UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

 

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 033-19694

FirstCity Financial Corporation
(Exact name of registrant as specified in its charter)

 

Delaware	76-0243729
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
6400 Imperial Drive,
Waco, TX	76712
(Address of principal executive offices)	(Zip Code)

(254) 761-2800
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one.)

Large accelerated filer o              Accelerated filer x             Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o     No x

The number of shares of common stock, par value $.01 per share, outstanding at August 9, 2006 was 11,314,437.

TABLE OF CONTENTS

PART I

Item 1. Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information

Item 6. Exhibits

SIGNATURES

Exhibit Index

Certification of CEO Pursuant to Section 302

Certification of CFO Pursuant to Section 302

Certification of CEO Pursuant to Section 906

Certification of CFO Pursuant to Section 906

 

 

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

		June 30,			December 31,
		2006			2005
		(Unaudited)
ASSETS
Cash and cash equivalents		$	10,312		$	12,901
Portfolio Assets, net		58,005			49,346
Loans receivable from Acquisition Partnerships held for investment		25,789			19,606
Equity investments		67,999			83,785
Deferred tax asset, net		20,101			20,101
Service fees receivable from affiliates		1,227			1,103
Other assets, net		7,078			7,870
Discontinued mortgage assets		100			157
Total Assets		$	190,611		$	194,869
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Notes payable other		$	81,658		$	89,653
Notes payable to affiliates		474			606
Minority interest		2,082			1,193
Liabilities from discontinued consumer operations		127			121
Other liabilities		3,373			4,385
Total Liabilities		87,714			95,958
Commitments and contingencies (note 11)
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; shares issued and outstanding: 11,309,437 and 11,307,187, respectively)		113			113
Paid in capital		100,094			99,843
Retained earnings (accumulated deficit)		1,227			(2,058		)
Accumulated other comprehensive income		1,463			1,013
Total Stockholders’ Equity		102,897			98,911
Total Liabilities and Stockholders’ Equity		$	190,611		$	194,869

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2006			2005			2006			2005
Revenues:
Servicing fees from affiliates		$	2,856		$	2,909		$	5,503		$	6,081
Income from Portfolio Assets		2,946			1,805			5,004			4,145
Interest income from affiliates		465			449			895			873
Other income		639			426			1,219			810
Total revenues		6,906			5,589			12,621			11,909
Expenses:
Interest and fees on notes payable — other		1,938			838			3,636			1,710
Interest and fees on notes payable to affiliates		10			10			20			18
Salaries and benefits		3,278			3,684			7,016			7,842
Provision (recovery) for loan and impairment losses		(58		)	29			51			114
Occupancy, data processing, communication and other		1,913			1,753			3,477			3,666
Total expenses		7,081			6,314			14,200			13,350
Equity in earnings of investments		1,387			3,690			5,021			7,091
Earnings from continuing operations before income taxes and minority interest		1,212			2,965			3,442			5,650
Income tax expense		(22		)	(103		)	(144		)	(242		)
Minority interest		73			(42		)	62			(39		)
Earnings from continuing operations		1,263			2,820			3,360			5,369
Discontinued operations
Loss from discontinued operations		—			(97		)	(75		)	(97		)
Income taxes		—			—			—			—
Net loss from discontinued operations		—			(97		)	(75		)	(97		)
Net earnings		$	1,263		$	2,723		$	3,285		$	5,272
Basic earnings per common share are as follows:
Earnings from continuing operations		$	0.11		$	0.25		$	0.30		$	0.48
Discontinued operations		$	—		$	(0.01	)	$	(0.01	)	$	(0.01	)
Net earnings to common stockholders		$	0.11		$	0.24		$	0.29		$	0.47
Weighted average common shares outstanding		11,308			11,274			11,308			11,268
Diluted earnings per common share are as follows:
Earnings from continuing operations		$	0.11		$	0.24		$	0.28		$	0.45
Discontinued operations		$	—		$	(0.01	)	$	(0.01	)	$	(0.01	)
Net earnings to common stockholders		$	0.11		$	0.23		$	0.27		$	0.44
Weighted average common shares outstanding		11,959			12,025			11,958			12,016

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(Dollars in thousands)

 

