<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 26, 1998
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM S-3
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
---------------------
FIRSTCITY FINANCIAL CORPORATION
(Exact name of Registrant as Specified in its Charter)
<TABLE>
<S> <C>
DELAWARE
(State or Other Jurisdiction 76-0243729
of Incorporation or Organization) (I.R.S. Employer Identification No.)
JAMES T. SARTAIN
FIRSTCITY FINANCIAL CORPORATION FIRSTCITY FINANCIAL CORPORATION
6400 IMPERIAL DRIVE P.O. BOX 8216
WACO, TEXAS 76712 WACO, TEXAS 76714-8216
(254) 751-1750 (254) 751-1750
(Address, Including Zip Code, and Telephone (Name, Address, Including Zip Code, and
Number, Including Area Code, of Registrant's Telephone Number, Including Area Code, of
Principal Executive Offices) Agent for Service)
Copies to:
STEVEN D. RUBIN, ESQ. TIMOTHY J. MELTON, ESQ.
WEIL, GOTSHAL & MANGES LLP JONES, DAY, REAVIS & POGUE
700 LOUISIANA, SUITE 1600 77 WEST WACKER DRIVE
HOUSTON, TEXAS 77002 CHICAGO, ILLINOIS 60601-1692
(713) 546-5000 (312) 782-3939
</TABLE>
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
If the only securities being registered on this Form are being offered pursuant
to dividend or interest reinvestment plans, please check the following box. [ ]
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, other than securities offered only in connection with dividend
or interest reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act of 1933, as amended, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act of 1933, as amended, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
=============================================================================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SHARES TO BE AMOUNT TO BE OFFERING PRICE PER AGGREGATE AMOUNT OF
REGISTERED REGISTERED(1) SHARE(2) OFFERING PRICE(2) REGISTRATION FEE
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value
$.01 per share...................... 1,542,150 shares $30.0625 $46,360,885 $13,677
=============================================================================================================================
</TABLE>
(1) Includes 201,150 shares covered by the over-allotment option.
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(c) under the Securities Act of 1933, as amended.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
================================================================================
<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED MARCH 25, 1998
PROSPECTUS
dated , 1998
1,341,000 SHARES
[FIRSTCITY LOGO]
FINANCIAL CORPORATION
COMMON STOCK
Of the 1,341,000 shares of Common Stock, par value $.01 per share ("Common
Stock"), offered hereby (the "Offering"), 1,000,000 are being sold by FirstCity
Financial Corporation, a Delaware corporation (the "Company"), and 341,000 are
being sold by the Selling Shareholders. See "Principal and Selling
Shareholders." The Company will not receive any proceeds from the sale of shares
of Common Stock by the Selling Shareholders.
The Common Stock is quoted on the Nasdaq National Market under the symbol
"FCFC." On March 24, 1998, the last reported sale price of the Common Stock on
the Nasdaq National Market was $30.00 per share. See "Price Range of Common
Stock and Dividend Policy."
SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
=======================================================================================================================
PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share.................... $ $ $ $
- -----------------------------------------------------------------------------------------------------------------------
Total(3)..................... $ $ $ $
=======================================================================================================================
</TABLE>
(1) The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $500,000.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
201,150 additional shares of Common Stock solely to cover over-allotments,
if any, at the Price to Public less the Underwriting Discount. If such
option is exercised in full, the Price to Public, Underwriting Discount and
Proceeds to Company will be $ , $ and $ ,
respectively. See "Underwriting."
The shares of Common Stock are offered by the Underwriters subject to prior sale
when, as and if delivered to and accepted by the Underwriters and subject to
their right to reject orders in whole or in part. It is expected that delivery
of the certificates for such shares of Common Stock will be made at the offices
of Piper Jaffray Inc. in Minneapolis, Minnesota on or about ,
1998.
PIPER JAFFRAY INC.
THE ROBINSON-HUMPHREY COMPANY
SANDLER O'NEILL & PARTNERS, L.P.
<PAGE> 3
FIRSTCITY FINANCIAL CORPORATION
------------------------------
OFFICE LOCATIONS
------------------------------
[MAP SHOWING THE COMPANY'S OFFICE LOCATIONS]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SHARES OF COMMON
STOCK. SUCH TRANSACTIONS MAY INCLUDE STABILIZING, THE PURCHASE OF COMMON STOCK
TO COVER SYNDICATE SHORT POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON
THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE
"UNDERWRITING."
2
<PAGE> 4
- --------------------------------------------------------------------------------
SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and the Consolidated
Financial Statements (including the Notes thereto) included elsewhere in this
Prospectus or incorporated by reference herein. Unless the context otherwise
requires, references in this Prospectus to the "Company" and "FirstCity" shall
mean FirstCity Financial Corporation, a Delaware corporation, and its
subsidiaries and predecessors. References to the Company for periods prior to
July 3, 1995 refer to the Company's predecessor, J-Hawk Corporation. Unless
otherwise indicated, the information contained in this Prospectus assumes that
the over-allotment option granted by the Company to the Underwriters is not
exercised.
THE COMPANY
GENERAL
The Company is a diversified financial services company headquartered in
Waco, Texas with over 90 offices throughout the United States and a presence in
France and Mexico. 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
$3.0 billion. In 1996, the Company adopted a growth strategy to diversify and
expand its financial services business. To implement its growth strategy, the
Company has acquired or established several businesses in the financial services
industry, building upon its core strength and expertise as one of the earliest
participants in the business of acquiring and resolving distressed financial
assets and other assets. 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 three principal
businesses: (i) residential and commercial mortgage banking; (ii) Portfolio
Asset acquisition and resolution; and (iii) consumer lending.
BUSINESS STRATEGY
The Company's business strategy is to continue to broaden and expand its
business within the financial services industry while building on its core
servicing strengths and credit expertise. The following principles are key
elements to the execution of the Company's business strategy:
- Expand the financial products and services offered by existing
businesses.
- Broaden its sources of revenue and operating earnings by developing or
acquiring additional businesses that leverage its core strengths and
management expertise.
- Cross-sell between the Company's businesses.
- Invest in fragmented or underdeveloped markets in which the Company has
the investment and servicing expertise to achieve attractive risk
adjusted rates of return.
- Pursue new business opportunities through joint ventures, thereby
capitalizing on the expertise of partners whose skills complement those
of the Company.
- Maximize growth in earnings, thereby permitting the utilization of the
Company's substantial tax net operating loss carryforwards.
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3
<PAGE> 5
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MORTGAGE BANKING
The Company engages in the mortgage banking business through two principal
subsidiaries, FirstCity Financial Mortgage Corporation ("Mortgage Corp.") and FC
Capital Corporation ("Capital Corp."). Mortgage Corp. is a direct retail and
broker retail mortgage bank, which originates, purchases, sells and services
residential and commercial mortgage loans through more than 80 offices
throughout the United States. The Company acquired Mortgage Corp. (then named
Harbor Financial Group, Inc.) by merger in July 1997 (the "Harbor Merger").
Mortgage Corp. originates and purchases both fixed rate and adjustable rate
residential mortgage loans, primarily secured by first liens on single family
residences. The majority of the residential loans originated by Mortgage Corp.
are conventional conforming loans that qualify for sale to, or conversion into
securities issued by, various government agencies. Substantially all of the
conventional conforming loans are originated with loan-to-value ratios at or
below 80% unless the borrower obtains private mortgage insurance. Mortgage Corp.
retains the right to service substantially all of the residential loans that it
originates and, as of December 31, 1997, had a residential servicing portfolio
of approximately $5.0 billion in principal balance of loans. Mortgage Corp.
ranks among the 50 largest mortgage banks in the United States.
In 1996, Mortgage Corp. implemented a program to supplement its origination
of conventional conforming loans by offering residential mortgage loans to
borrowers who have significant equity in their homes and who generally do not
satisfy the more rigid underwriting standards of the traditional residential
mortgage lending market (referred to herein as "Home Equity Loans"). These loans
are extended to borrowers who demonstrate an ability and willingness to repay
credit, but who might have experienced an adverse event, such as job loss,
illness or divorce, or have had past credit problems such as delinquency,
bankruptcy, repossession or charge-offs. Such an event normally will temporarily
impair a borrower's credit rating so that the borrower will not qualify as a
prime borrower from a traditional mortgage lender. Mortgage Corp. currently
sells its Home Equity Loans, servicing released, principally to other mortgage
banking companies.
Mortgage Corp.'s commercial mortgage business consists of the origination
and servicing of commercial mortgage loans secured by commercial real estate
properties and single family residential construction loans. Through eight
offices located in California, Texas and Colorado, Mortgage Corp. originates
commercial loans that are funded by third parties, primarily insurance
companies, for which Mortgage Corp serves as the correspondent. The loans are
secured by multi-family residential projects, office buildings, shopping centers
and other income producing properties. Revenues derived from Mortgage Corp.'s
commercial lending business are principally origination fees based on a
percentage of the loan amount. In 1995, Mortgage Corp. began originating for its
own account and servicing residential construction loans through a construction
loan department headquartered in Houston, Texas. Construction loans are
currently originated in nine states.
The Company formed Capital Corp. in August 1997 to acquire, originate,
warehouse, securitize and service Home Equity Loans. The Company owns 80% of the
outstanding stock of Capital Corp. and Capital Corp.'s senior management owns
the remaining 20%. Capital Corp. acquires Home Equity Loans individually and in
bulk from several independent loan origination sources. Substantially all of the
Home Equity Loans acquired by Capital Corp. are secured by first liens on the
underlying collateral. From its first acquisition of loans in October 1997
through February 28, 1998, Capital Corp. acquired Home Equity Loans with
principal balances totaling $75.6 million from six different sellers, $53.6
million of which were acquired through December 31, 1997. Although Capital Corp.
has not acquired Home Equity Loans originated by Mortgage Corp., it may acquire
such loans in the future.
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
The Company engages in the Portfolio Asset acquisition and resolution
business and is beginning to originate niche commercial loans through 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,
- --------------------------------------------------------------------------------
4
<PAGE> 6
- --------------------------------------------------------------------------------
including pools of real estate, which are generally acquired at a discount to
Face Value. 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. A Portfolio is designated as
nonperforming unless substantially all of the assets comprising the Portfolio
are performing. Purchases may be in the form of pools of assets or single
assets.
Portfolios are either acquired for Commercial Corp.'s own account or
through investment entities formed with Cargill Financial Services Corporation
("Cargill Financial") or one or more other co-investors (each such entity, an
"Acquisition Partnership"). Cargill Financial 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. The Company began its
relationship with Cargill Financial in 1991. Since that time, the Company and
Cargill Financial have formed a series of Acquisition Partnerships through which
they have jointly acquired over $2.2 billion in Face Value of distressed assets.
Historically, Commercial Corp. has leveraged its expertise in asset
resolution and servicing by investing in a wide variety of asset types in
virtually all 50 states, the Virgin Islands, Puerto Rico and France. Commercial
Corp. continues to follow this investment strategy and seeks expansion
opportunities into new asset classes and foreign markets when it believes it can
achieve attractive risk adjusted returns.
The Company's development of a niche commercial lending business is a
logical extension of its extensive experience with the resolution of distressed
assets. In many cases, the resolution of such assets involves the modification
of an existing debt into a new or modified extension of credit more suited to
the borrower's needs, ability to pay and value of the underlying collateral. The
Company intends to use such experience as the foundation upon which Commercial
Corp. will seek niche commercial lending opportunities.
CONSUMER LENDING
The Company conducts all of its consumer receivable origination activities
through FirstCity Consumer Lending Corporation and its subsidiaries ("Consumer
Corp."). Consumer Corp.'s current focus is 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. The significant majority
of Consumer Corp.'s current business is in the sub-prime automobile sector.
Consumer Corp.'s current practice is to individually underwrite and price each
loan prior to funding.
The Company's initial venture into the sub-prime automobile market involved
the acquisition of a distressed sub-prime automobile loan portfolio from a
secured lender and the equity of the company that operated the program through
which the loans had been originated. This program involved the indirect
acquisition of automobile loans from financial intermediaries that had direct
contact with automobile dealerships. The Company was required to purchase loans
that satisfied minimum contractual underwriting standards and was not permitted
to negotiate purchase discounts for a loan based on the individual risk profile
of the loan and the borrower. After operating the program for approximately 15
months, the Company concluded that the contractual underwriting standards and
purchase discounts on which the program was based were insufficient to generate
sub-prime automobile loans that produced acceptable risk adjusted returns. As a
result, the Company terminated its obligations with the financial institutions
participating in such origination program effective as of January 31, 1998.
With the benefit of the experience gained by the Company through its
initial sub-prime automobile financing program, the Company formed FirstCity
Funding Corporation ("Funding Corp.") in the third quarter of 1997. Funding
Corp.'s business model is predicated upon the acquisition of newly originated
sub-prime automobile finance contracts directly from franchised dealerships at a
discount that is adjusted to reflect the aggregate expected losses on defaulted
contracts. From its inception in September 1997 through
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5
<PAGE> 7
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February 28, 1998, Funding Corp. acquired approximately $16.6 million in
principal balance of loans, $7.1 million of which were acquired through December
31, 1997.
SERVICING
The Company is consolidating all of its servicing capabilities into a
single subsidiary, FirstCity Servicing Corporation ("Servicing Corp."). This
process is designed to combine all servicing activities under a single
management group in an effort to achieve further operating efficiencies, enhance
the quality of asset servicing and coordinate and improve the technology support
for all of the Company's businesses. When this consolidation is complete,
Servicing Corp. will have responsibility for the management of all of the
Company's activities related to servicing mortgage loans, Home Equity Loans,
Portfolio Assets and automobile and other consumer loans.
BACKGROUND
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 net operating loss carryforwards ("NOLs"). See
"Certain Federal Income Tax Considerations."
The Company's principal executive offices are located at 6400 Imperial
Drive, Waco, Texas 76712, and its telephone number is (254) 751-1750. The
mailing address of the Company's principal executive offices is P.O. Box 8216,
Waco, Texas 76714-8216
THE OFFERING
Common Stock offered by the
Company.................. 1,000,000 shares
Common Stock offered by the
Selling Shareholders..... 341,000 shares
Common Stock to be
outstanding after the
Offering................. 7,570,081 shares(1)
Nasdaq National Market
symbol................... FCFC
Use of proceeds............ The Company expects to use the net proceeds of the
Offering to repay outstanding indebtedness under
the Company's $35 million revolving credit
facility with Cargill Financial (the "Company
Credit Facility") and, to the extent any proceeds
remain, to repay outstanding indebtedness under
certain other revolving credit facilities to
which subsidiaries of the Company are parties.
The Company will not receive any proceeds from
the sale of shares of Common Stock by the Selling
Shareholders. See "Use of Proceeds."
- ---------------
(1) Excludes 497,198 shares of Common Stock issuable upon the exercise of
outstanding warrants and 311,800 shares of Common Stock issuable upon the
exercise of options granted under the Company's 1995 Stock Option and Award
Plan and 1996 Stock Option and Award Plan (collectively, the "Stock Option
Plans").
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6
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SUMMARY FINANCIAL AND OTHER INFORMATION
The following summary financial information is derived from the financial
statements of the Company as of and for the periods presented. The Harbor
Merger, which occurred on July 1, 1997, was accounted for as a pooling of
interests. The Company's historical financial statements have therefore been
retroactively restated to include the financial position and results of
operations of Mortgage Corp. for all periods presented. Prior to the Harbor
Merger, Mortgage Corp.'s fiscal year end was September 30. As a result, for
years prior to 1997, the financial statements of Mortgage Corp. for its prior
fiscal year periods are consolidated with calendar year end data for the
Company. The summary financial information below should be read in conjunction
with "Capitalization," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
of the Company (including the Notes thereto) included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
---------- ---------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
SUMMARY INCOME STATEMENT
Revenues:
Gain on sale of mortgage loans................. $ 36,496 $ 19,298 $ 7,864
Net mortgage warehouse income.................. 3,499 3,224 2,355
Gain on sale of mortgage servicing rights...... 4,246 2,641 2,011
Servicing fees:
Mortgage..................................... 14,732 10,079 6,508
Other........................................ 12,066 12,456 10,903
Gain on resolution of Portfolio Assets......... 24,183 19,510 11,984
Equity in earnings of Acquisition
Partnerships................................. 7,605 6,125 3,834
Rental income on real estate Portfolios........ 332 3,033 1,277
Interest income................................ 13,448 7,707 1,572
Other income................................... 9,462 3,415 3,060
Interest income on Class A Certificate......... 3,553 11,601 8,597
---------- ---------- --------
Total revenues............................ 129,622 99,089 59,965
---------- ---------- --------
Expenses:
Interest on other notes payable................ 12,433 10,403 4,721
Salaries and benefits.......................... 42,191 26,927 16,767
Amortization:
Mortgage servicing rights.................... 7,550 4,091 3,823
Other........................................ 2,563 3,113 1,534
Provision for loan losses...................... 6,613 2,029 --
Occupancy, data processing, communication and
other........................................ 37,972 23,254 11,955
Interest on senior subordinated notes.......... -- 3,892 4,721
---------- ---------- --------
Total expenses............................ 109,322 73,709 43,521
---------- ---------- --------
Net earnings before minority interest, preferred
dividends and income taxes..................... 20,300 25,380 16,444
Benefit (provision) for income taxes........... 15,485 13,749 (1,200)
---------- ---------- --------
Net earnings before minority interest and
preferred dividends............................ 35,785 39,129 15,244
Minority interest.............................. (157) -- --
Preferred dividends............................ (6,203) (7,709) (3,876)
---------- ---------- --------
Net earnings to common shareholders............... $ 29,425 $ 31,420 $ 11,368
========== ========== ========
Net earnings per common share - basic............. $ 4.51 $ 4.83 $ 2.18
Net earnings per common share - diluted........... $ 4.46 $ 4.79 $ 2.18
Weighted average common shares
outstanding - basic............................ 6,518 6,504 5,223
Weighted average common shares
outstanding - diluted.......................... 6,591 6,556 5,223
</TABLE>
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7
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<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
SUMMARY INCOME STATEMENT DATA FOR EACH BUSINESS
Mortgage Banking:
Revenues....................................... $ 65,726 $ 37,620 $ 20,442
Expenses....................................... 59,840 31,632 19,667
---------- ---------- --------
Operating contribution before direct taxes..... $ 5,886 $ 5,988 $ 775
========== ========== ========
Operating contribution, net of direct taxes.... $ 7,975 $ 3,724 $ 511
========== ========== ========
Portfolio Asset acquisition and resolution:
Revenues....................................... 47,703 44,667 30,926
Expenses....................................... 24,211 23,311 14,245
---------- ---------- --------
Operating contribution before direct taxes..... $ 23,492 $ 21,356 $ 16,681
========== ========== ========
Operating contribution, net of direct taxes.... $ 23,299 $ 21,210 $ 15,745
========== ========== ========
Consumer Lending:
Revenues....................................... 10,281 3,650 --
Expenses....................................... 16,019 5,480 --
---------- ---------- --------
Operating contribution before direct taxes..... $ (5,738) $ (1,830) $ --
========== ========== ========
Operating contribution, net of direct taxes.... $ (5,741) $ (1,830) $ --
========== ========== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
SUMMARY BALANCE SHEET DATA
Mortgage assets.................................. $ 650,775 $ 193,823 $ 123,006
Portfolio acquisition and resolution assets...... 125,480 98,001 122,126
Consumer assets.................................. 64,135 31,397 --
Deferred tax asset............................... 30,614 13,898 --
Total assets..................................... 940,119 425,189 439,051
Notes payable.................................... 750,781 266,166 317,189
Preferred stock.................................. 41,908 53,617 55,555
Total shareholders' equity....................... 112,758 84,802 52,788
</TABLE>
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8
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<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
ORIGINATION AND OTHER FINANCIAL DATA
Mortgage Corp.
Origination of residential mortgage loans:
Conventional................................ $2,404,872 $1,439,197 $ 509,447
Agency...................................... 593,003 240,015 132,159
Home Equity................................. 178,492 6,583 --
Other....................................... 63,155 20,062 44,530
---------- ---------- ----------
Total.................................... 3,239,522 1,705,857 686,136
Origination of commercial mortgage loans:
Correspondent............................... 348,060 35,600 53,405
Construction................................ 65,740 28,780 --
---------- ---------- ----------
Total.................................... 413,800 64,380 53,405
Capital Corp.
Acquisition of Home Equity Loans.............. 53,624 -- --
Portfolio Asset acquisition and resolution
activity(1)
Aggregate purchase price of assets
purchased................................... 183,229 205,524 213,187
Face Value of assets purchased................ 504,891 413,844 699,622
Proceeds(2)................................... 194,975 403,275 374,425
Number of assets purchased.................... 5,503 5,921 19,031
Consumer Corp.
Acquisition of automobile and other consumer
receivables................................. 89,845 17,635 --
</TABLE>
- ---------------
(1) Includes activities of all Acquisition Partnerships and for Commercial
Corp.'s own account.
(2) Includes proceeds of $158 million and $107 million attributable to assets
owned by the Trust in 1996 and 1995, respectively.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
SERVICING PORTFOLIO DATA
Residential mortgage loans
Conventional.................................. $4,280,315 $3,234,197 $ 894,840
Agency........................................ 695,510 521,637 390,047
Other......................................... 20,688 66,815 68,802
---------- ---------- ----------
Total.................................... 4,996,513 3,822,649 1,353,689
Commercial mortgage loans........................ 1,691,939 124,379 94,706
Automobile receivables........................... 100,869 33,583 --
Portfolio acquisition and resolution (Face
Value)........................................ 837,376 975,190 930,757
</TABLE>
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FORWARD-LOOKING STATEMENTS
This Prospectus may contain or incorporate by reference forward-looking
statements. The factors identified under "Risk Factors" 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, the Company.
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.
RISK FACTORS
In addition to the other information contained in this Prospectus and
incorporated herein by reference, prospective investors in the Common Stock
should carefully consider the following risk factors.
RISKS ASSOCIATED WITH RAPID GROWTH AND ENTRY INTO NEW BUSINESSES
Following the Merger, the Company embarked upon a strategic diversification
of its business. Previously, the Company had been engaged primarily in the
Portfolio Asset acquisition and resolution business. The Company has recently
entered the residential and commercial mortgage banking business and the
consumer lending business through a combination of acquisitions and the start-up
of new business ventures. The entry of the Company into these new businesses has
resulted in increased demands on the Company's personnel and systems. The
development and integration of the new businesses requires the investment of
additional capital and the continuous involvement of senior management. The
Company also must manage a variety of businesses with differing markets,
customer bases, financial products, systems and managements. An inability to
develop, integrate and manage its businesses could have a material adverse
effect on the Company's financial condition, results of operations and business
prospects. The Company's ability to support and manage continued growth is
dependent upon, among other things, its ability to attract and retain senior
management for each of its businesses, to hire, train, and manage its workforce
and to continue to develop the skills necessary for the Company to compete
successfully in its existing and new business lines. There can be no assurance
that the Company will successfully meet all of these challenges.
CONTINUING NEED FOR FINANCING
General. The successful execution of the Company's business strategy
depends on its continued access to financing for each of its major operating
subsidiaries. In addition to the need for such financing, the Company must have
access to liquidity to invest as equity or subordinated debt to meet the capital
needs of its subsidiaries. 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 Financial) 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
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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 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 Credit Facility. The credit
facilities to which the Company's major operating subsidiaries are party do not
contain similar cross-default or cross-acceleration provisions. Although the
Company intends to continue 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 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 mortgage banking
and consumer lending businesses, the Company's subsidiaries depend 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 Company'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 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 financial condition, results of operations and business
prospects.
RISKS OF SECURITIZATION
Significance of Securitization. The Company believes that it will become
increasingly dependent upon its ability to securitize Home Equity Loans,
sub-prime automobile loans and other loans 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 financial 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, thereby making 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 financial 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. Although the Company intends to sell substantially all of
the Home Equity Loans, sub-prime automobile loans and other consumer loans that
it originates or purchases, the Company retains
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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 they were purchased
by the Company. 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 dependent on the financial condition of the
originator. There can be no assurance that the Company will not experience a
material loss in respect of any of these contingencies.
Performance Assumptions. Capital Corp. and Funding Corp.'s future net
income will be highly dependent on realizing securitization gains on the sale of
loans. 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. 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 Capital Corp. and
Funding Corp. represent claims to future cash flow that are subordinated to
holders of senior interests, Capital Corp. and Funding Corp. retain 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 Capital Corp. and Funding Corp. 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. The Company
monitors the interest rate environment and employs hedging strategies designed
to mitigate certain effects of changes in interest rates when the Company deems
such strategies appropriate. 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 financial condition, results of operations and business prospects.
Among other things, a decline in interest rates could result in increased
prepayments of outstanding loans, particularly on loans in the servicing
portfolio of Mortgage Corp. The value of servicing rights is a significant asset
of Mortgage Corp. As prepayments of serviced mortgages increase, the value of
such servicing rights (as reflected on the Company's balance sheet) declines,
with a corresponding reduction in income as a result of the impairment of the
value of mortgage servicing rights. Although to date the impact of such effect
has largely been mitigated by increased production of mortgages from
refinancings during periods of declining
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interest rates, there can be no assurance that new mortgage production will be
sufficient to mitigate such effect in the future. Absent a level of new mortgage
production sufficient to mitigate the effect of mortgage loan prepayments, the
future revenue and earnings of the Company will be adversely affected. In
addition to prepayment risks, during periods of declining interest rates,
Mortgage Corp. experiences higher levels of borrowers who elect not to close on
loans for which they have applied because they tend to find loans at lower
interest rates. If Mortgage Corp. has entered into commitments to sell such a
loan on a forward basis and the prospective borrower fails to close, Mortgage
Corp. must nevertheless meet its commitment to deliver the contracted for loans
at the promised yields. Mortgage Corp. will incur a loss if it is required to
deliver loans to an investor at a committed yield higher than current market
rates. A substantial and sustained decline in interest rates also 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
mortgage and other 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
The Company'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 another adverse credit event. 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 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 financial
condition, results of operations and business prospects could be materially
adversely affected. The Company 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.
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.
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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 estimates that it has
generated an additional $12 million in NOLs. Accordingly, as of December 31,
1997, the Company believes that it had approximately $608 million of NOLs
available to offset future taxable income. In accordance with the terms of
Financial Accounting Standards Board Statement Number 109 (relating to
accounting for income taxes), the Company has established a future utilization
equivalent to approximately $87.7 million of the total $608 million of NOLs,
which equates to a $30.7 million deferred tax asset on the Company's books and
records. However, because the Company's position in respect of its NOLs 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 amount or availability of the NOLs to the
Company, there can be no assurance that the IRS will not challenge the amount or
availability of the Company's NOLs and, if challenged, that the IRS will not be
successful in disallowing the entire amount of the Company's NOLs, with the
result that the Company's $30.7 million deferred tax asset would be reduced or
eliminated.
Assuming that the $608 million in NOLs is available to the Company, the
entire amount of such NOLs may be carried forward to offset future taxable
income of the Company until the tax year 2005. Thereafter, the NOLs begin to
expire. 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"). In this regard, the Company believes that the
issuance of Common Stock pursuant to the Offering will not give rise to a more
than 50% ownership change of the Company and, therefore, that the Company's NOLs
will not be limited by section 382 as a result of the Offering. Although the
Company believes that the Offering will not give rise to a more than 50%
ownership change under section 382, any such future ownership change of the
Company will severely limit the utilization of the NOLs of the Company that are
available at that time.
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' pre-tax
income, and to have access to the cash flow that would otherwise be represented
by payments of federal tax liabilities.
For a more detailed discussion of these and other tax considerations,
including certain tax considerations relating to transactions undertaken in
connection with the Merger, see "Certain Federal Income Tax Considerations."
ASSUMPTIONS UNDERLYING PORTFOLIO ASSET PERFORMANCE
The purchase price and carrying value of Portfolio Assets acquired by
Commercial Corp. is 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 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
residential or 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 mortgage banking,
consumer and commercial finance businesses and negatively impact its
securitization activity and generally
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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 mortgage loans and other loans and could have a
material adverse effect on the Company's financial condition, results of
operations and business prospects. Such periods also may be accompanied by
declining values of homes, 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 homes or 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 foreclosed homes
or 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 financial condition, results of operations and business prospects.
RISK OF DECLINING VALUE OF COLLATERAL
The value of the collateral securing mortgage loans, 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 financial condition, results of operations and business
prospects of the Company.
GOVERNMENT REGULATION
Many 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, the Company's loan originations, credit activities, maximum interest
rates, finance and other charges, disclosures to customers, 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 interest and fee 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."
The mortgage banking industry in particular is highly regulated. Failure to
comply with any of the various state and federal laws affecting the industry,
all of which are subject to regular modification, may result in, among other
things, demands for indemnification or mortgage loan repurchases, certain rights
of rescission for mortgage loans, class action lawsuits, administrative
enforcement actions and civil and criminal liability. Furthermore, currently
there are proposed various laws, rules and regulations which, if adopted, could
materially affect the Company's business. There can be no assurance that these
proposed laws, rules and regulations, or other such laws, rules or regulations
will not be adopted in the future that will make compliance more difficult or
expensive, restrict the Company's ability to originate, purchase, service or
sell loans, further limit or restrict the amount of commissions, interest and
other charges earned on loans originated, purchased, serviced or sold by the
Company, or otherwise have a material adverse effect on the Company's financial
condition, results of operations and business prospects. See
"Business -- Government Regulation."
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower
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<PAGE> 17
income, type of loan or principal amount. The reduction or elimination of these
tax benefits may lessen the demand for residential mortgage loans and Home
Equity Loans, and could have a material adverse effect on the Company's
financial condition, results of operations and business prospects.
ENVIRONMENTAL LIABILITIES
The Company, through its subsidiaries and affiliates, acquires real
property in its Portfolio Asset acquisition and resolution business, and
periodically acquires real property through foreclosure of mortgage loans that
are in default. 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 mortgage or other 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.
RISKS ASSOCIATED WITH FOREIGN OPERATIONS
Commercial Corp. has acquired, and manages and resolves, Portfolio Assets
located in France, and is actively pursuing opportunities to purchase additional
pools of distressed assets in France, other areas of Western Europe and Mexico.
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 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 financial condition, results of
operations and business prospects.
DEPENDENCE ON INDEPENDENT MORTGAGE BROKERS
The Company depends in large part on independent mortgage brokers for the
origination and purchase of mortgage loans. In 1997, a substantial portion of
the loans originated by Mortgage Corp., and all of the loans originated by
Capital Corp., were originated by independent mortgage brokers or otherwise
acquired from third parties. These independent mortgage brokers deal with
multiple lenders for each prospective borrower. The Company competes with these
lenders for the independent brokers' business based on a number of factors,
including price, service, loan fees and costs. The Company's financial
condition, results of operations and business prospects could be adversely
affected by changes in the volume and profitability of mortgage loans resulting
from, among other things, competition with other lenders and purchasers of such
loans.
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Class action lawsuits have been filed against a number of mortgage lenders,
including Mortgage Corp., alleging that such lenders have violated the federal
Real Estate Settlement Procedures Act of 1974 by making certain payments to
independent mortgage brokers. If these cases are resolved against the lenders,
it may cause an industry-wide change in the way independent mortgage brokers are
compensated. Such changes may have a material adverse effect on the Company's
results of operations, financial condition and business prospects.
DEPENDENCE ON AUTOMOBILE DEALERSHIP RELATIONSHIPS
The ability of the Company 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 Company's ability to maintain or expand its dealership
network.
LITIGATION
Industry participants in the lending business 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 financial condition, results of operations and business
prospects.
RELATIONSHIP WITH AND DEPENDENCE UPON CARGILL
The Company's relationship with Cargill Financial is significant in a
number of respects. Cargill Financial, 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,
and provides a $35 million revolving line of credit to the Company, which
expires on March 28, 1998. Cargill Financial owns approximately 3.7% of the
Company's outstanding Common Stock, and a Cargill Financial designee, David W.
MacLennan, serves as a director of the Company. The Company believes its
relationship with Cargill Financial 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 Financial 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 Financial 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 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 Chief Executive Officer), James T.
Sartain (President and Chief Operating Officer), Rick R. Hagelstein (Executive
Vice President and Director of Subsidiary Operations), Matt A. Landry, Jr.
(Executive Vice President and Chief Administrative Officer) and Richard J.
Gillen (Managing Director of Mortgage Finance). 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 financial condition, results of operations and business
prospects. Except for Mr. Gillen, none of the senior executive officers has
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
other than Mr. Gillen.
17
<PAGE> 19
INFLUENCE OF CERTAIN SHAREHOLDERS
After giving effect to the Offering, the directors and executive officers
of the Company will collectively beneficially own approximately 33.7% 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
shareholders of the Company and thereby exert considerable influence over the
affairs of the Company. After giving effect to the Offering, James R. Hawkins,
the Chairman of the Board and Chief Executive Officer of the Company, will be
the beneficial owner of approximately 12.5% of the outstanding Common Stock.
James T. Sartain, President and Chief Operating Officer of the Company, and
ATARA I, Ltd. ("ATARA"), an entity associated with Rick R. Hagelstein, Executive
Vice President and Director of Subsidiary Operations of the Company, will, after
giving effect to the Offering, beneficially own approximately 4.7% and 4.5% of
the outstanding Common Stock, respectively. In addition, after giving effect to
the Offering, Cargill Financial will own approximately 2.9% of the Common Stock.
Mr. Hawkins, Mr. Sartain, Cargill Financial and ATARA are parties to a
shareholder voting agreement (the "Shareholder Voting Agreement"). Under the
Shareholder Voting Agreement, Mr. Hawkins, Mr. Sartain and ATARA are required to
vote their shares in favor of Cargill Financial's designee for director of the
Company, and Cargill Financial is required to vote its shares in favor of one or
more of the designees of Messrs. Hawkins and Sartain and ATARA. After giving
effect to the Offering, ATARA, Cargill Financial and Messrs. Hawkins and Sartain
will be the beneficial owners of an aggregate of 24.6% of the outstanding Common
Stock and likely will be able to continue to exert considerable influence over
the affairs of the Company. After giving effect to the Offering, Richard J.
Gillen, Managing Director of Mortgage Finance, and Ed Smith will be the
beneficial owners of 8.5% and 7.8%, respectively, of the Common Stock. As a
result, Messrs. Gillen and Smith may be able to exert influence over the affairs
of the Company and if their shares are combined with the holdings of Messrs.
Hawkins and Sartain and the shares held by ATARA, will have effective control of
the Company. 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 shareholders. See "Principal and Selling Shareholders."
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of Common Stock in the public market, or the
perception of the availability of shares for sale, following the Offering could
adversely affect the prevailing market price of the Common Stock. The Company's
directors and the other Selling Shareholders have agreed not to dispose of any
shares of Common Stock for a period of 90 days from the date of this Prospectus,
other than pursuant to the Offering, without the prior written consent of Piper
Jaffray Inc., as representative of the Underwriters. On a pro forma basis after
giving effect to the Offering, there would have been 7,570,081 shares of Common
Stock outstanding as of March 24, 1998. Upon completion of the Offering,
3,828,584, or 50.6%, of such shares may be sold without restriction under the
Securities Act of 1933, as amended (the "Securities Act"). The remaining shares
are "restricted securities" within the meaning of Rule 144 under the Securities
Act (the "Restricted Shares") and may be publicly resold only if registered
under the Securities Act or sold in accordance with an applicable exemption from
such registration, such as Rule 144. In this regard, the Company currently has
two effective shelf registration statements on Form S-3 on file with the
Securities and Exchange Commission (the "Commission") with respect to the
Restricted Shares, pursuant to which the holders of such Restricted Shares may
sell such Restricted Shares without restriction under the Securities Act. As of
March 24, 1998, warrants exercisable for 497,198 shares of Common Stock and
options exercisable for 311,800 shares of Common Stock were outstanding.
Generally, all shares issued upon the exercise of such warrants and options may
be sold without restriction under the Securities Act. The Company is unable to
make any prediction as to the effect, if any, that the future sales of Common
Stock or the availability of Common Stock for sale will have on the prevailing
market price of Common Stock. See "Shares Eligible for Future Sale."
The utilization of the Company's NOLs 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 from
18
<PAGE> 20
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. See "Transferability and Ownership of Capital Stock."
RELIANCE ON SYSTEMS; YEAR 2000 ISSUES
The Company's computer systems are integral to the operation of its
businesses. There can be no assurance that these systems will continue to be
adequate to support the Company's growth. A failure of the Company's computer
systems, including a failure of data integrity or accuracy, could have a
material adverse effect on the Company's financial condition, results of
operations and business prospects.
Although the Company maintains its own computer systems for a significant
portion of its operations, the Company is substantially dependent on the
services of third-party servicers in its mortgage banking and Portfolio Asset
acquisition and resolution businesses. The Company has been informed by such
servicers that, although they intend to make the necessary modifications to
their computer systems, the computer systems operated by them are not yet year
2000 compliant. In addition, the Company interacts electronically with several
government agencies, including FHLMC, FNMA, FHA, FMHA and GNMA, whose computer
systems are not yet year 2000 compliant. There can be no assurance that such
third parties and government agencies will make the necessary modifications to
their respective computer systems to enable proper processing of transactions
relating to the year 2000 and beyond. Any failure by such entities to timely
correct year 2000 issues could have a material adverse effect on the Company's
financial condition, results of operations and business prospects.
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. See
"Transferability and Ownership of Capital Stock."
PERIOD TO PERIOD VARIANCES
The Company recognizes revenue from Portfolio Assets and Acquisition
Partnerships 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 affecting the Company, may result in
significant fluctuations in the reported earnings 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
financial condition, results of operations and business prospects.
19
<PAGE> 21
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the shares
of Common Stock offered by the Company pursuant to this Offering will be
approximately $27.9 million ($33.6 million if the Underwriters' over-allotment
option is exercised in full) after deducting the underwriting discount and
estimated offering expenses. The Company expects to use such net proceeds to
repay outstanding indebtedness under the Company Credit Facility and, to the
extent any proceeds remain, to repay outstanding indebtedness under certain
other revolving credit facilities to which subsidiaries of the Company are
parties. As of March 24, 1998, outstanding indebtedness under the Company Credit
Facility totaled $33.1 million. The Company will not receive any proceeds from
the sale of shares of Common Stock by the Selling Shareholders. The Company
Credit Facility is a $35.0 million revolving credit facility, which is used by
the Company for general corporate purposes. Indebtedness under the Company
Credit Facility is secured by substantially all of the assets of the Company,
bears interest at LIBOR plus 5.0%, and matures on March 28, 1998.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Common Stock is quoted on the Nasdaq National Market under the symbol
"FCFC." The following table sets forth, for the calendar periods indicated, the
range of high and low bid prices for the Common Stock as quoted by the Nasdaq
National Market:
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1995
- ----
Third Quarter (from July 5)................................. $18.50 $12.00
Fourth Quarter.............................................. 22.38 15.13
1996
- ----
First Quarter............................................... $22.88 $18.25
Second Quarter.............................................. 29.00 18.75
Third Quarter............................................... 29.50 24.63
Fourth Quarter.............................................. 31.88 27.75
1997
- ----
First Quarter............................................... $29.50 $23.00
Second Quarter.............................................. 27.75 20.00
Third Quarter............................................... 29.00 23.88
Fourth Quarter.............................................. 30.75 25.25
1998
- ----
First Quarter (through March 24)............................ $31.50 $27.00
</TABLE>
For a recent closing sale price for the Common Stock, see the cover page of
this Prospectus. On March 24, 1998, the Company had approximately 515 record
holders of Common Stock, which excludes beneficial owners of shares registered
in nominee or street name.
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
Credit Facility and substantially all of the credit facilities to which the
Company's subsidiaries and the Acquisition Partnerships are parties contain
restrictions relating to the payment of dividends and other distributions.
20
<PAGE> 22
CAPITALIZATION
The following table presents the capitalization of the Company as of
December 31, 1997 and as adjusted as of such date to give effect to the issuance
and sale of 1,000,000 shares of Common Stock offered by the Company hereby at an
assumed public offering price of $30.00 per share, and the application of the
proceeds therefrom after deducting the underwriting discount and estimated
offering expenses. The information presented below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and with the Consolidated Financial Statements of the Company
(including the Notes thereto) included elsewhere in this Prospectus. See "Use of
Proceeds."
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
DEBT:
Notes payable, secured(1)................................. $747,180 $719,330
Notes payable to others................................... 3,601 3,601
-------- --------
Total debt........................................ 750,781 722,931
-------- --------
REDEEMABLE PREFERRED STOCK:
Special preferred stock, including dividends of $669
(nominal stated value of $21.00 per share); 2,500,000
shares authorized, 849,777 shares issued and
outstanding............................................ 18,515 18,515
Adjusting rate preferred stock, including dividends of
$846 (redemption value of $21.00 per share); 2,000,000
shares authorized, 1,073,704 shares issued and
outstanding............................................ 23,393 23,393
SHAREHOLDERS' EQUITY:
Optional preferred stock (par value $.01 per share);
98,000,000 shares authorized; no shares issued and
outstanding............................................ -- --
Common stock (par value $.01 per share); 100,000,000
shares authorized, 6,526,510 shares issued and
outstanding and 7,526,510 shares issued and outstanding
as adjusted............................................ 65 75
Paid in capital........................................... 29,509 57,349
Retained earnings......................................... 83,184 83,184
-------- --------
Total shareholders' equity................................ 112,758 140,608
-------- --------
Total capitalization.............................. $905,447 $905,447
======== ========
</TABLE>
- ---------------
(1) Each Acquisition Partnership generally is financed by separate senior debt
instruments, which are secured only by the assets of such Acquisition
Partnership and are nonrecourse to the Company, Commercial Corp., its
co-investors and the other Acquisition Partnerships. These borrowings are
not included in the capitalization table set forth above. See
"Business -- Portfolio Asset Acquisition and Resolution." At the date
indicated, the Acquisition Partnerships were obligated on an aggregate of
approximately $69 million of nonrecourse debt, secured by the assets of the
Acquisition Partnerships.
21
<PAGE> 23
SELECTED FINANCIAL AND OTHER INFORMATION
The following table presents, as of the dates and for the periods
indicated, selected financial and other information for the Company. For
accounting purposes, the Merger was treated as an acquisition of FCBOT by
J-Hawk. Accordingly, financial data prior to July 3, 1995 reflects the
historical financial position and results of operations of J-Hawk. As a result
of the consummation of the transactions contemplated by the Merger, financial
data for the periods prior to the Merger are not comparable with financial data
for periods after the Merger. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview." The Harbor Merger,
which occurred on July 1, 1997, was accounted for as a pooling of interests. The
Company's historical financial statements have therefore been retroactively
restated to include the financial position and results of operations of Mortgage
Corp. for all periods presented. Prior to the Harbor Merger, Mortgage Corp.'s
fiscal year end was September 30. As a result, for years prior to 1997, the
financial statements of Mortgage Corp. for its prior fiscal year periods are
consolidated with calendar year end data for the Company. The financial data as
of and for each of the three years in the period ended December 31, 1997 have
been derived from the Consolidated Financial Statements of the Company as of and
for such period audited by KPMG Peat Marwick LLP and included elsewhere herein.
All data set forth in the table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements of the Company (including the Notes
thereto) included elsewhere herein.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
SELECTED INCOME STATEMENT DATA
Revenues:
Gain on sale of mortgage loans........................ $ 36,496 $ 19,298 $ 7,864
Net mortgage warehouse income......................... 3,499 3,224 2,355
Gain on sale of mortgage servicing rights............. 4,246 2,641 2,011
Servicing fees:
Mortgage........................................... 14,732 10,079 6,508
Other.............................................. 12,066 12,456 10,903
Gain on resolution of Portfolio Assets................ 24,183 19,510 11,984
Equity in earnings of Acquisition Partnerships........ 7,605 6,125 3,834
Rental income on real estate Portfolios............... 332 3,033 1,277
Interest income....................................... 13,448 7,707 1,572
Other income.......................................... 9,462 3,415 3,060
Interest income on Class A Certificate................ 3,553 11,601 8,597
---------- ---------- --------
Total revenues................................ 129,622 99,089 59,965
---------- ---------- --------
Expenses:
Interest on other notes payable....................... 12,433 10,403 4,721
Salaries and benefits................................. 42,191 26,927 16,767
Amortization:
Mortgage servicing rights.......................... 7,550 4,091 3,823
Other.............................................. 2,563 3,113 1,534
Provision for loan losses............................. 6,613 2,029 --
Occupancy, data processing, communication and other... 37,972 23,254 11,955
Interest on senior subordinated notes................. -- 3,892 4,721
---------- ---------- --------
Total expenses................................ 109,322 73,709 43,521
---------- ---------- --------
Net earnings before minority interest, preferred
dividends and income taxes............................ 20,300 25,380 16,444
Benefit (provision) for income taxes.................. 15,485 13,749 (1,200)
---------- ---------- --------
Net earnings before minority interest and preferred
dividends............................................. 35,785 39,129 15,244
Minority interest..................................... (157) -- --
Preferred dividends................................... (6,203) (7,709) (3,876)
---------- ---------- --------
Net earnings to common shareholders..................... $ 29,425 $ 31,420 $ 11,368
========== ========== ========
Net earnings per common share -- basic.................. $ 4.51 $ 4.83 $ 2.18
Net earnings per common share -- diluted................ $ 4.46 $ 4.79 $ 2.18
Weighted average common shares outstanding -- basic..... 6,518 6,504 5,223
Weighted average common shares outstanding -- diluted... 6,591 6,556 5,223
</TABLE>
22
<PAGE> 24
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
SELECTED BALANCE SHEET DATA
Mortgage assets....................................... $ 650,775 $ 193,823 $123,006
Portfolio acquisition and resolution assets........... 125,480 98,001 122,126
Consumer assets....................................... 64,135 31,397 --
Deferred tax asset.................................... 30,614 13,898 --
Total assets.......................................... 940,119 425,189 439,051
Notes payable......................................... 750,781 266,166 317,189
Preferred stock....................................... 41,908 53,617 55,555
Total shareholders' equity............................ 112,758 84,802 52,788
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
ORIGINATION AND OTHER FINANCIAL DATA
Mortgage Corp.
Origination of residential mortgage loans:
Conventional..................................... $2,404,872 $1,439,197 $509,447
Agency........................................... 593,003 240,015 132,159
Home Equity...................................... 178,492 6,583 --
Other............................................ 63,155 20,062 44,530
---------- ---------- --------
Total......................................... 3,239,522 1,705,857 686,136
Origination of commercial mortgage loans:
Correspondent.................................... 348,060 35,600 53,405
Construction..................................... 65,740 28,780 --
---------- ---------- --------
Total......................................... 413,800 64,380 53,405
Capital Corp.
Acquisition of Home Equity Loans................... 53,624 -- --
Portfolio Asset acquisition and resolution activity(1)
Aggregate purchase price of assets purchased....... 183,229 205,524 213,187
Face Value of assets purchased..................... 504,891 413,844 699,622
Proceeds(2)........................................ 194,975 403,275 374,425
Number of assets purchased......................... 5,503 5,921 19,031
Consumer Corp.
Acquisition of automobile and other consumer
receivables...................................... 89,845 17,635 --
</TABLE>
- ---------------
(1) Includes activities of all Acquisition Partnerships and for Commercial
Corp.'s own account.
