**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

**Form 10-Q**
| **(Mark One)**                                    | ** **                                                                                    |
|---------------------------------------------------|-----------------------------------------------------------------------------------------------|
| **x**                                             | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                              | ** **                                                                                    |
| **For the quarterly period ended  June 30, 2007** |
| ** **                                        | ** **                                                                                    |
| **o**                                             | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 033-19694**

**FirstCity Financial Corporation**

(Exact name of registrant asspecified in its charter)

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

 

**(254)761-2800**

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x     No o

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer.  See definition of accelerated filerand large accelerated filer in Rule 12b-2 of the Exchange Act.   (Check one.)

Large acceleratedfiler o              Accelerated filer x             Non-acceleratedfiler o

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

Thenumber of shares of common stock, par value $.01 per share, outstanding atAugust 7, 2007 was 10,794,137.

 

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**TABLEOF CONTENTS**
| PART I                                                                                              |
|-----------------------------------------------------------------------------------------------------|
| Item 1. Financial Statements                                                                        |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 |
| Item 4. Controls and Procedures                                                                     |
| PART II                                                                                             |
| OTHER  INFORMATION                                                                                  |
| Item 1. Legal Proceedings                                                                           |
| Item 1A. Risk Factors                                                                               |
| Item 2. Unregistered Sales of Equity Securities and Use  of Proceeds                                |
| Item 3. Defaults Upon Senior Securities                                                             |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        |
| Item 5. Other Information                                                                           |
| Item  6. Exhibits                                                                                   |
| SIGNATURES                                                                                          |
| Exhibit  Index                                                                                      |
| Certification  of CEO Pursuant to Section 302                                                       |
| Certification of CFO Pursuant to  Section 302                                                       |
| Certification of CEO Pursuant to Section 906                                                        |
| Certification of CFO Pursuant to Section 906                                                        |

 

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Table of Contents

**PART I**

**FINANCIAL INFORMATION**

**Item 1.  Financial Statements.**

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Dollars inthousands, except per share data)**
| ** **                                                                                                                                                                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                     | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                     | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                     | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                                                                                                                                                     |       | $                 | 18,380     |                  | $          | 18,472 |   |
| Portfolio Assets, net                                                                                                                                                                          |       | 122,628           |       | 108,696               |       |
| Loans receivable from  Acquisition Partnerships held for investment                                                                                                                            |       | 5,084             |       | 4,755                 |       |
| Loans receivable - SBA  held for sale                                                                                                                                                          |       | 3,830             |       | —                |       |
| Loans receivable - SBA  held for investment, net                                                                                                                                               |       | 15,480            |       | —                |       |
| Loans receivable -  other                                                                                                                                                                      |       | 29,223            |       | 23,991                |       |
| Equity investments                                                                                                                                                                             |       | 115,275           |       | 112,357               |       |
| Deferred tax asset, net                                                                                                                                                                        |       | 20,101            |       | 20,101                |       |
| Service fees receivable  ($1,219 and $917 from affiliates, respectively)                                                                                                                       |       | 1,303             |       | 928                   |       |
| Loan servicing assets -  SBA                                                                                                                                                                   |       | 891               |       | —                |       |
| Other assets, net                                                                                                                                                                              |       | 9,418             |       | 8,363                 |       |
| Total Assets                                                                                                                                                                                   |       | $                 | 341,613    |                  | $          | 297,663 |   |
|                                                                                                                                                                                           |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 | ** ** | ** **        | ** ** | ** **            | ** ** |
| Liabilities:                                                                                                                                                                                   |       |              |       |                  |       |
| Notes payable  other                                                                                                                                                                           |       | $                 | 228,365    |                  | $          | 187,811 |   |
| Minority  interest                                                                                                                                                                             |       | 1,312             |       | 1,570                 |       |
| Other  liabilities                                                                                                                                                                             |       | 6,254             |       | 4,389                 |       |
| Total  Liabilities                                                                                                                                                                             |       | 235,931           |       | 193,770               |       |
| Commitments and  contingencies (note 12)                                                                                                                                                       |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                     |       |              |       |                  |       |
| Optional  preferred stock (par value $.01 per share; 98,000,000 shares authorized; no  shares issued or outstanding)                                                                           |       | —            |       | —                |       |
| Common stock  (par value $.01 per share; 100,000,000 shares authorized; shares issued:  11,319,437 and 11,316,937, respectively; shares outstanding: 10,789,137 and  10,786,637, respectively) |       | 113               |       | 113                   |       |
| Treasury stock,  at cost: 530,300 shares and 530,300 shares, respectively                                                                                                                      |       | (5,571            | )          | (5,571                | )          |
| Paid in capital                                                                                                                                                                                |       | 100,869           |       | 100,562               |       |
| Retained  earnings                                                                                                                                                                             |       | 8,308             |       | 7,417                 |       |
| Accumulated  other comprehensive income                                                                                                                                                        |       | 1,963             |       | 1,372                 |       |
| Total Stockholders’  Equity                                                                                                                                                               |       | 105,682           |       | 103,893               |       |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                               |       | $                 | 341,613    |                  | $          | 297,663 |   |

 

See accompanying notes to consolidated financial statements.

2

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Table of Contents

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Dollars in thousands, except per share data)**

**(Unaudited)**
| ** **                                                                                                                                                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                                                                                                          | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues:                                                                                                                                                                           |       |                             |       |                           |       |   |   |   |   |
| Servicing fees ($2,728 and $2,771 from affiliates  for the three month periods, respectively, and $5,181 and $5,352 from  affiliates for the six month month periods, respectively) |       | $                                | 2,977      |                           | $          | 2,856 |   | $ | 5,582 |   | $ | 5,503 |   |
| Income from Portfolio Assets                                                                                                                                                        |       | 5,685                            |       | 2,946                          |       | 10,720 |   | 5,004 |   |
| Gain on sale of SBA loans held for sale, net                                                                                                                                        |       | 343                              |       | —                         |       | 624 |   | — |   |
| Interest income from SBA loans                                                                                                                                                      |       | 606                              |       | —                         |       | 914 |   | — |   |
| Interest income from affiliates                                                                                                                                                     |       | 140                              |       | 465                            |       | 266 |   | 895 |   |
| Interest income from loans receivable - other                                                                                                                                       |       | 982                              |       | —                         |       | 1,889 |   | — |   |
| Other income                                                                                                                                                                        |       | 538                              |       | 612                            |       | 997 |   | 1,192 |   |
| Total revenues                                                                                                                                                                      |       | 11,271                           |       | 6,879                          |       | 20,992 |   | 12,594 |   |
| Expenses:                                                                                                                                                                           |       |                             |       |                           |       |   |   |   |   |
| Interest and fees on notes payable — other                                                                                                                                     |       | 4,668                            |       | 1,938                          |       | 8,919 |   | 3,636 |   |
| Interest and fees on notes payable to affiliates                                                                                                                                    |       | —                           |       | 10                             |       | — |   | 20 |   |
| Salaries and benefits                                                                                                                                                               |       | 3,864                            |       | 3,278                          |       | 7,857 |   | 7,016 |   |
| Provision (recovery) for loan and impairment losses                                                                                                                                 |       | 746                              |       | (58                            | )          | 1,072 |   | 51 |   |
| Occupancy, data processing, communication and other                                                                                                                                 |       | 4,388                            |       | 1,913                          |       | 8,231 |   | 3,477 |   |
| Total expenses                                                                                                                                                                      |       | 13,666                           |       | 7,081                          |       | 26,079 |   | 14,200 |   |
| Equity in  earnings of investments                                                                                                                                                  |       | 4,332                            |       | 1,387                          |       | 6,158 |   | 5,021 |   |
| Gain on sale of  interest in equity investments                                                                                                                                     |       | —                           |       | 27                             |       | — |   | 27 |   |
| Earnings from  continuing operations before income taxes and minority interest                                                                                                      |       | 1,937                            |       | 1,212                          |       | 1,071 |   | 3,442 |   |
| Income tax expense                                                                                                                                                                  |       | (146                             | )          | (22                            | )          | (303 | ) | (144 | ) |
| Minority interest                                                                                                                                                                   |       | 15                               |       | 73                             |       | 123 |   | 62 |   |
| Earnings from  continuing operations                                                                                                                                                |       | 1,806                            |       | 1,263                          |       | 891 |   | 3,360 |   |
| Discontinued  operations                                                                                                                                                            |       |                             |       |                           |       |   |   |   |   |
| Loss from discontinued operations                                                                                                                                                   |       | —                           |       | —                         |       | — |   | (75 | ) |
| Income taxes                                                                                                                                                                        |       | —                           |       | —                         |       | — |   | — |   |
| Net loss from discontinued operations                                                                                                                                               |       | —                           |       | —                         |       | — |   | (75 | ) |
| Net earnings                                                                                                                                                                        |       | $                                | 1,806      |                           | $          | 1,263 |   | $ | 891 |   | $ | 3,285 |   |
| Basic earnings  per common share are as follows:                                                                                                                                    |       |                             |       |                           |       |   |   |   |   |
| Earnings from continuing operations                                                                                                                                                 |       | $                                | 0.17       |                           | $          | 0.11 |   | $ | 0.08 |   | $ | 0.30 |   |
| Discontinued operations                                                                                                                                                             |       | $                                | —     |                           | $          | — |   | $ | — |   | $ | (0.01 | ) |
| Net earnings to common stockholders                                                                                                                                                 |       | $                                | 0.17       |                           | $          | 0.11 |   | $ | 0.08 |   | $ | 0.29 |   |
| Weighted average common shares outstanding                                                                                                                                          |       | 10,789                           |       | 11,308                         |       | 10,789 |   | 11,308 |   |
| Diluted earnings  per common share are as follows:                                                                                                                                  |       |                             |       |                           |       |   |   |   |   |
| Earnings from continuing operations                                                                                                                                                 |       | $                                | 0.16       |                           | $          | 0.11 |   | $ | 0.08 |   | $ | 0.28 |   |
| Discontinued operations                                                                                                                                                             |       | $                                | —     |                           | $          | — |   | $ | — |   | $ | (0.01 | ) |
| Net earnings to common stockholders                                                                                                                                                 |       | $                                | 0.16       |                           | $          | 0.11 |   | $ | 0.08 |   | $ | 0.27 |   |
| Weighted average  common shares outstanding                                                                                                                                         |       | 11,397                           |       | 11,959                         |       | 11,414 |   | 11,958 |   |

 

See accompanying notes to consolidated financial statements.

3

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Table of Contents

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOME**

**(Dollars in thousands)**

 
| ** **                                                                   | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Retained**           | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                   | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Earnings**           | ** ** | **Other**       | ** ** | **Total**  | ** ** |
| ** **                                                                   | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                   | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**       | ** ** | **Amount**       | ** ** | **Capital**       | ** ** | **Deficit)**           | ** ** | **Income**      | ** ** | **Equity** | ** ** |
| ** **                                                                   | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | ** **             | ** ** | ** **      | ** ** | ** ** | ** ** |
| **Balances, December 31, 2005**                                              |       | 11,307,187            |       | $                       | 113        |             | —     |             | $          | —            |       | $                      | 99,843     |            | $          | (2,058     | )          | $ | 1,013 |   | $ | 98,911 |   |
| Cumulative effect of  adjustments resulting from the adoption of SAB No. 108 |       | —                |       | —                  |       | —           |       | —           |       | —            |       | (327                   | )          | —          |       | (327       | )          |
| Exercise of common stock  options                                            |       | 9,750                 |       | —                  |       | —           |       | —           |       | 68                |       | —                 |       | —          |       | 68         |       |
| Repurchase of common  stock                                                  |       | —                |       | —                  |       | 530,300          |       | (5,571           | )          | —            |       | —                 |       | —          |       | (5,571     | )          |
| Additional paid-in  capital arising from stock option compensation expense   |       | —                |       | —                  |       | —           |       | —           |       | 651               |       | —                 |       | —          |       | 651        |       |
| Comprehensive income:                                                        |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net  earnings for 2006                                                       |       | —                |       | —                  |       | —           |       | —           |       | —            |       | 9,802                  |       | —          |       | 9,802      |       |
| Translation  adjustments                                                     |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 359             |       | 359        |       |
| Total comprehensive  income                                                  |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | 10,161     |       |
| **Balances, December 31, 2006**                                              |       | 11,316,937            |       | 113                     |       | 530,300          |       | (5,571           | )          | 100,562           |       | 7,417                  |       | 1,372           |       | 103,893    |       |
| Exercise of common stock  options                                            |       | 2,500                 |       | —                  |       | —           |       | —           |       | 18                |       | —                 |       | —          |       | 18         |       |
| Additional paid-in  capital arising from stock option compensation expense   |       | —                |       | —                  |       | —           |       | —           |       | 289               |       | —                 |       | —          |       | 289        |       |
| Comprehensive income:                                                        |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net  earnings for the first six months of 2007                               |       | —                |       | —                  |       | —           |       | —           |       | —            |       | 891                    |       | —          |       | 891        |       |
| Translation  adjustments                                                     |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 591             |       | 591        |       |
| Total comprehensive  income                                                  |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | 1,482      |       |
| **Balances, June 30, 2007 (unaudited)**                                      |       | 11,319,437            |       | $                       | 113        |             | 530,300    |             | $          | (5,571            | )          | $                      | 100,869    |            | $          | 8,308      |       | $ | 1,963 |   | $ | 105,682 |   |

 

See accompanying notes to consolidated financial statements.

4

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Table of Contents

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Dollars in thousands)**

**(Unaudited)**
| ** **                                                                       | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                           |       |                           |       |   |   |
| Net earnings                                                                     |       | $                              | 891        |   | $ | 3,285 |   |
| Adjustments to reconcile net earnings to net cash  used in operating activities: |       |                           |       |   |   |
| Net loss from discontinued operations                                            |       | —                         |       | 75 |   |
| Purchase of SBA loans held for sale                                              |       | (19,179                        | )          | — |   |
| Payments applied to principal on SBA loans held for  sale                        |       | 411                            |       | — |   |
| Proceeds from the sale of SBA loans held for sale,  net                          |       | 15,772                         |       | — |   |
| Purchase of Portfolio Assets, net                                                |       | (44,437                        | )          | (25,777 | ) |
| Proceeds applied to principal on Portfolio Assets                                |       | 40,280                         |       | 22,158 |   |
| Income from Portfolio Assets                                                     |       | (10,720                        | )          | (5,004 | ) |
| Capitalized interest and costs on Portfolio Assets  and loans receivable         |       | (685                           | )          | (246 | ) |
| Provision for loan and impairment losses                                         |       | 1,072                          |       | 51 |   |
| Equity in earnings of investments                                                |       | (6,158                         | )          | (5,021 | ) |
| Gain on sale of SBA loans held for sale                                          |       | (624                           | )          | — |   |
| Depreciation and amortization                                                    |       | 221                            |       | 274 |   |
| Stock-based compensation expense related to stock  options                       |       | 289                            |       | 246 |   |
| Increase in service fees receivable                                              |       | (375                           | )          | (124 | ) |
| Decrease (increase) in other assets                                              |       | (1,776                         | )          | 139 |   |
| Change in debt imputed value                                                     |       | —                         |       | (129 | ) |
| Increase (decrease) in other liabilities                                         |       | 2,210                          |       | (712 | ) |
| Net cash used in operating activities                                            |       | (22,808                        | )          | (10,785 | ) |
| Cash flows from  investing activities:                                           |       |                           |       |   |   |
| Property and equipment, net                                                      |       | (422                           | )          | (115 | ) |
| Net payments (advances) on loans receivable                                      |       | (4,499                         | )          | (5,972 | ) |
| Net increase in SBA loans held for investment                                    |       | (15,706                        | )          | — |   |
| Contributions to Acquisition Partnerships and  Servicing Entities                |       | (21,146                        | )          | (21,518 | ) |
| Distributions from Acquisition Partnerships and  Servicing Entities              |       | 25,205                         |       | 44,937 |   |
| Net cash provided by (used in) investing activities                              |       | (16,568                        | )          | 17,332 |   |
| Cash flows from  financing activities:                                           |       |                           |       |   |   |
| Borrowings under notes payable — other                                      |       | 116,973                        |       | 57,265 |   |
| Payments of notes payable to affiliates                                          |       | —                         |       | (3 | ) |
| Payments of notes payable — other                                           |       | (77,689                        | )          | (66,386 | ) |
| Proceeds from issuance of common stock                                           |       | 18                             |       | 5 |   |
| Net cash provided by (used in) financing activities                              |       | 39,302                         |       | (9,119 | ) |
| Net cash used in continuing operations                                           |       | (74                            | )          | (2,572 | ) |
| Cash flows from  discontinued operations:                                        |       |                           |       |   |   |
| Net cash used in operating activities                                            |       | (18                            | )          | (17 | ) |
| Net cash provided by investing activities                                        |       | —                         |       | — |   |
| Net cash used in discontinued operations                                         |       | (18                            | )          | (17 | ) |
| Net decrease in  cash and cash equivalents                                       |       | (92                            | )          | (2,589 | ) |
| Cash and cash  equivalents, beginning of period                                  |       | 18,472                         |       | 12,901 |   |
| Cash and cash  equivalents, end of period                                        |       | $                              | 18,380     |   | $ | 10,312 |   |
| Supplemental  disclosure of cash flow information:                               |       |                           |       |   |   |
| Cash paid during the period for:                                                 |       |                           |       |   |   |
| Interest                                                                         |       | $                              | 7,741      |   | $ | 3,144 |   |
| Income taxes,  net of refunds received                                           |       | 48                             |       | (34 | ) |

 

See accompanying notes to consolidated financial statements.

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** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**June 30,2007**

**(Dollars inthousands, except per share data)**

**(Unaudited)**

**(1)  Basis of Presentation and Summary ofSignificant Accounting Policies**

***The Company***

FirstCityFinancial Corporation (the “Company” or “FirstCity”) is a financial servicescompany with offices throughout the United States, Mexico and Brazil, with apresence in France, Germany, Argentina and Chile. At June 30, 2007, the Companywas engaged in one principal reportable segment - Portfolio Asset acquisitionand resolution.  The portfolio asset acquisition and resolution business involves acquiringportfolios of loans, real estate and other assets or single assets andinvestment in similar assets (collectively referred to as “Portfolios” or “PortfolioAssets”) generally at a discount to their legal principal balance orappraised value, and servicing andresolving such Portfolios in an effort to maximize the present value of theultimate cash recoveries, and the origination of loans secured by similarassets.

***Basis of Presentation***

The unaudited consolidatedfinancial statements of FirstCity reflect, in the opinion of management, alladjustments, consisting only of normal and recurring adjustments, necessary topresent fairly FirstCity’s consolidated financial position at June 30, 2007,its results of operations for the three and six month periods ended June 30,2007 and 2006 and cash flows for the six month periods ended June 30, 2007 and2006.  Certain disclosures have beencondensed or omitted from these financial statements. Accordingly, thesefinancial statements should be read with the consolidated financial statementsincluded in the Company’s 2006 Annual Report on Form 10-K.  Certain amounts in the consolidated financialstatements for prior years have been reclassified to conform with currentconsolidated financial statement presentation.

***Use of Estimates***

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Significant estimates include (i) theestimation of future collections on purchased Portfolio Assets used in thecalculation of income from Portfolio Assets, (ii) interest rate environments,(iii) valuation of the deferred tax asset, and (iv) prepayment speeds andcollectibility of loans held in inventory, in securitization trusts and forinvestment. Actual results could differ materially from those estimates.

