**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**Form 10-Q**

 

**(Mark One)**
| ý                                            | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                              |       |                                                                                          |
| **For the quarterly period ended March 31, 2006** |
| ** **                                        | ** ** | ** **                                                                                    |
| **o**                                             | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 033-19694**

 

**FirstCityFinancial Corporation**

(Exact name of registrant as specified in itscharter)

 

| **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, includingarea code)

 

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

 

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

 

Largeaccelerated filer o              Accelerated filer ý              Non-accelerated filer o

 

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

 

The number of shares of common stock, par value $.01 per share,outstanding at May 2, 2006 was 11,308,187.

 

 

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**TABLE OF 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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Tableof Contents

**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                       | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                                                       | ** ** | **(Unaudited)**     | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                       | ** ** | ** **          | ** ** | ** **             | ** ** |
| Cash and cash equivalents                                                                                                                        |       | $                   | 9,248      |                   | $          | 12,901 |   |
| Portfolio Assets, net                                                                                                                            |       | 52,124              |       | 49,346                 |       |
| Loans receivable from Acquisition  Partnerships held for investment                                                                              |       | 20,107              |       | 19,606                 |       |
| Equity investments                                                                                                                               |       | 92,892              |       | 83,785                 |       |
| Deferred tax asset, net                                                                                                                          |       | 20,101              |       | 20,101                 |       |
| Service fees receivable from affiliates                                                                                                          |       | 1,378               |       | 1,103                  |       |
| Other assets, net                                                                                                                                |       | 7,605               |       | 7,870                  |       |
| Discontinued mortgage assets                                                                                                                     |       | 91                  |       | 157                    |       |
| Total Assets                                                                                                                                     |       | $                   | 203,546    |                   | $          | 194,869 |   |
|                                                                                                                                             |       |                |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                   | ** ** | ** **          | ** ** | ** **             | ** ** |
| Liabilities:                                                                                                                                     |       |                |       |                   |       |
| Notes payable other                                                                                                                              |       | $                   | 95,330     |                   | $          | 89,653 |   |
| Notes payable to affiliates                                                                                                                      |       | 546                 |       | 606                    |       |
| Minority interest                                                                                                                                |       | 2,567               |       | 1,193                  |       |
| Liabilities from discontinued consumer  operations                                                                                               |       | 121                 |       | 121                    |       |
| Other liabilities                                                                                                                                |       | 4,016               |       | 4,385                  |       |
| Total Liabilities                                                                                                                                |       | 102,580             |       | 95,958                 |       |
| Commitments and contingencies (note 11)                                                                                                          |       |                |       |                   |       |
| 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 and outstanding: 11,307,187 and 11,307,187,  respectively) |       | 113                 |       | 113                    |       |
| Paid in capital                                                                                                                                  |       | 99,988              |       | 99,843                 |       |
| Accumulated deficit                                                                                                                              |       | (36                 | )          | (2,058                 | )          |
| Accumulated other comprehensive income                                                                                                           |       | 901                 |       | 1,013                  |       |
| Total Stockholders’ Equity                                                                                                                  |       | 100,966             |       | 98,911                 |       |
| Total Liabilities and Stockholders’ Equity                                                                                                  |       | $                   | 203,546    |                   | $          | 194,869 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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Tableof Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except per share data)**

**(Unaudited)**

 
| ** **                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Revenues:                                                                      |       |                              |       |   |   |
| Servicing fees from affiliates                                                 |       | $                                 | 2,647      |   | $ | 3,172 |   |
| Gain on resolution of Portfolio Assets                                         |       | 1,284                             |       | 1,862 |   |
| Interest income from affiliates                                                |       | 430                               |       | 424 |   |
| Loan interest income                                                           |       | 774                               |       | 478 |   |
| Other income                                                                   |       | 580                               |       | 384 |   |
| Total revenues                                                                 |       | 5,715                             |       | 6,320 |   |
| Expenses:                                                                      |       |                              |       |   |   |
| Interest and fees on notes payable — other                                |       | 1,698                             |       | 872 |   |
| Interest and fees on notes payable to  affiliates                              |       | 10                                |       | 8 |   |
| Salaries and benefits                                                          |       | 3,738                             |       | 4,158 |   |
| Provision for loan and impairment losses                                       |       | 109                               |       | 85 |   |
| Occupancy, data processing, communication  and other                           |       | 1,564                             |       | 1,913 |   |
| Total expenses                                                                 |       | 7,119                             |       | 7,036 |   |
| Equity in earnings of investments                                              |       | 3,634                             |       | 3,401 |   |
| Earnings from continuing operations before  income taxes and minority interest |       | 2,230                             |       | 2,685 |   |
| Income tax expense                                                             |       | (122                              | )          | (139 | ) |
| Minority interest                                                              |       | (11                               | )          | 3 |   |
| Earnings from continuing operations                                            |       | 2,097                             |       | 2,549 |   |
| Discontinued operations                                                        |       |                              |       |   |   |
| Loss from discontinued operations                                              |       | (75                               | )          | — |   |
| Income taxes                                                                   |       | —                            |       | — |   |
| Net loss from discontinued operations                                          |       | (75                               | )          | — |   |
| Net earnings                                                                   |       | $                                 | 2,022      |   | $ | 2,549 |   |
| Basic earnings per common share are as  follows:                               |       |                              |       |   |   |
| Earnings from continuing operations                                            |       | $                                 | 0.19       |   | $ | 0.23 |   |
| Discontinued operations                                                        |       | $                                 | (0.01      | ) | $ | — |   |
| Net earnings to common stockholders                                            |       | $                                 | 0.18       |   | $ | 0.23 |   |
| Weighted average common shares outstanding                                     |       | 11,307                            |       | 11,262 |   |
| Diluted earnings per common share are as  follows:                             |       |                              |       |   |   |
| Earnings from continuing operations                                            |       | $                                 | 0.18       |   | $ | 0.21 |   |
| Discontinued operations                                                        |       | $                                 | (0.01      | ) | $ | — |   |
| Net earnings to common stockholders                                            |       | $                                 | 0.17       |   | $ | 0.21 |   |
| Weighted average common shares outstanding                                     |       | 11,958                            |       | 12,007 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME**

**(Dollars in thousands)**

 
| ** **                                                                 | ** ** | **Number of  Common  Shares** | ** ** | **Common  Stock** | ** ** | **Paid in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------|------------|----------------------|------------|--------------------------|------------|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                 | ** ** | ** **                    | ** ** | ** **        | ** ** | ** **           | ** ** | ** **               | ** ** | ** **                                    | ** ** | ** **                            | ** ** |
| **Balances, December 31, 2004**                                            |       | 11,260,687                    |       | $                 | 113        |                 | $          | 99,364                   |       | $                                             | (10,289    | )                                     | $          | 3,235 |   | $ | 92,423 |   |
| Exercise of common stock options                                           |       | 46,500                        |       | —            |       | 196                  |       | —                   |       | —                                        |       | 196                                   |       |
| Additional paid-in capital arising from sale  of shares by investee        |       | —                        |       | —            |       | 283                  |       | —                   |       | —                                        |       | 283                                   |       |
| Comprehensive income:                                                      |       |                          |       |              |       |                 |       |                     |       |                                          |       |                                  |       |
| Net earnings for 2005                                                      |       | —                        |       | —            |       | —               |       | 8,231                    |       | —                                        |       | 8,231                                 |       |
| Translation adjustments                                                    |       | —                        |       | —            |       | —               |       | —                   |       | (2,222                                        | )          | (2,222                                | )          |
| Total comprehensive income                                                 |       |                          |       |              |       |                 |       |                     |       |                                          |       | 6,009                                 |       |
| **Balances, December 31, 2005**                                            |       | 11,307,187                    |       | 113               |       | 99,843               |       | (2,058                   | )          | 1,013                                         |       | 98,911                                |       |
| Exercise of common stock options                                           |       | —                        |       | —            |       | —               |       | —                   |       | —                                        |       | —                                |       |
| Additional paid-in capital arising from stock  option compensation expense |       | —                        |       | —            |       | 145                  |       | —                   |       | —                                        |       | 145                                   |       |
| Comprehensive income:                                                      |       |                          |       |              |       |                 |       |                     |       |                                          |       |                                  |       |
| Net earnings for the first three months of  2006                           |       | —                        |       | —            |       | —               |       | 2,022                    |       | —                                        |       | 2,022                                 |       |
| Translation adjustments                                                    |       | —                        |       | —            |       | —               |       | —                   |       | (112                                          | )          | (112                                  | )          |
| Total comprehensive income                                                 |       |                          |       |              |       |                 |       |                     |       |                                          |       | 1,910                                 |       |
| **Balances, March 31, 2006 (unaudited)**                                   |       | 11,307,187                    |       | $                 | 113        |                 | $          | 99,988                   |       | $                                             | (36        | )                                     | $          | 901 |   | $ | 100,966 |   |
|                                                                            |            |                               |            |                   |            |                      |            |                          |            |                                               |            |                                       |            |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidatedfinancial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Cash flows from operating activities:                                                          |       |                              |       |   |   |
| Net earnings                                                                                   |       | $                                 | 2,022      |   | $ | 2,549 |   |
| Adjustments to reconcile net earnings to  net cash provided by (used in) operating activities: |       |                              |       |   |   |
| Net loss from discontinued operations                                                          |       | 75                                |       | — |   |
| Purchase and advances of Portfolio Assets  and loans receivable, net                           |       | (8,231                            | )          | (532 | ) |
| Proceeds applied to principal on Portfolio  Assets and loans receivable                        |       | 6,941                             |       | 8,130 |   |
| Gain on resolution of Portfolio Assets                                                         |       | (1,284                            | )          | (1,862 | ) |
| Capitalized interest and costs on Portfolio  Assets and loans receivable                       |       | (457                              | )          | (96 | ) |
| Provision for loan and impairment losses                                                       |       | 109                               |       | 85 |   |
| Equity in earnings of investments                                                              |       | (3,634                            | )          | (3,401 | ) |
| Depreciation and amortization                                                                  |       | 157                               |       | 214 |   |
| Stock-based compensation expense related to  stock options                                     |       | 145                               |       | — |   |
| (Increase) decrease in service fees  receivable from affiliate                                 |       | (275                              | )          | 384 |   |
| Decrease in other assets                                                                       |       | 174                               |       | 1,801 |   |
| Change in debt imputed value                                                                   |       | (60                               | )          | 73 |   |
| Decrease in other liabilities                                                                  |       | 1,000                             |       | (1,184 | ) |
| Net cash provided by (used in) operating  activities                                           |       | (3,318                            | )          | 6,161 |   |
| Cash flows from investing activities:                                                          |       |                              |       |   |   |
| Property and equipment, net                                                                    |       | (83                               | )          | (39 | ) |
| Contributions to Acquisition Partnerships  and Servicing Entities                              |       | (17,529                           | )          | (3,690 | ) |
| Distributions from Acquisition Partnerships  and Servicing Entities                            |       | 11,992                            |       | 6,533 |   |
| Net cash provided by (used in) investing  activities                                           |       | (5,620                            | )          | 2,804 |   |
| Cash flows from financing activities:                                                          |       |                              |       |   |   |
| Borrowings under notes payable — other                                                    |       | 28,885                            |       | 15,332 |   |
| Payments of notes payable to affiliates                                                        |       | —                            |       | (4 | ) |
| Payments of notes payable — other                                                         |       | (23,591                           | )          | (17,344 | ) |
| Proceeds from issuance of common stock                                                         |       | —                            |       | 8 |   |
| Net cash provided by (used in) financing  activities                                           |       | 5,294                             |       | (2,008 | ) |
| Net cash provided by (used in) continuing  operations                                          |       | (3,644                            | )          | 6,957 |   |
| Cash flows from discontinued operations  (Revised - see note 1):                               |       |                              |       |   |   |
| Net cash used in operating activities                                                          |       | (9                                | )          | (8,064 | ) |
| Net cash provided by investing activities                                                      |       | —                            |       | 450 |   |
| Net cash used in discontinued operations                                                       |       | (9                                | )          | (7,614 | ) |
| Net decrease in cash and cash equivalents                                                      |       | (3,653                            | )          | (657 | ) |
| Cash and cash equivalents, beginning of  period                                                |       | 12,901                            |       | 9,724 |   |
| Cash and cash equivalents, end of period                                                       |       | $                                 | 9,248      |   | $ | 9,067 |   |
| Supplemental disclosure of cash flow  information:                                             |       |                              |       |   |   |
| Cash paid during the period for:                                                               |       |                              |       |   |   |
| Interest                                                                                       |       | $                                 | 1,475      |   | $ | 575 |   |
| Income taxes                                                                                   |       | 16                                |       | 146 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**March 31, 2006**