(2) Includes proceeds of $158 million and $107 million attributable to assets
owned by the Trust in 1996 and 1995, respectively.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
SERVICING PORTFOLIO DATA
Residential mortgage loans
Conventional....................................... $4,280,315 $3,234,197 $894,840
Agency............................................. 695,510 521,637 390,047
Other.............................................. 20,688 66,815 68,802
---------- ---------- --------
Total......................................... 4,996,513 3,822,649 1,353,689
Commercial mortgage loans............................. 1,691,939 124,379 94,706
Automobile receivables................................ 100,869 33,583 --
Portfolio acquisition and resolution (Face Value)..... 837,376 975,190 930,757
</TABLE>
23
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a diversified financial services company engaged in
residential and commercial mortgage banking, Portfolio Asset acquisition and
resolution and consumer lending. The mortgage banking business involves the
origination, acquisition and servicing of residential and commercial mortgage
loans and the subsequent warehousing, sale or securitization of such loans
through various public and private secondary markets. The Portfolio Asset
acquisition and resolution business involves acquiring Portfolio Assets at a
discount to Face Value and servicing and resolving such Portfolios in an effort
to maximize the present value of the ultimate cash recoveries. The Company also
seeks opportunities to originate and retain high yield commercial loans to
businesses and to finance real estate projects that are unable to access
traditional lending sources. The consumer lending business involves the
acquisition, origination, warehousing, securitization and servicing of consumer
receivables. The Company's current consumer lending operations are focused on
the acquisition of sub-prime automobile receivables.
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, 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.
The Company consummated the Merger of J-Hawk and FCBOT in July 1995. The
Company's financial statements reflect the Merger as an acquisition of FCBOT by
J-Hawk. For periods prior to July 1995 (with the exception of the restatement
for the Harbor Merger), the Company's financial statements reflect the
activities of J-Hawk. During such periods, J-Hawk was principally engaged in the
Portfolio Asset acquisition and resolution business. The Harbor Merger, which
occurred in July 1997, was accounted for as a pooling of interests. The
Company's historical financial statements have therefore been retroactively
restated to include the financial position and results of operations of Mortgage
Corp. for all periods presented. As a result of the Merger, the Harbor Merger
and the significant period to period fluctuations in the revenues and earnings
of the Company's Portfolio Asset acquisition and resolution business, period to
period comparisons of the Company's results of operations may not be meaningful.
24
<PAGE> 26
ANALYSIS OF REVENUES AND EXPENSES
The following table summarizes the revenues and expenses of each of the
Company's businesses and presents the contribution that each business makes to
the Company's operating margin.
ANALYSIS OF REVENUES AND EXPENSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
MORTGAGE BANKING:
Revenues:
Net mortgage warehouse income.......................... $ 3,499 $ 3,224 $ 2,355
Gain on sale of mortgage loans......................... 36,496 19,298 7,864
Servicing fees......................................... 14,732 10,079 6,508
Other.................................................. 10,999 5,019 3,715
------- ------- -------
Total............................................. 65,726 37,620 20,442
Expenses:
Salaries and benefits.................................. 30,398 16,105 8,673
Amortization of mortgage servicing rights.............. 7,550 4,091 3,823
Interest on other notes payables....................... 1,187 423 437
Occupancy, data processing, communication and other.... 20,705 11,013 6,734
------- ------- -------
Total............................................. 59,840 31,632 19,667
------- ------- -------
Operating contribution before direct taxes................ $ 5,886 $ 5,988 $ 775
======= ======= =======
Operating contribution, net of direct taxes............... $ 7,975 $ 3,724 $ 511
======= ======= =======
PORTFOLIO ASSET ACQUISITION AND RESOLUTION:
Revenues:
Gain on resolution of Portfolio Assets................. $24,183 $19,510 $11,984
Equity in earnings of Acquisition Partnerships......... 7,605 6,125 3,834
Servicing fees......................................... 11,513 12,440 10,903
Other.................................................. 4,402 6,592 4,205
------- ------- -------
Total............................................. 47,703 44,667 30,926
Expenses:
Salaries and benefits.................................. 5,353 6,002 4,500
Interest on other notes payable........................ 7,084 6,447 3,931
Asset level expenses, occupancy, data processing and
other................................................ 11,774 10,862 5,814
------- ------- -------
Total............................................. 24,211 23,311 14,245
------- ------- -------
Operating contribution before direct taxes................ $23,492 $21,356 $16,681
======= ======= =======
Operating contribution, net of direct taxes............... $23,299 $21,210 $15,745
======= ======= =======
</TABLE>
25
<PAGE> 27
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
CONSUMER LENDING:
Revenues:
Interest income........................................ $ 9,649 $ 3,604 $ --
Servicing fees and other............................... 632 46 --
------- ------- -------
Total............................................. 10,281 3,650 --
Expenses:
Salaries and benefits.................................. 2,959 698 --
Provision for loan losses.............................. 6,613 2,029 --
Interest on other notes payable........................ 3,033 1,284 --
Occupancy, data processing and other................... 3,414 1,469 --
------- ------- -------
Total............................................. 16,019 5,480
------- ------- -------
Operating contribution before direct taxes................ $(5,738) $(1,830) $ --
======= ======= =======
Operating contribution, net of direct taxes............... $(5,741) $(1,830) $ --
======= ======= =======
CORPORATE OVERHEAD:
Interest income on Class A Certificate(1)................. $ 3,553 $11,601 $ 8,597
Interest expense on senior subordinated notes............. -- (3,892) (4,721)
Salaries and benefits, occupancy, professional and other
income and expenses, net............................... (5,275) (7,843) (4,888)
------- ------- -------
Total............................................. (1,722) (134) (1,012)
------- ------- -------
Deferred tax benefit...................................... 13,592 16,159 --
Harbor Merger related expenses............................ (1,618) -- --
------- ------- -------
Net earnings before minority interest and preferred
dividends.............................................. 35,785 39,129 15,244
Minority interest......................................... (157) -- --
Preferred dividends....................................... (6,203) (7,709) (3,876)
------- ------- -------
Net earnings to common shareholders............... $29,425 $31,420 $11,368
======= ======= =======
SHARE DATA:
Net earnings per common share -- basic.................... $ 4.51 $ 4.83 $ 2.18
Net earnings per common share -- diluted.................. $ 4.46 $ 4.79 $ 2.18
Weighted average common shares outstanding -- basic....... 6,518 6,504 5,223
Weighted average common shares outstanding -- diluted..... 6,591 6,556 5,223
</TABLE>
- ---------------
(1) Represents dividends on preferred stock accrued or paid prior to June 30,
1997 and interest paid on outstanding senior subordinated notes.
26
<PAGE> 28
MORTGAGE BANKING
The primary components of revenues derived by Mortgage Corp. and Capital
Corp. are net mortgage warehouse income, gain on sale of mortgage loans,
servicing fees earned for loan servicing activities, and other miscellaneous
sources of revenues associated with the origination and servicing of residential
and commercial mortgages. The principal components of expenses of Mortgage Corp.
and Capital Corp. are salaries and employee benefits, amortization of originated
and acquired mortgage servicing rights, interest expense and other general and
administrative expenses. The following paragraphs describe the principal factors
affecting each of the significant components of revenues of Mortgage Corp. and
Capital Corp. The following table presents selected information regarding the
revenues and expenses of the Company's mortgage banking business.
ANALYSIS OF SELECTED REVENUES AND EXPENSES
MORTGAGE BANKING
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
WAREHOUSE INVENTORY:
Average inventory balance............................ $ 329,112 $ 138,035 $ 59,823
Net mortgage warehouse income:
Dollar amount..................................... 3,499 3,224 2,355
Percentage of average inventory balance........... 1.06% 2.34% 3.94%
GAIN ON SALE OF MORTGAGE LOANS:
Gain on sale of mortgage loans as a percentage of
loans sold:
Residential....................................... 0.98% 1.16% 1.27%
Home Equity....................................... 3.55% -- --
OMSR income as a percentage of residential mortgage
loans sold........................................ 1.75% 1.79% 1.82%
SERVICING REVENUES:
Average servicing portfolios:
Residential....................................... $3,661,031 $2,144,298 $1,262,497
Commercial........................................ 1,134,348 109,581 124,710
Sub-serviced...................................... 741,174 305,149 --
Servicing fees:
Residential....................................... $ 13,091 $ 9,625 $ 6,394
Commercial........................................ 809 126 114
Sub-serviced...................................... 832 328 --
---------- ---------- ----------
Total........................................ 14,732 10,079 6,508
Annualized servicing fee percentage:
Residential....................................... 0.36% 0.45% 0.51%
Commercial........................................ 0.07% 0.11% 0.09%
Sub-serviced...................................... 0.11% 0.11% --
Gain on sale of servicing rights..................... $ 4,246 $ 2,641 $ 2,011
Amortization of servicing rights:
Servicing rights amortization..................... $ 7,481 $ 4,091 $ 3,823
Servicing rights amortization as a percentage of
average servicing portfolio..................... 0.20% 0.19% 0.30%
PERSONNEL:
Personnel expenses................................... $ 30,398 $ 16,105 $ 8,673
Number of personnel (at period end):
Production........................................ 586 319 225
Servicing......................................... 118 93 49
Other............................................. 255 155 98
---------- ---------- ----------
Total........................................ 959 567 372
Salaried.......................................... 87% 84% 82%
Commission........................................ 13% 16% 18%
</TABLE>
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Net Mortgage Warehouse Income
Mortgage Corp. originates or acquires residential mortgage loans, which are
recorded as mortgage loans held for sale and financed under warehouse credit
facilities pending sale. The difference between interest income on the
originated or acquired loans and the cost of warehouse borrowings is recorded as
net mortgage warehouse income. The amount of recorded net mortgage warehouse
income varies with the average volume of loans in the warehouse and the spread
between the coupon rate of interest on the loans and the interest cost of the
warehouse credit facility.
Gain on Sale of Mortgage Loans
Residential mortgage loans originated or acquired by Mortgage Corp.
currently are accumulated in inventory and held for sale. The disposition of the
loans generally produces a gain. Such gains result from the cash sale of the
mortgage loans and the additional recognition of the value of mortgage servicing
rights as proceeds, less the basis of the mortgage loans sold.
As of December 31, 1997, Capital Corp. had not completed a securitization
of Home Equity Loans. The portion of the Company's mortgage banking business
conducted through Capital Corp. is devoted to the acquisition of Home Equity
Loans with the expectation that they will be pooled and sold in public or
private securitization transactions. Gains on the securitization and sale of
Home Equity Loans represent the amount by which the proceeds received (including
the estimated value of retained subordinated interests) exceed the basis of the
Home Equity Loans and the costs associated with the securitization process. The
retained interests will be valued at the discounted present value of the cash
flows expected to be realized over the anticipated average life of the assets
sold after deducting future estimated credit losses, estimated prepayments,
servicing fees and other securitization fees related to the Home Equity Loans
sold. The recorded value of retained interests will be computed using Capital
Corp.'s assumptions of market discount rates, prepayment speeds, default rates,
credit losses and other costs based upon the unique underlying characteristics
of the Home Equity Loans comprising each securitization.
Capital Corp. expects that the assumptions it will use in its
securitization transactions will include discount rates of 15% and prepayment
speeds at annualized rates starting at approximately 4% per year and, depending
upon the mix of fixed and variable rate and prepayment penalty provisions of the
underlying loans, increasing to 25% to 40% per year. Loss assumptions are
expected to vary depending upon the mix of the credit quality and loan to value
characteristics of the underlying loans that are securitized. The actual
assumptions used by Capital Corp. in its securitization transactions will vary
based on numerous factors, including those listed above, and there can be no
assurance that actual assumptions will correspond to Capital Corp.'s current
expectations.
Servicing Fees and Amortization of Mortgage Servicing Rights
A significant component of Mortgage Corp.'s residential mortgage banking
business is attributable to the future right to service the residential mortgage
loans it originates or acquires. Mortgage Corp. generally retains the servicing
right upon the sale of the originated loan (and expects to retain such rights
upon securitization) and records the value of such right as mortgage servicing
rights on its balance sheet. Subsequently, Mortgage Corp. earns revenues as
compensation for the servicing activities it performs. Mortgage Corp. amortizes
the mortgage servicing right asset as a periodic expense to allocate the cost of
the servicing right to the income generated on a periodic basis.
The recorded values of mortgage servicing rights are reviewed on a
quarterly basis by comparing the fair market value of these rights as determined
by a third party to their recorded values. Based on this review,
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<PAGE> 30
Mortgage Corp. either adjusts amortization rates of such mortgage servicing
rights or, if there is any impairment in value, records a charge to earnings in
the period during which such impairment is deemed to have occurred. The fair
market value of mortgage servicing rights is heavily impacted by the relative
levels of residential mortgage interest rates. When interest rates decline,
underlying loan prepayment speeds generally increase. Prepayments in excess of
anticipated levels will cause actual fair market values of mortgage servicing
rights to be less than recorded values thereby resulting in increases in the
rates of amortization, or a revaluation of recorded mortgage servicing rights as
described above.
A decline in interest rates generally contributes to higher levels of
mortgage loan origination (particularly refinancings) and the related
recognition of increased levels of gain on sale of mortgage loans. The ability
of Mortgage Corp. to originate loans and its ability to regenerate the recorded
value of its servicing portfolio on an annualized basis also provides Mortgage
Corp. with the ability to approximately replace the recorded value of its
residential servicing portfolio in a one-year time frame, based upon current
origination levels. Loans originated during periods of relatively low interest
rates generate servicing rights with a higher overall value due to the decreased
probability of future prepayment by the borrower. Accordingly, Mortgage Corp.
believes that it has an inherent hedge against a significant and swift decline
in the value of its recorded mortgage servicing rights. There can be no
assurance that, in the long term, Mortgage Corp. will be able to continue to
maintain an even balance between the production capacity of its origination
network and the principal value of its servicing portfolio.
In an environment of increasing interest rates, the rate of current and
projected future prepayments decreases, resulting in increases in fair market
values of mortgage servicing rights. Although the Company does not recognize
gain as a result of such increases in fair market values, it may decrease the
rate of amortization of the mortgage servicing rights. In addition, in periods
of rising interest rates, mortgage loan origination rates generally decline.
Other
In its commercial mortgage business, Mortgage Corp. generates loan
origination fees paid by commercial borrowers for underwriting and application
activities performed by Mortgage Corp. as a correspondent of various insurance
company and conduit lenders. In addition, Mortgage Corp. generates other fees
and revenues from various activities associated with originating and servicing
residential and commercial mortgage loans and in its construction lending
activities. Mortgage Corp. has in the past sold, and may in the future sell, a
portion of its rights to service residential mortgage loans. The results of such
sales are recorded as gains on sales of mortgage servicing rights and reflected
as a component of other revenue.
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
Revenues at Commercial Corp. consist primarily of cash proceeds on
disposition of assets acquired in Portfolio Asset acquisitions for Commercial
Corp.'s own account and its equity in the 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. Following the Merger, Commercial
Corp. serviced assets held in an affiliated liquidating trust created for the
benefit of former FCBOT shareholders (the "Trust") and derived servicing fees
for its activities under a servicing agreement between the Trust and Commercial
Corp. During the first quarter of 1997, the Trust terminated the servicing
agreement and paid Commercial Corp. a termination payment of $6.8 million
representing the present value of servicing fees projected to have been earned
by Commercial Corp. upon the liquidation of the assets of the Trust, which was
expected to occur principally in 1997.
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 whole and not on an
individual asset basis. To date, a substantial majority of the Portfolio Assets
acquired by Commercial Corp. have 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 Partner-
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<PAGE> 31
ships 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 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
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
GAIN ON RESOLUTION OF PORTFOLIO ASSETS:
Average investment:
Nonperforming Portfolios............................... $61,764 $42,123 $27,298
Performing Portfolios.................................. 9,759 10,280 3,776
Real estate Portfolios................................. 21,602 30,224 39,795
Gain on resolution of Portfolio Assets:
Nonperforming Portfolios............................... $20,288 $11,635 $10,189
Real estate Portfolios................................. 3,895 7,875 1,795
------- ------- -------
Total................................................ 24,183 19,510 11,984
Interest income on performing Portfolios.................. $ 2,052 $ 2,603 $ 1,112
Gross profit percentage on resolution of Portfolio Assets:
Nonperforming Portfolios............................... 27.8% 38.5% 28.0%
Real estate Portfolios................................. 27.9% 19.3% 21.6%
Weighted average gross profit percentage............... 27.8% 27.5% 26.8%
Interest yield on performing Portfolios................... 21.0% 25.3% 29.5%
SERVICING FEE REVENUES:
Acquisition Partnerships.................................. $ 4,363 $ 6,468 $ 6,834
Trust..................................................... 6,800 4,241 3,110
Affiliates................................................ 350 1,731 959
------- ------- -------
Total................................................ 11,513 12,440 10,903
PERSONNEL:
Personnel expenses........................................ $ 5,353 $ 6,002 $ 4,500
Number of personnel (at period end):
Production............................................. 9 12 9
Servicing.............................................. 68 107 116
INTEREST EXPENSE:
Average debt.............................................. $85,262 $64,343 $36,348
Interest expense.......................................... 7,084 6,447 3,931
Average yield............................................. 8.3% 10.0% 10.8%
</TABLE>
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
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<PAGE> 32
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,
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
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<PAGE> 33
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
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
GAIN ON RESOLUTION OF PORTFOLIO ASSETS:
Gain on resolution of Portfolio Assets................... $ 26,533 $ 39,505 $ 51,370
Gross profit percentage on resolution of Portfolio
Assets................................................ 16.7% 22.7% 27.2%
Interest income on performing Portfolios................. $ 8,432 $ 7,870 $ --
Other interest income.................................... 1,053 862 --
INTEREST EXPENSE:
Interest expense......................................... 10,294 22,065 26,482
Average debt............................................. 111,422 188,231 223,028
Average interest cost.................................... 9.24% 11.72% 11.87%
OTHER EXPENSES:
Servicing fees........................................... $ 4,353 $ 6,809 $ 6,834
Legal.................................................... 1,957 2,266 2,109
Property protection...................................... 3,956 5,712 3,797
Other.................................................... 531 693 2,606
-------- -------- --------
Total other expenses............................. 10,797 15,480 15,346
-------- -------- --------
NET EARNINGS............................................... $ 14,927 $ 10,692 $ 9,542
======== ======== ========
</TABLE>
The above table does not include equity earnings from the Acquisition
Partnerships operating in France, which equaled $519,000 in 1997.
Servicing Fee Revenues
Commercial Corp. derives fee income for its servicing activities performed
on behalf of the Acquisition Partnerships. Prior to the second quarter of 1997,
Commercial Corp. also derived servicing fees from the servicing of assets held
in the Trust. In connection with the Acquisition Partnerships, Commercial Corp.
earns a servicing fee of between 3% 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).
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CONSUMER LENDING
The primary components of revenue derived by Consumer Corp. are interest
income and gain on sale of loans. The primary expenses of Consumer Corp. are
salaries and benefits, provision for loan losses and interest expense. The
following chart presents selected information regarding the revenues and
expenses of Consumer Corp.'s consumer lending business during 1997 and 1996.
ANALYSIS OF SELECTED REVENUES AND EXPENSES
CONSUMER LENDING
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
INTEREST INCOME:
Average loans
Auto................................................... $50,154 $19,740
Other.................................................. 3,558 144
Interest income
Auto................................................... 9,067 3,546
Other.................................................. 570 30
Average yield
Auto................................................... 18.1% 18.0%
Other.................................................. 16.0% 20.8%
SERVICING REVENUES:
Affiliates................................................ $ 553 $ 16
PERSONNEL:
Personnel expenses........................................ $ 2,959 $ 698
Number of personnel (at period end):
Production............................................. 53 15
Servicing.............................................. 53 26
INTEREST EXPENSE:
Average debt.............................................. $34,129 $14,885
Interest expense.......................................... 3,016 1,258
Average yield............................................. 8.8% 8.5%
</TABLE>
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
Funding Corp. intends to accumulate and pool automobile loans acquired from
franchised dealerships for sales in public and private securitization
transactions. Such transactions are expected to 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 will be 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 will
be computed using Consumer Corp.'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.
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<PAGE> 35
In its securitization transaction completed in 1997, Consumer Corp. assumed
that losses would approximate an aggregate of 14% of the outstanding principal
balance of the underlying loans. Consumer Corp. calculated the present value of
future cash flows from the securitization using discount rates of 12% to 15% per
year.
Provision for Loan Losses
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.
The operating margin of Consumer Corp. was significantly impacted by 1997
provisions for loan losses in the amount of approximately $6.6 million related
to the loans originated in Consumer Corp.'s sub-prime auto receivable business.
The Company's initial venture into the sub-prime automobile market involved the
acquisition of a distressed sub-prime portfolio from a secured lender. Following
the acquisition of the portfolio, the Company began the acquisition of
additional loans on an indirect basis from financial institutions who originated
loans pursuant to contractual agreements with a subsidiary of Consumer Corp. The
Company concluded that the contractual underwriting standards and the purchase
discounts on which the initial program was based were insufficient to generate
automobile loans of acceptable quality to the Company. As a result, the Company
terminated its obligations with the financial institutions participating in the
original origination program effective January 31, 1998. The continued flow of
production into 1998 will require that the Company continue to provide for the
losses anticipated on such loans in 1998.
Based upon the experience gained with its initial consumer origination
program, the Company undertook to develop an origination and underwriting
approach that would give Consumer Corp. significantly greater control over the
origination and pricing standards governing its consumer lending activities. The
formation of Funding Corp. resulted from these development activities. The
underwriting process and purchase discount methodology employed by Funding Corp.
has significantly changed the underwriting criteria and purchase standards of
Consumer Corp. from the methodology employed during the majority of 1996 and
1997. In Funding Corp.'s case, the objectives established for purchasing loans
from originating dealers are designed to result in the purchase discount
equaling or exceeding the expected loss for all loans acquired.
BENEFIT (PROVISION) FOR 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 next three to four year period. 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 earnings.
Significant events that change the Company's view of its currently estimated
ability to utilize the tax benefits, such as the Harbor Merger 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. Similar events could occur in the future, and would impact
the quarterly recognition of the Company's estimate of the required valuation
allowance associated with its NOLs. See "Certain Federal Income Tax
Considerations."
Earnings for 1997 and 1996 were significantly increased by the recognition
of tax benefits resulting from the Company's reassessment of the valuation
allowance related to its NOL asset. 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
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<PAGE> 36
valuation reserve was adjusted based on the Company's estimate of its future
pre-tax income. The amount of tax benefits recognized will be adjusted in future
periods should the estimates of future taxable income change. If there are
changes in the estimated level of the required reserve, net earnings will be
affected accordingly.
FIRSTCITY LIQUIDATING TRUST AND EXCHANGE OF PREFERRED STOCK
In connection with the Merger, the Company received the Class A Certificate
of the Trust (the "Class A Certificate"). Distributions from the Trust in
respect of the Class A Certificate were used to retire the senior subordinated
notes of the Company and to pay dividends on, and repurchase some of, the
special preferred stock of the Company (the "Special Preferred"). Pursuant to a
June 1997 settlement agreement with the Company, the Trust's obligation to the
Company under the Class A Certificate was terminated (other than the Trust's
obligation to reimburse the Company for certain expenses) in exchange for the
Trust's agreement to pay the Company an amount equal to $22.75 per share for the
1,923,481 shares of Special Preferred outstanding at June 30, 1997, the 1997
second quarter dividend of $0.7875 per share, and 15% interest from June 30,
1997 on any unpaid portion of the settlement agreement. Under such agreement,
the Company assumes the obligation for the payment of the liquidation preference
amount and the future dividends on the Special Preferred. As of December 31,
1997, the Trust had distributed $44.1 million to the Company under the
settlement agreement.
In June 1997, the Company began an offer to exchange one share of newly
issued adjusting rate preferred stock ("Adjusting Rate Preferred") for each
outstanding share of Special Preferred. The Company completed such exchange
offer in the third quarter of 1997 pursuant to which 1,073,704 shares of Special
Preferred were tendered for a like number of shares of Adjusting Rate Preferred.
The Special Preferred has a redemption value of $21.00 per share, a 15% annual
dividend rate and a redemption date of September 30, 1998. The Adjusting Rate
Preferred has a redemption value of $21.00 per share and a 15% annual dividend
rate through September 30, 1998, at which time the dividend rate is reduced to
10% per annum. The Adjusting Rate Preferred is redeemable by the Company on or
after September 30, 2003, with a mandatory maturity date of September 30, 2005.
The redemption by the Trust of its obligation on the Class A Certificate
represented a premium over the redemption value of the Special Preferred, which
is reflected as a deferred credit in the Company's financial statements. The
deferred credit is being accreted to income over the weighted average life of
the Special Preferred and the Adjusting Rate Preferred.
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 Prospectus.
1997 COMPARED TO 1996
The Company reported net earnings before minority interest and preferred
dividends of $35.8 million in 1997 (including a $15.5 million deferred tax
benefit) compared to $39.1 million in 1996 (including a $13.7 million deferred
tax benefit). Net earnings to common shareholders were $29.4 million in 1997
compared to $31.4 million in 1996. On a per share basis, basic net earnings
attributable to common shareholders were $4.51 in 1997 compared to $4.83 in
1996. Diluted net earnings per common share were $4.46 in 1997 compared to $4.79
in 1996.
Mortgage Banking
Mortgage Corp. experienced significant revenue growth in 1997 relative to
1996. The Direct Retail and Broker Retail origination networks experienced
substantial growth in levels of origination volume reflecting, in part, the
level of capital that has been contributed to Mortgage Corp. by the Company
following the Harbor Merger and relatively lower interest rates in 1997 compared
to 1996. Such revenue growth was partially offset by increases in operating
expenses associated with the increased levels of origination volume.
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<PAGE> 37
The Company entered the mortgage conduit business in August 1997 with the
formation of Capital Corp. Capital Corp. has generated nominal interest revenue
from its acquired Home Equity Loans, has incurred interest expense to finance
the acquisition of such loans and has incurred general and administrative
expenses in its start-up phase.
Gain on sale of mortgage loans. Gain on sale of mortgage loans increased by
89% to $36.5 million in 1997 from $19.3 million in 1996. This increase was the
result of substantial increases in the levels of residential mortgage loan
origination generated principally by the Broker Retail network of Mortgage Corp.
and, to a lesser extent, the Direct Retail network of Mortgage Corp., and the
resulting sales of such loans to government agencies and other investors. The
change in the gain on sale percentage recognized in 1997 compared to 1996 is the
result of the sale, on a servicing released basis, of approximately $120 million
of Home Equity Loans in 1997.
Net mortgage warehouse income. Net mortgage warehouse income increased by
8.5% to $3.5 million in 1997 from $3.2 million in 1996. This increase is the
result of a significant increase in the average balance of loans held in
inventory during the year offset by a decrease in the spread earned between the
interest rate on the underlying mortgages and the interest cost of the warehouse
credit facility as the overall levels of interest rates on residential mortgage
loans reached their lowest levels in several years.
Servicing fee revenues. Servicing fee revenues increased by 46.2% to $14.7
million in 1997 from $10.1 million in 1996 as a result of an increase in the
size of the servicing portfolio. Mortgage Corp. increased its servicing
portfolio with the purchase, in the second quarter of 1996, of Hamilton
Financial Services Corporation ("Hamilton") and its right to service
approximately $1.7 billion in mortgage loans, and by retaining the servicing
rights to a substantial portion of the residential mortgage loans originated
since the Harbor Merger. In addition, Mortgage Corp. substantially increased its
commercial mortgage servicing portfolio and its ability to originate commercial
mortgage loans for correspondents and conduit lenders with the purchase, in the
second quarter of 1997, of MIG Financial Corporation ("MIG"), a commercial loan
origination and servicing company based in California with a $1.6 billion
commercial mortgage servicing portfolio.
Other revenues. Other revenues increased by 119% to $11.0 million in 1997
from $5.0 million in 1996. This increase resulted from an increase in the gain
on sale of mortgage servicing rights of $1.6 million to $4.2 million in 1997
from $2.6 million in 1996 and an increase of $2.2 million in fee income
associated with residential and commercial mortgage origination activity.
Operating expenses. Operating expenses of Mortgage Corp. increased by 89.2%
to $59.8 million in 1997 from $31.6 million in 1996. The acquisition of Hamilton
in 1996 and MIG in 1997, both of which were accounted for as purchases by
Mortgage Corp., produced higher relative totals for all components of Mortgage
Corp.'s operating expenses in 1997 compared to 1996. The commencement of Capital
Corp.'s operations in late 1997 also contributed to the year over year
increases.
Salaries and benefits increased by $14.3 million in 1997 compared to 1996
reflecting the over 400 additional staff required to support the increase in
origination volumes derived principally from the Broker Retail network and, to a
lesser extent, the Direct Retail network, and the increase in the size and
number of loans in the residential and commercial servicing portfolios in 1997
compared to 1996.
Amortization of mortgage servicing rights increased in 1997 compared to
1996 as a result of the substantially larger investment in mortgage servicing
rights in 1997 compared to 1996. Interest on other notes payable (the portion
not associated with Mortgage Corp.'s warehouse credit facility) increased due to
increased working capital borrowings during 1997 as compared to 1996.
Occupancy expense increased by $3.6 million in 1997 compared to 1996 as the
result of the opening or acquisition of several new offices in 1997 in the
Broker Retail and Direct Retail networks. Increases in data processing,
communication and other expenses in 1997 compared to 1996 resulted from the
substantial increases in the production and servicing volumes experienced during
1997.
36
<PAGE> 38
Portfolio Asset Acquisition and Resolution
Commercial Corp. purchased $183.2 million of Portfolio Assets during 1997
for its own account and through the Acquisition Partnerships compared to $205.5
million in acquisitions in 1996. Commercial Corp.'s year end investment in
Portfolio Assets increased to $90.0 million in 1997 from $76.2 million in 1996.
Commercial Corp. invested $37.1 million in equity in Portfolio Assets in 1997
compared to $36.0 million in 1996.
Net gain on resolution of Portfolio Assets. Proceeds from the resolution of
Portfolio Assets increased by 22.8% to $87.1 million in 1997 from $70.9 million
in 1996. The net gain on resolution of Portfolio Assets increased by 24.0% to
$24.2 million in 1997 from $19.5 million in 1996 as the result of increased cash
proceeds and a higher gross profit percentage in 1997 compared to 1996. The
gross profit percentage on the proceeds from the resolution of Portfolio Assets
in 1997 was 27.8% as compared to 27.5% in 1996.
Equity in earnings of Acquisition Partnerships. Proceeds from the
resolution of Portfolio Assets for the Acquisition Partnerships declined by
38.0% to $107.8 million in 1997 from $174.0 million in 1996 while the gross
profit percentage on proceeds increased to 25.2% in 1997 from 22.7% in 1996.
Offsetting the decline in cash proceeds was the reduction in interest and other
expenses incurred by the Acquisition Partnerships in 1997 compared to 1996.
Interest income in the Acquisition Partnerships increased nominally while
interest expense decreased by $11.8 million in 1997 compared to 1996. The year
to year comparisons result from the relative levels of interest earning assets
and interest bearing liabilities carried by the Acquisition Partnerships in each
of the two periods. In addition, the effect of refinancing Acquisition
Partnership Portfolio Assets reduced average interest rates incurred on
borrowings in 1997 to 9.2% from 11.7% in 1996. Other expenses of the Acquisition
Partnerships decreased by $4.7 million in 1997 generally reflecting the
relatively lower costs associated with the resolution of Portfolio Assets in
somewhat mature partnerships as compared to the property protection and
improvement expenses normally associated with new Portfolio Asset acquisitions.
The net result was an overall increase in the net income of the Acquisition
Partnerships of 39.6% to $14.9 million in 1997 from $10.7 million in 1996. As a
result, Commercial Corp.'s equity earnings from Acquisition Partnerships
increased by 24.2% to $7.6 million in 1997 from $6.1 million in 1996.
Servicing fee revenues. Servicing fee revenues decreased by 7.5% to $11.5
million in 1997 from $12.4 million in 1996. Servicing fees reported during 1997
included the receipt of a $6.8 million cash payment related to the early
termination of a servicing agreement between the Company and the Trust, under
which the Company serviced the assets of the Trust. The $6.8 million payment
represents the present value of servicing fees projected to have been earned by
Commercial Corp. upon liquidation of the Trust assets, which was expected to
occur principally in 1997. Servicing fees earned from the Trust in 1996 were
$4.2 million. Excluding fees related to Trust assets, servicing fees decreased
by 42.7% to $4.7 million in 1997 from $8.2 million in 1996 as a result of
decreased collection levels in the Acquisition Partnerships and affiliated
entities.
Other revenues. Other revenues declined to $4.4 million in 1997 compared to
$6.6 million in 1996 as a result of reduced levels of rental income derived from
lower average investments in real estate Portfolios in 1997 as compared to 1996.
Operating expenses. Operating expenses increased to $24.2 million in 1997
from $23.3 million in 1996. The relatively stable levels of operating expenses
incurred by Commercial Corp. in 1997 compared to 1996 reflect the relatively
consistent levels of investment and servicing activities associated with
Commercial Corp.'s operations during such periods.
Salaries and benefits declined in 1997 as a result of the consolidation of
some of the servicing offices as the Portfolios being serviced in the closed
offices reached final resolution.
Interest on other notes payable increased as a result of increased average
borrowing levels in 1997 as compared to 1996 offset by lower average costs of
borrowings.
37
<PAGE> 39
Asset level expenses incurred in connection with the servicing of Portfolio
Assets increased in 1997 compared to 1996 as a result of the increase in
investments in Portfolio Assets in 1997 compared to 1996. Occupancy and other
expenses decreased as a result of the consolidation of servicing offices in
1997.
Consumer Lending
Consumer Corp.'s revenues and expenses in 1997 were derived principally
from its original sub-prime automobile financing program, which was established
during the first quarter of 1996. Consumer Corp. terminated its obligations to
the financial institutions participating in such program effective as of January
31, 1998. In late 1997 Consumer Corp., through its 80% owned subsidiary, Funding
Corp., established a new sub-prime automobile financing program through which it
originates automobile loans through direct relationships with franchised
automobile dealerships. Substantially all of Consumer Corp.'s activities are
expected to be conducted through Funding Corp. during 1998.
Interest income. Interest income on consumer loans increased by 168% to
$9.6 million in 1997 from $3.6 million in 1996 reflecting increased levels of
loan origination activity in 1997 as compared to 1996 and an increase in the
average balance of aggregate loans held by Consumer Corp. during 1997.
Interest expense. Interest expense increased by 136% to $3.0 million in
1997 from $1.3 million in 1996 as a result of an increase in the average
outstanding level of borrowings secured by automobile receivables to $34.1
million in 1997 from $14.9 million in 1996. The average rate at which such
borrowings incurred interest increased to 8.8% from 8.5% for the same period.
Operating expenses. Salaries and benefits increased by 324% to $3.0 million
in 1997 from $0.7 million in 1996 as a result of the increased levels of
operating activity in 1997 as compared to 1996. In addition, during the later
portion of 1997, Consumer Corp.'s operating expenses reflected the duplicative
effects of the start up of Funding Corp. while still operating the indirect
origination program.
Provision for loan losses. The provision for loan losses on automobile
receivables increased by 226% to $6.6 million in 1997 from $2.0 million in 1996.
The increase is attributable to loan originations of $89.8 million in 1997
compared to loan originations of $17.6 million in 1996. Consumer Corp. increased
its rate of provision for loan losses based on its determination that the
discount rate at which it acquired loans under its original origination program
did not properly provide for the losses expected to be realized on the acquired
loans. The origination program currently operated by Funding Corp. generally
allows for the acquisition of loans from automobile dealerships at a larger
discount from par than Consumer Corp.'s original financing program. The Company
believes that such acquisition prices more closely approximate the expected loss
per occurrence on the loans originated. To the extent that Funding Corp. cannot
match such discount to expected losses, additional provisions might, in the
future, be required to properly provide for the risk of loss on the loans
originated. The Company expects to incur provisions for loan losses in 1998 on
automobile loans acquired by it during early 1998 through its original
origination program.
Securitization of automobile loans. During the second quarter of 1997,
Consumer Corp. completed its first sale and securitization of automobile loans.
Consumer Corp. has retained subordinated interests in the form of nonrated
tranches and excess spreads resulting from the securitization transaction and
reflected an aggregate of $6.7 million in such interests at December 31, 1997.
Other Items Affecting Net Income
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. Interest income on the Class A Certificate during 1997
represents reimbursement to the Company from the Trust of accrual of dividends
of $3.6 million on special preferred stock through June 30, 1997 and interest
paid under a June 1997 agreement to retire the Class A Certificate. Company
level interest expense declined by 49.8% to $1.1 million in 1997 from $2.2
million in 1996 as a result of lower volumes of debt associated with the equity
required to purchase Portfolio Assets, equity interests in Acquisition
Partnerships and capital support to operating subsidiaries. The Company incurred
less indebted-
38
<PAGE> 40
ness in 1997 because a substantial portion of the Company's funding needs in
1997 were met by the Trust's redemption of its obligation under the Class A
Certificate. Other corporate income increased due to interest earned on the
excess liquidity derived from the Trust's redemption of the Class A Certificate.
Salary and benefits, occupancy and professional fees account for the majority of
other overhead expenses, which decreased in 1997 compared to 1996 as a result of
the decrease in the amount of executive and other officer bonuses granted in
1997 compared to 1996.
Income taxes. Federal income taxes are provided at a 35% rate applied to
taxable income and are offset by NOLs that the Company believes are available to
it as a result of the Merger. The tax benefit of the NOLs is recorded in the
period during which the benefit is realized. The Company reported a deferred tax
benefit of $13.6 million in 1997 as compared to a benefit of $16.2 million in
1996.
Harbor Merger related expenses. In 1997 the Company incurred Harbor Merger
related expenses of $1.6 million for legal, other professional and financial
advisory costs associated with the Harbor Merger.
1996 COMPARED TO 1995
The Company reported net earnings before minority interest and preferred
dividends of $39.1 million in 1996 (including a $13.7 million deferred tax
benefit) compared to $15.2 million in 1995. Net earnings to common shareholders
were $31.4 million in 1996 compared to $11.4 million in 1995. On a per share
basis, basic net earnings attributable to common shareholders were $4.83 in 1996
compared to $2.18 in 1995. Diluted net earnings per common share were $4.79 in
1996 compared to $2.18 in 1995.
Mortgage Banking
Mortgage Corp. experienced significant revenue growth in 1996 relative to
1995. The Broker Retail origination network in particular experienced
substantial growth in levels of production and origination volume. Such revenue
growth was partially offset by increases in operating expenses associated with
the increased levels of production and origination volume.
Gain on sale of mortgage loans. Gain on sale of mortgage loans increased by
145% to $19.3 million in 1996 from $7.9 million in 1995 due to substantial
increases in the levels of residential mortgage loan origination generated
principally by the Broker Retail origination network of Mortgage Corp. and, to a
lesser extent, the Direct Retail network of Mortgage Corp. Total production in
1996 increased to over $1.7 billion from $0.7 billion in 1995, which resulted in
increased sales volume of originated loans to government agencies and other
investors.
Net mortgage warehouse income. Net mortgage warehouse income increased by
36.9% to $3.2 million in 1996 from $2.4 million in 1995. This increase is the
result of an increase in the average balance of loans held in inventory during
the year coupled with a favorable spread between the interest rate on the
underlying mortgages and the interest cost of the warehouse credit facility
during the year.
Servicing fee revenues. Servicing fee revenues increased by 54.9% to $10.1
million in 1996 from $6.5 million in 1995 as a result of an increase in the size
of the servicing portfolio. Mortgage Corp. increased its servicing portfolio
with the purchase in the second quarter of 1996 of Hamilton and its right to
service approximately $1.7 billion in residential mortgage loans.
Other revenues. Other revenues increased by 35.1% to $5.0 million in 1996
from $3.7 million in 1995. This increase resulted from an increase in the gain
on sale of mortgage servicing rights of $0.6 million to $2.6 million in 1996
from $2.0 million in 1995. Other miscellaneous sources of fee income associated
with increased levels of mortgage loan production account for the balance of the
1996 over 1995 increase in other revenues.
Operating expenses. Operating expenses of Mortgage Corp. increased by 60.8%
to $31.6 million in 1996 from $19.7 million in 1995. The acquisition of Hamilton
in 1996, which was accounted for as a purchase, produced higher relative totals
for all components of Mortgage Corp.'s operating expenses in 1996 as compared to
1995.
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<PAGE> 41
Salaries and benefits increased year over year reflecting the additional
staff required to support the increase in production volumes derived from the
Direct Retail and Broker Retail networks in 1996 as compared to 1995 and the
increase in the size and number of loans in the residential and commercial
servicing portfolios as compared to prior year totals.
Amortization of mortgage servicing rights increased in 1996 compared to
1995 as a result of the substantially larger investment in mortgage servicing
rights in 1996 compared to 1995.
Interest expense on other notes payable (the portion not associated with
Mortgage Corp.'s warehouse credit facility) remained constant from 1996 to 1995.
Increases in occupancy, data processing and other expenses in 1996 as
compared to 1995 resulted from the substantial increases in production and
servicing volume experienced during 1996.
Portfolio Asset Acquisition and Resolution
The Portfolio Asset acquisition and resolution business of the Company
generated substantial revenues in 1996. Commercial Corp. purchased $205.5
million of Portfolio Assets during 1996 for its own account and through
Acquisition Partnerships compared to $213.2 million in acquisitions in 1995.
Commercial Corp.'s investment in Portfolio Assets increased to $76.2 million at
year end 1996 from $47.0 million at year end 1995. Commercial Corp. invested
$36.0 million in equity in Portfolio Assets in 1996 compared to $24.6 million in
1995.
Net gain on resolution of Portfolio Assets. Proceeds from the resolution of
Portfolio Assets increased by 58.6% to $70.9 million in 1996 from $44.8 million
in 1995. The net gain on resolution of Portfolio Assets increased by 62.8% to
$19.5 million in 1996 from $12.0 million in 1995 as the result of increased cash
proceeds and a higher gross profit percentage in 1996 compared to 1995. The
gross profit percentage on the proceeds from the resolution of Portfolio Assets
in 1996 was 27.5% compared to 26.8% in 1995.
Equity in earnings of Acquisition Partnerships. Proceeds from the
resolution of Portfolio Assets for the Acquisition Partnerships declined by 7.9%
to $174.0 million in 1996 from $188.9 million in 1995 while the gross profit
percentage declined to 22.7% in 1996 from 27.2% in 1995. Offsetting the decline
in the gross profit percentage was an increase in the effective ownership
percentage of Commercial Corp. in the equity of the Acquisition Partnerships.
Interest income in the Acquisition Partnerships was $8.7 million in 1996
compared to no interest income in 1995. No performing Asset Portfolios were
acquired by the Acquisition Partnerships prior to 1996. Interest expense
decreased by $4.4 million in 1996 compared to 1995 reflecting a reduced level of
borrowing by the Acquisition Partnerships in 1996 compared to 1995. Interest
costs were relatively constant at 11.7% in 1996 as compared to 11.9% in 1995.
Other expenses of the Acquisition Partnerships were relatively unchanged at
$15.5 million in 1996 compared to $15.3 million in 1995. The net result was a
59.8% increase in the equity in earnings of Acquisition Partnerships to $6.1
million in 1996 from $3.8 million in 1995.
Servicing fee revenues. Servicing fee revenues increased by 14.1% to $12.4
million in 1996 from $10.9 million in 1995. Servicing fees from Acquisition
Partnerships totaled $6.5 million in 1996 compared to $6.8 million in 1995 while
fees from the Trust in 1996 were $4.2 million compared to $3.1 million in 1995.
Operating expenses. Salaries and benefits, amortization and other general
and administrative expenses increased by 63.6% to $23.3 million in 1996 from
$14.2 million in 1995, principally as a result of the increase in such costs
attributable to the acquisition of a portfolio and small commercial servicing
business in 1995, increased property expenses and amortization of goodwill and
servicing rights in 1996 (such expenses were incurred only in a portion of
1995). In addition, other expenses in 1995 included a recovery of $0.7 million
of prior year expenses related to the Merger.
Consumer Lending
The Company began its consumer lending business during the first quarter of
1996 with the acquisition of a sub-prime automobile loan portfolio and the
acquisition of the company through which the loans had been
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<PAGE> 42
originated. During 1996, Consumer Corp. acquired $24.1 million in consumer loans
and originated $17.6 million in consumer loans.
Interest income. Interest income on consumer loans totaled $3.6 million in
1996 and reflected the recognition of interest income on the automobile finance
receivable contracts purchased or originated during the year.
Interest expense. Interest expense incurred during 1996 totaled $1.3
million on average borrowings of $14.8 million. Such borrowings incurred
interest at an average interest rate of 8.5% during 1996.
Operating expenses. Operating expenses reflect salaries, occupancy and
other expenses incurred in the first year's operation of the Company's
automobile finance business.
Provision for loan losses. The provision for loan losses on automobile
loans was $2.0 million in 1996, which reflects Consumer Corp.'s estimate of the
amount by which expected losses would exceed the discount at which the loans
were purchased.
Other Items Affecting Net Income
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. Interest income on the Class A Certificate during 1996
represents reimbursement to the Company by the Trust of $3.9 million of interest
expense on the senior subordinated notes and accrual of dividends of $7.7
million on special preferred stock in 1996 compared to $4.7 million of interest
expense on the senior subordinated notes and $3.9 million of dividends on the
special preferred stock in 1995. Interest expense increased to $2.2 million in
1996 from $0.4 million in 1995 as a result of higher combined volumes of debt
associated with the equity required for the purchase of Portfolio Assets and
equity interests in Acquisition Partnerships, especially following the Merger. A
substantial portion of the Company's funding needs in 1995 were met by the cash
received by the Company in connection with the Merger. Increases in salaries and
benefits, occupancy and other expenses reflect the increases associated with
Company staff functions such as accounting, finance and treasury activities
required to support the growth and diversification efforts of the Company
following the Merger. A portion of the increase in overhead expenses is the
result of an increase in executive and officer bonuses in 1996 compared to 1995.
Income taxes. Federal income taxes are provided at a 35% rate applied to
taxable income and are offset by NOLs that the Company believes are available to
it as a result of the Merger. The tax benefit of the NOLs is recorded in the
period during which the benefit is realized. The Company reported a deferred tax
benefit of $16.2 million in 1996 as compared to an expense of $1.2 million in
1995 (reflecting income taxes accrued on income reported prior to the Merger).
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, investments in
expanding businesses to support their growth, 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 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.
In the future, the Company anticipates being able to raise capital through
a variety of sources including, but not limited to, public debt or equity
offerings (subject to limitations related to the preservation of the Company's
NOLs), thus enhancing the investment and growth opportunities of the Company.
The Company believes that these and other sources of liquidity, including
refinancing and expanding the Company's revolving credit facility to the extent
necessary, securitizations, and funding from senior lenders providing
41
<PAGE> 43
funding for Acquisition Partnership investments and direct portfolio and
business acquisitions, should prove adequate to continue to fund the Company's
contemplated activities and meet its liquidity needs.
The Company and each of its major operating subsidiaries have entered into
one or more credit facilities to finance its respective operations. Each of the
credit facilities to which the operating subsidiaries are parties are
nonrecourse to the Company and the other operating subsidiaries, except as
discussed below.
Excluding the term acquisition facilities of the unconsolidated Acquisition
Partnerships, as of December 31, 1997 the Company and its subsidiaries had
credit facilities providing for borrowings in an aggregate principal amount of
$1,041 million and outstanding borrowings of $751 million. The following table
summarizes the material terms of the credit facilities to which the Company, its
major operating subsidiaries and the Acquisition Partnerships were parties as of
March 24, 1998 and the outstanding borrowings under such facilities as of
December 31, 1997.