***Reclassifications***

Certain amounts in theconsolidated financial statements for prior periods have been reclassified toconform with current consolidated financial statement presentation.  In all reporting prior to December 31, 2006,FirstCity reported loans receivable advances and loans receivable payments incash flows from operating activities on the Consolidated Statements of CashFlows.  Beginning in the fourth quarterof 2006, the Company reports these items in cash flows from investingactivities.  Prior period amountsreported on the Consolidated Statements of Cash Flows have been adjusted toconform to this treatment which is required under GAAP.  The total amount thus reclassified was $5,972for the six months ended June 30, 2006. Management believes that the changes in the Consolidated Statements ofCash Flows for the six month period ended June 30, 2006 are immaterial relativeto the financial statements taken as a whole. These reclassifications have the following impact on the financialstatements:

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

|                                                                           | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                | ** ** | **June 30,**              | ** ** |
| ** **                                                                | ** ** | **2006**                       | ** ** |
| Statement of  Cash Flows:                                                 |       |                           |       |
| Cash flows from operating activities (as reported)                        |       | $                              | (16,757    | ) |
| Impact of reclassification on net loans receivable advances  and payments |       | 5,972                          |       |
| Cash flows from operating activities (as corrected)                       |       | $                              | (10,785    | ) |
|                                                                      |       |                           |       |
| Cash flows from investing activities (as reported)                        |       | $                              | 23,304     |   |
| Impact of reclassification on net loans receivable advances  and payments |       | (5,972                         | )          |
| Cash flows from  investing activities (as corrected)                      |       | $                              | 17,332     |   |

 

**(2)  New Accounting Pronouncements**

In February 2007, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No.159,*TheFair Value Option for Financial Assets and Financial Liabilities-Including anamendment of FASB Statement No. 115*(“SFAS 159”)**SFAS 159 permits entities tochoose to measure eligible items at fair value at specified election dates.Unrealized gains and losses on items for which the fair value option has beenelected are reported in earnings at each subsequent reporting date. The fairvalue option (i) may be applied instrument by instrument, with certainexceptions, (ii) is irrevocable (unless a new election date occurs) and (iii)is applied only to entire instruments and not to portions of instruments. SFAS159 is effective for the Company on January 1, 2008.  The Company is currently evaluating theimpact SFAS 159 will have on its financial statements.

In September 2006, SFAS No. 157, *Fair ValueMeasurements* (“SFAS 157”), was issued.  SFAS 157 establishes a framework formeasuring fair value and expands disclosures about fair valuemeasurements.  The changes to currentpractice resulting from the application of SFAS 157 relate to the definition offair value, the methods used to measure fair value, and the expandeddisclosures about fair value measurements. SFAS 157 is effective for the Company on January 1, 2008.  The Company is currently evaluating the impactSFAS 157 will have on its financial statements.

**(3)  Discontinued Operations**

Discontinued operations are comprised of twocomponents previously reported as the Company’s residential and commercialmortgage banking business (“Mortgage”) and the consumer lending businessconducted through the Company’s minority interest investment in Drive (“Consumer”).  There was no income or loss from discontinuedoperations in the first six months of 2007, and ($75) in the first six monthsof 2006.

*Mortgage*

At June 30, 2007, the only asset remaining from discontinued operationsis from mortgage operations, and represents an investment security resultingfrom the retention of a residual interest in a securitization transaction. Thissecurity is in “run-off,” and the Company is contractually obligated to servicethese assets.  The cash flows arecollected over a period of time and are valued using prepayment assumptions of32% for fixed rate loans and 33% for variable rate loans. Overall loss ratesare estimated at 14% of collateral.  TheCompany recorded provisions (recoveries) of $(18) and $58 in the first sixmonths of 2007 and 2006, respectively, for losses from discontinued mortgageoperations.  Discontinued mortgage assetsof $121 at June 30, 2007 are included in other assets.

*Consumer*

Liabilities fromdiscontinued consumer operations of $116 consisted of state taxes payable atJune 30, 2007, and are included in other liabilities.

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

**(4)  Portfolio Assets**

Portfolio Assets are summarized as follows:

|                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Loan Portfolios                             | ** ** | ** **        | ** ** | ** **            | ** ** |
| Loans Acquired Prior to 2005                | ** ** | ** **        | ** ** | ** **            | ** ** |
| Non-performing Portfolio Assets             |       | $                 | 5,259      |                  | $          | 6,163 |   |
| Performing Portfolio Assets                 |       | 3,061             |       | 5,166                 |       |
| Loans Acquired After 2004                   | ** ** | ** **        | ** ** | ** **            | ** ** |
| Loans acquired with credit deterioration    |       | 98,160            |       | 84,550                |       |
| Loans acquired with no credit deterioration |       | 5,544             |       | 6,473                 |       |
| Outstanding balance                         |       | 112,024           |       | 102,352               |       |
| Allowance for loan losses                   |       | (1,244            | )          | (333                  | )          |
| Carrying amount of loans, net of allowance  |       | 110,780           |       | 102,019               |       |
|                                        |       |              |       |                  |       |
| Real Estate  Portfolios                     |       | 9,787             |       | 4,574                 |       |
| Other                                       |       | 2,061             |       | 2,103                 |       |
| Portfolio  Assets, net                      |       | $                 | 122,628    |                  | $          | 108,696 |   |

 

Income from Portfolio Assets is summarized as follows:

|                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Loan Portfolios                             | ** ** | ** **                                      | ** ** | ** **                                    |       |   |   |   |   |
| Loans Acquired Prior to 2005                | ** ** | ** **                                      | ** ** | ** **                                    |       |   |   |   |   |
| Non-performing Portfolio Assets             |       | $                                               | 126        |                                          | $          | 886 |   | $ | 868 |   | $ | 1,852 |   |
| Performing Portfolio Assets                 |       | 213                                             |       | 428                                           |       | 562 |   | 881 |   |
| Loans Acquired After 2004                   | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans acquired with credit deterioration    |       | 5,084                                           |       | 698                                           |       | 8,150 |   | 1,009 |   |
| Loans acquired with no credit deterioration |       | 204                                             |       | 89                                            |       | 696 |   | 184 |   |
| Real Estate  Portfolios                     |       | —                                          |       | 698                                           |       | 328 |   | 872 |   |
| Other                                       |       | 58                                              |       | 147                                           |       | 116 |   | 206 |   |
| Income from  Portfolio Assets               |       | $                                               | 5,685      |                                          | $          | 2,946 |   | $ | 10,720 |   | $ | 5,004 |   |

 

Portfolio Assets are pledged to secure notes payable that are generallynon-recourse to FirstCity or any affiliate other than the entity that incurredthe debt.  See Note 2 to the Company’s2006 Annual Report on Form 10-K filed with the Securities and ExchangeCommission on July 24, 2007 for a description of the Revolving Credit agreementbetween FH Partners, L.P. and Bank of Scotland, which is guaranteed byFirstCity and the primary wholly-owned subsidiaries of FirstCity.

The Company recorded a provision for loan andimpairment losses on Portfolio Assets of approximately $1,003 for the six monthperiod ended June 30, 2007, which is comprised of a $92 impairment charge onreal estate portfolios and a $911 allowance for loan losses, net of recoveries.  For the six month period ended June 30, 2006,the Company recorded a provision for loan and impairment losses on PortfolioAssets of $51, which is comprised of a $2 impairment charge on real estateportfolios and a $49 allowance for loan losses.

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

The changes in theallowance for loan losses on Portfolio Assets are as follows:

|                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **         | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance |       | $                                               | (567       | )                                             | $          | (255 | ) | $ | (333 | ) | $ | (163 | ) |
| Provisions         |       | (791                                            | )          | (34                                           | )          | (1,025 | ) | (141 | ) |
| Recoveries         |       | 114                                             |       | 92                                            |       | 114 |   | 92 |   |
| Charge Offs        |       | —                                          |       | —                                        |       | — |   | 15 |   |
| Ending Balance     |       | $                                               | (1,244     | )                                             | $          | (197 | ) | $ | (1,244 | ) | $ | (197 | ) |

 

Changes in accretable yield for loans acquired withcredit deterioration are as follows:

|                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                     | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance                             |       | $                                               | 35,670     |                                          | $          | 4,808 |   | $ | 32,339 |   | $ | 3,765 |   |
| Additions                                      |       | 1,967                                           |       | 5,550                                         |       | 3,236 |   | 6,904 |   |
| Accretion                                      |       | (3,867                                          | )          | (694                                          | )          | (6,581 | ) | (1,004 | ) |
| Reclassification from nonaccretable difference |       | —                                          |       | —                                        |       | 5,165 |   | — |   |
| Disposals                                      |       | (1,567                                          | )          | (4                                            | )          | (1,919 | ) | (5 | ) |
| Translation adjustments                        |       | 38                                              |       | —                                        |       | 1 |   | — |   |
|  Ending Balance                           |       | $                                               | 32,241     |                                          | $          | 9,660 |   | $ | 32,241 |   | $ | 9,660 |   |

 

Loans acquired duringeach period for which it was probable at acquisition that all contractuallyrequired payments would not be collected are as follows:

|                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Face value at  acquisition                          |       | $                                               | 15,653     |                                          | $          | 32,621 |   | $ | 50,550 |   | $ | 43,640 |   |
| Cash flows  expected to be collected at acquisition |       | 7,869                                           |       | 21,109                                        |       | 37,991 |   | 29,964 |   |
| Basis in acquired loans  at acquisition             |       | 5,902                                           |       | 15,559                                        |       | 34,755 |   | 23,060 |   |
|                                                     |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

**(5)  Loans Receivable**

Loans receivable from Acquisition Partnerships heldfor investment

|                                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Outstanding  balance           |       | $                 | 4,783      |                  | $          | 4,598 |   |
| Capitalized costs              |       | 301               |       | 157                   |       |
| Carrying amount of  loans, net |       | $                 | 5,084      |                  | $          | 4,755 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

The summary of activity in loans receivable fromAcquisition Partnerships is as follows:

|                               | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                              | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance            |       | $                                                     | 4,876      |                                                | $          | 20,107 |   | $ | 4,755 |   | $ | 19,606 |   |
| Advances                      |       | 136                                                   |       | 6,417                                               |       | 486 |   | 7,147 |   |
| Payments received             |       | (52                                                   | )          | (182                                                | )          | (374 | ) | (1,175 | ) |
| Capitalized origination costs |       | 79                                                    |       | (617                                                | )          | 144 |   | 113 |   |
| Foreign exchange gains/losses |       | 45                                                    |       | 64                                                  |       | 73 |   | 98 |   |
| Ending Balance                |       | $                                                     | 5,084      |                                                | $          | 25,789 |   | $ | 5,084 |   | $ | 25,789 |   |

 

Loans receivable from Acquisition Partnerships heldfor investment are reported at their outstanding principle balances adjustedfor net deferred loan origination and other capitalized costs and the allowancefor loan losses.  Interest is recognizedon an accrual basis at the applicable interest rate on the principal amountoutstanding.  Loan origination fees anddirect costs are amortized as level yield adjustments over the respective loanterms.  Unamortized net fees or costs arerecognized upon early repayment of the loans. Loans receivable from AcquisitionPartnerships are secured by the assets/loans acquired by the partnerships withpurchase money loans provided by affiliates of the investors to thepartnerships to purchase the asset pools held in those entities. They areevaluated for impairment by analyzing the expected future cash flows from theunderlying assets within each pool to determine that the cash flows aresufficient to repay these notes. The Company applies the asset valuationmethodology consistently in all venues and uses the same proprietary assetmanagement system to evaluate impairment on all asset pools. The results ofthis evaluation indicated that cash flows from the pools will be sufficient torepay the loans and no allowances for impairment are necessary.

***Loans receivable - SBA held forsale***

Loans receivable - SBA held for sale are summarized asfollows:

|                                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Outstanding  balance           |       | $                 | 3,726      |                  | $          | — |   |
| Premiums                       |       | 104               |       | —                |       |
| Carrying amount of  loans, net |       | $                 | 3,830      |                  | $          | — |   |

 

Changes in loans receivable — SBA held for sale are asfollows:

|                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance                 |       | $                                               | 11,484     |                                          | $          | — |   | $ | — |   | $ | — |   |
| Purchases of loans                 |       | —                                          |       | —                                        |       | 18,355 |   | — |   |
| Originations and advances of loans |       | 760                                             |       | —                                        |       | 824 |   | — |   |
| Payments received                  |       | (224                                            | )          | —                                        |       | (411 | ) | — |   |
| Loans sold                         |       | (7,979                                          | )          | —                                        |       | (14,539 | ) | — |   |
| Discount, net                      |       | (211                                            | )          | —                                        |       | (399 | ) | — |   |
| Ending Balance                     |       | $                                               | 3,830      |                                          | $          | — |   | $ | 3,830 |   | $ | — |   |

$—

Loans receivable -Small Business Administration (“SBA”) held for sale are reflected at the lowerof aggregate cost or market value. The carrying value of SBA loans held forsale is net of premiums as well as deferred origination fees and costs.  Premiums and net origination fees and costsare deferred on SBA loans held for sale and included in the basis of the loansin calculating gains and losses upon sale. The Company generally sells theguaranteed portion of each loan to a third party and retains the servicingrights. The difference between the proceeds received and the allocated carryingvalue of the loans sold are recognized as gains on sales of loans.  The non-guaranteed portion is generally heldin the portfolio and classified as held for investment.

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

***Loansreceivable - SBA held for investment, net***

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

|                                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Outstanding  balance            |       | $                       | 17,208     |                        | $          | — |   |
| Allowance for loan losses       |       | (69                     | )          | —                      |       |
| Discounts, net                  |       | (1,661                  | )          | —                      |       |
| Capitalized origination costs   |       | 2                       |       | —                      |       |
| Carry ing amount of  loans, net |       | $                       | 15,480     |                        | $          | — |   |

 

Changes in loans receivable — SBA held for investmentare as follows:

|                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance                 |       | $                                               | 16,538     |                                          | $          | — |   | $ | — |   | $ | — |   |
| Purchases of loans                 |       | —                                          |       | —                                        |       | 17,406 |   | — |   |
| Originations and advances of loans |       | 253                                             |       | —                                        |       | 275 |   | — |   |
| Payments received                  |       | (1,152                                          | )          | —                                        |       | (1,977 | ) | — |   |
| Capitalized origination costs      |       | 2                                               |       | —                                        |       | 2 |   | — |   |
| Provision for SBA loan losses      |       | (69                                             | )          | —                                        |       | (69 | ) | — |   |
| Discount, net                      |       | (92                                             | )          | —                                        |       | (157 | ) | — |   |
| Ending Balance                     |       | $                                               | 15,480     |                                          | $          | — |   | $ | 15,480 |   | $ | — |   |

 

Loans receivable - SBA held for investment arereported at their outstanding principal balances adjusted for unearneddiscounts, net deferred loan origination costs and the allowance for loanlosses. Interest is recognized on an accrual basis at the applicable interestrate on the principal amount outstanding. Loan origination fees and direct costs as well as premiums and discountsare amortized as level yield adjustments over the respective loan terms.  Unamortized net fees or costs are recognizedupon early repayment of the loans.

The Company measures loan impairment in accordancewith SFAS No. 114, *Accounting by Creditorsfor Impairment of a Loan—an Amendment of FASB Statements No. 5 and 15*and No. 118, *Accounting by Creditors for Impairment of aLoan—Income Recognition and Disclosures—an Amendment of FASB StatementNo. 114*. When management believes there is sufficient doubt asto the ultimate collectibility of interest on any loan, interest accruals arediscontinued. These loans are evaluated for impairment by management based uponperformance of the loans and other portfolio characteristics, such as industryconcentrations and loan collateral, which also impacts management’s estimatesof the impairment.  The adequacy of theallowance for loan losses is reviewed by management quarterly and asadjustments become necessary, they will be reflected in operations during theperiods in which they become known. Considerations in this evaluation include past and current lossexperience, risks inherent in the current portfolio and evaluation ofcommercial and real estate collateral as well as current economicconditions.  The Company analyzed thecredit worthiness of the loans as of June 30, 2007, and recorded provisions of$69 to absorb expected losses.

Changes in the allowance for loan losses on loansreceivable - SBA held for investment are as follows:

|                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **         | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance |       | $                                               | —     |                                          | $          | — |   | $ | — |   | $ | — |   |
| Provisions         |       | (69                                             | )          | —                                        |       | (69 | ) | — |   |
| Recoveries         |       | —                                          |       | —                                        |       | — |   | — |   |
| Charge Offs        |       | —                                          |       | —                                        |       | — |   | — |   |
| Ending Balance     |       | $                                               | (69        | )                                             | $          | — |   | $ | (69 | ) | $ | — |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

***Loans receivable — Other***

Loans receivable - other are summarized as follows:

|                                | ** ** | **June 30,**2007 | ** ** | **December 31,**2006 | ** ** |
|--------------------------------|------------|-----------------------|------------|---------------------------|------------|
| Outstanding  balance           |       | $                     | 28,767     |                      | $          | 24,152 |   |
| Discounts, net                 |       | (45                   | )          | (161                      | )          |
| Capitalized costs              |       | 501                   |       | —                    |       |
| Carrying amount of  loans, net |       | $                     | 29,223     |                      | $          | 23,991 |   |

 

Changes in loans receivable — other are as follows:

|                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance            |       | $                                               | 27,956     |                                          | $          | — |   | $ | 23,991 |   | $ | — |   |
| Advances                      |       | 3,000                                           |       | —                                        |       | 6,646 |   | — |   |
| Payments received             |       | (2,259                                          | )          | —                                        |       | (2,259 | ) | — |   |
| Capitalized costs             |       | 267                                             |       | —                                        |       | 501 |   | — |   |
| Discount, net                 |       | 58                                              |       | —                                        |       | 119 |   | — |   |
| Foreign exchange gains/losses |       | 201                                             |       | —                                        |       | 225 |   | — |   |
| Ending Balance                |       | $                                               | 29,223     |                                          | $          | — |   | $ | 29,223 |   | $ | — |   |

 

Loans receivable – other are reported at theiroutstanding principle balances adjusted for unearned discounts, net deferredloan origination and other capitalized costs and the allowance for loanlosses.  Interest is recognized on anaccrual basis at the applicable interest rate on the principal amountoutstanding.  Loan origination fees anddirect costs are amortized as level yield adjustments over the respective loanterms.  Unamortized net fees or costs arerecognized upon early repayment of the loans. Loans receivable - Other aresecured by real estate. These loans are evaluated for impairment by analyzingthe expected future cash flows from the underlying assets within eachinvestment to determine that the cash flows are sufficient to repay thesenotes. The Company applies the asset valuation methodology consistently in allvenues and uses the same proprietary asset management system to evaluateimpairment on all asset pools. The results of this evaluation indicated thatcash flows from the investments will be sufficient to repay the loans and noallowances for impairment were necessary.

