**UNITEDSTATES**

**SECURITIESAND 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 September 30, 2005** |
| ** **                                            | ** ** | ** **                                                                                    |
| o                                                     | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commissionfile number 033-19694**

 

**FirstCityFinancial Corporation**

(Exactname of registrant as specified in its charter)

 

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

 

**(254)761-2800**

(Registrant’stelephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that 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 an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act). Yes o     No ý

 

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 November 1, 2005 was 11,307,187.

 

 

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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  2.  Unregistered Sales of Equity  Securities and Use of Proceeds                                |   |
| Item  3.  Defaults Upon Senior Securities                                                             |   |
| Item 4.   Submission of Matters to a Vote of Security Holders                                         |   |
| Item 5.   Other Information                                                                           |   |
| Item 6.  Exhibits                                                                                     |   |
| SIGNATURES                                                                                                 |   |
| Exhibit Index                                                                                              |   |
| Certification of CEO Pursuant to Section  302                                                              |   |
| Certification of CFO Pursuant to  Section 302                                                              |   |
| Certification of CEO Pursuant to  Section 906                                                              |   |
| Certification of CFO Pursuant to  Section 906                                                              |   |

 

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| **Table of Contents** |
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**PART I**

 

**FINANCIALINFORMATION**

 

**Item1.  Financial Statements.**

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                       | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                                                                       | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                       | ** ** | ** **        | ** ** | ** **       | ** ** |
| Cash and cash equivalents                                                                                                                        |       | $                 | 7,522      |             | $          | 9,724 |   |
| Portfolio Assets, net                                                                                                                            |       | 43,197            |       | 37,952           |       |
| Loans receivable from  Acquisition Partnerships held for investment                                                                              |       | 19,394            |       | 21,255           |       |
| Equity investments                                                                                                                               |       | 65,652            |       | 57,815           |       |
| Deferred tax asset, net                                                                                                                          |       | 20,101            |       | 20,101           |       |
| Service fees receivable  from affiliates                                                                                                         |       | 1,269             |       | 1,631            |       |
| Other assets, net                                                                                                                                |       | 7,851             |       | 8,562            |       |
| Discontinued mortgage  assets                                                                                                                    |       | 167               |       | 1,817            |       |
| Total Assets                                                                                                                                     |       | $                 | 165,153    |             | $          | 158,857 |   |
| ** **                                                                                                                                       | ** ** | ** **        | ** ** | ** **       | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                   |       |              |       |             |       |
| Liabilities:                                                                                                                                     |       |              |       |             |       |
| Notes payable to affiliates                                                                                                                      |       | $                 | 671        |             | $          | 491 |   |
| Notes payable other                                                                                                                              |       | 61,538            |       | 50,812           |       |
| Minority interest                                                                                                                                |       | 1,207             |       | 1,292            |       |
| Liabilities from discontinued consumer operations                                                                                                |       | 311               |       | 9,033            |       |
| Liabilities from discontinued mortgage operations                                                                                                |       | —            |       | 50               |       |
| Other liabilities                                                                                                                                |       | 4,160             |       | 4,756            |       |
| Total Liabilities                                                                                                                                |       | 67,887            |       | 66,434           |       |
| Commitments and  contingencies (note 12)                                                                                                         |       |              |       |             |       |
| Stockholders’ equity:                                                                                                                       |       |              |       |             |       |
| Optional preferred stock (par value $.01 per share;  98,000,000 shares authorized; no shares issued or outstanding)                              |       | —            |       | —           |       |
| Common stock (par value $.01 per share; 100,000,000  shares authorized; shares issued and outstanding: 11,299,687 and 11,260,687,  respectively) |       | 113               |       | 113              |       |
| Paid in capital                                                                                                                                  |       | 99,809            |       | 99,364           |       |
| Accumulated deficit                                                                                                                              |       | (4,006            | )          | (10,289          | )          |
| Accumulated other comprehensive income                                                                                                           |       | 1,350             |       | 3,235            |       |
| Total Stockholders’ Equity                                                                                                                  |       | 97,266            |       | 92,423           |       |
| Total Liabilities and Stockholders’ Equity                                                                                                  |       | $                 | 165,153    |             | $          | 158,857 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                     | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                                     | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                      |       |                   |       |                  |       |   |   |   |   |
| Servicing fees from affiliates                                                 |       | $                      | 2,891      |                  | $          | 3,328 |   | $ | 8,972 |   | $ | 10,076 |   |
| Gain on resolution of Portfolio Assets                                         |       | 1,299                  |       | 601                   |       | 4,366 |   | 838 |   |
| Interest income from affiliates                                                |       | 420                    |       | 653                   |       | 1,293 |   | 1,694 |   |
| Loan interest income                                                           |       | 825                    |       | 215                   |       | 1,903 |   | 339 |   |
| Other income                                                                   |       | 269                    |       | 489                   |       | 1,079 |   | 2,303 |   |
| Total revenues                                                                 |       | 5,704                  |       | 5,286                 |       | 17,613 |   | 15,250 |   |
| Expenses:                                                                      |       |                   |       |                  |       |   |   |   |   |
| Interest and fees on notes payable to affiliates                               |       | 9                      |       | 12                    |       | 27 |   | 57 |   |
| Interest and fees on notes payable — other                                |       | 909                    |       | 2,074                 |       | 2,619 |   | 5,580 |   |
| Interest on shares subject to mandatory redemption                             |       | —                 |       | 66                    |       | — |   | 199 |   |
| Salaries and benefits                                                          |       | 3,571                  |       | 3,673                 |       | 11,413 |   | 11,227 |   |
| Provision for loan and impairment losses                                       |       | 322                    |       | 1                     |       | 436 |   | 23 |   |
| Occupancy, data processing, communication and other                            |       | 1,908                  |       | 2,141                 |       | 5,574 |   | 5,374 |   |
| Total expenses                                                                 |       | 6,719                  |       | 7,967                 |       | 20,069 |   | 22,460 |   |
| Equity in earnings of investments                                              |       | 1,783                  |       | 3,656                 |       | 8,874 |   | 10,470 |   |
| Earnings from continuing operations before income  taxes and minority interest |       | 768                    |       | 975                   |       | 6,418 |   | 3,260 |   |
| Income tax benefit (expense)                                                   |       | (79                    | )          | 11                    |       | (321 | ) | (145 | ) |
| Minority interest                                                              |       | 3                      |       | (34                   | )          | (36 | ) | (43 | ) |
| Earnings from  continuing operations                                           |       | 692                    |       | 952                   |       | 6,061 |   | 3,072 |   |
| Discontinued operations                                                        |       |                   |       |                  |       |   |   |   |   |
| Earnings (loss) from discontinued operations                                   |       | (281                   | )          | 2,211                 |       | (378 | ) | 8,666 |   |
| Income taxes                                                                   |       | 600                    |       | (255                  | )          | 600 |   | (682 | ) |
| Net earnings from discontinued operations                                      |       | 319                    |       | 1,956                 |       | 222 |   | 7,984 |   |
| Net earnings                                                                   |       | $                      | 1,011      |                  | $          | 2,908 |   | $ | 6,283 |   | $ | 11,056 |   |
| Basic earnings per  common share are as follows:                               |       |                   |       |                  |       |   |   |   |   |
| Earnings from continuing operations                                            |       | $                      | 0.06       |                  | $          | 0.09 |   | $ | 0.54 |   | $ | 0.28 |   |
| Discontinued operations                                                        |       | $                      | 0.03       |                  | $          | 0.17 |   | $ | 0.02 |   | $ | 0.71 |   |
| Net earnings to common stockholders                                            |       | $                      | 0.09       |                  | $          | 0.26 |   | $ | 0.56 |   | $ | 0.99 |   |
| Weighted average common shares outstanding                                     |       | 11,298                 |       | 11,236                |       | 11,278 |   | 11,223 |   |
| Diluted earnings per common share are as follows:                              |       |                   |       |                  |       |   |   |   |   |
| Earnings from continuing operations                                            |       | $                      | 0.05       |                  | $          | 0.08 |   | $ | 0.50 |   | $ | 0.26 |   |
| Discontinued operations                                                        |       | $                      | 0.03       |                  | $          | 0.17 |   | $ | 0.02 |   | $ | 0.68 |   |
| Net earnings to common stockholders                                            |       | $                      | 0.08       |                  | $          | 0.25 |   | $ | 0.52 |   | $ | 0.94 |   |
| Weighted average common shares outstanding                                     |       | 12,008                 |       | 11,837                |       | 12,012 |   | 11,816 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** | **Accumulated**   | ** ** | ** **             | ** ** |
|---------------------------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                          | ** ** | **Number of** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** | **Other**         | ** ** | **Total**              | ** ** |
| ** **                                                          | ** ** | **Common**    | ** ** | **Common** | ** ** | **Paid in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                          | ** ** | **Shares**    | ** ** | **Stock**  | ** ** | **Capital** | ** ** | **Deficit**     | ** ** | **Income**        | ** ** | **Equity**             | ** ** |
| ** **                                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | ** **             | ** ** |
| **Balances, December 31, 2003**                                     |       | 11,193,687    |       | $          | 112        |        | $          | 99,168          |       | $                 | (73,923    | )                      | $          | 3,612 |   | $ | 28,969 |   |
| Exercise of common stock options                                    |       | 67,000        |       | 1          |       | 196         |       | —          |       | —            |       | 197                    |       |
| Comprehensive income:                                               |       |          |       |       |       |        |       |            |       |              |       |                   |       |
| Net earnings for 2004                                               |       | —        |       | —     |       | —      |       | 63,634          |       | —            |       | 63,634                 |       |
| Translation adjustments                                             |       | —        |       | —     |       | —      |       | —          |       | (377              | )          | (377                   | )          |
| Total comprehensive income                                          |       |          |       |       |       |        |       |            |       |              |       | 63,257                 |       |
| **Balances, December 31, 2004**                                     |       | 11,260,687    |       | 113        |       | 99,364      |       | (10,289         | )          | 3,235             |       | 92,423                 |       |
| Exercise of common stock options                                    |       | 39,000        |       | —     |       | 162         |       | —          |       | —            |       | 162                    |       |
| Additional paid-in capital arising from sale of  shares by investee |       | —        |       | —     |       | 283         |       | —          |       | —            |       | 283                    |       |
| Comprehensive income:                                               |       |          |       |       |       |        |       |            |       |              |       |                   |       |
| Net earnings for the first nine months of 2005                      |       | —        |       | —     |       | —      |       | 6,283           |       | —            |       | 6,283                  |       |
| Translation adjustments                                             |       | —        |       | —     |       | —      |       | —          |       | (1,885            | )          | (1,885                 | )          |
| Total comprehensive income                                          |       |          |       |       |       |        |       |            |       |              |       | 4,398                  |       |
| **Balances, September 30, 2005**                                    |       | 11,299,687    |       | $          | 113        |        | $          | 99,809          |       | $                 | (4,006     | )                      | $          | 1,350 |   | $ | 97,266 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                       | ** ** | **September 30,**     | ** ** |
| ** **                                                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                           |       |                  |       |   |   |
| Net earnings                                                                     |       | $                     | 6,283      |   | $ | 11,056 |   |
| Adjustments to reconcile net earnings to net cash  used in operating activities: |       |                  |       |   |   |
| Net earnings from discontinued operations                                        |       | (222                  | )          | (7,984 | ) |
| Purchase of Portfolio Assets and loans receivable,  net                          |       | (19,306               | )          | (38,237 | ) |
| Proceeds applied to principal on Portfolio Assets  and loans receivable          |       | 20,189                |       | 9,195 |   |
| Gain on resolution of Portfolio Assets                                           |       | (4,366                | )          | (838 | ) |
| Capitalized interest and costs on Portfolio Assets  and loans receivable         |       | (217                  | )          | (138 | ) |
| Provision for loan and impairment losses                                         |       | 436                   |       | 23 |   |
| Equity in earnings of investments                                                |       | (8,874                | )          | (10,470 | ) |
| Depreciation and amortization                                                    |       | 661                   |       | 612 |   |
| Decrease in service fees receivable from affiliate                               |       | 362                   |       | 504 |   |
| Increase in other assets                                                         |       | (489                  | )          | (81 | ) |
| Change in debt imputed value                                                     |       | 214                   |       | (759 | ) |
| Decrease in other liabilities                                                    |       | (1,722                | )          | (3,232 | ) |
| Net cash used in operating activities                                            |       | (7,051                | )          | (40,349 | ) |
| Cash flows from  investing activities:                                           |       |                  |       |   |   |
| Property and equipment, net                                                      |       | (108                  | )          | (168 | ) |
| Contributions to Acquisition Partnerships and  Servicing Entities                |       | (18,373               | )          | (9,732 | ) |
| Distributions from Acquisition Partnerships and  Servicing Entities              |       | 17,907                |       | 22,074 |   |
| Net cash provided by (used in) investing activities                              |       | (574                  | )          | 12,174 |   |
| Cash flows from  financing activities:                                           |       |                  |       |   |   |
| Borrowings under notes payable — other                                      |       | 68,622                |       | 60,767 |   |
| Payments of notes payable to affiliates                                          |       | (34                   | )          | (18 | ) |
| Payments of notes payable — other                                           |       | (56,427               | )          | (29,345 | ) |
| Payment of dividends on preferred stock                                          |       | —                |       | (1,392 | ) |
| Proceeds from issuance of common stock                                           |       | 162                   |       | 121 |   |
| Net cash provided by financing activities                                        |       | 12,323                |       | 30,133 |   |
| Net cash provided by continuing operations                                       |       | 4,698                 |       | 1,958 |   |
| Net cash provided by (used in) discontinued operations                           |       | (6,900                | )          | 562 |   |
| Net increase (decrease)  in cash and cash equivalents                            |       | (2,202                | )          | 2,520 |   |
| Cash and cash  equivalents, beginning of period                                  |       | 9,724                 |       | 2,745 |   |
| Cash and cash  equivalents, end of period                                        |       | $                     | 7,522      |   | $ | 5,265 |   |
| Supplemental disclosure  of cash flow information:                               |       |                  |       |   |   |
| Cash paid during the period for:                                                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Interest                                                                         |       | $                     | 1,982      |   | $ | 5,073 |   |
| Income taxes                                                                     |       | 317                   |       | 779 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

5

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**September30, 2005**

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

**(Unaudited)**

 

**(1)  Basis of Presentation**

 

FirstCityFinancial Corporation (the “Company” or “FirstCity”) is a financial servicescompany with offices throughout the United States and Mexico, with a presencein France and South America. At September 30, 2005, the Company was engaged in oneprincipal reportable segment - portfolio asset acquisition and resolution.  Theportfolio asset acquisition and resolution business involves acquiringportfolios of loans, real estate and other assets or single assets(collectively referred to as “Portfolios” or  “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. On September 21, 2004, FirstCity and certain of its subsidiariesentered into a Securities Purchase Agreement relating to the sale of a 31%beneficial ownership interest in Drive Financial Services LP (“Drive”) and itsgeneral partner, Drive GP LLC, to IFA Drive GP Holdings LLC (“IFA-GP”), IFADrive LP Holdings LLC (“IFA-LP”) and Drive Management LP (“MG-LP”).  As a result of the execution of the saleagreement, the consumer lending segment conducted through Drive was no longerconsidered a principal reportable segment and is treated as a discontinuedoperation.

