Table of Contents

 

 

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, 2009
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)

 

 

(254) 761-2800

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o   No  o

 

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

 

 

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 3, 2009 was 9,831,937.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I
Item 1.	Financial Statements	1
	Consolidated Balance Sheets	1
	Consolidated Statements of Operations	2
	Consolidated Statements of Stockholders’ Equity	3
	Consolidated Statements of Cash Flows	4
	Notes to Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	54
Item 4.	Controls and Procedures	55
PART II OTHER INFORMATION		57
Item 1.	Legal Proceedings	57
Item 1A.	Risk Factors	57
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 3.	Defaults Upon Senior Securities	57
Item 4.	Submission of Matters to a Vote of Security Holders	57
Item 5.	Other Information	57
Item 6.	Exhibits	57
SIGNATURES		62

 

Table of Contents

 

PART I

 

FINANCIAL INFORMATION

 

Item 1.  Financial Statements (Unaudited)

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

 

		June 30,			December 31,
		2009			2008
		(Unaudited)			(See Note 2)
ASSETS
Cash and cash equivalents		$	25,521		$	19,103
Restricted cash		1,115			1,217
Portfolio Assets:
Loan portfolios, net		212,511			121,137
Real estate held for sale		15,280			17,484
Real estate held for investment, net		9,635			9,592
Total Portfolio Assets		237,426			148,213
Loans receivable:
Loans receivable - affiliates		29,746			27,080
Loans receivable - SBA held for sale		3,492			4,901
Loans receivable - SBA held for investment, net		16,203			14,405
Loans receivable - other		11,698			13,533
Total loans receivable		61,139			59,919
Investment security available for sale		2,993			5,251
Equity investments		70,214			72,987
Service fees receivable ($864 and $553 from affiliates, respectively)		941			626
Servicing assets - SBA loans		974			722
Other assets, net		21,014			20,899
Total Assets		$	421,337		$	328,937
LIABILITIES AND EQUITY
Liabilities:
Notes payable to banks		$	295,975		$	242,889
Note payable to affiliate		8,658			8,658
Other liabilities		17,585			11,515
Total Liabilities		322,218			263,062
Commitments and contingencies (Note 17)
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; 11,331,937 shares issued; 9,831,937 shares outstanding)		113			113
Treasury stock, at cost: 1,500,000 shares		(10,923		)	(10,923		)
Paid in capital		102,779			101,875
Accumulated deficit		(28,683		)	(37,073		)
Accumulated other comprehensive loss		(1,145		)	(3,726		)
FirstCity Stockholders’ Equity		62,141			50,266
Noncontrolling interests		36,978			15,609
Total Equity		99,119			65,875
Total Liabilities and Equity		$	421,337		$	328,937

 

See accompanying notes to consolidated financial statements.

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2009			2008			2009			2008
Revenues:
Servicing fees ($2,137 and $2,484 from affiliates for the three month periods, respectively, and $4,264 and $4,648 from affiliates for the six month periods, respectively)		$	2,403		$	2,706		$	4,795		$	4,906
Income from Portfolio Assets		14,077			5,622			23,120			10,557
Gain on sale of SBA loans held for sale, net		610			133			610			142
Interest income from SBA loans		295			366			641			842
Interest income from loans receivable - affiliates		939			483			1,862			633
Interest income from loans receivable - other		364			355			793			630
Revenue from railroad operations		705			859			1,452			1,664
Other income		1,268			965			3,069			1,619
Total revenues		20,661			11,489			36,342			20,993
Expenses:
Interest and fees on notes payable to banks		3,145			3,758			6,189			7,441
Interest and fees on notes payable to affiliate		444			—			877			—
Salaries and benefits		6,032			5,297			11,086			10,327
Provision for loan and impairment losses		677			7,090			1,783			10,120
Asset-level expenses		1,417			1,427			2,654			2,988
Occupancy, data processing and other		2,182			3,303			5,588			5,758
Total expenses		13,897			20,875			28,177			36,634
Equity in net earnings of subsidiaries		1,198			3,008			1,052			5,848
Gain on step acquisition		1,455			—			1,455			—
Earnings (loss) before income taxes		9,417			(6,378		)	10,672			(9,793		)
Income tax expense		(440		)	(98		)	(703		)	(289		)
Net earnings (loss)		8,977			(6,476		)	9,969			(10,082		)
Less: Net income attributable to noncontrolling interests (See Note 2)		1,231			53			1,579			31
Net earnings (loss) attributable to FirstCity		$	7,746		$	(6,529	)	$	8,390		$	(10,113	)
Basic earnings (loss) per share		$	0.79		$	(0.63	)	$	0.85		$	(0.97	)
Diluted earnings (loss) per share		$	0.76		$	(0.63	)	$	0.84		$	(0.97	)

