XNAS:FCFC Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2012

 

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

 

Commission file number 033-19694

 

FirstCity Financial Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

76-0243729

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

6400 Imperial Drive,

 

 

Waco, TX

 

76712

(Address of principal executive offices)

 

(Zip Code)

 

(254) 761-2800

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of shares of common stock, par value $.01 per share, outstanding at August 8, 2012 was 10,556,197.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

PART I

 

 

 

 

Item 1.

Financial Statements

3

 

Consolidated Balance Sheets

3

 

Consolidated Statements of Earnings

5

 

Consolidated Statements of Comprehensive Income

6

 

Consolidated Statements of Stockholders’ Equity

7

 

Consolidated Statements of Cash Flows

8

 

Notes to Consolidated Financial Statements

9

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

50

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

79

Item 4.

Controls and Procedures

79

 

 

 

PART II OTHER INFORMATION

80

 

 

 

Item 1.

Legal Proceedings

80

Item 1A.

Risk Factors

80

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

80

Item 3.

Defaults Upon Senior Securities

80

Item 4.

Mine Safety Disclosures

80

Item 5.

Other Information

80

Item 6.

Exhibits

81

SIGNATURES

82

 

2



Table of Contents

 

PART I

 

FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

33,039

 

$

34,802

 

Restricted cash

 

1,250

 

1,229

 

Portfolio Assets:

 

 

 

 

 

Loan portfolios, net of allowance for loan losses of $617 and $781

 

68,353

 

97,090

 

Real estate held for sale, net

 

14,320

 

26,856

 

Total Portfolio Assets

 

82,673

 

123,946

 

Loans receivable:

 

 

 

 

 

Loans receivable - affiliates

 

6,757

 

6,719

 

Loans receivable - SBA held for sale

 

4,808

 

7,614

 

Loans receivable - SBA held for investment, net of allowance for loan losses of $425 and $333

 

20,226

 

19,151

 

Loans receivable - other, net of allowance for loan losses of $1,083

 

7,545

 

12,212

 

Total loans receivable, net

 

39,336

 

45,696

 

Investment securities available for sale

 

3,529

 

3,798

 

Investments in unconsolidated subsidiaries

 

103,864

 

109,393

 

Service fees receivable ($1,023 and $834 from affiliates)

 

1,106

 

913

 

Servicing assets - SBA loans

 

1,145

 

1,090

 

Assets held for sale

 

9,948

 

9,886

 

Other assets

 

27,502

 

25,593

 

Total Assets (1)

 

$

303,392

 

$

356,346

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Notes payable to banks and other

 

$

139,873

 

$

189,936

 

Liabilities associated with assets held for sale

 

5,189

 

5,317

 

Other liabilities

 

22,306

 

23,690

 

Total Liabilities (2)

 

167,368

 

218,943

 

 

 

 

 

 

 

Commitments and contingencies (Note 18)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Optional preferred stock (par value $.01 per share; 98,000,000 shares authorized; no shares issued or outstanding)

 

 

 

Common stock (par value $.01 per share; 100,000,000 shares authorized; shares issued: 12,056,197 and 11,890,590, respectively; shares outstanding: 10,556,197 and 10,390,590, respectively)

 

121

 

119

 

Treasury stock, at cost: 1,500,000 shares

 

(10,923

)

(10,923

)

Paid in capital

 

106,822

 

106,330

 

Retained earnings

 

28,243

 

18,391

 

Accumulated other comprehensive loss

 

(1,969

)

(1,941

)

FirstCity Stockholders’ Equity

 

122,294

 

111,976

 

Noncontrolling interests

 

13,730

 

25,427

 

Total Equity

 

136,024

 

137,403

 

Total Liabilities and Equity

 

$

303,392

 

$

356,346

 

 

3



Table of Contents

 


(1)          Our consolidated assets at June 30, 2012 and December 31, 2011 include the following assets of certain variable interest entities (“VIEs”) that can only be used to settle the liabilities of those VIEs: Cash and cash equivalents, $18.5 million and $20.4 million; Portfolio Assets, $68.9 million and $98.4 million; Loans receivable, $39.3 million and $45.7 million; Equity investments, $41.5 million and $51.7 million; various other assets, $37.8 million and $35.9 million; and Total assets, $206.0 million and $252.2 million, respectively.

 

(2)          Our consolidated liabilities at June 30, 2012 and December 31, 2011 include the following VIE liabilities for which the VIE creditors do not have recourse to FirstCity: Notes payable, $43.9 million and $70.2 million; Other liabilities, $17.3 million and $19.0 million; and Total liabilities, $61.2 million and $89.2 million, respectively.

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)

(Dollars in thousands, except per share data)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues:

 

 

 

 

 

 

 

 

 

Servicing fees ($3,170 and $2,303 from affiliates for the three-month periods, respectively, and $8,675 and $4,530 from affiliates for the six-month periods, respectively)

 

$

3,397

 

$

2,480

 

$

9,141

 

$

4,905

 

Income from Portfolio Assets

 

5,865

 

9,098

 

14,370

 

21,938

 

Gain on sale of SBA loans held for sale, net

 

284

 

646

 

856

 

1,530

 

Interest income from SBA loans

 

382

 

325

 

737

 

674

 

Interest income from loans receivable - affiliates

 

290

 

773

 

570

 

1,511

 

Interest income from loans receivable - other

 

91

 

112

 

192

 

300

 

Revenue from railroad operations

 

1,951

 

1,430

 

3,636

 

2,860

 

Other income

 

2,034

 

2,054

 

4,579

 

3,977

 

Total revenues

 

14,294

 

16,918

 

34,081

 

37,695

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Interest and fees on notes payable to banks and other

 

1,334

 

3,378

 

3,072

 

6,961

 

Interest and fees on notes payable to affiliates

 

 

386

 

 

766

 

Salaries and benefits

 

5,318

 

5,525

 

11,446

 

10,674

 

Provision for loan and impairment losses

 

769

 

178

 

1,239

 

817

 

Asset-level expenses

 

912

 

1,730

 

1,975

 

3,144

 

Costs and expenses from railroad operations

 

1,471

 

882

 

2,699

 

1,767

 

Other costs and expenses

 

4,449

 

2,706

 

7,770

 

4,867

 

Total costs and expenses

 

14,253

 

14,785

 

28,201

 

28,996

 

Earnings before other revenue and income taxes

 

41

 

2,133

 

5,880

 

8,699

 

Equity income from unconsolidated subsidiaries

 

2,081

 

3,283

 

6,548

 

5,154

 

Gain on business combinations

 

935

 

278

 

935

 

278

 

Gain on sale of subsidiaries

 

 

 

 

5

 

Earnings before income taxes

 

3,057

 

5,694

 

13,363

 

14,136

 

Income tax expense

 

5

 

1,024

 

838

 

1,626

 

Net earnings

 

3,052

 

4,670

 

12,525

 

12,510

 

Less: Net income attributable to noncontrolling interests

 

1,565

 

2,242

 

2,673

 

6,357

 

Net earnings attributable to FirstCity

 

$

1,487

 

$

2,428

 

$

9,852

 

$

6,153

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share of common stock

 

$

0.14

 

$

0.24

 

$

0.94

 

$

0.60

 

Diluted earnings per share of common stock

 

$

0.14

 

$

0.24

 

$

0.93

 

$

0.60

 

 

See accompanying notes to consolidated financial statements.

