UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FirstCity Financial Corporation

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     The number of shares of common stock, par value $.01 per share, outstanding at August 5, 2005 was 11,297,187.

 

 

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,
		2005				2004
		(Unaudited)
ASSETS
Cash and cash equivalents		$	5,337			$	9,724
Portfolio Assets, net			43,862				37,952
Loans receivable from Acquisition Partnerships held for investment			20,400				21,255
Equity investments			53,181				57,815
Deferred tax asset, net			20,101				20,101
Service fees receivable from affiliates			1,232				1,631
Other assets, net			7,196				8,562
Discontinued mortgage assets			409				1,817
Total Assets		$	151,718			$	158,857
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Notes payable to affiliates		$	545			$	491
Notes payable other			49,153				50,812
Minority interest			1,277				1,292
Liabilities from discontinued consumer operations			987				9,033
Liabilities from discontinued mortgage operations			—				50
Other liabilities			3,589				4,756
Total Liabilities			55,551				66,434
Commitments and contingencies (note 12)
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: 11,293,437 and 11,260,687, respectively)			113				113
Paid in capital			99,482				99,364
Accumulated deficit			(5,017	)			(10,289	)
Accumulated other comprehensive income			1,589				3,235
Total Stockholders’ Equity			96,167				92,423
Total Liabilities and Stockholders’ Equity		$	151,718			$	158,857

See accompanying notes to consolidated financial statements.

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,
		2005				2004				2005				2004
Revenues:
Servicing fees from affiliates		$	2,909			$	3,716			$	6,081			$	6,748
Gain on resolution of Portfolio Assets			1,205				162				3,067				237
Equity in earnings of investments			3,690				2,639				7,091				6,814
Interest income from affiliates			460				617				895				1,061
Loan interest income			589				25				1,056				104
Other income			426				470				810				1,814
Total revenues			9,279				7,629				19,000				16,778
Expenses:
Interest and fees on notes payable to affiliates			10				20				18				45
Interest and fees on notes payable — other			838				1,818				1,710				3,506
Interest on shares subject to mandatory redemption			—				67				—				133
Salaries and benefits			3,684				3,477				7,842				7,554
Provision for loan and impairment losses			29				22				114				22
Occupancy, data processing, communication and other			1,753				1,784				3,666				3,233
Total expenses			6,314				7,188				13,350				14,493
Earnings from continuing operations before income taxes and minority interest			2,965				441				5,650				2,285
Income taxes			(103	)			(72	)			(242	)			(156	)
Earnings from continuing operations before minority interest			2,862				369				5,408				2,129
Minority interest			(42	)			17				(39	)			(9	)
Earnings from continuing operations			2,820				386				5,369				2,120
Discontinued operations
Earnings (loss) from discontinued operations			(97	)			3,312				(97	)			6,455
Income taxes			—				(399	)			—				(427	)
Net earnings (loss) from discontinued operations			(97	)			2,913				(97	)			6,028
Net earnings		$	2,723			$	3,299			$	5,272			$	8,148
Basic earnings per common share are as follows:
Earnings from continuing operations		$	0.25			$	0.03			$	0.48			$	0.19
Discontinued operations		$	(0.01	)		$	0.26			$	(0.01	)		$	0.54
Net earnings to common stockholders		$	0.24			$	0.29			$	0.47			$	0.73
Weighted average common shares outstanding			11,274				11,235				11,268				11,216
Diluted earnings per common share are as follows:
Earnings from continuing operations		$	0.24			$	0.03			$	0.45			$	0.18
Discontinued operations		$	(0.01	)		$	0.25			$	(0.01	)		$	0.51
Net earnings to common stockholders		$	0.23			$	0.28			$	0.44			$	0.69
Weighted average common shares outstanding			12,025				11,820				12,016				11,806

See accompanying notes to consolidated financial statements.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)

																		Accumulated
		Number of																Other				Total
		Common				Common				Paid in				Accumulated				Comprehensive				Stockholders'
		Shares				Stock				Capital				Deficit				Income				Equity
Balances, December 31, 2003			11,193,687			$	112			$	99,168			$	(73,923	)		$	3,612			$	28,969
Exercise of common stock options			67,000				1				196				—				—				197
Comprehensive income:
Net earnings for 2004			—				—				—				63,634				—				63,634
Translation adjustments			—				—				—				—				(377	)			(377	)
Total comprehensive income																							63,257
Balances, December 31, 2004			11,260,687				113				99,364				(10,289	)			3,235				92,423
Exercise of common stock options			32,750				—				118				—				—				118
Comprehensive income:
Net earnings for the first six months of 2005			—				—				—				5,272				—				5,272
Translation adjustments			—				—				—				—				(1,646	)			(1,646	)
Total comprehensive income																							3,626
Balances, June 30, 2005			11,293,437			$	113			$	99,482			$	(5,017	)		$	1,589			$	96,167