 

See accompanying notes to consolidated financial statements.

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

 

		FirstCity Stockholders
											Retained			Accumulated			Non-
											Earnings			Other			controlling
		Common			Treasury			Paid in			(Accumulated			Comprehensive			Interests			Total
		Stock			Stock			Capital			Deficit)			Income (Loss)			(See Note 2)			Equity
Balances, December 31, 2007		$	113		$	(5,978	)	$	101,240		$	9,602		$	1,846		$	3,209		$	110,032
Repurchase of common stock		—			(3,245		)	—			—			—			—			(3,245		)
Stock option compensation expense		—			—			422			—			—			—			422
Investment in majority-owned entities		—			—			—			—			—			475			475
Distributions to noncontrolling interests		—			—			—			—			—			(773		)	(773		)
Other activity		—			—			—			—			—			10			10
Comprehensive loss:
Net loss		—			—			—			(10,113		)	—			31			(10,082		)
Foreign currency translation adjustments		—			—			—			—			305			114			419
Total comprehensive loss																				(9,663		)
Balances, June 30, 2008		$	113		$	(9,223	)	$	101,662		$	(511	)	$	2,151		$	3,066		$	97,258
Balances, December 31, 2008		$	113		$	(10,923	)	$	101,875		$	(37,073	)	$	(3,726	)	$	15,609		$	65,875
Stock option compensation expense		—			—			130			—			—			—			130
Purchases of subsidiary shares in noncontrolling interests		—			—			774			—			—			(3,591		)	(2,817		)
Investments in majority-owned entities		—			—			—			—			—			25,410			25,410
Distributions to noncontrolling interests		—			—			—			—			—			(2,245		)	(2,245		)
Comprehensive income:
Net earnings		—			—			—			8,390			—			1,579			9,969
Change in net unrealized gain on securities available for sale		—			—			—			—			310			—			310
Foreign currency translation adjustments		—			—			—			—			2,271			216			2,487
Total comprehensive income																				12,766
Balances, June 30, 2009 (unaudited)		$	113		$	(10,923	)	$	102,779		$	(28,683	)	$	(1,145	)	$	36,978		$	99,119

 