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

**(Unaudited)**

 

**(1)  Basis of Presentation andSummary of Significant Accounting Policies**

 

***TheCompany***

 

FirstCity Financial Corporation(the “Company” or “FirstCity”) is a financial services company with officesthroughout the United States and Mexico, with a presence in France, Germany andSouth America. At March 31, 2006, the Company was 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 (collectively referred to as “Portfolios” or “PortfolioAssets”) at a discount to their legal principal balance or appraised value, andservicing and resolving such Portfolios in an effort to maximize the presentvalue of the ultimate cash recoveries.

 

***Basisof 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 March 31, 2006,its results of operations for the three month periods ended March 31, 2006 and2005 and cash flows for the three month periods ended March 31, 2006 and2005.  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 2005 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. In the first quarter of 2006, equity in earnings of investments wasreclassified outside of revenues, which in prior periods was included withrevenues.  Also in the first quarter of2006, the Company has separately disclosed the operating, investing andfinancing portions of the cash flows attributable to its discontinuedoperations, which in prior periods were reported on a combined basis as asingle amount.

 

***Useof Estimates***

 

The preparation of financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Significant estimatesinclude (i) the estimation of future collections on purchased portfolio assetsused in the calculation of net gain on resolution of portfolio assets, (ii)interest rate environments, (iii) valuation of the deferred tax asset, and (iv)prepayment speeds and collectibility of loans held in inventory, insecuritization trusts and held for investment. Actual results could differmaterially from those estimates.

 

***Stock-BasedCompensation***

 

On January 1, 2006, FirstCityadopted Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123(R)”), that addresses theaccounting for share-based payment transactions in which an enterprise receivesemployee services in exchange for either equity instruments of the enterpriseor liabilities that are based on the fair value of the enterprise’s equityinstruments or that may be settled by the issuance of such equity instruments.The statement eliminates the ability to account for share-based compensationtransactions, as the Company formerly did, using the intrinsic value method asprescribed by Accounting Principles Board, or APB, Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB 25”), andgenerally requires that such transactions be accounted for using afair-value-based method and recognized as expenses in the consolidatedstatement of operations.

 

FirstCity adopted SFAS 123(R)using the modified prospective method which requires the application of theaccounting standard as of January 1, 2006. The consolidated financialstatements as of and for the first quarter of 2006 reflect the impact ofadopting SFAS 123(R). In accordance with the modified prospective method, theconsolidated financial statements for prior periods have not been restated toreflect, and do not include, the impact of SFAS 123(R). See Note 9 for furtherdetails.

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

Stock-based compensationexpense recognized during the period is based on the value of the portion ofstock-based payment awards that is ultimately expected to vest. Stock-basedcompensation expense recognized in the consolidated statement of operationsduring the first quarter of 2006 included compensation expense for stock-basedpayment awards granted prior to, but not yet vested, as of December 31, 2005based on the grant date fair value estimated in accordance with the pro formaprovisions of SFAS 148 and compensation expense for the stock-based paymentawards granted subsequent to December 31, 2005, based on the grant date fairvalue estimated in accordance with SFAS 123(R). As stock-based compensationexpense recognized in the statement of operations for the first quarter of 2006is based on awards ultimately expected to vest, it has been reduced forestimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. In the pro forma information requiredunder SFAS 148 for the periods prior to 2006, we accounted for forfeitures asthey occurred.

 

**(2)  New AccountingPronouncements**

 

In November 2005, the FASBissued FASB Staff Position SFAS 115-1, *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments*(“FSP115-1”).  FSP 115-1 addresses thedetermination as to when an investment is considered impaired, whether thatimpairment is other than temporary, and the measurement of an impairedloss.  FSP 115-1 also includes accountingconsiderations subsequent to the recognition of an other-than-temporaryimpairment and requires certain disclosures about unrealized losses that havenot been recognized as other-than-temporary impairments.  The provisions of FSP 115-1 were adopted onJanuary 1, 2006, and did not have a significant impact on the Company’sconsolidated financial statements.

 

**(3)  Discontinued Operations**

 

Discontinued operations arecomprised of two components previously reported as the Company’s residentialand commercial mortgage banking business (“Mortgage”) and the consumer lendingbusiness conducted through the Company’s minority interest investment in Drive(“Consumer”).  Earnings (loss) fromdiscontinued operations are summarized as follows:

 

| ** **                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Mortgage                              |       | $                                 | (75        | ) | $ | — |   |
| Consumer                              |       | —                            |       | — |   |
| Net loss from discontinued operations |       | $                                 | (75        | ) | $ | — |   |

 

*Mortgage*

 

At March 31, 2006, the onlyasset remaining from discontinued mortgage operations is an investment securityresulting from the retention of a residual interest in a securitizationtransaction. This security is in “run-off,” and the Company is contractuallyobligated to service these assets.  Thecash flows are collected over a period of time and are valued using prepaymentassumptions of 32% for fixed rate loans and 33% for variable rate loans.Overall loss rates are estimated at 14% of collateral.  The Company recorded provisions of $66 andzero in the first three months of 2006 and 2005, respectively, for losses fromdiscontinued mortgage operations.

 

In April 2005, the Companyexercised an early purchase option on the 1998-1 securitization.  Loans receivable were recorded at $6.1million in accordance with EITF 02-9, *Accounting for ChangesThat Result in a Transferor Regaining Control of Financial Assets Sold. *FirstCity evaluated each loan atthe acquisition date to determine whether there was evidence of creditdeterioration since origination.  AtMarch 31, 2006, the acquired loans are included in Portfolio Assets in theconsolidated balance sheet and classified as either “loans acquired with creditdeterioration” or “loans acquired without credit deterioration.”

 

*Consumer*

 

On September 21, 2004,FirstCity and certain of its subsidiaries entered into a definitive agreementto sell a 31% beneficial ownership interest in Drive Financial Services LP (“Drive”)and its general partner, Drive GP LLC, to IFA Drive GP Holdings LLC (“IFA-GP”),IFA Drive LP Holdings LLC (“IFA-LP”) and Drive Management LP (“MG-LP”) for atotal purchase price of $108.5 million in cash, resulting in distributions andpayments to FirstCity in the aggregate amount of $86.8 million in cash, fromvarious

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

sources.  The sale was completed on November 1, 2004,and net cash proceeds from these transactions were primarily used to pay offdebt.

 

Pursuant to SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,the consolidated financial statements have been reclassified for all periodspresented to reflect the operations, assets and liabilities of the consumerbusiness segment as discontinued operations. There were no consumer assets held for sale as of March 31, 2006 andDecember 31, 2005.  The liabilities ofsuch operations have been classified as “Liabilities from discontinued consumeroperations,” respectively on the March 31, 2006 and December 31, 2005 balancesheets and consisted of state taxes payable at March 31, 2006.

 

**(4)  Portfolio Assets**

 

Portfolio Assets are summarizedas follows:

 

| ** **                                  | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------|------------|---------------------|------------|------------------------|------------|
| Loan Portfolios                             |       |                |       |                   |       |
| Loans Acquired Prior to 2005                |       |                |       |                   |       |
| Non-performing Portfolio Assets             |       | $                   | 9,193      |                   | $          | 10,528 |   |
| Performing Portfolio Assets                 |       | 9,653               |       | 12,029                 |       |
| Loans Acquired After 2004                   |       |                |       |                   |       |
| Loans acquired with credit deterioration    |       | 19,740              |       | 12,703                 |       |
| Loans acquired with no credit deterioration |       | 3,716               |       | 3,976                  |       |
| Outstanding balance                         |       | 42,302              |       | 39,236                 |       |
| Allowance for loan losses                   |       | (255                | )          | (163                   | )          |
| Carrying amount of loans, net of allowance  |       | 42,047              |       | 39,073                 |       |
|                                        |       |                |       |                   |       |
| Real Estate Portfolios, net of allowance    |       | 7,885               |       | 8,018                  |       |
| Other                                       |       | 2,192               |       | 2,255                  |       |
| Portfolio Assets, net                       |       | $                   | 52,124     |                   | $          | 49,346 |   |

 

Portfolio Assets are pledged tosecure notes payable that are non-recourse to FirstCity or any affiliate otherthan the entity that incurred the debt. See Note 2 to the Company’s 2005 Annual Report on Form 10-K for adescription of the Revolving Credit agreement between FH Partners, L.P. andBank of Scotland, which is guaranteed by FirstCity and the primary wholly-ownedsubsidiaries of FirstCity.

 

The Company recorded aprovision for loan and impairment losses on Portfolio Assets of approximately$109 for the three month period ended March 31, 2006, which is comprised of $2impairment charge on real estate portfolios and $107 allowance for loan losses.  For the three month period ended March 31,2005, the Company recorded an allowance for impairment on Portfolio Assets of$85, which is comprised wholly of allowance for loan losses, with no impairmentcharge on real estate portfolios.

 

The change in the valuationallowance for loan losses for the quarters ended March 31, 2006 and 2005respectively, are as follows:

 

| ** **         | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Beginning  Balance |       | $                                 | (163       | ) | $ | — |   |
| Provisions         |       | (107                              | )          | (85 | ) |
| Charge Offs        |       | 15                                |       | — |   |
| Ending  Balance    |       | $                                 | (255       | ) | $ | (85 | ) |

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

Changes in accretable yield atMarch 31, 2006 were as follows:

 

| ** **                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                           | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Beginning Balance                                    |       | $                                 | 3,765      |   | $ | — |   |
| Additions                                            |       | 1,354                             |       | — |   |
| Accretion                                            |       | (310                              | )          | — |   |
| Reclassification from (to) nonaccretable  difference |       | —                            |       | — |   |
| Disposals                                            |       | (1                                | )          | — |   |
| Ending Balance                                       |       | $                                 | 4,808      |   | $ | — |   |

 

Loans acquired during eachperiod for which it was probable at acquisition that all contractually requiredpayments would not be collected follow. There were no loans acquired during the first quarter of 2005.