 

The unaudited consolidated financial statements of FirstCity reflect, inthe opinion of management, all adjustments, consisting only of normal andrecurring adjustments, necessary to present fairly FirstCity’s consolidatedfinancial position at September 30, 2005, its results of operations for the threeand nine month periods ended September 30, 2005 and 2004 and cash flows for thenine month periods ended September 30, 2005 and 2004.  Certain disclosures have been condensed oromitted from these financial statements. Accordingly, these financialstatements should be read with the consolidated financial statements includedin the Company’s 2004 Annual Report on Form 10-K.  Certain amounts in the consolidated financialstatements for prior years have been reclassified to conform with current consolidatedfinancial statement presentation.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Significant estimates include (i) theestimation of future collections on purchased portfolio assets used in thecalculation of net gain on resolution of portfolio assets, (ii) interest rateenvironments, (iii) valuation of the deferred tax asset, and (iv) prepaymentspeeds and collectibility of loans held in inventory, in securitization trustsand held for investment. Actual results could differ materially from thoseestimates.

 

**(2)  Liquidity and Capital Resources**

 

The Company requiresliquidity to fund its operations, working capital, payment of debt, equity foracquisition of Portfolio Assets, investments in and advances to entities formedwith other investors to acquire Portfolios (“Acquisition Partnerships”) andother investments. The potential sources of liquidity are funds generated fromoperations, equity distributions from the Acquisition Partnerships, interestand principal payments on subordinated intercompany debt, dividends from theCompany’s subsidiaries, borrowings from revolving lines of credit and othercredit facilities, proceeds from equity market transactions, securitization andother structured finance transactions and other special purpose short-termborrowings.

 

FirstCity has a $96million revolving acquisition facility with Bank of Scotland that matures in November2008.  This facility is used to financethe equity portion of distressed asset pool purchases and to provide for theissuance of Letters of Credit and working capital loans.  The $96 million facility (i) allows loans tobe made in Euros up to a maximum amount in Euros that is equivalent to 35million U.S. dollars, (ii) allows loans to be made for acquisition of PortfolioAssets in Latin America of up to $35 million, (iii) provides for an interestrate of London Interbank Offered Rate (LIBOR) plus 2.50% to 2.75%, (iv) providesfor an annual commitment fee of 0.20% of the unused balance of the revolvingacquisition facility, and (v) provides that the aggregate borrowings under thefacility do not exceed 60% of the net present value of FirstCity’s interest inPortfolio Assets and in Acquisition Partnerships pledged to secure theacquisition facility.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

In August 2005, FH Partners, L.P., an indirect wholly-owned affiliateof FirstCity, and Bank of Scotland, acting through its New York branch, asagent for itself as lender, entered into a Revolving Credit Agreement thatprovides a $50 million revolving portfolio acquisition facility for FHPartners, L.P. to be secured by all of the assets of FH Partners, L.P.  The loan facility will be used to financeportfolio and asset purchases.  Thefacility (i) allows loans to be made for the acquisition of portfolioassets in the United States, (ii) provides that each loan may be in anamount of up to 70% of the net present value of the assets being acquired withthe proceeds of the loan, (iii) provides that the aggregate outstandingbalances of all loans will not exceed 65% of the net present value of theassets securing the loan facility, (iv) provides for an interest rate of LIBORplus 2.0%, (v) provides for a commitment fee of 0.20% of the unusedbalance of the revolving acquisition facility, (vi) provides for autilization fee of 0.75% of the amount of each loan made under the loanfacility, (vii) provides for an upfront fee of $350 thousand,(viii) provides for facility fees of $100 thousand, for the periodcommencing on the Effective Date to but excluding the first anniversarythereof, $75 thousand, for the period commencing on the first anniversary ofthe Effective Date to but excluding the second anniversary thereof, and $50thousand, for each subsequent one-year period, and (ix) provides for a maturitydate of November 12, 2008.  Theobligations of FH Partners, L.P. under the Revolving Credit Agreement areguaranteed by FirstCity and the primary wholly-owned subsidiaries of FirstCity.

 

At September 30, 2005,the Company had $10.1 million in Euro-denominated debt for the purpose ofhedging a portion of the net equity investments in Europe. In general, the typeof risk hedged relates to the foreign currency exposure of net investments inEurope caused by movements in Euro exchange rates. The Company entered into thehedging relationship such that changes in the net investments being hedged areexpected to be offset by corresponding changes in the values of theEuro-denominated debt. Effectiveness of the hedging relationship is measuredand designated at the beginning of each month by comparing the outstandingbalance of the Euro-denominated debt to the carrying value of the designatednet equity investments. The net foreign currency translation gain (loss) includedin accumulated other comprehensive income relating to the Euro-denominated debtwas ($.10) million and $1.2 million, respectively, for the three and ninemonths ended September 30, 2005 and zero for the same periods in 2004.

 

BoS (USA) Inc. (“BoS(USA)”) has a warrant to purchase 425,000 shares of the Company’s voting CommonStock at $2.3125 per share. BoS (USA) is entitled to additional warrants inconnection with this existing warrant for 425,000 shares under certain specificsituations to retain its ability to acquire approximately 4.86% of the Company’svoting Common Stock.  The warrant willexpire on August 31, 2010, if it is not exercised prior to that date.

 

Management believes thatthe Bank of Scotland loan facilities, the related fees generated from theservicing of assets and equity distributions from existing AcquisitionPartnerships and wholly-owned portfolios will allow the Company to meet itsobligations as they come due during the next twelve months.

 

**(3)****         New Accounting Pronouncements**

 

In December 2003, theAccounting Standards Executive Committee issued Statement of Position No. 03-3,*Accounting for Certain Loans or DebtSecurities Acquired in a Transfer*(“SOP 03-3”). SOP 03-3 addressesaccounting for differences between contractual cash flows and cash flowsexpected to be collected from an investor’s initial investment in loans or debtsecurities acquired in a transfer if those differences are attributable, atleast in part, to credit quality. SOP 03-3 limits the yield that may beaccreted on a loan portfolio to the excess of undiscounted expected cash flowsover the initial investment in the loan portfolio. SOP 03-3 became effectiveJanuary 1, 2005. FirstCity accounts for all loans acquired after 2004 inaccordance with SOP 03-3. For loans acquired prior to January 1, 2005,FirstCity adopted the provisions of SOP 03-3, as they apply to decreases incash flows expected to be collected, on a prospective basis.

 

In December 2004, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), *Share-Based Payment*(“SFAS 123R”)*.* SFAS 123R supersedes APB Opinion No. 25, whichrequires recognition of an expense when goods or services are provided. SFAS123R requires the determination of the fair value of the share-basedcompensation at the grant date and the recognition of the related expense overthe period in which the share-based compensation vests. SFAS 123R permits aprospective or two modified versions of retrospective application under whichfinancial statements for prior periods are adjusted on a basis consistent withthe pro forma disclosures required for those periods by the original SFAS No.123. The Company will utilize the prospective method.  In April 2005, the SEC amended the compliancedate of SFAS 123R to allow companies to implement SFAS 123R at the beginning oftheir next fiscal year.  Therefore, onJanuary 1, 2006, the Company will begin recognizing an expense for unvestedshare-based compensation that has been issued or will be issued after thatdate. Based on current unvested stock options

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

outstanding, the Company anticipates approximately $1.7million in unvested compensation cost at January 1, 2006 to be expensedprospectively.

 

In December 2004, theFASB issued FASB Staff Position (FSP) No. 109-2, *Accountingand Disclosure Guidance for the Foreign Earnings Repatriation Provision withinthe American Jobs Creation Act of 2004*, which provides guidanceunder SFAS No. 109, *Accounting for IncomeTaxes*, with respect to recording the potential impact of therepatriation provisions of the American Jobs Creation Act of 2004 (the “JobsAct”) on enterprises’ income tax expense and deferred tax liability. The JobsAct was enacted on October 22, 2004. The Jobs Act creates a temporary incentivefor U.S. corporations to repatriate accumulated income earned abroad by providingan 85% dividends received deduction for certain dividends from controlledforeign corporations. FSP No. 109-2 states that an enterprise is allowed timebeyond the financial reporting period of enactment to evaluate the effect ofthe Jobs Act on its plan for reinvestment or repatriation of foreign earningsfor purposes of applying SFAS No. 109. Management does not expect FSP No. 109-2to have an impact on the Company as any taxes on repatriated foreign earningsare offset by the Company’s NOLs.

 

On June 29, 2005,the FASB ratified the consensus reached by Emerging Issues Task Force (“EITF”)on Issue No. 04-5, *Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity when the Limited Partners Have Certain Rights*.  The consensus reached by the EITF at theJune 2005 meeting was that a sole general partner is presumed to control alimited partnership (or similar entity) and should consolidate the limitedpartnership unless (1) the limited partners possess substantive kick-outrights or (2) the limited partners possess substantive participatingrights. This ratification of EITF Issue No. 04-5 has caused the amendmentsof Statement of Position 78-9, Accounting for Investments in Real Estate Ventures,  and EITF Issue No. 96-16, *Investor’s Accounting for an Investee When the Investor has a Majorityof the Voting Interest but the Minority Shareholder or Shareholders HaveCertain Approval or Veto Rights*. EITF 04-5 is effective for all new and modified agreements effectiveJune 29, 2005. For pre-existing agreements that are not modified, the EITFis effective as of the beginning of the first fiscal reporting period beginningafter December 15, 2005. The Company has evaluated the impact of theadoption of EITF 04-5 and does not believe the impact will be significant tothe Company’s results of operations or financial position.

 

In November 2005, theFASB issued FASB Staff Position FAS 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 impaired loss.  FSP 115-1 also includes accounting considerationssubsequent to the recognition of an other-than-temporary impairment andrequires certain disclosures about unrealized losses that have not beenrecognized as other-than-temporary impairments. The provisions of FSP 115-1 are effective for reporting periodsbeginning after December 15, 2005.  The Company does not anticipate thatthis statement will have a significant impact on its financial position orresults of operations.

 

**(4)  Discontinued Operations**

 

Discontinued operations are comprised of two components previouslyreported as the Company’s residential and commercial mortgage banking business (“Mortgage”)and the consumer lending business conducted through the Company’s minorityinterest investment in Drive (“Consumer”). Earnings (loss) from discontinued operations are summarized as follows:

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Mortgage                                  |       | $                      | (252       | )                     | $          | (950 | ) | $ | (346 | ) | $ | (1,200 | ) |
| Consumer                                  |       | 571                    |       | 2,906                 |       | 568 |   | 9,184 |   |
| Net earnings from discontinued operations |       | $                      | 319        |                  | $          | 1,956 |   | $ | 222 |   | $ | 7,984 |   |
|                                           |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |

 

*Mortgage*

 

At September 30, 2005, 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,” andthe Company is contractually obligated to service these assets.  The cash flows are collected over a period oftime and are valued using prepayment assumptions of 32% for fixed rate loansand 34% for variable rate loans. Overall loss rates are estimated at 14% ofcollateral.  The Company recorded provisionsof $.3 million and $1.2 million in the first nine months of 2005 and 2004,respectively, for losses from discontinued mortgage operations.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

In April 2005, theCompany exercised 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.  At September30, 2005, 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.”  See note 5 for a description of theaccounting policy for these loans.

 

*Consumer*

 

On September 21,2004, FirstCity and certain of its subsidiaries entered into a definitive agreementto sell a 31% beneficial ownership interest in Drive and its general partner,Drive GP LLC, to IFA-GP, IFA-LP and MG-LP for a total purchase price of $108.5million in cash, resulting in distributions and payments to FirstCity in theaggregate amount of $86.8 million in cash, from various sources.  The sale was completed on November 1, 2004,and net cash proceeds from these transactions were primarily used to pay offdebt.

 

Pursuant to SFASNo. 144, *Accounting for the Impairment or Disposal of Long-LivedAssets*, the consolidated financial statements have been reclassifiedfor all periods presented to reflect the operations, assets and liabilities ofthe consumer business segment as discontinued operations.  There were no consumer assets held for saleas of September 30, 2005 and December 31, 2004. The liabilities of such operations have been classified as “Liabilitiesfrom discontinued consumer operations,” respectively on the September 30, 2005and December 31, 2004 balance sheets and consisted primarily of accrued statetaxes at September 30, 2005.   Theliability at December 31, 2004 related to accrued state taxes and an $8.0million participation liability owed to Bank of Scotland, which was paid in thefirst quarter of 2005.  An estimated taxprovision of $.6 million was reversed in third quarter of 2005 due to lowerthan anticipated state income taxes related to the sale of Drive.

