** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

 

**Form 10-Q**

 

 

 

**(Mark One)**
| x          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|------------|------------|-----------------------------------------------------------------------------------------------|
|       |       |                                                                                          |
| ** ** | ** ** | **For the quarterly period ended September 30, 2007**                                         |
| ** ** | ** ** | ** **                                                                                    |
| £     | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|       |       |                                                                                          |
|       |       | **Commission file 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 x     No £

 

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

Largeaccelerated filer £    Accelerated filerx    Non-acceleratedfiler £

 

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

 

The number of shares of common stock, par value $.01 per share,outstanding at November 5, 2007 was 10,786,837.

 

 

** **

----

** **

** **

**TABLEOF CONTENTS**

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

 

 

----

 

Table of Contents

 

**PART I**

 

**FINANCIALINFORMATION**

 

**Item 1.  Financial Statements.**

 

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                                                    | ** ** | ** **        | ** ** | ** **       | ** ** |
| Cash and cash equivalents                                                                                                                                                                     |       | $                 | 32,909     |             | $          | 18,472 |   |
| Portfolio Assets, net                                                                                                                                                                         |       | 124,850           |       | 108,696          |       |
| Loans receivable from Acquisition Partnerships held  for investment                                                                                                                           |       | 5,515             |       | 4,755            |       |
| Loans receivable - SBA held for sale                                                                                                                                                          |       | 2,478             |       | —           |       |
| Loans receivable - SBA held for investment, net                                                                                                                                               |       | 14,980            |       | —           |       |
| Loans receivable - other                                                                                                                                                                      |       | 22,829            |       | 23,991           |       |
| Equity investments                                                                                                                                                                            |       | 93,258            |       | 112,357          |       |
| Deferred tax asset, net                                                                                                                                                                       |       | 20,101            |       | 20,101           |       |
| Service fees receivable ($624 and $917 from  affiliates, respectively)                                                                                                                        |       | 658               |       | 928              |       |
| Loan servicing assets - SBA                                                                                                                                                                   |       | 904               |       | —           |       |
| Other assets, net                                                                                                                                                                             |       | 21,034            |       | 8,363            |       |
| Total Assets                                                                                                                                                                                  |       | $                 | 339,516    |             | $          | 297,663 |   |
|                                                                                                                                                                                          |       |              |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 | ** ** | ** **        | ** ** | ** **       | ** ** |
| Liabilities:                                                                                                                                                                                  |       |              |       |             |       |
| Notes payable other                                                                                                                                                                           |       | $                 | 222,529    |             | $          | 187,811 |   |
| Minority interest                                                                                                                                                                             |       | 1,140             |       | 1,570            |       |
| Other liabilities                                                                                                                                                                             |       | 8,353             |       | 4,389            |       |
| Total Liabilities                                                                                                                                                                             |       | 232,022           |       | 193,770          |       |
| Commitments and contingencies (note 13)                                                                                                                                                       |       |              |       |             |       |
| Stockholders’ equity:                                                                                                                                                                    |       |              |       |             |       |
| Optional preferred stock (par value $.01 per share;  98,000,000 shares authorized; no shares issued or outstanding)                                                                           |       | —            |       | —           |       |
| Common stock (par value $.01 per share; 100,000,000  shares authorized; shares issued: 11,326,937 and 11,316,937, respectively; shares  outstanding: 10,786,837 and 10,786,637, respectively) |       | 113               |       | 113              |       |
| Treasury stock, at cost: 540,100 shares and 530,300  shares, respectively                                                                                                                     |       | (5,653            | )          | (5,571           | )          |
| Paid in capital                                                                                                                                                                               |       | 101,005           |       | 100,562          |       |
| Retained earnings                                                                                                                                                                             |       | 10,962            |       | 7,417            |       |
| Accumulated other comprehensive income                                                                                                                                                        |       | 1,067             |       | 1,372            |       |
| Total Stockholders’ Equity                                                                                                                                                               |       | 107,494           |       | 103,893          |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                               |       | $                 | 339,516    |             | $          | 297,663 |   |

 

 

Seeaccompanying notes to consolidated financial statements.

 

2

----

 

Table of Contents

 

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                                                                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **2007**                              | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues:                                                                                                                                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Servicing fees ($2,163 and $4,602 from affiliates  for the three month periods, respectively, and $7,344 and $9,954 from  affiliates for the nine month periods, respectively) |       | $                                     | 2,426      |                                 | $          | 4,679 |   | $ | 8,008 |   | $ | 10,182 |   |
| Income from Portfolio Assets                                                                                                                                                   |       | 5,743                                 |       | 2,547                                |       | 16,463 |   | 7,551 |   |
| Gain on sale of SBA loans held for sale, net                                                                                                                                   |       | 34                                    |       | —                               |       | 658 |   | — |   |
| Interest income from SBA loans                                                                                                                                                 |       | 752                                   |       | —                               |       | 1,666 |   | — |   |
| Interest income from affiliates                                                                                                                                                |       | 147                                   |       | 294                                  |       | 413 |   | 1,189 |   |
| Interest income from loans receivable - other                                                                                                                                  |       | 1,627                                 |       | 17                                   |       | 3,516 |   | 17 |   |
| Other income                                                                                                                                                                   |       | 903                                   |       | 654                                  |       | 1,900 |   | 1,846 |   |
| Total revenues                                                                                                                                                                 |       | 11,632                                |       | 8,191                                |       | 32,624 |   | 20,785 |   |
| Expenses:                                                                                                                                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Interest and fees on notes payable — other                                                                                                                                |       | 4,747                                 |       | 1,797                                |       | 13,666 |   | 5,433 |   |
| Interest and fees on notes payable to affiliates                                                                                                                               |       | —                                |       | 2                                    |       | — |   | 22 |   |
| Salaries and benefits                                                                                                                                                          |       | 4,446                                 |       | 4,094                                |       | 12,303 |   | 11,110 |   |
| Provision (recovery) for loan and impairment losses                                                                                                                            |       | (136                                  | )          | 50                                   |       | 936 |   | 101 |   |
| Occupancy, data processing, communication and other                                                                                                                            |       | 2,238                                 |       | 2,688                                |       | 10,469 |   | 6,165 |   |
| Total expenses                                                                                                                                                                 |       | 11,295                                |       | 8,631                                |       | 37,374 |   | 22,831 |   |
| Equity in earnings of investments                                                                                                                                              |       | 2,157                                 |       | 3,023                                |       | 8,315 |   | 8,044 |   |
| Gain on sale of subsidiaries and equity investments                                                                                                                            |       | 207                                   |       | 2,378                                |       | 207 |   | 2,405 |   |
| Earnings from continuing operations before income  taxes and minority interest                                                                                                 |       | 2,701                                 |       | 4,961                                |       | 3,772 |   | 8,403 |   |
| Income tax (expense) benefit                                                                                                                                                   |       | (134                                  | )          | 4                                    |       | (437 | ) | (140 | ) |
| Minority interest                                                                                                                                                              |       | 87                                    |       | 2                                    |       | 210 |   | 64 |   |
| Earnings from continuing operations                                                                                                                                            |       | 2,654                                 |       | 4,967                                |       | 3,545 |   | 8,327 |   |
| Discontinued operations                                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Loss from discontinued operations                                                                                                                                              |       | —                                |       | —                               |       | — |   | (75 | ) |
| Income taxes                                                                                                                                                                   |       | —                                |       | —                               |       | — |   | — |   |
| Net loss from discontinued operations                                                                                                                                          |       | —                                |       | —                               |       | — |   | (75 | ) |
| Net earnings                                                                                                                                                                   |       | $                                     | 2,654      |                                 | $          | 4,967 |   | $ | 3,545 |   | $ | 8,252 |   |
| Basic earnings per common share are as follows:                                                                                                                                |       |                                  |       |                                 |       |   |   |   |   |
| Earnings from continuing operations                                                                                                                                            |       | $                                     | 0.25       |                                 | $          | 0.45 |   | $ | 0.33 |   | $ | 0.74 |   |
| Discontinued operations                                                                                                                                                        |       | $                                     | —     |                                 | $          | — |   | $ | — |   | $ | (0.01 | ) |
| Net earnings to common stockholders                                                                                                                                            |       | $                                     | 0.25       |                                 | $          | 0.45 |   | $ | 0.33 |   | $ | 0.73 |   |
| Weighted average common shares outstanding                                                                                                                                     |       | 10,790                                |       | 11,104                               |       | 10,789 |   | 11,239 |   |
| Diluted earnings per common share are as follows:                                                                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Earnings from continuing operations                                                                                                                                            |       | $                                     | 0.23       |                                 | $          | 0.42 |   | $ | 0.31 |   | $ | 0.70 |   |
| Discontinued operations                                                                                                                                                        |       | $                                     | —     |                                 | $          | — |   | $ | — |   | $ | (0.01 | ) |
| Net earnings to common stockholders                                                                                                                                            |       | $                                     | 0.23       |                                 | $          | 0.42 |   | $ | 0.31 |   | $ | 0.69 |   |
| Weighted average common shares outstanding                                                                                                                                     |       | 11,379                                |       | 11,711                               |       | 11,402 |   | 11,875 |   |

 

 

Seeaccompanying notes to consolidated financial statements.

 

3

----

 

Table of Contents

 

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**ANDCOMPREHENSIVE INCOME**

**(Dollarsin thousands)**

| ** **                                                                   | ** ** | ** **        | ** ** | ** **          | ** ** | ** **  | ** ** | ** **       | ** ** | ** **        | ** ** | **Retained**      | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|---------------------|------------|-------------|------------|------------------|------------|-------------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                   | ** ** | ** **        | ** ** | ** **          | ** ** | ** **  | ** ** | ** **       | ** ** | ** **        | ** ** | **Earnings**      | ** ** | **Other**       | ** ** | **Total**  | ** ** |
| ** **                                                                   | ** ** | **Common  Stock** | ** ** | **Treasury  Stock** | ** ** | **Paid in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders'** | ** ** |
| ** **                                                                   | ** ** | **Shares**        | ** ** | **Amount**          | ** ** | **Shares**  | ** ** | **Amount**       | ** ** | **Capital**       | ** ** | **Deficit)**      | ** ** | **Income**      | ** ** | **Equity** | ** ** |
| ** **                                                                   | ** ** | ** **        | ** ** | ** **          | ** ** | ** **  | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **      | ** ** | ** ** | ** ** |
| **Balances, December 31, 2005**                                              |       | 11,307,187        |       | $                   | 113        |        | —     |             | $          | —            |       | $                 | 99,843     |            | $          | (2,058     | )          | $ | 1,013 |   | $ | 98,911 |   |
| Cumulative effect of adjustments resulting from the  adoption of SAB No. 108 |       | —            |       | —              |       | —      |       | —           |       | —            |       | (327              | )          | —          |       | (327       | )          |
| Exercise of common stock options                                             |       | 9,750             |       | —              |       | —      |       | —           |       | 68                |       | —            |       | —          |       | 68         |       |
| Repurchase of common stock                                                   |       | —            |       | —              |       | 530,300     |       | (5,571           | )          | —            |       | —            |       | —          |       | (5,571     | )          |
| Additional paid-in capital arising from stock option  compensation expense   |       | —            |       | —              |       | —      |       | —           |       | 651               |       | —            |       | —          |       | 651        |       |
|                                                                         |       |              |       |                |       |        |       |             |       |              |       |              |       |            |       |       |       |
| Comprehensive income:                                                        |       |              |       |                |       |        |       |             |       |              |       |              |       |            |       |       |       |
| Net earnings for 2006                                                        |       | —            |       | —              |       | —      |       | —           |       | —            |       | 9,802             |       | —          |       | 9,802      |       |
| Translation adjustments                                                      |       | —            |       | —              |       | —      |       | —           |       | —            |       | —            |       | 359             |       | 359        |       |
| Total comprehensive income                                                   |       |              |       |                |       |        |       |             |       |              |       |              |       |            |       | 10,161     |       |
| **Balances, December 31, 2006**                                              |       | 11,316,937        |       | 113                 |       | 530,300     |       | (5,571           | )          | 100,562           |       | 7,417             |       | 1,372           |       | 103,893    |       |
| Exercise of common stock options                                             |       | 10,000            |       | —              |       | —      |       | —           |       | 35                |       | —            |       | —          |       | 35         |       |
| Repurchase of common stock                                                   |       | —            |       | —              |       | 9,800       |       | (82              | )          | —            |       | —            |       | —          |       | (82        | )          |
| Additional paid-in capital arising from stock option  compensation expense   |       | —            |       | —              |       | —      |       | —           |       | 408               |       | —            |       | —          |       | 408        |       |
| Comprehensive income:                                                        |       |              |       |                |       |        |       |             |       |              |       |              |       |            |       |       |       |
| Net earnings for the first nine months of 2007                               |       | —            |       | —              |       | —      |       | —           |       | —            |       | 3,545             |       | —          |       | 3,545      |       |
| Translation adjustments                                                      |       | —            |       | —              |       | —      |       | —           |       | —            |       | —            |       | (305            | )          | (305       | )          |
| Total comprehensive income                                                   |       |              |       |                |       |        |       |             |       |              |       |              |       |            |       | 3,240      |       |
| **Balances, September 30, 2007 (unaudited)**                                 |       | 11,326,937        |       | $                   | 113        |        | 540,100    |             | $          | (5,653            | )          | $                 | 101,005    |            | $          | 10,962     |       | $ | 1,067 |   | $ | 107,494 |   |
|                                                                              |            |                   |            |                     |            |             |            |                  |            |                   |            |                   |            |                 |            |            |            |  |  |  |  |  |  |  |  |  |

 

Seeaccompanying notes to consolidated financial statements.

 

4

----

 

Table of Contents

 

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollarsin thousands)**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                       | ** ** | **September 30,**     | ** ** |
| ** **                                                                       | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Cash flows from operating activities:                                            |       |                  |       |   |   |
| Net earnings                                                                     |       | $                     | 3,545      |   | $ | 8,252 |   |
| Adjustments to reconcile net earnings to net cash  used in operating activities: |       |                  |       |   |   |
| Net loss from discontinued operations                                            |       | —                |       | 75 |   |
| Purchase of SBA loans held for sale                                              |       | (19,406               | )          | — |   |
| Payments applied to principal on SBA loans held for  sale                        |       | 693                   |       | — |   |
| Proceeds from the sale of SBA loans held for sale,  net                          |       | 17,123                |       | — |   |
| Purchase of Portfolio Assets, net                                                |       | (61,249               | )          | (52,958 | ) |
| Proceeds applied to principal on Portfolio Assets                                |       | 60,814                |       | 30,996 |   |
| Income from Portfolio Assets                                                     |       | (16,463               | )          | (7,551 | ) |
| Capitalized interest and costs on Portfolio Assets  and loans receivable         |       | (776                  | )          | (452 | ) |
| Provision for loan and impairment losses                                         |       | 936                   |       | 101 |   |
| Equity in earnings of investments                                                |       | (8,315                | )          | (8,044 | ) |
| Gain on sale of SBA loans held for sale                                          |       | (658                  | )          | — |   |
| Gain on sale of subsidiaries and equity investments                              |       | (207                  | )          | (2,405 | ) |
| Depreciation and amortization                                                    |       | 402                   |       | 391 |   |
| Discount accretion on loans held for investment                                  |       | (427                  | )          | — |   |
| Stock-based compensation expense related to stock  options                       |       | 408                   |       | 467 |   |
| Decrease in service fees receivable                                              |       | 270                   |       | 7 |   |
| Decrease (increase) in other assets                                              |       | (5,938                | )          | 791 |   |
| Change in debt imputed value                                                     |       | —                |       | (293 | ) |
| Increase (decrease) in other liabilities                                         |       | 1,533                 |       | (539 | ) |
| Net cash used in operating activities                                            |       | (27,715               | )          | (31,162 | ) |
| Cash flows from investing activities:                                            |       |                  |       |   |   |
| Property and equipment, net                                                      |       | (502                  | )          | (135 | ) |
| Proceeds from sale of subsidiaries and equity  investments                       |       | 726                   |       | 8,689 |   |
| Cash paid for business combination, net of cash  acquired                        |       | (5,629                | )          | — |   |
| Net payments (advances) on loans receivable                                      |       | 1,837                 |       | (10,365 | ) |
| Net increase in SBA loans held for investment                                    |       | (15,104               | )          | — |   |
| Contributions to Acquisition Partnerships and  Servicing Entities                |       | (22,352               | )          | (39,406 | ) |
| Distributions from Acquisition Partnerships and  Servicing Entities              |       | 52,291                |       | 63,346 |   |
| Net cash provided by investing activities                                        |       | 11,267                |       | 22,129 |   |
| Cash flows from financing activities:                                            |       |                  |       |   |   |
| Borrowings under notes payable — other                                      |       | 142,549               |       | 106,569 |   |
| Payments of notes payable to affiliates                                          |       | —                |       | (312 | ) |
| Payments of notes payable — other                                           |       | (111,593              | )          | (91,566 | ) |
| Repurchase of common stock                                                       |       | (82                   | )          | (5,571 | ) |
| Proceeds from issuance of common stock                                           |       | 35                    |       | 68 |   |
| Net cash provided by financing activities                                        |       | 30,909                |       | 9,188 |   |
| Net cash provided by continuing operations                                       |       | 14,461                |       | 155 |   |
| Cash flows from discontinued operations:                                         |       |                  |       |   |   |
| Net cash used in operating activities                                            |       | (24                   | )          | (20 | ) |
| Net cash used in discontinued operations                                         |       | (24                   | )          | (20 | ) |
| Net increase in cash and cash equivalents                                        |       | 14,437                |       | 135 |   |
| Cash and cash equivalents, beginning of period                                   |       | 18,472                |       | 12,901 |   |
| Cash and cash equivalents, end of period                                         |       | $                     | 32,909     |   | $ | 13,036 |   |
| Supplemental disclosure of cash flow information:                                |       |                  |       |   |   |
| Cash paid during the period for:                                                 |       |                  |       |   |   |
| Interest                                                                         |       | $                     | 11,268     |   | $ | 4,636 |   |
| Income taxes, net of refunds received                                            |       | 287                   |       | 121 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

 

5

----

 

Table of Contents

 

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**September30, 2007**

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

**(Unaudited)**

 

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

 

***The Company***

 

FirstCityFinancial Corporation and subsidiaries (the “Company” or “FirstCity”) is afinancial services company with offices throughout the United States, Mexicoand Brazil, with a presence in France, Germany, Argentina and Chile. AtSeptember 30, 2007, the Company was engaged in one principal reportable segment- Portfolio Asset acquisition and resolution. The portfolio asset acquisition andresolution business involves acquiring portfolios of loans, real estate andother assets or single assets and investment in similar assets (collectivelyreferred to as “Portfolios” or “Portfolio Assets”) generally at adiscount to their legal principal balance or appraised value, and servicing and resolving such Portfolios inan effort to maximize the present value of the ultimate cash recoveries, andthe origination of loans secured by similar assets.

 

***Basis of Presentation***

 

Theunaudited consolidated financial statements of FirstCity reflect, in theopinion of management, all adjustments, consisting only of normal and recurringadjustments, necessary to present fairly FirstCity’s consolidated financialposition at September 30, 2007, its results of operations for the three andnine month periods ended September 30, 2007 and 2006 and cash flows for thenine month periods ended September 30, 2007 and 2006.  Certain disclosures have been condensed or omittedfrom these financial statements. Accordingly, these financial statements shouldbe read with the consolidated financial statements included in the Company’s2006 Annual Report on Form 10-K.  Certainamounts in the consolidated financial statements for prior years have beenreclassified to conform to current consolidated financial statementpresentation.

 

***Use of Estimates***

 

The preparation of financial statements in conformity with U.S. generally accepted accountingprinciples requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Significant estimates include (i) the estimationof future collections on purchased Portfolio Assets used in the calculation ofincome from Portfolio Assets, (ii) interest rate environments, (iii) valuationof the deferred tax asset, and (iv) prepayment speeds and collectibility ofloans receivable, loans held in securitization trusts, and service feesreceivable. Actual results could differ materially from those estimates.