 

| ** **                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Face value  at acquisition                          |       | $                                 | 11,019     |   | $ | — |   |
| Cash flows  expected to be collected at acquisition |       | 8,855                             |       | — |   |
| Basis in  acquired loans at acquisition             |       | 7,501                             |       | — |   |
|                                                     |            |                                   |            |  |  |  |  |

 

**(5)  Loans Receivable fromAcquisition Partnerships Held for Investment**

 

Loans receivable fromAcquisition Partnerships held for investment consist primarily of loans fromcertain partnerships located in Mexico and are summarized as follows:

 

| ** **    | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------|------------|---------------------|------------|------------------------|------------|
| Latin America |       | $                   | 16,382     |                   | $          | 16,098 |   |
| Europe        |       | 1,820               |       | 1,674                  |       |
| Domestic      |       | 1,905               |       | 1,834                  |       |
|          |       | $                   | 20,107     |                   | $          | 19,606 |   |

 

There were no provisionsrecorded on these loans during the first quarter of 2006 and 2005.  The 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. These loansare evaluated for impairment by analyzing the expected future cash flows fromthe underlying assets within each pool to determine that the cash flows weresufficient 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 were necessary.

 

Equity method earnings (losses)which were recorded to reduce the loans and interest receivable from certainMexican partnerships were $.3 million and ($.2) million during the first threemonths of 2006 and 2005, respectively, in compliance with EITF 98-13, *Accounting by an Equity Method Investor for InvesteeLosses When the Investor Has Loans to and Investments in Other Securities ofthe Investee*.

 

**(6)  Equity Investments**

 

The Company has investments inAcquisition Partnerships and their general partners and investments inservicing entities that are accounted for under the equity method.  The condensed combined financial position andresults of operations of the Acquisition Partnerships (excluding servicingentities), which include the domestic and foreign Acquisition Partnerships andtheir general partners, are summarized below:

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

| **Condensed Combined Balance Sheets**          | ** ** |
|------------------------------------------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| Assets                                         |       | $ | 441,729 |   | $ | 444,825 |   |
| Liabilities                                    |       | $ | 325,380 |   | $ | 340,881 |   |
| Net equity                                     |       | 116,349 |   | 103,944 |   |
|                                           |       | $ | 441,729 |   | $ | 444,825 |   |
|                                           |       |   |   |   |   |
| Equity investment in Acquisition  Partnerships |       | $ | 86,953 |   | $ | 77,893 |   |
| Equity investment in servicing entities        |       | 5,939 |   | 5,892 |   |
|                                           |       | $ | 92,892 |   | $ | 83,785 |   |
|                                                |            |  |  |  |  |  |  |  |  |  |

 

| **Condensed Combined Summary of Operations**     | ** ** |
|--------------------------------------------------|------------|
| ** **                                       | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Proceeds  from resolution of Portfolio Assets    |       | $ | 32,158 |   | $ | 45,619 |   |
| Gain on  resolution of Portfolio Assets          |       | 15,042 |   | 20,164 |   |
| Interest  income on Portfolio Assets             |       | 3,972 |   | 2,106 |   |
| Net earnings  (loss)                             |       | $ | 12,821 |   | $ | 9,032 |   |
|                                             |       |   |   |   |   |
| Equity in  earnings of Acquisition Partnerships  |       | $ | 3,691 |   | $ | 3,048 |   |
| Equity in  earnings (loss) of servicing entities |       | (57 | ) | 353 |   |
|                                             |       | $ | 3,634 |   | $ | 3,401 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

The assets and equity of theAcquisition Partnerships and equity investments in the Acquisition Partnershipsare summarized by geographic region below. The WAMCO Partnerships representlimited partnerships and limited liability companies in which the Company has acommon ownership with Cargill.  MinnTexInvestment Partners LP is considered to be a significant subsidiary ofFirstCity.

 

| ** **                                      | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| Assets:                                         |       |                |       |                   |       |
| Domestic:                                       |       |                |       |                   |       |
| WAMCO Partnerships                              |       | $                   | 180,973    |                   | $          | 166,213 |   |
| MinnTex Investment Partners LP                  |       | 219                 |       | 307                    |       |
| Other                                           |       | 10,286              |       | 10,410                 |       |
| Latin America                                   |       | 176,149             |       | 185,702                |       |
| Europe                                          |       | 74,102              |       | 82,193                 |       |
|                                            |       | $                   | 441,729    |                   | $          | 444,825 |   |
|                                            |       |                |       |                   |       |
| Equity  (deficit):                              |       |                |       |                   |       |
| Domestic:                                       |       |                |       |                   |       |
| WAMCO Partnerships                              |       | $                   | 131,726    |                   | $          | 111,329 |   |
| MinnTex Investment Partners LP                  |       | 199                 |       | 283                    |       |
| Other                                           |       | 5,578               |       | 5,485                  |       |
| Latin America                                   |       | (78,472             | )          | (79,527                | )          |
| Europe                                          |       | 57,318              |       | 66,374                 |       |
|                                            |       | $                   | 116,349    |                   | $          | 103,944 |   |
| Equity  investment in Acquisition Partnerships: |       |                |       |                   |       |
| Domestic:                                       |       |                |       |                   |       |
| WAMCO Partnerships                              |       | $                   | 62,163     |                   | $          | 51,772 |   |
| MinnTex Investment Partners LP                  |       | 66                  |       | 93                     |       |
| Other                                           |       | 2,969               |       | 2,825                  |       |
| Latin America                                   |       | 2,646               |       | 2,771                  |       |
| Europe                                          |       | 19,109              |       | 20,432                 |       |
|                                            |       | $                   | 86,953     |                   | $          | 77,893 |   |
|                                                 |            |                     |            |                        |            |  |  |  |  |  |  |

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

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

 

| ** **                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Revenues:                                 |       |                              |       |   |   |
| Domestic:                                 |       |                              |       |   |   |
| WAMCO Partnerships                        |       | $                                 | 7,377      |   | $ | 8,942 |   |
| MinnTex Investment Partners LP            |       | 566                               |       | 1,605 |   |
| Other                                     |       | 292                               |       | 34 |   |
| Latin America                             |       | 5,663                             |       | 5,399 |   |
| Europe                                    |       | 6,271                             |       | 6,523 |   |
| ** **                                |       | $                                 | 20,169     |   | $ | 22,503 |   |
|                                      |       |                              |       |   |   |
| Net earnings  (loss):                     |       |                              |       |   |   |
| Domestic:                                 |       |                              |       |   |   |
| WAMCO Partnerships                        |       | $                                 | 4,023      |   | $ | 4,205 |   |
| MinnTex Investment Partners LP            |       | 510                               |       | 1,433 |   |
| Other                                     |       | 67                                |       | (107 | ) |
| Latin America                             |       | 3,927                             |       | (123 | ) |
| Europe                                    |       | 4,294                             |       | 3,624 |   |
|                                      |       | $                                 | 12,821     |   | $ | 9,032 |   |
| Equity in  earnings (loss) of Acquisition |       |                              |       |   |   |
| Partnerships:                             |       |                              |       |   |   |
| Domestic:                                 |       |                              |       |   |   |
| WAMCO Partnerships                        |       | $                                 | 2,052      |   | $ | 1,857 |   |
| MinnTex Investment Partners LP            |       | 168                               |       | 473 |   |
| Other                                     |       | 49                                |       | (17 | ) |
| Latin America                             |       | 444                               |       | (174 | ) |
| Europe                                    |       | 978                               |       | 909 |   |
|                                      |       | $                                 | 3,691      |   | $ | 3,048 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

Combining statements ofoperations for the WAMCO Partnerships follow. WAMCO XXX, WAMCO 31 and WAMCO 33are considered to be significant subsidiaries of FirstCity.

 

**Three Months Ended March 31, 2006**

 

| ** **                                      | ** ** | **WAMCO  XXX** | ** ** | **WAMCO  31** | ** ** | **WAMCO  33** | ** ** | **Other  Partnerships** | ** ** | **Combined** | ** ** |
|-------------------------------------------------|------------|----------------|------------|---------------|------------|---------------|------------|-------------------------|------------|--------------|------------|
| Proceeds from resolution of Portfolio  Assets   |       | $              | 828        |          | $          | 549           |       | $                       | 1,944      |         | $          | 7,096 |   | $ | 10,417 |   |
| Cost of Portfolio Assets resolved               |       | 589            |       | 412           |       | 1,475         |       | 4,187                   |       | 6,663        |       |
| Gain on resolution of Portfolio Assets          |       | 239            |       | 137           |       | 469           |       | 2,909                   |       | 3,754        |       |
| Interest income on Portfolio Assets             |       | —         |       | 109           |       | 441           |       | 1,980                   |       | 2,530        |       |
| Other income, net                               |       | 5              |       | 3             |       | —        |       | 1,085                   |       | 1,093        |       |
| Revenues                                        |       | 244            |       | 249           |       | 910           |       | 5,974                   |       | 7,377        |       |
| Interest and fees expense — affiliate      |       | —         |       | —        |       | —        |       | (170                    | )          | (170         | )          |
| Interest and fees expense — other          |       | —         |       | (217          | )          | (316          | )          | —                  |       | (533         | )          |
| Provision for loan and impairment losses        |       | (120           | )          | —        |       | (182          | )          | (361                    | )          | (663         | )          |
| Service fees — affiliate                   |       | (37            | )          | (44           | )          | (85           | )          | (625                    | )          | (791         | )          |
| General, administrative and operating  expenses |       | (35            | )          | (34           | )          | (136          | )          | (992                    | )          | (1,197       | )          |
| Expenses                                        |       | (192           | )          | (295          | )          | (719          | )          | (2,148                  | )          | (3,354       | )          |
| Net earnings (loss)                             |       | $              | 52         |          | $          | (46           | )          | $                       | 191        |         | $          | 3,826 |   | $ | 4,023 |   |
|                                                 |            |                |            |               |            |               |            |                         |            |              |            |  |  |  |  |  |  |  |  |  |

 

**Three Months Ended March 31, 2005**

 

| ** **                                      | ** ** | **WAMCO  XXX** | ** ** | **WAMCO  31** | ** ** | **WAMCO  33** | ** ** | **Other  Partnerships** | ** ** | **Combined** | ** ** |
|-------------------------------------------------|------------|----------------|------------|---------------|------------|---------------|------------|-------------------------|------------|--------------|------------|
| Proceeds from resolution of Portfolio  Assets   |       | $              | 1,006      |          | $          | 5,590         |       | $                       | 7,050      |         | $          | 8,884 |   | $ | 22,530 |   |
| Cost of Portfolio Assets resolved               |       | 745            |       | 4,792         |       | 5,286         |       | 4,015                   |       | 14,838       |       |
| Gain on resolution of Portfolio Assets          |       | 261            |       | 798           |       | 1,764         |       | 4,869                   |       | 7,692        |       |
| Interest income on Portfolio Assets             |       | —         |       | 263           |       | 448           |       | 505                     |       | 1,216        |       |
| Other income, net                               |       | 2              |       | 6             |       | —        |       | 26                      |       | 34           |       |
| Revenues                                        |       | 263            |       | 1,067         |       | 2,212         |       | 5,400                   |       | 8,942        |       |
| Interest and fees expense — affiliate      |       | —         |       | —        |       | (526          | )          | (196                    | )          | (722         | )          |
| Interest and fees expense — other          |       | (92            | )          | (321          | )          | —        |       | (45                     | )          | (458         | )          |
| Provision for loan and impairment losses        |       | —         |       | —        |       | (50           | )          | (42                     | )          | (92          | )          |
| Service fees — affiliate                   |       | (46            | )          | (202          | )          | (250          | )          | (509                    | )          | (1,007       | )          |
| General, administrative and operating  expenses |       | (85            | )          | (91           | )          | (119          | )          | (2,163                  | )          | (2,458       | )          |
| Expenses                                        |       | (223           | )          | (614          | )          | (945          | )          | (2,955                  | )          | (4,737       | )          |
| Net earnings                                    |       | $              | 40         |          | $          | 453           |       | $                       | 1,267      |         | $          | 2,445 |   | $ | 4,205 |   |
|                                                 |            |                |            |               |            |               |            |                         |            |              |            |  |  |  |  |  |  |

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

Statements of operations forMinnTex Investment Partners LP for the three month periods ended March 31, 2006and 2005 follow:

 

| ** **                                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Proceeds  from resolution of Portfolio Assets   |       | $                                 | 573        |   | $ | 1,639 |   |
| Cost of  Portfolio Assets resolved              |       | 9                                 |       | 36 |   |
| Gain on  resolution of Portfolio Assets         |       | 564                               |       | 1,603 |   |
| Other income                                    |       | 2                                 |       | 2 |   |
| Revenues                                        |       | 566                               |       | 1,605 |   |
| Service fees  — affiliate                  |       | (49                               | )          | (164 | ) |
| General,  administrative and operating expenses |       | (7                                | )          | (8 | ) |
| Expenses                                        |       | (56                               | )          | (172 | ) |
| Net earnings                                    |       | $                                 | 510        |   | $ | 1,433 |   |

 

FirstCity holds variableinterests in certain Acquisition Partnerships, which would be characterized asvariable interest entities (“VIE”), as defined in FIN 46R, *Consolidationof Variable Interest Entities* (“FIN 46R”). However, FirstCity is notdeemed to be the primary beneficiary of any of these entities based on thecriteria set forth in FIN 46R. At March 31, 2006, FirstCity’s maximum exposureto loss as a result of its involvement with the VIEs is $22.7 million.

