10-K405 1 h86114e10-k405.txt FIRSTCITY FINANCIAL CORP - YEAR ENDED 12/31/2000 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 033-19694 FIRSTCITY FINANCIAL CORPORATION (Exact name of Registrant as Specified in Its Charter) DELAWARE 76-0243729 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 6400 IMPERIAL DRIVE, WACO, TX 76712 (Address of Principal Executive Offices) (Zip Code)
(254) 751-1750 (Registrant's Telephone Number, Including Area Code) Securities Registered Pursuant to Section 12(b) of the Act: NONE Securities Registered Pursuant to Section 12(g) of the Act: TITLE OF EACH CLASS Common Stock, par value $.01 Adjusting Rate Preferred Stock, par value $.01 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The number of shares of common stock outstanding at March 28, 2001 was 8,368,344. As of such date, the aggregate market value of the voting and non-voting common equity held by non-affiliates, based upon the closing price of the common stock on the Nasdaq National Market System, was approximately $9,149,188. DOCUMENTS INCORPORATED BY REFERENCE
FORM 10-K --------- Notice of Annual Meeting and Proxy Statement for the 2001 Annual Meeting of Shareholders............................ III
-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 FIRSTCITY FINANCIAL CORPORATION TABLE OF CONTENTS
PAGE ---- PART I Item 1 Business.................................................... 1 Item 2 Properties.................................................. 9 Item 3 Legal Proceedings........................................... 9 Item 4 Submission of Matters to a Vote of Security Holders......... 10 PART II Item 5 Market for Registrant's Common Equity and Related Stockholder Matters....................................... 10 Item 6 Selected Financial Data..................................... 11 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 12 Item 7A Quantitative and Qualitative Disclosures About Market Risk...................................................... 38 Item 8 Financial Statements and Supplementary Data................. 40 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 78 PART III Item 10 Directors and Executive Officers of the Registrant.......... 78 Item 11 Executive Compensation...................................... 78 Item 12 Security Ownership of Certain Beneficial Owners and Management................................................ 78 Item 13 Certain Relationships and Related Transactions.............. 78 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................................... 79
i 3 FORWARD LOOKING INFORMATION This Annual Report on Form 10-K may contain forward-looking statements. The factors identified under "Risk Factors" contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, FirstCity Financial Corporation (the "Company" or "FirstCity"). When any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, the Company cautions that, while such assumptions or bases are believed to be reasonable and are made in good faith, assumed facts or bases almost always vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending upon the circumstances. When, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and is believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. The words "believe," "expect," "estimate," "project," "anticipate" and similar expressions identify forward-looking statements. PART I ITEM 1. BUSINESS. GENERAL The Company is a financial services company headquartered in Waco, Texas with offices throughout the United States and Mexico and a presence in France. The Company began operating in 1986 as a specialty financial services company focused on acquiring and resolving distressed loans and other assets purchased at a discount relative to the aggregate unpaid principal balance of the loans or the appraised value of the other assets ("Face Value"). To date the Company has acquired, for its own account and through various affiliated partnerships, pools of assets or single assets (collectively referred to as "Portfolio Assets" or "Portfolios") with a Face Value of approximately $5.6 billion. The Company's servicing expertise, which it has developed largely through the resolution of distressed assets, is a cornerstone of its growth strategy. Today the Company is engaged in two principal businesses: (i) Portfolio Asset acquisition and resolution and (ii) consumer lending through the Company's minority investment in Drive Financial Services LP ("Drive"). See Note 9 of the Company's Consolidated Financial Statements for certain financial information about these two segments of the Company. BUSINESS STRATEGY The Company's core business is the acquisition, management, servicing and resolution of purchased assets pools. Key elements of the Company's overall business strategy include: - Increasing the Company's investments in purchased asset pools acquired from financial institutions and government agencies, both for its own account or through investment entities formed with Cargill Financial Services Corporation ("Cargill" or "Cargill Financial") or one or more other co-investors, thereby capitalizing on the expertise of partners whose skills complement those of the Company. - Identifying and acquiring, through non-traditional niche sources, distressed assets that meet the Company's investment criteria, which may involve the utilization of special acquisition structures. - Acquiring, managing, servicing and resolving assets in certain international markets, either separately or in partnership with others, including Cargill. 1 4 - Capitalizing on the Company's servicing expertise to enter into new markets with servicing agreements which provide for reimbursement of costs of entry and operations plus an incentive servicing fee after certain thresholds are met without requiring substantial equity investments. - Retaining a minority interest investment in the consumer lending business line. - Maximizing growth in operations, thereby permitting the utilization of the Company's net operating loss carryforwards ("NOLs"). BACKGROUND The Company began operating in the financial service business in 1986 as a purchaser of distressed assets from the Federal Deposit Insurance Corporation ("FDIC") and the Resolution Trust Corporation ("RTC"). From its original office in Waco, Texas, with a staff of four professionals, the Company's asset acquisition and resolution business grew to become a significant participant in an industry fueled by the problems experienced by banks and thrifts throughout the United States. In the late 1980s, the Company also began acquiring assets from healthy financial institutions interested in eliminating nonperforming assets from their portfolios. The Company began its relationship with Cargill in 1991. Since that time, the Company and Cargill have formed a series of Acquisition Partnerships through which they have jointly acquired over $4.8 billion in Face Value of distressed assets. In July 1995, the Company acquired by merger (the "Merger") First City Bancorporation of Texas, Inc. ("FCBOT"), a former bank holding company that had been engaged in a proceeding under Chapter 11 of the Bankruptcy Code since November 1992. As a result of the Merger, the common stock of the Company became publicly held and the Company received $20 million of additional equity capital and entered into an incentive-based servicing agreement to manage approximately $300 million in assets for the benefit of the former equity holders of FCBOT. In addition, as a result of the Merger, the Company retained FCBOT's rights to approximately $596 million in NOLs, which the Company believes it can use to offset taxable income generated by the Company and its consolidated subsidiaries. Following the Merger, the Company adopted a growth and diversification strategy designed to capitalize on its servicing and credit expertise to expand into additional financial service businesses with management. To that end, in July 1997 the Company acquired Harbor Financial Group, Inc. and its subsidiaries (collectively referred to as "Mortgage Corp."), a company engaged in the residential and commercial mortgage banking business since 1983. During 1997, the Company also expanded into related niche financial services markets, such as mortgage conduit banking, conducted through FC Capital Corp. ("Capital Corp."), a subsidiary of the Company, and such as consumer finance, conducted through FirstCity Consumer Lending Corporation ("Consumer Corp."), a subsidiary of the Company. Effective during the third quarter of 1999, management of the Company adopted formal plans to discontinue the operations of Mortgage Corp. and Capital Corp. These entities comprise the operations that were previously reported as the Company's mortgage banking operations. Because the Company formally adopted plans to discontinue the operations of Mortgage Corp. and Capital Corp., and operations at each such entity have ceased, the results of historical operations have been reflected as discontinued operations. On October 14, 1999, Mortgage Corp. filed for protection under Chapter 11 of the Bankruptcy Code. Mortgage Corp.'s filings with the bankruptcy court reflected that it had stated assets of approximately $95 million and stated liabilities of approximately $98 million. The Company has not guaranteed the indebtedness of Mortgage Corp. and has previously reached agreement with its corporate revolving lenders to permanently waive any events of default related to Mortgage Corp., including bankruptcy. As a result of the liquidity constraints created by the discontinued operations of Mortgage Corp. and Capital Corp., in the third quarter of 2000, Consumer Corp. completed the sale of a 49% equity interest in its automobile finance operation to IFA Drive GP Holdings LLC ("IFA-GP") and IFA Drive LP Holdings LLC ("IFA-LP"), wholly-owned subsidiaries of BOS (USA) Inc., formerly IFA Incorporated ("IFA 2 5 Parent"), for a purchase price of $15 million cash, pursuant to the terms of a Securities Purchase Agreement dated as of August 18, 2000 (the "Securities Purchase Agreement"), by and among the Company, Consumer Corp., FirstCity Funding, LP ("Funding LP"), FirstCity Funding GP Corp. ("Funding GP"), IFA-GP and IFA-LP. The transaction generated $75 million in cash and resulted in a net gain of $8.1 million. Simultaneously, the Bank of Scotland and the Company completed a debt restructure whereby the Company reduced the outstanding debt under its senior and subordinate facilities from $113 million to approximately $44 million. The Company also retired approximately $6.4 million of debt owed to other lenders. PORTFOLIO ASSET ACQUISITION AND RESOLUTION The Company engages in the Portfolio Asset acquisition and resolution business through its wholly owned subsidiary, FirstCity Commercial Corporation, and its subsidiaries ("Commercial Corp."). In the Portfolio Asset acquisition and resolution business Commercial Corp. acquires and resolves portfolios of performing and nonperforming commercial and consumer loans and other assets, which are generally acquired at a discount to Face Value. Purchases may be in the form of pools of assets or single assets. Performing assets are those as to which debt service payments are being made in accordance with the original or restructured terms of such assets. Nonperforming assets are those as to which debt service payments are not being made in accordance with the original or restructured terms of such assets, or as to which no debt service payments are being made. Portfolios are designated as nonperforming unless substantially all of the assets comprising the Portfolio are performing. Once a Portfolio has been designated as either performing or nonperforming, such designation is generally not changed for accounting purposes regardless of the performance of the assets comprising the Portfolio. Portfolios are either acquired for Commercial Corp.'s own account or through investment entities formed with Cargill or one or more other co-investors (each such entity, an "Acquisition Partnership"). See "-- Portfolio Asset Acquisition and Resolution Business -- Relationship with Cargill" To date, Commercial Corp. and the Acquisition Partnerships have acquired over $5.6 billion in Face Value of assets. Revenues from the Portfolio Asset acquisition and resolution business attributable to foreign and domestic operations for the years ended December 31, 2000, 1999 and 1998 are summarized as follows:
YEAR ENDED DECEMBER 31, --------------------------- 2000 1999 1998 ------- ------- ------- (DOLLARS IN THOUSANDS) Domestic................................................ $14,616 $20,468 $24,241 Foreign................................................. 6,700 5,029 5,041 ------- ------- ------- $21,316 $25,497 $29,282 ======= ======= =======
Portfolio Asset Acquisition and Resolution Business SOURCES OF ASSETS ACQUIRED In the early 1990s large quantities of nonperforming assets were available for acquisition from the RTC and the FDIC. Since 1993, sellers of nonperforming assets have included private sellers as well as government agencies such as the Small Business Administration. Private sellers include financial institutions, insurance companies, and other institutional lenders, both in the United States and in various foreign countries. As a result of mergers, acquisitions and corporate downsizing efforts, other business entities frequently seek to dispose of excess real estate property or other financial assets not meeting the strategic needs of a seller. Sales of such assets improve the seller's balance sheet, reduce overhead costs, reduce staffing requirements and avoid management and personnel distractions associated with the intensive and time-consuming task of resolving loans and disposing of real estate. Consolidations within a broad range of industries, especially banking, have augmented the trend of financial institutions and other sellers packaging and selling asset portfolios to investors as a means of disposing of nonperforming loans or other surplus or non-strategic assets. 3 6 PORTFOLIO ASSETS Commercial Corp. acquires and manages Portfolio Assets, which are generally purchased at a discount to Face Value by Commercial Corp. or through Acquisition Partnerships. The Portfolio Assets are generally nonhomogeneous assets, including loans of varying qualities that are unsecured or secured by diverse collateral types and foreclosed properties. Some of the secured 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 either on business real estate or other collateral cash flow. Consumer loans may be secured (by real or personal property) or unsecured. Portfolio Assets may be designated as performing or nonperforming. Commercial Corp. generally expects to resolve Portfolio Assets within three to five years after purchase. To date, a substantial majority of the Portfolio Assets acquired by Commercial Corp. has been designated as nonperforming. Commercial Corp. seeks to resolve nonperforming Portfolio Assets through (i) a negotiated settlement with the borrower in which the borrower pays all or a discounted amount of the loan, (ii) conversion of the loan into a performing asset through extensive servicing efforts followed by either a sale of the loan to a third party or retention of the loan by Commercial Corp. or the Acquisition Partnership or (iii) foreclosure of the loan and sale of the collateral securing the loan. Commercial Corp. has substantial experience acquiring, managing and resolving a wide variety of asset types and classes. As a result, it does not limit itself as to the types of Portfolios it will evaluate and purchase. Commercial Corp.'s willingness to acquire Portfolio Assets is generally determined by factors including the information that is available regarding the assets in a Portfolio, the price at which the Portfolio can be acquired and the expected net cash flows from the resolution of such assets. Commercial Corp. has acquired Portfolio Assets in virtually all 50 states, the Virgin Islands, Puerto Rico, France, Japan and Mexico. Commercial Corp. believes that its willingness to acquire nonhomogeneous Portfolio Assets without regard to geographic location provides it with an advantage over certain competitors that limit their activities to either a specific asset type or geographic location. Commercial Corp. also seeks to capitalize on emerging opportunities in foreign markets in which the market for nonperforming loans of the type generally purchased by Commercial Corp. is less efficient than the market for such assets in the United States. Through December 31, 2000, Commercial Corp. has acquired, with Cargill and a local French partner, ten Portfolios in France, consisting of approximately 22,000 assets, for an aggregate purchase price of approximately $245 million. Such assets had a Face Value of approximately $945 million. Commercial Corp.'s share of the equity interest in the Portfolios acquired in France ranges from 10% to 33% and Commercial Corp. has made a total equity investment in these Portfolios of approximately $21 million. Commercial Corp. owns a 10% interest in MCS et Associates ("MCS"), a French asset servicing company and is, in conjunction with MCS and Cargill, actively pursuing opportunities to purchase additional pools of distressed assets in France and other areas of Western Europe. In addition, Commercial Corp. has formed a Mexican asset servicing company, which has offices in Guadalajara and Mexico City, Mexico, which facilitates its participation in acquisition of in Mexico. Through December 31, 2000 Commercial Corp. and its various partners have acquired five Portfolios in Mexico consisting of an aggregate of approximately 39,000 assets with a Face Value of approximately $1.6 billion for a total purchase price of approximately $333 million. Commercial Corp.'s share of the equity interest in the Portfolios acquired in Mexico ranges from 3% to 20%, and Commercial Corp. has made a total investment therein of approximately $16 million. 4 7 The following table presents, for the years ended December 31, 2000, 1999 and 1998,respectively, selected data for the Portfolio Assets acquired by Commercial Corp. PORTFOLIO ASSETS
YEAR ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 ---------- -------- -------- (DOLLARS IN THOUSANDS) Face Value.......................................... $1,578,932 $516,518 $537,356 Total purchase price................................ 394,927 210,799 139,691 Total equity invested(1)............................ 341,736 63,260 65,073 Commercial Corp. equity invested.................... $ 22,140 $ 11,203 $ 28,478 Total number of Portfolio Assets.................... 47,320 5,769 4,966
--------------- (1) Includes investments made in the form of equity and notes receivable from affiliates of the investor group to the Acquisition Partnerships. Sources of Portfolio Assets Commercial Corp. develops its Portfolio Asset opportunities through a variety of sources. The activities or contemplated activities of expected sellers are publicized in industry publications and through other similar sources. Commercial Corp. also maintains relationships with a variety of parties involved as sellers or as brokers or agents for sellers. Many of the brokers and agents concentrate by asset type and have become familiar with Commercial Corp.'s acquisition criteria and periodically approach Commercial Corp. with identified opportunities. In addition, repeat business referrals from Cargill or other co-investors in Acquisition Partnerships, repeat business from previous sellers, focused marketing by Commercial Corp. and the nationwide presence of Commercial Corp. and the Company are important sources of business. Commercial Corp. identifies investment opportunities in foreign markets in much the same manner as in the United States. In varying degrees of volume and efficiency, the markets of Europe, Asia, and Latin America all include sellers of nonperforming assets. In some countries, such as Mexico, the government has taken a very active role in the management and orderly disposition of these types of assets. Commercial Corp.'s established presence in Mexico and France provides a strong base for the identification, valuation, and acquisition of assets in those countries, as well as in adjacent markets. Commercial Corp. continues to identify partners who have contacts within various foreign markets and can bring Portfolio Asset opportunities to Commercial Corp. Asset Analysis and Underwriting Prior to making an offer to acquire any Portfolio, Commercial Corp. performs an extensive evaluation of the assets that comprise the Portfolio. If, as is often the case, the Portfolio Assets are nonhomogeneous, Commercial Corp. will evaluate all individual assets determined to be significant to the total of the proposed purchase. If the Portfolio Assets are homogenous in nature, a sample of the assets comprising the Portfolio is selected for evaluation. The evaluation of individual assets generally includes analyzing the credit and collateral file or other due diligence information supplied by the seller. Based upon such seller-provided information, Commercial Corp. will undertake additional evaluations of the asset, which, to the extent permitted by the seller, will include site visits to, and environmental reviews of the property securing the loan or the asset proposed to be purchased. Commercial Corp. will also analyze relevant local economic and market conditions based on information obtained from its prior experience in the market or from other sources, such as local appraisers, real estate principals, realtors and brokers. The evaluation further includes an analysis of an asset's projected cash flow and sources of repayment, including the availability of third party guarantees. Commercial Corp. values loans (and other assets included 5 8 in a portfolio) on the basis of its estimate of the present value of estimated cash flow to be derived in the resolution process. Once the cash flow estimates for a proposed purchase and the financing and partnership structure, if any, are finalized, Commercial Corp. can complete the determination of its proposed purchase price for the targeted Portfolio Assets. Purchases are subject to purchase and sale agreements between the seller and the purchasing affiliate of Commercial Corp. The analysis and underwriting procedure in foreign markets follows the same extensive diligence philosophy as that employed domestically. Additional risks are evaluated in foreign markets, including currency strength, short and long-term market stability and political concerns. These risks are appropriately priced into the cost of the acquisition. Servicing After a Portfolio is acquired, Commercial Corp. assigns the Portfolio Assets to account servicing officers who are independent of the personnel that performed the due diligence evaluation in connection with the purchase of the Portfolio. Portfolio Assets are serviced either at the Company's headquarters or in one of Commercial Corp.'s other offices. Commercial Corp. generally establishes servicing operations in locations in close proximity to significant concentrations of Portfolio Assets. Most of such offices are considered temporary and are reviewed for closing after the assets in the geographic region surrounding the office are substantially resolved. The assigned account servicing officer develops a business plan and budget for each asset based upon an independent review of the cash flow projections developed during the investment evaluation, physical inspections of assets on collateral underlying the related loans, evaluation of local market conditions and discussions with the relevant borrower. Budgets are periodically reviewed and revised as necessary. Commercial Corp. employs loan-tracking software and other operational systems that are generally similar to systems used by commercial banks, but which have been enhanced to track both the collected and the projected cash flows from Portfolio Assets. In prior years, Commercial Corp. completed three structured securitization/financing transactions. The basis for such transactions differs from traditional securitization structures in which the execution levels are predicated upon the existence of an underlying contractual stream of cash flows from periodic payments on underlying loans. Transactions completed by Commercial Corp. to date have been based not only on the cash flow from performing assets but also the projected cash flows from nonperforming assets such as unoccupied real estate and raw land parcels. To date, the net present value of Commercial Corp.'s cash flows from serviced assets has exceeded initial projections. Commercial Corp. believes that its success in predicting cash flows from Portfolio Assets has permitted it to access the securitization markets on attractive terms. Commercial Corp. services all of the Portfolio Assets owned for its own account, all of the Portfolio Assets owned by the Acquisition Partnerships and, to a very limited extent, Portfolio Assets owned by third parties. In connection with the Acquisition Partnerships in the United States, Commercial Corp. generally earns a servicing fee of between 1% and 8% of gross cash collections generated rather than a management fee based on the Face Value of the asset being serviced. The rate of servicing fee charged is generally a function of the average Face Value of the assets within each pool being serviced (the larger the average Face Value of the assets in a Portfolio, the lower the fee percentage within the prescribed range). For the Mexican Acquisition Partnerships, Commercial Corp. earns a servicing fee based on costs of servicing plus a profit margin. The Company also has certain consulting contracts with its Mexican investment entities whereby the Company is entitled to additional compensation for servicing once a specified return to the investors has been achieved. The Acquisition Partnerships in France are serviced by MCS in which the Company maintains an equity interest. Structure and Financing of Portfolio Asset Purchases Portfolio Assets are either acquired for the account of a subsidiary of Commercial Corp. or through the Acquisition Partnerships. Portfolio Assets owned directly by a subsidiary of Commercial Corp. may be funded 6 9 with cash contributed by Commercial Corp., equity financing provided by an affiliate of Cargill, and secured senior debt that is recourse only to such subsidiary. Each Acquisition Partnership is a separate legal entity, (generally a limited partnership, but may instead be a limited liability company, trust, corporation or other type of entity). Commercial Corp. and an investor typically form a corporation to serve as the corporate general partner of each Acquisition Partnership. Generally, Commercial Corp. and the investor each own 50% of the general partner and a 49.5% limited partnership interest in the Acquisition Partnership (the general partner owns the other 1% interest). Cargill or its affiliates are the investor in the vast majority of the Acquisition Partnerships currently in existence. See "-- Relationship with Cargill." Certain institutional investors have also held limited partnership interests in the Acquisition Partnerships and may hold interests in the related corporate general partners. The Acquisition Partnerships are generally financed by debt, secured only by the assets of the individual entity, and are nonrecourse to the Company, Commercial Corp., its co-investors and the other Acquisition Partnerships. Commercial Corp. believes that this legal structure insulates it, the Company and the other Acquisition Partnerships from certain potential risks, while permitting Commercial Corp. to share in the economic benefits of each Acquisition Partnership. Senior secured acquisition financing currently provides the majority of the funding for the purchase of Portfolios. Commercial Corp. and the Acquisition Partnerships have relationships with a number of senior lenders including Cargill. Senior acquisition financing is obtained at variable interest rates ranging from LIBOR to prime based pricing with negotiated spreads to the base rates. The final maturity of the senior secured acquisition debt is normally two years from the date of funding of each advance under the facility. The terms of the senior acquisition debt of the Acquisition Partnerships may allow, under certain conditions, distributions to equity partners before the debt is repaid in full. Prior to maturity of the senior acquisition debt, the Acquisition Partnerships typically refinance the senior acquisition debt with long-term debt secured by the assets of partnerships or transfer assets from the Portfolios to special purpose entities to affect structured financings or securitization transactions. Such long-term debt generally accrues interest at a lower rate than the senior acquisition debt, has collateral terms similar to the senior acquisition debt, and permits distributions of excess cash flow generated by the Acquisition Partnership to the equity partners so long as the partnership is in compliance with applicable financial covenants. In foreign markets, Commercial Corp. takes great care in the establishment of ownership structures. Prior to investment, Commercial Corp., in conjunction with its co-investors, performs significant diligence and planning on the tax, licensing, and other ownership issues of the particular country. As in the United States, each foreign Acquisition Partnership is a separate legal entity, generally formed as the equivalent of a limited liability company or a liquidating trust. Over the year, Commercial Corp. has cultivated successful relationships with several investors in its international acquisitions. Relationship with Cargill Cargill, a diversified financial services company, is a wholly owned subsidiary of Cargill, Incorporated, which is generally regarded as one of the world's largest privately held corporations and has offices worldwide. Cargill and its affiliates provide significant debt and equity financing to the Acquisition Partnerships. In addition, Commercial Corp. believes its relationship with Cargill significantly enhances Commercial Corp.'s credibility as a purchaser of Portfolio Assets and facilitates its ability to expand into related businesses and foreign markets. Under a Right of First Refusal Agreement and Due Diligence Reimbursement Agreement effective as of January 1, 1998, as amended (the "Right of First Refusal Agreement") among the Company, FirstCity Servicing Corporation, Cargill and its wholly owned subsidiary CFSC Capital Corp. II ("CFSC"), if the Company receives an invitation to bid on or otherwise obtains an opportunity to acquire interests in loans, receivables, real estate or other assets located in the United States, Canada, Mexico, or the Caribbean in which the aggregate amount to be bid exceeds $4 million, the Company is required to follow a prescribed 7 10 notice procedure pursuant to which CFSC has the option to participate in the proposed purchase by requiring that such purchase or acquisition be effected through an Acquisition Partnership formed by the Company and Cargill (or an affiliate). The Right of First Refusal Agreement does not prohibit the Company from holding discussions with entities other than CFSC regarding potential joint purchases of interests in loans, receivables, real estate or other assets, provided that any such purchase is subject to CFSC's right to participate in the Company's share of the investment. The Right of First Refusal Agreement further provides that, subject to certain conditions, CFSC will bear 50% of the due diligence expenses incurred by the Company in connection with proposed asset purchases. The Right of First Refusal Agreement is a restatement and extension of a similar agreement entered into among the Company, certain members of the Company's management and Cargill in 1992. The Right of First Refusal Agreement has a termination date of January 1, 2002. Business Strategy Historically, Commercial Corp. has leveraged its expertise in asset resolution and servicing by investing in a wide variety of asset types across a broad geographic scope. Commercial Corp. continues to follow this investment strategy and seeks expansion opportunities into new asset classes and geographic areas when it believes it can achieve attractive risk adjusted returns. The following are the key elements of Commercial Corp.'s business strategy in the portfolio acquisition and resolution business: - Traditional markets. Commercial Corp. will continue to invest in purchased asset pools acquired from financial institutions and government agencies, both for its own account or through investment entities formed with Cargill or one or more other co-investors. - Niche markets. Commercial Corp. will continue to pursue profitable private market niches in which to invest. The niche investment opportunities that Commercial Corp. has pursued to date include (i) the acquisition of improved or unimproved real estate, including excess retail sites, and (ii) periodic purchases of single financial or real estate assets from banks and other financial institutions with which Commercial Corp. has established relationships, and from a variety of other sellers that are familiar with the Company's reputation for acting quickly and efficiently. - Foreign markets. Commercial Corp. believes that the foreign markets for distressed assets are less developed than the U.S. market, and therefore provide a greater opportunity to achieve attractive risk adjusted returns. Commercial Corp. has purchased Portfolio Assets in France, Japan (sold in 1999) and Mexico and expects to continue to seek purchase opportunities outside of the United States. GOVERNMENT REGULATION Some aspects of the Company's Portfolio Asset acquisition and resolution business are subject to regulation under various federal, state and local statutes and regulations that impose requirements and restrictions affecting, among other things, disclosures to obligors, the terms of secured transactions, collection repossession and claims handling procedures, multiple qualification and licensing requirements for doing business in various jurisdictions, and other trade practices. COMPETITION The Portfolio Asset acquisition business is highly competitive. Some of the Company's principal competitors are substantially larger and better capitalized than the Company. Because of these resources, these companies may be better able than the Company to acquire Portfolio Assets, to pursue new business opportunities or to survive periods of industry consolidation. Generally, there are three aspects of the distressed asset business: due diligence, Portfolio management, and servicing. The Company is a major participant in all three areas. In comparison, certain of its competitors (including certain securities and banking firms) have historically competed primarily as portfolio purchasers and have customarily engaged other parties to conduct due diligence on potential portfolio purchases and to service acquired assets, and certain other competitors (including certain banking and other firms) have historically competed primarily as servicing companies. 