CREDIT FACILITIES
<TABLE>
<CAPTION>
OUTSTANDING
PRINCIPAL BORROWINGS AS OF
AMOUNT DECEMBER 31, 1997 INTEREST RATE OTHER TERMS AND CONDITIONS
--------- ----------------- ------------- --------------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
FIRSTCITY
Company Credit
Facility.............. $ 35 $ 7 LIBOR + 5.0% Secured by the assets of
the Company, expires March
28, 1998(1)
Term fixed asset
facility.............. 1 1 Fixed 9.25% Secured by certain fixed
assets, expires January 1,
2001
MORTGAGE CORP.
Warehouse facility...... 450 309 LIBOR + 0.5% to 2.5% Revolving line to
warehouse residential
mortgage loans, expires
March 31, 1999
Supplemental warehouse
facility.............. 36 29 LIBOR + 0.5% to 2.25% Revolving line to
warehouse residential
mortgage loans and related
receivables, expires March
31, 1999
FNMA warehouse
facility.............. 187 187 Fed Funds + 0.8% to Open facility to fund
1.0% committed loans to FNMA
Operating line.......... 45 38 LIBOR + 2.25% Revolving operating line
secured by the
unencumbered assets of
Harbor, expires December
15, 2002
CAPITAL CORP.
Warehouse facility...... 36 36 Fixed 6.85% Repurchase agreement to
facilitate the acquisition
of Home Equity Loans,
expires April 13, 1998
COMMERCIAL CORP.
Portfolio acquisition
facility.............. 100 -- LIBOR + 2.5% Acquisition facility to
acquire Portfolio Assets,
expires February 28, 1999
</TABLE>
42
<PAGE> 44
<TABLE>
<CAPTION>
OUTSTANDING
PRINCIPAL BORROWINGS AS OF
AMOUNT DECEMBER 31, 1997 INTEREST RATE OTHER TERMS AND CONDITIONS
--------- ----------------- ------------- --------------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
French acquisition
facility.............. 15 8 French franc Acquisition facility to
LIBOR + 3.5% fund equity investments in
French Portfolio Assets,
expires March 31, 1999.
Guaranteed by Commercial
Corp. and the Company.
Term acquisition
facilities............ 86 86 Fixed at 7% to 7.66% Acquisition facilities for
and LIBOR + 5% existing Portfolio Assets.
Secured by assets of
Acquisition Partnerships,
various maturities
CONSUMER CORP.
Warehouse facility...... 50 50 LIBOR + 3% Revolving line secured by
automobile receivables,
expires May 17, 1998
UNCONSOLIDATED ACQUISITION
PARTNERSHIPS
Term acquisition
facilities.............. 69 69 Fixed at 7.51% to Senior and subordinated
10.17%, LIBOR + 3% to loans secured by Portfolio
6.5% and Prime + 2% Assets, various maturities
to 7%
</TABLE>
- ---------------
(1) The Company Credit Facility maturing March 28, 1998 is expected to be
replaced by a similar facility totalling $40 million, maturing March 31,
1999.
FirstCity. The Company Credit Facility is a revolving credit facility with
Cargill Financial and is secured by the assets of the Company, including a
pledge of the stock of substantially all of its operating subsidiaries and its
equity interests in the Acquisition Partnerships. The amount of such facility
has ranged from $25 to $35 million since the Merger, with a maximum outstanding
amount of approximately $31 million. At December 31, 1997, the amount
outstanding under the facility totaled approximately $7 million. The Company
Credit Facility matures on March 28, 1998. The Company has received and executed
a preliminary term sheet commitment from a foreign bank outlining the terms of a
new credit facility to replace the Company Credit Facility. The term sheet
proposes a $40 million revolving credit facility, which will mature on March 31,
1999 and will be secured by substantially all of the Company's equity interests
in its subsidiaries and the Acquisition Partnerships.
Mortgage Corp. Currently, Mortgage Corp. has a primary warehouse facility
of $450 million with a group of banks led by Chase Bank, Houston. The facility,
which matures in March 1999, is used to finance mortgage warehouse operations as
well as other activities. The $450 million facility is priced at LIBOR plus a
different margin to LIBOR for each of the sub-limits within the facility. The
primary warehouse components of the facility are priced at LIBOR plus from
1.375% to 1.625%, depending upon the status of the warehouse collateral securing
the loan. In addition to its primary warehouse facility, Mortgage Corp.
maintains a $36 million supplemental facility priced at LIBOR plus 0.5% to 2.5%.
In addition, Mortgage Corp. has an additional revolving operating line with such
banks of $45 million, which bears interest at a rate of LIBOR plus 2.25%. The
banks are obligated to fund loans under such line through March 31, 1999,
although final maturity of any then outstanding loans may be extended, at
Mortgage Corp.'s election, to December 15, 2002.
43
<PAGE> 45
Mortgage Corp. considers these facilities adequate for its current and
anticipated levels of activity in its mortgage operations.
The Company has executed a performance guarantee in favor of the lending
bank group in the event of overdrafts arising in Mortgage Corp.'s funding
accounts. An overdraft could occur in the event of the presentment of a loan
closing draft to the drawee bank prior to receipt of full closed loan
documentation from the closing agent. The receipt of documents by the lending
bank would release funds under the warehouse facility to cover the closing draft
prior to the presentment of the draft, in normal circumstances. The possibility
exists, therefore, for an overdraft in Mortgage Corp.'s funding account. The
performance guarantee by the Company in favor of the lending bank group is to
cover such overdrafts that are not cleared in a specified period of time. In
addition, Mortgage Corp. has a $172 million warehouse facility for loans to be
resold to FNMA.
Capital Corp. Capital Corp. funds its activities with equity investments
and subordinated debt from the Company and is in the process of negotiating
nonrecourse warehouse credit and securitization facilities with three nationally
recognized investment banking firms in an aggregate amount of $500 million.
Funding for Home Equity Loans purchased by Capital Corp. is provided, in part,
under Mortgage Corp.'s warehouse credit facility and is subject to Mortgage
Corp.'s sub-limit for Home Equity Loans meeting the criteria established in
Mortgage Corp.'s warehouse credit agreement. The remainder of Capital Corp.'s
Home Equity Loan warehouse is funded under a loan repurchase agreement with
Nomura Securities, Inc. ("Nomura"). The repurchase agreement expires on April
13, 1998. Capital Corp. anticipates being able to successfully conclude
negotiations on some of its warehouse and securitization facilities prior to the
expiration of the Nomura repurchase facility. However, if it is unable to do so,
it would have to curtail activities to a significant degree.
Commercial Corp. Commercial Corp. funds its activities with equity
investments and subordinated debt from the Company and nonrecourse financing
provided by a variety of bank and institutional lenders. Such lenders provide
funds to the special purpose entities formed for the purpose of acquiring
Portfolio Assets or to Acquisition Partnerships formed for the purpose of
co-investing in asset pools with other investors, principally Cargill Financial.
Commercial Corp. recently entered into a credit facility with Nomura in the
amount of $100 million, priced at LIBOR plus 2.25% to 2.50%, the proceeds of
which fund up to 85% of the purchase price of Portfolio Assets acquired by
Commercial Corp. or the Acquisition Partnerships. This facility matures on
February 28, 1999. Commercial Corp. believes that such facility, when combined
with the cash flow from its existing Portfolio Assets and its investment in
equities of Acquisition Partnerships, is adequate to meet its current and
anticipated liquidity needs. A Commercial Corp. subsidiary recently entered into
a $15 million dollar equivalent French franc facility for use in Portfolio
purchases in France, which facility accrues interest at LIBOR plus 3.50%,
matures on March 31, 1999 and is guaranteed by Commercial Corp. and the Company.
Consumer Corp. Consumer Corp. funds its activities with equity investments
and subordinated debt from the Company and a limited recourse $50 million
warehouse credit facility with ContiTrade Services L.L.C. ("ContiTrade"). Funds
are advanced under the facility in accordance with an eligible loan borrowing
base with the facility priced at LIBOR plus 3.0%. Loans are eligible for
inclusion in the borrowing base if they meet documented underwriting standards
as approved by ContiTrade and are not delinquent beyond terms established in the
loan agreement. At various times, the size of the facility has been in excess of
the $50 million committed amount based upon approvals by the lender. Under the
terms of the credit facility, the Company guarantees 25% of the amount
outstanding under the facility from time to time in addition to an undertaking
by the Company to support the liquidity requirements required in securitization
transactions. The ContiTrade facility matures on May 17, 1998. Negotiations are
underway to extend the facility, but there can be no assurance that such
negotiations will be successful.
OTHER MATTERS
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities," is effective for transfers of financial
assets and extinguishment of liabilities occurring after December 31, 1996 and
is to be applied prospectively. The Statement provides accounting and reporting
standards for transfers and servicing of financial assets that are sales from
transfers that are secured
44
<PAGE> 46
borrowings. This Statement has not had a material impact on the Company's
financial position or results of operations. SFAS No. 128, "Earnings Per Share,"
is effective for per share earnings calculations and disclosures for periods
ending after December 15, 1997, including interim periods, and requires
restatement of all prior period earnings per share data that is presented. The
accompanying earnings per share data included in this document reflect the
retroactive application of SFAS No. 128.
SFAS No. 129, "Disclosure of Information about Capital Structure,"
establishes standards for disclosing information about an entity's capital
structure and is effective for financial statements for periods ending after
December 15, 1997. SFAS No. 130, issued in June 1997, "Reporting Comprehensive
Income," establishes standards for reporting and display of comprehensive income
and its components in the financial statements. SFAS No. 130 is effective for
fiscal years beginning after December 15, 1997. SFAS No. 131, issued in June
1997, "Disclosure about Segments of an Enterprise and Related Information,"
establishes standards as to how public companies disclose information about
operating segments, products and services, geographic areas and major customers.
SFAS No. 131 is effective for financial statements for periods beginning after
December 15, 1997. These statements relate principally to disclosure issues and
are not expected to have a material impact on the Company's consolidated
financial position or results of operations.
45
<PAGE> 47
BUSINESS
GENERAL
The Company is a diversified financial services company headquartered in
Waco, Texas with over 90 offices throughout the United States and a presence in
France and Mexico. 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 to Face Value. To date the Company has acquired,
for its own account and through Acquisition Partnerships, Portfolio Assets with
a Face Value of approximately $3.0 billion. In 1996, the Company adopted a
growth strategy to diversify and expand its financial services business. To
implement its growth strategy, the Company has acquired or established several
businesses in the financial services industry, building upon its core strength
and expertise as one of the earliest participants in the business of acquiring
and resolving distressed financial assets and other assets. 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 three principal businesses: (i) residential and commercial mortgage
banking; (ii) Portfolio Asset acquisition and resolution; and (iii) consumer
lending.
The following chart depicts the business conducted by the Company and the
principal entities through which such businesses are conducted.
[Organizational Chart]
The Company is consolidating all of its servicing capabilities into a
single subsidiary, Servicing Corp. This process is designed to combine all
servicing activities under a single management group in an effort to achieve
further operating efficiencies, enhance the quality of asset servicing and
coordinate and improve the technology support for all of the Company's
businesses. When this consolidation is complete, Servicing Corp. will have
responsibility for the management of all of the Company's activities related to
servicing mortgage loans, Home Equity Loans, Portfolio Assets and automobile and
other consumer loans.
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<PAGE> 48
BUSINESS STRATEGY
The Company's business strategy is to continue to broaden and expand its
business within the financial services industry while building on its core
servicing strengths and credit expertise. The following principles are key
elements to the execution of the Company's business strategy:
- Expand the financial products and services offered by existing
businesses.
- Broaden its sources of revenue and operating earnings by developing or
acquiring additional businesses that leverage its core strengths and
management expertise.
- Cross-sell between the Company's businesses.
- Invest in fragmented or underdeveloped markets in which the Company has
the investment and servicing expertise to achieve attractive risk
adjusted rates of return.
- Pursue new business opportunities through joint ventures, thereby
capitalizing on the expertise of partners whose skills complement those
of the Company.
- Maximize growth in earnings, thereby permitting the utilization of the
Company's 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"). 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 Financial in 1991.
Since that time, the Company and Cargill Financial have formed a series of
Acquisition Partnerships through which they have jointly acquired over $2.2
billion in Face Value of distressed assets. By the end of 1994, the Company had
grown to nine offices with over 180 professionals and had acquired portfolios
with assets in virtually every state.
In July 1995, the Company acquired by merger 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. See "Certain Federal Income Tax Considerations."
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 partners that have
distinguished themselves among competitors. To that end, in July 1997 the
Company acquired Harbor Financial Group, Inc., a company engaged in the
residential and commercial mortgage banking business since 1983. The Company has
also expanded into related niche financial services markets, such as consumer
finance and mortgage conduit banking.
MORTGAGE BANKING
General
The Company engages in the mortgage banking business through Mortgage Corp.
and Capital Corp. Mortgage Corp. is a direct retail and broker retail mortgage
bank, which originates, purchases, sells and services residential and commercial
mortgage loans through more than 80 offices throughout the United States. The
Company acquired Mortgage Corp. (then named Harbor Financial Group, Inc.) upon
consummation of the Harbor Merger in July 1997. Mortgage Corp.'s senior
management team has extensive
47
<PAGE> 49
experience with all aspects of the residential, construction and commercial
mortgage banking business, including the direct retail, broker retail, secondary
marketing, servicing, financial and operating expertise necessary to manage a
growing business. This management team formed Mortgage Corp. as a subsidiary of
a savings and loan association in 1983, completed a management led buy-out of
the ownership of Mortgage Corp. in 1987 and continued to expand through
acquisitions and internal growth. Many of Mortgage Corp.'s acquisitions
represented opportunistic situations whereby it was able to acquire origination
capability or servicing portfolios from the FDIC, the Resolution Trust
Corporation ("RTC") or other sellers of distressed assets. Mortgage Corp.
conducts its residential and commercial mortgage banking and servicing business
through its subsidiaries Harbor Financial Mortgage Corporation ("Harbor") and
New America Financial, Inc. ("New America"). Mortgage Corp. ranks among the 50
largest mortgage banks in the United States.
Capital Corp. was formed in 1997 to acquire, originate, warehouse,
securitize and service Home Equity Loans to borrowers who have significant
equity in their homes and who generally do not satisfy the more rigid
underwriting standards of the traditional residential mortgage lending market.
These loans are extended to borrowers who demonstrate an ability and willingness
to repay credit, but who might have experienced an adverse event, such as job
loss, illness or divorce, or have had past credit problems such as delinquency,
bankruptcy, repossession or charge-offs. Such an event normally will temporarily
impair a borrower's credit rating such that the borrower will not qualify as a
prime borrower from a traditional mortgage lender that concentrates on prime
credit quality conventional conforming loans.
The Company owns 80% of the outstanding stock of Capital Corp. and Capital
Corp.'s senior management owns the remaining 20%. This ownership structure
aligns the interests of the key management team of Capital Corp. with those of
the Company. The Company became acquainted with Capital Corp.'s management team
during their tenure as senior management for a Wall Street firm's mortgage
conduit and structured finance division. This team has demonstrated to the
Company a disciplined approach to growing a business where the emphasis is on
credit quality and sound operating standards. The Company and the management
shareholders of Capital Corp. entered into a shareholders' agreement in
connection with the formation of Capital Corp. in August 1997. Commencing on the
fifth anniversary of such agreement, the Company and the management shareholders
have put and call options with respect to the stock of Capital Corp. held by the
other party at a mutually agreed upon fair market value.
Residential Mortgage Banking
Products and Services
Mortgage Corp. originates and purchases both fixed rate and adjustable rate
mortgage loans, primarily secured by first liens on single family residences.
The majority of the residential loans originated by Mortgage Corp. are
conventional conforming loans that qualify for sale to, or conversion into
securities issued by, Federal National Mortgage Association ("FNMA") and Federal
Home Loan Mortgage Corporation ("FHLMC"). Additionally, Mortgage Corp.
originates loans insured by the Federal Housing Administration ("FHA") and the
Farmers Home Administration ("FMHA") and loans guaranteed by the Veterans
Administration ("VA"). These loans qualify for inclusion in guarantee programs
sponsored by the Government National Mortgage Association ("GNMA").
Substantially all the conventional conforming loans are originated with
loan-to-value ratios at or below 80% unless the borrower obtains private
mortgage insurance. The Company also originates a number of other mortgage loan
products to respond to a variety of customer needs. These products include:
- First lien residential mortgage loans that meet the specific underwriting
standards of private investors, issuers of mortgage backed securities,
and other conduits seeking to purchase loans originated by Mortgage Corp.
These loans do not meet the established standards of FNMA or FHLMC and
are generally referred to as non-conforming mortgage loans. The loans may
be non-conforming because, among other reasons, they exceed the dollar
limitations established by FNMA or FHLMC, are originated with an original
loan-to-value ratio in excess of 80%, or are made to a borrower who is
self-employed.
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<PAGE> 50
- First and second lien residential mortgage Home Equity Loans to borrowers
who have some level of impaired credit.
- First and second lien residential home improvement loans.
Mortgage Corp. offers its customers a range of choices with respect to
repayment plans and interest rates on the loans that it originates. Most loans
originated by Mortgage Corp. have either 15 or 30 year terms and accrue interest
at fixed or variable rates. Quoted interest rates are a function of the current
interest rate environment and generally may be reduced at the option of the
customer by paying additional discount points at the time the loan is
originated. The adjustable rate mortgage ("ARM") products offered by Mortgage
Corp. reflect the current offerings of its agency or private investors. A basic
ARM loan could have an interest rate that adjusts on an annual basis throughout
its term with limits on the amount of the annual and aggregate lifetime
adjustments. A more complicated ARM loan could have a fixed rate of interest for
a stipulated period of time (for example, five years) with the annual adjustment
rate option commencing on an annual basis after the expiration of the initial
fixed term. Mortgage Corp. continuously monitors and adjusts its product
offerings and pricing so that it is able to sell the loans that it originates in
the secondary markets. To that end, price quotes and product descriptions are
distributed throughout its origination network on a daily basis.
In 1996, Mortgage Corp. implemented a program to supplement its
conventional conforming loans by offering Home Equity Loans. Mortgage Corp.'s
customers use the proceeds of Home Equity Loans to finance home purchases and
improvements, debt consolidation, education and other consumer needs.
Approximately 74% of the Home Equity Loans originated by Mortgage Corp. in 1997
were secured by first mortgages. In addition to originating Home Equity Loans,
as a result of the formation of Capital Corp. in the third quarter of 1997, the
Company also operates a mortgage conduit business, which acquires Home Equity
Loans individually and in bulk from several independent loan origination
sources.
The Home Equity Loans originated and acquired by Mortgage Corp. and Capital
Corp. are similar in nature. Home Equity Loans have repayment options and
interest rate options that are similar to the options available for conventional
conforming loans. The primary difference between Home Equity Loans and
conventional conforming loans is the underwriting guidelines that govern the two
types of loans. Various underwriting criteria are evaluated to establish
guidelines as to the amount and type of credit for which the prospective
borrower is eligible. These factors also determine the interest rate and
repayment terms to be offered to the borrower. Interest rates on Home Equity
Loans are generally in excess of rates of interest charged on agency or
conforming residential loans. The underwriting guidelines and interest rates
charged for Home Equity Loans are revised as necessary to address market
conditions, the interest rate environment, general economic conditions and other
factors. See "-- Underwriting."
Through various other subsidiaries and affiliates, Mortgage Corp. conducts
business in a number of areas related to its principal mortgage business. Harbor
Financial Property Management, Inc. manages residential properties throughout
the United States for institutional investors. Dungey and Associates, Inc. is a
property appraisal and inspection company that provides services to Mortgage
Corp. and third parties in the Texas market. Hamilton, Carter, Smith & Co. is a
financial advisory firm that provides services to the mortgage industry in the
areas of portfolio/corporate evaluations, risk management and hedging advisory
services, marketing of loan servicing portfolios, and mergers and acquisitions
advisory services. Under management contracts, an affiliate of Mortgage Corp.
provides management and administrative services to Harbor Financial Insurance
Agency, which offers complete lines of personal, commercial and property
insurance products, and to JMC Title, Inc., which provides outside services for
title escrow and insurance services. None of these businesses contributes a
significant portion of the Company's earnings.
Loan Origination
General. Mortgage Corp. originates and acquires mortgage loans through a
direct retail group ("Direct Retail") that operates principally within Harbor,
and a broker retail group ("Broker Retail") whose activities are conducted
through New America. Mortgage Corp. believes that the Direct Retail and Broker
Retail origination channels offer distinct advantages and seeks to expand the
operations of both channels. A customer
49
<PAGE> 51
of the Direct Retail business works with an employee of Mortgage Corp.
throughout the entire loan origination process. Direct Retail loan origination
offers the advantage of greater fee retention to compensate for higher fixed
operating costs. It also facilitates the formation of direct relationships with
customers, which tends to create a more sustainable loan origination franchise
and results in increased control over the lending process and the refinance
activity that is becoming more prevalent in the mortgage industry. As of
December 31, 1997, Direct Retail employed 125 loan officers, who were supported
by 65 loan processing staff and 10 loan underwriting staff, all of whom are
employees of Mortgage Corp. The Direct Retail group operates through 37 branches
located in 11 states.
In the Broker Retail business, customers conduct a substantial portion of
their business with an independent broker who will present a relatively complete
loan application to the Broker Retail account executives for consideration.
Broker Retail mortgage loan origination is cost effective because it does not
involve fixed overhead costs for items such as offices, furniture, computer
equipment and telephones, or additional personnel costs, such as loan officers
and loan processors. By limiting the number of offices and personnel needed to
generate production, Mortgage Corp.'s Broker Retail business transfers the
overhead burden of mortgage origination to the independent mortgage loan
brokers. As a result, through its Broker Retail network Mortgage Corp. is able
to match its loan origination costs more closely with loan origination volume so
that a substantial portion of its loan origination costs are variable rather
than fixed. In addition, Broker Retail affords management the flexibility to
expand or contract production capacity as market conditions warrant. As of
December 31, 1997, Broker Retail employed 82 account executives working in 23
offices and operating in 42 states. Broker Retail account executives work with
and through a group of approximately 6,500 independent mortgage loan brokers,
approximately 2,700 of whom closed loans through the Broker Retail network in
1997.
As a complement to its Direct Retail and Broker Retail businesses, the
Company operates a mortgage conduit business through Capital Corp. Capital Corp.
acquires Home Equity Loans from third-party origination sources for
securitization. Capital Corp. was formed in August 1997 and, as of February 28,
1998, had 19 employees.
Direct Retail. The Direct Retail group originates mortgage loans using
direct contact with consumers and operates through a network of 37 branches
located in Texas, Oklahoma, Pennsylvania, Virginia, West Virginia, Maryland,
Florida, Washington, Arizona, Colorado and Illinois. The marketing efforts of
the Direct Retail group are focused on the loan origination activities of retail
loan officers located in the branch offices. These loan officers identify
prospective customers through contacts within their local markets by developing
relationships with real estate agents, large employers, home builders,
commercial bankers, accountants, attorneys and others who would have contact
with prospective home owners seeking financing or refinancing. Over time,
successful loan officers develop a reputation for being able to provide quick
and accurate service to the customer and often generate new customers through
referrals from existing customers. The marketing efforts of the loan officers
are supported by print media advertising in selected local markets to target
prospects with featured product types or to highlight Mortgage Corp.'s broad
range of service capabilities. Mortgage Corp. has expanded its Direct Retail
network of loan officers by hiring experienced lenders in targeted markets and
by acquiring successful retail mortgage origination businesses.
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<PAGE> 52
The following table presents the number and dollar amount of loan
originations through Direct Retail for the periods indicated.
DIRECT RETAIL RESIDENTIAL MORTGAGE LOAN ORIGINATIONS
<TABLE>
<CAPTION>
FISCAL YEAR(1)
------------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Conventional Loans:
Volume of loans...................................... $182,640 $162,117 $145,398
Number of loans...................................... 1,425 1,374 1,354
FHA/VA/FMHA Loans:
Volume of loans...................................... $319,667 $184,098 $108,074
Number of loans...................................... 3,300 2,073 1,474
Home Improvement Loans:(2)
Volume of loans...................................... $ 631 $ 211 $ 141
Number of loans...................................... 14 12 7
Brokered Loans:(3)
Volume of loans...................................... $ 62,524 $ 19,851 $ 32,799
Number of loans...................................... 532 99 133
Total Originations:
Volume of loans...................................... $565,462 $366,277 $286,412
Number of loans...................................... 5,271 3,558 2,968
</TABLE>
- ---------------
(1) 1997 data is for the 12 months ended December 31; data for all other years
is for the 12 months ended September 30, which was the fiscal year end for
Mortgage Corp. prior to the Harbor Merger.
(2) Home Improvement Loans are loans that are used by borrowers to finance
various home improvement projects and are generally secured by second liens.
(3) Brokered Loans are originated through the Direct Retail process but are
closed and funded by a third-party correspondent.
Broker Retail. Mortgage Corp. entered into the Broker Retail business
through the acquisition of New America in July 1994. At the time of the
acquisition, New America had offices in Dallas, Texas and Fort Lauderdale,
Florida. Since becoming a part of Mortgage Corp., New America has expanded to
its present complement of 23 offices. Broker Retail account executives work with
and through independent mortgage loan brokers to identify lending opportunities
for the various loan products offered by Mortgage Corp.
In arranging mortgage loans, independent mortgage loan brokers act as
intermediaries between prospective borrowers and Mortgage Corp. Mortgage Corp.
is an approved FHMA, FHLMC and GNMA seller/servicer and has access to private
investors as well, which provides brokers access to the secondary market for the
sale of mortgage loans that they otherwise could not access because they do not
meet the applicable seller/servicer net worth requirements. Mortgage Corp.
attracts and maintains relationships with mortgage brokers by offering a variety
of competitive and responsive services as well as a variety of mortgage loan
products at competitive prices. Mortgage Corp.'s relationship with these
independent mortgage brokers differs from traditional wholesale purchases in
that Mortgage Corp. underwrites and funds substantially all of the loans funded
through the Broker Retail channel in its own name.
Separately, the Broker Retail channel conducts a whole loan pool
acquisition business. In most cases, the loans purchased in bulk are
underwritten by the seller-originator to FHA, FMHA, VA, FNMA or FHLMC
underwriting standards, with the seller warranting that such loans comply with
such standards. Mortgage Corp. employs quality review procedures prior to
purchase in an effort to ensure that the loans acquired in bulk purchases meet
such standards. See "-- Underwriting." During 1997, bulk acquisitions of loans
constituted less than 1% of Broker Retail production.
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<PAGE> 53
The following table presents the number and dollar amount of Broker Retail
production, including bulk acquisitions, for the periods indicated.
BROKER RETAIL RESIDENTIAL MORTGAGE LOAN PRODUCTION
<TABLE>
<CAPTION>
FISCAL YEAR(1)
------------------------------------
1997 1996 1995
---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Conventional Loans:
Volume of loans....................................... $2,222,232 $1,270,497 $364,049
Number of loans....................................... 18,332 11,665 3,506
FHA/VA/FMHA Loans:
Volume of loans....................................... $ 273,336 $ 55,917 $ 24,085
Number of loans....................................... 2,741 632 315
Home Equity Loans:
Volume of loans....................................... $ 178,492 $ 6,583 --
Number of loans....................................... 2,423 183 --
Total Production:
Volume of loans....................................... $2,674,060 $1,332,997 $388,134
Number of loans....................................... 23,496 12,480 3,821
</TABLE>
- ---------------
(1) 1997 data is for the 12 months ended December 31; data for all other years
is for the 12 months ended September 30, which was the fiscal year end for
Mortgage Corp. prior to the Harbor Merger.
Characteristics of Retail Loan Production. As a result of Mortgage Corp.'s
extensive Direct Retail and Broker Retail origination networks, the portfolio of
retail mortgage loans originated by Mortgage Corp. on an annual basis is
comprised of loans with a variety of characteristics that are offered to
borrowers who are geographically dispersed. Based upon production data
maintained by Mortgage Corp., the following table sets forth, as a percentage of
aggregate principal balance, the geographic distribution and other data for the
loans originated through the retail network of Mortgage Corp. for the 12 month
periods ended December 31, 1997 and September 30, 1996.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 SEPTEMBER 30, 1996
----------------- ------------------
<S> <C> <C>
Production by State:
California............................................... 23% 9%
Texas.................................................... 13 25
Florida.................................................. 7 7
Oregon................................................... 7 --
Washington............................................... 7 5
Georgia.................................................. 6 9
Arizona.................................................. 5 7
All others............................................... 32 38
--- ---
Total............................................ 100% 100%
Interest rate characteristics:
Fixed rate loans......................................... 93% 93%
Variable rate loans...................................... 7 7
--- ---
Total............................................ 100% 100%
Loan purpose:
Purchase transactions.................................... 61% 69%
Refinance transactions................................... 39 31
--- ---
Total............................................ 100% 100%
</TABLE>
Substantially all of the retail mortgage production of Mortgage Corp. represents
loans secured by first liens on the underlying collateral.
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<PAGE> 54
Mortgage Conduit. The Company organized Capital Corp. in August 1997 to
acquire Home Equity Loans from third-party origination sources for
securitization. Capital Corp. acquires existing pools of Home Equity Loans in
individually negotiated transactions from several loan origination sources. From
its inception through December 31, 1997, Capital Corp. acquired 480 Home Equity
Loans in nine pools with principal balances totaling $53.6 million from four
different sellers, including one pool for $35.1 million purchased from the
former employer of Capital Corp.'s management. In addition to acquiring pools of
Home Equity Loans from third-party origination sources for securitization,
Capital Corp. intends to acquire loans originated by New America's extensive
Broker Retail network.
In addition to the acquisition of Home Equity Loans, Capital Corp. intends
to originate Home Equity Loans on a retail basis or through broker referrals.
Capital Corp. recently signed a letter of intent to acquire three existing
retail branch offices. In selected instances, Capital Corp. will seek
opportunities to extend secured warehouse lines of credit to certain approved
sellers of Home Equity Loans and will consider originating mezzanine loans to,
or making equity investments in, selected sellers. The objectives of such loans
and investments are to diversify and solidify the flow of product from selected
mortgage banks who provide Home Equity Loans to Capital Corp.
Characteristics of Mortgage Conduit Production. The loans acquired by
Capital Corp. have been acquired from Home Equity Loan originators who originate
loans throughout the United States. The following table sets forth, as a
percentage of aggregate principal balance, the geographic distribution and other
data for the portfolio of loans acquired by Capital Corp. from its first
acquisition of loans in October 1997 through December 31, 1997.
<TABLE>
<S> <C>
Production by state:
Georgia................................................... 29%
New York.................................................. 22
Florida................................................... 15
Illinois.................................................. 11
North Carolina............................................ 5
All others (27 states).................................... 18
---
Total............................................. 100%
Interest rate characteristics:
Fixed rate loans.......................................... 43%
Variable rate loans....................................... 57
---
Total............................................. 100%
Lien status:
First liens............................................... 96%
Subordinate liens......................................... 4
---
Total............................................. 100%
</TABLE>
Underwriting
Direct Retail and Broker Retail. Loan underwriting in both the Direct
Retail and Broker Retail groups is performed on a regional basis in larger
branch locations. Substantially all Direct Retail and Broker Retail loans are
processed and individually underwritten by Mortgage Corp. personnel and are
directly funded by Mortgage Corp. Mortgage Corp. believes that having
underwriters in each market area enables these personnel to remain abreast of
changing conditions in property values, employment conditions and various other
conditions in each market. Furthermore, in order to ensure compliance with
Mortgage Corp.'s underwriting guidelines, the underwriters operate independently
of origination personnel.
Mortgage Corp.'s guidelines for underwriting conventional conforming loans
comply with the criteria employed by FHLMC and FNMA, as applicable. Mortgage
Corp.'s guidelines for underwriting FHA and FMHA insured loans and VA guaranteed
loans comply with the criteria established by these agencies. Mortgage Corp.'s
guidelines for underwriting conventional non-conforming loans are based on the
underwrit-
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<PAGE> 55
ing standards employed by private mortgage insurers and private investors that
purchase such loans. Mortgage Corp.'s guidelines for underwriting Home Equity
Loans are based on the underwriting standards employed by the private and
conduit investors that purchase such loans and are similar to the underwriting
standards employed by Capital Corp. for acquired Home Equity Loans. Such private
investors (i) have given Mortgage Corp. delegated underwriting authority for
approval to close and sell such loans based on policy and guidelines established
by the investor, (ii) require that the loan be underwritten on a contract basis
for the closing and sale of such loans by an independent third party approved by
the investor, typically a mortgage insurance company, or (iii) are approved
directly by the investor before closing and sale of such loans.
Mortgage Corp. performs a quality control review of loans originated by
having approximately 10% of its loans re-underwritten by independent third
parties that contract with Mortgage Corp. to perform this service. This practice
is designed to ensure that the loan origination practices and decisions are
acceptable to Mortgage Corp.'s loan pool investors and are in compliance with
regulatory requirements. Mortgage Corp. believes that its quality control review
meets or exceeds the review requirements of FNMA, FHLMC and applicable laws and
regulations.
Home Equity Loans are extended to borrowers who, for some reason, do not
qualify for an agency or conventional mortgage loan. In most cases, borrowers
seeking Home Equity Loans have experienced some level of historical credit
difficulty. Through a tiered underwriting system, Mortgage Corp. subjects
borrowers seeking Home Equity Loans to limits based, among other things, on the
loan-to-value ratio applicable to the particular transaction. The maximum
allowed loan-to-value ratio varies depending upon whether the collateral is
classified as a primary, secondary or investor residence. Maximum loan amounts
established for each classification of collateral generally do not exceed
$500,000 for a primary residence with a loan-to-value ratio of less than 80%. At
the low end of the credit spectrum for qualified Home Equity Loan borrowers, the
maximum loan-to-value ratios cannot exceed 65%, with security limited to a
primary residence and the loan amount limited to $100,000. Sub-limits within the
underwriting guidelines also place loan-to-value and borrowing amount
limitations on the Home Equity Loan based upon whether the loan is a purchase
money or cash-out refinance loan. Through December 31, 1997, Mortgage Corp. has
sold, on a servicing released basis, substantially all of its Home Equity Loan
production.
Mortgage Conduit. Capital Corp. acquires existing Home Equity Loans from
several loan origination sources under a tiered underwriting system. Capital
Corp. acquires each loan pool in an individually negotiated transaction from the
seller after a full underwriting review by Capital Corp. prior to the offer to
purchase. The underwriting review is performed to determine that the loans to be
acquired meet the various underwriting criteria for each credit grade.
Generally, the underwriting grade is a function of the prospective borrower's
credit history, which, in turn, will drive the loan-to-value relationship, the
debt to income ratio, and other credit criteria to be applied by Capital Corp.
in evaluating a loan.
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<PAGE> 56
Capital Corp.'s categories and general criteria for grading the credit
history of potential Home Equity Loan borrowers are set forth in the table
below.
UNDERWRITING GUIDELINES(1)
<TABLE>
<CAPTION>
A1 PROGRAM A2 PROGRAM B PROGRAM C PROGRAM
-------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C> <C>
Existing mortgage
history.............. Maximum one 30-day Maximum two 30-day Maximum three 30-day Maximum five 30-day
late payment within late payments and no late payments and no and two 60-day late
last 12 months and 60-day late payments 60-day late payments payments within last
two 30-day late within last 12 within last 12 12 months: must be
payments in last 24 months; must be months; must be current at
months; must be current at current at application time
current at application time application time
application time
Other credit
history.............. No more than one No more than two Over 12 month prior Significant prior
30-day late payment 30-day late payments defaults acceptable; defaults acceptable
in last 12 months or in last 12 months. not more than $5,000 if over two years
two 30-day late Minor derogatory in open collection old; generally, not
payments in last 24 items allowed; no accounts or charge- more than $5,000 in
months; must be more than $2,500 in offs open after open collection
current at open collection funding; some 30- accounts or
application time accounts or and 60-day charge-offs open
charge-offs open delinquencies after funding; some
after funding, all 60- and 90-day
current credit must delinquencies
be current
Bankruptcy filings.... Generally, no notice Generally, no Generally, no Generally, no
of default filings bankruptcy or notice bankruptcy or notice bankruptcy or notice
in last two years of default filings of default filings of default filings
in last three years in last two years in last two years
and credit has been and credit has been
reestablished reestablished
subsequent to subsequent to
bankruptcy bankruptcy
Employment history.... Two years stable Two years stable Two years stable Two years stable
Debt service to income
ratio................ 45% or less 45% or less 50% or less 50% or less
Maximum loan-to-value
ratio:
Owner occupied;
single family...... 85% 85% 80% 75%
condo/two-to-four
unit............. 85% 80% 75% 75%
Non-owner occupied... 75% 75% 70% 70%
<CAPTION>
D PROGRAM
--------------------
<S> <C>
Existing mortgage
history.............. No more than three
months delinquent at
closing
Other credit
history.............. Significant defaults
acceptable; not more
than $5,000 in open
charge-offs or
collection amounts
may remain open
after funding;
applicant has
sporadic payment
history
Bankruptcy filings.... Bankruptcy, notice
of sale filing,
notice of default
filing or
foreclosure
permitted if over 12
months old
Employment history.... One year stable
Debt service to income
ratio................ 50% or less
Maximum loan-to-value
ratio:
Owner occupied;
single family...... 65%
condo/two-to-four
unit............. 60%
Non-owner occupied... N.A.
</TABLE>
- ---------------
(1) The letter grades applied to each risk classification reflect Capital
Corp.'s internal standards and do not necessarily correspond to the
classifications used by other home equity lenders. The data presented are
for first lien mortgages. More stringent requirements apply to mortgages
secured by second liens.
55
<PAGE> 57
The following table presents, for each of Capital Corp.'s underwriting
grades, for the period from Capital Corp.'s formation in August 1997 to December
31, 1997, the aggregate principal balance of loans acquired, the aggregate
number of loans acquired, the weighted average coupon rate of loans acquired,
and the relationship of amount financed to the estimated appraised value of the
mortgaged collateral. Because of the short time period reflected in the
following table, the characteristics of the loans reflected therein are not
necessarily indicative of future loans that may be acquired or originated by
Capital Corp.
CAPITAL CORP.'S LOAN PRODUCTION
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
AGGREGATE LOAN NUMBER OF WEIGHTED AVERAGE LOAN-TO-VALUE
CAPITAL CORP.'S GRADE BALANCE LOANS COUPON RATIO
--------------------- -------------- --------- ---------------- ----------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C> <C>
A1...................................... $17,582 131 9.6% 79.1%
A2...................................... 20,077 176 10.3 80.3
B....................................... 8,434 92 10.8 76.0
C....................................... 5,086 52 10.9 73.8
D....................................... 2,445 29 11.6 68.6
------- --- ---- ----
Total or Weighted Average..... $53,624 480 10.3% 78.2%
======= === ==== ====
</TABLE>
Through February 28, 1998, Capital Corp. acquired a total of 702 Home
Equity Loans with an aggregate principal balance of approximately $75.6 million,
including the loans acquired prior to December 31, 1997. The weighted average
coupon interest rate of all loans acquired was 10.3% and the weighted average
loan to value percentage was 76.5%. At February 28, 1998, Capital Corp. had
acquired Home Equity Loans from six originating mortgage banks.
Financing Strategy
Direct Retail and Broker Retail. Mortgage Corp. finances originated
mortgage loans primarily through its warehouse credit facilities provided by a
group of commercial bank lenders. Loans are generally held in inventory by
Mortgage Corp. for up to 45 days pending their sale to investors or agencies.
From the stage of initial application by the borrower through the final sale of
the loan, Mortgage Corp. bears interest rate risk.
In order to offset the risk that a change in interest rates will result in
a decrease in the value of Mortgage Corp.'s current mortgage loan inventory or
its commitments to purchase or originate mortgage loans ("Committed Pipeline"),
Mortgage Corp. enters into hedging transactions. Mortgage Corp.'s hedging
policies generally require that substantially all of its inventory of
conventional conforming and agency loans and the maximum portion of the
Committed Pipeline that Mortgage Corp. believes may close be hedged with forward
contracts for the delivery of mortgage-backed securities ("MBS") or options on
MBS. The inventory is then used to form the MBS that will fill the forward
delivery contracts and options. Mortgage Corp. hedges its inventory and
Committed Pipeline of jumbo (generally loans in excess of $227,200) and other
non-conforming mortgage loans, by using whole-loan sale commitments to ultimate
buyers or, because such loans are ultimately sold based on a market spread to
MBS, by selling a like amount of MBS. Because the market value of the loan and
the MBS are both subject to interest rate fluctuations, Mortgage Corp. is not
exposed to significant risk and will not derive any significant benefit from
changes in interest rates on the price of the inventory net of gains or losses
in associated hedge positions.
The correlation between price performance of the hedging instruments and
the inventory being hedged is very high as a result of the similarity of the
asset and the related hedge instrument. Mortgage Corp. is exposed to
interest-rate risk to the extent that the portion of loans from the Committed
Pipeline that actually closes at the committed price is different from the
portion expected to close and hedged in the manner described. Mortgage Corp.
determines the portion of its Committed Pipeline that it will hedge based on
numerous assumptions, including composition of the Committed Pipeline, the
portion of such Committed Pipeline likely
56
<PAGE> 58
to close, the timing of such closings and anticipated changes in interest rates.
See Notes 15 and 18 to the Company's Consolidated Financial Statements.
Mortgage Corp. customarily sells all loans that it originates or purchases.
Conventional conforming and agency loans are generally sold servicing retained
and non-conforming loans are generally sold servicing released. Mortgage Corp.
packages substantially all of its FHA- and FMHA-insured and VA-guaranteed
mortgage loans into pools of loans. It sells these pools to national or regional
broker-dealers in the form of modified pass-through MBS guaranteed by GNMA. With
respect to loans securitized through GNMA programs, Mortgage Corp. is insured
against foreclosure loss by the FHA or FMHA or partially guaranteed against
foreclosure loss by the VA (at present, generally 25% to 50% of the loan, up to
a maximum amount of $50,750, depending upon the amount of the loan).
Conventional conforming loans are also pooled by Mortgage Corp. and exchanged
for securities guaranteed by FNMA or FHLMC, which securities are then sold to
national or regional broker-dealers. Loans securitized through FNMA or FHLMC are
sold on a nonrecourse basis whereby foreclosure losses are generally the
responsibility of FNMA and FHLMC, and not Mortgage Corp. Alternatively, Mortgage
Corp. may sell FHA- and FMHA-insured and VA-guaranteed mortgage loans and
conventional conforming loans, and consistently sells its jumbo loan production
to large buyers in the secondary market (which can include national or regional
broker-dealers) on a nonrecourse basis. These loans can be sold either on a
whole-loan basis or in the form of pools backing securities which are not
guaranteed by any governmental instrumentality but which generally have the
benefit of some form of external credit enhancement, such as insurance, letter
of credit, payment guarantees or senior/subordinated structures. Substantially
all loans sold by Mortgage Corp. are sold without recourse, subject, in the case
of VA loans, to the limits of the VA guaranty described above. To date, losses
on VA loans in excess of the VA guaranty have not been material to Mortgage
Corp.
Mortgage Conduit. Capital Corp. currently finances the purchase of Home
Equity Loans with cash flow from the Company, a sub-line under Mortgage Corp.'s
warehouse credit facility and other short-term credit facilities. Typically,
under these credit facilities, Capital Corp. is only permitted to finance a
portion of the purchase price of loans, which are generally purchased at prices
that exceed their par value. Capital Corp. is in the process of negotiating
nonrecourse warehouse credit facilities in its own name for an aggregate amount
of $500 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Capital Corp. intends to securitize substantially all of the Home Equity
Loans it acquires or originates. The securitization transactions are expected to
be consummated through the creation of special purpose trusts. The Home Equity
Loans will be transferred to a trust in exchange for certificates representing
the senior interest in the securitized loans held by the trust and, if
applicable, a subordinated interest in the securitized loans. The subordinated
interests generally consist of the excess spread between the interest and
principal paid by the borrowers on the loans pooled in the securitization and
the interest and principal of the senior interests issued in the securitization,
and other unrated interests issued in the securitization. The senior interests
are subsequently sold to investors for cash. Capital Corp. may elect to retain
the subordinated interests or may sell all or some portion of the subordinated
interests to investors for cash. Capital Corp. anticipates that it will retain
the rights to the excess spreads.
Upon the sale of Home Equity Loans in securitization transactions, the sum
of the cash proceeds received, and the estimated present values of the
subordinated interests less the costs of origination and securitization and, the
basis in the Home Equity Loans sold results in the gain recognized at the time
of the securitization transaction. The present values of the subordinated
interests to be recognized by Capital Corp. are to be determined based upon
prepayment, loss and discount rate assumptions that will be determined in
accordance with the unique underlying characteristics of the Home Equity Loans
comprising each securitization.
Servicing
Direct Retail and Broker Retail. Generally, it is Mortgage Corp.'s strategy
to build and retain its servicing portfolio. With the exception of Home Equity
Loans, Mortgage Corp. services substantially all of the
57
<PAGE> 59
mortgage loans that it originates. In addition, Mortgage Corp. may, from time to
time, purchase bulk servicing contracts for servicing of single family
residential mortgage loans originated by other lenders. Following Mortgage
Corp.'s acquisition by the Company in July 1997, it has retained substantially
all of the newly originated mortgage servicing rights when the option to retain
such rights existed. Mortgage Corp. has been able to retain such rights as a
result of the capital support available from the Company to fund the cash
investment required to grow the servicing portfolio.
The servicing of mortgage loans generally includes collecting and remitting
loan payments, making advances when required, accounting for principal and
interest, holding custodial (escrow) funds for payment of property taxes and
hazard insurance, making necessary physical inspections of the property,
counseling delinquent mortgagors, supervising foreclosures and property
dispositions in the event of unremedied defaults, and generally administering
the loans. Mortgage Corp. receives a fee for servicing mortgage loans ranging
generally from 1/4% to 1/2% per annum on the declining principal balances of
the loans. The servicing fee is collected by Mortgage Corp. out of monthly
mortgage payments.
Currently, a large portion of Mortgage Corp.'s costs of servicing loans are
incurred as a result of the labor intensive data entry process required in
connection with each new loan. Mortgage Corp. is currently implementing a system
that will automate a large portion of the data entry process for serviced loans.
Mortgage Corp. expects that this system will be fully implemented by the third
quarter of 1998 and will significantly decrease the variable costs associated
with servicing loans.
Mortgage Corp.'s servicing portfolio is subject to reduction by scheduled
amortization or by prepayment or foreclosure of outstanding loans. In addition,
Mortgage Corp. has sold, and may sell in the future, a portion of its portfolio
of loan servicing rights to other mortgage servicers. In general, the decision
to sell servicing rights is based on management's assessment of the market value
of servicing rights and other factors.
The following table presents certain information regarding Mortgage Corp.'s
residential servicing portfolio, including loans held for sale as of the dates
indicated.
RESIDENTIAL SERVICING PORTFOLIO BALANCES
<TABLE>
<CAPTION>
FISCAL YEAR(1)
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
FHA-insured mortgage loans............................. $ 429,216 $ 342,694 $ 240,217
VA-guaranteed mortgage loans........................... 266,294 178,943 149,830
Conventional mortgage loans............................ 4,280,315 3,234,197 894,840
Other.................................................. 20,688 66,815 68,802
---------- ---------- ----------
Total residential servicing portfolio........ $4,996,513 $3,822,649 $1,353,689
</TABLE>
- ---------------
(1) 1997 data is as of December 31; data for all other years is as of September
30, which was the fiscal year end for Mortgage Corp. prior to the Harbor
Merger.