**(6)  Equity Investments**

The Company has investments in Acquisition Partnerships and their generalpartners and investments in servicing entities that are accounted for under theequity method.  The condensed combinedfinancial position and results of operations of the Acquisition Partnerships(excluding servicing entities), which include the domestic and foreignAcquisition Partnerships and their general partners, are summarized below:

**Condensed Combined Balance S heets**

|                                                | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Assets                                         |       | $                       | 474,907    |                        | $          | 457,173 |   |
| Liabilities                                    |       | $                       | 86,588     |                        | $          | 100,973 |   |
| Net equity                                     |       | 388,319                 |       | 356,200                     |       |
|                                           |       | $                       | 474,907    |                        | $          | 457,173 |   |
|                                           |       |                    |       |                        |       |
| Equity  investment in Acquisition Partnerships |       | $                       | 104,828    |                        | $          | 105,852 |   |
| Equity  investment in servicing entities       |       | 10,447                  |       | 6,505                       |       |
|                                           |       | $                       | 115,275    |                        | $          | 112,357 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

**Condensed Combined Summary of Operations**

|                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Income from  Portfolio Assets                   |       | $                                               | 21,672     |                                          | $          | 19,492 |   | $ | 44,836 |   | $ | 38,506 |   |
| Other income                                    |       | 174                                             |       | 366                                           |       | 722 |   | 1,521 |   |
| Revenues                                        |       | 21,846                                          |       | 19,858                                        |       | 45,558 |   | 40,027 |   |
| Interest expense                                |       | 2,801                                           |       | 3,328                                         |       | 5,808 |   | 6,308 |   |
| Average cost (annualized)                       |       | 13.79                                           | %          | 4.83                                          | %          | 13.00 | % | 4.63 | % |
| Service fees                                    |       | 4,912                                           |       | 3,986                                         |       | 9,633 |   | 7,195 |   |
| Provision for  loan and impairment losses       |       | 103                                             |       | 1,780                                         |       | 6,664 |   | 722 |   |
| Other op erating  costs                         |       | 1,950                                           |       | 4,770                                         |       | 6,057 |   | 8,517 |   |
| Foreign currency  (gains) losses                |       | (3,587)                                         |       | 14,873                                        |       | (3,322) |   | 13,218 |   |
| Income taxes                                    |       | 277                                             |       | 235                                           |       | 567 |   | 360 |   |
| Expenses                                        |       | 6,456                                           |       | 28,972                                        |       | 25,407 |   | 36,320 |   |
| Net earnings                                    |       | $                                               | 15,390     |                                          | $          | (9,114) |   | $ | 20,151 |   | $ | 3,707 |   |
|                                            |       |                                            |       |                                          |       |   |   |   |   |
| Equity in earnings  of Acquisition Partnerships |       | $                                               | 3,673      |                                          | $          | 1,128 |   | $ | 5,454 |   | $ | 4,819 |   |
| Equity in  earnings of servicing entities       |       | 659                                             |       | 259                                           |       | 704 |   | 202 |   |
|                                            |       | $                                               | 4,332      |                                          | $          | 1,387 |   | $ | 6,158 |   | $ | 5,021 |   |

 

The assets and equity of the Acquisition Partnershipsand equity investments in the Acquisition Partnerships are summarized bygeographic region below. The WAMCO Partnerships represent limited partnershipsand limited liability companies in which the Company has a common ownershipwith Cargill.  MinnTex InvestmentPartners LP is considered to be a significant subsidiary of FirstCity.

|                                                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Assets:                                         |       |                    |       |                        |       |
| Domestic:                                       |       |                    |       |                        |       |
| WAMCO Partnerships                              |       | $                       | 110,388    |                        | $          | 116,634 |   |
| MinnTex Investment Partners LP                  |       | 140                     |       | 71                          |       |
| Other                                           |       | 5,420                   |       | 4,206                       |       |
| Latin America                                   |       | 216,437                 |       | 167,407                     |       |
| Europe                                          |       | 142,522                 |       | 168,855                     |       |
|                                            |       | $                       | 474,907    |                        | $          | 457,173 |   |
| Equity:                                         |       |                    |       |                        |       |
| Domestic:                                       |       |                    |       |                        |       |
| WAMCO Partnerships                              |       | $                       | 73,335     |                        | $          | 69,579 |   |
| MinnTex Investment Partners LP                  |       | 129                     |       | 62                          |       |
| Other                                           |       | 2,794                   |       | 2,614                       |       |
| Latin America                                   |       | 178,099                 |       | 126,402                     |       |
| Europe                                          |       | 133,962                 |       | 157,543                     |       |
|                                            |       | $                       | 388,319    |                        | $          | 356,200 |   |
| Equity  investment in Acquisition Partnerships: |       |                    |       |                        |       |
| Domestic:                                       |       |                    |       |                        |       |
| WAMCO Partnerships                              |       | $                       | 36,182     |                        | $          | 34,203 |   |
| MinnTex Investment Partners LP                  |       | 43                      |       | 20                          |       |
| Other                                           |       | 1,748                   |       | 1,671                       |       |
| Latin America                                   |       | 22,348                  |       | 18,640                      |       |
| Europe                                          |       | 44,507                  |       | 51,318                      |       |
|                                            |       | $                       | 104,828    |                        | $          | 105,852 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

Revenues and earnings (loss) of the AcquisitionPartnerships and equity in earnings (loss) of the Acquisition Partnerships aresummarized by geographic region below.

|                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues:                                 |       |                                            |       |                                          |       |   |   |   |   |
| Domestic:                                 |       |                                            |       |                                          |       |   |   |   |   |
| WAMCO Partnerships                        |       | $                                               | 4,020      |                                          | $          | 7,122 |   | $ | 8,372 |   | $ | 14,499 |   |
| MinnTex Investment Partners LP            |       | 298                                             |       | 323                                           |       | 443 |   | 889 |   |
| Other                                     |       | 54                                              |       | 4                                             |       | 154 |   | 296 |   |
| Latin America                             |       | 9,706                                           |       | 7,134                                         |       | 19,442 |   | 12,797 |   |
| Europe                                    |       | 7,768                                           |       | 5,275                                         |       | 17,147 |   | 11,546 |   |
| ** **                                |       | $                                               | 21,846     |                                          | $          | 19,858 |   | $ | 45,558 |   | $ | 40,027 |   |
| Net earnings  (loss):                     |       |                                            |       |                                          |       |   |   |   |   |
| Domestic:                                 |       |                                            |       |                                          |       |   |   |   |   |
| WAMCO Partnerships                        |       | $                                               | 2,383      |                                          | $          | 3,282 |   | $ | 2,982 |   | $ | 7,305 |   |
| MinnTex Investment Partners LP            |       | 281                                             |       | 287                                           |       | 407 |   | 797 |   |
| Other                                     |       | (156                                            | )          | (211                                          | )          | (302 | ) | (144 | ) |
| Latin America                             |       | 7,972                                           |       | (16,246                                       | )          | 6,563 |   | (12,319 | ) |
| Europe                                    |       | 4,910                                           |       | 3,774                                         |       | 10,501 |   | 8,068 |   |
|                                      |       | $                                               | 15,390     |                                          | $          | (9,114 | ) | $ | 20,151 |   | $ | 3,707 |   |
| Equity in  earnings (loss) of Acquisition |       |                                            |       |                                          |       |   |   |   |   |
| Partnerships:                             |       |                                            |       |                                          |       |   |   |   |   |
| Domestic:                                 |       |                                            |       |                                          |       |   |   |   |   |
| WAMCO Partnerships                        |       | $                                               | 1,074      |                                          | $          | 1,580 |   | $ | 1,343 |   | $ | 3,632 |   |
| MinnTex Investment Partners LP            |       | 92                                              |       | 95                                            |       | 134 |   | 263 |   |
| Other                                     |       | (53                                             | )          | (90                                           | )          | (113 | ) | (41 | ) |
| Latin America                             |       | 887                                             |       | (1,575                                        | )          | 877 |   | (1,131 | ) |
| Europe                                    |       | 1,673                                           |       | 1,118                                         |       | 3,213 |   | 2,096 |   |
|                                      |       | $                                               | 3,673      |                                          | $          | 1,128 |   | $ | 5,454 |   | $ | 4,819 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

Combining statements of operations for the WAMCOPartnerships follow. WAMCO 31 and WAMCO 33 are considered to besignificant subsidiaries of FirstCity.

**Three MonthsEnded June 30, 2007**

|                                                 | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                      | ** ** | **31**    | ** ** | **33**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from  Portfolio Assets                   |       | $         | 196        |      | $          | 601              |       | $            | 3,159      |   | $ | 3,956 |   |
| Other income,  net                              |       | 6         |       | 14        |       | 44               |       | 64           |       |
| Revenues                                        |       | 202       |       | 615       |       | 3,203            |       | 4,020        |       |
| Interest and  fees expense — affiliate     |       | —    |       | —    |       | —           |       | —       |       |
| Interest and  fees expense — other         |       | (85       | )          | (60       | )          | (585             | )          | (730         | )          |
| Provision for  loan and impairment losses       |       | 66        |       | 148       |       | 302              |       | 516          |       |
| Service fees —  affiliate                  |       | (35       | )          | (123      | )          | (712             | )          | (870         | )          |
| General,  administrative and operating expenses |       | (76       | )          | (72       | )          | (405             | )          | (553         | )          |
| Expenses                                        |       | (130      | )          | (107      | )          | (1,400           | )          | (1,637       | )          |
| Net earnings (loss)                             |       | $         | 72         |      | $          | 508              |       | $            | 1,803      |   | $ | 2,383 |   |

 

**Three MonthsEnded June 30, 2006**

|                                                 | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                      | ** ** | **31**    | ** ** | **33**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from  Portfolio Assets                   |       | $         | 984        |      | $          | 1,691            |       | $            | 4,261      |   | $ | 6,936 |   |
| Other income,  net                              |       | 9         |       | 11        |       | 166              |       | 186          |       |
| Revenues                                        |       | 993       |       | 1,702     |       | 4,427            |       | 7,122        |       |
| Interest and  fees expense — affiliate     |       | —    |       | —    |       | (155             | )          | (155         | )          |
| Interest and  fees expense — other         |       | (207      | )          | (308      | )          | (276             | )          | (791         | )          |
| Provision for  loan and impairment losses       |       | (120      | )          | (4        | )          | (443             | )          | (567         | )          |
| Service fees —  affiliate                  |       | (146      | )          | (358      | )          | (882             | )          | (1,386       | )          |
| General,  administrative and operating expenses |       | (32       | )          | (161      | )          | (748             | )          | (941         | )          |
| Expenses                                        |       | (505      | )          | (831      | )          | (2,504           | )          | (3,840       | )          |
| Net earnings (loss)                             |       | $         | 488        |      | $          | 871              |       | $            | 1,923      |   | $ | 3,282 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

**Six Months EndedJune 30, 2007**

|                                            | ** ** | **WAMCO  31** | ** ** | **WAMCO  33** | ** ** | **Other  Partnerships** | ** ** | **Combined** | ** ** |
|-------------------------------------------------|------------|---------------|------------|---------------|------------|-------------------------|------------|--------------|------------|
| Income from Portfolio  Assets                   |       | $             | 435        |          | $          | 1,708                   |       | $            | 6,120      |   | $ | 8,263 |   |
| Other income, net                               |       | 14            |       | 21            |       | 74                      |       | 109          |       |
| Revenues                                        |       | 449           |       | 1,729         |       | 6,194                   |       | 8,372        |       |
| Interest and fees expense  — affiliate     |       | —        |       | —        |       | —                  |       | —       |       |
| Interest and fees  expense — other         |       | (177          | )          | (157          | )          | (1,228                  | )          | (1,562       | )          |
| Provision for loan and  impairment losses       |       | (83           | )          | 101           |       | (981                    | )          | (963         | )          |
| Service fees —  affiliate                  |       | (64           | )          | (216          | )          | (1,146                  | )          | (1,426       | )          |
| General, administrative  and operating expenses |       | (143          | )          | (164          | )          | (1,132                  | )          | (1,439       | )          |
| Expenses                                        |       | (467          | )          | (436          | )          | (4,487                  | )          | (5,390       | )          |
| Net earnings                                    |       | $             | (18        | )             | $          | 1,293                   |       | $            | 1,707      |   | $ | 2,982 |   |

 

**Six Months EndedJune 30, 2006**

|                                            | ** ** | **WAMCO  31** | ** ** | **WAMCO  33** | ** ** | **Other  Partnerships** | ** ** | **Combined** | ** ** |
|-------------------------------------------------|------------|---------------|------------|---------------|------------|-------------------------|------------|--------------|------------|
| Income from Portfolio  Assets                   |       | $             | 1,230      |          | $          | 2,601                   |       | $            | 9,389      |   | $ | 13,220 |   |
| Other income, net                               |       | 12            |       | 11            |       | 1,256                   |       | 1,279        |       |
| Revenues                                        |       | 1,242         |       | 2,612         |       | 10,645                  |       | 14,499       |       |
| Interest and fees  expense — affiliates    |       | —        |       | —        |       | (325                    | )          | (325         | )          |
| Interest and fees  expense — other         |       | (424          | )          | (624          | )          | (276                    | )          | (1,324       | )          |
| Provision for loan  losses                      |       | (120          | )          | (186          | )          | (924                    | )          | (1,230       | )          |
| Service fees —  affiliate                  |       | (190          | )          | (443          | )          | (1,544                  | )          | (2,177       | )          |
| General, administrative  and operating expenses |       | (66           | )          | (297          | )          | (1,775                  | )          | (2,138       | )          |
| Expenses                                        |       | (800          | )          | (1,550        | )          | (4,844                  | )          | (7,194       | )          |
| Net earnings                                    |       | $             | 442        |          | $          | 1,062                   |       | $            | 5,801      |   | $ | 7,305 |   |

 

Statements of operations for MinnTex Investment Partners LP for the threeand six month periods ended June 30, 2007and 2006 follow:

|                                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                      | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Income from Portfolio  Assets                   |       | $                                | 298        |                           | $          | 322 |   | $ | 443 |   | $ | 886 |   |
| Other income                                    |       | —                           |       | 1                              |       | — |   | 3 |   |
| Revenues                                        |       | 298                              |       | 323                            |       | 443 |   | 889 |   |
| Service fees —  affiliate                  |       | (15                              | )          | (32                            | )          | (30 | ) | (81 | ) |
| General, administrative  and operating expenses |       | (2                               | )          | (4                             | )          | (6 | ) | (11 | ) |
| Expenses                                        |       | (17                              | )          | (36                            | )          | (36 | ) | (92 | ) |
| Net earnings                                    |       | $                                | 281        |                           | $          | 287 |   | $ | 407 |   | $ | 797 |   |

 

FirstCity holds variable interests in certainAcquisition Partnerships, which would be characterized as variable interestentities (“VIE”), as defined in FASB Interpretation No. 46R, *Consolidation of Variable Interest Entities* (“FIN 46R”).However, FirstCity is not deemed to be the primary beneficiary of any of theseentities based on the criteria set forth in FIN 46R. At June 30, 2007, FirstCity’smaximum exposure to loss as a result of its involvement with the VIEs is $60.1million.

At June 30, 2007, the Company had $38.5 million inEuro-denominated debt for the purpose of hedging a portion of the net equityinvestments in Europe. In general, the type of risk hedged relates to theforeign currency exposure of net investments in Europe caused by movements inEuro exchange rates. The Company designated the hedging relationship such thatchanges in the net investments being hedged are expected to be offset bycorresponding changes in the values of the Euro-denominated debt.

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

Effectiveness of the hedging relationship is measuredand designated at the beginning of each month by comparing the outstandingbalance of the Euro-denominated debt to the carrying value of the designatednet equity investments. The net foreign currency translation gain (loss)included in accumulated other comprehensive income relating to theEuro-denominated debt was $156 for the six months ended June 30, 2007 and($1.5) million for the same period in 2006.

**(7)  Loan Servicing Assets — SBA**

On January 1,2007, FirstCity adopted SFAS No. 156, *Accountingfor Servicing of Financial Assets*(“SFAS 156”), which requires servicing rights be initiallymeasured at fair value at the date of sale. Subsequent to the sale, companiesare permitted to measure the carrying value of the servicing assets usingeither the amortization or fair value measurement method. The Company electedto measure the servicing assets, subsequent to the date of sale, by using theamortization method which amortizes servicing assets in proportion to and overthe period of estimated net servicing income and assesses servicing assets forimpairment based on fair value at each reporting date.  The adoption of SFAS 156 by the Company onJanuary 1, 2007 did not have a significant impact on the Company’s consolidatedfinancial position or earnings.

In February 2007, the Company, through its subsidiaryAmerican Business Lending, Inc. (“ABL”), acquired a portfolio of SBA loans for$36.8 million.  Included in the purchaseprice were the rights to service additional loans with an unpaid balance of$33.8 million.  The Company recorded aservicing asset of $758 relating to these servicing rights. The remainingservicing rights capitalized were recorded as a result of loans sold during thequarter.

Servicing rights are recognized as assets when the SBAloans are sold and the rights to service those loans are retained. The Companyrecorded net servicing assets of $891 during the first six months of 2007 whichincluded amortization of $70 and impairment of $48. ABL retains servicingresponsibilities and receives servicing fees of approximately 1%.

Changes in the Company’s amortized servicing rightsare as follows:

|                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                   | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance                           |       | $                                | 854        |                           | $          | — |   | $ | — |   | $ | — |   |
| Servicing Assets capitalized                 |       | 140                              |       | —                         |       | 1,009 |   | — |   |
| Servicing Assets amortized                   |       | (55                              | )          | —                         |       | (70 | ) | — |   |
| Ending Balance                               |       | $                                | 939        |                           | $          | — |   | $ | 939 |   | $ | — |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Reserve for impairment  of servicing assets: |       |                             |       |                           |       |   |   |   |   |
| Beginning  Balance                           |       | $                                | (39        | )                              | $          | — |   | $ | — |   | $ | — |   |
| Impairments                                  |       | (9                               | )          | —                         |       | (48 | ) | — |   |
| Recoveries                                   |       | —                           |       | —                         |       | — |   | — |   |
| Charge Offs                                  |       | —                           |       | —                         |       | — |   | — |   |
| Ending Balance                               |       | $                                | (48        | )                              | $          | — |   | $ | (48 | ) | $ | — |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Ending Balance  (net of reserve)             |       | $                                | 891        |                           | $          | — |   | $ | 891 |   | $ | — |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Fair value of  amortized servicing assets:   |       |                             |       |                           |       |   |   |   |   |
| Beginning balance                            |       | $                                | 815        |                           | $          | — |   | $ | — |   | $ | — |   |
| Ending balance                               |       | 891                              |       | —                         |       | 891 |   | — |   |

 

The Company reliesprimarily on a discounted cash flow model to estimate the fair value of itsservicing rights.  This model calculatesestimated fair value of the servicing assets using predominant riskcharacteristics of servicing assets such as discount rate, prepayment speed,weighted average life of the loans sold and the interest rate.  The estimated fair value of servicing wasdetermined using discount rates of 9.75% to 11.19%, prepayment speeds of 15%and weighted average lives ranging from 75 to 299 months.  In the event future prepayments aresignificant or impairments are incurred and future expected cash flows areinadequate to cover the unamortized servicing assets, additional amortizationor impairment charges would be recognized.

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

**(8)  Segment Reporting**

The Company is engaged in one reportable segment - Portfolio Asset acquisitionand resolution.  The following is asummary of results of operations for the Portfolio Asset acquisition andresolution segment and reconciliation to earnings from continuing operationsfor the three and six months ended June 30, 2007 and 2006.

|                                                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                         | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Portfolio  Asset Acquisition and Resolution:**                                   | ** ** | ** **                       |       |                           | ** ** | ** ** |   |   |   |
| Revenues:                                                                          |       |                             |       |                           |       |   |   |   |   |
| Servicing fees                                                                     |       | $                                | 2,977      |                           | $          | 2,856 |   | $ | 5,582 |   | $ | 5,503 |   |
| Income from Portfolio Assets                                                       |       | 5,685                            |       | 2,946                          |       | 10,720 |   | 5,004 |   |
| Gain on sale of SBA loans held for sale, net                                       |       | 343                              |       | —                         |       | 624 |   | — |   |
| Interest income from SBA loans                                                     |       | 606                              |       | —                         |       | 914 |   | — |   |
| Interest income from affiliates                                                    |       | 140                              |       | 465                            |       | 266 |   | 895 |   |
| Interest income from loans receivable - other                                      |       | 982                              |       | —                         |       | 1,889 |   | — |   |
| Other                                                                              |       | 455                              |       | 421                            |       | 785 |   | 832 |   |
| Total                                                                              |       | 11,188                           |       | 6,688                          |       | 20,780 |   | 12,234 |   |
| Expenses:                                                                          |       |                             |       |                           |       |   |   |   |   |
| Interest and fees on notes payable                                                 |       | 4,668                            |       | 1,948                          |       | 8,919 |   | 3,656 |   |
| Salaries and benefits                                                              |       | 3,025                            |       | 2,504                          |       | 6,139 |   | 5,437 |   |
| Provision for loan and impairment losses                                           |       | 746                              |       | (58                            | )          | 1,072 |   | 51 |   |
| Occupancy, data processing, communication and other                                |       | 2,741                            |       | 1,195                          |       | 4,643 |   | 2,192 |   |
| Minority interest                                                                  |       | (15                              | )          | (73                            | )          | (123 | ) | (62 | ) |
| Total                                                                              |       | 11,165                           |       | 5,516                          |       | 20,650 |   | 11,274 |   |
| Equity in earnings of investments                                                  |       | 4,332                            |       | 1,387                          |       | 6,158 |   | 5,021 |   |
| Gain on sale of interest in equity investments                                     |       | —                           |       | 27                             |       | — |   | 27 |   |
| Operating contribution before direct taxes                                         |       | $                                | 4,355      |                           | $          | 2,586 |   | $ | 6,288 |   | $ | 6,008 |   |
| Operating contribution, net of direct taxes                                        |       | $                                | 4,313      |                           | $          | 2,549 |   | $ | 6,183 |   | $ | 5,877 |   |
|                                                                               |       |                             |       |                           |       |   |   |   |   |
| **Corporate  Overhead:**                                                           |       |                             |       |                           |       |   |   |   |   |
| Salaries and benefits, occupancy, professional and  other income and expenses, net |       | 2,507                            |       | 1,286                          |       | 5,292 |   | 2,517 |   |
| Earnings (loss)  from continuing operations                                        |       | $                                | 1,806      |                           | $          | 1,263 |   | $ | 891 |   | $ | 3,360 |   |

 

Revenues and equity in earnings of investments from thePortfolio Asset acquisition and resolution segment are attributable to domesticand foreign operations as follows:

|               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **    | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Domestic      |       | $                                | 9,382      |                           | $          | 6,037 |   | $ | 16,349 |   | $ | 11,391 |   |
| Latin America |       | 3,693                            |       | 488                            |       | 6,225 |   | 3,141 |   |
| Europe        |       | 2,375                            |       | 1,550                          |       | 4,205 |   | 2,723 |   |
| Other         |       | 70                               |       | —                         |       | 159 |   | — |   |
| Total         |       | $                                | 15,520     |                           | $          | 8,075 |   | $ | 26,938 |   | $ | 17,255 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