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,
		2009			2008
		(See Note 2)
Cash flows from operating activities:
Net earnings (loss)		$	9,969		$	(10,082	)
Adjustments to reconcile net earnings (loss) to net cash used in operating activities:
Net principal advances on SBA loans held for sale		(11,437		)	(4,811		)
Proceeds from the sale of SBA loans held for sale, net		13,819			2,993
Purchases of Portfolio Assets		(134,966		)	(47,345		)
Proceeds applied to principal on Portfolio Assets		82,089			30,924
Income from Portfolio Assets		(23,120		)	(10,557		)
Capitalized interest and costs on Portfolio Assets and loans receivable		(768		)	(982		)
Provision for loan and impairment losses		1,783			10,120
Foreign currency transaction (gains) losses, net		(300		)	198
Equity in net earnings of non-consolidated subsidiaries		(1,052		)	(5,848		)
Gain on sale of SBA loans held for sale, net		(610		)	(142		)
Gain on sale of railroad property		(920		)	—
Gain on step acquisition		(1,455		)	—
Depreciation and amortization		1,991			1,834
Net premium amortization of loans receivable		(33		)	(199		)
Stock option compensation expense		130			422
Decrease (increase) in restricted cash		102			(681		)
Decrease (increase) in service fees receivable		(336		)	131
Increase in other assets		(965		)	(8,960		)
Increase in other liabilities		5,379			1,465
Net cash used in operating activities		(60,700		)	(41,520		)
Cash flows from investing activities:
Purchases of property and equipment, net		(1,358		)	(1,220		)
Proceeds from sale of railroad property		1,350			—
Cash paid for business combination, net of cash acquired		(7,149		)	—
Net principal advances on loans receivable		(1,611		)	(23,377		)
Net principal collections (advances) on SBA loans held for investment		(2,020		)	445
Net principal paydowns on investment security available for sale		2,242			—
Contributions to non-consolidated subsidiaries		(1,222		)	(2,491		)
Distributions from non-consolidated subsidiaries		7,034			11,052
Net cash used in investing activities		(2,734		)	(15,591		)
Cash flows from financing activities:
Borrowings under note payable to affiliate		—			8,658
Borrowings under notes payable to banks		137,604			93,807
Principal payments of notes payable to banks, net		(84,570		)	(51,773		)
Payments of debt issuance costs and loan fees		(647		)	(921		)
Contributions from noncontrolling interests		22,270			475
Distributions to noncontrolling interests		(2,245		)	(773		)
Repurchase of common stock		—			(3,245		)
Cash paid for subsidiary shares in noncontrolling interests		(2,796		)	—
Net cash provided by financing activities		69,616			46,228
Effect of exchange rate changes on cash and cash equivalents		236			162
Net increase (decrease) in cash and cash equivalents		6,418			(10,721		)
Cash and cash equivalents, beginning of period		19,103			23,037
Cash and cash equivalents, end of period		$	25,521		$	12,316
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	4,852		$	6,154
Income taxes, net of refunds received		90			179

 

See accompanying notes to consolidated financial statements.

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

 

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

 

Nature of Operations

 

FirstCity Financial Corporation and subsidiaries (collectively, “FirstCity”, “Company”, “we”, “us” or “our”) is a financial services company with offices in the United States and Mexico, and a presence in Europe and South America. FirstCity engages in two major business segments – Portfolio Asset Acquisition and Resolution and Special Situations Platform. The Portfolio Asset Acquisition and Resolution business has been the Company’s core business operation since commencing operations in 1986. In the Portfolio Asset Acquisition and Resolution business, the Company acquires portfolios of performing and non-performing commercial and consumer loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), generally at a discount to their legal principal balances or appraised values, and services and resolves such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. FirstCity acquires the Portfolio Assets for its own account or through investment entities formed with one or more other co-investors (each such entity, an “Acquisition Partnership”). The Company engages in its Special Situations Platform business through its majority ownership interest in FirstCity Denver Investment Corp. (“FirstCity Denver”) – which was formed in April 2007. Through its Special Situations Platform business, the Company provides investment capital to privately-held middle-market companies through flexible capital structuring arrangements to generate an attractive risk-adjusted return. These capital investments primarily take the form of senior and junior financing arrangements, but also include direct equity investments, common equity warrants, distressed debt transactions, and buyouts. Refer to Note 16 for additional information on the Company’s major business segments.

 

Basis of Presentation

 

The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of FirstCity and all other entities in which FirstCity has a controlling financial interest. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies the Company follows conform, in all material respects, to U.S. generally accepted accounting principles and to general practices within the financial services industry.

 

The consolidated financial statements in this Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s financial position and results of operations. All such adjustments were of a normal and recurring nature. We have prepared the accompanying unaudited consolidated financial statements in accordance with the accounting policies described in our 2008 Annual Report on Form 10-K, as amended (“2008 Form 10-K”), and with the instructions to Form 10-Q. Accordingly, the accompanying unaudited consolidated financial statements do not include all of the information and note disclosures normally included in our annual financial statements prepared in accordance with U.S. generally accepted accounting principles, and should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, included in our 2008 Form 10-K. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period. Certain amounts in the consolidated financial statements and disclosures for prior periods have been reclassified to conform to the current period’s presentation.

 

We have performed a review of subsequent events through August 13, 2009, the date the consolidated financial statements were issued, and concluded there were no events or transactions occurring during the period that required recognition or disclosure in our consolidated financial statements.