										Retained			Accumulated
		Number of								Earnings			Other			Total
		Common		Common			Paid in			(Accumulated			Comprehensive			Stockholders’
		Shares		Stock			Capital			Deficit)			Income			Equity
Balances, December 31, 2004		11,260,687		$	113		$	99,364		$	(10,289	)	$	3,235		$	92,423
Exercise of common stock options		46,500		—			196			—			—			196
Additional paid-in capital arising from sale of shares by investee		—		—			283			—			—			283
Comprehensive income:
Net earnings for 2005		—		—			—			8,231			—			8,231
Translation adjustments		—		—			—			—			(2,222		)	(2,222		)
Total comprehensive income																6,009
Balances, December 31, 2005		11,307,187		113			99,843			(2,058		)	1,013			98,911
Exercise of common stock options		2,250		—			5			—			—			5
Additional paid-in capital arising from stock option compensation expense		—		—			246			—			—			246
Comprehensive income:
Net earnings for the first six months of 2006		—		—			—			3,285			—			3,285
Translation adjustments		—		—			—			—			450			450
Total comprehensive income																3,735
Balances, June 30, 2006 (unaudited)		11,309,437		$	113		$	100,094		$	1,227		$	1,463		$	102,897

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

 

		Six Months Ended
		June 30,
		2006			2005
Cash flows from operating activities:
Net earnings		$	3,285		$	5,272
Adjustments to reconcile net earnings to net cash used in operating activities:
Net loss from discontinued operations		75			97
Purchase and advances of Portfolio Assets and loans receivable, net		(32,924		)	(15,883		)
Proceeds applied to principal on Portfolio Assets and loans receivable		23,333			15,518
Income from Portfolio Assets		(5,004		)	(4,145		)
Capitalized interest and costs on Portfolio Assets and loans receivable		(246		)	(155		)
Provision for loan and impairment losses		51			114
Equity in earnings of investments		(5,021		)	(7,091		)
Depreciation and amortization		274			461
Stock-based compensation expense related to stock options		246			—
(Increase) decrease in service fees receivable from affiliate		(124		)	399
Decrease in other assets		139			405
Change in debt imputed value		(129		)	58
Decrease in other liabilities		(712		)	(2,022		)
Net cash used in operating activities		(16,757		)	(6,972		)
Cash flows from investing activities:
Property and equipment, net		(115		)	(82		)
Contributions to Acquisition Partnerships and Servicing Entities		(21,518		)	(3,752		)
Distributions from Acquisition Partnerships and Servicing Entities		44,937			13,292
Net cash provided by investing activities		23,304			9,458
Cash flows from financing activities:
Borrowings under notes payable — other		57,265			29,532
Payments of notes payable to affiliates		(3		)	(4		)
Payments of notes payable — other		(66,386		)	(29,734		)
Proceeds from issuance of common stock		5			118
Net cash used in financing activities		(9,119		)	(88		)
Net cash provided by (used in) continuing operations		(2,572		)	2,398
Cash flows from discontinued operations (Revised - see note 1):
Net cash used in operating activities		(17		)	(8,115		)
Net cash provided by investing activities		—			1,330
Net cash used in discontinued operations		(17		)	(6,785		)
Net decrease in cash and cash equivalents		(2,589		)	(4,387		)
Cash and cash equivalents, beginning of period		12,901			9,724
Cash and cash equivalents, end of period		$	10,312		$	5,337
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	3,144		$	1,276
Income taxes, net of refunds received		(34		)	213

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(Dollars in thousands, except per share data)
(Unaudited)

(1)  Basis of Presentation and Summary of Significant Accounting Policies

The Company

FirstCity Financial Corporation (the “Company” or “FirstCity”) is a financial services company with offices throughout the United States and Mexico, with a presence in France, Germany and South America. At June 30, 2006, the Company was engaged in one principal reportable segment - Portfolio Asset acquisition and resolution.  The portfolio asset acquisition and resolution business involves acquiring portfolios of loans, real estate and other assets or single assets (collectively referred to as “Portfolios” or  “Portfolio Assets”) at a discount to their legal principal balance or appraised value, and servicing and resolving such Portfolios in an effort to maximize the present value of the ultimate cash recoveries.