Total assets for the Portfolio Asset acquisition andresolution segment and a reconciliation to total assets are as follows:

|                                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Cash                                          |       | $                 | 18,380     |                  | $          | 18,472 |   |
| Portfolio  acquisition and resolution assets: |       |              |       |                  |       |
| Domestic                                      |       | 203,582           |       | 158,147               |       |
| Latin America                                 |       | 35,017            |       | 28,883                |       |
| Europe                                        |       | 54,560            |       | 61,062                |       |
| Other                                         |       | 341               |       | 2,272                 |       |
| Deferred tax  asset, net                      |       | 20,101            |       | 20,101                |       |
| Other  non-earning assets, net                |       | 9,632             |       | 8,726                 |       |
| Total assets                                  |       | $                 | 341,613    |                  | $          | 297,663 |   |

 

**(9)  Earnings per Common Share**

Basic net earnings per common share calculations arebased upon the weighted average number of common shares outstanding.Potentially dilutive common share equivalents include warrants and employeestock options in the diluted earnings per common share calculations.  Basic and diluted earnings from continuingoperations per share were determined as follows:

|                                                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                        | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Earnings from  continuing operations                                              |       | $                                | 1,806      |                           | $          | 1,263 |   | $ | 891 |   | $ | 3,360 |   |
| Weighted average  outstanding shares of common stock                              |       | 10,789                           |       | 11,308                         |       | 10,789 |   | 11,308 |   |
| Dilutive effect  of:                                                              |       |                             |       |                           |       |   |   |   |   |
| Warrants                                                                          |       | 323                              |       | 340                            |       | 328 |   | 340 |   |
| Employee stock options                                                            |       | 285                              |       | 311                            |       | 297 |   | 310 |   |
| Weighted average  outstanding shares of common stock and common stock equivalents |       | 11,397                           |       | 11,959                         |       | 11,414 |   | 11,958 |   |
| Earnings from  continuing operations per share:                                   |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                             |       | $                                | 0.17       |                           | $          | 0.11 |   | $ | 0.08 |   | $ | 0.30 |   |
| Diluted                                                                           |       | $                                | 0.16       |                           | $          | 0.11 |   | $ | 0.08 |   | $ | 0.28 |   |

 

**(10)  Stock-Based Compensation**

The impact on the results of operations of recordingstock-based compensation for the three and six month periods ended June 30,2007 and 2006 was as follows:

|                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                        | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Amount of  compensation cost recognized in income |       | $                                | 109        |                           | $          | 101 |   | $ | 289 |   | $ | 246 |   |
| Tax benefit  recognized in income                 |       | $                                | —     |                           | $          | — |   | $ | — |   | $ | — |   |
| Amount capitalized as  part of an asset           |       | $                                | —     |                           | $          | — |   | $ | — |   | $ | — |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

A summary of stock optionactivity as of June 30, 2007 and changes during the period then ended ispresented below:

|                                 | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------|------------|------------|------------|----------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  January 1, 2007 |       | 779,100    |       | $                                      | 7.10       |                                                         |       |                            |       |   |
| Granted                         |       | —     |       | —                                 |       |                                                         |       |                            |       |
| Exercised                       |       | (2,500     | )          | 7.25                                   |       |                                                         |       |                            |       |
| Expired                         |       | (37,950    | )          | 27.25                                  |       |                                                         |       |                            |       |
| Forfeited                       |       | (8,500     | )          | 9.11                                   |       |                                                         |       |                            |       |
| Outstanding at  June 30, 2007   |       | 730,150    |       | $                                      | 6.03       |                                                         | 5.79       |                            | $          | 3,894 |   |
| Exercisable at  June 30, 2007   |       | 614,663    |       | $                                      | 5.31       |                                                         | 5.43       |                            | $          | 3,708 |   |

 

The total intrinsic value of stock options exercisedduring the three and six month periods ended June 30, 2007 was zero and $9,respectively.  The total intrinsic valueof stock options exercised during the three and six month periods ended June30, 2006 was $20 and $20, respectively. As of June 30, 2007, there was approximately $.7 million of totalunrecognized compensation cost related to unvested share-based compensationarrangements granted under the stock option plans.  That cost is expected to be recognized over aweighted average period of 1.8 years.

A summary of the status and changes of FirstCity’snonvested shares as of June 30, 2007, and changes during the six months endedJune 30, 2007 is presented below:

|                               | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
|-------------------------------|------------|------------|------------|---------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at January  1, 2007 |       | 196,737    |       | $                   | 6.67       |   |
| Granted                       |       | —     |       | —              |       |
| Vested                        |       | (77,375    | )          | $                   | 5.46       |   |
| Forfeited                     |       | (3,875     | )          | $                   | 7.78       |   |
| Nonvested at June 30,  2007   |       | 115,487    |       | $                   | 7.44       |   |

 

**(11)  Income Taxes**

Effective January 1, 2007, FirstCity adopted FASBInterpretation No. 48, *Accounting forUncertainty in Income Taxes — An Interpretation of FASB Statement No. 109* (“FIN 48”), which clarifies thefinancial statement recognition and disclosure requirements for uncertain taxpositions taken or expected to be taken in a tax return. Any interest andpenalties related to uncertain tax positions are recorded as interest expenseand general and administrative expense, respectively. At the time of adoptionand as of June 30, 2007, the Company’s unrecognized tax benefits are notconsidered material.  In addition,interest or penalties related to income tax reporting recorded in theconsolidated income statements or balance sheets are not material. The InternalRevenue Service is currently in process of examining FirstCity’s federal incometax return for 2004.  In addition,FirstCity currently files tax returns in approximately 35 states and iscurrently being examined in four states for the year 2004.  Tax year 1992 and subsequent years are opento federal examination, and tax year 2002 and subsequent years are open tostate examination.

Federal income taxes are provided at a 35% rate. The Company hassubstantial net operating loss carryforwards for federal income tax purposes (“NOLs”),which can be used to offset the tax liability associated with the Company’spre-tax earnings until the earlier of the expiration or utilization of suchNOLs. The Company accounts for the benefit of the NOLs by recording the benefitas an asset and 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

thenestablishing a valuation allowance to value the net deferred tax asset at alevel, which more likely than not, will be realized. Realization is determinedbased on management’s expectation of generating sufficient taxable income in alook forward period over the next four years. The ultimate realization of theresulting net deferred tax asset is dependent upon generating sufficienttaxable income from its continuing operations prior to expiration of the NOLs.Although realization is not assured, management believes it is more likely thannot that all of the recorded deferred tax asset, net of the allowance, will berealized. The amount of the deferred tax asset considered realizable, however,could be adjusted in the future if estimates of future taxable income duringthe carryforward period change. The ability of the Company to realize the deferredtax asset is periodically reviewed and the valuation allowance is adjustedaccordingly.

**(12)  Commitments and Contingencies**

In August 2000, Consumer Corp. and Funding LPcontributed all of the assets utilized in the operations of the automobilefinance operation to Drive pursuant to the terms of a Contribution andAssumption Agreement by and between Consumer Corp. and Drive, and aContribution and Assumption Agreement by and between Funding LP and Drive(collectively, the “Contribution Agreements”). Drive assumed substantially allof the liabilities of the automobile finance operation as set forth in theContribution Agreements. In addition, pursuant to the terms of a SecuritiesPurchase Agreement dated as of August 18, 2000 (the “2000 Securities PurchaseAgreement”), by and among FirstCity, Consumer Corp., FirstCity Funding LP (“FundingLP”), and FirstCity Funding GP Corp. (“Funding GP”), IFA-GP and IFA-LP;FirstCity, Consumer Corp., Funding LP and Funding GP made various warrantiesconcerning (i) their respective organizations, (ii) the automobile financeoperation conducted by Consumer Corp. and Funding LP, and (iii) the assetstransferred by Consumer Corp. and Funding LP to Drive. The Company, ConsumerCorp., Funding LP and Funding GP also agreed to indemnify BoS(USA), IFA-GP andIFA-LP from damages resulting from a breach of any representation or warrantycontained in the 2000 Securities Purchase Agreement or otherwise made by theCompany, Consumer Corp. or Funding LP in connection with the transaction. Theindemnity obligation under the 2000 Securities Purchase Agreement survives fora period of seven (7) years from August 25, 2000 (the “2000 Closing Date”) withrespect to tax-related representations and warranties and for thirty monthsfrom the 2000 Closing Date with respect to all other representations andwarranties. Neither the Company, Consumer Corp., Funding LP, or Funding GP isrequired to make any payments as a result of the indemnity provided under the2000 Securities Purchase Agreement until the aggregate amount payable exceeds$.25 million, and then only for the amount in excess of $.25 million in theaggregate; however certain representations and warranties are not subject tothis $.25 million threshold. Pursuant to the terms of the ContributionAgreements, Consumer Corp. and Funding LP have agreed to indemnify Drive fromany damages resulting in a material adverse effect on Drive resulting frombreaches of representations or warranties, failure to perform, pay or dischargeliabilities other than the assumed liabilities, or claims, lawsuits orproceedings resulting from the transactions contemplated by the ContributionAgreements. Pursuant to the terms of the Contribution Agreements, Drive hasagreed to indemnify Consumer Corp. and Funding LP for any breach of anyrepresentation or warranty by Drive, the failure of Drive to discharge anyassumed liability, or any claims arising out of any failure by Drive toproperly service receivables after August 1, 2000. Liability forindemnification pursuant to the terms of the Contribution Agreements will notarise until the total of all losses with respect to such matters exceeds $.25million and then only for the amount by which such losses exceed $.25 million;however this limitation will not apply to any breach of which the party hadknowledge at the time of the Closing Date or any intentional breach by a partyof any covenant or obligation under the Contribution Agreements. Management ofthe Company believes that FirstCity will not have to pay any amounts related tothese agreements.

On September 21, 2004, FirstCity, Consumer Corp.,Funding LP and Funding GP entered into the a Securities Purchase Agreement tosell a 31% beneficial ownership interest in Drive and its general partner,Drive GP LLC, to IFA-GP, IFA-LP and MG-LP (the “2004 Securities PurchaseAgreement”). In the 2004 Securities Purchase Agreement, FirstCity, ConsumerCorp., Funding LP and Funding GP made various representations and warrantiesconcerning (i) their respective organizations, (ii) their power and authorityto enter into the 2004 Securities Purchase Agreement and the transactionscontemplated therein, (iii) the ownership of the limited partnership interestsin Drive by Funding LP, (iv) the ownership of membership interests in Drive-GPby Consumer Corp., and (iv) the capital structure of Funding LP. FirstCity,Consumer Corp., Funding LP and Funding GP also agreed to indemnify BoS (USA),IFA-GP, IFA-LP and MG-LP from damages resulting from a breach of anyrepresentation or warranty contained in the 2004 Securities Purchase Agreementor otherwise made by FirstCity, Consumer Corp. or Funding LP in connection withthe transaction. The indemnity obligations under the 2004 Securities PurchaseAgreement survive for a maximum period of five (5) years from November 1, 2004.Neither FirstCity, Consumer Corp., Funding LP, or Funding GP is required tomake any payments as a result of the indemnity provided under the 2004Securities Purchase Agreement until the aggregate amount payable exceeds $.25million, and then only for the amount in excess of $.25 million in theaggregate; however certain representations and warranties are not subject tothis $.25 million threshold. Management of the Company believes that FirstCitywill not have to pay any amounts relating to these representations andwarranties.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, exceptper share data) — (continued)**

On August 8, 2006, an Interest Purchase and SaleAgreement was entered into by and among Bidmex Holding, LLC (“Buyer”), asbuyer, and SMIP and CFSI (collectively, the “Sellers”), as seller, and elevenof the LLCs and the AIG entities as additional parties.  In the InterestPurchase and Sale Agreement, the Sellers and the LLCs made variousrepresentations and warranties concerning (i) the existence and ownership ofthe LLCs and the related Mexican SRLs, (ii) the assets and liabilities of theLLCs, (iii) taxes related to periods prior to August 8, 2006, and (iv) theoperations of the LLCs and SRLs.  The Sellers agreed to indemnify theBuyer and AIG Entities from damages resulting from a breach of anyrepresentation or warranty contained in the Interest Purchase and SaleAgreement on a several and not joint basis according to their respectiveownership percentages in each LLC as to any matter related to a particular LLC,or on the basis of 80% to CFSI and 20% to SMIP as to any matter that could notbe identified to a particular LLC.  The indemnity obligation under theInterest Purchase and Sale Agreement survives for a period of the statute oflimitations for matters related to taxes, existence and authority, capitalizationand good standing of the LLCs and SRLs and for a period of two years fromAugust 8, 2006, the closing date with respect to all other representations andwarranties.  The Sellers are not required to make any payments as a resultof the indemnity provisions of the Interest Purchase and Sale Agreement untilthe aggregate amount payable under that agreement and the Asset PurchaseAgreement exceeds $.25 million; however, claims related to taxes and fraud arenot subject to this $.25 million threshold.  The Interest Purchase andSale Agreement limits the liability of the Sellers for indemnifiable lossesunder the Interest Purchase and Sale Agreement and the Asset Purchase Agreementto the Aggregate Purchase Price (without duplication of amounts recoveredpursuant to the terms of the Asset Purchase Agreement).  FirstCity does not believe that the potentialliability would have a material adverse effect on the consolidated financialposition, results of operations or liquidity of FirstCity, its subsidiaries,its affiliates or the Acquisition Partnerships.

Also on August 8, 2006, Bidmex Holding, LLC enteredinto an Agreement for the Onerous Transfer of Loans and Litigious Rights (the “AssetPurchase Agreement”) between and among Residencial Oeste, S. de R.L. de C.V.,as seller (the “Asset Seller”), an affiliate of CFSI and SMIP, ResidencialOeste 2, S. de R.L. de C.V., as purchaser (the “Asset Purchaser”), and CFSI,SMIP, and Bidmex Acquisition, LLC, the parent of the Asset Purchaser, asadditional parties.  The Asset Purchase Agreement provides for the sale ofthe loan portfolio owned by the Seller to the Purchaser for a purchase price of$10.1 million on the closing date, which purchase price is part of theAggregate Purchase Price.  In the Asset Purchase Agreement, the AssetSeller and the Sellers made various representations and warranties concerning(i) the existence and ownership of the Seller, (ii) the ownership of the loanportfolio, (iii) taxes related to periods arising prior to the closing date,and (iv) the existence of the loans comprising the loan portfolio and othermatters related to the loan portfolio.  The Asset Seller agreed toindemnify the Asset Purchaser from damages resulting from a breach of anyrepresentation or warranty.  The indemnity obligation under the AssetPurchase Agreement survives for a period of the statute of limitations formatters related to existence and ownership of the Seller, ownership of theloans, and taxes for periods prior to August 8, 2006, and for a period of twoyears from August 8, 2006, with respect to all other representations andwarranties.  The Seller is not required to make any payments as a resultof the indemnity provisions of the Asset Purchase Agreement until the aggregateamount payable under that Agreement exceeds $25; however, claims related totaxes and fraud are not subject to this $25 threshold.  The InterestPurchase and Sale Agreement limits the liability of the Sellers forindemnifiable losses under the Asset Purchase Agreement to the AggregatePurchase Price. FirstCity does not believe that the potential liability wouldhave a material adverse effect on the consolidated financial position, resultsof operations or liquidity of FirstCity, its subsidiaries, its affiliates orthe Acquisition Partnerships.

In connection withthe Interest Purchase and Sale Agreement, Recuperación de Carteras Mexicanas,S. de R.L. de C.V., as optionor (“RCM”), an affiliate of SMIP and CFSI, granteda put option dated August 8, 2006 to Bidmex Holding, LLC, as optionee, pursuantto the terms of a Put Option Agreement by and among RCM, Bidmex Holding, LLC,and Bidmex 6, LLC, the parent entity of RCM and SMIP.  RCM granted a putoption to Bidmex Holding, LLC related to the purchase of any loan of Soluciónde Activos Residenciales, S. de R.L. de C.V. or Solución de ActivosComerciales, S. de R.L. de C.V., each a Mexican SRL, if any borrowing on a loanmade by those entities has filed or files a challenge in a legal proceedingrelated to any such loan based on, in addition to any other defense claims, aclaim on grounds related to the Mexican Supreme Court Ruling that has put intoissue the actions required for transfer of loans by Mexican financialinstitutions after August 2003, provided that any such challenge is asserted onor before the earlier of (i) the reversal of the Supreme Court Ruling, or (ii)February 1, 2008.  The purchase price for any loan under the put option isto be the allocated purchase price set by the parties for the loan, pluscertain expenses related to the transfer and collection of the loan, plus anytaxes paid or payable with respect to the cash flow from each loan, reduced byany cash flow received by Bidmex Holding, LLC with respect to the loan.

FirstCity has minority interests in variouslimited-life partnerships with a carrying value of $.5 million at June 30,2007. The estimated amount that would be paid to the minority interest holderif the instruments were to be settled at June 30, 2007 is $2.4 million.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

Financial Security Assurance Inc. (“FSA”), in itscapacity as certificate insurer under the Pooling and Servicing Agreement,relating to the FirstCity Capital Home Equity Loan Trust 1998-2 (the “Trust”),dated as of November 1, 1998 by and among FC Capital Corp., in its capacitiesas seller and master servicer, and The Bank of New York, in its capacity astrustee, made demand on FC Capital Corp. to repurchase certain loans that weresubject to repurchase due to fraud of third parties in connection with theorigination of the loans. FC Capital Corp. agreed to provide a letter of creditin the amount of the repurchase price for the loans in lieu of being requiredto purchase the loans from the Trust. FirstCity has obtained and delivered to FSA, for the benefit of FCCapital Corp., an irrevocable letter of credit in the amount of $510 from theBank of Scotland.  Pursuant to theagreement with FSA, FC Capital Corp. will have the option to purchase the loansfor $510 prior to a call under the letter of credit.

On September 22, 2006, FirstCity NPL S.A., a Chileanaffiliate of FirstCity Chile Ltda and FirstCity, entered into a revolving lineof credit with a maximum loan amount in Chilean pesos equivalent to $10.0million U.S. Dollars with CORPBANCA Sociedad Anónima Bancaria (“CB”) to financethe purchase of delinquent and due accounts. The revolving line of credit was structured by Corpbanca AsesoríasFinancieras S.A. (“CAF”).  Pursuant tothe terms of the credit facility, FirstCity NPL S.A. was required to provide astand-by letter of credit from Bank of Scotland that would satisfy the loanbalance upon demand.  At June 30, 2007,FirstCity had a letter of credit in the amount of $4.6 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that ademand is made under the $4.6 million letter of credit, FirstCity is requiredto reimburse Bank of Scotland by making payment to Bank of Scotland for allamounts disbursed or to be disbursed by Bank of Scotland under the letter ofcredit.

On November 29,2006, FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, entered intoa revolving line of credit with a maximum loan amount of 148,096,800 Mexicanpesos with Banco Santander, S.A., which was equivalent to $13.7 million U.S.dollars at June 30, 2007.   The proceedswere used to pay down the acquisition facility with the Bankof Scotland.  Pursuant to the terms of the credit facility, FirstCityMexico SA de CV was required to provide a stand-by letter of credit fromBank of Scotland that would satisfy the loan balance upon demand.  At June30, 2007, FirstCity had a letter of credit in the amount of $14.1 million fromBank of Scotland under the terms of FirstCity’s revolving acquisition facilitywith Bank of Scotland.  In the event that a demand is made under the $14.1million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

ABL, a subsidiary ofFirstCity, has a $40 million revolving loan facility with Wells Fargo Foothill,LLC (“WFF”), as most recently amended on July 30, 2007, for the purpose offinancing and acquiring SBA loans.  Theobligations under this facility are secured by substantially all of the assetsof ABL.  At June 30, 2007, the balance of this facility was $13.1million.  In connection with the first amendment to this facility onFebruary 27, 2007, FirstCity provided WFF with an unconditional guaranty, up toa maximum of $5 million plus enforcement cost, of the obligations of ABL underthe loan facility that relate to funds in the amount of $31.7 advanced by WFFto ABL in connection of a portfolio of SBA loans in February 2007.  Thisguaranty will remain in effect until the obligations incurred in connection withthe advance related to the acquisition of the portfolio of SBA loans are paidin full.

Periodically, FirstCity, its subsidiaries, itsaffiliates and the Acquisition Partnerships are parties to or otherwiseinvolved in legal proceedings arising in the normal course of business.FirstCity does not believe that there is any proceeding threatened or pendingagainst it, its subsidiaries, its affiliates or the Acquisition Partnershipswhich, if determined adversely, would have a material adverse effect on theconsolidated financial position, results of operations or liquidity ofFirstCity, its subsidiaries, its affiliates or the Acquisition Partnershipsother than as described below.