 

5



Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(Dollars in thousands)

 

 

 

Three Months Ended

 

 

 

June 30,

 

 

 

2012

 

2011

 

Net earnings

 

$

3,052

 

$

4,670

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

Net unrealized gain on securities available for sale

 

53

 

126

 

Foreign currency translation adjustments

 

(2,373

)

1,329

 

Total other comprehensive income (loss), net of tax

 

(2,320

)

1,455

 

Total comprehensive income

 

732

 

6,125

 

Less comprehensive income attributable to noncontrolling interests:

 

 

 

 

 

Net income

 

(1,565

)

(2,242

)

Net unrealized (gain) loss on securities available for sale, net of tax

 

(2

)

66

 

Foreign currency translation adjustments

 

557

 

(286

)

Comprehensive income (loss) attributable to FirstCity

 

$

(278

)

$

3,663

 

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2012

 

2011

 

Net earnings

 

$

12,525

 

$

12,510

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

Net unrealized gain on securities available for sale

 

513

 

69

 

Foreign currency translation adjustments

 

(766

)

2,020

 

Total other comprehensive income (loss), net of tax

 

(253

)

2,089

 

Total comprehensive income

 

12,272

 

14,599

 

Less comprehensive income attributable to noncontrolling interests:

 

 

 

 

 

Net income

 

(2,673

)

(6,357

)

Net unrealized (gain) loss on securities available for sale, net of tax

 

(15

)

46

 

Foreign currency translation adjustments

 

240

 

(657

)

Comprehensive income attributable to FirstCity

 

$

9,824

 

$

7,631

 

 

See accompanying notes to consolidated financial statements.

 

6



Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)

(Dollars in thousands)

 

 

 

FirstCity Stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings

 

Other

 

Non-

 

 

 

 

 

Common

 

Treasury

 

Paid in

 

(Accumulated

 

Comprehensive

 

controlling

 

Total

 

 

 

Stock

 

Stock

 

Capital

 

Deficit)

 

Income (Loss)

 

Interests

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, December 31, 2010

 

$

118

 

$

(10,923

)

$

105,038

 

$

(5,826

)

$

(65

)

$

36,398

 

$

124,740

 

Net earnings

 

 

 

 

6,153

 

 

6,357

 

12,510

 

Change in net unrealized gain on securities available for sale, net of tax

 

 

 

 

 

115

 

(46

)

69

 

Foreign currency translation adjustments

 

 

 

 

 

1,363

 

657

 

2,020

 

Stock-based compensation expense

 

 

 

371

 

 

 

 

371

 

Sales of subsidiary shares in noncontrolling interests

 

 

 

484

 

 

 

207

 

691

 

Investments in majority-owned entities

 

 

 

 

 

 

524

 

524

 

Distributions to noncontrolling interests

 

 

 

 

 

 

(10,729

)

(10,729

)

Balances, June 30, 2011

 

$

118

 

$

(10,923

)

$

105,893

 

$

327

 

$

1,413

 

$

33,368

 

$

130,196

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, December 31, 2011

 

$

119

 

$

(10,923

)

$

106,330

 

$

18,391

 

$

(1,941

)

$

25,427

 

$

137,403

 

Net earnings

 

 

 

 

9,852

 

 

2,673

 

12,525

 

Change in net unrealized gain on securities available for sale, net of tax

 

 

 

 

 

498

 

15

 

513

 

Foreign currency translation adjustments

 

 

 

 

 

(526

)

(240

)

(766

)

Issuance of common stock under stock- based compensation plans

 

2

 

 

(2

)

 

 

 

 

Stock-based compensation expense

 

 

 

494

 

 

 

 

494

 

Deconsolidation of majority-owned entity (see Note 3)

 

 

 

 

 

 

(8,473

)

(8,473

)

Investments in majority-owned entities

 

 

 

 

 

 

10

 

10

 

Distributions to noncontrolling interests

 

 

 

 

 

 

(5,682

)

(5,682

)

Balances, June 30, 2012

 

$

121

 

$

(10,923

)

$

106,822

 

$

28,243

 

$

(1,969

)

$

13,730

 

$

136,024

 

 

See accompanying notes to consolidated financial statements.

 

7



Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net earnings

 

$

12,525

 

$

12,510

 

Adjustments to reconcile net earnings to net cash used in operating activities:

 

 

 

 

 

Net principal advances on SBA loans held for sale

 

(7,715

)

(10,809

)

Proceeds from sales of SBA loans held for sale, net

 

11,880

 

19,429

 

Proceeds applied to income from Portfolio Assets

 

576

 

2,816

 

Income from Portfolio Assets

 

(14,370

)

(21,938

)

Provision for loan and impairment losses

 

1,239

 

817

 

Foreign currency transaction losses (gains), net

 

130

 

(1,530

)

Equity income from unconsolidated subsidiaries

 

(6,548

)

(5,154

)

Gain on sale of SBA loans held for sale, net

 

(856

)

(1,530

)

Gain on business combinations

 

(935

)

(278

)

Depreciation and amortization, net

 

1,774

 

1,346

 

Decrease (increase) in other assets

 

145

 

(1,812

)

Increase (decrease) in other liabilities

 

(588

)

461

 

Other, net

 

(127

)

(404

)

Net cash used in operating activities

 

(2,870

)

(6,076

)

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment, net

 

(766

)

(1,137

)

Cash paid for business combinations, net of cash acquired

 

16

 

(498

)

Decrease in cash from deconsolidation of subsidiary

 

(2,855

)

 

Net principal payments on loans receivable

 

2,295

 

352

 

Purchases of SBA loans held for investment

 

 

(696

)

Net principal advances on SBA loans held for investment

 

(1,635

)

(1,468

)

Purchase of investment securities available for sale

 

 

(3,485

)

Net principal payments on investment securities available for sale

 

796

 

1,093

 

Purchases of Portfolio Assets

 

(1,444

)

(5,375

)

Proceeds applied to principal on Portfolio Assets

 

48,847

 

80,962

 

Contributions to unconsolidated subsidiaries

 

(18,443

)

(22,751

)

Distributions from unconsolidated subsidiaries

 

23,599

 

20,011

 

Net cash provided by investing activities

 

50,410

 

67,008

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings under notes payable to affiliates

 

 

696

 

Borrowings under notes payable to banks and other

 

15,942

 

21,882

 

Principal payments of notes payable to affiliates

 

 

(2,202

)

Principal payments of notes payable to banks and other

 