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

 

On January 1, 2009, the Company adopted SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS 160”), which changed the presentation requirements for noncontrolling (minority) interests. Refer to Note 2 for more information. In addition to the changes prescribed by SFAS 160, certain other amounts in prior period financial statements have been reclassified to conform to the current period presentation. These certain other reclassifications are not significant and have no impact on earnings, total assets or stockholders’ equity.

 

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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates that are particularly susceptible to significant change in the near-term relate to the estimation of future collections on Portfolio Assets used in the calculation of income from Portfolio Assets; valuation of deferred tax assets and assumptions used in the calculation of income taxes; valuation of servicing assets, investment securities, loans receivable (including loans receivable held in securitization trusts), and real estate; guarantee obligations; indemnifications; and legal contingencies. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. Illiquid credit markets; volatile financial, real estate and foreign currency markets; and declines in business and consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

 

Portfolio Assets

 

The Company invests in performing and non-performing commercial and consumer loans, real estate and certain other assets (“Portfolio Assets” or “Portfolios”), and services and resolves such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. The Portfolio Assets are generally non-homogeneous assets, including loans of varying qualities that are secured by diverse collateral types and real estate. Some Portfolio Assets are loans for which resolution is tied primarily to the real estate securing the loan, while others may be collateralized business loans, the resolution of which may be based on the cash flows of the business or the underlying collateral.

 

On January 1, 2005, FirstCity adopted and began accounting for its acquisitions of loan portfolios with credit deterioration in accordance with the provisions of AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”). SOP 03-3 addresses accounting differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in acquired loans if those differences are attributable, at least in part, to credit quality. SOP 03-3 requires acquired loans with credit deterioration to be initially recorded at fair value and prohibits “carrying over” or the creation of valuation allowances in the initial accounting of acquired loans that are within the scope of SOP 03-3. Under SOP 03-3, the excess cash flows expected at acquisition over the loan portfolio’s purchase price is recorded as interest income over the life of the portfolio.

 

Loans Acquired Prior to 2005

 

For Portfolio Assets acquired before January 1, 2005, the Company initially recorded the purchased assets at cost, and acquisition-date purchase discounts and loan loss allowances of the underlying assets were included as components of the cost and carrying value of the Portfolio Assets, as applicable. Income recognition for loans acquired prior to 2005 is based on management’s initial designation of the purchased Portfolio Assets as non-performing or performing. Such designations were made on the acquisition date and do not subsequently change even though the actual performance of the Portfolio Assets may subsequently change.

 

Income on non-performing Portfolio Assets acquired prior to 2005 is recognized only to the extent that collections exceed a pro-rata portion of allocated cost from the pool. Cost allocation is based on a proration of actual collections divided by total estimated collections of the pool. Interest income is not recognized separately on non-performing Portfolio Assets. All collection proceeds, of whatever type, are included in the determination of income recognition for these Portfolio Assets. The Company accounts for these non-performing Portfolio Assets on a pool basis.

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

 

Income on performing Portfolio Assets acquired prior to 2005 is recognized using the interest method, based on the Portfolio’s internal rate of return (“IRR”), and acquisition discounts for the Portfolios as a whole are accreted as an adjustment to yield over the estimated life of the respective Portfolios. Income on performing Portfolio Assets is accrued monthly based on each loan pool’s effective IRR. Significant increases in expected future cash flows may be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any increase to the IRR then becomes the new benchmark for impairment testing. Cash flows greater than the interest accrual will reduce the carrying value of the pool. Likewise, cash flows that are less than the accrual will increase the carrying balance. The IRR is estimated based on the timing and amount of anticipated cash flows using the Company’s proprietary collection model. Gains are recognized on performing Portfolio Assets when sufficient funds are received to fully satisfy the obligation on loans included in the pool, either from collections received from the borrower or proceeds received from the sale of the loan. The gain recognized represents the difference between the proceeds received and the allocated carrying value of the individual loan in the pool. The Company accounts for these performing Portfolio Assets on a pool basis.