 

The net earningsfrom discontinued consumer operations are classified on the consolidatedstatements of operations as “Earnings from discontinued operations.”  Summarized results of discontinued consumeroperations are as follows:

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                       | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Equity in earnings                               |       | $                      | —     |                  | $          | 4,680 |   | $ | — |   | $ | 14,835 |   |
| Interest and fees on  notes payable to affiliate |       | —                 |       | (584                  | )          | — |   | (2,001 | ) |
| Other expenses                                   |       | (29                    | )          | —                |       | (32 | ) | (4 | ) |
| Income taxes                                     |       | 600                    |       | (255                  | )          | 600 |   | (682 | ) |
| Minority interest                                |       | —                 |       | (935                  | )          | — |   | (2,964 | ) |
| Earnings from discontinued consumer operations   |       | $                      | 571        |                  | $          | 2,906 |   | $ | 568 |   | $ | 9,184 |   |

 

**(5)  Portfolio Assets**

 

Portfolio Assets are summarized as follows:

 
| ** **                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                  | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Loan Portfolios                             | ** ** | ** **        | ** ** | ** **       | ** ** |
| Loans Acquired Prior to 2005                | ** ** | ** **        | ** ** | ** **       | ** ** |
| Non-performing Portfolio Assets             |       | $                 | 11,950     |             | $          | 19,993 |   |
| Performing Portfolio Assets                 |       | 12,388            |       | 16,039           |       |
| Loans Acquired After 2004                   | ** ** | ** **        | ** ** | ** **       | ** ** |
| Loans acquired with credit deterioration    |       | 9,426             |       | —           |       |
| Loans acquired with no credit deterioration |       | 4,471             |       | —           |       |
| Outstanding balance                         |       | 38,235            |       | 36,032           |       |
| Allowance for loan losses                   |       | (419              | )          | —           |       |
| Carrying amount of loans, net of allowance  |       | 37,816            |       | 36,032           |       |
|                                        |       |              |       |             |       |
| Real Estate Portfolios,  net of allowance   |       | 2,985             |       | 1,920            |       |
| Operating Lease  Equipment, net             |       | 2,396             |       | —           |       |
| Portfolio Assets, net                       |       | $                 | 43,197     |             | $          | 37,952 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

Portfolio Assets are pledged to secure notes payable that arenon-recourse to FirstCity or any affiliate other than the entity that incurredthe debt.  See Note 2 for a descriptionof the Revolving Credit agreement between FH Partners, L.P. and Bank ofScotland, which is guaranteed by FirstCity and the primary wholly-ownedsubsidiaries of FirstCity.

 

FirstCity primarily acquiresloans in groups or portfolios that have experienced deterioration of creditquality between origination and the Company’s acquisition of the loans.  The amount paid for a loan reflects FirstCity’sdetermination that it is probable the Company will be unable to collect allamounts due according to the loan’s contractual terms.

 

On January 1, 2005, FirstCityadopted the provisions of SOP 03-3.  Theadoption of SOP 03-3 did not have a material impact on the Company’sconsolidated results of operations.  Forloan portfolios acquired prior to January 1, 2005, FirstCity designated theseloans as non-performing Portfolio Assets or performing Portfolio Assets.  Such designation was made at the acquisitionof the pool and does not change even though the actual performance of the loansmay change. FirstCity accounts for all loans acquired after 2004 in accordancewith SOP 03-3.  Pursuant to SOP 03-3, thefollowing is a description of each classification and the related accountingpolicy accorded to each Portfolio type:

 

**LoansAcquired Prior to 2005**

 

*Non-PerformingPortfolio Assets*

 

Non-performing PortfolioAssets consist primarily of distressed loans and loan related assets, such asforeclosed upon collateral. Prior to January 1, 2005, Portfolio Assets weredesignated as non-performing if a majority of all of the loans in the Portfoliowere significantly under performing in accordance with the contractual terms ofthe underlying loan agreements at the date of acquisition. Net gain onresolution of non-performing Portfolio Assets is recognized as income to theextent that proceeds collected exceed a pro rata portion of allocated cost fromthe pool. Cost allocation is based on a proration of actual proceeds divided bytotal estimated proceeds of the pool. No interest income is recognizedseparately on non-performing Portfolio Assets. All proceeds, of whatever type,are included in proceeds from resolution of Portfolio Assets in determining thegain on resolution of such assets. Once a non-performing Portfolio Assetbecomes impaired, all future proceeds are allocated to reduce the carryingvalue of the Portfolio.  Accounting fornon-performing Portfolios is on a pool basis as opposed to an individualasset-by-asset basis.

 

*PerformingPortfolio Assets*

 

Performing PortfolioAssets consist primarily of Portfolios of consumer and commercial loansacquired at a discount from the aggregate amount of the borrowers’ obligation.Prior to January 1, 2005, performing Portfolio Assets were accounted for usingthe interest method – acquisition discounts for the Portfolio as a whole areaccreted as an adjustment to yield over the estimated life of the Portfolio.  Performing Portfolio Assets are carried atthe unpaid principal balance of the underlying loans, net of acquisitiondiscounts and allowance for loan losses. Significant increases in expectedfuture cash flows may be recognized prospectively through an upward adjustmentof the internal rate of return (“IRR”) over a portfolio’s remaining life. Anyincrease to the IRR then becomes the new benchmark for impairment testing.Income on performing Portfolio Assets is accrued monthly based on each loanpool’s effective IRR. Cash flows greater than the interest accrual will reducethe carrying value of the pool. Likewise, cash flows that are less than theaccrual will increase the carrying balance. The IRR is estimated andperiodically recalculated based on the timing and amount of anticipated cash flowsusing the Company’s proprietary collection model. Gains are recognized on theperforming Portfolio Assets when sufficient funds are received to fully satisfythe obligation on loans included in the pool, either from funds from theborrower or sale of the loan. The gain recognized represents the differencebetween the proceeds received and the allocated carrying value of theindividual loan in the pool.

 

*Impairmentof Loans Acquired Prior to 2005*

 

Management’s bestestimate of IRR as of January 1, 2005, is the basis for subsequent impairmenttesting. If it is probable that all cash flows estimated at acquisition plusany changes to expected cash flows arising from changes in estimates afteracquisition would not be collected, the carrying value of a pool would bewritten down to maintain the then current IRR. Prior to January 1, 2005, impairment charges would be taken to theincome statement with a corresponding write-off of the receivable balance.  Consequently, no allowance for loan loss wasrecorded prior to January 1, 2005.  Forthe nine months ended September 30, 2005, FirstCity established an allowancefor loan losses by a charge to the income statement of $.4 million.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

A pool can become fullyamortized (zero carrying balance on the balance sheet) while still generatingcash collections. In this case, all cash collections are recognized as revenuewhen received. Additionally, the Company uses the cost recovery method whentiming and amount of collections on a particular pool of accounts cannot bereasonably predicted. Under the cost recovery method, no revenue is recognizeduntil the Company has fully collected the cost of the portfolio, or until suchtime that the Company considers the collections to be probable and estimableand begins to recognize income based on the interest method as described above.

 

**LoansAcquired After 2004**

 

*LoansAcquired With Credit Deterioration*

 

At acquisition, FirstCityreviews each loan to determine whether there is evidence of deterioration ofcredit quality since origination and if it is probable that FirstCity will beunable to collect all amounts due according to the loan’s contractual terms. Ifboth conditions exist, FirstCity determines whether each such loan is to beaccounted for individually or whether such loans will be assembled into poolsof loans based on common risk characteristics (loan type, collateral type,geographical location, performance status and borrower relationship).

 

FirstCity considersexpected prepayments, and estimates the amount and timing of undiscountedexpected principal, interest, and other cash flows (expected at acquisition)for each loan and each subsequently aggregated pool of loans. FirstCitydetermines the excess of the loan’s or pool’s scheduled contractual principaland contractual interest payments over all cash flows expected at acquisitionas an amount that should not be accreted (nonaccretable difference). The excessof the loan’s cash flows expected to be collected at acquisition over theinitial investment in the loan or pool is accreted into interest income overthe remaining life of the loan or pool (accretableyield).  Changes in accretableyield at September 30, 2005 were as follows:

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                          | ** ** | **2005**               | ** ** | **2005**              | ** ** |
| Beginning Balance                                   |       | $                      | 2,830      |                  | $          | — |   |
| Additions                                           |       | 326                    |       | 3,267                 |       |
| Accretion                                           |       | (250                   | )          | (361                  | )          |
| Reclassification from (to) nonaccretable difference |       | —                 |       | —                |       |
| Disposals                                           |       | (206                   | )          | (206                  | )          |
| Ending Balance                                      |       | $                      | 2,700      |                  | $          | 2,700 |   |

 

Over the life of the loanor pool, FirstCity continues to estimate cash flows expected to be collected.FirstCity evaluates at the balance sheet date whether the present value of itsloans determined using the effective interest rates has decreased below bookvalue and if so, a valuation allowance is established for any impairmentidentified through provisions charged to operations in the period theimpairment is identified. The present value of any subsequent increase in theloan’s or pool’s actual cash flows or cash flows expected to be collected isused first to reverse any existing valuation allowance for that loan or pool.Any remaining increases in the present value of cash flows expected to becollected will be used to recalculate the amount of accretable yield recognizedon a prospective basis over the pool’s remaining life.

 

FirstCity establishesvaluation allowances for all acquired loans subject to SOP 03-3 to reflect onlythose losses incurred after acquisition—that is, the present value of cashflows expected at acquisition that are not expected to be collected. Valuationallowances are established only subsequent to acquisition of the loans.  As of September 30, 2005, FirstCity did not establishan allowance for acquired loans subject to SOP 03-3.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

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

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                          | ** ** | **2005**               | ** ** | **2005**              | ** ** |
| Face value at  acquisition                          |       | $                      | 1,354      |                  | $          | 15,851 |   |
| Cash flows expected to  be collected at acquisition |       | 1,311                  |       | 15,004                |       |
| Basis in acquired loans  at acquisition             |       | 985                    |       | 11,737                |       |
|                                                     |            |                        |            |                       |            |  |  |

 

*LoansAcquired With No Credit Deterioration*

 

Loans acquired withoutevidence of credit deterioration at acquisition for which FirstCity has thepositive intent and ability to hold for the foreseeable future are classifiedas held for investment and reported at their unpaid principal balance net ofunamortized purchase discounts or premiums. The net unamortized purchasediscounts as of September 30, 2005 and December 31, 2004 were $36 thousand andzero, respectively.

 

Interest accrual ceaseswhen payments become 90 days contractually past due.  An allowance for loan losses is establishedwhen a loan becomes impaired.  A loan isimpaired when full payment under the loan terms is not expected.  Management estimates the allowance balancerequired using past loan loss experience, the nature and volume of theportfolio, information about specific borrower situations and estimatedcollateral values, economic conditions, and other factors.  Allocations of the allowance may be made forspecific loans, but the entire allowance is available for any loan that, inmanagement’s judgment, should be charged off. Loan losses are charged againstthe allowance when management believes that the uncollectibility of a loanbalance is confirmed.  At September 30,2005, the Company had established a valuation allowance of $22 thousand onthese loans.

 

**RealEstate Portfolios**

 

Real estate Portfoliosconsist of real estate acquired from a variety of sellers. Such Portfolios arecarried at the lower of cost or fair value less estimated costs to sell. Costsrelating to the development and improvement of real estate for its intended useare capitalized, whereas those relating to holding assets are charged toexpense. Income or loss is recognized upon the disposal of the real estate.Rental income, net of expenses, on real estate Portfolios is recognized whenreceived. Accounting for the Portfolios is on an individual asset-by-assetbasis as opposed to a pool basis. Subsequent to acquisition, the amortized costof a real estate Portfolio is evaluated for impairment on a quarterly basis.The evaluation of impairment is determined based on the review of the estimatedfuture cash receipts, which represents the net realizable value of the realestate Portfolio. A valuation allowance is established for any impairmentidentified through provisions charged to operations in the period theimpairment is identified. The Company recorded an allowance of $18 thousand forimpairment charges during the nine months ended September 30, 2005 and noneduring the nine months ended September 30, 2004.

 

**Operating Lease Equipment**

 

Operating lease equipment is carried at cost lessaccumulated depreciation and is depreciated to estimated residual value usingthe straight-line method over the estimated useful life or the term of thelease.  Income from this operating leaseis reported on a straight-line basis over, and in accordance with, the terms ofthe lease.

 

**(6)  Loans Receivable from Acquisition PartnershipsHeld for Investment**

 

Loans receivable from Acquisition Partnerships held for investmentconsist primarily of loans from certain partnerships located in Mexico and aresummarized as follows:

 

| ** **    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------|------------|-------------------|------------|------------------|------------|
| ** **    | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Latin America |       | $                 | 17,114     |             | $          | 19,170 |   |
| Europe        |       | 513               |       | 548              |       |
| Domestic      |       | 1,767             |       | 1,537            |       |
|          |       | $                 | 19,394     |             | $          | 21,255 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

The loans receivable fromAcquisition Partnerships are secured by the assets/loans acquired by thepartnerships with purchase money loans provided by affiliates of the investorsto the partnerships to purchase the asset pools held in those entities. Theseloans are evaluated for impairment by analyzing the expected future cash flowsfrom the underlying assets within each pool to determine that the cash flowswere sufficient 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 losses whichwere recorded to reduce the loans and interest receivable from certain Mexicanpartnerships were $.5 million and $.4 million during the first nine months of 2005and 2004, 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*.

 

**(7)  Equity Investments**

 

The Company has investments in Acquisition Partnerships and their generalpartners and investments in servicing entities that are accounted for under theequity method. During the first quarter of 2005, FirstCity invested $2.0million to increase its ownership percentage in MCS et Associes, S.A. (“MCS”), aFrench servicing company, from 10% to 12% and in PRL Development, SAS, a FrenchAcquisition Partnership, from 33% to 43%. These additional investments provideda combined direct and indirect ownership interest in MCS of 18.3%.

 

In 2005, MCS soldits investment in Common Stock of FirstCity resulting in a gain of $1.5million.  FirstCity accounted for its proportionate interest in this gainas an increase in the Company’s carrying amount of its investment in MCS of $.3million and an increase in additional paid-in capital.

 

The condensed combined financial position and results of operations ofthe Acquisition Partnerships (excluding servicing entities), which include thedomestic and foreign Acquisition Partnerships and their general partners, aresummarized below:

 

**Condensed Combined Balance Sheets**

 
| ** **                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Assets                                         |       | $                 | 410,048    |             | $          | 479,776 |   |
| Liabilities                                    |       | $                 | 363,299    |             | $          | 410,469 |   |
| Net equity                                     |       | 46,749            |       | 69,307           |       |
|                                           |       | $                 | 410,048    |             | $          | 479,776 |   |
|                                           |       |              |       |             |       |
| Equity investment in  Acquisition Partnerships |       | $                 | 59,830     |             | $          | 52,410 |   |
| Equity investment in  servicing entities       |       | 5,822             |       | 5,405            |       |
|                                           |       | $                 | 65,652     |             | $          | 57,815 |   |

 

**Condensed Combined Summary of Operations**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                       | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Proceeds from  resolution of Portfolio Assets    |       | $                      | 35,637     |                  | $          | 72,738 |   | $ | 136,310 |   | $ | 198,370 |   |
| Gain on resolution of  Portfolio Assets          |       | 14,668                 |       | 21,842                |       | 52,455 |   | 64,551 |   |
| Interest income on  Portfolio Assets             |       | 2,267                  |       | 2,365                 |       | 7,022 |   | 7,530 |   |
| Net earnings (loss)                              |       | $                      | (981       | )                     | $          | 11,849 |   | $ | 19,925 |   | $ | 28,704 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |
| Equity in earnings of  Acquisition Partnerships  |       | $                      | 1,975      |                  | $          | 3,507 |   | $ | 8,385 |   | $ | 9,844 |   |
| Equity in earnings  (loss) of servicing entities |       | (192                   | )          | 149                   |       | 489 |   | 626 |   |
|                                             |       | $                      | 1,783      |                  | $          | 3,656 |   | $ | 8,874 |   | $ | 10,470 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

The assets and equity of the Acquisition Partnerships and equityinvestments in the Acquisition Partnerships are summarized by geographic regionbelow. The WAMCO Partnerships represent limited partnerships and limited liabilitycompanies in which the Company has a common ownership with Cargill.  MinnTex Investment Partners LP is consideredto be a significant subsidiary of FirstCity.