(59,231

)

(81,417

)

Proceeds from secured borrowings, net

 

 

(4,302

)

Distributions to noncontrolling interests

 

(5,682

)

(10,729

)

Other, net

 

(282

)

(273

)

Net cash used in financing activities

 

(49,253

)

(76,345

)

Effect of exchange rate changes on cash and cash equivalents

 

(50

)

738

 

Net decrease in cash and cash equivalents

 

(1,763

)

(14,675

)

Cash and cash equivalents, beginning of period

 

34,802

 

46,597

 

Cash and cash equivalents, end of period

 

$

33,039

 

$

31,922

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for interest

 

$

1,674

 

$

5,878

 

Cash paid during the period for income taxes, net of refunds

 

1,400

 

634

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

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

 

Nature of Operations

 

FirstCity Financial Corporation, a Delaware corporation, is a multi-national specialty financial services company headquartered in Waco, Texas with offices throughout the United States and Mexico and a presence in Europe and South America. When we refer to “FirstCity,” “the Company,” “we,” “our” or “us” in this Quarterly Report on Form 10-Q, we mean FirstCity Financial Corporation and subsidiaries (consolidated).

 

The Company engages in two major business segments — Portfolio Asset Acquisition and Resolution and Special Situations Platform. The Portfolio Asset Acquisition and Resolution business has been the Company’s core business segment since it commenced operations in 1986. In the Portfolio Asset Acquisition and Resolution business, the Company acquires portfolios of under-performing and non-performing loans, and to a lesser extent, performing loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), generally at a discount to their legal principal balances or appraised values, and services and resolves such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. FirstCity acquires the Portfolio Assets for its own account or through investment entities formed with one or more other co-investors (each such entity, an “Acquisition Partnership”). The Company engages in its Special Situations Platform business through its majority ownership in a subsidiary that was formed in April 2007. Through its Special Situations Platform, the Company provides investment capital to privately-held middle-market companies through flexible capital structuring arrangements to generate an attractive risk-adjusted return. These capital investments primarily take the form of senior and junior financing arrangements, but also include direct equity investments and common equity warrants. In addition, our Special Situations Platform business engages in distressed debt transactions and leveraged buyouts. Refer to Note 17 for additional information on the Company’s major business segments.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements in this Form 10-Q were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the consolidated financial statements do not include all of the information and footnote disclosures required by GAAP for complete consolidated financial statements. In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and results of operations. The interim results of operations disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period. These interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended December 31, 2011, as amended (“2011 Form 10-K”).

 

The accompanying consolidated financial statements in this Form 10-Q include the accounts of FirstCity, its wholly-owned and majority-owned subsidiaries, and certain variable interest entities where we are the primary beneficiary as prescribed by the Financial Accounting Standards Board’s (the “FASB”) accounting guidance on variable interest entities (see discussion below). All significant intercompany transactions and balances have been eliminated in consolidation. Certain amounts in the consolidated financial statements and disclosures for prior periods were reclassified to conform to the current period presentation. These reclassifications were not significant and have no impact on FirstCity’s net earnings, total assets or stockholders’ equity.

 

9



Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Consolidated Subsidiaries

 

If we determine that we have a controlling financial interest in an entity, then we must consolidate the assets, liabilities and noncontrolling interests of the entity in our consolidated financial statements. A controlling financial interest typically arises as a result of ownership of a majority of the voting interests of an entity. However, we may also have a controlling financial interest in an entity through an arrangement that does not involve voting interests, such as a variable interest entity (“VIE”). We consolidate all VIEs where we are the primary beneficiary as prescribed by the FASB’s accounting guidance on the consolidation of VIEs. The primary beneficiary of a VIE is the party that has the power to direct the activities that most-significantly impact the economic performance of the entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. Refer to Note 15 for more information regarding the Company’s involvement with VIEs.

 

Unconsolidated Subsidiaries

 

The Company does not consolidate investments in entities that are not VIEs where the Company does not have an effective controlling interest, or investments in entities that are VIEs where the Company is not the primary beneficiary. Rather, such investments, which represent equity investments in non-publicly-traded entities, are accounted for under the equity method of accounting since the Company has the ability to exercise significant influence (but not control) over operating and financial policies of such subsidiaries (including certain entities where we have less than 20% ownership). FirstCity has the ability to exercise significant influence over the operating and financial policies of its less-than-20%-owned entities, despite its comparatively smaller ownership percentage, due primarily to its active participation in the policy-making process as well as its involvement in the daily management activities of the entities.

 

Under the equity method of accounting, the Company’s investments in these unconsolidated entities are carried at the cost of acquisition, plus the Company’s share of equity in undistributed earnings or losses since acquisition. We eliminate transactions with our equity-method subsidiaries to the extent of our ownership in such subsidiaries. Accordingly, our share of the income or losses of these equity-method subsidiaries is included in our consolidated net income.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates that are particularly susceptible to significant change in the near-term relate to (1) the estimation of future collections on Portfolio Assets used in the calculation of income from Portfolio Assets; (2) valuation of deferred tax assets and assumptions used in the calculation of income taxes; (3) valuation of servicing assets, investment securities, loans receivable (including loans receivable held in securitization entities) and related allowances for loan losses, real estate, and investments in unconsolidated subsidiaries; (4) guarantee obligations and indemnifications; and (5) legal contingencies. In addition, management has made significant estimates with respect to the valuation of assets, liabilities, non-controlling interests and contingencies attributable to business combinations. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. The continuance of challenging economic conditions and disruptions in the financial, capital, real estate and foreign currency markets, have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

 

Portfolio Assets

 

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

The following is a description of the classifications and related accounting policies for the Company’s significant classes of Portfolio Assets:

 

Purchased Credit-Impaired Loans

 

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

 

The Company accounts for Purchased Credit-Impaired Loans using either the interest method or a non-accrual method (through application of the cost-recovery or cash basis method of accounting). Application of the interest method is dependent on management’s ability to develop a reasonable expectation as to both the timing and amount of cash flows expected to be collected. In the event the Company cannot develop or establish a reasonable expectation as to both the timing and amount of cash flows expected to be collected, the Company uses the cost-recovery or cash basis method of accounting.