 

At March 31, 2006, the Companyhad $18 million in Euro-denominated debt for the purpose of hedging a portionof the net equity investments in Europe. In general, the type of risk hedgedrelates to the foreign currency exposure of net investments in Europe caused bymovements in Euro exchange rates. The Company designated the hedgingrelationship such that changes in the net investments being hedged are expectedto be offset by corresponding changes in the values of the Euro-denominateddebt. Effectiveness of the hedging relationship is measured and designated atthe beginning of each month by comparing the outstanding balance of theEuro-denominated debt to the carrying value of the designated net equityinvestments. The net foreign currency translation gain (loss) included inaccumulated other comprehensive income relating to the Euro-denominated debtwas $(660) for the three months ended March 31, 2006 and $528 for the sameperiod in 2005.

 

**(7)  Segment Reporting**

 

The Company is engaged in onereportable segment - Portfolio Asset acquisition and resolution.  The Portfolio Asset acquisition andresolution business involves acquiring Portfolio Assets at a discount to facevalue and servicing and resolving such Portfolios in an effort to maximize thepresent value of the ultimate cash recoveries. The following is a summary of results of operations for the PortfolioAsset acquisition and resolution segment and reconciliation to earnings fromcontinuing operations for the three months ended March 31, 2006 and 2005.

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**                                    | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Revenues:                                                                          |       |                              |       |   |   |
| Servicing fees                                                                     |       | $                                 | 2,647      |   | $ | 3,172 |   |
| Gain on resolution of Portfolio Assets                                             |       | 1,284                             |       | 1,862 |   |
| Interest income                                                                    |       | 1,204                             |       | 902 |   |
| Other                                                                              |       | 411                               |       | 271 |   |
| Total                                                                              |       | 5,546                             |       | 6,207 |   |
| Expenses:                                                                          |       |                              |       |   |   |
| Interest and fees on notes payable                                                 |       | 1,708                             |       | 880 |   |
| Salaries and benefits                                                              |       | 2,933                             |       | 3,269 |   |
| Provision for loan and impairment losses                                           |       | 109                               |       | 85 |   |
| Occupancy, data processing, communication  and other                               |       | 997                               |       | 1,148 |   |
| Minority interest                                                                  |       | 11                                |       | (3 | ) |
| Total                                                                              |       | 5,758                             |       | 5,379 |   |
| Equity in earnings of investments                                                  |       | 3,634                             |       | 3,401 |   |
| Operating contribution before direct taxes                                         |       | $                                 | 3,422      |   | $ | 4,229 |   |
| Operating contribution, net of direct taxes                                        |       | $                                 | 3,328      |   | $ | 4,115 |   |
|                                                                               |       |                              |       |   |   |
| **Corporate Overhead:**                                                            | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Salaries and benefits, occupancy,  professional and other income and expenses, net |       | 1,231                             |       | 1,566 |   |
| Earnings from continuing operations                                                |       | $                                 | 2,097      |   | $ | 2,549 |   |

 

Revenues and equity in earningsof investments from the Portfolio Asset acquisition and resolution segment areattributable to domestic and foreign operations as follows:

 

| ** **     | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------|------------|-----------------------------------|------------|
| ** **     | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Domestic       |       | $                                 | 5,354      |   | $ | 5,962 |   |
| Latin  America |       | 2,653                             |       | 2,397 |   |
| Europe         |       | 1,173                             |       | 1,249 |   |
| Total          |       | $                                 | 9,180      |   | $ | 9,608 |   |

 

Totalassets for each of the segments and a reconciliation to total assets are asfollows:

 

| ** **                                    | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                    | ** ** | ** **          | ** ** | ** **             | ** ** |
| Cash                                          |       | $                   | 9,248      |                   | $          | 12,901 |   |
| Portfolio  acquisition and resolution assets: |       |                |       |                   |       |
| Domestic                                      |       | 119,285             |       | 105,938                |       |
| Latin America                                 |       | 19,661              |       | 19,764                 |       |
| Europe                                        |       | 26,736              |       | 27,699                 |       |
| Deferred tax  asset, net                      |       | 20,101              |       | 20,101                 |       |
| Other  non-earning assets, net                |       | 8,424               |       | 8,309                  |       |
| Discontinued  mortgage assets                 |       | 91                  |       | 157                    |       |
| Total assets                                  |       | $                   | 203,546    |                   | $          | 194,869 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

**(8)  Earnings per Common Share**

 

Basic net earnings per commonshare calculations are based upon the weighted average number of common sharesoutstanding. Potentially dilutive common share equivalents include warrants andemployee stock options in the diluted earnings per common sharecalculations.  Basic and diluted earningsfrom continuing operations per share were determined as follows:

 

| ** **                                                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Earnings  from continuing operations                                              |       | $                                 | 2,097      |   | $ | 2,549 |   |
| Weighted  average outstanding shares of common stock                              |       | 11,307                            |       | 11,262 |   |
| Dilutive  effect of:                                                              |       |                              |       |   |   |
| Warrants                                                                          |       | 342                               |       | 342 |   |
| Employee stock options                                                            |       | 309                               |       | 403 |   |
| Weighted average outstanding shares of  common stock and common stock equivalents |       | 11,958                            |       | 12,007 |   |
| Earnings  from continuing operations per share:                                   |       |                              |       |   |   |
| Basic                                                                             |       | $                                 | 0.19       |   | $ | 0.23 |   |
| Diluted                                                                           |       | $                                 | 0.18       |   | $ | 0.21 |   |

 

**(9)  Stock-Based Compensation**

 

The Company has a stock optionand award plan for the benefit of key individuals, including its directors,officers and key employees. The plan is administered by a committee of theBoard of Directors and provides for the grant of up to a total of 300,000shares (net of shares cancelled and forfeited) of Common Stock.  The Company previously had a 1995 StockOption and Award Plan, and a 1996 Stock Option and Award Plan, which providedfor a grant of up to 700,000 shares. Both plans expired in 2005 under the terms of these plans, with existingoptions remaining in accordance with the terms of each grant.  Stock option awards are granted with anexercise price equal to the market price of FirstCity’s shares at the date ofgrant; those stock option awards generally vest 25% each year from the date ofgrant and have 10-year contractual terms. Certain stock options issued to non-employee directors in 2004 and 2005were exercisable immediately.

 

FirstCity adopted SFAS 123(R)using the modified prospective transition method beginning January 1, 2006.Accordingly, during the three-month period ended March 31, 2006, the Companyrecorded stock-based compensation expense for awards granted prior to, but notyet vested, as of January 1, 2006, as if the fair value method required for proforma disclosure under SFAS 123 were in effect for expense recognitionpurposes, adjusted for estimated forfeitures. For these awards, we recognizedcompensation expense using the straight-line amortization method. Forstock-based awards granted after January 1, 2006, the Company will recognizecompensation expense based on the estimated grant date fair value method usingthe Black-Scholes valuation model. For these awards, FirstCity will recognizecompensation expense using a straight-line amortization method. As SFAS 123(R)requires that stock-based compensation expense be based on awards that areultimately expected to vest, stock-based compensation for the three-monthperiod ended March 31, 2006 has been reduced for estimated forfeitures. Whenestimating forfeitures, FirstCity considers voluntary termination behaviors aswell as trends of actual option forfeitures. The impact on the results ofoperations of recording stock-based compensation for the three-month periodended March 31, 2006 was as follows (in thousands):

 

| ** **                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                        | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Amount of compensation cost recognized in  income |       | $                                 | 145        |   | $ | — |   |
| Tax benefit recognized in income                  |       | $                                 | —     |   | $ | — |   |
| Amount capitalized as part of an asset            |       | $                                 | —     |   | $ | — |   |

 

SFAS 123(R) requires cash flowsresulting from excess tax benefits to be classified as a part of cash flowsfrom financing activities. Excess tax benefits are realized tax benefits fromtax deductions for exercised options in excess of the deferred tax assetattributable to stock compensation costs for such options. As a result ofsubstantial net operating loss carryforwards, the Company currently does notrecord deferred tax assets attributable to stock compensation costs nor does itutilize tax deductions for exercised options. Cash received from optionexercises for the three-month periods ended March 31, 2006 and 2005 was zeroand $8, respectively.

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

The fair valueof stock options granted was estimated on the date of grant using theBlack-Scholes option pricing model. Expected volatilities are based onhistorical volatility of the Company’s stock. The Company estimated theexpected term of unvested options by taking the average of the vesting termremaining and the contractual term of the option, as illustrated in theSecurities and Exchange Commission’s Staff Accounting Bulletin No. 107.  The expected life represents the period oftime that options granted are expected to be outstanding. The risk-free rate isbased on the U.S. Treasury rate with a maturity date corresponding to theoptions’ expected life.  There were nooptions granted during the three months ended March 31, 2006 and 2005.

 

A summary ofstock option activity as of March 31, 2006 and changes during the period thenended is presented below:

 
| ** **                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------|------------|------------|------------|----------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** **                             | ** ** | ** **                                                   | ** ** | ** **                      | ** ** | ** ** |
| Outstanding  at January 1, 2006 |       | 755,850    |       | $                                      | 7.02       |                                                         |       |                            |       |   |
| Granted                         |       | —     |       | —                                 |       |                                                         |       |                            |       |
| Exercised                       |       | —     |       | —                                 |       |                                                         |       |                            |       |
| Expired                         |       | —     |       | —                                 |       |                                                         |       |                            |       |
| Forfeited                       |       | (2,000     | )          | 27.25                                  |       |                                                         |       |                            |       |
| Outstanding  at March 31, 2006  |       | 753,850    |       | $                                      | 6.97       |                                                         | 6.61       |                            | $          | 4,441 |   |
| Exercisable  at March 31, 2006  |       | 500,325    |       | $                                      | 6.12       |                                                         | 5.61       |                            | $          | 3,612 |   |

 

The totalintrinsic value of stock options exercised during the three months ended March31, 2006 and 2005 was zero and $22, respectively.  As of March 31, 2006, there was approximately$1.3 million of total unrecognized compensation cost related to unvestedshare-based compensation arrangements granted under the stock optionplans.  That cost is expected to berecognized over a weighted average period of 3 years.