See accompanying notes to consolidated financial statements.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

		Six Months Ended
		June 30,
		2005				2004
Cash flows from operating activities:
Net earnings		$	5,272			$	8,148
Adjustments to reconcile net earnings to net cash used in operating activities:
Net (earnings) loss from discontinued operations			97				(6,028	)
Purchase of Portfolio Assets and loans receivable, net			(15,883	)			(13,372	)
Proceeds applied to principal on Portfolio Assets and loans receivable			14,440				3,892
Gain on resolution of Portfolio Assets			(3,067	)			(237	)
Capitalized interest and costs on Portfolio Assets and loans receivable			(155	)			(92	)
Provision for loan and impairment losses			114				22
Equity in earnings of investments			(7,091	)			(6,814	)
Depreciation and amortization			461				409
Decrease in service fees receivable from affiliate			399				357
Decrease (increase) in other assets			405				(2,217	)
Change in debt imputed value			58				(759	)
Increase (decrease) in other liabilities			(2,022	)			457
Net cash used in operating activities			(6,972	)			(16,234	)
Cash flows from investing activities:
Property and equipment, net			(82	)			(124	)
Contributions to Acquisition Partnerships and Servicing Entities			(3,752	)			(8,552	)
Distributions from Acquisition Partnerships and Servicing Entities			13,292				13,248
Net cash provided by investing activities			9,458				4,572
Cash flows from financing activities:
Borrowings under notes payable to affiliates			—				—
Borrowing under notes payable — other			29,532				31,816
Payments of notes payable to affiliates			(4	)			(3	)
Payments of notes payable — other			(29,734	)			(19,565	)
Proceeds from issuance of common stock			118				120
Net cash used in financing activities			(88	)			12,368
Net cash provided by continuing operations			2,398				706
Net cash provided by (used in) discontinued operations			(6,785	)			372
Net increase (decrease) in cash and cash equivalents			(4,387	)			1,078
Cash and cash equivalents, beginning of period			9,724				2,745
Cash and cash equivalents, end of period		$	5,337			$	3,823
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	1,276			$	2,864
Income taxes			213				242
Non-cash financing activities:
Dividends accumulated and not paid on preferred stock			—				133

See accompanying notes to consolidated financial statements.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Dollars in thousands, except per share data)
(Unaudited)

(1) Basis of Presentation

     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 and South America. At June 30, 2005, 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 face value and servicing and resolving such portfolios in an effort to maximize the present value of the ultimate cash recoveries. On September 21, 2004, FirstCity and certain of its subsidiaries entered into a Securities Purchase Agreement relating to the sale of a 31% beneficial ownership interest in Drive Financial Services LP (“Drive”) and its general partner, Drive GP LLC, to IFA Drive GP Holdings LLC (“IFA-GP”), IFA Drive LP Holdings LLC (“IFA-LP”) and Drive Management LP (“MG-LP”). As a result of the execution of the sale agreement, the consumer lending segment conducted through Drive was no longer considered a principal reportable segment and is treated as a discontinued operation.

     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, 2005, its results of operations for the three and six month periods ended June 30, 2005 and 2004 and cash flows for the six month periods ended June 30, 2005 and 2004. 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 2004 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.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the estimation of future collections on purchased portfolio assets used in the calculation of net gain on resolution of portfolio assets, interest rate environments, valuation of the deferred tax asset, and prepayment speeds and collectibility of loans held in inventory, in securitization trusts and held for investment. Actual results could differ materially from those estimates.

(2) Liquidity and Capital Resources

     The Company requires liquidity to fund its operations, working capital, payment of debt, equity for acquisition of Portfolio Assets, investments in and advances to entities formed with other investors to acquire Portfolios (“Acquisition Partnerships”) and other investments. The potential sources of liquidity are funds generated from operations, equity distributions from the Acquisition Partnerships, interest and principal payments on subordinated intercompany debt, dividends from the Company’s subsidiaries, borrowings from revolving lines of credit and other credit facilities, proceeds from equity market transactions, securitization and other structured finance transactions and other special purpose short-term borrowings.