8 11 The Company believes that its ability to acquire Portfolios for its own account and through Acquisition Partnerships will be an important component of the Company's overall future growth. Acquisitions of Portfolios are often based on competitive bidding, which involves the danger of bidding too low (which generates no business), or bidding too high (which could win the Portfolio at an economically unattractive price). EMPLOYEES The Company had 140 employees as of December 31, 2000. No employee is a member of a labor union or party to a collective bargaining agreement. The Company believes that its employee relations are good. CONSUMER LENDING The Company historically conducted all of its consumer receivable origination activities through Consumer Corp. Consumer Corp.'s focus had been on the origination and servicing of sub-prime consumer loans. Such loans are extended to borrowers who evidence an ability and willingness to repay credit, but have experienced an adverse event, such as a job loss, illness or divorce, or have had past credit problems, such as delinquency, bankruptcy, repossession or charge-offs. In the third quarter of 2000, Consumer Corp. formed Drive and transferred the entire operations of its automobile finance platform to Drive. Consumer Corp. sold a 49% equity interest in Drive to IFA-GP and IFA-LP, subsidiaries of IFA Parent, a wholly owned subsidiary of the Bank of Scotland. See "Background" under Item 1 and "Overview -- Sale of 49% of Automobile Finance Operation and Debt Restructure" under Item 7 for additional information related to formation and structure of Drive. As a result of the sale, the majority of Consumer Corp.'s operations that have historically been consolidated are now accounted for under the equity method. Drive accumulates and pools automobile loans acquired from franchise dealerships for sales in public and private securitization transactions. Such transactions result in the recognition of gains to the extent that the proceeds received (including the estimated value of the retained subordinated interests) exceed the basis of the automobile loans and the costs associated with the securitization process. When the automobile loans are securitized and sold, the retained interests are valued at the discounted present value of the cash flows expected to be realized over the anticipated average life of the assets sold after future estimated credit losses, estimated pre-payments, servicing fees and other securitization fees related to loan sold. The discounted present value of such interests are computed using Drive's assumptions for market discount rates, pre-payment fees, default rates, credit losses and other costs based upon the unique underlying characteristics of the automobile loans comprising each securitization. Drive employs an underwriting process and purchase discount methodology that is designed to result in a purchase discount equaling or exceeding expected losses for all loans acquired by Drive. The carrying value of loans is evaluated by Drive on a monthly basis for impairment. A valuation allowance is established for any impairment identified with provisions to augment the allowance charged to earnings in the period identified. Loans are generally acquired by Drive at a discount from the face value of the loan with the acquisition discount established as an allowance to losses at the acquisition date of the loan. Ownership of Drive is allocated as follows: 49% of Drive is owned (directly and indirectly) by IFA-GP and IFA-LP, 31% of Drive is owned (directly and indirectly) by Consumer Corp., and 20% of Drive (directly and indirectly) by the Auto Finance Management Group. The partners of Drive have no obligation to make additional capital contributions to Drive. In connection with the sale of the interest in Drive to IFA-GP and IFA-LP, IFA Parent provided a term financing of $60 million to Drive and its subsidiary, Drive ABS LP, which was used to repay indebtedness owed to the Company by Consumer Corp. The Company provided a guaranty limited to a maximum of up to $4,000,000.00 of the $60 million loan by IFA Parent. The Company, Consumer Corp. and Funding L.P., secured the guaranty with security interests in their respective ownership interests in Consumer Corp., Funding L.P. and Drive. IFA Parent also provided a warehouse line to Drive through a $100 million Receivables Financing Agreement (the "Receivables Financing Agreement"). The 9 12 Receivables Financing Agreement was in addition to the $100 million warehouse line provided to Drive by Enterprise Funding Corporation, an affiliate of Bank of America. On February 16, 2001, IFA Parent and Drive entered into an amendment to the Receivables Financing Agreement providing for an increase in the maximum commitment under the facility to $150 million. On February 16, 2001, Drive entered into a subordinate capital loan agreement with IFA Parent which provides for working capital loans in the maximum aggregate principal amount of $40 million to be made available to Drive. An initial draw under this facility was made in the amount of $20 million, which amount was applied to a payment on the $60 million term facility provided by IFA Parent. On April 6, 2001, Drive terminated its prior warehouse facility with Enterprise Funding Corporation and entered into a $100 million commercial paper conduit warehouse facility with Enterprise Funding Corporation (the "Enterprise Facility") which will provide financing for Drive through April 5, 2002. IFA Parent was requested, as a condition to the effectiveness of the Enterprise Facility, to enter into agreements (the "Sponsor Agreements") which require IFA Parent, under certain circumstances to: (i) purchase nonconforming contracts in the event that the seller, the servicer, or the related originator fails to repurchase any contract which is required to be repurchased, (ii) pay certain premiums and other expenses, (iii) indemnify Enterprise Funding Corporation, the collateral agent, and the insurance provider from certain types of losses, and (iv) to make certain secondary servicer advances. IFA Parent required the Company to indemnify IFA Parent for 31% (the amount of the direct and indirect ownership of Consumer Corp. in Drive) of any losses resulting under the terms of the Sponsor Agreements. During the fourth quarter of 2000, Drive completed a securitization of $100 million of face value of automobile receivables. In connection with that securitization, IFA Parent was required to enter into agreements to pay certain fees and expenses, and to repurchase contracts under certain circumstances and to indemnify other parties to the securitization from certain liabilities pursuant to the securitization documents. IFA Parent required the Company to provide an indemnity to IFA Parent for 31% (the ownership interest held directly and indirectly by Consumer Corp. in Drive) of any and all losses suffered by IFA Parent under those agreements. The Company believes that additional funding provided by IFA Parent and Enterprise Funding Corporation along with improved capital markets execution should provide the liquidity needed by Drive to allow this business model to mature with planned, controlled growth. ITEM 2. PROPERTIES. The Company leases all its office locations. The Company leases its current headquarters building from a related party under a noncancellable operating lease, which expires December 2001. All leases of the other offices of the Company and subsidiaries expire prior to 2006. ITEM 3. LEGAL PROCEEDINGS. The Company and Harbor Financial Group, Inc. (formerly known as FirstCity Financial Mortgage Corporation) filed suit in the Federal District Court for the Western District of Texas, Waco Division, against Chase Bank of Texas, N.A. and Chase Securities, Inc. in September 1999 seeking damages resulting from alleged violations by the defendants of the Bank Holding Company Act and from civil conspiracy engaged in by the defendants, and injunctive relief, arising from an engagement letter entered into between the Company and Chase Securities, Inc. relating to the sale assets or securities of Harbor Financial Group, Inc., Harbor Financial Mortgage Corporation and their subsidiaries (collectively "Harbor"). The Company alleged that Chase Bank of Texas, N.A. conditioned its extension of credit to Harbor on the retention of Chase Securities, Inc. by the Company and Harbor violated the Bank Holding Company Act. The Company additionally sought a judicial declaration that the plaintiffs were not obligated to pay any commission to Chase Securities, Inc. under the engagement letter. The actual damages sought by the Company were in excess of $200 million. The Company also sought recovery of three times its damages pursuant to the Bank Holding Company Act and recovery of its costs of court, including reasonable attorneys fees. A motion to dismiss the Texas suit was granted based upon a provision in the engagement letter that provided that any suit arising from the 10 13 engagement letter would be pursued in the State of New York. The Company has requested leave of the Supreme Court for the State of New York to amend its answer in that proceeding to include these claims as a counterclaim to the suit brought by Chase Securities, Inc. and an action against Chase Bank of Texas, N.A. On October 4, 1999, Chase Securities, Inc. filed suit against the Company before the Supreme Court for the State of New York, County of New York: Commercial Part seeking recovery of $2.4 million as the balance of a transaction fee allegedly due it under the terms of the engagement letter and other just and proper relief. The Company denies that it has any liability to Chase Securities, Inc. and intends to vigorously defend the suit. The Company has asserted as a defense to this action the violations of the Bank Holding Company Act asserted in the litigation pending before the Federal District Court for the Western District of Texas. The Company has sought leave to amend its answer in the suit to include a counterclaim against Chase Securities, Inc. and an action against Chase Bank of Texas, N.A. under the Bank Holding Company Act as is asserted in the Texas suit. On October 14, 1999, Mortgage Corp. filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code before the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. In a motion filed in those proceedings requesting the appointment of a Chapter 11 Trustee, the debtors stated that they were reviewing pre-petition transfers to the Company to determine if those transfers are avoidable. On December 14, 1999, the bankruptcy proceedings were converted to liquidations under Chapter 7 of the United States Bankruptcy Code. The Chapter 7 Trustee has not initiated an action against the Company to assert an avoidance action to recover any preferential transfers. The Company believes that it has valid defenses to any allegations that might be made to avoid any pre-petition transfers in connection with the Mortgage Corp. bankruptcy proceedings. Periodically, the Company, its subsidiaries, its affiliates and the Acquisition Partnerships are parties to or otherwise involved in legal proceedings arising in the normal course of business. The Company does not believe that there is any proceeding threatened or pending against it, its subsidiaries, its affiliates or the Acquisition Partnerships which, if determined adversely, would have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company, its subsidiaries, its affiliates or the Acquisition Partnerships. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the fourth quarter ended December 31, 2000. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. COMMON AND PREFERRED STOCK DATA The Company's common stock, $.01 par value per share (the "Common Stock"), and adjusting rate preferred stock are listed on the Nasdaq National Market System under the symbols FCFC and FCFCO, respectively. The number of holders of record of Common Stock on March 31, 2001 was approximately 514. 11 14 High and low stock prices and dividends for the Common Stock and adjusting rate preferred stock in 2000 and 1999 are displayed in the following table:
2000 1999 -------------- --------------------------- MARKET PRICE MARKET PRICE CASH -------------- --------------- DIVIDENDS QUARTER ENDED HIGH LOW HIGH LOW PAID ------------- ------ ----- ------ ------ --------- Common Stock: March 31................................ $ 3.89 $2.13 $16.75 $ 8.88 -- June 30................................. 2.38 1.58 11.44 5.06 -- September 30............................ 2.88 1.50 6.63 0.75 -- December 31............................. 2.19 1.25 2.75 1.13 -- Adjusting Rate Preferred Stock(1): March 31................................ $11.00 $7.00 $20.75 $17.38 $0.525 June 30................................. 9.25 4.38 18.25 15.00 0.525 September 30............................ 11.88 8.25 15.75 5.00 0.525 December 31............................. 11.00 9.06 9.63 6.00 --
--------------- (1) In the third quarter of 1999, payment of dividends in respect to the Adjusting Rate Preferred Stock was suspended. The Company has never declared or paid a dividend on the Common Stock. The Company currently intends to retain future earnings to finance its growth and development and therefore does not anticipate that it will declare or pay any dividends on the Common Stock in the foreseeable future. Any future determination as to payment of dividends will be made at the discretion of the Board of Directors of the Company and will depend upon the Company's operating results, financial condition, capital requirements, general business conditions and such other factors that the Board of Directors deems relevant. The Company's Senior Facility and certain other credit facilities to which the Company and its subsidiaries are parties contain restrictions relating to the payment of dividends and other distributions. There have been no sales of unregistered securities. ITEM 6. SELECTED FINANCIAL DATA. In the third quarter of 2000, Consumer Corp. completed a sale of a 49% equity interest in its automobile finance operation to IFA-GP and IFA-LP. As a result of this sale, the Company no longer consolidates the financial statements of its automobile finance operation since August 1, 2000, but instead records its investment under the equity method of accounting. Effective during the third quarter of 1999, management of the Company adopted formal plans to discontinue the operations of Mortgage Corp and Capital Corp. These entities comprise the operations that were previously reported as the Company's residential and commercial mortgage banking business. Because the Company formally adopted plans to discontinue the operations of Mortgage Corp. and Capital Corp., and operations at each such entity have ceased, the results of historical operations have been reflected as discontinued operations. On October 14, 1999, Mortgage Corp. filed for protection under Chapter 11 of the Bankruptcy Code. Mortgage Corp.'s filings with the bankruptcy court reflected that it had stated assets of approximately $95 million and stated liabilities of approximately $98 million. FirstCity has not guaranteed the indebtedness of Mortgage Corp. and has previously reached agreement with its corporate revolving lenders to permanently waive any events of default related to Mortgage Corp., including bankruptcy. The Chapter 11 bankruptcy proceeding was subsequently converted to a Chapter 7 bankruptcy proceeding to liquidate Mortgage Corp. and certain of its subsidiaries. 12 15 The Selected Financial Data presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Item 7 of this Report and with the related Consolidated Financial Statements and Notes thereto under Item 8 of this Report. SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
2000 1999 1998 1997 1996 -------- --------- -------- -------- -------- Revenues................................... $ 52,176 $ 58,928 $ 51,544 $ 63,896 $ 61,469 Expenses................................... 56,288 58,197 51,719 49,482 42,077 Earnings (loss) from continuing operations............................... (11,733) (5,819) 785 27,623 35,405 Earnings (loss) from discontinued operations............................... (5,000) (102,337) (20,977) 8,005 3,724 Net earnings (loss)........................ (15,900) (108,156) (20,192) 35,628 39,129 Redeemable preferred dividends............. 2,568 2,568 5,186 6,203 7,709 Net earnings (loss) to common shareholders(1).......................... (18,468) (110,724) (25,378) 29,425 31,420 Net earnings (loss) from continuing operations per common share -- Basic(1)................................. (1.71) (0.92) (0.58) 3.28 4.26 Diluted(1)............................... (1.71) (0.92) (0.58) 3.25 4.22 Dividends per common share................. -- -- -- -- -- At year end: Total assets............................. 140,991 230,622 336,643 317,146 237,802 Total notes payable...................... 93,764 169,792 165,922 152,216 91,924 Preferred stock.......................... 29,533 26,965 26,323 41,908 53,617 Total common equity........................ 8,478 26,587 136,955 112,758 84,802
--------------- (1) Includes $1.2 million, $13.6 million and $16.2 million, respectively, of deferred tax benefits related to the recognition of benefits to be realized from net operating loss carryforwards (NOLs) in 1998, 1997 and 1996, and deferred tax provisions of $7.0 million and $4.9 million, respectively, in 2000 and 1999. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW The Company is a financial services company engaged in Portfolio Asset acquisition and resolution, conducted through Commercial Corp., and in consumer lending, conducted through its investment in Drive. The Company's financial results are affected by many factors including levels of and fluctuations in interest rates, fluctuations in the underlying values of real estate and other assets, the timing of and ability to liquidate assets, and the availability and prices for loans and assets acquired in all of the Company's businesses. The Company's business and results of operations are also affected by the availability of financing with terms acceptable to the Company and the Company's access to capital markets, including the securitization markets. As a result of the significant period to period fluctuations in the revenues and earnings or losses of the Company's Portfolio Asset acquisition and resolution business, the sale of the interest in the automobile finance operation, and the timing of securitization transactions of Consumer Corp., period to period comparisons of the Company's results of continuing operations may not be meaningful. The Company reported a loss for the quarter ended December 31, 2000 of $.5 million. After accrued dividends on the Company's preferred stock, the net loss to common shareholders was $1.2 million or $.14 per 13 16 share on a diluted basis. Components of the quarterly loss for the fourth quarter compared to the third quarter are as follows:
FOURTH THIRD QUARTER QUARTER 2000 2000 ------- ------- (IN THOUSANDS) Portfolio Asset Acquisition and Resolution.................. $ 254 $ 1,086 Consumer.................................................... 1,663 6,763 Corporate interest.......................................... (1,526) (2,905) Corporate overhead.......................................... (902) (2,059) Accrued preferred dividends................................. (642) (642) Extraordinary gain (early extinguishment of debt)........... -- 833 ------- ------- Net income (loss) to common shareholders.................. $(1,153) $ 3,076 ======= =======
For the year 2000, the Company reported a net loss to common shareholders of $18.5 million or $2.21 per share on a diluted basis. Components of the annual net loss for 2000 compared to 1999 are as follows:
2000 1999 -------- --------- (IN THOUSANDS) Portfolio Asset Acquisition and Resolution.................. $ 3,354 $ 9,743 Consumer.................................................... 10,362 5,635 Corporate interest.......................................... (12,175) (9,716) Corporate overhead.......................................... (13,274) (11,481) Accrued preferred dividends................................. (2,568) (2,568) Loss from discontinued operations........................... (5,000) (102,337) Extraordinary gain (early extinguishment of debt)........... 833 -- -------- --------- Net loss to common shareholders........................... $(18,468) $(110,724) ======== =========
Sale of 49% of Automobile Finance Operation and Corporate Debt Restructure In the third quarter of 2000, the Company completed a major transaction that generated significant cash to allow the Company to return to its emphasis in the Portfolio Asset acquisition and resolution business. The Company sold a 49% equity interest in its automobile finance operation to certain subsidiaries of IFA Parent, a wholly owned subsidiary of Bank of Scotland. The transaction generated $75 million in cash as described below and resulted in a gain of $12.1 million. Simultaneously, Bank of Scotland and the Company completed a debt reduction and restructure, which resulted in reduced interest rates and fees, increased liquidity, and an extended maturity. Additionally, this transaction brought the Company into compliance under its lending covenants and cured defaults that may have existed prior to the restructure. The new entity formed to facilitate the transaction is Drive. Drive assumed the entire operations of the former automobile finance platform of the Company created and developed by the Company and the Auto Finance Management Group in September of 1997. The platform will continue to be headquartered in Dallas, Texas. IFA Parent, through its wholly-owned subsidiaries IFA-GP and IFA-LP, purchased 49% of this newly formed entity for $15 million, and Bank of Scotland provided $60 million to Drive and its subsidiary, Drive ABS LP, in term financing which was used to repay indebtedness owed to The Company by its automobile finance operation. After taking into effect the sale of the 49% interest to IFA-GP and IFA-LP, the ownership of Drive is allocated as follows: 49% of Drive is owned (directly and indirectly) by IFA-GP and IFA-LP, 31% of Drive is owned (directly and indirectly) by Consumer Corp., and 20% of Drive is owned (directly and indirectly) by Thomas R. Brower, Scott A. Foith, Thomas G. Dundon, R. Tyler Whann, Bradley C. Reeves, 14 17 Stephen H. Trent and Blake P. Bozman (the "Auto Finance Management Group"). Bank of Scotland also provided a new $100 million warehouse line of credit to Drive (subsequently increased to $150 million). This new warehouse line is in addition to the current $100 million warehouse line of Drive with an affiliate of Bank of America. The Company believes that additional funding along with improved capital markets execution should provide the needed liquidity to allow this business model to mature with planned, controlled growth. The Company provided a guaranty limited to a maximum amount of up to $4 million of the $60 million term loan by IFA Parent, resulting in a $4 million deferral of the $12.1 million gain. The Company, Consumer Corp. and Funding LP secured the Company's guaranty with a security interest in their respective ownership interests in Consumer Corp., Funding LP and Drive. As a result of this transaction, the net operations of Drive have been recorded (since August 1, 2000) as equity in earnings of investments. As a result of the Drive transaction, the indebtedness of the Company owed to its senior lenders under its Senior Facility, to IFA Parent under its Subordinated Debt facility and certain other creditors was reduced from approximately $113 million to approximately $44.3 million. The Company also retired approximately $6.4 million of debt owed to other lenders. In the restructure, Bank of Scotland forgave a fee in the amount of $2.5 million, which resulted in accrued loan fees of $.8 million owed to the senior lender being recorded as an extraordinary gain in the consolidated financial statements. The Company's debt of $44.3 million remaining after the Drive transaction was restructured into a new facility provided solely by Bank of Scotland and IFA Parent, which provides for an aggregate maximum loan amount of $53 million comprised of a $10 million Revolving Line of Credit, a $31 million Term Loan A and a $12 million Term Loan B, with reduced interest rates and fees and a maturity date of December 31, 2003. The loans under the restructured loan facility mature December 31, 2003, and carry pricing of LIBOR plus 2.5% for the Revolving Line of Credit and Term Loan A and prime rate for Term Loan B. The new facility provides for a facility fee of $.5 million and a prepayment fee of $.5 million. The restructured loan facility requires the consent of the lenders prior to payment of any common and preferred dividends. The Company obtained waivers or modifications under the Second Amendment that brought the Company into compliance under the facility and cured defaults that existed prior to the restructure. In connection with the restructuring of the loan facility, the Company and IFA Parent amended IFA Parent's option to acquire a warrant for 1,975,000 shares of non-voting Common Stock, which was granted to IFA Parent in December 1999 in connection with the $25 million subordinated debt facility. The option, as amended, allows IFA to acquire a warrant to acquire 1,975,000 shares of the Company's non-voting Common Stock; the option can be exercised after August 31, 2001 if Term Loan B remains outstanding, but not prior to that date. The strike price of $2.3125 remains the same. In the event that prior to August 31, 2001 the Company either (a) refinances the $12 million Term Loan B with subordinated debt, or (b) pays off the balance of Term Loan B from proceeds of an equity offering, then the option to acquire a warrant for 1,975,000 shares of non-voting Common Stock will terminate. IFA Parent also retains its warrant to purchase 425,000 shares of the Company's voting Common Stock at $2.3125 per share, which was issued in connection with the debt restructure in December 1999. In the event that Term Loan B is terminated prior to August 31, 2001 through a transaction involving the issuance of warrants, IFA is entitled to additional warrants in connection with this existing warrant for 425,000 shares to retain its ability to acquire approximately 4.86% of the Company's common stock. Dividends on Preferred Stock Currently, the Company has approximately 1.2 million preferred shares outstanding with accrued and unpaid dividends of approximately $3.9 million. Term Loan B, which resulted from the corporate debt restructure completed in August 2000, restricts the payment of dividends on these shares until it is repaid in full. The Company stated previously that it intended to seek stockholder approval prior to the end of fiscal year 2000 for the replacement of Term Loan B with a private placement of subordinated debt provided by 15 18 certain insiders and other interested investors. At that time it was contemplated that warrants for common stock would be issued in connection with the private placement. The Company, however, is limited in its ability to issue common shares and warrants due to change of control issues related to its substantial net operating loss carryforwards. While the private placement originally contemplated would allow for the payment of future dividends on the preferred stock, management believes that a more strategic utilization of its limited authorized shares and would better serve the long-term interests of the Company's stockholders. The Company currently does not plan to pursue the private placement at this time. Management will continue to evaluate alternatives to repay Term Loan B prior to August 31, 2001 to terminate the option to obtain warrants to acquire the 1,975,000 shares of the Company's common stock. This would allow the Company to utilize these shares in a transaction that the Company believes would maximize long-term stockholder value. ANALYSIS OF REVENUES AND EXPENSES The Company reported a net loss to common stockholders for 2000 of $18.5 million. As a result of the sale of interest in the automobile finance operation, the net operations of Drive have been recorded (since August 1, 2000) as equity in earnings of investments. The following table summarizes the revenues and expenses of each of the Company's business segments and presents the contribution that each business makes to the Company's operating margin. ANALYSIS OF REVENUES AND EXPENSES
YEAR ENDED DECEMBER 31, ------------------------------------- 2000 1999 1998 ---------- ----------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) PORTFOLIO ASSET ACQUISITION AND RESOLUTION: Revenues: Servicing fees................................. $ 7,555 $ 3,850 $ 3,062 Gain on resolution of Portfolio Assets......... 3,120 4,054 9,208 Equity in earnings of investments.............. 7,369 11,318 12,827 Interest income................................ 2,143 2,610 2,452 Other.......................................... 1,129 3,665 1,733 -------- --------- -------- Total..................................... 21,316 25,497 29,282 Expenses: Interest and fees on notes payable............. 3,266 4,308 6,244 Salaries and benefits.......................... 5,531 5,542 4,619 Provision for loan and impairment losses....... 1,971 -- -- Occupancy, data processing and other........... 7,083 5,818 6,078 -------- --------- -------- Total..................................... 17,851 15,668 16,941 -------- --------- -------- Operating contribution before direct taxes........ $ 3,465 $ 9,829 $ 12,341 ======== ========= ======== Operating contribution, net of direct taxes....... $ 3,354 $ 9,743 $ 12,284 ======== ========= ========
16 19
YEAR ENDED DECEMBER 31, ------------------------------------- 2000 1999 1998 ---------- ----------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSUMER LENDING: Revenues: Servicing fees................................. $ 3,887 $ 5,086 $ 2,705 Equity in earnings of investments.............. 2,223 -- -- Interest income................................ 12,882 17,787 10,035 Gain on sale of automobile loans............... 2,836 10,280 7,214 Gain on sale of interest in subsidiary......... 8,091 -- -- Other.......................................... 71 171 106 -------- --------- -------- Total..................................... 29,990 33,324 20,060 Expenses: Interest and fees on notes payable............. 3,217 4,730 3,549 Salaries and benefits.......................... 7,277 8,053 5,602 Provision for loan and impairment losses....... 2,420 4,302 9,201 Occupancy, data processing and other........... 6,706 10,539 5,466 -------- --------- -------- Total..................................... 19,620 27,624 23,818 -------- --------- -------- Operating contribution (loss) before direct taxes.......................................... $ 10,370 $ 5,700 $ (3,758) ======== ========= ======== Operating contribution (loss), net of direct taxes.......................................... $ 10,362 $ 5,635 $ (3,758) ======== ========= ======== Total operating contribution, net of direct taxes.......................................... $ 13,716 $ 15,378 $ 8,526 ======== ========= ======== CORPORATE OVERHEAD: Other revenue..................................... $ 870 $ 107 $ 2,202 Corporate interest expense........................ (12,175) (9,716) (4,797) Salaries and benefits, occupancy, professional and other expenses................................. (7,144) (6,688) (6,335) Deferred tax valuation benefit (allowance)........ (7,000) (4,900) 1,189 -------- --------- -------- Earnings (loss) from continuing operations........ (11,733) (5,819) 785 Loss from discontinued operations................. (5,000) (102,337) (20,977) Extraordinary gain................................ 833 -- -- -------- --------- -------- Net loss.......................................... (15,900) (108,156) (20,192) Preferred dividends............................... (2,568) (2,568) (5,186) -------- --------- -------- Net loss to common shareholders................... $(18,468) $(110,724) $(25,378) ======== ========= ======== SHARE DATA: Basic and diluted earnings (loss) per common share are as follows: Loss from continuing operations before accounting change per common share........... $ (1.71) $ (0.92) $ (0.58) Discontinued operations per common share....... (0.60) (12.32) (2.77) Cumulative effect of accounting change......... -- (0.09) -- Extraordinary gain............................. 0.10 -- -- Net loss per common share...................... $ (2.21) $ (13.33) $ (3.35) Weighted average common shares outstanding..... 8,351 8,307 7,584
PORTFOLIO ASSET ACQUISITION AND RESOLUTION Acquisitions for the fourth quarter of 2000 were comprised of four portfolios, two of which were in France for $41 million, one in Mexico for $49 million and one in the United States at a cost of $10 million for a total purchase price of $100 million. The Company invested approximately $9.4 million in these portfolios for the quarter ended December 31, 2000, resulting in aggregate invested capital for the year 2000 of $22.1 million, 17 20 which approximates the Company's target of $22.5 million for the year. Not included in year 2000 acquisitions was a $66.3 million domestic portfolio purchased in January 2001, in which FirstCity invested $4.1 million in equity. This portfolio was originally contemplated to close prior to year-end. Aggregate acquisitions by the Company are as follows:
FIRSTCITY PURCHASE INVESTED PRICE EQUITY -------- --------- (IN THOUSANDS) 1st Quarter................................................. $ 13,629 $ 1,836 2nd Quarter................................................. 154,398 4,941 3rd Quarter................................................. 126,914 6,012 4th Quarter................................................. 99,986 9,351 -------- ------- Total 2000........................................ $394,927 $22,140 Total 1999........................................ $210,799 $11,203 Total 1998........................................ $139,691 $28,478 Total 1997........................................ $183,229 $37,109
In 2000 the Company completed its largest acquisition year in its history the purchase of $395 million of Portfolio Assets directly and through Acquisition Partnerships. While the Company was limited as to the amount of equity it could invest in these Portfolios due to lack of capital and limited availability under its funding facilities (the equity line available to Commercial Corp. was increased from $17 million to $30 million in January 2001), in certain markets the Company was able to obtain servicing contracts which provide for incentive fees to be paid to the Company once a target return threshold to the investors has been achieved. Current estimates indicate that these contracts should generate significant additional fee revenue over the next three to five years. The Company believes that prospects for investment in distressed assets in 2001 continue to be positive. The recent increase in non-performing assets in the domestic banking sector has resulted in a significant increase in the availability of product. Additionally, the Company continues to see increasing availability of distressed assets in France and Mexico. During January 2001 the Company increased its line of credit with a related party to $30 million from $17 million, which will provide liquidity for additional equity investments. To complement these equity investments the Company will continue to utilize its established acquisition and servicing franchise to attract new capital and generate incentive based servicing fees. Revenues at Commercial Corp. consist primarily of gain on disposition of assets, interest income on performing assets and equity in earnings of affiliated Acquisition Partnerships. In addition, Commercial Corp. derives servicing fees from Acquisition Partnerships for the servicing activities performed related to the assets held in the Acquisition Partnerships. In its Portfolio Asset acquisition and resolution business, Commercial Corp. acquires Portfolio Assets that are designated as nonperforming, performing or real estate. Each Portfolio is accounted for as a pool and not on an individual asset basis. To date, a substantial majority of the Portfolio Assets acquired by Commercial Corp. has been designated as nonperforming. Once a Portfolio has been designated as either nonperforming or performing, such designation is not changed regardless of the performance of the assets comprising the Portfolio. The Company recognizes revenue from Portfolio Assets and Acquisition Partnerships based on proceeds realized from the resolution of Portfolio Assets, which proceeds have historically varied significantly and likely will continue to vary significantly from period to period. The following table 18 21 presents selected information regarding the revenues and expenses of the Company's Portfolio Asset acquisition and resolution business. ANALYSIS OF SELECTED REVENUES AND EXPENSES PORTFOLIO ASSET ACQUISITION AND RESOLUTION
YEAR ENDED DECEMBER 31, ----------------------------- 2000 1999 1998 ------- ------- ------- (DOLLARS IN THOUSANDS) GAIN ON RESOLUTION OF PORTFOLIO ASSETS: Average investment: Nonperforming Portfolios......................... $21,446 $29,822 $41,873 Performing Portfolios............................ 12,416 15,618 14,629 Real estate Portfolios........................... 5,534 9,154 15,919 Gain on resolution of Portfolio Assets: Nonperforming Portfolios......................... $ 2,325 $ 3,047 $ 6,112 Performing Portfolios............................ 185 -- 299 Real estate Portfolios........................... 610 1,007 2,797 ------- ------- ------- Total....................................... $ 3,120 $ 4,054 $ 9,208 Interest income on performing Portfolios............ $ 2,120 $ 2,397 $ 2,140 Gross profit percentage on resolution of Portfolio Assets: Nonperforming Portfolios......................... 22.4% 19.8% 23.6% Performing Portfolios............................ 24.6% -- 8.0% Real estate Portfolios........................... 18.6% 23.7% 20.9% Weighted average gross profit percentage......... 21.7% 20.7% 21.4% Interest yield on performing Portfolios............. 17.1% 15.4% 14.6% SERVICING FEE REVENUES:............................... $ 7,555 $ 3,850 $ 3,062 PERSONNEL: Personnel expenses.................................... $ 5,531 $ 5,542 $ 4,619 Number of personnel (at period end): Production....................................... 23 12 12 Servicing........................................ 82 60 64 INTEREST EXPENSE: Average debt........................................ $32,878 $49,078 $71,091 Interest expense.................................... 3,266 4,308 6,244 Average cost........................................ 9.9% 8.8% 8.8%