Mortgage Corp.'s contractual right to subservice approximately $707 million
of residential mortgages at December 31, 1997 is included in the data presented
in the preceding table. Of the total subservicing portfolio, approximately $624
million (88.2%) represents subservicing for loans in California. No other state
accounts for more than 5% of Mortgage Corp.'s subservicing portfolio. These
subservicing rights represent Mortgage Corp.'s right to service loans as to
which third parties own the servicing rights. Such parties have contracted with
Mortgage Corp. to service the portfolio of loans under short-term contracts
(generally for original terms of less than five years) for a fixed dollar amount
of servicing fee per year (generally approximately $75.00 per loan per year).
58
<PAGE> 60
Mortgage Corp.'s residential servicing portfolio (excluding subserviced
loans), stratified by interest rate, was as follows as of the dates indicated:
RESIDENTIAL SERVICING PORTFOLIO
INTEREST RATE STRATIFICATION
<TABLE>
<CAPTION>
PERCENTAGE OF PRINCIPAL
BALANCE SERVICED
------------------------
FISCAL YEAR(1)
------------------------
1997 1996
--------- ---------
<S> <C> <C>
Under 7.0%.................................................. 7.9% 9.8%
7.0 to 7.49................................................. 15.2 14.7
7.5 to 7.99................................................. 28.1 21.1
8.0 to 8.49................................................. 22.4 18.0
8.5 to 8.99................................................. 15.0 15.8
9.0 to 9.49................................................. 3.4 6.7
9.5 to 9.99................................................. 4.0 6.9
10% and over................................................ 4.0 7.0
------ ------
Total residential servicing portfolio............. 100.0% 100.0%
====== ======
</TABLE>
- ---------------
(1) 1997 data is as of December 31; 1996 data is as of September 30, which was
the fiscal year end for Mortgage Corp. prior to the Harbor Merger.
At December 31, 1997, 92% of the principal balance of loans in the
servicing portfolio bore interest at fixed rates and 8% bore interest at
adjustable rates. The weighted average servicing fee of the portfolio was 0.34%
of the principal balance of serviced loans at December 31, 1997.
The following table presents the geographic distribution of Mortgage
Corp.'s residential servicing portfolio (excluding subserviced loans), as of the
dates indicated.
RESIDENTIAL SERVICING PORTFOLIO GEOGRAPHIC DISTRIBUTION
<TABLE>
<CAPTION>
PERCENTAGE OF PRINCIPAL
BALANCE SERVICED
------------------------
FISCAL YEAR(1)
------------------------
1997 1996
--------- ---------
<S> <C> <C>
California.................................................. 27.8% 29.5%
Texas....................................................... 17.3 40.3
Florida..................................................... 7.1 4.2
Washington.................................................. 6.7 2.4
Maryland.................................................... 5.2 3.4
Other states (none more than 5%)............................ 35.9 20.2
------ ------
Total residential servicing portfolio............. 100.0% 100.0%
====== ======
</TABLE>
- ---------------
(1) 1997 data is as of December 31; 1996 data is as of September 30, which was
the fiscal year end for Mortgage Corp. prior to the Harbor Merger.
59
<PAGE> 61
The following table presents, as a percentage of aggregate principal
balance, the delinquency statistics of Mortgage Corp.'s residential servicing
portfolio (excluding subserviced loans) as of the dates indicated.
RESIDENTIAL SERVICING PORTFOLIO DELINQUENCY STATISTICS
<TABLE>
<CAPTION>
FISCAL YEAR(1)
--------------
1997 1996
----- -----
<S> <C> <C>
Delinquencies at period end:
30 days................................................ 2.4% 2.1%
60 days................................................ 0.5 0.6
90 days or more........................................ 0.2 0.3
--- ---
Total delinquencies......................................... 3.1% 3.0%
=== ===
Foreclosures pending........................................ 0.7% 0.9%
=== ===
</TABLE>
- ---------------
(1) 1997 data is as of December 31; 1996 data is as of September 30, which was
the fiscal year end for Mortgage Corp. prior to the Harbor Merger.
The delinquency data included in the preceding table include the results of
three distressed servicing portfolios acquired by Mortgage Corp. At December 31,
1997, the distressed portfolios totaled approximately $172.3 million of
servicing, of which approximately 7.1% represented delinquent principal
balances. In addition, approximately 4.9% of the principal balance of these
distressed portfolios was in foreclosure at year end 1997.
Mortgage Corp. has increased its servicing portfolio by retaining the
servicing rights on the loans it originates and by acquiring servicing rights
from other mortgage banks. In particular, Mortgage Corp. has sought to acquire
servicing rights from other mortgage banks at a substantial discount to the
market value of currently originated servicing. Such servicing is available at
discounts because of high delinquency levels or other characteristics deemed
unattractive to other servicers seeking more traditional servicing portfolios.
Mortgage Corp. has been able to acquire these servicing portfolios at prices
that, in its view, are attractive compared to the market value of currently
originated servicing. Mortgage Corp. has devoted substantial attention to
improving the overall quality of these distressed servicing portfolios and, as a
result, has developed particular expertise in servicing loans evidencing some
level of distress.
To capitalize further on its distressed servicing expertise, Mortgage Corp.
has initiated a trial program whereby it will acquire delinquent FHA and VA
loans from other mortgage bankers' GNMA securitizations. Mortgage Corp. believes
that a financial and business incentive exists for some mortgage banks to sell
the targeted loans and, therefore, a significant amount of such loans are
available for sale. The GNMA seller-servicers are required to pass through to
the holder of the GNMA security the scheduled principal and interest payments on
all loans in the security pool, even though the borrower may not be making such
payments. The mortgage banker is, therefore, making corporate advances to the
security holder from its own funds. By removing the delinquent loans from the
securitization by a sale to Mortgage Corp., the selling mortgage banker is
relieved from further obligations to make such advances to the GNMA security
holder. Through December 31, 1997, Mortgage Corp. has acquired approximately $16
million of such loans.
Residential mortgage loans are serviced from facilities located in Houston,
Texas and Scottsbluff, Nebraska. The Scottsbluff center, a newly renovated
21,000 square foot facility, was acquired as part of Mortgage Corp.'s 1996
acquisition of Hamilton. This service center has advantageous lease terms and an
efficient cost structure as compared to metropolitan servicing centers. The
addition of Hamilton's servicing and subservicing portfolios almost doubled
Mortgage Corp.'s consolidated servicing portfolio.
In order to track information on its mortgage servicing portfolio, Mortgage
Corp. utilizes a data processing system provided by Alltel Information Systems,
Inc. ("Alltel"). Alltel is one of the largest mortgage banking service bureaus
in the United States. Management believes that this system gives Mortgage
60
<PAGE> 62
Corp. sufficient capacity to support the anticipated expansion of its
residential mortgage loan servicing portfolio. See "Risk Factors -- Reliance on
Systems; Year 2000 Issues."
Mortgage Conduit. The loans acquired by Capital Corp. to date are being
subserviced by Advanta Mortgage Corp. USA. Capital Corp. owns the servicing
rights to its loans as master servicer and intends to assign collection and
resolution responsibilities to a subsidiary of the Company as special servicer
when its loans reach certain stages of delinquency, thus placing the final
decisions as to collection management under the control of the Company. Having
acquired and managed consumer portfolios totaling in excess of $580 million in
Face Value in its Portfolio Asset acquisition and resolution business, the
Company believes that the servicing experience and skills it has gained are
valuable to support the unique collection and resolution needs of a Home Equity
Loan portfolio. Capital Corp. intends to ultimately replace Advanta Mortgage
Corp. USA with the combined capabilities of Mortgage Corp. and the Company to
service Capital Corp.'s portfolio of Home Equity Loans and the loans within its
securitized pools. The Company and Mortgage Corp. are in the process of seeking
the approval of the servicer rating agencies as a preliminary step in the
process of retaining the servicing of all new Home Equity Loans in-house.
Strategy
Direct Retail and Broker Retail. Mortgage Corp. intends to pursue the
following strategies in an effort to continue growth in earnings in all aspects
of its residential mortgage business:
- Maintain steady growth in earnings by increasing the size of Mortgage
Corp.'s servicing portfolio.
- Continue opportunistic geographic expansion.
- Increase the range of mortgage products offered.
- Expand the Direct Retail and Broker Retail origination channels.
- Acquire distressed servicing portfolios and delinquent FHA, FMHA and VA
loans from other seller-servicers' GNMA securitizations.
Mortgage Conduit. Capital Corp. intends to implement the following
strategies as it continues to develop and grow its mortgage conduit business:
- Capitalize on the existing Home Equity Loan origination network of
Mortgage Corp. to generate loans for securitization.
- Form strategic relationships with selected small originators of Home
Equity Loans by extending secured warehouse lines of credit or mezzanine
loans to, or making equity investments in, such entities.
- Capitalize on the distressed asset collection experience of Commercial
Corp. to address the collection and resolution challenges inherent in
Home Equity Loan servicing.
- Establish an internal servicing platform to service the Home Equity Loans
originated or acquired by Capital Corp.
61
<PAGE> 63
Commercial Mortgage Banking
Mortgage Corp.'s commercial mortgage banking business consists of
commercial loans secured by commercial real estate properties and single family
residential construction loans. The following table presents the number and
dollar amount of Mortgage Corp.'s commercial loan production for the periods
indicated.
COMMERCIAL MORTGAGE LOAN ORIGINATIONS
<TABLE>
<CAPTION>
FISCAL YEAR(1)
------------------------------
1997 1996 1995
-------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Correspondent Loans:
Volume of loans........................................ $348,060 $35,600 $53,405
Number of loans........................................ 86 3 9
Construction Loans:
Volume of loans........................................ $ 65,740 $28,780 --
Number of loans........................................ 466 263 --
Total Loans:
Volume of loans........................................ $413,800 $64,380 $53,405
======== ======= =======
Number of loans........................................ 552 266 9
======== ======= =======
</TABLE>
- ---------------
(1) 1997 data is for the 12 months ended December 31; data for all other years
is for the 12 months ended September 30, which was Mortgage Corp.'s fiscal
year end prior to the Harbor Merger.
Correspondent Loan Business
Through eight offices located in California, Texas and Colorado, Mortgage
Corp. originates commercial loans that are funded by third parties for which
Mortgage Corp. serves as the correspondent. The loans are secured by
multi-family residential projects, office buildings, shopping centers and other
income producing properties. Revenues derived from Mortgage Corp.'s commercial
lending business are principally origination fees based on a percentage of the
loan amount and, in certain instances, application fees assessed at the time a
loan application is processed by Mortgage Corp. During 1997, Mortgage Corp.
generated $2.7 million in origination fees from its commercial mortgage
origination business. Mortgage Corp.'s commercial lending offices are staffed by
20 loan officers and nine servicing personnel.
Mortgage Corp. originates commercial loans in accordance with the
underwriting guidelines of its investors. These investors include life insurance
companies, commercial mortgage conduits, real estate investment trusts, and
others. Commercial loans are funded by investors at closing. Mortgage Corp.
originated a substantial portion of its 1997 commercial production for a single
large insurance company. In addition, a substantial portion of its commercial
servicing portfolio consists of servicing for such company.
At December 31, 1997, Mortgage Corp. serviced a portfolio of commercial
loans for 36 investors totaling approximately $1.7 billion representing 543
loans (compared to approximately $129 million representing 93 loans at September
30, 1996). At December 31, 1997, the commercial servicing portfolio represented
loans in 23 states with California (65%), Texas (12%), Colorado (7%) and Arizona
(4%) representing the largest concentrations of the principal balance of loans
serviced. The significant increase in the commercial servicing portfolio as
compared to the prior year is the result of Mortgage Corp.'s acquisition of a
large commercial servicing portfolio in 1997.
Commercial loans are serviced in a servicing center located in Walnut
Creek, California. Mortgage Corp. owns the rights to service its correspondent's
loans, with termination rights by the correspondent on a 30-day notice basis.
Servicing fees for such loans range from five to eight basis points per annum of
the principal balance of the loans.
62
<PAGE> 64
Construction Loans
In 1995, Mortgage Corp. began originating for its own account and servicing
single-family residential construction loans through a construction loan
department headquartered in Houston, Texas. Mortgage Corp. serves customers in
nine states with construction loan products tailored to its builder and
individual customers. Mortgage Corp. extends construction lines of credit to
approximately 30 builders for the construction of custom and speculative homes.
Generally, builders are limited to no more than 50% of the committed line for
speculative homes. Total commitments outstanding at December 31, 1997 were
approximately $25 million with a maximum extended to any one builder of
approximately $2.5 million. During 1997, approximately 70% of total construction
loan volume was conducted with builder borrowers.
In addition to its builder customer base, Mortgage Corp. offers a
construction-to-permanent loan package to individual customers who are building
or remodeling their own home. Under this program, the customer has one
application and loan approval process to provide for both the interim
construction and permanent financing. During 1997, approximately 30% of total
construction loan volume was conducted with individual borrowers.
The underwriting and servicing of the construction loans is conducted in
Houston, Texas with the construction progress inspection support provided by the
branch office personnel or outside vendors specializing in property inspections
for construction lenders. Construction loans are extended for up to 90% of the
cost of construction for a period of up to nine months with one three month
renewal option on the part of the builder. If the loan remains unpaid after the
first renewal, amortization of at least 10% of the principal balance is required
for any further renewals. Substantially all construction loans bear interest at
variable rates of interest at margins over a base lending rate.
Mortgage Corp. solicits construction loan builder and individual customers
through its major Direct Retail offices and, as a result, conducts most of its
business in Texas (72% in 1997), Maryland (8% in 1997), Virginia (5% in 1997)
and Tennessee (5% in 1997).
Strategy
In its commercial mortgage banking business, Mortgage Corp. intends to
continue to serve its correspondent clients by sourcing opportunities through
its retail offices and its home builder clients. It is the Company's intention
to explore and develop cross-selling opportunities between the commercial
mortgage capability of Mortgage Corp. and the commercial lending business of
Commercial Corp.
In its construction lending business, Mortgage Corp. intends to expand its
customer base by continuing to emphasize the construction-to-permanent loan
product. To that end, a regional construction loan product specialist resides in
the mid-Atlantic regional retail office to introduce the construction loan
product to borrowers in the region. The balance of Mortgage Corp.'s expansion
efforts in the construction lending business are focused on providing a larger
volume of construction loan products to Mortgage Corp.'s existing builder
customers.
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
The Company engages in the Portfolio Asset acquisition and resolution
business and is beginning to originate commercial loans through its wholly owned
subsidiary, Commercial Corp. and its subsidiaries. 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. A portfolio is 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 not changed regardless of the performance of the assets
comprising the Portfolio. Portfolios are
63
<PAGE> 65
either acquired for Commercial Corp.'s own account or through Acquisition
Partnerships. See "-- Portfolio Asset Acquisition and Resolution
Business -- Relationship with Cargill Financial." To date, Commercial Corp. and
the Acquisition Partnerships have acquired over $3.0 billion in Face Value of
assets.
The Company's development of a niche commercial lending business is a
logical extension of its extensive experience with the resolution of distressed
assets. In many cases, the resolution of such assets involves the modification
of an existing debt into a new or modified extension of credit more suited to
the borrower's needs, ability to pay and value of the underlying collateral. The
Company intends to use such experience as the foundation upon which Commercial
Corp. will seek niche commercial lending opportunities.
Portfolio Asset Acquisition and Resolution Business
Background
In the early 1990s large quantities of nonperforming assets were available
for acquisition from the RTC and the FDIC. Since 1993, most sellers of
nonperforming assets have been private sellers, rather than government agencies.
These private sellers include financial institutions and other institutional
lenders, both in the United States and in various foreign countries, and, to a
lesser extent, insurance companies in the United States. As a result of mergers,
acquisitions and corporate downsizing efforts, other business entities
frequently access the market served by the Company 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
assets.
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 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. 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. have 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 (iii) foreclosure of the loan and
sale of the collateral securing the loan. Commercial Corp. generally retains
Portfolio Assets that are designated as performing for the life of the loans
comprising the Portfolio.
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. The
main factors determining Commercial Corp.'s willingness to acquire Portfolio
Assets include the information that is available regarding the assets in a
portfolio, the price at which such 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 and
France. Commercial Corp. believes that its willingness to acquire nonhomogeneous
Portfolio Assets without regard to geographical location provides it with an
advantage over certain competitors that limit their activities to either a
specific asset type or geographical location. Although Commercial Corp. imposes
no constraints on geographic
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locations of Portfolio Assets, the majority of assets acquired to date have been
in the Northeastern and Southern areas of the United States.
Commercial Corp. also seeks to capitalize on emerging opportunities in
foreign markets where 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, 1997, Commercial Corp. has acquired,
with Cargill Financial and a local French partner, three Portfolios in France,
consisting of approximately 6,500 assets, for an aggregate purchase price of
approximately $142 million. Such assets had a Face Value of approximately $513
million. Commercial Corp.'s share of the equity interest in the Portfolios
acquired in France ranges from 10% to 33 1/3% and Commercial Corp. has made a
total equity investment therein of approximately $10 million. The underlying
assets and debt are denominated in French francs and Commercial Corp.'s equity
investments are funded with a French franc line of credit, thereby mitigating
against foreign currency translation risks. Commercial Corp. does not otherwise
attempt to hedge any profits that might be derived from its equity investments.
Commercial Corp. has an established presence in Paris, France and is actively
pursuing opportunities to purchase additional pools of distressed assets in
France and other areas of Western Europe. In addition, Commercial Corp. has
established an office in Mexico City, Mexico to explore asset acquisition
opportunities in Mexico.
The following table presents, for each of the years in the three-year
period ended December 31, 1997, selected data for the Portfolio Assets acquired
by Commercial Corp.
PORTFOLIO ASSETS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Face Value......................................... $504,891 $413,844 $699,662
Total purchase price............................... 183,229 205,524 213,187
Total equity invested.............................. 54,764 92,937 26,534
Commercial Corp. equity invested................... $ 37,109 $ 35,973 $ 24,603
Total number of Portfolio Assets................... 5,503 5,921 19,031
</TABLE>
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
Financial 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. has identified and seeks to continue to identify foreign
partners that have contacts within each foreign market and can bring Portfolio
Asset opportunities to Commercial Corp. Commercial Corp. expects that it will
only pursue acquisitions in foreign markets in conjunction with a local foreign
partner. Commercial Corp. has in the past pursued, and expects in the
foreseeable future to pursue, foreign acquisition opportunities in markets where
Cargill Financial has a presence.
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 an individual asset generally includes analyzing the credit and
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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 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.
Servicing
After a Portfolio is acquired, Commercial Corp. assigns it to an account
servicing officer who is independent of the officer 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, a physical
inspection of each asset or the collateral underlying the related loan, 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.
To date, the net present value of Commercial Corp.'s cash flows from
serviced assets has exceeded initial projections. Because of this success,
Commercial Corp. has been able to structure securitization and structured
financing transactions based upon cash flow projections expected to be derived
from Portfolio Assets. 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. 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 related third parties. In
connection with the Acquisition Partnerships, Commercial Corp. earns a servicing
fee of between 3% and 8% of gross cash collections generated in the Acquisition
Partnerships rather than a periodic management fee based on the Face Value of
the asset being serviced. The rate of servicing fee charged is 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).
Structure and Financing of Portfolio Asset Purchases
Portfolio Assets are acquired for the account of a subsidiary of Commercial
Corp. and through the Acquisition Partnerships. Portfolio Assets owned directly
by a subsidiary of Commercial Corp. are financed with cash contributed by
Commercial Corp. and secured senior debt that is recourse only to such
subsidiary.
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Each Acquisition Partnership is a separate legal entity, generally formed
as a limited partnership. 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% limited partnership interest in the Acquisition
Partnership (the general partner owns the other 2% interest). Cargill Financial
or its affiliates are the investor in the vast majority of the Acquisition
Partnerships currently in existence. See "-- Relationship with Cargill
Financial." Certain institutional investors have also held limited partnership
interests in the Acquisition Partnerships and may hold interests in the related
corporate general partners. Acquisition Partnerships may also be formed as a
trust, corporation or other type of entity.
The Acquisition Partnerships generally are 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 such 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. Prior to the Merger, a significant portion of the
funding for each Acquisition Partnership was provided in the form of
subordinated debt provided by Cargill Financial. Because the Merger increased
the capital available to Commercial Corp., the need for subordinated debt has
been substantially eliminated, enabling Commercial Corp. to commit a larger
portion of its own funds to the Acquisition Partnerships. In addition, the
Merger has enhanced Commercial Corp.'s capacity to invest in Portfolios without
the participation of an investment partner.
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
Nomura, Cargill Financial and others. 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 generally 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 effect 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
partnership to the equity partners so long as the partnership is in compliance
with applicable financial covenants.
Relationship with Cargill Financial
Cargill Financial, 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 Financial and its affiliates provide significant debt and equity
financing to the Acquisition Partnerships. In addition, Commercial Corp.
believes its relationship with Cargill Financial significantly enhances
Commercial Corp.'s credibility as a purchaser of Portfolio Assets and
facilitates its ability to expand into other businesses and foreign markets.
Under a Right of First Refusal Agreement and Due Diligence Reimbursement
Agreement effective as of January 1, 1998 (the "Right of First Refusal
Agreement") among the Company, FirstCity Servicing Corporation, Cargill
Financial 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 domestic loans, receivables, real estate or other assets in
which the aggregate amount to be bid exceeds $4 million, the Company is required
to follow a prescribed 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 Financial (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
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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 an amendment and extension of a similar
agreement entered into among the Company, certain members of the Company's
management and Cargill Financial in 1992. The Right of First Refusal Agreement
terminates on January 1, 2000.
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:
- 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, (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 and (iii) the purchase of charged-off credit card
receivables.
- Emphasis on smaller Portfolios. Generally, Commercial Corp. seeks
purchases of Portfolio Assets with a purchase price of less than $100
million in order to avoid large portfolio offerings that attract larger
institutional purchasers and hedge funds, which have lower threshold
return requirements and lower funding costs than Commercial Corp.
- 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 and
expects to continue to seek purchase opportunities outside of the United
States.
Commercial Lending Opportunities
Commercial Corp.'s extensive experience in the asset acquisition and
resolution business has led to numerous opportunities to originate commercial
loans. In most cases, the prospective borrower was unwilling or unable to meet a
traditional lenders' requirements or found that a traditional lender could not
or would not be responsive within a short time frame. In some cases, the
prospective borrower was already aware of Commercial Corp.'s familiarity and
comfort with a particular type of collateral, such as lodging properties, small
commercial real estate developments, franchisee properties or small multi-family
projects. In Commercial Corp.'s view, its extensive experience in servicing
difficult distressed asset credits qualifies it to originate, and service,
commercial loans. To that end, Commercial Corp. is currently evaluating the
possibility of making debtor-in-possession loans to borrowers in bankruptcy
reorganization proceedings, mezzanine loans or venture capital investments in
emerging growth company situations and commercial loans meeting the underwriting
and other standards of qualification for a Small Business Administration
guarantee. Commercial Corp. is also analyzing the special funding needs of
borrowers who are franchisees, and is considering the factoring of receivables.
Commercial Corp. expects that it will analyze other commercial lending
opportunities as they arise. In some cases, the opportunity might be a unique
and defined lending opportunity. In others, an attractive opportunity would be
characterized by a flow of lending opportunities, such as in the factoring
business. Commercial Corp. will also entertain the opportunity to joint venture
with businesses already in the targeted business activity but which need
additional capital or funding and the servicing expertise of Commercial Corp.
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CONSUMER LENDING
The Company conducts all of its consumer receivable origination activities
through Consumer Corp. and its subsidiaries. Consumer Corp.'s current focus is
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. The significant majority of Consumer Corp.'s current business is
focused on the sub-prime automobile sector, with each loan funded after
individual underwriting and pricing of each proposed extension of credit.
Market Background
The sub-prime automobile finance business has been characterized by several
factors that the Company believes increase its likelihood of being able to build
a successful sub-prime automobile finance business. Within the past several
years, significant amounts of new capital have become available, thereby
allowing a large number of new market participants to originate loans to
sub-prime automobile borrowers. This increase in competition led to reduced
credit underwriting standards and lower dealer discounts as lenders sought to
maintain earnings by increasing loan origination levels. In the Company's view,
too little attention was paid to both the importance of matching the discount to
the expected loss per occurrence and the special effort required to service a
sub-prime automobile loan. Because of many notable failures, especially among
mono-line automobile finance businesses, the Company believes that the
opportunity now exists to increase market share by providing a fully
underwritten loan product that utilizes risk-adjusted pricing to franchised
automobile dealerships that seek a steady source of funding supported by
meaningful and responsive service.
Consumer Corp. Background
Through its Portfolio Asset acquisition and resolution business, the
Company has acquired approximately $580 million in Face Value of distressed
consumer loans. In addition, through its wholly owned subsidiary, FirstCity
Servicing Corporation of California ("Consumer Servicing") the Company has
extensive experience in the servicing of distressed sub-prime automobile loans.
The Company's initial venture into the sub-prime automobile market involved
the acquisition of a distressed sub-prime automobile loan portfolio from a
secured lender. In addition to acquiring the distressed loans, the Company
acquired the equity of the company that operated the program through which the
loans had been originated. This program involved the indirect acquisition of
automobile loans from financial intermediaries that had direct contact with
automobile dealerships. The Company was required to purchase loans that
satisfied minimum contractual underwriting standards and was not permitted to
negotiate purchase discounts for a loan based on the individual risk profile of
the loan and the borrower. After operating this program for approximately 15
months, the Company concluded that the contractual underwriting standards and
purchase discounts on which the program was based were insufficient to generate
sub-prime automobile loans of acceptable quality to the Company. As a result,
the Company terminated its obligations with the financial institutions
participating in such origination program effective as of January 31, 1998.
With the benefit of the experience gained by the Company through its
initial attempt at originating acceptable sub-prime automobile loans, the
Company began, in early 1997, to explore other business models that it felt
would be successful in the current market environment. This investigation and
research resulted in the formation, during the third quarter of 1997, of Funding
Corp., 80% of which is owned by the Company and 20% of which is owned by Funding
Corp.'s management team. Funding Corp.'s management team is experienced in the
automobile finance business, with significant prior experience in the sales and
finance activities of franchised dealerships. Funding Corp.'s business model is
predicated upon the acquisition of newly originated sub-prime automobile finance
contracts at a price that is adjusted to reflect the expected loss per
occurrence on defaulted contracts. The approach emphasizes service to the
dealership and a steady source of funding for contracts that meet Funding
Corp.'s underwriting and pricing criteria. In addition, all loans are serviced
by Consumer Servicing, which is dedicated exclusively to the servicing of
consumer loans originated or acquired by Consumer Corp.
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Consumer Corp. and the management shareholders of Funding Corp. entered
into a shareholders' agreement in connection with the formation of Funding Corp.
in September 1997. Commencing on the fifth anniversary of such agreement,
Consumer Corp. and the management shareholders have put and call options with
respect to the stock of Funding Corp. held by the other party, which will be
priced at a mutually agreed upon fair market value.
Product Description
Consumer Corp. currently acquires and originates loans, secured by
automobiles, to borrowers who have had past credit problems or have little or no
credit experience. Such loans are individually underwritten to Consumer Corp.'s
underwriting and credit guidelines. See "-- Loan Acquisition and Underwriting."
The collateral for the loan generally is a used automobile purchased from a
franchised automobile dealership. The loans generally have a term of no more
than 60 months and generally accrue interest at the maximum rate allowed by
applicable state law.
Origination Channels
Through a sales staff managed by professionals with an extensive automobile
dealership background, Funding Corp. markets its loan products and dealership
services directly to participating franchised automobile dealerships. Funding
Corp. currently maintains approximately 250 automobile dealership relationships
in Texas, Missouri and Oklahoma. Near term plans call for expansion into other
states as staffing levels, licensing and training permit. Funding Corp. is
targeting expansion into states that offer attractive opportunities due to
population growth, attractive consumer lending rate environments and
lender-friendly repossession and collection remedies with respect to defaulting
borrowers.
The dealership servicing and marketing staff of Funding Corp. consists of
eight marketing representatives who work with dealers that submit funding
applications to Funding Corp. These marketing representatives call upon new
dealership prospects within the current marketing territories and work with
existing dealerships to solicit additional loan acquisition opportunities. All
of the marketing staff are full time employees of Funding Corp. and have
completed an extensive training program. In addition to the initial training,
weekly updates with the marketing representatives and monthly meetings for the
entire staff are held to maintain current knowledge of the dealership programs
and product offerings.
Participating dealerships submit funding applications for each prospective
loan to Funding Corp.'s home office in Dallas, Texas. Applications are reviewed
and checked for completeness and all complete applications are forwarded to a
credit analyst for review. Within two hours after receipt of an application, a
representative of Funding Corp. will notify the dealership of the terms on which
it would acquire the loan, subject to confirmation of the application data. See
"-- Loan Acquisition and Underwriting."
In addition to Funding Corp.'s operations, FirstCity Consumer Finance
Corporation ("Consumer Finance"), a wholly owned subsidiary of Consumer Corp.,
originates loans with borrowers who have established payment records on recently
originated automobile receivables through direct marketing to the consumer.
Through contractual relationships with third parties, Consumer Finance
identifies loan prospects for underwriting, documentation and funding upon final
approval of a request for credit. The activities of Consumer Finance are not
significant to date, with 20 loans having an aggregate principal balance of
approximately $200,000 outstanding at December 31, 1997.
Loan Acquisition and Underwriting
Funding Corp. acquires sub-prime automobile loans originated by franchised
dealerships under a tiered pricing system. Under its pricing and underwriting
guidelines, each loan is purchased in an individually negotiated transaction
from the selling dealership only after it has been fully underwritten and
independently verified by Funding Corp. A staff of 22 credit and compliance
personnel in Funding Corp.'s home office completes the underwriting and due
diligence for each funding application. During the compliance phase of the
underwriting review, Funding Corp. verifies all pertinent information on a
borrower's credit application, including verification of landlord information
for borrowers without a mortgage. As an additional check on the
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quality of the prospective loan, each borrower is personally contacted by
Funding Corp. prior to the acquisition of the loan. At such time, all of the
details of the proposed transaction are confirmed with the borrower, including
the borrower's level of satisfaction with the purchased vehicle.
Each transaction is individually priced to achieve a risk-adjusted target
purchase price, which is expressed as a percentage of the par value of the loan.
The tiered pricing structure of Funding Corp. is designed as a guideline for
establishing minimum underwriting and pricing standards for the loans to be
acquired. The minimum amount of the discount from par for the four tiers ranges
from no discount for tier 1 loans to a 10% discount for tier 4 loans. Funding
Corp.'s underwriting standards do not permit the purchase of a loan for more
than its par value. Other factors impacting the tier level of a loan include,
but are not limited to, prior credit history, repossession and bankruptcy
history, open credit account status, income minimums, down payment requirements,
payment ratio tests and the contract advance amount as a percentage of the
wholesale value of the collateral vehicle. The purpose of the tiered
underwriting and pricing structure is to acquire loans that are priced in
accordance with risk characteristics and the underlying value of the collateral.
The process is designed to approve loan applications for borrowers who are
likely to pay as agreed, and to minimize the risk of loss on the disposition of
the underlying collateral in the event that a default occurs.
Funding Corp. seeks to acquire loans that have the following
characteristics:
- Loans originated by a new automobile franchised dealership
- Loans secured by automobiles that have established resale values and a
targeted age of approximately two years
- The borrower has made a substantial down payment on the automobile, which
evidences a significant equity commitment
- The loan is underwritten to provide a debt to income ratio permitting the
borrower to comfortably afford the monthly payments
- The borrower evidences a tendency toward repairing impaired credit
- Funding Corp.'s purchase price of the contract from the dealership is
less than the published wholesale value of the automobile
From its inception in September 1997 through December 31, 1997, Funding
Corp. acquired a total of 502 automobile loans representing an aggregate of
approximately $7.1 million in Face Value. The loans had a weighted average
coupon rate of 19.1%. The average Face Value of the loans acquired was $14,209,
which on average represented approximately 104.3% of the published wholesale
value of the financed automobile. Funding Corp. acquired the loans from
dealerships at an average discount of approximately 11.4% from their Face Value.
As a result, the average amount advanced by Funding Corp. for a particular loan
was equal to approximately 92.4% of the published wholesale value of the
financed automobile.
From its inception through February 28, 1998, Funding Corp. acquired a
total of 1,242 automobile loans representing an aggregate of approximately $16.6
million in Face Value. The characteristics of the loans acquired continue to
evidence characteristics similar to the loans acquired prior to December 31,
1997. Through February 28, 1998, the average Face Value of the loans acquired
was approximately 102.0% of the published wholesale value of the financed
automobile, the loans carried a weighted average coupon rate of 19.4% and were
purchased at a discount averaging 12.3% of their face value. As a result, the
average amount advanced by Funding Corp. for a particular loan was equal to
approximately 89.5% of the published wholesale value of the financed automobile.
The average downpayment on the automobile by the borrower was, as a percentage
of purchase price, approximately 21%. The monthly production during February
1998 exceeded $6 million.
The average automobile financed by Funding Corp. through February 28, 1998
was two years old with approximately 32,000 miles. The average contractual
repayment term for the loans acquired by Funding Corp. was 53 months. The ratio
of the borrower's monthly debt service amount to the borrower's monthly gross
income was, on average, equal to 11.9%.
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Through February 28, 1998, of the 1,242 loans originated by Funding Corp.,
three loans have defaulted resulting in the repossession and sale of the
underlying collateral. The sale of collateral produced net proceeds equal to
approximately 85% of the balance of the loan at the date of default (98% of the
unrecovered purchase price of the loan by Funding Corp. after considering the
discount at which the loans were purchased). At February 28, 1998, there were no
loans more than 60 days past due in the Portfolio. Given the relatively short
period over which Funding Corp. has been operating its automobile finance
program, the foregoing default data is not indicative of the expected future
performance of loans acquired through the program.
Financing Strategy
Funding Corp. finances its operations with a warehouse credit facility
provided by ContiTrade, in connection with which ContiFinancial Services
Corporation, an affiliate of ContiTrade, has the right to provide advisory and
placement services to Funding Corp. for the securitization of acquired loans.
Funding Corp. plans to provide permanent financing for its acquired consumer
loans through securitizations of pools of loans totaling between $40 and $50
million.
The securitization transactions are expected to be consummated through the
creation of special purpose trusts. The loans will be transferred to a trust in
exchange for certificates representing the senior interest in the securitized
loans held by the trust and, if applicable, a subordinated interest in the
securitized loans. The subordinated interests generally consist of the excess
spread between the interest and principal paid by the borrowers on the loans
pooled in the securitization and the interest and principal of the senior
interests issued in the securitization, and other unrated interests issued in
the securitization. The senior interests are subsequently sold to investors for
cash. Consumer Corp. may elect to retain the subordinated interests or may sell
all or some portion of the subordinated interests to investors for cash.
Consumer Corp. anticipates that it will retain the rights to the excess spreads.
Upon the sale of loans in securitization transactions, the sum of the cash
proceeds received and the estimated present values of the subordinated interests
less the costs of origination and securitization and the basis in the loans sold
results in the gain recognized at the time of the securitization transaction.
The present values of the subordinated interests to be recognized by Consumer
Corp. are to be determined based upon prepayment, loss and discount rate
assumptions that will be determined in accordance with the unique underlying
characteristics of the loans comprising each securitization.
Servicing
Consumer Servicing, an indirect wholly owned subsidiary of the Company, is
responsible for the loan accounting, collection, payment processing, skip
tracing and recovery activities associated with the Company's consumer lending
activities. Consumer Servicing has extensive experience in servicing automobile
loans and the Company believes that Consumer Servicing is a critical element to
the Company's ultimate success in the consumer loan business. Consumer
Servicing's activities are closely integrated with the activities of Consumer
Corp. This enables Consumer Servicing to take advantage of the information
regarding the quality of originated credit that is available from a servicer in
order to assist in the evaluation and modification of product design and
underwriting criteria.
The staffing of Consumer Servicing consists of 61 personnel, including 34
assigned to customer service and collections and 10 assigned to the special
recovery activities associated with assignments for repossession through the
liquidation of the collateral (in addition to two individuals at Funding Corp.
who work in asset liquidation). This group also coordinates any contract
reinstatements, notices of intent to dispose of collateral and recovery of any
insurance, warranty or other premium payments subject to recovery in the event
of cancellation. An additional staff of seven personnel is dedicated to asset
recovery, which includes tracing of individuals who cannot be located, seeking
to collect on deficiencies, managing the storage of repossessed vehicles prior
to their disposition and physical damage claims on collateral vehicles. An
administrative staff handles the special issues associated with borrowers in
bankruptcy and the more complicated issues associated with contracts involved in
other legal disputes.
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<PAGE> 74
The servicing practices associated with sub-prime loans are extensive. For
example, Consumer Servicing personnel contact each borrower three days prior to
the payment due date during each of the first three months of the contract. This
process assists in avoiding first payment defaults and confirms that the
customer can be located. If a borrower is delinquent in payment, an attempt to
contact the borrower is made on the first day of delinquency. Continual contact
is attempted until the borrower is located and payment is made, or a commitment
is made to bring the contract current. If the borrower cannot be contacted, the
account may be assigned to Consumer Servicing's asset recovery staff.
If the borrower does not meet a payment commitment and has not indicated a
verifiable and reasonable intention to bring the loan current, the account is
assigned to outside agents for repossession at the thirty-third day of
delinquency. At such time, the borrower has missed two payments and has not
indicated a willingness to enter into a repayment plan. After the collateral is
repossessed, the borrower has a limited opportunity to reinstate the obligation
under applicable state law by bringing the payment current and reimbursing
Consumer Servicing for its repossession expenses. If the loan is not reinstated
within the reinstatement period, the collateral is sold by the asset liquidation
group. Funding Corp. disposes of repossessed automobiles at auction after a
thorough inspection and detailing. A representative of Funding Corp. generally
will attend the auction to represent Funding Corp. and ensure that the
automobile is properly represented by the auction firm.
Strategy
The Company continues to evaluate a number of business opportunities in the
consumer sector, which have the capability of generating or acquiring consumer
loans that represent identifiable and predictable credit quality and whose
return thresholds match or exceed those targeted by the Company. These include
secured consumer loan products and certain aspects of direct and indirect
unsecured consumer lending. Through contacts with investment banks, business
brokers and others in the consumer lending field, the Company seeks acquisition
or merger candidates or qualified management teams with which to associate in
start-up ventures. As with other aspects of its business, the Company seeks to
be opportunistic in targeting additional consumer lending opportunities.
GOVERNMENT REGULATION
Many 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, the Company's loan originations, credit activities, maximum interest
rates, finance and other charges, disclosures to customers, 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.
Mortgage Banking. The Company's mortgage banking business is subject to
extensive and complex rules and regulations of, and examinations by, various
federal, state and local government authorities. These rules and regulations
impose obligations and restrictions on loan originations, credit activities and
secured transactions. In addition, these rules limit the interest rates, finance
charges and other fees that Mortgage Corp. and Capital Corp. may assess, mandate
extensive disclosure to their customers, prohibit discrimination and impose
multiple qualification and licensing obligations. Failure to comply with these
requirements may result in, among other things, demands for indemnification or
mortgage loan repurchases, certain rights of rescission for mortgage loans,
class action lawsuits, administrative enforcement actions and civil and criminal
liability. The Company believes that its mortgage banking business is in
compliance with these rules and regulations in all material respects.
Loan origination activities are subject to the laws and regulations in each
of the states in which those activities are conducted. For example, state usury
laws limit the interest rates that can be charged on loans. Lending activities
are also subject to various federal laws, including those described below.
Mortgage Corp. and Capital Corp. are subject to certain disclosure requirements
under the Federal Truth-In-Lending Act ("TILA") and the Federal Reserve Board's
Regulation Z promulgated thereunder. TILA is designed to provide consumers with
uniform, understandable information with respect to the terms and conditions of
loan
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and credit transactions. TILA also guarantees consumers a three day right to
cancel certain credit transactions, including loans of the type originated by
Mortgage Corp. and Capital Corp. Such three day right to rescind may remain
unexpired for up to three years if the lender fails to provide the requisite
disclosures to the consumer.
Mortgage Corp. and Capital Corp. are also subject to the High Cost Mortgage
Act ("HCMA"), which amends TILA. The HCMA generally applies to consumer credit
transactions secured by the consumer's principal residence, other than
residential mortgage transactions, reverse mortgage transactions or transactions
under an open-end credit plan, in which the loan has either (i) total points and
fees upon origination in excess of the greater of eight percent of the loan
amount or $400 or (ii) an annual percentage rate of more than ten percentage
points higher than United States Treasury securities of comparable maturity
("Covered Loans"). The HCMA imposes additional disclosure requirements on
lenders originating Covered Loans. In addition, it prohibits lenders from, among
other things, (i) originating Covered Loans that are underwritten solely on the
basis of the borrower's home equity without regard to the borrower's ability to
repay the loan and (ii) including prepayment fee clauses in Covered Loans to
borrowers with a debt-to-income ratio in excess of 50% or Covered Loans used to
refinance existing loans originated by the same lender. The HCMA also restricts,
among other things, certain balloon payments and negative amortization features.
Mortgage Corp. and Capital Corp. are also required to comply with the Equal
Credit Opportunity Act ("ECOA") and the Federal Reserve Board's Regulation B
promulgated thereunder, the Fair Credit Reporting Act ("FCRA"), the Real Estate
Settlement Procedures Act of 1974 ("RESPA"), the Home Mortgage Disclosure Act
("HMDA") and the Federal Fair Debt Collection Procedures Act. Regulation B
restricts creditors from requesting certain types of information from loan
applicants. FCRA requires lenders, among other things, to supply an applicant
with certain disclosures concerning settlement fees and charges and mortgage
servicing transfer practices. It also prohibits the payment or receipt of
kickbacks or referral fees in connection with the performance of settlement
services. In addition, beginning with loans originated in 1994, an annual report
must be filed with the Department of Housing and Urban Development pursuant to
HMDA, which requires the collection and reporting of statistical data concerning
loan transactions.
Regulation of Sub-prime Automobile Lending. Consumer Corp.'s automobile
lending activities are subject to various federal and state consumer protection
laws, including TILA, ECOA, FCRA, the Federal Fair Debt Collection Practices
Act, the Federal Trade Commission Act, the Federal Reserve Board's Regulations B
and Z, and state motor vehicle retail installment sales acts and other similar
laws that regulate the origination and collection of consumer receivables and
impact Consumer Corp.'s business. These laws, among other things, (i) require
Consumer Corp. to obtain and maintain certain licenses and qualifications, (ii)
limit the finance charges, fees and other charges on the contracts purchased,
(iii) require Consumer Corp. to provide specific disclosures to consumers, (iv)
limit the terms of the contracts, (v) regulate the credit application and
evaluation process, (vi) regulate certain servicing and collection practices,
and (vii) regulate the repossession and sale of collateral. These laws impose
specific statutory liabilities upon creditors who fail to comply with their
provisions and may give rise to defenses to the payment of the consumer's
obligation. In addition, certain of the laws make the assignee of a consumer
installment contract liable for the violations of the assignor.
Each dealer agreement contains representations and warranties by the dealer
that, as of the date of assignment, the dealer has complied with all applicable
laws and regulations with respect to each contract. The dealer is obligated to
indemnify Consumer Corp. for any breach of any of the representations and
warranties and to repurchase any non-conforming contracts. Consumer Corp.
generally verifies dealer compliance with usury laws, but does not audit a
dealer's full compliance with applicable laws. There can be no assurance that
Consumer Corp. will detect all dealer violations or that individual dealers will
have the financial ability and resources either to repurchase contracts or
indemnify Consumer Corp. against losses. Accordingly, failure by dealers to
comply with applicable laws, or with their representations and warranties under
the dealer agreement, could have a material adverse effect on Consumer Corp.
If a borrower defaults on a contract, Consumer Corp., as the servicer of
the contract, is entitled to exercise the remedies of a secured party under the
Uniform Commercial Code (the "UCC"), which typically
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<PAGE> 76
includes the right to repossession by self-help unless such means would
constitute a breach of peace. The UCC and other state laws regulate repossession
and sales of collateral by requiring reasonable notice to the borrower of the
date, time and place of any public sale of collateral, the date after which any
private sale of the collateral may be held and the borrower's right to redeem
the financed vehicle prior to any such sale, and by providing that any such sale
must be conducted in a commercially reasonable manner.
COMPETITION
All of the business lines in which the Company operates are highly
competitive. Some of the Company's principal competitors in certain of its
businesses are substantially larger and better capitalized than the Company.
Because of these resources, these companies may be better able than the Company
to obtain new customers for mortgage or other loan production, to acquire
Portfolio Assets, to pursue new business opportunities or to survive periods of
industry consolidation.
The Company encounters significant competition in its mortgage banking
business. Mortgage Corp. competes with other mortgage banking companies,
mortgage and servicing brokers, commercial banks, savings associations, credit
unions, other financial institutions and various other lenders. A number of
these competitors have substantially greater financial resources and greater
operating efficiencies. Customers distinguish between product and service
providers in the industries in which Mortgage Corp. operates for various
reasons, including convenience in obtaining the product or service, overall
customer service, marketing and distribution channels and pricing (primarily in
the form of prevailing interest rates). Competition for Mortgage Corp. is
particularly affected by fluctuations in interest rates. During periods of
rising interest rates, competitors of Mortgage Corp. who have locked into lower
borrowing costs may have a competitive advantage. During periods of declining
rates, competitors may solicit Mortgage Corp.'s customers to refinance their
loans.
The Company believes that it is one of the largest, independent,
full-service companies in the distressed asset business. There are, however, no
published rankings available, because many of the transactions that would be
used for ranking purposes are with private parties. Generally, there are three
aspects of the distressed asset business: due diligence, principal activities,
and servicing. The Company is a major participant in all three areas, whereas
certain of its competitors (including certain securities and banking firms) have
historically competed primarily as portfolio purchasers, as they 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.
The Company believes that its ability to acquire Portfolios for its own
account and through Acquisition Partnerships will be an important aspect 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).
The sub-prime automobile finance market is highly fragmented and very
competitive. There are numerous financial services companies serving, or capable
of serving, this market, including traditional financial institutions such as
banks, savings and loans, credit unions, and captive finance companies owned by
automobile manufacturers, and other non-traditional consumer finance companies,
many of which have significantly greater financial and other resources than the
Company.
The Company also encounters significant competition in its other
businesses. Within the Home Equity Loan securitization businesses, 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 for customers.
PROPERTIES
As of December 31, 1997, the Company maintained 92 offices in the United
States, including 29 offices in Texas, 12 offices in California, 7 offices in
Maryland, 5 offices in each of Florida, Illinois, Virginia and
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Washington, 3 offices in Colorado, 2 offices in each of Arizona, Oregon,
Pennsylvania and West Virginia, 1 office in each of Delaware, Georgia, Hawaii,
Indiana, Massachusetts, Michigan, Missouri, Nevada, New York, Oklahoma, Ohio,
Tennessee, Utah, and a presence in Paris, France and Mexico City, Mexico. The
Company leases all its offices. The Company leases its current headquarters
building in Waco, Texas from a related party under a noncancellable operating
lease, which expires December 2001.
LEGAL PROCEEDINGS
Periodically, the Company and its subsidiaries and affiliates are parties
to or otherwise involved in legal proceedings arising in the normal course of
business, such as claims to enforce liens, claims involved in servicing real
property loans and other issues incident to the Company's business. The Company
does not believe that there is any proceeding threatened or pending against it
or its subsidiaries or affiliates which, if determined adversely, would have a
material adverse effect on the financial position, results of operations and
business prospects of the Company.