On March 20, 2007, Superior Funding, Inc., Wave TecPools, Inc. and Nations Pool Supply, Inc. (collectively “Plaintiffs”) filed aFirst Amended Petition adding FH Partners, L.P. and FirstCity ServicingCorporation, each an indirectly wholly-owned subsidiary of FirstCity, andFirstCity Financial Corporation as defendants in a suit filed by Plaintiffsagainst State Bank and Cole Harmonson before the 98th Judicial District Courtof Travis County, Texas.  FirstCityFinancial Corporation was served with Plaintiff’s Notice of Nonsuit WithoutPrejudice in the suit on April 25, 2007. In the First Amended Petition the Plaintiffs sought unspecified damagesfor breach of contract and conversion related to alleged breaches by FHPartners, L.P. and FirstCity Servicing Corporation in connection with a loanagreement related to a loan from State Bank to Plaintiffs that was purchased byFH Partners, L.P. from State Bank on December 22, 2006.  The Plaintiffs also raised other claimssolely against the other defendants.  ThePlaintiffs allege that they entered into a loan or line of credit with State Bankand that due to an error by State Bank the Plaintiffs borrowed more on the lineof credit than was allowed under the borrowing base.  The Plaintiffs further allege that State Bankentered in an agreement with Plaintiffs that the default by Plaintiffs would becured if the Plaintiffs pledged additional property to secure the loans andthat the Plaintiffs would be allowed to borrow under the line of credit.  Plaintiffs allege that State Bank, andsubsequently FH Partners, L.P., have refused to honor 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) — (continued)**

the agreement by State Bank concerning the pledge ofthe additional property.  On July 25,2007, counsel for FH Partners received a Second Amended Petition in which thePlaintiffs allege that they have sustained actual damages of $165,000,000 as aresult of the joint actions of State Bank, Cole Harmonson, FH Partners, L.P.and FirstCity Servicing Corporation.  ThePlaintiffs assert claims against FH Partners, L.P. and FirstCity ServicingCorporation for breach of contract, conversion, civil conspiracy, tortiousinterference with prospective economic relationships and usury related to FHPartners, L.P. and FirstCity Servicing Corporation treating the loans that FHPartners, L.P. purchased from State Bank as being in default, retainingpayments delivered to the lockbox for the loan, retaining mortgage loan filesthat the Plaintiffs allege were unrelated to the loan agreement, interferingwith contracts and relationships of the Plaintiffs by such actions, andcharging interest higher than the maximum amount allowed under the Texas FinanceCode.  The Plaintiffs additionally seekrecovery of statutory penalties under the Texas Finance Code and attorney’sfees.  The Plaintiffs have madeadditional claims against the other defendants alleging promissory estoppel,fraud and business disparagement.  Nodiscovery has occurred in the lawsuit. FirstCity intends to contest the case vigorously.  FirstCity does not have sufficient informationto estimate any potential liability or probability of liability, but is unawareof any factual or legal basis for liability.

**(13)  Related Party Transactions**

In February 2007,the Company, through its subsidiary ABL, acquired a portfolio of SBA loans fromProsperity Bank for $36.8 million. FirstCity Directors, Robert E. Garrison II and D. Michael Hunter alsoserve as Directors of Prosperity Bank.

During the secondquarter 2007, FirstCity entered into a special situations platform that willbuy or finance distressed debt and companies, originate junior and seniorbridge loans, and execute lower middle market buyouts through its 80%investment in FirstCity Denver Investment Corp.   The other 20% interest in FirstCity DenverInvestment Corp. is owned by Crestone Capital LLC, a Colorado limited liabilitycompany owned by Richard W. Horrigan and Stephen C. Schmeltekopf.  Richard W. Horrigan, President of FirstCityDenver Investment Corp., and Stephen C. Schmeltekopf, Senior Vice President ofFirstCity Denver Investment Corp., are employees of FirstCity Denver InvestmentCorp. and have employment contracts with FirstCity Denver Investment Corp.  Stephen Schmeltekopf is the brother of AndrewSchmeltekopf, Senior Vice President of FirstCity Servicing.

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**Item 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations.**

**Overview**

FirstCity is a financial services company engaged in one principalreportable segment — Portfolio Asset acquisition and resolution.  The Portfolio Asset acquisition andresolution business involves acquiring portfolios of loans, real estate andother assets or single assets and investment in similar assets (collectively referredto as “Portfolios” or “Portfolio Assets”) generally at a discount totheir legal principal balance or appraised value, and servicing and resolving such Portfolios in an effort to maximizethe present value of the ultimate cash recoveries, and the origination of loanssecured by similar assets.

During the secondquarter of 2007, the Company recorded net earnings to common stockholders on adiluted basis of $1.8 million or $.16 per common share. The operatingcontribution from the Portfolio Asset acquisition and resolution segment was$4.3 million compared with $2.5 million for the same period in 2006.  Corporate overhead increased by $1.2 millionduring the quarter to $2.5 million compared to $1.3 million during the sameperiod in 2006, primarily due to $.8 million in fees related to an independentinvestigation authorized by the audit committee, which concluded in the secondquarter as previously disclosed.  SeeResults of Operations for a more detailed review of the second quarter 2007compared to the second quarter 2006.

The Companyinvested $25.2 million in portfolio acquisitions during the quarter.  FirstCity also invested $1.1 million in SBAloan originations and advances as well as $3.0 million in the form of advanceson loans receivable under the new special situations platform, FirstCityCrestone, which was formed in April 2007. Earning assets (equity investments,inventory, loans receivable, and interest receivable) totaled $293.5 million atquarter end.  FirstCity is currentlyevaluating 25 different transactions representing over $1.5 billion in facevalue of assets.

The revenues forthe second quarter were positively impacted by $1 million as a result ofincreases in expected cash flows in wholly-owned portfolios with a book valueof $62.7 million and certain portfolios held in acquisition partnerships with abook value of $21.3 million. Management will increase income accrual rates onportfolios that experience increases in cash flows as the portfolios mature.The majority of the $84 million in book value of portfolios that contributed tothis increase in interest income from portfolio assets ($.8 million) and Equityin earnings of investments ($.2 million) were purchased within the last 18months. Management may make additional adjustments to income accrual rates inthe future if facts and circumstances warrant it.

The Company’s financial results are affected by many factors includinglevels of, and fluctuations in, interest rates, fluctuations in the underlyingvalues of real estate and other assets, the timing of, and ability to,liquidate assets, and the availability and prices for loans and assets acquiredin all of the Company’s businesses. The Company’s business and results ofoperations are also affected by the availability of financing with termsacceptable to the Company and the Company’s access to capital markets,including the securitization markets.

The second quarter earnings were also negatively impacted by provisionsnet of recoveries for loan losses of $.5 million, of which $.7 million was onwholly-owned domestic portfolios.  The difference of ($.2) millionrepresents net recoveries primarily from domestic acquisitionpartnerships.  The Company experiencesfluctuations in estimated cash flows from time to time and does not believethat these provisions are indicative of any negative trend.

FirstCity isnegotiating a $50 million increase in its loan facility with Bank of Scotlandunder FirstCity’s Revolving Credit Agreement dated as of November 12, 2004,from $175 million to $225 million, a $50 million increase in the acquisitionfacility provided to FH Partners L.P., a wholly-owned affiliate of FirstCity,under the Revolving Credit Agreement dated as of August 26, 2005, from $50million to $100 million, and a new $25 million loan facility with BoS (USA),Inc., an affiliate of Bank of Scotland, which would be subordinated to theRevolving Credit Agreement provided to FirstCity by Bank of Scotland.  FirstCity believes that the increased fundingwith the Bank of Scotland and BoS (USA), Inc. will be completed on a timelybasis to accommodate future acquisitions and continued growth. FirstCitymanagement believes that the current negative market conditions related to subprime/finance companies has not had an effect on the Company’s liquidity andability to continue to grow the business. FirstCity Financial is not reliant onWall Street for operating capital but rather has a strong relationship withBank of Scotland and expects completion of the amendments contemplated withoutcomplications in the next few weeks. There can be no assurance that FirstCity can obtain the additionalfinancing from the Bank of Scotland or any other lender.

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As a result of the significant period to period fluctuations in therevenues and earnings and losses of the Company’s Portfolio Asset acquisitionand resolution business, period to period comparisons of the Company’s resultsof continuing operations may not be meaningful.

Components of the results for the three and six month periods ended June30, 2007 and 2006, respectively, are detailed below (dollars in thousandsexcept per share data):

|                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Portfolio Asset  Acquisition and Resolution |       | $                                               | 4,313      |                                          | $          | 2,549 |   | $ | 6,183 |   | $ | 5,877 |   |
| Corporate  overhead                         |       | (2,507                                          | )          | (1,286                                        | )          | (5,292 | ) | (2,517 | ) |
| Earnings from continuing operations         |       | 1,806                                           |       | 1,263                                         |       | 891 |   | 3,360 |   |
| Loss from discontinued operations           |       | —                                          |       | —                                        |       | — |   | (75 | ) |
| Net earnings to common stockholders         |       | $                                               | 1,806      |                                          | $          | 1,263 |   | $ | 891 |   | $ | 3,285 |   |
| Diluted earnings  per common share          |       | $                                               | 0.16       |                                          | $          | 0.11 |   | $ | 0.08 |   | $ | 0.27 |   |

 

**Results of Operations**

The following discussion and analysis is based on the segment reportinginformation presented in note 8 of the Consolidated Financial Statements of theCompany and should be read in conjunction with the Consolidated FinancialStatements (including the Notes thereto) included elsewhere in this QuarterlyReport on Form 10-Q.

***Second Quarter 2007 Compared to Second Quarter 2006***

The Company reported net earnings of $1.8 million in the second quarterof 2007 compared to net earnings of $1.3 million in the second quarter of 2006.On a per share basis, diluted net earnings to common stockholders were $.16 inthe second quarter of 2007 compared to $.11 diluted net earnings in the secondquarter of 2006.

*PortfolioAsset Acquisition and Resolution*

The operating contribution from the Portfolio Asset acquisition andresolution segment was $4.3 million in the second quarter of 2007 compared to$2.5 million in the second quarter of 2006. FirstCity invested $25.2 million inPortfolio acquisitions during the second quarter of 2007, of which $13.5 millionand $11.7 million were acquired through Acquisitions Partnerships andwholly-owned Portfolios, respectively, compared to $18.9 million in the secondquarter of 2006, which was comprised of $3.3 million through AcquisitionPartnerships and $15.6 million through wholly-owned Portfolios.  The quarter-end investment in PortfolioAssets increased to $122.6 million at June 30, 2007, from $58.0 million at June30, 2006, as a result of acquisitions of approximately $101.5 million since thesecond quarter of 2006. In addition to the portfolio acquisitions during thesecond quarter of 2007, FirstCity invested $1.1 million in SBA loanoriginations and advances as well as $3.1 million in the form of advances onloans receivable.

*Servicing fee revenues. *Servicing fee revenues were $3.0 million in thesecond quarter of 2007 compared to $2.9 million in the second quarter of 2006.

*Income from Portfolio Assets*.  Income from Portfolio Assetsincreased to $5.7 million in the second quarter of 2007 from $2.9 million inthe second quarter of 2006 due to increased purchases of portfolio assets.  FirstCity’s average investment in whollyowned portfolio assets was $121.9 million and $52.4 million during the secondquarters of 2007 and 2006, respectively.

*Gainon sale of SBA loans held for sale. *The Company recorded gains on the sale of SBA loans of $.3 million during thesecond quarter of 2007.  The Company’sbasis in SBA loans sold was $8.2 million. Gains on SBA loan sales reflect the participation in the SBA’sguaranteed loan program. Under the SBA 7(a) program, the SBA guarantees up to85 percent of the principal of a qualifying loan. The Company usually sells theguaranteed portion of the loan into the secondary market and retains theunguaranteed portion.

*Interest income from SBA loans. *Interest income from SBA loans was $.6 millionduring the second quarter of 2007 as a result of the SBA portfolio acquisitionin February 2007.

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* Interest income fromaffiliates. *Interest income from affiliates decreased to $.1million in the second quarter of 2007 from $.5 million in the secondquarter of 2006 due to the conversion of loans to equity as part of therestructure of investments in Mexico during the third quarter 2006, whichreduced the amount of loans outstanding and the corresponding income.

*Interest income from loans receivable - other. * Interest income from loansreceivable — other was $1.0 million in the second quarter of 2007 and relatesto loans originated in the latter half of 2006 which included loans to aCanadian real estate company, and two domestic real estate companies.

*Other income*.Other income remained relatively flat from quarter to quarter.

*Expenses. *Operating expenses were $11.2 million and $5.5million in the second quarters of 2007 and 2006, respectively.  Below is a discussion of the majorcomponents.

Interest and fees on notes payable were $4.7 million and $1.9 million inthe second quarters of 2007 and 2006, respectively. The average debt for thequarter increased to $224.8 million in the second quarter of 2007 from $88.5million in the second quarter of 2006, and the average cost of borrowingdecreased to 8.31% in 2007 compared to 8.8% in 2006.

Salaries and benefits increased 20.8% to $3.0 million in the secondquarter of 2007 from $2.5 million in the second quarter of 2006, primarily dueto additional salaries related to ABL and FirstCity Crestone in 2007 of$268,000 and $101,000 respectively. In Latin America, costs associated withlegal staff were absorbed into payroll during the third quarter of 2006resulting in an increase to salaries during the second quarter of 2007.  These increases were partially offset by areduction of $84,000 due to closing FirstCity Servicing of Minnesota in thesecond quarter of 2006. The total number of personnel within the PortfolioAsset acquisition and resolution segment were 185 and 179 at June 30, 2007 and2006, respectively.

The provision (recovery) for loan and impairment losses was $746,000compared to ($58,000) at June 30, 2007 and 2006, respectively primarily due toa decrease in the net present value of cash flows related to certain assetswithin one domestic partnership.

Occupancy, data processing, communication and other expenses increased to$2.7 million for the second quarter of 2007 from $1.2 million in the secondquarter of 2006 primarily due to servicing costs in Chile and increasedproperty taxes related to a domestic partnership of $213,000 and $493,000,respectively.  In addition, foreignexchange losses of $265,000 occurred during the second quarter of 2007 comparedto $239,000 foreign exchange gains for the same period in 2006.

Minority interest remained relatively flat from quarter to quarter.

*Equity in earnings of investments. *Equity in earningsof investments increased to $4.3 million in the second quarter of 2007 comparedto $1.4 million in the second quarter of 2006, primarily as a result ofincreased equity in earnings from Acquisition Partnerships to $3.7 million inthe second quarter of 2007 from $1.1 million in the second quarter of 2006.Following is a discussion of equity earnings from Acquisition Partnerships bygeographic region.

·             *Domestic* — Equity in earnings of domestic AcquisitionPartnerships was $1.1 million in the second quarter of 2007 compared to $1.6million in the second quarter of 2006.  These partnerships reflected netearnings of $2.5 million in the second quarter of 2007 compared to $3.4 millionin 2006. Collections on Portfolio Assets decreased to $25.3 million in thesecond quarter of 2007 from $43.8 million in 2006. This decrease was due inpart to income from Portfolio Assets in 2006 being generated primarily fromloans acquired prior to 2005, whereas income in 2007 was generated primarilyfrom loans acquired after 2004.  Income from Portfolio Assets acquiredafter 2004 is less sensitive to collections than from Portfolio Assets acquiredprior to 2005.  For Portfolios acquired after 2004, income is recognizedratably over the remaining life of the Portfolio based on an expected yield. For nonperforming loans acquired prior to 2005, income is recognized to theextent that collections exceed a pro rata portion of allocated cost from thepool.  These partnerships also reflected netprovisions, (recoveries) of ($516,000) million in the second quarter of 2007compared to $567,000 in the second quarter of 2006.

·             *Latin America* — Equityin earnings (loss) of Acquisition Partnerships located in Latin America was $.9million in the second quarter of 2007 compared to ($1.6) million in 2006,primarily due to foreign exchange gains. These partnerships reflected netearnings of $8.0 million in the second quarter of 2007 compared to net lossesof $16.2 million in 2006. During thesecond quarter of 2007, the partnerships recorded provisions net of recoveriesof allowance for loan losses of $.6 million compared to $1.9 million during the second quarter of 2006. Thepartnerships recorded $3.6 million of foreign exchange gains in the second 

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quarter of 2007 compared to $14.9 millionof foreign exchange losses in 2006 (ofwhich $.5 million gains and $1.3 million losses were included in equity earnings, respectively).

·             *Europe* — Equity inearnings of Acquisition Partnerships located in Europe increased to $1.7million in the second quarter of 2007 compared to $1.1 million in 2006primarily due to increased earnings as a result of new investments in Europesince June 2006.  These partnershipsrecorded $33,000 in provisions net of recoveries during the second quarter of2007 compared to net recoveries of ($640,000) during the same period in 2006.FirstCity recorded $204,000 in foreign currency transaction losses and $324,000in foreign currency transaction gains (included in other expenses) relating toinvestments in Europe during the second quarter of 2007 and 2006, respectively.

*Other ItemsAffecting Operations*

The following items affect the Company’s overall results of operationsand are not directly related to the Portfolio Asset acquisition and resolutionbusiness discussed above.

*Corporate overhead.   *Net corporate overhead expenses (excluding taxes)increased to $2.4 million in the second quarter of 2007 compared to $1.3million in the second quarter of 2006 primarily due to $824,000 in expensesincurred during the second quarter of 2007 relating to the investigationauthorized by the audit committee, and an increase in accounting fees to $.4million from $.2 million in the secondquarters of 2007 and 2006, respectively.

*Income taxes. *Provision for incometaxes was $146,000 and $22,000 in the second quarters of 2007 and 2006,respectively, and related primarily to state income taxes during both periods. Federal income taxes are provided at a 35% rateapplied to taxable income or loss and are offset by NOLs that the Companybelieves are available. The tax benefit of the NOLs is recorded in the periodduring which the benefit is realized. The Company recorded no deferred taxprovision in the second quarters of either 2007 or 2006.

***First Six Months of 2007 Compared to First Six Months of 2006***

The Company reported earnings from continuing operations of $.9 millionin the first six months of 2007 compared to $3.4 million for the same period of2006. Net earnings to common stockholders were $.9 million in the first sixmonths of 2007 compared to $3.3 million in the first six months of 2006. On aper share basis, diluted net earnings to common stockholders were $.08 in thefirst six months of 2007 compared to $.27 in the first six months of 2006.

*PortfolioAsset Acquisition and Resolution*

The operating contribution in the first six months of 2007 was $6.2million compared to $5.9 million for the same period last year.   FirstCity invested $94.7 million in Portfolioand SBA acquisitions during the first six months of 2007, of which $17.4million, $40.5 million and $36.8 million were acquired through AcquisitionsPartnerships, wholly-owned Portfolios and SBA loans acquired by ABL,respectively, compared to $42.3 million in the first six months of 2006, whichwas comprised of $20.8 million through Acquisition Partnerships and $21.5million through wholly-owned Portfolios. The investment in Portfolio Assets increased to $122.6 million at June30, 2007, from $58.0 million at June 30, 2006, as a result of acquisitions ofapproximately $101.5 million since June 30, 2006. In addition to the portfolioacquisitions during the first six months of 2007, FirstCity invested$4.0 million in a servicing entity as well as $6.9 million in the form ofadvances on loans receivable and$1.1 million in SBA loan originations and advances.

*Servicing fee revenues. *Servicing fee revenues increased 1.4% to $5.6million in the first six months of 2007 from $5.5 million in the first sixmonths of 2006. Service fees from the Latin American partnerships increased by$.3 million, or 9.5%, as a result of a third party contract in Brazil thatbegan in January 2007.  For the MexicanAcquisition Partnerships, FirstCity earns a servicing fee based on costs ofservicing plus a profit margin of 10%. Service fees from the domestic Acquisition Partnerships decreasedslightly to $1.7 million in the first six months of 2007 compared to $2.0million in the same period in 2006.

*Income from Portfolio Assets. *Income from Portfolio Assets increased to $10.7million in the first six months of 2007 compared to $5.0 million in the firstsix months of 2006, primarily due to increased purchases in wholly ownedacquisitions. FirstCity’s average investment in wholly-owned portfolio assetswas $114.9 million and $50.2 million during the first six months of 2007 and2006, respectively.