Nonperforming Portfolio Assets Nonperforming Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed-upon collateral. Portfolio Assets are designated as nonperforming unless substantially all of the assets comprising the Portfolio are being repaid in accordance with the contractual terms of the underlying loan agreements. Commercial Corp. acquires such assets on the basis of an evaluation of the timing and amount of cash flow expected to be derived from borrower payments or disposition of the underlying asset securing the loan. On a monthly basis, the amortized cost of each nonperforming Portfolio is evaluated for impairment. A valuation allowance is established for any impairment identified with provisions to establish such allowance charged to earnings in the period identified. All nonperforming Portfolio Assets are purchased at substantial discounts from their Face Value. Net gain on the resolution of nonperforming Portfolio Assets is recognized to the extent that proceeds collected on the Portfolio exceed a pro rata portion of allocated costs of the resolved Portfolio Assets. Proceeds from the resolution of Portfolio Assets that are nonperforming are recognized as cash is realized from the collection, 19 22 disposition and other resolution activities associated with the Portfolio Assets. No interest income or any other yield component of revenue is recognized separately on nonperforming Portfolio Assets. Performing Portfolio Assets Performing Portfolio Assets consist of consumer and commercial loans acquired at a discount from the aggregate amount of Face Value. Portfolio Assets are classified as performing if substantially all of the loans comprising the Portfolio are being repaid in accordance with the contractual terms of the underlying loan agreements. On a monthly basis, the amortized cost of each performing Portfolio is evaluated for impairment. A valuation allowance is established for any identified impairment with provisions to establish such allowance charged to earnings in the period identified. Interest income is recognized when accrued in accordance with the contractual terms of the loans. The accrual of interest is discontinued once a loan becomes past due 90 days or more. Acquisition discounts for the Portfolio Assets as a whole are accreted as an adjustment to yield over the estimated life of the Portfolio. Real Estate Portfolios Commercial Corp. also acquires Portfolios comprised solely of real estate. Real estate Portfolios are recorded at the lower of cost or fair value less estimated costs to sell. Costs relating to the development or improvement are capitalized and costs relating to holding assets are charged to expense as incurred. Rental income, net of expenses, is recognized as revenue when received. Gains and losses are recognized based on the allocated cost of each specific real estate asset. Equity in Earnings of Acquisition Partnerships Commercial Corp. accounts for its investments in Acquisition Partnerships using the equity method of accounting. This accounting method generally results in the pass-through of its pro rata share of earnings from the Acquisition Partnerships' activities as if it had a direct investment in the underlying Portfolio Assets held by the Acquisition Partnership. The revenues and earnings of the Acquisition Partnerships are determined on a basis consistent with the accounting methodology applied to nonperforming, performing and real estate Portfolios described in the preceding paragraphs. Distributions of cash flow from the Acquisition Partnerships are a function of the terms and covenants of the loan agreements related to the secured borrowings of the Acquisition Partnerships. Generally, the terms of the underlying loan agreements permit some distribution of cash flow to the equity partners so long as loan to cost and loan to value relationships are in compliance with the terms and covenants of the applicable loan agreement. Once the secured borrowings of the Acquisition Partnerships are fully paid, all cash flow in excess of operating expenses is available for distribution to the equity partners. The following chart presents selected information regarding the revenues and expenses of the Acquisition Partnerships. ANALYSIS OF SELECTED REVENUES AND EXPENSES ACQUISITION PARTNERSHIPS
YEAR ENDED DECEMBER 31, --------------------------- 2000 1999 1998 ------- ------- ------- (DOLLARS IN THOUSANDS) REVENUES: Gain on resolution of Portfolio Assets................ $75,788 $51,035 $57,628 Gross profit percentage on resolution of Portfolio Assets............................................. 46.4% 40.9% 33.9% Interest income....................................... $18,049 $16,409 $ 9,714 Other income.......................................... 2,195 1,914 3,127
20 23
YEAR ENDED DECEMBER 31, --------------------------- 2000 1999 1998 ------- ------- ------- (DOLLARS IN THOUSANDS) INTEREST EXPENSE(1): Interest expense...................................... 38,289 15,626 13,081 Average debt.......................................... 292,707 159,827 159,145 Average cost.......................................... 13.1% 9.8% 8.2% OTHER EXPENSES: Servicing fees........................................ $ 8,034 $ 6,391 $ 5,360 Legal................................................. 251 2,178 2,557 Property protection................................... 5,390 3,109 5,898 Other................................................. 7,302 5,599 9,867 ------- ------- ------- Total other expenses.......................... 20,977 17,277 23,682 ------- ------- ------- Net earnings.................................. $36,766 $36,455 $33,706 ======= ======= ======= Equity in earnings of Acquisition Partnerships.......... $ 7,203 $11,444 $12,827 Equity in earnings (loss) of Servicing Entities......... 166 (126) -- ------- ------- ------- $ 7,369 $11,318 $12,827 ======= ======= =======
--------------- (1) Interest expense for 2000 and 1999 includes interest on loans to the Acquisition Partnerships located in Mexico from affiliates of the investor groups. The rates on these loans range between 19% and 20%. The average cost on debt excluding the Mexican Acquisition Partnerships was 9.4% and 9.2% for 2000 and 1999, respectively. Servicing Fee Revenues Commercial Corp. derives fee income for its servicing activities performed on behalf of the Acquisition Partnerships. In connection with the Acquisition Partnerships in the United States, Commercial Corp. generally earns a servicing fee of between 1% and 8% of gross cash collections generated by the Acquisition Partnerships, rather than a periodic management fee based on the Face Value of the assets being serviced. The rate of servicing fee charged is a function of the average Face Value of the assets within each Portfolio being serviced (the larger the average Face Value of the assets in a Portfolio, the lower the fee percentage within the prescribed range). For the Mexican Acquisition Partnerships, Commercial Corp. earns a servicing fee based on costs of servicing plus a profit margin. Commercial Corp. also receives incentive fees once the Mexican Acquisition Partnerships reach a targeted return on the initial investment. CONSUMER LENDING During the fourth quarter of 2000, Drive completed a securitization of $100 million of face value of automobile receivables. FirstCity's portion of the quarterly earnings from this entity was $1.8 million. Earnings from this entity correlate closely with the timing, size and execution of securitizations of originated automobile receivables. Therefore, earnings from this entity on a quarterly basis will fluctuate. Management is encouraged with the results to date. Historically, the primary components of revenue derived by Consumer Corp. have been interest income and gain on sale of loans. The primary expenses of Consumer Corp. have been salaries and benefits, provision for loan losses and impairment of residual interests and interest expense. As noted above, the Company sold a 49% equity interest in the automobile finance operation (conducted through Drive) effective August 1, 2000. The Company recognized a gain of $8.1 million on the sale of equity interest. Subsequent to the sale, operating activity is recorded using the equity method of accounting. As a result, the majority of operations reported in the Consumer Lending segment are for activity prior to August 1, 2000. Therefore, period-to-period 21 24 comparisons of Consumer Corp.'s results of operations may not be meaningful. The following chart presents selected information regarding the revenues and expenses of Consumer Corp.'s consumer lending business. ANALYSIS OF SELECTED REVENUES AND EXPENSES CONSUMER LENDING
YEAR ENDED DECEMBER 31, --------------------------- 2000 1999 1998 ------- ------- ------- (DOLLARS IN THOUSANDS) INTEREST INCOME: Average loans and investments: Auto............................................... $35,710 $56,540 $35,880 Investments........................................ 33,757 41,864 26,720 Interest income: Auto............................................... 8,364 11,811 7,542 Investments........................................ 4,077 5,487 2,181 Other.............................................. 441 489 312 Average yield: Auto............................................... 23.4% 20.9% 21.0% Investments........................................ 12.1% 13.1% 8.2% SERVICING FEE REVENUES.................................. $ 3,887 $ 5,086 $ 2,705 PERSONNEL: Personnel expenses.................................... $ 7,277 $ 8,053 $ 5,602 Number of personnel (at period end)(1): Production......................................... -- 142 93 Servicing.......................................... -- 206 110 INTEREST EXPENSE: Average debt.......................................... $34,531 $53,948 $36,302 Interest expense...................................... 3,217 4,730 3,549 Average cost.......................................... 9.3% 8.8% 9.8%
--------------- (1) As a result of the Drive transaction, effective August 2000, Drive employs the personnel associated with the automobile finance operation. Interest Income Interest income is accrued on originated and acquired loans at the contractual rate of interest of the underlying loan. The accrual of interest income is discontinued once a loan becomes 90 days past due. Gain on Sale of Loans Drive accumulates and pools automobile loans acquired from franchised dealerships for sales in public and private securitization transactions. Such transactions result in the recognition of gains to the extent that the proceeds received (including the estimated value of the retained subordinated interests) exceed the basis of the automobile loans and the costs associated with the securitization process. When the automobile loans are securitized and sold, the retained interests are valued at the discounted present value of the cash flows expected to be realized over the anticipated average life of the assets sold after future estimated credit losses, estimated prepayments, servicing fees and other securitization fees related to the loans sold. The discounted present value of such interests is computed using Drive's assumptions of market discount rates, prepayment speeds, default rates, credit losses and other costs based upon the unique underlying characteristics of the automobile loans comprising each securitization. 22 25 During the second quarter 2000, Consumer Corp. completed one securitization transaction, FAR 2000-1, with an approximate aggregate loss assumption of 11.3%. Consumer Corp. completed two securitization transactions in 1999, FAR 1999-1 and FAR 1999-2. Approximate aggregate loss assumptions were 10.7% and 11.0%, respectively, of the outstanding principal balance of underlying loans. In its securitization transactions completed in 1998, NAF 1998-1, FAR 1998-2 and FAR 1998-3, Consumer Corp. assumed that losses would approximate an aggregate of 19.8%, 15.4% and 11.2%, respectively, of the outstanding principal balance of the underlying loans. Consumer Corp. calculated the present value of future cash flows from the securitizations using discount rates ranging from 7.3% (on one rated security) to 15% per year and prepayment speeds ranging from 10% to 15%. Provision for Loan Losses and Impairment of Residual Interests The carrying value of consumer loans is evaluated on a monthly basis for impairment. A valuation allowance is established for any impairment identified with provisions to augment the allowance charged to earnings in the period identified. The evaluation of the need for an allowance is determined on a pool basis, with each pool being the loans originated or acquired during a quarterly period of production or acquisition. Loans generally are acquired at a discount from the Face Value of the loan with the acquisition discount established as an allowance for losses at the acquisition date of the loan. If the initially established allowance is deemed to be insufficient, additional allowances are established through provisions charged to earnings. INCOME TAXES As a result of the Merger, the Company has substantial federal NOLs, which can be used to offset the tax liability associated with the Company's pre-tax earnings until the earlier of the expiration or utilization of such NOLs. The Company accounts for the benefit of the NOLs by recording the benefit as an asset and then establishing an allowance to value the net deferred tax asset at a value commensurate with the Company's expectation of being able to utilize the recognized benefit in the foreseeable future. Such estimates are reevaluated on a quarterly basis with the adjustment to the allowance recorded as an adjustment to the income tax expense generated by the quarterly operating results. Significant events that change the Company's view of its currently estimated ability to utilize the tax benefits, such as the acquisition of Harbor in the third quarter of 1997, result in substantial changes to the estimated allowance required to value the deferred tax benefits recognized in the Company's periodic financial statements. The Company's analysis resulted in an increase to the valuation allowance of $7.0 million in 2000. Due to the evaluation of the recoverability of the deferred tax asset recognized related to the mortgage banking operations, the Company increased its valuation allowance by $4.9 million in 1999. Similar events could occur in the future, and would impact the recognition of the Company's estimate of the required valuation allowance associated with its NOLs. If there are changes in the estimated level of the required reserve, net earnings will be affected accordingly. Results of operations for 1998 were nominally impacted by the effect of recording a deferred tax benefit of $1.2 million to recognize the benefit related to NOLs. Realization of the asset is dependent upon generating sufficient taxable earnings to utilize the NOL. Prior to 1996, the deferred tax asset resulting from the Company's NOL was entirely offset by its valuation reserve. In 1997 and 1996, the valuation reserve was adjusted based on the Company's estimate of its future pre-tax income. RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements of the Company (including the Notes thereto) included elsewhere in this Annual Report on Form 10-K. 23 26 2000 COMPARED TO 1999 The Company reported a loss from continuing operations of $11.7 million in 2000 (including a gain of $8.1 million on sale of the Company's interest in Consumer Corp. pursuant to the Drive transaction) compared to a loss of $5.8 million in 1999. The loss from discontinued operations totaled $5.0 million in 2000 and $102.3 million in 1999. Net loss to common stockholders was $18.5 million in 2000 compared to $110.7 million in 1999. The Company recorded an extraordinary gain of $.8 million, or $.10 per share, in 2000 in connection with the forgiveness of loan fees by the Bank of Scotland with respect to the Company's restructuring of its outstanding loans. On a per share basis, basic and diluted net loss attributable to common stockholders was $2.21 in 2000 compared to $13.33 in 1999. An accounting change related to SOP 98-5 resulted in a loss of $.8 million in the first quarter of 1999 or $0.09 per share. Portfolio Asset Acquisition and Resolution The operating contribution of $3.4 million in 2000 declined by $6.4 million, or 66%, compared with 1999. Commercial Corp. purchased $395 million of Portfolio Assets during 2000 through the Acquisition Partnerships compared to $211 million in acquisitions in 1999. Commercial Corp.'s quarter end investment in Portfolio Assets decreased to $30 million in 2000 from $39.4 million in 1999. Commercial Corp. invested $22.1 million in equity in Portfolio Assets in 2000 compared to $11.2 million in 1999. Servicing fee revenues. Servicing fees increased by 96% to $7.6 million in 2000 from $3.9 million in 1999 primarily as a result of increased operations from Acquisition Partnerships in Mexico formed during 2000 and 1999. The service fees for the Mexico Acquisition Partnerships are based on operating expenses, unlike the Acquisition Partnerships in the United States and France, which are based on collections. Gain on resolution of Portfolio Assets. Proceeds from the resolution of Portfolio Assets decreased by 27% to $14.4 million in 2000 from $19.6 million in 1999. The net gain on resolution of Portfolio Assets decreased by 23% to $3.1 million in 2000 from $4.1 million in 1999 as the result of decreased proceeds. The weighted average gross profit percentage on the resolution of Portfolio Assets in 2000 was 21.7% as compared to 20.7% in 1999. Equity in earnings of Investments. Proceeds from the resolution of Portfolio Assets for the Acquisition Partnerships increased 31% to $163 million in 2000 from $125 million in 1999 while the gross profit percentage increased to 46.4% in 2000 from 40.9% in 1999. The net result was an overall increase in the net income of the Acquisition Partnerships of 1% to $36.8 million in 2000 from $36.5 million in 1999. However, Commercial Corp.'s equity earnings from Acquisition Partnerships declined 37% to $7.2 million in 2000 from $11.4 million in 1999 due to smaller equity investments in recent partnership acquisitions. Equity in earnings of servicing entities was not significant. Interest Income. Interest income decreased by 18% to $2.1 million in 2000 compared to $2.6 million in 1999 principally as a result of lower balances of performing portfolios throughout 2000. Other revenues. Other revenues decreased by 69% to $1.1 million in 2000 compared to $3.7 million in 1999 due to $2.2 million of gains in 1999 from sales of investments in Acquisition Partnerships in Japan and France. Operating expenses. Operating expenses increased 14% to $17.9 million in 2000 from $15.7 million in 1999 primarily as a result of a provision for loan and impairment losses. Interest and fees on notes payable declined $1.0 million or 24% due to average debt declining to $32.9 million in 2000 from $49.1 million in 1999. The decline in average debt was partially offset by increased interest rates, which were 9.9% in 2000 compared to 8.8% in 1999. Salaries and benefits were consistent from year to year. 24 27 The provision for loan and impairment losses totaled $2.0 million and can be attributed to the write-down in estimated future collections of one of the Portfolio Asset pools. Occupancy, data processing and other expenses increased $1.3 million or 22% from year to year due to increased operations in Mexico. Consumer Lending The operating contribution of $10.4 million in 2000 increased by $4.7 million or 84% compared with 1999 due principally to the sale of 49% of the Company's equity interest in its automobile finance operation. Service fees. Service fee income declined $1.2 million or 24% due to the sale of 49% of the Company's equity interest in the automobile finance operation. Equity in earnings of investments. As a result of the sale of interest in the automobile finance operation, the Company's interest in the net operations of Drive was recorded (since August 1, 2000) as equity in earnings of investments of $2.2 million. FirstCity's share of earnings from a $100 million securitization by Drive was $1.8 million. Interest income. Interest income on consumer loans declined $4.9 million or 28% due to the sale of 49% of the Company's equity interest in its automobile finance operation. Gain on sale of automobile loans. A gain of $2.8 million or 6.9% resulted from the securitization of automobile loans totaling $41 million in 2000 as compared to $10.3 million or 6.6% on the sale of $156 million in automobile loans in 1999. Gain on sale of interest in subsidiary. A gain of $8.1 million was recorded in the third quarter of 2000 as a result of the sale of 49% of the Company's equity interest in its automobile finance operation. Operating expenses. Operating expenses decreased $8.0 million or 29% due to the sale of 49% of the Company's equity interest in its automobile finance operation. Other Items Affecting Operations The following items affect the Company's overall results of operations and are not directly related to any one of the Company's businesses discussed above. Corporate overhead. Company level interest expense increased by 25% to $12.2 million in 2000 from $9.7 million in 1999 as a result of higher volumes of debt associated with the equity required to purchase Portfolio Assets, equity interests in Acquisition Partnerships and capital support to operating subsidiaries and discontinued operations. Other corporate overhead increased $0.5 million or 7% due primarily to increased amortization of certain intangible assets. Income taxes. The Company recorded a deferred tax provision of $7.0 million in 2000 and $4.9 million in 1999 due to revisions of projections of future taxable income. 1999 COMPARED TO 1998 The Company reported a net loss of $108.2 million in 1999 (including a deferred tax provision of $4.9 million) compared to a loss of $20.2 million in 1998 (including a $1.2 million deferred tax benefit from NOLs). Net loss to common shareholders was $110.7 million in 1999 compared to a loss of $25.4 million in 1998. On a per share basis, net loss attributable to common shareholders was $13.33 in 1999 compared to $3.35 in 1998. The primary factor contributing to the loss for 1999 was losses from discontinued mortgage operations of $102.3 million or $12.31 per share for 1999 as compared to losses of $21.0 million or $2.77 per share in 1998. Additionally, an accounting change related to SOP 98-5 resulted in a loss of $.8 million in 1999 or $0.09 per share. 25 28 Portfolio Asset Acquisition and Resolution Commercial Corp.'s year-end investment in Portfolio Assets decreased to $39.4 million in 1999 from $68.4 million in 1998. Commercial Corp., through its investment in Acquisition Partnerships invested $11.2 million in equity in Portfolio Assets in 1999 compared to $28.5 million in 1998. Such investments represented Commercial Corp.'s share of Portfolio Assets acquired totaling $211 million and $140 million for 1999 and 1998, respectively. Servicing fee revenues. Servicing fees increased by 26% to $3.9 million in 1999 from $3.1 million in 1998 primarily as a result of collections from the acquisition partnership in Mexico formed at year-end 1998. Gain on resolution of Portfolio Assets. Proceeds from the resolution of Portfolio Assets decreased by 54% to $19.6 million in 1999 from $43.0 million in 1998. The net gain on resolution of Portfolio Assets decreased by 56% to $4.1 million in 1999 from $9.2 million in 1998 as the result of lower collections. The average gross profit percentage on the resolution of Portfolio Assets in 1999 was 20.7% as compared to 21.4% in 1998. Equity in earnings of Acquisition Partnerships and Servicing Entities. Proceeds from the resolution of Portfolio Assets for the Acquisition Partnerships decreased by 27% to $125 million in 1999 from $170 million in 1998 while the gross profit percentage increased to 40.9% in 1999 from 33.9% in 1998. Interest income rose $6.7 million in 1999. Other expenses of the Acquisition Partnerships decreased by $6.4 million in 1999 generally reflecting costs associated with the resolution of Portfolio Assets in Europe, which generated proceeds of $62.2 million. The net result was an overall increase in the net income of the Acquisition Partnerships of 8.2% to $36.5 million in 1999 from $33.7 million in 1998. However, Commercial Corp.'s equity earnings from Acquisition Partnerships decreased by 11% to $11.4 million in 1999 from $12.8 million in 1998 due primarily to lower equity interests in Portfolios purchased through Acquisition Partnerships during 1999 and at the end of 1998. Equity in earnings of Servicing Entities was not significant. Interest income. Interest income was consistent year to year. Other revenues. Other revenues increased by 111% to $3.7 million in 1999 from $1.7 million in 1998 due to $2.2 million of gains recognized in 1999 from sales of investments in Acquisition Partnerships in Japan and France. Operating expenses. Operating expenses declined by 8% to $15.7 million in 1999 from $16.9 million in 1998 primarily as a result of reduced interest expense and lower asset level expenses. Interest and fees on notes payable declined $1.9 million or 31% due to lower debt levels. Salaries and benefits increased $0.9 million or 20% due to higher number of employees required to support the growth in the acquisition and servicing of loan portfolios in Mexico. Occupancy, data processing and other expenses decreased by 4% to $5.8 million in 1999 from $6.1 million in 1998 as a result of lower investments in Portfolio Assets and the consolidation of servicing offices in 1999. Consumer Lending Service fees. Servicing fees increased $2.4 million or 88% due to increased service fee revenue from securitization trusts. Interest income. Interest income increased by 77% to $17.8 million in 1999 from $10.0 million in 1998, reflecting increased levels of loan origination activity and an increase in the average balance of aggregate loans and investments held by Consumer Corp. during 1999. Gain on sale of automobile loans. In 1999, Consumer Corp. realized a gain of $10.3 million on the sale of automobile loans as compared to $7.2 million in 1998, primarily due to higher purchase discounts associated with the underlying loans sold into the 1999 securitizations. 26 29 Operating expenses. Operating expenses increased by 16% to $27.6 million in 1999 from $23.8 million in 1998 primarily as a result of increased operating activity due to higher levels of loan fundings and servicing portfolio. Interest and fees on notes payable increased by 33% to $4.7 million in 1999 from $3.5 million in 1998 as a result of a higher volume of debt. Salaries and benefits increased by $2.5 million or 44% as a result of the increased levels of operating activity. Provision for loan and impairment losses decreased by $4.9 million or 53% from 1998 as a result of decreased losses in the NAF originated Auto Receivable residuals. Occupancy, data processing and other expenses increased by 93% to $10.5 million in 1999 from $5.5 million in 1998 as a result of increased levels of operating activity. Other Items Affecting Operations The following items affect the Company's overall results of operations and are not directly related to any one of the Company's businesses discussed above. Other revenue. During the first nine months of 1998 the Company recognized deferred premium income of $2.1 million related to the redemption of Special Preferred Stock. Corporate interest expense. Company level interest expense increased by 103% to $9.7 million in 1999 from $4.8 million in 1998 as a result of higher volumes of debt associated with the equity required to purchase Portfolio Assets, equity interests in Acquisition Partnerships and capital support to operating subsidiaries. Corporate overhead. Other overhead expenses were flat, including a write-off of $.8 million of organization costs in accordance with SOP 98-5. Income taxes. The Company recorded a deferred tax provision of $4.9 million to increase the valuation allowance on the deferred tax asset (based on an evaluation of the realization of income from the discontinued mortgage banking operations) in 1999 as compared to a benefit of $1.2 million in 1998. LIQUIDITY AND CAPITAL RESOURCES Generally, the Company requires liquidity to fund its operations, working capital, payment of debt, equity for acquisition of Portfolio Assets, investments in and advances to the Acquisition Partnerships, retirement of and dividends on preferred stock, and other investments by the Company. The potential sources of liquidity are funds generated from operations, equity distributions from the Acquisition Partnerships, interest and principal payments on subordinated intercompany debt and dividends from the Company's subsidiaries, short-term borrowings from revolving lines of credit, proceeds from equity market transactions, securitization and other structured finance transactions and other special purpose short-term borrowings. As a result of the Drive transaction, the indebtedness of the Company owed to its senior lenders under its Senior Facility, to IFA Parent under its Subordinate Debt facility and certain other creditors was reduced from approximately $113 million to approximately $44.3 million. The Company also retired approximately $6.4 million of debt owed to other lenders. In the restructure, Bank of Scotland forgave a fee in the amount of $2.5 million, which resulted in accrued loan fees of $.8 million owed to the senior lender being recorded as an extraordinary gain in the consolidated financial statements. The Company's debt of $44.3 million remaining after the Drive transaction was restructured into a new facility provided solely by Bank of Scotland and IFA Parent, which provides for an aggregate maximum loan amount of $53 million comprised of a $10 million Revolving Line of Credit, a $31 million Term Loan A and a $12 million Term Loan B with reduced interest rates and fees and a maturity date of December 31, 2003. The 27 30 loans under the restructured loan facility mature December 31, 2003, and carry pricing of LIBOR plus 2.5% for the Revolving Line of Credit and Term Loan A and prime rate for Term Loan B. The new facility provides for a facility fee of $.5 million and a prepayment fee of $.5 million. The restructured loan facility requires the consent of the lenders prior to payment of any common and preferred dividends. The Company obtained waivers or modifications under the Second Amendment that brought the Company into compliance under the facility and cured defaults that existed prior to the restructure. Currently, the Company has approximately 1.2 million preferred shares outstanding with accrued and unpaid dividends of approximately $3.9 million. Term Loan B, which resulted from the corporate debt restructure completed in August 2000, restricts the payment of dividends on these shares until it is repaid in full. The Company stated previously that it intended to seek stockholder approval prior to the end of fiscal year 2000 for the replacement of Term Loan B with a private placement of subordinated debt provided by certain insiders and other interested investors. At that time it was contemplated that warrants for common stock would be issued in connection with the private placement. The Company, however, is limited in its ability to issue common shares and warrants due to change of control issues related to its substantial net operating loss carryforwards. While the private placement originally contemplated would allow for the payment of future dividends on the preferred stock, management believes that a more strategic utilization of its limited authorized shares would better serve the long-term interests of the Company's stockholders. The Company currently does not plan to pursue the private placement at this time. Management will continue to evaluate alternatives to repay Term Loan B prior to August 31, 2001 to terminate the option to obtain warrants to acquire the 1,975,000 shares of the Company's common stock. This would allow the Company to utilize these shares in a transaction that the Company believes would maximize long-term stockholder value. The Company and each of its major operating subsidiaries have entered into one or more credit facilities to finance their respective operations. Each of the operating subsidiary credit facilities is nonrecourse to the Company, except as described below. The Company and Funding LP are parties to an Insurance Agreement and Letter Agreement related to the FCAR LLC Retail Automobile Installment Loan Agreement Financing Facility provided by Enterprise Funding Corporation (the "Enterprise Facility"). These agreements require the Company and Funding LP, as servicer and seller, to (i) purchase nonconforming contracts in the event that the seller, the servicer, or the related originator fails to repurchase any contract which is required to be repurchased, (ii) pay certain premiums and other expenses, and (iii) indemnify Enterprise Funding Corporation, the collateral agent, and the insurance provider. Additionally, the Company, pursuant to the terms of the Letter Agreement, has agreed to make certain secondary servicer advances. The Enterprise Facility was terminated on April 6, 2001 in connection with a $100 million warehouse facility provided by Enterprise Funding Corporation. The Company has indemnified IFA Parent for losses which might arise as a result of agreements it executed as a sponsor in connection with the $100 million warehouse facility. Excluding the term acquisition facilities of the unconsolidated Acquisition Partnerships and the term and warehouse facilities of Drive, as of December 31, 2000, the Company and its subsidiaries had credit facilities providing for borrowings in an aggregate principal amount of $113 million and outstanding borrowings of $94 million. The Company has also provided a guaranty limited to a maximum amount of up to $4 million of a $60 million term loan from IFA Parent to Drive. The following table summarizes the material terms of the credit 28 31 facilities to which the Company, its major operating subsidiaries and the Acquisition Partnerships were parties to as of March 31, 2000 and the outstanding borrowings under such facilities as of December 31, 2000. CREDIT FACILITIES
FUNDED AND UNFUNDED OUTSTANDING COMMITMENT BORROWINGS AMOUNT AS OF AS OF MARCH 31, DECEMBER 31, 2001 2000 INTEREST RATE OTHER TERMS AND CONDITIONS ------------ ------------ ------------- -------------------------- (DOLLARS IN MILLIONS) FIRSTCITY Company Senior Facility... Secured by the assets of the Company, matures December 31, 2003 Revolving Line of Credit.................. $ 10 $ 5 LIBOR + 2.5% Term Loan A............... 31 31 LIBOR + 2.5% Term Loan B............... 12 12 Prime Term credit facility...... 8 8 LIBOR + 5.0% Secured by ownership interests in certain acquisition partnerships matures February 2002 COMMERCIAL CORP. Acquisition facilities.... 8 8 LIBOR + 4.0% Secured by existing Portfolio Assets, matures June 15, 2001 Term facilities........... 14 14 Fixed at Secured by Portfolio 7.00% to Assets, matures June 5, 7.66% 2002 and November 7, 2002 Equity investment facility................ 30 16 --------- --------- LIBOR + 4.5% Acquisition facility for the investment in future acquisition partnerships, matures March 2002 Total........... $113 $ 94 --------- --------- --------- --------- Unconsolidated Acquisition Partnerships term Facilities(1)........... $145 $145 --------- --------- --------- --------- Fixed at 10%, Secured by Portfolio LIBOR + 2.25% Assets, various Maturities to 5% and Prime + 1% to 7% $150 $ 72 Unconsolidated Drive Warehouse Facility...... LIBOR + 1% Secured by warehouse inventory, Commitment Termination Date is February 15, 2002; Final Scheduled Payment Date matures 72 months after Commitment Termination Date
29 32
FUNDED AND UNFUNDED OUTSTANDING COMMITMENT BORROWINGS AMOUNT AS OF AS OF MARCH 31, DECEMBER 31, 2001 2000 INTEREST RATE OTHER TERMS AND CONDITIONS ------------ ------------ ------------- -------------------------- (DOLLARS IN MILLIONS) Warehouse Facility........ 100 17 Rate based on Secured by warehouse commercial inventory, matures April paper rates 2002 combined with certain facility fees Term Facility............. 53 53 --------- --------- LIBOR Secured by residual interests, matures August 18, 2003 $303 $142 ==== ====
--------------- (1) In addition to the term acquisition facilities of the unconsolidated Acquisition Partnerships, the Mexican Acquisition Partnerships also have term debt of approximately $264 million outstanding as of December 31, 2000 owed to affiliates of the investor groups. Of this amount, the Company has recorded approximately $13 million as Loans Receivable on the Consolidated Balance Sheets. FOURTH QUARTER Net loss for the fourth quarter of 2000 was $.5 million. After deducting preferred dividends, net loss to common equity was $1.2 million, or $0.14 per basic and diluted share. Net earnings for the fourth quarter of 1999 were $1.2 million. After deducting preferred dividends, net earnings attributable to common equity were $.5 million in 1999, or $0.06 per basic and diluted share. The following table presents a summary of operations for the fourth quarters of 2000 and 1999. CONDENSED CONSOLIDATED SUMMARY OF OPERATIONS
FOURTH QUARTER ----------------------- 2000 1999 ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues.................................................... $ 7,924 $18,466 Expenses.................................................... 8,025 17,061 Earnings (loss) from continuing operations.................. (511) 1,154 Earnings from discontinued operations....................... -- -- ------- ------- Net earnings (loss)......................................... (511) 1,154 ------- ------- Preferred dividends......................................... 642 642 ------- ------- Net earnings (loss) to common shareholders.................. $(1,153) $ 512 ======= ======= Net earnings (loss) from continuing operations per common share -- basic and diluted................................ $ (0.14) $ 0.06