 

A summary ofthe status and changes of FirstCity’s nonvested shares as of March 31, 2006,and changes during the three months ended March 31, 2006 is presented below:

 
| ** **                    | ** ** | **Shares** | ** ** | **Weighted-  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------|------------|------------|------------|------------------------------------------------|------------|
| Nonvested at  January 1, 2006 |       | 253,525    |       | $                                              | 6.58       |   |
| Granted                       |       | —     |       | —                                         |       |
| Vested                        |       | —     |       | —                                         |       |
| Forfeited                     |       | —     |       | —                                         |       |
| Nonvested at  March 31, 2006  |       | 253,525    |       | $                                              | 6.58       |   |

 

Prior to theadoption of SFAS No. 123(R), FirstCity provided the disclosures required underSFAS No. 123, as amended by SFAS No. 148, *Accounting for Stock-BasedCompensation — Transition and Disclosures*. Employee stock-basedcompensation expense recognized under SFAS 123(R) was not reflected in theresults of operations for the three-month period ended March 31, 2005 foremployee stock option awards as all options were granted with an exercise priceequal to the market value of the underlying common stock on the date of grant.Forfeitures of awards were recognized as they occurred. Previously reportedamounts have not been restated.

 

The pro formainformation for the three months ended March 31, 2005 was as follows:

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

| Net earnings  to common stockholders, as reported                                                                                            |   | $      | 2,549  |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Less: Total stock-based employee  compensation expense  determined under fair value based method for all  awards, net of related tax effects |   | (74    | )      |
| Pro forma  net earnings to common stockholders                                                                                               |   | $      | 2,475  |   |
| Net earnings  per common share:                                                                                                              |   |   |   |
| Basic — as  reported                                                                                                                    |   | $      | 0.23   |   |
| Basic — pro  forma                                                                                                                      |   | $      | 0.22   |   |
| Diluted — as  reported                                                                                                                  |   | $      | 0.21   |   |
| Diluted —  pro forma                                                                                                                    |   | $      | 0.21   |   |

 

**(10)  Income Taxes**

 

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 then establishing a valuation allowance to value the netdeferred tax asset at a level, which more likely than not, will be realized.Realization is determined based on management’s expectation of generatingsufficient taxable income in a look forward period over the next four years.The ultimate realization of the resulting net deferred tax asset is dependentupon generating sufficient taxable income from its continuing operations priorto expiration of the NOLs. Although realization is not assured, managementbelieves it is more likely than not that all of the recorded deferred taxasset, net of the allowance, will be realized. The amount of the deferred taxasset considered realizable, however, could be adjusted in the future if estimatesof future taxable income during the carryforward period change. The ability ofthe Company to realize the deferred tax asset is periodically reviewed and thevaluation allowance is adjusted accordingly.

 

**(11)  Commitments andContingencies**

 

Periodically,FirstCity, its subsidiaries, its affiliates and the Acquisition Partnershipsare parties to or otherwise involved in legal proceedings arising in the normalcourse of business. FirstCity does not believe that there is any proceedingthreatened or pending against it, its subsidiaries, its affiliates or theAcquisition Partnerships which, if determined adversely, would have a materialadverse effect on the consolidated financial position, results of operations orliquidity of FirstCity, its subsidiaries, its affiliates or the AcquisitionPartnerships.

 

In August2000, Consumer Corp. and Funding LP contributed all of the assets utilized inthe operations of the automobile finance operation to Drive pursuant to theterms of a Contribution and Assumption Agreement by and between Consumer Corp.and Drive, and a Contribution and Assumption Agreement by and between FundingLP and Drive (collectively, the “Contribution Agreements”). Drive assumedsubstantially all of the liabilities of the automobile finance operation as setforth in the Contribution Agreements.  Inaddition, pursuant to the terms of a Securities Purchase Agreement dated as ofAugust 18, 2000 (the “2000 Securities Purchase Agreement”), by and amongFirstCity, Consumer Corp., FirstCity Funding LP (“Funding LP”), and FirstCityFunding GP Corp. (“Funding GP”), IFA-GP and IFA-LP; FirstCity, Consumer Corp.,Funding LP and Funding GP made various warranties concerning (i) theirrespective organizations, (ii) the automobile finance operation conducted byConsumer Corp. and Funding LP, and (iii) the assets transferred by ConsumerCorp. and Funding LP to Drive. The Company, Consumer Corp., Funding LP andFunding GP also agreed to indemnify BoS (USA), IFA-GP and IFA-LP from damagesresulting from a breach of any representation or warranty contained in the 2000Securities Purchase Agreement or otherwise made by the Company, Consumer Corp.or Funding LP in connection with the transaction. All indemnity obligationsunder the 2000 Securities Purchase Agreement terminated after thirty (30)months with the exception of tax-related representations and warranties whichsurvive for a period of seven (7) years from August 25, 2000 (the “2000 ClosingDate”). Neither the Company, Consumer Corp., Funding LP, or Funding GP is requiredto make any payments as a result of the indemnity provided under the 2000Securities 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.  Managementof the Company believes that FirstCity will not have to pay any amounts relatedto these agreements.

 

On September21, 2004, FirstCity, Consumer Corp., Funding LP and Funding GP entered into aSecurities Purchase Agreement to sell a 31% beneficial ownership interest inDrive and its general partner, Drive GP LLC, to IFA GP, IFA LP and MG-LP (the “2004

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –(continued)**

 

Securities Purchase Agreement”).  In the2004 Securities Purchase Agreement, FirstCity, Consumer Corp., Funding LP andFunding GP made various representations and warranties concerning (i) theirrespective organizations, (ii) their power and authority to enter into the 2004Securities Purchase Agreement and the transactions contemplated therein, (iii)the ownership of the limited partnership interests in Drive by Funding LP, (iv)the ownership of membership interests in Drive-GP by Consumer Corp., and (iv)the capital structure of Funding LP. FirstCity, Consumer Corp., Funding LP andFunding GP also agreed to indemnify BoS (USA), IFA-GP, IFA-LP and MG-LP fromdamages resulting from a breach of any representation or warranty contained inthe 2004 Securities Purchase Agreement or otherwise made by FirstCity, ConsumerCorp. or Funding LP in connection with the transaction. The indemnityobligations under the 2004 Securities Purchase Agreement survive for a maximumperiod of five (5) years from November 1, 2004. Neither FirstCity, ConsumerCorp., Funding LP, or Funding GP is required to make any payments as a resultof the indemnity provided under the 2004 Securities Purchase Agreement untilthe aggregate amount payable exceeds $.25 million, and then only for the amountin excess of $.25 million in the aggregate; however, certain representationsand warranties are not subject to this $.25 million threshold. Managementof the Company believes that FirstCity will not have to pay any amountsrelating to these representations and warranties.

 

FirstCity hasminority interests in various limited-life partnerships with a carrying valueof $1.1 million at March 31, 2006. The estimated amount that would be paid tothe minority interest holder if the instruments were to be settled at March 31,2006 is $1.4 million.

 

Financial Security Assurance Inc. (“FSA”), inits capacity as certificate insurer under the Pooling and Servicing Agreement(the “Pooling and Servicing Agreement”), relating to the FirstCity Capital HomeEquity Loan Trust 1998-2 (the “Trust”), dated as of November 1, 1998 by andamong FC Capital Corp., in its capacities as seller and master servicer, andThe Bank of New York, in its capacity as trustee (the “Trustee”), made demandon FC Capital Corp. to repurchase certain loans that were subject to repurchasedue to fraud of third parties in connection with the origination of the loans.FC Capital Corp. agreed to provide a letter of credit in the amount of therepurchase price for the loans in lieu of being required to purchase the loansfrom the Trust.  FirstCity has obtainedand delivered to FSA, for the benefit of FC Capital Corp., an irrevocableletter of credit in the amount of $510,000 from the Bank of Scotland.  Pursuant to the agreement with FSA, FCCapital Corp. will have the option to purchase the loans for $510,000 prior toa call under the letter of credit.

 

The Companyhas unsecured notes payable to Terry R. DeWitt, G. Stephen Fillip and James C.Holmes, each of whom were Senior Vice Presidents of FirstCity, in connectionwith the acquisition of the minority interest in FirstCity Holdings. The notesare to be periodically redeemed by the Company for an aggregate of up to $3.2million out of certain cash collections from servicing income from Portfoliosin Mexico. FirstCity valued the loans at the inception date using an imputedinterest rate based on the Company’s cost of funds. At March 31, 2006, thesenotes had an imputed balance of $.5 million and mature in December 2011.

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.**

 

**Overview**

 

FirstCity is a financial services company engaged in the acquisitionand resolution of portfolios of assets or single assets (collectively referredto as “Portfolio Assets”).  The PortfolioAsset acquisition and resolution business involves acquiring Portfolio Assetsat a discount to face value and servicing and resolving such portfolios in aneffort to maximize the present value of the ultimate cash recoveries.

 

During thefirst quarter of 2006, the Company recorded earnings to common stockholders ona diluted basis of $2 million or $.17 per common share. The operatingcontribution from the Portfolio Asset acquisition and resolution segment was$3.3 million compared with $4.1 million for the same period in 2005.  The Company was able to invest $23.3 millionin portfolio acquisitions during the quarter.

 

Managementremains positive on the outlook of the Company. The acquisitions for the quarter contributed to a $12.4 million netincrease in the primary earning assets base of the Company and FirstCity iscurrently evaluating 29 different transactions representing over $4 billion inface value of assets.

 

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 liquidateassets, and the availability and prices for loans and assets acquired in all ofthe Company’s businesses. The Company’s business and results of operations arealso affected by the availability of financing with terms acceptable to theCompany and the Company’s access to capital markets, including thesecuritization markets.

 

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 months ended March 31, 2006 and2005, respectively, are detailed below (dollars in thousands except per sharedata):

 

| ** **                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Portfolio  Asset Acquisition and Resolution |       | $                                 | 3,328      |   | $ | 4,115 |   |
| Corporate  overhead                         |       | (1,231                            | )          | (1,566 | ) |
| Earnings from continuing operations         |       | 2,097                             |       | 2,549 |   |
| Loss from discontinued operations           |       | (75                               | )          | — |   |
| Net earnings to common stockholders         |       | $                                 | 2,022      |   | $ | 2,549 |   |
| Diluted earnings per common share           |       | $                                 | 0.17       |   | $ | 0.21 |   |

 

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**Results of Operations**

 

The following discussion and analysis is based on the segment reportinginformation presented in note 7 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.

 

***FirstQuarter 2006 Compared to First Quarter 2005***

 

The Company reported net earnings of $2.0 million in the first quarterof 2006 compared to $2.5 million in the first quarter of 2005. On a per sharebasis, diluted net earnings to common stockholders were $.17 in the firstquarter of 2006 compared to $.21 in the first quarter of 2005.

 

*Portfolio Asset Acquisition and Resolution*

 

The operating contribution from the Portfolio Asset acquisition andresolution segment was $3.3 million in the first quarter of 2006 compared to$4.1 million in the first quarter of 2005. FirstCity invested $23.3 million inPortfolio acquisitions during the first quarter of 2006, of which $17.5 millionwas acquired through Acquisition Partnerships in the U.S., compared to $2.2million in the first quarter of 2005, of which $1.5 million waspurchased in the U.S. and $.7 million in Mexico.  Thequarter-end investment in Portfolio Assets increased to $52.1 million at March31, 2006, from $31.6 million at March 31, 2005, as a result of acquisitions ofapproximately $36.6 million since the first quarter of 2005.