*Gainon sale of SBA loans held for sale. *The Company recorded gains on the sale of SBA loans of $.6 million during the first six months of 2007.  The Company’s basis in SBAloans sold was $14.9 million.  Gains onSBA loan sales reflect the participation in the 

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SBA’s guaranteed loan program. Under the SBA 7(a)program, the SBA guarantees up to 85 percent of the principal of a qualifyingloan.

*Interest income from SBA loans. *Interest income from SBA loans was $.9 millionduring the first six months of 2007 as a result of the SBA portfolioacquisition in February 2007.

*Interest income from affiliates. *Interest incomefrom affiliates decreased to $.3 million in the first six months of 2007compared to  $.9 million in the first sixmonths of 2006 primarily due to the conversion of loans to equity as part ofthe restructure of investments in Mexico during the third quarter 2006, whichreduced the amount of loans outstanding and the corresponding income.

*Interest income from loans receivable - other. *Interest income from loans receivable — other was $1.9 million in thefirst six months of 2007 and relates to loans originated in the latter half of2006 which included loans to a Canadian real estate company and two domesticreal estate companies.

*Other income. *Other income remained flat at $.8 million in thefirst six months of 2007 compared to $.8 million in 2006.

*Expenses. *Operating expenses were $20.7 million in thefirst six months of 2007 compared to $11.3 million in the first six months of2006.  The following is a discussion ofthe major components.

Interest and feeson notes payable increased to $8.9 million inthe first six months of 2007 from $3.7 million in the first six months of 2006. The average debt for the periodincreased to $211.4 million in the first six months of 2007 from $87.5 millionin the first six months of 2006, and the average cost of borrowing increased to8.44% in 2007 from 8.35% in 2006.

Salaries and benefits increased to $6.1 million in the first six monthsof 2007 from $5.4 million in the first six months of 2006, primarily due toadditional salaries related to ABL and FirstCity Crestone in 2007 of $502,000and $101,000; respectively. In Latin America, costs associated with legal staffwere absorbed into payroll the third quarter of 2006 resulting in an increaseto salaries during the first six months of 2007.  These increases were partially offset by areduction of $190,000 due to closing FirstCity Servicing of Minnesota in thesecond quarter of 2006. The total number of personnel within the PortfolioAsset acquisition and resolution segment were 185 and 179 at June 30, 2007 and2006, respectively.

The provision for loan and impairment losses was $1.1 million in thefirst six months of 2007 compared to $51,000 in 2006.

Occupancy, data processing, communication and other expenses increased to$4.6 million in the first six months of 2007 compared to $2.2 million in thefirst six months of 2006 primarily due to increased foreign exchange losses of$481,000 in the first six months of 2007 compared to foreign exchange gains of$581,000 in the first six months of 2006.

Minority interest was ($123,000) and ($62,000) for the first six monthsof 2007 and 2006, respectively.  Thedifference between the quarters is primarily as result of the Company’s 60%ownership in a Chilean acquisition partnership, which was acquired in the thirdquarter of 2006.

*Equity in earnings of investments. *Equity in earningsof investments increased 22.6% to $6.2 million in the first six months of 2007compared to $5.0 million in the first six months of 2006 as a result of anincrease in equity in earnings of Acquisition Partnerships of 13.2% to $5.5million in the first six months of 2007 from $4.8 million in the first sixmonths of 2006.  Additionally, equity inearnings of servicing entities increased to $.7 million in the first six monthsof 2007 from $.2 million in the first six months of 2006.  Following is a discussion of equity earningsin Acquisition Partnerships by geographic region.  See note 6 to the consolidated financialstatements for a summary of revenues and earnings of the AcquisitionPartnerships and equity in earnings of the Acquisition Partnerships.

·             *Domestic* — Equityin earnings of domestic Acquisition Partnerships decreased 64.6% to $1.4million in the first six months of 2007 from $3.9 million in the first sixmonths of 2006. These partnershipsreflected net earnings of $3.1 million in the first six months of 2007 comparedto $8.0 million in the first six months of 2006. This decrease was due in partto income from Portfolio Assets in 2006 being generated primarily from loansacquired prior to 2005, whereas income in 2007 was generated primarily fromloans acquired after 2004.  Collections on Portfolio Assets decreased to$42.5 million in the first six months of 2007 from $67.1 million in the firstsix months of 2006. Income from Portfolio Assets acquired after 2004 is lesssensitive to collections than from Portfolio Assets acquired prior to2005.  For Portfolios acquired after 2004, income is recognized ratablyover the remaining life of the Portfolio based on an expected yield.  Fornonperforming loans acquired prior to 2005, income is 

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recognized to the extent that collections exceeda pro rata portion of allocated cost from the pool.  These partnerships also reflected provisions,net of recoveries, of $963,000 in the first six months of 2007 compared to $1.2 million in the first sixmonths of 2006.

·             *Latin America* — Equityin earnings (losses) of Latin American Acquisition Partnerships were $.9million in the first six months of 2007 and ($1.1) million in 2006. Thesepartnerships reflected earnings of $6.6 million in the first six months of 2007compared to losses of ($12.3) million in 2006. During the first six months of 2007, the partnerships recordedprovisions net of recoveries of allowance for loan losses of $4.9 millioncompared to $.54 million during thefirst six months of 2006. Provisions for the second quarter of 2007 areprimarily due to certain portfolios in Mexico, where the overall projected cashcollections increased, but the net present value decreased due to extending theanticipated period of collection. The partnerships recorded $3.3 million offoreign exchange gains in the first six months of 2007 compared to $13.2million of foreign exchange losses in 2006(of which $.4 million gains and $1.1 million losses were included in equity earnings, respectively).

·             *Europe* — Equity inearnings of Acquisition Partnerships located in Europe was $3.2 million in thefirst six months of 2007 compared to $2.1 million in 2006 primarily due tocollections related to portfolio assets acquired in the fourth quarter of2006.  During the first six months of2007 and 2006, FirstCity also recorded $.4 million losses and $.7 milliongains, respectively, in foreign currency transactions (included in otherexpenses) relating to investments in Europe.

*Other ItemsAffecting Operations*

The following items affect the Company’s overall results of operationsand are not directly related to the Company’s Portfolio Asset acquisition andresolution business discussed above.

*Corporate overhead. *Corporate overhead expenses (excluding taxes)increased to $5.1 million in the first six months of 2007 from $2.5 million inthe first six months of 2006, primarily due to $2.0 million expenses incurredduring the first six months of 2007 relating to the investigation authorized bythe audit committee.

*Income taxes. *Provision for incometaxes was $.3 million in the first six months of 2007 compared to $.1 millionin the first six months of 2006 and related primarily to state incometaxes.  Federal income taxes are provided at a 35% rate applied to taxable incomeor loss and are offset by NOLs that the Company believes are available. The taxbenefit of the NOLs is recorded in the period during which the benefit isrealized. The Company recorded no deferred tax provision in either of the firstsix months of 2007 or 2006.

*Discontinued Operations.* There were no additional losses from discontinued mortgage operationsduring the first six months of 2007 compared to $75,000 in the first six monthsof 2006. At June 30, 2007, the only asset remaining from discontinued mortgageoperations is an investment security resulting from the retention of a residualinterest in a securitization transaction.

**FinancialCondition**

Major changes in FirstCity’s financial condition resulted from thefollowing:

Consolidated assets of $341.6 million at June 30, 2007, were $44.0million higher than that at December 31, 2006, primarily due to increases inPortfolio Assets and SBA loans. Portfolio Assets increased by $13.9 million asa result of acquisitions made during 2007. SBA loans increased by $19.3 million.

Consolidated liabilities of $235.9 million as of June 30, 2007, were$42.2 million higher than that at December 31, 2006. Total notes payableincreased by $40.6 million and reflected advances of $117.0 million primarilyfor portfolio acquisitions, net of repayments of $77.7 million.

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**Portfolio AssetAcquisition and Resolution**

Aggregate acquisitions by the Company are as follows (in thousands):

|                           | ** ** | **Purchase  Price** | ** ** | **FirstCity  Investment** | ** ** |
|---------------------------|------------|---------------------|------------|---------------------------|------------|
| First six months  of 2007 |       | $                   | 170,202    |                      | $          | 94,748 |   |
| Total 2006                |       | 296,990             |       | 144,048                   |       |
| Total 2005                |       | 146,581             |       | 71,405                    |       |
| Total 2004                |       | 174,139             |       | 59,762                    |       |
| Total 2003                |       | 129,192             |       | 22,944                    |       |
| Total 2002                |       | 171,769             |       | 16,717                    |       |
|                           |            |                     |            |                           |            |  |  |

 

**Provisionfor Income Taxes**

The Company has substantial NOLs, which can be used to offset the taxliability associated with the Company’s pre-tax earnings until the earlier ofthe expiration or utilization of such NOLs. The Company accounts for thebenefit of the NOLs by recording the benefit as an asset and then establishinga valuation allowance to value the net deferred tax asset at a level, whichmore likely than not, will be realized. Realization is determined based onmanagement’s expectation of generating sufficient taxable income in a lookforward period over the next four years. The ultimate realization of theresulting net deferred tax asset is dependent upon generating sufficienttaxable income from its continuing operations prior to expiration of the NOLs.Although realization is not assured, management believes it is more likely thannot that all of the recorded deferred tax asset, net of the allowance, will berealized. The amount of the deferred tax asset considered realizable, however,could be adjusted in the future if estimates of future taxable income duringthe carryforward period change. The ability of the Company to realize thedeferred tax asset is periodically reviewed and the valuation allowance isadjusted accordingly.

**Liquidityand Capital Resources**

Generally, the Company requires liquidity to fund itsoperations, working capital, payment of debt, repurchase of the Company’scommon stock, equity for acquisition of Portfolio Assets, investments in andadvances to the Acquisition Partnerships, and other investments by the Company.The potential sources of liquidity are funds generated from operations, equitydistributions from the Acquisition Partnerships, interest and principalpayments on subordinated intercompany debt and dividends from the Company’ssubsidiaries, borrowings from revolving lines of credit, proceeds from equitymarket transactions, securitization and other structured finance transactionsand other special purpose short-term borrowings.

FirstCityhas a $175 million revolving acquisition facility with Bank of Scotland as mostrecently amended on June 29, 2007, used to finance the senior debt and equityportion of portfolio and asset purchases made by FirstCity and to provide forthe issuance of letters of credit and working capital loans. The obligations ofFirstCity under this facility are guaranteed by substantially all of thewholly-owned subsidiaries of FirstCity and are secured by security interests insubstantially all of the assets of FirstCity and its wholly-ownedsubsidiaries.  The primary terms and keycovenants of this facility are as follows:

·                  The maximumoutstanding amount of loans and letters of credit issued under the loanfacility that may be outstanding under the loan facility is $175 million;

·                  The availableinterest rates under the loan facility are LIBOR plus 2.00% to 2.50% per annum;

·                  The maximumvalue for assets that can be included in the borrowing base from theacquisition of portfolio assets in certain countries are as follows: Mexico -$30 million, Brazil - $5 million, Chile - $10 million, and Argentina or Uruguay- $6 million;

·                  The limit forloans that can be borrowed in Euros under the loan facility is $50 million;

·                  The maximumamount of letters of credit that can be issued under the loan facility is $40million;

·                  The maximumamount of working capital loans that can be outstanding under the loan facilityis $35 million;

·                  The ratio ofEBITDA to Interest Coverage should not be not less than 1.50 to 1.00 for eachtwelve month period;

·                  The ratio ofIndebtedness to Tangible Net Worth should be equal to or less than 3.5 to 1.00 forthe last day of the fiscal quarter;

·                  The ratio ofCumulative Current Recovered and Projected Collections to Cumulative OriginalProjected Collections should not be less than 0.90 to 1.00; and

·                  The maturitydate for the loan facility is November 12, 2010.

FHPartners, L.P., an indirect wholly-owned affiliate of FirstCity, has arevolving loan facility with Bank of Scotland as most recently amended on June29, 2007, that provides for a $50 million revolving Portfolio acquisitionfacility for FH Partners, L.P. to be 

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secured by all of theassets of FH Partners, L.P.  The loanfacility will be used to finance Portfolio and asset purchases.  The obligations of FH Partners, L.P. underthe facility are guaranteed by FirstCity and the primary wholly-ownedsubsidiaries of FirstCity.  The primaryterms and key covenants of this facility are as follows:

·                  allowsloans to be made for the acquisition of Portfolio Assets in the United States;

·                  providesthat each loan may be in an amount of up to 70% of the net present value of theassets being acquired with the proceeds of the loan;

·                  providesthat the aggregate outstanding balances of all loans will not exceed 65% of thenet present value of the assets securing the loan facility;

·                  providesfor an interest rate of LIBOR plus 2.0%;

·                  providesfor an annual commitment fee of 0.20% of the average daily unused balance ofthe revolving acquisition facility;

·                  providesfor a utilization fee of 0.75% of the amount of each loan made under the loanfacility;

·                  providesfor facility fees of $100,000, for the period commencing on the effective dateand ending the day before the first anniversary thereof, $75,000, for theperiod commencing on the first anniversary of the effective date and ending theday before the second anniversary thereof, and $50,000, for each subsequentone-year period;

·                  providesthat all other financial covenants will mirror the key covenants of thefacility that FirstCity has with Bank of Scotland; and

·                  providesfor a maturity date of November 12, 2008.

ABL, a subsidiary ofFirstCity, has a $40 million revolving loan facility with Wells Fargo Foothill,LLC (“WFF”), as most recently amended on July 30, 2007, for the purpose offinancing and acquiring SBA loans.  Theobligations under this facility are secured by substantially all of the assetsof ABL.  At June 30, 2007, the balance of this facility was $13.1million.  In connection with the first amendment to this facility onFebruary 27, 2007, FirstCity provided WFF with an unconditional guaranty, up toa maximum of $5 million plus enforcement cost, of the obligations of ABL underthe loan facility that relate to funds in the amount of $31.7 advanced by WFFto ABL in connection of a portfolio of SBA loans in February 2007.  Thisguaranty will remain in effect until the obligations incurred in connectionwith the advance related to the acquisition of the portfolio of SBA loans arepaid in full.

On July 30, 2007, ABL andWFF entered into a second amendment to the existing loan facility, whichamended certain covenants under the loan facility.  This amendment madethe following changes to the existing loan facility effective as of June 30,2007: (i) reduced the minimum tangible net worth requirement for the fiscalquarter ending June 30, 2007, and for each quarter thereafter; (ii) revised thedefinition of minimum net interest coverage ratio applicable to a portfolio ofacquired performing SBA loans and added an additional covenant requiring aratio of 1.25 to 1.0 for net interest coverage for all of the loans owned byAmerican; (iii) amended the requirements for bad debt reserves for theportfolio of acquired SBA loans; (iv) amended the delivery requirement forinformation and reports related to sales of SBA loans; (v) deleted therequirement for delivery of statements of cash flows with monthly financialstatements; and (vi) extended to June 30, 2008, the time period before (a) afacility fee of one-quarter of one percent (0.25%) per annum will be chargedfor non-use of the available maximum credit line, (b) the concentration limitof 7.5% for non-guaranteed SBA loans would be applicable, and (c) theconcentration limit of 30% for non-guaranteed SBA loans owed by borrowers whosebusiness activities fall within a single industry is applicable.  Theprimary terms and key covenants of this revolving loan facility, as amended,are as follows:

·                  allows advancesin the maximum amount of $40 million (the “Maximum Credit Line”) to be made underthe facility;

·                  provides for aborrowing base for originating loans by which (a) the sum of (1) up to onehundred percent (100%) of the net eligible SBA guaranteed loans originated byABL, plus (2) up to eighty percent (80%) of the net eligible non-guaranteedloans originated by ABL, exceeds (b) the sum of (1) any reserves forobligations of ABL related to the bank products, plus (2) the aggregate amount,if any, of loan reserves then established and outstanding, plus (3) theaggregate amount of any other reserves established by WFF;

·                  provides for aborrowing base for the portfolio of SBA loans acquired in February 2007 bywhich (a) the sum of (1) up to one hundred percent (100%) of the net eligibleSBA guaranteed performing loans acquired by ABL in February 2007, (provided,that such percentage shall be reduced by five percent (5%) on November 1, 2007and on the first day of each month thereafter), plus (2) up to eighty percent(80%) of the net eligible non-guaranteed performing loans acquired by ABL,exceeds (b) the sum of (1) any reserves with respect to acquired performingloans related to the bank products, plus (2) the aggregate amount, if any, ofloan reserves then established and outstanding, plus (3) the aggregate amountof any other reserves established by WFF;

·                  provides for aninterest rate of LIBOR plus 2.625% or, alternatively, the greater of (x) theWells Fargo prime rate or (y) seven and one-half percent (7.50%) per annum;

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·                  provides for anunused credit line fee in an amount equal to one-quarter of one percent (0.25%)per annum of the average daily difference during the month in question (orportion thereof) between the Maximum Credit Line and the aggregate outstandingprincipal amount of the advances outstanding under the facility for such month(or portion thereof);

·                  provides in theevent of the termination of the facility by ABL for a prepayment fee of threepercent (3.0%) of the Maximum Credit Line if paid prior to December 14, 2007,two percent (2.0%) of the Maximum Credit Line if paid during the periodbeginning December 15, 2007 and ending December 14, 2008, and one percent(1.0%) of the Maximum Credit Line if paid during the period beginning December15, 2008 and ending December 13, 2009; and

·                  provides for amaturity date of December 14, 2009.

At June 30, 2007, the Company had $38.5 million inEuro-denominated debt for the purpose of hedging a portion of the net equityinvestments in Europe. In general, the type of risk hedged relates to theforeign currency exposure of net investments in Europe caused by movements inEuro exchange rates. The Company designated the hedging relationship such thatchanges in the net investments being hedged are expected to be offset bycorresponding changes in the values of the Euro-denominated debt.  Effectiveness of the hedging relationship ismeasured and designated at the beginning of each month by comparing theoutstanding balance of the Euro-denominated debt to the carrying value of thedesignated net equity investments. The net foreign currency translation gain(loss) included in accumulated other comprehensive income relating to theEuro-denominated debt was $156,000 for the six months ended June 30, 2007 and ($1.5)million for the same period in 2006.

On September 22, 2006, FirstCity NPL S.A., a Chileanaffiliate of FirstCity Chile Ltda and FirstCity, entered into a revolving lineof credit with a maximum loan amount in Chilean pesos equivalent to $10.0million U.S. Dollars with CORPBANCA Sociedad Anónima Bancaria (“CB”) to financethe purchase of delinquent and due accounts. The revolving line of credit was structured by Corpbanca AsesoríasFinancieras S.A. (“CAF”).  Pursuant tothe terms of the credit facility, FirstCity NPL S.A. was required to provide astand-by letter of credit from Bank of Scotland that would satisfy the loanbalance upon demand.  At June 30, 2007,FirstCity had a letter of credit in the amount of $4.6 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that ademand is made under the $4.6 million letter of credit, FirstCity is requiredto reimburse Bank of Scotland by making payment to Bank of Scotland for all amountsdisbursed or to be disbursed by Bank of Scotland under the letter of credit.

On November 29,2006, FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, entered intoa revolving line of credit with a maximum loan amount of 148,096,800 Mexican pesoswith Banco Santander, S.A., which was equivalent to $13.7 million U.S. dollarsat June 30, 2007.   The proceeds wereused to pay down the acquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA deCV was required to provide a stand-by letter of credit from Bank ofScotland that would satisfy the loan balance upon demand.  At June 30,2007, FirstCity had a letter of credit in the amount of $14.1 million from Bankof Scotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that a demand is made under the $14.1million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

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

Excluding the term acquisition facilities of theunconsolidated Acquisition Partnerships, the Company and its subsidiariescurrently have credit facilities providing for borrowings in an aggregateprincipal amount of $296 million, and outstanding borrowings of $228 million asof June 30, 2007.

Management believes that the existing loan facilities,the related fees generated from the servicing of assets, equity distributionsfrom existing Acquisition Partnerships and wholly-owned portfolios, sales ofinterests in equity investments, and origination and sales of guaranteedportions of SBA 7(a) loans, will allow the Company to meet its obligations asthey come due during the next twelve months.

The following table summarizes the material terms ofthe credit facilities to which the Company, its major operating subsidiariesand the Acquisition Partnerships were parties to as of July 31, 2007, and theoutstanding borrowings under such facilities as of June 30, 2007.