EFFECT OF NEW ACCOUNTING STANDARDS Statements of Financial Accounting Standards No. 133 and No. 138 (SFAS 133 and 138), Accounting for Derivative Instruments and Hedging Activities, requires companies to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS 133 and 138 require that changes in fair value of a derivative be recognized currently in earnings unless specific hedge accounting criteria are met. The Company adopted SFAS 133 and 138 on January 1, 2001, and there was no impact on the consolidated financial statements. 30 33 In September 2000, the Financial Accounting Standards Board issued Statement of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a replacement of FASB Statement No. 125 (SFAS 140). This Statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS 125's provisions without reconsideration. SFAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. SFAS 140 is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. In connection with discontinued operations, the Company has investment securities resulting from the retention of residual interests in securitization transactions. See note 3 of the consolidated financial statements for required disclosures. RISK FACTORS RISKS ASSOCIATED WITH DISCONTINUED OPERATIONS During the third quarter of 1999, management of the Company adopted formal plans to discontinue the operations of Mortgage Corp. and Capital Corp. Potential liability of the Company could arise in regard to the bankruptcy filing of Mortgage Corp. The risk that the value of Capital Corp.'s retained interests in the securitizations could be adversely affected by the level and fluctuation of interest rates, delinquency rates and property values, resulting in a lower realizable value. The above items could have a material adverse impact on the formal plans of termination and the future operations of the Company. CONTINUING NEED FOR FINANCING General. The successful execution of the Company's business strategy depends on its continued access to financing. In addition to the need for such financing, the Company must have access to liquidity to invest as equity or subordinated debt to meet its capital needs. Liquidity is generated by the cash flow to the Company from subsidiaries, access to the public debt and equity markets and borrowings incurred by the Company. The Company's access to the capital markets is affected by such factors as changes in interest rates, general economic conditions, and the perception in the capital markets of the Company's business, results of operations, leverage, financial condition and business prospects. In addition, the Company's ability to issue and sell common equity (including securities convertible into, or exercisable or exchangeable for, common equity) is limited as a result of the tax laws relating to the preservation of the NOLs available to the Company as a result of the Merger. There can be no assurance that the Company's funding relationships with commercial banks, investment banks and financial services companies (including Cargill and Bank of Scotland) that have previously provided financing for the Company and its subsidiaries will continue past their respective current maturity dates. The majority of the credit facilities to which the Company and its subsidiaries are parties have short-term maturities. Negotiations are underway to extend certain of such credit facilities that are approaching maturity and the Company expects that it will be necessary to extend the maturities of other such credit facilities in the near future. There can be no assurance that such negotiations will be successful. If such negotiations do not result in the extension of the maturities of such credit facilities and the Company or its subsidiaries cannot find alternative funding sources on satisfactory terms, or at all, the Company's consolidated financial condition, results of operations and business prospects would be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Each of the Company and its major operating subsidiaries has its own source of debt financing. In certain circumstances, a default by the Company or any of its major operating subsidiaries in respect of indebtedness owed to a third party constitutes a default under the Company's credit facility. Although the Company intends to segregate the debt obligations of each such subsidiary, there can be no assurance that its existing financing sources will continue to agree to such arrangements or that alternative financing sources that would accept 31 34 such arrangements would be available. In the event the Company's major operating subsidiaries are compelled to accept cross-guarantees, or cross-default or cross-acceleration provisions in connection with their respective credit facilities, financial difficulties experienced by one of the Company's subsidiaries could adversely impact the Company's other subsidiaries. Dependence on Warehouse Financing. As is customary in the consumer lending businesses, Drive depends upon warehouse credit facilities with financial institutions or institutional lenders to finance the origination and purchase of loans on a short-term basis pending sale or securitization. Implementation of the Drive's business strategy requires the continued availability of warehouse credit facilities, and may require increases in the permitted borrowing levels under such facilities. There can be no assurance that such financing will be available on terms satisfactory to the Company. The inability of the Company or its subsidiaries to arrange additional warehouse credit facilities, to extend or replace existing facilities when they expire or to increase the capacity of such facilities may have a material adverse effect on the Company's consolidated condition, results of operations and business prospects. RISKS OF SECURITIZATION Significance of Securitization. The Company continues to believe that its ability to securitize sub-prime automobile loans and other loans, including Portfolio Assets) is necessary to efficiently finance the volume of assets expected to be generated. Accordingly, adverse changes in the secondary market for such loans could impair the Company's ability to originate, purchase and sell loans on a favorable or timely basis. Any such impairment could have a material adverse effect upon the Company's consolidated condition, results of operations and business prospects. Proceeds from the securitization of originated and acquired loans are required to be used to repay borrowings under warehouse credit facilities, which makes such facilities available to finance the origination and purchase of additional loan assets. There can be no assurance that, as the Company's volume of loans originated or purchased increases and other new products available for securitization increases, the Company will be able to securitize its loan production efficiently. An inability to efficiently securitize its loan production could have a material adverse effect on the Company's consolidated condition, results of operations and business prospects. Securitization transactions may be affected by a number of factors, some of which are beyond the Company's control, including, among other things, the adverse financial condition of, or developments related to, some of the Company's competitors, conditions in the securities markets in general, and conditions in the asset-backed securitization market. The Company's securitizations typically utilize credit enhancements in the form of financial guaranty insurance policies in order to achieve enhanced credit ratings. Failure to obtain insurance company credit enhancement could adversely affect the timing of or ability of the Company to effect securitizations. In addition, the failure to satisfy rating agency requirements with respect to loan pools would adversely impact the Company's ability to effect securitizations. Contingent Risks. The Company retains some degree of credit risk on substantially all loans sold. During the period in which loans are held pending sale, the Company is subject to various business risks associated with the lending business, including the risk of borrower default, the risk of foreclosure and the risk that a rapid increase in interest rates would result in a decline in the value of loans to potential purchasers. The Company expects that the terms of its securitizations will require it to establish deposit accounts or build over-collateralization levels through retention of distributions otherwise payable to the holders of subordinated interests in the securitization. The Company also expects to be required to commit to repurchase or replace loans that do not conform to the representations and warranties made by the Company at the time of sale. Retained Risks of Securitized Loans. The Company makes various representations with respect to the loans that it securitizes. With respect to acquired loans, the Company's representations rely in part on similar representations made by the originators of such loans when the Company purchased them. In the event of a breach of its representations, the Company may be required to repurchase or replace the related loan using its own funds. While the Company may have a claim against the originator in the event of a breach of any of these representations made by the originators, the Company's ability to recover on any such claim will be 32 35 dependent on the financial condition of the originator. There can be no assurance that the Company will not experience a material loss associated with any of these contingencies. Performance Assumptions. Securitization gains realized on the sale of loans will be an important part of Drive's future net income. Such gains will be dependent largely upon the estimated present values of the subordinated interests expected to be derived from the transactions and retained by the Company. Also, the timing and size of the securitizations could have a material effect on the net income of the Company. Management makes a number of assumptions in determining the estimated present values for the subordinated interests. These assumptions include, but are not limited to, prepayment speeds, default rates and subsequent losses on the underlying loans, and the discount rates used to present value the future cash flows. All of the assumptions are subjective. Varying the assumptions can have a material effect on the present value determination in one securitization as compared to any other. Subsequent events will cause the actual occurrences of prepayments, losses and interest rates to be different from the assumptions used for such factors at the time of the recognition of the sale of the loans. The effect of the subsequently occurring events could cause a re-evaluation of the carrying values of the previously estimated values of the subordinated interests and excess spreads and such adjustment could be material. Because the subordinated interests to be retained by Drive represent claims to future cash flow that are subordinated to holders of senior interests, Drive retains a significant portion of the risk of whether the full value of the underlying loans may be realized. In addition, holders of the senior interests may have the right to receive certain additional payments on account of principal in order to reduce the balance of the senior interests in proportion to the credit enhancement requirements of any particular transaction. Such payments for the benefit of the senior interest holders will delay the payment, if any, of excess cash flow to Drive as the holder of the subordinated interests. IMPACT OF CHANGING INTEREST RATES Because most of the Company's borrowings are at variable rates of interest, the Company will be impacted by fluctuations in interest rates. However, certain effects of changes in interest rates, such as increased prepayments of outstanding loans, cannot be mitigated. Fluctuations in interest rates could have a material adverse effect on the Company's consolidated financial condition, results of operations and business prospects. A substantial and sustained decline in interest rates may adversely impact the amount of distressed assets available for purchase by Commercial Corp. The value of the Company's interest-earning assets and liabilities may be directly affected by the level of and fluctuations in interest rates, including the valuation of any residual interests in securitizations that would be severely impacted by increased loan prepayments resulting from declining interest rates. Conversely, a substantial and sustained increase in interest rates could adversely affect the ability of the Company to originate loans and could reduce the gains recognized by the Company upon their securitization and sale. Fluctuating interest rates also may affect the net interest income earned by the Company resulting from the difference between the yield to the Company on loans held pending sale and the interest paid by the Company for funds borrowed under the Company's warehouse credit facilities or otherwise. CREDIT IMPAIRED BORROWERS Consumer Corp.'s sub-prime borrowers generally are unable to obtain credit from traditional financial institutions due to factors such as an impaired or poor credit history, low income or other adverse credit events. The Company is subject to various risks associated with these borrowers, including, but not limited to, the risk that the borrowers will not satisfy their debt service obligations and that the realizable value of the assets securing their loans will not be sufficient to repay the borrowers' debt. While the Company believes that the underwriting criteria and collection methods it employs enable it to identify and control the higher risks inherent in loans made to such borrowers, and that the interest rates charged compensate the Company for the 33 36 risks inherent in such loans, no assurance can be given that such criteria or methods, or such interest rates, will afford adequate protection against, or compensation for, higher than anticipated delinquencies, foreclosures or losses. The actual rate of delinquencies, foreclosures or losses could be significantly accelerated by an economic downturn or recession. Consequently, the Company's consolidated financial condition, results of operations (primarily Consumer Corp.'s 31% equity earnings in Drive) and business prospects could be materially adversely affected. Drive has established an allowance for loan losses through periodic earnings charges and purchase discounts on acquired receivables to cover anticipated loan losses on the loans currently in its portfolio. No assurance can be given, however, that loan losses in excess of the allowance will not occur in the future or that additional provisions will not be required to provide for adequate allowances in the future. AVAILABILITY OF PORTFOLIO ASSETS The Portfolio Asset acquisition and resolution business is affected by long-term cycles in the general economy. In addition, the volume of domestic Portfolio Assets available for purchase by investors such as the Company has generally declined since 1993 as large pools of distressed assets acquired by governmental agencies in the 1980s and early 1990s have been resolved or sold. The Company cannot predict its future annual acquisition volume of Portfolio Assets. Moreover, future Portfolio Asset purchases will depend on the availability of Portfolios offered for sale, the availability of capital and the Company's ability to submit successful bids to purchase Portfolio Assets. The acquisition of Portfolio Assets has become highly competitive in the United States. This may require the Company to acquire Portfolio Assets at higher prices thereby lowering profit margins on the resolution of such Portfolios. To offset these changes in the domestic arena, the Company continues to develop its presence in other markets. Under certain circumstances, the Company may choose not to bid for Portfolio Assets that it believes cannot be acquired at attractive prices. As a result of all the above factors, Portfolio Asset purchases, and the revenue derived from the resolution of Portfolio Assets, may vary significantly from quarter to quarter. AVAILABILITY OF NET OPERATING LOSS CARRYFORWARDS The Company believes that, as a result of the Merger, approximately $596 million of NOLs were available to the Company to offset future taxable income as of December 31, 1995. Since December 31, 1995, the Company has generated an additional $137 million in tax operating losses. Accordingly, as of December 31, 2000, the Company believes that it has approximately $733 million of NOLs available to offset future taxable income. Out of the total $733 million of NOLs, the Company estimates it will be able to utilize $57.4 million, which equates to a $20.1 million deferred tax asset on the Company's books and records. However, because the Company's position in respect of its $596 million NOLs resulting from the Merger is based upon factual determinations and upon legal issues with respect to which there is uncertainty and because no ruling has been obtained from the Internal Revenue Service (the "IRS") regarding the availability of the NOLs to the Company, there can be no assurance that the IRS will not challenge the availability of such NOLs and, if challenged, that the IRS will not be successful in disallowing this portion of the Company's NOLs, with the result that the Company's $20.1 million deferred tax asset would be reduced or eliminated. The NOLs may be carried forward to offset future federal taxable income of the Company through the year 2020; however, the availability of these NOLs begins to expire beginning in 2005. The ability of the Company to utilize such NOLs will be severely limited if there is a more than 50% ownership change of the Company during a three-year testing period within the meaning of section 382 of the Internal Revenue Code of 1986, as amended (the "Tax Code"). If the Company were unable to utilize its NOLs to offset future taxable income, it would lose significant competitive advantages that it now enjoys. Such advantages include, but are not limited to, the Company's ability to offset non-cash income recognized by the Company in connection with certain securitizations, to generate capital to support its expansion plans on a tax-advantaged basis, to offset its and its consolidated subsidiaries' pretax income, and to have access to the cash flow that would otherwise be represented by payments of federal tax liabilities. 34 37 ASSUMPTIONS REGARDING RECOGNITION OF DEFERRED TAX ASSET As noted above, the Company has NOLs available for federal income tax purposes to offset future federal taxable income, if any, through the year 2020. A valuation allowance is provided to reduce the deferred tax assets to a level, which, more likely than not, will be realized. The ultimate realization of the resulting net deferred tax asset is dependent upon generating sufficient taxable income prior to expiration of the net operating loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the recorded deferred tax asset, net of the allowance, will be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted in the future if estimates of future taxable income during the carryforward period change. The change in valuation allowance represents a change in the estimate of the future taxable income during the carryforward period since the prior year-end and utilization of net operating loss carryforwards since the Merger. The ability of the Company to realize the deferred tax asset is periodically reviewed and the valuation allowance is adjusted accordingly. ASSUMPTIONS UNDERLYING PORTFOLIO ASSET PERFORMANCE The purchase price and carrying value of Portfolio Assets acquired by Commercial Corp. are determined largely by estimating expected future cash flows from such assets. Commercial Corp. develops and revises such estimates based on its historical experience and current market conditions, and based on the discount rates that the Company believes are appropriate for the assets comprising the Portfolios. In addition, many obligors on Portfolio Assets have impaired credit, with risks associated with such obligors similar to the risks described in respect of borrowers under "-- Credit Impaired Borrowers." If the amount and timing of actual cash flows is materially different from estimates, the Company's consolidated financial condition, results of operations and business prospects could be materially adversely affected. GENERAL ECONOMIC CONDITIONS Periods of economic slowdown or recession, or declining demand for commercial real estate, automobile loans or other commercial or consumer loans may adversely affect the Company's business. Economic downturns may reduce the number of loan originations by the Company's consumer business and negatively impact its securitization activity and generally reduce the value of the Company's assets. In addition, periods of economic slowdown or recession, whether general, regional or industry-related, may increase the risk of default on loans and could have a material adverse effect on the Company's consolidated financial condition, results of operations and business prospects. Such periods also may be accompanied by declining values of automobiles and other property securing outstanding loans, thereby weakening collateral coverage and increasing the possibility of losses in the event of default. Significant increases in automobiles for sale during recessionary economic periods may depress the prices at which such collateral may be sold or delay the timing of such sales. There can be no assurance that there will be adequate markets for the sale of repossessed automobiles. Any material deterioration of such markets could reduce recoveries from the sale of collateral. Such economic conditions could also adversely affect the resolution of Portfolio Assets, lead to a decline in prices or demand for collateral underlying Portfolio Assets, or increase the cost of capital invested by the Company and the length of time that capital is invested in a particular Portfolio. All or any one of these events could decrease the rate of return and profits to be realized from such Portfolio and materially adversely affect the Company's consolidated financial condition, results of operations and business prospects. RISK OF DECLINING VALUE OF COLLATERAL The value of the collateral securing automobile and other consumer loans and loans acquired for resolution, as well as real estate or other acquired distressed assets, is subject to various risks, including uninsured damage, change in location or decline in value caused by use, age or market conditions. Any material decline in the value of such collateral could adversely affect the consolidated financial condition, results of operations and business prospects of the Company. 35 38 GOVERNMENT REGULATION Some aspects of the Company's business are subject to regulation, examination and licensing under various federal, state and local statutes and regulations that impose requirements and restrictions affecting, among other things, credit activities, maximum interest rates, finance and other charges, disclosures to obligors, the terms of secured transactions, collection, repossession and claims handling procedures, multiple qualification and licensing requirements for doing business in various jurisdictions, and other trade practices. The Company believes it is currently in compliance in all material respects with applicable regulations, but there can be no assurance that the Company will be able to maintain such compliance. Failure to comply with, or changes in, these laws or regulations, or the expansion of the Company's business into jurisdictions that have adopted more stringent regulatory requirements than those in which the Company currently conducts business, could have an adverse effect on the Company by, among other things, limiting the income the Company may generate on existing and additional loans, limiting the states in which the Company may operate or restricting the Company's ability to realize on the collateral securing its loans. See "Business --Government Regulation." ENVIRONMENTAL LIABILITIES The Company, through its subsidiaries and affiliates, acquires real property in its Portfolio Asset acquisition and resolution business. There is a risk that properties acquired by the Company could contain hazardous substances or waste, contaminants or pollutants. The Company may be required to remove such substances from the affected properties at its expense, and the cost of such removal may substantially exceed the value of the affected properties or the loans secured by such properties. Furthermore, the Company may not have adequate remedies against the prior owners or other responsible parties to recover its costs, either as a matter of law or regulation, or as a result of such prior owners' financial inability to pay such costs. The Company may find it difficult or impossible to sell the affected properties either prior to or following any such removal. COMPETITION All of the businesses in which the Company operates are highly competitive. Some of the Company's principal competitors are substantially larger and better capitalized than the Company. Because of their resources, these companies may be better able than the Company to obtain new customers for loan production, to acquire Portfolio Assets, to pursue new business opportunities or to survive periods of industry consolidation. Access to and the cost of capital are critical to the Company's ability to compete. Many of the Company's competitors have superior access to capital sources and can arrange or obtain lower cost of capital, resulting in a competitive disadvantage to the Company with respect to such competitors. In addition, certain of the Company's competitors may have higher risk tolerances or different risk assessments, which could allow these competitors to establish lower margin requirements and pricing levels than those established by the Company. In the event a significant number of competitors establish pricing levels below those established by the Company, the Company's ability to compete would be adversely affected. RISK ASSOCIATED WITH FOREIGN OPERATIONS Commercial Corp. has acquired, and manages and resolves, Portfolio Assets located in France and Mexico and is actively pursuing opportunities to purchase additional pools of distressed assets in these locations as well as other areas of Western Europe and Southeast Asia. Foreign operations are subject to various special risks, including currency translation risks, currency exchange rate fluctuations, exchange controls and different political, social and legal environments within such foreign markets. To the extent future financing in foreign currencies is unavailable at reasonable rates, the Company would be further exposed to currency translation risks, currency exchange rate fluctuations and exchange controls. In addition, earnings of foreign operations may be subject to foreign income taxes that reduce cash flow available to meet debt service 36 39 requirements and other obligations of the Company, which may be payable even if the Company has no earnings on a consolidated basis. Any or all of the foregoing could have a material adverse effect on the Company's consolidated condition, results of operations and business prospects. DEPENDENCE ON AUTOMOBILE DEALERSHIP RELATIONSHIPS The ability of the Drive to expand into new geographic markets and to maintain or increase its volume of automobile loans is dependent upon maintaining and expanding the network of franchised automobile dealerships from which it purchases contracts. Increased competition, including competition from captive finance affiliates of automobile manufacturers, could have a material adverse effect on the Drive's ability to maintain or expand its dealership network. RISK OF MINORITY INVESTMENT IN DRIVE Although the Company continues to have some influence on Drive and its operations, due to the sale of 49% of its interest, the Company now maintains a minority interest in Drive. There can be no guarantee that Drive's future operations will be consistent with the Company's goals. LITIGATION Industry participants in the consumer lending businesses from time to time are named as defendants in litigation involving alleged violations of federal and state consumer protection or other similar laws and regulations. A judgment against the Company in connection with any such litigation could have a material adverse effect on the Company's consolidated financial condition, results of operations and business prospects. RELATIONSHIP WITH AND DEPENDENCE UPON CARGILL The Company's relationship with Cargill is significant in a number of respects. Cargill, a subsidiary of Cargill, Incorporated, a privately held, multi-national agricultural and financial services company, provides equity and debt financings for many of the Acquisition Partnerships. Cargill owns approximately 2.7% of the Company's outstanding Common Stock, and a Cargill designee, Jeffery Leu, serves as a director of the Company. The Company believes its relationship with Cargill significantly enhances the Company's credibility as a purchaser of Portfolio Assets and facilitates its ability to expand into other businesses and foreign markets. Although management believes that the Company's relationship with Cargill is excellent, there can be no assurance that such relationship will continue in the future. Absent such relationship, the Company and the Acquisition Partnerships would be required to find alternative sources for the financing that Cargill has historically provided. There can be no assurance that such alternative financing would be available. Any termination of such relationship could have a material adverse effect on the Company's consolidated financial condition, results of operations and business prospects. DEPENDENCE ON KEY PERSONNEL The Company is dependent on the efforts of its senior executive officers, particularly James R. Hawkins (Chairman) and James T. Sartain (President and Chief Executive Officer effective January 16, 2000). The Company is also dependent on several of the key members of management of each of its operating subsidiaries, many of whom were instrumental in developing and implementing the business strategy for such subsidiaries. The inability or unwillingness of one or more of these individuals to continue in his present role could have a material adverse effect on the Company's consolidated condition, results of operations and business prospects. Certain senior executive officers have entered into an employment agreement with the Company. There can be no assurance that any of the foregoing individuals will continue to serve in his current capacity or for what time period such service might continue. The Company does not maintain key person life insurance for any of its senior executive officers. 37 40 The borrowing facilities for the Company, Commercial Corp. and Consumer Corp. each include key personnel provisions. These provisions generally provide that if certain key personnel are no longer employed and suitable replacements are not found within a defined time limit certain facilities become due and payable. INFLUENCE OF CERTAIN SHAREHOLDERS The directors and executive officers of the Company collectively beneficially own 18.6% of the Common Stock. Although there are no agreements or arrangements with respect to voting such Common Stock among such persons except as described below, such persons, if acting together, may effectively be able to control any vote of stockholders of the Company and thereby exert considerable influence over the affairs of the Company. James R. Hawkins, the Chairman of the Board, is the beneficial owner of 11.2% of the Common Stock. James T. Sartain, President and Chief Executive Officer (effective January 16, 2001) of the Company, is the beneficial owner of 4.4% of the Common Stock. ATARA I, Ltd. ("ATARA"), an entity associated with Rick R. Hagelstein, former Executive Vice President of the Company and former Chief Executive Officer of Mortgage Corp., beneficially owns 4.1% of the outstanding Common Stock. In addition, Cargill owns approximately 2.7% of the Common Stock. Mr. Hawkins, Mr. Sartain, Cargill and ATARA are parties to a shareholder voting agreement (the "Stockholder Voting Agreement"). Under the Stockholder Voting Agreement, Mr. Hawkins, Mr. Sartain and ATARA are required to vote their shares in favor of Cargill's designee for director of the Company, and Cargill is required to vote its shares in favor of one or more of the designees of Messrs. Hawkins and Sartain and ATARA. There can be no assurance that the interests of management or the other entities and individuals named above will be aligned with the Company's other stockholders. SHARES ELIGIBLE FOR FUTURE SALE The utilization of the Company's $596 million in NOLs resulting from the Merger may be limited or prohibited under the Tax Code in the event of certain ownership changes. The Company's Amended and Restated Certificate of Incorporation (the "Certificate of Incorporation") contains provisions restricting the transfer of its securities that are designed to avoid the possibility of such changes. Such restrictions may prevent certain holders of common stock of the Company from transferring such stock even if such holders are permitted to sell such stock without restriction under the Securities Act, and may limit the Company's ability to sell common stock to certain existing holders of common stock at an advantageous time or at a time when capital may be required but unavailable from any other source. ANTI-TAKEOVER CONSIDERATIONS The Company's Certificate of Incorporation and by-laws contain a number of provisions relating to corporate governance and the rights of shareholders. Certain of these provisions may be deemed to have a potential "anti-takeover" effect to the extent they are utilized to delay, defer or prevent a change of control of the Company by deterring unsolicited tender offers or other unilateral takeover proposals and compelling negotiations with the Company's Board of Directors rather than non-negotiated takeover attempts even if such events may be in the best interests of the Company's shareholders. The Certificate of Incorporation also contains certain provisions restricting the transfer of its securities that are designed to prevent ownership changes that might limit or eliminate the ability of the Company to use its NOLs resulting from the Merger. PERIOD TO PERIOD VARIANCES The revenue of Commercial Corp. and Acquisition Partnerships is based on proceeds realized from the resolution of the Portfolio Assets, which proceeds have historically varied significantly and likely will continue to vary significantly from period to period. Consequently, the Company's period-to-period revenue and net income have historically varied, and are likely to continue to vary, correspondingly. Such variances, alone or with other factors, such as conditions in the economy or the financial services industries or other developments 38 41 affecting the Company, may result in significant fluctuations in the reported operations of the Company and in the trading prices of the Company's securities, particularly the Common Stock. TAX, MONETARY AND FISCAL POLICY CHANGES The Company originates and acquires financial assets, the value and income potential of which are subject to influence by various state and federal tax, monetary and fiscal policies in effect from time to time. The nature and direction of such policies are entirely outside the control of the Company, and the Company cannot predict the timing or effect of changes in such policies. Changes in such policies could have a material adverse effect on the Company's consolidated financial condition, results of operations and business prospects. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market risk is the risk of loss from adverse changes in market prices and interest rates. The Company's operations are materially impacted by net gains on sales of loans and net interest margins. The level of gains from loan sales the Company achieves is dependent on demand for the products originated. Net interest margins are dependent on the Company to maintain the spread or interest differential between the interest it charges the customer for loans and the interest the Company is charged for the financing of those loans. The following describes each component of interest bearing assets held by the Company and how each could be affected by changes in interest rates. The Company invests in Portfolio Assets both directly through consolidated subsidiaries and indirectly through equity investments in Acquisition Partnerships. Portfolio Assets consist of investments in pools of non-homogenous assets that predominantly consist of loan and real estate assets. Earnings from these assets are based on the estimated future cash flows from such assets and recorded when those cash flows occur. The underlying loans within these pools bear both fixed and variable rates. Due to the non-performing nature and history of these loans, changes in prevailing benchmark rates (such as the prime rate or LIBOR) generally have a nominal effect on the ultimate future cash flow to be realized from the loan assets. Furthermore, these pools of assets are held for sale, not for investment; therefore, the disposition strategy is to liquidate these assets as quickly as possible. Loans receivable consists of investment loans made to Acquisition Partnerships and bear interest based on both fixed and variable rates. Rising interest rates would negatively affect the ability and speed of payment on these loans. The Company's equity investment in Drive is materially impacted by net gains realized on securitization transactions and net interest margins. The sub-prime loans that Drive sells are included in asset-backed securities the investor or purchaser issues. These securities are priced at spreads over the LIBOR or an equivalent term treasury security. These spreads are determined by demand for the security. Demand is affected by the perception of credit quality and prepayment risk associated with the loans Drive originates and sells. The timing and size of the securitizations could also have a material effect on the net income of Drive. Interest rates offered to customers also affect prices paid for loans. These rates are determined by review of competitors' rate offerings to the public and current prices being paid to Drive for the products. Drive does not hedge these price risks. Drive's residual interests in securitizations represent the present value of the excess cash flows Drive expects to receive over the life of the underlying sub-prime automobile loans. The sub-prime automobile residual interests are affected less by prepayment speeds due to the shorter term of the underlying assets and the fact that the loans are fixed rate, generally at the highest rate allowable by law. Additionally the Company has various sources of financing which have been previously described in the Liquidity and Capital Resources section of Item 7. In summary, the Company would be negatively impacted by rising interest rates and declining prices for its sub-prime loans. Rising interest rates would negatively impact the value of residual interests in 39 42 securitizations and costs of borrowings. Declining prices for the Company's sub-prime loans would adversely affect the levels of gains achieved upon the sale of those loans. The following table is a summary of the interest earning assets and interest bearing liabilities, as of December 31, 2000, segregated by asset type as described in the previous paragraphs, with expected maturity or sales dates as indicated (dollars in thousands):
