UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

 

Commission file number 033-19694

FirstCity Financial Corporation

(Exact name of registrant as specified in its charter)

 

(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.)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes o      No x

The number of shares of common stock, par value $.01 per share, outstanding at November 9, 2006 was 11,316,937.

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)

		September 30,			December 31,
		2006			2005
		(Unaudited)
ASSETS
Cash and cash equivalents		$	13,036		$	12,901
Portfolio Assets, net		78,908			49,346
Loans receivable from Acquisition Partnerships held for investment		7,144			19,606
Loans receivable - other		2,292			—
Equity investments		84,853			83,785
Deferred tax asset, net		20,101			20,101
Service fees receivable from affiliates		1,096			1,103
Other assets, net		5,925			7,870
Discontinued mortgage assets		103			157
Total Assets		$	213,458		$	194,869
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Notes payable other		$	105,963		$	89,653
Notes payable to affiliates		—			606
Minority interest		1,800			1,193
Liabilities from discontinued consumer operations		72			121
Other liabilities		3,974			4,385
Total Liabilities		111,809			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: 11,316,937 and 11,307,187, respectively)		113			113
Treasury stock, at cost: 530,300 shares and zero shares, respectively		(5,571		)	—
Paid in capital		100,378			99,843
Retained earnings (accumulated deficit)		6,194			(2,058		)
Accumulated other comprehensive income		535			1,013
Total Stockholders’ Equity		101,649			98,911
Total Liabilities and Stockholders’ Equity		$	213,458		$	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						Nine Months Ended
		September 30,						September 30,
		2006			2005			2006			2005
Revenues:
Servicing fees from affiliates		$	4,679		$	2,891		$	10,182		$	8,972
Income from Portfolio Assets		2,547			2,124			7,551			6,269
Interest income from affiliates		294			420			1,189			1,293
Interest income from loans receivable - other		17			—			17			—
Other income		654			269			1,846			1,079
Total revenues		8,191			5,704			20,785			17,613
Expenses:
Interest and fees on notes payable — other		1,797			909			5,433			2,619
Interest and fees on notes payable to affiliates		2			9			22			27
Salaries and benefits		4,094			3,571			11,110			11,413
Provision for loan and impairment losses		50			322			101			436
Occupancy, data processing, communication and other		2,688			1,908			6,165			5,574
Total expenses		8,631			6,719			22,831			20,069
Equity in earnings of investments		3,023			1,783			8,044			8,874
Gain on sale of interest in equity investments		2,378			—			2,405			—
Earnings from continuing operations before income taxes and minority interest		4,961			768			8,403			6,418
Income tax benefit (expense)		4			(79		)	(140		)	(321		)
Minority interest		2			3			64			(36		)
Earnings from continuing operations		4,967			692			8,327			6,061
Discontinued operations
Loss from discontinued operations		—			(281		)	(75		)	(378		)
Income taxes		—			600			—			600
Net earnings (loss) from discontinued operations		—			319			(75		)	222
Net earnings		$	4,967		$	1,011		$	8,252		$	6,283
Basic earnings per common share are as follows:
Earnings from continuing operations		$	0.45		$	0.06		$	0.74		$	0.54
Discontinued operations		$	—		$	0.03		$	(0.01	)	$	0.02
Net earnings to common stockholders		$	0.45		$	0.09		$	0.73		$	0.56
Weighted average common shares outstanding		11,104			11,298			11,239			11,278
Diluted earnings per common share are as follows:
Earnings from continuing operations		$	0.42		$	0.05		$	0.70		$	0.50
Discontinued operations		$	—		$	0.03		$	(0.01	)	$	0.02
Net earnings to common stockholders		$	0.42		$	0.08		$	0.69		$	0.52
Weighted average common shares outstanding		11,711			12,008			11,875			12,012

 

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
															Earnings			Other			Total
		Common Stock					Treasury Stock					Paid in			(Accumulated			Comprehensive			Stockholders’
		Shares		Amount			Shares		Amount			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		9,750		—			—		—			68			—			—			68
Repurchase of common stock		—		—			530,300		(5,571		)	—			—			—			(5,571		)
Additional paid-in capital arising from stock option compensation expense		—		—			—		—			467			—			—			467
Comprehensive income:
Net earnings for the first nine months of 2006		—		—			—		—			—			8,252			—			8,252
Translation adjustments		—		—			—		—			—			—			(478		)	(478		)
Total comprehensive income																					7,774
Balances, September 30, 2006 (unaudited)		11,316,937		$	113		530,300		$	(5,571	)	$	100,378		$	6,194		$	535		$	101,649

 

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)