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**CreditFacilities**
| ** **                                                                                              | ** ** | **Funded and  Unfunded  Commitment  Amount as of  July 31,  2007** | ** ** | **Outstanding  Borrowings  as of  June 30,  2007** | ** ** | **Interest Rate**                                                | ** ** | **Other Terms and Conditions**                                                |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|
| ** **                                                                                              | ** ** | **(Dollars in millions)**                                          | ** ** | ** **                                         | ** ** | ** **                                                       |
| Bank of Scotland $175 million portfolio acquisition  and working capital facility (1)                   |       | $                                                                  | 175        |                                               | $          | 147                                                              |       | LIBOR + 2.0% - 2.50%                                                                         |   | Secured by equity interests and other assets of  FirstCity, matures November 2010 |
|                                                                                                    |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| Bank of Scotland $50 million portfolio acquisition -  revolving credit                                  |       | 50                                                                 |       | 42                                                 |       | LIBOR + 2.0%                                                     |       | Secured by assets of FH Partners, L.P. and guaranteed  by the Company, matures November 2008 |
|                                                                                                    |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| American Bank term loan for portfolio acquisition by  FC Washington                                     |       | 2                                                                  |       | 2                                                  |       | Fixed 5.625%                                                     |       | Secured by assets of FC Washington and guaranteed by  the Company, matures 2008              |
|                                                                                                    |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| Participation payable                                                                                   |       | 1                                                                  |       | 1                                                  |       | 32.56% imputed rate                                              |       | Participation agreement on 33% of net cash flows  received on one portfolio                  |
|                                                                                                    |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| CorpBanca revolving line of credit for Chilean  portfolio acquisition                                   |       | 10                                                                 |       | 5                                                  |       | Rate based on monthly Chilean index rate plus .0625 %  per month |       | Secured by Bank of Scotland letter of credit.  Renewable every 30 days.                      |
|                                                                                                    |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| Banco Santander line of credit facility                                                                 |       | 13                                                                 |       | 13                                                 |       | Rate based on 28 day Mexican index rate plus 1.5%                |       | Secured by Bank of Scotland letter of credit, matures  November 2008                         |
| ** **                                                                                              |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| Wells Fargo Foothill, Inc. $40 million revolving loan  facility                                         |       | 40                                                                 |       | 13                                                 |       | LIBOR + 2.625% or greater of Wells Fargo prime or  7.5%          |       | Secured by assets of American Business Lending, Inc.,  matures December 2009.                |
| ** **                                                                                              |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| The First National Bank of Central Texas term loan  for portfolio acquisition by MPortfolio Corporation |       | 5                                                                  |       | 5                                                  |       | LIBOR + 1.75%                                                    |       | Secured by assets of MPortfolio Corporation, matures  June 2010.                             |
|                                                                                                    |       |                                                               |       |                                               |       |                                                             |       |                                                                                         |
| Total                                                                                                   |       | $                                                                  | 296        |                                               | $          | 228                                                              |       |                                                                                         |   |   |

----

(1)          The Bank of Scotland facility allows loans to be madein Euros up to a maximum amount in Euros that is equivalent to $50million.  At June 30, 2007, the Companyhad approximately $38.5 million outstanding under the Euro-denominated portionof this facility.

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**Forward-LookingStatements**

Certainstatements contained in this Quarterly Report on Form 10-Q or incorporated byreference from time to time, including, but not limited to, statements relatingto the Company’s strategic objectives and future performance, which are nothistorical facts, may be deemed to be forward-looking statements under thePrivate Securities Litigation Reform Act of 1995. Forward-looking statementsinclude, without limitation, any statement that may project, indicate or implyfuture results, performance or achievements, and may contain the words “expect,”“intend,” “plan,” “estimate,” “believe,” “will be,” “will continue,” “willlikely result,” and similar expressions. Such statements inherently are subjectto a variety of risks and uncertainties that could cause actual results todiffer materially from those projected. There are many important factors thatcould cause the Company’s actual results to differ materially from thoseindicated in the forward-looking statements. Such factors include, but are notlimited to, the performance of the Company’s subsidiaries and affiliates; theavailability of Portfolio Assets; assumptions underlying Portfolio asset performance;risks associated with foreign operations; currency exchange rate fluctuations;risks associated with start up of new businesses and entry into new foreignmarkets; interest rate risk; the degree to which the Company is leveraged; theCompany’s continued need for financing; availability of the Company’s creditfacilities;  ability to obtainadditional financing from the Bank of Scotland or any other lender; the impactof certain covenants in loan agreements of the Company and its subsidiaries;risks of declining value of loans, collateral or assets; the ability of theCompany to utilize NOLs; uncertainties of any litigation that might arise fromdiscontinued operations; general economic conditions; foreign social andeconomic conditions; changes (legislative and otherwise) in the assetsecuritization industry; fluctuations in residential and commercial real estatevalues; capital market conditions, including the markets for asset-backedsecurities; factors more fully discussed and identified in the Company’s AnnualReport on Form 10-K, for the year ended December 31, 2006, filed with theSecurities and Exchange Commission on July 24, 2007 (including those discussedunder “Item 7. Management’s Discussion and Analysis of Financial Condition andResults of Operations”), as well as in other Securities and Exchange Commissionfilings of the Company. Many of these factors are beyond the Company’s control.In addition, it should be noted that past financial and operational performanceof the Company is not necessarily indicative of future financial andoperational performance. Given these risks and uncertainties, investors shouldnot place undue reliance on forward-looking statements. The forward-lookingstatements in this Quarterly Report on Form 10-Q speak only as of the date ofthis Quarterly Report on Form 10-Q. The Company expressly disclaims anyobligation or undertaking to release publicly any updates or revisions to anyforward-looking statement to reflect any change in the Company’s expectationswith regard thereto or any change in events, conditions or circumstances onwhich any forward-looking statement is based.

**Item 3.  Quantitative andQualitative Disclosures About Market Risk.**

**Interest Rate Risk**

Market risk is the risk of loss from adverse changes inmarket prices and interest rates. The Company’s operations are materiallyimpacted by net gains on sales of loans and net interest margins. The level ofgains from loan sales the Company achieves is dependent on demand for theproducts originated. Net interest margins are dependent on the Company’sability to maintain the spread or interest differential between the interest itcharges the customer for loans and the interest the Company is charged for thefinancing of those loans. The following describes each component of interestbearing assets held by the Company and how each could be affected by changes ininterest rates.

The Company invests in Portfolio Assets both directlythrough consolidated subsidiaries and indirectly through equity investments in AcquisitionPartnerships. Portfolio Assets consist of investments in pools ofnon-homogenous assets that predominantly consist of loan and real estateassets. Earnings from these assets are based on the estimated future cash flowsfrom such assets and recorded when those cash flows occur. The underlying loanswithin these pools bear both fixed and variable rates. Due to thenon-performing nature and history of these loans, changes in prevailingbenchmark rates (such as the prime rate or LIBOR) generally have a nominaleffect on the ultimate future cash flow to be realized from the PortfolioAssets.

Loans receivable consist of investment loans made toAcquisition Partnerships and other unrelated entities, and bear interest atpredominately fixed rates. The collectibility of these loans is directlyrelated to the underlying Portfolio Assets of those Acquisition Partnerships,which are non-performing in nature. Therefore, changes in benchmark rates wouldhave minimal effect on the collectibility of these loans.

SBA loansreceivable were $19.3 million at June 30, 2007 of which $3.8 million wererelated to the guaranteed portion of these loans.  The guaranteed portion is backed by the fullfaith and credit of the US Small Business Administration, and is generally soldinto the secondary market.  Virtually allof the SBA loans have variable interest rates. Assuming that the balance sheet were to remain constant and no actionswere taken to alter the existing interest rate sensitivity, a hypotheticalimmediate change in interest rates

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would have a minimaleffect on interest income from SBA loans for the second quarter of 2007.Although management believes that this measure is indicative of our sensitivityto interest rate changes, it does not adjust for potential changes in creditquality, size and composition of the assets on the balance sheet, and otherbusiness developments that could affect a net increase (decrease) in assets. Accordingly,no assurances can be given that actual results would not differ materially fromthe potential outcome simulated by this estimate.

FirstCity had $228.4 million in debt outstanding atJune 30, 2007. The Company is exposed to interest rate risk primarily throughits variable rate debt, which totaled $226.8 million or 99% of the Company’stotal debt. A 50 basis point change in interest rates would increase ordecrease FirstCity’s interest expense by approximately $1.1 million annually.

**Foreign Currency Risk**

The Company currently has loans and equity investmentsin Europe, Latin America (i.e. Mexico, Argentina, Dominican Republic and Chile)and Canada.

In Europe and in Mexico, the Company’s investments areprimarily in the form of equity and represent a significant portion of theCompany’s total equity investments. As previously discussed, the revolvingacquisition facility with Bank of Scotland for $175 million allows loans to bemade in Euros up to a maximum amount in Euros that is equivalent to $50 millionU.S. dollars. At June 30, 2007, the Company had $38.5 million inEuro-denominated debt for the purpose of hedging a portion of the net equityinvestments in Europe.  In November 2006,the Company acquired a line of credit facility with Banco Santander, S.A. thatallows loans to be made up to a maximum of 148,096,800 Mexican pesos. At June30, 2007, the Company had 148,096,800 in Mexican peso-denominated debt, whichwas equivalent to $13.7 million U.S. dollars.. Management of the Company feels that these loan agreements will helpreduce the risk of adverse effects of currency changes on these investments.

A sharp change in the foreign currencies related tothe investments in Europe, Latin America and Canada relative to the U.S. dollarcould materially adversely affect the financial position and results ofoperations of the Company. A 5% and 10% incremental depreciation of thesecurrencies would result in an estimated decline in the valuation of the Company’sforeign investments and are indicated in the following table. These amounts areestimates; consequently, these amounts are not necessarily indicative of theactual effect of such changes with respect to the Company’s consolidatedfinancial position or results of operations.

|                     | ** ** | ** ** | ** ** | **One U.S.  dollar  equals** | ** ** | **Estimated decline in  valuation of investments  resulting from  incremental depreciation  of foreign currency of  (dollars in thousands)** | ** ** |
|---------------------|------------|------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **          | ** ** | ** ** | ** ** | ** **                        | ** ** | **5%**                                                                                                                                                                                              | ** ** | **10%** | ** ** |
| Europe              |       | EUR        |       | 0.74                              |       | $                                                                                                                                                                                                   | 2,603      |   | $ | 4,978 |   |
|                |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Mexico              |       | MXN        |       | 10.87                             |       | $                                                                                                                                                                                                   | 2,035      |   | $ | 3,930 |   |
|                |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Argentina           |       | ARS        |       | 3.09                              |       | $                                                                                                                                                                                                   | 92         |   | $ | 179 |   |
|                |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Dominican  Republic |       | DOP        |       | 33.69                             |       | $                                                                                                                                                                                                   | 38         |   | $ | 73 |   |
|                |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Chile               |       | CLP        |       | 527.80                            |       | $                                                                                                                                                                                                   | 151        |   | $ | 287 |   |
|                |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Canada              |       | CAD        |       | 1.06                              |       | $                                                                                                                                                                                                   | 17         |   | $ | 33 |   |

 

**Item 4.  Controls and Procedures.**

An evaluation was performed under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934) as of 

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June30, 2007.  Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective, in all material respects, toensure that information required to be disclosed in the reports the Companyfiles and submits under the Exchange Act is recorded, processed, summarized andreported as and when required.  TheCompany’s management, including the Company’s Chief Executive Officer and ChiefFinancial Officer, also evaluated whether any change in the Company’s internalcontrols over financial reporting or in other factors had occurred during thefiscal quarter covered by this report. Based upon that evaluation, management concluded that there had been nosuch changes during the period covered by this report that have materially affected,or is reasonably likely to affect, the registrant’s internal control overfinancial reporting.

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**PART II**

**OTHERINFORMATION**

**Item 1.  Legal Proceedings.**

Exceptas disclosed below, there have been no material developments with regard to anymatters disclosed in the Company’s 2006 Annual Report on Form 10-K.

On March 20, 2007, Superior Funding, Inc., Wave TecPools, Inc. and Nations Pool Supply, Inc. (collectively “Plaintiffs”) filed aFirst Amended Petition adding FH Partners, L.P. and FirstCity ServicingCorporation, each an indirectly wholly-owned subsidiary of FirstCity, andFirstCity Financial Corporation as defendants in a suit filed by Plaintiffsagainst State Bank and Cole Harmonson before the 98th Judicial District Courtof Travis County, Texas.  FirstCityFinancial Corporation was served with Plaintiff’s Notice of Nonsuit WithoutPrejudice in the suit on April 25, 2007. In the First Amended Petition the Plaintiffs sought unspecified damagesfor breach of contract and conversion related to alleged breaches by FHPartners, L.P. and FirstCity Servicing Corporation in connection with a loanagreement related to a loan from State Bank to Plaintiffs that was purchased byFH Partners, L.P. from State Bank on December 22, 2006.  The Plaintiffs also raised other claimssolely against the other defendants.  ThePlaintiffs allege that they entered into a loan or line of credit with StateBank and that due to an error by State Bank the Plaintiffs borrowed more on theline of credit than was allowed under the borrowing base.  The Plaintiffs further allege that State Bankentered in an agreement with Plaintiffs that the default by Plaintiffs would becured if the Plaintiffs pledged additional property to secure the loans andthat the Plaintiffs would be allowed to borrow under the line of credit.  Plaintiffs allege that State Bank, andsubsequently FH Partners, L.P., have refused to honor the agreement by StateBank concerning the pledge of the additional property.  On July 25, 2007, counsel for FH Partnersreceived a Second Amended Petition in which the Plaintiffs allege that theyhave sustained actual damages of $165,000,000 as a result of the joint actionsof State Bank, Cole Harmonson, FH Partners, L.P. and FirstCity ServicingCorporation.  The Plaintiffs assertclaims against FH Partners, L.P. and FirstCity Servicing Corporation for breachof contract, conversion, civil conspiracy, tortious interference withprospective economic relationships and usury related to FH Partners, L.P. andFirstCity Servicing Corporation treating the loans that FH Partners, L.P.purchased from State Bank as being in default, retaining payments delivered tothe lockbox for the loan, retaining mortgage loan files that the Plaintiffsallege were unrelated to the loan agreement, interfering with contracts andrelationships of the Plaintiffs by such actions, and charging interest higherthan the maximum amount allowed under the Texas Finance Code.  The Plaintiffs additionally seek recovery ofstatutory penalties under the Texas Finance Code and attorney’s fees.  The Plaintiffs have made additional claimsagainst the other defendants alleging promissory estoppel, fraud and businessdisparagement.  No discovery has occurredin the lawsuit.  FirstCity intends tocontest the case vigorously.  FirstCitydoes not have sufficient information to estimate any potential liability orprobability of liability, but is unaware of any factual or legal basis forliability.

***Other Litigation***

Periodically, FirstCity, its subsidiaries, itsaffiliates and the Acquisition Partnerships are parties to or otherwiseinvolved in legal proceedings arising in the normal course of business. Whilethe outcome of the ordinary course legal proceedings, and the relatedactivities, are not certain, based on present assessments, management does notbelieve that they will have a material adverse effect on the consolidatedfinancial position, results of operations or liquidity of FirstCity, its subsidiaries,its affiliates or the Acquisition Partnerships.

**Item 1A.  Risk Factors.**

Therehave been no material changes to the risk factors as previously disclosed underItem 1A in the Company’s Annual Report on Form 10-K for the year ended December31, 2006.

**Item 2.  Unregistered Sales ofEquity Securities and Use of Proceeds.**

The Company has a repurchase program approved by the Board of Directorsin August 2006 for the repurchase of up to 1,000,000 shares of the Company’scommon stock.  There were no repurchasesin the second quarter of 2007.

**Item 3.  Defaults Upon SeniorSecurities.**

None

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**Item 4.  Submission of Matters to a Vote of Security Holders.**

None

**Item 5.  Other Information.**

On June 29, 2007, FirstCity Financial Corporation (“FirstCity”) and Bankof Scotland, as agent for the lenders, entered into an Amendment No. 9 (the “FirstCityAmendment”) to the Revolving Credit Agreement dated November 12, 2004.  The FirstCity Amendment dated June 29, 2007,amended the existing $96,000,000 revolving credit facility which is used tofinance acquisitions made by FirstCity, for the issuance of letters of creditand for working capital loans.  TheFirstCity Amendment made the following changes to the existing loan facility:(i) amended provisions of the revolving credit agreement to allow loans to bemade at fixed interest rates for periods of time agreed to by FirstCity and theBank of Scotland; and (ii) amended the covenant for the Indebtedness toTangible Net Worth ratio to require that the ratio be equal to or less than3.50 to 1.00 for each fiscal quarter. The obligations of FirstCity under the Revolving Credit Agreement areguaranteed by substantially all of the wholly-owned subsidiaries of FirstCityand are secured by security interests in substantially all of the assets ofFirstCity and its wholly-owned subsidiaries.

On June 29, 2007, FH Partners, LLC, an indirect wholly-owned affiliate ofFirstCity, and Bank of Scotland, acting through its New York branch, as agentfor itself as lender, entered into an Amendment No. 1 (the “FH PartnersAmendment”) to the Revolving Credit Agreement dated June 29, 2007.  The FH Partners Amendment dated June 29,2007, amended the existing $50,000,000 revolving portfolio acquisition facilityused by FH Partners, LLC to finance portfolio and asset purchases.  The Amendment made the following changes tothe existing loan facility: (i) amended the requirement for the ratio of EBITDAto Interest Coverage to be not less than 1.50 to 1.00 for each twelve monthperiod; and (ii) amended the requirement for the ratio of Indebtedness toTangible Net Worth ratio to be equal to or less than 3.50 to 1.00 for eachfiscal quarter.  The obligations of FHPartners, LLC under the loan facility are secured by all of the assets of FHPartners, LLC and are guaranteed by FirstCity and the primary wholly-ownedsubsidiaries of FirstCity.

**Nature ofMaterial Relationship with Bank of Scotland**

FirstCity has had a significant relationship with Bank of Scotland andThe Governor and The Company of the Bank of Scotland (“BoS-UK”) and theirsubsidiaries since September 1997. FirstCity and its wholly-owned subsidiarieshave entered into loan agreements with Bank of Scotland, BoS (USA) Inc. andBoS-UK from time to time since 1997.

Since December 2002, the Bank of Scotland provided a loan facilityconsisting of (i) a revolving acquisition loan facility providing for a maximumprincipal balance of loans outstanding at any time of $45,000,000, and (ii) arevolving loan facility in the maximum principal amount of $5,000,000 forcorporate purposes. These facilities were secured by all of the assets ofFirstCity and certain of its wholly-owned subsidiaries. The outstandingbalances under those facilities were converted to loans under the revolvingcredit agreement between FirstCity and the Bank of Scotland dated November 12,2004.  The revolving loan facilities weresubsequently amended to provide for loans up to a maximum of $175,000,000 tofinance acquisitions made by FirstCity and issuance of letters of credit andworking capital.  This loan facility isbeing amended by the FirstCity Amendment.

On August 26, 2005, FH Partners, LLC, an indirect wholly-owned affiliateof FirstCity, and Bank of Scotland entered into a revolving credit agreement(the “FHP Revolving Credit Agreement”) that provides a $50,000,000 revolvingportfolio acquisition facility for FH Partners, LLC to be secured by all of theassets of FH Partners, LLC. The loan facility is used by FH Partners, LLC tofinance portfolio and asset purchases. The obligations of FH Partners, LLC under the FHP Revolving CreditAgreement are guaranteed by FirstCity and the primary wholly-owned subsidiariesof FirstCity.  The FHP Revolving CreditAgreement is being amended by the FH Partners Amendment.

In December 2002, in connection with an exchange offer to the holders ofFirstCity’s New Preferred Stock, BoS-UK provided a non-recourse loan in theamount of $16,000,000 to FirstCity, which was used to pay the cash portion ofthe exchange offer to the holders of the New Preferred Stock, to pay expensesof the exchange offer and recapitalization, and to reduce FirstCity’s debt toBank of Scotland and BoS (USA) Inc. (the “Senior Lenders”).  The $16,000,000 loan was secured by a 20%interest in Drive Financial Services LP (“Drive”) (64.51% of FirstCity’sremaining 31% interest in Drive) and other assets of FirstCity ConsumerCorporation (“Consumer Corp.”) as were necessary and only to the extent to allowBoS-UK to realize the security interest in the 20% interest in Drive. Inconnection with the $16,000,000 loan, FirstCity agreed to pay a contingent feeto BoS-UK equal to 20% of all amounts received by FirstCity and Consumer Corp.upon any sale of the 20% interest in Drive or any receipt of distributions fromDrive related to the 20% ownership interest, once such payments exceeded$16,000,000 in the aggregate.  Theoutstanding principal and accrued

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interestof $16,003,947 under the $16,000,000 loan was paid in full on November 1, 2004,in connection with the sale of the 31% beneficial interest in Drive.