WEIGHTED GREATER AVERAGE 0-3 3-6 6-9 9-12 THAN RATE MONTHS MONTHS MONTHS MONTHS 12 MONTHS TOTAL -------- ------- ------- ------ ------ --------- ------- INTEREST BEARING ASSETS Portfolio assets(1)........... N/A $11,119 $ 3,401 $1,463 $1,593 $12,442 $30,018 Loans receivable(2)........... 19.37% 1,729 837 1,202 1,326 9,445 14,539 Equity investments(3) Acquisition Partnerships.... N/A 2,095 7,185 1,618 3,720 19,244 33,862 Drive....................... N/A -- -- -- -- 3,738 3,738 ------- ------- ------ ------ ------- ------- $14,943 $11,423 $4,283 $6,639 $44,869 $82,157 ======= ======= ====== ====== ======= ======= INTEREST BEARING LIABILITIES Notes payable secured by Portfolio Assets, loans receivable and equity in Acquisition Partnerships(4)............. 10.27% $ -- $ 1,642 $ -- $ -- $43,422 $45,064 Unsecured notes............... 7.10% -- 60 -- -- 862 922 Company credit facility....... 9.22% -- -- -- -- 47,778 47,778 ------- ------- ------ ------ ------- ------- $ -- $ 1,702 $ -- $ -- $92,062 $93,764 ======= ======= ====== ====== ======= =======
--------------- (1) Portfolio assets are shown based on estimated proceeds from disposition, which could occur much faster or slower than anticipated or as directed. (2) Loans receivable are shown in the table based upon the expected date of sale or repayment. (3) Equity investments are shown based on anticipated equity disbursements, which could occur much faster or slower than anticipated. (4) Notes payable mature in the periods indicated. This does not necessarily indicate when the outstanding balances would be paid. Notes payable secured by Portfolio Assets fund up to 100% of the corresponding asset class. If the asset balance declines whether through a sale or a payment from the borrower, the corresponding liability must be paid. 40 43 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, ----------------------- 2000 1999 ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Cash and cash equivalents................................... $ 8,043 $ 11,263 Portfolio Assets, net....................................... 30,018 39,437 Loans receivable, net....................................... 14,539 30,144 Residual interests in securitizations....................... -- 55,661 Equity investments.......................................... 39,022 31,104 Deferred tax benefit, net................................... 20,101 27,101 Other assets, net........................................... 8,824 15,786 Net assets of discontinued operations....................... 20,444 20,126 -------- -------- Total Assets...................................... $140,991 $230,622 ======== ======== LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY Liabilities: Notes payable............................................. $ 93,764 $169,792 Other liabilities......................................... 9,216 7,278 -------- -------- Total Liabilities................................. 102,980 177,070 Commitments and contingencies (notes 2, 3, 8, 10, 11, 13 and 15)....................................................... -- -- Redeemable preferred stock: Adjusting rate preferred stock, including accumulated dividends in arrears of $3,852 and $1,284, respectively (par value $.01, redemption value of $21 per share; 2,000,000 shares authorized; 1,222,901 shares issued and outstanding)....................................... 29,533 26,965 Shareholders' 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; issued and outstanding: 8,368,344 and 8,333,300 shares, respectively)........................ 84 83 Paid in capital........................................... 79,634 79,562 Accumulated deficit....................................... (71,131) (52,663) Accumulated other comprehensive loss...................... (109) (395) -------- -------- Total Shareholders' Equity........................ 8,478 26,587 -------- -------- Total Liabilities, Redeemable Preferred Stock and Shareholders' Equity............................. $140,991 $230,622 ======== ========
See accompanying notes to consolidated financial statements. 41 44 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, --------------------------------------- 2000 1999 1998 ---------- ----------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues: Servicing fees............................................ $ 11,442 $ 8,936 $ 5,767 Gain on resolution of Portfolio Assets.................... 3,120 4,054 9,208 Equity in earnings of investments......................... 9,592 11,318 12,827 Interest income........................................... 15,094 20,502 12,590 Gain on sale of automobile loans.......................... 2,836 10,280 7,214 Gain on sale of interest in subsidiary.................... 8,091 -- -- Other income.............................................. 2,001 3,838 3,938 -------- --------- -------- Total revenues..................................... 52,176 58,928 51,544 Expenses: Interest and fees on notes payable........................ 18,658 18,754 14,590 Salaries and benefits..................................... 16,329 17,199 13,755 Provision for loan and impairment losses.................. 4,391 4,302 9,201 Occupancy, data processing, communication and other....... 16,910 17,942 14,173 -------- --------- -------- Total expenses..................................... 56,288 58,197 51,719 -------- --------- -------- Earnings (loss) from continuing operations before income taxes, minority interest and accounting change............ (4,112) 731 (175) Benefit (provision) for income taxes........................ (7,414) (5,051) 1,132 -------- --------- -------- Earnings (loss) from continuing operations before minority interest and accounting change............................ (11,526) (4,320) 957 Minority interest........................................... (207) (734) (172) Cumulative effect of accounting change...................... -- (765) -- -------- --------- -------- Earnings (loss) from continuing operations.................. (11,733) (5,819) 785 Loss from discontinued operations, net of provision for income taxes of $89 in 1998............................... (5,000) (102,337) (20,977) Extraordinary gain, net of income taxes of $0............... 833 -- -- -------- --------- -------- Net loss.................................................... (15,900) (108,156) (20,192) Preferred dividends (Includes accumulated dividends in arrears after June 30, 1999).............................. (2,568) (2,568) (5,186) -------- --------- -------- Net loss to common shareholders.................... $(18,468) $(110,724) $(25,378) ======== ========= ======== Basic and diluted loss per common share are as follows: Loss from continuing operations before accounting change per common share........................................ $ (1.71) $ (0.92) $ (0.58) Discontinued operations per common share.................. (0.60) (12.32) (2.77) Cumulative effect of accounting change.................... -- (0.09) -- Extraordinary gain........................................ 0.10 -- -- Net loss per common share................................. $ (2.21) $ (13.33) $ (3.35) Weighted average common shares outstanding................ 8,351 8,307 7,584
See accompanying notes to consolidated financial statements. 42 45 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED RETAINED OTHER NUMBER OF EARNINGS COMPREHENSIVE TOTAL COMMON COMMON PAID IN (ACCUMULATED INCOME SHAREHOLDERS' SHARES STOCK CAPITAL DEFICIT) (LOSS) EQUITY --------- ------ ------- ------------ ------------- ------------- (DOLLARS IN THOUSANDS) BALANCES, DECEMBER 31, 1997....................... 6,526,510 $65 $29,509 $ 83,140 $ 44 $112,758 Exercise of warrants, options and purchase of shares through employee stock purchase plan.............. 519,299 5 12,675 -- -- 12,680 Issuance of common stock to acquire the minority interest of subsidiary..... 41,000 1 2,149 -- -- 2,150 Issuance of common stock in public offering............ 1,201,150 12 34,123 -- -- 34,135 Comprehensive loss: Net loss for 1998.......... -- -- -- (20,192) -- (20,192) Foreign currency items..... -- -- -- -- 311 311 -------- Total comprehensive loss..... (19,881) -------- Other........................ -- -- -- 299 -- 299 Preferred dividends.......... -- -- -- (5,186) -- (5,186) --------- --- ------- --------- ----- -------- BALANCES, DECEMBER 31, 1998....................... 8,287,959 83 78,456 58,061 355 136,955 Purchase of shares through employee stock purchase plan....................... 45,341 -- 231 -- -- 231 Issuance of common stock warrant.................... -- -- 875 -- -- 875 Comprehensive loss: Net loss for 1999.......... -- -- -- (108,156) -- (108,156) Foreign currency items..... -- -- -- -- (750) (750) -------- Total comprehensive loss..... (108,906) -------- Preferred dividends.......... -- -- -- (2,568) -- (2,568) --------- --- ------- --------- ----- -------- BALANCES, DECEMBER 31, 1999....................... 8,333,300 83 79,562 (52,663) (395) 26,587 Purchase of shares through employee stock purchase plan....................... 35,044 1 72 -- -- 73 Comprehensive loss: Net loss for 2000.......... -- -- -- (15,900) -- (15,900) Foreign currency items..... -- -- -- -- 286 286 -------- Total comprehensive loss..... (15,614) -------- Preferred dividends.......... -- -- -- (2,568) -- (2,568) --------- --- ------- --------- ----- -------- BALANCES, DECEMBER 31, 2000....................... 8,368,344 $84 $79,634 $ (71,131) $(109) $ 8,478 ========= === ======= ========= ===== ========
See accompanying notes to consolidated financial statements. 43 46 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------- 2000 1999 1998 --------- --------- --------- (DOLLARS IN THOUSANDS) Cash flows from operating activities: Net loss.................................................. $ (15,900) $(108,156) $ (20,192) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Loss from discontinued operations....................... 5,000 102,337 20,977 Proceeds from resolution of Portfolio Assets............ 14,398 19,610 42,976 Gain on resolution of Portfolio Assets.................. (3,120) (4,054) (9,208) Purchase of Portfolio Assets and loans receivable, net................................................... (26,161) (307) (26,420) Origination of automobile receivables, net of purchase discount.............................................. (106,311) (166,476) (119,096) Provision for loan and impairment losses................ 4,391 4,302 9,201 Equity in earnings of investments....................... (9,592) (11,318) (12,827) Proceeds from performing Portfolio Assets and loans receivable, net....................................... 54,172 150,043 144,627 (Increase) decrease in net deferred tax asset........... 7,000 5,061 (1,637) Depreciation and amortization........................... 1,994 2,912 2,058 (Increase) decrease in other assets..................... (974) 895 (10,246) Deferred gain from sale of interest in subsidiary....... (4,000) -- -- Gain on sale of interest in subsidiary.................. (8,091) -- -- Increase in other liabilities........................... 2,296 1,198 12,742 --------- --------- --------- Net cash provided by (used in) operating activities....................................... (84,898) (3,953) 32,955 --------- --------- --------- Cash flows from investing activities: Proceeds from sale of interest in subsidiary.............. 15,000 -- -- Proceeds on notes receivable from sale of interest in subsidiary.............................................. 60,000 -- -- Property and equipment, net............................... 210 (5,321) (1,840) Contributions to Acquisition Partnerships and Servicing Entities................................................ (6,715) (15,500) (22,534) Distributions from Acquisition Partnerships and Servicing Entities................................................ 10,313 36,045 28,050 --------- --------- --------- Net cash provided by investing activities.......... 78,808 15,224 3,676 --------- --------- --------- Cash flows from financing activities: Borrowings under notes payable............................ 148,310 237,702 340,680 Payments of notes payable................................. (140,195) (235,598) (329,232) Purchase or redemption of special preferred stock......... -- -- (14,716) Proceeds from issuance of common stock.................... 73 231 46,815 Preferred dividends paid.................................. -- (1,926) (6,059) --------- --------- --------- Net cash provided by financing activities.......... 8,188 409 37,488 --------- --------- --------- Net cash provided by continuing operations................ $ 2,098 $ 11,680 $ 74,119 Net cash used by discontinued operations.................. (5,318) (6,372) (95,489) --------- --------- --------- Net increase (decrease) in cash and cash equivalents........ $ (3,220) $ 5,308 $ (21,370) Cash and cash equivalents, beginning of year................ 11,263 5,955 27,325 --------- --------- --------- Cash and cash equivalents, end of year...................... $ 8,043 $ 11,263 $ 5,955 ========= ========= ========= Supplemental disclosure of cash flow information: Cash paid during the year for: Interest................................................ $ 15,932 $ 16,097 $ 12,399 ========= ========= ========= Income taxes............................................ $ 637 $ 235 $ 627 ========= ========= ========= Non-cash investing activities: Residual interests received as a result of sales of loans through securitizations......................... $ 5,713 $ 27,306 $ 44,309 ========= ========= ========= Non-cash financing activities: Dividends accumulated and not paid on preferred stock... $ 2,568 $ 1,284 $ 642 Issuance of common stock warrant........................ -- 875 -- --------- --------- --------- $ 2,568 $ 2,159 $ 642 ========= ========= =========
See accompanying notes to consolidated financial statements. 44 47 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) BASIS OF PRESENTATION On July 3, 1995, FirstCity Financial Corporation (the "Company" or "FirstCity") was formed by the merger of J-Hawk Corporation and First City Bancorporation of Texas, Inc. (the "Merger"). The Company's merger with Harbor Financial Group, Inc. ("Mortgage Corp.") on July 1, 1997 was accounted for as a pooling of interests. 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, securitization trusts and for investment. Actual results could differ materially from those estimates. (b) DESCRIPTION OF BUSINESS The Company is a financial services company with offices throughout the United States and Mexico, with a presence in France. At December 31, 2000, the Company was engaged in two principal reportable segments: (i) portfolio asset acquisition and resolution and (ii) consumer lending. Refer to Note 9 for operational information related to each of these principal segments. Effective in the third quarter of 1999, the Company adopted formal plans to discontinue its mortgage banking operations (refer to Note 3), which had previously also been reported as a principal segment. Activities related to the mortgage banking operations have been reclassified in the accompanying consolidated financial statements to discontinued operations. In the third quarter of 2000, FirstCity Consumer Lending Corporation ("Consumer Corp."), a wholly-owned subsidiary of FirstCity, completed a sale of a 49% equity interest in its automobile finance operation to IFA Drive GP Holdings LLC ("IFA-GP") and IFA Drive LP Holdings LLC ("IFA-LP"), wholly-owned subsidiaries of IFA Incorporated ("IFA Parent"), for a purchase price of $15 million cash pursuant to the terms of a Securities Purchase Agreement dated as of August 18, 2000 (the "Securities Purchase Agreement"), by and among the Company, Consumer Corp., FirstCity Funding LP ("Funding LP"), and FirstCity Funding GP Corp. ("Funding GP"), IFA-GP and IFA-LP (see Note 2 for further discussion). As a result of this sale, the Company no longer consolidates the financial statements of its automobile finance operation since August 1, 2000, but instead records its investment under the equity method of accounting. Also, in relation to the sale, Bank of Scotland forgave a loan fee in the amount of $2.5 million, which resulted in accrued loan fees of $.8 million owed to the senior lender being recorded as an extraordinary gain in the consolidated financial statements. In the portfolio asset acquisition and resolution business the Company acquires and resolves portfolios of performing and nonperforming commercial and consumer loans and other assets (collectively, "Portfolio Assets" or "Portfolios"), which are generally acquired at a discount to their legal principal balance or appraised value. Purchases may be in the form of pools of assets or single assets. The Portfolio Assets are generally nonhomogeneous assets, including loans of varying qualities that are secured or unsecured by diverse collateral types and foreclosed properties. 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 either on business or real estate or other collateral cash flow. Portfolio Assets are acquired on behalf of the Company or its wholly owned subsidiaries, and on behalf of legally independent 45 48 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) domestic and foreign partnerships and other entities ("Acquisition Partnerships") in which a partially owned affiliate of the Company is the general partner and the Company and other investors are limited partners. The Company services, manages and ultimately resolves or otherwise disposes of substantially all of the assets it, its Acquisition Partnerships, or other related entities acquire. The Company services all such assets until they are collected or sold and normally does not manage assets for non-affiliated third parties. (c) PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of all of the majority owned subsidiaries of the Company. Investments in 20 percent to 50 percent owned affiliates are accounted for on the equity method. Investments in less than 20 percent owned affiliates are also accounted for on the equity method if the investments are considered to be corporate joint ventures. All significant intercompany transactions and balances have been eliminated in consolidation. (d) CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. The Company has maintained balances in various operating and money market accounts in excess of federally insured limits. (e) PORTFOLIO ASSETS Portfolio Assets are reflected in the accompanying consolidated financial statements as non-performing Portfolio Assets, performing Portfolio Assets or real estate Portfolios. The following is a description of each classification and the related accounting policy accorded to each Portfolio type: Non-Performing Portfolio Assets Non-performing Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed upon collateral. Portfolio Assets are designated as non-performing unless substantially all of the loans in the Portfolio are being repaid in accordance with the contractual terms of the underlying loan agreements. Such Portfolios are acquired on the basis of an evaluation by the Company of the timing and amount of cash flow expected to be derived from borrower payments or other resolution of the underlying collateral securing the loan. All non-performing Portfolio Assets are purchased at substantial discounts from their outstanding legal principal amount, the total of the aggregate of expected future sales prices and the total payments to be received from obligors. Subsequent to acquisition, the amortized cost of non-performing Portfolio Assets is evaluated for impairment on a quarterly basis. A valuation allowance is established for any impairment identified through provisions charged to earnings in the period the impairment is identified. No valuation allowance was required as of December 31, 2000, 1999 or 1998. 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 Portfolio. 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. Accounting for Portfolios is on a pool basis as opposed to an individual asset-by-asset basis. 46 49 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Performing Portfolio Assets Performing Portfolio Assets consist primarily of Portfolios of consumer and commercial loans acquired at a discount from the aggregate amount of the borrowers' obligation. Portfolios are classified as performing if substantially all of the loans in the Portfolio are being repaid in accordance with the contractual terms of the underlying loan agreements. Performing Portfolio Assets are carried at the unpaid principal balance of the underlying loans, net of acquisition discounts. Interest is accrued when earned in accordance with the contractual terms of the loans. The accrual of interest is discontinued once a loan becomes past due 90 days or more. Acquisition discounts for the Portfolio as a whole are accreted as an adjustment to yield over the estimated life of the Portfolio. Accounting for these Portfolios is on a pool basis as opposed to an individual asset-by-asset basis. The Company accounts for performing Portfolio Assets in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, which requires creditors to evaluate the collectibility of both contractual interest and principal of loans when assessing the need for a loss accrual. Impairment is measured based on the present value of the expected future cash flows discounted at the loans' effective interest rates, or the fair value of the collateral, less estimated selling costs, if any loans are collateral dependent and foreclosure is probable. Real Estate Portfolios Real estate Portfolios consist of real estate assets acquired from a variety of sellers. Such Portfolios are carried at the lower of cost or fair value less estimated costs to sell. Costs relating to the development and improvement of real estate are capitalized, whereas those relating to holding assets are charged to expense. Income or loss is recognized upon the disposal of the real estate. Rental income, net of expenses, on real estate Portfolios is recognized when received. Accounting for the Portfolios is on an individual asset-by-asset basis as opposed to a pool basis. A valuation allowance is established for any impairment identified through provisions charged to earnings in the period the impairment is identified. The Company recorded an allowance for impairment of a real estate Portfolio of $2.0 million in 2000. No valuation allowance was required in 1999 and 1998. (f) LOANS RECEIVABLE At December 31, 2000, loans receivable consist of loans made to Acquisition Partnerships at both variable and fixed rates, the repayment of which is generally dependent upon future cash flows and distributions made from those Acquisition Partnerships. In prior years, the majority of the balance was comprised of automobile and consumer finance receivables. Automobile and consumer finance receivables consisted of sub-prime automobile finance receivables and student loan receivables, which were originated and acquired from third party dealers and other originators, purchased at a non-refundable discount from the contractual principal amount. This discount was allocated between discount available for loan losses and discount available for accretion to interest income. Discounts allocated to discounts available for accretion were deferred and accreted to income using the interest method. To date all acquired discounts have been allocated as discounts available for loan losses. To the extent the discount is considered insufficient to absorb anticipated losses on the loans receivable, additions to the allowance are made through a periodic provision for loan losses (see Note 5). The evaluation of the allowance considers loan portfolio performance, historical losses, delinquency statistics, collateral valuations and current economic conditions. Such evaluation is made on an individual loan basis using static pool analyses. Interest is accrued when earned in accordance with the contractual terms of the loans. The accrual of interest is discontinued once a loan becomes past due 90 days or more. 47 50 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (g) RESIDUAL INTERESTS IN SECURITIZATIONS The Company had residual interests in securitizations consisting of rated securities, retained interests and related interest only strips (collectively referred to as residual interests), which were attributable to loans sold through securitization transactions by the Company. The residual interests were classified as available for sale. Accordingly, the Company recorded these investments at estimated fair value. The increases or decreases in estimated fair value were recorded as unrealized gains or losses in the accompanying consolidated statements of shareholders' equity. The determination of fair value was based on the present value of the anticipated excess cash flows using valuation assumptions unique to each securitization. Impairment in the fair value of residual interests that is deemed to be other than temporary was reflected in a valuation allowance with provisions charged to earnings in the period in which the impairment was identified. (h) PROPERTY AND EQUIPMENT Property and equipment are carried at cost, less accumulated depreciation and are included in other assets. Depreciation is provided using straight-line method over the estimated useful lives of the assets. (i) INTANGIBLES Intangible assets represent the excess of cost over fair value of assets acquired in connection with purchase transactions (goodwill) as well as the purchase price of future service fee revenues and are included in other assets. These intangible assets are amortized over periods estimated to coincide with the expected life of the underlying asset pool owned or serviced by the acquired subsidiary. The Company periodically evaluates the existence of intangible asset impairment on the basis of whether such intangibles are fully recoverable from the projected, undiscounted net cash flows of the related assets acquired. An accounting change due to the adoption of Statement of Financial Position 98-5, Reporting on the Cost of Start-Up Activities, which requires previously capitalized start-up costs including organizational costs to be written off and future costs related to start-up entities to be charged to expense as incurred, resulted in a write-off of $.8 million in previously capitalized organizational costs in 1999 and has been reflected as a cumulative effect of a change in accounting principle. (j) REVENUE RECOGNITION ON CONTINGENT FEES The Company currently has certain servicing contracts with its Mexican investment entities whereby the Company is entitled to additional compensation for servicing once a specified return to the investors has been achieved. The Company will not recognize any revenue related to these contracts until the investors have received the required level of returns specified in the contracts and the Mexican investment entity has received cash in an amount greater than the required returns. There is no guarantee that the required level of returns to the investors will be achieved or that any additional compensation to the Company related to the contracts will be realized. The amount of these fees recognized by the Company was $763 in 2000. No related income was recognized in 1999 and 1998. (k) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Statement of Financial Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income established standards for reporting and displaying comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 also requires the accumulated balance of other comprehensive income to be displayed separately in the equity section of the consolidated balance sheet. The Company's other comprehensive income consists of foreign currency transactions only and had an accumulated balance of $(109), $(395) and $355 at December 31, 2000, 1999 and 1998, respectively. 48 51 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (l) FOREIGN CURRENCY TRANSLATIONS The Company has determined that the local currency is the functional currency for its operations outside the United States (primarily France and Mexico). Assets and liabilities denominated in foreign functional currencies are translated at the exchange rate as of the balance sheet date. Translation adjustments are recorded as a separate component of shareholders' equity in accumulated other comprehensive income (loss). Revenues, costs and expenses denominated in foreign currencies are translated at the weighted average exchange rate for the period. (m) INCOME TAXES The Company files a consolidated federal income tax return with its 80% or greater owned subsidiaries. The Company records all of the allocated federal income tax provision of the consolidated group in the parent corporation. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effects of future changes in tax laws or changes in tax rates are not anticipated. The measurement of deferred tax assets, if any, is reduced by the amount of any tax benefits that, based on available evidence, are not expected to be realized. (n) NET LOSS PER COMMON SHARE Basic net loss per common share calculations are based upon the weighted average number of common shares outstanding. Losses included in the loss per common share calculation are reduced by minority interest and preferred stock dividends. Potentially dilutive common share equivalents include warrants and stock options in the diluted loss per common share calculations. The effects of any common stock equivalents are antidilutive for 2000, 1999 and 1998 due to the net loss for the periods; therefore, diluted loss per common share is reported the same as basic loss per common share. (o) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company assesses the impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. (p) EFFECT OF NEW ACCOUNTING STANDARDS Statements of Financial Accounting Standards No. 133 and No. 138 (SFAS 133 and 138), Accounting for Derivative Instruments and Hedging Activities,requires companies to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS 133 and 138 require that changes in fair value of a derivative be recognized currently in earnings unless specific hedge accounting criteria are met. The Company adopted SFAS 133 and 138 on January 1, 2001, and there was no impact on the consolidated financial statements. 49 52 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In September 2000, the Financial Accounting Standards Board issued Statement of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a replacement of FASB Statement No. 125 (SFAS 140). This Statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS 125's provisions without reconsideration. SFAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. SFAS 140 is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. In connection with discontinued operations, the Company has investment securities resulting from the retention of residual interests in securitization transactions. See note 3 for required disclosures. (q) RECLASSIFICATIONS Certain amounts in the financial statements for prior years have been reclassified to conform with current financial statement presentation. (2) RESTRUCTURE, LIQUIDITY AND CAPITAL RESOURCES Generally, the Company requires liquidity to fund its operations, working capital, payment of debt, equity for acquisition of Portfolio Assets, investments in and advances to the Acquisition Partnerships, retirement of and dividends on preferred stock, and other investments by the Company. The potential sources of liquidity are funds generated from operations, equity distributions from the Acquisition Partnerships, interest and principal payments on subordinated intercompany debt and dividends from the Company's subsidiaries, short-term borrowings from revolving lines of credit, proceeds from equity market transactions, securitization and other structured finance transactions and other special purpose short-term borrowings. As stated in Note 1, in the third quarter of 2000, Consumer Corp. completed the sale of a 49% equity interest in its automobile finance operation to IFA-GP and IFA-LP. The transaction generated $75 million in cash as described below and resulted in a gain of $12.1 million. Simultaneously, Bank of Scotland and the Company completed a debt restructure, which resulted in reduced interest rates and fees, increased liquidity, and an extended maturity. Additionally, this transaction brought FirstCity into compliance under its lending covenants and cured any defaults that may have existed prior to the restructure. The new entity formed to facilitate the transaction is Drive Financial Services LP ("Drive"). IFA, through wholly owned subsidiaries formed for the purpose of the acquisition, purchased 49% of this newly formed entity for $15 million and IFA provided $60 million in term financing to Drive and its subsidiary, Drive ABS LP, which was used to repay indebtedness owed to FirstCity by its automobile finance operation. After taking into effect the sale of the 49% interest to IFA-GP and IFA-LP, the ownership of Drive is allocated as follows: 49% of Drive is owned (directly and indirectly) by IFA-GP and IFA-LP, 31% of Drive is owned (directly and indirectly) by Consumer Corp., and 20% of Drive is owned (directly and indirectly) by Thomas R. Brower, Scot A. Foith, Thomas G. Dundon, R. Tyler Whann, Bradley C. Reeves, Stephen H. Trent and Blake P. Bozman (the "Auto Finance Management Group"). The Auto Finance Management Group consists of officers and shareholders of Funding GP and limited partners of Funding LP who indirectly and directly owned the remaining 20% equity interest in Funding LP. The Company has reflected the Auto Finance Management Group's 20% equity interest in Funding LP as a minority interest in the consolidated financial statements. The Company provided a guaranty limited to a maximum amount of up to $4 million of the $60 million term loan by IFA. The Company, Consumer Corp. and Funding LP secured the guaranty with a security interest in their respective ownership interests in Consumer Corp., Funding LP and Drive. IFA provided a new $100 million warehouse line of credit to Drive. This new warehouse line is in addition to the current $100 million warehouse line of Drive with Enterprise Funding Corporation, an affiliate of Bank of America. 