EMPLOYEES
The Company had 1,186 employees as of December 31, 1997. 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.
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth certain information concerning the directors
and executive officers, and certain key employees, of the Company as of March 1,
1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Directors and Executive Officers
James R. Hawkins.................. 62 Chairman of the Board and Chief Executive Officer
C. Ivan Wilson.................... 70 Vice Chairman of the Board
James T. Sartain.................. 49 President, Chief Operating Officer and Director
Rick R. Hagelstein................ 51 Executive Vice President, Director of Subsidiary
Operations and Director
Matt A. Landry, Jr. .............. 55 Executive Vice President, Chief Administrative Officer and
Director
Richard J. Gillen................. 57 Managing Director of Mortgage Finance and Director
Richard E. Bean................... 54 Director
Bart A. Brown, Jr. ............... 66 Director
Donald J. Douglass................ 66 Director
David W. MacLennan................ 38 Director
Thomas E. Smith................... 40 Director
Terry R. DeWitt................... 40 Senior Vice President
G. Stephen Fillip................. 46 Senior Vice President and Chief Credit Officer
Joe S. Greak...................... 49 Senior Vice President, Tax Director and Secretary
Ronald E. Hames................... 50 Senior Vice President, Information Technology
James C. Holmes................... 41 Senior Vice President and Treasurer
Kathy McNair...................... 48 Senior Vice President, Credit Administration
Gary H. Miller.................... 38 Senior Vice President and Chief Financial Officer
Jim W. Moore...................... 47 Senior Vice President and Manager of Subsidiary Activities
Richard J. Vander Woude........... 43 Senior Vice President and General Counsel
Other Key Employees
James H. Aronoff.................. 41 Chairman of the Board and Chief Executive Officer of
Capital Corp.
Thomas R. Brower.................. 39 President of Funding Corp.
Scot A. Foith..................... 31 Executive Vice President and Director of Operations of
Funding Corp.
Christopher J. Morrissey.......... 44 President and Chief Operating Officer of Capital Corp.
</TABLE>
JAMES R. HAWKINS has been Chairman of the Board and Chief Executive Officer
of the Company since the Merger, and was Chairman of the Board and Chief
Executive Officer of J-Hawk from 1976 to the Merger.
C. IVAN WILSON has been Vice Chairman of the Board of the Company since the
Merger, and is currently Chairman, President and Chief Executive Officer of
Mercantile Bank, N.A., Corpus Christi, Texas, a national banking organization.
Mr. Wilson was Chairman of the Board and Chief Executive Officer of FCBOT from
1991 to the Merger. Prior to 1991, Mr. Wilson was the Chief Executive Officer of
FirstCity, Texas -- Corpus Christi, one of FCBOT's banking subsidiaries.
JAMES T. SARTAIN has been President, Chief Operating Officer and a Director
of the Company since the Merger, and was President and Chief Operating Officer
of J-Hawk from 1988 to the Merger.
RICK R. HAGELSTEIN has been Executive Vice President and Director of
Subsidiary Operations of the Company since November 1996 and a Director of the
Company since the Merger. From the Merger to November 1996, Mr. Hagelstein was
Executive Vice President and Chief Credit Officer of the Company, and
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was Executive Vice President and Chief Credit Officer of J-Hawk from 1990 to the
Merger. From 1988 to 1990, Mr. Hagelstein was Executive Vice President of ASK
Corporation, a manufacturer of solar energy devices. Mr. Hagelstein has also
been a member of the Portfolio Committee of the Trust since the Merger, which
committee administers the Trust.
MATT A. LANDRY, JR. has been Executive Vice President and Chief
Administrative Officer of the Company since November 1996, and was Executive
Vice President and Chief Financial Officer of the Company from the Merger to
November 1996. Mr. Landry has been a Director of the Company since the Merger.
Mr. Landry was Executive Vice President and Chief Financial Officer of J-Hawk
from 1992 to the Merger. From 1988 to 1992, Mr. Landry was President and Chief
Operating Officer and a director of AmWest Savings Association, a savings and
loan association (and a predecessor to First American Bank, S.S.B., a state
savings bank). From 1989 to 1992, Mr. Landry was also a director of First
American Bank, a state chartered commercial bank.
RICHARD J. GILLEN has been the Managing Director of Mortgage Finance and a
Director of the Company since July 1997. Mr. Gillen has also been the Chairman
of the Board of Harbor since 1987 and the President and Chief Executive Officer
of Harbor since 1983. Mr. Gillen has served on several committees of the
Mortgage Bankers Association of America, and served as President of the Texas
Mortgage Bankers Association in 1997.
RICHARD E. BEAN has been a Director of the Company since the Merger and has
been Executive Vice President and Chief Financial Officer of Pearce Industries,
Inc. ("Pearce") since 1976. Pearce, through its subsidiaries, markets a variety
of oilfield equipment and machinery. Mr. Bean has also been a member of the
Portfolio Committee of the Trust since the Merger. Prior to the Merger, Mr. Bean
was Chairman of the FCBOT's Official Committee of Equity Security Holders. Mr.
Bean is a director of TransAmerican Waste Industries, Inc.
BART A. BROWN, JR. has been a Director of the Company since the Merger and
has been President, Chief Executive Officer and a director of Main Street and
Main Incorporated since December 1996. Main Street is the largest franchisee of
the T.G.I. Friday's restaurant chain with 47 locations. From April 1996 until
December 1996, Mr. Brown was a consultant with Investcorp International, N.A.
("Investcorp"). From August 1995 until joining Investcorp, Mr. Brown was
Chairman and Chief Executive Officer of Color Tile, Inc., an Investcorp-owned
company. Prior to joining Color Tile, Inc., Mr. Brown was Chief Executive
Officer of The Circle K Corporation from 1991 to 1993, and served as Chairman of
that company from June 1990 until August 1995. Mr. Brown is a director of
Factory Card Outlet Corp. and Edison Brothers Stores, Inc.
DONALD J. DOUGLASS has been a Director of the Company since the Merger and
has been Chairman and Chief Executive Officer of Alamo Group, Inc. ("Alamo")
since 1969. Alamo, through its subsidiaries, designs and markets a variety of
mowing equipment, replacement parts and other products. Prior to the Merger, Mr.
Douglass was a member of FCBOT's Official Committee of Equity Security Holders.
DAVID W. MACLENNAN has been a Director of the Company since the Merger and
has been employed by subsidiaries of Cargill, Incorporated since 1991. From 1993
to February 1996, Mr. MacLennan was a Vice President of Cargill Financial, a
wholly owned subsidiary of Cargill, Incorporated that is engaged primarily in
the investment of proprietary funds and in the proprietary trading of financial
instruments and assets. Since February 1996, Mr. MacLennan has been Managing
Director of Cargill Financial Markets, PLC in London.
THOMAS E. SMITH has been a Director of the Company since July 1997 and the
President of High Island Oil Corporation since 1991. From 1992 to July 1997, Mr.
Smith was a director of Harbor, and from 1991 to 1992 Mr. Smith was a director
of American Mortgage Company, Inc., which merged with Harbor Financial Mortgage
Corporation in 1992. Mr. Smith serves on the Board of Consolidated Graphics
Corporation.
TERRY R. DEWITT has been Senior Vice President responsible for due
diligence and investment evaluation for the Company since the Merger. Mr. DeWitt
held the same position with J-Hawk from 1992 to the Merger. From 1991 to 1992,
Mr. DeWitt was Senior Vice President of the First National Bank of Central
Texas, a national banking association, and, from 1989 to 1991, was President of
the First National Bank of Goldthwaite, a national banking association.
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<PAGE> 80
G. STEPHEN FILLIP has been Chief Credit Officer of the Company since
November 1996 and Senior Vice President of the Company since the Merger. Mr.
Fillip was Senior Vice President of J-Hawk from 1991 to the Merger. From 1989 to
1991, Mr. Fillip was Executive Vice President and Chief Credit Officer of
BancOne, Texas, N.A. (Waco), a national banking association.
JOE S. GREAK has been Senior Vice President, Tax Director and Secretary of
the Company since the Merger. Mr. Greak was the Tax Manager of FCBOT from 1993
to the Merger. From 1992 to 1993, Mr. Greak was the Tax Manager of New First
City -- Houston, N.A. Prior thereto, he was Senior Vice President and Tax
Director of First City, Texas -- Houston, N.A.
RONALD E. HAMES has been Senior Vice President, Information Technology of
the Company since the Harbor Merger. Mr. Hames was Senior Vice President and
Chief Financial Officer of Harbor from 1992 to 1997.
JAMES C. HOLMES has been Senior Vice President and Treasurer of the Company
since the Merger. Mr. Holmes held the same positions with J-Hawk from 1991 to
the Merger. From 1988 to 1991, Mr. Holmes was a Vice President of MBank, Waco, a
national banking association.
KATHY MCNAIR has been Senior Vice President, Credit Administration of the
Company since the Merger. Ms. McNair held the same position with a wholly owned
subsidiary of J-Hawk from 1992 to the Merger. From 1990 to 1992, Ms. McNair was
a Vice President of Investors Savings Bank, a savings and loan association, and
from 1988 to 1990, Ms. McNair was a Vice President of Old Kent Bank Southwest, a
state chartered bank.
GARY H. MILLER has been Senior Vice President and Chief Financial Officer
of the Company since November 1996. Mr. Miller served as Senior Vice President
and Controller of the Company from the Merger to November 1996, and held the
same position with J-Hawk from 1994 to the Merger. From 1990 to 1994, Mr. Miller
was a senior manager of Jaynes, Reitmeier, Boyd & Therrell, P.C., an independent
public accounting firm. From 1988 to 1990, Mr. Miller was a Vice President of
NCNB Texas National Bank, a national banking association.
JIM W. MOORE has been Senior Vice President and Manager of Subsidiary
Activities of the Company since November 1996. Mr. Moore served as Senior Vice
President and Manager of Assets of the Company from the Merger to November 1996,
and held the same position with J-Hawk from 1992 to the Merger. From 1990 to
1992, Mr. Moore was a management consultant for MBank, Waco, a national banking
association, and from 1988 to 1990, Mr. Moore was President and a Director of
Central Texas Savings and Loan, a savings and loan association.
RICHARD J. VANDER WOUDE has been Senior Vice President and General Counsel
of the Company since January 1998. Mr. Vander Woude was a partner in the law
firm of Vander Woude & Istre, Waco, Texas from 1992 through 1997.
JAMES H. ARONOFF has been Chairman of the Board and Chief Executive Officer
of Capital Corp. since August 1997. Mr. Aronoff has fifteen years of experience
in the mortgage banking business, and from 1993 to 1997 was a Managing Director
of Fixed Income Structured Finance at Nomura Securities, International, Inc.
THOMAS R. BROWER has been President of Funding Corp. since September 1997.
From 1995 to 1997, he was President of The Brower Group, a sub-prime automobile
finance company. Mr. Brower has over fifteen years of experience in the
automotive industry, and was named Man of the Year in 1995 by the Association of
Finance and Insurance Professionals.
SCOT A. FOITH has been Executive Vice President and Director of Operations
of Funding Corp. since September 1997. From 1995 to 1997, he was Executive Vice
President of The Brower Group. Mr. Foith has nine years of experience in the
sub-prime automobile finance business.
CHRISTOPHER J. MORRISSEY has been President and Chief Operating Officer of
Capital Corp. since August 1997. Mr. Morrissey has fifteen years of experience
in the mortgage banking business, and from 1994 to 1997 was a Managing Director
of Fixed Income Structured Finance at Nomura Securities, International, Inc.
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<PAGE> 81
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information as of March 24, 1998
(the "Measurement Date") and as adjusted to reflect the sale of securities
offered hereby (assuming the Underwriters' over-allotment option is not
exercised), based on information obtained from the persons named below, with
respect to the beneficial ownership of shares of Common Stock by: (i) each
director and certain executive officers of the Company; (ii) all directors and
executive officers of the Company as a group; (iii) each shareholder known to
the Company to beneficially own more than 5% of the outstanding shares of Common
Stock; and (iv) other Selling Shareholders.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO OFFERING AFTER OFFERING
NAME OF ------------------------ SHARES ---------------------
BENEFICIAL OWNER(1) SHARES PERCENT OFFERED SHARES PERCENT
------------------- --------- ------- ------- ---------- --------
<S> <C> <C> <C> <C> <C>
James R. Hawkins........................ 1,036,445(2)(13) 15.75% 86,875 949,570 12.53%
C. Ivan Wilson.......................... 2,664(3) * -- 2,664 *
James T. Sartain........................ 382,320(4)(13) 5.81 30,003 352,317 4.65
Rick R. Hagelstein...................... 382,320(5) 5.81 30,003 352,317 4.65
Matt A. Landry, Jr...................... 62,125(6) * 12,000 50,125 *
Richard J. Gillen....................... 696,659 10.60 56,204 640,455 8.46
340 N. Sam Houston Pkwy. E., #100
Houston, Texas 77060
Richard E. Bean......................... 78,633(7) 1.20 -- 78,633 1.04
Bart A. Brown, Jr....................... -- -- -- -- --
Donald J. Douglass...................... 10,000 * -- 10,000 *
David W. MacLennan...................... --(8) -- -- -- --
Thomas E. Smith......................... 14,357 * 10,000 4,357 *
G. Stephen Fillip....................... 57,721(9) * 4,034 53,687 *
James C. Holmes......................... 21,035(10) * 1,500 19,535 *
Gary H. Miller.......................... 15,535(11) * 1,000 14,535 *
All directors and executive officers as
a group (20 persons).................. 2,815,652(2)-(11) 42.26 231,619 2,584,033 33.72
Ed Smith................................ 634,931(12) 9.66 41,280 593,651 7.84
1021 Main Street, #1000
Houston, Texas 77002
Lindsey Capital Corporation............. 419,969 6.39 -- 419,969 5.55
1021 Main Street, #1000
Houston, Texas 77002
ATARA Corp.............................. 372,400(13) 5.67 30,003 342,397 4.52
P.O. Box 8216
Waco, Texas 76714
Cargill Financial Services
Corporation........................... 241,137(14) 3.67 19,454 221,683 2.93
Lori Hawkins Trust
Rondy T. Gray, Trustee................ 107,618 1.64 4,203 103,415 1.37
Lisa Hawkins Trust
Rondy T. Gray, Trustee................ 98,213 1.49 3,444 94,769 1.25
Five Star Management, Inc............... 57,445(15) * 4,635 52,810 *
Enovest Investments, Inc. .............. 53,065 * 12,000 41,065 *
Texas Commerce Shareholders Company..... 41,000(16) * 41,000 -- --
</TABLE>
- ---------------
* Less than 1%
(1) The business address of each beneficial owner of more than 5% of the
outstanding shares of Common Stock (except as otherwise indicated) is 6400
Imperial Drive, Waco, Texas 76712.
(2) Includes 9,000 and 506 shares of Common Stock, respectively, that may be
acquired within 60 days of the Measurement Date upon the exercise of
options granted under the Company's 1995 Stock Option
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and Award Plan and upon the exercise of warrants to purchase Common Stock.
Also includes 57,445 shares of Common Stock held of record by J-Hawk, Ltd.,
the sole general partner of which is Five Star Management, Inc. Mr. Hawkins
may be deemed to beneficially own such shares of Common Stock as a result
of his ownership of 50% of the common stock of Five Star Management, Inc.
(3) Includes 676 shares of Common Stock that may be acquired within 60 days of
the Measurement Date upon the exercise of warrants to purchase Common
Stock.
(4) Includes 9,920 and 506 shares of Common Stock, respectively, that may be
acquired within 60 days of the Measurement Date upon the exercise of
options granted under the Company's 1995 Stock Option and Award Plan and
upon the exercise of warrants to purchase Common Stock.
(5) 372,400 of such shares of Common Stock are held of record by ATARA I Ltd.
("ATARA"), including 506 shares that may be acquired within 60 days of the
Measurement Date upon the exercise of warrants to purchase Common Stock.
ATARA is principally engaged in the investment in Common Stock. The sole
general partner of ATARA is ATARA Corp., a Texas corporation ("ATARA
Corp."), which is also principally engaged in the investment in Common
Stock. Mr. Hagelstein may be deemed to beneficially own all such 372,400
shares because (i) he is the Chairman of the Board and President of ATARA
Corp. and (ii) his wife is the only other officer or director of ATARA
Corp. and she owns 33.33% of the outstanding shares of common stock of
ATARA Corp. Includes 9,920 shares of Common Stock that may be acquired
within 60 days of the Measurement Date upon the exercise of options granted
under the Company's 1995 Stock Option and Award Plan.
(6) 53,065 of such shares of Common Stock are held of record by Enovest
Associates, Ltd., a Texas limited partnership ("Associates"), which is
principally engaged in the business of investments, including its
investment in the Company's Common Stock. The sole general partner of
Associates is Enovest Investments, Inc., a Texas corporation
("Investments"). Mr. Landry may be deemed to beneficially own all such
53,065 shares by virtue of being a Vice President of Investments. Includes
9,060 shares that may be acquired within 60 days of the Measurement Date
upon the exercise of options granted under the Company's 1995 Stock Option
and Award Plan.
(7) Includes 9,964 shares of Common Stock that may be acquired within 60 days
of the Measurement Date upon the exercise of warrants of the Company to
purchase Common Stock.
(8) Mr. MacLennan is an officer of certain affiliates of Cargill Financial,
which, as of the Measurement Date was the record owner of 241,137 shares of
Common Stock. Mr. MacLennan disclaims beneficial ownership of such shares.
Cargill Financial is party to the Shareholder Voting Agreement with Messrs.
Hawkins and Sartain, and ATARA, regarding the Common Stock.
(9) Includes 57 and 7,300 shares of Common Stock, respectively, that may be
acquired within 60 days of the Measurement Date upon the exercise of
warrants to purchase Common Stock and upon the exercise of options granted
under the Company's Stock Option Plans.
(10) Includes 6,200 shares of Common Stock that may be acquired within 60 days
of the Measurement Date upon the exercise of options granted under the
Company's Stock Option Plans.
(11) Includes 4,700 shares of Common Stock that may be acquired within 60 days
of the Measurement Date upon the exercise of options granted under the
Company's Stock Option Plans.
(12) 419,969 of such shares of Common Stock are held of record by Lindsey
Capital Corporation. Mr. Smith beneficially owns such shares of Common
Stock as a result of his ownership of 100% of the common stock of Lindsey
Capital Corporation.
(13) Messrs. Hawkins and Sartain and ATARA, the sole general partner of which is
ATARA Corp., are parties to a Shareholder Voting Agreement (the
"Shareholder Voting Agreement") with Cargill Financial regarding the Common
Stock, pursuant to which ATARA and Messrs. Hawkins and Sartain are required
to vote their shares of Common Stock to elect one designee of Cargill
Financial as a director of the Company, and Cargill Financial is required
to vote its shares of Common Stock to elect one or more of the designees of
ATARA and Messrs. Hawkins and Sartain as directors of the Company. Each of
Messrs. Hawkins and Sartain and ATARA disclaims beneficial ownership of the
shares of Common Stock owned by Cargill Financial.
(14) Cargill Financial provides financing to the Company and the Acquisition
Partnerships and is a party to an agreement with the Company whereby the
parties jointly pursue opportunities to acquire Portfolio Assets. See
"Business -- Portfolio Asset Acquisition and Resolution -- Portfolio Asset
Acquisition and Resolution Business -- Relationship with Cargill
Financial."
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<PAGE> 83
(15) All of such shares of Common Stock are held of record by J-Hawk, Ltd., the
sole general partner of which is Five Star Management, Inc.
(16) Texas Commerce Shareholders Company acquired such shares in exchange for
17,917 shares, or 4%, of the common stock of Harbor. Such shares of common
stock of Harbor were acquired in December 1997 upon the exercise of
warrants granted to an affiliate of Texas Commerce Shareholders Company in
1987. Texas Commerce Shareholders Company is an affiliate of Chase Bank,
Houston, which provides financing to Mortgage Corp.
TRANSFERABILITY AND OWNERSHIP OF CAPITAL STOCK
As explained below under "Certain Federal Income Tax Considerations," if
the Company experiences a more than 50% ownership change during any three-year
testing period, its ability to use the NOLs acquired in the Merger will be
severely limited. A more than 50% ownership change occurs when the percentage of
capital stock of the Company owned by one or more five-percent shareholders has
increased by more than 50 percentage points (determined by value) over the
lowest percentage of the Company's capital stock owned by the same shareholders
during the three-year testing period. In order to prevent such a change in
ownership, the Company's Certificate of Incorporation contains certain transfer
restrictions on the Company's capital stock. The Certificate of Incorporation
provides that subject to certain limited exceptions (including the prior
approval of the board of directors of the Company), during the period (the
"Restricted Transfer Period") beginning as of the Merger and ending on the
earlier of (1) the expiration of 15 years after the Merger and (2) the first day
of the taxable year of the Company to which no Tax Benefits (as such term is
defined below) may be carried forward by the Company, any transfer of Common
Stock, any warrants, rights or options to purchase Common Stock, or any other
interests that would be treated as "stock" of the Company under section 382 of
the Tax Code (collectively, "Capital Stock") to any transferee (including a
group acting in concert) who directly or indirectly owns or is treated as owning
4.75% of the total outstanding shares of any class of Capital Stock or, after
giving effect to the transfer, would directly or indirectly own more than 4.75%
of the outstanding shares of any class of Capital Stock, shall be void ab initio
and shall not be effective to transfer any of such shares of Capital Stock to
the extent the transfer increases the transferee's direct or indirect ownership
of the Capital Stock above 4.75% of the total outstanding shares of the Capital
Stock. In addition, any transfer of Capital Stock by a transferor who directly
or indirectly owns or is treated as owning 5% or more of the outstanding shares
of any class of Capital Stock shall be void ab initio and shall not be effective
to transfer any of such shares of Capital Stock to the purported transferee.
"Tax Benefits" is defined as net operating loss carryovers, capital loss
carryovers, general business credit carryovers, alternative minimum tax
carryovers, foreign tax credit carryovers and any net unrealized built-in
losses. The shares of Common Stock issued in the Offering will be subject to
such transfer restrictions and will contain legends to that effect.
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<PAGE> 84
SHARES ELIGIBLE FOR FUTURE SALE
On a pro forma basis after giving effect to the Offering, there would have
been 7,570,081 shares of Common Stock (7,771,231 if the Underwriters'
over-allotment option is exercised in full) outstanding as of March 24, 1998.
Upon completion of the Offering, 3,828,584 or 50.6%, of such shares may be sold
without restriction under the Securities Act. The remaining shares are
"restricted securities" within the meaning of Rule 144 promulgated under the
Securities Act (the "Restricted Shares"), and may be publicly resold only if
registered under the Securities Act or sold in accordance with an applicable
exemption from registration, such as Rule 144. In this regard, the Company
currently has two effective shelf registration statements on Form S-3 on file
with the Commission with respect to the Restricted Shares, pursuant to which the
holders of such Restricted Shares may sell such Restricted Shares without
restriction under the Securities Act.
In general, under Rule 144 as currently in effect, a person who has
beneficially owned Restricted Shares for at least one year, including an
"affiliate" of the Company, is entitled to sell within any three-month period a
number of shares of Common Stock that does not exceed the greater of 1% of the
then outstanding shares of Common Stock of the Company or the average weekly
trading volume of Common Stock on the open market during the four calendar weeks
preceding the date of which notice of the sale is filed with the Commission.
Sales under Rule 144 are subject to certain restrictions relating to manner of
sale, notice and availability of current public information about the Company. A
person who has not been an "affiliate" at any time during the 90 days preceding
a sale, and who has beneficially owned shares for at least two years, is
entitled to sell such shares free of certain of these restrictions. Shares of
Common Stock issued pursuant to the Company's stock option plans generally will
be available for sale in the open market and will be freely tradeable, except to
the extent that the holders thereof are affiliates of the Company, in which case
the limitations of Rule 144 (other than the holding period) will apply. As of
March 24, 1998, warrants exercisable for 497,198 shares of Common Stock and
options exercisable for 311,800 shares of Common Stock were outstanding.
The shares of Common Stock offered hereby may be resold without restriction
under the Securities Act except for any such shares acquired by an "affiliate"
of the Company, which shares will be subject to the resale limitations of Rule
144. The Company is unable to make any prediction as to the effect, if any, that
the availability of Common Stock for sale, or the future sales of Common Stock,
under Rule 144 or otherwise, will have on the prevailing market price of Common
Stock. Sales of substantial amounts of Common Stock in the public market, or the
perception of the availability of shares for sale, could adversely affect the
prevailing market price of the Common Stock.
The Company's directors and the other Selling Shareholders have agreed not
to dispose of any shares of Common Stock for a period of 90 days from the date
of this Prospectus, other than pursuant to the Offering, without the prior
written consent of Piper Jaffray Inc., as representative of the Underwriters.
See "Underwriting."
The utilization of the Company's NOLs may be limited or prohibited under
the Tax Code in the event of certain ownership changes. The Certificate of
Incorporation contains certain 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 from transferring such
stock even if such holders are permitted to sell such stock publicly 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. See
"Transferability and Ownership of Capital Stock."
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<PAGE> 85
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
THE FOLLOWING DISCUSSION IS A SUMMARY OF CERTAIN OF THE SIGNIFICANT FEDERAL
INCOME TAX CONSIDERATIONS IN RESPECT OF THE OFFERING. NO LEGAL OPINIONS WILL BE
RENDERED WITH RESPECT TO SUCH CONSIDERATIONS AND NO RULINGS HAVE BEEN REQUESTED
FROM THE IRS. THE FOLLOWING DISCUSSION DOES NOT ADDRESS ANY ASPECT OF STATE AND
LOCAL TAXATION, INCLUDING, WITHOUT LIMITATION, THE EFFECT OF STATE LAW
LIMITATIONS ON THE USE OF THE COMPANY'S NOLS.
THIS SUMMARY IS BASED ON THE TAX CODE, TREASURY REGULATIONS PROMULGATED AND
PROPOSED THEREUNDER, JUDICIAL DECISIONS AND PUBLISHED ADMINISTRATIVE RULES AND
PRONOUNCEMENTS OF THE IRS AS IN EFFECT ON THE DATE HEREOF. CHANGES IN SUCH RULES
OR NEW INTERPRETATIONS THEREOF MAY HAVE RETROACTIVE EFFECT AND COULD THEREFORE
SIGNIFICANTLY AFFECT THE TAX CONSEQUENCES DESCRIBED BELOW.
CERTAIN TAX CONSEQUENCES OF THE MERGER
The Merger. On July 3, 1995, J-Hawk merged with and into FCBOT. The Company
believes that the Merger constituted a tax-free reorganization under the Tax
Code. Therefore, no gain or loss was recognized by J-Hawk as a result of the
reorganization and the initial tax basis of the Company in the acquired assets
was the same as it was in the hands of J-Hawk immediately prior to the
reorganization. The Company did not obtain any rulings from the IRS or any legal
opinions from counsel with respect to any tax aspects of the Merger and there
can be no assurance that the Company's position will be sustained.
The Spin-off. Prior to, and in anticipation of, the consummation of the
Merger, J-Hawk formed Combined Financial Corporation ("Combined Financial"), to
which it transferred certain of its assets and assigned certain of its
indebtedness, and then distributed the stock of Combined Financial to its
shareholders (the "Spin-off"). The Company believes that the transfer of these
assets from J-Hawk to Combined Financial and the distribution of the Combined
Financial stock by J-Hawk to its shareholders constituted a tax free spin-off
under section 355 of the Tax Code. However, no private letter ruling from the
IRS or opinion of counsel to that effect was sought or obtained, and there can
be no assurance that the Company's position will be sustained. If the Company's
position is sustained, then no gain or loss would be recognized by J-Hawk as a
result of the Spin-off. If the Company's position is not sustained, gain or loss
would be recognized in an amount equal to the difference between the fair market
value of the assets transferred to Combined Financial and their adjusted tax
basis at the time of the transfer, and any tax liability incurred by J-Hawk on
the Spin-off would be inherited by the Company as a consequence of the Merger.
Although the Company believes that there was not any significant gain realized
as a result of the consummation of the Spin-off, it is possible that the IRS
could contend both that the Spin-off was taxable to J-Hawk and that the value of
the assets transferred was greater than the value assigned to such assets by
J-Hawk. In such event, there might be taxable gain incurred by J-Hawk in
connection with the Spin-off that would be inherited by the Company and such
gain could not be offset by the Company's NOLs.
Net Operating Loss Carryforwards Generally. 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 estimates that it has generated an additional $12 million
in NOLs. Accordingly, as of December 31, 1997, the Company had approximately
$608 million of NOLs available to offset future taxable income. In this regard,
the Tax Code provides that, for tax years beginning before August 6, 1997, a net
operating loss for a taxable year may be carried back to offset income in each
of the three taxable years preceding the taxable year of such loss and carried
forward to each of the fifteen taxable years following the taxable year of the
loss. Under this provision of the Tax Code, the entire $608 million of the
Company's NOLs may be carried forward to offset future taxable income until the
tax year 2005. Thereafter, the Company's NOLs begin to expire and (assuming that
the Company has not previously
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<PAGE> 86
utilized any of its NOLs) the amount available to offset future taxable income
would be reduced as set forth below opposite the applicable tax year:
<TABLE>
<CAPTION>
AMOUNT OF
EXPIRING NOLS AMOUNT OF
AS OF END OF REMAINING
TAX YEAR PRIOR TAX YEAR NOLS AVAILABLE
-------- -------------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
2006.................................................. $ 68,147 $539,853
2007.................................................. 192,885 346,968
2008.................................................. 153,611 193,357
2009.................................................. 12,980 180,377
2010.................................................. 99,566 80,811
2011.................................................. 68,811 12,000
2012.................................................. -0- 12,000
</TABLE>
The amount of the foregoing NOLs is based upon factual and legal issues
with respect to which there can be no certainty. No ruling has been obtained
from the IRS regarding the amount or availability of the NOLs. The amount and
availability of such NOLs is therefore subject to audit and adjustment by the
IRS and it is possible that such NOLs could be significantly less than the
amounts set forth above.
Utilization of Net Operating Loss Carryforwards and other Tax Attributes
under Tax Code Sections 382, 383 and 384. In general, whenever there is a more
than 50% ownership change of a corporation during a three-year testing period,
the ownership change rules in section 382 of the Tax Code limit the
corporation's utilization of pre-change NOLs on an annual basis following the
ownership change to the product of the fair market value of the stock of the
corporation immediately before the ownership change and the "long-term tax-
exempt rate" then in effect (which is an interest rate published monthly by the
IRS). A more than 50% ownership change occurs when the percentage of stock of
the corporation owned by one or more five-percent shareholders has increased by
more than 50 percentage points (determined by value) over the lowest percentage
of the corporation's stock owned by the same shareholders during the three-year
testing period. In any given year, the annual limitation imposed by section 382
may be increased by certain built-in gains realized after, but accruing
economically before, the ownership change and by the carryover of unused section
382 limitations from prior years. Pursuant to section 383 of the Tax Code, the
principles of section 382 similarly apply to certain other tax attributes (such
as general business credits, minimum tax credits, foreign tax credits and
capital loss carryovers).
The harsh effect of the ownership change rules of section 382 may be
ameliorated by an exception that applies in the case of federal bankruptcy
reorganizations. Under the so-called "section 382(l)(5) bankruptcy exception" to
section 382, if the reorganization results in an exchange by qualifying
creditors and stockholders of their claims and interests for at least 50% of the
debtor corporation's stock (determined by vote and value), then the general
ownership change rules will not apply. Instead, the debtor corporation will be
subject to a different tax regime under which NOLs are not limited on an annual
basis but are reduced by (i) the amount of interest deductions claimed during
the three taxable years preceding the date of the reorganization, and during the
part of the taxable year prior to and including the reorganization, in respect
of debt of the corporation converted into stock in the reorganization, and (ii)
in the case of a title 11 case filed on or before December 31, 1994 (such as
that of the Company), 50% of the excess of the amount of debt of the corporation
(other than indebtedness for interest included in clause (i)) satisfied with
stock in an exchange to which the former stock-for-debt exception from the
realization of discharge of indebtedness income applied over the value of the
stock so issued. Moreover, if the section 382(l)(5) bankruptcy exception
applies, section 382(l)(5)(D) provides that any further more than 50% ownership
change (as defined in section 382(g) of the Tax Code) of the debtor within a
two-year period will result in forfeiture of all of the debtor's NOLs incurred
through the date of such second ownership change.
The Company believes that a more than 50% ownership change occurred as a
result of the Merger. However, because of the application of the section
382(l)(5) bankruptcy exception, the Company believes that the general ownership
change rules of section 382 did not apply to limit the utilization of the
Company's
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<PAGE> 87
NOLs. In addition, none of the mandatory reductions in the amount of NOLs
required by the section 382(l)(5) bankruptcy exception applied. Accordingly, the
Company believes that section 382 did not limit, or otherwise reduce, the NOLs
that existed at the time of the Merger and, therefore, approximately $596
million of NOLs were available to the Company to offset future taxable income as
of December 31, 1995. In addition, the Company believes that it has not
experienced a more than 50% ownership change (as defined in section 382(g) of
the Tax Code) since the prior ownership change that occurred as a result of the
Merger and, therefore, that the Company's NOLs have not been forfeited under
section 382(l)(5)(D) and are not otherwise subject to an annual limitation
imposed by section 382. In order to prevent such a future change in ownership,
the Company's Certificate of Incorporation contains certain transfer
restrictions on the Company's capital stock, including the Common Stock. See
"Transferability and Ownership of Capital Stock." The Company also believes that
section 383 did not apply to limit the Company's utilization of certain other
tax attributes (such as general business credits, minimum tax credits, foreign
tax credits and capital loss carryovers).
Aside from sections 382 and 383, section 384 of the Tax Code provides that,
if the assets of a corporation are acquired by another corporation in a
reorganization described in subparagraphs (A), (C) or (D) of section 368(a)(1)
of the Tax Code, any built-in gain in the acquired assets that is recognized
(i.e., the "recognized built-in gain") during the five-year period beginning on
the acquisition date (i.e., the "recognition period") may not be offset by any
preacquisition loss (including NOLs and possible built-in losses). For purposes
of applying this rule, the term "recognized built-in gain" means any gain
recognized during the recognition period on the disposition of any asset except
to the extent that it is established by the acquiring corporation that (1) such
asset was not held on the acquisition date or (2) such gain exceeds the excess
(if any) of the fair market value of such asset on the acquisition date over the
adjusted tax basis of such asset on such date. Moreover, any item of income
which is properly taken into account for any recognition period taxable year but
which is attributable to periods before the acquisition date will be treated as
a recognized built-in gain for the taxable year in which it is properly taken
into account. The amount of the recognized built-in gains for any recognition
period taxable year cannot exceed the "net unrealized built-in gain" (as defined
in section 382(h) of the Tax Code) immediately before the acquisition date,
reduced by the recognized built-in gains for the prior years ending in the
recognition period which (but for the application of this rule) would have been
offset by preacquisition losses.
The Company has taken the position that the Merger was a reorganization
described in section 368(a)(1)(G) of the Tax Code and, therefore, section 384
does not apply to limit the Company's ability to use its NOLs to offset any
built-in gain that may be inherent in the assets acquired from J-Hawk. Based
upon a private letter ruling issued to another taxpayer, the Company believes
that the IRS may take a contrary position. If the IRS were successful in
challenging the Company's position, the Company would not be able to use its
NOLs to offset any such recognized built-in gains. The Company believes,
however, that even if its position with respect to section 384 is not sustained
in a dispute with the IRS, the amount of any built-in gain that may be inherent
in the assets acquired from J-Hawk and subject to section 384 will not have a
material adverse effect on the Company's consolidated financial position or
results of operations. In addition to potentially applying to the assets
acquired from J-Hawk, section 384 will apply to limit the Company's ability to
use its NOLs to offset any built-in gain that may be inherent in the assets of
Harbor acquired by the Company, and may limit the Company's ability to use its
NOLs to offset any built-in gain which may be inherent in the assets of other
corporations acquired by the Company.
Application of Tax Code Section 269. Pursuant to section 269(a) of the Tax
Code, the IRS may disallow a corporate tax benefit if the principal purpose for
(1) an acquisition of 50% or more (determined by vote or value) of the stock of
a corporation (see section 269(a)(1)) or (2) a tax-free acquisition, directly or
indirectly, of property of another corporation, which corporation was not
controlled by the acquiring corporation or its stockholders immediately prior to
such acquisition (see section 269(a)(2)), is the evasion or avoidance of federal
income tax by securing a corporate tax benefit that would not otherwise be
available. Thus, in addition to the limitations on, and reductions in, tax
attributes set forth in sections 382, 383 and 384, the IRS may assert that
section 269 authorizes it to disallow any deduction of the Company's NOLs if
section 269(a)(1) or section 269(a)(2) were to apply and the Merger is
determined to have been structured principally for tax avoidance purposes. This
determination is primarily a question of fact. In connection with a
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<PAGE> 88
more than 50% ownership change(as defined in section 382(g) of the Tax Code) to
which the section 382(l)(5) bankruptcy exception (discussed above) applies, an
acquisition of control or property within the meaning of sections 269(a)(1) and
269(a)(2), respectively, is presumed to be made for the principal purpose of tax
avoidance unless the corporation carries on more than an insignificant amount of
an active trade or business during and subsequent to the title 11 case.
Because certain J-Hawk shareholders owned FCBOT common stock prior to the
Merger such that former J-Hawk shareholders' aggregate ownership of FCBOT
immediately following the Merger exceeded 50%, an acquisition of control may
have occurred within the meaning of section 269(a)(1). Furthermore, even if such
an acquisition of control did not occur, section 269 may nevertheless be
rendered potentially applicable as a result of the Company's acquisition of
J-Hawk (see section 269(a)(2)). In either case, the Company does not believe
that section 269 will limit the utilization of the $596 million of NOLs
available to the Company as of December 31, 1995 because the Merger was
structured primarily for business reasons and the Company has retained and
carried on more than an insignificant amount of FCBOT's pre-bankruptcy active
trade or business. Nonetheless, there can be no assurance that the IRS will not
challenge the utilization of such NOLs under section 269 and, if challenged,
that the IRS would not be successful in disallowing all or a significant portion
of the Company's NOLs arising prior to the Merger.
IMPACT OF THE OFFERING
Pursuant to this Offering, the Company will issue a maximum of 1,201,150
additional shares of Common Stock, which includes any Common Stock covered by
the Underwriters' over-allotment option, and 5% shareholders of the Company will
sell 244,365 shares of Common Stock. Under section 382, as a result of the
Offering, the percentage of stock of the Company owned by one or more 5%
shareholders will be increased by approximately 10% (determined by value) over
the lowest percentage of the Company's stock owned by the same shareholders
during the applicable three-year testing period, which began on July 3, 1995.
When combined with other such increases in ownership by 5% shareholders during
the three-year testing period, this Offering will give rise to a cumulative
increase in ownership by such shareholders during such testing period of
approximately 34%. Accordingly, because this Offering will not give rise to a
more than 50% ownership change of the Company during the three-year testing
period, the Company believes that the Offering will not cause section 382 to
limit the Company's utilization of its NOLs, which totaled approximately $608
million as of December 31, 1997. Investors should note, however, that the amount
of NOLs available to the Company is based on factual and legal issues with
respect to which there can be no certainty. The amount and availability of such
NOLs is subject to audit and adjustment by the IRS and it is entirely possible
that such NOLs could be significantly less than $608 million. Moreover, any
future more than 50% ownership change of the Company may result in the
limitation of such NOLs.
CURRENT IRS AUDIT
The federal income tax returns of J-Hawk for the tax year ended December
31, 1994 and for the short tax year ended July 2, 1995 are currently being
audited by the IRS. To date, the IRS has not proposed any significant
adjustments to the tax returns as originally filed. The IRS, however, has not
completed its audit and it is possible that future adjustments to the tax
returns could be proposed. None of the Company's federal income tax returns are
currently under audit.
ALTERNATIVE MINIMUM TAX
A corporation is required to pay alternative minimum tax to the extent that
20% of the corporation's "alternative minimum taxable income" ("AMTI") exceeds
the corporation's regular tax liability for the year. AMTI is generally equal to
regular taxable income with certain adjustments. For purposes of computing AMTI,
a corporation is entitled to offset no more than 90% of its AMTI with NOLs (as
computed for alternative minimum tax purposes). Thus, if the Company is subject
to the alternative minimum tax, a federal tax of 2% (20% of the 10% of AMTI not
offset by NOLs) will apply to any net taxable income earned by the Company that
is otherwise offset by NOLs.
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<PAGE> 89
UNDERWRITING
The Underwriters named below have agreed, subject to the terms of a
Purchase Agreement, to purchase from the Company the number of shares of Common
Stock set forth opposite their names below. The Underwriters are committed to
purchase and pay for all such shares if any are purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Piper Jaffray Inc...........................................
The Robinson-Humphrey Company, LLC..........................
Sandler O'Neill & Partners, L.P. ...........................
---------
Total............................................. 1,341,000
=========
</TABLE>
The Underwriters have advised the Company that they propose to offer the
shares directly to the public at the public offering price set forth on the
cover page of this Prospectus and to selected dealers at such price less a
concession not in excess of $ per share. The Underwriters may allow and
such dealers may reallow a concession not in excess of $ per share to
certain other brokers and dealers. After the public offering, the public
offering price, concession and reallowance, and other selling terms may be
changed by the Underwriters.
The Company has granted to the Underwriters an option, exercisable during
the 30-day period after the date of this Prospectus, under which the
Underwriters may purchase up to an additional 201,150 shares of Common Stock
from the Company at the Price to Public less the Underwriting Discount set forth
on the cover page of the Prospectus. The Underwriters may exercise the option
only to cover over-allotments, if any. To the extent such option is exercised,
each Underwriter will become obligated, subject to certain conditions, to
purchase approximately the same percentage of such additional shares as it was
obligated to purchase under the Purchase Agreement.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including civil liabilities under the Securities Act, or to
contribute to payments that the Underwriters may be required to make in respect
thereof.
In order to facilitate the Offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Stock during and after the Offering. Specifically, the Underwriters may
over-allot or otherwise create a short position in the Common Stock for their
own account by selling more shares of Common Stock than have been sold to them
by the Company. The Underwriters may elect to cover any such short position by
purchasing shares of Common Stock in the open market or by exercising the over-
allotment option granted to the Underwriters. In addition, the Underwriters may
stabilize or maintain the price of the Common Stock by bidding for or purchasing
shares of Common Stock in the open market and may impose penalty bids, under
which selling concessions allowed to syndicate members or other broker-dealers
participating in the Offering are reclaimed if shares of Common Stock previously
distributed in the Offering are repurchased in connection with stabilization
transactions or otherwise. The effect of these transactions may be to stabilize
or maintain the market price of the Common Stock at a level above that which
might otherwise prevail in the open market. The imposition of a penalty bid may
also affect the price of the Common Stock to the extent that it discourages
resales thereof. No representations are made as to the magnitude or effect of
any such stabilization or other transactions. Such transactions may be effected
on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
In connection with this Offering, certain Underwriters (and selling group
members) may also engage in passive market making transactions in the Common
Stock on the Nasdaq National Market. Passive market making consists of
displaying bids on the Nasdaq National Market limited by the prices of
independent market makers and effecting purchases limited by such prices and in
response to order flow. Rule 103 of Regulation M promulgated by the Commission
limits the amount of net purchases that each passive market maker may make and
the displayed size of each bid. Passive market making may stabilize the market
price of
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<PAGE> 90
the Common Stock at a level above that which might otherwise prevail in the open
market and, if commenced, may be discontinued at any time.
LEGAL MATTERS
The validity of the issuance of the Common Stock offered hereby will be
passed upon for the Company by Weil, Gotshal & Manges LLP, Houston, Texas.
Certain legal matters with respect to such securities will be passed upon for
the Underwriters by Jones, Day, Reavis & Pogue, Chicago, Illinois.
EXPERTS
The Consolidated Financial Statements of the Company as of December 31,
1997 and 1996, and for each of the years in the three-year period ended December
31, 1997 have been included herein in reliance upon the report of KPMG Peat
Marwick LLP, independent certified public accountants, appearing elsewhere
herein, and given upon authority of said firm as experts in accounting and
auditing.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). In accordance with the
Exchange Act, the Company files reports, proxy and information statements and
other information with the Securities and Exchange Commission (the
"Commission"). The reports, proxy and information statements and other
information can be inspected and copied at the public reference facilities that
the Commission maintains at Room 1024, 450 Fifth Street, N.W., Washington, D.C.
20549, and at the Commission's regional offices located at 7 World Trade Center,
13th Floor, New York, New York 10048, and 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Copies of these materials can be obtained at prescribed
rates from the Public Reference Section of the Commission at the principal
offices of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. In
addition, the Commission maintains a site on the World Wide Web at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission.
The Company has filed with the Commission a registration statement on Form
S-3 (the "Registration Statement") under the Securities Act, with respect to the
Common Stock. This Prospectus, which constitutes a part of the Registration
Statement, does not contain all the information set forth in the Registration
Statement, certain items of which are contained in schedules and exhibits to the
Registration Statement as permitted by the rules and regulations of the
Commission. Statements made in this Prospectus concerning the contents of any
documents referred to herein are not necessarily complete. With respect to each
such document filed with the Commission as an exhibit to the Registration
Statement, reference is made to the exhibit for a more complete description, and
each such statement shall be deemed qualified in its entirety by such reference.
The Common Stock is quoted on the Nasdaq National Market under the symbol
"FCFC." Reports, proxy and information statements and other information
concerning the Company may be inspected at the offices of the Nasdaq National
Market, 1735 K Street, N.W., Washington, D.C. 20006.
89
<PAGE> 91
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by the Company with the Commission under the
Exchange Act are hereby incorporated by reference into this Prospectus: (a) the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1997; and (b) the description of the Common Stock contained in the Company's
Form 8-A Registration Statement filed with the Commission on July 25, 1995 (File
No. 0-26500), as amended by the Company's Form 8-A/A filed with the Commission
on August 25, 1995 and the Company's Form 8-B Registration Statement filed with
the Commission on September 6, 1995, including any amendment or report filed for
the purpose of updating such description.
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or
15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to
the termination of the Offering shall be deemed to be incorporated by reference
into this Prospectus and to be a part hereof from the respective dates of filing
of such documents.
Any statement or information contained herein or in any document all or
part of which is incorporated or deemed to be incorporated by reference herein
shall be deemed to be modified or superseded for purposes of this Prospectus to
the extent that a statement or information contained herein or in any other
subsequently filed document which also is or is deemed to be incorporated by
reference herein modifies or supersedes such statement or information. Any such
statement or information so modified or superseded shall not be deemed, except
as so modified or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to any person to whom this
Prospectus is delivered, upon the written or oral request of such person, a copy
of any or all of the foregoing documents incorporated herein by reference (other
than certain exhibits to such documents). Requests for such copies should be
directed to Gary H. Miller, Senior Vice President and Chief Financial Officer,
FirstCity Financial Corporation, 6400 Imperial Drive, Waco, Texas 76712,
telephone number (254) 751-1750.