 

***Reclassifications***

 

Certain amounts in theconsolidated financial statements for prior periods have been reclassified toconform to current consolidated financial statement presentation.  In all reporting prior to December 31, 2006,FirstCity reported loans receivable advances and loans receivable payments incash flows from operating activities on the Consolidated Statements of CashFlows.  Beginning in the fourth quarterof 2006, the Company reports these items in cash flows from investingactivities.  Prior period amountsreported on the Consolidated Statements of Cash Flows have been adjusted toconform to this treatment which is required under GAAP.  The total amount thus reclassified was$10,365 for the nine months ended September 30, 2006.  Management believes that the changes in theConsolidated Statements of Cash Flows for the nine month period ended September30, 2006 are immaterial relative to the financial statements taken as awhole.  These reclassifications have thefollowing impact on the financial statements:

 

 

6

----

 

Table of Contents

 

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data)- (continued)**

 

 

 

| ** **                                                                | ** ** | **Nine Months Ended** | ** **     |
|---------------------------------------------------------------------------|------------|-----------------------|----------------|
| ** **                                                                | ** ** | **September 30,**     | ** **     |
| ** **                                                                | ** ** | **2006**              | ** **     |
|                                                                      |       |                  |           |
| Statement of Cash Flows:                                                  |       |                  |           |
| Cash flows from operating activities (as reported)                        |       | $                     |   (41,527 | ) |
| Impact of reclassification on net loans receivable advances  and payments |       | 10,365                |           |
|                                                                      |
| Cash flows from operating activities (as corrected)                       |       | $                     |   (31,162 | ) |
|                                                                      |       |                  |           |
| Cash flows from investing activities (as reported)                        |       | $                     |   32,494  |   |
| Impact of reclassification on net loans receivable advances  and payments |       |                  |           |
|                                                                      | (10,365    | )                     |
| Cash flows from investing activities (as corrected)                       |       | $                     |   22,129  |   |

 

 

**(2)  New Accounting Pronouncements**

 

InFebruary 2007, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No.159,*The Fair Value Option for Financial Assets andFinancial Liabilities-Including an amendment of FASB Statement No. 115*(“SFAS159”)**SFAS 159 permits entities to choose to measureeligible items at fair value at specified election dates. Unrealized gains andlosses on items for which the fair value option has been elected are reportedin earnings at each subsequent reporting date. The fair value option (i) may beapplied instrument by instrument, with certain exceptions, (ii) is irrevocable(unless a new election date occurs) and (iii) is applied only to entireinstruments and not to portions of instruments. SFAS 159 is effective for theCompany on January 1, 2008.  The Companyis currently evaluating the impact SFAS 159 will have on its financialstatements.

 

In September 2006, SFASNo. 157, *Fair Value Measurements* (“SFAS 157”),was issued.  SFAS 157 establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements.  The changes to currentpractice resulting from the application of SFAS 157 relate to the definition offair value, the methods used to measure fair value, and the expandeddisclosures about fair value measurements. SFAS 157 is effective for the Company on January 1, 2008.  The Company is currently evaluating theimpact SFAS 157 will have on its financial statements.

 

**(3)  Discontinued Operations**

 

Discontinued operations are comprised of twocomponents previously reported as the Company’s residential and commercialmortgage banking business (“Mortgage”) and the consumer lending businessconducted through the Company’s minority interest investment in Drive FinancialServices LP (“Consumer”).  There was noincome or loss from discontinued operations in the first nine months of 2007,and    ($75) in the first nine months of2006.

 

*Mortgage*

 

At September 30, 2007, the only asset remaining from discontinued operationsis from mortgage operations, and represents an investment security resultingfrom the retention of a residual interest in a securitization transaction. Thissecurity is in “run-off,” and the Company is contractually obligated to servicethese assets.  The cash flows arecollected over a period of time and are valued using prepayment assumptions of32% for fixed rate loans and 33% for variable rate loans. Overall loss ratesare estimated at 14% of collateral.  The Companyrecorded provisions (recoveries) of ($24) and $54 in the first nine months of2007 and 2006, respectively, for losses from discontinued mortgageoperations.  Discontinued mortgage assetsof $127 at September 30, 2007 are included in other assets.

 

*Consumer*

 

Liabilities fromdiscontinued consumer operations of $320 consisted of state taxes payable atSeptember 30, 2007, and are included in other liabilities.

 

 

7

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Dollars in thousands, except per share data) - (continued)**

** **

**(4)  Portfolio Assets**

 

Portfolio Assets are summarized as follows:

 

| ** **                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                  | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Loan Portfolios                             |       |              |       |             |       |
| Loans Acquired Prior to 2005                |       |              |       |             |       |
| Non-performing Portfolio Assets             |       | $                 | 5,030      |             | $          | 6,163 |   |
| Performing Portfolio Assets                 |       | 2,935             |       | 5,166            |       |
| Loans Acquired After 2004                   |       |              |       |             |       |
| Loans acquired with credit deterioration    |       | 100,843           |       | 84,550           |       |
| Loans acquired with no credit deterioration |       | 4,176             |       | 6,473            |       |
| Outstanding balance                         |       | 112,984           |       | 102,352          |       |
| Allowance for loan losses                   |       | (997              | )          | (333             | )          |
| Carrying amount of loans, net of allowance  |       | 111,987           |       | 102,019          |       |
|                                        |       |              |       |             |       |
| Real Estate Portfolios                      |       | 10,859            |       | 4,574            |       |
| Other                                       |       | 2,004             |       | 2,103            |       |
| Portfolio Assets, net                       |       | $                 | 124,850    |             | $          | 108,696 |   |

 

 

Income from Portfolio Assets issummarized as follows:

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                  | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Loan Portfolios                             |       |                   |       |                  |       |   |   |   |   |
| Loans Acquired Prior to 2005                |       |                   |       |                  |       |   |   |   |   |
| Non-performing Portfolio Assets             |       | $                      | 325        |                  | $          | 612 |   | $ | 1,193 |   | $ | 2,464 |   |
| Performing Portfolio Assets                 |       | 165                    |       | 412                   |       | 727 |   | 1,293 |   |
| Loans Acquired After 2004                   |       |                   |       |                  |       |   |   |   |   |
| Loans acquired with credit deterioration    |       | 4,300                  |       | 1,403                 |       | 12,450 |   | 2,412 |   |
| Loans acquired with no credit deterioration |       | 417                    |       | 93                    |       | 1,113 |   | 277 |   |
| Real Estate Portfolios                      |       | 478                    |       | 51                    |       | 806 |   | 923 |   |
| Other                                       |       | 58                     |       | (24                   | )          | 174 |   | 182 |   |
| Income from Portfolio Assets                |       | $                      | 5,743      |                  | $          | 2,547 |   | $ | 16,463 |   | $ | 7,551 |   |

 

 

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

 

The Company recorded a provisionfor loan and impairment losses on Portfolio Assets of approximately $757 forthe nine month period ended September 30, 2007, which is comprised of a $93impairment charge on real estate portfolios and a $664 allowance for loanlosses, net of recoveries.  For the ninemonth period ended September 30, 2006, the Company recorded a provision forloan and impairment losses on Portfolio Assets of $101, which is comprised of a$24 impairment charge on real estate portfolios and a $77 allowance for loan losses.

 

During the third quarterof 2007, management determined that actual cash flows related to certain loanportfolios have exceeded management’s historical estimates.  The increase in estimated cash flows is aresult of adjusting cash flows related to certain asset-level expenses, whichare accounted for as period expenses and recognized in the periodincurred.  Beginning with the thirdquarter of 2007, management is using estimated gross cash receipts net of estimatedselling costs in the estimates of future cash flows.  As a result of this change in estimate, inthe third quarter of 2007, the Company recognized net recoveries of loan lossprovisions of $0.5 million.

 

8

----

 

Table of Contents

** **

**FIRSTCITY FINANCIAL CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

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

 

| ** **        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **        | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance |       | $                      | (1,244     | )                     | $          | (197 | ) | $ | (333 | ) | $ | (163 | ) |
| Provisions        |       | (661                   | )          | (42                   | )          | (1,686 | ) | (183 | ) |
| Recoveries        |       | 908                    |       | 14                    |       | 1,022 |   | 106 |   |
| Charge Offs       |       | —                 |       | 33                    |       | — |   | 48 |   |
| Ending Balance    |       | $                      | (997       | )                     | $          | (192 | ) | $ | (997 | ) | $ | (192 | ) |

 

 

Changes in accretableyield for loans acquired with credit deterioration are as follows:

 

| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                     | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  Balance                             |       | $                      | 32,241     |                  | $          | 9,660 |   | $ | 32,339 |   | $ | 3,765 |   |
| Additions                                      |       | 6,549                  |       | 9,710                 |       | 9,785 |   | 16,614 |   |
| Accretion                                      |       | (3,505                 | )          | (980                  | )          | (10,086 | ) | (1,984 | ) |
| Reclassification from nonaccretable difference |       | (327                   | )          | (111                  | )          | 4,838 |   | (111 | ) |
| Disposals                                      |       | (1,005                 | )          | (423                  | )          | (2,924 | ) | (428 | ) |
| Translation adjustments                        |       | 22                     |       | —                |       | 23 |   | — |   |
| Ending Balance                                 |       | $                      | 33,975     |                  | $          | 17,856 |   | $ | 33,975 |   | $ | 17,856 |   |
|                                           |       |                   |       |                  |       |   |   |   |   |

 

 

Loans acquiredduring each period for which it was probable at acquisition that allcontractually required payments would not be collected are as follows:

 

| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                         | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Face value at acquisition                          |       | $                      | 27,480     |                  | $          | 132,926 |   | $ | 78,030 |   | $ | 176,566 |   |
| Cash flows expected to be collected at acquisition |       | 21,638                 |       | 39,608                |       | 60,465 |   | 69,572 |   |
| Basis in acquired loans at acquisition             |       | 15,089                 |       | 29,898                |       | 50,680 |   | 52,958 |   |
|                                                    |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

 

**(5)  Loans Receivable**

 

***Loans receivable from AcquisitionPartnerships held for investment***

 

Loans receivable fromAcquisition Partnerships are summarized as follows:

 

| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                    | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Outstanding balance           |       | $                 | 5,125      |             | $          | 4,598 |   |
| Capitalized costs             |       | 390               |       | 157              |       |
| Carrying amount of loans, net |       | $                 | 5,515      |             | $          | 4,755 |   |

 

 

 

9

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

The summary ofactivity in loans receivable from Acquisition Partnerships is as follows:

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                      | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance               |       | $                      | 5,084      |                  | $          | 25,789 |   | $ | 4,755 |   | $ | 19,606 |   |
| Advances                        |       | 181                    |       | 2,355                 |       | 667 |   | 9,502 |   |
| Payments received               |       | (73                    | )          | (260                  | )          | (447 | ) | (1,435 | ) |
| Capitalized origination costs   |       | 89                     |       | 173                   |       | 233 |   | 334 |   |
| Other noncash adjustments       |       | —                 |       | (20,921               | )          | — |   | (20,969 | ) |
| Foreign exchange gains (losses) |       | 234                    |       | 8                     |       | 307 |   | 106 |   |
| Ending Balance                  |       | $                      | 5,515      |                  | $          | 7,144 |   | $ | 5,515 |   | $ | 7,144 |   |

 

Loans receivable fromAcquisition Partnerships held for investment are reported at their outstanding principalbalances adjusted for net deferred loan origination and other capitalized costsand the allowance for loan losses. Interest is recognized on an accrual basis at the applicable interestrate on the principal amount outstanding. Loan origination fees and direct costs are amortized as level yieldadjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of theloans.  Loans receivable from AcquisitionPartnerships are secured by the assets/loans acquired by the partnerships withpurchase money loans provided by affiliates of the investors to the partnershipsto purchase the asset pools held in those entities. They are evaluated forimpairment by analyzing the expected future cash flows from the underlyingassets within each pool to determine that the cash flows are sufficient torepay these notes. The Company applies the asset valuation methodologyconsistently in all venues and uses the same proprietary asset managementsystem to evaluate impairment on all asset pools. The results of thisevaluation indicated that cash flows from the pools will be sufficient to repaythe loans and no allowances for impairment are necessary.

 

In August 2006, FirstCitycompleted a restructuring of its investments in Mexico in a transaction withAmerican International Group, Inc. (“AIG”). As a result, FirstCity eliminated substantially all of its loansreceivable from Mexico acquisition partnerships.  Equity method losses were recorded to reducethe loans receivable from certain Mexican partnerships, in compliance with EITF98-13, *Accounting by an Equity Method Investor forInvestee Losses When the Investor Has Loans to and Investments in OtherSecurities of the Investee*, and EITF 99-10, *PercentageUsed to Determine the Amount of Equity Method Losses*.

 

***Loansreceivable - SBA held for sale***

 

Loans receivable - SBAheld for sale are summarized as follows:

 
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                     | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Outstanding balance            |       | $                 | 2,403      |             | $          | — |   |
| Premiums                       |       | 75                |       | —           |       |
| Carrying amount of  loans, net |       | $                 | 2,478      |             | $          | — |   |

 

 

 

10

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(Dollars in thousands, except pershare data) - (continued)**

 

Changes in loansreceivable — SBA held for sale are as follows:

 

| ** **                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                         | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance                  |       | $                      | 3,830      |                  | $          | — |   | $ | — |   | $ | — |   |
| Purchases of loans                 |       | —                 |       | —                |       | 18,355 |   | — |   |
| Originations and advances of loans |       | 227                    |       | —                |       | 1,051 |   | — |   |
| Payments received                  |       | (282                   | )          | —                |       | (693 | ) | — |   |
| Loans sold                         |       | (1,267                 | )          | —                |       | (15,806 | ) | — |   |
| Discount, net                      |       | (30                    | )          | —                |       | (429 | ) | — |   |
| Ending Balance                     |       | $                      | 2,478      |                  | $          | — |   | $ | 2,478 |   | $ | — |   |

 

Loans receivable -Small Business Administration (“SBA”) held for sale are reflected at the lowerof aggregate cost or market value.  Thecarrying value of SBA loans held for sale is net of premiums as well asdeferred origination fees and costs. Premiums and net origination fees and costs are deferred on SBA loansheld for sale and included in the basis of the loans in calculating gains andlosses upon sale.  The Company generallysells the guaranteed portion of each loan to a third party and retains theservicing rights. The difference between the proceeds received and theallocated carrying value of the loans sold are recognized as gains on sales ofloans.  The non-guaranteed portion isgenerally held in the portfolio and classified as held for investment.

 

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

 

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

 

| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                    | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Outstanding balance           |       | $                 | 16,618     |             | $          | — |   |
| Allowance for loan losses     |       | (179              | )          | —           |       |
| Discounts, net                |       | (1,461            | )          | —           |       |
| Capitalized origination costs |       | 2                 |       | —           |       |
| Carrying amount of loans, net |       | $                 | 14,980     |             | $          | — |   |

 

 

Changes in loansreceivable — SBA held for investment are as follows:

 

| ** **                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                         | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance                  |       | $                      | 15,480     |                  | $          | — |   | $ | — |   | $ | — |   |
| Purchases of loans                 |       | —                 |       | —                |       | 17,406 |   | — |   |
| Originations and advances of loans |       | 76                     |       | —                |       | 351 |   | — |   |
| Payments received                  |       | (678                   | )          | —                |       | (2,655 | ) | — |   |
| Capitalized origination costs      |       | —                 |       | —                |       | 2 |   | — |   |
| Provision for SBA loan losses      |       | (110                   | )          | —                |       | (179 | ) | — |   |
| Discount, net                      |       | 212                    |       | —                |       | 55 |   | — |   |
| Ending Balance                     |       | $                      | 14,980     |                  | $          | — |   | $ | 14,980 |   | $ | — |   |

 

Loans receivable -SBA held for investment are reported at their outstanding principal balancesadjusted for unearned discounts, net deferred loan origination costs and theallowance for loan losses. Interest is recognized on an accrual basis at theapplicable interest rate on the principal amount outstanding.  Loan origination fees and direct costs aswell as premiums and discounts are amortized as level yield adjustments overthe respective loan terms.  Unamortizednet fees or costs are recognized upon early repayment of the loans.

 

 

11

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(Dollars in thousands, except pershare data) - (continued)**

** **

 

The Company measures loanimpairment in accordance with SFAS No. 114, *Accountingby Creditors for Impairment of a Loan—an Amendment of FASB StatementsNo. 5 and 15* and No. 118, *Accountingby Creditors for Impairment of a Loan—Income Recognition and Disclosures—anAmendment of FASB Statement No. 114*. When management believesthere is sufficient doubt as to the ultimate collectibility of interest on anyloan, interest accruals are discontinued. These loans are evaluated forimpairment by management based upon performance of the loans and otherportfolio characteristics, such as industry concentrations and loan collateral,which also impacts management’s estimates of the impairment.  The adequacy of the allowance for loan lossesis reviewed by management quarterly and as adjustments become necessary, theywill be reflected in operations during the periods in which they becomeknown.  Considerations in this evaluationinclude past and current loss experience, risks inherent in the currentportfolio and evaluation of commercial and real estate collateral as well ascurrent economic conditions.  The Companyanalyzed the credit worthiness of the loans as of September 30, 2007 andrecorded provisions of $179 to absorb expected losses.

 

Changesin the allowance for loan losses on loans receivable - SBA held for investmentare as follows:

 
| ** **        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **        | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance |       | $                      | —     |                  | $          | — |   | $ | — |   | $ | — |   |
| Provisions        |       | (110                   | )          | —                |       | (179 | ) | — |   |
| Recoveries        |       | —                 |       | —                |       | — |   | — |   |
| Charge Offs       |       | —                 |       | —                |       | — |   | — |   |
| Ending Balance    |       | $                      | (110       | )                     | $          | — |   | $ | (179 | ) | $ | — |   |

 

 

***Loans receivable — Other***

 

Loans receivable - otherare summarized as follows:

 

| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                    | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Outstanding balance           |       | $                 | 22,348     |             | $          | 24,152 |   |
| Discounts, net                |       | (18               | )          | (161             | )          |
| Capitalized costs             |       | 499               |       | —           |       |
| Carrying amount of loans, net |       | $                 | 22,829     |             | $          | 23,991 |   |

 

 

Changes in loansreceivable — other are as follows:

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                      | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance               |       | $                      | 29,223     |                  | $          | — |   | $ | 23,991 |   | $ | — |   |
| Advances                        |       | —                 |       | 2,298                 |       | 6,646 |   | 2,298 |   |
| Payments received               |       | (6,444                 | )          | —                |       | (8,703 | ) | — |   |
| Capitalized costs               |       | (2                     | )          | —                |       | 499 |   | — |   |
| Discount, net                   |       | 29                     |       | —                |       | 148 |   | — |   |
| Foreign exchange gains (losses) |       | 23                     |       | (6                    | )          | 248 |   | (6 | ) |
| Ending Balance                  |       | $                      | 22,829     |                  | $          | 2,292 |   | $ | 22,829 |   | $ | 2,292 |   |
|                                 |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Loans receivable —other are reported at their outstanding principal balances adjusted forunearned discounts, net deferred loan origination and other capitalized costsand the allowance for loan losses. Interest is recognized on an accrual basis at the applicable interestrate on the principal amount outstanding. Loan origination fees and direct costs are amortized as level yieldadjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of theloans.  Loans receivable - Other aresecured by real estate. These loans are evaluated for impairment by analyzingthe expected future cash flows from the underlying 

 

 

12

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(Dollars in thousands, except pershare data) - (continued)**

** **

 

assets within eachinvestment to determine that the cash flows are sufficient to repay thesenotes. The Company applies the asset valuation methodology consistently in allvenues and uses the same proprietary asset management system to evaluateimpairment on all asset pools. The results of this evaluation indicated thatcash flows from the investments will be sufficient to repay the loans and noallowances for impairment were necessary.

 

**(6)  Equity Investments**

 

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

 

| **Condensed  Combined Balance Sheets**        | ** ** |
|-----------------------------------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Assets                                        |       | $ | 443,970 |   | $ | 457,173 |   |
| Liabilities                                   |       | $ | 76,070 |   | $ | 100,973 |   |
| Net equity                                    |       | 367,900 |   | 356,200 |   |
|                                          |       | $ | 443,970 |   | $ | 457,173 |   |
|                                          |       |   |   |   |   |
| Equity investment in Acquisition Partnerships |       | $ | 82,636 |   | $ | 105,852 |   |
| Equity investment in servicing entities       |       | 10,622 |   | 6,505 |   |
|                                          |       | $ | 93,258 |   | $ | 112,357 |   |

 

 

**CondensedCombined Summary of Operations**

** **

| ** **                                     | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
| ** **                                     | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                     | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007**   | ** ** | **2006**   | ** ** |
| Income from Portfolio Assets                   |       | $                      | 25,379     |                  | $          | 26,066     |       | $          | 70,215     |   | $ | 64,572 |   |
| Other income                                   |       | 204                    |       | 336                   |       | 926        |       | 1,884      |       |
| Revenues                                       |       | 25,583                 |       | 26,402                |       | 71,141     |       | 66,456     |       |
| Interest expense                               |       | 2,588                  |       | 4,931                 |       | 8,396      |       | 11,239     |       |
| Average cost (annualized)                      |       | 14.47                  | %          | 8.17                  | %          | 13.86      | %          | 5.78       | %          |
| Service fees                                   |       | 4,960                  |       | 5,486                 |       | 14,593     |       | 12,681     |       |
| Provision for loan and impairment losses       |       | 685                    |       | 514                   |       | 7,349      |       | 1,236      |       |
| Other operating costs                          |       | 5,687                  |       | 5,150                 |       | 14,018     |       | 12,619     |       |
| Foreign currency (gains) losses                |       | 5,368                  |       | (4,660                | )          | 2,046      |       | 8,558      |       |
| Income and other taxes                         |       | 25                     |       | 2,484                 |       | (1,682     | )          | 3,895      |       |
| Expenses                                       |       | 19,313                 |       | 13,905                |       | 44,720     |       | 50,228     |       |
| Net earnings                                   |       | $                      | 6,270      |                  | $          | 12,497     |       | $          | 26,421     |   | $ | 16,228 |   |
|                                           |       |                   |       |                  |       |       |       |       |       |
| Equity in earnings of Acquisition Partnerships |       | $                      | 2,084      |                  | $          | 2,992      |       | $          | 7,538      |   | $ | 7,811 |   |
| Equity in earnings of servicing entities       |       | 73                     |       | 31                    |       | 777        |       | 233        |       |
|                                           |       | $                      | 2,157      |                  | $          | 3,023      |       | $          | 8,315      |   | $ | 8,044 |   |

 

 

As discussed in Note 4,during the third quarter of 2007, management determined that actual cash flowsrelated to certain loan portfolios have exceeded management’s historicalestimates.  The increase in estimatedcash flows is a result of adjusting cash flows related to certain asset-levelexpenses, which are accounted for as period expenses and recognized in theperiod incurred.  Beginning with thethird quarter of 2007, management is using estimated gross cash receipts net ofestimated selling costs in the Acquisition Partnerships’ estimates of futurecash flows.  As a result of this changein estimate, in the third quarter of 2007, the Acquisition Partnershipsrecognized net recoveries of loan loss provisions of $1.0 million, of which theCompany recognized $0.4 million.