50 53 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The $4 million guaranty by the Company resulted in a $4 million deferral of the $12.1 million gain. As a result of this transaction, the net operations of Drive have been recorded (since August 1, 2000) as equity in earnings of investments. As a result of the sale of the 49% interest in the automobile finance operation, the Company reduced the outstanding debt under its senior and subordinate facilities from $113 million to approximately $44 million. The Company also retired approximately $6.4 million of debt owed to other lenders. The Company, the Bank of Scotland, as agent, The Governor and Company of the Bank of Scotland and IFA Parent (collectively, the "Lenders"), entered into a Second Amendment to Amended and Restated Loan Agreement dated as of August 18, 2000 (the "Second Amendment") pursuant to which the remaining debt under the Company's senior and subordinate debt facilities was restructured into a new loan facility that provides for a maximum aggregate loan amount of $53 million. The restructured facility is comprised of a $10 million Revolving Line of Credit, a $31 million Term Loan A and a $12 million Term Loan B. The loans under the restructured loan facility mature December 31, 2003, and carry pricing of LIBOR plus 2.5% for the Revolving Line of Credit and Term Loan A and prime rate for Term Loan B. In the restructure, the Bank of Scotland forgave a fee in the amount of $2.5 million, which resulted in accrued loan fees of $.8 million owed to the senior lender being recorded as an extraordinary gain in the consolidated financial statements. The Second Amendment provides for a facility fee of $.5 million and a prepayment fee of $.5 million. The restructured loan facility requires the consent of the Lenders prior to payment of any common and preferred dividends. The Company obtained waivers or modifications under the Second Amendment that brought the Company into compliance under the facility and cured defaults that existed prior to the restructure. In connection with the restructuring of the loan facility, the Company and IFA Parent amended IFA Parent's option to acquire a warrant for 1,975,000 shares of non-voting Common Stock, which was granted to IFA Parent in December 1999 in connection with the $25 million subordinated debt facility. The option, as amended, allows IFA Parent to acquire a warrant for 1,975,000 shares of the Company's non-voting Common Stock; the option can be exercised after August 31, 2001 if Term Loan B remains outstanding, but not prior to that date. The strike price of $2.3125 remains the same. In the event that prior to August 31, 2001 the Company either (a) refinances the $12 million Term Loan B with subordinated debt, or (b) pays off the balance of Term Loan B from proceeds of an equity offering, then the option to acquire a warrant for 1,975,000 shares of non-voting Common Stock will terminate. IFA Parent also retains its warrant to purchase 425,000 shares of the Company's voting Common Stock at $2.3125 per share, which was issued in connection with the debt restructure in December 2000. In the event that Term Loan B is terminated prior to August 31, 2001 through a transaction involving the issuance of warrants, IFA Parent is entitled to additional warrants in connection with this existing warrant for 425,000 shares to retain its ability to acquire approximately 4.86% of the Company's common stock. Dividends on outstanding preferred stock of FirstCity will be restricted until Term Loan B is paid in full. The Company stated previously that it intended to seek stockholder approval prior to the end of fiscal year 2000 for the replacement of Term Loan B with a private placement of subordinated debt provided by certain insiders and other interested investors. At that time it was contemplated that warrants for common stock would be issued in connection with the private placement. The Company, however, is limited in its ability to issue common shares and warrants due to change of control issues related to its substantial net operating loss carryforwards. While the private placement originally contemplated would allow for the payment of future dividends on the preferred stock, management believes that a more strategic utilization of the shares available would better serve the long-term interests of the Company's stockholders. The Company currently does not plan to pursue the private placement at this time. Management will continue to evaluate alternatives to repay Term Loan B prior to August 31, 2001 to terminate the option to obtain warrants for 1,975,000 shares of the Company's non-voting common stock. This would allow the Company to utilize these shares in a transaction that the Company believes would maximize long-term stockholder value. 51 54 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) During the second quarter of 2000, the Portfolio Asset acquisition and resolution group of the Company entered into a $17 million loan facility with a related party. This facility is being used exclusively to provide equity in new portfolio acquisitions in partnerships with this related party. In January 2001, this facility was increased to $30 million. As of December 31, 2000, the Company has $15.6 million outstanding under this facility. Management believes that the IFA Parent loan facilities described above along with the liquidity from the Cargill line, the related fees generated from the servicing of assets and equity distributions (totaling approximately $11.6 million in 2000) 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) DISCONTINUED OPERATIONS The Company recorded a provision of $5 million in 2000 for additional losses from discontinued operations. Effective during the third quarter of 1999, management of the Company adopted formal plans to discontinue the operations of Harbor Financial Group, Inc. (formerly known as FirstCity Financial Mortgage Corp.) and its subsidiaries (collectively referred to as "Mortgage Corp."), and FC Capital Corp. ("Capital Corp."). These entities comprise the operations that were previously reported as the Company's residential and commercial mortgage banking business. As formal termination plans were adopted and historical business operations at each entity have ceased, the results of operations for 1999 have been reflected as discontinued operations in the accompanying consolidated statements of operations. Additionally, the net assets related to the resolution of activity from the discontinued operations have been reflected in the accompanying consolidated balance sheets. The results of operations from discontinued operations for 1999 were composed of an operating loss of $39.1 million, the Company's write-off of its investment of $50.5 million in Mortgage Corp. and the write down of its net investment in Capital Corp. by $12.7 million. In 1998, the results of operations from discontinued operations were composed of an operating loss of $21.0 million. Revenues from discontinued operations were zero in 2000, $56.3 million in 1999 and $148.0 million in 1998. The following is a summary of activity related to each of the entities' operations. Mortgage Corp. -- During the third quarter of 1999, Mortgage Corp. incurred significant losses from operations and the liquidation of certain assets. Ultimately, on October 14, 1999, Mortgage Corp. filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas. On December 14, 1999 the bankruptcy proceedings were converted to liquidations under Chapter 7 of the United States Bankruptcy Code. In the filings, the stated assets of Mortgage Corp. were approximately $95 million and the stated liabilities were approximately $98 million. Additionally, it is anticipated that the liquidation of any remaining assets will yield proceeds, which are less than the stated amount of the assets as listed in the filings. The Company does not guarantee any of the debt of Mortgage Corp. Furthermore, management of the Company was not involved in the daily operations of Mortgage Corp. during a significant portion of the third quarter of 1999 and no longer had access to financial records of Mortgage Corp. Based on the above, Mortgage Corp. was deemed insolvent and the Company wrote off its entire investment in and advances to (collectively referred to as the Net Investment) Mortgage Corp. Capital Corp. -- Management of the Company made the decision to completely exit all mortgage banking activities due to the significant negative impact realized from Mortgage Corp. The Company ceased acquiring mortgage loans under Capital Corp.'s platform during the fourth quarter of 1999. The only assets remaining from Capital Corp.'s operations are the investment securities resulting from the retention of residual interests in securitization transactions completed by Capital Corp. The Company has considered the estimated future gross cash receipts from such investment securities in the computation of the loss from discontinued operations. The cash flows are valued using prepayment assumptions of 25% for fixed 52 55 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) rate loans and 35% to 50% for variable rate loans. Loss rates are estimated at 2%. If the prepayment speeds were to increase by 10% and 20%, the estimated future gross cash receipts would decrease by $1,736 and $3,416, respectively. The net assets from discontinued operations consist of the following:
DECEMBER 31, ----------------- 2000 1999 ------- ------- Estimated future gross cash receipts on residual interests in securitizations........................................ $24,652 $28,602 Accrual for loss on operations and disposal of discontinued operations, net........................................... (4,208) (8,476) ------- ------- Net assets of discontinued operations............. $20,444 $20,126 ======= =======
An accrual of $5.0 million for costs to complete the plan of discontinuation was recorded in the second quarter of 2000. No additional accrual was deemed necessary by management during the remainder of 2000. (4) PORTFOLIO ASSETS Portfolio Assets are summarized as follows:
DECEMBER 31, ----------------- 2000 1999 ------- ------- Non-performing Portfolio Assets............................. $55,807 $82,291 Performing Portfolio Assets................................. 15,162 7,983 Real estate Portfolios...................................... 3,075 7,663 ------- ------- Total Portfolio Assets............................ 74,044 97,937 Adjusted purchase discount required to reflect Portfolio Assets at carrying value.................................. (44,026) (58,500) ------- ------- Portfolio Assets, net............................. $30,018 $39,437 ======= =======
The Company recorded an allowance for impairment on a real estate Portfolio of approximately $2.0 million in 2000. Portfolio Assets are pledged to secure non-recourse notes payable. (5) LOANS RECEIVABLE A significant portion of the automobile loans was transferred to Drive in connection with the sale of the 49% equity interest in the Company's automobile finance operation. The Company also has other loans held for investment, which are comprised of loans from certain Acquisition Partnerships. Loans receivable are summarized as follows:
DECEMBER 31, ----------------- 2000 1999 ------- ------- Automobile and consumer finance receivables................. $ 332 $37,718 Other loans held for investment............................. 14,207 883 Allowance for loan losses................................... -- (8,457) ------- ------- Loans receivable, net............................. $14,539 $30,144 ======= =======
53 56 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The activity in the allowance for loan losses is summarized as follows for the periods indicated:
YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- Balances, beginning of year.......................... $ 8,457 $ 5,894 $ 9,282 Provision for loan losses............................ 822 368 4,751 Discounts acquired................................... 18,989 26,484 18,334 Allocation of reserves to sold loans................. (5,606) (22,036) (17,133) Charge off activity: Principal balances charged off..................... (9,041) (4,362) (12,958) Recoveries......................................... 1,902 2,109 3,618 -------- -------- -------- Net charge offs................................. (7,139) (2,253) (9,340) Adjustment from sale of interest in Drive............ (15,523) -- -- -------- -------- -------- Balances, end of year................................ $ -- $ 8,457 $ 5,894 ======== ======== ========
The provision for loan losses during 1998 was predominantly for automobile finance receivables generated by the Company's original automobile platform, referred to as NAF, which was discontinued in January 1998. (6) RESIDUAL INTERESTS IN SECURITIZATIONS The Company had residual interests in securitizations (which were transferred to Drive in connection with the Company's sale of the 49% equity interest in its automobile finance operations) consisting of rated securities, retained interests, servicing interests and related interest only strips (collectively referred to as residual interests), which were attributable to loans sold through securitization transactions by the Company. No residual interests were held by the Company at December 31, 2000. Residual interests were comprised of the following at December 31, 1999: Rated securities............................................ $ 1,313 Residual interests.......................................... 62,167 Accrued interest............................................ 565 Valuation allowance......................................... (8,384) ------- $55,661 =======
The activity related to residual interests is as follows:
YEAR ENDED DECEMBER 31, ----------------------------- 2000 1999 1998 -------- -------- ------- Balance, beginning of year............................ $ 55,661 $ 41,849 $ 6,935 Residual interests received from securitizations...... 5,713 27,306 44,309 Cost allocated from securitizations................... 1,694 -- -- Interest accreted..................................... 4,077 5,487 2,181 Cash received from trusts............................. (16,919) (15,047) (7,126) Provision for permanent impairment of value........... (1,598) (3,934) (4,450) Adjustment from sale of interest in Drive............. (48,628) -- -- -------- -------- ------- Balance, end of year.................................. $ -- $ 55,661 $41,849 ======== ======== =======
54 57 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (7) EQUITY INVESTMENTS The Company has investments in Acquisition Partnerships and their general partners that are accounted for under the equity method. During 1999, the Company also acquired investments in servicing entities that are accounted for on the equity method. Activity relating to the servicing entities was not significant during 2000 and 1999. The condensed combined financial position and results of operations of the Acquisition Partnerships (excluding servicing entities), which include the domestic and foreign Acquisition Partnerships and their general partners, are summarized below: CONDENSED COMBINED BALANCE SHEETS
DECEMBER 31, ------------------- 2000 1999 -------- -------- Assets...................................................... $603,353 $324,954 ======== ======== Liabilities................................................. 471,336 210,967 Net equity.................................................. 132,017 113,987 -------- -------- $603,353 $324,954 ======== ======== Equity investment in Acquisition Partnerships............... $ 33,862 $ 29,639 Equity investment in Servicing Entities..................... 1,422 1,465 -------- -------- $ 35,284 $ 31,104 ======== ========
CONDENSED COMBINED SUMMARY OF EARNINGS
YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- Proceeds from resolution of Portfolio Assets......... $163,386 $124,912 $170,187 Gain on resolution of Portfolio Assets............... 75,788 51,035 57,628 Interest income on performing Portfolio Assets....... 18,049 16,409 9,714 Net earnings......................................... $ 36,766 $ 36,455 $ 33,706 ======== ======== ======== Equity in earnings of Acquisition Partnerships....... $ 7,203 $ 11,444 $ 12,827 Equity in earnings (loss) of Servicing Entities...... 166 (126) -- -------- -------- -------- $ 7,369 $ 11,318 $ 12,827 ======== ======== ========
As discussed in Note 2, in the third quarter of 2000, the Company completed the sale of a 49% equity interest in its automobile finance operation to certain subsidiaries of IFA Parent. As a result of the sale, the net operations of Drive have been recorded (since August 1, 2000) as equity investments. The Company's 55 58 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) investment in Drive is accounted for under the equity method. The condensed consolidated financial position and results of operations of Drive are summarized below: CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 ------------ Assets...................................................... $164,208 ======== Liabilities................................................. 154,561 Net equity.................................................. 9,647 -------- $164,208 ======== Equity investment in Drive.................................. $ 3,738 Minority interest......................................... (748) -------- Net investment in Drive................................ $ 2,990 ========
CONDENSED CONSOLIDATED SUMMARY OF EARNINGS
AUGUST 1, 2000 THROUGH DECEMBER 31, 2000 ----------------- Revenues.................................................... $20,268 Expenses.................................................... 14,529 ------- Net earnings................................................ $ 5,739 ------- Equity in earnings of Drive................................. $ 2,223 Minority interest......................................... (444) ------- Net equity in earnings of Drive........................ $ 1,779 =======
(8) NOTES PAYABLE Notes payable consisted of the following:
DECEMBER 31, ------------------ 2000 1999 ------- -------- Collateralized loans, secured by Portfolio Assets: Fixed rate (7.66% at December 31, 2000), due 2002......... $13,251 $ 21,873 LIBOR (6.64% at December 31, 2000) plus 4% to 5%, due at various dates through 2002............................. 16,190 16,442 Senior Credit Facility, secured and with recourse to the Company................................................... 47,778 77,000 Acquisition Facility, secured by certain equity interests of the Company: LIBOR (6.64% at December 31, 2000) plus 4.50%, due 2002........................................... 15,623 -- Collateralized loans, secured by automobile finance receivables............................................... -- 20,092 Collateralized loan, secured by residual interests in securitizations........................................... -- 4,257 Senior subordinated notes................................... -- 24,125 Other borrowings, secured by fixed assets................... -- 2,604 ------- -------- Notes payable, secured.................................... 92,842 166,393 Notes payable to others at various fixed rates between 7.00% and 9.56%, due at various dates through 2002..... 922 3,399 ------- -------- $93,764 $169,792 ======= ========
56 59 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Refer to Note 2 for a description of terms related to the Company's Senior Credit Facility at December 31, 2000 and other matters concerning the Company's liquidity. Under terms of certain borrowings, the Company and its subsidiaries are required to maintain certain tangible net worth levels and debt to equity and debt service coverage ratios. The terms also restrict future levels of debt. At December 31, 2000, the Company was in compliance with the aforementioned covenants. The aggregate maturities of notes payable for the three years ending December 31, 2003 are as follows: $1,702 in 2001, $44,940 in 2002 and $47,122 in 2003. (9) SEGMENT REPORTING The Company is engaged in two reportable segments i) portfolio asset acquisition and resolution and ii) consumer lending. These segments have been segregated based on products and services offered by each. As a result of the sale of a 49% equity interest in the Company's automobile finance operation, the net operations of Drive have been recorded (since August 1, 2000) as equity in earnings of investments. Prior to June 30, 1999, the Company also reflected operations from its mortgage banking segment. As described in Note 3, the Company has discontinued operations in the mortgage banking segment effective in the third quarter of 1999. Accordingly, all activity related to the mortgage banking segment has been reclassified as discontinued operations in the consolidated financial statements. The following is a summary of results of operations for each of the two remaining segments and a reconciliation to earnings (loss) from continuing operations for 2000, 1999 and 1998. 57 60 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, ---------------------------- 2000 1999 1998 -------- ------- ------- PORTFOLIO ASSET ACQUISITION AND RESOLUTION: Revenues: Servicing fees......................................... $ 7,555 $ 3,850 $ 3,062 Gain on resolution of Portfolio Assets................. 3,120 4,054 9,208 Equity in earnings of investments...................... 7,369 11,318 12,827 Interest income........................................ 2,143 2,610 2,452 Other.................................................. 1,129 3,665 1,733 -------- ------- ------- Total............................................. 21,316 25,497 29,282 Expenses: Interest and fees on notes payable..................... 3,266 4,308 6,244 Salaries and benefits.................................. 5,531 5,542 4,619 Provision for loan and impairment losses............... 1,971 -- -- Occupancy, data processing and other................... 7,083 5,818 6,078 -------- ------- ------- Total............................................. 17,851 15,668 16,941 -------- ------- ------- Operating contribution before direct taxes................ $ 3,465 $ 9,829 $12,341 ======== ======= ======= Operating contribution, net of direct taxes............... $ 3,354 $ 9,743 $12,284 ======== ======= ======= CONSUMER LENDING: Revenues: Servicing fees......................................... $ 3,887 $ 5,086 $ 2,705 Equity in earnings of investments...................... 2,223 -- -- Gain on sale of automobile loans....................... 2,836 10,280 7,214 Interest income........................................ 12,882 17,787 10,035 Gain on sale of interest in subsidiary................. 8,091 -- -- Other.................................................. 71 171 106 -------- ------- ------- Total............................................. 29,990 33,324 20,060 Expenses: Interest and fees on notes payable..................... 3,217 4,730 3,549 Salaries and benefits.................................. 7,277 8,053 5,602 Provision for loan and impairment losses............... 2,420 4,302 9,201 Occupancy, data processing and other................... 6,706 10,539 5,466 -------- ------- ------- Total............................................. 19,620 27,624 23,818 -------- ------- ------- Operating contribution (loss) before direct taxes......... $ 10,370 $ 5,700 $(3,758) ======== ======= ======= Operating contribution (loss), net of direct taxes........ $ 10,362 $ 5,635 $(3,758) ======== ======= ======= Total operating income, net of direct taxes....... $ 13,716 $15,378 $ 8,526 ======== ======= ======= CORPORATE OVERHEAD: Other revenue.......................................... $ 870 $ 107 $ 2,202 Corporate interest expense................................ (12,175) (9,716) (4,797) Salaries and benefits, occupancy, professional and other expenses............................................... (7,144) (6,688) (6,335) Deferred tax valuation benefit (allowance)................ (7,000) (4,900) 1,189 -------- ------- ------- Earnings (loss) from continuing operations................ $(11,733) $(5,819) $ 785 ======== ======= =======
58 61 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Revenues from the Portfolio Asset acquisition and resolution business attributable to foreign and domestic operations for the years ended December 31, 2000, 1999 and 1998 are summarized as follows:
YEAR ENDED DECEMBER 31, --------------------------- 2000 1999 1998 ------- ------- ------- Domestic................................................. $14,616 $20,468 $24,241 Foreign.................................................. 6,700 5,029 5,041 ------- ------- ------- $21,316 $25,497 $29,282
Total assets for each of the segments and a reconciliation to total assets is as follows:
DECEMBER 31, ------------------- 2000 1999 -------- -------- Portfolio acquisition and resolution assets................. $ 79,567 $ 71,479 Consumer assets............................................. 4,069 85,261 Deferred tax benefit, net................................... 20,101 27,101 Other assets, net........................................... 16,810 26,655 Net assets of discontinued operations....................... 20,444 20,126 -------- -------- Total assets...................................... $140,991 $230,622 ======== ========
(10) PREFERRED STOCK, SHAREHOLDERS' EQUITY AND LOSS PER SHARE In May 1998, the Company completed the public offering of 1,542,150 shares of FirstCity common stock, of which 341,000 shares were sold by selling shareholders. Net proceeds (after expenses) of $34.1 million were used to retire debt. On May 11, 1998, the Company notified holders of its outstanding 1995 warrants to purchase shares of common stock that it was exercising its option to repurchase such warrants for $1.00 each. In June 1998, as a result of such notification, warrants representing 471,380 shares of common stock were exercised for an aggregate warrant purchase price of $11.8 million. On July 17, 1998 the Company filed a shelf registration statement with the Securities and Exchange Commission, which allows the Company to issue up to $250 million in debt and equity securities from time to time in the future. The registration statement became effective July 28, 1998. As of December 31, 2000, there have been no securities issued under this registration statement. In connection with the issuance of $25 million in senior subordinated debt, the Company issued a warrant for the purchase of 425,000 shares of the Company's common stock at $2.3125 per share (the closing price on the date of issuance of December 21, 1999). The estimated fair value of the warrant totaling $875 was allocated to shareholders' equity with an offsetting discount reflected on the debt. The Company also issued an option to the holder of the senior subordinated notes allowing it to acquire a warrant for 1,975,000 shares of the Company's non-voting common stock. As discussed in Note 2, in the third quarter of 2000, the Company restructured its remaining debt into a new facility provided solely by Bank of Scotland and IFA. IFA will retain its option to acquire warrants for 1,975,000 shares of the Company's common stock. The strike price of $2.3125 will remain the same, but the initial date upon which the option can be exercised has been extended to August 31, 2001. The option can be exercised after August 31, 2001 if Term Loan B remains outstanding, but not prior to such date. In the event that prior to August 31, 2001 the Company either (a) refinances the $12 million Term Loan B with subordinated debt, or (b) pays off the balance of Term Loan B from proceeds of an equity offering, then the option to acquire a warrant for 1,975,000 shares of non-voting common stock will terminate. In the event that Term Loan B is terminated prior to August 31, 2001 through a transaction involving the issuance of warrants, IFA is entitled to additional 59 62 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) warrants in connection with its existing warrant for 425,000 shares to retain its ability to acquire approximately 4.86% of the Company's common stock. The holders of shares of common stock are entitled to one vote for each share on all matters submitted to a vote of common shareholders. In order to preserve certain tax benefits available to the Company, transactions involving shareholders holding or proposing to acquire more than 4.75% of outstanding common shares are prohibited unless the prior approval of the Board of Directors is obtained. In 1997, the Company purchased 537,430 shares (representing $11.3 million in liquidation preference) of special preferred stock. The special preferred stock was redeemed for $14.7 million plus accrued dividends in 1998. Dividends of $2.7 million, or $3.15 per share, were paid in 1998. In June 1997, the Company initiated an offer to exchange one share of special preferred stock for one share of the newly designated adjusting rate preferred stock. The adjusting rate preferred stock has a redemption value of $21.00 per share and cumulative quarterly cash dividends at the annual rate of $3.15 per share through September 30, 1998, adjusting to $2.10 per share through the redemption date of September 30, 2005. The Company may redeem the adjusting rate preferred stock after September 30, 2003 for $21 per share plus accrued dividends. The adjusting rate preferred stock carries no voting rights except in the event of non-payment of dividends. Pursuant to the exchange offer, 1,073,704 shares in 1997 and 149,197 shares in 1998 of special preferred stock were exchanged for a like number of shares of adjusting rate preferred stock. Dividends of $1.9 million and $3.4 million, respectively, or $1.575 and $3.15 per share, respectively, were paid in 1999 and 1998. In the third quarter of 1999, dividends on the Company's adjusting rate preferred stock were suspended. At December 31, 2000, accumulated dividends in arrears on such preferred stock totaled $3.9 million, or $3.15 per share. Since the Company failed to pay quarterly dividends for six consecutive quarters, the holders of adjusting rate preferred stock are entitled to elect two directors to the Company's Board until cumulative dividends have been paid in full. The Board of Directors of the Company may designate the relative rights and preferences of the optional preferred stock when and if issued. Such rights and preferences can include liquidation preferences, redemption rights, voting rights and dividends and shares can be issued in multiple series with different rights and preferences. The Company has no current plans for the issuance of an additional series of optional preferred stock. The Company has stock option and award plans for the benefit of key individuals, including its directors, officers and key employees. The plans are administered by a committee of the Board of Directors and provide for the grant of up to a total of 730,000 shares of common stock. The per share weighted-average fair value of stock options granted during 2000 was $1.84 on the grant date using the Black-Scholes option pricing model with the following assumptions: $0 expected dividend yield, risk-free interest rate of 6.0%, expected volatility of 30%, and an expected life of 10 years. The Company applies Accounting Principles Board Opinion No. 25 in accounting for its stock option and award plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, Accounting for Stock-Based Compensation, the Company's net loss to 60 63 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) common shareholders and net loss per common share would have been reflected as the pro forma amounts indicated below:
2000 1999 1998 -------- --------- -------- Net loss to common shareholders: As reported..................................... $(18,468) $(110,724) $(25,378) Pro forma....................................... (19,130) (111,502) (26,659) Net loss per common share -- diluted: As reported..................................... $ (2.21) $ (13.33) $ (3.35) Pro forma....................................... (2.29) (13.42) (3.52)
Stock option activity during the periods indicated is as follows:
2000 1999 1998 ------------------ ------------------ ------------------ WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------- -------- ------- -------- ------- -------- Outstanding at beginning of Year...................... 236,650 $22.96 284,950 $23.06 314,300 $22.64 Granted..................... 183,000 2.00 -- -- 15,000 29.69 Exercised................... -- -- -- -- (12,350) 22.04 Cancelled................... (22,500) 22.00 -- -- -- -- Forfeited................... (49,400) 23.60 (48,300) 23.54 (32,000) 22.50 ------- ------ ------- ------ ------- ------ Outstanding at end of year...................... 347,750 $12.03 236,650 $22.96 284,950 $23.06 ======= ====== ======= ====== ======= ======
At December 31, 2000, the range of exercise prices and weighted-average remaining contractual life of outstanding options was $2.00 to $30.75 and 7.78 years, respectively. In addition, 146,938 options were exercisable with a weighted-average exercise price of $22.62. The Company has an employee stock purchase plan, which allows employees to acquire approximately 150,000 shares of common stock of the Company at 85% of the fair value at the end of each quarterly plan period. The value of the shares purchased under the plan is limited to the lesser of 10% of compensation or $25,000 per year. Under the plan, 35,044 shares were issued in 2000, 45,341 shares were issued in 1999, and 35,220 shares were issued in 1998. At December 31, 2000, approximately 30,000 shares of common stock are available for issuance pursuant to the plan. No effect was given to dilutive securities in the 2000, 1999 and 1998 loss per share calculations as such had an anti-dilutive effect. However, during 2000, an average of 234,629 options were outstanding that could have a potentially dilutive per share calculation effect in the future. (11) INCOME TAXES Income tax benefit (expense) from continuing operations consists of:
YEAR ENDED DECEMBER 31, -------------------------- 2000 1999 1998 ------- ------- ------ Federal and state current benefit (expense).............. $ (414) $ 10 $ (505) Federal deferred benefit (expense)....................... (7,000) (5,061) 1,637 ------- ------- ------ Total.......................................... $(7,414) $(5,051) $1,132 ======= ======= ======
Income taxes attributed to discontinued operations consist of deferred expense of $89 in 1998. 61 64 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The actual income tax benefit (expense) attributable to earnings (loss) from continuing operations differs from the expected tax benefit (expense) (computed by applying the federal corporate tax rate of 35% to earnings (loss) from continuing operations before income taxes, minority interest and accounting change) as follows:
2000 1999 1998 ------- ------- ------ Computed expected tax benefit (expense).................. $ 1,439 $ (256) $ 61 (Increase) reduction in income taxes resulting from: Change in valuation allowance.......................... (8,439) (4,253) 1,777 Alternative minimum tax and state income tax........... (414) -- (505) Other.................................................. -- (542) (201) ------- ------- ------ $(7,414), $(5,051) $1,132 ======= ======= ======
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets at December 31, 2000 and 1999 are as follows:
2000 1999 --------- --------- Deferred tax assets: Investments in Acquisition Partnerships, principally due to differences in basis for tax and financial reporting purposes............................................... $ 1,902 $ 676 Intangibles, principally due to differences in amortization........................................... 269 325 Book loss reserve greater than tax loss reserve........... -- 2,960 Tax basis in fixed assets greater (less) than book........ (581) 2,118 Other..................................................... 2,133 -- Federal net operating loss carryforwards.................. 203,428 199,633 --------- --------- Total gross deferred tax assets................... 207,151 205,712 Valuation allowance....................................... (187,050) (178,611) --------- --------- Net deferred tax assets........................... $ 20,101 $ 27,101 ========= =========