 

| ** **                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                      | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Assets:                                         |       |              |       |             |       |
| Domestic:                                       |       |              |       |             |       |
| WAMCO Partnerships                              |       | $                 | 162,458    |             | $          | 172,464 |   |
| MinnTex Investment Partners LP                  |       | 407               |       | 840              |       |
| Other                                           |       | 10,209            |       | 10,406           |       |
| Latin America                                   |       | 183,822           |       | 207,455          |       |
| Europe                                          |       | 53,152            |       | 88,611           |       |
|                                            |       | $                 | 410,048    |             | $          | 479,776 |   |
|                                            |       |              |       |             |       |
| Equity (deficit):                               |       |              |       |             |       |
| Domestic:                                       |       |              |       |             |       |
| WAMCO Partnerships                              |       | $                 | 97,070     |             | $          | 81,233 |   |
| MinnTex Investment Partners LP                  |       | 373               |       | 763              |       |
| Other                                           |       | 5,545             |       | 6,012            |       |
| Latin America                                   |       | (94,318           | )          | (85,789          | )          |
| Europe                                          |       | 38,079            |       | 67,088           |       |
|                                            |       | $                 | 46,749     |             | $          | 69,307 |   |
| Equity investment in  Acquisition Partnerships: |       |              |       |             |       |
| Domestic:                                       |       |              |       |             |       |
| WAMCO Partnerships                              |       | $                 | 44,380     |             | $          | 34,521 |   |
| MinnTex Investment Partners LP                  |       | 123               |       | 252              |       |
| Other                                           |       | 2,781             |       | 2,916            |       |
| Latin America                                   |       | 1,539             |       | 1,538            |       |
| Europe                                          |       | 11,007            |       | 13,183           |       |
|                                            |       | $                 | 59,830     |             | $          | 52,410 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

Revenues and earnings (loss) of the Acquisition Partnerships and equityin earnings (loss) of the Acquisition Partnerships are summarized by geographicregion below.

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                             | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                              |       |                   |       |                  |       |   |   |   |   |
| Domestic:                                              |       |                   |       |                  |       |   |   |   |   |
| WAMCO Partnerships                                     |       | $                      | 4,591      |                  | $          | 7,743 |   | $ | 21,599 |   | $ | 22,592 |   |
| MinnTex Investment Partners LP                         |       | 991                    |       | 2,110                 |       | 4,098 |   | 6,914 |   |
| Other                                                  |       | 866                    |       | 22                    |       | 932 |   | 70 |   |
| Latin America                                          |       | 6,053                  |       | 7,473                 |       | 17,267 |   | 18,284 |   |
| Europe                                                 |       | 4,686                  |       | 8,821                 |       | 16,202 |   | 26,699 |   |
|                                                   |       | $                      | 17,187     |                  | $          | 26,169 |   | $ | 60,098 |   | $ | 74,559 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Net earnings (loss):                                   |       |                   |       |                  |       |   |   |   |   |
| Domestic:                                              |       |                   |       |                  |       |   |   |   |   |
| WAMCO Partnerships                                     |       | $                      | 2,079      |                  | $          | 3,822 |   | $ | 9,706 |   | $ | 10,841 |   |
| MinnTex Investment Partners LP                         |       | 900                    |       | 1,885                 |       | 3,676 |   | 6,169 |   |
| Other                                                  |       | 614                    |       | (165                  | )          | 381 |   | (549 | ) |
| Latin America                                          |       | (7,522                 | )          | 562                   |       | (4,777 | ) | (5,167 | ) |
| Europe                                                 |       | 2,948                  |       | 5,745                 |       | 10,939 |   | 17,410 |   |
|                                                   |       | $                      | (981       | )                     | $          | 11,849 |   | $ | 19,925 |   | $ | 28,704 |   |
| Equity in earnings (loss) of Acquisition Partnerships: |       |                   |       |                  |       |   |   |   |   |
| Domestic:                                              |       |                   |       |                  |       |   |   |   |   |
| WAMCO Partnerships                                     |       | $                      | 1,162      |                  | $          | 1,852 |   | $ | 4,518 |   | $ | 5,099 |   |
| MinnTex Investment Partners LP                         |       | 297                    |       | 622                   |       | 1,213 |   | 2,036 |   |
| Other                                                  |       | 325                    |       | (54                   | )          | 277 |   | (172 | ) |
| Latin America                                          |       | (441                   | )          | (70                   | )          | (250 | ) | (849 | ) |
| Europe                                                 |       | 632                    |       | 1,157                 |       | 2,627 |   | 3,730 |   |
|                                                   |       | $                      | 1,975      |                  | $          | 3,507 |   | $ | 8,385 |   | $ | 9,844 |   |
|                                                        |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

Combining statements of operations for the WAMCO Partnerships follow. WAMCOXXVIII, WAMCO XXX, WAMCO 31 and WAMCO 33 are considered to be significantsubsidiaries of FirstCity.

 

**Three Months Ended September 30, 2005**

 
| ** **                                     | ** ** | **WAMCO**  | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **XXVIII** | ** ** | **XXX**   | ** ** | **31**    | ** ** | **33**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Proceeds from resolution of Portfolio Assets   |       | $          | 539        |      | $          | 2,042     |       | $         | 1,784      |             | $          | 4,662        |       | $ | 1,817 |   | $ | 10,844 |   |
| Cost of Portfolio Assets resolved              |       | 346        |       | 1,567     |       | 1,507     |       | 3,265     |       | 945              |       | 7,630        |       |
| Gain on resolution of Portfolio Assets         |       | 193        |       | 475       |       | 277       |       | 1,397     |       | 872              |       | 3,214        |       |
| Interest income on Portfolio Assets            |       | 38         |       | —    |       | 130       |       | 503       |       | 672              |       | 1,343        |       |
| Interest and fees expense — affiliate     |       | (31        | )          | —    |       | —    |       | —    |       | (194             | )          | (225         | )          |
| Interest and fees expense — other         |       | —     |       | (15       | )          | (281      | )          | (443      | )          | (10              | )          | (749         | )          |
| Provision for loan and impairment losses       |       | (15        | )          | (52       | )          | —    |       | 169       |       | (37              | )          | 65           |       |
| Service fees — affiliate                  |       | (35        | )          | (81       | )          | (76       | )          | (287      | )          | (219             | )          | (698         | )          |
| General, administrative and operating expenses |       | (15        | )          | (75       | )          | (61       | )          | (192      | )          | (562             | )          | (905         | )          |
| Other income, net                              |       | 3          |       | 5         |       | 8         |       | —    |       | 18               |       | 34           |       |
| Net earnings (loss)                            |       | $          | 138        |      | $          | 257       |       | $         | (3         | )                | $          | 1,147        |       | $ | 540 |   | $ | 2,079 |   |

 

**Three Months Ended September 30, 2004**

 
| ** **                                     | ** ** | **WAMCO**  | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **XXVIII** | ** ** | **XXX**   | ** ** | **31**    | ** ** | **33**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Proceeds from resolution of Portfolio Assets   |       | $          | 693        |      | $          | 2,401     |       | $         | 7,448      |             | $          | 10,282       |       | $ | 5,107 |   | $ | 25,931 |   |
| Cost of Portfolio Assets resolved              |       | 468        |       | 1,780     |       | 5,741     |       | 9,074     |       | 3,223            |       | 20,286       |       |
| Gain on resolution of Portfolio Assets         |       | 225        |       | 621       |       | 1,707     |       | 1,208     |       | 1,884            |       | 5,645        |       |
| Interest income on Portfolio Assets            |       | 34         |       | —    |       | 390       |       | 404       |       | 669              |       | 1,497        |       |
| Interest and fees expense — affiliate     |       | (107       | )          | —    |       | —    |       | (369      | )          | (156             | )          | (632         | )          |
| Interest and fees expense — other         |       | (23        | )          | (103      | )          | (377      | )          | —    |       | (42              | )          | (545         | )          |
| Provision for loan and impairment losses       |       | —     |       | —    |       | (100      | )          | —    |       | (567             | )          | (667         | )          |
| Service fees — affiliate                  |       | (46        | )          | (86       | )          | (234      | )          | (361      | )          | (330             | )          | (1,057       | )          |
| General, administrative and operating expenses |       | (58        | )          | (112      | )          | (63       | )          | (142      | )          | (645             | )          | (1,020       | )          |
| Other income, net                              |       | 1          |       | 2         |       | 2         |       | —    |       | 596              |       | 601          |       |
| Net earnings                                   |       | $          | 26         |      | $          | 322       |       | $         | 1,325      |             | $          | 740          |       | $ | 1,409 |   | $ | 3,822 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

**Nine Months Ended September 30, 2005**

 
| ** **                                     | ** ** | **WAMCO**  | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **XXVIII** | ** ** | **XXX**   | ** ** | **31**    | ** ** | **33**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Proceeds from  resolution of Portfolio Assets  |       | $          | 2,704      |      | $          | 7,185     |       | $         | 12,699     |             | $          | 15,089       |       | $ | 16,399 |   | $ | 54,076 |   |
| Cost of Portfolio  Assets resolved             |       | 2,009      |       | 5,410     |       | 10,179    |       | 11,275    |       | 7,632            |       | 36,505       |       |
| Gain on resolution of  Portfolio Assets        |       | 695        |       | 1,775     |       | 2,520     |       | 3,814     |       | 8,767            |       | 17,571       |       |
| Interest income on  Portfolio Assets           |       | 70         |       | —    |       | 531       |       | 1,541     |       | 1,802            |       | 3,944        |       |
| Interest and fees  expense — affiliate    |       | (108       | )          | —    |       | —    |       | (893      | )          | (544             | )          | (1,545       | )          |
| Interest and fees  expense — other        |       | (6         | )          | (166      | )          | (911      | )          | (592      | )          | (75              | )          | (1,750       | )          |
| Provision for loan and  impairment losses      |       | (15        | )          | (109      | )          | —    |       | (506      | )          | (208             | )          | (838         | )          |
| Service fees —  affiliate                 |       | (145       | )          | (264      | )          | (435      | )          | (664      | )          | (989             | )          | (2,497       | )          |
| General, administrative and operating expenses |       | (62        | )          | (320      | )          | (253      | )          | (435      | )          | (4,193           | )          | (5,263       | )          |
| Other income, net                              |       | 9          |       | 10        |       | 22        |       | —    |       | 43               |       | 84           |       |
| Net earnings                                   |       | $          | 438        |      | $          | 926       |       | $         | 1,474      |             | $          | 2,265        |       | $ | 4,603 |   | $ | 9,706 |   |

 

**Nine Months Ended September 30, 2004**

 
| ** **                                     | ** ** | **WAMCO**  | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **XXVIII** | ** ** | **XXX**   | ** ** | **31**    | ** ** | **33**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Proceeds from  resolution of Portfolio Assets  |       | $          | 7,265      |      | $          | 8,854     |       | $         | 17,556     |             | $          | 15,345       |       | $ | 22,372 |   | $ | 71,392 |   |
| Cost of Portfolio  Assets resolved             |       | 5,658      |       | 6,703     |       | 14,183    |       | 12,949    |       | 14,483           |       | 53,976       |       |
| Gain on resolution of  Portfolio Assets        |       | 1,607      |       | 2,151     |       | 3,373     |       | 2,396     |       | 7,889            |       | 17,416       |       |
| Interest income on  Portfolio Assets           |       | 187        |       | —    |       | 1,320     |       | 457       |       | 2,594            |       | 4,558        |       |
| Interest and fees  expense – affiliates   |       | (335       | )          | —    |       | (133      | )          | (718      | )          | (564             | )          | (1,750       | )          |
| Interest and fees  expense – other        |       | (208       | )          | (347      | )          | (1,129    | )          | —    |       | (143             | )          | (1,827       | )          |
| Provision for loan  losses                     |       | (70        | )          | —    |       | (100      | )          | —    |       | (1,148           | )          | (1,318       | )          |
| Service fees –  affiliate                 |       | (309       | )          | (318      | )          | (633      | )          | (532      | )          | (1,138           | )          | (2,930       | )          |
| General, administrative and operating expenses |       | (14        | )          | (320      | )          | (289      | )          | (319      | )          | (2,984           | )          | (3,926       | )          |
| Other income, net                              |       | 3          |       | 5         |       | 7         |       | —    |       | 603              |       | 618          |       |
| Net earnings                                   |       | $          | 861        |      | $          | 1,171     |       | $         | 2,416      |             | $          | 1,284        |       | $ | 5,109 |   | $ | 10,841 |   |

 

Statements of operations for MinnTex Investment Partners LP for the threeand nine month periods ended September 30, 2005 and 2004 follow:

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                      | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Proceeds from  resolution of Portfolio Assets   |       | $                      | 1,004      |                  | $          | 2,182 |   | $ | 4,168 |   | $ | 7,234 |   |
| Cost of Portfolio  Assets resolved              |       | 16                     |       | 73                    |       | 78 |   | 323 |   |
| Gain on resolution of  Portfolio Assets         |       | 988                    |       | 2,109                 |       | 4,090 |   | 6,911 |   |
| Service fees —  affiliate                  |       | (86                    | )          | (218                  | )          | (402 | ) | (723 | ) |
| General, administrative  and operating expenses |       | (4                     | )          | (7                    | )          | (19 | ) | (22 | ) |
| Other income                                    |       | 2                      |       | 1                     |       | 7 |   | 3 |   |
| Net earnings                                    |       | $                      | 900        |                  | $          | 1,885 |   | $ | 3,676 |   | $ | 6,169 |   |

 

FirstCity adopted FASBInterpretation No. 46R, *Consolidation ofVariable Interest Entities*(“FIN 46R”) on January 1, 2004.  FIN 46R requires consolidation by themajority holder of expected residual gains and losses of the activities of avariable interest entity (“VIE”). FirstCity holds variable interests in certainAcquisition Partnerships, which would be characterized as VIEs. However,FirstCity is not deemed to be the primary beneficiary of any of these entitiesbased on the criteria set forth in FIN 46R. At September 30, 2005, FirstCity’smaximum exposure to loss as a result of its involvement with the VIEs is $21.1 million.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

** (8) Segment Reporting**

 

The Company is engaged in one reportable segment - Portfolio Assetacquisition and resolution.  ThePortfolio Asset acquisition and resolution business involves acquiringPortfolio Assets at a discount to face value and servicing and resolving suchPortfolios in an effort to maximize the present value of the ultimate cashrecoveries.  The following is a summaryof results of operations for the Portfolio Asset acquisition and resolution segmentand reconciliation to earnings from continuing operations for the three and ninemonths ended September 30, 2005 and 2004.