 

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

 

Cost-recovery method of accounting.  If the amount and timing of future cash collections on a loan are not reasonably estimable, the Company accounts for such asset on the cost-recovery method. Under the cost-recovery method, no income is recognized until the Company has fully collected the cost of the loan, or until such time as the Company considers the timing and amount of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. At least quarterly, the Company performs an evaluation to determine if the remaining amount that is probable of collection is less than the carrying value of the loan or loan pool, and if so, recognizes impairment through provisions charged to operations, with a corresponding valuation allowance offsetting the loan or loan pool in the consolidated balance sheets. The carrying value of Purchased Credit-Impaired Loans accounted for under the cost-recovery method approximated $25.4 million at June 30, 2012 (including $1.3 million of loans pending management’s post-purchase evaluation) and $27.9 million at December 31, 2011.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Cash basis method of accounting.  If only the amount of future cash collections on a loan is reasonably estimable, the Company accounts for such asset on an individual loan basis under the cash basis method of accounting. Under the cash basis method, no income is recognized unless collections are received during the period, or until such time as the Company considers the timing of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. Income is recognized for the difference between the collections and a pro-rata portion of cost on a loan. Cost allocation is based on a proration of actual collections divided by total projected collections on the loan. Significant increases in future cash flows may be recognized prospectively as income over the remaining life of the loan through increased amounts allocated to income when collections are subsequently received. Subsequent decreases in projected cash flows are recognized as impairment of the loan’s cost basis to maintain a constant cost allocation based on initial projections. The Company evaluates the projected cash flows for these loans and loan pools at least quarterly to determine if impairment exists, and if so, recognizes the impairment through provisions charged to operations, with a corresponding valuation allowance offsetting the loan or loan pool in the consolidated balance sheets. Management uses the cash basis method of accounting for such eligible loans primarily due to the increased uncertainty in the timing of future collections (attributable primarily to the borrowers’ inability to obtain financing to refinance the loans). The carrying value of Purchased Credit-Impaired Loans accounted for under the cash basis method approximated $37.5 million and $53.8 million at June 30, 2012 and December 31, 2011, respectively.

 

Troubled debt restructurings (TDRs):  Modified Purchased Credit-Impaired Loans are not removed from a loan pool even if those loans would otherwise be deemed TDRs. Modified Purchased Credit-Impaired Loans that are accounted for on an individual basis are considered TDRs if there has been a concession granted to the borrower and the Company does not expect to recover its recorded investment in the loan. Purchased Credit-Impaired Loans that are classified as TDRs are measured for impairment. See Troubled debt restructurings (TDRs) below for accounting guidance on loan modifications that result in classification as TDRs.

 

Real Estate

 

Real estate Portfolio Assets consist of real estate properties purchased from a variety of sellers or acquired through loan foreclosure. Rental income, net of expenses, is generally recognized when received. The Company accounts for its real estate properties on an individual-asset basis as opposed to a pool basis. The Company classifies a property as held for sale if (1) management commits to a plan to sell the property; (2) the Company actively markets the property in its current condition for a price that is reasonable in comparison to its fair value; and (3) management considers the sale of such property within one year of the balance sheet date to be probable. Real estate held for sale is stated at the lower of cost or fair value less estimated disposition costs. Real estate is not depreciated while it is classified as held for sale. Impairment losses are recorded if a property’s fair value less estimated disposition costs is less than its carrying amount, and charged to operations in the period the impairment is identified.

 

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

 

Gains on disposition of real estate are recognized upon the sale of the underlying property if the transaction qualifies for gain recognition under the full accrual method, as prescribed by the FASB’s accounting guidance on real estate sales transactions. If the transaction does not meet the criteria for the full accrual method of profit recognition based on our assessment, we account for the sale based on an appropriate deferral method determined by the nature and extent of the buyer’s investment and our continuing involvement.

 

Loans Receivable

 

Loans Held for Sale

 

The portions of U.S. Small Business Administration (“SBA”) loans that are guaranteed by the SBA are classified by management as loans held for sale. These loans are recorded at the lower of aggregate cost or estimated fair value. The fair value of SBA loans held for sale is based primarily on prices that secondary markets are currently offering for loans with similar characteristics. Net unrealized losses, if any, are recognized through a valuation allowance through a charge to income. The carrying value of SBA loans held for sale is net of premiums as well as deferred origination fees and costs. Premiums and net origination fees and costs are deferred and

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

included in the basis of the loans in calculating gains and losses upon sale. SBA loans are generally secured by the borrowing entities’ assets such as accounts receivable, property and equipment, and other business assets. The Company generally sells the guaranteed portion of each loan to a third-party investor and retains the servicing rights. The Company recognizes gains or losses on these loan sales based on the difference between the sales proceeds received and the allocated carrying value of the loans sold (which included deferred premiums and net origination fees and costs). The non-guaranteed portion of SBA loans is classified as held for investment (discussed below).

 

Loans Held for Investment

 

Loans receivable consisting of loans made to affiliated entities (including Acquisition Partnerships and other equity-method investees) and non-affiliated entities, and the non-guaranteed portions of SBA loans, are classified by management as held for investment. These loans are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan origination fees and costs, as well as purchase premiums and discounts, are amortized as level-yield adjustments over the respective loan terms. Unamortized net fees, costs, premiums or discounts are recognized upon early repayment or sale of the loan. Repayment of the loans is generally dependent upon future cash flows of the borrowers, future cash flows of the underlying collateral, and distributions made from affiliated entities. Interest is accrued when earned in accordance with the contractual terms of the loans, except for loans on non-accrual status. Interest is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding.

 

The Company has established an allowance for loan losses to absorb probable, estimable losses inherent in its portfolio of loans receivable held for investment. This allowance for loan losses includes specific allowances, based on individual evaluations of certain loans and loan relationships, and allowances for pools of loans with similar risk characteristics. Management’s determination of the adequacy of the allowance is a quarterly process and is based on evaluating the collectibility of the loans in light of various factors, as applicable, such as quality and composition of the loan portfolio segments, estimated future cash receipts of the borrower’s operations or underlying collateral, historical experience, estimated value of underlying collateral, prevailing economic conditions, industry concentrations and conditions, and other relevant factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Actual losses experienced in the future may vary from management’s estimates. Management attributes portions of the allowance to loans that it evaluates and determines to be impaired and to groups of loans that it evaluates collectively.

 

In determining the appropriate level of allowance, management uses information to stratify its portfolio of loans receivable held for investment into loan pools with common risk characteristics. Classes in the affiliated and non-affiliated portfolio asset and commercial loan portfolio segments are generally disaggregated by accrual status (which is generally based on management’s assessment on the probability of default). Classes in the non-guaranteed SBA commercial loan portfolio segment are disaggregated based upon underlying credit quality. Certain portions of the allowance are attributed to loan pools based on various factors and analyses, including but not limited to, current and historical loss experience trends, collateral, region, current economic conditions, and industry concentrations and conditions. Loans deemed to be impaired, including loans with an increased probability of default as determined by management, are evaluated individually rather than on a pool basis as described above. We consider a loan to be impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan’s contractual terms (including scheduled interest payments). When management identifies a loan as impaired, we measure the impairment based on discounted future cash flows, except when foreclosure is probable or the source of repayment is the operation or liquidation of the collateral. In these cases, we use the current fair value of the collateral, less estimated selling costs, instead of discounted cash flows. When a loan is determined to be impaired, we cease to accrue interest on the note and interest previously accrued but not collected becomes part of our recorded investment in the loan and is collectively reviewed for impairment. When ultimate collectibility of the impaired note is in doubt, all collections are applied to reduce the principal amount of such notes until the principal has been recovered, and collections thereafter are recognized as interest income. We return a loan to accrual status when we determine that the collectibility of principal and interest is reasonably assured. Impairment losses are charged against an allowance account through provisions charged to operations in the period impairment is identified. Loans are written-off against the allowance when all possible means of collection have been exhausted and the potential for recovery is considered remote.