The Company has net operating loss carryforwards for federal income tax purposes of approximately $581.2 million from continuing operations and $152.1 million from discontinued operations at December 31, 2000, available to offset future federal taxable income, if any, through the year 2020. A valuation allowance is provided to reduce the deferred tax assets to a level, which, more likely than not, will be realized. During 2000, 1999 and 1998, the Company adjusted the previously established valuation allowance to recognize a deferred tax benefit (expense) of $(8.4) million, $(4.3) million and $1.8 million, respectively. The ultimate realization of the resulting net deferred tax asset is dependent upon generating sufficient taxable income from its continuing operations remaining prior to expiration of the net operating loss carryforwards. The expense recognized in 2000 is attributed to a reduction in anticipated taxable income. The expense recognized in 1999 is attributed to a revaluation of the realization of the deferred tax asset for the effects of the discontinuance of the mortgage operations. Although realization is not assured, management believes it is more likely than not that all of the recorded deferred tax asset, net of the allowance, will be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted in the future if estimates of future taxable income during the carryforward period change. The ability of the Company to realize the deferred tax asset is periodically reviewed and the valuation allowance is adjusted accordingly. (12) EMPLOYEE BENEFIT PLAN The Company has a defined contribution 401(k) employee profit sharing plan pursuant to which the Company matches employee contributions at a stated percentage of employee contributions to a defined 62 65 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) maximum. The Company's contributions to the 401(k) plan were $263 in 2000, $238 in 1999, and $192 in 1998. (13) LEASES The Company leases its current headquarters from a related party under a noncancellable operating lease. The lease calls for monthly payments of $7.5 thousand through its expiration in December 2001 and includes an option to renew for two additional five-year periods. Rental expense for 2000, 1999 and 1998 under this lease was $90 each year. The Company also leases office space and equipment from unrelated parties under operating leases expiring in various years through 2005. Rental expense under these leases for 2000, 1999 and 1998 was $1.7 million, $2.1 million and $1.1 million, respectively. As of December 31, 2000, the future minimum lease payments under all noncancellable operating leases are: $217 in 2001, $96 in 2002, $53 in 2003, $41 in 2004 and $35 in 2005. (14) OTHER RELATED PARTY TRANSACTIONS The Company has contracted with the Acquisition Partnerships and related parties as a third party loan servicer. Servicing fees totaling $11.4 million, $8.9 million and $5.8 million for 2000, 1999 and 1998, respectively, and due diligence fees (included in other income) were derived from such affiliates. (15) COMMITMENTS AND CONTINGENCIES The Company and Harbor Financial Group, Inc. (formerly known as FirstCity Financial Mortgage Corporation) filed suit in the Federal District Court for the Western District of Texas, Waco Division, against Chase Bank of Texas, N.A. and Chase Securities, Inc. in September 1999 seeking damages resulting from alleged violations by the defendants of the Bank Holding Company Act and from civil conspiracy engaged in by the defendants, and injunctive relief, arising from an engagement letter entered into between the Company and Chase Securities, Inc. relating to the sale assets or securities of Harbor Financial Group, Inc., Harbor Financial Mortgage Corporation and their subsidiaries (collectively "Harbor"). The Company alleged that Chase Bank of Texas, N.A. conditioned its extension of credit to Harbor on the retention of Chase Securities, Inc. by the Company and Harbor violated the Bank Holding Company Act. The Company additionally sought a judicial declaration that the plaintiffs were not obligated to pay any commission to Chase Securities, Inc. under the engagement letter. The actual damages sought by the Company were in excess of $200 million. The Company also sought recovery of three times its damages pursuant to the Bank Holding Company Act and recovery of its costs of court, including reasonable attorneys fees. A motion to dismiss the Texas suit was granted based upon a provision in the engagement letter that provided that any suit arising from the engagement letter would be pursued in the State of New York. The Company has requested leave of the Supreme Court for the State of New York to amend its answer in that proceeding to include these claims as a counterclaim to the suit brought by Chase Securities, Inc. and an action against Chase Bank of Texas, N.A. On October 4, 1999, Chase Securities, Inc. filed suit against the Company before the Supreme Court for the State of New York, County of New York: Commercial Part seeking recovery of $2.4 million as the balance of a transaction fee allegedly due it under the terms of the engagement letter and other just and proper relief. The Company denies that it has any liability to Chase Securities, Inc. and intends to vigorously defend the suit. The Company has asserted as a defense to this action the violations of the Bank Holding Company Act asserted in the litigation pending before the Federal District Court for the Western District of Texas. The Company has sought leave to amend its answer in the suit to include a counterclaim against Chase Securities, Inc. and an action against Chase Bank of Texas, N.A. under the Bank Holding Company Act as is asserted in the Texas suit. 63 66 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) On October 14, 1999, Mortgage Corp. filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code before the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. In a motion filed in those proceedings requesting the appointment of a Chapter 11 Trustee, the debtors stated that they were reviewing pre-petition transfers to the Company to determine if those transfers are avoidable. On December 14, 1999, the bankruptcy proceedings were converted to liquidations under Chapter 7 of the United States Bankruptcy Code. The Chapter 7 Trustee has not initiated an action against the Company to assert an avoidance action to recover any preferential transfers. The Company believes that it has valid defenses to any allegations that might be made to avoid any pre-petition transfers in connection with the Mortgage Corp. bankruptcy proceedings. Periodically, the Company, its subsidiaries, its affiliates and the Acquisition Partnerships are parties to or otherwise involved in legal proceedings arising in the normal course of business. The Company does not believe that there is any proceeding threatened or pending against it, its subsidiaries, its affiliates or the Acquisition Partnerships which, if determined adversely, would have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company, its subsidiaries, its affiliates or the Acquisition Partnerships. The Company is a 50% owner in an entity that is obligated to advance up to $2.5 million toward the acquisition of Portfolio Assets from financial institutions in California. At December 31, 2000, advances of $2.4 million had been made under the obligation. In connection with the transactions contemplated by the Securities Purchase Agreement, Consumer Corp. and Funding LP contributed all of the assets utilized in the operations of the automobile finance operation to Drive pursuant to the terms of a Contribution and Assumption Agreement dated as of August 18, 2000, by and between Consumer Corp. and Drive, and a Contribution and Assumption Agreement dated as of August 18, 2000, by and between Funding LP and Drive (collectively, the "Contribution Agreements"). Drive assumed substantially all of the liabilities of the automobile finance operation as set forth in the Contribution Agreements. In addition, in the Securities Purchase Agreement, the Company, Consumer Corp., Funding LP and Funding GP made various representations and warranties concerning (i) their respective organizations, (ii) the automobile finance operation conducted by Consumer Corp. and Funding LP, and (iii) the assets transferred by Consumer Corp. and Funding LP to Drive. The Company, Consumer Corp., Funding LP and Funding GP also agreed to indemnify IFA, IFA-GP and IFA-LP from damages resulting from a breach of any representation or warranty contained in the Securities Purchase Agreement or otherwise made by the Company, Consumer Corp. or Funding LP in connection with the transaction. The indemnity obligation under the Securities Purchase Agreement survives for a period of seven (7) years from August 25, 2000 (the "Closing Date") with respect to tax-related representations and warranties and for thirty (30) months from the Closing Date with respect to all other representations and warranties. None of the Company, Consumer Corp., Funding LP, or Funding GP is required to make any payments as a result of the indemnity provided under the Securities Purchase Agreement until the aggregate amount payable exceeds $.25 million, and then only for the amount in excess of $.25 million in the aggregate; however certain representations and warranties are not subject to this $.25 million threshold. Pursuant to the terms of the Contribution Agreements, Consumer Corp. and Funding LP have agreed to indemnify Drive from any damages resulting in a material adverse effect on Drive resulting from breaches of representations or warranties, failure to perform, pay or discharge liabilities other than the assumed liabilities, or claims, lawsuits or proceedings resulting from the transactions contemplated by the Contribution Agreements. Pursuant to the terms of the Contribution Agreements, Drive has agreed to indemnify Consumer Corp. and Funding LP for any breach of any representation or warranty by Drive, the failure of Drive to discharge any assumed liability, or any claims arising out of any failure by Drive to properly service receivables after August 1, 2000. Liability for indemnification pursuant to the terms of the Contribution Agreements will not arise until the total of all losses 64 67 FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) with respect to such matters exceeds $.25 million and then only for the amount by which such losses exceed $.25 million; however this limitation will not apply to any breach of which the party had knowledge at the time of the Closing Date or any intentional breach by a party of any covenant or obligation under the Contribution Agreements. (16) SUBSEQUENT EVENTS During January 2001 FirstCity increased its line of credit with a related party to $30 million from $17 million, which will provide liquidity for additional equity investments. (17) FINANCIAL INSTRUMENTS SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Company disclose estimated fair values of its financial instruments. Fair value estimates, methods and assumptions are set forth below. (a) CASH AND CASH EQUIVALENTS The carrying amount of cash and cash equivalents approximated fair value at December 31, 2000 and 1999. (b) PORTFOLIO ASSETS AND LOANS RECEIVABLE The Portfolio Assets and loans receivable are carried at the lower of cost or estimated fair value. The estimated fair value is calculated by discounting projected cash flows on an asset-by-asset basis using estimated market discount rates that reflect the credit and interest rate risks inherent in the assets. The carrying value of the Portfolio Assets and loans receivable was $44.6 million and $69.6 million, respectively, at December 31, 2000 and 1999. The estimated fair value of the Portfolio Assets and loans receivable was approximately $47.2 million and $71.8 million, respectively, at December 31, 2000 and 1999. (c) NOTES PAYABLE Management believes that the repayment terms for similar rate financial instruments with similar credit risks and the stated interest rates at December 31, 2000 and 1999 approximate the market terms for similar credit instruments. Accordingly, the carrying amount of notes payable is believed to approximate fair value. (d) REDEEMABLE PREFERRED STOCK Redeemable preferred stock is carried at redemption value plus accrued but unpaid dividends. Carrying values were $29,533 and $26,965 at December 31, 2000 and 1999, respectively. Fair market values based on quoted market rates were $11,618 and $11,770 at December 31, 2000 and 1999, respectively. 65 68 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders FirstCity Financial Corporation: We have audited the accompanying consolidated balance sheets of FirstCity Financial Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FirstCity Financial Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United Sates of America. As discussed in note 1 to the consolidated financial statements, in 1999 the Company changed its method of accounting for organizational costs in accordance with the American Institute of Certified Public Accountants Statement of Position 98-5, Reporting on the Costs of Start-Up Activities. KPMG LLP Dallas, Texas February 6, 2001 66 69 FIRSTCITY FINANCIAL CORPORATION SELECTED QUARTERLY FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
2000 1999 -------------------------------------- --------------------------------------- FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER ------- -------- ------- ------- ------- -------- -------- ------- Revenues........................ $15,676 $ 12,390 $16,186 $ 7,924 $10,977 $ 16,396 $ 13,089 $18,466 Expenses........................ 15,546 19,493 13,224 8,025 12,286 14,460 14,390 17,061 Earnings (loss) from continuing operations before accounting change(1)..................... (129) (13,978) 2,885 (511) (1,262) (3,753) (1,193) 1,154 Accounting change............... -- -- -- -- (765) -- -- -- Extraordinary gain.............. -- -- 833 -- -- -- -- -- Earnings (loss) from discontinued operations(2).... -- (5,000) -- -- 525 (40,128) (62,734) -- Net earnings (loss)............. (129) (18,978) 3,718 (511) (1,502) (43,881) (63,927) 1,154 Preferred dividends............. 642 642 642 642 642 642 642 642 Net earnings (loss) to common shareholders.................. $ (771) $(19,620) $ 3,076 $(1,153) $(2,144) $(44,523) $(64,569) $ 512 Net earnings (loss) from continuing operations before accounting change per common share -- Basic and diluted.... $ (0.09) $ (1.75) $ 0.27 $ (0.14) $ (0.23) $ (0.52) $ (0.22) $ 0.06
--------------- (1) During the second quarter of 2000, the Company reflected significant losses from continuing operations. These losses were primarily related to a $7.0 million increase in the valuation allowance of the deferred tax asset and $2.7 million of provisions for loan and impairment losses. (2) During the second and third quarters of 1999, the Company reflected significant losses from discontinued operations. The loss in the second quarter 1999 was comprised primarily of losses on sales of loans of $6.6 million, losses on sales of mortgage servicing rights of $11.3 million, reserves and write-offs of other assets of $9.1 million, with the balance representing losses from operations. The loss in the third quarter 1999 is primarily due to the write-off of the Company's investment in Mortgage Corp of $50.5 million and the write down of the Company's net investment in Capital Corp by $12.7 million. 67 70 WAMCO PARTNERSHIPS COMBINED BALANCE SHEETS DECEMBER 31, 2000 AND 1999 (DOLLARS IN THOUSANDS) ASSETS
2000 1999 -------- -------- Cash........................................................ $ 6,677 $ 6,453 Portfolio Assets, net....................................... 194,942 225,622 Investments in partnerships................................. 2,254 1,681 Investments in trust certificates........................... 6,908 6,486 Deferred profit sharing..................................... 16,174 7,882 Other assets, net........................................... 1,697 6,915 -------- -------- $228,652 $255,039 ======== ======== LIABILITIES AND PARTNERS' CAPITAL Notes payable (including$128,208 and $162,881 to affiliates in 2000 and 1999, respectively)........................... 135,833 171,908 Deferred compensation....................................... 22,356 12,857 Other liabilities (including $883 and $325 to affiliates in 2000 and 1999, respectively).............................. 3,928 2,546 -------- -------- Total liabilities................................. 162,117 187,311 Commitments and contingencies............................... -- -- Preferred equity............................................ 3,556 3,556 Partners' capital........................................... 62,979 64,172 -------- -------- $228,652 $255,039 ======== ========
See accompanying notes to combined financial statements. 68 71 WAMCO PARTNERSHIPS COMBINED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
2000 1999 1998 -------- -------- -------- Proceeds from resolution of Portfolio Assets............... $ 44,328 $ 51,459 $ 71,473 Cost of Portfolio Assets resolved.......................... 30,115 34,108 49,855 -------- -------- -------- Gain on resolution of Portfolio Assets..................... 14,213 17,351 21,618 Interest income on performing Portfolio Assets............. 18,049 15,599 8,341 Interest expense (including $13,078, $9,624 and $4,494 to affiliates in 2000, 1999 and 1998, respectively)......... (14,776) (11,425) (7,483) General, administrative and operating expenses............. (6,712) (6,949) (10,033) Other income, net.......................................... 1,704 1,938 1,772 -------- -------- -------- Net earnings..................................... $ 12,478 $ 16,514 $ 14,215 ======== ======== ========
See accompanying notes to combined financial statements. 69 72 WAMCO PARTNERSHIPS COMBINED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
CLASS B CLASS A EQUITY EQUITY ------------------- -------- GENERAL LIMITED LIMITED GENERAL LIMITED PARTNERS PARTNERS PARTNERS PARTNERS PARTNERS TOTAL -------- -------- -------- -------- -------- -------- Balance at December 31, 1997....... 272 13,320 3,346 682 37,650 55,270 Contributions.................... 10 483 -- 503 34,077 35,073 Distributions.................... (111) (5,456) (1,111) (699) (41,125) (48,502) Net earnings..................... (5) (224) (290) 201 14,533 14,215 ----- ------- ------- ----- -------- -------- Balance at December 31, 1998....... 166 8,123 1,945 687 45,135 56,056 Contributions.................... 1 40 -- 540 27,558 28,139 Distributions.................... (48) (2,355) (440) (527) (33,167) (36,537) Net earnings..................... 10 476 (81) 250 15,859 16,514 ----- ------- ------- ----- -------- -------- Balance at December 31, 1999....... 129 6,284 1,424 950 55,385 64,172 Contributions.................... 6 325 -- 62 5,821 6,214 Distributions.................... (36) (1,778) (283) (341) (17,447) (19,885) Net earnings..................... 18 884 6 207 11,363 12,478 ----- ------- ------- ----- -------- -------- Balance at December 31, 2000....... $ 117 $ 5,715 $ 1,147 $ 878 $ 55,122 $ 62,979 ===== ======= ======= ===== ======== ========
See accompanying notes to combined financial statements. 70 73 WAMCO PARTNERSHIPS COMBINED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
2000 1999 1998 -------- --------- -------- Cash flows from operating activities: Net earnings.............................................. $ 12,478 $ 16,514 $ 14,215 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Amortization of loan origination and commitment fees... 376 1,334 678 Provision for losses................................... 58 -- -- Gain on resolution of Portfolio Assets................. (14,213) (17,351) (21,618) Purchase of Portfolio Assets........................... (24,172) (107,704) (91,713) Capitalized costs on Portfolio Assets.................. (3,112) (5,304) (2,095) Proceeds from resolution of Portfolio Assets........... 44,328 51,459 71,473 Principal payments on Performing Portfolio Assets...... 27,791 1,420 -- Increase in deferred profit sharing.................... (8,292) (3,336) (5,307) (Increase) decrease in other assets.................... 531 (138) 857 Increase in deferred compensation...................... 9,499 3,437 9420 Increase (decrease) in other liabilities............... 1,894 (571) 1,574 -------- --------- -------- Net cash provided by (used in) operating activities...................................... 47,166 (60,240) (22,516) Cash flows from investing activities: Contribution to subsidiaries.............................. (573) (1,090) (406) Purchase of trust certificates............................ (420) (330) (281) -------- --------- -------- Net cash used in operating activities............. (993) (1,420) (687) Cash flows from financing activities: Borrowing of debt......................................... 29,673 160,903 93,308 Repayment of debt......................................... (61,951) (100,057) (56,269) Issuance of preferred equity.............................. -- 3,556 -- Capital contributions..................................... 6,214 28,139 35,073 Capital distributions..................................... (19,885) (36,537) (48,502) -------- --------- -------- Net cash provided by (used in) financing activities...................................... (45,949) 56,004 23,610 -------- --------- -------- Net increase (decrease) in cash............................. 224 (5,656) 407 Cash at beginning of year................................... 6,453 12,109 11,702 -------- --------- -------- Cash at end of year......................................... $ 6,677 $ 6,453 $ 12,109 ======== ========= ========
Supplemental disclosure of cash flow information (note 6): Cash paid for interest was approximately $13,638, $11,104 and $6,889 for 2000, 1999, and 1998, respectively. See accompanying notes to combined financial statements. 71 74 WAMCO PARTNERSHIPS NOTES TO COMBINED FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999, AND 1998 (DOLLARS IN THOUSANDS) (1) ORGANIZATION AND PARTNERSHIP AGREEMENTS The combined financial statements include the accounts of WAMCO III, Ltd.; WAMCO V, Ltd.; WAMCO IX, Ltd.; WAMCO XVII, Ltd.; WAMCO XXIV, Ltd.; WAMCO XXV, Ltd.; WAMCO XXVI Ltd.; WAMCO XXVII Ltd.; WAMCO XVIII Ltd.; Calibat Fund, LLC; First B Realty, L.P.; First Paradee, L.P.; First Street LLC; FC Properties; Ltd; FCS Creamer, Ltd.; FCS Wildhorse, Ltd.; FCS Wood, Ltd.; FCS Fischer, Ltd.; Imperial Fund I, L.P.; and VOJ Partners, L.P., all of which are Texas limited partnerships ("Acquisition Partnerships" or "Partnerships"). FirstCity Financial Corporation or its subsidiaries, FirstCity Commercial Corporation and FirstCity Holdings Corporation, own limited and general partnership interests in all of the Partnerships. During November 2000, WAMCO V, Ltd. and WAMCO XVII, Ltd. were merged with and into WAMCO III, Ltd., with WAMCO III, Ltd. being the surviving entity. The merger of the acquisition partnerships has no effect on the comparability of the combined financial statements. All significant intercompany balances have been eliminated. The Partnerships were formed to acquire, hold and dispose of Portfolio Assets acquired from the Federal Deposit Insurance Corporation, Resolution Trust Corporation and other nongovernmental agency sellers, pursuant to certain purchase agreements or assignments of such purchase agreements. In accordance with the purchase agreements, the Partnerships retain certain rights of return regarding the assets related to defective title, past due real estate taxes, environmental contamination, structural damage and other limited legal representations and warranties. Generally, the partnership agreements of the Partnerships provide for certain preferences as to the distribution of cash flows. Proceeds from disposition of and payments received on the Portfolio Assets are allocated based on the partnership and other agreements which ordinarily provide for the payment of interest and mandatory principal installments on outstanding debt before payment of intercompany servicing fees and return of capital and restricted distributions to partners. Additionally, WAMCO III, Ltd., WAMCO V, Ltd. and WAMCO XVII, Ltd. provide for Class A and Class B Equity partners in their individual partnership agreements. The Class B Equity limited partners are allocated 20 percent of cumulative net income recognized by the respective partnerships prior to allocation to the Class A Equity limited partners and the general partners. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) PORTFOLIO ASSETS The Partnerships acquire and resolve portfolios of performing and nonperforming commercial and consumer loans and other assets (collectively, "Portfolio Assets" or "Portfolios"), which are generally acquired at a discount to their legal principal balance. Purchases may be in the form of pools of assets or single assets. The Portfolio Assets are generally nonhomogeneous assets, including loans of varying qualities that are secured by diverse collateral types and foreclosed properties. 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 either on business or real estate or other collateral cash flow. Portfolio Assets are acquired on behalf of legally independent partnerships ("Acquisition Partnerships") in which a corporate general partner, FirstCity Financial Corporation ("FirstCity") and other investors are limited partners. 72 75 WAMCO PARTNERSHIPS NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) Portfolio Assets are reflected in the accompanying combined financial statements as non-performing Portfolio Assets, performing Portfolio Assets or real estate Portfolios. The following is a description of each classification and the related accounting policy accorded to each Portfolio type: Non-Performing Portfolio Assets Non-performing Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed upon collateral. Portfolio Assets are designated as non-performing unless substantially all of the loans in the Portfolio are being repaid in accordance with the contractual terms of the underlying loan agreements. Such Portfolios are acquired on the basis of an evaluation by the Partnerships of the timing and amount of cash flow expected to be derived from borrower payments or other resolution of the underlying collateral securing the loan. All non-performing Portfolio Assets are purchased at substantial discounts from their outstanding legal principal amount, the total of the aggregate of expected future sales prices and the total payments to be received from obligors. Subsequent to acquisition, the amortized cost of non-performing Portfolio Assets is evaluated for impairment on a quarterly basis. A valuation allowance is established for any impairment identified through provisions charged to earnings in the period the impairment is identified. 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 Portfolio. Cost allocation is based on a proration of actual proceeds divided by total estimated proceeds of the Portfolio. 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. Accounting for Portfolios is on a pool basis as opposed to an individual asset-by-asset basis. Performing Portfolio Assets Performing Portfolio Assets consist primarily of Portfolios of consumer and commercial loans acquired at a discount from the aggregate amount of the borrowers' obligation. Portfolios are classified as performing if substantially all of the loans in the Portfolio are being repaid in accordance with the contractual terms of the underlying loan agreements. Performing Portfolio Assets are carried at the unpaid principal balance of the underlying loans, net of acquisition discounts. Interest is accrued when earned in accordance with the contractual terms of the loans. The accrual of interest is discontinued once a loan becomes past due 90 days or more. Acquisition discounts for the Portfolio as a whole are accreted as an adjustment to yield over the estimated life of the Portfolio. Accounting for these Portfolios is on a pool basis as opposed to an individual asset-by-asset basis. The Partnerships account for performing Portfolio Assets in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, which requires creditors to evaluate the collectibility of both contractual interest and principal of loans when assessing the need for a loss accrual. Impairment is measured based on the present value of the expected future cash flows discounted at the loans' effective interest rates, or the fair value of the collateral, less estimated selling costs, if any loans are collateral dependent and foreclosure is probable. Real Estate Portfolios Real estate Portfolios consist of real estate assets acquired from a variety of sellers. Such Portfolios are carried at the lower of cost or fair value less estimated costs to sell. Costs relating to the development and improvement of real estate are capitalized, whereas those relating to holding assets are charged to expense. Income or loss is recognized upon the disposal of the real estate. Rental income, net of expenses, on real estate Portfolios is recognized when received. Accounting for the Portfolios is on an individual asset-by-asset basis as 73 76 WAMCO PARTNERSHIPS NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) opposed to a pool basis. A valuation allowance is established for any impairment identified through provisions charged to earnings in the period the impairment is identified. Assets are foreclosed when necessary through an arrangement with an affiliated entity whereby title to the foreclosed asset is held by the affiliated entity and a note receivable from the affiliate is held by the Partnerships. For financial statement presentation, the affiliated entity note receivable created by the arrangement is included in Portfolio Assets and is recorded at the lower of allocated cost or fair value less estimated cost to sell the underlying asset. (b) INVESTMENT IN TRUST CERTIFICATES The Partnerships hold an investment in trust certificates, representing an interest in a REMIC created by the sale of certain Partnership assets. This interest is subordinate to the senior tranches of the certificate. The investment is carried at the lower of cost (the unpaid balance of the certificate, net of acquisition discounts) or fair value. Interest is accrued in accordance with the contractual terms of the agreement. Acquisition discounts are accreted as an adjustment to yield over the estimated life of the investment. (c) INCOME TAXES Under current Federal laws, partnerships are not subject to income taxes; therefore, no provision has been made for such taxes in the accompanying combined financial statements. For tax purposes, income or loss is included in the individual tax returns of the partners. (d) USE OF ESTIMATES 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. Actual results could differ from those estimates. (3) PORTFOLIO ASSETS Portfolio Assets are summarized as follows:
DECEMBER 31, ------------------- 2000 1999 -------- -------- Non-performing Portfolio Assets............................. $ 98,138 $121,055 Performing Portfolio Assets................................. 158,634 182,534 Real estate Portfolios...................................... 34,136 39,491 -------- -------- Total Portfolio Assets............................ 290,908 343,080 Discount required to reflect Portfolio Assets at carrying value..................................................... (95,966) (117,458) -------- -------- Portfolio Assets, net............................. $194,942 $225,622 ======== ========
Portfolio Assets are pledged to secure non-recourse notes payable. (4) DEFERRED PROFIT SHARING AND DEFERRED COMPENSATION In connection with the formation of FC Properties, Ltd., an agreement was entered into which provided for potential payments to the project manager based on a percentage of total estimated sales. An equal amount of deferred profit participation and deferred compensation is recorded based on such estimates with the deferred profit participation being amortized into expense in proportion to actual sales realized. No profit 74 77 WAMCO PARTNERSHIPS NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) participation will be paid until the limited partners recognize a 20% return on their investment. Management anticipates this return threshold will be met in 2001. At December 31, 2000 and 1999, the estimated liability for this profit participation was $21,175 and $11,767, respectively, and was included in deferred compensation in the accompanying combined balance sheets. Additionally, amortization of $1,118 and $761 was recognized during 2000 and 1999, respectively, and has been included in general, administrative and operating expense in the accompanying statements of operations. Other deferred compensation at December 31, 2000 and 1999 of $1,181 and $1,090, respectively, represent commissions owed to the project manager of FC Properties Ltd. These commissions are based on sales incurred to date and will be paid out after the limited partners recognize a 20% return on their investment. As noted above, management anticipates this return will be met in 2001. (5) NOTES PAYABLE Notes payable at December 31, 2000 and 1999 consist of the following:
2000 1999 -------- -------- Senior collateralized loans, secured by Portfolio Assets: Prime (9.5% at December 31, 2000) plus 0.5% to 7%......... $ 2,145 $ 4,650 LIBOR (6.4% at December 31, 2000) plus 2.25% to 5%........ 115,233 142,951 Fixed rate -- 6.5% to 13%................................. 16,200 22,020 Subordinated collateralized loans, secured by Portfolio Assets: Prime (9.5% at December 31, 2000) plus 1% to 7%........... 2,255 1,215 Uncollateralized intercompany loans: Prime (9.5% at December 31, 2000) plus 1%................. -- 1,072 -------- -------- $135,833 $171,908 ======== ========
Collateralized loans are typically payable based on proceeds from disposition of and payments received on the Portfolio Assets. Contractual maturities (excluding principal and interest payments payable from proceeds from dispositions of and payments received on the Portfolio Assets) of notes payable are as follows:
YEAR ENDING DECEMBER 31: 2001.................................................... 44,298 2002.................................................... 81,739 2003.................................................... 3,262 2004.................................................... 1,298 2005.................................................... 757 Thereafter.............................................. 4,479 -------- $135,833 ========