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                                         | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Portfolio Asset Acquisition and  Resolution:**                                   |       |                   |       |                  |       |   |   |   |   |
| Revenues and equity in earnings of investments:                                    |       |                   |       |                  |       |   |   |   |   |
| Servicing fees                                                                     |       | $                      | 2,891      |                  | $          | 3,328 |   | $ | 8,972 |   | $ | 10,076 |   |
| Gain on resolution of Portfolio Assets                                             |       | 1,299                  |       | 601                   |       | 4,366 |   | 838 |   |
| Equity in earnings of investments                                                  |       | 1,783                  |       | 3,656                 |       | 8,874 |   | 10,470 |   |
| Interest income                                                                    |       | 1,245                  |       | 868                   |       | 3,196 |   | 2,033 |   |
| Other                                                                              |       | 141                    |       | 362                   |       | 718 |   | 1,832 |   |
| Total                                                                              |       | 7,359                  |       | 8,815                 |       | 26,126 |   | 25,249 |   |
| Expenses:                                                                          |       |                   |       |                  |       |   |   |   |   |
| Interest and fees on notes payable                                                 |       | 917                    |       | 1,174                 |       | 2,645 |   | 2,832 |   |
| Salaries and benefits                                                              |       | 2,852                  |       | 2,851                 |       | 9,039 |   | 8,830 |   |
| Provision for loan and impairment losses                                           |       | 322                    |       | 1                     |       | 436 |   | 23 |   |
| Occupancy, data processing, communication and other                                |       | 1,224                  |       | 1,110                 |       | 3,523 |   | 3,335 |   |
| Minority interest                                                                  |       | (3                     | )          | 34                    |       | 36 |   | 43 |   |
| Total                                                                              |       | 5,312                  |       | 5,170                 |       | 15,679 |   | 15,063 |   |
| Operating contribution before direct taxes                                         |       | $                      | 2,047      |                  | $          | 3,645 |   | $ | 10,447 |   | $ | 10,186 |   |
| Operating contribution, net of direct taxes                                        |       | $                      | 2,020      |                  | $          | 3,638 |   | $ | 10,263 |   | $ | 10,127 |   |
|                                                                               |       |                   |       |                  |       |   |   |   |   |
| **Corporate Overhead:**                                                            |       |                   |       |                  |       |   |   |   |   |
| Corporate interest expense                                                         |       | —                 |       | 978                   |       | — |   | 3,004 |   |
| Salaries and benefits, occupancy, professional and  other income and expenses, net |       | 1,328                  |       | 1,708                 |       | 4,202 |   | 4,051 |   |
| Earnings from continuing operations                                                |       | $                      | 692        |                  | $          | 952 |   | $ | 6,061 |   | $ | 3,072 |   |
|                                                                                    |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

Revenues and equity in earnings of investments from the Portfolio Assetacquisition and resolution segment are attributable to domestic and foreignoperations as follows:

 
| ** **    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------|------------|------------------------|------------|-----------------------|------------|
| ** **    | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Domestic      |       | $                      | 4,692      |                  | $          | 4,686 |   | $ | 15,418 |   | $ | 13,035 |   |
| Latin America |       | 2,088                  |       | 2,751                 |       | 7,458 |   | 7,613 |   |
| Europe        |       | 579                    |       | 1,378                 |       | 3,250 |   | 4,601 |   |
| Total         |       | $                      | 7,359      |                  | $          | 8,815 |   | $ | 26,126 |   | $ | 25,249 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

Totalearning assets of the segments and reconciliation to total assets is asfollows:

 
| ** **                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                    | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                    | ** ** | ** **        | ** ** | ** **       | ** ** |
| Cash                                          |       | $                 | 7,522      |             | $          | 9,724 |   |
| Portfolio acquisition  and resolution assets: |       |              |       |             |       |
| Domestic                                      |       | 92,317            |       | 77,280           |       |
| Latin America                                 |       | 19,002            |       | 20,876           |       |
| Europe                                        |       | 17,063            |       | 19,859           |       |
| Deferred tax asset, net                       |       | 20,101            |       | 20,101           |       |
| Other non-earning  assets, net                |       | 8,981             |       | 9,200            |       |
| Discontinued mortgage  assets                 |       | 167               |       | 1,817            |       |
| Total assets                                  |       | $                 | 165,153    |             | $          | 158,857 |   |

 

**(9)  Earnings per Common Share**

 

Basic net earnings percommon share calculations are based upon the weighted average number of commonshares outstanding. Potentially dilutive common share equivalents includewarrants and employee stock options in the diluted earnings per common sharecalculations.  Basic and diluted earningsfrom continuing operations per share were determined as follows:

 
| ** **                                                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                        | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                                        | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings from  continuing operations                                              |       | $                      | 692        |                  | $          | 952 |   | $ | 6,061 |   | $ | 3,072 |   |
| Weighted average  outstanding shares of common stock                              |       | 11,298                 |       | 11,236                |       | 11,278 |   | 11,223 |   |
| Dilutive effect of:                                                               |       |                   |       |                  |       |   |   |   |   |
| Warrants                                                                          |       | 340                    |       | 299                   |       | 343 |   | 296 |   |
| Employee stock options                                                            |       | 370                    |       | 302                   |       | 391 |   | 297 |   |
| Weighted average outstanding shares of common stock  and common stock equivalents |       | 12,008                 |       | 11,837                |       | 12,012 |   | 11,816 |   |
| Earnings from  continuing operations per share:                                   |       |                   |       |                  |       |   |   |   |   |
| Basic                                                                             |       | $                      | 0.06       |                  | $          | 0.09 |   | $ | 0.54 |   | $ | 0.28 |   |
| Diluted                                                                           |       | $                      | 0.05       |                  | $          | 0.08 |   | $ | 0.50 |   | $ | 0.26 |   |

 

**(10)  Stock-Based Compensation**

 

At September 30, 2005,the Company has three stock-based employee compensation plans. The Companyaccounts for those plans under the recognition and measurement principles ofAPB Opinion No. 25, *Accounting for StockIssued to Employees,* and related Interpretations. No stock-basedemployee compensation cost is reflected in the consolidated statements ofoperations, as all options granted under those plans had an exercise priceequal to the market value of the underlying common stock on the date of grant.  As required by FASB Statement No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure,*the following table represents the effect on netearnings and earnings per share if the Company had applied the fair valuerecognition provisions of FASB Statement No. 123, *Accounting for Stock-Based Compensation,* to stock-basedemployee compensation.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 
| ** **                                                                                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                  | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                                                                                                  | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net earnings to common stockholders, as reported                                                                                            |       | $                      | 1,011      |                  | $          | 2,908 |   | $ | 6,283 |   | $ | 11,056 |   |
| Less: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (66                    | )          | (118                  | )          | (244 | ) | (248 | ) |
| Pro forma net earnings to common stockholders                                                                                               |       | $                      | 945        |                  | $          | 2,790 |   | $ | 6,039 |   | $ | 10,808 |   |
| Net earnings per common share:                                                                                                              |       |                   |       |                  |       |   |   |   |   |
| Basic — as reported                                                                                                                    |       | $                      | 0.09       |                  | $          | 0.26 |   | $ | 0.56 |   | $ | 0.99 |   |
| Basic — pro forma                                                                                                                      |       | $                      | 0.08       |                  | $          | 0.25 |   | $ | 0.54 |   | $ | 0.96 |   |
| Diluted — as reported                                                                                                                  |       | $                      | 0.08       |                  | $          | 0.25 |   | $ | 0.52 |   | $ | 0.94 |   |
| Diluted — pro forma                                                                                                                    |       | $                      | 0.08       |                  | $          | 0.24 |   | $ | 0.50 |   | $ | 0.91 |   |
|                                                                                                                                             |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**(11)  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 ifestimates of future taxable income during the carryforward period change. The abilityof the Company to realize the deferred tax asset is periodically reviewed andthe valuation allowance is adjusted accordingly.

 

**(12)  Commitments and Contingencies**

 

Periodically, FirstCity,its subsidiaries, its affiliates and the Acquisition Partnerships are partiesto or otherwise involved in legal proceedings arising in the normal course ofbusiness. FirstCity does not believe that there is any proceeding threatened orpending against it, its subsidiaries, its affiliates or the Acquisition Partnershipswhich, if determined adversely, would have a material adverse effect on theconsolidated financial position, results of operations or liquidity ofFirstCity, its subsidiaries, its affiliates or the Acquisition Partnerships.

 

In August 2000, ConsumerCorp. and Funding LP contributed all of the assets utilized in the operationsof the automobile finance operation to Drive pursuant to the terms of aContribution and Assumption Agreement by and between Consumer Corp. and Drive,and a Contribution and Assumption Agreement by and between Funding LP and Drive(collectively, the “Contribution Agreements”). Drive assumed substantially allof the liabilities of the automobile finance operation as set forth in theContribution Agreements.  In addition,pursuant to the terms of a Securities Purchase Agreement dated as of August 18,2000 (the “2000 Securities Purchase Agreement”), by and among FirstCity,Consumer Corp., FirstCity Funding LP (“Funding LP”), and FirstCity Funding GPCorp. (“Funding GP”), IFA-GP and IFA-LP; FirstCity, Consumer Corp., Funding LPand Funding GP made various warranties concerning (i) their respectiveorganizations, (ii) the automobile finance operation conducted by ConsumerCorp. and Funding LP, and (iii) the assets transferred by Consumer Corp. andFunding LP to Drive. The Company, Consumer Corp., Funding LP and Funding GPalso agreed to indemnify BoS (USA), IFA-GP and IFA-LP from damages resultingfrom 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 withsurvive for a period of seven (7) years from August 25, 2000 (the “2000 ClosingDate”). Neither the Company, Consumer Corp., Funding LP, or Funding GP isrequired to make any payments as a result of the indemnity provided under the2000 Securities Purchase Agreement until the aggregate amount payable exceeds$.25 million, and then only for the amount in excess of $.25 million in theaggregate; however certain representations and warranties are not subject tothis $.25 million threshold.  Managementof the Company believes that FirstCity will not have to pay any amounts relatedto these agreements.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS – (continued)**

 

On September 21, 2004,FirstCity, Consumer Corp., Funding LP and Funding GP entered into a SecuritiesPurchase Agreement to sell a 31% beneficial ownership interest in Drive and itsgeneral partner, Drive GP LLC, to IFA GP, IFA LP and MG-LP (the “2004Securities Purchase Agreement”).  In the 2004 Securities Purchase Agreement,FirstCity, Consumer Corp., Funding LP and Funding GP made various representationsand warranties concerning (i) their respective organizations, (ii) their powerand authority to enter into the 2004 Securities Purchase Agreement and thetransactions contemplated therein, (iii) the ownership of the limitedpartnership interests in Drive by Funding LP, (iv) the ownership of membershipinterests in Drive-GP by Consumer Corp., and (iv) the capital structure ofFunding LP. FirstCity, Consumer Corp., Funding LP and Funding GP also agreed toindemnify BoS (USA), IFA-GP, IFA-LP and MG-LP from damages resulting from abreach of any representation or warranty contained in the 2004 SecuritiesPurchase Agreement or otherwise made by FirstCity, Consumer Corp. or Funding LPin connection with the transaction. The indemnity obligations under the 2004Securities Purchase Agreement survive for a maximum period of five (5) yearsfrom November 1, 2004. Neither FirstCity, Consumer Corp., Funding LP, orFunding GP is required to make any payments as a result of the indemnityprovided under the 2004 Securities Purchase Agreement until the aggregateamount payable exceeds $.25 million, and then only for the amount in excess of$.25 million in the aggregate; however, certain representations and warrantiesare not subject to this $.25 million threshold. Management of theCompany believes that FirstCity will not have to pay any amounts relating tothese representations and warranties.

 

FirstCity has minorityinterests in various limited-life partnerships with a carrying value of $1.2million at September 30, 2005. The estimated amount that would be paid to theminority interest holder if the instruments were to be settled at September 30,2005 is $1.7 million.

 

Financial Security Assurance Inc. (“FSA”), in itscapacity as certificate insurer under the Pooling and Servicing Agreement (the “Poolingand Servicing Agreement”), relating to the FirstCity Capital Home Equity LoanTrust 1998-2 (the “Trust”), dated as of November 1, 1998 by and among FCCapital Corp., in its capacities as seller and master servicer, and The Bank ofNew York, in its capacity as trustee (the “Trustee”), made demand on FC CapitalCorp. to repurchase certain loans that were subject to repurchase due to fraudof third parties in connection with the origination of the loans. FC CapitalCorp. agreed to provide a letter of credit in the amount of the repurchaseprice for the loans in lieu of being required to purchase the loans from theTrust.  FirstCity has obtained anddelivered to FSA, for the benefit of FC Capital Corp., an irrevocable letter ofcredit 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 Company has unsecurednotes payable to Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, eachof whom were Senior Vice Presidents of FirstCity, in connection with theacquisition of the minority interest in FirstCity Holdings. The notes are to beperiodically redeemed by the Company for an aggregate of up to $3.2 million outof certain cash collections from servicing income from Portfolios in Mexico.FirstCity valued the loans at the inception date using an imputed interest ratebased on the Company’s cost of funds. At September 30, 2005, these notes had animputed balance of $.67 million and mature in December 2011.