 

*Servicing fee revenues. *Servicing fee revenues decreased by 17 % to $2.6million in the first quarter of 2006 from $3.2 million in the first quarter of2005 primarily due to decreased collections in domestic AcquisitionPartnerships.

 

*Gain on resolution of Portfolio Assets. *The netgain on resolution of Portfolio Assets decreased to $1.3 million in the firstquarter of 2006 from $1.9 million in the first quarter of 2005 primarily due todeclining collections on portfolios assets acquired prior to 2005.

 

*Equity in earnings of investments. *Equity inearnings of investments increased 7% to $3.6 million in the first quarter of2006 compared to $3.4 million in the first quarter of 2005.  Equity earnings in Acquisition Partnershipsincreased 21% to $3.7 million in the first quarter of 2006 from $3 million inthe first quarter of 2005. Following is a discussion of equity earnings fromAcquisition Partnerships by geographic region.

 

•             *Domestic* — Equity in earnings of domestic AcquisitionPartnerships was $2.3 million in the first quarter of 2006 and $2.3 million inthe first quarter of 2005.

 

•             *Latin America* — Equity earnings of Acquisition Partnershipslocated in Latin America (primarily Mexico) were $.44 million in the firstquarter of 2006 compared to equity losses of $.17 million in 2005.  These partnerships reflected net earnings of$3.9 million in the first quarter of 2006 compared to net losses of $.123million in 2005. During the first quarter of 2006, the partnerships recordednet recoveries of allowance for loan losses of $1.3 million.  There were no provisions or recoveries in thefirst quarter of 2005.  The partnershipsalso recorded $1.7 million of foreign exchange gains in the first quarter of2006 compared to $4.0 million of foreign exchange gains in 2005 (of which $.18million and $.31 million are included in equity earnings, respectively).  Interest expense of $2.2 million and $3.1million were recorded in the first quarter of 2006 and 2005, respectively. Thisinterest is owed to affiliates of the investors of these partnerships, of whichFirstCity recorded $.33 million and $.36 million as interest income in thefirst quarters of 2006 and 2005, respectively.

 

•             *Europe* — Equity in earnings of Acquisition Partnershipslocated in France increased 8% to $.98 million in the first quarter of 2006from $.91 million in 2005, primarily due to an increase in collections to $17million in the first quarter of 2006 from $13 million in the first quarter of2005.  FirstCity also recorded $.33million and $.23 million in foreign currency transactions gains (included inother expenses) relating to investments in France in the first quarters of 2006and 2005, respectively.

 

*Interest income. *Interest income increased 33% from $.9 million inthe first quarter of 2005 to $1.2 million in the first quarter of 2006 and isprimarily due to increased purchases of portfolios.

 

*Other income. *Other income increased to $.4 million in thefirst quarter of 2006 from $.3 million in the first quarter of 2005 primarilydue to an increase in reimbursements of due diligence expenses which will varyfrom period to period.

 

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*Expenses. *Operating expenses were $5.8 million and $5.4million in the first quarter of 2006 and 2005, respectively.

 

Interest and fees on notes payable were $1.7 million and $.9 million inthe first quarters of 2006 and 2005, respectively. The average debt for thequarter increased to $88.6 million in the first quarter of 2006 from $50.3million in the first quarter of 2005, and the average cost of borrowingincreased from 7.0% in 2005 to 7.7% in 2006.

 

Salaries and benefits decreased 10% to $2.9 million in the firstquarter of 2006 from $3.3 million in the first quarter of 2005. The totalnumber of personnel within the Portfolio Asset acquisition and resolutionsegment was 177 and 194 at March 31, 2006 and 2005, respectively.

 

The provision for loan and impairment losses was $109,000 in the firstquarter of 2006 and $85,000 in the first quarter of 2005.

 

Occupancy, data processing, communication and other expenses were $1.0million for the first quarter of 2006 and $1.1 million in the first quarter of2005.

 

Minority interest was minimal from period to period.

 

*Other Items Affecting 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.   *Corporate overhead expenses decreased 21% to $1.2million in the first quarter of 2006 from $1.6 million in the first quarter of2005, primarily due to decreased legal and accounting fees and other expenses.

 

*Income taxes. *Provision for incometaxes was $122,000 and $139,000 in the first quarters of 2006 and 2005,respectively, and related primarily to state income taxes.  Federalincome taxes are provided at a 35% rate applied to taxable income or loss andare offset by NOLs that the Company believes are available. The tax benefit ofthe NOLs is recorded in the period during which the benefit is realized. TheCompany recorded no deferred tax provision in the first quarters of either 2006or 2005.

 

*Discontinued Operations. *Discontinued operations of $75,000 includes aprovision of $66,000 the first quarter of 2006 for additional losses fromdiscontinued mortgage operations compared to none in the first quarter of 2005.At March 31, 2006, the only asset remaining from discontinued mortgageoperations is an investment security resulting from the retention of a residualinterest in a securitization transaction. This security is in “run-off,” and the Company is contractually obligatedto service the underlying assets. The assumptions used in the valuation modelconsider both industry as well as the Company’s historical experience. As thesecurity “runs off,” assumptions are reviewed in light of historical evidencein revising the prospective results of the model. These revised assumptionscould potentially result in either an increase or decrease in the estimatedcash receipts. An additional provision is booked based on the output of thevaluation model if deemed necessary.

 

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#### **FinancialCondition**

 

Major changes in FirstCity’s financial position resulted from thefollowing.

 

Consolidated assets of $204 million at March 31, 2006, were $8.7million higher than that at December 31, 2005, primarily as a result ofPortfolio Asset acquisitions during the quarter, net of normal liquidation ofexisting Portfolio Assets. During the first three months of 2006, FirstCityinvested $23.3 million in Portfolio Asset acquisitions, and made additionalinvestments in loans receivable from Acquisition Partnerships of $.7 million.

 

Conolidated liabilities of $103 million as of March 31, 2006, were $6.6million higher than that at December 31, 2005. Total notes payable increased by$5.6 million, which reflected advances of $28.9 million primarily for portfolioacquisitions, net of repayments of $23.6 million.  Minority interest increased to $2.6 millionas of March 31, 2006, from $1.2 million in December 31, 2005, due to thepurchase of one portfolio during the first quarter which had a 20% minorityinterest.

 

#### **Portfolio AssetAcquisition and Resolution**

 

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

 

| ** **                  | ** ** | **Purchase  Price** | ** ** | **FirstCity  Investment** | ** ** |
|-----------------------------|------------|---------------------|------------|---------------------------|------------|
| First three  months of 2006 |       | $                   | 42,351     |                      | $          | 23,342 |   |
| Total 2005                  |       | 146,581             |       | 71,405                    |       |
| Total 2004                  |       | 174,139             |       | 59,762                    |       |
| Total 2003                  |       | 129,192             |       | 22,944                    |       |
| Total 2002                  |       | 171,769             |       | 16,717                    |       |
| Total 2001                  |       | 224,927             |       | 24,319                    |       |
|                             |            |                     |            |                           |            |  |  |

 

Thefollowing table presents selected information regarding the revenues andexpenses of the Company’s Portfolio Asset acquisition and resolution business(in thousands):

 

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**Analysis of Selected Revenues and ExpensesPortfolio Asset Acquisition and Resolution**

 
| ** **                                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                    | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| **Portfolio  Assets and Loans Receivable:**                   | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Average investment in Portfolio Assets and  loans receivable: |       |                              |       |   |   |
| Domestic                                                      |       | $                                 | 50,263     |   | $ | 36,315 |   |
| Latin America                                                 |       | 16,123                            |       | 19,096 |   |
| Europe                                                        |       | 1,748                             |       | 530 |   |
| Total                                                         |       | $                                 | 68,134     |   | $ | 55,941 |   |
| Income from Portfolio Assets and loans  receivable:           |       |                              |       |   |   |
| Domestic                                                      |       | $                                 | 2,130      |   | $ | 2,393 |   |
| Latin America                                                 |       | 331                               |       | 363 |   |
| Europe                                                        |       | 27                                |       | 8 |   |
| Total                                                         |       | $                                 | 2,488      |   | $ | 2,764 |   |
| Average return (annualized):                                  |       |                              |       |   |   |
| Domestic                                                      |       | 17.0                              | %          | 26.4 | % |
| Latin America                                                 |       | 8.2                               | %          | 7.6 | % |
| Europe                                                        |       | 6.2                               | %          | 6.0 | % |
| Total                                                         |       | 14.6                              | %          | 19.8 | % |
| **Servicing  fee revenues:**                                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Domestic partnerships:                                        |       |                              |       |   |   |
| Servicing fee revenue                                         |       | $                                 | 759        |   | $ | 1,141 |   |
| Average servicing fee%                                        |       | 3.3                               | %          | 4.2 | % |
| Latin American partnerships:                                  |       |                              |       |   |   |
| Servicing fee revenue                                         |       | $                                 | 1,826      |   | $ | 1,981 |   |
| Average servicing fee%                                        |       | 15.0                              | %          | 18.2 | % |
| Incentive service fees                                        |       | $                                 | 62         |   | $ | 50 |   |
| Total Service Fees:                                           |       |                              |       |   |   |
| Servicing fee revenue                                         |       | 2,647                             |       | 3,172 |   |
| Average servicing fee%                                        |       | 7.5                               | %          | 8.3 | % |
| **Collections:**                                              | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Domestic                                                      |       | $                                 | 23,269     |   | $ | 27,434 |   |
| Latin America                                                 |       | 12,145                            |       | 10,898 |   |
| Europe                                                        |       | 16,697                            |       | 13,198 |   |
| Subtotal                                                      |       | 52,111                            |       | 51,530 |   |
| Wholly owned:                                                 |       | 6,731                             |       | 8,338 |   |
| Total                                                         |       | $                                 | 58,842     |   | $ | 59,868 |   |
| **Personnel:**                                                | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Personnel expenses                                            |       | $                                 | 2,933      |   | $ | 3,269 |   |
| Number of personnel (at period end):                          |       |                              |       |   |   |
| Domestic                                                      |       | 64                                |       | 65 |   |
| Latin America                                                 |       | 113                               |       | 129 |   |
| Subtotal                                                      |       | 177                               |       | 194 |   |
| Corporate                                                     |       | 30                                |       | 31 |   |
| Total                                                         |       | 207                               |       | 225 |   |
| **Interest  expense:**                                        | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Average debt                                                  |       | $                                 | 88,596     |   | $ | 50,310 |   |
| Interest expense                                              |       | 1,708                             |       | 880 |   |
| Average cost (annualized)                                     |       | 7.7                               | %          | 7.0 | % |
| **Provision  for impairment on Portfolio Assets:**            | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Non-performing                                                |       | $                                 | 14         |   | $ | 5 |   |
| Performing                                                    |       | 91                                |       | 80 |   |
| Real estate                                                   |       | 2                                 |       | — |   |
| Loans acquired after 2004 with credit  deterioration          |       | 2                                 |       | — |   |
| Loans acquired after 2004 with no credit  deterioration       |       | —                            |       | — |   |
|                                                          |       | $                                 | 109        |   | $ | 85 |   |

 

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The following table presents selected information regarding therevenues and expenses of the Acquisition Partnerships (dollars in thousands):

 