It is anticipated that the notes payable maturing in 2001 will be renewed or refinanced into financing arrangements with terms similar to current facilities. The loan agreements and master note purchase agreements, under which notes payable were incurred, contain various covenants including limitations on other indebtedness, maintenance of service agreements and restrictions on use of proceeds from disposition of and payments received on the Portfolio Assets. As of December 31, 2000, the Partnerships were in compliance with the aforementioned covenants. In connection with notes payable, the Partnerships incurred origination and commitment fees. These fees are amortized proportionate to the principal reductions on the related notes and are included in general, 75 78 WAMCO PARTNERSHIPS NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) administrative and operating expenses. At December 31, 2000 and 1999, approximately $696 and $792, respectively, of origination and commitment fees are included in other assets, net. (6) TRANSACTIONS WITH AFFILIATES Under the terms of the various servicing agreements between the Partnerships and FirstCity, FirstCity receives a servicing fee based on proceeds from resolution of the Portfolio Assets for processing transactions on the Portfolio Assets and for conducting settlement, collection and other resolution activities. Included in general, administrative and operating expenses in the accompanying combined statements of operations is approximately $2,566, $2,613, and $2,752 in servicing fees incurred by the Partnerships in 2000, 1999 and 1998, respectively. During 2000, WAMCO V merged with WAMCO III, with WAMCO III being the surviving entity. As a result of the merger, WAMCO V contributed $3,370 in assets and $1,461 in liabilities to WAMCO III. The contributed assets and liabilities were recorded at historical cost on WAMCO III. The partners in WAMCO V received interests in WAMCO III reflecting the net contribution from WAMCO V to WAMCO III. During 2000, WAMCO XVII merged with WAMCO III, with WAMCO III being the surviving entity. As a result of the merger, WAMCO XVII contributed $4,024 in assets and $2,275 in liabilities to WAMCO III. The contributed assets and liabilities were recorded at historical cost on WAMCO III. The partners in WAMCO XVII received interests in WAMCO III reflecting the net contribution from WAMCO XVII to WAMCO III. (7) FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Partnerships disclose estimated fair values of their financial instruments. Fair value estimates, methods and assumptions are set forth below. (a) CASH, OTHER ASSETS AND OTHER LIABILITIES The carrying amount of cash, other assets and other liabilities approximates fair value at December 31, 2000 and 1999 due to the short-term nature of such accounts. (b) PORTFOLIO ASSETS Portfolio Assets are carried at the lower of cost or estimated fair value. The estimated fair value is calculated by discounting projected cash flows on an asset-by-asset basis using estimated market discount rates that reflect the credit and interest rate risk inherent in the assets. The carrying value of Portfolio Assets was $194,942 and $225,622 at December 31, 2000 and 1999, respectively. The estimated fair value of the Portfolio Assets was approximately $253,255 and $277,397 at December 31, 2000 and 1999, respectively. (c) INVESTMENTS IN TRUST CERTIFICATES Investments in trust certificates are carried at the lower of cost or estimated fair value. Fair value of the investments is estimated by discounting future anticipated cash flows at a rate consistent with similar types of investments. The carrying value of Investments in Trust Certificates was $6,908 and $6,486 at December 31, 2000 and 1999, respectively. The estimated fair value of the Investments in Trust Certificates was approximately $8,611 and $8,335, respectively. 76 79 WAMCO PARTNERSHIPS NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (d) NOTES PAYABLE Management believes that for similar financial instruments with comparable credit risks, the stated interest rates at December 31, 2000 and 1999 approximate market rates. Accordingly, the carrying amount of notes payable is believed to approximate fair value. Additional, the majority of the partnerships' debt is at variable rates of interest. (8) PREFERRED EQUITY WAMCO XXIV, Ltd. invested in Community Development Investment LLC in 1999. This investment carries Preferred Equity belonging to a third party. All net cash flow is payable monthly first to the Preferred Return member in an amount equal to its unreturned contribution, plus interest accrued thereon at a rate of Libor (6.4%) plus 5%, compounded monthly, until such contribution plus accrued interest is returned in full. The remainder, if any, is distributed to the common member interest holder, WAMCO XXIV, Ltd. Not withstanding anything to the contrary, all net losses, net cash use or other situations resulting in a situation requiring additional contributions shall be allocated to, or made by, WAMCO XXIV, Ltd. (9) COMMITMENTS AND CONTINGENCIES Calibat Fund, LLC has committed to make additional investments in partnerships up to $137 at December 31, 2000. The Partnerships are involved in various legal proceedings in the ordinary course of business. In the opinion of management, the resolution of such matters will not have a material adverse impact on the combined financial condition, results of operations or liquidity of the Partnerships. 77 80 INDEPENDENT AUDITORS' REPORT The Partners WAMCO Partnerships: We have audited the accompanying combined balance sheets of the WAMCO Partnerships as of December 31, 2000 and 1999, and the related combined statements of operations, changes in partners' capital, and cash flows for each of the years in the three-year period ended December 31, 2000. These combined financial statements are the responsibility of the Partnerships' management. Our responsibility is to express an opinion on these combined financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of the WAMCO Partnerships as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Dallas, Texas February 6, 2001 78 81 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information called for by this item with respect to the Company's directors and executive officers is incorporated by reference from the information contained under the headings "Election of Directors," "Executive Officers" and "Compliance with Section 16(a) of the Exchange Act" in the Company's definitive proxy statement pertaining to the 2001 Annual Meeting of Stockholders. ITEM 11. EXECUTIVE COMPENSATION. The information called for by this item is incorporated by reference from the information contained under the headings "Director Compensation," "Executive Compensation," "Summary Compensation Table," "Stock Option and Purchase Plans and 401(k) Plan," "Other Exercises and Year-End Values," "Board Compensation Committee Report on Executive Compensation," "Compensation Committee Interlocks and Insider Participation," "Employment Agreements" and "Cumulative Total Stockholder Return" in the Company's definitive proxy statement pertaining to the 2001 Annual Meeting of Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information called for by this item is incorporated by reference from the information contained under the headings "Stock Ownership of Certain Beneficial Owners and Management" in the Company's definitive proxy statement pertaining to the 2001 Annual Meeting of Stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information called for by this item is incorporated by reference from the information contained under the heading "Certain Relationships and Related Transactions" in the Company's definitive proxy statement pertaining to the 2001 Annual Meeting of Stockholders. 79 82 PART IV ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1. Financial Statements The consolidated financial statements of FirstCity and combined financial statements of the WAMCO Partnerships (Acquisition Partnerships) are incorporated herein by reference to Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K. 2. Financial Statement Schedules Financial statement schedules have been omitted because the information is either not required, not applicable, or is included in Item 8, "Financial Statements and Supplementary Data." 3. Exhibits
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1 -- Joint Plan of Reorganization by First City Bancorporation of Texas, Inc., Official Committee of Equity Security Holders and J-Hawk Corporation, with the Participation of Cargill Financial Services Corporation, Under Chapter 11 of the United States Bankruptcy Code, Case No. 392-39474-HCA-11 (incorporated herein by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 2.2 -- Agreement and Plan of Merger, dated as of July 3, 1995, by and between First City Bancorporation of Texas, Inc. and J-Hawk Corporation (incorporated herein by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 3.1 -- Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 3.2 -- Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 4.1 -- Certificate of Designations of the New Preferred Stock ($0.01 par value) of the Company. (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on form 10-K dated March 24, 1998 filed with the Commission on March 26, 1998). 4.2 -- Warrant Agreement, dated July 3, 1995, by and between the Company and American Stock Transfer & Trust Company, as Warrant Agent (incorporated herein by reference to Exhibit 4.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 4.3 -- Registration Rights Agreement, dated July 1, 1997, among the Company, Richard J. Gillen, Bernice J. Gillen, Harbor Financial Mortgage Company Employees Pension Plan, Lindsey Capital Corporation, Ed Smith and Thomas E. Smith. (incorporated herein by reference to Exhibit 4.3 of the Company's Form 10-K dated March 24, 1998 filed with the Commission on March 26, 1998). 4.4 -- Stock Purchase Agreement, dated March 24, 1998, between the Company and Texas Commerce Shareholders Company. (incorporated herein by reference to Exhibit 4.4 of the Company's Form 10-K dated March 24, 1998 filed with the Commission on March 26, 1998).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 4.5 -- Registration Rights Agreement, dated March 24, 1998, between the Company and Texas Commerce Shareholders Company. (incorporated herein by reference to Exhibit 4.5 of the Company's Form 10-K dated March 24, 1998 filed with the Commission on March 24, 1998). 9.1 -- Shareholder Voting Agreement, dated as of June 29, 1995, among ATARA I Ltd., James R. Hawkins, James T. Sartain and Cargill Financial Services Corporation. (incorporated herein by reference to Exhibit 9.1 of the Company's Form 10-K dated March 24,1998 filed with the Commission on March 26, 1998). 10.1 -- Trust Agreement of FirstCity Liquidating Trust, dated July 3, 1995 (incorporated herein by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 10.2 -- Investment Management Agreement, dated July 3, 1995, between the Company and FirstCity Liquidating Trust (incorporated herein by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995 10.3 -- Lock-Box Agreement, dated July 11, 1995, among the Company, NationsBank of Texas, N.A., as lock-box agent, FirstCity Liquidating Trust, FCLT Loans, L.P., and the other Trust-Owned Affiliates signatory thereto, and each of NationsBank of Texas, N.A. and Fleet National Bank, as co-lenders (incorporated herein by reference to Exhibit 10.3 of the Company's Form 8-A/A dated August 25, 1995 filed with the Commission on August 25, 1995). 10.4 -- Custodial Agreement, dated July 11, 1995, among Fleet National Bank, as custodian, Fleet National Bank, as agent, FCLT Loans, L.P., FirstCity Liquidating Trust, and the Company (incorporated herein by reference to Exhibit 10.4 of the Company's Form 8-A/A dated August 25, 1995 filed with the Commission on August 25, 1995). 10.5 -- Tier 3 Custodial Agreement, dated July 11, 1995, among the Company, as custodian, Fleet National Bank, as agent, FCLT Loans, L.P., FirstCity Liquidating Trust, and the Company, as servicer (incorporated herein by reference to Exhibit 10.5 of the Company's Form 8-A/A dated August 25, 1995 filed with the Commission on August 25, 1995). 10.6 -- 12/97 Amended and Restated Facilities Agreement, dated effective as of December 3, 1997, among Harbor Financial Mortgage Corporation, New America Financial, Inc., Texas Commerce Bank National Association and the other warehouse lenders party thereto. (incorporated herein by reference to Exhibit 10.6 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.7 -- Modification Agreement, dated January 26, 1998, to the Amended and Restated Facilities Agreement, dated as of December 3, 1997, among Harbor Financial Mortgage Corporation, New America Financial, Inc. and Chase Bank of Texas, National Association (formerly known as Texas Commerce Bank National Association). (incorporated herein by reference to Exhibit 10,7 of the company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.8 -- $50,000,000 3/98 Chase Texas Temporary Additional Warehouse Note, dated March 17, 1998, by Harbor Financial Mortgage Corporation and New America Financial, Inc., in favor of Chase Bank of Texas, National Association. (incorporated herein by reference to Exhibit 10.8 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.9 -- Employment Agreement, dated as of July 1, 1997, by and between Harbor Financial Mortgage Corporation and Richard J. Gillen. (incorporated herein by reference to Exhibit 10.9 of the Company's 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.10 -- Employment Agreement, dated as of September 8, 1997, by and between FirstCity Funding Corporation and Thomas R. Brower, with similar agreements between FC Capital Corp. and each of James H. Aronoff and Christopher J. Morrissey. (incorporated herein by reference to Exhibit 10.10 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.11 -- Shareholder Agreement, dated as of September 8, 1997, among FirstCity Funding Corporation, FirstCity Consumer Lending Corporation, Thomas R. Brower, Scot A. Foith, Thomas G. Dundon, R. Tyler Whann, Bradley C. Reeves, Stephen H. Trent and Blake P. Bozman. (incorporated herein by reference to Exhibit 10.11 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.12 -- Revolving Credit Loan Agreement, dated as of March 20, 1998, by and between FC Properties, Ltd. and Nomura Asset Capital Corporation. (incorporated herein by reference to Exhibit 10.12 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.13 -- Revolving Credit Loan Agreement, dated as of February 27, 1998, by and between FH Partners, L.P. and Nomura Asset Capital Corporation. (incorporated herein by reference to Exhibit 10.13 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.14 -- Note Agreement, dated as of June 6, 1997, among Bosque Asset Corp., SVD Realty, L.P., SOWAMCO XXII, LTD., Bosque Investment Realty Partners, L.P. and Bankers Trust Company of California, N.A. (incorporated herein by reference to Exhibit 10.14 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.15 -- 60,000,000 French Franc Revolving Promissory Note, dated September 25, 1997, by J-Hawk International Corporation in favor of the Bank of Scotland. (incorporated herein by reference to Exhibit 10.15 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.16 -- Loan Agreement, dated as of September 25, 1997, by and between Bank of Scotland and J-Hawk International Corporation. (incorporated herein reference to Exhibit 10.16 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.17 -- Guaranty Agreement, dated as of September 25, 1997, by J-Hawk (incorporated herein by reference to Exhibit 10.17 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.18 -- Guaranty Agreement, dated as of September 25, 1997, by FirstCity Financial Corporation in favor of Bank of Scotland. (incorporated herein by reference to Exhibit 10.18 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.19 -- Warehouse Credit Agreement, dated as of May 17, 1996, among ContiTrade Services L.L.C., N.A.F. Auto Loan Trust and National Auto Funding Corporation. (incorporated herein by reference to Exhibit 10.19 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.20 -- Funding Commitment, dated as of May 17, 1996 by and between ContiTrade Services L.L.C. and The Company. (incorporated herein by reference to Exhibit 10.20 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.21 -- Revolving Credit Agreement, dated as of December 29, 1995, by and between the Company and Cargill financial Services Corporation, as amended by the Eighth Amendment to Revolving Credit Agreement dated February 1998. (incorporated herein by reference to Exhibit 10.21 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.22 -- Master Repurchase Agreement Governing Purchased and Sales of Mortgage Loans, dated as of July 1998, between Lehman Commercial Paper Inc. and FHB Funding Corp. (incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 18, 1998). 10.23 -- Warehouse Credit Agreement, dated as of April 30, 1998 among ContiTrade Services, L.L.C., FirstCity Consumer Lending Corporation, FirstCity Auto Receivables L.L.C. and FirstCity Financial Corporation. (incorporated herein by reference to Exhibit 10.2 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 16, 1998). 10.24 -- Servicing Agreement, dated as of April 30, 1998 among FirstCity Auto Receivables L.L.C. , FirstCity Servicing Corporation of California, FirstCity Consumer Lending Corporation and ContiTrade Services L.L.C. (incorporated herein by reference to Exhibit 10.3 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 16, 1998). 10.25 -- Security and Collateral Agreement, dated as of April 30, 1998 among FirstCity Auto Receivables L.L.C., ContiTrade Services L.L.C. and Chase Bank of Texas, National Association. (incorporated herein by reference to Exhibit 10.4 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 16, 1998). 10.26 -- Loan Agreement, dated as of July 24, 1998, between FirstCity Commercial Corporation and CFSC Capital Corp. XXX (incorporated herein by reference Exhibit 10.5 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission on August 18, 1998). 10.27 -- Loan Agreement, dated April 8, 1998 between Bank of Scotland and the Company (incorporated herein by reference to Exhibit 10.6 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission on August 18, 1998) 10.28 -- First Amendment to Loan Agreement, dated July 20, 1998, between Bank of Scotland and the Company (incorporated herein by reference to Exhibit 10.7 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission on August 18, 1998). 10.29 -- Employment Agreement, dated October 1, 1998, by and between FirstCity. Financial Mortgage Corporation, and Buddy L. Terrell (incorporated herein by reference to Exhibit 10.29 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.30 -- Security Agreement, dated as of April 30, 1998 among Enterprise Funding Corporation, FCAR Receivables L.L.C., MBIA Insurance Corporation, FirstCity Funding Corporation, NationsBank N.A. and CSC Logic/MSA LLP d/b/a Loan Servicing enterprise (incorporated herein by reference to Exhibit 10.30 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999). 10.31 -- Note purchase agreement, dated March 30, 1999 among Enterprise Funding Corporation, FCAR Receivables, L.L.C. and NationsBank, N.A. (incorporated herein by reference to Exhibit 10.31 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999). 10.32 -- Custodian Agreement, dated March 30, 1999, among FCAR Receivables L.L.C., FirstCity Funding Corporation, NationsBank, N.A., Enterprise Funding Corporation and Chase Bank of Texas, N.A. (incorporated herein by reference to Exhibit 10.32 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999). 10.33 -- Credit agreement dated effective as of May 28, 1999 made by and among Harbor Financial Mortgage, New America Financial, Inc., FirstCity Financial Mortgage Corporation, and Guaranty Federal Bank F.S.B. as Administrative Agent and Bank One, Texas, N.A. as Collateral Agent (incorporated herein by reference to Exhibit 10.33 of the Company's Form 10-Q dated August 16, 1999, filed with the commission on August 16, 1999). 10.34 -- Tenth Amendment to Loan Agreement, dated August 11, 1999 between Bank of Scotland and the Company (incorporated herein by reference to Exhibit 10.34 of the Company's Form 10-Q dated August 16, 1999, filed with the Commission on August 16, 1999). 10.35 -- Amended and Restated Loan Agreement, dated December 20, 1999, By and Among FirstCity Financial Corporation as Borrower and The Lenders Named Herein, as Lenders and Bank of Scotland as Agent (incorporated herein by reference to Exhibit 10.1 of the Company's Form 8-K dated December 22, 1999, filed with the commission on December 28, 1999). 10.36 -- Subordinated Secured Senior Note Purchase Agreement, dated December 20, 1999, between FirstCity Financial Corporation, as Issuer and IFA Corporation, as Purchaser (incorporated herein by reference to Exhibit 10.2 of the Company's Form 8-K dated December 22, 1999, filed with the commission on December 28, 1999). 10.37 -- Employment Agreement, dated October 1, 1999, by and between FirstCity Commercial Corporation and Terry R. DeWitt. (incorporated herein by reference to Exhibit 10.37 of the Company's Form 10-K dated February 8, 2000, filed with the commission of February 8, 2000). 10.38 -- Employment Agreement, dated October 1, 1999, by and between FirstCity Commercial Corporation and G. Stephen Fillip. (incorporated herein by reference to Exhibit 10.38 of the Company's Form 10-K dated February 8, 2000, filed with the commission of February 8, 2000). 10.39 -- Shareholder Agreement, dated October 1, 1999, by and among FirstCity Holdings Corporation, FirstCity Commercial Corporation, Terry R. DeWitt, G. Stephen Fillip and James C. Holmes. (incorporated herein by reference to Exhibit 10.39 of the Company's Form 10-K dated February 8, 2000, filed with the commission of February 8, 2000).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.40 -- Securities Purchase Agreement, dated as of August 18, 2000, by and among the Company, Consumer Corp., Funding LP, Funding GP, IFA-GP and IFA-LP. (incorporated herein by reference to Exhibit 10.40 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.41 -- Contribution and Assumption Agreement by and between Consumer Corp. and Drive dated as of August 18, 2000. (incorporated herein by reference to Exhibit 10.41 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.42 -- Contribution and Assumption Agreement by and between Funding LP and Drive dated as of August 18, 2000. (incorporated herein by reference to Exhibit 10.42 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.43 -- Second Amendment to Amended and Restated Loan Agreement, dated December 20, 1999, by and among the Company, as borrower, and the Lenders, as lenders, and Bank of Scotland, as Agent. (incorporated herein by reference to Exhibit 10.43 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.44 -- Receivables Financing Agreement, dated August 18, 2000, among Drive BOS LP, Drive Financial Services LP, each Lender, IPA Inc. and Wells Fargo Bank Minnesota, N.A. 10.45 -- Amendment to Loan Agreement and extension of Promissory Note, dated January 12, 2001, by and between FirstCity Holdings Corporation and CSFC Capital Corp. XXX. 10.46 -- Second Amendment, dated as of February 16, 2001, to the Receivables Financing Agreement, dated as of August 18, 2000, among Drive BOS LP, Drive Financial Services LP the Lenders party thereto, IPA Incorporated and Wells Fargo Bank Minnesota, NA. 10.47 -- Subordinate Capital Loan Agreement, dated as of February 16, 2001, among Drive Financial Services LP, DRIVE BOS LP, the financial institutions from time to time party hereto and IPA Incorporated. 21.1 -- Subsidiaries of the Registrant. 23.1 -- Consent of KPMG LLP. 23.2 -- Consent of KPMG LLP.
(b) Reports on Form 8-K. No reports on Form 8-K were filed with the Commission during the fourth quarter of 2000. 85 88 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRSTCITY FINANCIAL CORPORATION By: /s/ JAMES R. HAWKINS ---------------------------------- James R. Hawkins Chairman of the Board April 12, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ JAMES R. HAWKINS Chairman of the Board and April 12, 2001 ----------------------------------------------------- Director James R. Hawkins /s/ JAMES T. SARTAIN President, Chief Executive April 12, 2001 ----------------------------------------------------- Officer and Director James T. Sartain (Principal Executive Officer) /s/ J. BRYAN BAKER Senior Vice President, and April 12, 2001 ----------------------------------------------------- Chief Financial Officer J. Bryan Baker (Principal financial officer) /s/ RICHARD E. BEAN Director April 12, 2001 ----------------------------------------------------- Richard E. Bean /s/ C. IVAN WILSON Director April 12, 2001 ----------------------------------------------------- C. Ivan Wilson /s/ ROBERT E. GARRISON Director April 12, 2001 ----------------------------------------------------- Robert E. Garrison /s/ DANE FULMER Director April 12, 2001 ----------------------------------------------------- Dane Fulmer /s/ DAVE MACLENNAN Director April 12, 2001 ----------------------------------------------------- Dave MacLennan
86 89 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1 -- Joint Plan of Reorganization by First City Bancorporation of Texas, Inc., Official Committee of Equity Security Holders and J-Hawk Corporation, with the Participation of Cargill Financial Services Corporation, Under Chapter 11 of the United States Bankruptcy Code, Case No. 392-39474-HCA-11 (incorporated herein by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 2.2 -- Agreement and Plan of Merger, dated as of July 3, 1995, by and between First City Bancorporation of Texas, Inc. and J-Hawk Corporation (incorporated herein by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 3.1 -- Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 3.2 -- Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 4.1 -- Certificate of Designations of the New Preferred Stock ($0.01 par value) of the Company. (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on form 10-K dated March 24, 1998 filed with the Commission on March 26, 1998). 4.2 -- Warrant Agreement, dated July 3, 1995, by and between the Company and American Stock Transfer & Trust Company, as Warrant Agent (incorporated herein by reference to Exhibit 4.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995). 4.3 -- Registration Rights Agreement, dated July 1, 1997, among the Company, Richard J. Gillen, Bernice J. Gillen, Harbor Financial Mortgage Company Employees Pension Plan, Lindsey Capital Corporation, Ed Smith and Thomas E. Smith. (incorporated herein by reference to Exhibit 4.3 of the Company's Form 10-K dated March 24, 1998 filed with the Commission on March 26, 1998). 4.4 -- Stock Purchase Agreement, dated March 24, 1998, between the Company and Texas Commerce Shareholders Company. (incorporated herein by reference to Exhibit 4.4 of the Company's Form 10-K dated March 24, 1998 filed with the Commission on March 26, 1998). 4.5 -- Registration Rights Agreement, dated March 24, 1998, between the Company and Texas Commerce Shareholders Company. (incorporated herein by reference to Exhibit 4.5 of the Company's Form 10-K dated March 24, 1998 filed with the Commission on March 24, 1998). 9.1 -- Shareholder Voting Agreement, dated as of June 29, 1995, among ATARA I Ltd., James R. Hawkins, James T. Sartain and Cargill Financial Services Corporation. (incorporated herein by reference to Exhibit 9.1 of the Company's Form 10-K dated March 24,1998 filed with the Commission on March 26, 1998). 10.1 -- Trust Agreement of FirstCity Liquidating Trust, dated July 3, 1995 (incorporated herein by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995).
90
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.2 -- Investment Management Agreement, dated July 3, 1995, between the Company and FirstCity Liquidating Trust (incorporated herein by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated July 3, 1995 filed with the Commission on July 18, 1995 10.3 -- Lock-Box Agreement, dated July 11, 1995, among the Company, NationsBank of Texas, N.A., as lock-box agent, FirstCity Liquidating Trust, FCLT Loans, L.P., and the other Trust-Owned Affiliates signatory thereto, and each of NationsBank of Texas, N.A. and Fleet National Bank, as co-lenders (incorporated herein by reference to Exhibit 10.3 of the Company's Form 8-A/A dated August 25, 1995 filed with the Commission on August 25, 1995). 10.4 -- Custodial Agreement, dated July 11, 1995, among Fleet National Bank, as custodian, Fleet National Bank, as agent, FCLT Loans, L.P., FirstCity Liquidating Trust, and the Company (incorporated herein by reference to Exhibit 10.4 of the Company's Form 8-A/A dated August 25, 1995 filed with the Commission on August 25, 1995). 10.5 -- Tier 3 Custodial Agreement, dated July 11, 1995, among the Company, as custodian, Fleet National Bank, as agent, FCLT Loans, L.P., FirstCity Liquidating Trust, and the Company, as servicer (incorporated herein by reference to Exhibit 10.5 of the Company's Form 8-A/A dated August 25, 1995 filed with the Commission on August 25, 1995). 10.6 -- 12/97 Amended and Restated Facilities Agreement, dated effective as of December 3, 1997, among Harbor Financial Mortgage Corporation, New America Financial, Inc., Texas Commerce Bank National Association and the other warehouse lenders party thereto. (incorporated herein by reference to Exhibit 10.6 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.7 -- Modification Agreement, dated January 26, 1998, to the Amended and Restated Facilities Agreement, dated as of December 3, 1997, among Harbor Financial Mortgage Corporation, New America Financial, Inc. and Chase Bank of Texas, National Association (formerly known as Texas Commerce Bank National Association). (incorporated herein by reference to Exhibit 10,7 of the company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.8 -- $50,000,000 3/98 Chase Texas Temporary Additional Warehouse Note, dated March 17, 1998, by Harbor Financial Mortgage Corporation and New America Financial, Inc., in favor of Chase Bank of Texas, National Association. (incorporated herein by reference to Exhibit 10.8 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.9 -- Employment Agreement, dated as of July 1, 1997, by and between Harbor Financial Mortgage Corporation and Richard J. Gillen. (incorporated herein by reference to Exhibit 10.9 of the Company's 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.10 -- Employment Agreement, dated as of September 8, 1997, by and between FirstCity Funding Corporation and Thomas R. Brower, with similar agreements between FC Capital Corp. and each of James H. Aronoff and Christopher J. Morrissey. (incorporated herein by reference to Exhibit 10.10 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998).
91
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.11 -- Shareholder Agreement, dated as of September 8, 1997, among FirstCity Funding Corporation, FirstCity Consumer Lending Corporation, Thomas R. Brower, Scot A. Foith, Thomas G. Dundon, R. Tyler Whann, Bradley C. Reeves, Stephen H. Trent and Blake P. Bozman. (incorporated herein by reference to Exhibit 10.11 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.12 -- Revolving Credit Loan Agreement, dated as of March 20, 1998, by and between FC Properties, Ltd. and Nomura Asset Capital Corporation. (incorporated herein by reference to Exhibit 10.12 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.13 -- Revolving Credit Loan Agreement, dated as of February 27, 1998, by and between FH Partners, L.P. and Nomura Asset Capital Corporation. (incorporated herein by reference to Exhibit 10.13 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.14 -- Note Agreement, dated as of June 6, 1997, among Bosque Asset Corp., SVD Realty, L.P., SOWAMCO XXII, LTD., Bosque Investment Realty Partners, L.P. and Bankers Trust Company of California, N.A. (incorporated herein by reference to Exhibit 10.14 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.15 -- 60,000,000 French Franc Revolving Promissory Note, dated September 25, 1997, by J-Hawk International Corporation in favor of the Bank of Scotland. (incorporated herein by reference to Exhibit 10.15 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.16 -- Loan Agreement, dated as of September 25, 1997, by and between Bank of Scotland and J-Hawk International Corporation. (incorporated herein reference to Exhibit 10.16 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.17 -- Guaranty Agreement, dated as of September 25, 1997, by J-Hawk (incorporated herein by reference to Exhibit 10.17 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.18 -- Guaranty Agreement, dated as of September 25, 1997, by FirstCity Financial Corporation in favor of Bank of Scotland. (incorporated herein by reference to Exhibit 10.18 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.19 -- Warehouse Credit Agreement, dated as of May 17, 1996, among ContiTrade Services L.L.C., N.A.F. Auto Loan Trust and National Auto Funding Corporation. (incorporated herein by reference to Exhibit 10.19 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.20 -- Funding Commitment, dated as of May 17, 1996 by and between ContiTrade Services L.L.C. and The Company. (incorporated herein by reference to Exhibit 10.20 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998). 10.21 -- Revolving Credit Agreement, dated as of December 29, 1995, by and between the Company and Cargill financial Services Corporation, as amended by the Eighth Amendment to Revolving Credit Agreement dated February 1998. (incorporated herein by reference to Exhibit 10.21 of the Company's Form 10-K dated March 24, 1998 filed with the Commission March 26, 1998).
92
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.22 -- Master Repurchase Agreement Governing Purchased and Sales of Mortgage Loans, dated as of July 1998, between Lehman Commercial Paper Inc. and FHB Funding Corp. (incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 18, 1998). 10.23 -- Warehouse Credit Agreement, dated as of April 30, 1998 among ContiTrade Services, L.L.C., FirstCity Consumer Lending Corporation, FirstCity Auto Receivables L.L.C. and FirstCity Financial Corporation. (incorporated herein by reference to Exhibit 10.2 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 16, 1998). 10.24 -- Servicing Agreement, dated as of April 30, 1998 among FirstCity Auto Receivables L.L.C., FirstCity Servicing Corporation of California, FirstCity Consumer Lending Corporation and ContiTrade Services L.L.C. (incorporated herein by reference to Exhibit 10.3 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 16, 1998). 10.25 -- Security and Collateral Agreement, dated as of April 30, 1998 among FirstCity Auto Receivables L.L.C., ContiTrade Services L.L.C. and Chase Bank of Texas, National Association. (incorporated herein by reference to Exhibit 10.4 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission August 16, 1998). 10.26 -- Loan Agreement, dated as of July 24, 1998, between FirstCity Commercial Corporation and CFSC Capital Corp. XXX (incorporated herein by reference Exhibit 10.5 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission on August 18, 1998). 10.27 -- Loan Agreement, dated April 8, 1998 between Bank of Scotland and the Company (incorporated herein by reference to Exhibit 10.6 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission on August 18, 1998) 10.28 -- First Amendment to Loan Agreement, dated July 20, 1998, between Bank of Scotland and the Company (incorporated herein by reference to Exhibit 10.7 of the Company's Form 10-Q dated August 14, 1998, filed with the Commission on August 18, 1998). 10.29 -- Employment Agreement, dated October 1, 1998, by and between FirstCity. Financial Mortgage Corporation, and Buddy L. Terrell (incorporated herein by reference to Exhibit 10.29 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999). 10.30 -- Security Agreement, dated as of April 30, 1998 among Enterprise Funding Corporation, FCAR Receivables L.L.C., MBIA Insurance Corporation, FirstCity Funding Corporation, NationsBank N.A. and CSC Logic/MSA LLP d/b/a Loan Servicing enterprise (incorporated herein by reference to Exhibit 10.30 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999). 10.31 -- Note purchase agreement, dated March 30, 1999 among Enterprise Funding Corporation, FCAR Receivables, L.L.C. and NationsBank, N.A. (incorporated herein by reference to Exhibit 10.31 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999).
93
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.32 -- Custodian Agreement, dated March 30, 1999, among FCAR Receivables L.L.C., FirstCity Funding Corporation, NationsBank, N.A., Enterprise Funding Corporation and Chase Bank of Texas, N.A. (incorporated herein by reference to Exhibit 10.32 of the Company's Form 10-Q dated May 17, 1999, filed with the commission on May 17, 1999). 10.33 -- Credit agreement dated effective as of May 28, 1999 made by and among Harbor Financial Mortgage, New America Financial, Inc., FirstCity Financial Mortgage Corporation, and Guaranty Federal Bank F.S.B. as Administrative Agent and Bank One, Texas, N.A. as Collateral Agent (incorporated herein by reference to Exhibit 10.33 of the Company's Form 10-Q dated August 16, 1999, filed with the commission on August 16, 1999). 10.34 -- Tenth Amendment to Loan Agreement, dated August 11, 1999 between Bank of Scotland and the Company (incorporated herein by reference to Exhibit 10.34 of the Company's Form 10-Q dated August 16, 1999, filed with the Commission on August 16, 1999). 10.35 -- Amended and Restated Loan Agreement, dated December 20, 1999, By and Among FirstCity Financial Corporation as Borrower and The Lenders Named Herein, as Lenders and Bank of Scotland as Agent (incorporated herein by reference to Exhibit 10.1 of the Company's Form 8-K dated December 22, 1999, filed with the commission on December 28, 1999). 10.36 -- Subordinated Secured Senior Note Purchase Agreement, dated December 20, 1999, between FirstCity Financial Corporation, as Issuer and IFA Corporation, as Purchaser (incorporated herein by reference to Exhibit 10.2 of the Company's Form 8-K dated December 22, 1999, filed with the commission on December 28, 1999). 10.37 -- Employment Agreement, dated October 1, 1999, by and between FirstCity Commercial Corporation and Terry R. DeWitt. (incorporated herein by reference to Exhibit 10.37 of the Company's Form 10-K dated February 8, 2000, filed with the commission of February 8, 2000). 10.38 -- Employment Agreement, dated October 1, 1999, by and between FirstCity Commercial Corporation and G. Stephen Fillip. (incorporated herein by reference to Exhibit 10.38 of the Company's Form 10-K dated February 8, 2000, filed with the commission of February 8, 2000). 10.39 -- Shareholder Agreement, dated October 1, 1999, by and among FirstCity Holdings Corporation, FirstCity Commercial Corporation, Terry R. DeWitt, G. Stephen Fillip and James C. Holmes. (incorporated herein by reference to Exhibit 10.39 of the Company's Form 10-K dated February 8, 2000, filed with the commission of February 8, 2000). 10.40 -- Securities Purchase Agreement, dated as of August 18, 2000, by and among the Company, Consumer Corp., Funding LP, Funding GP, IFA-GP and IFA-LP. (incorporated herein by reference to Exhibit 10.40 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.41 -- Contribution and Assumption Agreement by and between Consumer Corp. and Drive dated as of August 18, 2000. (incorporated herein by reference to Exhibit 10.41 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000).
94
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.42 -- Contribution and Assumption Agreement by and between Funding LP and Drive dated as of August 18, 2000. (incorporated herein by reference to Exhibit 10.42 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.43 -- Second Amendment to Amended and Restated Loan Agreement, dated December 20, 1999, by and among the Company, as borrower, and the Lenders, as lenders, and Bank of Scotland, as Agent. (incorporated herein by reference to Exhibit 10.43 of the Company's Form 8-K dated August 25, 2000, filed with the commission on September 11, 2000). 10.44 -- Receivables Financing Agreement, dated August 18, 2000, among Drive BOS LP, Drive Financial Services LP, each Lender, IPA Inc. and Wells Fargo Bank Minnesota, N.A. 10.45 -- Amendment to Loan Agreement and extension of Promissory Note, dated January 12, 2001, by and between FirstCity Holdings Corporation and CSFC Capital Corp. XXX. 10.46 -- Second Amendment, dated as of February 16, 2001, to the Receivables Financing Agreement, dated as of August 18, 2000, among Drive BOS LP, Drive Financial Services LP the Lenders party thereto, IPA Incorporated and Wells Fargo Bank Minnesota, NA. 10.47 -- Subordinate Capital Loan Agreement, dated as of February 16, 2001, among Drive Financial Services LP, DRIVE BOS LP, the financial institutions from time to time party hereto and IPA Incorporated. 21.1 -- Subsidiaries of the Registrant. 23.1 -- Consent of KPMG LLP. 23.2 -- Consent of KPMG LLP.