 

The Company haspreliminarily evaluated the potential impact of Hurricanes Katrina and Rita,and while it is too early to determine the full extent of any losses experiencedon the Gulf Coast as a result of these hurricanes, management has beendiligently reviewing any exposure that FirstCity might have in theregion.  Based on information available as of the date of this report onForm 10-Q, results indicated that the hurricanes will not have a materialimpact on the consolidated financial statements.  These estimates involve considerable judgmentand are inherently imprecise due to a variety of factors, including the scopeof the disaster and the preliminary nature of the information used to preparethese estimates.  There can be no assurance that FirstCity’s ultimatelosses associated with these events will not be materially different frompreliminary estimates.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

**Overview**

 

FirstCity is a financial services company engaged in the acquisition andresolution of portfolios of assets or single assets (collectively referred toas “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 the thirdquarter of 2005, the Company recorded earnings to common stockholders on adiluted basis of $1.0 million or $.08 per common share. The operating contributionfrom the Portfolio Asset acquisition and resolution segment was $2.0 millioncompared with $3.6 million for the same period in 2004.  The Company was able to invest $18.1 millionin portfolio acquisitions during the quarter, $3.4 million are wholly-owned,$14.4 million are in acquisition partnerships in the U.S. and $.3 million was asmall investment in a Latin American acquisition partnership.

 

Earnings fromcontinuing operations for the quarter were down from the second quarter,primarily due to lower earnings from equity investments. The earnings fromequity investments is primarily impacted by collection levels which were downby $16.9 million when compared to the second quarter. Operating expenses wererelatively flat compared to the second quarter with the exception of $.3million of provisions recorded on wholly-owned portfolios.

 

Management remainspositive on the outlook of the Company, as it is typical for the timing of thecash collections to vary quarter to quarter and the lower collections duringthe third quarter is directly related to timing and does not indicate anoverall decline in value of the portfolio investments. The acquisitions for thequarter contributed to an $11 million net increase in the primary earningassets base of the Company and FirstCity is currently evaluating 22 differenttransactions representing over $2.0 billion in face 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 are alsoaffected by the availability of financing with terms acceptable to the Companyand the Company’s access to capital markets, including the securitizationmarkets.

 

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

 

Components of the results for the three and nine months ended September30, 2005 and 2004, respectively, are detailed below (dollars in thousandsexcept per share data):

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                  | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Portfolio Asset  Acquisition and Resolution |       | $                      | 2,020      |                  | $          | 3,638 |   | $ | 10,263 |   | $ | 10,127 |   |
| Corporate interest                          |       | —                 |       | (978                  | )          | — |   | (3,004 | ) |
| Corporate overhead                          |       | (1,328                 | )          | (1,708                | )          | (4,202 | ) | (4,051 | ) |
| Earnings from continuing operations         |       | 692                    |       | 952                   |       | 6,061 |   | 3,072 |   |
| Earnings from  discontinued operations      |       | 319                    |       | 1,956                 |       | 222 |   | 7,984 |   |
| Net earnings to common stockholders         |       | $                      | 1,011      |                  | $          | 2,908 |   | $ | 6,283 |   | $ | 11,056 |   |
| Diluted earnings per common share           |       | $                      | 0.08       |                  | $          | 0.25 |   | $ | 0.52 |   | $ | 0.94 |   |

 

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**Results ofOperations**

 

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

 

***Third Quarter 2005 Compared to Third Quarter 2004***

 

The Company reported net earnings of $1.0 million in the third quarter of2005 compared to $2.9 million in the third quarter of 2004. On a per sharebasis, diluted net earnings to common stockholders were $.08 in the thirdquarter of 2005 compared to $.25 in the third quarter of 2004.

 

*PortfolioAsset Acquisition and Resolution*

 

The operating contribution from the Portfolio Asset acquisition andresolution segment was $2 million in the third quarter of 2005 compared to $3.6million in the third quarter of 2004. FirstCity invested $18.1 million in Portfolioacquisitions during the third quarter of 2005, which was comprised of $14.7million through Acquisition Partnerships and $3.4 million through wholly-ownedPortfolio Assets, compared to $27.1 million in the third quarter of 2004, whichwas comprised of $2.3 million through Acquisition Partnerships and $24.8million wholly-owned Portfolio Assets. The quarter-end investment in wholly-ownedPortfolio Assets increased to $43.2 million at September 30, 2005, from $33.6million at September 30, 2004, as a result of wholly-owned acquisitions of approximately$26 million since the third quarter of 2004.

 

*Servicing fee revenues. *Servicing fee revenues decreased by 13% to $2.9million in the third quarter of 2005 from $3.3 million in the third quarter of 2004primarily due to decreased collections in domestic and Latin American AcquisitionPartnerships.

 

*Gain on resolution of Portfolio Assets. *The net gain onresolution of Portfolio Assets increased to $1.3 million in the third quarterof 2005 from $.6 million in the third quarter of 2004 primarily due to thepurchase of several wholly-owned Portfolios during 2004.

 

*Equity in earnings of investments.  *Equity in earnings of investments decreased 51% to $1.8 million in the thirdquarter of 2005 compared to $3.7 million in the third quarter of 2004.  Equity earnings in Acquisition Partnerships decreased44% to $2 million in the third quarter of 2005 from $3.5 million in the thirdquarter of 2004. Following is a discussion of equity earnings from AcquisitionPartnerships by geographic region.

 

•             *Domestic* — Equity in earnings of domestic AcquisitionPartnerships decreased to $1.8 million in the third quarter of 2005 from $2.4million in 2004, primarily as a result of a decrease in collections to $20million in the third quarter of 2005 from $32 million in the third quarter of2004.

 

•             *Latin America* — Equity losses of Acquisition Partnerships locatedin Latin America (primarily Mexico) were $.4 million in the third quarter of 2005compared to $.1 million in 2004 primarily due to a decrease in collections to$15 million in the third quarter of 2005 from $26 million in the third quarterof 2004. In addition, a provision for impairment on loans of $5.2 million wasrecorded in the third quarter of 2005, of which $.3 million was included inequity earnings.  There was no provisionfor impairment on loans for the same period in 2004. These partnershipsreflected net losses of $7.5 million in the third quarter of 2005 compared to netincome of $.6 million in 2004.  Thepartnerships recorded $.1 million of foreign exchange gains in the thirdquarter of 2005 compared to $2.0 million of foreign exchange losses in 2004 (ofwhich $.03 million and ($.17) million are included in equity earnings,respectively).  Interest expense of $2.5million and $3.5 million were recorded in the third quarter of 2005 and 2004,respectively. This interest is owed to affiliates of the investors of thesepartnerships, of which FirstCity recorded $.4 million and $.6 million asinterest income in the third quarters of 2005 and 2004, respectively.

 

•             *Europe* — Equity in earnings of Acquisition Partnershipslocated in France decreased 45% to $.6 million in the third quarter of 2005from $1.2 million in 2004, primarily due to a decrease in collections to $12.5 millionin the third quarter of 2005 from $20.9 million in the third quarter of 2004.  FirstCity also recorded $.2 million and $.3million in foreign currency transactions gains (included in other expenses)relating to investments in France in the third quarters of 2005 and 2004, respectively.

 

*Interest income. *Interest income increased 44% from $.9 million inthe third quarter of 2004 to $1.2 million in the third quarter of 2005 and is primarilydue to increased purchases of wholly-owned Portfolios.  Also, income on all Portfolios purchased in2005 is

 

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reflectedas interest income as a result of FirstCity’s adopting a new accountingpronouncement on January 1, 2005 (see note 3 to the consolidated financialstatements).

 

*Other income. *Other income decreased 61% to $.1 million in thethird quarter of 2005 from $.4 million in the third quarter of 2004. In thethird quarter of 2005, FirstCity increased the estimated carrying value ofloans payable to certain members of management by $.2 million.

 

*Expenses. *Operating expenses were $5.3 million and $5.2million in the third quarters of 2005 and 2004, respectively.

 

Interest and fees on notes payable were $.9 million and $1.2 million inthe third quarters of 2005 and 2004, respectively. The average debt for thequarter decreased to $52.4 million in the third quarter of 2005 from $54.3million in the third quarter of 2004, and the average cost of borrowing declinedfrom 8.7% in 2004 to 7.0% in 2005, which reflects the lower rates achieved fromthe debt restructure in the fourth quarter of 2004.

 

Salaries and benefits were flat at $2.9 million in the third quarter of 2005and 2004. The total number of personnel within the Portfolio Asset acquisitionand resolution segment was 204 and 199 at September 30, 2005 and 2004, respectively.

 

The provision for loan and impairment losses was $.3 million in the thirdquarter of 2005.  See note 5 to the consolidatedfinancial statements for a discussion regarding the Company’s adoption onJanuary 1, 2005 of AICPA Statement of Position No. 03-3, *Accounting for Certain Loans or Debt Securities Acquired in a Transfer*(“SOP03-3”).

 

Occupancy, data processing, communication and other expenses were $1.2million for the third quarter of 2005 and $1.1 million in the third quarter of2004.

 

Minority interest was minimal from period to period.

 

*Other ItemsAffecting Operations*

 

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

 

*Corporate interest and overhead. *Company levelinterest expense decreased to zero in the third quarter of 2005 from $1.0million in the third quarter of 2004 as a result of the payoff of corporatedebt in November 2004 from proceeds received on the sale of the Company’s 31%beneficial interest in Drive.  Othercorporate overhead expenses decreased 22% to $1.3 million in the third quarterof 2005 from $1.7 million in the third quarter of 2004, primarily due to decreasedlegal and accounting fees and other expenses.

 

*Income taxes. *Provision for incometaxes was $.08 million and ($.01) million in the third quarters of 2005 and 2004,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 third quarters of either 2005or 2004.

 

*Discontinued Operations. *The Company recorded a provision of $.3 millionthe third quarter of 2005 for additional losses from discontinued mortgageoperations compared to a provision of $.95 million in the third quarter of 2004.At September 30, 2005, the only asset remaining from discontinued mortgage operationsis an investment security resulting from the retention of a residual interestin a securitization transaction.  Thissecurity is in “run-off,” and the Company is contractually obligated to servicethe underlying assets. The assumptions used in the valuation model considerboth industry as well as the Company’s historical experience. As the security “runsoff,” assumptions are reviewed in light of historical evidence in revising theprospective results of the model. These revised assumptions could potentiallyresult in either an increase or decrease in the estimated cash receipts. Anadditional provision is booked based on the output of the valuation model ifdeemed necessary.

 

Earnings fromdiscontinued consumer operations were $.6 million in the third quarter of 2005,which reflects the reversal of estimated state tax provisions related to thesale of Drive. Earnings from discontinued consumer operations were $2.9 millionin the third quarter of 2004.  Aspreviously discussed, FirstCity sold its interest in Drive in November 2004.

 

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***First Nine Months of 2005 Compared to First Nine Months of 2004***

 

The Company reported earnings from continuing operations of $6.1 millionin the first nine months of 2005. Net earnings to common stockholders were $6.3million in the first nine months of 2005 compared to $11.1 million in the firstnine months of 2004. On a per share basis, diluted net earnings to commonstockholders were $.52 in the first nine months of 2005 compared to $.94 in thefirst nine months of 2004.

 

*PortfolioAsset Acquisition and Resolution*

 

The operating contribution in the first nine months of 2005 was $10.3million compared to $10.1 million for the same period last year.  FirstCity purchased $63.9 million ofPortfolio Assets during the first nine months of 2005 ($44.4 million throughAcquisition Partnerships), compared to $128 million in acquisitions in thefirst nine months of 2004.  FirstCity’sinvestment in these acquisitions was $36.4 million and $48.7 million in thefirst nine months of 2005 and 2004, respectively.  FirstCity’s investment in wholly-ownedPortfolio Assets increased to $43.2 million from $33.6 million at September 30,2005 and 2004, respectively.

 

*Servicing fee revenues. *Servicing fee revenues decreased 11% to $9.0million in the first nine months of 2005 from $10.1 million in the first ninemonths of 2004. Service fees from the Mexican partnerships decreased by $.4million, or 6%, as a result of efforts to reduce operating costs inMexico.  For the Mexican AcquisitionPartnerships, FirstCity earns a servicing fee based on costs of servicing plusa profit margin.  Service fees from thedomestic Acquisition Partnerships decreased to $2.7 million in the first ninemonths of 2005 compared to $3.5 million in the same period in 2004 as a resultof lower collections in those partnerships.

 

*Gain on resolution of Portfolio Assets. *The net gain onresolution of Portfolio Assets increased to $4.4 million in the first ninemonths of 2005 from $.8 million in the first nine months of 2004, primarily dueto the purchase of several wholly-owned nonperforming Portfolios in the thirdand fourth quarters of 2004.

 

*Equity in earnings of investments. *Equity in earningsof investments decreased 15% to $8.9 million in the first nine months of 2005compared to $10.5 million in the first nine months of 2004. Equity earnings inAcquisition Partnerships decreased 15% to $8.4 million in the first nine monthsof 2005 from $9.8 million in the first nine months of 2004. Equity in earningsof servicing entities decreased 22% to $.5 million in the first nine months of2005 from $.6 million in the first nine months of 2004.  Following is a discussion of equity earnings inAcquisition Partnerships by geographic region. See note 7 to the consolidated financial statements for a summary ofrevenues and earnings of the Acquisition Partnerships and equity in earnings ofthe Acquisition Partnerships.

 

•             *Domestic* — Equity in earnings of domesticAcquisition Partnerships decreased 14% to $6.0 million in the first nine monthsof 2005 from $7.0 million in the first nine months of 2004 primarily as aresult of a decrease in collections to $72 million in the first nine months of2005 from $90 million in the first nine months of 2004.

 

•             *Latin America* — Equity losses of Latin American AcquisitionPartnerships decreased to $.3 million in the first nine months of 2005 comparedto $.8 million in 2004. The partnerships recorded foreign exchange gains of $9.2million in the first nine months of 2005 compared to $.04 million in 2004 (ofwhich $.74 million and $.02 million are included in equity earnings,respectively).  These gains reduced theimpact of a decrease in collections in the first nine months of 2005 to $49million from $61 million in the first nine months of 2004, and an increase inthe provision for impairments on loans of $6.6 million recorded in the firstnine months of 2005 compared to zero for the same period in 2004. Thesepartnerships reflected a loss of $4.8 million in the first nine months of 2005compared to $5.2 million in 2004. Interest expense of $8.1 million and $8.2million were recorded during the first nine months of 2005 and 2004,respectively.  This interest is owed tothe investors of these partnerships, of which FirstCity recorded $1.1 millionand $1.5 million, in 2005 and 2004, respectively, as interest income.

 

•             *Europe* — Equity in earnings of Acquisition Partnershipslocated in France decreased to $2.6 million in the first nine months of 2005 comparedto $3.7 million in 2004 primarily due to a decrease in collections of $41.5 millionin the first nine months of 2005 from $70.6 million for the same period in2004. In addition, there have been no equity investments in new Portfoliosduring 2005.  During the first ninemonths of 2005 and 2004, FirstCity also recorded $.7 million and $.9 million,respectively,  in foreign currencytransaction gains (included in other expenses) relating to investments inFrance.