90
<PAGE> 92
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
Independent Auditors' Report to The Board of Directors and
Shareholders of FirstCity Financial Corporation........ F-2
Consolidated Balance Sheets as of December 31, 1997 and
1996................................................... F-3
Consolidated Statements of Income for the Years Ended
December 31, 1997, 1996 and 1995....................... F-4
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1997, 1996 and 1995........... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995....................... F-6
Notes to Consolidated Financial Statements................ F-7
</TABLE>
F-1
<PAGE> 93
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
FirstCity Financial Corporation:
We have audited the accompanying consolidated balance sheets of FirstCity
Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 1997. 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 generally accepted auditing
standards. 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, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Fort Worth, Texas
March 24, 1998
F-2
<PAGE> 94
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
ASSETS --------- ---------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Cash and cash equivalents................................... $ 31,605 $ 16,445
Portfolio Assets, net....................................... 89,951 76,240
Loans receivable, net....................................... 90,115 41,310
Mortgage loans held for sale................................ 533,751 134,348
Equity investments in and advances to Acquisition
Partnerships.............................................. 35,529 21,761
Class A Certificate of FirstCity Liquidating Trust.......... -- 53,617
Mortgage servicing rights................................... 69,634 33,517
Receivable for servicing advances and accrued interest...... 21,410 16,045
Deferred tax benefit, net................................... 30,614 13,898
Other assets, net........................................... 37,510 18,008
-------- --------
Total Assets...................................... $940,119 $425,189
======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable............................................. $750,781 $266,166
Other liabilities......................................... 34,672 20,604
-------- --------
Total Liabilities................................. 785,453 286,770
Commitments and contingencies............................... -- --
Redeemable preferred stock:
Special preferred stock, including dividends of $669 and
$1,938, respectively (nominal stated value of $21 per
share; 2,500,000 shares authorized; 849,777 and
2,460,911 shares, respectively, issued and
outstanding)........................................... 18,515 53,617
Adjusting rate preferred stock, including dividends of
$846 in 1997 (redemption value of $21 per share;
2,000,000 shares authorized; 1,073,704 shares issued
and outstanding in 1997)............................... 23,393 --
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: 6,526,510 and
6,513,346 shares, respectively)........................ 65 65
Paid in capital........................................... 29,509 29,783
Retained earnings......................................... 83,184 54,954
-------- --------
Total Shareholders' Equity........................ 112,758 84,802
-------- --------
Total Liabilities, Redeemable Preferred Stock and
Shareholders' Equity............................ $940,119 $425,189
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 95
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
---------- ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenues:
Gain on sale of mortgage loans............................ $ 36,496 $ 19,298 $ 7,864
Net mortgage warehouse income............................. 3,499 3,224 2,355
Gain on sale of mortgage servicing rights................. 4,246 2,641 2,011
Servicing fees:
Mortgage............................................... 14,732 10,079 6,508
Other.................................................. 12,066 12,456 10,903
Gain on resolution of Portfolio Assets.................... 24,183 19,510 11,984
Equity in earnings of Acquisition Partnerships............ 7,605 6,125 3,834
Rental income on real estate Portfolios................... 332 3,033 1,277
Interest income........................................... 13,448 7,707 1,572
Other income.............................................. 9,462 3,415 3,060
Interest income on Class A Certificate.................... 3,553 11,601 8,597
-------- -------- -------
Total revenues.................................... 129,622 99,089 59,965
-------- -------- -------
Expenses:
Interest on other notes payable........................... 12,433 10,403 4,721
Salaries and benefits..................................... 42,191 26,927 16,767
Amortization:
Mortgage servicing rights.............................. 7,550 4,091 3,823
Other.................................................. 2,563 3,113 1,534
Provision for loan losses................................. 6,613 2,029 --
Harbor Merger related expenses............................ 1,618 -- --
Occupancy, data processing, communication and other....... 36,354 23,254 11,955
Interest on senior subordinated notes..................... -- 3,892 4,721
-------- -------- -------
Total expenses.................................... 109,322 73,709 43,521
-------- -------- -------
Net earnings before minority interest, preferred dividends
and income taxes.......................................... 20,300 25,380 16,444
Benefit (provision) for income taxes...................... 15,485 13,749 (1,200)
-------- -------- -------
Net earnings before minority interest and preferred
dividends................................................. 35,785 39,129 15,244
Minority interest......................................... (157) -- --
Preferred dividends....................................... (6,203) (7,709) (3,876)
-------- -------- -------
Net earnings to common shareholders......................... $ 29,425 $ 31,420 $11,368
======== ======== =======
Net earnings per common share -- basic...................... $ 4.51 $ 4.83 $ 2.18
Net earnings per common share -- diluted.................... $ 4.46 $ 4.79 $ 2.18
Weighted average common shares outstanding -- basic......... 6,518 6,504 5,223
Weighted average common shares outstanding -- diluted....... 6,591 6,556 5,223
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 96
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
NUMBER OF TOTAL
COMMON COMMON PAID IN RETAINED SHAREHOLDERS'
SHARES STOCK CAPITAL EARNINGS EQUITY
--------- ------- ------- -------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCES, DECEMBER 31, 1994.................. 255,257 $ 1,590 $ 8,014 $17,518 $ 27,122
Common stock issued........................ 5,935 59 720 -- 779
Common stock retired....................... (11,080) (111) (1,089) -- (1,200)
Net assets spun off to Combined Financial
Corporation............................. -- -- -- (5,352) (5,352)
Merger with First City Bancorporation of
Texas, Inc. (Note 2).................... 6,252,296 (1,473) 21,473 -- 20,000
Net earnings for 1995...................... -- -- -- 15,244 15,244
Preferred dividends........................ -- -- -- (3,876) (3,876)
Other...................................... -- -- 71 -- 71
--------- ------- ------- ------- --------
BALANCES, DECEMBER 31, 1995.................. 6,502,408 65 29,189 23,534 52,788
Exercise of warrants, options and employee
stock purchase plan..................... 10,938 -- 266 -- 266
Net earnings for 1996...................... -- -- -- 39,129 39,129
Preferred dividends........................ -- -- -- (7,709) (7,709)
Other...................................... -- -- 328 -- 328
--------- ------- ------- ------- --------
BALANCES, DECEMBER 31, 1996.................. 6,513,346.. 65 29,783 54,954 84,802
--------- ------- ------- ------- --------
Exercise of warrants, options and employee
stock purchase plan..................... 13,164 -- 318 -- 318
Change in subsidiary year end.............. -- -- -- (1,195) (1,195)
Net earnings for 1997, after minority
interest................................ -- -- -- 35,628 35,628
Preferred dividends........................ -- -- -- (6,203) (6,203)
Other...................................... -- -- (592) -- (592)
--------- ------- ------- ------- --------
BALANCES, DECEMBER 31, 1997.................. 6,526,510 $ 65 $29,509 $83,184 $112,758
========= ======= ======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 97
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings.............................................. $ 35,785 $ 39,129 $ 15,244
Adjustments to reconcile net earnings to net cash used in
operating activities, net of effect of acquisitions:
Proceeds from resolution of Portfolio Assets............ 87,138 70,940 44,760
Gain on resolution of Portfolio Assets.................. (24,183) (19,510) (11,984)
Purchase of Portfolio Assets............................ (38,367) (60,329) (42,727)
Origination of automobile receivables................... (89,845) (17,635) --
Gain on sale of mortgage servicing rights............... (4,246) (2,641) (2,011)
Increase in mortgage loans held for sale................ (396,599) (30,418) (67,690)
Increase in construction loans receivable............... (10,414) (7,370) (1,446)
Originated mortgage servicing rights.................... (40,734) (18,128) (3,950)
Purchases of mortgage servicing rights.................. (5,798) (3,075) (2,429)
Proceeds from sale of mortgage servicing rights......... 14,598 9,048 2,130
Provision for loan losses............................... 6,613 2,029 --
Equity in earnings of Acquisition Partnerships.......... (7,605) (6,125) (3,834)
Proceeds from performing Portfolio Assets............... 78,821 11,646 1,293
(Increase) decrease in net deferred tax asset........... (14,200) (14,235) 186
Depreciation and amortization........................... 11,791 8,791 6,200
Increase in other assets................................ (25,370) (18,554) (11,770)
Increase (decrease) in other liabilities................ 17,220 (344) 2,797
Adjustment to equity from change in subsidiary year
end................................................... (1,195) -- --
----------- ----------- -----------
Net cash used in operating activities.............. (406,590) (56,781) (75,231)
----------- ----------- -----------
Cash flows from investing activities, net of effect of
acquisitions:
Advances to Acquisition Partnerships...................... (50) (1,256) (9,755)
Payments on advances to Acquisition Partnerships.......... 1,029 9,821 169
Acquisition of subsidiaries............................... 1,118 (3,936) (7,753)
Proceeds from sales of and payments on loans held for
investment.............................................. 492 122 465
Repurchases of loans from investors....................... (5,983) (1,196) --
Principal payments on Class A Certificate................. 46,477 115,337 --
Property and equipment, net............................... (2,919) (2,530) (1,821)
Contributions to Acquisition Partnerships................. (25,282) (30,704) (3,583)
Distributions from Acquisition Partnerships............... 11,833 31,279 5,206
----------- ----------- -----------
Net cash provided by (used in) investing
activities....................................... 26,715 116,937 (17,072)
----------- ----------- -----------
Cash flows from financing activities, net of effect of
acquisitions:
Borrowings under notes payable............................ 9,196,377 4,105,451 1,137,662
Payments of notes payable................................. (8,777,337) (4,048,369) (1,056,179)
Payment of senior subordinated notes...................... -- (105,690) --
Additions to notes payable to shareholders and officers... -- -- 1,930
Reduction of notes payable to shareholders and officers... -- -- (1,843)
Capital contribution of FCBOT ............................ -- -- 20,000
Purchase of special preferred stock....................... (12,567) -- --
Proceeds from issuance of common stock.................... 318 266 779
Distributions to minority interest........................ (5,129) -- --
Preferred dividends paid.................................. (6,627) (9,647) --
Retirement of common stock................................ -- -- (1,200)
Other increases in paid in capital........................ -- 64 64
----------- ----------- -----------
Net cash provided by (used in) financing
activities....................................... 395,035 (57,925) 101,213
----------- ----------- -----------
Net increase in cash........................................ $ 15,160 $ 2,231 $ 8,910
Cash, beginning of year..................................... 16,445 14,214 5,304
----------- ----------- -----------
Cash, end of year........................................... $ 31,605 $ 16,445 $ 14,214
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest................................................ $ 37,284 $ 21,420 $ 10,476
=========== =========== ===========
Income taxes............................................ $ 852 $ 116 $ 1,000
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 98
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION
As more fully discussed in Note 2, 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. Historical financial
statements prior to the merger date reflect the financial position and results
of operations of J-Hawk Corporation. Additionally, the Company's merger with
Harbor Financial Group, Inc. ("Mortgage Corp.") on July 1, 1997 is accounted for
as a pooling of interests. The accompanying consolidated financial statements
are retroactively restated to reflect the pooling of interests.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include the estimation of future
collections on purchased portfolio assets used in the calculation of net gain on
resolution of portfolio assets, interest rate environments, prepayment speeds of
loans in servicing portfolios, collectibility on loans held in inventory and for
investment. Actual results could differ materially from those estimates.
(b) DESCRIPTION OF BUSINESS
The Company is a diversified financial services company with offices
throughout the United States, and a presence in France and Mexico. The Company
is engaged in three principal businesses: (i) residential and commercial
mortgage banking; (ii) portfolio asset acquisition and resolution; and (iii)
consumer lending.
The Company engages in the mortgage banking business through direct retail
and broker retail mortgage banking activities through which it originates,
purchases, sells and services residential and commercial mortgage loans
throughout the United States. Additionally the Company acquires, originates,
warehouses and securitizes mortgage loans to borrowers who have significant
equity in their homes and who generally do not satisfy the more rigid
underwriting standards of the traditional residential mortgage lending market
(referred to herein as "Home Equity Loans"). In addition to mortgage banking
activities, the Company performs other ancillary services such as residential
property management, property appraisal and inspection, portfolio/corporate
evaluations, risk management and hedging advisory services, marketing of loan
servicing portfolios, and mergers and acquisitions advisory services.
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. 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 the Company or its wholly-owned subsidiaries, and on
behalf of legally independent 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's consumer lending activities include the origination,
acquisition and servicing of sub-prime consumer loans principally secured by
automobiles with the intention of selling the acquired loans in securitization
transactions.
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.
F-7
<PAGE> 99
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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. 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.
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.
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 its 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
F-8
<PAGE> 100
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
(F) LOANS RECEIVABLE
Construction loans receivable consist of single-family residential
construction loans originated by the Company and are carried at the lower of
cost or market.
Loans held for investment include originated residential mortgage loans and
other loans made to third parties. Mortgage loans held for investment are
transferred to the investment category at the lower of cost or market on the
date of transfer. The mortgage loans consist principally of loans originated by
the Company which do not meet investor purchase criteria and loans repurchased
from mortgage-backed securities pools.
Automobile and consumer finance receivables consist of sub-prime automobile
finance receivables and student loan receivables, which are originated and
acquired from third party dealers and other originators, purchased at a
non-refundable discount from the contractual principal amount. This discount is
allocated between discount available for loan losses and discount available for
accretion to interest income. Discounts allocated to discounts available for
accretion are 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 4). 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.
(G) MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale include the market value of related hedge
contracts and are stated at the lower of cost or market value, as determined by
outstanding commitments from investors on an aggregate portfolio basis. Any
differences between the carrying amounts and the proceeds from sales are
credited or charged to operations at the time the sale proceeds are collected.
Loan origination fees and certain direct loan origination costs are
deferred until the related loan is sold. Discounts from origination of mortgage
loans held for sale are deferred and recognized as adjustments to gain or loss
upon sale. Loan servicing income represents fees earned for servicing loans
owned by investors. The fees generally are based on a contractual percentage of
the outstanding principal balance. Fees are recorded as income when cash
payments are received. Loan servicing costs are charged to expense as incurred.
(H) MORTGAGE SERVICING RIGHTS
The Company accounts for mortgage servicing rights in accordance with the
provisions of SFAS No. 122 ("Statement 122"), Accounting for Mortgage Servicing
Rights, an Amendment of FASB Statement No. 65.
F-9
<PAGE> 101
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Statement 122 requires a mortgage banking enterprise to recognize, as separate
assets, the rights to service mortgage loans for others, regardless of how those
servicing rights are acquired. This statement also requires that these
capitalized mortgage servicing rights be assessed for impairment based on the
fair value of those rights. In assessing impairment, the mortgage servicing
rights capitalized after adoption of Statement 122 are to be stratified based on
one or more of the predominant risk characteristics of the underlying loans.
Impairment is to be recognized through a valuation allowance for each impaired
stratum.
Mortgage servicing rights are recorded at the lower of cost or present
value of the estimated net future servicing income. The recorded cost is
amortized in proportion to, and over the period of, estimated future servicing
income adjusted to reflect the effect of prepayments received and anticipated.
The carrying value of mortgage servicing rights is stratified into pools based
on loan type and note rate. The fair value of each pool is evaluated in relation
to the estimated future discounted net servicing income over the estimated
remaining loan lives.
When mortgage loans are sold with servicing retained and the stated
servicing fee rate differs materially from the normal servicing fee rate, the
sales price is adjusted for this excess servicing for purposes of determining
gain or loss on the sale to provide for the recognition of a reduced servicing
fee in subsequent years. The adjustment approximates the present value of the
difference between the normal and stated servicing fees over the estimated life
of the mortgage loans. The capitalized excess fees are amortized in proportion
to, and over the period of, estimated net servicing income.
SFAS No. 125 ("Statement 125"), Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities, provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of a
financial-components approach that focuses on control of assets and liabilities.
Under this approach, after a transfer, an entity recognizes all financial and
servicing assets it controls and liabilities it has incurred and derecognizes
financial assets it no longer controls and liabilities that have been
extinguished. Statement 125 is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after December 31,
1996, and is to be applied prospectively. The Company adopted Statement 125
effective January 1, 1997. Adoption of Statement 125 did not have a material
impact on the consolidated financial position or results of operations of the
Company.
(I) PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation
and are included in other assets. Depreciation is provided using accelerated
methods over the estimated useful lives of the assets.
(J) RECEIVABLE FOR SERVICING ADVANCES
Funds advanced for escrow, foreclosure and other investor requirements are
recorded as receivables and a loss provision is recorded for estimated
uncollectible amounts. An allowance for losses is provided for potential losses
on loans serviced for others that are in the process of foreclosure or may be
reasonably expected to be foreclosed in the future.
(K) PREPAID COMMITMENT FEES
Prepaid commitment fees are included in other assets and represent fees
paid primarily to permanent investors for the right to deliver mortgage loans in
the future at a specified yield. These fees are recognized as expense when the
loans are sold to permanent investors, when the commitment expires, or when it
is determined that loans will not be delivered under the commitment. Deferred
gains or losses are included in the carrying amount of the loans being hedged,
which are valued at the lower of aggregate cost or market value.
F-10
<PAGE> 102
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(L) 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.
(M) 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 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 EARNINGS PER COMMON SHARE
The Company adopted the provisions of SFAS No. 128, Earnings Per Share,
which revised the previous calculation methods and presentation of earnings per
share in the fourth quarter of 1997. Basic net earnings per common share
calculations are based upon the weighted average number of common shares
outstanding restated to reflect the equivalent number of shares of the Company's
common stock that were issued to the J-Hawk Corporation shareholders in
connection with the Merger and the Harbor Merger discussed in Note 2. Earnings
included in the earnings 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 earnings per
common share calculations.
(O) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of SFAS No. 121, ("Statement 121"),
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of, on January 1, 1996. Statement 121 requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment 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 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. Adoption of Statement 121 did not have a material impact on the
consolidated financial position or results of operations of the Company.
(P) RECLASSIFICATIONS
Certain amounts in the financial statements for prior periods have been
reclassified to conform with current financial statement presentation.
F-11
<PAGE> 103
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) MERGERS AND ACQUISITIONS
A Joint Plan of Reorganization by First City Bancorporation of Texas, Inc.
("FCBOT"), Official Committee of Equity Security Holders, and J-Hawk Corporation
("J-Hawk"), with the Participation of Cargill Financial Services Corporation
("Cargill Financial"), Under Chapter 11 of the United States Bankruptcy Code,
(the "Plan of Reorganization"), became effective on July 3, 1995. Pursuant to
the Plan of Reorganization and an Agreement and Plan of Merger (collectively
referred to as the "Plan") between FCBOT and J-Hawk, on July 3, 1995, J-Hawk was
merged (the "Merger") with and into FCBOT. Pursuant to the Merger, (i) the
former holders of common stock of J-Hawk received, in the aggregate,
approximately 49.9% of the outstanding common stock of the surviving entity, in
exchange for their shares of J-Hawk common stock, (ii) 2,460,911 shares or
approximately 50.1% of the outstanding common stock of the surviving entity was
distributed among former security holders of FCBOT pursuant to the Plan, and
(iii) the name of the corporation was changed to FirstCity Financial
Corporation. As a result of the implementation of the Plan and the consummation
of the Merger, FirstCity also issued (i) 9% senior subordinated notes (all of
which have been redeemed), (ii) warrants to purchase 500,000 shares of its
common stock at an exercise price of $25 per share, and (iii) special preferred
stock to certain former security holders of FCBOT.
J-Hawk contributed substantially all of its interests in its Acquisition
Partnerships, all of its servicing operations, substantially all of its
leasehold improvements and equipment and its entire management team to
FirstCity. All remaining assets and liabilities of J-Hawk were spun out to
Combined Financial Corporation (owned by the former J-Hawk shareholders) in June
1995. The common stock of J-Hawk was converted into 2,460,511 shares of
FirstCity common stock. FCBOT contributed $20 million in cash to FirstCity.
While the transaction was legally structured as a merger, substantively, the
transaction has been treated for accounting purposes as a purchase of FCBOT by
J-Hawk. The net assets of J-Hawk spun out to Combined Financial Corporation were
as follows:
<TABLE>
<CAPTION>
<S> <C>
Cash and equivalents........................................ $ 232
Purchased asset pools....................................... 12,375
Other assets................................................ 2,839
Notes payable............................................... (8,187)
Payable to stockholders and officers........................ (1,669)
Other liabilities........................................... (238)
-------
Net assets spun out............................... $ 5,352
=======
</TABLE>
Pursuant to the Plan, substantially all of the legal and beneficial
interest in the assets of FCBOT, other than the $20 million in cash contributed
to FirstCity, were transferred to the newly-formed FirstCity Liquidating Trust
(the "Trust"), or to subsidiaries of the Trust. Such assets are being liquidated
over the life of the Trust pursuant to the terms thereof. FirstCity, as the sole
holder of the Class A Certificate of the Trust (the "Class A Certificate"),
received from the Trust amounts sufficient to pay certain expenses and its
obligations under the 9% senior subordinated notes and the special preferred
stock. The liquidation of the assets transferred to the Trust was managed by the
Company pursuant to an Investment Management Agreement between the Trust and the
Company. In the first quarter of 1997, the Investment Management Agreement was
terminated and the Company received $6.8 million.
F-12
<PAGE> 104
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On September 21, 1995, the Company acquired the capital stock of
Diversified Financial Systems, Inc. and Diversified Performing Assets, Inc.
(collectively, "Diversified") for $12.9 million in cash, notes and additional
contingent consideration payable in the form of "cash flow" notes. The aggregate
purchase price was allocated to the net assets of Diversified based upon fair
value at acquisition date as follows (dollars in thousands):
<TABLE>
<S> <C>
Purchased asset pools....................................... $ 68,834
Intangibles................................................. 9,379
Other assets................................................ 414
Notes payable............................................... (63,515)
Other liabilities........................................... (2,196)
--------
Purchase price, net of cash received........................ $ 12,916
========
</TABLE>
At December 31, 1996, the Company reflected a liability of $3.1 million to
a former shareholder related to such cash flow notes in a transaction accounted
for as a purchase and a note receivable from the same shareholder in the amount
of $1 million. In 1997, the Company entered into a modified note agreement with
the former shareholder providing for an amended note payable in the amount of
$5.4 million. The modified note agreement extinguishes the Company's liability
for any amounts due related to the cash flow notes and acts to off-set the note
receivable from the former shareholder. The additional net liability resulting
from this modification was reflected as an adjustment to goodwill in the
Company's 1997 consolidated balance sheet.
On July 1, 1997, the Company merged with Mortgage Corp. (the "Harbor
Merger"). The Company issued 1,580,986 shares of its common stock in exchange
for 100% of Mortgage Corp.'s outstanding capital stock in a transaction
accounted for as a pooling of interests. Mortgage Corp. originates and services
residential and commercial mortgage loans. Mortgage Corp. had approximately $12
million in equity, assets of over $300 million and 700 employees prior to the
Harbor Merger. The consolidated financial statements of the Company have been
restated to reflect the Harbor Merger as if it occurred on January 1, 1995.
Prior to the Harbor Merger, Mortgage Corp.'s fiscal year end was September 30.
During 1997, the year end of Mortgage Corp. and its subsidiaries was changed to
conform with the year end of the Company. Accordingly, the consolidated balance
sheet as of December 31, 1996 and the consolidated statements of income,
shareholders' equity and cash flows for the years ended December 31, 1996 and
1995 include information and contain the accounts of Mortgage Corp. and its
subsidiaries as of September 30, 1996 and for the years ended September 30, 1996
and 1995.
On May 15, 1996, Mortgage Corp. acquired for $3.6 million all of the
outstanding common stock of Hamilton Financial Services Corporation ("Hamilton")
and subsidiaries in a transaction accounted for as a purchase. The assets and
liabilities assumed have been recorded at their fair values effective May 1,
1996. No goodwill was recorded as a result of the acquisition. The Company's
consolidated financial statements include the results of operations and cash
flows of Hamilton since the acquisition date. Because the assets acquired by
Mortgage Corp. are immaterial to the consolidated financial position or results
of operations of the Company, the presentation of pro forma results of
operations of the Company and Hamilton for periods prior to the acquisition
would not be meaningful.
On May 15, 1997, Mortgage Corp. acquired substantially all of the assets of
MIG Financial Corporation ("MIG"), MIG's $1.7 billion commercial mortgage
servicing portfolio, and MIG's commercial mortgage operations headquartered in
Walnut Creek, California for an aggregate purchase price of $4 million plus the
assumption of certain liabilities in a transaction accounted for as a purchase.
The assets purchased consisted of servicing rights, fixed assets and the
business relationships of MIG. MIG's asset revenues and historical earnings are
insignificant to the total assets and results of operations of the Company. The
transaction was accounted for as a purchase. MIG originated about $400 million
in commercial mortgage loans in 1996. The
F-13
<PAGE> 105
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
transaction was funded by $1.3 million of senior debt and $2.6 million of
subordinated debt. The Company provided the $2.6 million subordinated loan in
connection with such transaction. The terms of the loan reflected market terms
for comparable loans made on an arms'-length basis.
The Company's net revenues, net earnings to common shareholders and net
earnings per common share, for the six months ended June 30, 1997 and each of
the years in the two-year period ended December 31, 1996, before and after the
Harbor Merger are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED
SIX MONTHS DECEMBER 31,
ENDED -----------------
JUNE 30, 1997 1996 1995
------------- ------- -------
<S> <C> <C> <C>
Net revenues (including equity earnings):
Before 1997 pooling................................. $34,838 $61,469 $39,523
1997 pooling........................................ 29,830 37,620 20,442
After 1997 pooling.................................. 64,668 99,089 59,965
Net earnings to common shareholders:
Before 1997 pooling................................. $ 8,966 $27,696 $10,857
1997 pooling........................................ 1,447 3,724 511
After 1997 pooling.................................. 10,413 31,420 11,368
Net earnings per common share -- diluted:
Before 1997 pooling................................. $ 1.79 $ 5.57 $ 2.98
1997 pooling........................................ (0.21) (0.78) (0.80)
After 1997 pooling.................................. 1.58 4.79 2.18
</TABLE>
(3) PORTFOLIO ASSETS
Portfolio Assets are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
-------- ---------
<S> <C> <C>
Non-performing Portfolio Assets............................. $130,657 $ 302,239
Performing Portfolio Assets................................. 16,131 13,986
Real estate Portfolios...................................... 22,777 25,303
-------- ---------
Total Portfolio Assets............................ 169,565 341,528
Discount required to reflect Portfolio Assets at carrying
value..................................................... (79,614) (265,288)
-------- ---------
Portfolio Assets, net............................. $ 89,951 $ 76,240
======== =========
</TABLE>
Portfolio Assets are pledged to secure non-recourse notes payable.
(4) LOANS RECEIVABLE
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Construction loans receivable............................... $19,594 $ 8,816
Residential mortgage loans held for investment.............. 6,386 1,097
Automobile and consumer finance receivables................. 73,417 34,090
Allowance for loan losses................................... (9,282) (2,693)
------- -------
Loans receivable, net..................................... $90,115 $41,310
======= =======
</TABLE>
F-14
<PAGE> 106
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:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
Balances, beginning of year................................. $ 2,693 $ --
Provision for loan losses................................. 6,613 2,029
Discounts acquired........................................ 13,152 5,989
Reduction in contingent liabilities....................... 458 1,415
Other (allocation of reserves to sold loans).............. (1,363) --
Charge off activity:
Principal balances charged off......................... (15,126) (7,390)
Recoveries............................................. 2,855 650
-------- -------
Net charge offs...................................... (12,271) (6,740)
-------- -------
Balances, end of year....................................... $ 9,282 $ 2,693
======== =======
</TABLE>
During 1997 and 1996, a note recorded at the time of original purchase of
the initial automobile finance receivables pool and contingent on the ultimate
performance of the pool was adjusted to reflect a reduction in anticipated
payments due pursuant to the contingency. The reductions in the recorded
contingent liability were recorded as increases in the allowance for losses.
(5) MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale include loans collateralized by first lien
mortgages on one-to-four family residences as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Residential mortgage loans.................................. $522,970 $132,193
Unamortized premiums and discounts.......................... 10,781 2,155
-------- --------
$533,751 $134,348
======== ========
</TABLE>
(6) INVESTMENTS IN ACQUISITION PARTNERSHIPS
The Company has investments in Acquisition Partnerships and their general
partners that are accounted for on the equity method. Acquisition Partnerships
invest in Portfolio Assets in a manner similar to the Company, as described in
Note 1. The condensed combined financial position and results of operations of
the Acquisition Partnerships, which include the domestic and foreign Acquisition
Partnerships and their general partners, are summarized below:
CONDENSED COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Assets...................................................... $338,484 $240,733
======== ========
Liabilities................................................. $250,477 $144,094
Net equity.................................................. 88,007 96,639
-------- --------
$338,484 $240,733
======== ========
Company's equity in Acquisition Partnerships................ $ 35,529 $ 21,761
======== ========
</TABLE>
F-15
<PAGE> 107
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED COMBINED SUMMARY OF EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Proceeds from resolution of Portfolio Assets....... $178,222 $174,012 $188,934
Gross margin....................................... 33,398 39,505 51,370
Interest income on performing Portfolio Assets..... 8,432 7,870 --
Net earnings....................................... $ 20,117 $ 10,692 $ 9,542
======== ======== ========
Company's equity in earnings of Acquisition
Partnerships..................................... $ 7,605 $ 6,125 $ 3,834
======== ======== ========
</TABLE>
In the third quarter of 1996, the Company recognized $2.0 million in
servicing fees in connection with the sale and securitization of $75 million of
performing loans from the Acquisition Partnerships. During the third quarter of
1996, a majority of the debt of the Acquisition Partnerships was refinanced,
resulting in a $7 million equity distribution to the Company.
(7) CLASS A CERTIFICATE
The Company was the sole holder of the Class A Certificate. Distributions
from the Trust in respect of the Class A Certificate were used to retire the
senior subordinated notes payable. Pursuant to a June 1997 agreement with the
Trust, the Trust's obligation to the Company under the Class A Certificate was
terminated (other than the Trust's obligation to reimburse the Company for
certain expenses) in exchange for the Trust's agreement to pay the Company an
amount equal to $22.75 per share for the 1,923,481 outstanding shares of the
Company's special preferred stock at June 30, 1997, the 1997 second quarter
dividend of $.7875 per share, and 15% interest from June 30, 1997 on any unpaid
portion of the settlement amount. In 1997, the Company paid dividends of $5.1
million on special preferred stock and purchased 537,430 shares (representing
$11.3 million in liquidation preference) of special preferred stock with
distributions from the Trust. The Trust has distributed $44.1 million to the
Company as full satisfaction of the June 1997 agreement.
(8) MORTGAGE SERVICING RIGHTS AND DEFERRED EXCESS SERVICING FEES
Mortgage servicing rights and deferred excess servicing fees consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Mortgage servicing rights................................... $ 87,742 $ 46,814
Deferred excess servicing fees.............................. 5,929 2,791
-------- --------
93,671 49,605
Accumulated amortization.................................... (23,489) (15,640)
-------- --------
70,182 33,965
Valuation allowance......................................... (548) (448)
-------- --------
$ 69,634 $ 33,517
======== ========
</TABLE>
F-16
<PAGE> 108
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) NOTES PAYABLE
Notes payable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Collateralized loans, secured by Portfolio Assets:
Fixed rate (7.66% at December 31, 1997), due 2002......... $ 79,206 $ --
Prime (8.25% at December 31, 1996) plus 3.00% to 5.00%.... -- 37,491
French franc LIBOR (3.5156% at December 31, 1997) plus
4.00%, due 1998........................................ 8,301
LIBOR (5.9637% at December 31, 1997) plus 4.00% to 5.00%,
due 1998............................................... 3,259 7,947
Collateralized loans, secured by automobile finance
receivables:
LIBOR (5.9637% at December 31, 1997) plus 3.00%, due
1998................................................... 50,006 25,329
Residential mortgage warehouse lines of credit, secured by
individual notes:
LIBOR (5.9637% at December 31, 1997) plus .50 to 2.50%,
due 1998............................................... 337,598 148,579
Fed Funds (6.75% at December 31, 1997) plus .80 to 1.0%,
due 1998............................................... 187,141 --
Repurchase agreements (5.9637% at December 31, 1997) plus
0.85%, due 1998........................................ 35,826 --
Other notes payable, secured by substantially all the assets
of Mortgage Corp.:
LIBOR (5.9637% at December 31, 1997) plus 2.25%, due
2002................................................... 38,000 20,000
Borrowings under revolving line of credit, secured and with
recourse to the Company................................... 6,994 19,384
Other secured borrowings, secured by fixed assets........... 849 2,689
-------- --------
Notes payable, secured.................................... 747,180 261,419
Notes payable to others (Diversified shareholder debt) 7%,
due 2003............................................... 3,601 4,747
-------- --------
$750,781 $266,166
======== ========
</TABLE>
The Company has a $35 million revolving line of credit with Cargill
Financial. The line bears interest at LIBOR plus 5% and expires on March 28,
1998. The line is secured by substantially all of the Company's unencumbered
assets.
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. The
Company was in compliance with all covenants at December 31, 1997. At December
31, 1997, cash restricted pursuant to loan covenants totaled $2.1 million. The
aggregate maturities of notes payable for the five years ending December 31,
2002 are as follows: $627,693 in 1998, $11,409 in 1999, $10,671 in 2000, $11,240
in 2001 and $89,693 in 2002.
F-17
<PAGE> 109
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) MORTGAGE SERVICING PORTFOLIO AND RELATED OFF-BALANCE SHEET CREDIT RISK, AND
INSURANCE COVERAGE
At December 31, 1997, a substantial portion of the Company's loan
production activity and collateral for loans serviced is concentrated within the
states of Texas and California. The Company's mortgage servicing portfolio is
comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Number of loans (in thousands).............................. 62 52
Aggregate principal balance................................. $6,688,452 $3,947,028
Related escrow funds........................................ $ 32,708 $ 49,462
</TABLE>
The above table includes subserviced mortgage loans of approximately $707
million and $835 million at December 31, 1997 and 1996, respectively.
The Company is required to advance, from corporate funds, escrow and
foreclosure costs for loans which it services. A portion of these advances for
loans serviced for GNMA are not recoverable. As of December 31, 1997 and 1996,
reserves for unrecoverable advances of approximately $357 and $232,
respectively, were established for GNMA loans in default.
Upon foreclosure, an FHA/VA property is typically conveyed to HUD or the
VA. However, the VA has the authority to deny conveyance of the foreclosed
property to the VA (a "VA no-bid"). The VA, instead, reimburses the Company
based on a percentage of the loan's outstanding principal balance ("guarantee"
amount). For GNMA VA no-bids, the foreclosed property is conveyed to the Company
and the Company then assumes the market risk of disposing of the property. The
related allowance for GNMA VA loans in default for potential no-bid losses as of
December 31, 1997 and 1996, is included in the allowance for unrecoverable
advances described above.
The Company is servicing approximately $11.2 million in loans with recourse
to Mortgage Corp. on behalf of FNMA and other investors. The recourse obligation
is the result of servicing purchases by Mortgage Corp. pursuant to which
Mortgage Corp. assumed the recourse obligation. As a result, Mortgage Corp. is
obligated to repurchase those loans that ultimately foreclose.
In addition, Mortgage Corp. has issued various representations and
warranties associated with whole loan and bulk servicing sales. The
representations and warranties may require Mortgage Corp. to repurchase
defective loans as defined by the applicable servicing and sales agreements.
Mortgage Corp. and its subsidiaries originated and purchased mortgage loans
with principal balances totaling approximately $3.7 billion, $1.8 billion and
$.7 billion, respectively, in 1997, 1996 and 1995. Errors and omissions and
fidelity bond insurance coverage under a mortgage banker's bond was $4.5 million
at December 31, 1997 and 1996.
(11) PREFERRED STOCK AND SHAREHOLDERS' EQUITY
The authorized capital stock of the Company consists of the following: (1)
2.5 million shares of special preferred stock, par value $.01 per share, with a
nominal stated value of $21.00 per share; (2) 2 million shares of adjusting rate
preferred stock, par value $.01 per share, with a redemption value of $21.00 per
share; (3) 98 million shares of optional preferred stock, par value $.01 per
share; and (4) 100 million shares of common stock, par value $.01 per share.
Additionally, on July 3, 1995, under the Plan, the Company authorized the
issuance of up to 500,000 warrants to purchase common stock to certain of FCBOT
shareholders. In connection with the Merger, 4,921,422 shares of common stock,
2,460,911 shares of special preferred stock and 500,000 warrants to purchase
common stock were issued.
F-18
<PAGE> 110
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
The holders of special preferred stock are entitled to receive the nominal
stated value on September 30, 1998, and cumulative quarterly cash dividends at
the annual rate of $3.15 per share. Accrued dividends through September 30, 1996
of $9.6 million, or $3.92 per share, were paid in 1996. Dividends of $5.8
million, or $3.15 per share, were paid in 1997. At December 31, 1997, accrued
dividends totaled $.7 million, or $.7875 per share, and were paid on January 15,
1998. In 1997, the Company purchased 537,430 shares (representing $11.3 million
in liquidation preference) of special preferred stock with a distribution from
the Trust. The special preferred stock carries no voting rights, except in the
event of non-payment of declared dividends.
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 of special preferred stock were accepted for exchange for a like number
of shares of adjusting rate preferred stock. Dividends of $.8 million, or $.7875
per share, were paid in 1997 and additional dividends of $.8 million, or $.7875
per share were accrued at December 31, 1997 (paid on January 15, 1998).
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.
Each warrant entitles the holder to purchase one share of common stock at
an exercise price of $25.00 per share, subject to adjustment in certain
circumstances, and expires on July 3, 1999. The Company may repurchase the
warrants for $1.00 per warrant should the quoted market price of the Company's
common stock exceed $31.25 for any 10 out of 15 consecutive trading days. During
1997 and 1996, 106 and 2,625 warrants, respectively, were exercised, with
497,269 warrants outstanding at December 31, 1997.
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
1997 and 1996 was $19.14 and $13.19, respectively, on the grant date using the
Black-Scholes option pricing model with the following assumptions: 1997 -- $0
expected dividend yield, risk-free interest rate of 6.46%, expected volatility
of 30%, and an expected life of 10 years; 1996 -- $0 expected dividend yield,
risk-free interest rate of 5.75%, expected volatility of 30%, and an expected
life of 9.7 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 earnings
F-19
<PAGE> 111
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to common shareholders and net earnings per common share would have been reduced
to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Net earnings to common shareholders:
As reported............................................... $29,425 $31,420
Pro forma................................................. 28,263 30,707
Net earnings per common share -- diluted:
As reported............................................... $ 4.46 $ 4.79
Pro forma................................................. 4.29 4.68
</TABLE>
Stock option activity during the periods indicated is as follows:
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
------- -------- ------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year.............. 223,100 $21.07 229,600 $20.20
Granted....................................... 125,200 26.47 18,000 30.75
Exercised..................................... (4,750) 20.00 (4,500) 20.00
Forfeited..................................... (29,250) 25.91 (20,000) 20.00
------- -------
Outstanding at end of year.................... 314,300 $22.64 223,100 $21.07
======= =======
</TABLE>
At December 31, 1997, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $20.00 -- $30.75 and 7
years, respectively.
At December 31, 1997, there were 87,710 options exercisable with a
weighted-average exercise price of $20.25.
The Company has an employee stock purchase plan which allows employees to
acquire an aggregate of 100,000 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, 8,308 shares were issued in 1997 and 3,813
shares were issued during 1996. At December 31, 1997, an additional 87,879
shares of common stock are available for issuance pursuant to the plan.
Earnings per share ("EPS") has been calculated in conformity with SFAS No.
128, Earnings Per Share, and all prior periods have been restated. A
reconciliation between the weighted average shares outstanding used in the basic
and diluted EPS computations is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net earnings to common shareholders.............. $ 29,425 $ 31,420 $ 11,368
========== ========== ==========
Weighted average common shares
outstanding -- basic........................... 6,517,716 6,504,065 5,223,021
Effect of dilutive securities:
Assumed exercise of stock options.............. 48,824 45,467 --
Assumed exercise of warrants................... 24,672 6,392 --
---------- ---------- ----------
Weighted average common shares
outstanding -- diluted......................... 6,591,212 6,555,924 5,223,021
========== ========== ==========
Net earnings per common share -- basic........... $ 4.51 $ 4.83 $ 2.18
Net earnings per common share -- diluted......... $ 4.46 $ 4.79 $ 2.18
</TABLE>
F-20
<PAGE> 112
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) INCOME TAXES
Income tax expense (benefit) consists of:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997 1996 1995
-------- -------- ------
<S> <C> <C> <C>
Federal and state current expense...................... $ 1,231 $ 2,751 $1,264
Federal deferred expense (benefit)..................... (16,716) (16,500) (64)
-------- -------- ------
Total........................................ $(15,485) $(13,749) $1,200
======== ======== ======
</TABLE>
The actual income tax expense (benefit) attributable to earnings from
operations differs from the expected tax expense (computed by applying the
federal corporate tax rate of 35% to earnings from operations before income
taxes) as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Computed expected tax expense......................... $ 7,105 $ 8,883 $ 5,755
Increase (reduction) in income taxes resulting from:
Tax effect of Class A Certificate................... (1,243) (4,060) (3,009)
Change in valuation allowance....................... (23,388) (18,616) (1,522)
Alternative minimum tax and state income tax........ 1,646 -- --
REMIC excess inclusion income....................... 266 -- --
Other............................................... 127 44 (24)
-------- -------- -------
$(15,485) $(13,749) $ 1,200
======== ======== =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at December 31, 1997 and 1996, are as
follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Deferred tax assets:
Investments in Acquisition Partnerships, principally due
to differences in basis for tax and financial reporting
purposes............................................... 1,453 $ 403
Intangibles, principally due to differences in
amortization........................................... 1,317 1,138
Book loss reserve greater than tax loss reserve........... (1,200) 849
Tax basis in fixed assets greater than book............... 255 255
Federal net operating loss carryforward................... 213,028 210,681
Valuation allowance....................................... (168,971) (192,360)
--------- ---------
Total deferred tax assets......................... 45,882 20,966
Deferred tax liabilities:
Book basis in servicing rights greater than tax basis..... (15,231) (7,031)
Other, net................................................ (37) (37)
--------- ---------
Total deferred tax liabilities.................... 15,268 (7,068)
--------- ---------
Net deferred tax asset...................................... $ 30,614 $ 13,898
========= =========
</TABLE>
As a result of the Merger described in Note 2, the Company has net
operating loss carryforwards for federal income tax purposes of approximately
$608 million at December 31, 1997, available to offset future federal taxable
income, if any, through the year 2012. A valuation allowance is provided to
reduce the deferred tax assets to a level which, more likely than not, will be
realized. During 1997 and 1996, the Company adjusted the previously established
valuation allowance to recognize a deferred tax benefit of $23.4 million. The
ultimate realization of the resulting net deferred tax asset is dependent upon
generating sufficient taxable
F-21
<PAGE> 113
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
primarily an increase in the estimate of the future taxable income during the
carryforward period since the prior year end and the 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.
(13) 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 maximum. The Company's
contributions to the 401(k) plan were $603 in 1997, $407 in 1996 and $226 in
1995.
(14) LEASES
The Company leases its current headquarters from a related party under a
noncancelable operating lease. The lease calls for monthly payments of $7.5
through its expiration in December 2001 and includes an option to renew for two
additional five-year periods. Rental expense for 1997, 1996 and 1995 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 2004. Rental expense
under these leases for 1997, 1996 and 1995 was $4.1 million, $2.3 million and
$1.5 million, respectively. As of December 31, 1997, the future minimum lease
payments under all noncancelable operating leases are: $4,992 in 1998, $4,326 in
1999, $2,234 in 2000, $1,486 in 2001 and $1,360 in 2002 and beyond.
The Company has subleased various office space. These sublease agreements
primarily relate to leases assumed in the acquisition of Hamilton. Future
minimum rentals to be received under noncancelable operating leases are $1,109,
$1,036 and $227 for the years 1998, 1999 and 2000, respectively.
(15) MORTGAGE LOAN PIPELINE, HEDGES, AND RELATED OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business through the origination and selling of mortgage
loans. The risks are associated with fluctuations in interest rates. The
financial instruments include commitments to extend credit, mandatory forward
contracts, and various hedging instruments. The instruments involve, to varying
degrees, interest rate risk in excess of the amount recognized in the
consolidated financial statements.
The Company's mortgage loan pipeline as of December 31, 1997, totaled
approximately $1.6 billion. The Company's exposure to loss in the event of
nonperformance by the party committed to purchase the mortgage loan is
represented by the amount of loss in value due to increases in interest rates on
its fixed rate commitments. The pipeline consists of approximately $300 million
of fixed rate commitments and $1.3 billion of floating rate obligations. The
floating rate commitments are not subject to significant interest rate risk.
Management believes that the Company had adequate lines of credit at December
31, 1997 to fund its projected loan closings from its mortgage loan pipeline.
The Company uses a variety of methods to hedge the interest rate risk of
the mortgage loans in the pipeline that are expected to close and the mortgage
loans held for sale. Mandatory forward commitments to sell whole loans and
mortgage-backed securities are the Company's primary hedge instruments. At
December 31, 1997, the Company had approximately $423 million of mandatory
forward commitments to sell. To the
F-22
<PAGE> 114
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
extent mortgage loans at the appropriate rates are not available to fill these
commitments, the Company has interest rate risk due primarily to the impact of
interest rate fluctuations on its obligations to fill forward commitments.
The Company's mortgage loan pipeline and mandatory forward commitments are
included in the lower of cost or market value calculation of mortgage loans held
for sale.
(16) OTHER RELATED PARTY TRANSACTIONS
During 1996, the Company acquired a portfolio of sub-prime automobile
finance receivables from an Acquisition Partnership for approximately $23.6
million. This acquisition was at the carrying value of the Portfolio in the
Acquisition Partnership, thus resulting in no gain or loss on the transaction to
the Acquisition Partnership.
In January 1995, the Company entered into an agreement with a shareholder
to repurchase 11,080 shares of J-Hawk common stock for $1.2 million. The Company
paid the former shareholder $.4 million in cash and issued a $.8 million note,
which was assumed by Combined Financial Corporation, an affiliated entity, prior
to the Merger.
In 1995, the Company sold approximately $12 million (allocated cost) of
loans to a partnership owned by certain executive officers of J-Hawk. The
Company recognized approximately $3 million in gain from the transaction.
Additionally, the Company entered into a servicing arrangement with the
partnership to service the sold assets for a fee based on collections.
The Company has contracted with the Trust, the Acquisition Partnerships and
related parties as a third party loan servicer. Servicing fees totaling $12.1
million, $12.5 million and $10.9 million for 1997, 1996 and 1995, respectively,
and due diligence fees (included in other income) were derived from such
affiliates.
During 1997, the Company, along with selected Acquisition Partnerships,
sold certain assets to an entity 80% owned by the Company. The gain on the sale
of the assets was deferred and is being recognized as the assets are ultimately
resolved.
(17) COMMITMENTS AND CONTINGENCIES
The Company is 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 consolidated financial condition,
results of operations or liquidity of the Company.
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, 1997, advances of $.2 million had
been made under the obligation.
(18) 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 AND CLASS A CERTIFICATE
The carrying amount of cash and cash equivalents and the Class A
Certificate approximated fair value at December 31, 1997 and 1996.
F-23
<PAGE> 115
FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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 $180 million
and $118 million, respectively, at December 31, 1997 and 1996. The estimated
fair value of the Portfolio Assets and loans receivable was approximately $199
million and $134 million, respectively, at December 31, 1997 and 1996.
(C) MORTGAGE LOANS HELD FOR SALE
Market values of loans held for sale are generally based on quoted market
prices or dealer quotes. The carrying value of mortgage loans held for sale was
$534 million and $134 million, respectively, at December 31, 1997 and 1996. The
estimated fair value of mortgage loans held for sale approximated their carrying
value at December 31, 1997 and 1996.