     FirstCity has a $96 million revolving acquisition facility with Bank of Scotland that matures in November 2008. This facility is used to finance the equity portion of distressed asset pool purchases and to provide for the issuance of Letters of Credit and working capital loans. The $96 million facility (i) allows loans to be made in Euros up to a maximum amount in Euros that is equivalent to $35 million U.S. dollars, (ii) allows loans to be made for acquisition of Portfolio Assets in Latin America of up to $35 million, (iii) provides for an interest rate of Libor plus 2.50% to 2.75%, (iv) provides for a commitment fee of 0.20% of the unused balance of the revolving acquisition facility, and (v) provides that the aggregate borrowings under the facility do not exceed 60% of the net present value of FirstCity’s interest in Portfolio Assets and in Acquisition Partnerships pledged to secure the acquisition facility.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

     At June 30, 2005, the Company had $11.3 million in Euro-denominated debt for the purpose of hedging a portion of the net equity investments in Europe. In general, the type of risk hedged relates to the foreign currency exposure of net investments in Europe caused by movements in Euro exchange rates. The Company entered into the hedging relationship such that changes in the net investments being hedged are expected to be offset by corresponding changes in the values of the Euro-denominated debt. Effectiveness of the hedging relationship is measured and designated at the beginning of each month by comparing the outstanding balance of the Euro-denominated debt to the carrying value of the designated net equity investments. The net foreign currency translation gain included in accumulated other comprehensive income relating to the Euro-denominated debt was $771 and $1,299, respectively, for the three and six months ended June 30, 2005 and zero for the same periods in 2004.

     BoS (USA) Inc. (“BoS (USA)”) has a warrant to purchase 425,000 shares of the Company’s voting Common Stock at $2.3125 per share. BoS (USA) is entitled to additional warrants in connection with this existing warrant for 425,000 shares under certain specific situations to retain its ability to acquire approximately 4.86% of the Company’s voting Common Stock. The warrant will expire on August 31, 2010, if it is not exercised prior to that date.

     Management believes that the Bank of Scotland loan facility, the related fees generated from the servicing of assets and equity distributions from existing Acquisition Partnerships and wholly-owned portfolios will allow the Company to meet its obligations as they come due during the next twelve months.

(3) New Accounting Pronouncements

     In December 2003, the Accounting Standards Executive Committee issued Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. SOP 03-3 limits the yield that may be accreted on a loan portfolio to the excess of undiscounted expected cash flows over the initial investment in the loan portfolio. SOP 03-3 became effective January 1, 2005. FirstCity accounts for all loans acquired after 2004 in accordance with SOP 03-3. For loans acquired prior to January 1, 2005, FirstCity adopted the provisions of SOP 03-3, as they apply to decreases in cash flows expected to be collected, on a prospective basis.

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”). SFAS 123R supersedes APB Opinion No. 25, which requires recognition of an expense when goods or services are provided. SFAS 123R requires the determination of the fair value of the share-based compensation at the grant date and the recognition of the related expense over the period in which the share-based compensation vests. SFAS 123R permits a prospective or two modified versions of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by the original SFAS No. 123. The Company will utilize the prospective method. In April 2005, the SEC amended the compliance date of SFAS 123R to allow companies to implement SFAS 123R at the beginning of their next fiscal year. Therefore, on January 1, 2006, the Company will begin recognizing an expense for unvested share-based compensation that has been issued or will be issued after that date. Based on current unvested stock options outstanding, the Company anticipates approximately $.8 million in unvested compensation cost at January 1, 2006 to be expensed prospectively.

     In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, which provides guidance under SFAS No. 109, “Accounting for Income Taxes,” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) on enterprises’ income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. The Jobs Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. FSP No. 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. Management does not expect FSP No. 109-2 to have an impact on the Company as any taxes on repatriated foreign earnings are offset by the Company’s NOLs.

     On June 29, 2005, the FASB ratified the consensus reached by Emerging Issues Task Force (“EITF”) on Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity when the Limited Partners Have Certain Rights. The consensus reached by the EITF at the June 2005 meeting was that a sole general partner is presumed to control a limited partnership (or similar entity) and should consolidate the limited partnership unless (1) the

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

limited partners possess substantive kick-out rights or (2) the limited partners possess substantive participating rights. This ratification of EITF Issue No. 04-5 has caused the amendments of Statement of Position 78-9, Accounting for Investments in Real Estate Ventures, and EITF Issue No. 96-16, Investor’s Accounting for an Investee When the Investor has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights. EITF 04-5 is effective for all new and modified agreements effective June 29, 2005. For pre-existing agreements that are not modified, the EITF is effective as of the beginning of the first fiscal reporting period beginning after December 15, 2005. The Company has evaluated the impact of the adoption of EITF 04-5 and does not believe the impact will be significant to the Company’s results of operations or financial position.

