First City: Nothing Succeeds Like Distress

The former bank, near death twice, now thrives on bad loans

FirstCity Financial Corp., based in Waco, Tex., has made a tidy profit mining the detritus of the financial system. It collects on bad loans that it buys cheaply from financial institutions that would rather not be bothered with them. Its stock has doubled since 1995. In a somewhat risky but potentially lucrative move, FirstCity is poised to extend its reach into Europe and Mexico and into new business areas. It is negotiating to purchase a $50 million package of bad commercial and real estate loans from a French seller.

And FirstCity knows quite a lot about bad loans. Four years ago, federal banking regulators seized First City Bancorp. of Texas Inc., FirstCity Financial's predecessor. They declared its 20 banks insolvent and predicted a $500 million bailout. It seemed almost certain the bank holding company had taken its last breath. After all, this was the second time in four years that federal regulators had stepped in to rescue First City. On Halloween, 1992, the day after the seizure, bondholders pushed First City, once Texas' largest independent bank, into involuntary bankruptcy. "I was pretty sure we were dead," says First City's former chief financial officer, Robert W. Brown.

WINDFALL. But a funny thing happened on the way to the big bank vault in the sky. In February, 1993, the Federal Deposit Insurance Corp.'s sale of First City's 20 banks raked in a $434 million premium, leaving $60 million more than needed to pay off depositors--unusual in bailouts. Equally rare, First City sued the FDIC for illegally seizing its banks--and won. In November, the FDIC agreed to return $380 million in cash and other assets to the bank holding company.

Armed with that windfall and a merger with J-Hawk Corp., based in Waco, Tex., First City emerged from Chapter 11 in July, 1995, to begin its third life. The new company, FirstCity Financial Corp., adopted J. Hawk's main business of managing distressed loans and real estate. "This is a very rare case," says analyst William L. Eddleman Jr. of Coastal Securities. "Most banks in First City's position were liquidated and went away."

The new company's CEO, James R. Hawkins, who founded J-Hawk, is a 60-year-old former retail executive and certified public accountant. He cut his teeth running now mostly defunct Gibson's Discount Center, a Southern store chain that often dealt in closeout merchandise. With $6 million in tax-loss carryforwards from Gibson's, Hawkins in 1986 started buying pools of consumer loans from the FDIC, but quickly shifted to acquiring commercial loans and foreclosed real estate when the government began selling billions of dollars in assets seized from failed banks and thrifts. By paying a discount for the loans, and then working with the borrowers to pay them off for substantially more, J-Hawk helped pioneer a profitable financial-services niche. Since 1986, J-Hawk has bought $2.3 billion in distressed assets for $950 million and expects to collect more than the full value as profit.

FirstCity Financial has produced impressive results so far. Its earnings jumped 66%, to $13.8 million, in the first nine months of 1996. Analyst Steven R. Schroll of Piper Jaffray Inc. expects full-year net income of $20 million, up 36% from 1995. Helping earnings now and well into the next century are $600 million of tax benefits from the old First City's losses on oil and real estate loans.

Wall Street is taking note of the strong earnings. FirstCity Financial's shares are trading at 28 3/4, vs. 12 when it began trading in July, 1995. Its preferred shares are up 14%, to 23 1/16. That's a hefty payoff for old First City shareholders, who exchanged their holdings for shares in the new company. For example, one old preferred share, which traded for a penny in December, 1992, is now worth about $70 in common and preferred stock and warrants of the new company. "I guess I looked real dumb when I didn't sell my shares back in 1992," says longtime First City shareholder Richard E. Bean, who is now a FirstCity Financial director. "But I just felt something positive would come out of this for shareholders. In the end, I guess I was real smart because I've made 70 times the amount I originally invested on First City's preferred shares."

There are some shadows on the horizon. FirstCity Financial is feeling pressure in its core distressed-asset business since the now strong U.S. economy and banking system creates a smaller supply of distressed assets, which hurts margins. "When we started out, the margins were just incredible," says Hawkins. "We consistently brought in 50% to 70% return on equity. Now it's down to the 30s."

SOUR ASSETS. In recent months, the company has begun to diversify into new businesses that will use its skills at managing loan portfolios and disposing of assets that have gone sour. It is targeting "subprime" or "high-risk" performing consumer loans such as auto loans to borrowers with poor credit records. Within three years, Hawkins expects the new businesses to account for about 80% of FirstCity Financial's profits. To get there, the company has embarked on an aggressive acquisition strategy, gobbling up competitors in the secondary auto-finance markets, for example. Next year, the company will enter the mortgage business. "FirstCity Financial's expertise is readily transferable" into the new areas, says analyst Schroll.

But don't expect FirstCity Financial to turn its back entirely on distressed assets. In addition to its foray overseas, Hawkins sees bad assets continuing to trickle in from U.S. banks. "There will always be distressed assets out there," he says. For FirstCity Financial, distress these days means a profit opportunity, not a trip to the courthouse.

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