 

Loans With Credit Deterioration Acquired After 2004

 

A substantial portion of the Company’s loans acquired after 2004 have experienced deterioration of credit quality between origination and the Company’s acquisition of the accounts. The amounts paid for the loans reflect the Company’s determination that the loans have experienced deterioration in credit quality since origination and that it is probable the Company will be unable to collect all amounts due according to the contractual terms of the underlying loans. Commencing January 1, 2005, FirstCity adopted and began accounting for its acquisitions of loan portfolios with credit deterioration in accordance with the provisions of SOP 03-3.

 

At acquisition, the Company reviews the individual loans purchased to determine whether there is evidence of credit quality deterioration since origination and for which it is probable that the Company will be unable to collect all amounts due according to the loan’s contractual terms. If both conditions exist, the Company determines whether each such loan account is to be accounted for individually or whether such loan accounts will be assembled into static pools based on common risk characteristics (primarily loan type and collateral). As permitted by SOP 03-3, static pools of individual loan accounts may be established and accounted for as a single economic unit for the recognition of income, principal payments and loss provision. Once a static loan pool is established, individual accounts are generally not added to or removed from the pool (unless the Company sells, forecloses or writes-off the loan). At acquisition, FirstCity determines the excess of the scheduled contractual payments over all cash flows expected to be collected for the loan or loan pool as an amount that should not be accreted (“nonaccretable difference”). The excess of the cash flows from the loan or loan pool expected to be collected at acquisition over the initial investment (“accretable yield”) is generally accreted into interest income over the remaining life of the loan or loan pool. The discount (i.e. the difference between the cost of each loan or static pool and the related aggregate contractual receivable balance) is not recorded because the Company does not expect to fully collect each contractual receivable balance for the loan or loan pool. As a result, loans and loan pools are generally recorded at cost (which approximates fair value) at the time of acquisition.

 

In accordance with SOP 03-3, the Company accounts for its investments in SOP 03-3 loans and loan pools using either the interest method or the non-accrual method (through application of the cost-recovery basis of accounting). Application of the interest method is dependent on management’s ability to develop a reasonable expectation as to both the timing and amount of cash flows expected to be collected. In the event the Company cannot develop or establish a reasonable expectation as to both the timing and amount of cash flows expected to be collected, SOP 03-3 permits the use of the cost-recovery method.

 

Under the interest method, an effective interest rate, or IRR, is applied to the cost basis of the loan or loan pool. SOP 03-3 requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of income or expense or on the balance sheet. SOP 03-3 requires the IRR that is estimated when the loan accounts are purchased to remain constant as the basis for subsequent impairment testing (performed at least quarterly) and income recognition. Significant increases in actual, or expected future cash flows, is used first to reverse any existing valuation allowance for that loan or loan pool; and any remaining increase may be recognized prospectively through an upward adjustment of the IRR over the remaining life of the loan or loan pool. Any increase to the IRR then becomes the new benchmark for impairment testing and income recognition. Under SOP 03-3, subsequent decreases in projected cash flows do not change the IRR, but are recognized as an impairment of the cost basis of the loan or loan pool (to maintain the then-current IRR), and are reflected in the consolidated statements of operations through provisions charged to operations, with a corresponding valuation allowance off-setting the loan or loan pool in the consolidated balance sheets. FirstCity establishes valuation allowances for loans and loan pools acquired with credit deterioration to reflect only those losses incurred after acquisition — that is, the cash flows expected at acquisition that are no longer expected to be collected. Income from loans and loan pools accounted for under the interest method is accrued based on the IRR of each loan or loan pool applied to their respective adjusted cost basis. Gross collections in excess of the interest accrual and impairments will reduce the carrying value of the loan or loan pool, while gross

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

 

collections less than the interest accrual will increase the carrying value. The IRR is estimated based on the timing and amount of anticipated cash flows using the Company’s proprietary collection models. A loan or loan pool can become fully amortized (zero-basis carrying balance on the balance sheet) while still generating cash collections. In this case, cash collections are recognized as income when received.