On November 1, 2004, FirstCity and certain of its subsidiaries completedthe sale of a 31% beneficial ownership interest in Drive and its generalpartner, Drive GP LLC, to IFA Drive GP Holdings LLC (“IFA-GP”), IFA Drive LPHoldings LLC (“IFA-LP”) and Drive Management LP (“MG-LP”) for a total purchaseprice of $108,478,300 in cash, which resulted in distributions and payments toFirstCity and Consumer Corp. in the aggregate amount of $86,800,000 in cash,from various sources. The proceeds of the sale were used in part to payindebtedness owed to the Senior Lenders and BoS-UK.

BoS (USA) Inc. has a warrant to purchase 425,000 shares of FirstCity’svoting Common Stock at $2.3125 per share, which is subject to adjustment in thenumber of shares in the event of certain changes in the Common Stock, grants ofoptions or issuance of convertible securities by FirstCity or certain corporatechanges or reorganizations.  The warrantwill expire on August 31, 2010, if it is not exercised prior to that date.

**Item 6.  Exhibits.**
| Exhibit  Number | ** ** | ** ** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|-----------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1             |       | —     |       | Joint Plan of Reorganization by First City  Bancorporation of Texas, Inc., Official Committee of Equity Security Holders  and J-Hawk Corporation, with the Participation of Cargill Financial Services  Corporation, Under Chapter 11 of the United States Bankruptcy Code, Case No.  392-39474-HCA-11 (incorporated herein by reference to Exhibit 2.1 of the  Company’s Current Report on Form 8-K dated July 3, 1995 filed with the  Commission on July 18, 1995). |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.2             |       | —     |       | Agreement and Plan of Merger, dated as of July 3,  1995, by and between First City Bancorporation of Texas, Inc. and J-Hawk  Corporation (incorporated herein by reference to Exhibit 2.2 of the Company’s  Current Report on Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995).                                                                                                                                                               |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.1             |       | —     |       | Amended and Restated Certificate of Incorporation of  the Company (incorporated herein by reference to Exhibit 3.1 of the Company’s  Current Report on Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995).                                                                                                                                                                                                                                      |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2             |       | —     |       | Amended and Restated Bylaws of the Company  (incorporated herein by reference to Exhibit 3.1 of the Company’s Current  Report on Form 8-K dated December 30, 2005 filed with the Commission on  December 30, 2005).                                                                                                                                                                                                                                                   |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1            |       | —     |       | Revolving Credit Agreement, dated August 26, 2005,  among FH Partners, L.P., as Borrower, and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated September 1, 2005).                                                                                                                                                                                           |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2            |       | —     |       | Guaranty Agreement, dated August 26, 2005, executed  by FirstCity Financial Corporation, FirstCity Commercial Corporation,  FirstCity Europe Corporation, FirstCity Holdings Corporation, FirstCity  International Corporation, FirstCity Mexico, Inc., and FirstCity Servicing  Corporation for the benefit of Bank of Scotland, as agent, and lenders  (incorporated herein by reference to Exhibit 10.2 of the Company’s Form 8-K  dated September 1, 2005).       |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3            |       | —     |       | Contribution and Assumption Agreement, dated August  18, 2000, by and between Funding LP and Drive (incorporated herein by  reference to Exhibit 10.42 of the Company’s Form 8-K dated August 25, 2000,  filed with the Commission on September 11, 2000).                                                                                                                                                                                                            |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4            |       | —     |       | Separation Agreement and Release, dated March 31,  2004, by and between G. Stephen Fillip, FirstCity Servicing Corporation and  FirstCity Financial Corporation (incorporated herein by reference to Exhibit  10.19 of the Company’s Form 10-Q dated May 14, 2004).                                                                                                                                                                                                   |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

 

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| 10.5   |       | —     |   | Consultant Agreement, dated April 1, 2004, by and  between FirstCity Servicing Corporation and G. Stephen Fillip (incorporated  herein by reference to Exhibit 10.20 of the Company’s Form 10-Q dated May 14,  2004).                                                                                                                                                                                                              |
|--------|------------|------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.6   |       | —     |   | Securities Purchase Agreement dated as of September  21, 2004 by and among FirstCity Financial Corporation and certain affiliates  of FirstCity and IFA Drive GP Holdings LLC, IFA Drive LP Holdings LLC, Drive  Management LP and certain affiliates of those persons. (incorporated herein  by reference to Exhibit 10.1 of the Company’s Form 8-K dated September 27,  2004)                                                    |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.7   |       | —     |   | Revolving Credit Agreement, dated November 12, 2004,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.12 of the Company’s Form 10-Q dated November 15,  2004)                                                                                                                                        |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.8   |       | —     |   | 1995 Stock Option and Award Plan (incorporated herein  by reference to Exhibit A of the Company’s Schedule 14A, Definitive Proxy  Statement, dated March 27, 1996)                                                                                                                                                                                                                                                                 |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.9   |       | —     |   | 1996 Stock Option and Award Plan (incorporated  herein by reference to Exhibit C of the Company’s Schedule 14A, Definitive  Proxy Statement, dated March 27, 1996)                                                                                                                                                                                                                                                                 |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.10  |       | —     |   | 2004 Stock Option and Award Plan (incorporated  herein by reference to Appendix A of the Company’s Schedule 14A, Definitive  Proxy Statement, dated October 21, 2003)                                                                                                                                                                                                                                                              |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.11  |       | —     |   | Sixth Amendment to Right Of First Refusal Agreement  And Due Diligence Reimbursement Agreement dated effective as of  February 1, 2006 (incorporated herein by reference to Exhibit 10.1 of  the Company’s Form 8-K dated February 6, 2006)                                                                                                                                                                                   |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.12  |       | —     |   | Asset Purchase Agreement, dated June 30, 2006, by  and among FirstCity Financial Corporation and its subsidiaries, FirstCity  Business Lending Corporation and American Business Lending, Inc.; and AMRESCO  SBA Holdings, Inc. and NCS I, LLC (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated July 7, 2006)                                                                                    |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.13  |       | —     |   | 2006 Stock Option and Award Plan (incorporated  herein by reference to Appendix A of the Company’s Schedule 14A, Definitive  Proxy Statement, dated June 26, 2006)                                                                                                                                                                                                                                                                 |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.14  | ** ** | **—** |   | Interest Purchase and Sale Agreement, dated August  8, 2006, by and among Bidmex Holding, LLC, and Strategic Mexican Investment  Partners, L.P. and Cargill Financial Services International, Inc. and certain  other parties (incorporated herein by reference to Exhibit 10.14 of the  Company’s Form 10-Q dated November 9, 2006)                                                                                               |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.15  | ** ** | **—** |   | Put Option Agreement dated August 8, 2006, by and  among Bidmex Holding, LLC, Recuperacion de Carteras Mexicanas, S. de R.L. de  C.V., Bidmex 6, LLC, Strategic Mexican Investment Partners 2, L.P. and  Cargill Financial Services International, Inc. (incorporated herein by  reference to Exhibit 10.15 of the Company’s Form 10-Q dated November 9, 2006)                                                                     |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.16  | ** ** | **—** |   | Guarantee dated August 8, 2006, executed by  FirstCity Financial Corporation for the benefit of Bidmex Holding, LLC,  Residencial Oeste 2 S. de R.L. de C.V., National Union Fire Insurance Company  of Pittsburg, P.A., American General Life Insurance Company, and American  General Life and Accident Insurance Company (incorporated herein by reference  to Exhibit 10.15 of the Company’s Form 10-Q dated November 9, 2006) |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.17  |       | —     |   | Amendment No. 4 to Revolving Credit Agreement, dated  as of October 31, 2006, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated November 7, 2006)                                                                                                                   |
|   |       |       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    |

 

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| 10.18      |       | —     |       | Management Employment Contract dated November 30,  2006, between FirstCity Business Lending  Corporation, American Business Lending, Inc., and Charles P. Bell, Jr. (incorporated herein by  reference to Exhibit 10.2 of the Company’s Form 8-K dated December 7, 2006)                                           |
|------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** ** | ** ** |                                                                                                                                                                                                                                                                                                                    |
| 10.19      |       | —     |       | Management Employment Contract dated November 30,  2006, between FirstCity Business Lending  Corporation, American Business Lending, Inc., and Joe N. Smith (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated December 7, 2006)                                                   |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                              |
| 10.20      |       | —     |       | Amendment No. 5 to Revolving Credit Agreement, dated  as of December 14, 2006, among FirstCity Financial Corporation as Borrower  and the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated December 20, 2006) |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                              |
| 10.21      |       | —     |       | Loan Agreement, dated as of December 15, 2006 by and  between American Business Lending, Inc., as Borrower, and Wells Fargo  Foothill, LLC, as lender (incorporated herein by reference to Exhibit 10.1 of  the Company’s Form 8-K dated December 28, 2006)                                                        |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 10.22      |       | —     |       | Amendment No. 1 to Loan Agreement, dated as of  February 27, 2007, by and between American Business Lending, Inc., as  Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.22 of the Company’s Form 10-K dated July 24, 2007)                                      |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 10.23*     |       | —     |       | Amendment No. 9 to Revolving Credit Agreement, dated  as of June 29, 2007, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent                                                                                                                 |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 10.24*     |       | —     |       | Amendment No. 1 to Revolving Credit Agreement, dated  June 29, 2007, among FH Partners, L.P., as Borrower, and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent                                                                                                                                   |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 10.25      |       | —     |       | Amendment No. 2 to Loan Agreement, dated as of July  30, 2007, by and between American Business Lending, Inc., as Borrower, and  Wells Fargo Foothill, LLC, as lender (incorporated herein by reference to Exhibit  10.1 of the Company’s Form 8-K dated August 3, 2007)                                           |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 31.1*      |       | —     |       | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                 |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 31.2*      |       | —     |       | Certification of J. Bryan Baker, Chief Financial  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                   |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 32.1*      |       | —     |       | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to 18 U.S.C Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and relating to the  Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.                                             |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                    |
| 32.2*      |       | —     |       | Certification of J. Bryan Baker, Chief Financial  Officer of the Company, pursuant to 18 U.S.C Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and relating to the  Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.                                               |

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* Filed herewith.

42

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|        | FIRSTCITY  FINANCIAL CORPORATION |
|--------|----------------------------------|
|   |                             |   |   |
|   |                             |   |   |
|   |                             |   |   |
|   | By:                              |   | /s/ JAMES T. SARTAIN |
|   |                             |   | James T. Sartain |
|   |                             |   | *President and Chief Executive  Officer and Director  (Duly authorized officer and  principal executive officer of the  Registrant)* |
|   |                             |   |   |
|   |                             |   |   |
|   |                             |   |   |
|   | By:                              |   | /s/ J. BRYAN BAKER |
|   |                             |   | J. Bryan Baker |
|   |                             |   | *Senior Vice President and Chief  Financial Officer  (Duly authorized officer and  principal financial and accounting  officer of the Registrant)* |
|   |                             |   |   |

 

Dated:  August 10, 2007

 

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**Exhibit Index**
| Exhibit  Number | ** ** | ** ** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|-----------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1             |       | —     |       | Joint Plan of Reorganization by First City  Bancorporation of Texas, Inc., Official Committee of Equity Security Holders  and J-Hawk Corporation, with the Participation of Cargill Financial Services  Corporation, Under Chapter 11 of the United States Bankruptcy Code, Case No.  392-39474-HCA-11 (incorporated herein by reference to Exhibit 2.1 of the  Company’s Current Report on Form 8-K dated July 3, 1995 filed with the  Commission on July 18, 1995). |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.2             |       | —     |       | Agreement and Plan of Merger, dated as of July 3,  1995, by and between First City Bancorporation of Texas, Inc. and J-Hawk  Corporation (incorporated herein by reference to Exhibit 2.2 of the Company’s  Current Report on Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995).                                                                                                                                                               |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.1             |       | —     |       | Amended and Restated Certificate of Incorporation of  the Company (incorporated herein by reference to Exhibit 3.1 of the Company’s  Current Report on Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995).                                                                                                                                                                                                                                      |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2             |       | —     |       | Amended and Restated Bylaws of the Company  (incorporated herein by reference to Exhibit 3.1 of the Company’s Current  Report on Form 8-K dated December 30, 2005 filed with the Commission on  December 30, 2005).                                                                                                                                                                                                                                                   |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1            |       | —     |       | Revolving Credit Agreement, dated August 26, 2005,  among FH Partners, L.P., as Borrower, and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated September 1, 2005).                                                                                                                                                                                           |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2            |       | —     |       | Guaranty Agreement, dated August 26, 2005, executed  by FirstCity Financial Corporation, FirstCity Commercial Corporation,  FirstCity Europe Corporation, FirstCity Holdings Corporation, FirstCity  International Corporation, FirstCity Mexico, Inc., and FirstCity Servicing  Corporation for the benefit of Bank of Scotland, as agent, and lenders  (incorporated herein by reference to Exhibit 10.2 of the Company’s Form 8-K  dated September 1, 2005).       |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3            |       | —     |       | Contribution and Assumption Agreement, dated August  18, 2000, by and between Funding LP and Drive (incorporated herein by  reference to Exhibit 10.42 of the Company’s Form 8-K dated August 25, 2000,  filed with the Commission on September 11, 2000).                                                                                                                                                                                                            |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4            |       | —     |       | Separation Agreement and Release, dated March 31,  2004, by and between G. Stephen Fillip, FirstCity Servicing Corporation and  FirstCity Financial Corporation (incorporated herein by reference to Exhibit  10.19 of the Company’s Form 10-Q dated May 14, 2004).                                                                                                                                                                                                   |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5            |       | —     |       | Consultant Agreement, dated April 1, 2004, by and  between FirstCity Servicing Corporation and G. Stephen Fillip (incorporated  herein by reference to Exhibit 10.20 of the Company’s Form 10-Q dated May 14,  2004).                                                                                                                                                                                                                                                 |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.6            |       | —     |       | Securities Purchase Agreement dated as of September  21, 2004 by and among FirstCity Financial Corporation and certain affiliates  of FirstCity and IFA Drive GP Holdings LLC, IFA Drive LP Holdings LLC, Drive  Management LP and certain affiliates of those persons. (incorporated herein  by reference to Exhibit 10.1 of the Company’s Form 8-K dated September 27,  2004)                                                                                       |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.7            |       | —     |       | Revolving Credit Agreement, dated November 12, 2004,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.12 of the Company’s Form 10-Q dated November 15,  2004)                                                                                                                                                                           |
|            |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

 

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Table of Contents

 
| 10.8       | —     | 1995 Stock  Option and Award Plan (incorporated herein by reference to Exhibit A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated March 27, 1996)                                                                                                                                                                                                                                                                  |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.9       | —     | 1996 Stock  Option and Award Plan (incorporated herein by reference to Exhibit C of the  Company’s Schedule 14A, Definitive Proxy Statement, dated March 27, 1996)                                                                                                                                                                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.10      | —     | 2004 Stock  Option and Award Plan (incorporated herein by reference to Appendix A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated October 21, 2003)                                                                                                                                                                                                                                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.11      | —     | Sixth Amendment  to Right Of First Refusal Agreement And Due Diligence Reimbursement Agreement  dated effective as of February 1, 2006 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated February 6, 2006)                                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.12      | —     | Asset Purchase  Agreement, dated June 30, 2006, by and among FirstCity Financial Corporation  and its subsidiaries, FirstCity Business Lending Corporation and American  Business Lending, Inc.; and AMRESCO SBA Holdings, Inc. and NCS I, LLC  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated July 7, 2006)                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.13      | —     | 2006 Stock  Option and Award Plan (incorporated herein by reference to Appendix A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated June 26, 2006)                                                                                                                                                                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.14      | **—** | Interest  Purchase and Sale Agreement, dated August 8, 2006, by and among Bidmex  Holding, LLC, and Strategic Mexican Investment Partners, L.P. and Cargill  Financial Services International, Inc.   and certain other parties (incorporated herein by reference to Exhibit  10.14 of the Company’s Form 10-Q dated November 9, 2006)                                                                                         |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.15      | **—** | Put Option  Agreement dated August 8, 2006, by and among Bidmex Holding, LLC,  Recuperacion de Carteras Mexicanas, S. de  R.L. de C.V., Bidmex 6, LLC, Strategic Mexican Investment Partners 2, L.P.  and Cargill Financial Services International, Inc. (incorporated herein by  reference to Exhibit 10.15 of the Company’s Form 10-Q dated November 9, 2006)                                                                |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.16      | **—** | Guarantee dated  August 8, 2006, executed by FirstCity Financial Corporation for the benefit  of Bidmex Holding, LLC, Residencial Oeste 2 S. de R.L. de C.V., National  Union Fire Insurance Company of Pittsburg, P.A., American General Life  Insurance Company, and American General Life and Accident Insurance Company  (incorporated herein by reference to Exhibit 10.15 of the Company’s Form 10-Q  dated November 9, 2006) |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.17      | —     | Amendment No. 4  to Revolving Credit Agreement, dated as of October 31, 2006, among FirstCity  Financial Corporation as Borrower and the Lenders named therein, as Lenders,  and Bank of Scotland, as Agent (incorporated herein by reference to Exhibit  10.1 of the Company’s Form 8-K dated November 7, 2006)                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.18      | —     | Management  Employment Contract dated November 30, 2006, between FirstCity Business Lending Corporation, American Business Lending,  Inc**.,**and Charles P.  Bell, Jr. (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated December 7, 2006)                                                                                                                                                        |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.19      | —     | Management  Employment Contract dated November 30, 2006, between FirstCity Business Lending Corporation, American Business Lending,  Inc**.,**and Joe N. Smith  (incorporated herein by reference to Exhibit 10.3 of the Company’s Form 8-K  dated December 7, 2006)                                                                                                                                                                |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.20      | —     | Amendment No. 5  to Revolving Credit Agreement, dated as of December 14, 2006, among FirstCity  Financial Corporation as Borrower and the Lenders named therein, as Lenders,  and Bank of Scotland, as Agent (incorporated herein by reference to Exhibit  10.1 of the Company’s Form 8-K dated December 20, 2006)                                                                                                                  |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

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| 10.21  | — | Loan Agreement, dated as of December 15, 2006 by and  between American Business Lending, Inc., as Borrower, and Wells Fargo  Foothill, LLC, as lender (incorporated herein by reference to Exhibit 10.1 of  the Company’s Form 8-K dated December 28, 2006)                   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                               |
| 10.22  | — | Amendment No. 1 to Loan Agreement, dated as of  February 27, 2007, by and between American Business Lending, Inc., as  Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.22 of the Company’s Form 10-K dated July 24, 2007) |
|   |   |                                                                                                                                                                                                                                                                               |
| 10.23* | — | Amendment No. 9  to Revolving Credit Agreement, dated as of June 29, 2007, among FirstCity  Financial Corporation as Borrower and the Lenders named therein, as Lenders,  and Bank of Scotland, as Agent                                                                      |
|   |   |                                                                                                                                                                                                                                                                               |
| 10.24* | — | Amendment No. 1  to Revolving Credit Agreement, dated June 29, 2007, among FH Partners, L.P.,  as Borrower, and the Lenders named therein, as Lenders, and Bank of Scotland,  as Agent                                                                                             |
|   |   |                                                                                                                                                                                                                                                                               |
| 10.25  | — | Amendment No. 2 to Loan Agreement, dated as of July  30, 2007, by and between American Business Lending, Inc., as Borrower, and  Wells Fargo Foothill, LLC, as lender (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated August 3, 2007)      |
|   |   |                                                                                                                                                                                                                                                                               |
| 31.1*  | — | Certification of  James T. Sartain, Chief Executive Officer of the Company, pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                               |
| 31.2*  | — | Certification of  J. Bryan Baker, Chief Financial Officer of the Company, pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                               |
| 32.1*  | — | Certification of  James T. Sartain, Chief Executive Officer of the Company, pursuant to 18  U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 and relating to the Quarterly Report on Form 10-Q for the quarter  ended June 30, 2007.       |
|   |   |                                                                                                                                                                                                                                                                               |
| 32.2*  | — | Certification of  J. Bryan Baker, Chief Financial Officer of the Company, pursuant to 18 U.S.C  Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 and relating to the Quarterly Report on Form 10-Q for the quarter ended  June 30, 2007.         |

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*                    Filedherewith

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