 

 

13

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(Dollars in thousands, except pershare data) - (continued)**

** **

 

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

 

| ** **                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Assets:                                        |       |              |       |             |       |
| Domestic:                                      |       |              |       |             |       |
| WAMCO Partnerships                             |       | $                 | 95,042     |             | $          | 116,634 |   |
| MinnTex Investment Partners LP                 |       | 57                |       | 71               |       |
| Other                                          |       | 7,672             |       | 4,206            |       |
| Latin America                                  |       | 209,217           |       | 167,407          |       |
| Europe                                         |       | 131,982           |       | 168,855          |       |
|                                           |       | $                 | 443,970    |             | $          | 457,173 |   |
|                                           |       |              |       |             |       |
| Equity:                                        |       |              |       |             |       |
| Domestic:                                      |       |              |       |             |       |
| WAMCO Partnerships                             |       | $                 | 65,208     |             | $          | 69,579 |   |
| MinnTex Investment Partners LP                 |       | 45                |       | 62               |       |
| Other                                          |       | 4,175             |       | 2,614            |       |
| Latin America                                  |       | 173,764           |       | 126,402          |       |
| Europe                                         |       | 124,708           |       | 157,543          |       |
|                                           |       | $                 | 367,900    |             | $          | 356,200 |   |
| Equity investment in Acquisition Partnerships: |       |              |       |             |       |
| Domestic:                                      |       |              |       |             |       |
| WAMCO Partnerships                             |       | $                 | 32,221     |             | $          | 34,203 |   |
| MinnTex Investment Partners LP                 |       | 15                |       | 20               |       |
| Other                                          |       | 2,160             |       | 1,671            |       |
| Latin America                                  |       | 21,527            |       | 18,640           |       |
| Europe                                         |       | 26,713            |       | 51,318           |       |
|                                           |       | $                 | 82,636     |             | $          | 105,852 |   |

 

 

 

 

 

14

----

 

 

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

** **

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

 

| ** **                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |     |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|----------|
| ** **                               | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |     |
| ** **                               | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |   |
| Revenues:                                |       |                   |       |                  |       |     |   |   |   |   |
| Domestic:                                |       |                   |       |                  |       |     |   |   |   |   |
| WAMCO Partnerships                       |       | $                      | 5,404      |                  | $          | 6,719    |   | $ | 13,776 |   | $ | 21,218 |   |   |
| MinnTex Investment Partners LP           |       | 167                    |       | 353                   |       | 610      |   | 1,242 |   |   |
| Other                                    |       | 29                     |       | 27                    |       | 183      |   | 323 |   |   |
| Latin America                            |       | 11,702                 |       | 14,382                |       | 31,144   |   | 27,206 |   |   |
| Europe                                   |       | 8,281                  |       | 4,921                 |       | 25,428   |   | 16,467 |   |   |
| ** **                               |       | $                      | 25,583     |                  | $          | 26,402   |   | $ | 71,141 |   | $ | 66,456 |   |   |
|                                     |       |                   |       |                  |       |     |   |   |   |   |
| Net earnings (loss):                     |       |                   |       |                  |       |     |   |   |   |   |
| Domestic:                                |       |                   |       |                  |       |     |   |   |   |   |
| WAMCO Partnerships                       |       | $                      | 2,167      |                  | $          | 3,233    |   | $ | 5,149 |   | $ | 10,538 |   |   |
| MinnTex Investment Partners LP           |       | 150                    |       | 321                   |       | 557      |   | 1,118 |   |   |
| Other                                    |       | (227                   | )          | (460                  | )          | (529     | ) | (590 | ) |   |
| Latin America                            |       | 833                    |       | 6,307                 |       | 7,396    |   | (6,001 | ) |   |
| Europe                                   |       | 3,347                  |       | 3,096                 |       | 13,848   |   | 11,163 |   |   |
|                                     |       | $                      | 6,270      |                  | $          | 12,497   |   | $ | 26,421 |   | $ | 16,228 |   |   |
| Equity in earnings (loss) of Acquisition |       |                   |       |                  |       |     |   |   |   |   |
| Partnerships:                            |       |                   |       |                  |       |     |   |   |   |   |
| Domestic:                                |       |                   |       |                  |       |     |   |   |   |   |
| WAMCO Partnerships                       |       | $                      | 1,102      |                  | $          | 1,394    |   | $ | 2,445 |   | $ | 5,026 |   |
| MinnTex Investment Partners LP           |       | 50                     |       | 106                   |       | 184      |   | 369 |   |   |
| Other                                    |       | (88                    | )          | (218                  | )          | (201     | ) | (259 | ) |   |
| Latin America                            |       | (62                    | )          | 815                   |       | 815      |   | (316 | ) |   |
| Europe                                   |       | 1,082                  |       | 895                   |       | 4,295    |   | 2,991 |   |   |
|                                     |       | $                      | 2,084      |                  | $          | 2,992    |   | $ | 7,538 |   | $ | 7,811 |   |   |
|                                          |            |                        |            |                       |            |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

15

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

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

 
| **Three  Months Ended September 30, 2007**     |
|------------------------------------------------|
| ** **                                     |
| ** **                                     | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **31** | ** ** | **33** | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |   | $ | 180 |   | $ | 268 |   | $ | 4,902 |   | $ | 5,350 |   |
| Other income, net                              |   | 5 |   | 9 |   | 40 |   | 54 |   |
| Revenues                                       |   | 185 |   | 277 |   | 4,942 |   | 5,404 |   |
| Interest and fees expense — affiliate     |   | — |   | — |   | — |   | — |   |
| Interest and fees expense — other         |   | (76 | ) | (8 | ) | (527 | ) | (611 | ) |
| Provision for loan and impairment losses       |   | 41 |   | 17 |   | (804 | ) | (746 | ) |
| Service fees — affiliate                  |   | (31 | ) | (28 | ) | (444 | ) | (503 | ) |
| General, administrative and operating expenses |   | (71 | ) | (156 | ) | (1,150 | ) | (1,377 | ) |
| Expenses                                       |   | (137 | ) | (175 | ) | (2,925 | ) | (3,237 | ) |
| Net earnings (loss)                            |   | $ | 48 |   | $ | 102 |   | $ | 2,017 |   | $ | 2,167 |   |

 

| **Three  Months Ended September 30, 2006**     |
|------------------------------------------------|
| ** **                                     |
| ** **                                     | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **31** | ** ** | **33** | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |   | $ | 294 |   | $ | 1,817 |   | $ | 4,431 |   | $ | 6,542 |   |
| Other income, net                              |   | 18 |   | 37 |   | 122 |   | 177 |   |
| Revenues                                       |   | 312 |   | 1,854 |   | 4,553 |   | 6,719 |   |
| Interest and fees expense — affiliate     |   | — |   | — |   | (142 | ) | (142 | ) |
| Interest and fees expense — other         |   | (160 | ) | (199 | ) | (738 | ) | (1,097 | ) |
| Provision for loan and impairment losses       |   | 120 |   | 126 |   | (843 | ) | (597 | ) |
| Service fees — affiliate                  |   | (35 | ) | (234 | ) | (595 | ) | (864 | ) |
| General, administrative and operating expenses |   | (67 | ) | (38 | ) | (681 | ) | (786 | ) |
| Expenses                                       |   | (142 | ) | (345 | ) | (2,999 | ) | (3,486 | ) |
| Net earnings (loss)                            |   | $ | 170 |   | $ | 1,509 |   | $ | 1,554 |   | $ | 3,233 |   |

 

 

16

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

| **Nine  Months Ended September 30, 2007**      |
|------------------------------------------------|
| ** **                                     |
| ** **                                     | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **31** | ** ** | **33** | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |   | $ | 615 |   | $ | 1,976 |   | $ | 11,022 |   | $ | 13,613 |   |
| Other income, net                              |   | 19 |   | 30 |   | 114 |   | 163 |   |
| Revenues                                       |   | 634 |   | 2,006 |   | 11,136 |   | 13,776 |   |
| Interest and fees expense — affiliate     |   | — |   | — |   | — |   | — |   |
| Interest and fees expense — other         |   | (253 | ) | (165 | ) | (1,755 | ) | (2,173 | ) |
| Provision for loan and impairment losses       |   | (42 | ) | 118 |   | (1,785 | ) | (1,709 | ) |
| Service fees — affiliate                  |   | (95 | ) | (244 | ) | (1,590 | ) | (1,929 | ) |
| General, administrative and operating expenses |   | (214 | ) | (320 | ) | (2,282 | ) | (2,816 | ) |
| Expenses                                       |   | (604 | ) | (611 | ) | (7,412 | ) | (8,627 | ) |
| Net earnings                                   |   | $ | 30 |   | $ | 1,395 |   | $ | 3,724 |   | $ | 5,149 |   |

 
| **Nine  Months Ended September 30, 2006**      |
|------------------------------------------------|
| ** **                                     |
| ** **                                     | ** ** | **WAMCO** | ** ** | **WAMCO** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **31** | ** ** | **33** | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |   | $ | 1,524 |   | $ | 4,418 |   | $ | 13,820 |   | $ | 19,762 |   |
| Other income, net                              |   | 30 |   | 48 |   | 1,378 |   | 1,456 |   |
| Revenues                                       |   | 1,554 |   | 4,466 |   | 15,198 |   | 21,218 |   |
| Interest and fees expense – affiliates    |   | — |   | — |   | (467 | ) | (467 | ) |
| Interest and fees expense – other         |   | (584 | ) | (823 | ) | (1,014 | ) | (2,421 | ) |
| Provision for loan losses                      |   | — |   | (60 | ) | (1,767 | ) | (1,827 | ) |
| Service fees – affiliate                  |   | (225 | ) | (677 | ) | (2,139 | ) | (3,041 | ) |
| General, administrative and operating expenses |   | (133 | ) | (335 | ) | (2,456 | ) | (2,924 | ) |
| Expenses                                       |   | (942 | ) | (1,895 | ) | (7,843 | ) | (10,680 | ) |
| Net earnings                                   |   | $ | 612 |   | $ | 2,571 |   | $ | 7,355 |   | $ | 10,538 |   |

 

 

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

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                     | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Income from Portfolio Assets                   |       | $                      | 167        |                  | $          | 353 |   | $ | 610 |   | $ | 1,239 |   |
| Other income                                   |       | —                 |       | —                |       | — |   | 3 |   |
| Revenues                                       |       | 167                    |       | 353                   |       | 610 |   | 1,242 |   |
| Service fees — affiliate                  |       | (11                    | )          | (30                   | )          | (41 | ) | (111 | ) |
| General, administrative and operating expenses |       | (6                     | )          | (2                    | )          | (12 | ) | (13 | ) |
| Expenses                                       |       | (17                    | )          | (32                   | )          | (53 | ) | (124 | ) |
| Net earnings                                   |       | $                      | 150        |                  | $          | 321 |   | $ | 557 |   | $ | 1,118 |   |

 

 

FirstCity holds variableinterests in certain Acquisition Partnerships, which would be characterized asvariable interest entities (“VIE”), as defined in FASB Interpretation No. 46R, *Consolidation of Variable Interest Entities* (“FIN 46R”).However, FirstCity is not deemed to be the primary beneficiary of any of theseentities based on the criteria set forth in FIN 46R. At September 30, 2007,FirstCity’s maximum exposure to loss as a result of its involvement with theVIEs is $55.4 million.

 

At September 30, 2007,the Company had $36.8 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 designated 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.

 

 

17

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

Effectiveness of thehedging relationship is measured and designated at the beginning of each monthby comparing the outstanding balance of the Euro-denominated debt to thecarrying value of the designated net equity investments. The net foreigncurrency translation loss included in accumulated other comprehensive incomerelating to the Euro-denominated debt was $1.4 million for the nine monthsended September 30, 2007 and $1.7 million for the same period in 2006.

 

**(7)  Loan Servicing Assets — SBA**

 

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

 

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

 

Servicing rights arerecognized as assets when the SBA loans are sold and the rights to servicethose loans are retained. The Company recorded net servicing assets of $904during the first nine months of 2007 which included amortization of $123 andimpairment net of recoveries of $5.  ABLretains servicing responsibilities and receives servicing fees of approximately1%.

 

Changes in the Company’samortized servicing rights are as follows:

 

| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                  | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning Balance                           |       | $                      | 939        |                  | $          | — |   | $ | — |   | $ | — |   |
| Servicing Assets capitalized                |       | 23                     |       | —                |       | 1,032 |   | — |   |
| Servicing Assets amortized                  |       | (53                    | )          | —                |       | (123 | ) | — |   |
| Ending Balance                              |       | $                      | 909        |                  | $          | — |   | $ | 909 |   | $ | — |   |
|                                        |       |                   |       |                  |       |   |   |   |   |
| Reserve for impairment of servicing assets: |       |                   |       |                  |       |   |   |   |   |
| Beginning Balance                           |       | $                      | (48        | )                     | $          | — |   | $ | — |   | $ | — |   |
| Impairments                                 |       | (5                     | )          | —                |       | (53 | ) | — |   |
| Recoveries                                  |       | 48                     |       | —                |       | 48 |   | — |   |
| Charge Offs                                 |       | —                 |       | —                |       | — |   | — |   |
| Ending Balance                              |       | $                      | (5         | )                     | $          | — |   | $ | (5 | ) | $ | — |   |
|                                        |       |                   |       |                  |       |   |   |   |   |
| Ending Balance (net of reserve)             |       | $                      | 904        |                  | $          | — |   | $ | 904 |   | $ | — |   |
|                                        |       |                   |       |                  |       |   |   |   |   |
| Fair value of amortized servicing assets:   |       |                   |       |                  |       |   |   |   |   |
| Beginning balance                           |       | $                      | 891        |                  | $          | — |   | $ | — |   | $ | — |   |
| Ending balance                              |       | 904                    |       | —                |       | 904 |   | — |   |

 

 

The Company reliesprimarily on a discounted cash flow model to estimate the fair value of its servicingrights.  This model calculates estimatedfair value of the servicing assets using predominant risk characteristics ofservicing assets such as discount rate, prepayment speed, weighted average lifeof the loans sold and the interest rate. The estimated fair value of servicing was determined using discountrates of 9.75% to 11.19%, prepayment speeds of 15% and weighted average livesranging from 75 to 299 months.  In 

 

 

18

----

 

Table of Contents

** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

the event futureprepayments are significant or impairments are incurred and future expectedcash flows are inadequate to cover the unamortized servicing assets, additionalamortization or impairment charges would be recognized.

 

**(8)  Segment Reporting**

 

The Company is engaged in one reportable segment - Portfolio Assetacquisition and resolution.  Thefollowing is a summary of results of operations for the Portfolio Assetacquisition and resolution segment and reconciliation to earnings fromcontinuing operations for the three and nine months ended September 30, 2007 and2006.

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**           |       |                   |       |                  |       |   |   |   |   |
| Revenues:                                                 |       |                   |       |                  |       |   |   |   |   |
| Servicing fees                                            |       | $                      | 2,426      |                  | $          | 4,679 |   | $ | 8,008 |   | $ | 10,182 |   |
| Income from Portfolio Assets                              |       | 5,743                  |       | 2,547                 |       | 16,463 |   | 7,551 |   |
| Gain on sale of SBA loans held for sale, net              |       | 34                     |       | —                |       | 658 |   | — |   |
| Interest income from SBA loans                            |       | 752                    |       | —                |       | 1,666 |   | — |   |
| Interest income from affiliates                           |       | 147                    |       | 294                   |       | 413 |   | 1,189 |   |
| Interest income from loans receivable - other             |       | 1,627                  |       | 17                    |       | 3,516 |   | 17 |   |
| Other                                                     |       | 763                    |       | 281                   |       | 1,548 |   | 1,113 |   |
| Total                                                     |       | 11,492                 |       | 7,818                 |       | 32,272 |   | 20,052 |   |
| Expenses:                                                 |       |                   |       |                  |       |   |   |   |   |
| Interest and fees on notes payable                        |       | 4,747                  |       | 1,799                 |       | 13,666 |   | 5,455 |   |
| Salaries and benefits                                     |       | 3,549                  |       | 3,120                 |       | 9,688 |   | 8,557 |   |
| Provision (recovery) for loan and impairment losses       |       | (136                   | )          | 50                    |       | 936 |   | 101 |   |
| Occupancy, data processing, communication and other       |       | 1,136                  |       | 2,002                 |       | 5,779 |   | 4,194 |   |
| Minority interest                                         |       | (87                    | )          | (2                    | )          | (210 | ) | (64 | ) |
| Total                                                     |       | 9,209                  |       | 6,969                 |       | 29,859 |   | 18,243 |   |
| Equity in earnings of investments                         |       | 2,157                  |       | 3,023                 |       | 8,315 |   | 8,044 |   |
| Gain on sale of subsidiaries and equity investments       |       | 207                    |       | 2,378                 |       | 207 |   | 2,405 |   |
| Operating contribution before direct taxes                |       | $                      | 4,647      |                  | $          | 6,250 |   | $ | 10,935 |   | $ | 12,258 |   |
| Operating contribution, net of direct taxes               |       | $                      | 4,680      |                  | $          | 6,218 |   | $ | 10,863 |   | $ | 12,095 |   |
|                                                      |       |                   |       |                  |       |   |   |   |   |
| **Corporate Overhead:**                                   | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries and benefits, occupancy, professional and  other |       |                   |       |                  |       |   |   |   |   |
| income and expenses, net                                  |       | 2,026                  |       | 1,251                 |       | 7,318 |   | 3,768 |   |
| Earnings from continuing operations                       |       | $                      | 2,654      |                  | $          | 4,967 |   | $ | 3,545 |   | $ | 8,327 |   |

 

 

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

 
| ** **    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------|------------|------------------------|------------|-----------------------|------------|
| ** **    | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **    | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Domestic      |       | $                      | 9,869      |                  | $          | 4,953 |   | $ | 26,218 |   | $ | 16,344 |   |
| Latin America |       | 2,303                  |       | 4,761                 |       | 8,528 |   | 7,902 |   |
| Europe        |       | 1,462                  |       | 1,110                 |       | 5,667 |   | 3,833 |   |
| Other         |       | 15                     |       | 17                    |       | 174 |   | 17 |   |
| Total         |       | $                      | 13,649     |                  | $          | 10,841 |   | $ | 40,587 |   | $ | 28,096 |   |

 

 

 

19

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

Total assets for the PortfolioAsset acquisition and resolution segment and a reconciliation to total assetsare as follows:

 

| ** **                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                   | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| ** **                                   | ** ** | ** **        | ** ** | ** **       | ** ** |
| Cash                                         |       | $                 | 32,909     |             | $          | 18,472 |   |
| Portfolio acquisition and resolution assets: |       |              |       |             |       |
| Domestic                                     |       | 202,622           |       | 158,147          |       |
| Latin America                                |       | 32,750            |       | 28,883           |       |
| Europe                                       |       | 37,816            |       | 61,062           |       |
| Other                                        |       | 379               |       | 2,272            |       |
| Deferred tax asset, net                      |       | 20,101            |       | 20,101           |       |
| Other non-earning assets, net                |       | 12,939            |       | 8,726            |       |
| Total assets                                 |       | $                 | 339,516    |             | $          | 297,663 |   |

 

 

**(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,**     | ** ** |
| ** **                                                                        | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                        | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings from continuing operations                                               |       | $                      | 2,654      |                  | $          | 4,967 |   | $ | 3,545 |   | $ | 8,327 |   |
| Weighted average outstanding shares of common stock                               |       | 10,790                 |       | 11,104                |       | 10,789 |   | 11,239 |   |
| Dilutive effect of:                                                               |       |                   |       |                  |       |   |   |   |   |
| Warrants                                                                          |       | 317                    |       | 328                   |       | 324 |   | 336 |   |
| Employee stock options                                                            |       | 272                    |       | 279                   |       | 289 |   | 300 |   |
| Weighted average outstanding shares of common stock  and common stock equivalents |       | 11,379                 |       | 11,711                |       | 11,402 |   | 11,875 |   |
| Earnings from continuing operations per share:                                    |       |                   |       |                  |       |   |   |   |   |
| Basic                                                                             |       | $                      | 0.25       |                  | $          | 0.45 |   | $ | 0.33 |   | $ | 0.74 |   |
| Diluted                                                                           |       | $                      | 0.23       |                  | $          | 0.42 |   | $ | 0.31 |   | $ | 0.70 |   |

 

 

**(10)  Stock-Based Compensation**

 

The impact on the resultsof operations of recording stock-based compensation for the three and ninemonth periods ended September 30, 2007 and 2006 was as follows:

 

| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                       | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Amount of compensation cost recognized in income |       | $                      | 119        |                  | $          | 221 |   | $ | 408 |   | $ | 467 |   |
| Tax benefit recognized in income                 |       | $                      | —     |                  | $          | — |   | $ | — |   | $ | — |   |
| Amount capitalized as part of an asset           |       | $                      | —     |                  | $          | — |   | $ | — |   | $ | — |   |

 

 

20

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

A summary of stockoption activity as of September 30, 2007 and changes during the period then endedis presented below:

 

| ** **                        | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|-----------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                        | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **    | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic** | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**     | ** ** |
| Outstanding at January 1, 2007    |       |       |       |         |       |            |       |          |       |
|                              | 779,100    |       | $          | 7.10         |       |            |       |          |       |
| Granted                           |       | —     |       | —       |       |            |       |          |       |
| Exercised                         |       | (10,000    | )          | 3.48         |       |            |       |          |       |
| Expired                           |       | (37,950    | )          | 27.25        |       |            |       |          |       |
| Forfeited                         |       | (8,500     | )          | 9.11         |       |            |       |          |       |
| Outstanding at September 30, 2007 |       |       |       |         |       |            |       |          |       |
|                              | 722,650    |       | $          | 6.07         |       | 5.54            |       | $             | 3,827      |   |
| Exercisable at September 30, 2007 |       |       |       |         |       |            |       |          |       |
|                              | 629,450    |       | $          | 5.57         |       | 5.28            |       | $             | 3,641      |   |

 

 

The total intrinsic valueof stock options exercised during the three and nine month periods endedSeptember 30, 2007 was $47 and $56, respectively.  The total intrinsic value of stock optionsexercised during the three and nine month periods ended September 30, 2006 was$16 and $36, respectively.  As ofSeptember 30, 2007, there was approximately $0.6 million of total unrecognizedcompensation cost related to unvested share-based compensation arrangementsgranted under the stock option plans. That cost is expected to be recognized over a weighted average period of1.6 years.