 

*Interest income. *Interest income increased 57% to $3.2 million inthe first nine months of 2005 from $2.0 million in the first nine months of2004, primarily due to increased purchases of wholly-owned Portfolios.  Also, income on all Portfolios purchased in2005 is reflected as interest income as a result of FirstCity adopting a newaccounting pronouncement on January 1, 2005 (see note 3 to the consolidatedfinancial statements).

 

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*Other income. *Other income was $.7 million in the first ninemonths of 2005 compared to $1.8 million in 2004.  In 2004, FirstCity reduced the estimatedcarrying value of loans payable to certain members of management by $.8 million,and in 2005, this estimated carrying value was increased by $.2 million.

 

*Expenses. *Operating expenses were $15.7 million in thefirst nine months of 2005 compared to $15.1 million in the first nine months of2004.

 

Interest and feeson notes payable decreased to $2.6 million inthe first nine months of 2005 from $2.8 million in the first nine months of 2004. The average debt for the periodincreased to $51.2 million in the first nine months of 2005 from $41.5 millionin the first nine months of 2004; however, the average cost of borrowingdeclined to 6.9% in 2005 from 9.1% in 2004.

 

Salaries and benefits increased to $9.0 million in the first nine monthsof 2005 from $8.8 million in the first nine months of 2004. Total personnelwithin the Portfolio Asset acquisition and resolution segment were 204 and 199 atSeptember 30, 2005 and 2004, respectively.

 

The provision for loan and impairment losses was $.44 million in thefirst nine months of 2005 compared to $.02 million in 2004.  See note 5 of the consolidated financialstatements for a detailed discussion on FirstCity’s allowance for loan losses.

 

Occupancy, data processing, communication and other expenses increased by6% to $3.5 million in the first nine months of 2005 from $3.3 million in thefirst nine months of 2004.

 

### *Other Items Affecting Operations*

 

The following items affect the Company’s overall results of operationsand are not directly related to any one of the Company’s businesses discussedabove.

 

*Corporate interest and overhead. *Company level interestexpense was zero in the first nine months of 2005 compared to $3.0 million inthe first nine months of 2004 as a result of the payoff of corporate debt inNovember 2004 from proceeds received on the sale of the Company’s 31%beneficial interest in Drive.  Othercorporate overhead expenses remained relatively flat at $4.2 million in thefirst nine months of 2005 compared to $4.1 million for the same period in 2004.

 

*Income taxes. *Provision for incometaxes was $.3 million in the first nine months of 2005 and $.1 million in thefirst nine months of 2004 and was 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 either of the first nine monthsof 2005 or 2004.

 

*Discontinued Operations. *The Company recorded a provision of $.3 million inthe first nine months of 2005 for additional losses from discontinued mortgageoperations compared to a provision of $1.2 million in the first nine months of 2004. At September 30, 2005, the only assetremaining from discontinued mortgage operations is an investment securityresulting from the retention of a residual interest in a securitizationtransaction.  In April 2005, theCompany exercised 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. *The transaction**did not have an impact on the results of operations, butdid result in the elimination of $.8 million of residual interests previouslyclassified as discontinued mortgage assets.

 

Earnings fromdiscontinued consumer operations was $.6 million in the first nine months of 2005compared to earnings of $9.2 million in the first nine months of 2004 as aresult of the sale of FirstCity’s interest in Drive in November 2004.   During the third quarter of 2005, anestimated tax provision of $.6 million was reversed due to lower thananticipated state income taxes related to the sale of Drive.

 

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#### **Financial Condition**

 

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

 

Consolidated assets of $165 million at September 30, 2005, were $6.3million higher than that at December 31, 2004, primarily as a result of increasesin Portfolio Assets and equity investments offset by decreases in cash, loansreceivable, discontinued operations and investment securities.  During the first nine months of 2005,FirstCity invested $16.9 million in Portfolio Asset acquisitions throughAcquisition Partnerships and $19.5 million through wholly-owned subsidiaries.  In addition, FirstCity invested $2.0 millionto increase its ownership percentage in a French servicing company from 10% to12% and in an Acquisition Partnership located in France from 33% to 43%.  During the first quarter of 2005, FirstCityalso sold its investment in certain bonds receivable, with a carrying value ofapproximately $.68 million, for a net gain of $.064 million.

 

Consolidated liabilities of $68 million as of September 30, 2005, were $1.5million higher than that at December 31, 2004. Total notes payable increased by$11 million, which reflected advances for portfolio acquisitions offset by a $9.5million decrease in other liabilities primarily related to a $8.0 millionparticipation liability owed to Bank of Scotland upon the sale of Drive, whichwas paid in the first quarter of 2005.

 

#### **Portfolio Asset Acquisition and Resolution**

 

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

 

| ** **                 | ** ** | **Purchase** | ** ** | **FirstCity**  | ** ** |
|----------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **Price**    | ** ** | **Investment** | ** ** |
| First nine months of  2005 |       | $            | 63,869     |           | $          | 36,395 |   |
| Total 2004                 |       | 174,139      |       | 59,762         |       |
| Total 2003                 |       | 129,192      |       | 22,944         |       |
| Total 2002                 |       | 171,769      |       | 16,717         |       |
| Total 2001                 |       | 224,927      |       | 24,319         |       |
| Total 2000                 |       | 394,927      |       | 22,140         |       |
|                            |            |              |            |                |            |  |  |

 

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

 

**Analysis of Selected Revenues and Expenses**

**Portfolio Asset Acquisition and Resolution**

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Portfolio Assets and Loans Receivable:**                    |       |                   |       |                  |       |   |   |   |   |
| Average investment in Portfolio Assets and loans  receivable: |       |                   |       |                  |       |   |   |   |   |
| Domestic                                                      |       | $                      | 44,568     |                  | $          | 22,160 |   | $ | 40,305 |   | $ | 13,552 |   |
| Latin America                                                 |       | 17,766                 |       | 18,090                |       | 18,548 |   | 16,163 |   |
| Europe                                                        |       | 509                    |       | 609                   |       | 517 |   | 1,391 |   |
| Total                                                         |       | $                      | 62,843     |                  | $          | 40,859 |   | $ | 59,370 |   | $ | 31,106 |   |
| Income from Portfolio Assets and loans receivable:            |       |                   |       |                  |       |   |   |   |   |
| Domestic                                                      |       | $                      | 2,189      |                  | $          | 863 |   | $ | 6,445 |   | $ | 1,309 |   |
| Latin America                                                 |       | 349                    |       | 600                   |       | 1,096 |   | 1,513 |   |
| Europe                                                        |       | 7                      |       | 6                     |       | 22 |   | 49 |   |
| Total                                                         |       | $                      | 2,545      |                  | $          | 1,469 |   | $ | 7,563 |   | $ | 2,871 |   |
| Average return (annualized):                                  |       |                   |       |                  |       |   |   |   |   |
| Domestic                                                      |       | 19.6                   | %          | 15.6                  | %          | 21.3 | % | 12.9 | % |
| Latin America                                                 |       | 7.9                    | %          | 13.3                  | %          | 7.9 | % | 12.5 | % |
| Europe                                                        |       | 5.5                    | %          | 3.9                   | %          | 5.7 | % | 4.7 | % |
| Total                                                         |       | 16.2                   | %          | 14.4                  | %          | 17.0 | % | 12.3 | % |
| **Servicing fee revenues:**                                   |       |                   |       |                  |       |   |   |   |   |
| Domestic partnerships:                                        |       |                   |       |                  |       |   |   |   |   |
| Servicing fee revenue                                         |       | $                      | 751        |                  | $          | 1,192 |   | $ | 2,725 |   | $ | 3,453 |   |
| Average servicing fee %                                       |       | 3.8                    | %          | 3.7                   | %          | 3.8 | % | 3.8 | % |
| Latin American partnerships:                                  |       |                   |       |                  |       |   |   |   |   |
| Servicing fee revenue                                         |       | $                      | 2,039      |                  | $          | 2,017 |   | $ | 5,935 |   | $ | 6,373 |   |
| Average servicing fee %                                       |       | 13.8                   | %          | 7.7                   | %          | 12.1 | % | 10.4 | % |
| Incentive service fees                                        |       | $                      | 101        |                  | $          | 119 |   | $ | 312 |   | $ | 250 |   |
| Total Service Fees:                                           |       |                   |       |                  |       |   |   |   |   |
| Servicing fee revenue                                         |       | 2,891                  |       | 3,328                 |       | 8,972 |   | 10,076 |   |
| Average servicing fee %                                       |       | 8.4                    | %          | 5.7                   | %          | 7.4 | % | 6.7 | % |
| **Collections:**                                              |       |                   |       |                  |       |   |   |   |   |
| Domestic                                                      |       | $                      | 19,781     |                  | $          | 32,282 |   | $ | 72,008 |   | $ | 89,720 |   |
| Latin America                                                 |       | 14,749                 |       | 26,352                |       | 48,924 |   | 61,447 |   |
| Europe                                                        |       | 12,477                 |       | 20,867                |       | 41,463 |   | 70,574 |   |
| Subtotal                                                      |       | 47,007                 |       | 79,501                |       | 162,395 |   | 221,741 |   |
| Wholly owned:                                                 |       | 5,804                  |       | 3,157                 |       | 19,735 |   | 4,311 |   |
| Total                                                         |       | $                      | 52,811     |                  | $          | 82,658 |   | $ | 182,130 |   | $ | 226,052 |   |
| **Personnel:**                                                |       |                   |       |                  |       |   |   |   |   |
| Personnel expenses                                            |       | $                      | 2,852      |                  | $          | 2,851 |   | $ | 9,039 |   | $ | 8,830 |   |
| Number of personnel (at period end):                          |       |                   |       |                  |       |   |   |   |   |
| Domestic                                                      |       | 65                     |       | 62                    |       |   |   |   |   |
| Mexico                                                        |       | 139                    |       | 137                   |       |   |   |   |   |
| Subtotal                                                      |       | 204                    |       | 199                   |       |   |   |   |   |
| Corporate                                                     |       | 33                     |       | 33                    |       |   |   |   |   |
| Total                                                         |       | 237                    |       | 232                   |       |   |   |   |   |
| **Interest expense:**                                         |       |                   |       |                  |       |   |   |   |   |
| Average debt                                                  |       | $                      | 52,385     |                  | $          | 54,254 |   | $ | 51,154 |   | $ | 41,516 |   |
| Interest expense                                              |       | 917                    |       | 1,174                 |       | 2,645 |   | 2,832 |   |
| Average cost (annualized)                                     |       | 7.0                    | %          | 8.7                   | %          | 6.9 | % | 9.1 | % |

 

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

 

**Analysis of Selected Revenues and Expenses**

**Acquisition Partnerships**

 
| ** **                                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                 | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                 | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                  |       |                   |       |                  |       |   |   |   |   |
| Gain on resolution of Portfolio Assets                     |       | $                      | 14,668     |                  | $          | 21,842 |   | $ | 52,455 |   | $ | 64,551 |   |
| Gross profit percentage on resolution of Portfolio  Assets |       | 41.16                  | %          | 30.03                 | %          | 38.48 | % | 32.54 | % |
| Interest income                                            |       | $                      | 2,267      |                  | $          | 2,365 |   | $ | 7,022 |   | $ | 7,530 |   |
| Other income                                               |       | 252                    |       | 1,963                 |       | 621 |   | 2,479 |   |
| Interest expense (1):                                      |       |                   |       |                  |       |   |   |   |   |
| Interest expense                                           |       | $                      | 3,559      |                  | $          | 4,916 |   | $ | 11,736 |   | $ | 13,119 |   |
| Average cost (annualized)                                  |       | 4.68                   | %          | 5.64                  | %          | 4.90 | % | 5.00 | % |
| Other expenses:                                            |       |                   |       |                  |       |   |   |   |   |
| Service fees                                               |       | $                      | 5,416      |                  | $          | 4,207 |   | 14,803 |   | 13,005 |   |
| Other operating costs                                      |       | 9,037                  |       | 7,241                 |       | 21,752 |   | 19,599 |   |
| Foreign currency gains                                     |       | (113                   | )          | (2,046                | )          | (9,188 | ) | (37 | ) |
| Income taxes                                               |       | 269                    |       | 3                     |       | 1,070 |   | 170 |   |
| Total other expenses                                       |       | 14,609                 |       | 9,405                 |       | 28,437 |   | 32,737 |   |
| Net earnings (loss)                                        |       | $                      | (981       | )                     | $          | 11,849 |   | $ | 19,925 |   | $ | 28,704 |   |
| Equity in earnings of Acquisition Partnerships             |       | $                      | 1,975      |                  | $          | 3,507 |   | $ | 8,385 |   | $ | 9,844 |   |
| Equity in earnings (loss) of Servicing Entities            |       | (192                   | )          | 149                   |       | 489 |   | 626 |   |
| Equity in earnings of investments                          |       | $                      | 1,783      |                  | $          | 3,656 |   | $ | 8,874 |   | $ | 10,470 |   |

 

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(1)          Interest expense includes interest on loans to the AcquisitionPartnerships located primarily in Mexico from affiliates of the investorgroups. Beginning in 2003, FirstCity amended seven loan agreements from MexicanAcquisition Partnerships to provide for no interest to be payable with respectto periods after the effective date of the amendment. This change had no impacton the consolidated net earnings as the effect is offset through equityearnings in these Partnerships.

 

**Provisionfor Income Taxes**

 

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

 

**Liquidityand Capital Resources**

 

Generally, the Companyrequires liquidity to fund its operations, working capital, payment of debt,equity for acquisition of Portfolio Assets, investments in and advances to theAcquisition Partnerships, and other investments by the Company. The potentialsources of liquidity are funds generated from operations, equity distributionsfrom the Acquisition Partnerships, interest and principal payments onsubordinated intercompany debt and dividends from the Company’s subsidiaries,borrowings from revolving lines of credit, proceeds from equity markettransactions, securitization and other structured finance transactions andother special purpose short-term borrowings.

 

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FirstCity has a $96million revolving acquisition facility with Bank of Scotland that matures inNovember 2008.  This facility is used tofinance 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 aninterest rate of LIBOR plus 2.50% to 2.75%, (iv) provides for a commitment feeof 0.20% of the unused balance of the revolving acquisition facility, and (v)provides that the aggregate borrowings under the facility does not exceed 60%of the net present value of FirstCity’s interest in Portfolio Assets and inAcquisition Partnerships pledged to secure the acquisition facility.