**Analysis of Selected Revenues and ExpensesAcquisition Partnerships**

 
| ** **                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Revenues:                                                  |       |                              |       |   |   |
| Gain on resolution of Portfolio Assets                     |       | $                                 | 15,042     |   | $ | 20,164 |   |
| Gross profit percentage on resolution of  Portfolio Assets |       | 46.78                             | %          | 44.20 | % |
| Interest income                                            |       | $                                 | 3,972      |   | $ | 2,106 |   |
| Other income                                               |       | 1,155                             |       | 233 |   |
| Interest  expense (1):                                     |       |                              |       |   |   |
| Interest expense                                           |       | $                                 | 2,980      |   | $ | 4,404 |   |
| Average cost (annualized)                                  |       | 4.47                              | %          | 5.29 | % |
| Other  expenses:                                           |       |                              |       |   |   |
| Service fees                                               |       | $                                 | 3,209      |   | $ | 3,823 |   |
| Other operating costs                                      |       | 2,689                             |       | 8,730 |   |
| Foreign currency gains                                     |       | (1,655                            | )          | (4,009 | ) |
| Income taxes                                               |       | 125                               |       | 523 |   |
| Total other expenses                                       |       | 4,368                             |       | 9,067 |   |
| Net earnings                                               |       | $                                 | 12,821     |   | $ | 9,032 |   |
| Equity in  earnings of Acquisition Partnerships            |       | $                                 | 3,691      |   | $ | 3,048 |   |
| Equity in  earnings (loss) of Servicing Entities           |       | (57                               | )          | 353 |   |
| Equity in earnings of investments                          |       | $                                 | 3,634      |   | $ | 3,401 |   |

 

----

(1)          Interest expense includes interest on loans tothe Acquisition Partnerships located primarily in Mexico from affiliatesof the investor groups. Beginning in 2003, FirstCity amended seven loanagreements from Mexican Acquisition Partnerships to provide for no interest tobe payable with respect to periods after the effective date of the amendment.This change had no impact on the consolidated net earnings as the effect isoffset through equity earnings in these Partnerships.

 

**Analysis of Equity Investments in Acquisition Partnerships**

 
| ** **                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                           | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| **FirstCity’s  Average investment in Acquisition Partnerships** | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Domestic                                                             |       | $                                 | 55,682     |   | $ | 36,552 |   |
| Latin America                                                        |       | 2,778                             |       | 1,474 |   |
| Europe                                                               |       | 19,645                            |       | 12,726 |   |
| Europe-Servicing subsidiaries                                        |       | 5,622                             |       | 6,148 |   |
| Latin America-Servicing subsidiaries                                 |       | 260                               |       | 44 |   |
| Total                                                                |       | $                                 | 83,987     |   | $ | 56,944 |   |
|                                                                 |       |                              |       |   |   |
| **FirstCity  share of equity earnings (loss)**                       | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Domestic                                                             |       | $                                 | 2,269      |   | $ | 2,313 |   |
| Latin America                                                        |       | 444                               |       | (174 | ) |
| Europe                                                               |       | 978                               |       | 909 |   |
| Europe-Servicing subsidiaries                                        |       | 74                                |       | 176 |   |
| Latin America-Servicing subsidiaries                                 |       | (131                              | )          | 177 |   |
| Total                                                                |       | $                                 | 3,634      |   | $ | 3,401 |   |

 

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**Provision for 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 on management’sexpectation of generating sufficient taxable income in a look forward periodover the next four years. The ultimate realization of the resulting netdeferred tax asset is dependent upon generating sufficient taxable income fromits continuing operations prior to expiration of the NOLs. Although realizationis not assured, management believes it is more likely than not that all of therecorded deferred tax asset, net of the allowance, will be realized. The amountof the deferred tax asset considered realizable, however, could be adjusted inthe future if estimates of future taxable income during the carryforward periodchange. The ability of the Company to realize the deferred tax asset isperiodically reviewed and the valuation allowance is adjusted accordingly.

 

**Liquidity and Capital Resources**

 

Generally, theCompany requires liquidity to fund its operations, working capital, payment ofdebt, equity for acquisition of Portfolio Assets, investments in and advancesto the Acquisition Partnerships, and other investments by the Company. Thepotential 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.

 

FirstCity hasa $93 million revolving acquisition facility with Bank of Scotland that maturesin November 2008.  This facility is usedto finance the equity portion of distressed asset pool purchases and to providefor the issuance of Letters of Credit and working capital loans.  This facility (i) allows loans to be made inEuros up to a maximum amount in Euros that is equivalent to 35 million U.S.dollars, (ii) allows loans to be made for acquisition of Portfolio Assetsoriginated in Latin America of up to $35 million, (iii) provides for an interestrate of LIBOR plus 2.50% to 2.75%, (iv) provides for an annual commitment feeof 0.20% of the average daily unused balance of the revolving acquisitionfacility, (v) provides that the aggregate borrowings under the facility doesnot exceed 60% of the net present value of FirstCity’s interest in PortfolioAssets and in Acquisition Partnerships pledged to secure the acquisitionfacility, and (vi) provides for a reduction in the total loan commitment of$1.3 million per quarter, commencing on December 27, 2005.

 

In August2005, FH Partners, L.P., an indirect wholly-owned affiliate of FirstCity, andBank of Scotland, acting through its New York branch, as agent for itself aslender, entered into a Revolving Credit Agreement that provides a $50 millionrevolving portfolio acquisition facility for FH Partners, L.P. to be secured byall of the assets of FH Partners, L.P. The loan facility will be used to finance portfolio and assetpurchases.  The facility (i) allowsloans to be made for the acquisition of portfolio assets in the United States,(ii) provides that each loan may be in an amount of up to 70% of the netpresent value of the assets being acquired with the proceeds of the loan, (iii)provides that the aggregate outstanding balances of all loans will not exceed65% of the net present value of the assets securing the loan facility,(iv) provides for an interest rate of LIBOR plus 2.0%, (v) providesfor an annual commitment fee of 0.20% of the average daily unused balance ofthe revolving acquisition facility, (vi) provides for a utilization fee of0.75% of the amount of each loan made under the loan facility,(vii) provides for an upfront fee of $350 thousand, (viii) providesfor facility fees of $100 thousand, for the period commencing on the EffectiveDate to but excluding the first anniversary thereof, $75 thousand, for theperiod commencing on the first anniversary of the Effective Date to butexcluding the second anniversary thereof, and $50 thousand, for each subsequentone-year period, and (ix) provides for a maturity date of November 12,2008.  The obligations of FH Partners,L.P. under the Revolving Credit Agreement are guaranteed by FirstCity and theprimary wholly-owned subsidiaries of FirstCity.

 

BoS (USA) hasa warrant to purchase 425,000 shares of the Company’s voting Common Stock at$2.3125 per share. BoS (USA) is entitled to additional warrants in connectionwith this existing warrant for 425,000 shares under certain specific situationsto retain its ability to acquire approximately 4.86% of the Company’s votingCommon Stock.  The warrant will expire onAugust 31, 2010, if it is not exercised prior to that date.

 

Excluding theterm acquisition facilities of the unconsolidated Acquisition Partnerships, asof March 31, 2006, the Company and its subsidiaries had credit facilitiesproviding for borrowings in an aggregate principal amount of $147 million andoutstanding borrowings of $96 million.

 

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Managementbelieves that the Bank of Scotland facilities, the related fees generated fromthe servicing of assets, equity distributions from existing AcquisitionPartnerships and wholly-owned portfolios, as well as sales of interests inequity investments, will allow the Company to meet its obligations as they comedue during the next twelve months.

 

The followingtable summarizes the material terms of the credit facilities to which theCompany, its major operating subsidiaries and the Acquisition Partnerships wereparties to as of May 2, 2006, and the outstanding borrowings under suchfacilities as of March 31, 2006.

 

**Credit Facilities**

 
| ** **                                                                           | ** ** | **Funded and  Unfunded  Commitment  Amount as of  May 2,  2006** | ** ** | **Outstanding  Borrowings  as of  March 31,  2006** | ** ** | **Interest Rate**                        | ** ** | **Other Terms and Conditions**                                                | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **(Dollars in millions )**                                            | ** ** | ** **                                                    | ** ** | ** **                                    | ** ** |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |
| Bank of Scotland $93 million portfolio  acquisition and working capital facility (1) |       | $                                                                                    | 93         |                                                          | $          | 74                                            |       | LIBOR + 2.5  - 2.75%                                                                         |       | Secured by  equity interests  and other assets of FirstCity,  matures November 2008 |   |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |
| Bank of Scotland $50 million portfolio  acquisition - revolving credit               |       | 50                                                                                   |       | 18                                                            |       | 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                  |       | 3                                                                                    |       | 3                                                             |       | Fixed 5.625%                                  |       | Secured by  assets of FC Washington and guaranteed by the Company, matures 2008              |       |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |
| Unsecured loans payable to senior  management                                        |       | 1                                                                                    |       | 1                                                             |       | Rate based  Corporate  average cost  of funds |       | Contingent  liability related to acquisition of minority interest, matures December 2011     |       |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |
| Total                                                                                |       | $                                                                                    | 147        |                                                          | $          | 96                                            |       |                                                                                         |       |   |   |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |
| Unconsolidated Acquisition Partnerships  Term Facilities (2)                         |       | $                                                                                    | 50         |                                                          | $          | 50                                            |       | Various  rates                                                                               |       | Secured by  Portfolio Assets, various maturities non-recourse |   |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |
|                                                                                 |       |                                                                                 |       |                                                          |       |                                          |       |                                                                                         |       |

 

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(1)          TheBank of Scotland facility allows loans to be made in Euros up to a maximumamount in Euros that is equivalent to $35 million.  At March 31, 2006, the Company hadapproximately $18 million outstanding under the Euro-denominated portion ofthis facility.

(2)          Inaddition to the term acquisition facilities of the unconsolidated AcquisitionPartnerships, the Latin American Acquisition Partnerships also have term debtof approximately $212 million outstanding as of March 31, 2006, owed toaffiliates of the investor groups. Of this amount, the Company has recordedapproximately $16.4 million as Loans Receivable on the Consolidated Balance Sheets.

 

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**Forward-Looking Statements**

 

Certain statements contained in this Quarterly Report on Form 10-Q orincorporated by reference from time to time, including, but not limited to,statements relating to the Company’s strategic objectives and futureperformance, which are not historical facts, may be deemed to beforward-looking statements under the Private Securities Litigation Reform Actof 1995. Forward-looking statements include, without limitation, any statementthat may project, indicate or imply future results, performance orachievements, and may contain the words “expect,” “intend,” “plan,” “estimate,”“believe,” “will be,” “will continue,” “will likely result,” and similarexpressions. Such statements inherently are subject to a variety of risks anduncertainties that could cause actual results to differ materially from thoseprojected. There are many important factors that could cause the Company’sactual results to differ materially from those indicated in the forward-lookingstatements. Such factors include, but are not limited to, risks associated withforeign operations; currency exchange rate fluctuations; the performance of theCompany’s subsidiaries and affiliates; the availability of Portfolio Assets;assumptions underlying Portfolio asset performance; interest rate risk; thedegree to which the Company is leveraged; the Company’s continued need forfinancing; availability of the Company’s credit facilities; the impact ofcertain covenants in loan agreements of the Company and its subsidiaries; risksof declining value of loans, collateral or assets; the ability of the Companyto 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, 2005 (including thosediscussed under “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations”), as well as in other Securities andExchange Commission filings of the Company. Many of these factors are beyondthe Company’s control. In addition, it should be noted that past financial andoperational performance of the Company is not necessarily indicative of futurefinancial and operational performance. Given these risks and uncertainties,investors should not 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 and Qualitative Disclosures About Market Risk.**

 

Market risk isthe risk of loss from adverse changes in market prices and interest rates. TheCompany’s operations are materially impacted by net gains on sales of loans andnet interest margins. The level of gains from loan sales the Company achievesis dependent on demand for the products originated. Net interest margins aredependent on the Company’s ability to maintain the spread or interestdifferential between the interest it charges the customer for loans and theinterest the Company is charged for the financing of those loans. The followingdescribes each component of interest bearing assets held by the Company and howeach could be affected by changes in interest rates.