 

A summary of the statusand changes of FirstCity’s nonvested shares as of September 30, 2007, andchanges during the nine months ended September 30, 2007 is presented below:

 

| ** **                      | ** ** | ** ** | ** ** | **Weighted-**  | ** ** |
|---------------------------------|------------|------------|------------|----------------|------------|
| ** **                      | ** ** | ** ** | ** ** | **Average**    | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Grant-Date** | ** ** |
| ** **                      | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at January 1, 2007    |       | 196,737    |       | $              | 6.67       |   |
| Granted                         |       | —     |       | —         |       |
| Vested                          |       | (95,912    | )          | $              | 6.22       |   |
| Forfeited                       |       | (7,625     | )          | $              | 6.72       |   |
| Nonvested at September 30, 2007 |       | 93,200     |       | $              | 7.13       |   |

 

 

**(11)  Income Taxes**

Effective January 1, 2007, FirstCity adopted FASB InterpretationNo. 48, *Accounting for Uncertainty inIncome Taxes — An Interpretation of FASB Statement No. 109* (“FIN 48”), which clarifies thefinancial statement recognition and disclosure requirements for uncertain taxpositions taken or expected to be taken in a tax return. Any interest andpenalties related to uncertain tax positions are recorded as interest expenseand general and administrative expense, respectively. At the time of adoptionand as of September 30, 2007, the Company’s unrecognized tax benefits are notconsidered material.  In addition,interest or penalties related to income tax reporting recorded in theconsolidated income statements or balance sheets are not material. The InternalRevenue Service is currently examining FirstCity’s federal income tax returnfor 2004.  In addition, FirstCitycurrently files tax returns in approximately 35 states and is currently beingexamined in four states for the year 2004. Tax year 1992 and subsequent years are open to federal examination, andtax year 2003 and subsequent years are open to state examination.

 

Federal income taxes are provided at a 35% rate. The Company hassubstantial net operating loss carryforwards for federal income tax purposes (“NOLs”),which can be used to offset the tax liability associated with the Company’spre-tax earnings until the earlier of 

 

 

21

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

theexpiration or utilization of such NOLs. The Company accounts for the benefit ofthe NOLs by recording the benefit as an asset and then establishing a valuationallowance to value the net deferred tax asset at a level, which more likelythan not, will be realized. Realization is determined based on management’sexpectation of generating sufficient taxable income in a look forward periodover the next four years. The ultimate realization of the resulting netdeferred tax asset is dependent upon generating sufficient taxable income fromits continuing operations prior to expiration of the NOLs. Although realizationis not assured, management believes it is more likely than not that all of therecorded deferred tax asset, net of the allowance, will be realized. The amountof the deferred tax asset considered realizable, however, could be adjusted inthe future if estimates of future taxable income during the carryforward periodchange. The ability of the Company to realize the deferred tax asset isperiodically reviewed and the valuation allowance is adjusted accordingly.

 

OnOctober 1, 2007 the Entrepreneurial Tax of Unique Rate (referred to by itsSpanish acronym, IETU or “Flat Tax”) in Mexico was published. The Flat Tax lawwill be effective on January 1, 2008 and replaces the existingasset-based tax. The Flat Taxapplies to a different tax base than the income tax and will be paid if theFlat Tax exceeds the income tax computed under existing law. Additionalsecondary laws and clarifying rulings will be published before the effectivedate of the Flat Tax. The Company is assessing various tax alternatives and isawaiting additional rulings expected to be issued in the fourth quarter. Inaccordance with SFAS 109, *Accounting for IncomeTaxes*, the effects of the Flat Tax should be reflected in theconsolidated financial statements during the fourth quarter 2007.  The Company is currently unable to determinewith certainty the full impact of the new tax law and whether it will have amaterial effect on the consolidated financial statements.

 

**(12)  Business Acquisitions**

 

On August 27,2007, the Company acquired through one of its consolidated subsidiaries 100% ofEast Penn Railroad LLC (“East Penn”) for $5.9 million in cash.  East Penn owns and operates a short line freight railroad in theNortheastern United States. The acquisition has been accounted for asa purchase business combination.  Theresults of operations since August 27, 2007 for the acquired entities have beenincluded in the consolidated statements of operations.  The following table summarizes thepreliminary calculation of estimated fair value of the assets acquired andliabilities assumed at the date of acquisition.

 

| Cash                      |   | $     | 274    |   |
|---------------------------|--------|-------|--------|--------|
| Property and equipment    |   | 7,100 |   |
| Other assets              |   | 678   |   |
| Total assets acquired     |   | 8,052 |   |
| Deferred grant income     |   | 1,734 |   |
| Other liabilities         |   | 415   |   |
| Total liabilities assumed |   | 2,149 |   |
| Net assets acquired       |   | $     | 5,903  |   |

 

 

At September 30, 2007, the Company’s consolidated balance sheet includes$7.9 million of property, equipment and other assets in “Other assets, net” and$2.2 million of deferred grant income and other liabilities in “Otherliabilities” related to East Penn’s accounts.

 

 

 

 

22

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

**(13)  Commitments and Contingencies**

 

On September 21, 2004,FirstCity, FirstCity Consumer Corporation (“Consumer Corp”), FirstCity FundingLP (“Funding LP”) and FirstCity Funding GP (“Funding GP”) entered into the aSecurities Purchase Agreement to sell a 31% beneficial ownership interest inDrive and its general partner, Drive GP LLC, to IFA-GP, IFA-LP and MG-LP (the “2004Securities Purchase Agreement”). In the 2004 Securities Purchase Agreement,FirstCity, Consumer Corp., Funding LP and Funding GP made variousrepresentations and warranties concerning (i) their respective organizations,(ii) their power and authority to enter into the 2004 Securities PurchaseAgreement and the transactions contemplated therein, (iii) the ownership of thelimited partnership interests in Drive by Funding LP, (iv) the ownership ofmembership interests in Drive-GP by Consumer Corp., and (iv) the capitalstructure of Funding LP. FirstCity, Consumer Corp., Funding LP and Funding GPalso agreed to indemnify BoS (USA), IFA-GP, IFA-LP and MG-LP from damagesresulting from a breach of any representation or warranty contained in the 2004Securities Purchase Agreement or otherwise made by FirstCity, Consumer Corp. orFunding LP in connection with the transaction. The indemnity obligations underthe 2004 Securities Purchase Agreement survive for a maximum period of five (5)years from 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 the Companybelieves that FirstCity will not have to pay any amounts relating to theserepresentations and warranties.

 

On August 8, 2006, anInterest Purchase and Sale Agreement was entered into by and among BidmexHolding, LLC (“Buyer”), as buyer, and Strategic Mexican Investment Partners,L.P. (“SMIP”), an affiliate of the Company and Cargill Financial ServicesInternational, Inc. (“CFSI”), (collectively, the “Sellers”), as seller, andeleven U.S. limited liability companies (“LLCs”), which invested in Mexicanportfolio acquisition entities (“SRLs”) and the AIG entities as additionalparties.  In the Interest Purchase and Sale Agreement, the Sellers and theLLCs made various representations and warranties concerning (i) the existenceand ownership of the LLCs and the SRLs, (ii) the assets and liabilities of theLLCs, (iii) taxes related to periods prior to August 8, 2006, and (iv) theoperations of the LLCs and SRLs.  The Sellers agreed to indemnify theBuyer and AIG Entities from damages resulting from a breach of anyrepresentation or warranty contained in the Interest Purchase and Sale Agreementon a several and not joint basis according to their respective ownershippercentages in each LLC as to any matter related to a particular LLC, or on thebasis of 80% to CFSI and 20% to SMIP as to any matter that could not beidentified to a particular LLC.  The indemnity obligation under theInterest Purchase and Sale Agreement survives for a period of the statute oflimitations for matters related to taxes, existence and authority,capitalization and good standing of the LLCs and SRLs and for a period of two yearsfrom August 8, 2006, the closing date with respect to all other representationsand warranties.  The Sellers are not required to make any payments as aresult of the indemnity provisions of the Interest Purchase and Sale Agreementuntil the aggregate amount payable under that agreement and the Asset PurchaseAgreement exceeds $.25 million; however, claims related to taxes and fraud arenot subject to this $.25 million threshold.  The Interest Purchase andSale Agreement limits the liability of the Sellers for indemnifiable lossesunder the Interest Purchase and Sale Agreement and the Asset Purchase Agreementto the Aggregate Purchase Price (without duplication of amounts recoveredpursuant to the terms of the Asset Purchase Agreement).  FirstCity does not believe that the potentialliability would have a material adverse effect on the consolidated financialposition, results of operations or liquidity of FirstCity, its subsidiaries,its affiliates or the Acquisition Partnerships.

 

Also on August 8, 2006,Bidmex Holding, LLC entered into an Agreement for the Onerous Transfer of Loansand Litigious Rights (the “Asset Purchase Agreement”) between and amongResidencial Oeste, S. de R.L. de C.V., as seller (the “Asset Seller”), anaffiliate 

 

 

23

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

of CFSI and SMIP, Residencial Oeste 2, S. de R.L. deC.V., as purchaser (the “Asset Purchaser”), and CFSI, SMIP, and BidmexAcquisition, LLC, the parent of the Asset Purchaser, as additionalparties.  The Asset Purchase Agreement provides for the sale of the loanportfolio owned by the Seller to the Purchaser for a purchase price of $10.1million on the closing date, which purchase price is part of the AggregatePurchase Price.  In the Asset Purchase Agreement, the Asset Seller and theSellers made various representations and warranties concerning (i) theexistence and ownership of the Seller, (ii) the ownership of the loanportfolio, (iii) taxes related to periods arising prior to the closing date,and (iv) the existence of the loans comprising the loan portfolio and othermatters related to the loan portfolio.  The Asset Seller agreed toindemnify the Asset Purchaser from damages resulting from a breach of anyrepresentation or warranty.  The indemnity obligation under the AssetPurchase Agreement survives for a period of the statute of limitations formatters related to existence and ownership of the Seller, ownership of theloans, and taxes for periods prior to August 8, 2006, and for a period of twoyears from August 8, 2006, with respect to all other representations andwarranties.  The Seller is not required to make any payments as a resultof the indemnity provisions of the Asset Purchase Agreement until the aggregateamount payable under that Agreement exceeds $25; however, claims related to taxesand fraud are not subject to this $25 threshold.  The Interest Purchaseand Sale Agreement limits the liability of the Sellers for indemnifiable lossesunder the Asset Purchase Agreement to the Aggregate Purchase Price. FirstCitydoes not believe that the potential liability would have a material adverseeffect on the consolidated financial position, results of operations orliquidity of FirstCity, its subsidiaries, its affiliates or the AcquisitionPartnerships.

 

In connection withthe Interest Purchase and Sale Agreement, Recuperación de Carteras Mexicanas,S. de R.L. de C.V., as optionor (“RCM”), an affiliate of SMIP and CFSI, granteda put option dated August 8, 2006 to Bidmex Holding, LLC, as optionee, pursuantto the terms of a Put Option Agreement by and among RCM, Bidmex Holding, LLC,and Bidmex 6, LLC, the parent entity of RCM and SMIP.  RCM granted a putoption to Bidmex Holding, LLC related to the purchase of any loan of Soluciónde Activos Residenciales, S. de R.L. de C.V. or Solución de Activos Comerciales,S. de R.L. de C.V., each a Mexican SRL, if any borrowing on a loan made bythose entities has filed or files a challenge in a legal proceeding related toany such loan based on, in addition to any other defense claims, a claim ongrounds related to the Mexican Supreme Court Ruling that has put into issue theactions required for transfer of loans by Mexican financial institutions afterAugust 2003, provided that any such challenge is asserted on or before theearlier of (i) the reversal of the Supreme Court Ruling, or (ii) February 1,2008.  The purchase price for any loan under the put option is to be theallocated purchase price set by the parties for the loan, plus certain expensesrelated to the transfer and collection of the loan, plus any taxes paid orpayable with respect to the cash flow from each loan, reduced by any cash flowreceived by Bidmex Holding, LLC with respect to the loan.

 

FirstCity has minorityinterests in various limited-life partnerships with a carrying value of $.4million at September 30, 2007. The estimated amount that would be paid to theminority interest holder if the instruments were to be settled at September 30,2007 is $2.0 million.

 

Financial Security Assurance Inc. (“FSA”), in itscapacity as certificate insurer under the Pooling and Servicing Agreement,relating to the FirstCity Capital Home Equity Loan Trust 1998-2 (the “Trust”),dated as of November 1, 1998 by and among FC Capital Corp., in its capacitiesas seller and master servicer, and The Bank of New York, in its capacity astrustee, made demand on FC Capital Corp. to repurchase certain loans that weresubject to repurchase due to fraud of third parties in connection with theorigination of the loans. FC Capital Corp. agreed to provide a letter of creditin the amount of the repurchase price for the loans in lieu of being requiredto purchase the loans from the Trust. FirstCity has obtained and delivered to FSA, for the benefit of FCCapital Corp., an irrevocable letter of credit in the amount of $.5 millionfrom the Bank of Scotland.  Pursuant tothe agreement with FSA, FC Capital Corp. will have the option to purchase theloans for $.5 million prior to a call under the letter of credit.

 

On September 22, 2006,FirstCity NPL S.A., a Chilean affiliate of FirstCity Chile Ltda and FirstCity,entered into a revolving line of credit with a maximum loan amount in Chileanpesos equivalent to $10.0 million U.S. Dollars with CORPBANCA Sociedad AnónimaBancaria to finance the purchase of delinquent and due accounts.  The revolving line of credit was structuredby Corpbanca Asesorías Financieras S.A. Pursuant to the terms of the credit facility, FirstCity NPL S.A. wasrequired to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand. At September 30, 2007, FirstCity had a letter of credit in the amount of$5.3 million from Bank of Scotland under the terms of FirstCity’s revolvingacquisition facility with Bank of Scotland. In the event that a demand is made under the $5.3 million letter ofcredit, FirstCity is required to reimburse Bank of Scotland by making paymentto Bank of Scotland for all amounts disbursed or to be disbursed by Bank ofScotland under the letter of credit.

 

On November 29, 2006, FirstCity Mexico SA de CV, a Mexican affiliate ofFirstCity, entered into a revolving line of credit with a maximum loan amountof 148,096,800 Mexican pesos with Banco Santander, S.A., which was equivalentto $13.3 million U.S. 

 

24

----

 

Table of Contents

** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

dollars atSeptember 30, 2007.   The proceeds wereused to pay down the acquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA deCV was required to provide a stand-by letter of credit from Bank ofScotland that would satisfy the loan balance upon demand.  At September30, 2007, FirstCity had a letter of credit in the amount of $14.1 million fromBank of Scotland under the terms of FirstCity’s revolving acquisition facilitywith Bank of Scotland.  In the event that a demand is made under the $14.1million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

ABL, a subsidiary of FirstCity,has a $40.0 million revolving loan facility with Wells Fargo Foothill, LLC (“WFF”),as most recently amended on July 30, 2007, for the purpose of financing andacquiring SBA loans.  The obligationsunder this facility are secured by substantially all of the assets ofABL.  At September 30, 2007, the balance of this facility was $10.5million.  In connection with the first amendment to this facility onFebruary 27, 2007, FirstCity provided WFF with an unconditional guaranty, up toa maximum of $5 million plus enforcement cost, of the obligations of ABL underthe loan facility that relate to funds in the amount of $31.7 advanced by WFFto ABL in connection of a portfolio of SBA loans in February 2007.  Thisguaranty will remain in effect until the obligations incurred in connectionwith the advance related to the acquisition of the portfolio of SBA loans arepaid in full.

 

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 other than as described below.

 

On March 20, 2007,Superior Funding, Inc., Wave Tec Pools, Inc. and Nations Pool Supply, Inc.(collectively “Plaintiffs”) filed a First Amended Petition adding FH Partners,L.P. and FirstCity Servicing Corporation, each an indirectly wholly-ownedsubsidiary of FirstCity, and FirstCity Financial Corporation as defendants in asuit filed by Plaintiffs against State Bank and Cole Harmonson before the 98thJudicial District Court of Travis County, Texas.  FirstCity Financial Corporation was servedwith Plaintiff’s Notice of Nonsuit Without Prejudice in the suit on April 25,2007.  In the First Amended Petition thePlaintiffs sought unspecified damages for breach of contract and conversionrelated to alleged breaches by FH Partners, L.P. and FirstCity Servicing Corporationin connection with a loan agreement related to a loan from State Bank toPlaintiffs that was purchased by FH Partners, L.P. from State Bank on December22, 2006.  The Plaintiffs also raisedother claims solely against the other defendants.  The Plaintiffs allege that they entered intoa loan or line of credit with State Bank and that due to an error by State Bankthe Plaintiffs borrowed more on the line of credit than was allowed under theborrowing base.  The Plaintiffs furtherallege that State Bank entered in an agreement with Plaintiffs that the defaultby Plaintiffs would be cured if the Plaintiffs pledged additional property tosecure the loans and that the Plaintiffs would be allowed to borrow under theline of credit.  Plaintiffs allege that StateBank, and subsequently FH Partners, L.P., have refused to honor the agreementby State Bank concerning the pledge of the additional property.  On July 25, 2007, counsel for FH Partnersreceived a Second Amended Petition in which the Plaintiffs allege that theyhave sustained actual damages of $165 million as a result of the joint actionsof State Bank, Cole Harmonson, FH Partners, L.P. and FirstCity ServicingCorporation.  The Plaintiffs assertclaims against FH Partners, L.P. and FirstCity Servicing Corporation for breachof contract, conversion, civil conspiracy, tortious interference withprospective economic relationships and usury related to FH Partners, L.P. andFirstCity Servicing Corporation treating the loans that FH Partners, L.P.purchased from State Bank as being in default, retaining payments delivered tothe lockbox for the loan, retaining mortgage loan files that the Plaintiffsallege were unrelated to the loan agreement, interfering with contracts andrelationships of the Plaintiffs by such actions, and charging interest higherthan the maximum amount allowed under the Texas Finance Code.  The Plaintiffs additionally seek recovery ofstatutory penalties under the Texas Finance Code and attorney’s fees.  The Plaintiffs have made additional claimsagainst the other defendants alleging promissory estoppel, fraud and businessdisparagement.  No discovery has occurredin the lawsuit.  FirstCity intends tocontest the case vigorously.  FirstCitydoes not have sufficient information to estimate any potential liability orprobability of liability, but is unaware of any factual or legal basis forliability.  Prosperity Bank, thesuccessor in interest by merger to State Bank, has filed a motion for summaryjudgment in the original suit based upon a General Release and IndemnityAgreement.  A hearing has been set forDecember 3, 2007 at 2:00 p.m.  On October9, 2007, FH Partners LLC, formerly known as FH Partners, L.P., filed a separatecollection suit against the Plaintiffs and guarantors, Jason Herring andKimberly Herring, now known as Kimberly McCormick, to recover indebtedness owedby under the loan from State Bank to Plaintiffs that was purchased by FHPartners, LLC.  Plaintiffs’ haveindicated that the Plaintiffs and guarantor defendants in the collection suitwill probably seek to consolidate the collection suit with the originalaction.  All defendants in the collectionsuit except Ms. McCormick have been served and their answers are due onNovember 21, 2007. Efforts to serve Ms. McCormick continue.