(D) 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, 1997 and 1996 approximate the market terms for similar credit instruments.
Accordingly, the carrying amount of notes payable is believed to approximate
fair value.
(E) REDEEMABLE PREFERRED STOCK
Redeemable preferred stock is carried at redemption value plus accrued but
unpaid dividends. Carrying values were $41,908 and $53,617 at December 31, 1997
and 1996, respectively. Fair market values based on quoted market rates were
$42,048 and $59,062 at December 31, 1997 and 1996, respectively.
F-24
<PAGE> 116
No dealer, salesperson or other person has been authorized to give any
information or to make any representation other than those contained in this
Prospectus, and, if given or made, such information or representation must not
be relied upon as having been authorized. This Prospectus does not constitute an
offer to sell or the solicitation of an offer to buy any securities other than
the securities to which it relates or any offer to sell or the solicitation of
an offer to buy such securities in any circumstances in which such offer or
solicitation is unlawful. Neither the delivery of this Prospectus nor any sale
made hereunder shall, under any circumstances, create any implication that there
has been no change in the affairs of the Company since the date hereof or that
the information contained herein is correct as of any time subsequent to the
date hereof.
------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary............................... 3
Forward-Looking Statements............ 10
Risk Factors.......................... 10
Use of Proceeds....................... 20
Price Range of Common Stock and
Dividend Policy..................... 20
Capitalization........................ 21
Selected Financial and Other
Information......................... 22
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 24
Business.............................. 46
Management............................ 77
Principal and Selling Shareholders.... 80
Transferability and Ownership of
Capital Stock....................... 82
Shares Eligible for Future Sale....... 83
Certain Federal Income Tax
Considerations...................... 84
Underwriting.......................... 88
Legal Matters......................... 89
Experts............................... 89
Available Information................. 89
Incorporation of Certain Documents by
Reference........................... 90
Index to Financial Statements......... F-1
</TABLE>
1,341,000 SHARES
LOGO
COMMON STOCK
-----------------------
PROSPECTUS
-----------------------
PIPER JAFFRAY INC.
THE ROBINSON-HUMPHREY
COMPANY
SANDLER O'NEILL &
PARTNERS, L.P.
, 1998
<PAGE> 117
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee......... $14,137
NASD filing fee............................................. 5,166
Printing and engraving costs................................ 100,000
Accountants' fees........................................... 50,000
Legal fees.................................................. 275,000
Transfer agent and registrar fees........................... 5,000
Miscellaneous............................................... 50,697
--------
Total..................................................... $500,000
========
</TABLE>
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Certificate of Incorporation provides that no director of the Company
shall be liable to the Company or its stockholders for monetary damages for
breach of fiduciary duty or the duty of care as a director, except for liability
for breach of the director's duty of loyalty, acts or omissions not in good
faith or that involve intentional misconduct or knowing violations of law,
unlawful payment of dividends or stock purchases or redemptions, or transactions
in which the director derived an improper personal benefit. The Company's
Certificate of Incorporation provides for the indemnification of directors and
officers to the fullest extent permitted by Delaware law.
Generally, Section 145 of the Delaware General Corporation Law provides
that a corporation may indemnify any person who is or was a party or is
threatened to be made a party to any threatened, pending or completed action,
including any action by or in the right of the corporation (unless such person
was adjudged liable to the corporation, in which event indemnification is
permitted if, but only to the extent that, the court in which such action was
brought determined such indemnification is fair and reasonable) by reason of the
fact that such person is or was a director, officer, employee or agent of the
corporation, or is or was serving in such capacity for another corporation or
entity at the request of the corporation, if he acted in good faith and in a
manner he reasonably believed to be in or not opposed to the best interests of
the corporation and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. Such indemnification may
include all expenses (including attorneys' fees) and, in the case of any action
other than an action by or in the right of the corporation, all judgments, fines
and amounts paid in settlement, to the extent such expenses, judgments, fines
and amounts were actually paid and reasonably incurred by the indemnified party
in connection with such action.
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<C> <S>
1.1 -- Form of Purchase Agreement
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 by reference herein 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)
4.1 -- 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)
</TABLE>
II-1
<PAGE> 118
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<C> <S>
4.2 -- Certificate of Designations of the New Preferred Stock
($0.01 par value) of the Company (incorporated herein by
reference to Exhibit 4.1 of the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997)
4.3 -- 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)
4.4 -- 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)
4.5 -- 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 Annual Report on Form 10-K for the fiscal year
ended December 31, 1997)
4.6 -- 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 Annual Report on Form 10-K for the fiscal year
ended December 31, 1997)
4.7 -- 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 Annual Report on Form 10-K for the
fiscal year ended December 31, 1997)
5.1 -- Opinion of Weil, Gotshal & Manges LLP regarding validity
of the securities being registered*
23.1 -- Consent of Weil, Gotshal & Manges LLP (contained in
Exhibit 5.1)*
23.2 -- Consent of KPMG Peat Marwick LLP
24.1 -- Power of Attorney (set forth on the signature page to
this Registration Statement)
</TABLE>
- ---------------
* To be filed by amendment.
ITEM 17. UNDERTAKINGS.
(a) The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
Registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (and, where applicable, each filing of an employee benefit
plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of
1934) that is incorporated by reference in this registration statement shall be
deemed to be a new registration statement relating to the securities offered
herein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions described in Item 15 above
or otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act of 1933, as amended, and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act of 1933, as amended, and will be
governed by the final adjudication of such issue.
(c) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon
II-2
<PAGE> 119
Rule 430A and contained in a form of prospectus filed by the Registrant
pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall
be deemed to be part of this registration statement as of the time it was
declared effective.
(2) For the purposes of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE> 120
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Company certifies that it has reasonable grounds to believe that it meets all of
the requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Waco, State of Texas, on March 24, 1998.
FIRSTCITY FINANCIAL CORPORATION
By: /s/ JAMES R. HAWKINS
----------------------------------
James R. Hawkins
Chairman of the Board
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints
James R. Hawkins, James T. Sartain and Matt A. Landry, Jr., and each of them,
his true and lawful attorneys-in-fact and agents with full power of substitution
and resubstitution, for him and in his name, place and stead, and in any and all
capacities, to sign any and all amendments (including post-effective amendments)
to this Registration Statement, and to file the same, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, and hereby grants to such attorneys-in-fact and agents, and each of
them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them or his or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ JAMES R. HAWKINS Chairman of the Board, Chief March 24, 1998
- ----------------------------------------------------- Executive Officer and
James R. Hawkins Director (principal executive
officer)
/s/ MATT A. LANDRY, JR. Executive Vice President, Chief March 24, 1998
- ----------------------------------------------------- Administrative Officer and
Matt A. Landry, Jr. Director (principal financial
officer and accounting
officer)
/s/ C. IVAN WILSON Director March 24, 1998
- -----------------------------------------------------
C. Ivan Wilson
/s/ JAMES T. SARTAIN Director March 24, 1998
- -----------------------------------------------------
James T. Sartain
/s/ RICK R. HAGELSTEIN Director March 24, 1998
- -----------------------------------------------------
Rick R. Hagelstein
/s/ RICHARD J. GILLEN Director March 24, 1998
- -----------------------------------------------------
Richard J. Gillen
</TABLE>
II-4
<PAGE> 121
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ RICHARD E. BEAN Director March 24, 1998
- -----------------------------------------------------
Richard E. Bean
/s/ BART A. BROWN Director March 24, 1998
- -----------------------------------------------------
Bart A. Brown
/s/ DONALD J. DOUGLASS Director March 24, 1998
- -----------------------------------------------------
Donald J. Douglass
/s/ THOMAS E. SMITH Director March 24, 1998
- -----------------------------------------------------
Thomas E. Smith
</TABLE>
II-5
<PAGE> 122
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<C> <S>
1.1 -- Form of Purchase Agreement
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 by reference herein 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)
4.1 -- Amended and Restated Certificate of Incorporation of the
Registrant (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)
4.2 -- Certificate of Designations of the New Preferred Stock
($0.01 par value) of the Company (incorporated herein by
reference to Exhibit 4.5 of the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997)
4.3 -- 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)
4.4 -- 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)
4.5 -- 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 4.2 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997)
4.6 -- Stock Purchase Agreement, dated March 24, 1998, between
the Company and Texas Commerce Shareholders Company
(incorporated herein by reference to Exhibit 4.3 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997)
4.7 -- Registration Rights 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 Annual Report on Form 10-K for the
fiscal year ended December 31, 1997)
5.1 -- Opinion of Weil, Gotshal & Manges LLP regarding validity
of the securities being registered*
23.1 -- Consent of Weil, Gotshal & Manges LLP (contained in
Exhibit 5.1)*
23.2 -- Consent of KPMG Peat Marwick LLP
24.1 -- Power of Attorney (set forth on the signature page to
this Registration Statement)
</TABLE>
- ---------------
* To be filed by amendment.
<PAGE> 1
EXHIBIT 1.1
1,341,000 SHARES(1)
FIRSTCITY FINANCIAL CORPORATION
COMMON STOCK
PURCHASE AGREEMENT
__________, 1998
Piper Jaffray Inc.
As Representative of the several Underwriters
named in Schedule II hereto c/o
Piper Jaffray Inc.
Piper Jaffray Tower
222 South Ninth Street
Minneapolis, Minnesota 55402
Ladies and Gentlemen:
FirstCity Financial Corporation, a Delaware corporation (the
"Company"), and the stockholders of the Company listed in Schedule I hereto (the
"Selling Stockholders") severally propose to sell to the several Underwriters
named in Schedule II hereto (the "Underwriters") an aggregate of 1,341,000
shares (the "Firm Shares") of Common Stock, $0.01 par value per share (the
"Common Stock"), of the Company. The Firm Shares consist of 1,000,000 authorized
but unissued shares of Common Stock to be issued and sold by the Company and
341,000 outstanding shares of Common Stock to be sold by the Selling
Stockholders. The Company has also granted to the several Underwriters an option
to purchase up to 201,150 additional shares of Common Stock on the terms and for
the purposes set forth in Section 3 hereof (the "Option Shares"). The Firm
Shares and any Option Shares purchased pursuant to this Purchase Agreement are
herein collectively called the "Securities."
The Company and the Selling Stockholders hereby confirm their agreement
with respect to the sale of the Securities to the several Underwriters, for whom
you are acting as Representative (the "Representative").
1. Registration Statement and Prospectus. A registration statement
on Form S-3 (File No. 333-_______) with respect to the Securities, including a
preliminary form of prospectus, has been prepared by the Company in conformity
with the requirements of the Securities Act of 1933, as amended (the "Act"), and
the rules and regulations ("Rules and Regulations") of the Securities and
Exchange Commission (the "Commission") thereunder and has been filed with the
Commission;
- --------
1 Plus an option to purchase up to 201,150 additional shares to cover
over-allotments.
<PAGE> 2
one or more amendments to such registration statement have also been so prepared
and have been, or will be, so filed; and, if the Company has elected to rely
upon Rule 462(b) of the Rules and Regulations to increase the size of the
offering registered under the Act, the Company will prepare and file with the
Commission a registration statement with respect to such increase pursuant to
Rule 462(b). Copies of such registration statement(s) and amendments and each
related preliminary prospectus have been delivered to the Underwriters.
If the Company has elected not to rely upon Rule 430A of the Rules and
Regulations, the Company has prepared and will promptly file an amendment to the
registration statement and an amended prospectus (including a term sheet meeting
the requirements of Rule 434 of the Rules and Regulations). If the Company has
elected to rely upon Rule 430A of the Rules and Regulations, it will prepare and
file a prospectus (or a term sheet meeting the requirements of Rule 434)
pursuant to Rule 424(b) that discloses the information previously omitted from
the prospectus in reliance upon Rule 430A. Such registration statement as
amended at the time it is or was declared effective by the Commission, and, in
the event of any amendment thereto after the effective date and prior to the
First Closing Date (as hereinafter defined), such registration statement as so
amended (but only from and after the effectiveness of such amendment), including
a registration statement (if any) filed pursuant to Rule 462(b) of the Rules and
Regulations increasing the size of the offering registered under the Act,
documents incorporated by reference therein and information (if any) deemed to
be part of the registration statement at the time of effectiveness pursuant to
Rules 430A(b) and 434(d) of the Rules and Regulations, is hereinafter called the
"Registration Statement." The prospectus included in the Registration Statement
at the time it is or was declared effective by the Commission is hereinafter
called the "Prospectus," except that if any prospectus (including any term sheet
meeting the requirements of Rule 434 of the Rules and Regulations provided by
the Company for use with a prospectus subject to completion within the meaning
of Rule 434 in order to meet the requirements of Section 10(a) of the Rules and
Regulations) filed by the Company with the Commission pursuant to Rule 424(b)
(and Rule 434, if applicable) of the Rules and Regulations or any other such
prospectus provided to the Underwriters by the Company for use in connection
with the offering of the Securities (whether or not required to be filed by the
Company with the Commission pursuant to Rule 424(b) of the Rules and
Regulations) differs from the prospectus on file at the time the Registration
Statement is or was declared effective by the Commission, the term "Prospectus"
shall refer to such differing prospectus (including any term sheet within the
meaning of Rule 434 of the Rules and Regulations) from and after the time such
prospectus is filed with the Commission or transmitted to the Commission for
filing pursuant to such Rule 424(b) (and Rule 434, if applicable) or from and
after the time it is first provided to the Underwriters by the Company for such
use. The term "Preliminary Prospectus" as used herein means any preliminary
prospectus included in the Registration Statement prior to the time it becomes
or became effective under the Act and any prospectus subject to completion as
described in Rule 430A or 434 of the Rules and Regulations.
All references in this Agreement to financial statements and schedules
and other information which is "contained," "included," "stated" or "set forth"
in the Registration Statement, any preliminary prospectus or the Prospectus (or
other references of like import) shall be deemed to mean and include all such
financial statements and schedules and other information which is incorporated
by reference in the Registration Statement, any preliminary prospectus or the
Prospectus, as the case may be, and any reference herein to the Registration
Statement, any
2
<PAGE> 3
preliminary prospectus or the Prospectus shall be deemed to refer to and include
such information and any documents incorporated by reference therein pursuant to
Form S-3 under the Act (collectively, the "Incorporated Documents"), as of the
date of the Preliminary Prospectus or the Prospectus, as the case may be. Any
document filed by the Company under the Securities Exchange Act of 1934, as
amended and the rules and regulations of the Commission thereunder (collectively
the "Exchange Act"), after the effective date of the Registration Statement or
the date of the Prospectus and incorporated by reference in the Prospectus shall
be deemed to be included in the Registration Statement and the Prospectus as of
the date of such filing.
2. Representations and Warranties of the Company and the Selling
Stockholders.
(a) The Company represents and warrants to, and agrees
with, the several Underwriters as follows:
(i) No order preventing or suspending the use of
any Preliminary Prospectus has been issued by the Commission and each
Preliminary Prospectus, at the time of filing thereof, did not contain
an untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements
therein, in the light of the circumstances under which they were made,
not misleading; except that the foregoing shall not apply to statements
in or omissions from any Preliminary Prospectus in reliance upon, and
in conformity with, written information furnished to the Company by
you, or by any Underwriter through you, specifically for use in the
preparation thereof.
(ii) As of the time the Registration Statement
(or any post-effective amendment thereto, including a registration
statement (if any) filed pursuant to Rule 462(b) of the Rules and
Regulations increasing the size of the offering registered under the
Act) is or was declared effective by the Commission, upon the filing or
first delivery to the Underwriters of the Prospectus (or any supplement
to the Prospectus (including any term sheet meeting the requirements of
Rule 434 of the Rules and Regulations)) and at the First Closing Date
and Second Closing Date (as hereinafter defined), (A) the Registration
Statement and Prospectus (in each case, as so amended and/or
supplemented) conformed or will conform in all material respects to the
requirements of the Act and the Rules and Regulations, (B) the
Registration Statement (as so amended) did not or will not include an
untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements
therein not misleading, and (C) the Prospectus (as so supplemented) did
not or will not include an untrue statement of a material fact or omit
to state a material fact required to be stated therein or necessary to
make the statements therein, in the light of the circumstances in which
they are or were made, not misleading; except that the foregoing shall
not apply to statements in or omissions from any such document in
reliance upon, and in conformity with, written information furnished to
the Company by you, or by any Underwriter through you, specifically for
use in the preparation thereof. If the Registration Statement has been
declared effective by the Commission, no stop order suspending the
effectiveness of the Registration Statement has been issued, and no
proceeding for that purpose has been initiated or, to the Company's
knowledge, threatened by the Commission.
3
<PAGE> 4
(iii) The consolidated financial statements of
the Company and its subsidiaries, together with the notes thereto, set
forth in the Registration Statement and Prospectus comply in all
material respects with the requirements of the Act and fairly present
the consolidated financial condition of the Company as of the dates
indicated and the consolidated results of operations and changes in
cash flows for the periods therein specified in conformity with
generally accepted accounting principles consistently applied
throughout the periods involved (except as otherwise stated therein);
and the supporting schedules and other financial and statistical
information and data included in the Registration Statement and
Prospectus present fairly the information required to be stated therein
and are in all material respects accurately presented and prepared on a
basis consistent with such financial statements and the books and
records of the Company. No other financial statements or schedules are
required to be included in the Registration Statement or Prospectus.
KPMG Peat Marwick LLP, which has expressed its opinion with respect to
the financial statements filed as a part of the Registration Statement
and included in the Registration Statement and Prospectus, are
independent public accountants as required by the Act and the Rules and
Regulations.
(iv) Each of the Company and its subsidiaries
(including for all purposes of this Agreement the subsidiary of the
Company that is the general partner or limited partner of each
Acquisition Partnership (as defined in the Prospectus)) has been duly
organized and is validly existing as a corporation, in good standing
under the laws of its jurisdiction of incorporation. Each of the
Acquisition Partnerships is identified on Schedule III hereto and has
been duly organized and is validly existing as a limited partnership
under the laws of its jurisdiction of organization. Each of the
Company, its subsidiaries and the Acquisition Partnerships has full
corporate power and authority to own its properties and conduct its
business as currently being carried on and as described in the
Registration Statement and the Prospectus, and is duly qualified to do
business as a foreign corporation or limited partnership in good
standing in each jurisdiction in which it owns or leases real property
or in which the conduct of its business makes such qualification
necessary and in which the failure to so quality would have a material
adverse effect upon the condition (financial or otherwise), business,
prospects, net worth or results of operations of the Company and its
subsidiaries, taken as a whole.
(v) Except as contemplated in the Prospectus,
subsequent to the respective dates as of which information is given in
the Registration Statement and the Prospectus, none of the Company, its
subsidiaries or the Acquisition Partnerships has incurred any material
liabilities or obligations, direct or contingent, or entered into any
material transactions, or declared or paid any dividends or made any
distribution of any kind with respect to its capital stock; and there
has not been any change in the capital stock (other than a change in
the number of outstanding shares of Common Stock due to the issuance of
shares upon the exercise of outstanding options or warrants), or any
material change in the short-term or long-term debt, or any issuance of
options, warrants, convertible securities or other rights to purchase
the capital stock, except for issuances of stock options pursuant to
the Stock Option Plans (as defined in the Prospectus) in the ordinary
course consistent with the Company's past practice, of the Company,
any of its subsidiaries or any of the Acquisition Partnerships, or any
material adverse change, or any development involving a prospective
material adverse change, in the condition (financial or otherwise),
business,
4
<PAGE> 5
prospects, net worth or results of operations of the Company and its
subsidiaries, taken as a whole.
(vi) Except as set forth in the Prospectus, there
is not pending or, to the knowledge of the Company, threatened, any
action, suit or proceeding to which the Company or any of its
subsidiaries or Acquisition Partnerships is a party before or by any
court or governmental agency, authority or body, or any arbitrator,
which might result in any material adverse change in the condition
(financial or otherwise), business, prospects, net worth or results of
operations of the Company and its subsidiaries, taken as a whole.
(vii) There are no contracts or documents of the
Company or any of its subsidiaries or Acquisition Partnerships that are
required to be filed as exhibits to the Registration Statement by the
Act or by the Rules and Regulations or as exhibits to the Incorporated
Documents by the Exchange Act that have not been so filed.
(viii) This Agreement has been duly authorized,
executed and delivered by the Company, and constitutes a valid, legal
and binding obligation of the Company, enforceable in accordance with
its terms, except as rights to indemnity hereunder may be limited by
federal or state securities laws and except as such enforceability may
be limited by bankruptcy, insolvency, reorganization or similar laws
affecting the rights of creditors generally and subject to general
principles of equity. The execution, delivery and performance of this
Agreement and the consummation of the transactions herein contemplated
will not result in a breach or violation of any of the terms and
provisions of, or constitute a default under, any statute, any
agreement or instrument to which the Company is a party or by which it
is bound or to which any of its property is subject, the Company's
charter or by-laws, or any order, rule, regulation or decree of any
court or governmental agency or body having jurisdiction over the
Company or any of its properties; no consent, approval, authorization
or order of, or filing with, any court or governmental agency or body
is required for the execution, delivery and performance of this
Agreement or for the consummation of the transactions contemplated
hereby, including the issuance or sale of the Securities by the
Company, except such as may be required under the Act or state
securities or blue sky laws; and the Company has full power and
authority to enter into this Agreement and to authorize, issue and sell
the Securities as contemplated by this Agreement.
(ix) All of the issued and outstanding shares of
capital stock of the Company, including the outstanding shares of
Common Stock, are duly authorized and validly issued, fully paid and
nonassessable, have been issued in compliance with all federal and
state securities laws, were not issued in violation of or subject to
any preemptive rights or other rights to subscribe for or purchase
securities, and the holders thereof are not subject to personal
liability by reason of being such holders; the Securities which may be
sold hereunder by the Company have been duly authorized and, when
issued, delivered and paid for in accordance with the terms hereof,
will have been validly issued and will be fully paid and nonassessable,
the holders thereof will not be subject to personal liability by reason
of being such holders, and the certificates evidencing the Securities
will comply with all
5
<PAGE> 6
applicable requirements of Delaware law and The Nasdaq Stock Market
("Nasdaq"); and the capital stock of the Company, including the Common
Stock, conforms to the description thereof in the Registration
Statement and Prospectus, the Company's charter and the Company's Form
8-A Registration Statement filed with the Commission on July 12, 1997.
Except as otherwise stated in the Registration Statement and
Prospectus, there are no preemptive rights or other rights to subscribe
for or to purchase, or any restriction upon the voting or transfer of,
any shares of Common Stock pursuant to the Company's charter, by-laws
or any agreement or other instrument to which the Company is a party or
by which the Company is bound. Except as disclosed in the Prospectus or
set forth in an exhibit to the Registration Statement, there are no
contracts, agreements or understandings between the Company and any
person with respect to the registration under the Act of any securities
of the Company owned or to be owned by such person. Neither the filing
of the Registration Statement nor the offering or sale of the
Securities as contemplated by this Agreement gives rise to any rights
for or relating to the registration of any shares of Common Stock or
other securities of the Company. All of the issued and outstanding
shares of capital stock of each of the Company's subsidiaries have been
duly and validly authorized and issued and are fully paid and
nonassessable, and, except as otherwise described in the Registration
Statement and Prospectus, and except for any directors' qualifying
shares, the Company owns of record and beneficially, free and clear of
any security interests, claims, liens, proxies, equities or other
encumbrances, all of the issued and outstanding shares of such stock.
Except as described in the Registration Statement and the Prospectus,
there are no options, warrants, agreements, contracts or other rights
in existence to purchase or acquire from the Company or any subsidiary
of the Company any shares of the capital stock of the Company or any
subsidiary of the Company. The Company has an equity interest in each
of the Acquisition Partnerships as set forth in the Registration
Statement and the Prospectus, and there are no options, warrants,
agreements, contracts or other rights in existence to purchase or
acquire from any Acquisition Partnership any equity interest in any
Acquisition Partnership. The Company has an authorized and outstanding
capitalization as set forth in the Registration Statement and the
Prospectus.
(x) Except as would not, singly or in the
aggregate, result in a material adverse effect on the condition
(financial or otherwise), business, prospects, net worth or results of
operations of the Company and its subsidiaries, taken as a whole, (A)
each of the Company, its subsidiaries and the Acquisition Partnerships
holds, and is operating in compliance in all respects with, all
franchises, grants, authorizations, licenses, permits, easements,
consents, certificates and orders of any governmental or
self-regulatory body required for the conduct of its business and all
such franchises, grants, authorizations, licenses, permits, easements,
consents, certificates and orders are valid and in full force and
effect; and (B) the Company and each of its subsidiaries and
Acquisition Partnerships is in compliance in all respects with all
applicable federal, state, local and foreign laws, rules, regulations,
orders, judgments and decrees.
(xi) Except as would not, singly or in the
aggregate, result in a material adverse effect on the condition
(financial or otherwise), business, prospects, net worth or results of
operations of the Company and its subsidiaries, taken as a whole, (A)
each of the Company, its subsidiaries and the Acquisition Partnerships
has good and marketable title to all property described in the
Registration Statement and Prospectus as being owned by it, in each
case free and clear of all liens, claims, security interests or other
encumbrances except such as are described in the Registration Statement
and the Prospectus; (B) the property held under lease by the Company,
its subsidiaries and the Acquisition Partnerships is held by them under
valid, subsisting and enforceable leases with only such exceptions with
respect to any particular lease as do not interfere in any
6
<PAGE> 7
respect with the conduct of the business of the Company, its
subsidiaries or the Acquisition Partnerships; (C) each of the Company,
its subsidiaries and the Acquisition Partnerships owns or possesses all
patents, patent applications, trademarks, service marks, tradenames,
trademark registrations, service mark registrations, copyrights,
licenses, inventions, trade secrets and rights necessary for the
conduct of the business of the Company, its subsidiaries and the
Acquisition Partnerships as currently carried on and as described in
the Registration Statement and Prospectus; (D) except as stated in the
Registration Statement and Prospectus, no name which the Company, any
of its subsidiaries or any of the Acquisition Partnerships uses and no
other aspect of the business of the Company, any of its subsidiaries or
any of the Acquisition Partnerships will, to the best knowledge of the
Company, involve or give rise to any infringement of, or license or
similar fees for, any patents, patent applications, trademarks, service
marks, tradenames, trademark registrations, service mark registrations,
copyrights, licenses, inventions, trade secrets or other similar rights
and neither the Company nor any of its subsidiaries or any of the
Acquisition Partnerships has received any notice alleging any such
infringement or fee.
(xii) Neither the Company nor any of its
subsidiaries or any of the Acquisition Partnerships is, and no event
has occurred that with the giving of notice or passage of time or both
would cause the Company, any of its subsidiaries or any of the
Acquisition Partnerships to be, in violation of its respective charter
or by-laws or other organizational document or in breach of or
otherwise in default in the performance of any material obligation,
agreement or condition contained in any bond, debenture, note,
indenture, loan agreement or any other material contract, lease or
other instrument to which it is subject or by which any of them may be
bound, or to which any of the material property or assets of the
Company, any of its subsidiaries or any of the Acquisition Partnerships
is subject.
(xiii) Each of the Company, its subsidiaries
and the Acquisition Partnerships has filed all federal, state, local
and foreign income and franchise tax returns required to be filed and
is not in default in the payment of any taxes which were payable
pursuant to said returns or any assessments with respect thereto, other
than any which the Company, any of its subsidiaries or any of the
Acquisition Partnerships is contesting in good faith. No deficiency
with respect to any such return has been assessed or proposed.
(xiv) The Company has not distributed and will
not distribute any prospectus or other offering material in connection
with the offering and sale of the Securities other than any Preliminary
Prospectus or the Prospectus or other materials permitted by the Act to
be distributed by the Company.
(xv) A registration statement relating to the
Common Stock has been declared effective by the Commission pursuant to
the Exchange Act, and the Common Stock is duly registered thereunder.
The Securities have been listed on the Nasdaq National Market subject
to notification of issuance of the Securities. The Company has taken no
action designed to terminate, or likely to have the effect of
terminating, the registration of the Securities under the Exchange Act
or qualification of the Securities on the Nasdaq National Market, nor
has the Company received any notification that the Commission or the
National
7
<PAGE> 8
Association of Securities Dealers, Inc. ("NASD") is contemplating
terminating such registration or qualification.
(xvi) Other than the subsidiaries of the
Company and the Acquisition Partnerships listed on Schedule III hereto,
the Company owns no capital stock or other equity or ownership or
proprietary interest in any corporation, partnership, association,
trust or other entity.
(xvii) Each of the Company, its subsidiaries and
the Acquisition Partnerships maintains a system of internal accounting
controls sufficient to provide reasonable assurances that (i)
transactions are executed in accordance with management's general or
specific authorization; (ii) transactions are recorded as necessary to
permit preparation of financial statements in conformity with generally
accepted accounting principles and to maintain accountability for
assets; (iii) access to assets is permitted only in accordance with
management's general or specific authorization; and (iv) the recorded
accountability for assets is compared with existing assets at
reasonable intervals and appropriate action is taken with respect to
any differences.
(xviii) Other than as contemplated by this
Agreement, the Company has not incurred any liability for any finder's
or broker's fee or agent's commission in connection with the execution
and delivery of this Agreement or the consummation of the transactions
contemplated hereby.
(xix) The Company is not, will not become as a
result of the transactions contemplated hereby, and does not intend to
conduct its business in a manner that would cause it to become, an
"investment company" or a company "controlled" by an "investment
company" within the meaning of the Investment Company Act of 1940.
(xx) Except as set forth in the loan agreements
entered into by the Company's subsidiaries, which loan agreements are
identified in the Registration Statement, or as set forth in loan
agreements entered into by the Acquisition Partnerships, no subsidiary
of the Company or any Acquisition Partnership is currently prohibited,
directly or indirectly, from paying any dividends to the Company, from
making any other distributions, from repaying to the Company any loans
or advances to such entity or from transferring any of such entity's
property or assets to the Company or any other subsidiary of the
Company or Acquisition Partnership, except as disclosed in the
Registration Statement and the Prospectus.
(xxi) The Incorporated Documents, when such
documents or the documents from which such information was
incorporated, including any amendments to such documents, were filed
with the Commission, conformed in all materials respects to the
requirements of the Exchange Act and the rules and regulations of the
Commission thereunder, and none of such documents or information
contained an untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the
statements therein, in the light of the circumstances under which they
were made, not misleading, and any further documents so filed and
incorporated by reference in the Prospectus, when such documents are
filed with the Commission, will conform in all
8
<PAGE> 9
material respects to the requirements of the Exchange Act and the rules
and regulations of the Commission thereunder and will not contain an
untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements
therein, in the light of the circumstances under which they were made,
not misleading.
(xxii) Since the date of the most recent audited
financial statements included in the Registration Statement and the
Prospectus, neither the Company nor any of its subsidiaries or
Acquisition Partnerships has sustained any material loss or
interference with its business, which loss or interference was material
to the Company, its subsidiaries and the Acquisition Partnerships taken
as a whole, from fire, explosion, flood or other calamity, whether or
not covered by insurance, or from any labor dispute or court or
governmental action, order or decree, otherwise than as disclosed in or
contemplated by the Registration Statement and the Prospectus.
(xxiii) Neither the Company nor any of its
officers, directors or affiliates has (A) taken, directly or
indirectly, any action designed to cause or result in, or that has
constituted or might reasonably be expected to constitute, the
stabilization or manipulation of the price of any security of the
Company to facilitate the sale or resale of the Securities, or (B)
since the filing of the Registration Statement, sold, or paid anyone
any compensation for soliciting purchases of, the Securities.
(xxiv) The Company, each of its subsidiaries and
the Acquisition Partnerships are insured by insurers of recognized
financial responsibility against such losses and risks and in such
amounts as is prudent; and neither the Company nor any such subsidiary
or Acquisition Partnership has any reason to believe that it will not
be able to renew its existing insurance coverage from similar insurers
as may be necessary to continue its business at a comparable cost,
except as disclosed in the Registration Statement and the Prospectus.
(xxv) Except as would not, singly or in the
aggregate, result in a material adverse effect on the condition
(financial or otherwise), business, prospects, net worth or results of
operations of the Company and its subsidiaries, taken as a whole, (A)
neither the Company nor any of its subsidiaries or the Acquisition
Partnerships is in violation of any federal, state, local or foreign
state, law, rule, regulation, ordinance, code, policy or rule of common
law or any judicial or administrative interpretation thereof, including
any judicial or administrative order, consent, decree or judgment,
relating to pollution or protection of human health, the environment
(including, without limitation, ambient air, surface water,
groundwater, land surface or subsurface strata) or wildlife, including,
without limitation, laws and regulations relating to the release or
threatened release of chemical, pollutants, contaminants, wastes, toxic
substances, hazardous substances, petroleum or petroleum products
(collectively, "Hazardous Materials") or to the manufacture,
processing, distribution, use, treatment, storage, disposal, transport
or handling of Hazardous Materials (collectively, "Environmental
Laws"), (B) there are no pending or threatened administrative,
regulatory or judicial actions, suits, demands, demand letters, claims,
liens, notices of noncompliance or violation, investigation or
proceedings relating to any Environmental Law against the Company or
any of its subsidiaries or Acquisition
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<PAGE> 10
Partnerships and (C) there are no events or circumstances that may
reasonably be expected to form the basis of an order for clean-up or
remediation, or an action, suit or proceeding by any private party or
governmental body or agency, against or affecting the Company or any of
its subsidiaries or Acquisition Partnerships relating to Hazardous
Materials or any Environmental Laws.
(xxvi) Except as set forth in the Prospectus, to
the best of the Company's knowledge, the computer information systems
used by the Company, its subsidiaries and the Acquisition Partnerships
will not be adversely affected by issues relating to the Year 2000,
including the processing of information with dates after December 31,
1999.
(b) Each Selling Stockholder represents and warrants to,
and agrees with, the several Underwriters as follows:
(i) Such Selling Stockholder is the record
and beneficial owner of, and has, and on the First Closing Date (as
herein defined), as the case may be, will have, valid and marketable
title to the Securities to be sold by such Selling Stockholder, free
and clear of all security interests, claims, liens, voting trust
arrangements, restrictions on transferability, legends, proxies,
equities or other encumbrances; and upon delivery of and payment for
such Securities hereunder, the several Underwriters will acquire valid
and marketable title thereto, free and clear of any security interests,
claims, liens, voting trust arrangements, restrictions on
transferability, legends, proxies, equities or other encumbrances. Such
Selling Stockholder is selling the Securities to be sold by such
Selling Stockholder for such Selling Stockholder's own account and is
not selling such Securities, directly or indirectly, for the benefit of
the Company, and no part of the proceeds of such sale received by such
Selling Stockholder will inure, either directly or indirectly, to the
benefit of the Company other than as described in the Registration
Statement and Prospectus.
(ii) Such Selling Stockholder has duly
authorized, executed and delivered a letter of Transmittal and Custody
Agreement ("Custody Agreement"), which Custody Agreement is a valid and
binding obligation of such Selling Stockholder, to
__________________________, as Custodian (the "Custodian"); pursuant to
the Custody Agreement the Selling Stockholder has placed in custody
with the Custodian, for delivery under this Agreement, the certificates
representing the Securities to be sold by such Selling Stockholder;
such certificates represent validly issued, outstanding, fully paid and
nonassessable shares of Common Stock; and such certificates were duly
and properly endorsed in blank for transfer, or were accompanied by all
documents duly and properly executed that are necessary to validate the
transfer of title thereto, to the Underwriters, free of any legend,
restriction on transferability, proxy, lien or claim, whatsoever.
(iii) Such Selling Stockholder has the power and
authority to enter into this Agreement and to sell, transfer and
deliver the Securities to be sold by such Selling
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<PAGE> 11
Stockholder; and such Selling Stockholder has duly authorized, executed
and delivered to ________ and __________, as attorneys-in-fact (the
"Attorneys-in-Fact"), an irrevocable power of attorney (a "Power of
Attorney") authorizing and directing the Attorneys-in-Fact, or either
of them, to effect the sale and delivery of the Securities being sold
by such Selling Stockholder, to enter into this Agreement and to take
all such other action as may be necessary hereunder.
(iv) This Agreement, the Custody Agreement and
the Power of Attorney have each been duly authorized, executed and
delivered by or on behalf of such Selling Stockholder and each
constitutes a valid and binding agreement of such Selling Stockholder,
enforceable in accordance with its terms, except as rights to indemnity
hereunder or thereunder may be limited by federal or state securities
laws and except as such enforceability may be limited by bankruptcy,
insolvency, reorganization or laws affecting the rights of creditors
generally and subject to general principles of equity. The execution
and delivery of this Agreement, the Custody Agreement and the Power of
Attorney and the performance of the terms hereof and thereof and the
consummation of the transactions herein and therein contemplated will
not result in a breach or violation of any of the terms and provisions
of, or constitute a default under, any agreement or instrument to which
such Selling Stockholder is a party or by which such Selling
Stockholder is bound, or any law, regulation, order or decree
applicable to such Selling Stockholder; no consent, approval,
authorization or order of, or filing with, any court or governmental
agency or body is required for the execution, delivery and performance
of this Agreement, the Custody Agreement and the Power of Attorney or
for the consummation of the transactions contemplated hereby and
thereby, including the sale of the Securities being sold by such
Selling Stockholder, except such as may be required under the Act or
state securities laws or blue sky laws.
(v) Such Selling Stockholder has not
distributed and will not distribute any prospectus or other offering
material in connection with the offering and sale of the Securities
other than any Preliminary Prospectus or the Prospectus or other
materials permitted by the Act to be distributed by such Selling
Stockholder.
(vi) Such Selling Stockholder has reviewed the
Registration Statement and the Prospectus and to the best knowledge of
such Selling Stockholder neither the Registration Statement nor the
Prospectus contains any untrue statement of a material fact or omits to
state any material fact required to be stated therein or necessary to
make the statements therein not misleading regarding such Selling
Stockholder.
(vii) Such Selling Stockholder and each of its
affiliates, directly or indirectly through one or more intermediaries,
do not control, are not controlled by, are not under common control
with, and have no other association with (within the meaning of Article
I, Section 1(m) of the By-laws of the NASD) any member firm of the
NASD.
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<PAGE> 12
(c) Any certificate signed by any officer of the Company
and delivered to you or the Underwriters or to counsel for the Underwriters
shall be deemed a representation and warranty by the Company to each Underwriter
as to the matters covered thereby; any certificate signed by or on behalf of any
Selling Stockholder as such and delivered to you or the Underwriters or to
counsel for the Underwriters shall be deemed a representation and warranty by
such Selling Stockholder to each Underwriter as to the matters covered thereby.
3. Purchase, Sale and Delivery of Securities.
(a) On the basis of the representations, warranties and
agreements herein contained, but subject to the terms and conditions herein set
forth, the Company agrees to issue and sell 1,000,000 Firm Shares, and each
Selling Stockholder agrees, severally and not jointly, to sell the number of
Firm Shares set forth opposite the name of such Selling Stockholder in Schedule
I hereto, to the several Underwriters, and each Underwriter agrees, severally
and not jointly, to purchase from the Company and the Selling Stockholders the
number of Firm Shares set forth opposite the name of such Underwriter in
Schedule II hereto. The purchase price for each Firm Share shall be $ per
share. The obligation of each Underwriter to each of the Company and the Selling
Stockholders shall be to purchase from each of the Company and the Selling
Stockholders that number of Firm Shares (to be adjusted by the Underwriters to
avoid fractional shares) which represents the same proportion of the number of
Firm Shares to be sold by each of the Company and the Selling Stockholders
pursuant to this Agreement as the number of Firm Shares set forth opposite the
name of such Underwriter in Schedule II hereto represents to the total number of
Firm Shares to be purchased by all Underwriters pursuant to this Agreement. In
making this Agreement, each Underwriter is contracting severally and not
jointly; except as provided in paragraph (c) of this Section 3 and in Section 8
hereof, the agreement of each Underwriter is to purchase only the respective
number of Firm Shares specified in Schedule II.
The Firm Shares will be delivered by the Company and the Custodian to
you for the accounts of the several Underwriters against payment of the purchase
price therefor by certified or official bank check or other next day funds
payable to the order of the Company and the Custodian, as appropriate, at the
offices of Piper Jaffray Inc., Piper Jaffray Tower, 222 South Ninth Street,
Minneapolis, Minnesota, or such other location as may be mutually acceptable, at
9:00 a.m. Central time on the third (or if the Securities are priced, as
contemplated by Rule 15c6-1(c) under the Exchange Act, after 4:30 p.m. Eastern
time, the fourth) full business day following the date hereof, or at such other
time and date as you and the Company determine pursuant to Rule 15c6-1(a) under
the Exchange Act, such time and date of delivery being herein referred to as the
"First Closing Date." If the Underwriters so elect, delivery of the Firm Shares
may be made by credit through full fast transfer to the accounts at The
Depository Trust Company designated by the Underwriters. Certificates
representing the Firm Shares, in definitive form and in such denominations and
registered in such names as you may request upon at least two business days'
prior notice to the Company and the Custodian, will be made available for
checking and packaging not later than 10:30
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<PAGE> 13
a.m., Central time, on the business day next preceding the First Closing Date at
the offices of Piper Jaffray Inc., Piper Jaffray Tower, 222 South Ninth Street,
Minneapolis, Minnesota, or such other location as may be mutually acceptable.
(b) On the basis of the representations, warranties and
agreements herein contained, but subject to the terms and conditions herein set
forth, the Company, with respect to the Option Shares, hereby grants to the
several Underwriters an option to purchase all or any portion of the Option
Shares at the same purchase price as the Firm Shares, for use solely in covering
any over-allotments made by the Underwriters in the sale and distribution of the
Firm Shares. The option granted hereunder may be exercised at any time (but not
more than once) within 30 days after the effective date of this Agreement upon
notice (confirmed in writing) by the Underwriters to the Company setting forth
the aggregate number of Option Shares as to which the several Underwriters are
exercising the option, the names and denominations in which the certificates for
the Option Shares are to be registered and the date and time, as determined by
the Underwriters, when the Option Shares are to be delivered, such time and date
being herein referred to as the "Second Closing" and "Second Closing Date",
respectively; provided, however, that the Second Closing Date shall not be
earlier than the First Closing Date nor earlier than the second business day
after the date on which the option shall have been exercised. If the option is
exercised, the obligation of each Underwriter shall be to purchase from the
Company up to an aggregate of 195,000 Option Shares. The number of Option Shares
to be purchased by each Underwriter shall be the same percentage of the total
number of Option Shares to be purchased by the several Underwriters as the
number of Firm Shares to be purchased by such Underwriter is of the total number
of Firm Shares to be purchased by the several Underwriters, as adjusted by the
Underwriters in such manner as the Underwriters deem advisable to avoid
fractional shares. No Option Shares shall be sold and delivered unless the Firm
Shares previously have been, or simultaneously are, sold and delivered.
The Option Shares will be delivered by the Company to you for the
accounts of the several Underwriters against payment of the purchase price
therefor by certified or official bank check or other next day funds payable to
the order of the Company at the offices of Piper Jaffray Inc., Piper Jaffray
Tower, 222 South Ninth Street, Minneapolis, Minnesota, or such other location as
may be mutually acceptable at 9:00 a.m., Central time, on the Second Closing
Date. If the Underwriters so elect, delivery of the Option Shares may be made by
credit through full fast transfer to the accounts at The Depository Trust
Company designated by the Underwriters. Certificates representing the Option
Shares in definitive form and in such denominations and registered in such names
as you have set forth in your notice of option exercise, will be made available
for checking and packaging not later than 10:30 a.m., Central time, on the
business day next preceding the Second Closing Date at the office of Piper
Jaffray Inc., Piper Jaffray Tower, 222 South Ninth Street, Minneapolis,
Minnesota, or such other location as may be mutually acceptable.
(c) It is understood that you, individually and not as
Representative of the Underwriters, may (but shall not be obligated to) make
payment to the Company or the Selling Stockholders, on behalf of any Underwriter
for the Securities to be purchased by such Underwriter. Any such payment by you
shall not relieve any such Underwriter of any of its obligations hereunder.
Nothing herein contained shall constitute any of the Underwriters an
unincorporated association or partner with the Company or any Selling
Stockholder.
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<PAGE> 14
4. Covenants.
(a) The Company covenants and agrees with the several
Underwriters as follows:
(i) If the Registration Statement has not
already been declared effective by the Commission, the Company will use
its best efforts to cause the Registration Statement and any
post-effective amendments thereto to become effective as promptly as
possible; the Company will notify you promptly of the time when the
Registration Statement or any post-effective amendment to the
Registration Statement has become effective or any supplement to the
Prospectus (including any term sheet within the meaning of Rule 434 of
the Rules and Regulations) has been filed and of any request by the
Commission for any amendment or supplement to the Registration
Statement or Prospectus or additional information; if the Company has
elected to rely on Rule 430A of the Rules and Regulations, the Company
will prepare and file a Prospectus (or term sheet within the meaning of
Rule 434 of the Rules and Regulations) containing the information
omitted therefrom pursuant to Rule 430A of the Rules and Regulations
with the Commission within the time period required by, and otherwise
in accordance with the provisions of, Rules 424(b), 430A and 434, if
applicable, of the Rules and Regulations; if the Company has elected to
rely upon Rule 462(b) of the Rules and Regulations to increase the size
of the offering registered under the Act, the Company will prepare and
file a registration statement with respect to such increase with the
Commission within the time period required by, and otherwise in
accordance with the provisions of, Rule 462(b); the Company will
prepare and file with the Commission, promptly upon your request, any
amendments or supplements to the Registration Statement or Prospectus
(including any term sheet within the meaning of Rule 434 of the Rules
and Regulations) that, in your opinion, may be necessary or advisable
in connection with the distribution of the Securities by the
Underwriters; and the Company will not file any amendment or supplement
to the Registration Statement or Prospectus (including any term sheet
within the meaning of Rule 434 of the Rules and Regulations) to which
you shall reasonably object by notice to the Company after having been
finished a copy a reasonable time prior to the filing.
(ii) The Company will advise you, promptly after
it shall receive notice or obtain knowledge thereof, of the issuance by
the Commission of any stop order suspending the effectiveness of the
Registration Statement or any part thereof, of the suspension of the
qualification of the Securities for offering or sale in any
jurisdiction, or of the initiation or threatening of any proceeding for
any such purpose; and the Company will promptly use its best efforts to
prevent the issuance of any stop order or to obtain its withdrawal if
such a stop order should be issued.
(iii) Within the time during which a prospectus
(including any term sheet within the meaning of Rule 434 of the Rules
and Regulations) relating to the Securities is required to be delivered
under the Act, the Company will comply as far as it is able with all
requirements imposed upon it by the Act, as now and hereafter amended,
and by the Rules and Regulations, as from time to time in force, so far
as necessary to permit the continuance of sales of or dealings in the
Securities as contemplated by the provisions hereof and the
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<PAGE> 15
Prospectus. If during such period any event occurs as a result of which
the Prospectus would include an untrue statement of a material fact or
omit to state a material fact necessary to make the statements therein,
in the light of the circumstances then existing, not misleading, or if
during such period it is necessary to amend the Registration Statement
or supplement the Prospectus to comply with the Act, the Company will
promptly notify you and will amend the Registration Statement or
supplement the Prospectus (at the expense of the Company) so as to
correct such statement or omission or effect such compliance.
(iv) The Company will use its best efforts to
qualify the Securities for sale under the securities laws of such
jurisdictions as you reasonably designate and to continue such
qualifications in effect so long as required for the distribution of
the Securities, except that the Company shall not be required in
connection therewith to qualify as a foreign corporation or to execute
a general consent to service of process in any state.