 

If the amount and timing of future cash collections on a loan or loan pool are not reasonably estimable, the Company accounts for such assets on the cost-recovery method. Under the cost-recovery method, no income is recognized until the Company has fully collected the cost of the loan or loan pool, or until such time the Company considers the timing and amount of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. At least quarterly, the Company performs an evaluation to determine if the remaining amount that is probable of collection is less than the carrying value of the loan or loan pool, and if so, recognizes impairment through provisions charged to operations. At June 30, 2009 and December 31, 2008, the carrying value of SOP 03-3 loans and loan pools accounted for under the cost-recovery method approximated $73.2 million and $20.7 million, respectively.

 

Real Estate

 

Real estate Portfolio Assets consist of real estate properties purchased from a variety of sellers or acquired through loan foreclosure. Rental income, net of expenses, is generally recognized when received. The Company accounts for its real estate properties on an individual-asset basis as opposed to a pool basis. The following is a description of the classifications and related accounting policies for the Company’s various classes of real estate Portfolio Assets:

 

Classification and Impairment Evaluation

 

Real estate held for sale primarily includes real estate acquired through loan foreclosure. The Company classifies a property as held for sale if (1) management commits to a plan to sell the property; (2) the Company actively markets the property in its current condition for a price that is reasonable in comparison to its fair value; and (3) management considers the sale of such property within one year of the balance sheet date to be probable. Real estate held for sale is stated at the lower of cost or fair value less estimated disposition costs. Real estate is not depreciated while it is classified as held for sale. Impairment losses are recorded if a property’s fair value less estimated disposition costs is less than its carrying amount, and charged to operations in the period the impairment is identified.

 

Real estate held for investment generally includes acquired properties and is carried at cost less depreciation and amortization, as applicable. The Company classifies a property as held for investment if the property is still under development and/or management does not expect the property to be sold within one year of the balance sheet date. The Company periodically reviews its property held for investment for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability of property held for investment is measured by comparison of the carrying amount of the asset to future net undiscounted cash flows expected to be generated by the property. If the property is considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property exceeds the fair value of the property. Fair value is determined by discounted cash flows or market comparisons.

 

Cost Capitalization and Allocation

 

Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of cost (i.e. the underlying loan’s carrying value) or estimated fair value less disposition costs at the date of foreclosure — establishing a new cost basis. The amount, if any, by which the carrying value of the underlying loan exceeds the property’s fair value less estimated disposition costs at the foreclosure date is charged as a loss against operations. Expenditures for repairs, maintenance, and other holding costs are charged to operations as incurred.

 

Real estate properties acquired through a purchase transaction are initially recorded at the cost of the acquisition. The cost of acquired property includes the purchase price of the property, legal fees, and certain other acquisition costs. Subsequent to acquisition, the Company capitalizes capital improvements and expenditures related to significant betterments and replacements, including costs related to the development and improvement of the property for its intended use. Expenditures for repairs, maintenance, and other holding costs are charged to operations as incurred.

 

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(2)  Recently Adopted Accounting Standards

 

Business Combinations and Noncontrolling Interests

 

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS 141R”). SFAS 141R establishes principle requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination, recognizing assets acquired and liabilities assumed arising from contingencies, and determining what information to disclose to enable users of the financial statements to evaluate the nature and financial impact of the business combination. We adopted SFAS 141R effective January 1, 2009 and it applies to all business combinations prospectively from that date. The impact of SFAS 141R on our consolidated financial statements will depend upon the nature, terms and size of the acquisitions that the Company consummates in the future.

 

In April 2009, the FASB issued Staff Position No. FSP FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (“FSP FAS 141R-1”). This FSP amends the accounting in SFAS 141R for assets and liabilities arising from contingencies in a business combination. FSP FAS 141R-1 requires that pre-acquisition contingencies be recognized at fair value, if fair value can be reasonably determined. If fair value cannot be reasonably determined, FSP FAS 141R-1 requires measurement based on the best estimate in accordance with SFAS No. 5, Accounting for Contingencies. FSP FAS 141R-1 is effective as of January 1, 2009 in connection with the adoption of SFAS 141R.