 

 

25

----

 

Table of Contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollarsin thousands, except per share data) - (continued)**

 

**(14)  Related Party Transactions**

 

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

 

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

 

**(15)  Equity**

 

On August 14, 2006,FirstCity announced that the Board of Directors authorized a stock repurchaseplan providing for the purchase of up to one million shares of the company’scommon stock.  In the third quarter of2007, FirstCity repurchased 9,800 shares of the Company’s common stock on theopen market for a total of $82.

 

 

26

----

Table of Contents

 

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

 

**Overview**

 

FirstCity is a financial services company engaged in one principalreportable segment — Portfolio Asset acquisition and resolution.  The Portfolio Asset acquisition andresolution business involves acquiring portfolios of loans, real estate andother assets or single assets and investment in similar assets (collectivelyreferred to as “Portfolios” or “Portfolio Assets”) generally at a discount to their legal principalbalance or appraised value, and servicingand resolving such Portfolios in an effort to maximize the present value of theultimate cash recoveries, and the origination of loans secured by similarassets.

 

During the thirdquarter of 2007, the Company recorded net earnings to common stockholders on adiluted basis of $2.7 million or $0.23 per common share.  The operating contribution from the PortfolioAsset acquisition and resolution segment was $4.7 million compared with $6.2million for the same period in 2006.  Netcorporate overhead (excluding taxes) increased by $0.6 million during thequarter to $1.9 million compared to $1.3 million during the same period in2006, primarily due to a $0.5 million increase in legal and accountingfees.  See **Results ofOperations** for a more detailed review of the third quarter 2007compared to the third quarter 2006.

 

The Companyinvested $16.3 million in portfolio acquisitions during the quarter.  FirstCity also invested $0.3 million in SBAloan originations and advances as well as $5.9 million in the form of abusiness acquisition under the new special situations platform, FirstCityCrestone, which was formed in April 2007. Earning assets (equity investments, inventory, loans receivable,interest receivable and railroad assets) totaled $273.6 million at quarterend.  FirstCity is currently evaluating27 different transactions representing over $2.0 billion in face value ofassets.

 

The earnings forthe third quarter were positively impacted by $0.9 million as a result of achange in estimated future cash flows on loan portfolios.  Management determined that actual cash flowsrelated to certain loan portfolios have exceeded management’s historicalestimates.  The increase in estimatedcash flows is a result of adjusting cash flows related to certain asset-levelexpenses, which are accounted for as period expenses and recognized in theperiod incurred.  Beginning with thethird quarter of 2007, management is using estimated gross cash receipts net ofestimated selling costs in the estimates of future cash flows, and will applythe revised cash flow estimates on a prospective basis.  Third quarter earnings were also positivelyimpacted by $0.8 million from the Company’s sale of certain subsidiaries ($0.2million gain) and the Company’s sale of its interest in a profit participationcontract ($0.6 million income).  Inaddition, third quarter earnings were positively impacted by $0.9 million inforeign currency exchange gains from wholly-owned and Acquisition Partnershipportfolios.  Furthermore, revenue streamsgenerated by the Company’s earning assets continue to positively impactearnings.  See **Results ofOperations** for a more detailed review of the third quarter 2007compared to the third quarter 2006.

 

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

 

On July 30, 2007,American Business Lending, Inc. (“ABL”), an affiliate of FirstCity, and WellsFargo Foothill, LLC entered into an amendment to the existing $40.0 millionrevolving loan facility, to be effective as of June 30, 2007, which amendedcertain covenants under the loan facility and waived certain defaults under theloan facility which occurred in April 2007. This loan facility is used to finance the acquisition and origination ofloans made by ABL.  Refer to **Liquidity and Capital Resources**for more detail.

 

On and effectiveAugust 22, 2007, FirstCity Financial and Bank of Scotland entered into anamendment to the existing revolving credit facility to increase the maximumavailable commitment under the credit facility from $175.0 million to $225.0million.  FirstCity uses this revolvingcredit agreement to finance equity investments made in connection withportfolio and asset purchases, to provide for the issuance of letters ofcredit, and for working capital loans. Refer to **Liquidity and Capital Resources**formore detail.

 

On and effective August 22, 2007, FH Partners, LLC (“FH Partners”), awholly-owned affiliate of FirstCity, and Bank of Scotland entered into anamendment to the existing revolving credit facility to increase the maximumavailable commitment under the revolving credit facility from $50.0 million to$100.0 million.  FH Partners uses thisrevolving credit agreement to finance its portfolio and asset purchases.  Refer to **Liquidity and CapitalResources**for more detail.

 

 

27

----

 

Table of Contents

 

On September 5,2007, FirstCity and BoS (USA), Inc., an affiliate of Bank of Scotland, enteredinto a subordinated credit agreement which provides a $25.0 million loanfacility to FirstCity.  The subordinatedcredit agreement is to be effective as of November 16, 2007, provided thatcertain conditions are satisfied by FirstCity. FirstCity will use this loan facility to finance equity investments innew ventures, the senior debt and equity portion of portfolio and assetpurchases, to provide for the issuance of letters of credit and for workingcapital loans.  BoS (USA) is not requiredto make any loans under the agreement until the conditions precedent set forthin the agreement are satisfied. FirstCity believes that the increased funding with BoS (USA) will becompleted on a timely basis to accommodate future acquisitions and continuedgrowth.  Refer to **Liquidityand Capital Resources**for more detail.

 

Current market conditions are creating liquidity constraints primarily asa result of the deterioration in the sub-prime mortgage industry and tighteningcredit standards in the marketplace. Management believes that these conditions have not impacted the Company’sability to obtain financing for its operations, nor hindered its ability tocontinue to grow its business.  This isevidenced by the recent increases in the Bank of Scotland credit facilities andcontinued acquisitions during the third quarter of 2007.  Management believes that the prospects forcontinued growth are strong based on existing acquisition opportunities and thepotential to acquire additional distressed assets as a result of marketconditions.

 

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 month periods endedSeptember 30, 2007 and 2006, respectively, are detailed below (dollars inthousands except per share data):

 

| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                 | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Portfolio Asset Acquisition and Resolution |       | $                      | 4,680      |                  | $          | 6,218 |   | $ | 10,863 |   | $ | 12,095 |   |
| Corporate overhead                         |       | (2,026                 | )          | (1,251                | )          | (7,318 | ) | (3,768 | ) |
| Earnings from continuing operations        |       | 2,654                  |       | 4,967                 |       | 3,545 |   | 8,327 |   |
| Loss from discontinued operations          |       | —                 |       | —                |       | — |   | (75 | ) |
| Net earnings to common stockholders        |       | $                      | 2,654      |                  | $          | 4,967 |   | $ | 3,545 |   | $ | 8,252 |   |
| Diluted earnings per common share          |       | $                      | 0.23       |                  | $          | 0.42 |   | $ | 0.31 |   | $ | 0.69 |   |

 

 

**Results of Operations**

 

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

 

***Third Quarter 2007 Compared to Third Quarter 2006***

 

The Company reported net earnings of $2.7 million in the third quarter of2007 compared to net earnings of $5.0 million in the third quarter of 2006. Ona per share basis, diluted net earnings to common stockholders were $0.23 inthe third quarter of 2007 compared to $0.42 diluted net earnings in the thirdquarter of 2006.

 

*PortfolioAsset Acquisition and Resolution*

 

The operating contribution from the Portfolio Asset acquisition andresolution segment was $4.7 million in the third quarter of 2007 compared to$6.2 million in the third quarter of 2006. FirstCity invested $16.3 million in Portfolio acquisitions during thethird quarter of 2007, of which $15.1 million and $1.2 million were acquiredthrough wholly-owned Portfolios and Acquisition Partnerships, respectively,compared to $31.5 million in the third quarter of 2006, which was comprised of$23.3 million through wholly-owned Portfolios and $8.2 million throughAcquisition Partnerships.  Thequarter-end investment in Portfolio Assets increased to $124.9 million atSeptember 30, 2007, from $78.9 million at September 30, 2006, as a result ofacquisitions of approximately $130.1 million since the third quarter of2006.  In addition to the portfolioacquisitions during the third quarter of 2007, FirstCity invested $0.3 million in SBA loanoriginations and advances as well as $5.9 million in the form of a business acquisition.

 

 

28

----

 

Table of Contents

 

*Servicing fee revenues. *Servicing feerevenues were $2.4 million in the third quarter of 2007 compared to $4.7million in the third quarter of 2006. Servicing fee revenues in the third quarter of 2006 include $2.0 millionof incentive service fees resulting from the restructure of Mexican InvestmentPlatform in the third quarter of 2006. Also contributing to the decrease in servicing fees is a decline incollections from loans held by domestic and Latin American AcquisitionPartnerships to $30.1 million in the third quarter 2007 from $56.5 million inthe third quarter of 2006.  Since amajority of the Portfolio acquisitions over the last twelve months wereacquired through wholly-owned Portfolios instead of Acquisition Partnerships,the Company expects income from Portfolio Assets to off-set the decline inservicing fee revenues — which are generated primarily from loan portfoliosheld by Acquisition Partnerships.

 

*Income from Portfolio Assets*.  Income from Portfolio Assets increased to$5.7 million in the third quarter of 2007 from $2.5 million in the thirdquarter of 2006 due to increased purchases of portfolio assets acquired throughwholly-owned Portfolios.  FirstCity’saverage investment in wholly-owned portfolio assets was $118.8 million and$62.0 million for the third quarters of 2007 and 2006, respectively.  Refer to Note 4 to the consolidated financialstatements for a summary of income from Portfolio Assets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded a nominal gain on the sales of SBA loans during the third quarter of2007.  The Company’s basis in SBA loanssold was $1.3 million.  Gains on SBA loansales reflect the participation in the SBA’s guaranteed loan program.  Under the SBA 7(a) program, the SBAguarantees up to 85 percent of the principal of a qualifying loan.  The Company generally sells the guaranteedportion of the loan into the secondary market and retains the unguaranteedportion.

 

*Interest income from SBA loans. *Interest incomefrom SBA loans was $0.8 million during the third quarter of 2007 as a result ofthe SBA portfolio acquisition in February 2007.

 

* Interest income from affiliates. *Interest income from affiliatesdecreased to $0.1 million in the third quarter of 2007 from $0.3 million in thethird quarter of 2006 due to the conversion of loans to equity as part of therestructure of investments in Mexico during the third quarter 2006, whichreduced the amount of affiliated loans outstanding and the correspondingincome.

 

*Interest income from loans receivable - other. * Interest income from loans receivable — otherwas $1.6 million in the third quarter of 2007 and relates primarily to theCompany’s investments in loans originated to domestic real estate companiessince the third quarter of 2006. FirstCity’s average investment in loans receivable — other approximated$27.7 million for the third quarter of 2007.

 

*Other income*. Other income for the third quarter of 2007 increasedby $0.5 million in comparison to the third quarter of 2006 primarily due to$0.3 million of revenues generated from a majority-owned operating entity thatthe Company acquired in 2007.

 

*Expenses. *Operating expenseswere $9.2 million and $7.0 million in the third quarters of 2007 and 2006,respectively.  The following is adiscussion of the major components of operating expenses.

 

Interest and fees on notes payable were $4.7 million and $1.8 million inthe third quarters of 2007 and 2006, respectively.  The average debt for the quarter increased to$219.3 million in the third quarter of 2007 from $84.9 million in the thirdquarter of 2006, and the average cost of borrowing increased to 8.66% in 2007compared to 8.47% in 2006.  The increasein debt is a result of additional loan facilities and increased limits onexisting credit agreements the Company secured over the last nine months toaccommodate its investment acquisitions and growth.

 

Salaries and benefits increased to $3.5 million in the third quarter of2007 from $3.1 million in the third quarter of 2006, primarily due toadditional salaries related to ABL and FirstCity Crestone of $0.2 million and$0.2 million, respectively, for the third quarter of 2007 in comparison to2006.** **Thetotal number of personnel within the Portfolio Asset acquisition and resolutionsegment were 200 and 176 at September 30, 2007 and 2006, respectively.

 

The provision (recovery) for loan and impairment losses was ($136)thousand compared to $50 thousand at September 30, 2007 and 2006, respectively,primarily due to the Company’s change in estimating cash flows on loanportfolios as previously described.

 

Occupancy, data processing, communication and other expenses decreased to$1.1 million for the third quarter of 2007 from $2.0 million in the thirdquarter of 2006.  The decrease isprimarily attributed toforeign currency exchange gains of $1.6 million from wholly-owned portfolios thatoccurred in the third quarter of 2007 compared to $0.1 million of such gainsfor the same period in 2006, off-set primarily by $0.4 million of increasedoperating expenses related to ABL and FirstCity Crestone and $0.3 million ofincreased property tax and insurance expenses related to the Company’s wholly-owneddomestic portfolios during the third quarter of 2007.

 

 

29

----

 

Table of Contents

 

The Company’s minority interests in net income (loss) of consolidatedsubsidiaries for the third quarter of 2007 remained relatively flat compared tothe third quarter of 2006.

 

*Equity in earnings of investments. *Equity in earnings of investments decreased to $2.2 million in the thirdquarter of 2007 compared to $3.0 million in the third quarter of 2006,primarily as a result of decreased equity in earnings from AcquisitionPartnerships to $2.1 million in the third quarter of 2007 from $3.0 million inthe third quarter of 2006.  Refer to Note6 to the consolidated financial statements for a summary of revenues, earningsand equity in earnings of the Company’s equity investments.  The following is a discussion of equity inearnings from Acquisition Partnerships by geographic region.

 

•             *Domestic* — Equity inearnings of domestic Acquisition Partnerships was $1.1 million in the thirdquarter of 2007 compared to $1.3 million in the third quarter of 2006. These partnerships reflected net earnings of $2.1 million in the third quarterof 2007 compared to $3.1 million in 2006. The decrease in the partnership’s net earnings is primarily attributedto a decline in the average investment in domestic partnerships to $36.1million for the third quarter of 2007 from an average investment of $39.0million for the third quarter of 2006. Since a majority of the domestic portfolio acquisitions over the lasttwelve months were acquired through wholly-owned Portfolios instead ofAcquisition Partnerships, the Company expects income from wholly-ownedPortfolios to off-set the decline in equity in earnings from loan portfoliosheld by domestic partnerships.  Anotherfactor that contributed to a decrease in the partnerships’ net earnings resultsfrom a decline in collections on Portfolio Assets to $14.2 million in the thirdquarter of 2007 from $27.9 million in 2006. These partnerships also reflected net impairment provisions of $0.7million in the third quarter of 2007 compared to $0.6 million in the thirdquarter of 2006.

 

•             *LatinAmerica* — Equity in earnings (losses) of Acquisition Partnerships located inLatin America was ($0.1) million in the third quarter of 2007 compared to $0.8million in 2006.  These partnershipsreflected net earnings of $0.8 million in the third quarter of 2007 compared tonet earnings of $6.3million in 2006.  The decrease in the partnerships’ netearnings is primarily attributed to foreign currency exchange losses and adecline in collections in the third quarter of 2007, off-set primarily by anincrease in net impairment recoveries. The partnerships recorded $5.4 million of foreign currency exchangelosses in the third quarter of 2007 compared to $4.7 million of foreigncurrency exchange gains in 2006. Collections on these Portfolio Assets decreased to $15.9 million for thethird quarter of 2007 from $28.6 million for the same period in 2006.  During the third quarter of 2007, thepartnerships recorded $1.3 million of net impairment recoveries compared to $0.4million of net impairment provisions duringthe third quarter of 2006.

 

•             *Europe* — Equity inearnings of Acquisition Partnerships located in Europe increased to $1.1million in the third quarter of 2007 compared to $0.9 million in 2006.  These partnerships reflected net earnings of$3.3 million in the third quarter of 2007 compared to net earnings of $3.1 million in 2006.  The increase in thepartnerships’ net earnings is primarily attributed to increased collections andforeign currency exchange gains in the third quarter of 2007, off-set primarilyby net impairment provisions. Collections on these Portfolio Assets increased to $22.3 million for thethird quarter of 2007 from $11.0 million for the same period in 2006.  FirstCity recorded $1.2 million and $0.1million in foreign currency transaction gains (included in other expenses)relating to investments in Europe during the third quarter of 2007 and 2006,respectively.  During the third quarterof 2007, the partnerships recorded $1.2 million of net impairment provisionscompared to $0.4 million of net impairment recoveries during the third quarter of 2006.

 

*Gain on sale of subsidiaries and equity investments.*  Gain on sale of subsidiaries of $0.2 millionwas recorded in the third quarter of 2007, which consists of the sale of twoLatin American subsidiaries.  The $2.4million gain that was recorded in 2006 consisted of (1) the sale of a domesticequity investment resulting in a gain of $1.3 million; and (2) a partial saleof twelve Latin American equity investments to AIG resulting in a gain of $1.1million in accordance with the restructuring of investments in Mexico in thethird quarter of 2006.

 

*Other ItemsAffecting Operations*

 

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

 

*Corporate overhead.   *Net corporateoverhead expenses (excluding taxes) increased to $1.9 million in the thirdquarter of 2007 compared to $1.3 million in the third quarter of 2006 primarilydue to a $0.5 millionincrease in legal and accounting fees, of which $0.2 million of such increaserelates to an independent investigation authorized by the audit committee,which concluded during 2007.

 

 

30

----

 

Table of Contents

 

*Income taxes. *Provision for income tax expense (benefit) was $134,000 and ($4,000) inthe third quarters of 2007 and 2006, respectively, and related primarily tostate income taxes during both periods.  Federal incometaxes are provided at a 35% rate applied to taxable income or loss and areoff-set by NOLs that the Company believes are available.  The tax benefit of the NOLs is recorded inthe period during which the benefit is realized.  The Company recorded no deferred taxprovision in the third quarters of either 2007 or 2006.

 

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

 

The Company reported earnings from continuing operations of $3.5 millionin the first nine months of 2007 compared to $8.3 million for the same periodof 2006.  Net earnings to commonstockholders were $3.5 million in the first nine months of 2007 compared to$8.3 million in the first nine months of 2006. On a per share basis, diluted net earnings to common stockholders were    $0.31 in the first nine months of 2007compared to $0.69 in the first nine months of 2006.

 

*PortfolioAsset Acquisition and Resolution*

 

The operating contribution in the first nine months of 2007 was $10.9million compared to $12.1 million for the same period last year.   FirstCity invested $111.0 million inPortfolio and SBA loan acquisitions during the first nine months of 2007, ofwhich $55.6 million, $18.6 million and $36.8 million were acquired throughwholly-owned Portfolios, Acquisitions Partnerships, and SBA loans acquired byABL, respectively, compared to $73.8 million of investments in acquisitions forthe first nine months of 2006, which was comprised of $44.8 million throughwholly-owned Portfolios and $29.0 million through AcquisitionPartnerships.  The investment inPortfolio Assets increased to $124.9 million at September 30, 2007, from $78.9million at September 30, 2006, as a result of acquisitions of approximately$130.1 million since September 30, 2006. In addition to the Portfolio and SBA loan acquisitions during the firstnine months of 2007, FirstCityinvested $4.0 million in a servicing entity, $7.0 million in the form of loanreceivable originations and advances, $1.4million in SBA loan originations and advances, and $5.9 million in the form ofa business acquisition.

 

*Servicing fee revenues. *Servicing feerevenues decreased to $8.0 million in the first nine months of 2007 from $10.2million in the first nine months of 2006. Servicing fee revenues in 2006 include $2.0 million of incentive servicefees resulting from the restructure of Mexican Investment Platform in the thirdquarter of 2006.  This contributed to thedecrease in service fees from Latin American partnerships to $5.7 million inthe first nine months of 2007 from $7.4 million in the same period in2006.  Service fees from the domesticAcquisition Partnerships was $2.3 million for the first nine months of 2007compared to $2.8 million in the same period in 2006.  Also contributing to the overall decrease inservicing fees is a decline in collections from loans held by domestic andLatin American Acquisition Partnerships to $99.9 million in the first ninemonths of 2007 from $152.8 million in 2006. Since a majority of the Portfolio acquisitions over the last twelvemonths were acquired through wholly-owned Portfolios instead of AcquisitionPartnerships, the Company expects income from Portfolio Assets to off-set thedecline in servicing fee revenues — which are generated primarily from loanportfolios held by Acquisition Partnerships.