(4) 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 conducted through the Company’s minority interest investment in Drive (“Consumer”). Earnings (loss) from discontinued operations are summarized as follows:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Mortgage		$	(94	)		$	(250	)		$	(94	)		$	(250	)
Consumer			(3	)			3,163				(3	)			6,278
Net earnings (loss) from discontinued operations		$	(97	)		$	2,913			$	(97	)		$	6,028

     Mortgage

     At June 30, 2005, 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 security is recorded at the lower of its carrying value or fair value less cost to sell. 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 $78 and $250 in the first six months of 2005 and 2004, 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, 2005, 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”. See note 5 for a description of the accounting policy for these loans.

     Consumer

     On September 21, 2004, FirstCity and certain of its subsidiaries entered into a definitive agreement to sell a 31% beneficial ownership interest in Drive and its general partner, Drive GP LLC, to IFA-GP, IFA-LP and MG-LP for a total purchase price of $108.5 million in cash, resulting in distributions and payments to FirstCity in the aggregate amount of $86.8 million in cash, from various sources. The sale was completed on November 1, 2004, and net cash proceeds from these transactions were primarily used to pay off debt.

     Pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the consolidated financial statements have been reclassified for all periods presented to reflect the operations, assets and liabilities of the consumer business segment as discontinued operations. There were no consumer assets held for sale as of June 30, 2005 and December 31, 2004. The liabilities of such operations have been classified as “Liabilities from discontinued consumer operations,” respectively on the June 30, 2005 and December 31, 2004 balance sheets and consisted primarily of accrued state taxes at June 30, 2005. The liability at December 31, 2004 related to accrued state taxes and an $8.0 million participation liability owed to Bank of Scotland, which was paid in the first quarter of 2005.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

     The net earnings from discontinued consumer operations are classified on the consolidated statements of operations as “Earnings from discontinued operations.” Summarized results of discontinued consumer operations are as follows:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Equity in earnings		$	—			$	5,118			$	—			$	10,155
Interest and fees on notes payable to affiliate			—				(532	)			—				(1,417	)
Other expenses			(3	)			(1	)			(3	)			(4	)
Income taxes			—				(399	)			—				(427	)
Minority interest			—				(1,023	)			—				(2,029	)
Earnings (loss) from discontinued consumer operations		$	(3	)		$	3,163			$	(3	)		$	6,278

(5) Portfolio Assets

     Portfolio Assets are summarized as follows:

		June 30,				December 31,
		2005				2004
Loan Portfolios
Loans Acquired Prior to 2005
Non-performing Portfolio Assets		$	13,732			$	19,993
Performing Portfolio Assets			12,750				16,039
Loans Acquired After 2004
Loans acquired with credit deterioration			10,668				—
Loans acquired with no credit deterioration			4,887				—
Outstanding balance			42,037				36,032
Allowance for loan losses			(114	)			—
Carrying amount of loans, net of allowance			41,923				36,032
Real Estate Portfolios			1,939				1,920
Portfolio Assets, net		$	43,862			$	37,952

     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.

     FirstCity primarily acquires loans in groups or portfolios that have experienced deterioration of credit quality between origination and the Company’s acquisition of the loans. The amount paid for a loan reflects FirstCity’s determination that it is probable the Company will be unable to collect all amounts due according to the loan’s contractual terms. FirstCity acquired no wholly-owned loan portfolios during the first quarter of 2005, and eight wholly-owned loan portfolios during the second quarter of 2005.

     On January 1, 2005, FirstCity adopted the provisions of SOP 03-3. The adoption of SOP 03-3 did not have a material impact on the Company’s consolidated results of operations. For loan portfolios acquired prior to January 1, 2005, FirstCity designated these loans as non-performing Portfolio Assets or performing Portfolio Assets. Such designation was made at the acquisition of the pool and does not change even though the actual performance of the loans may change. FirstCity accounts for all loans acquired after 2004 in accordance with SOP 03-3. Pursuant to SOP 03-3, the following is a description of each classification and the related accounting policy accorded to each Portfolio type:

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

   Loans Acquired Prior to 2005

   Non-Performing Portfolio Assets

     Non-performing Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed upon collateral. Prior to January 1, 2005, Portfolio Assets were designated as non-performing if a majority of all of the loans in the Portfolio were significantly under performing in accordance with the contractual terms of the underlying loan agreements at date of acquisition. Net gain on resolution of non-performing Portfolio Assets is recognized as income to the extent that proceeds collected exceed a pro rata portion of allocated cost from the pool. Cost allocation is based on a proration of actual proceeds divided by total estimated proceeds of the pool. No interest income is recognized separately on non-performing Portfolio Assets. All proceeds, of whatever type, are included in proceeds from resolution of Portfolio Assets in determining the gain on resolution of such assets. Once a non-performing Portfolio Asset becomes impaired, all future proceeds are allocated to reduce the carrying value of the Portfolio. Accounting for non-performing Portfolios is on a pool basis as opposed to an individual as