 

Troubled debt restructurings (TDRs):  In situations where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. Modification of loan terms that may be considered a concession to the borrower may include rate reductions, principal forgiveness, term extensions, payment forbearance and other actions intended to minimize our

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

economic loss and to avoid foreclosure or repossession of the collateral. For modifications where we may forgive loan principal, the entire amount of such principal forgiveness is immediately charged-off. Loans classified as TDRs are considered impaired loans.

 

Accounting for Transfers and Servicing of Financial Assets

 

The Company accounts for transfers of financial assets as sales when control over the transferred assets is surrendered. Control is generally considered to have been surrendered when (1) the transferred assets are legally isolated from the Company or its consolidated affiliates; (2) the transferee has the right to pledge or exchange the assets with no conditions that constrain the transferee and provide more than a trivial benefit to the Company; and (3) the Company does not maintain the obligation or unilateral ability to reclaim or repurchase the assets. If these sale criteria are met, the transferred assets are removed from the Company’s balance sheet and a gain or loss on sale is recognized. If not met, the transfer is recorded as a secured borrowing, and the assets remain on the Company’s balance sheet, the proceeds from the transaction are recognized as a liability, and gain or loss on sale is deferred until the sale criterion are achieved.

 

The Company generally services Portfolio Assets acquired through its investments in Acquisition Partnerships. The Company does not recognize capitalized servicing rights related to its Portfolio Assets owned by the Acquisition Partnerships because (1) servicing is not contractually separated from the underlying assets by sale or securitization of the assets with servicing retained or separate purchase or assumption of the servicing; (2) consideration is not exchanged between the Company and the Acquisition Partnerships for the servicing rights of the acquired Portfolio Assets; (3) the Company has ownership interests in the Acquisition Partnerships that own the Portfolio Assets it services; and (4) the Company does not have the risks and rewards of ownership of servicing rights. The Company services, in all material respects, the Portfolio Assets owned for its own account, the Portfolio Assets owned by the Acquisition Partnerships and, to a very limited extent, certain Portfolio Assets owned by third parties. In connection with the Acquisition Partnerships in the United States, the Company generally earns a servicing fee, which is based on a percentage of gross cash collections generated from the Portfolio Assets. 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), the type of assets and the level of servicing required for each asset. For the Mexican Acquisition Partnerships, the Company earns a servicing fee based on costs of servicing plus a profit margin. The Acquisition Partnerships in Europe and South America are serviced by various entities in which the Company maintains non-controlling equity interests. In all cases, service fees are recognized when they are earned in accordance with the servicing agreements.

 

The Company has servicing contracts with certain of its Acquisition Partnerships that entitle the Company to receive additional compensation for servicing after a specified return to the investors has been achieved. The Company recognizes revenue related to these contracts when the required level of returns specified in the investor contracts are attained. 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 Acquisition Partnerships accrue a liability for these contingent fees provided that payment of the fees is probable and reasonably estimable.

 

In connection with the Company’s SBA lending activities, the Company recognizes servicing assets through the sale of originated or purchased loans when servicing rights are retained. The Company initially recognizes and measures at fair value servicing rights obtained from SBA loan sales and purchased servicing rights. The Company subsequently measures these servicing assets by using the amortization method, which amortizes servicing assets in proportion to, and over the period of, estimated net servicing income. The amortization of the servicing assets is analyzed periodically and is adjusted to reflect changes in prepayment rates and other estimates.

 

(2)  Recently Adopted Accounting Guidance

 

Comprehensive Income Presentation

 

In June 2011, the FASB issued guidance on the presentation of other comprehensive income. This guidance requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity was eliminated. In December 2011, the FASB issued updated guidance that defers indefinitely certain requirements from its June 2011 guidance that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. We adopted this guidance for the quarterly period ended March 31, 2012. The adoption of this guidance did not have a material impact on our consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Fair Value Measurements Disclosures

 

In May 2011, the FASB issued guidance clarifying how to measure and disclose fair value. This guidance amends the application of the “highest and best use” concept to be used only in the measurement of fair value of nonfinancial assets, clarifies that the measurement of the fair value of equity-classified financial instruments should be performed from the perspective of a market participant who holds the instrument as an asset, clarifies that an entity that manages a group of financial assets and liabilities on the basis of its net risk exposure can measure those financial instruments on the basis of its net exposure to those risks, and clarifies when premiums and discounts should be taken into account when measuring fair value. This guidance also requires new and enhanced disclosures on the quantification and valuation processes for significant unobservable inputs, transfers between Levels 1 and 2, and the categorization of all fair value measurements into the fair value hierarchy, even where those measurements are only for disclosure purposes. We adopted this guidance for the quarterly period ended March 31, 2012. Since this guidance was disclosure-only in nature, and since the Company’s Level 3 fair value measurements were not significant for the quarterly period ended March 31, 2012, the adoption of this updated guidance did not have a material impact on our financial condition and results of operations. Refer to Note 14 for additional information.

 

(3)  Business Combinations, Deconsolidation of Subsidiary, and Disposal Groups Held for Sale

 

European Acquisition Partnership and European Servicing Entity — Capital and Ownership Restructure

 

In June 2012, the capital and ownership structures of two European entities under common control of FirstCity and a non-affiliated investor group were modified (as agreed-upon by FirstCity and the non-affiliated investor group). The entities involved included UBN, SAS (“UBN,” an Acquisition Partnership) and MCS et Associés (“MCS,” a servicing entity). At the time of restructure, FirstCity had a direct 70% controlling ownership interest in UBN and a combined direct and indirect 37% noncontrolling ownership interest in MCS. FirstCity’s indirect ownership interest in MCS resulted from its ownership in UBN, which had a direct 35% noncontrolling ownership interest in MCS. Under terms of the restructure, FirstCity and the non-affiliated investor group contributed their MCS ownership interests to UBN in exchange for modified ownership interests in UBN that approximated their respective economic interests in these entities (on a combined basis) prior to the restructure. As a result, UBN now has a 100% controlling interest in MCS, and FirstCity’s ownership interest in UBN decreased to 38% (the controlling 62% interest in UBN is now held by the non-affiliated investor group). As such, the form of FirstCity’s investment in UBN changed from a consolidated subsidiary to an unconsolidated subsidiary (now treated as an equity-method investment), and FirstCity no longer has any direct investment in MCS.