 

*Income from Portfolio Assets. *Income fromPortfolio Assets increased to $16.5 million in the first nine months of 2007compared to $7.6 million in the first nine months of 2006, primarily due toincreased purchases of portfolio assets acquired through wholly-ownedPortfolios.  FirstCity’s averageinvestment in wholly-owned portfolio assets was $115.7 million and $54.1million during the first nine months of 2007 and 2006, respectively.  Refer toNote 4 to the consolidated financial statements for a summary of income fromPortfolio Assets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded gains on the sale of SBA loans of $0.7 million during the first nine months of 2007.  TheCompany’s basis in SBA loans sold approximated $16.2 million.  Gains on SBA loan sales reflect the participationin the SBA’s guaranteed loan program. Under the SBA 7(a) program, the SBAguarantees up to 85 percent of the principal of a qualifying loan.

 

*Interest income from SBA loans. *Interest incomefrom SBA loans was $1.7 million during the first nine months of 2007 as aresult of the SBA loan portfolio acquisition in February 2007.

 

*Interest income from affiliates. *Interest income from affiliates decreased to $0.4 million in the firstnine months of 2007 compared to $1.2 million in the first nine months of 2006primarily due to the conversion of loans to equity as part of the restructureof investments in Mexico during the third quarter 2006, which reduced theamount of affiliated loans outstanding and the corresponding income.

 

 

31

----

 

Table of Contents

 

*Interest income from loans receivable - other. *Interest income from loansreceivable — other was $3.5 million in the first nine months of 2007 andrelates primarily to the Company’s investments in loans originated to domesticreal estate companies since the third quarter of 2006.  FirstCity’s average investment in loansreceivable — other approximated $27.1 million for the first nine months of2007.

 

*Other income*. Other income for the first nine months of 2007increased by $0.4 million in comparison to 2006 primarily due to $0.3 millionof revenues generated from a majority-owned operating entity that the Companyacquired in the third quarter of 2007.

 

*Expenses. *Operating expenseswere $29.9 million in the first nine months of 2007 compared to $18.2 millionin the first nine months of 2006.  Thefollowing is a discussion of the major components of operating expenses.

 

Interest and feeson notes payable increased to $13.7 million inthe first nine months of 2007 from $5.5 million in the first nine months of 2006. The average debt for the period increased to $212.9 million in the firstnine months of 2007 from $87.0 million in the first nine months of 2006, and theaverage cost of borrowing increased to 8.56% in 2007 from 8.36% in 2006.  Theincrease in debt is a result of additional loan facilities and increased limitson existing credit agreements the Company secured over the last nine months toaccommodate its investment acquisitions and growth.

 

Salaries and benefits increased to $9.7 million in the first nine monthsof 2007 from $8.6 million in the first nine months of 2006, primarily due toadditional salaries related to ABL and FirstCity Crestone of $0.7 million and$0.3 million, respectively, for the first nine months of 2007 in comparison to2006.  The total number of personnelwithin the Portfolio Asset acquisition and resolution segment were 200 and 176at September 30, 2007 and 2006, respectively.

 

The provision for loan and impairment losses was $0.9 million in thefirst nine months of 2007 compared to $0.1 million in 2006.  The increase in loan and impairmentprovisions from 2006 to 2007 is attributed primarily to a decrease in overallprojected cash flows and a decrease in the net present value of cash flows fromthe loan portfolios held in the Latin American and European AcquisitionsPartnerships.

 

Occupancy, data processing, communication and other expenses increased to$5.8 million in the first nine months of 2007 compared to $4.2 million in thefirst nine months of 2006.  The increaseis primarily attributed to additional operating expenses of $0.7 million fromABL and FirstCity Crestone and $1.2 million of additional asset-level costsrelated to the Company’s wholly-owned domestic portfolios incurred in 2007 when compared to2006; off-set primarily by $0.4 million of additional foreign currency exchangegains in 2007 on wholly-owned domestic portfolios when compared to such gainsin the same period in 2006.

 

The Company’s minority interests in net income of consolidatedsubsidiaries was $0.2 million and $0.1 million for the first nine months of2007 and 2006, respectively.

 

*Equity in earnings of investments. *Equity in earnings of investments increased to $8.3 million in the firstnine months of 2007 compared to $8.0 million in the first nine months of 2006as a result of an increase in equity in earnings of Servicing Entities to $0.8million in the first nine months of 2007 from $0.2 million in the same periodin 2006, off-set by a decrease in equity in earnings of AcquisitionPartnerships to $7.5 million in the first nine months of 2007 from $7.8 millionin 2006.  Refer to Note 6 to theconsolidated financial statements for a summary of revenues, earnings andequity in earnings of the Company’s equity investments.  The following is a discussion of equity inearnings from Acquisition Partnerships by geographic region.

 

•             *Domestic* — Equity in earnings of domesticAcquisition Partnerships decreased to $2.4 million in the first nine months of2007 from $5.1 million in the first nine months of 2006.  Thesepartnerships reflected net earnings of $5.2 million in the first nine months of2007 compared to $11.1 million in the first nine months of 2006.  The decrease in the partnership’s netearnings is primarily attributed to a decline in the average investment indomestic partnerships to $35.2 million for the first nine months of 2007 froman average investment of $47.8 million in 2006. Since a majority of the domestic portfolio acquisitions over the lasttwelve months were acquired through wholly-owned Portfolios instead ofAcquisition Partnerships, the Company expects income from wholly-ownedPortfolios to off-set the decline in equity in earning from loan portfoliosheld by domestic partnerships.  Anotherfactor that contributed to a decrease in the partnerships’ net earnings resultsfrom a decline in collections on Portfolio Assets to $56.7 million in the firstnine months of 2007 from $95.0 million in 2006. These partnerships also reflected net impairment provisions of $1.7million in the first nine months of 2007 compared to $1.8 million in 2006.

 

•             *LatinAmerica* — Equity in earnings (losses) of Latin American Acquisition Partnershipsincreased to $0.8 million in the first nine months of 2007 and ($0.3) millionin 2006.  These partnerships reflectednet earnings of $7.4 million in the first nine 

 

 

32

----

 

Table of Contents

 

                   months of 2007 compared to net losses of ($6.0) million in 2006.  The increase in thepartnerships’ net earnings is primarily attributed to a decline in foreigncurrency exchange losses and a decrease in income tax expense, off-setprimarily by decreased collections and increased net impairmentprovisions.  The partnerships recorded$2.0 million of foreign currency exchange losses in the first nine months of2007 compared to $8.6 million of such losses in 2006.  The partnerships recorded ($2.4) million ofincome tax benefits for the first nine months of 2007 compared to $3.3 millionof income tax expense in 2006. Collections on these Portfolio Assets decreased to $43.2 million for thefirst nine months of 2007 from $57.8 million for the same period in 2006.  During the first nine months of 2007, thepartnerships recorded $3.6 million of net impairment provisions compared to $0.9million of net impairment provisions in2006.

 

•             *Europe* — Equity inearnings of Acquisition Partnerships located in Europe increased to $4.3million in the first nine months of 2007 compared to $3.0 million in 2006.  These partnerships reflected net earnings of$13.8 million in the first nine months of 2007 compared to net earnings of $11.2 million in 2006.  The increase in thepartnerships’ net earnings is primarily attributed to increased collections inthe first nine months of 2007, off-set primarily by net impairmentprovisions.  Collections on thesePortfolio Assets increased to $70.1 million for the first nine months of 2007from $40.2 million for the same period in 2006. For the first nine months of 2007, the partnerships recorded $2.0million of net impairment provisions compared to ($1.5) million of netimpairment recoveries in 2006.

 

*Gain on sale of subsidiaries and equity investments.*  Gain on sale of subsidiaries of $0.2 millionwas recorded in the first nine months of 2007, which consists of the sale oftwo Latin American subsidiaries.  The$2.4 million gain that was recorded in 2006 consisted of (1) the sale of a domesticequity investment resulting in a gain of $1.3 million; and (2) a partial saleof twelve Latin American equity investments to AIG resulting in a gain of $1.1million in accordance with the restructuring of investments in Mexico in thethird quarter of 2006.

 

### *Other ItemsAffecting Operations*

 

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

 

*Corporate overhead. *Net corporateoverhead expenses (excluding taxes) increased to $7.0 million in the first ninemonths of 2007 from $3.8 million in the first nine months of 2006, primarilydue to $2.2 millionof expenses incurred in the first nine months of 2007 relating to theinvestigation authorized by the audit committee.

 

*Income taxes. *Provision for income taxes was $0.4 million in the first nine months of2007 compared to $0.1 million in the first nine months of 2006 and relatedprimarily to state income taxes during both periods.  Federal income taxes areprovided at a 35% rate applied to taxable income or loss and are offset by NOLsthat the Company believes are available. The tax benefit of the NOLs is recorded in the period during which thebenefit is realized.  The Companyrecorded no deferred tax provision in either of the first nine months of 2007or 2006.

 

*Discontinued Operations.* There were no additional lossesfrom discontinued mortgage operations during the first nine months of 2007compared to ($0.1) million in the first nine months of 2006.  At September 30, 2007, the only assetremaining from discontinued mortgage operations is an investment securityresulting from the retention of a residual interest in a securitizationtransaction.

 

#### **FinancialCondition**

 

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

 

Consolidated assets of $339.5 million at September 30, 2007 were $41.9million higher than assets at December 31, 2006.  The increase in consolidated assets isprimarily attributed to (1) $33.6 million increase in Portfolio Assets and SBAloans as a result of acquisitions made in 2007; (2) $12.7 million increase inother assets attributed primarily to a business acquisition made in 2007 (referto Note 12 to the consolidated financial statements) and a $2.2 millionincrease in interest receivable on loans receivable; and (3) $14.4 millionincrease in cash resulting primarily from excess cash distributions overcontributions from the Acquisition Partnerships (which contributed to the $19.1million decrease in equity investments) and net advances on notes payableduring the period.

 

Consolidated liabilities of $232.0 million as of September 30, 2007 were$38.3 million higher than that at December 31, 2006.  Total notes payable increased by $34.7million and reflected advances of $142.6 million primarily for acquisitions ofPortfolio Assets 

 

 

33

----

 

Table of Contents

 

andSBA loans, net of repayments of $111.6 million. Other liabilities increased by $4.0 million primarily due to liabilitiesassumed in connection with a business acquisition in 2007 (refer to Note 12 tothe consolidated financial statements).

 

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

 

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

 

| ** **                | ** ** | **Purchase** | ** ** | **FirstCity**  | ** ** |
|---------------------------|------------|--------------|------------|----------------|------------|
| ** **                | ** ** | **Price**    | ** ** | **Investment** | ** ** |
| First nine months of 2007 |       | $            | 189,867    |           | $          | 111,018 |   |
| Total 2006                |       | 296,990      |       | 144,048        |       |
| Total 2005                |       | 146,581      |       | 71,405         |       |
| Total 2004                |       | 174,139      |       | 59,762         |       |
| Total 2003                |       | 129,192      |       | 22,944         |       |
| Total 2002                |       | 171,769      |       | 16,717         |       |
|                           |            |              |            |                |            |  |  |

 

 

**Provisionfor Income Taxes**

 

The Company has substantial NOLs, which can be used to offset the taxliability associated with the Company’s pre-tax earnings until the earlier of theexpiration or utilization of such NOLs. The Company accounts for the benefit of the NOLs by recording thebenefit as an asset and then establishing a valuation allowance to value thenet deferred tax asset at a level, which more likely than not, will berealized.  Realization is determinedbased on management’s expectation of generating sufficient taxable income in alook forward period over the next four years. The ultimate realization of the resulting net deferred tax asset isdependent upon generating sufficient taxable income from its continuingoperations prior to expiration of the NOLs. Although realization is not assured, management believes it is morelikely than not that all of the recorded deferred tax asset, net of theallowance, will be realized.  The amountof the deferred tax asset considered realizable, however, could be adjusted inthe future if estimates of future taxable income during the carryforward periodchange.  The ability of the Company torealize the deferred tax asset is periodically reviewed and the valuationallowance is adjusted accordingly.

 

OnOctober 1, 2007 the Entrepreneurial Tax of Unique Rate (referred to by itsSpanish acronym, IETU or “Flat Tax”) in Mexico was published. The Flat Tax lawwill be effective on January 1, 2008 and replaces the existingasset-based tax. The Flat Taxapplies to a different tax base than the income tax and will be paid if theFlat Tax exceeds the income tax computed under existing law. Additionalsecondary laws and clarifying rulings will be published before the effectivedate of the Flat Tax. The Company is assessing various tax alternatives and isawaiting additional rulings expected to be issued in the fourth quarter. Inaccordance with SFAS 109, *Accounting for IncomeTaxes*, the effects of the Flat Tax should be reflected in theconsolidated financial statements during the fourth quarter 2007.  The Company is currently unable to determinewith certainty the full impact of the new tax law and whether it will have amaterial effect on the consolidated financial statements.

 

**Liquidityand Capital Resources**

 

Generally, the Companyrequires liquidity to fund its operations, working capital, payment of debt,repurchase of the Company’s common stock, equity for acquisition of PortfolioAssets, investments in and advances to the Acquisition Partnerships, and otherinvestments by the Company. The potential sources of liquidity are fundsgenerated from operations, equity distributions from the AcquisitionPartnerships, interest and principal payments on subordinated intercompany debtand dividends from the Company’s subsidiaries, borrowings from revolving linesof credit, proceeds from equity market transactions, securitization and otherstructured finance transactions and other special purpose short-termborrowings.

 

FirstCity has a $225.0 million revolving acquisition facility with Bankof Scotland as most recently amended on August 22, 2007, used to finance thesenior debt and equity portion of portfolio and asset purchases made byFirstCity and to provide for the issuance of letters of credit and workingcapital loans. The obligations of FirstCity under this facility are guaranteedby substantially all of the wholly-owned subsidiaries of FirstCity and aresecured by security interests in substantially all of the assets of FirstCityand its wholly-owned subsidiaries.

 

On and effective August 22, 2007, FirstCity and Bank of Scotlandentered into a tenth amendment to the existing revolving credit facility, whichincreased the maximum available commitment under the revolving credit facilityfrom $175.0 million to $225.0 

 

 

34

----

 

Table of Contents

 

million.  This amendment also made the followingchanges to the existing revolving credit facility effective as of August 22,2007: (i) increased the maximum outstanding amount of loans and letters ofcredit issued under the loan facility that may be outstanding under the loanfacility from $175.0 million to $225.0 million; (ii) increased the maximumvalue for assets that can be included in the borrowing base from theacquisition of portfolio assets in certain countries as follows (a) Mexicoincreased to $40.0 million, (b) Brazil increased to $10.0 million, and (c) Chileto $25.0 million; (iii) provided for inclusion in the borrowing base of loansmade to the FirstCity Denver Investment Corp. to be advanced to FC Crestone 07Corp. for the purpose of investing in distressed debt, special loanoriginations, leveraged buyouts and other special opportunities and revisedother terms and provisions of the facility to allow acquisition loans under thefacility to be loaned to FC Crestone 07 Corp. for those purposes; (iv) addedprovisions allowing loans to be made for investments in new ventures, includingAmerican Pioneer Bank, with inclusion of the equity investments in theborrowing base based on forty percent (40%) of the equity interest in each newventure; (v) provided for inclusion in the borrowing base of certain loans madeby FirstCity subsidiaries to non-affiliated entities that are secured by realestate; (vi) added provisions allowing for subordinated debt facility to beprovided by BoS(USA), Inc., an affiliate of the Bank of Scotland, and forwaterfall of payments to include payments on the subordinated debt; (vii)increased the tangible net worth covenant from $75.0 million to $85.0 million;and (vii) provided for an additional upfront fee paid to Bank of Scotland inthe amount of $0.5 million.

 

The primary terms and key covenants of the $225.0 million revolvingcredit facility, as amended, are as follows:

 

•                  The maximum outstanding amount of loans and letters of credit issuedunder the loan facility that may be outstanding under the loan facility is$225.0 million;

•                  The available interest rates under the loan facility are LIBOR plus2.00% to 2.50% per annum;

•                  The maximum value for assets that can be included in the borrowing basefrom the acquisition of portfolio assets in certain countries are as follows:Mexico - $40.0 million, Brazil - $10.0 million, Chile - $25.0 million, andArgentina or Uruguay - $6.0 million;

•                  The limit for loans that can be borrowed in Euros under the loanfacility is $50.0 million;

•                  The maximum amount of letters of credit that can be issued under theloan facility is $40.0 million;

•                  The maximum amount of working capital loans that can be outstandingunder the loan facility is $35.0 million;

•                  The ratio of EBITDA to Interest Coverage should not be not less than1.50 to 1.00 for each twelve month period;

•                  The ratio of Indebtedness to Tangible Net Worth should be equal to orless than 3.5 to 1.00 for the last day of the fiscal quarter;

•                  Tangible net worth should not fall below $85.0 million;

•                  The ratio of Cumulative Current Recovered and Projected Collections toCumulative Original Projected Collections should not be less than 0.90 to 1.00;and

•                  The maturity date for the loan facility is November 12, 2010.

 

FH Partners, LLC (“FH Partners”), an indirect wholly-owned affiliate ofFirstCity, has a revolving loan facility with Bank of Scotland as most recentlyamended on August 22, 2007, that provides for a $100.0 million revolvingPortfolio acquisition facility for FH Partners to be secured by all of theassets of FH Partners.  The loan facilitywill be used to finance Portfolio and asset purchases.  The obligations of FH Partners under thefacility are guaranteed by FirstCity and the primary wholly-owned subsidiariesof FirstCity.

 

On and effective August 22, 2007, FH Partners and Bank of Scotland enteredinto a third amendment to the existing revolving loan facility, which increasedthe maximum available commitment under the revolving credit facility to $100.0million.  This amendment also made thefollowing changes to the existing revolving credit facility effective as ofAugust 22, 2007:

 

•                  Increased the maximum outstanding amount of loans thatmay be outstanding under the loan facility from $50.0 million to $100.0million;

•                  Added a new covenant that FH Partners, LLC mustmaintain a ratio of Cumulative Current Recovered and Projected Collections toCumulative Original Projected Collections of not less than 0.90 to 1.00;

•                  Added a provision for loans under the facility to beused for purposes other than the acquisition of portfolios or assets with theadvance approval of the agent;

•                  Increased the tangible net worth covenant from $75.0million to $85.0 million;

•                  Added a loan to value ratio for each asset pool not toexceed seventy percent (70%) and an aggregate loan to value ratio for all assetpools not to exceed sixty-five percent (65%);

•                  Increased the utilization fee to 0.50% of the amountof each loan made, with the total utilization fees not to exceed $375,000;

•      Providedfor an additional upfront fee paid to be paid to Bank of Scotland in the amountof $350,000; and 

 

 

 

35

----

 

Table of Contents

 

•                  Extended the maturity date for the loan facility toNovember 12, 2010.

 

The primary terms and key covenants of the $100.0 million revolvingloan facility, as amended, are as follows:

 

•                  Allows loans to be made for the acquisition ofPortfolio Assets in the United States, and provides for loans to be used forother purposes with advance approval from Bank of Scotland;

•                  Provides that each loan may be in an amount of up to70% of the net present value of the assets being acquired with the proceeds ofthe loan;

•                  Provides that the aggregate outstanding balances ofall loans will not exceed 65% of the net present value of the assets securingthe loan facility;

•                  Provides that FH Partners must maintain a ratio ofCumulative Current Recovered and Projected Collections to Cumulative OriginalProjected Collections of not less than 0.90 to 1.00;

•                  Provides for an interest rate of LIBOR plus 2.0%;

•                  Provides for an annual commitment fee of 0.20% of theaverage daily unused balance of the revolving acquisition facility;

•                  Provides for a utilization fee of 0.50% of the amountof each loan made under the loan facility, with total utilization fees not toexceed $375,000;

•                  Provides for facility fees of $100,000, for the periodcommencing on the effective date and ending the day before the firstanniversary thereof, $75,000 for the period commencing on the first anniversaryof the effective date and ending the day before the second anniversary thereof,and $50,000 for each subsequent one-year period;

•                  Provides that all other financial covenants willmirror the key covenants of the facility that FirstCity has with Bank ofScotland; and

•                  Provides for a maturity date of November 12, 2010.

 

On September 5, 2007, FirstCity and BoS (USA), Inc. (“BoS (USA)”)entered into a Subordinated Delayed Draw Credit Agreement (the “SubordinatedCredit Agreement”) which may be used to finance equity investments in newventures, equity investments made in connection with portfolio and assetpurchases and loans made by FirstCity and its subsidiaries to acquisitionentities, provide for the issuance of letters of credit, and for workingcapital loans.  The Subordinated CreditAgreement is to be effective as of November 16, 2007, provided that certainconditions are satisfied by FirstCity, including consents of certain thirdparties to the pledge of assets by FirstCity and its subsidiaries andinformation required to be delivered by FirstCity under the Subordinated CreditAgreement.  BoS (USA) is not required tomake any loans under the Subordinated Credit Agreement until the conditionsprecedent set forth in the Subordinated Credit Agreement are satisfied.