 

In December 2007, the FASB issued SFAS 160, which defines noncontrolling interest as the portion of equity in a subsidiary not attributable, directly or indirectly, to the parent. SFAS 160 requires the ownership interests in subsidiaries held by parties other than the parent (previously referred to as minority interest) to be clearly presented in the consolidated balance sheet within equity, but separate from the parent’s equity. The amount of consolidated net income attributable to the parent and to any noncontrolling interest must be clearly presented on the face of the consolidated statement of operations. Changes in the parent’s ownership interest while the parent retains its controlling financial interest (greater than 50 percent ownership) are to be accounted for as equity transactions with no remeasurement to fair value. Upon a loss of control, any gain or loss on the interest sold will be recognized in earnings. Additionally, any ownership interest retained will be re-measured at fair value on the date control is lost, with any gain or loss recognized in earnings. SFAS 160 also requires companies to report a consolidated net income (loss) measure that includes the amount attributable to such noncontrolling interests. We adopted SFAS 160 effective January 1, 2009, and it applies to noncontrolling interests prospectively from that date. However, the presentation and disclosure requirements of SFAS 160 were applied retrospectively for all periods presented. As a result of this adoption, we reclassified noncontrolling interests in the amount of $15.6 million from total liabilities to equity in the December 31, 2008 consolidated balance sheet; and net distributions to noncontrolling interests of $0.3 million from operating activities to financing activities in the consolidated statement of cash flows for the six-month period ended June 30, 2008.

 

Fair Value

 

In 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a market-based framework or hierarchy for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. SFAS 157 does not expand or require any new fair value measures, however the application of SFAS 157 may change current practice. We adopted SFAS 157 for financial assets and liabilities effective January 1, 2008 and for non-financial assets and liabilities effective January 1, 2009. The adoption of SFAS 157 did not have a material impact on our consolidated financial statements. See Note 13 for additional information.

 

In April 2009, the FASB issued three FASB Staff Positions (“FSPs”) in order to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities.

 

·                  FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”). FSP FAS 157-4 relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive.

 

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·                  FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. This FSP is intended to bring consistency to the timing of impairment recognition, and provide improved disclosures about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and more-timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses.

·                  FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. This FSP relates to fair value disclosures for financial instruments that are not currently reflected on the balance sheet at fair value. Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed once a year. The FSP now requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.

 

We adopted the FSPs effective April 1, 2009. The adoption of the provisions of the FSPs did not have a material impact on our consolidated financial statements. See Note 13 for additional information.

 

Other

 

Effective January 1, 2009, the Company adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”), an amendment to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 161 applies to all entities and requires enhanced disclosures about derivative instruments and hedged items that are accounted for under SFAS No. 133 and related interpretations. The Company applied the requirements of SFAS 161 on a prospective basis. Accordingly, disclosures related to interim periods prior to the date of adoption have not been presented. Since SFAS 161 relates to disclosures only, it had no impact on the Company’s financial condition or results of operations. See Note 18 for additional information.

 

Effective January 1, 2009, the Company adopted EITF Issue No. 08-6, Equity-Method Investment Accounting (“EITF 08-6”). EITF 08-6 addresses a number of matters associated with the impact that SFAS 141R and SFAS 160 might have on the accounting for equity-method investments. EITF 08-6 clarifies the following: (1) the cost basis of a new equity-method investment should be determined using a cost-accumulation mode, which would continue the practice of including transaction costs in the cost of investment and would exclude the value of contingent consideration; and (2) equity-method investments should continue to be subject to other-than-temporary impairment analysis pursuant to APB Opinion No. 18. EITF 08-6 also provides guidance on gain recognition when a portion of the investor’s ownership is sold, how changes in classification from equity-method to cost-method should be treated, and certain other issues. The adoption of EITF 08-6 did not have a material impact on the Company’s consolidated financial statements.

 

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”). SFAS 165 establishes the general standards of accounting for and disclosure of subsequent events. In addition, it requires disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. This new accounting standard was adopted for our financial statements for the quarterly period ending June 30, 2009. The adoption of SFAS 165 did not have a material impact on the Company’s consolidated financial statements. See Note 1 for additional information.