Basis of Presentation

The unaudited consolidated financial statements of FirstCity reflect, in the opinion of management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly FirstCity’s consolidated financial position at June 30, 2006, its results of operations for the three and six month periods ended June 30, 2006 and 2005 and cash flows for the six month periods ended June 30, 2006 and 2005.  Certain disclosures have been condensed or omitted from these financial statements. Accordingly, these financial statements should be read with the consolidated financial statements included in the Company’s 2005 Annual Report on Form 10-K.  Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with current consolidated financial statement presentation.  In the first quarter of 2006, equity in earnings of investments was reclassified outside of revenues, which in prior periods was included with revenues.  Also in the first quarter of 2006, the Company has separately disclosed the operating, investing and financing portions of the cash flows attributable to its discontinued operations, which in prior periods were reported on a combined basis as a single amount.  In the second quarter of 2006, the Company reclassified gain on resolution of Portfolio Assets and loan interest income as income from Portfolio Assets.  These items were reported separately in prior periods.

Use of Estimates

The preparation of financial statements in conformity with U.S. 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 (i) the estimation of future collections on purchased Portfolio Assets used in the calculation of income from Portfolio Assets, (ii) interest rate environments, (iii) valuation of the deferred tax asset, and (iv) prepayment speeds and collectibility of loans held in inventory, in securitization trusts and for investment. Actual results could differ materially from those estimates.

Stock-Based Compensation

On January 1, 2006, FirstCity adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions, as the Company formerly did, using the intrinsic value method as prescribed by Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in the consolidated statement of operations.

FirstCity adopted SFAS 123(R) using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. The consolidated financial statements as of and for the six months ended June 30, 2006, reflect the impact of adopting SFAS 123(R). In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). See Note 9 for further details.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest. Stock-based compensation expense recognized in the consolidated statement of operations during the three and six months ended June 30, 2006, included compensation expense for stock-based payment awards that were granted prior to, but were not yet vested, as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 148 and compensation expense for the stock-based payment awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with SFAS 123(R). As stock-based compensation expense recognized in the statement of operations for the three and six months ended June 30, 2006, is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the pro forma information required under SFAS 148 for the periods prior to 2006, we accounted for forfeitures as they occurred.

(2)  New Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes . FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company is evaluating any future effect of this pronouncement.

In November 2005, the FASB issued FASB Staff Position SFAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP 115-1”).  FSP 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impaired loss.  FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.  The provisions of FSP 115-1 were adopted on January 1, 2006, and did not have a significant impact on the Company’s consolidated financial statements.

(3)  Discontinued Operations

Discontinued operations are comprised of two components previously reported as the Company’s residential and commercial mortgage banking business (“Mortgage”) and the consumer lending business (“Consumer”) conducted through the Company’s minority interest investment in Drive Financial Services LP (“Drive”).  Losses from discontinued operations are summarized as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Mortgage		$	—		$	(94	)	$	(75	)	$	(94	)
Consumer		—			(3		)	—			(3		)
Net loss from discontinued operations		$	—		$	(97	)	$	(75	)	$	(97	)

 

Mortgage

At June 30, 2006, the only asset remaining from discontinued mortgage operations is an investment security resulting from the retention of a residual interest in a securitization transaction. This security is in “run-off,” and the Company is contractually obligated to service these assets.  The cash flows are collected over a period of time and are valued using prepayment assumptions of 32% for fixed rate loans and 33% for variable rate loans. Overall loss rates are estimated at 14% of collateral.  The Company recorded provisions of $58 and $78 in the first six months of 2006 and 2005, respectively, for losses from discontinued mortgage operations.

In April 2005, the Company exercised an early purchase option on the 1998-1 securitization.  Loans receivable were recorded at $6.1 million in accordance with EITF 02-9, Accounting for Changes That Result in a Transferor Regaining Control of Financial Assets Sold.  FirstCity evaluated each loan at the acquisition date to determine whether there was evidence of credit deterioration since origination.  At June 30, 2006, the acquired loans are included in Portfolio Assets in the consolidated balance sheet and classified as either “loans acquired with credit deterioration” or “loans acquired without credit deterioration.”

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Consumer

There were no consumer assets held for sale as of June 30, 2006 and December 31, 2005.  Liabilities from discontinued consumer operations consisted of state taxes payable at June 30, 2006.