 

On November 5, 2007,FirstCity and BoS (USA) Inc., as agent for the lenders and as lender, enteredinto a letter agreement dated and effective October 31, 2007, which amendedSection 6 of the Subordinated Credit Agreement dated as of September 5, 2007,to extend the time period for FirstCity to deliver consents of certain thirdparties to the pledge of assets and information required to be delivered by FirstCity under theSubordinated Credit Agreement to November 16, 2007, and Section4.1 of the Subordinate Credit Agreement to provide that the commitmentcommission will be payable for the period commencing on October 31, 2007, toand including the Maturity Date (as defined in the Agreement), the first suchpayment to be due and payable on December 26, 2007.  The primary terms and key covenants of this$25.0 million loan facility are as follows:

 

•                  Allows loans to be made in maximum aggregate amount of$25.0 million during the term of the loan facility;

•                  Has a maturity date of November 12, 2010;

•                  Provides for interest rates, at FirstCity’s election,of London Interbank Offered Rate plus 5.0%, Bank of Scotland base or prime rateplus 3.0%, or a fixed rate for a period agreed to by FirstCity and BoS (USA) asagent;

•                  Allows loans to be made based upon a borrowing base of(a) 80% of the net present equity value of certain affiliates of FirstCityengaged in the asset and portfolio investment business, and (b) 90% of theequity investment of FirstCity and its subsidiaries in certain new ventures;

•                  Limits that the maximum value for assets that can beincluded in the borrowing base from the acquisition of portfolio assets incertain countries as follows (a) Mexico up to $40.0 million, (b) Brazil up to$10.0 million, (c) Chile up to $25.0 million and (d) Argentina and Uruguay upto $6.0 million;

•                  Provides for inclusion in the borrowing base of loansmade to the FirstCity Denver Investment Corp. to be advanced to FC Crestone 07Corp. for the purpose of investing in distressed debt, special loanoriginations, leveraged buyouts and other special opportunities and revisedother terms and provisions of the facility to allow acquisition loans under thefacility to be loaned to FC Crestone 07 Corp. for those purposes;

•                  Provides for inclusion in the borrowing base ofcertain loans made by FirstCity subsidiaries to non-affiliated entities thatare secured by real estate;

•                  Includes financial covenants that the ratio ofearnings before interest, taxes depreciation and amortization to interestcoverage will be not less than 1.50 to 1.00 for each twelve month period, thatthe ratio of indebtedness to tangible net worth should be equal to or less than3.5 to 1.00 for the last day of each fiscal quarter, and that the ratio ofcumulative 

 

36

----

 

Table of Contents

 

currentrecovered and projected collections to cumulative original projectedcollections should not be less than 0.90 to 1.00 for each fiscal quarter;

•                  Provides for a commitment fee of 0.25% of the averagedaily  unused balance of the subordinateddebt facility;

•                  Provides for an upfront fee of $250,000.

 

The obligations ofFirstCity under the Subordinated Credit Agreement are to be guaranteed bysubstantially all of the wholly-owned subsidiaries of FirstCity and are to besecured by security interests in substantially all of the assets of FirstCityand its wholly-owned subsidiaries.  TheSubordinated Credit Agreement has other covenants that are customary for afacility of this type.  The SubordinatedCredit Agreement contains representations and warranties by FirstCity that arecustomary for a facility of this type. The Subordinated Credit Agreement provides that any failure to make apayment or acceleration of debt under the revolving credit facility enteredinto between FirstCity and Bank of Scotland on November 12, 2004, is a defaultunder the Subordinated Credit Agreement and provides for other events ofdefault and other provisions that are customary for a facility of this type.

 

ABL, a subsidiary ofFirstCity, has a $40.0 million revolving loan facility with Wells FargoFoothill, LLC (“WFF”), as most recently amended on July 30, 2007, for thepurpose of financing and acquiring SBA loans. The obligations under this facility are secured by substantially all ofthe assets of ABL.  In connection with the first amendment to thisfacility on February 27, 2007, FirstCity provided WFF with an unconditionalguaranty, up to a maximum of $5 million plus enforcement cost, of theobligations of ABL under the loan facility that relate to funds in the amountof $31.7 million advanced by WFF to ABL in connection of a portfolio of SBAloans in February 2007.  This guaranty will remain in effect until theobligations incurred in connection with the advance related to the acquisitionof the portfolio of SBA loans are paid in full.

 

On July 30, 2007, ABL andWFF entered into a second amendment to the existing $40.0 million loanfacility, which amended certain covenants under the loan facility.  Thisamendment made the following changes to the existing loan facility effective asof June 30, 2007:

 

•                  Reduced the minimum tangible net worth requirement forthe fiscal quarter ending June 30, 2007, and for each quarter thereafter;

•                  Revised the definition of minimum net interestcoverage ratio applicable to a portfolio of acquired performing SBA loans andadded an additional covenant requiring a ratio of 1.25 to 1.0 for net interestcoverage for all of the loans owned by American;

•                  Amended the requirements for bad debt reserves for theportfolio of acquired SBA loans;

•                  Amended the delivery requirement for information andreports related to sales of SBA loans;

•                  Deleted the requirement for delivery of statements ofcash flows with monthly financial statements; and

•                  Extended to June 30, 2008, the time period before (a)a facility fee of one-quarter of one percent (0.25%) per annum will be chargedfor non-use of the available maximum credit line, (b) the concentration limitof 7.5% for non-guaranteed SBA loans would be applicable, and (c) theconcentration limit of 30% for non-guaranteed SBA loans owed by borrowers whosebusiness activities fall within a single industry is applicable.

 

The primary terms and keycovenants of the $40.0 million revolving loan facility, as amended, are asfollows:

 

•                  Allows advances in the maximum amount of $40.0 million(the “Maximum Credit Line”) to be made under the facility;

•                  Provides for a borrowing base for originating loans bywhich (a) the sum of (1) up to one hundred percent (100%) of the net eligibleSBA guaranteed loans originated by ABL, plus (2) up to eighty percent (80%) ofthe net eligible non-guaranteed loans originated by ABL, exceeds (b) the sum of(1) any reserves for obligations of ABL related to the bank products, plus (2)the aggregate amount, if any, of loan reserves then established andoutstanding, plus (3) the aggregate amount of any other reserves established byWFF;

•                  Provides for a borrowing base for the portfolio of SBAloans acquired in February 2007 by which (a) the sum of (1) up to one hundredpercent (100%) of the net eligible SBA guaranteed performing loans acquired byABL in February 2007, (provided, that such percentage shall be reduced by fivepercent (5%) on November 1, 2007 and on the first day of each monththereafter), plus (2) up to eighty percent (80%) of the net eligiblenon-guaranteed performing loans acquired by ABL, exceeds (b) the sum of (1) anyreserves with respect to acquired performing loans related to the bankproducts, plus (2) the aggregate amount, if any, of loan reserves thenestablished and outstanding, plus (3) the aggregate amount of any otherreserves established by WFF;

•                  Provides for an interest rate of LIBOR plus 2.625% or, alternatively,the greater of (x) the Wells Fargo prime rate or (y) seven and one-half percent(7.50%) per annum;

 

 

37

----

 

Table of Contents

 

•                  Provides for an unused credit line fee in an amount equal toone-quarter of one percent (0.25%) per annum of the average daily differenceduring the month in question (or portion thereof) between the Maximum CreditLine and the aggregate outstanding principal amount of the advances outstandingunder the facility for such month (or portion thereof);

•                  Provides in the event of the termination of the facilityby ABL for a prepayment fee of three percent (3.0%) of the Maximum Credit Lineif paid prior to December 14, 2007, two percent (2.0%) of the Maximum CreditLine if paid during the period beginning December 15, 2007 and ending December14, 2008, and one percent (1.0%) of the Maximum Credit Line if paid during theperiod beginning December 15, 2008 and ending December 13, 2009; and

•                  Provides for a maturity date of December 14, 2009.

 

At September 30, 2007,the Company had $36.8 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 designated 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 ofthe hedging relationship is measured and designated at the beginning of eachmonth by comparing the outstanding balance of the Euro-denominated debt to thecarrying value of the designated net equity investments. The net foreigncurrency translation loss included in accumulated other comprehensive incomerelating to the Euro-denominated debt was $1.4 million for the nine monthsended September 30, 2007 and $1.7 million for the same period in 2006.

 

On September 22, 2006,FirstCity NPL S.A., a Chilean affiliate of FirstCity Chile Ltda and FirstCity,entered into a revolving line of credit with a maximum loan amount in Chileanpesos equivalent to $10.0 million U.S. Dollars with CORPBANCA Sociedad AnónimaBancaria to finance the purchase of delinquent and due accounts.  The revolving line of credit was structuredby Corpbanca Asesorías Financieras S.A. Pursuant to the terms of the credit facility, FirstCity NPL S.A. wasrequired to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand. At September 30, 2007, FirstCity had a letter of credit in the amount of$5.3 million from Bank of Scotland under the terms of FirstCity’s revolvingacquisition facility with Bank of Scotland. In the event that a demand is made under the $5.3 million letter ofcredit, FirstCity is required to reimburse Bank of Scotland by making paymentto Bank of Scotland for all amounts disbursed or to be disbursed by Bank ofScotland under the letter of credit.

 

On November 29, 2006, FirstCity Mexico SA de CV, a Mexican affiliate ofFirstCity, entered into a revolving line of credit with a maximum loan amountof 148,096,800 Mexican pesos with Banco Santander, S.A., which was equivalentto $13.3 million U.S. dollars at September 30, 2007.   The proceeds were used to pay down theacquisition facility with the Bank of Scotland.  Pursuant to theterms of the credit facility, FirstCity Mexico SA de CV was required toprovide a stand-by letter of credit from Bank of Scotland that would satisfythe loan balance upon demand.  At September 30, 2007, FirstCity had aletter of credit in the amount of $14.1 million from Bank of Scotland under theterms of FirstCity’s revolving acquisition facility with Bank ofScotland.  In the event that a demand is made under the $14.1 millionletter of credit, FirstCity is required to reimburse Bank of Scotland by makingpayment to Bank of Scotland for all amounts disbursed or to be disbursed byBank of Scotland under the letter of credit.

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, theCompany and its subsidiaries currently have credit facilities providing forborrowings in an aggregate principal amount of $394 million, and outstandingborrowings of $222.5 million as of September 30, 2007.

 

Management believes thatthe existing loan facilities, the related fees generated from the servicing ofassets, equity distributions from existing Acquisition Partnerships andwholly-owned portfolios, sales of interests in equity investments, andorigination and sales of guaranteed portions of SBA 7(a) loans, will allow theCompany to meet its obligations as they come due during the next twelve months.

 

 

38

----

 

Table of Contents

 

The following tablesummarizes the material terms of the credit facilities to which the Company,its major operating subsidiaries and the Acquisition Partnerships were partiesto as of November 5, 2007, and the outstanding borrowings under such facilitiesas of September 30, 2007.

 
| ** **                                                                                              | ** ** | **Credit  Facilities**     | ** ** | ** **         | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------|------------|
| ** **                                                                                              | ** ** | **Funded and**             | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **Unfunded**               | ** ** | **Outstanding**    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **Commitment**             | ** ** | **Borrowings**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **Amount as of**           | ** ** | **as of**          | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **November 5,**            | ** ** | **September  30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **2007**                   | ** ** | **2007**           | ** ** | **Interest  Rate** | ** ** | **Other  Terms and Conditions** | ** ** |
| ** **                                                                                              | ** ** | **(Dollars  in millions)** | ** ** | ** **         | ** ** | ** ** | ** ** |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| Bank of Scotland $225 million portfolio acquisition  and working capital facility (1)                   |       | $                          | 225        |               | $          | 146 |   | LIBOR + 2.0% - 2.50% |   | Secured by equity  interests and other assets of FirstCity, matures November 2010 |   |
|                                                                                                    |
|                                                                                                    |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| Bank of Scotland $100 million portfolio acquisition  - revolving credit                                 |       | 100                        |       | 42                 |       | LIBOR + 2.0% |   | Secured by assets of FH  Partners, L.P. and guaranteed by the Company, matures November 2010 |   |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| American Bank term loan for portfolio acquisition by  FC Washington                                     |       | 2                          |       | 2                  |       | Fixed 5.625% |   | Secured by assets of FC  Washington and guaranteed by the Company, matures 2008 |   |
|                                                                                                    |
|                                                                                                    |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| Participation payable                                                                                   |       | 1                          |       | 1                  |       | 31.44% imputed rate |   | Participation agreement  on 33% of net cash flows received on one portfolio |   |
|                                                                                                    |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| CorpBanca revolving line of credit for Chilean portfolio  acquisition                                   |       | 10                         |       | 5                  |       | Rate based on monthly Chilean  index rate plus .0625% per month |   | Secured by Bank of  Scotland letter of credit. Renewable every 30 days. |   |
|                                                                                                    |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| Banco Santander line of credit facility                                                                 |       | 13                         |       | 13                 |       | Rate based on 28 day  Mexican index rate plus 1.5% |   | Secured by Bank of  Scotland letter of credit, matures November 2008 |   |
|                                                                                                    |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| Wells Fargo Foothill, Inc. $40 million revolving  loan facility                                         |       | 40                         |       | 11                 |       | LIBOR + 2.625% or  greater of Wells Fargo prime or 7.5% |   | Secured by assets of  American Business Lending, Inc., matures December 2009. |   |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| The First National Bank of Central Texas term loan  for portfolio acquisition by MPortfolio Corporation |       | 3                          |       | 3                  |       | LIBOR + 1.75% |   | Secured by assets of  MPortfolio Corporation, matures June 2010. |   |
|                                                                                                    |
|                                                                                                    |
|                                                                                                    |       |                       |       |               |       |   |   |   |   |
| Total                                                                                                   |       | $                          | 394        |               | $          | 223 |   |   |   |   |   |
|                                                                                                         |            |                            |            |                    |            |  |  |  |  |  |  |  |  |

----

(1)          The Bank of Scotland facility allowsloans to be made in Euros up to a maximum amount in Euros that is equivalent to$50 million.  At September 30, 2007, theCompany had approximately $36.8 million outstanding under the Euro-denominatedportion of this facility.

** **

 

39

----

 

Table of Contents

 

**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, Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. Forward-looking statementsinclude, without limitation, statements based on management's expectations andstatements regarding revenues, earnings guidance and future projected cashcollections, as well as any statement that may project, indicate or implyfuture results, performance or achievements, and may contain the words “expect,”“intend,” “plan,” “estimate,” “believe,” “will be,” “will continue,” “willlikely result,” "indication," and similar expressions. Suchstatements inherently are subject to a variety of risks and uncertainties thatcould cause actual results to differ materially from those projected. There aremany important factors that could cause the Company’s actual results to differmaterially from those indicated in the forward-looking statements. Such factorsinclude, but are not limited to, the performance of the Company’s subsidiariesand affiliates; the availability of Portfolio Assets; assumptions underlyingPortfolio asset performance; risks associated with foreign operations; currencyexchange rate fluctuations; risks associated with start up of new businessesand entry into new foreign markets; interest rate risk; the degree to which theCompany is leveraged; the Company’s continued need for financing; availabilityof the Company’s credit facilities;  ability to obtainadditional financing from the Bank of Scotland or any other lender; the impactof certain covenants in loan agreements of the Company and its subsidiaries;risks of declining value of loans, collateral or assets; the ability of theCompany to utilize NOLs; uncertainties of any litigation that might arise fromdiscontinued operations; general economic conditions; foreign social andeconomic conditions; changes (legislative and otherwise) in the assetsecuritization industry; fluctuations in residential and commercial real estatevalues; capital market conditions, including the markets for asset-backedsecurities; factors more fully discussed and identified in the Company’s AnnualReport on Form 10-K, for the year ended December 31, 2006, filed with theSecurities and Exchange Commission on July 24, 2007 (including those discussedunder “Item 7. Management’s Discussion and Analysis of Financial Condition andResults of Operations”), as well as in other Securities and Exchange Commissionfilings of the Company. Many of these factors are beyond the Company’s control.In addition, it should be noted that past financial and operational performanceof the Company is not necessarily indicative of future financial andoperational performance. Given these risks and uncertainties, investors shouldnot place undue reliance on forward-looking statements. The forward-lookingstatements in this Quarterly Report on Form 10-Q speak only as of the date ofthis Quarterly Report on Form 10-Q. The Company expressly disclaims anyobligation or undertaking to release publicly any updates or revisions to anyforward-looking statement to reflect any change in the Company’s expectationswith regard thereto or any change in events, conditions or circumstances onwhich any forward-looking statement is based.

 

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

 

**Interest Rate Risk**

 

Market risk is the 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 Portfolio Assets.

 

Loans receivable consistof investment loans made to Acquisition Partnerships and other unrelatedentities, and bear interest at predominately fixed rates. The collectibility ofthese loans is directly related to the underlying Portfolio Assets of thoseAcquisition Partnerships, which are non-performing in nature. Therefore,changes in benchmark rates would have minimal effect on the collectibility ofthese loans.

 

SBA loansreceivable were $17.5 million at September 30, 2007, of which $2.5 million wererelated to the guaranteed portion of these loans.  The guaranteed portion is backed by the fullfaith and credit of the US Small Business Administration, and is generally soldinto the secondary market.  Virtually allof the SBA loans have variable interest rates. Assuming that the balance sheet were to remain constant and no actionswere taken to alter the existing interest rate sensitivity, a hypotheticalimmediate change in interest 

 

40

----

 

Table of Contents

 

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

 

FirstCity had $222.5million in debt outstanding at September 30, 2007. The Company is exposed tointerest rate risk primarily through its variable rate debt, which totaled $191million or 86% of the Company’s total debt. A 50 basis point change ininterest rates would increase or decrease FirstCity’s interest expense byapproximately $1.1 million annually.

 

**Foreign Currency Risk**

 

The Company currently hasloans and equity investments in Europe, Latin America (i.e. Mexico, Argentina,Dominican Republic and Chile) and Canada.

 

In Europe and in Mexico,the Company’s investments are primarily in the form of equity and represent asignificant portion of the Company’s total equity investments. As previouslydiscussed, the revolving acquisition facility with Bank of Scotland for $225million allows loans to be made in Euros up to a maximum amount in Euros thatis equivalent to $50 million U.S. dollars. At September 30, 2007, the Companyhad $36.8 million in Euro-denominated debt for the purpose of hedging a portionof the net equity investments in Europe. In November 2006, the Company acquired a line of credit facility withBanco Santander, S.A. that allows loans to be made up to a maximum of148,096,800 Mexican pesos. At September 30, 2007, the Company had 148,096,800in Mexican peso-denominated debt, which was equivalent to $13.3 million U.S.dollars.  Management of the Company feelsthat these loan agreements will help reduce the risk of adverse effects ofcurrency changes on these investments.

 

A sharp change in theforeign currencies related to the investments in Europe, Latin America andCanada relative to the U.S. dollar could materially adversely affect thefinancial position and results of operations of the Company. A 5% and 10%incremental depreciation of these currencies would result in an estimateddecline in the valuation of the Company’s foreign investments and are indicatedin the following table. These amounts are estimates; consequently, theseamounts are not necessarily indicative of the actual effect of such changeswith respect to the Company’s consolidated financial position or results ofoperations.

 

| ** **         | ** ** | ** ** | ** ** | ** **   | ** ** | **Estimated decline in**     | ** ** |
|--------------------|------------|------------|------------|--------------|------------|------------------------------|------------|
| ** **         | ** ** | ** ** | ** ** | ** **   | ** ** | **valuation of investments** | ** ** |
| ** **         | ** ** | ** ** | ** ** | ** **   | ** ** | **resulting from**           | ** ** |
| ** **         | ** ** | ** ** | ** ** | **One U.S.** | ** ** | **incremental depreciation** | ** ** |
| ** **         | ** ** | ** ** | ** ** | **dollar**   | ** ** | **of foreign currency of**   | ** ** |
| ** **         | ** ** | ** ** | ** ** | **equals**   | ** ** | **(dollars in thousands)**   | ** ** |
| ** **         | ** ** | ** ** | ** ** | ** **   | ** ** | **5%**                       | ** ** | **10%** | ** ** |
|               |       |       |       |         |       |                         |       |   |   |
| Europe             |       | EUR        |       | 0.70         |       | $                            | 1,794      |   | $ | 3,435 |   |
|               |       |       |       |         |       |                         |       |   |   |
| Mexico             |       | MXN        |       | 10.92        |       | $                            | 2,063      |   | $ | 3,986 |   |
|               |       |       |       |         |       |                         |       |   |   |
| Argentina          |       | ARS        |       | 3.15         |       | $                            | 63         |   | $ | 123 |   |
|               |       |       |       |         |       |                         |       |   |   |
| Dominican Republic |       | DOP        |       | 34.08        |       | $                            | 26         |   | $ | 50 |   |
|               |       |       |       |         |       |                         |       |   |   |
| Chile              |       | CLP        |       | 511.20       |       | $                            | 153        |   | $ | 292 |   |
|               |       |       |       |         |       |                         |       |   |   |
| Canada             |       | CAD        |       | 0.99         |       | $                            | 19         |   | $ | 36 |   |

 

**Item 4.  Controls and Procedures.**

 

An evaluation was performed under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s 

 

41

----

 

Table of Contents

 

disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934) as of September 30, 2007.  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures were effective, in all material respects, to ensurethat information required to be disclosed in the reports the Company files andsubmits under the Exchange Act is recorded, processed, summarized and reportedas and when required.  The Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, also evaluated whether any change in the Company’s internal controlsover financial reporting or in other factors had occurred during the fiscalquarter covered by this report.  Basedupon that evaluation, management concluded that there had been no such changesduring the period covered by this report that have materially affected, or isreasonably likely to affect, the registrant’s internal control over financialreporting.