(v) The Company will furnish to the
Underwriters copies of the Registration Statement (three of which will
be signed and will include all exhibits), each Preliminary Prospectus,
the Prospectus, each Incorporated Document and all amendments and
supplements (including any term sheet within the meaning of Rule 434 of
the Rules and Regulations) to such documents, in each case as soon as
available and in such quantities as the Underwriters may from time to
time reasonably request.
(vi) During a period of three years commencing
with the date hereof, the Company will furnish to each Underwriter
copies of all periodic and special reports furnished to the
stockholders of the Company and all information, documents and reports
filed with the Commission, the NASD, Nasdaq or any securities exchange.
(vii) The Company will make generally available
to its security holders as soon as practicable, but in any event not
later than 15 months after the end of the Company's current fiscal
quarter, an earnings statement (which need not be audited) covering a
12-month period beginning after the effective date of the Registration
Statement that shall satisfy the provisions of Section 11(a) of the Act
and Rule 158 of the Rules and Regulations.
(viii) The Company, whether or not the
transactions contemplated hereunder are consummated or this Agreement
is prevented from becoming effective under the provisions of Section
9(a) hereof or is terminated, will pay or cause to be paid (A) all
expenses (including transfer taxes allocated to the respective
transferees) incurred in connection with the delivery to the
Underwriters of the Securities, (B) all expenses and fees (including,
without limitation, fees and expenses of the Company's accountants and
counsel and the Selling Stockholder's counsel but, except as otherwise
provided below, not including fees of the Underwriters' counsel) in
connection with the preparation, printing, filing, delivery and
shipping of the Registration Statement (including the financial
statements therein and all amendments, schedules, and exhibits
thereto), the Securities, each Preliminary Prospectus, the Prospectus,
and any amendment thereof or supplement thereto, and the printing,
delivery, and shipping of this Agreement and other underwriting or
selling group documents, including blue sky memoranda, (C) all filing
fees and fees and disbursements of
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<PAGE> 16
the Underwriters' counsel incurred in connection with the qualification
of the Securities for offering and sale by the Underwriters or by
dealers under the securities or blue sky laws of the states and other
jurisdictions which you shall designate in accordance with Section 4(d)
hereof, (D) the fees and expenses of any transfer agent or registrar,
(E) the filing fees incident to, and the reasonable fees and
disbursements of counsel to the Underwriters in connection with, any
required review by the NASD of the terms of the sale of the Securities,
(F) listing or quotation fees of Nasdaq and (G) all other costs and
expenses incident to the performance of its obligations hereunder that
are not otherwise specifically provided for herein. If the sale of the
Securities provided for herein is not consummated by reason of action
by the Company pursuant to Section 9(a) hereof which prevents this
Agreement from becoming effective, or by reason of any failure, refusal
or inability on the part of the Company to perform any agreement on its
part to be performed, or because any other condition of the
Underwriters' obligations hereunder required to be fulfilled by the
Company is not fulfilled or because this Agreement is terminated
pursuant to Section 9(b)(i) or (ii) (with respect to 9(b)(ii), insofar
as such condition is required to be fulfilled by the Company), the
Company will reimburse the several Underwriters for all out-of-pocket
disbursements (including fees and disbursements of counsel) incurred by
the Underwriters in connection with their investigation, preparing to
market and marketing the Securities or in contemplation of performing
their obligations hereunder. The Company shall not in any event be
liable to any of the Underwriters for loss of anticipated profits from
the transactions covered by this Agreement.
(ix) During a period of 90 days from the date
of the Prospectus, the Company will not, without the prior written
consent of the Underwriters, (A) directly or indirectly, offer, pledge,
sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or
warrant to purchase or otherwise transfer or dispose of, or announce an
offering, sale or contract of sale of, any share of Common Stock or any
securities convertible into or exercisable or exchangeable for Common
Stock or file any registration statement under the Act with respect to
any of the foregoing or (B) enter into any swap or any other agreement
or any transaction that transfers, in whole or in part, directly or
indirectly, the economic consequence of ownership of the Common Stock,
whether any such swap or transaction described in clause (A) or (B)
above is to be settled by delivery of Common Stock or such other
securities, in cash or otherwise.
(x) The Company either has caused to be
delivered to you or will cause to be delivered to you prior to the
effective date of the Registration Statement a letter from each of the
Company's directors and the other Selling Stockholders stating that
such person agrees that during a period of 90 days from the date of the
Prospectus, such person will not, without your prior written consent
(A) directly or indirectly, offer, sell, contract to sell, sell any
option or contract to purchase, purchase any option or contract to
sell, grant any option, right or warrant to purchase or otherwise
transfer or dispose of, or announce an offering, sale or contract of
sale of, any share of Common Stock or any securities convertible into
or exercisable or exchangeable for Common Stock or (B) enter into any
swap or any other agreement or any transaction that transfers, in whole
or in part, directly or indirectly, the economic consequence of
ownership of the Common Stock, whether any such swap or
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<PAGE> 17
transaction described in clause (A) or (B) above is to be settled by
delivery of Common Stock or such other securities, in cash or
otherwise.
(xi) The Company, its subsidiaries and the
Acquisition Partnerships have not taken and will not take, directly or
indirectly, any action designed to or which might reasonably be
expected to cause or result in, or which has constituted, the
stabilization or manipulation of the price of any security of the
Company to facilitate the sale or resale of the Securities, and the
Company has not effected any sales of Common Stock which are required
to be disclosed in response to Item 701 of Regulation S-K under the Act
which have not been so disclosed in the Registration Statement.
(xii) Except as contemplated hereby, the
Company, its subsidiaries and the Acquisition Partnerships will not
incur any liability for any finder's or broker's fee or agent's
commission in connection with the execution and delivery of this
Agreement or the consummation of the transactions contemplated hereby.
(b) Each Selling Stockholder covenants and agrees with
the several Underwriters as follows:
(i) If this Agreement is terminated by the
Underwriters because of any failure, refusal or inability on the part
of such Selling Stockholder to perform any agreement on such Selling
Stockholder's part to be performed, or because any other condition of
the Underwriters' obligations hereunder required to be fulfilled by
such Selling Stockholder is not fulfilled, such Selling Stockholder
agrees to reimburse the several Underwriters for all out-of-pocket
disbursements (including fees and disbursements of counsel for the
Underwriters) incurred by the Underwriters in connection with their
investigation, preparing to market and marketing the Securities or in
contemplation of performing their obligations hereunder. The Selling
Stockholder shall not in any event be liable to any of the Underwriters
for loss of anticipated profits from the transactions covered by this
Agreement.
(ii) The Securities to be sold by such Selling
Stockholder, represented by the certificates on deposit with the
Custodian pursuant to the Custody Agreement of such Selling
Stockholder, are subject to the interest of the several Underwriters
and the other Selling Stockholders; the arrangements made for such
custody are, except as specifically provided in the Custody Agreement,
irrevocable; and the obligations of such Selling Stockholder hereunder
shall not be terminated, except as provided in this Agreement or in the
Custody Agreement, by any act of such Selling Stockholder, by operation
of law, whether by the liquidation, dissolution or merger of such
Selling Stockholder, by the death of such Selling Stockholder, or by
the occurrence of any other event. If any Selling Stockholder should
liquidate, dissolve or be a party to a merger or if any other such
event should occur before the delivery of the Securities hereunder,
certificates for the Securities deposited with the Custodian shall be
delivered by the Custodian in accordance with the terms and conditions
of this Agreement as if such liquidation, dissolution, merger or other
event had not occurred, whether or not the Custodian shall have
received notice thereof.
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<PAGE> 18
(iii) Such Selling Stockholder will not, during
a period of 90 days from the date of the Prospectus, without the prior
written consent of the Underwriters, (A) directly or indirectly, offer,
sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or
warrant to purchase or otherwise transfer or dispose of, or announce an
offering, sale or contract of sale of, any share of Common Stock or any
securities convertible into or exercisable or exchangeable for Common
Stock or (B) enter into any swap or any other agreement or any
transaction that transfers, in whole or in part, directly or
indirectly, the economic consequence of ownership of the Common Stock,
whether any such swap or transaction described in clause (A) or (B)
above is to be settled by delivery of Common Stock or such other
securities, in cash or otherwise.
(iv) Selling Stockholder has not taken and will
not take, directly or indirectly, any action designed to or which might
reasonably be expected to cause or result in stabilization or
manipulation of the price of any security of the Company to facilitate
the sale or resale of the Securities, and has not effected any sales of
Common Stock which, if effected by the Company, would be required to be
disclosed in response to Item 701 of Regulation S-K.
(v) Such Selling Stockholder shall immediately
notify you if any event occurs, or of any change in information
relating to such Selling Stockholder, which results in the Prospectus
(as supplemented) including an untrue statement of a material fact or
omitting to state any material fact necessary to make the statements
therein, in the light of the circumstances under which they were made,
not misleading.
5. Conditions of Underwriters' Obligations. The obligations of
the several Underwriters to purchase and pay for the Firm Shares on the First
Closing Date and the Option Shares on the Second Closing Date are subject to the
accuracy, as of the date hereof and at each of the First Closing Date and the
Second Closing Date (as if made at such Closing Date), of and compliance with
all representations, warranties and agreements of the Company and the Selling
Stockholders contained herein, to the performance by the Company and the Selling
Stockholders of their respective obligations hereunder and to the following
additional conditions:
(a) The Registration Statement shall have become
effective not later than 5:00 p.m., Central time, on the date of this Agreement,
or such later time and date as the Underwriters shall approve and all filings
required by Rules 424, 430A and 434 of the Rules and Regulations shall have been
timely made; no stop order suspending the effectiveness of the Registration
Statement or any amendment thereof shall have been issued; no proceedings for
the issuance of such an order shall have been initiated or threatened; and any
request of the Commission for additional information (to be included in the
Registration Statement or the Prospectus or otherwise) shall have been complied
with to your satisfaction.
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(b) No Underwriter shall have advised the Company that
the Registration Statement or the Prospectus, or any amendment thereof or
supplement thereto (including any term sheet within the meaning of Rule 434 of
the Rules and Regulations), contains an untrue statement of fact which, in your
opinion, is material, or omits to state a fact which, in your opinion, is
material and is required to be stated therein or necessary to make the
statements therein not misleading.
(c) Except as contemplated in the Prospectus, subsequent
to the respective dates as of which information is given in the Registration
Statement and the Prospectus, neither the Company nor any of its subsidiaries or
any of the Acquisition Partnerships shall have incurred any material liabilities
or obligations, direct or contingent, or entered into any material transactions,
or declared or paid any dividends or made any distribution of any kind with
respect to its capital stock; and there shall not have been any change in the
capital stock (other than a change in the number of outstanding shares of Common
Stock due to the issuance of shares upon the exercise of outstanding options or
warrants), or any material change in the short-term or long-term debt of the
Company, or any issuance of options, warrants, convertible securities or other
rights to purchase the capital stock of the Company or any of its subsidiaries
or an equity interest in any Acquisition Partnership, or any material adverse
change or any development involving a prospective material adverse change
(whether or not arising in the ordinary course of business), in the condition
(financial or otherwise), business prospects, net worth or results of operations
of the Company and its subsidiaries, taken as a whole, that, in your judgment,
makes it impractical or inadvisable to offer or deliver the Securities on the
terms and in the manner contemplated in the Prospectus.
(d) On each Closing Date, there shall have been furnished
to the Underwriters the opinion of Weil, Gotshal & Manges LLP, counsel for the
Company, dated such Closing Date and addressed to you, to the effect that:
(i) Each of the Company and its subsidiaries has
been duly organized and is validly existing as a corporation in good
standing under the laws of its jurisdiction of incorporation. Each
Acquisition Partnership has been duly organized and is validly existing
as a limited partnership in good standing under the laws of its
jurisdiction of organization. Each of the Company, its subsidiaries and
the Acquisition Partnerships has full corporate power and authority to
own its properties and conduct its business as currently being carried
on and as described in the Registration Statement and Prospectus, and
is duly qualified to do business as a foreign corporation or limited
partnership and is in good standing in each jurisdiction in which it
owns or leases real property or in which the conduct of its business
makes such qualification necessary and in which the failure to so
qualify would have a material adverse effect upon the business,
condition (financial or otherwise) or properties of the Company and its
subsidiaries, taken as a whole.
(ii) The capital stock of the Company conforms as
to legal matters to the description thereof contained in the
Registration Statement and Prospectus, the Company's charter and the
Company's Form 8-A Registration Statement filed with the Commission on
July 12, 1997
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All of the issued and outstanding shares of the capital stock of the
Company have been duly authorized and validly issued and are fully paid
and nonassessable, and the holders thereof are not subject to personal
liability by reason of being such holders. The Securities to be issued
and sold by the Company hereunder have been duly authorized and, when
issued, delivered and paid for in accordance with the terms of this
Agreement, will have been validly issued and will be fully paid and
nonassessable, the holders thereof will not be subject to personal
liability by reason of being such holders and the certificates
evidencing the Securities comply with all applicable requirements of
Delaware law and Nasdaq. Except as otherwise stated in the Registration
Statement and Prospectus, there are no preemptive rights or other
rights to subscribe for or to purchase, or any restriction upon the
voting or transfer of, any shares of Common Stock pursuant to the
Company's charter, by-laws or any agreement or other instrument known
to such counsel to which the Company is a party or by which the Company
is bound.
(iii) All of the issued and outstanding shares of
capital stock of each of the Company's subsidiaries have been duly and
validly authorized and issued and are fully paid and nonassessable,
and, to the best of such counsel's knowledge, except as otherwise
described in the Registration Statement and Prospectus, the Company
owns of record and beneficially, free and clear of any security
interests, claims, liens, proxies, equities or other encumbrances, all
of the issued and outstanding shares of such stock. To the best of such
counsel's knowledge, except as described in the Registration Statement
and Prospectus, there are no options, warrants, agreements, contracts
or other rights in existence to purchase or acquire from the Company or
any subsidiary or Acquisition Partnership any shares of the capital
stock of the Company or any subsidiary of the Company or any equity
interest in any Acquisition Partnership.
(iv) The Registration Statement has become
effective under the Act and, to the best of such counsel's knowledge,
no stop order suspending the effectiveness of the Registration
Statement has been issued and no proceeding for that purpose has been
instituted or, to the knowledge of such counsel, threatened by the
Commission.
(v) The descriptions in the Registration
Statement and Prospectus of statutes, legal and governmental
proceedings, contracts and other documents are accurate and fairly
present the information required to be shown; and such counsel does not
know of any statutes or legal or governmental proceedings required to
be described in the Prospectus that are not described as required, or
of any contracts or documents of a character required to be
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<PAGE> 21
described in the Registration Statement or Prospectus or included as
exhibits to the Registration Statement that are not described or
included as required.
(vi) The Company has full corporate power and
authority to enter into this Agreement, and this Agreement has been
duly authorized, executed and delivered by the Company and constitutes
a valid, legal and binding obligation of the Company enforceable in
accordance with its terms (except as rights to indemnity hereunder may
be limited by federal or state securities laws and except as such
enforceability may be limited by bankruptcy, insolvency, reorganization
or similar laws affecting the rights of creditors generally and subject
to general principles of equity); the execution, delivery and
performance of this Agreement and the consummation of the transactions
herein contemplated will not result in a breach or violation of any of
the terms and provisions of, or constitute a default under, any
statute, rule or regulation, any agreement or instrument known to such
counsel to which the Company is a party or by which it is bound or to
which any of its property is subject, the Company's charter or by-laws,
or any order or decree known to such counsel of any court or
governmental agency or body having jurisdiction over the Company or any
of its respective properties; and no consent, approval, authorization
or order of, or filing with, any court or governmental agency or body
is required for the execution, delivery and performance of this
Agreement or for the consummation of the transactions contemplated
hereby, including the issuance or sale of the Securities by the
Company, except such as may be required under the Act or state
securities laws.
(vii) The Registration Statement and the
Prospectus, and any amendment thereof or supplement thereto (including
any term sheet within the meaning of Rule 434 of the Rules and
Regulations), comply as to form in all material respects with the
requirements of the Act and the Rules and Regulations; and on the basis
of conferences with officers,
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<PAGE> 22
directors and certain employees of the Company and KPMG Peat Marwick
LLP, who examined certain of the financial statements of the Company
included in the Registration Statement and the Prospectus, examination
of documents referred to in the Registration Statement and Prospectus
and such other procedures as such counsel deemed appropriate, nothing
has come to the attention of such counsel that causes such counsel to
believe that the Registration Statement or any amendment thereof, at
the time the Registration Statement became effective and as of such
Closing Date (including any Registration Statement filed under Rule
462(b) of the Rules and Regulations), contained any untrue statement of
a material fact or omitted to state any material fact required to be
stated therein or necessary to make the statements therein not
misleading or that the Prospectus (as of its date and as of such
Closing Date), as amended or supplemented, includes any untrue
statement of material fact or omits to state a material fact necessary
to make the statements therein, in the light of the circumstances under
which they were made, not misleading; it being understood that such
counsel need express no opinion as to the financial statements or other
financial data included in any of the documents mentioned in this
clause.
(viii) All documents incorporated by reference in
the Prospectus, when they were filed with the Commission, complied as
to form in all material respects with the requirements of the Exchange
Act; and such counsel has no reason to believe that any of such
documents, when they were so filed, contained an untrue statement of a
material fact or omitted to state a material fact necessary in order to
make the statements therein, in the light of the circumstances under
which they were made when such documents were so filed, not misleading.
(ix) The Company is not, and immediately after
the consummation of the Offering in accordance with this Agreement will
not be, required to be registered under the Investment Company Act of
1940, as amended, as an "investment company" and, to the actual
knowledge of such counsel, is not a Company "controlled" by an
"investment company" within the meaning of the Investment Company Act
of 1940, as amended.
(x) The statements contained in the Prospectus
under the captions "Business -- Government Regulation,"
"Transferability and Ownership of Capital Stock" and "Certain Federal
Income Tax Considerations", insofar as such statements constitute a
summary of the legal matters referred to therein, are a fair and
accurate summary in all material respects of such legal matters.
(xi) The merger of J-Hawk Corporation ("J-Hawk")
with and into First City Bancorporation of Texas, Inc. ("FCBOT") on
July 3, 1995, pursuant to an Agreement
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and Plan of Merger by and between FCBOT and J-Hawk, dated as of July 3,
1995, qualified for federal income tax purposes as a reorganization
within the meaning of Section 368(a) of the Code.
In rendering such opinion such counsel may rely (i) as to
matters of law other than Texas, Delaware, New York and federal law, upon the
opinion or opinions of local counsel provided that the extent of such reliance
is specified in such opinion and that such counsel shall state that such opinion
or opinions of local counsel are satisfactory to them and that they believe they
and you are justified in relying thereon and (ii) as to matters of fact, to the
extent such counsel deems reasonable upon certificates of officers of the
Company, its subsidiaries and the Acquisition Partnerships provided that the
extent of such reliance is specified in such opinion. In addition, with respect
to such of the matters above as may be reasonably agreed upon by the Company and
the Underwriters, such matters may be set forth in an opinion of the Company's
Senior Vice President and General Counsel.
(e) On each Closing Date, there shall have been furnished
to the Underwriters the opinion of Weil, Gotshal & Manges LLP, counsel for the
Selling Stockholders, dated such Closing Date and addressed to you, to the
effect that:
(i) Each of the Selling Stockholders is the sole
record owner of the Securities to be sold by such Selling Stockholder
and delivery of the certificates for the Securities to be sold by each
Selling Stockholder pursuant to this Agreement, upon payment therefor
by the Underwriters, will pass marketable title to such Securities to
the Underwriters and the Underwriters will acquire all the rights of
such Selling Stockholder in the Securities (assuming the Underwriters
have no knowledge of an adverse claim), free and clear of any security
interests, claims, liens, voting trust arrangements, restrictions on
transferability, legends, proxies, equities or other encumbrances.
(ii) Each of the Selling Stockholders that is not
an individual has the power and authority to enter into the Custody
Agreement, the Power of Attorney and this Agreement and to perform and
discharge such Selling Stockholder's obligations thereunder and
hereunder; and this Agreement, the Custody Agreements and the Powers of
Attorney have been duly and validly authorized, executed and delivered
by (or by the Attorneys-in-Fact, or either of them, on behalf of) the
Selling Stockholders and are valid and binding agreements of the
Selling Stockholders, enforceable in accordance with their respective
terms (except as rights to indemnity hereunder or thereunder may be
limited by federal or state securities laws and except as such
enforceability may be limited by bankruptcy, insolvency, reorganization
or similar laws affecting creditors' rights generally and subject to
general principles of equity).
(iii) The execution and delivery of this
Agreement, the Custody Agreement and the Power of Attorney and the
performance of the terms hereof and thereof and the consummation of the
transactions herein and therein contemplated will not result in a
breach or violation of any of the terms and provisions of, or
constitute a default under, any statute, rule or regulation, or any
agreement or instrument known to such counsel to which any Selling
Stockholder that is not an individual is a party or by which such
Selling Stockholder is bound or to which any of its property is
subject, any such Selling Stockholder's charter or by-laws, or any
order or
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<PAGE> 24
decree known to such counsel of any court or government agency or body
having jurisdiction over such Selling Stockholder or any of its
respective properties; and no consent, approval, authorization or order
of, or filing with, any court or governmental agency or body is
required for the execution, delivery and performance of this Agreement,
the Custody Agreement and the Power of Attorney or for the consummation
of the transactions contemplated hereby and thereby, including the sale
of the Securities being sold by such Selling Stockholder, except such
as may be required under the Act or state securities laws or blue sky
laws.
(iv) Such other matters as you may reasonably
request.
In rendering such opinion such counsel may rely (i) as to matters of
law other than Texas, Delaware, New York and federal law, upon the opinion or
opinions of local counsel provided that the extent of such reliance is specified
in such opinion and that such counsel shall state that such opinion or opinions
of local counsel are satisfactory to them and that they believe they and you are
justified in relying thereon and (ii) as to matters of fact, to the extent such
counsel deems reasonable upon certificates of officers of the Selling
Stockholders provided that the extent of such reliance is specified in such
opinion.
(f) On each Closing Date, there shall have been furnished
to the Underwriters such opinion or opinions from Jones, Day, Reavis & Pogue,
counsel for the several Underwriters, dated such Closing Date and addressed to
you, with respect to the formation of the Company, the validity of the
Securities, the Registration Statement, the Prospectus and other related matters
as you reasonably may request, and such counsel shall have received such papers
and information as they request to enable them to pass upon such matters.
(g) On each Closing Date the Underwriters shall have
received a letter of KPMG Peat Marwick LLP, dated such Closing Date and
addressed to the Underwriters, confirming that they are independent public
accountants within the meaning of the Act and are in compliance with the
applicable requirements relating to the qualifications of accountants under Rule
2-01 of Regulation S-X of the Commission, and stating, as of the date of such
letter (or, with respect to matters involving changes or developments since the
respective dates as of which specified financial information is given in the
Prospectus, as of a date not more than five days prior to the date of such
letter), the conclusions and findings of said firm with respect to the financial
information and other matters covered by its letter delivered to the
Underwriters concurrently with the execution of this Agreement, and the effect
of the letter so to be delivered on such Closing Date shall be to confirm the
conclusions and findings set forth in such prior letter.
(h) On each Closing Date, there shall have been furnished
to the Underwriters, a certificate, dated such Closing Date and addressed to the
Underwriters, signed by the chief executive officer and the chief financial
officer or chief administrative officer of the Company, to the effect that:
(i) The representations and warranties of the
Company in this Agreement are true and correct, in all material
respects, as if made at and as of such Closing Date, and
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<PAGE> 25
the Company has complied with all the agreements and satisfied all the
conditions on its part to be performed or satisfied at or prior to such
Closing Date;
(ii) No stop order or other order suspending the
effectiveness of the Registration Statement or any amendment thereof,
the use of the Prospectus or any supplement thereof, or the
qualification of the Securities for offering or sale has been issued,
and no proceeding for that purpose has been instituted or, to the best
of their knowledge, is contemplated by the Commission or any state or
regulatory body; and
(iii) The signers of said certificate have
carefully examined the Registration Statement and the Prospectus, and
any amendments thereof or supplements thereto (including any term sheet
within the meaning of Rule 434 of the Rules and Regulations), and (A)
such documents contain all statements and information required to be
included therein, the Registration Statement, or any amendment thereof,
does not contain any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to
make the statements therein not misleading, and the Prospectus, as
amended or supplemented, does not include any untrue statement of
material fact or omit to state a material fact necessary to make the
statements therein, in the light of the circumstances under which they
were made, not misleading, (B) since the effective date of the
Registration Statement, there has occurred no event required to be set
forth in an amended or supplemented prospectus which has not been so
set forth, (C) subsequent to the respective dates as of which
information is given in the Registration Statement and the Prospectus,
neither the Company nor any of its subsidiaries or any of the
Acquisition Partnerships has incurred any material liabilities or
obligations, direct or contingent, or entered into any material
transactions, not in the ordinary course of business, or declared or
paid any dividends or made any distribution of any kind with respect to
its capital stock, and except as disclosed in the Prospectus, there has
not been any change in the capital stock (other than a change in the
number of outstanding shares of Common Stock due to the issuance of
shares upon the exercise of outstanding options or warrants), or any
material change in the short-term or long-term debt, or any issuance of
options, warrants, convertible securities or other rights to purchase
the capital stock, of the Company, or any of its subsidiaries or any of
the Acquisition Partnerships, or any material adverse change or any
development involving a prospective material adverse change (whether or
not arising in the ordinary course of business), in the condition
(financial or otherwise), business, prospects, net worth or results of
operations of the Company and its subsidiaries, taken as a whole, and
(D) except as stated in the Registration Statement and the Prospectus,
there is not pending, or, to the knowledge of the Company, threatened
any action, suit or proceeding to which the Company, any of its
subsidiaries or any of the Acquisition Partnerships is a party before
or by any court or governmental agency, authority or body, or any
arbitrator, which might result in any material adverse change in the
condition (financial or otherwise), business, prospects, net worth or
results of operations of the Company and its subsidiaries and taken as
a whole.
(i) On each Closing Date, there shall have been furnished
to the Underwriters a certificate or certificates, dated such Closing Date and
addressed to the Underwriters, signed by each
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of the Selling Stockholders or either of such Selling Stockholder's
Attorneys-in-Fact to the effect that the representations and warranties of such
Selling Stockholder contained in this Agreement are true and correct as if made
at and as of such Closing Date, and that such Selling Stockholder has complied
with all the agreements and satisfied all the conditions on such Selling
Stockholder's part to be performed or satisfied at or prior to such Closing
Date.
(j) The NASD has confirmed that it has not raised any
objection with respect to the fairness and reasonableness of the underwriting
terms and arrangements.
(k) The Company shall have furnished to the Underwriters
and counsel for the Underwriters such additional documents, certificates and
evidence as the Underwriters or they may have reasonably requested.
All such opinions, certificates, letters and other documents will be in
compliance with the provisions hereof only if they are satisfactory in form and
substance to the Underwriters and counsel for the Underwriters. The Company will
furnish the Underwriters with such conformed copies of such opinions,
certificates, letters and other documents as the Underwriters shall reasonably
request.
6. Indemnification and Contribution.
(a) The Company and each Selling Stockholder, jointly and
severally, agree to indemnify and hold harmless each Underwriter against any
losses, claims, damages or liabilities, joint or several, to which such
Underwriter may become subject, under the Act or otherwise (including in
settlement of any litigation if such settlement is effected with the written
consent of the Company and/or such Selling Stockholders, as the case may be),
insofar as such losses, claims, damages or liabilities (or actions in respect
thereof) arise out of or are based upon an untrue statement or alleged untrue
statement of a material fact contained in the Registration Statement, including
the information deemed to be a part of the Registration Statement at the time of
effectiveness pursuant to Rules 430A and 434(d) of the Rules and Regulations, if
applicable, any Preliminary Prospectus, the Prospectus, or any amendment or
supplement thereto (including any term sheet within the meaning of Rule 434 of
the Rules and Regulations), or arise out of or are based upon the omission or
alleged omission to state therein a material fact required to be stated therein
or necessary to make the statements therein not misleading, and will reimburse
each Underwriter for any legal or other expenses reasonably incurred by it in
connection with investigating or defending against such loss, claim, damage,
liability or action; provided, however, that neither the Company nor any Selling
Stockholder shall be liable in any such case to the extent that any such loss,
claim, damage, liability or action arises out of or is based upon an untrue
statement or alleged untrue statement or omission or alleged omission made in
the Registration Statement, any Preliminary Prospectus, the Prospectus or any
such amendment or supplement, in reliance upon and in conformity with written
information furnished to the Company by you, or by any Underwriter through you,
specifically for use in the preparation thereof; and further provided, however,
that in no event shall any Selling Stockholder be liable under the provisions of
this Section 6 for any amount in excess of the aggregate amount of proceeds such
Selling Stockholder received from the sale of the Securities pursuant to this
Agreement.
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In addition to their other obligations under this Section 6(a), the
Company and each Selling Stockholder, jointly and severally, agree that, as an
interim measure during the pendency of any claim, action, investigation, inquiry
or other proceeding arising out of or based upon any statement or omission, or
any alleged statement or omission, described in this Section 6(a), they will
reimburse each Underwriter on a monthly basis for all reasonable legal fees or
other expenses incurred in connection with investigating or defending any such
claim, action, investigation, inquiry or other proceeding, notwithstanding the
absence of a judicial determination as to the propriety and enforceability of
the Company's and/or the Selling Stockholder's obligation to reimburse the
Underwriters for such expenses and the possibility that such payments might
later be held to have been improper by a court of competent jurisdiction. To the
extent that any such interim reimbursement payment is so held to have been
improper, the Underwriter that received such payment shall promptly return it to
the party or parties that made such payment, together with interest, compounded
daily, determined on the basis of the prime rate (or other commercial lending
rate for borrowers of the highest credit standing) announced from time to time
by __________________ (the "Prime Rate"). Any such interim reimbursement
payments which are not made to an Underwriter within 30 days of a request for
reimbursement shall bear interest at the Prime Rate from the date of such
request. This indemnity agreement shall be in addition to any liabilities which
the Company or the Selling Stockholders may otherwise have.
(b) Each Underwriter, severally but not jointly, will
indemnify and hold harmless the Company and each Selling Stockholder against any
losses, claims, damages or liabilities to which the Company and the Selling
Stockholders may become subject, under the Act or otherwise (including in
settlement of any litigation, if such settlement is effected with the written
consent of such Underwriter), insofar as such losses, claims, damages or
liabilities (or actions in respect thereof) arise out of or are based upon an
untrue statement or alleged untrue statement of a material fact contained in the
Registration Statement, any Preliminary Prospectus, the Prospectus, or any
amendment or supplement thereto (including any term sheet within the meaning of
Rule 434 of the Rules and Regulations), or arise out of or are based upon the
omission or alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein not misleading, in
each case to the extent, but only to the extent, that such untrue statement or
alleged untrue statement or omission or alleged omission was made in the
Registration Statement, any Preliminary Prospectus, the Prospectus, or any such
amendment or supplement, in reliance upon and in conformity with written
information furnished to the Company by you, or by such Underwriter through you,
specifically for use in the preparation thereof, and will reimburse the Company
and the Selling Stockholders for any legal or other expenses reasonably incurred
by the Company or any such Selling Stockholder in connection with investigating
or defending against any such loss, claim, damage, liability or action.
(c) Promptly after receipt by an indemnified party under
subsection (a) or (b) above of notice of the commencement of any action, such
indemnified party shall, if a claim in respect thereof is to be made against the
indemnifying party under such subsection, notify the indemnifying party in
writing of the commencement thereof, but the omission so to notify the
indemnifying party shall not relieve the indemnifying party from any liability
that it may have to any indemnified party. In case any such action shall be
brought against any indemnified party, and it shall notify the indemnifying
party of the commencement thereof, the indemnifying party shall be
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<PAGE> 28
entitled to participate in, and, to the extent that it shall wish, jointly with
any other indemnifying party similarly notified, to assume the defense thereof,
with counsel satisfactory to such indemnified party and after notice from the
indemnifying party to such indemnified party of the indemnifying party's
election so to assume the defense thereof, the indemnifying party shall not be
liable to such indemnified party under such subsection for any legal or other
expenses subsequently incurred by such indemnified party in connection with the
defense thereof other than reasonable costs of investigation; provided, however,
that if, in the sole judgment of the Underwriters, it is advisable for the
Underwriters to be represented as a group by separate counsel, the Underwriters
shall have the right to employ a single counsel to represent all Underwriters
who may be subject to liability arising from any claim in respect of which
indemnity may be sought by the Underwriters under subsection (a) of this Section
6, in which event the reasonable fees and expenses of such separate counsel
shall be borne by the indemnifying party or parties and reimbursed to the
Underwriters as incurred (in accordance with the provisions of the second
paragraph in subsection (a) above). An indemnifying party shall not be obligated
under any settlement agreement relating to any action under this Section 6 to
which it has not agreed in writing.
(d) If the indemnification provided for in this Section 6
is unavailable or insufficient to hold harmless an indemnified party under
subsection (a) or (b) above, then each indemnifying party shall contribute to
the amount paid or payable by such indemnified party as a result of the losses,
claims, damages or liabilities referred to in subsection (a) or (b) above, (i)
in such proportion as is appropriate to reflect the relative benefits received
by the Company and the Selling Stockholders on the one hand and the Underwriters
on the other from the offering of the Securities or (ii) if the allocation
provided by clause (i) above is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (i) above but also the relative fault of the Company and the
Selling Stockholders on the one hand and the Underwriters on the other in
connection with the statements or omissions that resulted in such losses,
claims, damages or liabilities, as well as any other relevant equitable
considerations. The relative benefits received by the Company and the Selling
Stockholders on the one hand and the Underwriters on the other shall be deemed
to be in the same proportion as the total net proceeds from the offering (before
deducting expenses) received by the Company and Selling Stockholders bear to the
total underwriting discounts and commissions received by the Underwriters, in
each case as set forth in the table on the cover page of the Prospectus. The
relative fault shall be determined by reference to, among other things, whether
the untrue or alleged untrue statement of a material fact or the omission or
alleged omission to state a material fact relates to information supplied by the
Company, the Selling Stockholders or the Underwriters and the parties' relevant
intent, knowledge, access to information and opportunity to correct or prevent
such untrue statement or omission. The Company, the Selling Stockholders and the
Underwriters agree that it would not be just and equitable if contributions
pursuant to this subsection (d) were to be determined by pro rata allocation
(even if the Underwriters were treated as one entity for such purpose) or by any
other method of allocation which does not take account of the equitable
considerations referred to in the first sentence of this subsection (d). The
amount paid by an indemnified party as a result of the losses, claims, damages
or liabilities referred to in the first sentence of this subsection (d) shall be
deemed to include any legal or other expenses reasonably incurred by such
indemnified party in connection with investigating or defending against any
action or claim which is the subject of this subsection (d). Notwithstanding the
provisions of this subsection (d), no Underwriter shall be required to
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contribute any amount in excess of the amount by which the total price at which
the Securities underwritten by it and distributed to the public were offered to
the public exceeds the amount of any damages that such Underwriter has otherwise
been required to pay by reason of such untrue or alleged untrue statement or
omission or alleged omission. No person guilty of fraudulent misrepresentation
(within the meaning of Section 11(f) of the Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent
misrepresentation. The Underwriters' obligations in this subsection (d) to
contribute are several in proportion to their respective underwriting
obligations and not joint.
(e) The obligations of the Company and the Selling
Stockholders under this Section 6 shall be in addition to any liability which
the Company and the Selling Stockholders may otherwise have and shall extend,
upon the same terms and conditions, to each person, if any, who controls any
Underwriter within the meaning of the Act; and the obligations of the
Underwriters under this Section 6 shall be in addition to any liability that the
respective Underwriters may otherwise have and shall extend, upon the same terms
and conditions, to each director of the Company (including any person who, with
such person's consent, is named in the Registration Statement as about to become
a director of the Company), to each officer of the Company who has signed the
Registration Statement and to each person, if any, who controls the Company or
any Selling Stockholder within the meaning of the Act.
7. Representations and Agreements to Survive Delivery. All
representations, warranties, and agreements of the Company herein or in
certificates delivered pursuant hereto, and the agreements of the several
Underwriters, the Company and the Selling Stockholders contained in Section 6
hereof, shall remain operative and in full force and effect regardless of any
investigation made by or on behalf of any Underwriter or any controlling person
thereof, or the Company or any of its officers, directors, or controlling
persons, or any Selling Stockholders or any controlling person thereof, and
shall survive delivery of, and payment for, the Securities to and by the
Underwriters hereunder.
8. Substitution of Underwriters.
(a) If any Underwriter or Underwriters shall fail to take
up and pay for the amount of Firm Shares agreed by such Underwriter or
Underwriters to be purchased hereunder, upon tender of such Firm Shares in
accordance with the terms hereof, and the amount of Firm Shares not purchased
does not aggregate more than 10% of the total amount of Firm Shares set forth in
Schedule II hereto, the remaining Underwriters shall be obligated to take up and
pay for (in proportion to their respective underwriting obligations hereunder as
set forth in Schedule II hereto except as may otherwise be determined by you)
the Firm Shares that the withdrawing or defaulting Underwriters agreed but
failed to purchase.
(b) If any Underwriter or Underwriters shall fail to take
up and pay for the amount of Firm Shares agreed by such Underwriter or
Underwriters to be purchased hereunder, upon tender of such Firm Shares in
accordance with the terms hereof, and the amount of Firm Shares not purchased
aggregates more than 10% of the total amount of Firm Shares set forth in
Schedule II hereto, and arrangements satisfactory to you for the purchase of
such Firm Shares by other persons
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are not made within 36 hours thereafter, this Agreement shall terminate. In the
event of any such termination neither the Company nor any Selling Stockholder
shall be under any liability to any Underwriter (except to the extent provided
in Section 4(a)(viii) or Section 6 hereof) nor shall any Underwriter (other than
an Underwriter who shall have failed, otherwise than for some reason permitted
under this Agreement, to purchase the amount of Firm Shares agreed by such
Underwriter to be purchased hereunder) be under any liability to the Company or
the Selling Stockholders (except to the extent provided in Section 6 hereof).
If Firm Shares to which a default relates are to be purchased by the
non-defaulting Underwriters or by any other party or parties, the Underwriters
or the Company shall have the right to postpone the First Closing Date for not
more than seven business days in order that the necessary changes in the
Registration Statement, Prospectus and any other documents, as well as any other
arrangements, may be effected. As used herein, the term "Underwriter" includes
any person substituted for an Underwriter under this Section 8.
9. Effective Date of this Agreement and Termination.
(a) This Agreement shall become effective at 10:00 a.m.,
Central time, on the first full business day following the effective date of the
Registration Statement, or at such earlier time after the effective time of the
Registration Statement as the Underwriters in their discretion shall first
release the Securities for sale to the public; provided, that if the
Registration Statement is effective at the time this Agreement is executed, this
Agreement shall become effective at such time as the Underwriters in their
discretion shall first release the Securities for sale to the public. For the
purpose of this Section, the Securities shall be deemed to have been released
for sale to the public upon release by the Underwriters of the publication of a
newspaper advertisement relating thereto or upon release by the Underwriters of
telexes offering the Securities for sale to securities dealers, whichever shall
first occur. By giving notice as hereinafter specified before the time this
Agreement becomes effective, the Underwriters or the Company may prevent this
Agreement from becoming effective without liability of any party to any other
party, except that the provisions of Section 4(a)(viii) or Section 6 hereof
shall at all times be effective.
(b) The Underwriters shall have the right to terminate
this Agreement by giving notice as hereinafter specified at any time at or prior
to the First Closing Date, and the option referred to in Section 3(b), if
exercised, may be canceled at any time prior to the Second Closing Date, if (i)
the Company shall have failed, refused or been unable, at or prior to such
Closing Date, to perform any agreement on its part to be performed hereunder,
(ii) any other condition of the Underwriters' obligations hereunder is not
fulfilled, (iii) trading on the New York Stock Exchange, the American Stock
Exchange or the Nasdaq National Market shall have been suspended, (iv) minimum
or maximum prices for trading shall have been fixed, or maximum ranges for
prices for securities shall have been required, on the New York Stock Exchange,
the American Stock Exchange or the Nasdaq National Market, by such Exchange or
market or by order of the Commission or the NASD or any other governmental
authority having jurisdiction, (v) a banking moratorium shall have been declared
by Federal, New York or Texas authorities, or (vi) there has occurred any
material adverse change in the financial markets in the United States or an
outbreak of major hostilities (or an escalation thereof) in which the United
States is involved, a declaration
30
<PAGE> 31
of war by Congress, any other substantial national or international calamity or
any change or development involving a prospective change in national or
international political, financial or economic conditions or any other event or
occurrence of a similar character shall have occurred since the execution of
this Agreement that, in the Underwriters' judgment, makes it impractical or
inadvisable to proceed with the completion of the sale of and payment for the
Securities. Any such termination shall be without liability of any party to any
other party except that the provisions of Section 4(a)(viii) or Section 6 hereof
shall at all times be effective.
(c) If the Underwriters elect to prevent this Agreement
from becoming effective or to terminate this Agreement as provided in this
Section, the Company and an Attorney-in-Fact, on behalf of the Selling
Stockholders, shall be notified promptly by the Underwriters by telephone or
telegram, confirmed by letter. If the Company elects to prevent this Agreement
from becoming effective, the Underwriters and an Attorney-in-Fact, on behalf of
the Selling Stockholders, shall be notified by the Company by telephone or
telegram, confirmed by letter.
10. Default by One or More of the Selling Stockholders or the
Company. If one or more of the Selling Stockholders shall fail at the First
Closing Date to sell and deliver the number of Securities which such Selling
Stockholder or Selling Stockholders are obligated to sell hereunder, and the
remaining Selling Stockholders do not exercise the right hereby granted to
increase, pro rata or otherwise, the number of Securities to be sold by them
hereunder to the total number of Securities to be sold by all Selling
Stockholders as set forth in Schedule I, then the Underwriters may at their
option, by notice from the Underwriters to the Company and the non-defaulting
Selling Stockholders, either (a) terminate this Agreement without any liability
on the part of any non-defaulting party or (b) elect to purchase the Securities
which the Company and the non-defaulting Selling Stockholders have agreed to
sell hereunder.
In the event of a default by any Selling Stockholder as referred to in
this Section, either the Underwriters or the Company or, by joint action only,
the non-defaulting Selling Stockholders shall have the right to postpone the
First Closing Date for a period not exceeding seven business days in order to
effect any required changes in the Registration Statement or Prospectus or in
any other documents or arrangements.
If the Company shall fail at the First Closing Date to sell and deliver
the number of Securities which it is obligated to sell hereunder, then this
Agreement shall terminate without any liability on the part of any
non-defaulting party.
No action taken pursuant to this Section shall relieve the Company or
any Selling Stockholders so defaulting from liability, if any, in respect of
such default.
11. Information Furnished by Underwriters. The statements set
forth in the last two paragraphs of the inside front cover page and in the fifth
and sixth paragraphs under the caption "Underwriting" in any Preliminary
Prospectus and in the Prospectus constitute the only written information
furnished by or on behalf of the Underwriters referred to in Section 2 and
Section 6 hereof.
31
<PAGE> 32
12. Notices. Except as otherwise provided herein, all
communications hereunder shall be in writing or by telegraph and, if to the
Underwriters, shall be mailed, telegraphed or delivered to the Underwriters c/o
Piper Jaffray Inc., Piper Jaffray Tower, 222 South Ninth Street, Minneapolis,
Minnesota 55402, except that notices given to an Underwriter pursuant to Section
6 hereof shall be sent to such Underwriter at the following address, as
appropriate: Piper Jaffray Inc., 222 South Ninth Street, Minneapolis, Minnesota
55402, The Robinson-Humphrey Company, Inc., 3333 Peachtree Road, N.E., 10th
Floor, Atlanta, Georgia 30326, Sandler O'Neill & Partners, L.P., Two World Trade
Center, 104th Floor, New York, New York 10048; if to the Company, shall be
mailed, telegraphed or delivered to it at FirstCity Financial Corporation, 6400
Imperial Drive, Waco, Texas 76712 Attention: President; if to any of the Selling
Stockholders, at the address of the Attorneys-in-Fact as set forth in the Powers
of Attorney, or in each case to such other address as the person to be notified
may have requested in writing. All notices given by telegram shall be promptly
confirmed by letter. Any party to this Agreement may change such address for
notices by sending to the parties to this Agreement written notice of a new
address for such purpose.
13. Persons Entitled to Benefit of Agreement. This Agreement shall
inure to the benefit of and be binding upon the parties hereto and their
respective successors and assigns and the controlling persons, officers and
directors referred to in Section 6. Nothing in this Agreement is intended or
shall be construed to give to any other person, film or corporation any legal or
equitable remedy or claim under or in respect of this Agreement or any provision
herein contained. The term "successors and assigns" as herein used shall not
include any purchaser, as such purchaser, of any of the Securities from any of
the several Underwriters.
14. Governing Law. This Agreement shall be governed by and
construed in accordance with the internal laws of the State of Minnesota without
reference to the conflicts of laws principles thereof.
[Signature Page Follows]
32
<PAGE> 33
Please sign and return to the Company the enclosed duplicates of this
letter whereupon this letter will become a binding agreement between the
Company, the Selling Stockholders and the several Underwriters in accordance
with its terms.
Very truly yours,
FIRSTCITY FINANCIAL CORPORATION
By
--------------------------------------
Executive Vice President
Selling Stockholders
By
--------------------------------------
Attorney-in-Fact
Confirmed as of the date first
above mentioned, on behalf of
themselves and the other several
Underwriters named in Schedule II
hereto:
PIPER JAFFRAY INC.
By
-------------------------------
Title:
------------------------
<PAGE> 34
SCHEDULE I
Selling Stockholders
<TABLE>
<CAPTION>
Number of Firm
Name Shares to be Sold
---- -----------------
<S> <C>
-----------------
Total . . . . . . . 341,000
=================
</TABLE>
<PAGE> 35
SCHEDULE II
<TABLE>
<CAPTION>
Underwriter Number of Firm Shares(1)
- -----------
<S> <C>
Piper Jaffray Inc.
The Robinson-Humphrey Company, LLC
Sandler O'Neill & Partners, L.P.
-----------------
Total . . . . . . . . 1,341,000
=================
</TABLE>
- ----------
(1) The Underwriters may purchase up to an additional 201,150 Option
Shares, to the extent the option described in Section 3(b) of the
Agreement is exercised, in the proportions and in the manner described
in the Agreement.
<PAGE> 36
SCHEDULE III
Acquisition Partnership Percentage of Ownership
- ----------------------- -----------------------
Subsidiary Percentage of Ownership
- ---------- -----------------------
<PAGE> 1
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
The Board of Directors and Shareholders
FirstCity Financial Corporation:
We consent to the inclusion in the registration statement on Form S-3 of
FirstCity Financial Corporation of our report dated March 24, 1998, relating to
the consolidated balance sheets of FirstCity Financial Corporation and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income, shareholders' equity and cash flows for each of the years
in the three-year period ended December 31, 1997, and to the incorporation by
reference in such registration statement of our report dated March 24, 1998,
relating to the combined balance sheets of the WAMCO Partnerships as of December
31, 1997 and 1996, 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, 1997, which report appears in the December 31, 1997 annual
report on Form 10-K of FirstCity Financial Corporation.
We also consent to the reference to our Firm under the heading "Experts" in
the registration statement and Prospectus.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
Fort Worth, Texas
March 25, 1998
