921 2,285 Return on average equity (annualized) 12.4% 18.0% 20 21 The following table analyzes the composition of FirstCity's major revenue resources: ANALYSIS OF REVENUE SOURCES =========================================================================== Three months ended March 31, ------------------ (Dollars in thousands) 1996 1995 -------- -------- SERVICE FEE REVENUES -------------------- ACQUISITION PARTNERSHIPS $ collected $ 25,322 40,006 Service fee revenue 941 1,647 Average service fee % 3.72% 4.12% TRUST $ collected FDIC receivable $ 17,698 - Other trust assets 23,875 - Service fee revenue 1,136 - Average service fee % 2.73% - OTHER AFFILIATE ENTITIES $ collected $ 5,070 1,088 Service fee revenue 441 9 Average service fee % 8.70% 0.83% TOTAL SERVICE FEES $ collected $ 71,965 41,094 Service fee revenue 2,518 1,656 Average service fee % 3.50% 4.03% EQUITY EARNINGS IN ACQUISITION PARTNERSHIPS ------------------------ Asset portfolios purchased $ 98,436 46,634 Average FirstCity investment 19,886 14,457 Equity earnings in investments 714 628 GAINS ON PURCHASED ASSET POOLS ------------------------------ Asset portfolios purchased $ 1,741 - $ collected 13,995 14,109 Net gain on collections 4,664 1,417 Profit margin on purchased asset pools 33.33% 34.49% =========================================================================== 21 22 The following table analyzes operations of acquisition partnerships: ANALYSIS OF ACQUISITION PARTNERSHIPS ========================================================= Three months ended March 31, ------------------- (Dollars in thousands) 1996 1995 -------- -------- GAINS ON DISPOSITION OF ASSET POOLS Total gain on disposition of asset pools $ 8,186 $ 11,302 Variance from previous year due to: Collection levels (4,148) (1,523) Gross profit margins 1,631 2,770 Mix (599) (404) -------- -------- Total variance from previous year (3,116) 843 INTEREST INCOME ON PERFORMING ASSET POOLS $ 1,768 $ - COST OF BORROWINGS Interest expense $ 5,774 $ 7,227 Average borrowings 177,590 232,199 Weighted average rate 13.01% 12.45% OTHER EXPENSES Service fee expense $ 966 $ 1,647 Legal 546 519 Property protection 889 (52) Other 340 480 -------- -------- Total other expenses 2,741 2,594 ========================================================= FIRST QUARTER 1996 COMPARED TO FIRST QUARTER 1995 Net earnings in the first quarter 1996 were $3.4 million, up from $.9 million in the first quarter 1995. Net earnings to common in the 1996 period were $ 1.5 million, up 53% from $.9 million in the 1995 period. On a per share basis, earnings attributable to common equity were $0.30 for the 1996 period compared to $0.42 per share for the 1995 period. Results for periods prior to July 3, 1995 reflect the historical net earnings of J-Hawk. The related earnings per share are restated to reflect the equivalent number of FirstCity common shares issued to the J-Hawk shareholders in connection with the merger of J- Hawk and FCBOT. NET GAIN ON PURCHASED ASSET POOLS The net gain on purchased asset pools increased to $4.7 million in the first quarter 1996 from $1.4 million in such period for 1995. The average investment in purchased asset pools in the first quarter 1996 of $91.4 million exceeded the average investment levels for such period in 1995 of $29.0 million, with the resulting gain on disposition of purchased asset pools higher in the 1996 period due to increased levels of collections and larger asset pools. The profit margin on collections in 1996 was 33% as compared to 34% in 1995. Many of the assumptions upon which the future collections from purchased asset pools are based, and therefore the gross profits recognized upon collections, are subject to significant uncertainties such as timing and levels of collections and the cost of maintaining and protecting such assets within the pools. Additionally, 22 23 unanticipated events and circumstances may occur. Consequently, there may be differences between current recognized gross profit rates and actual results achieved over the life of a portfolio. FirstCity believes that financial institutions and other lenders will continue to offer asset pools as a result of their consolidation and investor and regulatory pressure to dispose of non-performing and under-performing assets. However, changes in the regulatory environment could cause the asset pool sales to decline in the future. When FirstCity acquires asset pools, cash flows and sale prices are projected based upon economic conditions then prevailing and projected in the United States and in the economic region in which the assets are situated. If such economic conditions deteriorate, FirstCity's earnings from its then existing asset portfolios may be adversely affected. SERVICING FEES Servicing fees grew to $2.5 million in the first quarter 1996 from $1.7 million for such period in 1995, an increase of 52%. Excluding $1.1 million in fees from collection of Trust assets, servicing fees declined $.3 million from 1995 because of lower collection levels achieved in the remaining serviced asset pools. INTEREST INCOME AND EXPENSE As a result of the merger, interest income on the Class A Certificate was recorded in the first quarter 1996, representing reimbursement to FirstCity (by the Trust) of interest expense of $2.4 million on the senior subordinated notes and accrual of dividends of $1.9 million on special preferred stock. Other interest income resulted primarily from performing loans acquired in the Diversified transaction. Interest expense on other notes payable rose in proportion to higher volumes of debt associated with purchased asset pools. OTHER INCOME Rental income on purchased real estate pools resulted from a third quarter 1995 acquisition of a pool consisting entirely of real estate assets. On such purchases, the net operating income derived from such assets is recognized as other income with gains on sales recognized upon disposition of the asset. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expenses increased $4.2 million, reflecting higher costs since acquiring Diversified, increased property expenses and amortization of goodwill and servicing rights in the first quarter 1996 (none in the first quarter of 1995). Also, general and administrative expenses in 1995 include a recovery of $.7 million of prior year expenses related to the merger with FCBOT (these expenses were reimbursed by FCBOT). EQUITY IN EARNINGS OF ACQUISITION PARTNERSHIPS Equity earnings of acquisition partnerships in the first quarter 1996 increased marginally from such period in 1995. Collections in the acquisition partnerships decreased $14.7 million, or 37%, and caused a decrease in gross profit of $4.1 million. However, this reduction was more than offset by a higher gross profit margin ($1.6 million), interest income on newly-acquired performing asset pools ($1.8 million) and an increased ownership percentage by FirstCity in the new partnerships. Most of the indebtedness incurred by FirstCity and its acquisition partnerships is floating rate debt, the rates of which change when certain short term benchmark rates increase. If these benchmark rates increase beyond what FirstCity had originally projected, the profitability of FirstCity and the acquisition partnerships will be adversely affected. FEDERAL INCOME TAXES Federal income taxes are provided at 35% of taxable income. The Company believes net operating loss carryforwards are available to FirstCity after July 3, 1995, and are recognized as an offset to the provision in the period during which the benefit is realized. LIQUIDITY AND CAPITAL RESOURCES 23 24 Generally, the liquidity needs of FirstCity are for operations, payment of debt and acquisitions of asset portfolios, investments in and advances to acquisition partnerships and other investments by the company. The sources of liquidity come from funds generated from operations, distributions from the "A" Certificate of the Trust (FirstCity, as the sole holder of the Class "A" Certificate under the Trust, will receive from the Trust amounts sufficient to pay certain expenses, to retire the senior subordinated notes and to redeem and pay dividends on the special preferred stock), the $20 million in equity as a result of the merger with FCBOT, equity distributions from acquisition partnerships and short term borrowings from lines of credit and other specific purpose short term borrowings. FirstCity contributed equity to acquisition partnerships totaling $13.1 million to facilitate the purchase of $98.4 million in portfolios of assets during the first quarter of 1996. During the quarter, FirstCity borrowed $18.8 million under a credit facility with Cargill Financial Services, increasing the balance under that facility to $24.0 million at quarter end. Cargill has agreed in principle to increase the facility from $25 million to $35 million. On March 29, 1996, FirstCity redeemed early $53.3 million of senior subordinated notes via a distribution from the Trust. The Class "A" Certificate was reduced by a like amount. Also, at March 31, 1996, the Trust held (through purchase) $2 million principal of senior subordinated notes. In the future, FirstCity anticipates being able to raise capital through public debt or equity offerings, thus enhancing the investment and growth opportunities of the Company. FirstCity believes liquidity from these sources should be sufficient for continued growth in partnership formation and direct investment activities. Other sources of liquidity, including the Cargill credit facility, potential public offerings, and funding from senior lenders providing funding for acquisition partnership formation and direct portfolio acquisitions, should prove adequate to continue to fund the company's other contemplated investment activities. At March 31, 1996, total common equity was $47.7 million and is considered by management adequate to support the current capital requirements and planned growth of the Company. FirstCity attributes a significant portion of its recent financial success to its affiliation with Cargill. Participation by Cargill in a transaction provides assurances to any potential seller of a portfolio of distressed assets that FirstCity will have the financial ability to consummate the targeted portfolio acquisition. In addition, FirstCity believes that Cargill's general reputation in the financial markets provides FirstCity with more opportunities to acquire portfolios than FirstCity would otherwise have acting alone. Discontinuation of this arrangement with Cargill could have a negative economic impact upon the continued results of operations of FirstCity. FirstCity's continued success in its asset acquisition business is dependent upon the availability of senior debt financing for the acquisition partnerships. Although FirstCity continues to enjoy good relationships with its current lenders and to develop new sources of senior debt financing, there can be no assurances that these and other sources of senior debt financing will be available in the future. 24 25 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 27.1 - Financial Data Schedule. (Exhibit 27.1 is being submitted as an exhibit only in the electronic format of this Quarterly Report on Form 10-Q being submitted to the Securities and Exchange Commission. Exhibit 27.1 shall not be deemed filed for purposes of Section 11 of the Securities Act of 1933, as amended, Section 18 of the Securities Exchange Act of 1934, as amended, or Section 323 of the Trust Indenture Act of 1939, as amended, or otherwise be subject to the liabilities of such sections, nor shall it be deemed a part of any registration statement to which it relates.) (b) Reports on Form 8-K. No report on Form 8-K was filed by the Registrant with the Commission during the quarterly period ended March 31, 1996. 25 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRSTCITY FINANCIAL CORPORATION /s/ Gary H. Miller ------------------------------- Name: Gary H. Miller Title: Senior Vice President and Controller (Duly authorized officer and chief accounting officer of the Registrant) Dated: May 10, 1996 26 27 EXHIBIT INDEX 27 -- Financial Data Schedule