** **

 

42

----

 

Table of Contents

 

**PART II**

 

**OTHER INFORMATION**

 

**Item 1.  Legal Proceedings.**

 

Except as disclosed below, there have been nomaterial developments with regard to any matters disclosed in the Company’s2006 Annual Report on Form 10-K.

 

On March 20, 2007,Superior Funding, Inc., Wave Tec Pools, Inc. and Nations Pool Supply, Inc.(collectively “Plaintiffs”) filed a First Amended Petition adding FH Partners,L.P. and FirstCity Servicing Corporation, each an indirectly wholly-ownedsubsidiary of FirstCity, and FirstCity Financial Corporation as defendants in asuit filed by Plaintiffs against State Bank and Cole Harmonson before the 98thJudicial District Court of Travis County, Texas.  FirstCity Financial Corporation was servedwith Plaintiff’s Notice of Nonsuit Without Prejudice in the suit on April 25,2007.  In the First Amended Petition thePlaintiffs sought unspecified damages for breach of contract and conversionrelated to alleged breaches by FH Partners, L.P. and FirstCity ServicingCorporation in connection with a loan agreement related to a loan from StateBank to Plaintiffs that was purchased by FH Partners, L.P. from State Bank onDecember 22, 2006.  The Plaintiffs alsoraised other claims solely against the other defendants.  The Plaintiffs allege that they entered intoa loan or line of credit with State Bank and that due to an error by State Bankthe Plaintiffs borrowed more on the line of credit than was allowed under theborrowing base.  The Plaintiffs furtherallege that State Bank entered in an agreement with Plaintiffs that the defaultby Plaintiffs would be cured if the Plaintiffs pledged additional property tosecure the loans and that the Plaintiffs would be allowed to borrow under theline of credit.  Plaintiffs allege thatState Bank, and subsequently FH Partners, L.P., have refused to honor theagreement by State Bank concerning the pledge of the additional property.  On July 25, 2007, counsel for FH Partnersreceived a Second Amended Petition in which the Plaintiffs allege that theyhave sustained actual damages of $165 million as a result of the joint actionsof State Bank, Cole Harmonson, FH Partners, L.P. and FirstCity ServicingCorporation.  The Plaintiffs assertclaims against FH Partners, L.P. and FirstCity Servicing Corporation for breachof contract, conversion, civil conspiracy, tortious interference withprospective economic relationships and usury related to FH Partners, L.P. andFirstCity Servicing Corporation treating the loans that FH Partners, L.P.purchased from State Bank as being in default, retaining payments delivered tothe lockbox for the loan, retaining mortgage loan files that the Plaintiffsallege were unrelated to the loan agreement, interfering with contracts andrelationships of the Plaintiffs by such actions, and charging interest higherthan the maximum amount allowed under the Texas Finance Code.  The Plaintiffs additionally seek recovery ofstatutory penalties under the Texas Finance Code and attorney’s fees.  The Plaintiffs have made additional claimsagainst the other defendants alleging promissory estoppel, fraud and businessdisparagement.  No discovery has occurredin the lawsuit.  FirstCity intends tocontest the case vigorously.  FirstCity doesnot have sufficient information to estimate any potential liability orprobability of liability, but is unaware of any factual or legal basis forliability.  Prosperity Bank, thesuccessor in interest by merger to State Bank, has filed a motion for summaryjudgment in the original suit based upon a General Release and IndemnityAgreement.  A hearing has been set forDecember 3, 2007 at 2:00 p.m.  On October9, 2007, FH Partners LLC, formerly known as FH Partners, L.P., filed a separatecollection suit against the Plaintiffs and guarantors, Jason Herring andKimberly Herring, now known as Kimberly McCormick, to recover indebtedness owedby under the loan from State Bank to Plaintiffs that was purchased by FHPartners, LLC.  Plaintiffs’ haveindicated that the Plaintiffs and guarantor defendants in the collection suitwill probably seek to consolidate the collection suit with the originalaction.  All defendants in the collectionsuit except Ms. McCormick have been served and their answers are due on November21, 2007. Efforts to serve Ms. McCormick continue.

 

***Other Litigation***

 

Periodically, FirstCity,its subsidiaries, its affiliates and the Acquisition Partnerships are partiesto or otherwise involved in legal proceedings arising in the normal course ofbusiness. While the outcome of the ordinary course legal proceedings, and therelated activities, are not certain, based on present assessments, managementdoes not believe that they will have a material adverse effect on theconsolidated financial position, results of operations or liquidity ofFirstCity, its subsidiaries, its affiliates or the Acquisition Partnerships.

 

**Item 1A.  Risk Factors.**

 

There have been nomaterial changes to the risk factors as previously disclosed under Item 1A inthe Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

 

43

----

 

Table of Contents

 

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

 

The following summarizes purchases of common stock during the thirdquarter 2007:

 
| ** ** | ** ** | ** **       | ** ** | ** **     | ** ** | **Total Number**        | ** ** | **Maximum Number**     | ** ** |
|------------|------------|------------------|------------|----------------|------------|-------------------------|------------|------------------------|------------|
| ** ** | ** ** | ** **       | ** ** | ** **     | ** ** | **of Shares Purchased** | ** ** | **of Shares that May** | ** ** |
| ** ** | ** ** | **Total Number** | ** ** | **Average**    | ** ** | **as Part of Publicly** | ** ** | **Yet Be Purchased**   | ** ** |
| ** ** | ** ** | **of Shares**    | ** ** | **Price Paid** | ** ** | **Announced Plans**     | ** ** | **Under the Plans**    | ** ** |
| **Month**  | ** ** | **Purchased**    | ** ** | **Per Share**  | ** ** | **or Programs (1)**     | ** ** | **or Programs**        | ** ** |
| July       |       | —           |       | $              | —     |                    | —     |                   |       |   |
| August     |       | 9,800            |       | $              | 8.36       |                    | 9,800      |                   |       |   |
| September  |       | —           |       | $              | —     |                    | —     |                   |       |   |
| Total      |       | 9,800            |       | $              | 8.36       |                    | 9,800      |                   | 459,900    |   |

----

(1)  TheCompany has a repurchase program approved by the Board of Directors in August2006 for the repurchase of up to 1,000,000 shares of the Company’s commonstock.

 

**Item 3.  Defaults Upon SeniorSecurities.**

 

None

 

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

 

None

 

**Item 5.  Other Information.**

 

None

 

**Item 6.  Exhibits.**

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

 

 

44

----

 

Table of Contents

 
| 10.3   | —     | Contribution and Assumption Agreement, dated August  18, 2000, by and between Funding LP and Drive (incorporated herein by  reference to Exhibit 10.42 of the Company’s Form 8-K dated August 25, 2000,  filed with the Commission on September 11, 2000).                                                                                                                      |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.4   | —     | Separation Agreement and Release, dated March 31,  2004, by and between G. Stephen Fillip, FirstCity Servicing Corporation and  FirstCity Financial Corporation (incorporated herein by reference to Exhibit  10.19 of the Company’s Form 10-Q dated May 14, 2004).                                                                                                             |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.5   | —     | Consultant Agreement, dated April 1, 2004, by and  between FirstCity Servicing Corporation and G. Stephen Fillip (incorporated  herein by reference to Exhibit 10.20 of the Company’s Form 10-Q dated May 14,  2004).                                                                                                                                                           |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.6   | —     | Securities Purchase Agreement dated as of September  21, 2004 by and among FirstCity Financial Corporation and certain affiliates  of FirstCity and IFA Drive GP Holdings LLC, IFA Drive LP Holdings LLC, Drive  Management LP and certain affiliates of those persons. (incorporated herein  by reference to Exhibit 10.1 of the Company’s Form 8-K dated September 27,  2004) |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.7   | —     | Revolving Credit Agreement, dated November 12, 2004,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.12 of the Company’s Form 10-Q dated November 15,  2004)                                                                                     |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.8   | —     | 1995 Stock Option and Award Plan (incorporated  herein by reference to Exhibit A of the Company’s Schedule 14A, Definitive  Proxy Statement, dated March 27, 1996)                                                                                                                                                                                                              |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.9   | —     | 1996 Stock Option and Award Plan (incorporated  herein by reference to Exhibit C of the Company’s Schedule 14A, Definitive  Proxy Statement, dated March 27, 1996)                                                                                                                                                                                                              |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.10  | —     | 2004 Stock Option and Award Plan (incorporated  herein by reference to Appendix A of the Company’s Schedule 14A, Definitive  Proxy Statement, dated October 21, 2003)                                                                                                                                                                                                           |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.11  | —     | Sixth Amendment to Right Of First Refusal Agreement  And Due Diligence Reimbursement Agreement dated effective as of  February 1, 2006 (incorporated herein by reference to Exhibit 10.1 of  the Company’s Form 8-K dated February 6, 2006)                                                                                                                                |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.12  | —     | Asset Purchase Agreement, dated June 30, 2006, by  and among FirstCity Financial Corporation and its subsidiaries, FirstCity  Business Lending Corporation and American Business Lending, Inc.; and AMRESCO  SBA Holdings, Inc. and NCS I, LLC (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated July 7, 2006)                                 |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.13  | —     | 2006 Stock Option and Award Plan (incorporated  herein by reference to Appendix A of the Company’s Schedule 14A, Definitive  Proxy Statement, dated June 26, 2006)                                                                                                                                                                                                              |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.14  | **—** | Interest Purchase and Sale Agreement, dated August  8, 2006, by and among Bidmex Holding, LLC, and Strategic Mexican Investment  Partners, L.P. and Cargill Financial Services International, Inc. and certain  other parties (incorporated herein by reference to Exhibit 10.14 of the  Company’s Form 10-Q dated November 9, 2006)                                            |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.15  | **—** | Put Option Agreement dated August 8, 2006, by and  among Bidmex Holding, LLC, Recuperacion de Carteras Mexicanas, S. de R.L. de  C.V., Bidmex 6, LLC, Strategic Mexican Investment Partners 2, L.P. and  Cargill Financial Services International, Inc. (incorporated herein by  reference to Exhibit 10.15 of the Company’s Form 10-Q dated November 9, 2006)                  |

 

 

45

----

 

Table of Contents

 
| 10.16      | **—** | Guarantee dated August 8, 2006, executed by  FirstCity Financial Corporation for the benefit of Bidmex Holding, LLC,  Residencial Oeste 2 S. de R.L. de C.V., National Union Fire Insurance Company  of Pittsburg, P.A., American General Life Insurance Company, and American  General Life and Accident Insurance Company (incorporated herein by reference  to Exhibit 10.15 of the Company’s Form 10-Q dated November 9, 2006) |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.17      | —     | Amendment No. 4 to Revolving Credit Agreement, dated  as of October 31, 2006, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated November 7, 2006)                                                                                                                   |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.18      | —     | Management Employment Contract dated November 30,  2006, between FirstCity Business Lending  Corporation, American Business Lending, Inc**.,**and Charles P. Bell, Jr. (incorporated herein by reference  to Exhibit 10.2 of the Company’s Form 8-K dated December 7, 2006)                                                                                                                                                        |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.19      | —     | Management Employment Contract dated November 30,  2006, between FirstCity Business Lending  Corporation, American Business Lending, Inc**.,**and Joe N. Smith (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated December 7, 2006)                                                                                                                                                                |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.20      | —     | Amendment No. 5 to Revolving Credit Agreement, dated  as of December 14, 2006, among FirstCity Financial Corporation as Borrower  and the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated December 20, 2006)                                                                                                                 |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.21      | —     | Loan Agreement, dated  as of December 15, 2006 by and between American Business Lending, Inc., as  Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated December 28, 2006)                                                                                                                                                                        |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.22      | —     | Amendment No. 1 to Loan  Agreement, dated as of February 27, 2007, by and between American Business  Lending, Inc., as Borrower, and Wells Fargo Foothill, LLC, as lender  (incorporated herein by reference to Exhibit 10.22 of the Company’s Form 10-K  dated July 24, 2007)                                                                                                                                                     |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.23      | —     | Amendment No. 9 to Revolving Credit Agreement, dated  as of June 29, 2007, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.23 of the Company's Form 10-Q  dated August 10, 2007)                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.24      | —     | Amendment No. 1 to Revolving Credit Agreement, dated  June 29, 2007, among FH Partners, L.P., as Borrower, and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to  Exhibit 10.24 of the Company's Form 10-Q dated August 10, 2007)                                                                                                                                       |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.25      | —     | Amendment No. 2 to Loan  Agreement, dated as of July 30, 2007, by and between American Business  Lending, Inc., as Borrower, and Wells Fargo Foothill, LLC, as lender  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated August 3, 2007)                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.26      | —     | Amendment No. 10 to Revolving Credit Agreement,  dated as of August 22, 2007, among FirstCity Financial Corporation as  Borrower and the Lenders named therein, as Lenders, and Bank of Scotland, as  Agent (incorporated herein by reference to Exhibit 10.1 of the Company’s Form  8-K dated August 28, 2007)                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.27      | —     | Amendment No. 3 and Consent to Revolving Credit  Agreement, dated August 22, 2007, among FH Partners, L.L.C., as Borrower, and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent (incorporated  herein by reference to Exhibit 10.2 of the Company’s Form 8-K dated August  28, 2007)                                                                                                                         |

 

46

----

 

Table of Contents

 
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.28  | — | Subordinated Delayed Draw Credit Agreement, dated as  of September 5, 2007, among FirstCity Financial Corporation, as Borrower, and  the Lenders named therein, as Lenders, and BoS (USA), Inc., as agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated September 10, 2007)                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.29  | — | Letter agreement between FirstCity Financial  Corporation and Bank of Scotland extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to October 2,  2007 (incorporated herein by reference to Exhibit 10.2 of the Company’s Form  8-K dated September 10, 2007)                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.30  | — | Letter agreement between FirstCity Financial  Corporation and BoS (USA), Inc. extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to October 31,  2007 (incorporated herein by reference to Exhibit 10.1 of the Company’s Form  8-K dated October 5, 2007)                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.31  | — | Letter agreement between FirstCity Financial  Corporation and Bank of Scotland extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to October 31,  2007 (incorporated herein by reference to Exhibit 10.2 of the Company’s Form  8-K dated October 5, 2007)                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.32  | — | Letter agreement between FirstCity Financial  Corporation and BoS (USA), Inc. extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to November 16,  2007 (incorporated herein by reference to Exhibit 10.1 of the Company’s Form  8-K dated November 8, 2007)                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.33  |   | Letter agreement between FirstCity Financial  Corporation and Bank of Scotland which amended the Revolving Credit Agreement  to extend time period for closing of subordinate credit facility to be  provided by BoS (USA), Inc. to November 16, 2007 (incorporated herein by  reference to Exhibit 10.2 of the Company's Form 8-K dated  November 8, 2007) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1*  | — | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2*  | — | Certification of J. Bryan Baker, Chief Financial  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1*  | — | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to 18 U.S.C Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and relating to the  Quarterly Report on Form 10-Q for the quarter ended September 30, 2007.                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.2*  | — | Certification of J. Bryan Baker, Chief Financial  Officer of the Company, pursuant to 18 U.S.C Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and relating to the  Quarterly Report on Form 10-Q for the quarter ended September 30, 2007.                                                                                             |

----

*Filed herewith.

 

47

----

 

Table of Contents

 

**SIGNATURES**

 

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

 
|     | Firstcity Financial Corporation |                                  |
|----------|---------------------------------|---------------------------------------|
|     |                            |                                  |   |   |
|     | By:                             | /s/  James T. Sartain       |
|     |                            | James T. Sartain                      |
| * * | * *                        | *President and Chief Executive*       |
| * * | * *                        | *Officer and Director*                |
| * * | * *                        | *(Duly authorized officer and*        |
| * * | * *                        | *principal executive officer of  the* |
| * * | * *                        | *Registrant)*                         |
|     |                            |                                  |   |
|     | By:                             | /s/  J. Bryan Baker         |
|     |                            | J. Bryan Baker                        |
| * * | * *                        | *Senior Vice President and Chief*     |
| * * | * *                        | *Financial Officer*                   |
| * * | * *                        | *(Duly authorized officer and*        |
| * * | * *                        | *principal financial and  accounting* |
| * * | * *                        | *officer of the Registrant)*          |
|          |                                 |                                       |  |  |  |  |

 

Dated:  November 9, 2007

 

 

 

48

----

 

Table of Contents

 

 

**Exhibit Index**

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

 

 

----

 

Table of Contents

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

 

----

 

Table of Contents

 
| 10.21  | — | Loan Agreement, dated  as of December 15, 2006 by and between American Business Lending, Inc., as  Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated December 28, 2006)                                                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.22  | — | Amendment No. 1 to Loan  Agreement, dated as of February 27, 2007, by and between American Business  Lending, Inc., as Borrower, and Wells Fargo Foothill, LLC, as lender  (incorporated herein by reference to Exhibit 10.22 of the Company’s Form 10-K  dated July 24, 2007)                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.23  | — | Amendment No. 9 to Revolving Credit Agreement, dated  as of June 29, 2007, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to  Exhibit 10.23 of the Company's Form 10-Q dated August 10, 2007)                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.24  | — | Amendment No. 1 to Revolving Credit Agreement, dated  June 29, 2007, among FH Partners, L.P., as Borrower, and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to  Exhibit 10.24 of the Company's Form 10-Q dated August 10, 2007)                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.25  | — | Amendment No. 2 to Loan  Agreement, dated as of July 30, 2007, by and between American Business  Lending, Inc., as Borrower, and Wells Fargo Foothill, LLC, as lender  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated August 3, 2007)                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.26  | — | Amendment No. 10 to Revolving Credit Agreement,  dated as of August 22, 2007, among FirstCity Financial Corporation as  Borrower and the Lenders named therein, as Lenders, and Bank of Scotland, as  Agent (incorporated herein by reference to Exhibit 10.1 of the Company’s Form  8-K dated August 28, 2007)                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.27  | — | Amendment No. 3 and Consent to Revolving Credit  Agreement, dated August 22, 2007, among FH Partners, L.L.C., as Borrower, and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s Form 8-K  dated August 28, 2007)                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.28  | — | Subordinated Delayed Draw Credit Agreement, dated as  of September 5, 2007, among FirstCity Financial Corporation, as Borrower, and  the Lenders named therein, as Lenders, and BoS (USA), Inc., as agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K  dated September 10, 2007)                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.29  | — | Letter agreement between FirstCity Financial  Corporation and Bank of Scotland extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to October 2,  2007 (incorporated herein by reference to Exhibit 10.2 of the Company’s Form  8-K dated September 10, 2007)                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.30  | — | Letter agreement between FirstCity Financial  Corporation and BoS (USA), Inc. extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to October 31,  2007 (incorporated herein by reference to Exhibit 10.1 of the Company’s Form  8-K dated October 5, 2007)                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.31  | — | Letter agreement between FirstCity Financial  Corporation and Bank of Scotland extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to October 31,  2007 (incorporated herein by reference to Exhibit 10.2 of the Company’s Form  8-K dated October 5, 2007)                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.32  | — | Letter agreement between FirstCity Financial  Corporation and BoS (USA), Inc. extending time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to November 16,  2007 (incorporated herein by reference to Exhibit 10.1 of the Company’s Form  8-K dated November 8, 2007)                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.33  |   | Letter agreement between FirstCity Financial  Corporation and Bank of Scotland which amended the Revolving Credit Agreement  to extend time period for closing of subordinate credit facility to be  provided by BoS (USA), Inc. to November 16, 2007 (incorporated herein by  reference to Exhibit 10.2 of the Company's Form 8-K dated  November 8, 2007) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1*  | — | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2*  | — | Certification of J. Bryan Baker, Chief Financial  Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1*  | — | Certification of James T. Sartain, Chief Executive  Officer of the Company, pursuant to 18 U.S.C Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and relating to the  Quarterly Report on Form 10-Q for the quarter ended September 30, 2007.                                                                                           |

 

 

----

 

Table of Contents

 
| 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, 2007. |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

----

*  Filed Herewith

 

 

 

----