		Nine Months Ended
		September 30,
		2006			2005
Cash flows from operating activities:
Net earnings		$	8,252		$	6,283
Adjustments to reconcile net earnings to net cash used in operating activities:
Net (earnings) loss from discontinued operations		75			(222		)
Purchase and advances of Portfolio Assets and loans receivable, net		(64,759		)	(19,306		)
Proceeds applied to principal on Portfolio Assets and loans receivable		32,432			22,092
Income from Portfolio Assets		(7,551		)	(6,269		)
Capitalized interest and costs on Portfolio Assets and loans receivable		(452		)	(217		)
Provision for loan and impairment losses		101			436
Equity in earnings of investments		(8,044		)	(8,874		)
Gain on sale of interest in equity investments		(2,405		)	—
Depreciation and amortization		391			661
Stock-based compensation expense related to stock options		467			—
Decrease in service fees receivable from affiliates		7			362
Decrease (increase) in other assets		791			(489		)
Change in debt imputed value		(293		)	214
Decrease in other liabilities		(539		)	(1,722		)
Net cash used in operating activities		(41,527		)	(7,051		)
Cash flows from investing activities:
Property and equipment, net		(135		)	(108		)
Proceeds from sale of interest in equity investments		8,689			—
Contributions to Acquisition Partnerships and Servicing Entities		(39,406		)	(18,373		)
Distributions from Acquisition Partnerships and Servicing Entities		63,346			17,907
Net cash provided by (used in) investing activities		32,494			(574		)
Cash flows from financing activities:
Borrowings under notes payable — other		106,569			68,622
Payments of notes payable to affiliates		(312		)	(34		)
Payments of notes payable — other		(91,566		)	(56,427		)
Repurchase of common stock		(5,571		)	—
Proceeds from issuance of common stock		68			162
Net cash provided by financing activities		9,188			12,323
Net cash provided by continuing operations		155			4,698
Cash flows from discontinued operations (Revised - see note 1):
Net cash used in operating activities		(20		)	(8,229		)
Net cash provided by investing activities		—			1,329
Net cash used in discontinued operations		(20		)	(6,900		)
Net increase (decrease) in cash and cash equivalents		135			(2,202		)
Cash and cash equivalents, beginning of period		12,901			9,724
Cash and cash equivalents, end of period		$	13,036		$	7,522
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	4,636		$	1,982
Income taxes, net of refunds received		121			317

 

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 September 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 September 30, 2006, its results of operations for the three and nine month periods ended September 30, 2006 and 2005 and cash flows for the nine month periods ended September 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.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands, except per share data)—(continued)

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 nine months ended September 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.

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 nine months ended September 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 nine months ended September 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 September 2006, Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, was issued. SFAS No. 157 provides guidance for using fair value to measure assets and liabilities. It applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. The provisions of Statement 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007. The effect of adopting SFAS No. 157 has not been determined, but it is not expected to have a significant effect on the Company’s consolidated financial position or earnings.

In September 2006, the SEC staff issued Staff Accounting Bulletin Topic 1N, Financial Statements - Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides guidance on how prior year misstatements should be evaluated when determining the materiality of misstatements in the current year financial statements. SAB 108 requires materiality to be determined by considering the effect of prior year misstatements on both the current year balance sheet and income statement, with consideration of their carryover and reversing effects. SAB 108 also addresses how to correct material misstatements. The provisions of SAB 108 are effective for financial statements issued for fiscal years ending after November 15, 2006. The effect of adopting SAB 108 has not been determined, but it is not expected to have a significant effect on our reported financial position or earnings.

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 March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140 (“SFAS 156”). SFAS 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in specified situations. Such servicing assets or liabilities would be initially measured at fair value, if practicable, and subsequently measured at amortized value or fair value based upon an election of the reporting entity. SFAS 156 also specifies certain financial statement presentations and disclosures in connection with servicing assets and liabilities. SFAS 156 is effective for fiscal years beginning after September 15, 2006 and may be adopted earlier but only if the adoption is in the first quarter of the fiscal year. FirstCity did not adopt in 2006 and does not expect that the adoption of SFAS 156 in future periods will have a material effect on its Consolidated Financial Statements.

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

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands, except per share data)—(continued)

unrealized losses that have not been recognized as other-than-temporary impairments.  The Company adopted the provisions of FSP 115-1 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”).  Earnings (losses) from discontinued operations, net of taxes, are summarized as follows:

 

Mortgage

At September 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 $54 and $321 in the first nine 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 September 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 with no credit deterioration.”

Consumer

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

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands, except per share data)—(continued)

(4)  Portfolio Assets

Portfolio Assets are summarized as follows:

 

Income from Portfolio Assets is summarized as follows:

 

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 filed with the Securities and Exchange Commission on March 16, 2006 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 $101 for the nine month period ended September 30, 2006, which is comprised of a $24 impairment charge on real estate portfolios and a $77 allowance for loan losses, net of recoveries.  For the nine month period ended September 30, 2005, the Company recorded an allowance for impairment on Portfolio Assets of $436, which is comprised of a $17 impairment charge on real estate portfolios and a $419 allowance for loan losses.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands, except per share data)—(continued)

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

 

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

 

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