(4)  Portfolio Assets

Portfolio Assets are summarized as follows:

		June 30,			December 31,
		2006			2005
Loan Portfolios
Loans Acquired Prior to 2005
Non-performing Portfolio Assets		$	8,355		$	10,528
Performing Portfolio Assets		7,009			12,029
Loans Acquired After 2004
Loans acquired with credit deterioration		30,546			12,703
Loans acquired with no credit deterioration		3,292			3,976
Outstanding balance		49,202			39,236
Allowance for loan losses		(197		)	(163		)
Carrying amount of loans, net of allowance		49,005			39,073
Real Estate Portfolios		4,958			8,018
Other		4,042			2,255
Portfolio Assets, net		$	58,005		$	49,346

 

Income from Portfolio Assets is summarized as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Loan Portfolios
Loans Acquired Prior to 2005
Non-performing Portfolio Assets		$	886		$	988		$	1,852		$	2,583
Performing Portfolio Assets		428			602			881			1,347
Loans Acquired After 2004
Loans acquired with credit deterioration		698			111			1,009			111
Loans acquired with no credit deterioration		89			74			184			74
Real Estate Portfolios		698			30			872			30
Other		147			—			206			—
Income from Portfolio Assets		$	2,946		$	1,805		$	5,004		$	4,145

 

Portfolio Assets are pledged to secure notes payable that are non-recourse to FirstCity or any affiliate other than the entity that incurred the debt.  See Note 2 to the Company’s 2005 Annual Report on Form 10-K for a description of the Revolving Credit agreement between FH Partners, L.P. and Bank of Scotland, which is guaranteed by FirstCity and the primary wholly-owned subsidiaries of FirstCity.

The Company recorded a provision for loan and impairment losses on Portfolio Assets of approximately $51 for the six month period ended June 30, 2006, which is comprised of $2 impairment charge on real estate portfolios and $49 allowance for loan losses.  For the six month period ended June 30, 2005, the Company recorded an allowance for impairment on Portfolio Assets of $114, which is comprised wholly of allowance for loan losses.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)

The changes in the allowance for loan losses are as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Beginning Balance		$	(255	)	$	(85	)	$	(163	)	$	—
Provisions		(34		)	(29		)	(141		)	(114		)
Recoveries		92			—			92			—
Charge Offs		—			—			15			—
Ending Balance		$	(197	)	$	(114	)	$	(197	)	$	(114	)

 

Changes in accretable yield for loans acquired with credit deterioration are as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Beginning Balance		$	4,808		$	—		$	3,765		$	—
Additions		5,550			3,239			6,904			3,239
Accretion		(694		)	(111		)	(1,004		)	(111		)
Reclassification from (to) nonaccretable difference		—			—			—			—
Disposals		(4		)	—			(5		)	—
Ending Balance		$	9,660		$	3,128		$	9,660		$	3,128

 

Loans acquired during each period for which it was probable at acquisition that all contractually required payments would not be collected are as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Face value at acquisition		$	32,621		$	14,497		$	43,640		$	14,497
Cash flows expected to be collected at acquisition		21,109			13,991			29,964			13,991
Basis in acquired loans at acquisition		15,559			10,751			23,060			10,751

 

(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:

 

In May 2006, FirstCity and Cargill acquired the outstanding loan and equity interest in certain Mexican Partnerships that were owned by other investors.  As a result, FirstCity’s loans receivable increased by $6.2 million.

There were no provisions recorded on these loans during the first six months of 2006 and 2005.  The loans receivable from Acquisition Partnerships are secured by the assets/loans acquired by the partnerships with purchase money loans provided by affiliates of the investors to the 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 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 are necessary.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Equity method losses which were recorded to reduce the loans and interest receivable from certain Mexican partnerships were $.9 million and $.08 million during the first six months of 2006 and 2005, respectively, 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, and EITF 99-10, Percentage Used to Determine the Amount of Equity Method Losses.

(6)  Equity Investments

The Company has investments in Acquisition Partnerships and their general partners and investments in servicing entities that are accounted for under 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 below:

Condensed Combined Balance Sheets

 

 

Condensed Combined Summary of Operations