 

The restructure resulted in FirstCity’s deconsolidation of UBN (since FirstCity now has a noncontrolling interest in UBN) and the exchange of an equity-method investment in MCS with an equity-method investment in UBN. FirstCity accounted for this activity as a non-monetary exchange transaction between entities with a high degree of common ownership, and accounted for the restructure at historical cost (i.e. there was no impact to FirstCity’s consolidated earnings). The net impact to FirstCity’s consolidated balance sheet from recording this activity on the restructure date consisted primarily of the following: (1) $2.9 million decrease in cash (remove cash held by UBN upon deconsolidation); (2) $0.5 million non-cash decrease in other liabilities (remove obligations of UBN upon deconsolidation); (3) $8.5 million non-cash decrease in noncontrolling interest (remove the noncontrolling equity interest in UBN attributable to the non-affiliated investor group upon deconsolidation); and (4) $6.1 million non-cash decrease to investments in unconsolidated subsidiaries (upon FirstCity’s exchange of an equity-method investment in MCS with an equity-method investment in UBN).

 

Railroad Operation — Business Combination

 

In June 2012, FirstCity, through its majority-owned Special Situations Platform subsidiary, acquired certain assets from a company that operated a rail-served debris transfer station, as partial payment of the company’s debt obligation to FirstCity. The Company’s acquisition of the operating assets was accounted for as a business combination, and accordingly, all of the assets acquired and liabilities assumed were measured at fair value on the acquisition date and included in the Company’s consolidated balance sheet. The estimated fair value of the identifiable assets acquired included $2.8 million of property and equipment, $0.5 million of trade receivables, and $0.2 million of various other assets. The estimated fair value of the identifiable liabilities assumed by the Company was not significant. The fair value of the net asset acquired by the Company exceeded its $2.5 million purchase price by approximately $0.9 million, which the Company recognized as “Gain on business combination” in its consolidated statement of earnings for the three- and six-month periods ended June 30, 2012.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Mexican Acquisition Partnerships — Disposal Groups Held for Sale

 

In the fourth quarter of 2011, the Company determined that it expected to sell or otherwise dispose of its three consolidated Mexican Acquisition Partnerships over the next twelve months. The Company wholly-owns two of these subsidiaries, and holds a majority ownership interest in the other subsidiary. In connection with the Company’s disposal plan and expectations, each subsidiary was determined to be a separate disposal group, and the assets and liabilities of each subsidiary are measured at the lower of their respective carrying amount or estimated fair value (less costs to sell) and classified as “held for sale” on the Company’s consolidated balance sheet.

 

The consolidated assets and liabilities for these Mexican subsidiaries, as measured at the lower of their respective carrying amount or estimated fair value (less costs to sell), have been respectively classified as “Assets held for sale” and “Liabilities associated with assets held for sale” on our consolidated balance sheets. At June 30, 2012 and December 31, 2011, the assets included primarily Portfolio Assets ($4.9 million and $4.8 million, respectively) and an affiliated loan receivable ($5.1 million), and the liabilities included primarily an affiliated note payable ($5.1 million). See Note 16 for additional information related to the affiliated loan receivable and affiliated note payable.

 

In July 2012, the Company sold its interests in two of these Mexican subsidiaries for $5.5 million. The Company recognized a gain of approximately $1.3 million on this transaction, which included recognition of $0.5 million of previously-deferred income attributed to one of the subsidiaries.

 

European Acquisition Partnership — Business Combination

 

In June 2011, the Company acquired a controlling interest in a European Acquisition Partnership from a foreign equity-method investee for $0.6 million. The Company owned a noncontrolling equity interest in this entity prior to the transaction. As a result of this transaction, the Company’s ownership interest in the Acquisition Partnership increased to 100% and the Company obtained control of such entity, resulting in the Acquisition Partnership becoming a consolidated subsidiary of the Company. The transaction was accounted for as a business combination, and accordingly, all of the assets and liabilities of the Acquisition Partnership were measured at fair value on the acquisition date and included in the Company’s consolidated balance sheet. The estimated fair value of the Acquisition Partnership’s identifiable assets and liabilities that were added to the Company’s consolidated balance sheet on the acquisition date included $2.7 million of Portfolio Assets and $1.7 million of notes payable and accrued liabilities (including $0.9 million of intercompany notes payable that were eliminated in consolidation with the Company’s consolidated financial statements).

 

Under business combination accounting guidance, the Company’s carrying value of its previously-held equity-method investment in the Acquisition Partnership was re-measured to fair value at the acquisition date. The fair value of the Company’s previously-held equity interest exceeded the aggregate carrying value by approximately $0.3 million, which the Company recognized as “Gain on business combination” in its consolidated statement of operations for the six-month period ended June 30, 2011.

 

(4)  Portfolio Assets

 

Portfolio Assets are summarized as follows:

 

 

 

June 30, 2012

 

 

 

(Dollars in thousands)

 

 

 

Carrying

 

Allowance for

 

Carrying

 

 

 

Value

 

Loan Losses

 

Value, net

 

Loan Portfolios:

 

 

 

 

 

 

 

Purchased Credit-Impaired Loans

 

 

 

 

 

 

 

Domestic:

 

 

 

 

 

 

 

Commercial real estate

 

$

47,211

 

$

415

 

$

46,796

 

Business assets

 

9,229

 

170

 

9,059

 

Other

 

3,253

 

12

 

3,241

 

Europe - commercial real estate

 

3,820

 

 

3,820

 

Other

 

5,457

 

20

 

5,437

 

Total Loan Portfolios

 

$

68,970

 

$

617

 

68,353

 

Real estate held for sale, net

 

 

 

 

 

14,320

 

 

 

 

 

 

 

 

 

Total Portfolio Assets

 

 

 

 

 

$

82,673

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

 

December 31, 2011

 

 

 

(Dollars in thousands)

 

 

 

Carrying

 

Allowance for

 

Carrying

 

 

 

Value

 

Loan Losses

 

Value, net

 

Loan Portfolios:

 

 

 

 

 

 

 

Purchased Credit-Impaired Loans

 

 

 

 

 

 

 

Domestic:

 

 

 

 

 

 

 

Commercial real estate

 

$

73,154

 

$

553

 

$

72,601

 

Business assets

 

10,742

 

185

 

10,557

 

Other

 

3,754

 

38

 

3,716

 

Latin America - commercial real estate

 

50

 

 

50

 

Europe - commercial real estate

 

4,267

 

 

4,267

 

Other

 

5,904

 

5

 

5,899

 

Total Loan Portfolios

 

$

97,871

 

$

781

 

97,090

 

Real estate held for sale, net

 

 

 

 

 

26,856

 

 

 

 

 

 

 

 

 

Total Portfolio Assets

 

 

 

 

 

$

123,946

 

 

Certain Portfolio Assets are pledged to secure a loan facility with Bank of Scotland and Bank of America (see Note 8). In addition, certain Portfolio Assets are pledged to secure notes payable of certain consolidated affiliates of FirstCity that are generally non-recourse to FirstCity or any affiliate other than the entity that incurred the debt.