 

In August 2005, FH Partners, L.P., an indirect wholly-owned affiliateof FirstCity, and Bank of Scotland, acting through its New York branch, asagent for itself as lender, entered into a Revolving Credit Agreement thatprovides a $50 million revolving portfolio acquisition facility for FHPartners, L.P. to be secured by all of the assets of FH Partners, L.P.  The loan facility will be used to financeportfolio and asset purchases.  Thefacility (i) allows loans to be made for the acquisition of portfolioassets in the United States, (ii) provides that each loan may be in anamount of up to 70% of the net present value of the assets being acquired withthe proceeds of the loan, (iii) provides that the aggregate outstandingbalances of all loans will not exceed 65% of the net present value of theassets securing the loan facility, (iv) provides for an interest rate of LIBORplus 2.0%, (v) provides for an annual commitment fee of 0.20% of theunused balance of the revolving acquisition facility, (vi) provides for autilization fee of 0.75% of the amount of each loan made under the loanfacility, (vii) provides for an upfront fee of $350 thousand,(viii) provides for facility fees of $100 thousand, for the periodcommencing on the Effective Date to but excluding the first anniversarythereof, $75 thousand, for the period commencing on the first anniversary ofthe Effective Date to but excluding the second anniversary thereof, and $50thousand, for each subsequent one-year period, and (ix) provides for a maturitydate of November 12, 2008.  Theobligations of FH Partners, L.P. under the Revolving Credit Agreement areguaranteed by FirstCity and the primary wholly-owned subsidiaries of FirstCity.

 

FirstCity’s $35 millionloan facility with CFSC Capital Corp. XXX, a subsidiary of Cargill, terminatedby its own terms on March 31, 2005.  Thisfacility had been used to provide equity in new Portfolio acquisitions inpartnerships with Cargill and its affiliates. On November 12, 2004, the outstanding balances on the Cargill facilitywere paid down to zero funded out of proceeds from the $96 million facility.  FirstCity has not used the facility sinceSeptember 2004 and determined that the facility was no longer necessary inlight of the $96 million revolving acquisition facility provided by the Bank ofScotland.

 

BoS (USA) has a warrantto purchase 425,000 shares of the Company’s voting Common Stock at $2.3125 pershare. BoS (USA) is entitled to additional warrants in connection with thisexisting warrant for 425,000 shares under certain specific situations to retainits ability to acquire approximately 4.86% of the Company’s voting CommonStock.  The warrant will expire on August31, 2010, if it is not exercised prior to that date.

 

Excluding the termacquisition facilities of the unconsolidated Acquisition Partnerships, as of September30, 2005, the Company and its subsidiaries had credit facilities providing forborrowings in an aggregate principal amount of $152 million and outstandingborrowings of $62 million.

 

Management believes thatthe Bank of Scotland facilities, the related fees generated from the servicingof assets, equity distributions from existing Acquisition Partnerships andwholly-owned portfolios, as well as sales of interests in equity investments,will allow the Company to meet its obligations as they come due during the nexttwelve months.

 

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The following table summarizesthe material terms of the credit facilities to which the Company, its majoroperating subsidiaries and the Acquisition Partnerships were parties to as of November9, 2005, and the outstanding borrowings under such facilities as of September30, 2005.

 

**CreditFacilities**

 
| ** **                                                                           | ** ** | **Funded and**            | ** ** | ** **        | ** ** | ** **                                  | ** ** | ** **                                                                                   | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **Unfunded**              | ** ** | **Outstanding**   | ** ** | ** **                                  | ** ** | ** **                                                                                   | ** ** |
| ** **                                                                           | ** ** | **Commitment**            | ** ** | **Borrowings**    | ** ** | ** **                                  | ** ** | ** **                                                                                   | ** ** |
| ** **                                                                           | ** ** | **Amount as of**          | ** ** | **as of**         | ** ** | ** **                                  | ** ** | ** **                                                                                   | ** ** |
| ** **                                                                           | ** ** | **November 9,**           | ** ** | **September 30,** | ** ** | ** **                                  | ** ** | ** **                                                                                   | ** ** |
| ** **                                                                           | ** ** | **2005**                  | ** ** | **2005**          | ** ** | **Interest Rate**                           | ** ** | **Other Terms and Conditions**                                                               | ** ** |
| ** **                                                                           | ** ** | **(Dollars in millions)** | ** ** | ** **        | ** ** | ** **                                  | ** ** |
|                                                                                 |       |                      |       |              |       |                                        |       |                                                                                         |       |
| Bank of Scotland $96 million portfolio acquisition  and working capital facility (1) |       | $                         | 96         |              | $          | 39                                          |       | LIBOR + 2.5% - 2.75%                                                                         |       | Secured by equity  interests and other assets of FirstCity, matures November 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     |       |
|                                                                                 |       |                      |       |              |       |                                        |       |                                                                                         |       |
| 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                  |       | 5                         |       | 4                 |       | Fixed 5.625%                                |       | Secured by assets of FC  Washington and guaranteed by the Company, 3-year term loan          |       |
|                                                                                 |       |                      |       |              |       |                                        |       |                                                                                         |       |
| Total                                                                                |       | $                         | 152        |              | $          | 62                                          |       |                                                                                         |       |   |   |
|                                                                                 |       |                      |       |              |       |                                        |       |                                                                                         |       |
| Unconsolidated Acquisition Partnerships Term  Facilities (2)                    |       | $                         | 62         |              | $          | 62                                          |       | 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 September 30, 2005, the Company hadapproximately $10.1 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 $232 million outstanding as of September 30, 2005, owed toaffiliates of the investor groups. Of this amount, the Company has recordedapproximately $17.1 million as Loans Receivable on the Consolidated BalanceSheets.

 

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**Forward-LookingStatements**

 

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, 2004 (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. Theforward-looking statements in this Quarterly Report on Form 10-Q speak only asof the date of this Quarterly Report on Form 10-Q. The Company expresslydisclaims any obligation or undertaking to release publicly any updates orrevisions to any forward-looking statement to reflect any change in the Company’sexpectations with regard thereto or any change in events, conditions orcircumstances on which any forward-looking statement is based.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk.**

 

Market risk is the riskof loss from adverse changes in market prices and interest rates. The Company’soperations are materially impacted by net gains on sales of loans and netinterest margins. The level of gains from loan sales the Company achieves isdependent 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 Company invests inPortfolio Assets both directly through consolidated subsidiaries and indirectlythrough equity investments in Acquisition Partnerships. Portfolio Assetsconsist of investments in pools of non-homogenous assets that predominantlyconsist of loan and real estate assets. Earnings from these assets are based onthe estimated future cash flows from such assets and recorded when those cashflows occur. The underlying loans within these pools bear both fixed andvariable rates. Due to the non-performing nature and history of these loans,changes in prevailing benchmark rates (such as the prime rate or LIBOR)generally have a nominal effect on the ultimate future cash flow to be realizedfrom the loan assets. Furthermore, these pools of assets are held for sale, notfor investment; therefore, the disposition strategy is to liquidate theseassets as quickly as possible.

 

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

 

The Company currently hasinvestments in Europe and Latin America (primarily Mexico and Argentina). InEurope, the Company’s investments are in the form of equity and represent asignificant portion of the Company’s total equity investments. As of September30, 2005, one U.S. dollar equaled .83 Euros. A sharp change in the Eurorelative to the U.S. dollar could materially adversely affect the financialposition and results of operations of the Company. A 5% and 10% incrementaldepreciation of the Euro would result in an estimated decline in the valuationof the Company’s equity investments in Europe of approximately $.8 million and$1.6 million, respectively. These amounts are estimates of the financial impactof a depreciation of the Euro relative to the U.S. dollar. Consequently, theseamounts are not necessarily indicative of the actual effect of such changeswith respect to the Company’s consolidated financial position or results ofoperations. As discussed above, the revolving acquisition facility with Bank ofScotland

 

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for $96 million allows loans to be made in Euros up toa maximum amount in Euros that is equivalent to $35 million U.S. dollars. At September30, 2005, the Company had $10.1 million in Euro-denominated debt for thepurpose of hedging a portion of the net equity investments in Europe.Management of the Company feels that this loan agreement will help reduce therisk of adverse effects of currency changes on Euro-denominated investments.

 

In Mexico, approximately95% of the Company’s investments are made through U.S. dollar denominated loansto the Partnerships located in Mexico. The remaining investment is in the formof equity in these same Partnerships. The loans receivable are required to berepaid in U.S. dollars. Although the U.S. dollar balance of these loans willnot change due to a change in the Mexican peso, the future estimated cash flowsof the underlying assets in Mexico could become less valuable as a result of achange in the exchange rate for the Mexican peso, and thus, could affect theoverall total returns to the Company on these investments. As of September 30,2005, one U.S. dollar equaled 10.85 Mexican pesos. A 5% and 10% incrementaldepreciation of the Mexican peso would result in an estimated decline in thevaluation of the Company’s total investments in Mexico of approximately $.8million and $1.6 million, respectively. These amounts are estimates of thefinancial impact of a depreciation of the Mexican peso relative to the U.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.

 

FirstCity has investmentsin three Portfolios in South America — primarily in the form of loansreceivable from Argentina Acquisition Partnerships. As of September 30, 2005,one U.S. dollar equaled 2.92 Argentine pesos. The Company estimates that a 5%and 10% incremental depreciation of the Argentine peso would result in adecline in the valuation of the Company’s total investments in Argentina ofapproximately $.083 million and $.16 million, respectively. These amounts areestimates of the financial impact of a depreciation of the Argentine pesorelative to the U.S. dollar. Consequently, these amounts are not necessarilyindicative of the actual effect of such changes with respect to the Company’sconsolidated financial position or results of operations.

 

**Item4.  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 September 30, 2005.  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 Partnerships are partiesto or otherwise involved in legal proceedings arising in the normal course ofbusiness. FirstCity does not believe that there is any proceeding threatened orpending against it, its subsidiaries, its affiliates or the AcquisitionPartnerships 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”), as purportedassignee of the FirstCity Liquidating Trust, JP Morgan Chase Bank, NationalAssociation (“JPMCB”), and First-City National Bank of Houston as trustee ofthe Trust were made defendants in the suit as claimants to the Prudentialcommon stock. An agreed order dated January 27, 2005, was entered providingthat the Prudential common stock be transferred to JPMBC as record owner andfor the sale of the stock. The January 27, 2005 court order also provided thatthe proceeds from the sale are to be held by JPMCB pending resolution, byagreement or court order, of all conflicting claims to the proceeds. JPMBC hasindicated that the Prudential common stock was sold on January 28, 2005 fortotal proceeds of approximately $17.5 million. JPMCB also holds funds in theamount of approximately $489 thousand, which were dividend payments related tothe Prudential common stock. FirstCity and FCLT have filed cross claimsasserting ownership of the proceeds. JPMCB, in its capacity as successortrustee of the Trust filed an answer indicating that it was only acting in thesuit in its capacity as trustee for the Trust. JPMBC also sought to add asadditional parties to the suit a putative class of former employees of FirstCity Bancorporation of Texas, Inc. (now FirstCity) who were participants in thePlan. JPMCB also seeks a declaration from the court as to whether the proceedsshould be distributed to the successor of First City Bancorporation or to theputative class. Timothy Blair answered JPMCB’s third party action and the classof former employees has been certified by the court.  FCLT has included in its counterclaim againstFirstCity claims for damages related to alleged breaches of contract byFirstCity related to failure to assign the proceeds to FCLT and FirstCity’sassertion of a claim to the proceeds and a claim for tortious interference byFirstCity as a result of FirstCity’s claim for the proceeds.  FirstCityintends to vigorously contest the claims of FCLT, as FirstCity believes thatthe claims of FCLT are without merit and that it has valid defenses to theseclaims.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

None

 

**Item3.  Defaults Upon Senior Securities.**

 

None

 

**Item4.  Submission of Matters to a Vote of Security Holders.**

 

The Company held itsannual meeting of stockholders (the “Annual Meeting”) on August 4, 2005. Thefollowing items for business were considered at the Annual Meeting.

 

**(a) Election of Directors**

 

The following wereelected as directors to serve as members of the Company’s Board of Directorsuntil the Company’s 2006 annual meeting of stockholders. The number of votescast for each nominee was as follows:

 

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| **Table of Contents** |
|-----------------------|

 

| **Nominee**           | ** ** | **Votes For** | ** ** | **Votes  Against** | ** ** | **Abstained** | ** ** |
|-----------------------|------------|---------------|------------|--------------------|------------|---------------|------------|
|                  |       |          |       |               |       |          |       |
| James R. Hawkins      |       | 10,661,686    |       | 22,083             |       | —        |       |
| C. Ivan Wilson        |       | 9,922,076     |       | 761,693            |       | —        |       |
| James T. Sartain      |       | 10,674,286    |       | 9,483              |       | —        |       |
| Richard E. Bean       |       | 10,674,186    |       | 9,583              |       | —        |       |
| Dane Fulmer           |       | 9,926,066     |       | 757,703            |       | —        |       |
| Robert E. Garrison II |       | 10,674,086    |       | 9,683              |       | —        |       |
| D. Michael Hunter     |       | 10,674,056    |       | 9,713              |       | —        |       |
| Jeffery D. Leu        |       | 10,442,821    |       | 240,948            |       | —        |       |

 

**(b) Ratification of Appointment ofAuditors**

 

A proposal toratify the Board of Directors’ appointment of KPMG LLP as the Company’sindependent auditors for 2005 was approved by the stockholders. The number ofvotes for the proposal: 10,676,097; votes against: 4,858; abstentions: 2,814.

 

**Item 5.  OtherInformation.**

 

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).       |
|                  |   |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1*                 |   | —     |       | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                                                                                                                    |

 

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| **Table of Contents** |
|-----------------------|

 
| 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 September 30, 2005. |
|   |   |   |   |                                                                                                                                                                                                                                                                             |
| 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 September 30, 2005.   |

 

----

*           Filed herewith.

 

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|-----------------------|

 

**SIGNATURES**

 

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

 
|                      | Firstcity Financial  Corporation |
|---------------------------|----------------------------------|
|                      |                             |   |
|                      |                             |   |
|                      | By:                              | /s/   James T. Sartain |
|                      |                             | James T. Sartain |
| * *                  | * *                         | *President and Chief Executive* |
| * *                  | * *                         | *Officer and Director* |
| * *                  | * *                         | *(Duly authorized officer 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:  November 14, 2005 |                             |   |

 

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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).       |
|                  |   |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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 September 30, 2005.                                                                                                                                                                                           |
|                  |   |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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 September 30, 2005.                                                                                                                                                                                             |

 

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