 

The Companyinvests in Portfolio Assets both directly through consolidated subsidiaries andindirectly through equity investments in Acquisition Partnerships. PortfolioAssets consist of investments in pools of non-homogenous assets thatpredominantly consist of loan and real estate assets. Earnings from theseassets are based on the estimated future cash flows from such assets andrecorded when those cash flows occur. The underlying loans within these poolsbear both fixed and variable rates. Due to the non-performing nature andhistory of these loans, changes in prevailing benchmark rates (such as theprime rate or LIBOR) generally have a nominal effect on the ultimate futurecash flow to be realized from the loan assets. Furthermore, these pools ofassets are held for sale, not for investment; therefore, the dispositionstrategy is to liquidate these assets as quickly as possible.

 

Loansreceivable consist of investment loans made to Acquisition Partnerships andbear interest at predominately fixed rates. The collectibility of these loansis directly related to the underlying Portfolio Assets of those AcquisitionPartnerships, which are non-performing in nature. Therefore, changes inbenchmark rates would have minimal effect on the collectibility of these loans.

 

The Companycurrently has investments in Europe and Latin America (i.e. Mexico, Argentinaand Dominican Republic). In Europe, the Company’s investments are in the formof equity and represent a significant portion of the Company’s total equityinvestments. As of March 31, 2006, one U.S. dollar equaled .83 Euros. A sharpchange in the Euro relative to the U.S. dollar could materially adverselyaffect the financial position and results of operations of the Company. A 5%and 10% incremental depreciation of the Euro would result in an estimateddecline in the valuation of the Company’s equity investments in Europe ofapproximately $1.3 million and $2.4 million, respectively. These amounts areestimates of the financial impact of a depreciation of the Euro relative to theU.S. dollar. 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. As discussed above, the revolvingacquisition facility with Bank of

 

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Scotland for $93 million allows loans to bemade in Euros up to a maximum amount in Euros that is equivalent to $35 millionU.S. dollars. At March 31, 2006, the Company had $18 million inEuro-denominated debt for the purpose of hedging a portion of the net equityinvestments in Europe. Management of the Company feels that this loan agreementwill help reduce the risk of adverse effects of currency changes onEuro-denominated investments.

 

In Mexico,approximately 95% of the Company’s investments are made through U.S. dollardenominated loans to the Partnerships located in Mexico. The remaininginvestment is in the form of equity in these same Partnerships. The loansreceivable are required to be repaid in U.S. dollars. Although the U.S. dollarbalance of these loans will not change due to a change in the Mexican peso, thefuture estimated cash flows of the underlying assets in Mexico could becomeless valuable as a result of a change in the exchange rate for the Mexicanpeso, and thus, could affect the overall total returns to the Company on theseinvestments. As of March 31, 2006, one U.S. dollar equaled 10.95 Mexican pesos.A 5% and 10% incremental depreciation of the Mexican peso would result in anestimated decline in the valuation of the Company’s total investments in Mexicoof approximately $.8 million and $1.5 million, respectively. These amounts areestimates of the financial impact of a depreciation of the Mexican peso relativeto the U.S. dollar. Consequently, these amounts are not necessarily indicativeof the actual effect of such changes with respect to the Company’s consolidatedfinancial position or results of operations.

 

FirstCity hasloans and equity investments in South America — primarily in ArgentinaAcquisition Partnerships. As of March 31, 2006, one U.S. dollar equaled 3.14Argentine pesos. The Company estimates that a 5% and 10% incrementaldepreciation of the Argentine peso would result in a decline in the valuationof the Company’s total investments in Argentina of approximately $.082 millionand $.16 million, respectively. These amounts are estimates of the financialimpact of a depreciation of the Argentine peso relative to the U.S. dollar.Consequently, these amounts are not necessarily indicative of the actual effectof such changes with respect to the Company’s consolidated financial positionor results of operations.

 

Also in SouthAmerica, FirstCity has an equity investment in a Dominican Republic AcquisitionPartnership. As of March 31, 2006, one U.S. dollar equaled 33.21 DominicanRepublic pesos. The Company estimates that a 5% and 10% incrementaldepreciation of the Dominican Republic peso would result in a decline in thevaluation of the Company’s total investments in Dominican Republic ofapproximately $.037 million and $.071 million, respectively. These amounts areestimates of the financial impact of a depreciation of the Dominican Republicpeso relative to the U.S. dollar. Consequently, these amounts are notnecessarily indicative of the actual effect of such changes with respect to theCompany’s consolidated financial position or results of operations.

 

**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 March 31, 2006.  Based onthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effective,in all material respects, to ensure that information required to be disclosedin the reports the Company files and submits under the Exchange Act isrecorded, processed, summarized and reported as and when required.  There has been no change in the Company’sinternal controls over financial reporting or in other factors that hasmaterially affected, or is reasonably likely to affect, the registrant’sinternal control over financial reporting.

 

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**PART II**

 

**OTHER INFORMATION**

 

**Item 1. Legal Proceedings.**

 

Periodically,FirstCity, its subsidiaries, its affiliates and the Acquisition Partnershipsare parties to or otherwise involved in legal proceedings arising in the normalcourse of business. FirstCity does not believe that there is any proceedingthreatened or pending against it, its subsidiaries, its affiliates or theAcquisition Partnerships which, if determined adversely, would have a material adverseeffect on the consolidated financial position, results of operations orliquidity of FirstCity, its subsidiaries, its affiliates or the AcquisitionPartnerships.

 

On January 19,2005, Prudential Financial, Inc. filed a petition in interpleader seeking tointerplead 321,211 shares of Prudential common stock and any associateddividends arising from the demutualization of Prudential Financial, Inc. inDecember 2000. The shares of Prudential common stock related to group annuitycontracts purchased by First-City National Bank of Houston, as trustee of theFirst City Bancorporation Employee Retirement Trust (the “Trust”) to fundobligations to participants in the First City Bancorporation EmployeeRetirement Plan (the “Plan”) in connection with termination of the Plan and theTrust in 1987. FirstCity, FCLT Loans Asset Corp. (“FCLT”), an alleged assigneeof the FirstCity Liquidating Trust, JP Morgan Chase Bank, National Association(“JP Morgan”), and First-City National Bank of Houston as trustee of the Trustwere made defendants in the suit as claimants to the Prudential common stockand dividends. An agreed order dated January 27, 2005, was entered providingthat the Prudential common stock be transferred to JP Morgan as record ownerand that JP Morgan sell the stock. The January 27, 2005 court order alsoprovided that the proceeds from the sale be held by JP Morgan pendingresolution, by agreement or court order, of all conflicting claims to theproceeds. JP Morgan advised that the Prudential common stock was sold onJanuary 28, 2005 for total proceeds of approximately $17.5 million. JP Morganalso received funds in the amount of approximately $489,000, which weredividend payments related to the Prudential common stock. JP Morgan filed athird party action naming Mr. Blair as a third party defendant with an allegedinterest in the demutualization proceeds. On October 1, 2005, the court certified a class represented by Mr.Blair.

 

OnMarch 21, 2006, FirstCity received notice that the 152nd DistrictCourt, Harris County, Texas granted FirstCity’s motion for partial summaryjudgment.  The court’s summary judgmentorder additionally denied the claims to ownership of the demutualizationproceeds by FCLT Loans Asset Corporation and Tony J. Blair, individually and asrepresentative of the proposed class of employee beneficiaries.  The proceeds are being held by JP Morganpending resolution of the conflicting claims. According to JP Morgan’s report dated as of the close of businessFebruary 28, 2006, the demutualization proceeds held by JP Morgan totaledapproximately $17.7 million. The order granting FirstCity’s motion for partialsummary judgment rendered judgment in favor of FirstCity as to the ownership ofthe demutualization proceeds.  Thesummary judgment order is not final as all claims made by the parties were notaddressed by the summary judgment motions filed by the parties to thesuit.  FirstCity believes that the issueswhich were not resolved in the Court’s order primarily relate to claims made byFCLT Loans Asset Corporation for alleged breach of contract by FirstCity inclaiming the demutualization proceeds and alleged tortious interference byFirstCity with FCLT Loans Asset Corporation’s alleged right to thedemutualization proceeds.  FirstCityintends to move for summary judgment on these remaining claims.  The time period for filing of appeals of thecourt’s summary judgment order will not begin until a final judgment isentered.  Mr. Blair, as classrepresentative, has filed a motion for new trial to set aside the summaryjudgment in favor of FirstCity and for reconsideration of granting TimothyBlair’s motion for summary judgment.  Mr.Blair’s motion was submitted to the Court on April 24, 2006. FCLT Loans AssetCorporation has filed a motion for the Court to reconsider its order grantingthe partial summary judgment for FirstCity. FCLT Loans Asset Corporation’s motion was submitted to the Court on May1, 2006. FCLT Loans Asset Corporation and Timothy Blair have already indicatedtheir intent to appeal a final judgment awarding the demutualization proceedsto FirstCity.  FirstCity can not give anyassurances as to the time period for the appeal of any final judgment or thetiming of receipt or ultimate amount of any proceeds to be received.

 

**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, 2005.

 

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

 

None

 

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**Item 3. Defaults Upon Senior Securities.**

 

None

 

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

 

None

 

**Item 5. Other Information.**

 

None

 

**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                       |       | —     |       | Bylaws of the Company (incorporated herein  by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K dated  July 3, 1995 filed with the Commission on July 18, 1995).                                                                                                                                                                                                                                                                                  |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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 by  and between Funding LP and Drive dated as of August 18, 2000. (incorporated  herein by reference to Exhibit 10.42 of the Company’s Form 8-K dated August  25, 2000, filed with the Commission on September 11, 2000).                                                                                                                                                                                                       |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4                      |       | —     |       | 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).                                                                                                                                                                                                                                                 |

 

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| 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)                                                                                                                                |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                 |
| 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 March 31,  2006.                                                                                                        |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                 |
| 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 March 31,  2006.                                                                                                          |

 

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*           Filed herewith.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant 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: May 10, 2006 |                             |   |

 

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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                       |       | —     |       | Bylaws of the Company (incorporated herein  by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K dated  July 3, 1995 filed with the Commission on July 18, 1995).                                                                                                                                                                                                                                                                                  |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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 by  and between Funding LP and Drive dated as of August 18, 2000. (incorporated  herein by reference to Exhibit 10.42 of the Company’s Form 8-K dated August  25, 2000, filed with the Commission on September 11, 2000).                                                                                                                                                                                                       |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4                      |       | —     |       | 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)                                                                                                                                                                           |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.8                      |       | —     |       | 1995 Stock Option and Award Plan  (incorporated herein by reference to Exhibit A of the                                                                                                                                                                                                                                                                                                                                                                                    |

 

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|   |   |   |   | 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)                         |
|   |   |   |   |                                                                                                                                                                                                                                                                          |
| 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 March 31,  2006. |
|   |   |   |   |                                                                                                                                                                                                                                                                          |
| 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 March 31,  2006.   |

 

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