 

In March 2012, a real estate property with a carrying value of $6.9 million (owned by a subsidiary under the Company’s Special Situations Platform business segment) was acquired by the creditor holding the mortgage secured by this property in a foreclosure transaction. The Company had the legal right to bring the account into good standing by paying all past due payments; however, the Company believed it would be unable to facilitate a positive cash flow on the property for an extended period of time based on local economic conditions. Management further believed that the property’s liquidation value was less than the debt obligation securing the property. Upon acquisition of the real estate property by the creditor and legal release from the obligation, the Company de-recognized the related non-recourse debt obligation from its consolidated balance sheet (see Note 8). This non-cash activity did not have a material impact on the Company’s results of operations for the six-month period ended June 30, 2012.

 

Income from Portfolio Assets is summarized as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Loan Portfolios:

 

 

 

 

 

 

 

 

 

Purchased Credit-Impaired Loans

 

$

5,500

 

$

7,850

 

$

13,075

 

$

20,177

 

Purchased performing loans

 

68

 

194

 

139

 

286

 

UBN

 

 

455

 

 

542

 

Other

 

10

 

89

 

45

 

143

 

Real Estate Portfolios

 

287

 

510

 

1,111

 

790

 

Income from Portfolio Assets

 

$

5,865

 

$

9,098

 

$

14,370

 

$

21,938

 

 

Accretable yield represents the amount of income the Company can expect to generate over the remaining life of its existing income-accruing Purchased Credit-Impaired Loans based on estimated future cash flows as of June 30, 2012 and 2011, respectively. Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimates of future cash flows on Purchased Credit-Impaired Loans, whereas reclassifications to nonaccretable difference from accretable yield primarily result from the Company’s decrease in its estimates of future cash flows on these loans. Transfers from (to) non-accrual primarily result from adjustments to the income-recognition method applied to Purchased Credit-Impaired Loans based on management’s ability to reasonably estimate both the timing and amount of future cash flows (see Note 1). Changes in accretable

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

yield related to the Company’s Purchased Credit-Impaired Loans for the three- and six-month periods ended June 30, 2012 and 2011 are as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Beginning Balance

 

$

4,378

 

$

19,980

 

$

4,732

 

$

1,380

 

Accretion

 

(229

)

(1,137

)

(576

)

(2,668

)

Reclassification from (to) nonaccretable difference

 

(2,103

)

2,669

 

(2,085

)

2,895

 

Disposals

 

(2,046

)

(1,920

)

(2,071

)

(3,302

)

Transfer from non-accrual

 

 

8,052

 

 

29,325

 

Translation adjustments

 

 

7

 

 

21

 

Ending Balance

 

$

 

$

27,651

 

$

 

$

27,651

 

 

Acquisitions of Purchased Credit-Impaired Loans for the three- and six-month month periods ended June 30, 2012 and 2011, respectively, are summarized in the table below:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Face value at acquisition

 

$

2,380

 

$

1,574

 

$

7,585

 

$

5,711

 

Cash flows expected to be collected at acquisition, net of adjustments

 

1,663

 

1,270

 

3,362

 

5,480

 

Basis in acquired loans at acquisition

 

1,314

 

976

 

1,696

 

4,080

 

 

During the six-month period ended June 30, 2012, the Company sold loan Portfolio Assets with an aggregate carrying value of $18.7 million. The Company sold loan Portfolio Assets with an aggregate carrying value of $39.9 million during the six-month period ended June 30, 2011 — which included $21.9 million of loans (plus real estate and certain other assets) that were sold to a European securitization entity (formed by an affiliate of Värde) in February 2011. FirstCity has a non-controlling beneficial interest in this securitization entity, and accounts for this investment as an available-for-sale security.

 

For the six-month period ended June 30, 2012, the Company recorded provisions for loan and impairment losses, net of recoveries, through a charge to income of $0.9 million — which was comprised of a $0.5 million provision for loan losses, net of recoveries, and a $0.4 million impairment charge on real estate portfolios. For the six-month period ended June 30, 2011, the Company recorded provisions for loan and impairment losses, net of recoveries, by a charge to income of $0.6 million — which was comprised of a $0.3 million provision for loan losses, net of recoveries, and a $0.3 million impairment charge on real estate portfolios.

 

Changes in the allowance for loan losses related to our loan Portfolio Assets for the three- and six-month month periods ended June 30, 2012, are as follows:

 

 

 

Purchased Credit-Impaired Loans

 

Other

 

 

 

 

 

Domestic

 

Latin America

 

Europe

 

 

 

 

 

 

 

 

 

Commercial

 

Business

 

 

 

Commercial

 

Commercial

 

 

 

 

 

(dollars in thousands)

 

Real Estate

 

Assets

 

Other

 

Real Estate

 

Real Estate

 

UBN (1)

 

Other

 

Total

 

Beginning balance, April 1, 2012

 

$

510

 

$

200

 

$

38

 

$

 

$

 

$

 

$

5

 

$

753

 

Provisions

 

277

 

35

 

 

 

 

 

25

 

337

 

Recoveries

 

 

 

 

 

 

 

 

 

Charge offs

 

(372

)

(65

)

(26

)

 

 

 

(10

)

(473

)

Ending balance, June 30, 2012

 

$

415

 

$

170

 

$

12

 

$

 

$

 

$

 

$

20

 

$

617

 

 

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Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

 

Purchased Credit-Impaired Loans

 

Other

 

 

 

 

 

Domestic

 

Latin America

 

Europe

 

 

 

 

 

 

 

 

 

Commercial

 

Business

 

 

 

Commercial

 

Commercial

 

 

 

 

 

 

 

(dollars in thousands)

 

Real Estate

 

Assets

 

Other

 

Real Estate

 

Real Estate

 

UBN (1)

 

Other

 

Total

 

Beginning balance, January 1, 2012

 

$

553

 

$

185

 

$

38

 

$

 

$

 

$

 

$

5

 

$

781

 

Provisions

 

405

 

97

 

5

 

 

 

 

25

 

532

 

Recoveries

 

 

(44

)

 

 

 

 

 

(44

)

Charge offs

 

(543

)

(68

)

(31

)

 

 

 

(10

)

(652

)

Ending balance, June 30, 2012

 

$

415

 

$

170

 

$

12

 

$

 

$

 

$

 

$

20

 

$

617

 

 


(1)  The Company sold the underlying UBN loan portfolio in November 2011.