 

(3)  Recently Issued Accounting Standards

 

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140 (“SFAS 166”). SFAS 166 amends SFAS 140 by including the following: the elimination of the qualifying special-purpose entity (QSPE) concept; a new participating interest definition that must be met for transfers of portions of financial assets to be eligible for sale accounting; clarifications and changes to the de-recognition criteria for a transfer to be accounted for as a sale; and a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor. Additionally, the standard requires extensive new disclosures regarding an entity’s involvement in a transfer of financial assets. Finally, existing QSPEs (prior to the effective date of SFAS 166) must be evaluated for consolidation by reporting entities in accordance with the applicable consolidation guidance upon the elimination of this concept. SFAS 166 is effective for fiscal years beginning after November 15, 2009. Accordingly, the Company will adopt the provisions of SFAS 166 in the first quarter of 2010. We are currently evaluating the impact of the provisions of SFAS 166.

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46R (“SFAS 167”). SFAS 167 replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has both the power to direct the activities of

 

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the variable interest entity that most significantly impacts the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits that could be significant to the entity. In addition, SFAS 167 requires reconsideration of whether an entity is a variable interest entity when any changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance. It also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and additional disclosures about an enterprise’s involvement in variable interest entities. SFAS 167 is effective for fiscal years beginning after November 15, 2009. Accordingly, the Company will adopt the provisions of SFAS 167 in the first quarter of 2010. We are currently evaluating the impact of the provisions of SFAS 167.

 

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification (the Codification) as the single source of authoritative, nongovernmental U.S. GAAP. The Codification does not change U.S. GAAP. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered non-authoritative. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. Accordingly, the Company will adopt the provisions of SFAS 168 and revise its financial statement disclosures in compliance with the new codification numbering system in the third quarter ended September 30, 2009. The Company does not expect the adoption of the provisions of SFAS 168 to have any impact on the Company’s financial condition or results of operations.

 

(4)  Business Acquisitions

 

The following is a summary of acquisitions completed by the Company during the six-month period ended June 30, 2009 that were accounted for as a purchase business combination pursuant to SFAS 141R or noncontrolling interest purchases pursuant to SFAS 160:

 

French Acquisition Partnerships

 

In May 2009, the Company, through a majority-owned subsidiary (UBN, SA), acquired additional ownership interests (ranging from 55.0% to 95.0%) in sixteen French Acquisition Partnerships for $7.8 million in cash. As a result of the transaction, the Company acquired a majority ownership interest (i.e. controlling financial interest) in each of the sixteen French entities — resulting in the entities becoming consolidated subsidiaries of the Company. Prior to this transaction, the Company, through a wholly-owned subsidiary, owned a direct equity-method investment in nine of the French entities (the aggregate carrying value of the Company’s equity-method investments in these nine French entities approximated $0.5 million at the time of the transaction). In addition, prior to this transaction, the Company, through an equity-method investee, owned an indirect equity-method investment in all of the French entities.

 

The transaction was accounted for as a business combination under SFAS 141R, and accordingly, the French entities’ assets (primarily loans that Company management considers to be SOP 03-3 loans) and liabilities and the noncontrolling interests were measured at fair value on the acquisition date and included in the Company’s consolidated balance sheet. The fair value of the Portfolio Assets was measured using a discounted cash flow model, employing a 20% market discount rate, based on the projected future cash flows of the underlying loan portfolios. In management’s opinion, the market discount rate used in the cash flow model reflects the rate of return a market participant would consider for this type of loan investment. The amounts attributable to the French entities that were included in the Company’s consolidated balance sheet on the acquisition date are as follows (in thousands):

 

Cash		$	766
Portfolio Assets		12,912
Other liabilities		766
Noncontrolling interests (component of FirstCity’s equity)		3,080

 

In addition, pursuant to provisions under SFAS 141R, the Company’s previously-held direct equity-method investments in nine of the French entities were remeasured to fair value at the acquisition date. The fair value of the Company’s previously-held equity interests exceeded the aggregate carrying value of $0.5 million by approximately $1.5 million. As such, under SFAS 141R, the Company recognized a $1.5 million gain attributable to the remeasurement of its previously-held equity interests on the acquisition date (presented as “Gain on step acquisition” on the face of the Company’s consolidated statement of operations for the six-month period ended June 30, 2009).

 

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