 

Changes in the allowance for loan losses related to our loan Portfolio Assets for the three- and six-month month period ended June 30, 2011, are as follows:

 

 

 

Purchased Credit-Impaired Loans

 

Other

 

 

 

 

 

Domestic

 

Latin America

 

Europe

 

 

 

 

 

 

 

 

 

Commercial

 

Business

 

 

 

Commercial

 

Commercial

 

 

 

 

 

 

 

(dollars in thousands)

 

Real Estate

 

Assets

 

Other

 

Real Estate

 

Real Estate

 

UBN

 

Other

 

Total

 

Beginning balance, April 1, 2011

 

$

422

 

$

244

 

$

90

 

$

287

 

$

50

 

$

45,084

 

$

49

 

$

46,226

 

Provisions

 

371

 

205

 

18

 

32

 

 

 

16

 

642

 

Recoveries

 

(19

)

(7

)

 

 

 

(607

)

(19

)

(652

)

Charge offs

 

(228

)

(259

)

(9

)

 

 

 

(34

)

(530

)

Translation adjustments

 

 

 

 

20

 

2

 

1,756

 

 

1,778

 

Ending balance, June 30, 2011

 

$

546

 

$

183

 

$

99

 

$

339

 

$

52

 

$

46,233

 

$

12

 

$

47,464

 

 

 

 

Purchased Credit-Impaired Loans

 

Other

 

 

 

 

 

Domestic

 

Latin America

 

Europe

 

 

 

 

 

 

 

 

 

Commercial

 

Business

 

 

 

Commercial

 

Commercial

 

 

 

 

 

 

 

(dollars in thousands)

 

Real Estate

 

Assets

 

Other

 

Real Estate

 

Real Estate

 

UBN

 

Other

 

Total

 

Beginning balance, January 1, 2011

 

$

354

 

$

252

 

$

90

 

$

260

 

$

866

 

$

43,291

 

$

49

 

$

45,162

 

Provisions

 

607

 

352

 

18

 

49

 

 

 

16

 

1,042

 

Recoveries

 

(32

)

(7

)

 

 

 

(641

)

(19

)

(699

)

Charge offs

 

(383

)

(414

)

(9

)

 

(856

)

 

(34

)

(1,696

)

Translation adjustments

 

 

 

 

30

 

42

 

3,583

 

 

3,655

 

Ending balance, June 30, 2011

 

$

546

 

$

183

 

$

99

 

$

339

 

$

52

 

$

46,233

 

$

12

 

$

47,464

 

 

The following table presents our recorded investment in loan Portfolio Assets by credit quality indicator. Our loan Portfolio Assets, which are primarily comprised of Purchased Credit-Impaired Loans, are categorized by credit quality indicators based on the common risk characteristics that management generally uses for pooling purposes (when management elects to pool purchased loans).

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Commercial real estate

 

$

50,616

 

$

76,918

 

Business assets

 

9,059

 

10,557

 

Other commercial

 

8,678

 

9,615

 

 

 

$

68,353

 

$

97,090

 

 

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

(5)    Loans Receivable

 

The following is a composition of the Company’s loans receivable by loan type and region:

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Domestic:

 

 

 

 

 

Commercial loans:

 

 

 

 

 

Affiliates

 

$

6,757

 

$

6,719

 

SBA, net of allowance for loan losses of $425 and $333, respectively

 

25,034

 

26,765

 

Other, net of allowance for loan losses of $1,083

 

7,545

 

12,212

 

 

 

 

 

 

 

Total loans, net

 

$

39,336

 

$

45,696

 

 

Loans receivable — SBA held for sale

 

Loans receivable — SBA held for sale are summarized as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Outstanding balance

 

$

4,747

 

$

7,483

 

Capitalized costs, net of fees

 

61

 

131

 

Carrying amount of loans, net

 

$

4,808

 

$

7,614

 

 

Changes in loans receivable — SBA held for sale are as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Beginning Balance

 

$

3,260

 

$

7,769

 

$

7,614

 

$

11,608

 

Originations and advances of loans

 

4,929

 

4,933

 

7,754

 

10,872

 

Payments received

 

(18

)

(36

)

(39

)

(63

)

Capitalized costs, net

 

13

 

(76

)

(69

)

(125

)

Loans sold and transferred

 

(3,376

)

(7,518

)

(10,452

)

(17,220

)

Ending Balance

 

$

4,808

 

$

5,072

 

$

4,808

 

$

5,072

 

 

Loans receivable — SBA held for sale represent the portions of SBA loans originated or acquired by the Company that are guaranteed by the SBA. These loans are generally secured by assets such as accounts receivable, property and equipment, and other business assets. The Company did not record any write-downs of SBA loans held for sale below their cost for the six-month periods ended June 30, 2012 and 2011.

 

20



Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Loans receivable — affiliates

 

Loans receivable — affiliates, which are designated by management as held for investment, are summarized as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Outstanding balance

 

$

6,391

 

$

6,518

 

Discounts, net

 

(15

)

(59

)

Capitalized interest

 

381

 

260

 

Carrying amount of loans, net

 

$

6,757

 

$

6,719

 

 

A summary of activity in loans receivable — affiliates follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Beginning Balance

 

$

6,677

 

$

15,636

 

$

6,719

 

$

16,781

 

Advances

 

 

 

 

700

 

Payments received

 

 

(287

)

(128

)

(717

)

Capitalized costs, net

 

58

 

140

 

122

 

8

 

Discount accretion, net

 

22

 

22

 

44

 

44

 

Loan transfer (1)

 

 

 

 

(1,402

)

Other noncash adjustments

 

 

(492

)

 

(492

)

Foreign exchange gains

 

 

10

 

 

107

 

Ending Balance

 

$

6,757

 

$

15,029

 

$

6,757

 

$

15,029

 

 


(1)   Represents the sale and transfer of a loan to an affiliated entity as partial consideration for the repayment of a note payable to that affiliated entity.

 

Loans receivable — affiliates represent advances to Acquisition Partnerships and other affiliates to acquire portfolios of under-performing and non-performing commercial and consumer loans and other assets; and senior debt financing arrangements with equity-method investees to provide capital for business expansion and operations. Advances to affiliates to acquire loan portfolios are secured by the underlying collateral of the individual notes within the portfolios, which is generally real estate; whereas advances to affiliates for capital investments and working capital are generally secured by business assets (i.e. accounts receivable, inventory and equipment).

 

The Company did not record any provisions for impairment during the six-month periods ended June 30, 2012 and 2011. During the six-month period ended June 30, 2011, the Company sold an affiliated loan with a carrying value of $1.4 million. The Company did not sell any affiliated loans during the six-month period ended June 30, 2012. Information related to the credit quality and loan loss allowances related to loans receivable — affiliates is presented under the heading “Credit Quality and Allowance for Loan Losses — Loans Held for Investment” below.

 

21



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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Loans receivable — SBA held for investment, net

 

Loans receivable — SBA held for investment are summarized as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Outstanding balance

 

$

21,758

 

$

20,503

 

Allowance for loan losses

 

(425

)

(333

)

Discounts, net

 

(1,447

)

(1,292

)

Capitalized costs

 

340

 

273

 

Carrying amount of loans, net

 

$

20,226

 

$

19,151

 

 

Changes in loans receivable — SBA held for investment are as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Dollars in thousands)

 

Beginning Balance

 

$

19,389

 

$

15,574

 

$

19,151

 

$

15,415

 

Purchases of loans

 

 

696

 

 

696

 

Originations and advances of loans